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Legal Update

United States District Court Holds That Section 11 Claims Attacking Other Than Temporary Impairment Balances Require Pleading Objective And Subjective Falsity

2 January 2013
Mayer Brown Legal Update

On December 19, 2012, the United States District Court for the District of Colorado dismissed various claims under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Securities and Exchange Commission’s Rule 10b-5, holding that the named plaintiffs in the purported class action failed to satisfy the applicable pleading requirements. In MHC Mut. Conversion Fund, L.P. v. United W. Bancorp, Inc., No. 11-cv-00624 (D. Colo. Dec. 19, 2012), the Court’s central conclusion was that statements addressing other than temporary impairment (“OTTI”) are “opinions,” which required Plaintiffs to plead that those opinions were both objectively and subjectively false and that the complaint did not plead such falsity.

Plaintiffs in MHC Mutual allegedly purchased securities issued by United Western Bancorp, Inc. in a public offering held September 17, 2009. According to Plaintiffs, acting on their own behalf and on behalf of a purported class, United Western Bancorp’s registration statement materially misstated the value of certain collateralized mortgage obligations and mortgage backed securities. Specifically, Plaintiffs alleged that United Western Bancorp failed to timely recognize as much as $69 million in OTTI, which improperly inflated the value of the underlying securities. Among others, Plaintiffs named Crowe Horwath LLP, United Western Bancorp’s independent auditor, in its Section 11 claim.

In its opinion, the Court began by addressing a question of first impression for the District Court of Colorado: whether the determination of a security as other than temporarily impaired is an “opinion.” In holding that OTTI determinations are opinions, the Court acknowledged the inherent subjectivity of impairment and fair value analysis. For example, the Court noted that all impairment analysis requires the issuer to determine an asset’s fair value, which itself takes into account such subjective indicia as “market forces, market trends, and buyers’ whims,” and it also observed that the issuer must subjectively assess its “expectation” as to whether it will recover the security’s amortized cost. Again, such a determination is wrapped up in assessments of “market forces, market trends, and unknown variables,” none of which are readily or objectively verifiable. 

Once the Court concluded that OTTI statements are opinions, it next considered whether plaintiffs must allege objective and subjective falsity to successfully plead a claim. In concluding that such allegations were necessary, the Court primarily relied on Virginia Bankshares v. Sandberg, 501 U.S. 1083 (1991), for the proposition that “subjective falsity alone is insufficient to establish a claim under the Securities Exchange Act when such claim is based on an opinion.” The Court noted, however, that a litany of lower court opinions all interpreted Virginia Bankshares as requiring a dual showing of objective and subjective falsity. It then joined those lower courts requiring claims under the Securities Act, the Exchange Act, and Rule 10b-5 to include an allegation that the misstatement was objectively and subjectively false. Because plaintiffs failed to allege that the defendants did not objectively and subjectively believe the OTTI statements, the Court dismissed plaintiffs’ claims with prejudice.

The MHC Mutual decision is significant because it continues a recent trend in holding that Section 11 claims relating to financial statement amounts—if deemed to be matters of opinion—require allegations of objective and subjective falsity and applies the doctrine to a different balance sheet item, OTTI.1 Because parties frequently attack OTTI statements and the value of the underlying assets in litigation of this sort, this decision, like its predecessors, is likely to have a significant impact in many other cases in which plaintiffs allege Section 11 claims against banks and their outside auditors, based on alleged misstatements made in registration statements and incorporated audit reports.

Mayer Brown LLP represented Crowe Horwath LLP in this action.

For more information about the MHC Mutual opinion, or any other matter raised in this Legal Update, please contact at +1 312 701 7326.

1 See, e.g., Fait v. Regions Fin. Corp., 655 F.3d 105 (2d Cir. 2011). 

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