1

06-2902-cv

Teamsters Local 445 Freight Division Pension Fund v. Dynex Capital Inc.

1 UNITED STATES COURT OF APPEALS

2 FOR THE SECOND CIRCUIT

3

4 August Term 2007

5 (Argued: January 30, 2008 Decided: June 26, 2008)

6 Docket No. 06-2902-cv

7 -----------------------------------------------------x

8 TEAMSTERS LOCAL 445 FREIGHT DIVISION PENSION FUND,

9

10 Plaintiff-Appellee,

11

12 -- v. --

13

14 DYNEX CAPITAL INC. and MERIT SECURITIES CORPORATION, 

15

16 Defendants-Appellants,

17

18 STEPHEN J. BENEDETTI, THOMAS H. POTTS, LEHMAN

19 BROTHERS, INC. and GREENWICH CAPITAL MARKETS, INC.,

20

21 Defendants.

22

23 -----------------------------------------------------x

24

25 B e f o r e : WALKER, CALABRESI, and POOLER, Circuit Judges. 

26

27 Interlocutory appeal from a partial denial of a motion to

28 dismiss in a securities fraud action in the United States

29 District Court for the Southern District of New York (Harold

30 Baer, Jr., Judge). Defendants-Appellants Dynex Capital and Merit

31 Securities argue that the district court erred in finding that
2

1 plaintiff adequately pleaded scienter as to the corporate

2 defendants even though it did not successfully plead scienter as

3 to any specific individual defendant. 

4

5 VACATED and REMANDED.

6 JOEL P. LAITMAN (Kurt Hunciker and

7 Frank R. Schirripa, on the brief),

8 Schoengold Sporn Laitman & Lometti,

9 P.C., New York, N. Y., for

10 Plaintiff-Appellee.

11

12 EDWARD J. FUHR (Terence J.

13 Rasmussen and Joseph J. Saltarelli,

14 on the brief), Hunton & Williams

15 LLP, New York, N.Y., for

16 Defendants-Appellees.

17

18 Carter G. Phillips, Sidley Austin

19 LLP, Washington, D.C., for Amici

20 Curiae Business Roundtable, Chamber

21 of Commerce of the United States of

22 America, Financial Markets

23 Association, and Securities

24 Industry Association.

25

26 Daniel J. Popeo, Washington, D.C.,

27 for Amicus Curiae Washington Legal

28 Foundation.

29

30 Edward Labaton, Goodkin Labaton

31 Rudoff & Scharow, New York, N.Y.,

32 for Amicus Curiae National

33 Association of Shareholder and

34 Consumer Attorneys.

35

36 Eric Alan Isaacson, Coughlin Stoa

37 Geller Rudman & Robbins LLP, San

38 Diego, Cal., for Amicus Curiae

39 Amalgamated Bank.

40

41 Stanley D. Bernstein, Bernstein

42 Liebhard & Lifshitz, LLP, New York,

43 N.Y., for Amici Curia States of
3

1 Mississippi, New Jersey, New

2 Mexico, and Rhode Island; Iowa

3 Public Employees’ Retirement

4 System; Pennsylvania Public School

5 Employees’ Retirement System;

6 Pennsylvania State Employees’

7 Retirement System.

8

9 JOHN M. WALKER, JR., Circuit Judge: 

10 In this putative securities fraud class action, defendants11 appellants Dynex Capital Inc. (“Dynex”) and Merit Securities

12 Corp. (“Merit”) appeal an order entered on February 10, 2006 in

13 the District Court for the Southern District of New York (Harold

14 Baer, Jr., Judge) denying a motion by Dynex and Merit to dismiss

15 the action as to them. On appeal, defendants argue that the

16 district court erred when it found that plaintiff had

17 successfully pleaded scienter against Dynex and Merit despite

18 failing to find scienter pleaded as to any specific officer or

19 employee of either company. They also assert that certain

20 aspects of this action are barred by standing rules and the

21 applicable statute of limitations.

22 Although there are circumstances in which a plaintiff may

23 plead the requisite scienter against a corporate defendant

24 without successfully pleading scienter against a specifically

25 named individual defendant, the plaintiff here has failed to do

26 so. As a result, we vacate the district court’s order and remand

27 with instructions to dismiss Teamsters’ complaint but allow them

28 an opportunity to replead. It is not necessary, on this
4

1 interlocutory appeal, to reach defendants’ arguments concerning

2 standing and the statute of limitations.

3 BACKGROUND

4 Dynex, a Virginia-based financial services company, invests

5 in bonds secured by mortgages on manufactured housing. Merit is

6 one of its subsidiaries. Stephen Benedetti served as president

7 and CEO of Merit at all relevant times, and also held various

8 officer and director positions at Dynex. Thomas Potts served as

9 Dynex’s president and principal executive officer from 1997 to

10 June 2002. 

11 Between 1996 and 1999, Merit made thousands of loans to

12 people seeking to buy manufactured homes. In March and August of

13 1999, Merit pooled these loans and issued two sets of asset14 backed securities secured by the loans, the Series 12 Bonds and

15 the Series 13 Bonds, with the income generated by the loans as

16 collateral. Each series was backed by a separate pool of loans,

17 and each was divided into several classes. 

18 After the bond issue, the value of the collateral began a

19 sharp decline. Increasing numbers of borrowers defaulted on

20 their loans: in August 1999, 1.35% of Merit’s borrowers were

21 delinquent, but, by November 2001, that figure had risen to

22 5.01%. During the same period, Merit’s “loss severities,”

23 namely, the difference between amounts loaned to finance home

24 purchases and the lesser amounts realized from the sale of those
5

1 properties after foreclosure, also increased. In other words,

2 not only were more people defaulting on their loans, but each

3 default was becoming more financially damaging to Merit. 

4 In October 2003, Dynex disclosed that it had understated

5 the repossession rates on the Series 13 Bond collateral by

6 approximately 34%. At the same time, Moody’s Investor Service

7 began a review of the bonds, with an eye toward downgrading their

8 credit ratings. On February 24, 2004, Moody’s downgraded the

9 Series 13 Bonds’ rating from “high quality” to “speculative,”

10 based partly on the collateral’s rising repossession rates. In

11 March, Fitch Ratings issued a similar downgrade for the Series 12

12 Bonds. In April 2004, Merit disclosed that it had identified “an

13 internal control deficiency” related to the recording of loan

14 losses, and would therefore restate its earnings for two periods

15 in 2003. In the aftermath of these events, the prices of the

16 various classes of Series 12 and 13 Bonds decreased by varying

17 amounts, up to 85%. 

18 In February 2005, plaintiff-appellee Teamsters Local 445

19 Freight Division Pension Fund (“Teamsters”), which had purchased

20 approximately $450,000 worth of Dynex’s Series 13 Bonds in early

21 2002, filed an action in the Southern District of New York

22 alleging violations of sections 10(b) and 20(a) of the Securities

23 Exchange Act of 1934 (“Exchange Act”). Teamsters named Dynex and

24 Merit as corporate defendants, and Benedetti and Potts as
6

1 individual defendants. Teamsters brought the putative class

2 action “on behalf of all open market purchasers of Series 12 and

3 13 bonds between February 7, 2000 and May 13, 2004.” (the “class

4 period”). In re Dynex Capital, Inc. Sec. Litig. (Dynex I), No.

5 05-civ-1897, 2006 WL 314524, at *1 (S.D.N.Y. Feb. 10, 2006). 

6 There is no allegation, however, that Teamsters purchased the

7 Series 12 bonds. 

8 The complaint alleged that Dynex, a late entrant to the

9 manufactured homes financing market looking to increase its

10 market share, had to purchase loans made to “uncreditworthy

11 borrowers.” Id. In order to do so, they “overtly” told dealers

12 that they were willing to buy “bad paper” (i.e., very risky

13 loans) and failed to disclose these practices in the offering

14 materials that accompanied the 1999 bond issues. Id. After the

15 initial offering and throughout the class period, Teamsters

16 alleges, the defendants “misrepresented the cause of the bond

17 collateral’s poor performance; misrepresented the reasons for

18 restating its loan loss reserves; and concealed the loans’ faulty

19 underwriting.” Id. The defendants moved to dismiss the

20 complaint, claiming, inter alia, that Teamsters had failed to

21 adequately plead scienter. 

22 The district court agreed with defendants that Teamsters

23 “ha[d] failed to adequately plead scienter with respect to Potts

24 and Benedetti,” the individual defendants. Id. at *9. Although
7

1 Teamsters “aptly described a pattern of reckless corporate

2 behavior,” they did not “allege[] that Potts or Benedetti saw or

3 had access to specific reports or statements that indicated

4 malfeasance,” nor “directly supervised or knew of any identified

5 individual(s) who were engaged in specific wrongdoing,” and

6 therefore “failed to link that [reckless] behavior to any

7 culpable individuals.” Id. Because plaintiff’s complaint did

8 not show that Potts or Benedetti’s “culpability [was] based upon

9 more than [each man’s] mere position in the corporate hierarchy,”

10 id. at *8, the district court determined that it did not satisfy

11 the heightened scienter pleading requirement of the Public

12 Securities Litigation Reform Act (the “PSLRA”).

13 As to the corporate defendants Dynex and Merit, however, the

14 district court found scienter adequately pleaded. “A plaintiff

15 may, and in this case has, alleged scienter on the part of a

16 corporate defendant without pleading scienter against any

17 particular employees of the corporation.” Id. at *9. The

18 district court noted plaintiff’s allegation that “Dynex

19 systematically originated defective loans, despite clear signs

20 that borrowers were not creditworthy.” Id. at *10. In its view,

21 these allegations allowed the inference that “officers and

22 employees of the corporate defendants had the motive and

23 opportunity to commit fraud.” Id. The district court found

24 that, because plaintiff’s allegations constituted strong
8

1 circumstantial evidence of recklessness, a sufficiently culpable

2 mental state, Teamsters had successfully alleged scienter as to

3 Dynex and Merit. Id. The district court denied defendants’

4 motion for reconsideration, but certified the issue for an

5 interlocutory appeal. In re Dynex Capital, Inc. Sec. Litig., No.

6 05-civ-1897, 2006 WL 1517580 (S.D.N.Y. June 2, 2006). 

7 

8 DISCUSSION

9 We review the denial of a motion to dismiss the complaint de

10 novo, accepting the truth of each factual allegation it contains. 

11 United States v. Baylor Univ. Med. Ctr., 469 F.3d 263, 267 (2d

12 Cir. 2006). While we normally draw reasonable inferences in the

13 non-movant’s favor on a motion to dismiss, see id., section

14 21D(b)(2) of the PSLRA, which governs scienter pleading in

15 securities fraud actions, establishes a more stringent rule for

16 inferences involving scienter, and requires that a plaintiff’s

17 complaint “state with particularity facts giving rise to a strong

18 inference that the defendant acted with the required state of

19 mind.” 15 U.S.C. § 78u-4(b)(2). 

20 Congress did not define “strong inference,” but the Supreme

21 Court has recently held that, to qualify as “strong,” an

22 “inference of scienter must be more than merely plausible or

23 reasonable–it must be cogent and at least as compelling as any

24 opposing inference of nonfraudulent intent.” Tellabs, Inc. v.
9

1 Makor Issues & Rights, Ltd., 127 S.Ct. 2499, 2504-05 (2007). The

2 Court has also defined the required state of mind as “a mental

3 state embracing intent to deceive, manipulate, or defraud.” Id.

4 at 2507 (internal quotation marks and citation omitted). In

5 addition to actual intent, the Second Circuit has also concluded

6 that recklessness is a sufficiently culpable mental state in the

7 securities fraud context. See Novak v. Kasaks, 216 F.3d 300,

8 308-09 (2d Cir. 2000). In Novak, we also summarized our case law

9 in this area as suggesting that the required strong inference

10

11 may arise where the complaint sufficiently alleges that the

12 defendants: (1) benefitted in a concrete and personal way

13 from the purported fraud; (2) engaged in deliberately

14 illegal behavior; (3) knew facts or had access to

15 information suggesting that their public statements were not

16 accurate; or (4) failed to check information they had a duty

17 to monitor. 

18

19 Id. at 311 (internal citations omitted).

20 Appellants Dynex and Merit contend that the district court’s

21 finding that the Teamsters’ complaint did not raise a strong

22 inference of scienter with regard to the individual defendants,

23 Potts and Benedetti, precludes as a matter of law the finding of

24 such an inference with regard to the corporate defendants. Thus,

25 they argue that the refusal to dismiss as against Dynex and Merit

26 rests on a legal error; namely, the district court’s belief that

27 “[a] plaintiff may, and in this case has, alleged scienter on the

28 part of a corporate defendant without pleading scienter against
10

1 any particular employees of the corporation.” Dynex I at *10. To

2 accept this view, defendants contend, would be tantamount to

3 endorsing a doctrine of “collective scienter,” which posits,

4 contrary to “settled principles of corporate liability,” that a

5 corporate entity can act with an intent that is not derivative of

6 the intent of one of its agents. Appellants’ Br. at 17. 

7 In support of their position, defendants point to State

8 Teachers Retirement Board v. Fluor Corp., 654 F.2d 843 (2d Cir.

9 1981). In that case, we affirmed a grant of summary judgment for

10 a securities-fraud defendant because “there [wa]s no evidence on

11 the record...that [Fluor director of investor relations] Russler

12 or any other Fluor officer acted with scienter.” Id. at 853

13 (emphasis added). To the defendants, this demonstrates this

14 court’s view that “[t]he lack of scienter on the part of the

15 corporation’s agents precluded any finding of scienter on the

16 part of the corporation.” Appellants’ Br. at 18.

17 The language emphasized above clearly distinguishes Fluor

18 from the instant case. In Fluor, there was “no evidence” of

19 scienter as to “Russler or any other Fluor officer.” 654 F.2d at

20 853. In this case, by contrast, while the district court

21 similarly found no evidence of scienter on the part of the

22 specifically named officers, it did find sufficient allegations

23 of scienter as to other unnamed “officers” of the company. See

24 Dynex I at *10. Specifically, the district court found
11

1 Teamsters’ allegations “sufficient to infer that officers and

2 employees of the corporate defendants had the motive and

3 opportunity to commit fraud.” Id. And under Novak, properly

4 alleging an individual’s motive and opportunity to commit fraud

5 is one way of raising a strong inference of scienter as to that

6 individual. See 216 F.3d at 307. 

7 Furthermore, defendants’ reliance on Fluor, a case decided

8 over a decade before the enactment of PSLRA, and one involving a

9 motion for summary judgment, rather than a motion to dismiss (as

10 here), demonstrates the fundamental flaw in their argument: they

11 improperly conflate pleading rules and liability rules. To prove

12 liability against a corporation, of course, a plaintiff must

13 prove that an agent of the corporation committed a culpable act

14 with the requisite scienter, and that the act (and accompanying

15 mental state) are attributable to the corporation. See, e.g.,

16 Fluor, 654 F.2d at 853; Makor Issues & Rights, Ltd. v. Tellabs,

17 Inc., 513 F.3d 702, 708 (7th Cir. 2008).

18 To survive a Rule 12(b)(6) motion under the PSLRA, a

19 plaintiff must only state facts “giving rise to a strong

20 inference that the defendant acted with the required state of

21 mind.” 15 U.S.C. § 78u-4(b)(2). When the defendant is a

22 corporate entity, this means that the pleaded facts must create a

23 strong inference that someone whose intent could be imputed to

24 the corporation acted with the requisite scienter. In most
12

1 cases, the most straightforward way to raise such an inference

2 for a corporate defendant will be to plead it for an individual

3 defendant. But it is possible to raise the required inference

4 with regard to a corporate defendant without doing so with regard

5 to a specific individual defendant. As the Seventh Circuit

6 recently observed in the wake of the Supreme Court’s remand in

7 Tellabs,

8 [I]t is possible to draw a strong inference of corporate

9 scienter without being able to name the individuals who

10 concocted and disseminated the fraud. Suppose General

11 Motors announced that it had sold one million SUVs in 2006,

12 and the actual number was zero. There would be a strong

13 inference of corporate scienter, since so dramatic an

14 announcement would have been approved by corporate officials

15 sufficiently knowledgeable about the company to know that

16 the announcement was false.

17

18 Makor Issues & Rights, 513 F.3d at 710. Accordingly, we reject

19 appellants’ contention that Teamsters failed as a matter of law

20 to plead scienter against Dynex and Merit when it failed to plead

21 scienter against Potts and Benedetti. Congress has imposed

22 strict requirements on securities fraud pleading, but we do not

23 believe they have imposed the rule urged by defendants, that in

24 no case can corporate scienter be pleaded in the absence of

25 successfully pleading scienter as to an expressly named officer.

26 Nevertheless, because we review the denial of a motion to

27 dismiss de novo, we must still determine whether Teamsters has

28 raised a “strong inference” of scienter against Dynex and Merit. 

29 Teamsters argues that their complaint satisfies the pleading
13

1 requirements of the PSLRA, as explained in Novak, in three ways. 

2 First, they claim that they have sufficiently pleaded that Dynex

3 “knew facts or had access to information suggesting that their

4 public statements were not accurate,” Novak, 216 F.3d at 311, 

5 because senior executives such as Potts and Benedetti had access

6 to “collection data” which “reflected the high percentage of Buy

7 Fair [sic] Loans, First Payment Default delinquencies and failed

8 or impaired repossessions.” Complaint at 14-15, ¶¶ 27-28. These

9 data, Teamsters claims, would reveal “that the true reason” for

10 the underperforming bond collateral was “the manner in which the

11 collateral was originated.” Id. But, as we observed in Novak,

12 “[w]here plaintiffs contend defendants had access to contrary

13 facts, they must specifically identify the reports or statements

14 containing this information.” 216 F.3d at 309. Teamsters’ broad

15 reference to raw data lacks even an allegation that these data

16 had been collected into reports that demonstrated that loan

17 origination practices were undermining the collateral’s

18 performance. Accordingly, they have not raised an inference of

19 scienter based on knowledge of or access to information

20 demonstrating the inaccuracy of Dynex’s public statements. 

21 Teamsters’ second contention fails for much the same reason. 

22 They argue that they have raised an inference of scienter by

23 alleging that “the defendants failed to review or check

24 information that they had a duty to monitor.” Id. at 308. But
14

1 again, they have not specifically identified any reports or

2 statements that would have come to light in a reasonable

3 investigation and that would have demonstrated the falsity of the

4 allegedly misleading statements. 

5 Finally, Teamsters argues it satisfied Novak’s “motive and

6 opportunity prong” by demonstrating that unspecified employees or

7 officers of Dynex and Merit, and, by imputation, the corporate

8 entities themselves, benefitted “in a concrete and personal way”

9 from the alleged fraud. Appellee’s Br. at 30 (citing Novak, 216

10 F.3d at 311). Their motive, according to Teamsters, was to avoid

11 “fully disclos[ing] the impaired quality of the collateral.” Id. 

12 This alleged motive is insufficient. In Novak, we observed that

13 “[p]laintiffs could not proceed based on motives possessed by

14 virtually all corporate insiders, including . . . the desire to .

15 . . sustain the appearance of corporate profitability, or of the

16 success of an investment.” 216 F.3d at 307 (internal quotation

17 and citation omitted). Teamsters’ proffered motive is the same

18 desire to maintain the appearance of profitability that we have

19 consistently rejected as insufficient in securities fraud

20 pleading. See Chill v. Gen. Elec. Co., 101 F.3d 263, 268 (2d

21 Cir. 1996) (“[I]f scienter could be pleaded on that basis alone,

22 virtually every company in the United States that experiences a

23 downturn in stock price could be forced to defend securities

24 fraud actions.” (internal quotation marks and citation omitted)).
15

1 In sum, Teamsters fails to allege the existence of

2 information that would demonstrate that the statements made to

3 investors were misleading, e.g., information showing that the

4 primary cause of the bonds’ poor performance was not the general

5 weakness in the mobile homes market. They have also failed to

6 allege that anyone at Dynex or Merit had a compelling motive to

7 mislead investors regarding the bonds. As a result, a number of

8 competing inferences regarding scienter arise. One might infer

9 that no one at Dynex or Merit found the statements misleading

10 because they identified the cause of the bonds’ performance as

11 accurately as possible, or that no one responsible for the

12 statements made to investors had reason to believe that Dynex

13 employees were systematically flouting its underwriting

14 guidelines or giving them false information about the cause of

15 the bonds’ poor performance. Teamsters would have us infer that

16 someone whose scienter is imputable to the corporate defendants

17 and who was responsible for the statements made was at least

18 reckless toward the alleged falsity of those statements. We

19 cannot say, based on the allegations in the complaint, that this

20 inference is “at least as compelling” as the competing inference,

21 Tellabs, 127 S.Ct. at 2505; i.e., that the statements either were

22 not misleading or “were the result of merely careless mistakes at

23 the management level based on false information fed it from

24 below.” Makor Issues & Rights, 513 F.3d at 709. Accordingly, the
16

1 PSLRA requires dismissal of the complaint. We note, however,

2 that before it authorized the interlocutory appeal at bar, the

3 district court granted plaintiff leave to replead within 30 days. 

4 We believe this course to be proper on remand, with respect to

5 both the individual and corporate defendants.

6 Finally, defendants argue that the plaintiff lacks standing

7 to represent the Series 12 bondholders, and that the statute of

8 limitations has run as to some of the statements plaintiff

9 alleges to be fraudulent. While we have discretion to address

10 these issues on an interlocutory appeal, see Yamaha Motor Corp.

11 v. Calhoun, 516 U.S. 199, 205 (1996), we decline to do so at this

12 stage, as the resolution of these issues will not “materially

13 advance the ultimate termination of the litigation.” 28 U.S.C. §

14 1292(b).

15

16 CONCLUSION

17 For the foregoing reasons, the judgment of the district

18 court is VACATED insofar as it denied the motion to dismiss

19 defendants Dynex and Merit. The case is REMANDED with

20 instructions to dismiss as to these two defendants with leave to

21 replead.