Corporate Governance

: The Race to the Bottom

In re Centerline Holdings Co., Sec. Litig. and Scienter

By Justin Loyola (index)

In In re Centerline Holdings Co., Securities Litigation, No. 08 Civ. 505 (S.D.N.Y. Jan. 12, 2009) the court granted Centerline’s motion to dismiss because the plaintiffs failed to argue particularized facts sufficient to demonstrate scienter. Plaintiffs alleged that Centerline Chairman Stephen M. Ross and Managing Trustee Jeff T. Blau violated Section 10(b) and Rule 10b-5 when it engineered a fraudulent transaction with The Related Companies, L.P., (“Related”) to increase their voting control over Centerline and increase their dividends.

Centerline is a trust company with holdings in tax-exempt affordable housing. In early 2007, it began transforming the company into an alternative asset management company. As part of the process, the Centerline entered into an agreement with Freddie Mac to sell its tax-exempt bonds. Centerline’s largest shareholder, the Related Companies, L.P., would provide $131 million in financing in exchange for 12.2 million shares of convertible preferred stock that would pay an 11 percent dividend. It was not until December 28, 2007, nearly a year later, that Centerline made this plan public and announced that it would cut dividends from $1.68 to $0.60 per share. The announcement resulted in a 25 percent drop in the its stock price.

Plaintiff sought compensatory damages for losses under Section 10(b) and Rule 10b-5 of the Securities Exchange Act. As part of Plaintiff’s claim, they must prove that Centerline acted with scienter when omitting the plan from its investors; scienter may be shown with particularized facts indicating motive and opportunity to commit the fraud.

Plaintiff alleged that Ross and Blau were motivated to commit the fraud because of the increased voter control and dividends. The United States District Court for the Southern District of New York, held that Plaintiff’s allegations of motive were insufficient because the allegations amounted to evidence of why Ross and Blau would want to invest, but not why they would conceal the information. The Court pointed out that it would have been more advantageous to release the information sooner so they could negotiate a better stock price. For example, Related’s common shares were converted at a price of $10.75 before the announcement; Centerline’s shares dropped to a price of $7.70 after the announcement. Therefore, since Related could have negotiated for a more favorable share price, Ross and Blau lacked the motivation to conceal the information. Since the complaint lacked particularized facts that Ross and Blau acted with scienter, the court granted defendants’ motion to dismiss.

The primary materials for this post are available on the DU Corporate Governance web site.

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Full post as published by The Race to the Bottom on February 18, 2009 (boomark / email).