Davis Polk achieved a major victory on behalf of Morgan Stanley and certain of its officers and directors in a Section 10(b) shareholder class action arising from Morgan Stanley’s 2007 subprime write-downs when the Second Circuit affirmed the district court’s April 2011 and January 2013 orders dismissing all of plaintiffs’ claims.

Following Morgan Stanley’s disclosure in November 2007 of several billion dollars in write-downs relating to a trading position in subprime securities, plaintiffs filed a class action alleging that Morgan Stanley and the individual defendants violated Section 10(b) of the Securities Exchange Act of 1934 by (1) misrepresenting Morgan Stanley’s risk controls relating to monitoring its subprime trading positions, (2) misstating and omitting information regarding the extent of Morgan Stanley’s exposure to subprime-related assets, including one of Morgan Stanley’s subprime trading positions, and (3) overvaluing that subprime trading position in Morgan Stanley’s third-quarter 2007 financial results. Davis Polk moved to dismiss the action on several grounds, including that the allegations concerning Morgan Stanley’s statements about its risk controls were not actionable, that the complaint failed to adequately allege that Morgan Stanley’s statements about its subprime exposure were false and failed to plead that Morgan Stanley had any obligation to disclose the details of its subprime trading position, and that plaintiffs failed to demonstrate loss causation with respect to Morgan Stanley’s valuation of that position. The district court dismissed the complaint on these grounds in April 2011 but granted plaintiffs leave to replead.

Plaintiffs filed a second amended complaint in June 2011, again alleging misrepresentations and omissions relating to Morgan Stanley’s disclosures about its exposure to subprime-related assets and its third-quarter 2007 valuation of one of its subprime trading positions. Davis Polk moved to dismiss the complaint, arguing among other things that (1) Morgan Stanley had no duty to disclose its subprime trading position and, even if it did, plaintiffs had failed to plead scienter with respect to any such omission, (2) the complaint failed to identify any misstatements relating to Morgan Stanley’s subprime exposure and (3) plaintiffs failed to plead loss causation in connection with their claim that Morgan Stanley misstated the value of its subprime trading position. The district court dismissed the complaint in January 2013. The court found that Morgan Stanley was obligated by Item 303 of Regulation S-K to disclose its subprime trading position but that plaintiffs had failed to plead scienter with respect to any failure to disclose that position. The court also concluded that the complaint failed to plead any misstatements concerning the extent of Morgan Stanley’s subprime exposure or loss causation relating to Morgan Stanley’s valuation of its trading position. Plaintiffs appealed both decisions to the Second Circuit.

On January 12, 2015, the Second Circuit affirmed the district court’s dismissals in an opinion and related summary order. The Second Circuit held that, as Davis Polk had argued, plaintiffs failed to plead that Morgan Stanley had made any misrepresentations concerning its exposure to subprime-related assets and failed to plead loss causation relating to Morgan Stanley’s valuation of its subprime trading position. The Second Circuit concluded that the complaint adequately alleged that Morgan Stanley failed to make certain disclosures regarding its subprime trading position required by Item 303 of Regulation S-K and assumed that such omissions were material, but the court agreed with Davis Polk’s argument that plaintiffs failed to plead a strong inference of scienter and therefore dismissed the claim.

The Davis Polk litigation team included senior counsel Robert F. Wise Jr., partner Charles S. Duggan, associates Brett M. McMahon, Andrew Ditchfield, Joanna Geneve-Third and Katherine A. Marshall, and former associates Jessica Kate Foschi and Sallie S. Kim. All members of the Davis Polk team are based in the New York office.

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