Martin LITWIN, Max Poulter, Francis Brady, and Landmen Partners, Inc., Individually and on behalf of all others similarly situated, Plaintiffs-Appellants,
v.
The BLACKSTONE GROUP, L.P., Stephen A. Schwarzman, Michael A. Puglisi, Peter J. Peterson, and Hamilton E. James, Defendants-Appellees.[*]
United States Court of Appeals, Second Circuit.
707*707 David A.P. Brower, Brower Piven, PC, New York, NY (Caitlin M. Moyna, Brower 708*708 Piven, PC, and Samuel H. Rudman, David A. Rosenfeld, and Mark M. Millkey, Robbins Geller Rudman & Dowd LLP, Melville, NY, on the brief), for Plaintiffs-Appellants.
Bruce D. Angiolillo, Simpson Thacher & Bartlett LLP (Jonathan K. Youngwood, on the brief), New York, NY, for Defendants-Appellees.
Before: MINER, CABRANES, and STRAUB, Circuit Judges.
STRAUB, Circuit Judge:
Plaintiffs-Appellants appeal from a judgment of the United States District Court for the Southern District of New York (Harold Baer, Jr., Judge), entered on September 25, 2009, dismissing plaintiffs' putative securities class action complaint pursuant to Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim. See Landmen Partners Inc. v. Blackstone Group, L.P., 659 F.Supp.2d 532 (S.D.N.Y.2009). We conclude that the District Court erred in dismissing plaintiffs' complaint because plaintiffs plausibly allege that material information was omitted from, or misstated in, defendants' initial public offering registration statement and prospectus in violation of Sections 11 and 12(a)(2) of the Securities Act of 1933. Accordingly, we vacate the District Court's judgment and remand for further proceedings.
BACKGROUND
Because this is an appeal from a motion to dismiss under Federal Rule of Civil Procedure 12(b)(6), the following facts, which we assume to be true, are drawn from plaintiffs' Consolidated Amended Class Action Complaint as filed on October 27, 2008. See Slayton v. Am. Express Co., 604 F.3d 758, 766 (2d Cir.2010). Where relevant, however, we include information from Securities and Exchange Commission ("SEC") filings by the Blackstone Group, L.P. ("Blackstone") to which plaintiffs refer in their complaint, particularly the Form S-1 Registration Statement ("Registration Statement") and Prospectus filed by Blackstone in connection with its June 21, 2007 initial public offering ("IPO"). See Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 322, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007) ("[C]ourts must consider the complaint in its entirety, as well as other sources ..., in particular, documents incorporated into the complaint by reference, and matters of which a court may take judicial notice."); see also ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 98 (2d Cir.2007) ("[W]e may consider... legally required public disclosure documents filed with the SEC, and documents possessed by or known to the plaintiff and upon which it relied in bringing the suit.").
Lead plaintiffs Martin Litwin, Max Poulter, and Francis Brady, appointed by the District Court on September 15, 2008, bring this putative securities class action on behalf of themselves and all others who purchased the common units of Blackstone at the time of its IPO. Plaintiffs seek remedies under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. §§ 77k, 77l (a)(2), 77o, for alleged material omissions from, and misstatements in, Blackstone's Registration Statement and Prospectus.[1] Defendants 709*709 are Blackstone and Blackstone executives Stephen A. Schwarzman, Michael A. Puglisi, Peter J. Peterson, and Hamilton E. James (collectively referred to herein as "Blackstone").
Blackstone is "a leading global alternative asset manager and provider of financial advisory services" and "one of the largest independent alternative asset managers in the world," with total assets under management of approximately $88.4 billion as of May 1, 2007. Blackstone is divided into four business segments: (1) Corporate Private Equity, which comprises its management of corporate private equity funds; (2) Real Estate, which comprises its management of general real estate funds and internationally focused real estate funds; (3) Marketable Alternative Asset Management, which comprises its management of hedge funds, mezzanine funds, senior debt vehicles, proprietary hedge funds, and publicly traded closed-end mutual funds; and (4) Financial Advisory, which comprises a variety of advisory services. The Corporate Private Equity segment constitutes approximately 37.4% of Blackstone's total assets under management ($33.1 billion of $88.4 billion), and the Real Estate segment constitutes approximately 22.6% of Blackstone's assets under management ($20 billion of $88.4 billion). According to Blackstone, "[b]oth the corporate private equity fund and the two real estate opportunity funds (taken together) ... are among the largest funds ever raised in their respective sectors." Blackstone further represents to prospective investors that its "long-term leadership in private equity has imbued the Blackstone brand with value that enhances all of [its] different businesses and facilitates [its] ability to expand into complementary new businesses."
In preparation for its 2007 IPO, Blackstone reorganized its corporate structure. Prior to the IPO, Blackstone's business was operated through a large number of separately owned predecessor entities. On March 12, 2007, just prior to the launch of the IPO, Blackstone was formed as a Delaware limited partnership and eventually became the sole general partner of five newly formed holding partnerships into which the majority of the operating predecessor entities were contributed. Blackstone receives a substantial portion of its revenues from two sources: (1) a 1.5% management fee on its total assets under management and (2) performance fees of 20% of the profits generated from the capital it invests on behalf of its limited partners. Under certain circumstances, when investments perform poorly, Blackstone may be subject to a "claw-back" of already paid performance fees, in other words, the required return of fees which it had already collected.
On March 22, 2007, Blackstone filed its Form S-1 Registration Statement with the SEC for the IPO. Blackstone filed several amendments to its Registration Statement, and the Prospectus, which formed part of 710*710 the Registration Statement, finally became effective on June 21, 2007. At this time, 153 million common units of Blackstone were sold to the public, raising more than $4.5 billion. The individual defendants and other Blackstone insiders received nearly all of the net proceeds from the IPO.
Plaintiffs principally allege that, at the time of the IPO, and unbeknownst to non-insider purchasers of Blackstone common units, two of Blackstone's portfolio companies as well as its real estate fund investments were experiencing problems. Blackstone allegedly knew of, and reasonably expected, these problems to subject it to a claw-back of performance fees and reduced performance fees, thereby materially affecting its future revenues.
FGIC Corporation
In 2003, a consortium of investors that included Blackstone purchased an 88% interest in FGIC Corp. ("FGIC"), a monoline financial guarantor, from General Electric Co. for $1.86 billion. FGIC is the parent company of Financial Guaranty, which primarily provides insurance for bonds. Although municipal bond insurance traditionally constituted the majority of Financial Guaranty's business, in the years leading up to Blackstone's IPO it began writing "insurance" on collateralized debt obligations ("CDOs"),[2] including CDOs backed by sub-prime mortgages to higher-risk borrowers. Financial Guaranty also began writing "insurance" on residential mortgage-backed securities ("RMBSs")[3] linked to non-prime and sub-prime mortgages. This "insurance" on RMBSs and CDOs was in the form of credit default swaps ("CDSs").[4]
By the summer of 2007, FGIC, as a result of Financial Guaranty's underwriting practices, was exposed to billions of dollars in non-prime mortgages, with its total CDS exposure close to $13 billion. From mid-2004 through mid-2007, factors including rising interest rates, the adjustment of interest rates on sub-prime mortgages, and a substantial slowing of property-value appreciation (and in some markets, property-value depreciation) caused many borrowers to be unable to refinance their existing loans when they could not meet their payment obligations. As a result, beginning in 2005, there was a significant increase in mortgage-default rates, particularly for sub-prime mortgage loans. By early 2007, before the IPO, some of the top mortgage lenders with sub-prime mortgage exposure began revealing large losses and warned of future 711*711 market losses. All of these symptoms, plaintiffs allege, provided a strong indication that the problems plaguing sub-prime lenders would generate substantial losses for FGIC on the CDSs it issued to its counterparties. This likelihood was allegedly exacerbated because, in many instances, FGIC's CDS-counterparties were able to demand accelerated payments from FGIC even before a default event occurred on the underlying referenced assets.
Blackstone's 23% equity interest in FGIC was worth approximately $331 million at the time of the IPO. Plaintiffs allege that, due to this significant interest, Blackstone was required to disclose the then-known trends, events, or uncertainties related to FGIC's business that were reasonably likely to cause Blackstone's financial information not to be indicative of future operating results. Following the IPO, in a March 10, 2008 press release, Blackstone announced its full-year and fourth-quarter 2007 earnings. The company's Corporate Private Equity segment reported 2007 revenues of $821.3 million, down 18% from 2006 revenues. "Most significantly, Blackstone reduced the value of its portfolio investment in [FGIC], ... which accounted for $122.2 million, or 69%, of the decline in revenues for the year." Blackstone reported that its "Corporate Private Equity fourth quarter revenues of ($15.4) million were negative, as compared with revenues of $533.8 million for the fourth quarter of 2006," a change "driven primarily by decreases in the value of Blackstone's portfolio investment in [FGIC] ... and lower net appreciation of portfolio investments in other sectors as compared with the prior year."
Freescale
Freescale Semiconductor, Inc. ("Freescale"), is a semiconductor designer and manufacturer. In 2006, Blackstone invested $3.1 billion in Freescale, the single largest investment by a Blackstone corporate private equity fund since 2004. The Freescale investment accounted for 9.4% of the Corporate Private Equity segment's assets under management and 3.5% of Blackstone's total assets under management.[5]
Shortly before the IPO, in March 2007, Freescale lost an exclusive agreement to manufacture wireless 3G chipsets for its largest customer, Motorola, Inc. ("Motorola"). The loss of this exclusive agreement followed two years of manufacturing and production problems for Freescale. On April 25, 2007, Freescale's management held an analysts' call, on which it stated that "revenue[s] in our wireless business were negatively impacted by a sales decline 712*712 due to weak demand in our largest customer Motorola.... During the last several weeks of the quarter, our main wireless customer began to reduce their orders." Plaintiffs allege that "[t]hese adverse facts[] had a material adverse effect on Freescale's business and, concomitantly, the material corporate private equity fund controlled by Blackstone." Plaintiffs argue that Blackstone was required to disclose this material adverse development in its Registration Statement.
Real Estate Investments
As noted above, Blackstone's Real Estate segment constitutes 22.6% of its total assets under management. Although the parties seem to agree that the majority of Blackstone's real estate investments were non-residential in nature, the Registration Statement provides that its "real estate opportunity funds have made a significant number of investments in lodging, major urban office buildings, residential properties, distribution and warehousing centers and a variety of real estate operating companies." Moreover, Blackstone concedes that its real estate funds maintained at least one "modest-sized residential real estate investment." There is no indication in the record, however, of the exact dollar amount of Blackstone's residential real estate investment(s), and thus it is not possible to discern the exact percentage of the Real Estate segment's assets under management attributable to residential properties.[6]
As detailed above with respect to FGIC, several factors were causing the real estate and mortgage securities markets to deteriorate by the time of the IPO, including the adverse effects of a series of negative developments in the credit markets. Thus, plaintiffs allege, it was foreseeable that Blackstone would have performance fees clawed back in connection with its real estate investments and that Blackstone would not generate additional performance fees on those investments.
In addition to Blackstone's alleged material omission of information related to the downward trend in the real estate market and its likely impact on Blackstone's real estate investments, plaintiffs allege that the Registration Statement included the following affirmative material misstatement:
The real estate industry is also experiencing historically high levels of growth and liquidity driven by the strength of the U.S. economy ... and the availability of financing for acquiring real estate assets.... The strong investor demand for real estate assets is due to a number of factors, including persistent, reasonable levels of interest rates ... and the ability of lenders to repackage their loans into securitizations, thereby diversifying and limiting their risk. These factors have combined to significantly increase the capital committed to real estate funds from a variety of institutional investors.
GAAP and Risk Disclosure Allegations
Plaintiffs' complaint includes additional allegations that are related to, and in many ways overlap with, the allegations detailed above. First, they allege that Blackstone's unaudited financial statements for the 713*713 three-month periods ending March 31, 2007, and March 31, 2006, respectively, which were included in the Registration Statement, violated generally accepted accounting principles ("GAAP") and materially overstated the values of Blackstone's real estate investments and its investment in FGIC. Plaintiffs also allege that Blackstone's disclosure of certain risk factors was too general and failed to inform investors adequately of the then-existing specific risks related to the real estate and credit markets.
Procedural History and District Court Opinion
The initial complaint was filed in the District Court by Landmen Partners, Inc., on April 15, 2008. On September 15, 2008, the District Court appointed Martin Litwin, Max Poulter, and Francis Brady as lead plaintiffs, and on October 27, 2008, the lead plaintiffs filed the operative Consolidated Amended Class Action Complaint. Blackstone filed a motion to dismiss the complaint on December 4, 2008, and, following oral argument, the District Court granted the motion, with prejudice, in an opinion dated September 22, 2009. See Landmen Partners Inc. v. Blackstone Group, L.P., 659 F.Supp.2d 532 (S.D.N.Y. 2009).
The District Court's opinion primarily focused on the materiality of the alleged omissions and misstatements concerning FGIC, Freescale, and Blackstone's real estate investments. First, the District Court analyzed the relative scale or quantitative materiality of the alleged FGIC and Freescale omissions. After noting our (and the SEC's) acceptance of a 5% threshold as an appropriate "starting place" or "preliminary assumption" of immateriality, the District Court noted that "Blackstone's $331 million investment in FGIC represented a mere 0.4% of Blackstone's [total] assets under management at the time of the IPO."[7] Id. at 541 (citing ECA & Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co., 553 F.3d 187, 204 (2d Cir.2009)). The District Court then addressed plaintiffs' argument that the materiality of the omissions is best illustrated by the effect the eventual $122.2 million drop in value of Blackstone's FGIC investment had on Blackstone's 2007 annual revenues. Id. The District Court found that while the decline in FGIC's investment value may have been significant relative to the Corporate Private Equity segment's annual revenues, it was quantitatively immaterial as compared with Blackstone's $3.12 billion in total revenues for 2007.[8] Id.
The District Court next looked at the quantitative materiality of the Freescale omissions, again comparing Blackstone's investment to its total assets under management. The court stated that "the $3.1 billion investment in Freescale represented 3.6% of the total $88.4 billion the Company had under management at the time of the IPO." Id. The District Court did not mention that the investment in Freescale accounted for 9.4% of the Corporate Private Equity segment's $33.1 billion of assets under management. The District Court found it significant that the complaint did not (and likely could not) allege that Freescale's loss of its exclusive supplier relationship with Motorola would cause 714*714 Blackstone's investment in Freescale to lose 100% of its value. Id. at 542.
The District Court then pointed to the structure of the Blackstone enterprise as further support for the immateriality of the alleged omissions. According to the District Court, because the performance of individual portfolio companies only affects Blackstone's revenues after investment gains or losses are aggregated at the fund level, the poor performance of one investment may be offset by the strong performance of another. Id. Accordingly, "there is no way to make a principled distinction between the negative information that Plaintiff[s] claim[] was wrongfully omitted from the Registration Statement and information... about every other portfolio company." Id. The District Court found that requiring disclosure of information about particular portfolio companies or investments would risk "obfuscat[ing] truly material information in a flood of unnecessary detail, a result that the securities laws forbid." Id.
Next, recognizing that a quantitative analysis is not dispositive of materiality, the District Court found that only one of the qualitative factors that we, or the SEC, often consider was present in this case. Specifically, the court found that: (1) none of the omissions concealed unlawful transactions or conduct; (2) the alleged omissions did not relate to a significant aspect of Blackstone's operations; (3) there was no significant market reaction to the public disclosure of the alleged omissions; (4) the alleged omissions did not hide a failure to meet analysts' expectations; (5) the alleged omissions did not change a loss into income or vice versa; and (6) the alleged omissions did not affect Blackstone's compliance with loan covenants or other contractual requirements. The District Court noted that the one qualitative factor it found present in this case — that the alleged omissions had the effect of increasing Blackstone's management's compensation — was not enough, by itself, to make the omissions material. Id. at 543-44. Accordingly, the District Court held that the alleged omissions concerning FGIC and Freescale were immaterial as a matter of law. Id. at 544.
The District Court then separately analyzed the alleged omissions and misstatements regarding Blackstone's real estate investments. The District Court first noted that the complaint failed to "identify a single real estate investment or allege a single fact capable of linking the problems in the subprime residential mortgage market in late 2006 and early 2007 and the roughly contemporaneous decline in home prices (which are well-documented by the [complaint]) to Blackstone's real estate investments, 85% of which were in commercial and hotel properties." Id. According to the District Court, without further factual enhancement as to how the troubles in the residential mortgage markets could have a foreseeable material effect on Blackstone's real estate investments, plaintiffs' allegations fell short of the plausibility standard set forth in Bell Atlantic Corp. v. Twombly, 550 U.S. 544, 570, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007). In addition, the District Court found that plaintiffs had failed to allege any facts that, if true, would render false those statements alleged to be affirmative misrepresentations. The District Court further found that insofar as plaintiffs alleged that Blackstone was required to disclose general market conditions, such omissions are not actionable because Sections 11 and 12(a)(2) do not require disclosure of publicly available information: "The omission of generally known macro-economic conditions is not material because such matters are already part of the `total mix' of information available to investors." Landmen Partners, 659 F.Supp.2d at 545. Finally, the District 715*715 Court noted that the complaint contained no allegations that Blackstone knew that market conditions "were reasonably likely to have a material effect on its portfolio of real estate investments," id. at 545, and stated that "generalized allegations that problems brewing in the market at large made it `foreseeable' that a particular set of unidentified investments would sour are insufficient to `nudge[] [the] claims across the line from conceivable to plausible,'" id. at 546 (alterations in original) (quoting Twombly, 550 U.S. at 570, 127 S.Ct. 1955). The District Court's opinion concluded with a brief analysis of the GAAP allegations. The District Court found that because those allegations were largely derivative of plaintiffs' other allegations, they were insufficient to state a claim for essentially the same reasons that the primary allegations failed. Accordingly, the District Court granted Blackstone's motion to dismiss and dismissed plaintiffs' claims with prejudice. Judgment was entered in favor of Blackstone on September 25, 2009. Plaintiffs filed a timely notice of appeal on October 23, 2009.
DISCUSSION
Standard of Review
"We review de novo the dismissal of a complaint under Rule 12(b)(6), accepting all factual allegations as true and drawing all reasonable inferences in favor of the plaintiff." ECA & Local 134, 553 F.3d at 196. "To survive a motion to dismiss, a complaint must plead enough facts to state a claim to relief that is plausible on its face." Id. (internal quotation marks omitted). "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." Ashcroft v. Iqbal, 556 U.S. ___, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009).
Notably, plaintiffs' complaint explicitly does not allege fraud; rather, it alleges that Blackstone acted negligently in preparing its Registration Statement and Prospectus. See Rombach v. Chang, 355 F.3d 164, 171 (2d Cir.2004) ("Fraud is not an element or a requisite to a claim under Section 11 or Section 12(a)(2).... [A] plaintiff need allege no more than negligence to proceed under Section 11 and Section 12(a)(2)...."). Moreover, Blackstone does not argue on appeal that plaintiffs' claims are premised on allegations of fraud. Accordingly, as pleaded, plaintiffs' claims are not subject to the heightened pleading standard of Federal Rule of Civil Procedure 9(b). See id. (holding that Rule 9(b)'s heightened pleading standard applies to claims under Section 11 and Section 12(a)(2) only "insofar as the claims are premised on allegations of fraud"). Stated differently, this is an ordinary notice pleading case, subject only to the "short and plain statement" requirements of Federal Rule of Civil Procedure 8(a).
Sections 11 and 12(a)(2) of the Securities Act
Section 11 of the Securities Act imposes liability on issuers and other signatories of a registration statement that, upon becoming effective, "contain[s] an untrue statement of a material fact or omit[s] to state a material fact required to be stated therein or necessary to make the statements therein not misleading." 15 U.S.C. § 77k(a). Section 12(a)(2) imposes liability under similar circumstances on issuers or sellers of securities by means of a prospectus. See id. § 77l(a)(2). So long as a plaintiff establishes one of the three bases for liability under these provisions — (1) a material misrepresentation; (2) a material omission in contravention of an affirmative legal disclosure obligation; or (3) a material omission of information that is necessary to prevent existing disclosures from 716*716 being misleading, see In re Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347, 360 (2d Cir.2010) — then, in a Section 11 case, "the general rule [is] that an issuer's liability ... is absolute." In re Initial Pub. Offering Sec. Litig., 483 F.3d 70, 73 n. 1 (2d Cir.2007); see also Herman & MacLean v. Huddleston, 459 U.S. 375, 381-82, 103 S.Ct. 683, 74 L.Ed.2d 548 (1983) ("[Section 11] was designed to assure compliance with the disclosure provisions of the [Securities] Act by imposing a stringent standard of liability on the parties who play a direct role in a registered offering.... Although limited in scope, Section 11 places a relatively minimal burden on a plaintiff." (footnote omitted)). The primary issue before us is the second basis for liability; that is, whether Blackstone's Registration Statement and Prospectus omitted material information that Blackstone was legally required to disclose.[9]
Required Disclosures Under Item 303 of Regulation S-K
Plaintiffs principally contend that Item 303 of SEC Regulation S-K, 17 C.F.R. § 229.303(a)(3)(ii), provides the basis for Blackstone's disclosure obligation. Pursuant to Subsection (a)(3)(ii) of Item 303, a registrant must "[d]escribe any known trends or uncertainties ... that the registrant reasonably expects will have a material ... unfavorable impact on ... revenues or income from continuing operations." Instruction 3 to paragraph 303(a) provides that "[t]he discussion and analysis shall focus specifically on material events and uncertainties known to management that would cause reported financial information not to be necessarily indicative of future operating results or of future financial condition." 17 C.F.R. § 229.303(a) instruction 3. The SEC's interpretive release regarding Item 303 clarifies that the Regulation imposes a disclosure duty "where a trend, demand, commitment, event or uncertainty is both [1] presently known to management and [2] reasonably likely to have material effects on the registrant's financial condition or results of operations." Management's Discussion and Analysis of Financial Condition and Results of Operations, Securities Act Release No. 6835, Exchange Act Release No. 26,831, Investment Company Act Release No. 16,961, 43 SEC Docket 1330 (May 18, 1989) [hereinafter MD&A].
Although the District Court opinion and the parties on appeal primarily focus on the materiality of Blackstone's alleged omissions, Blackstone does urge that plaintiffs' complaint fails to adequately allege that Blackstone was required by Item 303 to disclose trends in the real estate market for the purpose of Sections 11 and 12(a)(2). We disagree. Plaintiffs allege that the downward trend in the real estate market was already known and existing at the time of the IPO, and that the trend or uncertainty in the market was reasonably likely to have a material impact on Blackstone's financial condition. Therefore, plaintiffs have adequately pleaded a presently existing trend, event, or uncertainty, and the sole remaining issue is whether the effect of the "known" information was "reasonably likely" to be material for the purpose of Item 303 and, in turn, for the purpose of Sections 11 and 12(a)(2).
Legal Standard of Materiality
Materiality is an "inherently fact-specific finding," Basic Inc. v. Levinson, 717*717 485 U.S. 224, 236, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988), that is satisfied when a plaintiff alleges "a statement or omission that a reasonable investor would have considered significant in making investment decisions," Ganino v. Citizens Utils. Co., 228 F.3d 154, 161-62 (2d Cir.2000) (citing Basic, 485 U.S. at 231, 108 S.Ct. 978).[10] "[T]here must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available." Id. at 162 (alteration in original) (internal quotation marks omitted). However, "it is not necessary to assert that the investor would have acted differently if an accurate disclosure was made." Id. Rather, when a district court is presented with a Rule 12(b)(6) motion, "`a complaint may not properly be dismissed ... on the ground that the alleged misstatements or omissions are not material unless they are so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance.'" Id. (quoting Goldman v. Belden, 754 F.2d 1059, 1067 (2d Cir.1985)); see also TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 450, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976) (noting that even at the summary judgment stage, the "determination [of materiality] requires delicate assessments of the inferences a `reasonable shareholder' would draw from a given set of facts and the significance of those inferences to him, and these assessments are peculiarly ones for the trier of fact").
"[W]e have consistently rejected a formulaic approach to assessing the materiality of an alleged misrepresentation." Ganino, 228 F.3d at 162; see also ECA & Local 134 IBEW Joint Pension Trust v. JP Morgan Chase Co., 553 F.3d 187, 204 (2d Cir.2009) ("While Ganino held that bright-line numerical tests for materiality are inappropriate, it did not exclude analysis based on, or even emphasis of, quantitative considerations."). In both Ganino and ECA & Local 134, we cited with approval SEC Staff Accounting Bulletin No. 99, 64 Fed.Reg. 45,150 (1999) [hereinafter SAB No. 99], which provides relevant guidance regarding the proper assessment of materiality. See ECA & Local 134, 553 F.3d at 197-98; Ganino, 228 F.3d at 163-64.
As the SEC stated,
[t]he use of a percentage as a numerical threshold, such as 5%, may provide the basis for a preliminary assumption that ... a deviation of less than the specified percentage with respect to a particular item ... is unlikely to be material.... But quantifying, in percentage terms, the magnitude of a misstatement... cannot appropriately be used as a substitute for a full analysis of all relevant considerations.
SAB No. 99, 64 Fed.Reg. at 45,151; see also ECA & Local 134, 553 F.3d at 204 (noting that a "five percent numerical threshold is a good starting place for assessing... materiality" (emphasis added)). Accordingly, a court must consider "both `quantitative' and `qualitative' factors in assessing an item's materiality," SAB No. 99, 64 Fed.Reg. at 45,151, and that consideration should be undertaken in an integrative manner. See Ganino, 228 F.3d at 163; see also In re Kidder Peabody Sec. Litig., 10 F.Supp.2d 398, 410-11 (S.D.N.Y. 1998); SAB No. 99, 64 Fed.Reg. at 45,152 ("Qualitative factors may cause misstatements 718*718 of quantitatively small amounts to be material....").
In this case, the District Court confronted a Rule 12(b)(6) motion, a motion for which plaintiffs need only satisfy the basic notice pleading requirements of Rule 8. So long as plaintiffs plausibly allege that Blackstone omitted material information that it was required to disclose or made material misstatements in its offering documents, they meet the relatively minimal burden of stating a claim pursuant to Sections 11 and 12(a)(2), under which, should plaintiffs' claims be substantiated, Blackstone's liability as an issuer is absolute. Where the principal issue is materiality, an inherently fact-specific finding, the burden on plaintiffs to state a claim is even lower. Accordingly, we cannot agree with the District Court at this preliminary stage of litigation that the alleged omissions and misstatements "are so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance." Ganino, 228 F.3d at 162 (internal quotation marks omitted).
Materiality of Omissions Related to FGIC and Freescale
As to the materiality of the omissions related to FGIC and Freescale, Blackstone first argues that the relevant information was public knowledge, and thus could not be material because it was already part of the "total mix" of information available to investors. Specifically, Blackstone contends that, as the complaint itself alleges based on citations to news articles and analysts' calls, the shift in FGIC's strategy toward a less conservative approach to bond insurance and Freescale's loss of its exclusive contract with Motorola were facts publicly known at the time of the IPO.
It is true that, as a general matter, the "`total mix' of information may ... include information already in the public domain and facts known or reasonably available to [potential investors]." United Paperworkers Int'l Union v. Int'l Paper Co., 985 F.2d 1190, 1199 (2d Cir.1993) (internal quotation marks omitted); see also Garber v. Legg Mason, Inc., 537 F.Supp.2d 597, 612 (S.D.N.Y.2008) (holding that defendants had no duty under the securities laws to disclose the publicly reported departure of an asset manager), aff'd, 347 Fed.Appx. 665 (2d Cir.2009) (summary order). But case law does not support the sweeping proposition that an issuer of securities is never required to disclose publicly available information. See, e.g., Kapps v. Torch Offshore, Inc., 379 F.3d 207, 213, 215 (5th Cir.2004) (holding that the "definition of `material' under Section 11 is not strictly limited to information that is firm-specific and non-public" and noting that "the SEC requires an issuer to disclose certain `trends' that could affect its business, and in appropriate circumstances this requirement may extend to certain trends that are not firm-specific or are publicly available"); United Paperworkers, 985 F.2d at 1199 (stating that "the mere presence in the media of sporadic news reports ... should not be considered to be part of the total mix of information that would clarify or place in proper context the company's representations in its proxy materials"); see also Kronfeld v. Trans World Airlines, Inc., 832 F.2d 726, 736 (2d Cir.1987) ("There are serious limitations on a corporation's ability to charge its stockholders with knowledge of information omitted from a document such as a ... prospectus on the basis that the information is public knowledge and otherwise available to them."), cert. denied, 485 U.S. 1007, 108 S.Ct. 1470, 99 L.Ed.2d 700 (1988).
In this case, the key information that plaintiffs assert should have been disclosed is whether, and to what extent, the particular known trend, event, or uncertainty 719*719 might have been reasonably expected to materially affect Blackstone's investments. And this potential future impact was certainly not public knowledge, particularly in the case of FGIC, which was not even mentioned in Blackstone's Registration Statement and thus cannot be considered part of the "total mix" of information already available to investors. Again, the focus of plaintiffs' claims is the required disclosures under Item 303 — plaintiffs are not seeking the disclosure of the mere fact of Blackstone's investment in FGIC, of the downward trend in the real estate market, or of Freescale's loss of its exclusive contract with Motorola. Rather, plaintiffs claim that Blackstone was required to disclose the manner in which those then-known trends, events, or uncertainties might reasonably be expected to materially impact Blackstone's future revenues.
While it is true that Blackstone's investments in FGIC and Freescale fall below the presumptive 5% threshold of materiality, we find that the District Court erred in its analysis of certain qualitative factors related to materiality. First, the District Court and Blackstone place too much emphasis on Blackstone's structure and on the fact that a loss in one portfolio company might be offset by a gain in another portfolio company. Blackstone is not permitted, in assessing materiality, to aggregate negative and positive effects on its performance fees in order to avoid disclosure of a particular material negative event. Cf. SAB No. 99, Fed.Reg. at 45,153 (noting in the context of aggregating and netting multiple misstatements that "[r]egistrants and their auditors first should consider whether each misstatement is material, irrespective of its effect when combined with other misstatements"). Were we to hold otherwise, we would effectively sanction misstatements in a registration statement or prospectus related to particular portfolio companies so long as the net effect on the revenues of a public private equity firm like Blackstone was immaterial. The question, of course, is not whether a loss in a particular investment's value will merely affect revenues, because even after aggregation of gains and losses at the fund level, it will almost certainly have some effect. The relevant question under Item 303 is whether Blackstone reasonably expects the impact to be material. We see no principled basis for holding that an historically "private" equity company that has chosen to go public is somehow subject to a different standard under the securities disclosure laws and regulations than a traditional public company with numerous subsidiaries. See Mohsen Manesh, Legal Asymmetry and the End of Corporate Law, 34 Del. J. Corp. L. 465, 482 (2009) (noting that Blackstone, as a publicly listed entity, is "substantively indistinguishable from [its] publicly traded corporate counterparts"). In a case of pure omissions, to the extent that the securities laws require information to be disclosed and the information in question is material in the eyes of a reasonable investor, Blackstone must disclose the information. Blackstone's structure is no defense on a motion to dismiss.[11]
Second, the District Court erred in finding that the alleged omissions did not relate to a significant aspect of Blackstone's operations. In discussing "considerations that may well render material a quantitatively small misstatement," SAB No. 99 provides that "materiality ... may turn on where [the misstatement] appears in the financial statements": "[S]ituations may 720*720 arise ... where the auditor will conclude that a matter relating to segment information is qualitatively material even though, in his or her judgment, it is quantitatively immaterial to the financial statements taken as a whole." SAB No. 99, 64 Fed.Reg. at 45,152. SAB No. 99 also provides that one factor affecting qualitative materiality is whether the misstatement or omission relates to a segment that plays a "significant role" in the registrant's business. Id. In this case, Blackstone makes clear in its offering documents that Corporate Private Equity is its flagship segment, playing a significant role in the company's history, operations, and value. Blackstone states that its Corporate Private Equity fund is "among the largest ... ever raised," and that its "long-term leadership in private equity has imbued the Blackstone brand with value that enhances all of [its] different businesses and facilitates [its] ability to expand into complementary new businesses." Because Blackstone's Corporate Private Equity segment plays such an important role in Blackstone's business and provides value to all of its other asset management and financial advisory services, a reasonable investor would almost certainly want to know information related to that segment that Blackstone reasonably expects will have a material adverse effect on its future revenues. Therefore, the alleged misstatements and omissions relating to FGIC and Freescale were plausibly material.
Furthermore, with respect to Freescale in particular, Blackstone's investment in the company accounted for 9.4% of the Corporate Private Equity segment's assets under management, and the investment was nearly three times larger than the next largest investment in that segment as reported in Blackstone's Prospectus. Even where a misstatement or omission may be quantitatively small compared to a registrant's firm-wide financial results, its significance to a particularly important segment of a registrant's business tends to show its materiality. See In re Kidder Peabody, 10 F.Supp.2d at 410-11 (noting that while amount of "false profits may have been minor compared to GE's earnings as a whole, they were quite significant to" a subsidiary's profits, which, "in turn, represented a significant portion of GE's balance sheet"). Viewed in that light, we cannot hold that the alleged loss of Freescale's exclusive contract with its largest customer and the concomitant potential negative impact on one of the largest investments in Blackstone's Corporate Private Equity segment was immaterial.
Finally, the District Court failed to consider another relevant qualitative factor — that the omissions "mask[] a change in earnings or other trends." SAB No. 99, 64 Fed.Reg. at 45,152. Such a possibility is precisely what the required disclosures under Item 303 aim to avoid. Here, Blackstone omitted information related to FGIC and Freescale that plaintiffs allege was reasonably likely to have a material effect on the revenues of Blackstone's Corporate Private Equity segment and, in turn, on Blackstone as a whole. Blackstone's failure to disclose that information masked a reasonably likely change in earnings, as well as the trend, event, or uncertainty that was likely to cause such a change.
All of these qualitative factors, together with the District Court's correct observation that the alleged omissions "doubtless had `the effect of increasing management's compensation,'" see id., show that the alleged omissions were material. Accordingly, we hold that plaintiffs have adequately pleaded that Blackstone omitted material information related to FGIC and Freescale that it was required to disclose under Item 303 of Regulation S-K.
721*721 Materiality of Omissions and Misstatements Related to Real Estate Investments
We also find that the District Court erred in its analysis of the alleged omissions and misstatements related to Blackstone's real estate investments. First, the District Court's opinion implies that to state a plausible claim, plaintiffs' complaint had to identify specific real estate investments made or assets held by Blackstone funds that might have been at risk as a result of the then-known trends in the real estate industry. See Landmen Partners Inc. v. Blackstone Group, L.P., 659 F.Supp.2d 532, 545-46 (S.D.N.Y.2009). This expectation, however, misses the very core of plaintiffs' allegations, namely, that Blackstone omitted material information that it had a duty to report. In other words, plaintiffs' precise, actionable allegation is that Blackstone failed to disclose material details of its real estate investments, and specifically that it failed to disclose the manner in which those unidentified, particular investments might be materially affected by the then-existing downward trend in housing prices, the increasing default rates for sub-prime mortgage loans, and the pending problems for complex mortgage securities. That is all Item 303 requires in order to trigger a disclosure obligation: a known trend that Blackstone reasonably expected would materially affect its investments and revenues. Plaintiffs allege that they were unaware of, but legally entitled to disclosure of, the very information that the District Court held had to be specified in plaintiffs' complaint.
Moreover, there are two problems with the District Court's finding that plaintiffs' claims fail because they cannot establish any "link[]" between the declining residential real estate market and Blackstone's heavy investments in commercial real estate. See id. at 544. First, the offering documents indicate, and Blackstone admits, that Blackstone has at least one modest-sized residential real estate investment, and, drawing all reasonable inferences in plaintiffs' favor, its residential real estate holdings might constitute as much as $3 billion and 15% of the Real Estate segment's assets under management. See supra n. 6. This alone is enough on a Rule 12(b)(6) motion to establish a plausible link between the alleged trend in the residential real estate market and Blackstone's real estate investments. Second, even if the overwhelming majority of Blackstone's real estate investments are commercial in nature, it is certainly plausible for plaintiffs to allege that a collapse in the residential real estate market, and, more importantly, in the market for complex securitizations of residential mortgages, might reasonably be expected to adversely affect commercial real estate investments. Blackstone's own disclosures in its Registration Statement make this link clear, given that it admits that "the ability of lenders to repackage their [residential] loans into securitizations" is one factor contributing to the "significant[] increase [in] the capital committed to [predominantly commercial] real estate funds."
Finally, the District Court erred when it stated that "Plaintiff[s] fail[] to allege any facts ... that if true, would render false the few statements alleged to be affirmative misrepresentations." Landmen Partners, 659 F.Supp.2d at 544. To the contrary, plaintiffs provide significant factual detail about the general deterioration of the real estate market and specific facts that, drawing all reasonable inferences in plaintiffs' favor, directly contradict statements made by Blackstone in its Registration Statement. First, the chart in plaintiffs' complaint illustrating the seasonally adjusted price change in the U.S. housing market contradicts Blackstone's representation 722*722 that the "real estate industry [was]... experiencing historically high levels of growth," because the chart shows that the rate of price appreciation began to decline significantly beginning in late 2005. In addition, Blackstone's representation that "strong investor demand for real estate assets is due [in part] to ... persistent, reasonable levels of interest rates" is refuted by plaintiffs' allegations that "[a]s key short-term and the prime rates rose [beginning in June 2004], other interest rates rose as well, including those for most residential mortgage loans" and that "[t]his rise in interest rates made it more difficult for borrowers to meet their payment obligations." Also, Blackstone's statement that "lenders [were able] to repackage their loans into securitizations, thereby diversifying and limiting their risk," is at least impliedly refuted by plaintiffs' detailed allegations as to how the increasing sub-prime mortgage loan defaults were going to impact negatively the existing and future uses of, and value associated with, CDOs, RMBSs, and CDSs.
Absent these errors, the materiality of the alleged omitted and misstated information related to Blackstone's real estate investments becomes clear. First, Blackstone's real estate segment played a "significant role," SAB No. 99, 64 Fed.Reg. at 45,152, in Blackstone's business. While Blackstone's real estate segment may not be as prominent to the company's traditional identity as its Corporate Private Equity segment, Blackstone's real estate segment nevertheless constituted 22.6% of Blackstone's total assets under management. A reasonable Blackstone investor may well have wanted to know of any potentially adverse trends concerning a segment that constituted nearly a quarter of Blackstone's total assets under management. Second, the alleged misstatements and omissions regarding real estate were qualitatively material because they masked a potential change in earnings or other trends. Finally, the alleged misstatements and omissions, if proven, had "the effect of increasing management's compensation," id. For all these reasons, we conclude that the District Court erred in dismissing plaintiffs' allegations relating to Blackstone's real estate investments. Plaintiffs plausibly allege that Blackstone omitted material information that it was required to disclose and that it made material misstatements in its IPO offering documents.
With regard to all of the alleged omissions and misrepresentations, the District Court and Blackstone raise the legitimate concern that plaintiffs' view of materiality would require companies like Blackstone to "issue compilations of prospectuses for the scores of portfolio companies and real estate assets in which its private equity and real estate funds have any interest." Although, as the District Court correctly noted, "[i]ncluding all such information would ... obfuscate[] truly material information in a flood of unnecessary detail, a result that the securities laws forbid," id. at 542 (citing I. Meyer Pincus & Assocs. v. Oppenheimer & Co., 936 F.2d 759, 762 (2d Cir.1991)), we are not persuaded that such a concern is warranted in this case because of two protections from that result. First, as in all bases for liability under Sections 11 and 12(a)(2), the omitted information must be material. Although materiality is undoubtedly a flexible concept due to its fact-specific nature, it is still capable of some defined boundaries. And needless to say, not every portfolio company or real estate asset in which Blackstone invests will be deemed material. Moreover, in the area of pure omissions, disclosure of the information must be required. Here, plaintiffs adequately plead that Item 303 of Regulation S-K requires Blackstone to disclose the omitted information, but without 723*723 that regulatory requirement Blackstone would be under no obligation to disclose even material information. Thus, it is only when there is both materiality and a duty to disclose that a company may be held liable for omitting information from a registration statement or prospectus. These requirements provide sufficient protection against the opening-of-the-flood-gates argument advanced by Blackstone and accepted by the District Court.
Additional Allegations and Denial of Leave to Amend
We conclude by briefly addressing two remaining issues presented by this appeal. First, as to plaintiffs' remaining allegations, we find, as did the District Court, that plaintiffs' GAAP allegations "are essentially derivative of those discussed above," id. at 546, although we, in turn, conclude that these allegations are sufficient to state a claim for largely the same reasons. In addition, although the District Court did not specifically address plaintiffs' risk disclosure allegations, we similarly conclude that these allegations are derivative of those already discussed and, accordingly, those claims are also reinstated upon remand.
Second, we do not reach the issue whether the District Court exceeded its allowable discretion by dismissing plaintiffs' complaint without providing leave to amend. However, we note that where, as here, leave to amend is requested informally in a brief in opposition to a motion to dismiss, we have held that it is within the district "court's discretion to deny leave to amend implicitly by not addressing the request." In re Tamoxifen Citrate Antitrust Litig., 466 F.3d 187, 220 (2d Cir. 2006).
CONCLUSION
In sum, we hold that the District Court erred in dismissing for failure to state a claim plaintiffs' complaint brought pursuant to Sections 11, 12(a)(2), and 15 of the Securities Act because (1) plaintiffs plausibly allege that Blackstone omitted from its Registration Statement and Prospectus material information related to its investments in FGIC and Freescale that Blackstone was required to disclose under Item 303 of Regulation S-K; (2) plaintiffs plausibly allege that Blackstone both omitted material information that it was required to disclose under Item 303 and made material misstatements in its offering documents related to its real estate investments; and (3) plaintiffs' remaining GAAP and risk disclosure allegations are derivative of their primary allegations, and therefore these secondary allegations are sufficient to state a claim. Accordingly, we vacate the District Court's judgment and remand for further proceedings.
[*] The Clerk of the Court is directed to amend the official caption as set forth above.
[1] Defendants correctly point out that plaintiffs did not refer to their control-person liability claims under Section 15 of the Securities Act, which were dismissed by the District Court, in their opening brief on appeal. Typically, we consider challenges to district court rulings not raised on appeal to be abandoned. See, e.g., Major League Baseball Props. Inc. v. Salvino, Inc., 542 F.3d 290, 294 (2d Cir. 2008); Hobbs v. County of Westchester, 397 F.3d 133, 147 (2d Cir.2005), cert. denied, 546 U.S. 815, 126 S.Ct. 340, 163 L.Ed.2d 51 (2005); see also Fed. R.App. P. 28(a)(9). However, in this case, the District Court did not make a particular ruling on plaintiffs' Section 15 claims. Rather, the District Court mentioned the Section 15 claims only once, noting that they were "derivative" of plaintiffs' Section 11 claims. Landmen Partners, 659 F.Supp.2d at 539 n. 6. The District Court then addressed plaintiffs' Section 11 and 12(a)(2) claims on the merits, and, finding them lacking, dismissed all of plaintiffs' claims. Id. at 547. Because plaintiffs' Section 15 claims are necessarily dependent on their Section 11 and 12(a)(2) claims, see 15 U.S.C. § 77o; In re Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347, 358 (2d Cir. 2010), and were treated as such by the District Court, we decline to find that plaintiffs abandoned their Section 15 claims by failing to specifically refer to the claims in their opening brief.
[2] "CDOs are diversified collections of bonds that are divided into various risk groups and then sold to investors as securities." Slayton v. Am. Express Co., 460 F.3d 215, 219 n. 3 (2d Cir.2006).
[3] RMBSs are "a type of asset-backed security — that is, a security whose value is derived from a specified pool of underlying assets. Typically, an entity (such as a bank) will buy up a large number of mortgages from other banks, assemble those mortgages into pools, securitize the pools (i.e., split them into shares that can be sold off), and then sell them, usually as bonds, to banks or other investors." Gearren v. McGraw-Hill Cos., 690 F.Supp.2d 254, 258 n. 2 (S.D.N.Y.2010).
[4] CDSs "are contracts that provide protection against the credit risk of a particular company. The seller of a CDS agrees to pay the buyer a specific sum of money, called the notional amount, if a credit event, such as bankruptcy, occurs in the referenced company.... In exchange for this risk protection from the CDS-seller, the CDS-buyer agrees to make periodic premium payments during the course of the contract. The CDS-buyer can use the CDS to provide protection, like insurance, against the possibility that the debt instruments the buyer holds will seriously deteriorate in value because of a credit event in the referenced company." SEC v. Rorech, 720 F.Supp.2d 367, 370-71 (S.D.N.Y.2010); see also Aon Fin. Prods., Inc. v. Societe Generale, 476 F.3d 90, 92 n. 1 (2d Cir.2007).
[5] There is some ambiguity in the record as to exactly how much of the $3.1 billion was invested directly by Blackstone-sponsored funds. The Registration Statement includes a footnote that states, with respect to all portfolio companies, that the amount of equity invested "includes equity invested by limited partner co-investors and additional equity invested by limited partners of our corporate private equity funds outside of our corporate private equity funds." However, the Registration Statement's chart indicating the amount of equity invested in various corporate private equity fund portfolio companies does not describe the investment amount in any more detail. Moreover, although Blackstone states in its brief that plaintiffs "use an erroneous $3.1 billion figure," and further asserts that Blackstone's investment was "a fraction of the total [$3.1 billion] equity invest[ment]," nowhere does Blackstone specify the precise amount invested by Blackstone-sponsored funds and the record does not support any amount other than $3.1 billion. Accordingly, because this is a motion to dismiss, we draw the reasonable inference in favor of plaintiffs that Blackstone's equity investment in Freescale was the full $3.1 billion. See Elec. Trading Group, LLC v. Banc of Am. Sec. LLC, 588 F.3d 128, 133 (2d Cir.2009), cert. denied, ___ U.S. ___, 130 S.Ct. 3276, 176 L.Ed.2d 1209 (2010).
[6] The Registration Statement does disclose that "over 85% of the investments of [Blackstone's] real estate opportunity funds are in office building and hotel assets," i.e., commercial real estate. It is unclear, however, whether that means that the remaining 15% of Blackstone real estate investments are in residential real estate, which would amount to a $3 billion investment. Such an investment, in addition to being 15% of the assets under management in the Real Estate segment, would be 3.4% of Blackstone's total assets under management.
[7] The investment accounted for approximately 1% of the Corporate Private Equity segment's assets under management.
[8] The District Court incorrectly stated that the "$122 million write down for FGIC was a mere 0.4% of Blackstone's $3.12 billion in annual revenue." Landmen Partners, 659 F.Supp.2d at 541. In fact, $122 million is nearly 4% of $3.12 billion.
[9] There is, of course, the additional issue of the alleged material misstatements related to Blackstone's affirmative disclosures about the strength of the real estate market at the time of the IPO. We will address those alleged misstatements below.
[10] Although Ganino addresses materiality in the context of claims brought pursuant to Section 10(b) of the Securities Exchange Act of 1934, the test for materiality is the same when claims are brought pursuant to Sections 11 and 12(a)(2) of the Securities Act. See Rombach, 355 F.3d at 178 n. 11.
[11] Blackstone would certainly be free to argue before a jury that its structure renders the omissions related to FGIC and Freescale immaterial. We simply hold that Blackstone's structure does not permit a finding of immateriality as a matter of law.