According to the Second Circuit, in an opinion issued yesterday, financial firms dabbling in toxic assets (or, more specifically, selling CDS "insurance" for toxic assets to other people) should have put 2 and 2 together for their investors when it came to the sub-prime meltdown.
They can't hide behind the fact that there was a widely-known downturn in the housing market, or that defaults on mortgage loans were on the rise.
No, instead they should have (at least under Item 303 of the SEC's Reg S-K) pointed out exactly how that downturn would impact their profit margin -- even if that impact would only affect a relatively small portion of the firm's overall assets.
After reading the Court's opinion, one might conclude that Plaintiffs would have lost their appeal had the culprit at issue -- Blackstone -- not sold its private equity business to prospective investors in quite such glowing terms. Having made this part of its business -- which included the CDS mess -- its masthead, it shot itself in the foot. Now it's got to air all its dirty laundry, even if it's just one lone smelly sock in a walk-in closet full of fresh clothes.
Regardless, the future is yet uncertain for Blackstone, who must now proceed through litigation. Plaintiff has to leap a higher hurdle this time around.
The standard on a motion to dismiss based on the alleged non-materiality of a misstatement is something like: you can keep your case as long as you can't say no reasonable investor anywhere would ever find the misstatement material.
At trial, the standard is something else: the average reasonable investor would have found the misstatement material.
Speaking of plain English. God bless the lawyers that scribed those juicy little tidbits.
