City of Pontiac Policemen's & Firemen's Retirement System v. UBS AG

Citations: 752 F.3d 173; 2014 WL 1778041; 2014 U.S. App. LEXIS 8533Docket: No. 12-4355-cv

Court: Court of Appeals for the Second Circuit; May 6, 2014; Federal Appellate Court

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The appeal considers whether the U.S. securities laws, specifically as established in Morrison v. National Australia Bank Ltd., apply to claims related to foreign-issued securities purchased on foreign exchanges but listed on a U.S. exchange. The court concludes that the Morrison decision bars claims under the Securities Exchange Act of 1934 for purchasers of foreign issuer shares on foreign exchanges, regardless of their cross-listing on U.S. exchanges. Furthermore, it finds that claims under the Securities Act of 1933 related to a UBS rights offering were properly dismissed as they constituted immaterial “puffery.” Additionally, claims regarding defendants’ statements on mortgage-related assets were dismissed due to inadequate pleading of material misrepresentation or scienter. The court affirms the lower court's dismissal of all claims with prejudice. The plaintiffs, consisting of both foreign and domestic institutional investors, alleged that UBS and its officers made fraudulent statements about UBS's mortgage-related assets and compliance with U.S. laws during the Class Period, which lasted from August 13, 2003, to February 23, 2009. The specific allegations included a "CDO/RMBS Fraud" related to UBS’s asset portfolio and a "Tax Fraud" concerning UBS’s private banking operations. One plaintiff, the Alaska Laborers-Employers Retirement Fund, claimed misleading statements during the June 13, 2008 Rights Offering violated the Securities Act.

UBS is accused by the CDO/RMBS Fraud Plaintiffs of accumulating and misrepresenting $100 billion in residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs) from February 13, 2006, to April 21, 2008. This was allegedly done without informing shareholders and contrary to UBS's stated risk management policies. The acquisition began with the 2006 establishment of Dillon Read Capital Management (DRCM), led by John Costas, which pressured the Investment Bank (IB) to expand its RMBS/CDO holdings. After significant write-downs in DRCM's subprime portfolio, it was closed, and its $20 billion portfolio was reintegrated into the IB. The plaintiffs argue that UBS misrepresented the IB's subprime exposure, disclosing only $23 billion instead of $100 billion, and failed to revalue assets as the subprime market declined, leading to a delayed write-down announcement of $4 billion in October 2007, culminating in a total write-down of $48 billion.

In a separate allegation, the Tax Fraud Plaintiffs claim UBS made misleading statements regarding a scheme where Swiss bankers advised American clients on illegal investments. Following the indictment of certain employees in May 2008, UBS disclosed investigations by the DOJ and SEC concerning their cross-border services from 2001 to 2007. UBS later entered a Deferred Prosecution Agreement on February 19, 2009, admitting violations of U.S. tax laws, paying a $780 million fine, and acknowledging involvement in a conspiracy to defraud the IRS.

Procedurally, the District Court dismissed claims from foreign and domestic plaintiffs who purchased UBS shares on foreign exchanges on September 13, 2011, and on September 28, 2012, dismissed remaining claims under the Exchange Act due to insufficient fraud pleadings. This dismissal included Alaska Laborers’ claims under the Securities Act for lack of material misstatement and standing. The appeal followed these dismissals, with the reviewing court accepting factual allegations in the complaint as true and determining the plausibility of claims based on legal precedents, including the Morrison v. National Australia Bank case concerning foreign shares purchased on foreign exchanges.

Morrison determined that Section 10(b) of the Exchange Act does not provide a cause of action for foreign plaintiffs against foreign defendants for misconduct related to securities traded on foreign exchanges. It limits private causes of action to transactions involving securities listed on domestic exchanges or domestic transactions in other securities. Plaintiffs' argument, based on the “listing theory” that dual listing on the NYSE makes these claims actionable under Rule 10(b), is rejected. The Court emphasized that the Exchange Act focuses on the location of securities transactions rather than the exchange where securities are listed. The Supreme Court explicitly ruled that the national public interest does not extend to transactions conducted on foreign markets. Although certain shares were listed on the NYSE, this did not impact the analysis of shares purchased on foreign exchanges. Morrison also dismissed a previous "conduct and effects" test, establishing that merely having shares listed domestically does not allow for claims by foreign purchasers of foreign securities.

In a related case involving OPEB, a U.S. entity that placed a buy order in the U.S. for UBS shares executed on a Swiss exchange, the court considered whether this purchase qualified as a domestic transaction under Morrison. It established that a purchase is considered domestic if the parties incur irrevocable liability or title passes within the U.S. The court ultimately ruled that merely placing a buy order in the U.S. for foreign securities does not constitute incurring irrevocable liability in the U.S., thus the U.S. securities laws do not apply to this transaction.

Plaintiffs contend that a U.S. entity incurs irrevocable liability upon placing a buy order in the U.S. instead of when the security is purchased on a foreign exchange. However, the court clarifies that a purchaser’s citizenship or residency does not determine the transaction's location. Therefore, OPEB’s status as a U.S. entity does not qualify the transaction as domestic, nor does placing a buy order in the U.S. establish irrevocable liability when executed on a foreign exchange. Consequently, the District Court's dismissal of OPEB's claims regarding foreign share purchases is affirmed.

In relation to Securities Act claims, Alaska Laborers argue that UBS’s offering materials from June 13, 2008, falsely claimed adherence to ethical standards and compliance with laws, while failing to disclose ongoing cross-border tax activities. The District Court dismissed these claims under Sections 11 and 12(a)(2) for lack of material misrepresentations. Section 11 holds issuers liable for false or misleading statements in registration statements, without requiring proof of scienter, reliance, or causation. However, claims sounding in fraud must meet a heightened pleading standard under Rule 9(b), demanding particularity in allegations.

The plaintiffs assert that UBS's tax fraud involvement rendered its statements about compliance and reputation misleading. The court notes that general claims about reputation and ethical compliance are considered non-actionable “puffery,” as they are too vague to be relied upon by reasonable investors. The aspirational nature of UBS’s statements, including qualifiers like “aims to” and “should,” further undermines their materiality, preventing the claims from being valid grounds for investment assessment.

Plaintiffs contend that defendants’ failure to disclose a tax scheme breached Regulation S-K, Item 503(c), which requires registrants to outline significant speculative or risky factors in offering materials. They argue that UBS’s disclosures regarding the Department of Justice (DOJ) investigation were materially incomplete, asserting that UBS was engaged in ongoing tax evasion, not just the existence of an investigation. However, it is established that companies are not obligated to confess to uncharged wrongdoing. UBS adequately disclosed its involvement in legal matters, indicating potential monetary damages and penalties, thus fulfilling its disclosure responsibilities. The court affirmed the District Court's dismissal of Alaska Laborers' claims under sections 11 and 12(a)(2) of the Securities Act, noting no misstatements were pleaded.

Regarding claims under Section 10(b) of the Exchange Act, the District Court dismissed plaintiffs’ claims due to failure to plead materiality or scienter related to both CDO/RMBS and Tax Fraud. The standards set by Rule 9(b) and the PSLRA necessitate that securities fraud complaints detail misleading statements and provide strong evidence of the defendant's intent. Scienter can be inferred from the defendant's motive and opportunity or through strong circumstantial evidence of recklessness. Recklessness is defined as conduct that significantly deviates from ordinary care, where the danger was obvious to the defendant. The plaintiffs identified two categories of misstatements related to alleged CDO/RMBS fraud: UBS's claims about avoiding “asset concentrations” and its valuation of mortgage-related assets, each to be addressed separately.

Plaintiffs allege that UBS misrepresented its risk management practices, claiming it avoided concentrated asset positions, implemented portfolio limits, and engaged in limited proprietary investing while being aware of a significant $100 billion RMBS/CDO portfolio without portfolio limits. They argue that these representations were materially false and misleading. However, the court finds that the plaintiffs fail to demonstrate that UBS's statements about avoiding asset concentrations were materially misleading. The representations made by UBS were deemed too vague and subjective to constitute guarantees about specific risk limits or outcomes, failing to meet the materiality standard under Section 10(b). Furthermore, UBS disclosed its intent to expand its fixed income business and provided specific figures regarding increases in its portfolio, which counters the claim that UBS concealed the accumulation of mortgage-related securities. As for the second category concerning UBS's valuation of mortgage-related assets, UBS claimed to use mark-to-market accounting. Plaintiffs argue that sales by UBS's hedge fund indicated a need to write down similar assets, suggesting that UBS ignored warning signs. The court finds the plaintiffs' allegations of recklessness in this regard to be insufficient. Overall, the plaintiffs have not convincingly shown that UBS's risk management and asset valuation representations were materially misleading or that there was conscious recklessness involved.

To establish "reckless conduct" under securities laws, the failure to write down the mortgage-related securities portfolio must be deemed highly unreasonable and an extreme deviation from ordinary care standards. Plaintiffs claim defendants should have anticipated impairments in AAA-rated assets backed by lower-rated securities, referencing their knowledge of write-downs in lower-grade assets held by DRCM. However, even if plaintiffs' assertions about defendants' obligations are accepted, they fail to establish a strong inference of recklessness regarding the decision not to write down the IB's assets based on the information available about DRCM's holdings and the broader subprime market. The structure of these securitized products was predicated on the expectation that higher-rated tranches would maintain value despite the devaluation of lower-rated ones, as evidenced by the fact that these highly-rated assets traded at par value until mid-2007. While there were disagreements and uncertainties regarding the valuation of mortgage-related assets, the complaint does not convincingly show that UBS defendants recklessly ignored known facts that contradicted their asset valuations. Poor judgment related to the subprime market collapse does not equate to recklessness, especially in the absence of compelling evidence that would support such an inference.

Regarding tax fraud claims, the definition of “materiality” aligns under both the Securities Act and the Exchange Act, leading to the affirmation of the dismissal of the 10(b) claims related to tax fraud.

Lastly, the District Court's dismissal of the Amended Complaint with prejudice is upheld. Plaintiffs had previously amended their complaint and failed to address specific pleading deficiencies raised. The court's denial of leave to amend is reviewed for abuse of discretion; however, since plaintiffs did not present new facts or legal theories that could justify further amendment, the court acted appropriately in denying this request.

1. Morrison bars foreign plaintiffs from claiming under Section 10(b) of the Securities Exchange Act of 1934 for purchases of foreign securities on foreign exchanges, even if the securities are also listed on a U.S. exchange. 

2. A U.S. entity's buy order for foreign securities on a foreign exchange does not create irrevocable liability in the U.S. as established in Absolute Activist.

3. Claims under Sections 11 and 12(a) of the Securities Act of 1933 were dismissed due to failure to adequately plead actionable misstatements.

4. Claims under Section 10(b) of the Exchange Act related to alleged Tax Fraud were dismissed for the same reason.

5. Claims under Section 10(b) concerning alleged CDO/RMBS Fraud were dismissed for lack of materiality and insufficient evidence of scienter.

6. The District Court's decision to deny leave for a second amendment was not erroneous.

The judgments from September 13, 2011, and September 28, 2012, are affirmed. The plaintiffs include various foreign and U.S. entities, while the "UBS Defendants" consist of UBS AG and key officers and board members. Other underwriters involved are major financial institutions. RMBS are defined as asset-backed securities derived from pools of mortgages, specifically subprime loans. CDOs are described as bonds secured by RMBS pools. The document also references the Volcker Rule's impact on proprietary trading within financial institutions.

UBS’s Swiss-based cross-border private banking business allegedly violated a 2001 Qualified Intermediary Agreement with the IRS, which mandated disclosure and withholding of income taxes for American clients engaged in U.S. securities trading or with U.S.-sourced income. The excerpt references the SEC’s deferred prosecution agreements (DPAs), which incentivize companies to cooperate by providing information about misconduct in exchange for immunity from prosecution for their own violations. It also discusses the concept of "foreign-cubed" actions, where foreign plaintiffs sue foreign issuers in U.S. courts under American securities laws for transactions occurring in foreign countries. The excerpt notes that no Circuit has yet determined the viability of the "listing theory," which questions whether listing on a U.S. exchange, without an associated transaction, can provide grounds for a private cause of action under Section 10(b). The second prong of the Morrison test distinguishes between "domestic transactions in other securities" and "transactions in domestic securities." It further emphasizes that the Exchange Act was not intended to regulate foreign exchanges, and lacks standing for plaintiffs who did not purchase shares on domestic exchanges. Lastly, it highlights that allegations of fraud must demonstrate a significant connection to the U.S. to support private actions for damages incurred abroad.

The Second Circuit has removed the presumption against extraterritoriality in the context of Section 10(b) of the Securities Exchange Act. In Schoenbaum, the situation involved the sale of treasury shares of a Canadian corporation, which were publicly traded in both the U.S. and Canadian exchanges. The parties did not reference the Absolute Activist ruling during their District Court arguments, but OPEB later cited it in their appeal without introducing new facts that could classify the transactions as domestic. The court concluded that it could resolve the appeal without allowing amendments or remanding the case. 

The court clarified that while a foreign resident can purchase securities in the U.S., and vice versa, merely placing a purchase order does not alone establish irrevocable liability for transactions involving foreign securities on foreign exchanges. This aligns with the Supreme Court's ruling in Morrison, which indicated that the Exchange Act does not extend to foreign exchanges. The concurring opinions in Morrison provide insight into the limitations of the majority opinion, where Justice Breyer noted that the relevant purchases involved solely Australian investors and securities listed only on foreign exchanges. 

The court also mentioned that the Offering Materials consisted of SEC filings from March to May 2008, and while the District Court found a lack of statutory standing under Section 12(a)(2), the appeal was affirmed based on the failure to allege a material misstatement or omission. Claims under Sections 11 or 12(a)(2) of the Securities Act can arise from material misrepresentations.

A material omission can violate legal disclosure obligations in two main contexts: (1) failing to disclose information required by law, and (2) omitting information necessary to prevent existing disclosures from being misleading. Relevant case law, including Litwin and In re Morgan Stanley, establishes that the heightened pleading standard under Rule 9(b) applies to claims under Sections 11 and 12(a)(2) when based on fraud allegations. The court noted that a bank's reputation for integrity is not inherently material, as such statements are commonly made in the industry. Plaintiffs argued that UBS's assertion regarding WMI's lack of services in the U.S. was misleading due to ongoing tax fraud activities, but this claim was not included in the initial complaint, resulting in a waiver. The plaintiffs contended that specific identification of misrepresentations is not a requirement of the Securities Act; however, Rule 9(b) necessitates detailing why the statements are fraudulent. Furthermore, the plaintiffs did not propose any amendments to their pleadings that would create a viable claim. The court affirmed that reviewing the denial of leave to amend involves assessing whether proposed amendments plausibly support a claim for relief. The plaintiffs failed to convincingly argue that defendants had the motive and opportunity to commit fraud, and the court rejected their theory of scienter, citing relevant case law.

The District Court dismissed individual defendants Walter Stuerzinger, James Stehli, and Michael Hutchins in a CDO/RMBS fraud case, citing Janus Capital Grp. Inc. v. First Derivative Traders, which requires that defendants must have made the statements to be held liable under Section 10(b). Appellants appealed the dismissal of Stuerzinger, claiming he made actionable misstatements. However, the District Court found that the plaintiffs waived this argument by not addressing it in their opposition brief. Even if not waived, the court affirmed the dismissal, stating that Stuerzinger's general statements about risk management were not actionable, referencing similar cases where general claims about best practices were deemed immaterial. The court noted that while a bank's reputation is important, this does not make all statements regarding integrity material. The plaintiffs also argued that comparisons to UBS's overall portfolio were improper, insisting that comparisons should be made to its trading portfolio. The court clarified that the generality of the statements regarding risk strategies rendered them insufficient to guarantee that UBS would not accumulate a risky portfolio. The court did not dismiss the potential for fraud claims based on more specific allegations of misrepresentation regarding risk policies, as seen in the In re Lehman Bros. case. The document also mentioned the exchange rate of the Swiss franc to U.S. dollars in 2006.

Plaintiffs contend that the District Court improperly utilized a "truth on the market" defense, arguing that UBS's disclosures aimed to demonstrate that the plaintiffs were aware of the portfolio's condition. However, the disclosures were pertinent to countering the notion that UBS sought to conceal the truth. Plaintiffs claimed the assets held by UBS's Investment Bank (IB) were similar to those held by DRCM but acknowledged that the IB's assets had AAA ratings, while declines in the subprime market predominantly impacted BBB-rated and lower-grade assets. UBS's risk models anticipated that AAA-rated bonds would retain at least 98 percent of their face value. The court stated that a complaint must present a strong inference of scienter that is at least as compelling as any opposing inference. Upon reviewing the plaintiffs' additional allegations related to scienter, the court found them insufficient to establish the necessary inference. It emphasized that poor business judgment does not constitute grounds for actionable claims under section 10(b), and mere anticipation of future events or delayed disclosures do not substantiate claims of securities fraud. The intent to maintain investment success or stock prices for executive compensation does not establish fraudulent intent. The District Court's failure to provide reasoning for denying leave to amend is interpreted as a decision based on futility, which will be reviewed de novo, considering proposed amendments alongside the original complaint.