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Gosselin v. First Trust Advisors L.P.

December 17, 2009


The opinion of the court was delivered by: Samuel Der-yeghiayan, District Judge


This matter is before the court on Defendants' motion to dismiss. For the reasons stated below, we deny the motion to dismiss in its entirety.


Plaintiffs are various classes of investors that purchased or otherwise acquired shares of mutual funds offered by Defendant First Trust Portfolios L.P. (FTP), including shares of Defendant First Trust Strategic High Income Fund (FHI Fund), First Trust Strategic High Income Fund II (FHY Fund), and Defendant First Trust Strategic High Income Fund III (FHO Fund) (collectively referred to as "Funds"). Defendant First Trust Advisors (First Trust) serves as the investment manager for the Funds. Plaintiffs contend that the Funds invest a significant amount of their managed assets in "high-yield" or "junk bonds." (Cons. Compl. Par. 7). According to Plaintiffs, such investment strategies heighten the risks of loss and investors do not have the capacity to monitor such risks. Such investors allegedly rely on the Funds' management to place sufficient controls in place to monitor and manage the heightened risks. Throughout the class period, Defendants allegedly falsely represented that they had sufficient internal controls in place to monitor and manage the risks of the Funds' investments. Defendants allegedly invested in extremely risky areas and incurred losses due to their lack of controls to monitor and manage the risks. Defendants then allegedly inflated the valuation of the net asset values (NAV) of the mortgage-related securities to conceal the impact of the investment losses. Defendants also allegedly disseminated false and misleading Prospectus/Registration Statements and annual, semi-annual, and quarterly reports regarding the NAV of the Funds. Defendants allegedly failed to perform good faith valuations of the Funds' investments and as a result the Funds' shares traded at artificially inflated prices. The Funds' value allegedly rapidly decreased in 2007 and Defendants allegedly failed to respond with a proper defensive strategy. Instead, Defendants allegedly recommended to shareholders to increase their exposure to the riskiest types of residential mortgage-backed securities. As a result of Defendants' alleged misconduct, Plaintiffs allegedly lost substantial amounts of money.

Plaintiffs include in their consolidated class action complaint claims alleging violations of Section 11 (Section 11) of the Securities Act of 1933(Securities Act), 15 U.S.C. § 77k (Counts I-II), claims alleging violations of Section 12(a)(2) (Section 12(a)(2)) of the Securities Act (Counts III-IV), claims alleging violations of Section 15 (Section 15) of the Securities Act (Counts V-VI), claims alleging violations of Section 11 (Counts VII- IX), claims alleging violations of Section 12(a)(2) (Counts X-XII), claims alleging violations of Section 15 (Counts XIII-XV), claims alleging violations of Section 14(a) (Section 14(a)) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 14a-9 (Counts XVI-XVII), claims alleging violations of Section 10(b) (Section 10(b)) of the Exchange Act and Rule 10b-5 promulgated thereunder (Counts XVIII-XX), and claims alleging violations of Section 20(a) (Section 20(a)) of the Exchange Act for the FHI Fund (Counts XXI-XXIII). Defendants move to dismiss all claims.


In ruling on a motion to dismiss, a court must "take all of the factual allegations in the complaint as true" and make reasonable inferences in favor of the plaintiff. Ashcroft v. Iqbal, 129 S.Ct. 1937, 1949 (2009); Thompson v. Ill. Dep't of Prof'l Regulation, 300 F.3d 750, 753 (7th Cir. 2002). To defeat a motion to dismiss brought pursuant to Federal Rule of Civil Procedure 12(b)(6), "a complaint must contain sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face." Iqbal, 129 S.Ct. at 1949 (internal quotations omitted) (emphasis in original)(quoting in part Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570 (2007)); Hecker v. Deere & Co., 569 F.3d 708, 710-11 (7th Cir. 2009)(stating that "Iqbal reinforces Twombly's message that '[a] claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged'")(quoting in part Iqbal, 129 S.Ct. at 1949). A plaintiff is not required to "plead facts that, if true, establish each element of a 'cause of action....'" See Sanjuan v. Amer. Bd. of Psychiatry and Neurology, Inc., 40 F.3d 247, 251 (7th Cir. 1994)(stating that "[a]t this stage the plaintiff receives the benefit of imagination, so long as the hypotheses are consistent with the complaint" and that "[m]atching facts against legal elements comes later").


I. Corporate Mismanagement

Defendants argue that Plaintiffs merely contend that Defendants mismanaged the Funds and that the entire complaint should be dismissed because allegations of corporate mismanagement are not actionable under federal securities laws. Generally, absent some sort of deception, misrepresentation, or purposeful omission, the federal securities laws do not protect investors from mismanagement of investments or poor business judgment. See Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 474, 479-480 (1977)(stating that "the transaction, if carried out as alleged in the complaint, was neither deceptive nor manipulative and therefore did not violate either § 10(b) of the Act or Rule 10b-5")(quoting Superintendent of Insurance v. Bankers Life & Cas. Co., 404 U.S. 6, 12 (1971) for the proposition that "Congress by s 10(b) did not seek to regulate transactions which constitute no more than internal corporate mismanagement"); DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990)(stating that "[s]ecurities laws do not guarantee sound business practices and do not protect investors against reverses"). In the instant action, however, Plaintiffs have alleged more than a displeasure with Defendants' business judgment and management of the Funds. Although the Plaintiffs contend that Defendants used poor business judgment, Plaintiffs also contend that Defendants engaged in deception through material misrepresentations and omissions to conceal the ramifications of Defendants' alleged misconduct. Plaintiffs allege that Defendants made "untrue statements of material fact" (Cons. Compl. Par. 275-76, 282, 292, 303, 311, 388, 398, 408, 443, 462, 479, 496, 510), disseminated reports that were "materially false and misleading" (Cons. Compl. Par. 209-10, 226, 242, 441, 460), and provided a Registration Statement that was "inaccurate and misleading." (Cons. Compl. Par. 282, 292).

Plaintiffs also allege Defendants "represented that the Funds had systems in place to ensure compliance with legal and regulatory requirements that relate to the Funds' accounting and financial reporting," but that "[i]n fact, contrary to Defendants' representations, the Funds lacked adequate systems to ensure compliance and intentionally or recklessly ignored the risks inherent in their portfolios." (Cons. Compl. Par. 8). Plaintiffs also contend, for example, that Defendants "concealed" the failure of a reckless investment strategy "by utilizing improper accounting for mortgage-related investments to hide losses and inflate each of the Funds' NAV during the Class Periods." (Cons. Compl. Par. 9). Another example of an alleged misrepresentation by Defendants was that "[i]n the July 9, 2007 FHI Fund Semi-Annual Report rather than admit the deterioration in the value of the FHI Fund's mortgage-related securities, Defendants deceptively tried to differentiate FHI Funds' portfolio from the 'trouble' in sub-prime mortgages." (Cons. Compl. Par. 189). Defendants also allegedly "inflated the valuation of the mortgage-related securities during the respective class periods in order to conceal the impact" of their poor business decisions. (Cons. Compl. Par. 11). Plaintiffs also allege omissions by Defendants. For example, Plaintiffs allege that due to the nature of the Funds' investments, it would be expected that the funds had controls in place to manage and monitor the inherent risks and Defendants represented they had such controls, but that "[t]he Funds did not inform their investors of the absence of adequate controls to manage and monitor the risk inherent in th[e] mortgage-related securities...." (Cons. Compl. Par. 8, 11). Thus, based on the allegations in the consolidated complaint, Plaintiffs' case at the pleadings stage does not rest merely on the issue of whether Defendants mismanaged the Funds and used poor business judgment. We note however, that we are merely ruling based on the pleadings at this juncture. It remains to be determined after discovery whether there is sufficient evidence to justify Plaintiffs' allegations of deception and to assess whether Plaintiffs' case merely rests on a dissatisfaction with the outcome of Defendants' investment decisions.

II. Pleading Misrepresentations or Omissions with Particularity

Defendants contend that Plaintiffs' claims must be pled with particularity and Plaintiffs have not pled with the required specificity.

A. Heightened Pleading Standards for Claims

Defendants contend that Plaintiffs' Exchange Act claims are subject to the pleading requirements of the Private Securities Litigation Reform Act (PSLRA) and that Plaintiffs' Securities Act claims are subject to the heightened pleading standard in Federal Rule of Civil Procedure 9(b) (Rule 9(b)). Pursuant to 15 U.S.C. § 78u-4 (b)(1) of PSLRA, "[i]n any private action arising under th[e] chapter in which the plaintiff alleges that the defendant-- (A) made an untrue statement of a material fact; or (B) omitted to state a material fact necessary in order to make the statements made, in the light of the circumstances in which they were made, not misleading; the complaint shall specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed." 15 U.S.C. § 78u-4 (b)(1). Pursuant to Rule 9(b), fraud must be pled with particularity, which requires a plaintiff to plead "the identity of the person who made the misrepresentation, the time, place and content of the misrepresentation, and the method by which the misrepresentation was communicated to the plaintiff." Windy City Metal Fabricators & Supply, Inc. v. CIT Technical Financing Services, Inc., 536 F.3d 663, 668 (7th Cir. 2008)(internal quotations omitted); see also DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir. 1990)(stating in a securities litigation case that Rule 9(b) requires a plaintiffs to plead "the who, what, when, where, and how: the first paragraph of any newspaper story"). The heightened pleading requirement in Federal Rule of Civil Procedure 9(b) "applies to 'averments of fraud,' not claims of fraud, so whether the rule applies will depend on the plaintiffs' factual allegations" and whether the claim "'sounds in fraud'-in other words, one that is premised upon a course of fraudulent ...

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