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PSLRA Class Action Defense Cases–In re 2007 NovaStar Financial: Missouri Federal Court Grants Defense Motion To Dismiss Class Action Complaint Concluding Class Action Failed To Satisfy PSLRA’s Heightened Pleading Requirements

Class Action Complaint Failed to Plead Securities Fraud with Specificity Required by Private Securities Litigation Reform Act (PSLRA) thus Subjecting Class Action to Motion to Dismiss without Leave to Amend Missouri Federal Court Holds

Plaintiff filed a class action complaint against NovaStar Financial and three of its directors alleging securities fraud violations. In re 2007 NovaStar Financial, Inc., Securities Litig., ___ F.Supp.2d ___ (W.D. Mo. June 4, 2008) [Slip Opn., at 1]. Defense attorneys moved to dismiss the class action, id.; the class action complaint failed to meet the heightened pleading requirements under the Private Securities Litigation Reform Act (PSLRA), which “is intended to eliminate abusive securities litigation and put an end to the practice of pleading ‘fraud by hindsight,’” id., at 2 (citation omitted). The district court granted the defense motion, holding that the class action “has not – and cannot – satisfy the PSLRA’s pleading requirements.” Id., at 3. The language of the district court’s opinion should prove useful to class action defense attorneys, so we quote it at length.

The federal court began its analysis with a cogent observation, noting at page 3: “One might be tempted to think that a complaint spanning more than 100 pages and consisting of more than 200 paragraphs could not fail to be specific. The temptation is dangerous and must be resisted.” Under the district court’s careful analysis, it found that the class action complaint “has not specified the allegedly misleading statements, nor has he specified why the statements he has referred to are misleading.” Id. Instead, the class action “presents a very broad picture, and Plaintiff discusses his claims in generalities – precisely what the PSLRA counsels against.” Id. In the court’s words, “This has allowed Plaintiff to pick isolated threads and snippets from the Complaint to create an illusion of detail and insinuate the existence of fraud, which in turn has made it exceedingly difficult for the Court to conduct the analysis required by law.” Id. Relying on the Eighth Circuit’s opinion in In re Cerner Corp. Sec. Litig., 425 F.3d 1079 (8th Cir. 2005), the district court held that the class action failed to plead falsity with the required specificity. See id., at 3-6. At bottom, the class action “has not stated a claim because companies…are not expected to be clairvoyant, and bad decisions do not constitute securities fraud.” Id., at 6.

The district court further held that the class action complaint failed to adequately allege scienter. The court explained at pages 6 and 7, “Relying on the confidential informants, Plaintiff alleges Defendants ‘each knew about, or disregarded in a severely reckless manner, the disastrous problems arising from Novastar’s bad and/or weakened underwriting practices during the Class Period through regularly scheduled meetings and reports.’ [Citation.] Plaintiff theorizes an intent to defraud can be inferred because Defendants regularly attended meetings during which the adverse effects of policy changes, adverse changes in the Company’s financial position, and ways to improve the Company’s operations were discussed. This conduct is normal and expected, and does not indicate fraudulent intent. Management is supposed to review results and search for ways to improve operations, and this customary endeavor does not indicate an intent to deceive when positive information is disseminated.” Based on Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S.Ct. 2499 (2007), the district court concluded that the class action failed to “creat[e] an inference of scienter that is at least as strong as an inference that Defendants lacked fraudulent intent, and this failing constitutes an independent reason to dismiss the case.” Id., at 7. Finally, the court denied plaintiff leave to file an amended class action complaint, concluding that such an amendment would be futile. Id., at 7-8. Accordingly, the federal court granted the defense motion to dismiss the class action, id., at 8.

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