Circuit Upholds Dismissal of Putative Securities Class Action Lawsuit Against Bank for Alleged Failure to Disclose Deteriorating Bond Market Conditions | Shearman & Sterling LLP


On May 20, 2022, the United States Court of Appeals for the First Circuit upheld the District Court’s dismissal of the claims under Section 10(b) of the Securities Exchange Act (the “Securities Act”). Exchanges”) and Rule 10b-5 thereunder against a bank and its affiliates (the “Bank”). Ponsa-Rabell c. Santander Sec. LLC,et al., no. 20-01857 (1st Cir. May 20, 2022). The plaintiffs alleged that the Bank devised a scheme to induce investors to buy Puerto Rican government bonds by omitting important information about the state of the market and its own alleged program to dispose of those securities. The appeal did not concern the district court’s dismissal of claims under Section 17(a) of the Securities Act of 1933 or plaintiffs’ claims filed under Puerto Rican law for which the court district declined to exercise additional jurisdiction after dismissing the plaintiffs’ securities claims.

According to the Complaint, the Bank acted as a broker for Plaintiffs who allegedly purchased Puerto Rico Municipal Bonds, Puerto Rico Closed Ended Funds and Puerto Rico Open Ended Funds (collectively “PRMB Securities”) from December 1, 2012 to October 31, 2013 (the “Putative Class Period”). Plaintiffs alleged that PRMB securities were marketed to the public through fund-specific prospectuses that disclosed the investment objectives, risk factors and tax consequences of the fund, as well as the investment risks associated with each particular fund. . According to the complaint, the PRMB securities were “attractive investments” that offered relatively high interest and were exempt from Puerto Rican and federal income and estate taxes. However, shortly before the putative class action period, the complaint alleges that Puerto Rico began to experience an economic recession, which made investing in PRMB securities particularly risky. The plaintiffs alleged that during the recession, Puerto Rico issued billions of dollars in PRMB securities and used the proceeds to pay off existing debts rather than to stimulate the Puerto Rican economy. Puerto Rico’s deficit would have increased to about $2.2 billion and become unpayable.

According to the complaint, in 2012 various public sources began to warn of the heightened risks of holding PRMB securities, including a March 2012 report that warned that Puerto Rico was “flirting with insolvency”, and an August 2012 report by Moody’s Investor Service (“Moody’s”) downgrading Puerto Rico’s bond credit rating to Baa1 and advising that “conservative investors . . . should pursue portfolio diversification. Complainants alleged that the Dec. 13, 2012, Moody’s downgraded Puerto Rico’s credit rating again to Baa3, “just above junk bond status” The complaint alleges the bond market “collapsed” in the fall 2013, resulting in financial losses for all those who invested in PRMB’s securities.The plaintiffs alleged that prior to this crash, the Bank had actively attempted to dispose of its stock of PRMB securities “at an accelerated pace”, which who, according to the plaintiffs, had motivated the Bank to sell the securities to the plaintiffs. The plaintiffs filed their original lawsuit against the Bank four years after the crash, alleging that they would never have purchased PRMB’s securities if the Bank had disclosed the risk of the crash. The district court dismissed the federal securities claims with prejudice and the claims under state law without prejudice, and the plaintiffs appealed the dismissal of the claims under Section 10 (b ) – in particular, whether plaintiffs have sufficiently pleaded (i) a material misrepresentation or omission, and (ii) scientific.

The First Circuit first considered the misstatement or omission of Plaintiffs’ claim under Section 10(b). The plaintiffs alleged that two disclosures in the fund’s prospectus were “fatally flawed” due to information omitted by the Bank. In the disclosures, the Bank reportedly disclosed that “there is no guarantee that a secondary market for the bonds offered will develop” and that “the underwriters are not obligated to do so. [meaning to guarantee a secondary market] and any such market making may be discontinued at any time at the sole discretion of the Underwriters. The plaintiffs argued that these disclosures did not include the material facts that were necessary for them not to be misleading; namely that market conditions were deteriorating in Puerto Rico and the Bank was selling its own stock of PRMB securities for that very reason. The plaintiffs further alleged that even if the omitted information was public, this did not relieve the Bank of its obligation to disclose the information at the time the plaintiffs allegedly purchased PRMB’s securities, nor of its continuing obligation to update its prospectus.

In upholding the district court’s decision, the Court rejected plaintiffs’ argument that the Bank should have disclosed information regarding deteriorating market conditions, finding that the Bank “simply had no obligation to repeat information already known or easily accessible to investors”. In so ruling, the Court held that “it is not a material omission not to report information of which the market is already aware” and added that “plaintiffs’ own complaint refers to public statements about the deterioration of the economy in Puerto Rico”.

Turning to plaintiffs’ allegation that the Bank should have disclosed that it was divesting PRMB securities, the Court also upheld the dismissal of the District Court. In particular, the Court distinguished Tutor Perini Corp. vs. Banc of Am. Second. SARL, 842 F.3d 71, 90 (1st Cir. 2016), a case in which a bank allegedly knew the market for a particular security was “on the brink of collapse” when it encouraged the plaintiff to buy more securities while selling the same securities. The Court distinguished Tutor on the basis that the bank had a “special relationship” with the plaintiff as an investment adviser; whereas, by contrast, the plaintiffs here have made no allegation that they had a special relationship or had given the Bank any particular investment instructions that would warrant a disclosure requirement. The Court determined that the plaintiffs merely allege that the Bank “solicited” (or recommended) them to purchase the PRMB securities, and that their investment objectives were “capital preservation” and “current fixed income”. Furthermore, the Court held that, contrary to Tutor, the plaintiffs made no allegation that the Bank promised to outline the risks of their investment or failed to inform the plaintiffs of a stock market crash that they knew was occurring. Accordingly, the Court upheld the district court’s decision that the plaintiffs failed to sufficiently allege an actionable omission. After issuing its conclusion, the Court noted that it was able to avoid a lengthy analysis of whether the plaintiffs sufficiently pleaded scienter.

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Ponsa-Rabell c. Santander Sec. LLC, et al.

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