Academic

So, we all know that there are approximately 5,000 lawsuits pending against Citigroup and other financial institutions alleging various causes of action relating to actions taken with regard to subprime mortgages and the financial meltdown generally.  Most of these will fail.

However, one such case was handed a victory today by Judge Sidney Stein of the Southern District of New York.  Opinion and Order here.  In In re Citigroup Bond Holding Litigation, 08-CIV-9522, the bondholders allege Section 11 claims regarding false statements in the registration statement for the bonds they bought on the secondary market. 

Before you start to yawn, hold on to your securities regulation hats, because it actually gets interesting.  So, Section 11 is a much easier case to bring than a Section 10(b) case, but you have to get over the tracing problem -- plaintiffs have to be able to trace the shares they bought back to the shares offered pursuant to the registration statement.  Here, the issue is much more interesting than normal and sort of shakes up the cozy world of the seasoned issuer working from a shelf registration that incorporates other filings by reference.  From just reading the order, it seems that the plaintiffs named in the class action bought bonds offered in only 19 of the 48 offerings from May 2006 to August 2008 that are at issue.  However, all 48 offerings were from three shelf registrations, and the plaintiffs purchased from offerings made from each of those three shelf registrations.  So, the court says that standing lies for the case to proceed as against all 48 offerings, not just the 19 because what is at issue are the statements in the three shelf registrations. 

OK, so that's one interesting thing.  Now, think about this.  Many of the statements at issue are from filings that are incorporated by reference.  Specifically, Citigroup said in various disclosure documents that it was "well-capitalized," that it had limited exposure to the subprime mortgage crisis, etc., that it complied with GAAP, etc.  These statements may have been true when made, but not when incorporated by reference once the shelf offering is made. 

Most Section 11 cases in the Securities Regulation books are boring tracing cases.  This case, I think, shows nicely the interesting double-edged sword of the shelf registration.  Also, the case also makes a very nice comparison with the 10(b)-5 cases on the same topic.  This case is not subject to heightened pleading under F.R.C.P. 9(b) because it does not sound in fraud and intent is not an element under Section 11.  Plaintiffs do not have the burden on loss causation.  These plaintiffs will have a much easier time than their garden-variety equity shareholder counterparts.

Also, compare with the shareholder derivative litigation surrounding the same business decisions.  A year ago, Judge Stein dismissed a derivative lawsuit against Citigroup for poor business decisions resulting in exposure to the "toxic" subprime mortgage market (In re Citigroup Inc. Shareholder Derivative Litigation, 2009 WL 2610746 (Aug. 25, 2009)).  Citing a similar suit that was dismissed in part from the Delaware Court of Chancery (In re Citigroup Inc. Shareholder Derivative Litigation, 964 A.2d 106 (Ch. Ct. 2009)), Judge Stein reminded plaintiffs that when no board action is involved, the plaintiffs must be alleging a Caremark-type claim of complete lack of oversight, and those cases don't win.  Sorry.  Next time, be a Section 11 plaintiff!