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In re Bof I Holding, Inc. Securities Litigation

United States District Court, S.D. California

May 23, 2017




          Hon. Gonzalo P. Curiel United States District Judge

         Before the Court is a Motion to Dismiss the Second Amended Complaint filed by Defendants Bof I Holding, Inc., Gregory Garrabrants, Andrew J. Micheletti, Paul J. Grinberg, Nicholas A. Mosich, and James S. Argalas. Dkt. No. 88-1. The motion has been fully briefed. Lead Plaintiff Houston Municipal Employees Pension System (“Lead Plaintiff” or “HMEPS”) filed an opposition response on February 3, 2017, Dkt. No. 94, and Defendants filed a reply on February 17, 2017, Dkt. No. 95-1. Upon review of the moving papers, the applicable law, and for the foregoing reasons the Court hereby DENIES in part and GRANTS in part Defendants' Motion to Dismiss.


         The facts of this case are familiar to both the Court and the parties and were recited at length in the Court's Order Granting in Part and Denying in Part Defendants' Motion to Dismiss the Consolidated Class Action Complaint (“CAC”). See generally Dkt. No. 64. In that order (the “First Motion to Dismiss Order”), the Court concluded that Lead Plaintiff had stated a viable claim for securities fraud under Section 10(b) of the 1934 Securities Act, Rule 10b-5 promulgated thereunder, and Section 20(a) of the Securities Act - one that met the heightened pleading standard of Rule 9(b) and the Private Securities Litigation Reform Act (PSLRA) - against Defendant Bof I Holding, Inc. (Bof I) and Defendant Gregory Garrabrants. The Court, however, dismissed Defendants Andrew Micheletti, Paul Grinberg, Nicholas Mosich, and James Argalas from the action, having concluded that Lead Plaintiff failed to plead enough for the Court to find that they acted with the requisite scienter or control to be liable under Section 10(b) or Section 20(a).

         Lead Plaintiff filed their Second Amended Class Action Complaint[1] (“SAC”) on November 25, 2016. Dkt. No. 79. The SAC, comprised of 147 pages and 471 paragraphs of allegations, is virtually identical to the CAC. Compare SAC, Dkt. No. 79 with CAC, Dkt. No. 26. It contains just 10 more pages of text and 23 more paragraphs of allegations than the CAC. Id. Although the Court granted Lead Plaintiff, in its First Motion to Dismiss Order, leave to amend both their Section 10(b) and Section 20(a) claims against Micheletti, Grinberg, Mosich, and Argalas, the new allegations in the SAC are directed at Section 20(a) liability only. As Lead Plaintiff stated in the SAC: “Plaintiff filed this Second Amended Complaint primarily to make clear it asserts Section 20(a) claims against those Defendants notwithstanding the Court's dismissal of the Section 10(b) claims against them. Plaintiff also, however, retains Section 10(b) claims against those Defendants in this Complaint to preserve them for appeal or in the event discovery reveals additional information supporting those claims.” SAC, Dkt. No. 79 at 12 n.6. In other words, the SAC contains no new allegations as to Lead Plaintiff's previously dismissed Section 10(b) claims against Micheletti, Mosich, Grinberg, and Argalas, but does contain new allegations as to their Section 20(a) liability. Accordingly and to the extent that Lead Plaintiff has not provided the Court with new allegations or argument as to the Section 10(b) liability of Micheletti, Mosich, Grinberg and Argalas, the Court stands by its previous ruling. See First Motion to Dismiss Order, Dkt. No. 64.

         Defendants moved to dismiss the SAC on December 23, 2016. Dkt. No. 88-1. In it, Defendants primarily argue that Lead Plaintiff has failed to state Section 10(b) claims against the remaining individual defendants - Micheletti, Grinberg, Mosich, and Argalas - and that it has also failed to state Section 20(a) claims against those defendants. See generally Id. Yet while the focus of their motion to dismiss - per the Court's December 15, 2016 Order Denying Defendants' Ex Parte Application for An Order Increasing The Page Limits On The Briefing, Dkt. No. 87 - was on Lead Plaintiff's amendments to the complaint, the tenor of the motion to dismiss unmistakably seeks to persuade the Court to revisit the conclusions made in its First Motion to Dismiss Order. In fact, in its conclusion, Defendants state in no uncertain terms that “the Court [should] grant their motion to dismiss the SAC for failure to meet the heightened pleading requirements of the PSLRA, and in particular to dismiss plaintiff's claims against Defendants Micheletti, Grinberg, Mosich and Argalas, with prejudice.” Dkt. No. 88-1 at 31.

         Mindful of the fact that the Second Amended Complaint supersedes the First Amended Complaint, see Hal Roach Studios, Inc. v. Richard Feiner & Co., Inc., 896 F.2d 1542, 1546 (9th Cir. 1989), the Court has accepted, in part, Defendants' invitation to revisit Lead Plaintiff's Section 10(b) claims. The SAC, like the CAC, has identified over a hundred of Bof I's statements as false and misleading. See, e.g., Dkt. No. 79 at ¶¶ 246-370. While the Court continues to adhere to the view that some of these statements are actionable under the securities laws - and therefore, that Lead Plaintiff has pleaded enough to survive a motion to dismiss - the Court is also convinced that many of them are not. As such and to the extent that Defendants have challenged certain categories of statements as inadequate to support a securities fraud claim, the Court has rendered a decision below for the purpose of whittling down the actionable fraudulent statements and narrowing the scope of future discovery. The Court's underlying conclusion, however, has not changed, as it continues to find that many of Bof I's statements concerning its loan underwriting standards and internal controls were sufficiently false or misleading when made to survive the motion to dismiss and, specifically, the heightened pleading requirements of the PSLRA and Rule 9(b).


         Founded in 1999, Bof I[2] is a federally-chartered Internet bank that operates from its headquarters in San Diego, California. See SAC ¶ 3. Bof I is not your typical bank. Instead of relying on brick-and-mortar branches to generate business, Bof I offers its products through retail distribution channels, such as websites, online advertising, a call center of salespeople, referrals from financial advisory firms, and referrals from affinity groups. Id. Bof I is in the business of providing consumer and business products, including checking, savings, and time-deposit accounts, and services, such as financing for residential and commercial real estate, business, and vehicles. Id. ¶¶ 2-3. Bof I is also in the business of consumer and business lending. Id. ¶ 32. Bof I engages in Single Family Mortgage Secured Lending, Multifamily Mortgage Secured Lending, Commercial Real Estate Secured and Commercial Lending, Specialty Financial Factoring, Prepaid Cards, and Auto, RV, and other consumer-related lending. Id.

         Bof I has grown tremendously in recent years. Id. ¶ 5. Over the last five years, total deposits increased to $5.2 billion, signaling 235% growth, and net income increased from $20.6 million in fiscal year 2011 to $82.7 million in fiscal year 2015. Id. Development of the bank's loan portfolio propelled Bof I's growth during these years. Id. ¶ 44. From 2011 to 2015, Bof I's loan portfolio grew from $1.33 billion to $5 billion, representing 274% in growth. Id. By the end of calendar year 2015, Bof I had a loan portfolio worth $5.715 billion. Id. ¶ 32. From September 4, 2013 to February 3, 2016 (the putative “Class Period”), Lead Plaintiff HMEPS and other class members similarly situated purchased Bof I's common stock. Id. ¶ 1. During the Class Period, Bof I's stock reached a high of $142.54 per share, representing a 1, 100% increase over its initial public offering of $11.50 per share in 2005. Id. ¶ 6. As of January 22, 2016, HMEPS had 63, 032, 258 in common stock shares outstanding. Id. ¶ 34.

         On October 13, 2015, The New York Times reported that a formal internal auditor at Bof I had filed a federal whistleblower lawsuit (“the Erhart Case”)[3] alleging that Bof I was engaged in widespread misconduct. Id. ¶ 20. After the Erhart Case was filed, the price of Bof I's stock fell by $10.72 per share (or $42.87 per share on a pre-split adjusted basis), or by 30.2%, and closed at $24.78 on October 14, 2015. Id. ¶ 21. The total capital loss amounted to $675 million. Id. The price of Defendants' stock then continued to decrease through February 3, 2016 (i.e., the last day of the Class Period). Id. ¶ 22. Lead Plaintiff now alleges that the decline in the market value of Bof I's securities caused Lead Plaintiff, along with the other Plaintiffs, to suffer significant damages. Id.

         In addition to Bof I, Lead Plaintiff has named five individuals as defendants in this action, all of whom served as Bof I executives throughout the Class Period. Gregory Garrabrants is the Chief Executive Officer (CEO), President, and a Director of Bof I. Id. ¶ 35. He has held the CEO position since 2007 and been President and Director since 2008. Id. Andrew J. Micheletti is Bof I's Executive Vice President and Chief Financial Officer (CFO), and has held those positions throughout the Class Period. Id. ¶ 36. Paul J. Grinberg is a member of Bof I's Board of Directors and has been the Chairman of the Board Audit Committee, the Board Compensation Committee, and a member of the Board Nominating Committee for the Class Period. Id. ¶ 37. Nicholas A. Mosich has served as the Vice Chairman of Bof I's Board of Directors and as a member of the Board Audit Committee throughout the Class Period. Id. ¶ 38. James S. Argalas served as a member of the Board of Directors and a member of the Board Audit Committee throughout the Class Period. Id. ¶ 39.

         1. Defendants' Alleged Fraudulent Scheme

         The gravamen of Lead Plaintiff's claims is that Defendants materially misrepresented the risk of investing in Bof I by engaging in knowing and reckless conduct that rendered the bank a “materially-less safe investment than investors were led to believe.” Id. ¶ 23. The Defendants, Lead Plaintiff alleges, sold themselves as offering “significant cost savings and operation efficiencies derived from its purported branchless business model, as well as low loan losses.” Id. ¶ 7. Yet while Defendants touted themselves as a “careful, prudent institution” and emphasized their “conservative loan-underwriting standards, ” Lead Plaintiff alleges that the bank actually had a “troubled identity that resorted to lax lending practices and other unlawful conduct to fraudulently boost its loan volume and earnings.” Id. ¶¶ 1, 8.

         By way of numerous false and misleading representations, Bof I allegedly concealed the actual risk of loss present on its ledger and deceived investors as to its true financial condition. In their more than 140-page complaint, Lead Plaintiff identifies hundreds of statements or omissions that were allegedly false or misleading when made and offers voluminous contentions why those statements amounted to misrepresentations. The heart of Lead Plaintiffs allegations concerns Defendants' deviations from Bof I's loan underwriting standards, inadequate internal control and audit measures, inaccurate financial results and risk figures, undisclosed related-party transactions, and other violations of the federal securities laws.

         2. Defendants' False and Misleading Statements

         Lead Plaintiff has identified four types of misleading statements made by Bof I during the Class Period: 1) SEC filings; 2) conference calls about the results in SEC filings; 3) press releases about the results in SEC filings; and 4) earnings calls.[4] Id. ¶¶ 47, 246-370. With regards to the SEC filings, Lead Plaintiff has specifically identified Defendants' 2013 Form 10-K, 2014 Form 10-K, and 2015 Form 10-K as misleading, id. ¶¶ 255, 309, & 367, as well as Defendants' 10-Q forms for Quarters 1 through 3 of 2014, Quarters 1 through 3 of 2015, and Quarter 1 of 2016, id. ¶¶ 261, 274, 288, 318, 332, 344, 393. Most of the press releases and conference calls that Lead Plaintiff has identified refer specifically to Bof I's financial earnings as published in the respective SEC filings.


         Federal Rule of Civil Procedure (“Rule”) 12(b)(6) permits dismissal for “failure to state a claim upon which relief can be granted.” Fed.R.Civ.P. 12(b)(6). Dismissal under Rule 12(b)(6) is appropriate where the complaint lacks a cognizable legal theory or sufficient facts to support a cognizable legal theory. See Balistreri v. Pacifica Police Dep't., 901 F.2d 696, 699 (9th Cir. 1990). Under Rule 8(a)(2), the plaintiff is required only to set forth a “short and plain statement of the claim showing that the pleader is entitled to relief, ” and “give the defendant fair notice of what the . . . claim is and the grounds upon which it rests.” Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 555 (2007).

         A complaint may survive a motion to dismiss only if, taking all well-pleaded factual allegations as true, it contains enough facts to “state a claim to relief that is plausible on its face.” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009) (quoting Twombly, 550 U.S. at 570). “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.” Id. “Threadbare recitals of the elements of a cause of action, supported by mere conclusory statements, do not suffice.” Id. “In sum, for a complaint to survive a motion to dismiss, the non-conclusory factual content, and reasonable inferences from that content, must be plausibly suggestive of a claim entitling the plaintiff to relief.” Moss v. U.S. Secret Serv., 572 F.3d 962, 969 (9th Cir. 2009) (citations omitted).


         The SAC's voluminous allegations assert that Bof I engaged in widespread wrongdoing during the Class Period. For instance, Lead Plaintiff argues that Bof I violated the “Ability to Repay Rule, ” 12 C.F.R. § 1026, see SAC ¶ 17-24; that it engaged in illicit lending partnerships that ran afoul of the Office of the Comptroller of the Currency (OCC)'s guidance on payday lending, see Id. ¶¶ 24-36; that it violated the Bank Secrecy Act, among other laws, by making loans to foreign nationals without proper vetting, see Id. ¶¶ 40-46; that it violated 12 C.F.R. § 215 by failing to disclose related-party loans made to its senior officers, see Id. ¶¶61-68; and more. Defendants, in turn, spend a fair amount of their briefing explaining why Bof I's conduct did not amount to a violation of any of these rules or regulations. See, e.g., Dkt. No. 88-1 at 17 (explaining why the SAC's allegations do not demonstrate a violation of 12 C.F.R. § 1026, the Ability to Repay Rule).

         The Court observes, however, that the Section 10(b) inquiry - and by extension the Section 20(a) inquiry - is not tantamount to an investigation into fiduciary misconduct or internal corporate mismanagement. See Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 479 (1977) (“Congress by [enacting] ¶ 10(b) did not seek to regulate transactions which constitute no more than internal corporate mismanagement.”); see also Retail Wholesale & Dep't Store Union Local 338 Ret. Fund, 845 F.3d 1268, 1278 (9th Cir. 2017) (rejecting plaintiff's interpretation of Section 10(b) liability because it would “turn all corporate wrongdoing into securities fraud.”); In re GlenFed, Inc. Sec. Litig., 11 F.3d 843, 849 (9th Cir. 1993) (“Fiduciary misconduct or internal mismanagement of a corporation is an area traditionally left to state law, not federal securities law.”), vacated and remanded by In re GlenFed Sec. Litig., 60 F.3d 591 (9th Cir. 1995) (en banc) (holding that Rule 9(b) does not require inference of scienter).

         Rather, the Court, here, is concerned with whether Bof I made material misrepresentations or omissions in its public statements - that is, whether it lied. See 15 U.S.C. § 78u-4(b)(1) (creating private actions for when defendants make an “untrue statement of a material fact” or “omit[ ] 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”). As such, the Court's analysis focuses, not on whether any specific violation of law was committed, but whether the Lead Plaintiff has identified public statements that were rendered false or misleading by the facts alleged in the complaint, including those facts suggesting that Bof I's banking practices had fun afoul of the law.

         With this background in mind, the Court conducts the following analysis and concludes that Lead Plaintiff has pleaded actionable fraudulent or misleading statements as to Bof I's loan underwriting practices and as to its internal controls and compliance infrastructure, but has not sufficiently demonstrated that Defendants' statements about its Allowance for Loan Losses (ALL), Net income/diluted price per share, Loan-to-Value Ratio (LTV), or undisclosed lending partnerships are actionable under the securities laws.

         I. Violations of Section 10(b) of the Exchange Act

         Section 10(b) of the Securities Exchange Act makes it unlawful for “any person . . . [t]o use or employ, in connection with the purchase or sale of any security registered on a national securities exchange . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or . . . for the protection of investors.” 15 U.S.C. § 78j(b). Rule 10b-5 implements this provision by making it unlawful to “make any untrue statement of material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading . . . .” 17 C.F.R. § 240.10b-5(b). Rule 10b-5 also makes it unlawful for any person “[t]o employ any device, scheme, or artifice to defraud” or “[t]o engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.” 17 C.F.R. § 240.10b-5(a), (c).

         To state a securities fraud claim under 10(b) of the Act and Rule 10b-5, a plaintiff must show (1) a material misrepresentation or omission, (2) scienter, (3) in connection with the purchase or sale of a security, (4) reliance, (5) economic loss, and (6) loss causation.[5] Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 341-42 (2005). A complaint alleging claims under Section 10(b) and Rule 10b-5 must also satisfy the pleading requirements of both the PSLRA and Rule 9(b). In re Verifone Holdings, Inc. Sec. Litig., 704 F.3d 694, 701 (9th Cir. 2012).

         Any complaint alleging fraud must comply with Rule 9(b), which requires the complaint to state with particularity the circumstances constituting fraud. Fed.R.Civ.P. 9(b). Malice, intent, knowledge, and other conditions of a person's mind may be alleged generally. Id. To satisfy this heightened pleading requirement, the plaintiff must set forth “the time, place, and specific content of the false representations as well as the identities of the parties to the misrepresentation.” Odom v. Microsoft Corp., 486 F.3d 541, 553 (9th Cir. 2007) (internal citations omitted). In addition, the complaint must indicate “what is false or misleading about a statement, and why it is false” and “be specific enough to give defendants notice of the particular misconduct that they can defend against the charge and not just deny that they have done anything wrong.” Vess v. Ciba-Geigy Corp. USA, 317 F.3d 1097, 1107 (9th Cir. 2003) (internal citations omitted).

         Complaints alleging violations of Section 10(b) of the Exchange Act must also comply with the Private Securities Litigation Reform Act, codified at 15 U.S.C. § 78u-4(b)(1). The PSLRA imposes a heightened pleading requirement for securities fraud actions brought under § 10(b) and Rule 10b-5, requiring that falsity and scienter be plead with particularity. Amgen, Inc. v. Conn. Ret. Plans & Trust Funds, 133 S.Ct. 1184, 1200 (2013); Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, 990 (9th Cir. 2009). Congress enacted it into law in 1995 to curb abuses of securities fraud litigation. Amgen, 133 S.Ct. at 1200. Such abuses included “nuisance filings, targeting of deep-pocket defendants, vexatious discovery request and manipulation by class action lawyers.” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 320 (2007).

         Under the PSLRA's heightened pleading instructions, a complaint alleging that a defendant made a false or misleading statement must: “(1) ‘specify each statement alleged to have been misleading [and] the reason or reasons why the statement is misleading, ' 15 U.S.C. § 78u-4(b)(1); and (2) ‘state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind, ' § 78u-4(b)(2).” Tellabs, 551 U.S. at 321. In order for an omission to be actionable, the omitted information must have been “necessary . . . to make the statements made, in light of the circumstances under which they were made, not misleading.” Retail Wholesale, 845 F.3d at 1278.

         Actionable misrepresentations or omissions must also be material to investors. 15 U.S.C. § 78u-4(b)(1)(A)-(B). “The materiality of the misrepresentation or an omission depends upon whether there is ‘a substantial likelihood that it would have been viewed by the reasonable investor as having significantly altered the ‘total mix' of information made available' for the purpose of decisionmaking by stockholders concerning their investments.” Retail Wholesale, 845 F.3d at 1274 (quoting Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988)).

         1. Material Misrepresentations

         Determining the sufficiency of material misrepresentations alleged in a securities fraud complaint requires a court to make two inquiries. First, and as stated above, the court must assess “the reason or reasons” why the statements are misleading. 15 U.S.C. § 78u-4(b)(1). Second, and often as a threshold matter, the court must also analyze whether the statement itself could be a misleading statement under Section 10(b).

         “[A] statement is misleading if it would give a reasonable investor the impression of a state of affairs that differs in a material way from the one that actually exists.” Berson v. Applied Signal Tech., Inc., 527 F.3d 982, 985 (9th Cir. 2008). In assessing whether a statement is actionable or not, the Ninth Circuit distinguishes between “puffery” and misrepresentations. In re Cutera Sec. Litig., 610 F.3d 1103, 1111 (9th Cir. 2010). “‘Puffing' concerns expressions of opinion, as opposed to knowingly false statements of fact.” Or. Pub. Emps. Ret. Fund v. Apollo Grp. Inc., 774 F.3d 598, 606 (9th Cir. 2014). “Mere puffery” is “extremely unlikely to induce consumer reliance.” Newcal Indus., Inc. v. Ikon Office Solution, 513 F.3d 1038, 1053 (9th Cir. 2008). Consumer reliance, in turn, is affected “by specific rather than general assertions.” Id. “Thus, a statement that is quantifiable, that makes a claim as to the ‘specific or absolute characteristics of a product, ' may be an actionable statement of fact while a general, subjective claim about a product is non-actionable puffery.” Id. In other words, misleading statements must be “capable of objective verification.” Retail Wholesale, 845 F.3d at 1275.

         “Vague statements of optimism like ‘good, ' ‘well-regarded, ' or other feel good monikers” are not capable of objective verification and are not actionable. See In re Cutera Sec. Litig., 610 F.3d at 1111. Statements that are preceded by qualifiers such as “We believe” are similarly not actionable as they cannot be measured as true or false on an objective standard. See Or. Pub. Empls. Ret. Fund, 774 F.3d at 606-07. Aspirational statements, that emphasize commitment to certain values or goals, are not capable of objective verification either. See Retail Wholesale, 845 F.3d at 1276. Also generally immune from Section 10(b) challenges, are “forward-looking statements.” See U.S.C. § 78-u5(i)(1)(A) (PSLRA “safe harbor” provision for certain forward-looking statements); see also In re Cutera Sec. Litig., 610 F.3d at 1111. Forward-looking statements, unlike actionable statements, are not “descriptive of historical fact.” S.E.C. v. Todd, 642 F.3d 1207, 1221 (9th Cir. 2011) (quoting Ronconi v. Larkin, 253 F.3d 423, 430 (9th Cir. 2001)).

         A. Loan Underwriting Standards

         The allegations set forth in the SAC demonstrate with sufficiently particularity that many of Bof I's statements concerning its loan underwriting standards and credit quality were materially false and misleading at the time they were made.

         CEO Garrabrants, in a press release and a conference call concerning Bof I's Q1 2015 results filed November 4, 2014, made a variety of statements that highlighted Bof I's “record” financial results as the result of “strong credit discipline.” See SAC ¶ 319.

[1] Garrabrants also touted that “[w]e continue to have an unwavering focus on credit quality of the bank and have not sacrificed credit quality to increase origination.” He further claimed that “[o]ur strong credit discipline and low loan to value ratio of portfolio had resulted in consistently low credit losses and servicing costs.” Id. ¶ 324 (emphasis added).
[2] In the release, Garrabrants was quoted as stating, in relevant part, that Bof I's “[s]trong loan growth was achieved while maintaining high quality credit standards[.]Id. ¶ 320 (emphasis added).
[3] “For all multifamily and commercial loans, we rely primarily on the cash flow from the underlying property as the expected source of repayment . . . In evaluating a multifamily or commercial credit, we consider all relevant factors including . . . [assets, payment history at Bof I, other financial resources, net operating income, debt service, and appraised value].” Id. ¶ 305.
[4] “Each loan, regardless of how it is originated, must meet underwriting criteria set forth in our lending policies and the requirements of applicable lending regulations of our federal regulators.” Id. ¶ 250 (made with respect to loan underwriting standards generally).
[5] “[W]e continue to originate only full documentation, high credit quality, low loan-to-value, jumbo single-family mortgages and have not reduced our loan rates for these products.” Id. ¶ 298 (made with regard to single-family loan origination).

         After having reviewed these statements, for a second time, the Court is still convinced that they were false or misleading when made. There is ample evidence in the SAC, as was the case with the CAC, that Bof I was not adhering to high credit quality standards and that it had, in fact, begun to “sacrifice credit quality to increase origination” and that its “strong loan growth” was not the result of “maintaining high credit quality standards.” In reaching this conclusion, the Court was particularly influenced by the allegations attributed to a handful of confidential witnesses, which - if true - demonstrate that much of Bof I's loan growth was due to management's knowing loosening of credit quality standards.

         Take the allegations attributed to CW 1, for example. CW 1 was a former Senior Underwriter at Bof I's San Diego Headquarters. SAC ¶ 54. According to CW 1, “beginning in early 2014” him and his group “were being pressured by Bof I's Executive Vice President and Chief Credit Officer Thomas Constantine, as well as Leigh Porter, who was in charge of Bof I's Multifamily-Income Property Lending group, to underwrite loans that CW 1 was not comfortable signing off on and that did not make economic sense for Bof I to issue.” Id. CW 1 went on to give an example of such a loan.

         In mid-2014, CW 1 worked on a loan for a multi-family property in Laguna Beach, California that was to be leveraged at a LTV of 70% to 75%. Id. ¶ 55. “According to CW 1, the borrower sought a cash-out refinancing loan of several million dollars but had bad credit and no cash.” Id. CW 1 then recalled how he “reviewed bank statements provided by the borrower that showed less than a $100 balance in some accounts, including one account that had a negative balance.” Id. These facts led CW 1 to believe that the borrower “was using the property basically to support a lifestyle the borrower no longer had the money to support” and that her “spending habits outstripped her income.” Id. ¶¶ 55, 57. CW 1 further noted that Bof I had “already issued a highly leveraged refinancing loan for a mixed-use property to the same borrower” and that “since the first cash-out refinancing loan from Bof I, the borrower had taken on an additional $80, 000 in debt from Mercedes-Benz, which CW 1 believed indicated the borrower had recently purchased a new luxury vehicle.” Id. ¶¶ 56-57. CW 1 then noted that for these reasons and because “the operating standards of the property showed barely any cash flow” - the primary factor assessed by Bof I for multifamily and commercial loans, see supra statement [3] - she recommended against financing the property. Id.

         Notwithstanding his recommendation, however, Bof I issued the loan. The SAC recounts how CW 1 expressed her concerns about the approval to the Chief Credit Officer, Thomas Constantine, but that he brushed them aside saying “that the transaction was a good deal for Bof I” because, “even if it had to foreclose on the underlying properties, ” Bof I would take control of a valuable property. See Id. ¶ 58. The SAC further alleges that Constantine's comments were “at odds with the ability-to-repay/QM rule, which does not include a property's foreclosure value among the factors that should be considered in determining a borrower's ability to repay a loan.” Id. ¶ 59 CW 1, however, was not the only former employee who described Bof I's lending practices differently than executive management. CW 2, who worked in the Multifamily-Income Property Lending group and later in the Commercial & Industrial (C&I) Lending Group, worked on a multimillion-dollar C&I loan in mid-2014 for a property located in downtown San Diego. Id. ¶ 63. According to CW 2, the property was owned by an individual who had hoped to build a hotel on the property and the borrower was a limited liability company. Id. ¶¶ 63-64. CW 2 explained that the property “had been listed for sale for three years at approximately $13 million, which . . . indicated that the property was not worth $13 million.” Id. ¶ 63. As such, when an appraiser, who was a friend of Chief Credit Officer Constantine, appraised the property at $18 million, CW 2 “refused to recommend the loan.” Id. CW 2 explained that his refusal to approve the loan was also due, at least in part, to a “suspicious clause” in the borrower's LLC agreement that CW 2 “thought was part of a scam designed for the owner to regain ownership of the property.” See id.

         CW 2 informed Constantine and the Bof I loan originator that he would not approve the loan, and he maintained his position even after Constantine “pressured” him to approve it. Id. ¶ 65. Nonetheless, however, Garrabrants, eventually approved the loan upon Constantine's recommendation, for between $11 and $13 million dollars with an appraised value of $18 million. Id. According to CW 10, a senior underwriter who worked at Bof I just prior to the Class Period, it was not unusual for Bof I's executive management to fund loans that other underwriters “declined to sign off on, ” as was the case for the loan that CW 2 refused to approve.[6] Id. ¶ 68.

         The allegations attributed to CW 1 and CW 2, at the very least, render “false or misleading” Bof I's statements in November 2014 that they “ha[d] not sacrificed credit quality to increase origination” and that the Company's “strong loan growth was achieved while maintaining high quality credit standards.” Both statements were made by Bof I's CEO Garrabrants, the former during a conference call with analysts and investors, in which Micheletti participated, and the latter in the corresponding press release. Both are affirmative statements about the origins of Bof I's “record” financial results. And both represent to the public that the Company had increased its revenue without resorting to “race-to-the-bottom” tactics, and specifically, that Bof I had not sacrificed credit quality to issue more loans. The above-mentioned confidential witness allegations, however, and to say nothing of the other allegations in the complaint, render that affirmative message not just misleading, but untrue.

         A statement is misleading it if would give a reasonable investor the “impression of a state of affairs that differs in a material way from the one that actually exists.” Brody v. Transitional Hosps. Corp., 280 F.3d 997, 1006 (9th Cir. 2002). The CW allegations recited above make evident that the reality of Bof I's loan underwriting practices, on the ground, in 2014, differed materially from the representations made by Bof I in its disclosures made in November 2014. While Bof I's management assured investors that its loan originations were the result of anything but deteriorating credit standards, former underwriters at Bof I painted a picture of a bank that made end-runs around the procedures, controls, and persons tasked with ensuring that the Company adhered to high credit standards.

         Former underwriters were “pressured” by Bof I's management to approve loans that the underwriters refused to recommend because they did not meet high credit-quality standards. Those employees, in turn, expressed their concerns to upper-level management - including the Executive Vice President/Chief Credit Officer (Constantine), the Chief Legal Officer (Bar-Adon), the Chief Lending Officer (Swanson), and the CEO (Garrabrants) - about loans that were approved in spite of their conclusions. Members of management, however, were not only unreceptive to these reservations, but at times they acted in spite of them. That management then sought approval from corporate executives, such as Garrabrants, for loans that assigned underwriters would not approve, lends even greater support to the notion that Bof I's management was circumventing conservative underwriting procedures to increase loan origination. Misrepresentations concerning the origins of Bof I's loan growth, moreover, would undoubtedly have been material to potential investors as the development of Bof I's loan portfolio was the primary driver of the Company's growth during the Class Period and, thus, a key metric in attracting and retaining investors.

         In reaching this conclusion, the Court is not persuaded by Defendants' murmurings questioning the reliability of Lead Plaintiff's confidential witnesses or the particularized nature of their allegations. See Dkt. No. 88-1 at 18 n.8. As the Court stated in its First Motion to Dismiss Order, the Court finds that the CWs are described with sufficient detail to meet the standard laid out in Zucco Partners and in In re Daou Sys., Inc., 411 F.3d 1006, 1015-16 (9th Cir. 2005). See First Motion to Dismiss Order. Dkt. No. 64 at 17 (citing Zucco Partners, 552 F.3d at 991). What is more, the Court is also confident that the specific CW allegations referenced in this Order are reliable and based upon personal knowledge. See Zucco, 552 F.3d at 991. As loan underwriters, CW 1 and CW 2 were in a position to evaluate the credit quality of Bof I's potential borrowers, to identify any indicia of risk apparent in the loans they worked on, and to speak to the “pressure” they felt to issue imprudent loans. They had personal knowledge about the loans referenced in the SAC and they would be in a position to testify to that anecdotal evidence were this case to go to trial. See Berson, 527 F.3d at 985 (concluding that CW allegations were sufficiently particularized if it was plausible that they “would know” or “could reasonably deduce” a certain fact about the company). Accordingly, there is no reliability issue at this stage.

         Moreover, the Court is also satisfied that the CW allegations recounted above are sufficiently particularized to withstand scrutiny under the PSLRA and Rule 9(b). The SAC captures tremendous details concerning the CWs' experiences at Bof I. It includes general statements about how the CWs viewed Bof I's underwriting practices and specific examples detailing how the approval of particular loans contradicted management's representations about its underwriting practices. The CWs identified above described when the challenged loans were approved (in mid-2014), who approved them or did not approve them (i.e., the underwriter), what their terms were, and under what circumstances they were approved. Such descriptions are more than sufficient to state the circumstances constituting fraud and provide the “reason or reasons” why Bof I's representations that it had not sacrificed loan and credit quality to increase loan origination, made on November 14, 2014, were false or misleading when made.

         B. Internal Controls & Compliance Infrastructure

         The Court likewise concludes here, as it did in its First Motion to Dismiss Order, that Lead Plaintiff has identified actionable false and misleading statements made by Bof I about the adequacy of its compliance infrastructure and internal controls.

         The SAC highlights, for instance, the following statements made by Garrabrants, during a conference call, concerning the state of staffing in Bof I's various compliance departments:

[1] “We have made significant investments in our overall compliance infrastructure over the past several quarters, including BSA and AML compliance. We believe that we are on the same page with our regulators about their expectations.” Id. ¶ 299 (referencing quarter results before August 7, 2014) (emphasis added).
[2] “We have spent a significant amount of money on BSA/AML compliance upgrades and new systems and new personnel. We have also been beefing up our compliance teams.” Id. (statement made August 7, 2014) (emphasis added).

         Lead Plaintiff contends that these representations were rendered “false and misleading” by CW allegations indicating that Bof I had not adequately staffed its BSA and AML compliance along with other internal control departments. The Court agrees.

         At least two of the confidential witnesses described their departments as being insufficiently staffed. CW 3, a former BSA and Third Party Risk Officer who was in charge of the department, stated that Bof I's “BSA and Third Party Risk Department Team was “understaffed consisting of only three members” throughout his tenure. Id. CW 9, a senior accounting officer who reported to Garrabrants, albeit before the Class Period, similarly stated that his department was “short-staffed and [that] Garrabrants did not allow CW 9 to hire additional personnel.” Id. ¶ 166.

         CW 3, moreover, not only described his department as “understaffed” but also described an interaction between himself and CEO Garrabrants that strongly suggests that Garrabrants, too, knew that CW 3's department was understaffed.

         CW 3, the SAC explains, was responsible for “develop[ing] bank staff” and for “remediating regulatory issues” with BSA examinations and internal audits, and reported, for a time, directly to John Tolla, Bof I's Chief Governance Risk and Compliance Officer and Senior Vice President of Compliance and Audit. Id. ¶ 126. As such and by virtue of his position and responsibility at the Company, CW 3 was also in the position to attend meetings with senior executives, including CEO Garrabrants. Id. ¶ 126. At one such meeting, a couple of weeks after CW 3 joined Bof I, CW 3 told management that he “needed a lot more people in the BSA department because of the risk Garrabrants was causing Bof I to take on.” Id. And in response, Garrabrants stated that CW 3's tombstone was going to read “died understaffed.” Id.

         The allegations attributed to these CWs render “false or misleading” Bof I's representations about the investment and money it was spending on personnel to run its internal control departments. “[A] statement is misleading if it would give a reasonable investor the impression of a state of affairs that differs in a material way from the one that actually exists.” Berson, 527 F.3d at 985. The above statements were made by Garrabrants during a conference call about Bof I's Q4 earnings on August 7, 2014. Id. ¶ 297. Both statements represented to investors that Bof I had made “significant investments” in their compliance infrastructure, and specifically that they had hired “new personnel” and “beef[ed] up ...

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