Second Circuit Reverses Dismissal Of Section 11 And 12(A)(2) Claims, Holding That Plaintiff's Allegations Were Sufficient To Plead A Reasonable Inference Of Misrepresentations In A Prospectus

In New Jersey Carpenters Health Fund v. Royal Bank of Scotland Group, PLC, 2013 U.S. App. LEXIS 4317 (2d Cir. Mar. 1, 2013), the United States Court of Appeals for the Second Circuit reversed the dismissal of a claim for violations of Sections 11 and 12(a)(2) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. §§ 77k, 77l, holding that the plaintiff pleaded sufficient facts to support a reasonable inference that defendants misstated mortgage underwriting guidelines to investors. This decision is notable for its application of the Federal Rule of Civil Procedure 8(a) pleading standard, as clarified by the United States Supreme Court in BellAtlantic Corp. v. Twombly, 550 U.S. 544 (2007), and Ashcroft v. Iqbal, 556 U.S. 662 (2009), to claims under the Securities Act.

Plaintiff's allegations centered on its May 2007 investment in a mortgage fund trust (the "trust") offered by defendants. The trust was offered under a registration statement and supplemental prospectus (the "prospectus") that provided a detailed description of the underwriting guidelines used in originating the mortgage loans. The prospectus also contained statements warning investors of certain risks associated with the trust, including a likelihood of higher loss and foreclosure rates, characteristics which would increase the likelihood of default, and systemic risks such as market decline.

The value of plaintiff's investment decreased substantially between May 2007 and March 2010. Plaintiff sued, alleging that the registration statement and amended prospectus misstated defendants' underwriting guidelines and failed to disclose defendants' abandonment of those guidelines, thus violating Sections 11 and 12(a)(2).

The United States District Court for the Southern District of New York dismissed plaintiff's complaint for failure to state a plausible claim, holding that plaintiff had failed to make allegations "specific to" the loan origination practices. N.J. Carpenters Health Fund v. NovaStar Mortg., Inc., No. 08 Civ. 5310(DAB), 2012 WL 1076143 (S.D.N.Y. Mar. 29, 2012). The district court also held that plaintiff had failed to allege the materiality of any potential misstatements or omissions in light of the risk disclosures that were contained in the prospectus. Plaintiff appealed.

The Second Circuit reversed. The Court acknowledged that the Rule 8(a) notice pleading standards set forth in Twombly and Iqbal apply to claims under Section 11 and 12(a)(2). The Second Circuit...