Blue v. Doral Financial Corp.

Citations: 123 F. Supp. 3d 236; 2015 U.S. Dist. LEXIS 96593; 2015 WL 4476163Docket: Civil No. 14-1393 (GAG)

Court: District Court, D. Puerto Rico; July 22, 2015; Federal District Court

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Lead Plaintiffs Jensine Andresen, Ken M. Nimmons, and Mordechai Hakim have initiated a putative class action against Doral Financial Corporation and several current and former executives (collectively referred to as "Defendants") on behalf of investors who purchased Doral stock between April 2, 2012, and May 1, 2014. The plaintiffs allege that Defendants made false and misleading statements that violated sections 10(b) and 20(a) of the 1934 Securities Exchange Act, resulting in artificially inflated stock prices due to misrepresentation of Doral’s regulatory compliance.

The Consolidated Class Action Amended Complaint, spanning 122 pages and 328 paragraphs, asserts two primary points of fraud. First, the plaintiffs claim that Doral misrepresented the quality of its loan portfolio by understating the Allowance for Loan and Lease Losses (ALLL) and failing to disclose deficiencies in procedures for determining ALLL, which is crucial for accurately representing the lender's financial status. Second, they assert that Defendants did not disclose the risk that the Puerto Rico Treasury Department and the FDIC would disallow a significant tax receivable from being counted as part of Doral's Tier 1 capital.

The lawsuit contends that these actions led to inflated stock prices, which eventually fell when Doral announced on March 18, 2014, that it could not file its 2013 financial results due to material weaknesses in its internal controls, followed by a May 1, 2014 announcement about the FDIC's decision regarding the tax receivable.

Currently, Defendants have filed a motion to dismiss the complaint, arguing that the plaintiffs have not sufficiently stated a claim under federal securities laws. The court is also addressing the implications of Doral’s Chapter 11 bankruptcy filing, which has automatically stayed the case against the company but allows the case against the Individual Defendants to proceed. After reviewing the submissions, the court has partially granted and partially denied the motion to dismiss regarding the Individual Defendants.

Plaintiffs in this case are stockholders who purchased Doral common stock during the specified class period. Doral, a diversified financial services company incorporated in San Juan, Puerto Rico, engaged in retail banking, mortgage banking, investment banking, institutional securities, and insurance agency operations. Key defendants include CEO and President Wakeman, CFO Wahlman, Interim CFO Ivanov, Executive Vice President Hooston, Chief Compliance Officer Ubarri, and Chief Business Development Officer Poulton, all of whom held significant roles during the class period.

Doral Financial Corporation is the parent company of Doral Bank, which provided retail banking services primarily in Puerto Rico, operating a total of thirty branches across Puerto Rico, New York, and Florida as of December 31, 2013. Doral Bank focused on various lending activities, especially residential mortgage loans, and was publicly traded on the NYSE, with over 6.6 million shares outstanding by April 30, 2014.

Leading up to the class period, Doral faced significant financial difficulties, including a major restatement due to fraudulent mortgage sales and a subsequent securities fraud lawsuit that resulted in a $74.25 million settlement. On April 2, 2012, the start of the class period, the FDIC deemed Doral Bank to be in troubled condition. Doral, as a bank holding company, was subject to oversight by federal and local regulators, including the FDIC and the Federal Reserve Bank of New York. In August 2012, Doral disclosed its troubled status and entered a “Consent Order” with the FDIC and the PR Commissioner, which imposed operational restrictions and regulatory requirements aimed at restoring the bank's success.

On September 13, 2012, Doral entered into a Written Agreement with the Federal Reserve Bank of New York (FRBNY), replacing a cease and desist order from March 16, 2006. Understanding the Consent Order and the Written Agreement necessitates familiarity with key accounting principles governing bank regulation under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). Federal regulators must take prompt corrective action for banks failing to meet capital requirements, assessed through metrics like the Total Risk-Based Capital Ratio, Tier 1 Risk-Based Capital Ratio, and Tier 1 Leverage Ratio. At least 50% of Total Risk-Based Capital must be Tier 1 Capital, which includes common equity and retained earnings, while Tier 2 Capital may consist of subordinated debt and other instruments. The FDIC categorizes banks based on these ratios into classifications such as well-capitalized and critically undercapitalized, with specific restrictions on capital distributions and growth for undercapitalized banks. Critically undercapitalized banks risk having a receiver appointed. Furthermore, banks not deemed well-capitalized face restrictions on brokered deposits, which are defined as deposits with interest rates exceeding seventy-five basis points above the market rate. Banks must also maintain an Allowance for Loan and Lease Losses (ALLL) to account for potential losses on impaired loans, which are loans where collection of all amounts due is uncertain.

The Allowance for Loan and Lease Losses (ALLL) is crucial for a bank's financial statements, representing significant estimates in financial reporting. On December 13, 2006, the FDIC and the Federal Reserve, along with other regulators, issued a policy statement emphasizing the need for banks to develop and document a systematic approach to determine the ALLL and the Provision for Loan and Lease Losses (PLLL). Each institution must ensure that its ALLL is consistent with Generally Accepted Accounting Principles (GAAP) and relevant supervisory guidance, analyzing loan collectability quarterly or more frequently as needed. The ALLL must account for estimated credit losses on impaired loans as well as inherent losses in the broader loan portfolio.

Doral Bank's Consent Order with the FDIC mandated several actions to enhance its ALLL policy and methodology, including: 1) implementing a comprehensive ALLL policy; 2) obtaining FDIC waivers for brokered deposits; 3) establishing an independent loan review program; 4) revising appraisal compliance; and 5) maintaining a higher capital level than the minimum for being considered well-capitalized. Doral was required to submit a capital plan within sixty days to ensure a Tier 1 Leverage Ratio of at least 8%, a Tier 1 Risk-Based Capital Ratio of at least 10%, and a Total Risk-Based Capital Ratio of at least 12%. Additionally, Doral must notify the FDIC if any capital ratio falls below these thresholds and either raise sufficient capital or submit a contingency plan for potential sale, merger, or liquidation of the Bank. The agreement also mandated the establishment of a loan review program to periodically assess and report problem credits to the Board.

The Bank was mandated to create an independent loan review program to ensure an adequate Allowance for Loan and Lease Losses (ALLL), with loan review information being communicated to the Board to reassure investors. Additionally, the Consent Order required the Bank to enhance its appraisal compliance program, focusing on timely appraisals and appropriate valuation methods to support assigned values. Furthermore, Doral entered into a Written Agreement with the Federal Reserve Bank of New York (FRBNY), which imposed operational restrictions and similar regulatory requirements to the Consent Order. This agreement mandated Doral to submit a written plan for maintaining sufficient capital, adhering to capital adequacy guidelines, and establishing robust credit risk management practices, including improved appraisal standards and loan grading procedures. Doral was also required to provide quarterly progress reports to the FRBNY regarding its compliance.

The Written Agreement necessitated the establishment of ALLL methodology consistent with supervisory guidance, including regular board reviews of the ALLL, documentation of review processes, and prompt remediation of any identified deficiencies. Doral was to submit reports to the FRBNY within sixty days of each quarter's end, detailing the board's review of the ALLL and any methodological changes. Additionally, Doral entered into a 2012 Closing Agreement with the Treasury Department, which replaced a previous 2006 agreement, following a significant restatement of Doral's financial results for the five years ending December 31, 2004.

Doral retained interest-only strips from spurious mortgage sales, inaccurately booking gains from these transactions, which were actually loans secured by the mortgages. Through informal agreements, Doral granted purchasers full recourse rights, further supporting the characterization of these transactions as loans. After uncovering this scheme, Doral restated its financials and sought to recover over $162 million in taxes from the Treasury Department. On September 26, 2006, Doral entered into a Closing Agreement with the Treasury, allowing it to recognize a deferred tax asset of $889,723,361, amortizable over fifteen years instead of claiming a tax reimbursement. By March 26, 2012, Doral had amortized $123,443,072 of this asset, leaving a balance of $766,280,289. The 2012 Closing Agreement voided this balance and recognized a tax overpayment of $229,884,087, which could be used by Doral’s subsidiaries to offset future income taxes in Puerto Rico. This figure was calculated using the lowest applicable tax rate of 30%, contrary to the higher rate in the Internal Revenue Code. Doral committed to enhancing its home preservation and commercial development program by $70 million to support the Puerto Rican economy. Despite regulatory assurances regarding its capital adequacy and compliance with agreed policies, plaintiffs allege Doral misrepresented its financial health while intentionally violating the terms of agreements to conceal its true financial condition.

Plaintiffs assert that Defendants intentionally understated Doral's Allowance for Loan and Lease Losses (ALLL) prior to and during the class period, misrepresenting the Bank's financial health to inflate regulatory capital ratios. This was allegedly achieved by misreporting asset bookings and failing to address internal control deficiencies in financial reporting, leading to an overstatement of net income and capital. Additionally, Plaintiffs allege that Doral misrepresented its deferred tax asset amortization during the 2012 Closing Agreement, falsely claiming a $152 million tax overpayment, thereby fraudulently obtaining a larger tax receivable than allowed. This misrepresentation risked the Treasury Department voiding the agreement, which later occurred, resulting in the FDIC disallowing Doral's inclusion of a nearly $230 million tax receivable in its Tier 1 capital.

The Securities Fraud Claims involve allegations that Defendants issued false and misleading statements about Doral's ALLL and the risk of the Treasury Department invalidating the 2012 agreement. While acknowledging some internal control deficiencies, Defendants allegedly maintained an overly optimistic portrayal of Doral's financial position and failed to disclose the pervasive issues affecting its ALLL and PLLL calculations, contrary to Generally Accepted Accounting Principles (GAAP). The Plaintiffs detail these misleading statements in over fifty-seven pages of the complaint, drawing from SEC filings and other communications, claiming that Individual Defendants were aware of the inaccuracies due to their positions and access to confidential information.

Insider stock trades and salary increases for certain Individual Defendants are cited by Plaintiffs as evidence of the Defendants' motivation for issuing false and misleading statements. The complaint alleges that these misrepresentations led to a significant decline in Doral's stock price once disclosed. Specifically, on March 18, 2014, Doral announced a delay in filing its annual 10-K due to internal control weaknesses, causing a drop in stock price from $12.30 to $11.17 per share (over 9%). Following the release of the 2013 10-K, which revealed an understatement of the Allowance for Loan and Lease Losses (ALLL) and substantial internal control deficiencies, the stock fell 6.8% from $11.65 to $10.76 per share. Over the next four days, the stock continued to decline, reaching $8.59 per share—a total drop of 25.6%. Furthermore, on May 1, 2014, when Doral disclosed that the FDIC would no longer allow a nearly $230 million tax receivable to be counted in its Tier 1 capital, the stock plummeted 62%, from $9.82 to $3.73 per share, erasing over $141 million in market capitalization.

On May 14, 2014, Robert Blue filed a complaint against Doral and the Individual Defendants on behalf of Doral common stock purchasers from April 2, 2012, to May 1, 2014. The court appointed lead plaintiffs on August 1, 2014, and on November 6, 2014, a Consolidated Class Action Amended Complaint was filed, alleging violations of the Securities Exchange Act of 1934. Defendants moved to dismiss the complaint, claiming Plaintiffs failed to allege actionable misrepresentations, scienter, loss causation, and control-person liability. Plaintiffs opposed the motion, and subsequent filings ensued. Doral then filed for Chapter 11 bankruptcy, automatically staying the case against it, while the case against the Individual Defendants continues, with the court set to assess the sufficiency of the complaint against them.

The standard of review under Rule 12(b)(6) requires courts to disregard legal conclusions and focus on well-pled facts in the complaint, taking those facts as true and favoring reasonable inferences for the pleader. To survive a motion to dismiss, a complaint must demonstrate a "plausible entitlement to relief." In securities fraud claims, plaintiffs must prove six elements: material misrepresentation or omission, scienter, connection to the purchase or sale of a security, reliance, economic loss, and loss causation. The complaint must plead fraud with particularity under Rule 9(b) and comply with the heightened pleading requirements of the Private Securities Litigation Reform Act (PSLRA). Under PSLRA, complaints must specify misleading statements and the reasons they are misleading, as well as provide strong inferences of scienter. While evidence is not required, the complaint must contain substantial factual detail. Courts evaluate the complaint in its entirety, balancing competing inferences, and if inferences for and against scienter are equally strong, the plaintiff prevails.

Section 10(b) of the Securities Exchange Act of 1934 prohibits the use of manipulative or deceptive devices in security transactions, as enforced by the SEC. Rule 10b-5 further clarifies this by making it unlawful to: (a) employ devices or schemes to defraud, (b) make false statements or omit necessary facts, and (c) engage in acts that constitute fraud or deceit in connection with security transactions. A claim under Rule 10b-5 must establish six elements: (1) a material misrepresentation or omission, (2) scienter (wrongful intent), (3) connection to the purchase or sale of a security, (4) reliance by the plaintiff, (5) economic loss, and (6) loss causation. Section 20(a) imposes liability on individuals who control those found liable under Section 10(b), unless they acted in good faith and did not induce the violation.

In response to the plaintiffs’ complaint, defendants argue that it fails to adequately allege actionable misrepresentations or omissions, a strong inference of scienter, loss causation, and control-person liability. They systematically address each argument, beginning with whether the plaintiffs sufficiently alleged misleading statements or omissions by the defendants in SEC filings and communications. The plaintiffs claim that the defendants made false and misleading statements regarding the accuracy of the Bank's Allowance for Loan and Lease Losses (ALLL), Provision for Loan and Lease Losses (PLLL), and Doral's capital levels, specifically related to a tax receivable from the Treasury and internal financial controls, aiming to inflate Doral’s capital and conceal its financial difficulties.

Doral Bank maintained compliance with all regulatory requirements and was classified as well-capitalized under its regulatory agreements. Key points include:

1. Doral's Allowance for Loan and Lease Losses (ALLL) and Provision for Loan and Lease Losses (PLLL) figures were disclosed, with a conservative approach noted in its ALLL model.
2. There were material weaknesses identified in internal controls regarding the completeness and valuation of its ALLL and PLLL, but Doral was actively working to address these issues.
3. All financial statements were reported to comply with Generally Accepted Accounting Principles (GAAP).
4. A significant tax receivable of nearly $230 million from the 2012 Closing Agreement positively impacted Doral's financial standing and capital.
5. In the 2011 annual SEC Form 10-K, filed on March 30, 2012, Doral reported compliance with regulatory capital requirements, with ratios above the minimum thresholds for well-capitalized banks.
6. The 2011 10-K also outlined the Bank's provisions for loan and lease losses and acknowledged material weaknesses in internal controls, specifically regarding the valuation of second mortgages and commercial real estate loans.
7. By early 2012, Doral continued to declare compliance with regulatory requirements and attributed its quarterly performance to the benefits from the 2012 tax agreement while detailing the implications of the tax receivable.

Overall, while Doral Bank reported strong capital compliance and financial performance, it acknowledged internal control weaknesses and was in the process of implementing remediation efforts.

On May 16, 2012, after filing the first quarter 10-Q, Defendants conducted a conference call where Defendant Wakeman highlighted Doral's strong position in the challenging Puerto Rico market, attributing it to increased capital and credit reserves. Wakeman discussed a new agreement with the Puerto Rican government regarding deferred tax assets (DTAs), specifically an asset linked to a prior tax overpayment from Doral’s legacy trading business. This agreement replaced a previous one from 2005, allowing the asset to be recognized as a receivable, no longer contingent on future earnings. As a result, Doral eliminated a $112 million reserve against this asset, improving its financial statements. Additionally, the entire amount of the DTA, $228 million, was now included in Tier 1 capital, compared to less than $10 million under the prior agreement.

Despite these developments, Doral's first quarter 10-Q reported ongoing material weaknesses in its internal control over financial reporting, with ineffective disclosure controls as of March 31, 2013. The Defendants asserted that reasonable steps were taken to ensure the financial information adhered to GAAP. The second quarter 10-Q reiterated similar points, noting a payable of approximately $230 million owed to Doral by the Commonwealth of Puerto Rico due to past tax payments, which could offset future tax obligations or be refunded over five years. The report also indicated that Doral adopted a more conservative perspective on its financial outlook and loan performance in light of the uncertain economic and regulatory conditions.

Changes in estimates are reflected in the June 30, 2012, allowance for loan and lease losses. Plaintiffs assert that defendants made materially false and misleading statements by: a) inflating Doral’s capital through the deliberate understatement of the ALLL and PLLL; b) failing to disclose issues with the accuracy of Doral’s ALLL and PLLL, including flaws in the ALLL model and loan appraisal data; c) non-compliance with the Consent Order and Written Agreement concerning ALLL and loan review; d) misrepresentation of Doral’s financial results in accordance with GAAP; e) indicating that internal control deficiencies were widespread rather than isolated, affecting the accuracy of the ALLL and PLLL; and f) presenting a risk that the Treasury Department might void the 2012 Closing Agreement, jeopardizing the Bank's capital status. The case hinges on whether the defendants had sufficient information to justify the alleged omissions. New Jersey Carpenters case law indicates that omissions cannot be deemed material without evidence of intentional understatement. The First Circuit requires securities fraud plaintiffs to substantiate their allegations with factual support. Plaintiffs argue that ongoing ALLL-related issues indicate systematic fraud by the defendants. Specificity regarding the time, place, and content of misrepresentations, along with evidence of known adverse circumstances, is necessary for the claims. The court will assume, arguendo, that the defendants engaged in the alleged fraudulent scheme to evaluate whether a jury could find the statements misleading in the given context.

The determination of whether statements made by Defendants are false or misleading, and thus actionable under Rule 10b-5, is ultimately for the jury. The court will analyze these statements alongside the claim of scienter, which requires showing that Defendants had a conscious intent to defraud or acted with high recklessness. Because the Plaintiffs' allegations regarding the fraudulent scheme overlap with their assertion of Defendants' state of mind, the court will focus on the misleading statements in light of other statements made by Defendants.

Defendants did not contest the specificity or materiality of the Plaintiffs' articulated statements but argued that their numerous disclosures throughout the class period preclude a jury from finding material misrepresentations or omissions. While the court acknowledges this argument, it will examine the public disclosures made by Defendants during the relevant time frame, opting not to detail the alleged misleading statements in full due to the case's focus on scienter.

Material facts are defined as those that, if disclosed, would significantly alter the total mix of information available to a reasonable investor. A statement may be considered false or incomplete but not actionable if the misrepresented fact is deemed insignificant. The Individual Defendants challenge the presence of misrepresentations and omissions rather than their materiality. Furthermore, Section 10(b) does not impose a duty to disclose all material information; such a duty arises only when affirmative statements are made that require the disclosure of additional facts to avoid misleading investors. Even voluntary disclosures must be complete and accurate, but companies are not required to reveal all potentially interesting information, only what is necessary to prevent misleading omissions. The excerpt specifically mentions a failure to disclose that Defendants inflated Doral’s capital by understating its Allowance for Loan and Lease Losses (ALLL).

Plaintiffs allege that Defendants made materially false and misleading statements regarding Doral's capital levels, specifically the ALLL (Allowance for Loan and Lease Losses) and PLLL (Provision for Loan and Lease Losses), in various SEC filings, press releases, and conference calls. They assert that these disclosures misrepresented the true state of Doral's reserves, claiming that the ALLL and PLLL were intentionally understated. The court, for the sake of argument, assumes that the Individual Defendants did indeed deliberately understate these figures. If true, the court suggests that a jury could reasonably conclude that the disclosures misled the public by portraying Doral's capital levels as healthy while omitting crucial information about the fraudulent inflation of these numbers.

Additionally, the complaint highlights that Doral failed to disclose significant issues undermining the accuracy of its ALLL and PLLL, including problems with the ALLL model and the underlying loan and appraisal data. Plaintiffs argue that these omissions are central to their claims of misleading statements related to a fraudulent scheme to manipulate Doral’s capital levels. In their motion to dismiss, Defendants challenge the sufficiency of the fraud allegations, suggesting that these claims contradict the history of Doral’s disclosures, which acknowledged deficiencies in its ALLL procedures and internal controls up until March 13, 2013.

Plaintiffs assert that Defendants' disclosures did not adequately reveal the extent of internal control deficiencies, which they claim stemmed from a systematic fraudulent scheme by the Defendants. An analysis of the disclosures from April 2, 2012, to March 13, 2013, indicates that the Individual Defendants acknowledged material weaknesses in their internal controls over the allowance for loan and lease losses (ALLL and PLLL) in filings like the 2011 Form 10-K. This form stated that the Company lacked effective controls over the completeness and valuation of ALLL and PLLL, potentially leading to material misstatements in financial statements. Throughout 2012, Defendants continued to report material weaknesses in their internal controls.

Plaintiffs reference confidential sources to argue that the deficiencies were more widespread than disclosed. They contend that Defendants' assurances to investors of "expeditious" remedial actions and the adequacy of loan loss reserves were misleading, given the alleged ongoing fraudulent activities. The court is tasked with evaluating the Plaintiffs’ scienter allegations to determine if the disclosures made by Defendants were indeed misleading or simply cautionary, which could impact the viability of the Plaintiffs' claims under securities law. If it is assumed that the Individual Defendants were involved in fraud, a jury might find that Defendants’ disclosures were insufficient to counter the misleading implications of their statements regarding the severity of the internal control issues.

Plaintiffs must demonstrate the existence of a fraudulent scheme; if they only show negligence in Defendants' internal financial controls, then disclosures may excuse those errors. The court references prior cases indicating that issuing warnings about uninvestigated risks can be irresponsible. Regarding statements from March 15, 2013, to March 18, 2014, Defendants acknowledged that their internal controls related to the ALLL were ineffective, admitting that their statements during the latter part of the class period were largely false. They had previously claimed in their March 2013 Form 10-K that remediation of internal control issues had occurred. However, in November 2013, they announced necessary adjustments impacting prior reports and subsequently disclosed material weaknesses in their internal controls in March 2014. A jury could reasonably find these statements materially false and misleading. Defendants argue that Plaintiffs have not sufficiently alleged that the Individual Defendants knew the statements were false at the time they were made, an issue to be addressed later. Additionally, Plaintiffs allege that Defendants misrepresented Doral's compliance with a Consent Order and a Written Agreement by manipulating capital levels and understating financial metrics. The court will first analyze the fraud allegations, noting that if sufficiently alleged, a jury could reasonably find that Defendants' compliance claims were misleading. For claims regarding misrepresentation of financial results in accordance with GAAP, Defendants contend that Plaintiffs' allegations lack specificity, citing the need for detailed descriptions of GAAP violations rather than general claims.

Plaintiffs assert that Doral's statements regarding its compliance with GAAP were false and misleading, not due to GAAP violations themselves, but because the reported ALLL metrics were deliberately understated and flawed due to undisclosed issues with methodology and inputs, as supported by confidential witnesses. The court must evaluate the fraud allegations to determine if a jury could reasonably conclude that Doral's GAAP compliance statements were materially false. 

Additionally, Plaintiffs claim that the Individual Defendants failed to disclose a significant risk of the Treasury Department seeking to void the 2012 Closing Agreement while discussing a nearly $230 million tax receivable. They argue that the Individual Defendants, aware of this risk, misled investors by incorporating the tax receivable into Tier 1 capital and emphasizing the positive aspects of the Agreement in SEC filings and public communications. 

Defendants counter that Plaintiffs have not adequately demonstrated a real material risk that needed disclosure, citing a Puerto Rico court's ruling that there was no intentional misrepresentation regarding the Agreement. They also contend that they disclosed the potential challenge from regulators regarding the tax receivable's use. 

The court will first consider the facts presented by Plaintiffs alongside the relevant Puerto Rico court decisions. Plaintiffs note that in May 2014, the Treasury Department questioned the legitimacy of the tax receivable, claiming Doral had misrepresented the amortization balance of a deferred tax asset, resulting in an inflated tax receivable. The Treasury asserted that Doral improperly included unamortized losses in its calculations, which led to a discrepancy in the tax receivable amount. Furthermore, the Treasury claimed Doral had not overpaid taxes as represented, challenging the legitimacy of the claimed tax receivable amount.

The Treasury Department declared the 2012 Closing Agreement null, citing it as the product of an illicit pretense. Subsequently, Doral filed a lawsuit in Puerto Rico’s Court of First Instance seeking a declaratory judgment to affirm the validity of the Agreement and related tax receivable. After a three-day hearing, the trial court found that Doral did not make false representations to the Treasury and was entitled to nearly $230 million in tax receivables.

However, the Treasury Department appealed, and on February 25, 2015, the Puerto Rico Court of Appeals reversed the trial court's decision. The Appeals Court determined that evidence showed Doral misrepresented the nature of its tax payments, specifically the claimed overpayment of $152 million, which was unsupported by documentary evidence, invalidating the 2012 Agreement. Despite acknowledging this misrepresentation, the court concluded that Doral did not intentionally provide false information. 

The court emphasized that a misrepresentation of a material fact is sufficient to contest the validity of a tax agreement, regardless of intent. It highlighted that the significance of the misrepresented fact could lead a reasonable person to withhold consent. The Appeals Court's ruling indicated that there was a material risk due to Doral's failure to inform the investing public about the misrepresentation, rendering its statements misleading. As Doral publicly discussed the benefits of the tax receivable and its financial health, it had a duty to disclose relevant information to avoid misleading investors.

Omission of known risks and their potential impact is critical in disclosures related to future actions. A duty to disclose arises when secret information makes prior public statements misleading. The court has not determined the Individual Defendants' knowledge or disregard of misrepresentations, which will be addressed later in the scienter discussion. Defendants argue they disclosed the risk of regulatory action affecting Doral’s Tier 1 capital due to a 2012 agreement with the Commonwealth of Puerto Rico, referencing specific disclosures in their 2011 Form 10-K. These disclosures indicated that regulatory agencies could review and potentially reduce the Tier 1 capital increase resulting from the agreement, highlighting potential material adverse effects on operations. Plaintiffs counter that this generic disclosure was insufficient to address the significant risk of the 2012 Closing Agreement being nullified due to inaccurate information given to the Treasury Department. They argue that unlike in other cases where explicit disclosures were made, Doral's disclosures failed to convey the real risk of the agreement's potential invalidation. Additionally, Plaintiffs note Defendants' repeated assertions that Doral's capital was well above required levels and their assurances about accessing capital if necessary.

Doral's 2011 Form 10-K disclosed potential regulatory reductions to its Tier 1 capital but failed to explicitly mention the significant risk of a challenge by the Treasury Department regarding the validity of the Closing Agreement. As established in Geffon v. Micrion Corp., when a corporation discloses information, it must be complete and accurate. The reliance on a nearly $230 million tax receivable to assure investors of the bank's financial health raises concerns about the misleading nature of Doral's disclosures, despite any cautionary language included. The court will next address whether the complaint adequately alleges actionable scienter, focusing on whether the Individual Defendants intended to defraud investors by inflating Doral's capital. Rule 9(b) mandates that fraud claims be stated with particularity, specifying the time, place, and content of false representations. Conclusory allegations are insufficient under this rule. The Private Securities Litigation Reform Act (PSLRA) imposes a higher standard for scienter, which includes intent to deceive or manipulate. A complaint must present facts that create a strong inference that the defendants acted with the intent to defraud or with high recklessness, which is distinct from ordinary negligence. This strong inference must be more than plausible or reasonable, as highlighted in relevant case law.

A strong inference of scienter must be cogent and as compelling as any nonfraudulent intent, with the plaintiff benefiting when inferences are equally strong. Scienter is assessed based on the collective allegations in the complaint rather than in isolation, and there is no definitive pattern for establishing it; each case is evaluated individually. A complaint may still satisfy the PSLRA even if some questions remain, as long as it is sufficiently detailed overall. Allegations from confidential witnesses must be sufficiently substantiated without needing to name them, as long as their credibility and the plausibility of their claims are supported by additional facts. Plaintiffs must provide particularized facts supporting a strong inference of scienter for each individual defendant. In the case at hand, plaintiffs assert that defendants fraudulently inflated the Bank's capital ratios by understating its Allowance for Loan and Lease Losses (ALLL), primarily relying on accounts from four former Doral employees who had significant roles in financial reporting and regulatory compliance.

FE3 contributed to the preparation of monthly and quarterly presentations for Doral’s Board of Directors, the Risk Policy Committee, and the ALLL Committee. FE4 served as Vice President of Commercial Administration at Doral from June 2012 to August 2013, overseeing the updating of policies and procedures for Doral’s commercial real estate operations. FE1 indicated that the defendants' attempts to inflate Doral’s capital ratios began prior to the class period. During a January 11, 2012 meeting regarding Doral's financial results, Defendant Wakeman expressed a desire for a leverage ratio above nine percent, suggesting that this could involve postponing asset bookings. Plaintiffs argue that this statement implies intentional manipulation of Doral’s reported Tier 1 Leverage Ratio in its 2011 Form 10-K.

Both FE1 and FE2 believed that Doral was regularly altering its ALLL model not for legitimate methodological improvements, but to maintain a lower ALLL, thereby indirectly enhancing capital ratios. FE1 noted that Defendant Wahlman, who was actively involved with the ALLL model, consistently pushed for changes, despite concerns from Doral’s Chief Risk Officer and the employee managing the model. Management frequently discussed model modifications in relation to capital levels. FE2 acknowledged that the ALLL significantly influenced Doral’s capital ratios and indicated that defendants understated the ALLL during the class period to meet regulatory capital requirements. FE3 also noted that Doral manipulated reporting practices to favorably present numbers without analytical support and that asset reallocation was used to justify the ALLL, which, if accurately calculated in the face of higher loan losses, would have negatively impacted capital ratios. FE2 was tasked with providing capital ratio calculations to the CFO regularly, suggesting an effort to manipulate the timing of these calculations for improved ratios. FE1 reported that Doral’s ALLL relied on outdated property appraisals and that defendants intentionally delayed obtaining current appraisals, compromising the accuracy of the ALLL.

Outdated property values in Doral's ALLL model resulted in an understatement of the allowance for loan and lease losses (ALLL) due to declining property values in Puerto Rico. Doral's significant land portfolio had a fair value below the carrying value of loans, yet the Defendants opted not to adjust this, fearing it would lower reported earnings and capital ratios. Instructions from Doral's Senior Vice President explicitly directed loan processors not to input updated appraisals that were below a certain threshold, and significant declines in property values were also ignored. Concerns regarding these practices were raised to Defendant Wahlman in January 2012, just before the Class Period, but he instructed to leave the data unchanged, keeping the ALLL understated.

Doral executives, including Wakeman and Wahlman, were aware of the appraisal issues. During the Class Period, appraisals faced delays, and problematic commercial real estate loans were not addressed, further contributing to the understatement of ALLL. Additionally, the underlying loan data for the ALLL calculation was deemed unreliable, with missing or incorrect information. For instance, loans where borrowers missed balloon payments were not classified as delinquent. A review of loans during the Class Period revealed systematic errors, yet Doral management did not take necessary actions to rectify these issues due to a reluctance to allocate resources.

During the preparation of Doral's 2013 Form 10-K, an error in the ALLL model was discovered and corrected, but management subsequently adjusted the ALLL to present a more favorable figure. Concerns about the inaccuracy of the ALLL calculation and the need for a complete overhaul of the model were raised by FE2 to the Principal Accounting Officer, Nancy Reinhard, who refused to take action. The manipulation of assumptions for non-performing loans during the Class Period, including extending the non-payment classification period, further underscores that the issues with Doral's ALLL went beyond simple errors.

A change implemented by Doral aimed to postpone the reversal of accrued interest on non-performing loans and minimize the Allowance for Loan and Lease Losses (ALLL). Although this alteration seemed minor, it significantly advanced these objectives. In March 2013, FE3 was instructed by the Chief Risk and Credit Officer to lower a forecast for expected mortgage loan charge-offs, despite FE3's belief that the revised figure was unattainable based on actual charge-offs to date.

Plaintiffs assert that the Defendants were aware of risks related to tax receivables impacting Doral's regulatory capital ratios due to ongoing communications with the Treasury Department, including bi-monthly meetings between Doral’s Vice President of Tax and Treasury representatives. There were internal discussions regarding the inclusion of tax receivables in Tier 1 Capital, which involved executives and audit committee meetings, indicating that Defendants were cognizant of the risks associated with these receivables, particularly given the financial instability of the Puerto Rican Government. Concerns about the tax receivable's inclusion in Tier 1 Capital were also heightened by scrutiny from the FDIC by early 2014, yet this information was not disclosed to investors.

The Plaintiffs contend that the Individual Defendants, due to their positions and access to confidential information, were complicit in the alleged fraudulent activities surrounding Doral's misleading statements. They argue that the internal reporting structure and high-ranking roles of the Individual Defendants provide further evidence of their scienter, making them liable for inaccuracies in Doral’s disclosures. Monthly management reports, distributed to senior management, included critical financial data and were supplemented by weekly and monthly reports mandated by the FDIC and submitted to the Federal Reserve Bank of New York, detailing Doral's liquidity and loan activities.

Receivables, deposits, and exposure to the Puerto Rico government were outlined, with FE2 indicating that, starting January 2014, the FDIC required daily liquidity reports from Doral, which were reviewed by Defendant Hoosten and Principal Accounting Officer Reinhard. This heightened reporting stemmed from concerns about Doral's precarious financial state and its reliance on tax receivables for capital.

Plaintiffs allege the Individual Defendants were motivated to commit fraud to enable stock sales. Between August 30 and September 11, 2013, Defendants Ivanov, Poulton, and Ubarri sold a total of 16,305 shares for $387,168, with significant percentages of their holdings sold while privy to material non-public information about Doral’s financial misstatements. Notably, no insider sales had occurred since November 2006, raising suspicions regarding these transactions.

Additionally, Plaintiffs claim that a 2012 Closing Agreement, which improved Doral’s capital ratios, justified salary increases for several Individual Defendants shortly thereafter. In April 2012, Doral’s Board approved significant salary hikes for four executives.

Defendants counter Plaintiffs' allegations by arguing that they insufficiently differentiate between individual defendants, fail to meet the strict pleading standard, include pre-class period communications, and reference employees not involved during the class period. They also claim that remaining factual accounts lack merit due to the absence of contact with the Individual Defendants and that a Court of Appeals decision does not address intent to defraud the Treasury Department. Plaintiffs defend their position by asserting that the accounts provide credible evidence and that pre-class facts are relevant to the alleged scheme.

The Court of Appeals decision undermines the Defendants’ defense, indicating that they were aware of the substantial risk that the 2012 Closing Agreement would be annulled. The court evaluates the Plaintiffs’ allegations regarding Wakeman and Wahlman’s involvement in a fraudulent scheme, specifically their manipulation of the Allowance for Loan and Lease Losses (ALLL) and the Provision for Loan and Lease Losses (PLLL) as reported in SEC filings and public communications. The Plaintiffs assert that Wakeman directed management to “book assets in later periods” to maintain a Tier 1 Leverage Ratio above nine percent, suggesting deliberate manipulation of financial reports. A confidential witness, FE1, who held a senior position and interacted regularly with Doral’s executives, corroborates this claim.

The court finds that the detailed allegations regarding Wakeman’s statements and actions provide a strong inference of his knowledge of the inaccuracies in Doral’s 2011 Form 10-K. Although Ubarri was present during the relevant meeting, the lack of further allegations connecting him to the scheme weakens the inference of his involvement. Additionally, the court considers the context of a substantial salary increase for Wakeman as a factor that supports the inference of his motive and opportunity for fraudulent actions. Ultimately, the court concludes that the allegations against Wakeman meet the heightened pleading standards for scienter under Rule 9(b) and the Private Securities Litigation Reform Act (PSLRA), while the inferences regarding Ubarri are less compelling.

Plaintiffs' allegations rely on inferences regarding defendants' scienter. Wakeman is implicated in nearly all allegedly false and misleading statements. The court rejects defendants' argument that FEl's claims should be disregarded due to his lack of employment during the class period, citing precedent that a witness can provide relevant information regardless of their employment duration. Notably, Wakeman's statement concerning the 2011 Form 10-K, which was released at the start of the class period, is deemed probative as it influenced public disclosures during that time. 

Wahlman is specifically alleged to have ignored concerns raised by FEl regarding Doral's Allowance for Loan and Lease Losses (ALLL) being based on outdated appraisals. Despite being informed of these issues shortly before the class period, Wahlman allegedly instructed that the data remain unchanged. This suggests he was aware of the intentional understatement of the ALLL prior to the Form 10-K release. Additional allegations indicate that Doral's Chief Risk Officer and the employee managing the ALLL model expressed discomfort with its calculations and constant modifications overseen by Wahlman, further bolstering claims of his involvement in fraudulent activity.

The court notes Wahlman’s significant salary increase and high-ranking positions during the class period as additional indicators of his potential participation in the alleged scheme. The court emphasizes the procedural context, stating that requiring more concrete evidence, like written proof, is not necessary at this stage of the case.

The rigorous standards for pleading securities fraud do not necessitate that a plaintiff provide evidence; however, the court dismissed conclusory allegations against Doral executives, noting that such general claims do not satisfy the Private Securities Litigation Reform Act (PSLRA). Specifically, allegations that certain executives were aware of appraisal issues were deemed insufficient, as they merely implied culpability without concrete details. To comply with Rule 9(b), allegations must detail the specific actions and knowledge of each defendant rather than generalize across all Individual Defendants. Claims that the defendants frequently discussed Doral's models lacked specificity regarding the what, where, and when of the alleged fraud. Furthermore, statements made on information and belief must be substantiated with factual bases, yet the confidential sources cited did not have direct interactions with the Individual Defendants. The absence of direct contact or documentation regarding the alleged fraud further undermined the Plaintiffs' claims, reinforcing the court's conclusion that vague and generalized assertions do not meet the necessary legal standards.

Plaintiffs assert that FE2 raised concerns about widespread errors to Nancy Rein, but since Rein is not a defendant, this claim does not provide evidence of the Individual Defendants' intentional misrepresentation of Doral's ALLL during the class period or knowledge of fraudulent activities by others. The court finds the allegations against the Individual Defendants to be weak and circumstantial, concluding that frequent communication with regulators does not imply fraudulent conduct; rather, it suggests motivation to avoid fraud due to increased oversight. The court also notes that compliance with regulatory agreements required Doral to submit regular reports and develop a comprehensive ALLL methodology, which aligns with the Defendants' actions. Furthermore, allegations of unusual insider trading by Ivanov, Poulton, and Ubarri are deemed weak; the defendants' limited involvement in public statements and the minor volume of shares sold do not support a strong inference of scienter. The court cites precedent indicating that one executive's insider trading does not infer wrongdoing by others, particularly when their trading activities are not suspicious.

Plaintiffs failed to establish a strong inference of scienter against individual defendants Ivanov, Hooston, Ubarri, and Poulton regarding the alleged fraudulent understatement of Doral's Allowance for Loan and Lease Losses (ALLL) and Provision for Loan and Lease Losses (PLLL). While the Private Securities Litigation Reform Act (PSLRA) does not mandate the pleading of evidence, the court determined that the allegations primarily relied on circumstantial evidence, lacking specific factual support, particularly concerning the awareness of a material risk related to the Treasury Department potentially voiding the 2012 Closing Agreement. 

Despite acknowledging the existence of a material risk, the court found that Plaintiffs did not convincingly allege the Individual Defendants' awareness of this risk. Key elements cited by Plaintiffs, such as the importance of the tax receivable to Doral's regulatory capital, communications with the Treasury, and internal discussions, did not sufficiently demonstrate knowledge of any misrepresentation. The court referenced case law indicating that claims based solely on the significance of a company's core operations require additional specific factual allegations to support an inference of knowledge of wrongdoing. Conclusory assertions regarding the defendants' general awareness of risks were deemed insufficient under the PSLRA, as were claims about the frequency of meetings with Treasury representatives, which failed to clarify the content of those discussions or the Individual Defendants' knowledge of any misrepresentations.

Plaintiffs' allegations that negative outcomes imply prior knowledge of wrongdoing by Individual Defendants are dismissed as fraud by hindsight. The court finds sufficient pleading of scienter regarding Defendants Wakeman and Wahlman concerning the ALLL claim, noting their misleading statements about Doral's capital levels and compliance with regulations from April 2, 2012, to March 3, 2013. However, the remaining defendants lack the requisite specificity in pleading their involvement in fraud under Rule 9(b) and the PSLRA, with allegations only supporting negligence rather than intentional misconduct. Allegations of corporate mismanagement are insufficient for Rule 10b-5 claims, and although Doral may face liability, the current dismissal review focuses solely on Individual Defendants due to a stay on Doral. The First Circuit emphasizes that not all corporate mistakes equate to securities fraud. Regarding loss causation, while plaintiffs must demonstrate that defendants’ misrepresentations caused their losses, they are not bound by the same specificity requirements as for fraud and scienter claims, making it easier for plaintiffs to establish a causal connection for economic losses.

Loss causation pleading requirements should be interpreted to avoid imposing a heavy burden on plaintiffs, as disputes regarding loss causation primarily involve factual questions. The complaint alleges that following the disclosure of Defendants' misrepresentations and fraudulent conduct, Doral’s stock price fell significantly. On March 18, 2014, after Doral announced a delay in its annual 10-K report due to a material weakness in internal controls, the stock dropped from $12.30 to $11.17 per share, a decline of over 9%. Following the release of the 10-K report revealing substantial understatements and ongoing internal control deficiencies, the stock further declined from $11.55 to $10.76 per share on March 24, 2014, totaling a 25.6% decrease by March 28, 2014. Additionally, after Doral disclosed on May 1, 2014, that the FDIC disallowed a $230 million tax receivable from Tier 1 capital, the stock plummeted 62% from $9.82 to $3.73 per share, resulting in a loss of over $141 million in market capitalization. The court finds these allegations provide sufficient indications of loss and causal connections.

Under Section 20(a) of the Securities Exchange Act, there is joint and several liability for individuals who control a party liable under the Act, but such liability is secondary and contingent upon establishing primary liability. The plaintiffs did not allege that Ivanov, Hooston, Ubarri, or Poulton controlled Wakeman or Wahlman, leading to the dismissal of the control person liability claim. Additionally, plaintiffs failed to establish the required scienter for Ivanov, Hooston, Ubarri, and Poulton, which undermines the primary liability under the 10b-5 claim and consequently the secondary liability under Section 20(a).

The Court partially grants and partially denies the Defendants’ Motion to Dismiss, allowing the case to proceed against Individual Defendants Wakeman and Wahlman while dismissing claims against the other defendants. The Plaintiffs are advised to consider individual proceedings rather than class certification due to Doral's bankruptcy, which limits recovery possibilities. The Court encourages the parties to explore settlement options before the initial scheduling conference with Magistrate Judge Bruce J. McGiverin. Following Doral's bankruptcy declaration on February 27, 2015, and subsequent stock delisting, the Court emphasizes that the "bespeaks caution" doctrine is irrelevant to statements of present fact made by the defendants. Judicial notice of public records can be taken when assessing a motion to dismiss, allowing the Court to incorporate recent Commonwealth court decisions into the Plaintiffs' complaint. The group pleading doctrine remains contentious, but the Plaintiffs have not adequately shown that each Individual Defendant was aware of the alleged fraud concerning Doral's financial representations. Consequently, the claims against the Individual Defendants lack sufficient pleading.