In Re Imperial Credit Industries, Inc. Securities Litigation

Citations: 252 F. Supp. 2d 1005; 2003 WL 1563084Docket: CV 98-8842 SVW

Court: District Court, C.D. California; February 21, 2003; Federal District Court

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The United States District Court for the Central District of California granted the motion for summary judgment filed by Defendants Imperial Credit Industries, Inc. (ICII) and its officers, concluding that the securities fraud class action lacked merit. The lawsuit claimed violations of Sections 10(b) and 20(a) of the 1934 Securities Exchange Act, asserting that ICII’s public filings inflated the value of its securities by misrepresenting the worth of its 46.9% equity interest in Southern Pacific Funding Corporation (SPFC) during the class period from January 27, 1998, to October 1, 1998. SPFC, a subprime mortgage lender, filed for bankruptcy on October 1, 1998, and was found to have misvalued its assets, contributing to the inflated securities value of both SPFC and ICII. Other related litigations involving similar allegations were noted, including a settled case in Oregon concerning SPFC. The court's findings indicated that ICII's financial statements were not consolidated with SPFC's during the relevant period and revealed that related actions were filed shortly after the initial claim.

On June 21, 1999, Defendants moved to dismiss complaints in four specified cases. The Court granted these motions on September 7, 1999, allowing Plaintiffs to amend their complaints. Plaintiffs subsequently filed a consolidated amended complaint on October 4, 1999, omitting allegations regarding ICII's equity interest in FMAC. On February 23, 2000, the Court denied another motion to dismiss, lifting the stay on discovery. A Pre-Trial Conference was scheduled for April 30, 2001, with a discovery cut-off date of April 9, 2001. 

On August 7, 2000, the Court certified a class of individuals who purchased ICII securities from January 27, 1998, to October 1, 1998. A Third Amended Complaint was filed on February 12, 2001, naming KPMG LLP as a defendant for the first time, as KPMG served as the auditor for ICII and SPFC during the class period. KPMG moved to dismiss this complaint on March 7, 2001, which reinstated the stay on discovery.

Between February 23, 2000, and March 6, 2001, Plaintiffs conducted only three depositions, none of which involved individual Defendants or other relevant personnel from ICII, SPFC, or KPMG. Additionally, they submitted only six interrogatories and no requests for admission during this period.

On March 8, 2001, thirty-two days prior to the discovery cut-off, Plaintiffs served Defendants with 265 additional requests for admission and four interrogatories, despite an automatic stay of discovery due to KPMG's motion to dismiss. Plaintiffs did not file any motions to compel against Defendants or KPMG. On March 2, 2001, Plaintiffs provided two expert reports: the Moore Report, assessing the adequacy of financial disclosures by ICII and SPFC, and the Marek Report, addressing damages. These were the only expert reports included in the initial expert designations, with Plaintiffs failing to submit a report from a residual modeling or valuation expert, as neither Moore nor Marek qualified as such.

Moore's report relied on excerpts from an expert report by Andrew Davidson, a residual valuation expert involved in unrelated Oregon Litigation, without a comprehensive review of Davidson's entire report. Plaintiffs had not retained Davidson as an expert for this action, nor had they identified him for testimony, and there was no evidence that he was aware of the use of his excerpts. Consequently, Defendants could not depose Davidson. The excerpts used by Moore did not constitute a reasonable basis for an accountant's audit of SPFC and ICII's financial statements. Additionally, the Marek Report lacked an event study or similar analysis.

On March 16, 2001, after the automatic stay of discovery was reinstated, Plaintiffs filed an ex parte application to lift the stay and extend the discovery cut-off, pretrial conference, and trial dates. On April 9, 2001, Defendants sought summary judgment on all of Plaintiffs' claims. Subsequently, on April 16, 2001, in opposition to the summary judgment motion, Plaintiffs requested a continuation of the hearing under Federal Rule of Civil Procedure 56(f) to permit additional discovery.

1. The Court has jurisdiction over this case based on 15 U.S.C. § 78aa and 28 U.S.C. § 1331. 

2. To establish claims under § 10(b) of the 1934 Securities Exchange Act, Plaintiffs must demonstrate: (1) a misrepresentation or omission; (2) of material fact; (3) made with scienter; (4) upon which they justifiably relied; and (5) that caused the alleged loss, as established in Binder v. Gillespie.

3. For claims under § 20(a) of the same Act, Plaintiffs must also prove a primary violation of § 10(b), following Paracor Finance, Inc. v. General Elec. Capital Corp.

4. Rule 56(c) requires summary judgment against any party that does not adequately show an essential element of their case, meaning the moving party is entitled to judgment as a matter of law if the nonmoving party fails to make such a showing.

5. Defendants are granted summary judgment on all claims due to the lack of a legally sufficient basis for a reasonable jury to find in favor of Plaintiffs regarding material misrepresentation or omission. Plaintiffs asserted that SPFC's inflated residual valuations inflated the value of SPFC's and ICII's securities. However, they did not provide expert testimony to prove that the valuations were inflated, as they failed to designate a residual valuation expert or present a relevant report.

6. The Court deems reliance on excerpts from another expert's opinion, created for different litigation, as improper. The Moore Report's reliance on Davidson’s opinion about SPFC's residuals is inadmissible because Federal Rules of Evidence 702 and 703 do not allow an expert to depend on another expert’s litigation-based opinion. This situation contrasts with medical malpractice cases, where experts may rely on medical records that were not created solely for litigation purposes and have an independent reliability.

Moore's reliance on excerpts from Davidson's opinion is deemed improper based on established case law, which states that one expert cannot rely on another's opinion unless that expert testifies. Expert opinions must stand on their own and cannot be based on others' opinions, whether those opinions are in evidence or not. Thus, on retrial, the trial court must exclude any expert opinion that depends on another opinion.

Under Daubert, the Court is required to act as a gatekeeper for expert testimony, ensuring that any evidence presented is based on facts and data that experts in the field reasonably rely upon. Moore, as an accountant, classified his opinion as an audit opinion regarding the financial statements of ICII and SPFC. However, evidence showed that it is unprecedented for an auditor to base their opinion on excerpts from litigation opinions, which do not constitute reasonable reliance for accountants.

Consequently, the Court determined that the Moore Report should be excluded since it references Davidson's excerpts, which lack the necessary foundation as reliable data for forming expert opinions. Additionally, the Plaintiffs' argument that SPFC's inflated residuals could be supported by sensitivity analyses from Bruce Horowitz was found insufficient, as Moore's opinion relied on Davidson, not Horowitz. The Plaintiffs failed to designate Horowitz as an expert or provide an expert report, nor did they demonstrate the reliability of Horowitz's methodology or his qualifications in residual valuation. Without an expert opinion on the valuation of SPFC's residuals, the Plaintiffs could not substantiate their claim of material misrepresentation.

In actions under Rule 10b-5 for material omissions or misstatements, plaintiffs must establish both transaction causation (that the violations prompted the transaction) and loss causation (that the misrepresentations or omissions caused the harm). The requirement of loss causation has been explicitly mandated by Congress, particularly under the Private Securities Litigation Reform Act of 1995, which places the burden on plaintiffs to prove that the defendant's actions caused the loss for which recovery is sought. Defendants are entitled to summary judgment on all claims due to insufficient evidence for a reasonable jury to find loss causation and damages. The plaintiffs' expert report, the Marek Report, is deemed inadequate as it lacks an event study, a necessary statistical analysis to measure the impact of alleged fraud on stock prices. Damages in securities fraud are determined by the difference in stock price due to alleged misrepresentations. Courts have frequently rejected damages reports that do not include event studies, as these are essential for distinguishing between fraud-related and non-fraud related influences on stock prices. The plaintiffs previously claimed ICII's stock was inflated due to misrepresentations regarding FMAC but must now differentiate between actionable and non-actionable effects on stock prices. Additionally, external market events, including the Russian default and the Asian crisis, may have influenced stock price declines, and without an event study, plaintiffs cannot separate these effects from alleged wrongdoing.

The Court excludes the Marek Report under Daubert and Federal Rule of Evidence 702 due to flawed methodology, concluding it lacks a "reliable basis in the knowledge and experience" of Marek's discipline. Plaintiffs argued against this exclusion, claiming an event study was unnecessary as SPFC's stock value was zero during the Class Period, thus damages could be calculated from the difference between true and stated values. The Court rejects this argument for several reasons: 

1. Plaintiffs failed to cite authorities supporting their approach as a reliable methodology or a substitute for event study analysis recognized in legal precedent.
2. Their assertion of SPFC’s zero stock value relies on the Moore Report, which improperly uses excerpts from Davidson's report related to a different case.
3. Even if SPFC's value was assumed to be zero, the Court noted that without an event study, Plaintiffs could not prove the extent to which the value difference was fraud-related.

Regarding Plaintiffs' Rule 56(f) request to delay the summary judgment hearing for additional discovery, the Court denies the request based on three grounds: 

1. Plaintiffs have not diligently pursued discovery.
2. They did not demonstrate how additional discovery would address the deficiencies in their expert reports.
3. The timing of the summary judgment hearing, set shortly after the discovery cut-off, means granting the request would necessitate modifying the existing scheduling order without a showing of good cause.

The "good cause" analysis under Rule 16(b) emphasizes the diligence of the party seeking a modification of the scheduling order. The Court determined that Plaintiffs did not diligently pursue discovery, failing to demonstrate the "good cause" necessary to amend the scheduling order and extend the discovery cut-off. Despite acknowledging the challenges posed by the automatic stay of discovery, the Court noted that these challenges do not excuse the Plaintiffs’ lack of diligence during the over year-long period when discovery was not stayed. Consequently, the Court denied the Plaintiffs' ex parte application to vacate the stay and extend deadlines. Furthermore, the Court granted Defendants' Motion for Summary Judgment under Federal Rule of Civil Procedure 56, concluding that Plaintiffs could not prove essential elements of their claims. Additionally, the Court denied Plaintiffs' Motion under Federal Rule of Civil Procedure 56(f) and their ex parte application.

Docket references pertain to Case No. CV 98-8842 SVW. The Eighth Circuit Court of Appeals recently outlined the securitization process pioneered by Green Tree, which involved pooling manufactured housing loans into a trust that sold securities backed by these loans. These securities provided fixed interest and principal payments to purchasers. Green Tree retained rights to a portion of the loan payments and the obligation to service the loans, profiting from the difference between the interest charged to borrowers and the interest promised to investors, minus servicing costs.

On August 17, 2001, the Court granted KPMG's Motion to Dismiss due to the statute of limitations. The excerpt further discusses the reliance of physicians on various information sources for diagnoses, emphasizing the trustworthiness of data generated in professional contexts, as noted in Federal Rule of Evidence 703. In contrast, the data relied upon by Moore for his testimony lacks this circumstantial guarantee of trustworthiness because it is derived from a litigation-prepared opinion rather than from regular professional duties. Moore is not qualified to validate Davidson's opinions on residual valuation, preventing meaningful adversarial testing since Davidson will not testify, limiting the opportunity for cross-examination.