Full opinion text
OPINION SWEET, District Judge. TABLE OF CONTENTS I. PRIOR PROCEEDINGS..................................................443 II. THE MOTION OF THE BEAR STEARNS DEFENDANTS TO DISMISS THE SECURITIES COMPLAINT IS DENIED............................443 A. The Parties ..........................................................443 B. Summary of the Securities Complaint....................................444 1. Bear Steams History.............................................445 2. Bear Steams Securitization.......................................447 8. Leveraging......................................................448 k. The Hedge Funds................................................448 5. Valuation and Risk..............................................450 6. False and Misleading Statements..................................453 7. Accounting Standards Violations..................................467 a) GAAP Overview..............................................467 b) Fraud Risk Factors ..........................................468 c) Audit Risk Alerts ............................................469 d) Internal Controls ............................................470 e) Financial Statements.........................................472 8. Banking Regulations Violations...................................477 a) Capital Requirements ........................................477 b) Incorrect Marks..............................................478 c) VaR Misrepresentations......................................479 9. Scienter.........................................................479 10. Loss Causation..................................................483 11. Additional Allegations............................................484 C. The Applicable Standards..............................................484 l. Pleading Scienter................................................485 2. Pleading Liability under Exchange Act § 20A.......................487 3. Pleading Control Person Liability under Exchange Act § 20(a)........488 A Pleading Loss Causation..........................................488 D. The Allegations of Materially False and Misleading Statements by the Bear Stearns Defendants Are Adequate................................488 1. Statements Regarding Asset Values................................488 2. Statements Regarding Risk Management...........................489 3. Statements Regarding the BSAM Write-downs ......................495 A Statements Regarding Bear Steams’ Liquidity ......................497 E. The Alleged Misstatements by the Bear Stearns Defendants are Material...........................................................497 F. The Securities Complaint Has Adequately Pleaded Scienter Against the Bear Stearns Defendants.............................................499 1. Motive and Opportunity..........................................499 2. Conscious Misbehavior or Recklessness.............................501 G. The Allegations of Loss Causation are Adequate..........................505 H. The Securities Complaint Has Adequately Pleaded a § 20A Claim...........508 I. The Securities Complaint Has Adequately Pleaded Control Person Liability under § 20(a)...............................................509 III. THE MOTION BY DELOITTE TO DISMISS THE SECURITIES COMPLAINT IS DENIED...............................................510 A. The Allegations.......................................................510 B. The Applicable Standard...............................................511 C. The Securities Complaint Has Adequately Alleged Deloitte’s Misstatements and Scienter..........................................511 1. Valuation Models and Fair Value Measurements....................512 2. The Hedge Funds................................................516 3. The Collapse of Bear Steams Is Evidence Of Scienter.................517 A Reckless Disregard Rather Than Hindsight.........................518 D. The Securities Complaint Has Adequately Alleged Material Misstatements......................................................518 E. The Securities Complaint Has Adequately Alleged Loss Causation...........520 IV. THE MOTION TO DISMISS THE DERIVATIVE COMPLAINT IS GRANTED.............................................................522 A. The Parties ..........................................................522 B. Summary of the Derivative Complaint...................................523 1. Bear Steams’Acquisition of Encore Credit Corp. ....................524 2. The Hedge-Fund Collapse.........................................524 3. Individual Defendants ’ Allegedly False and Misleading Statements Issued During the Relevant Period....................524 A The Improper Buyback and Insider Selling .........................525 5. Bear Steams’ Subprime Disclosures and Their Aftermath.............525 6. The Acquisition of Bear Steams by JPMorgan ......................526 7. The Counts......................................................528 C. Derivative Plaintiff Does Not Have Standing .............................535 1. Derivative Plaintiff Does Not Come within the “Fraud Exception”.....535 2. Derivative Plaintiff Fails to Establish a Double Derivative Suit.....537 D. The Derivative Claims Fail to Satisfy Rule 23.1(b)(3)’s Demand Requirement.......................................................539 1. Derivative Plaintiff Fails to Establish the Futility of a Demand on the JPMorgan Board........................................541 E. The Class Claim is Dismissed on Res Judicata and Collateral Estoppel Grounds...........................................................543 1. Count XIII is Dismissed Under Res Judicata.......................543 2. Count XIII is Dismissed through Collateral Estoppel.................546 F. The Derivative Defendants’ Motion to Dismiss the § 10b, § 20A, § 20(a), and Common Law Claims Is Not Reached..............................547 V. THE MOTION TO DISMISS THE ERISA COMPLAINT IS GRANTED.....547 A. The Parties ..........................................................547 B. The Plan.............................................................549 C. Summary of the ERISA Complaint......................................551 1. The Counts......................................................551 2. Bear Steams Stock was an Imprudent Investment...................555 3. Notice of Excessive Risk..........................................555 A Concealment of Risk..............................................561 5. Failure to Provide Complete and Accurate Information...............562 6. Conflicts of Interest ..............................................563 7. Causation.......................................................564 D. The Applicable Standard...............................................564 E. The ERISA Complaint Fails to State a Prudence Claim in Count I..........564 1. The Plan Agreement Does Not Establish a Duty to Divest the Plan of Bear Steams Stock...........................................565 2. The ESOP Committee Does Not Have the Fiduciary Duty to Diversify or Divest Plan Investments.............................566 3. Bear Steams is Not a Fiduciary of the Plan.........................567 a) Bear Stearns’ Ability to Make Contributions to the Plan in Stock or Cash Does Not Establish a Duty of Prudence.....568 b) Bear Stearns is Not Liable as an ERISA Fiduciary Through the Fiduciary Duties of its Employees .......................568 A Bear Steams Had No Discretion and Duty to Divest the ESOP of Bear Steams Stock.............................................570 5. The ERISA Complaint Fails to Overcome the Moench Presumption..................................................570 6. Defendants Had No Duty to Disclose and No Liability for Misleading Statements .........................................575 a) Defendants Had No Duty to Disclose Bear Stearns’ Financial Condition........................................575 b) Defendants Were Not Acting as Plan Fiduciaries When They Allegedly Made Affirmative Misrepresentations .........577 F. The ERISA Complaint Fails to State a Claim for Conflicts of Interest in Count II...........................................................578 G. There Is No Liability for Defendants’ Duty to Monitor and No Co-Fiduciary Liability...............................................580 VI. LEAD PLAINTIFF’S MOTIONS TO MODIFY THE STAY AND STRIKE EXTRANEOUS DOCUMENTS ARE DENIED............................581 A. Lead Plaintiffs Motion to Modify the Stay of Discovery is Denied as Moot..............................................................581 B. Lead Plaintiffs Motion to Strike Extraneous Documents is Denied..........581 VII. CONCLUSION...........................................................584 By Order dated August 18, 2008, the MDL Panel assigned a number of actions filed in United States District Courts for the Southern and Eastern Districts of New York to this Court. An Order dated January 6, 2009 consolidated the actions, appointed lead counsel, and scheduled the filing of consolidated complaints in the actions captioned In re Bear Stearns Companies, Inc. Securities, Derivative and ERISA Litigation. These actions arose out of the March 2008 collapse of Bear Stearns, a well-regarded investment bank founded in 1923. This was an early and major event in the turmoil that has affected the financial markets and the national and world economies. Motions to dismiss pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6) have been made by the Defendants with respect to each of the three consolidated complaints. The motions to dismiss the Securities Complaint are denied, and the motions to dismiss the Derivative Complaint and the ERISA Complaint are granted. The Lead Securities Plaintiffs motions to modify the PSLRA stay and to strike certain documents are denied. I. PRIOR PROCEEDINGS The Consolidated Class Action Complaint for Violations of the Federal Securities Laws (hereinafter “Securities Complaint” or “Sec. Compl.”) and the Verified Amended Third Derivative and Class Action Complaint (hereinafter “Derivative Complaint” or “Deriv. Compl.”) were both filed on February 27, 2009. The Corrected Amended Consolidated Complaint for Violations of the Employee Retirement Income Security Act (hereinafter “ERISA Complaint” or “ERISA Compl.”) was filed on July 21, 2009. Defendants The Bear Stearns Companies Inc. (“Bear Stearns” or the “Company”), James E. Cayne, Alan D. Schwartz, Warren J. Spector, Alan C. Greenberg, Samuel L. Molinaro, Jr., Michael Alix, Jeffrey M. Farber (collectively, the “Bear Stearns Defendants”), and Deloitte & Touche LLP (“Deloitte”) have moved to dismiss the Securities Complaint pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6). Defendants Henry S. Bienen, James E. Cayne, Carl D. Glickman, Michael Gold-stein, Alan C. Greenberg, Donald J. Harrington, Frank T. Nickell, Paul A. Novelly, Frederic V. Salerno, Alan D. Schwartz, Vincent Tese, Wesley S. Williams, Jr., Jeffrey M. Farber, Jeffrey Mayer, Michael Minikes, Samuel L. Molinaro, and Warren J. Spector, and Nominal Defendants Bear Stearns and JPMorgan Chase & Co. (“JPMorgan”) have moved to dismiss the Derivative Complaint pursuant to Federal Rules of Civil Procedure 9(b), 12(b)(6), and 23.1. Defendants Bear Stearns, Henry S. Bienen, James E. Cayne, Carl D. Glickman, Michael Goldstein, Alan C. Green-berg, Donald J. Harrington, Frank T. Nickell, Paul A. Novelly, Frederic V. Salerno, Alan D. Schwartz, Vincent Tese, Wesley S. Williams, Jr., Jeffrey Mayer, Samuel L. Molinaro, Warren J. Spector, Kathleen Cavallo, Stephen Lacoff, and Robert Stein-berg have moved to dismiss the ERISA Complaint pursuant to Federal Rule of Civil Procedure 12(b)(6). The State of Michigan Retirement System, Lead Plaintiff in the Securities Action, has moved to modify the automatic stay of discovery imposed by the PSLRA, 15 U.S.C. § 78u-4(b)(3)(B) and to strike certain documents submitted by the Bear Stearns and Deloitte Defendants. The motion to strike was marked fully submitted on July 14, 2009. The motions to dismiss the Securities and Derivative Complaints and the motion to modify the automatic stay were marked fully submitted on July 30, 2009. The motion to dismiss the ERISA Complaint was marked fully submitted on April 28, 2010. II. THE MOTION OF THE BEAR STEARNS DEFENDANTS TO DISMISS THE SECURITIES COMPLAINT IS DENIED What follows is a description of the parties, a summary of the allegations of the Securities Complaint, the standards applicable to the motion, and the conclusions reached with respect to the adequacy of the allegations of false and misleading statements, materiality, scienter and loss causation. A. The Parties The Lead Plaintiff, State of Michigan Retirement Systems (“Securities Lead Plaintiff’) serves four systems: the Public School Employees Retirement System; the State Employees’ Retirement System; the State Police Retirement System; and the Judges Retirement System. With combined assets of nearly $64 billion, the Securities Lead Plaintiff is the fourteenth largest public pension system in the United States, the twentieth-largest pension system in the United States, and the thirty-ninth largest pension system in the world. (Sec. Compl. ¶ 19.) The Securities Lead Plaintiff purchased Bear Stearns common stock on the open market during the class period from December 14, 2006 to March 14, 2008 (the “Class Period”) and has alleged damages as a result of conduct alleged in the Securities Complaint. (Sec. Compl. ¶ 20.) Bear Stearns was a leading publicly traded financial services institution. (Sec. Compl. ¶21.) Prior to its acquisition by JPMorgan on May 30, 2008, its principal business lines included institutional equities, fixed income, investment banking, global clearing services, asset management, and private client services. (Sec. Compl. ¶ 22.) The individual Defendants were directors and/or officers of Bear Stearns before the JPMorgan merger. They are James E. Cayne, Bear Stearns’ former Chief Executive Officer (CEO) and Chairman of the Board (“Cayne”); Alan D. Schwartz, former President and co-COO, and, beginning January 2008, CEO (“Schwartz”); Warren J. Spector, former co-President and co-Chief Operating Officer (COO) until August 2007 (“Spector”); Alan C. Greenberg, former Chairman of the Executive Committee (“Greenberg”); Samuel L. Molinaro, Jr., former Chief Financial Officer (CFO), and, beginning August 27, 2007, COO (“Molinaro”); Michael Alix, former Global Head of Credit Risk Management (“Alix”); and Jeffrey M. Farber, former Controller and Principal Accountant (“Farber”) (collectively, the “Individual Defendants”). (Sec. Compl. ¶¶ 23-29.) Deloitte was the independent outside auditor for Bear Stearns and provided audit, audit-related, tax and other services to Bear Stearns during the Class Period, including the issuance of unqualified opinions on the Company’s financial statements for fiscal years 2006 and 2007. Deloitte also allegedly certified the Company’s 10-Q Forms for the first through third quarters of 2007. (Sec. Compl. ¶ 32). B. Summary of the Securities Complaint The Securities Complaint consists of 834 numbered paragraphs in 218 pages, plus two exhibits. It contains three counts supported by allegations set forth in the following twelve sections: 1. Nature and Summary of the Action (Sec. Compl. ¶¶ 1-14) 2. Jurisdiction and Venue (Sec. Compl. ¶¶ 15-18) 3. Parties (Sec. Compl. ¶¶ 19-32) 4. Factual Background and Substantive Allegations (Sec. Compl. ¶¶ 33-452) 5. Defendants’ Scienter (Sec. Compl. ¶¶ 453-506) 6. Additional Allegations Supporting the Officer Defendants’ Scienter (Sec. Compl. ¶¶ 507-522) 7. Deloitte’s Deficient Audits of Bear Stearns’ Financial Statements (Sec. Compl. ¶¶ 523-588) 8. Defendants’ Materially False and Misleading Statements (Sec. Compl. ¶¶ 589-794) 9. Loss Causation (Sec. Compl. ¶¶ 795-802) 10. Class Action Allegations (Sec. Compl. ¶¶ 803-808) 11. Presumption of Reliance (Sec. Compl. ¶¶ 809-811) 12. Inapplicability of Statutory Safe Harbor (Sec. Compl. ¶ 812). The Securities Complaint contains the following three claims for relief: violation of Section 10(b) of the Exchange Act and Rule 10b-5 against all the Defendants (Count I) (Sec. Comp. ¶¶ 813-822); violation of Section 20(a) of the Exchange Act against certain officer Defendants (Count II) (Sec. Compl. ¶¶ 823-827); and violations of Section 20(a) of the Exchange Act against Defendants Cayne, Schwartz, Spector, Molinaro, Greenberg, and Farber (the “Section 20(a) Defendants”) (Count III) (Sec. Compl. ¶¶ 828-834). 1. Bear Steams History Bear Stearns was the fifth largest investment bank in the world and until December 2007 had never posted a loss and was known to be conservative in its approach to risk. (Sec. Compl. ¶ 33.) As a registered broker-dealer, Bear Stearns was subject to the “Broker-Dealer Risk Assessment Program” created in 1990, under which the Division of Trading and Markets (“TM”) of the Securities & Exchange Commission (“SEC”) monitored the financial markets. During the Class Period, TM reviewed in detail the filings of the seven most prominent firms, including Bear Stearns, which participated in the SEC’s Consolidated Supervised Entity (“CSE”) program. (Sec. Compl. ¶¶ 34-35.) Bear Stearns experienced rapid growth through the 1990s and became larger and more profitable with its business model of trading, mortgage underwriting, prime brokerage and private client services. By mid-2000, the Company increased its debt securitization, pooling and repackaging of cash flow-producing financial assets into securities that are sold to investors termed asset-backed securities (“ABS”). Bear Stearns purchased and originated mortgages to securitize and sell, and maintained billions of dollars of these assets on its own books, using them as collateral and to finance daily operations. (Sec. Compl. ¶¶ 36, 38.) In 2005 and again in 2006, the SEC advised the Company of deficiencies in models it used to value mortgage-backed securities (“MBS”) due to its failure to assess the risk of default or incorporate data about such risk, and further advised that its value at risk (“VaR”) models did not account for key factors such as changes in housing prices. (Sec. Compl. ¶¶ 4, 92,100-105,107.) When two hedge funds overseen by Bear Stearns collapsed in the spring of 2007, the Company’s exposure to the growing housing crisis increased as it absorbed nearly two billion dollars of the hedge funds’ subprime-backed assets, which were worthless within weeks. (Sec. Compl. ¶¶ 7, 205-206, 212.) By the late fall of 2007, the Company began to write down billions of dollars of its devalued assets. The Company’s lenders became unwilling to lend it the vast sums necessary for its daily operations. (Sec. Compl. ¶¶ 8, 218.) In its public statements in December 2007 and January 2008, the Company offered the public misleading accounts of its earnings and asset values. (Sec. Compl. ¶¶ 8-9.) Major shareholders began questioning Cayne’s leadership and, on January 8, 2008, the Company announced that Cayne would step down as CEO. (Sec. Compl. ¶ 255.) On March 10, 2008, rumors began to circulate on Wall Street that Bear Stearns was facing a liquidity problem, which was denied by the Company and, on March 12, 2008, by Schwartz. (Sec. Compl. ¶ 272.) The Company’s liquidity fell to $2 billion on March 13, 2008 and Schwartz and JPMorgan CEO Jamie Dimon (“Dimon”) began negotiations for Bear Stearns to be given access to the Federal Reserve’s “window,” a credit facility available to the nation’s commercial banks, but not to investment banks. JPMorgan and Bear Stearns contemplated that the Company could get the facility through JPMorgan as part of a transaction in which JPMorgan bought Bear Stearns. (Sec. Compl. ¶¶ 280-284.) On March 14, 2008, it was announced that JPMorgan would provide short-term funding to Bear Stearns while the Company worked on alternative forms of financing. Bear Stearns’ stock fell on the news from $57 per share to $30 per share, a 47% one-day drop. (Sec. Compl. ¶ 11.) On March 16, 2008, Dimon stated that Bear Stearns faced $40 billion in credit exposure, including mortgage liabilities, and made an offer to purchase the Company at a $2 per share, a price that Dimon claimed was necessary to protect JPMorgan. (Sec. Compl. ¶ 12.) On March 17, 2008, news of Bear Stearns’ exposure led the stock to close at $4.81 per share, an 85% drop from its previous close. (Sec. Compl. ¶¶ 14, 294.) JPMorgan renegotiated the price after it discovered that a mistake in the language of its guaranty agreement with Bear Stearns obligated JPMorgan to guarantee Bear Stearns’ trades even if the Company’s shareholders voted down the acquisition deal. (Sec. Compl. ¶¶ 295-296.) Shareholders approved the sale to JPMorgan on May 29, 2008. Under the terms of the merger, shareholders received $10 of JPMorgan shares for every Bear Stearns share they held as of the date of the merger. (Sec. Compl. ¶ 299.) In June 2008 the Department of Justice, through the U.S. Attorney for the Eastern District of New York, indicted Ralph Cioffi (“Cioffi”), the originator of the hedge funds, charging that he had misled investors regarding the value of MBS and collateralized debt obligations (“CDOs”) containing MBS owned by the hedge funds, and had caused $1.8 billion in losses to investors. On the same day, the SEC filed a civil complaint against Cioffi. (Sec. Compl. ¶¶ 300-301.) By July 3, 2008 the assets of Maiden Lane LLC, a holding company created to hold Bear Stearns ABS following the JPMorgan merger, had decreased in value from $30 billion to $28.9 billion. By October 22, 2008, the value of the assets had dropped another $2.1 billion, to $26.8 billion, 10.6% less than the value provided by Bear Stearns. (Sec. Compl. ¶ 302.) After Bear Stearns’ March 2008 collapse, the SEC’s Office of the Inspector General (“OIG”) was asked to analyze the SEC’s oversight of the CSE firms, with a special emphasis on Bear Stearns. (Sec. Compl. ¶ 74.) The OIG issued its conclusions in a September 25, 2008 Report, titled “SEC’s Oversight of Bear Stearns and Related Entities: The Consolidated Supervised Entity Program” (the “OIG Report”), which stated that “[b]y November of 2005 the Company’s ARM business was operating in excess of allocated limits, reaching new highs with respect to the net market value of its positions” and that the large concentration of business in this area left the Company exposed to declines in the riskiest part of the housing market. (Sec. Compl. ¶¶ 74-76.) Certain conclusions of the OIG Report are cited throughout the Securities Complaint, constituting allegations of the Bear Stearns history and practices, including details about Bear Stearns’ VaR, mortgage valuation models, and its treatment of asset values. 2. Bear Steams Securitization Mortgages packaged together for securitization are referred to as mortgage-backed securities (“MBS”), and when the mortgages are residential, those securities are referred to as residential mortgage-backed securities (“RMBS”). RMBS are, in turn, divided into layers based on the credit ratings of the underlying assets. (Sec. Compl. ¶¶ 39-41.) The “B-Pieces” of an RMBS, its riskier parts, were pooled together to form a collateralized debt obligation (“CDO”) divided by the issuer into different tranches, or layers, based on gradations in credit quality. While the top tranche of a CDO may be rated “AAA,” CDOs formed from RMBS are rated BBB or lower. Lower-rated tranches of CDOs, such as the “mezzanine” tranches, bear even greater risk of loss. The “equity” tranche bears the first risk of loss. (Sec. Compl. ¶¶ 42^44.) Mezzanine CDOs made up more than 75% of the total CDO market by April 2007 and contained cash flows from especially risky types of residential mortgage loans, termed “subprime” or “A1L-A” made to borrowers with a heightened risk of default, such as those who have a history of loan delinquency or default. Alb-A loans were made to borrowers with problems including lack of documentation of income and assets, high debt-to-income ratios, and troubled credit histories. Sub-prime and Alt-A mortgages are termed “nonprime” mortgages. Between 2003 and 2007, the total proportion of nonprime loans wrapped into the majority of all mezzanine CDOs increased dramatically market-wide. (Sec. Compl. ¶¶ 45-48.) Bear Stearns originated and purchased home loans, packaged them into RMBS, collected these RMBS to form CDOs, sold CDOs to investors and thereby acquired a large exposure to declines in the housing and credit markets. (Sec. Compl. ¶ 49.) It originated loans through two wholly-owned subsidiaries, the Bear Stearns Residential Mortgage Corporation (“BEARRES”) and later through Encore Credit Corporation (“ECC”), which the Company purchased in early 2007. ECC specialized in providing loans to borrowers with compromised credit. BEARRES made Alt-A loans to borrowers with somewhat better, but still compromised credit. The Company actively encouraged its loan originator subsidiaries to offer loans even to borrowers with poor credit scores and troubled credit histories and to originate riskier loans that “cut corners” with respect to credit scores or loan to value (“LTV”) ratios. While the national rejection rate of applications was 29% in 2006, the BEARRES rejection rate was 13%. (Sec. Compl. ¶¶ 50-55.) In 2006, BEARRES and ECC originated 19,715 mortgages, worth $4.37 billion, which were securitized by Bear Stearns. Bear Stearns also purchased loans originated by other companies through its EMC Mortgage Corporation (“EMC”) subsidiary, which from 1990 until 2007 purchased more than $200 billion in mortgages. (Sec. Compl. ¶¶ 55-57.) In late 2006 and early 2007, because of the potential for profits from securitizing these loans, Bear Stearns managers failed to enforce basic underwriting standards and ignored due diligence findings that borrowers would be unable to pay. (Sec. Compl. ¶¶ 58-60.) Bear Steams also funded and purchased closed-end second-lien (“CES”) loans and home-equity lines of credit (“HELOCs”) made to borrowers with poor credit secured by secondary liens on the home, which were to be paid after the first mortgage was satisfied and were at risk of not being paid in full if the value of the home dropped. By the end of 2006, EMC had purchased $1.2 billion of HELOC and $6.7 billion of CES loans. (Sec. Compl. ¶ 61.) Through EMC, Bear Stearns also purchased mortgages already in default, so-called “scratch and dent” loans, to securitize and sell to investors. Because of its underwriting standards, the loans that the Company purchased to package into RMBS and CDOs were especially vulnerable to declines in housing prices. (Sec. Compl. ¶¶ 61-63.) Individual nonprime home loans were wrapped into an RMBS, sold to investors, and packaged into CDOs. Especially risky tranches of RMBS were kept on the Company’s books as retained interests (“RI”). The amount of RI grew throughout the Class Period, from $5.6 billion on November 30, 2006 to $9.6 billion on August 31, 2007. (Sec. Compl. ¶¶ 64-65.) Nearly all CDOs Bear Stearns structured during the Class Period were backed by a combination of RMBS and derivatives, or “synthetic securities.” These synthetic securities were effectively insurance contracts in which the party buying the insurance paid a premium equivalent to the cash flow of an underlying RMBS that it was copying, and the counterparty insured against a decline or default in the underlying RMBS. Such CDOs were called “Synthetic CDOs,” and a CDO backed by other CDO notes was called a “CDO squared.” (Sec. Compl. ¶¶ 66-67.) To sell the largest possible CDOs, the Company retained on its books increasing amounts of the CDOs it packaged. By August 2007, this figure had reached $2,072 billion. (Sec. Compl. ¶¶ 68-69.) During the Class Period, the Company’s growing accumulation of subprime-backed RMBS and CDOs, combined with its leveraging practices, left it extraordinarily vulnerable to declines in the housing market. (Sec. Compl. ¶ 70.) Before the Class Period began, on multiple occasions the amount of mortgage securities held by the Company exceeded its internal concentration limits. (Sec. Compl. ¶ 71.) 3. Leveraging In leveraging, a company takes out a loan secured by assets in order to invest in assets with a greater rate of return than the cost of interest for the loan. The potential for loss is greater if the investment becomes worthless, because of the loan principal and all accrued interest. A 4-to-l leverage ratio increases loss potential by about 15%, while a 35-to-l leverage ratio increases loss potential by more than 100%. (Sec. Compl. ¶¶ 77-78.) In 2005, Bear Stearns was leveraged at a ratio of approximately 26.5-to-l. By November 2007, the Company had leveraged its net equity position of $11.8 billion to purchase $395 billion in assets, a ratio of nearly 33-to-l. Because of the interest charges required to support this leverage ratio, the amount of cash the Company needed to finance its daily operations increased dramatically during the Class Period. By the close of the Class Period, Bear Stearns’ daily borrowing needs exceeded $50 billion. (Sec. Compl. ¶¶ 79-80.) L The Hedge Funds In October 2003, Cioffi started the High Grade Structured Credit Strategies Fund, LP (the “High Grade Fund”) as part of Bear Stearns Asset Management (“BSAM”), which was under the supervision of Spector. The High Grade Fund consisted of a Delaware partnership to raise money from investors in the United States and a Cayman Island corporation to raise money from foreign investors. (Sec. Compl. ¶ 82.) In August 2006, Cioffi created the High Grade Structured Credit Strategies Enhanced Leverage Fund, LP (“the High Grade Enhanced Fund”) (the High Grade Fund and the High Grade Enhanced Fund are collectively referred to as the “Hedge Funds”), which was structured similarly to the High Grade Fund, but with greater leverage to increase potential returns. (Sec. Compl. ¶ 83.) Bear Stearns Securities Corporation, a wholly-owned subsidiary of the Company, served as the prime broker for the Hedge Funds, and PFPC Inc., another Bear Stearns subsidiary, was the Hedge Funds’ administrator. BSAM was the investment manager for the Hedge Funds. Spector was responsible for the business of both funds. (Sec. Compl. ¶¶ 84-85.) Because of BSAM’s role as an asset manager, Bear Stearns was one of the few repurchase lenders willing to take the Hedge Funds’ CDOs as collateral for short term lending facilities. The Hedge Funds, through BSAM, entered into repurchase agreements on favorable terms with Bear Stearns as the counterparty. By offering cash to the Hedge Funds in exchange for subprime mortgage-backed CDOs of questionable value, Bear Stearns increased it exposure to declines in the subprime market. (Sec. Compl. ¶¶ 89-91.) BSAM misrepresented the Hedge Funds’ subprime exposure to hedge fund investors in “Preliminary Performance Profiles” (“PPPs”) by disclosing only the Hedge Funds’ direct subprime RMBS holdings. The Hedge Funds also held large amounts of subprime RMBS indirectly through purchased CDOs. Returns in the subprime CDOs, and CDOs backed by CDO-squares, diminished, resulting in diminishing yield spreads, and accelerating losses for the Hedge Funds. The High Grade Enhanced Fund experienced its first negative return in February 2007. Declines in the High Grade Fund soon followed, resulting in its first negative return in March 2007. (Sec. Compl. ¶¶ 193— 196.) The Hedge Funds began to experience difficulties with margin calls and failed to disclose Bear Stearns’ exposure to the declining value of the subprime-backed Hedge Fund assets it held as collateral on its own books. (Sec. Compl. ¶¶ 198-199.) They continued to deteriorate throughout the spring of 2007. On April 19, 2007, Matthew M. Tannin, COO of the Hedge Funds (“Tannin”), reviewed a credit model that showed increasing losses on subprime linked assets. On May 13, 2007, Tannin stated that the High Grade Enhanced Fund had to be liquidated. (Sec. Compl. ¶¶ 200-201.) To avoid a forced “fire sale” of the thinly-traded CDOs held by the Hedge Funds, which would have required acknowledging huge declines in the value of the subprimebacked assets Bear Stearns held as collateral and would have revealed the Company’s gross overvaluation of its thinly-traded assets, Spector decided to extend a line of credit to the High Grade Fund to allow it to liquidate in an orderly way by gradually selling assets into the market. This was done to avoid having other assets seized by repurchase agreement counter-parties, who would mark the assets to their true value. Spector permitted the High Grade Enhanced Fund to fail, because its high leverage ratios left it virtually unsalvageable. (Sec. Compl. ¶¶ 202-204.) On June 22, 2007, Bear Stearns announced that it was entering into a $3.2 billion securitized financing agreement with the High Grade Fund in the form of a collateralized repurchase agreement. In exchange for lending the funds, Bear Stearns received as collateral CDOs backed by subprime mortgages allegedly worth between $1.7 and $2 billion. Pursuant to the agreement, Bear Stearns gave up the right to collect all of the upside in the event that the collateral saw an increase in value. Molinaro stated that the Hedge Funds’ problems with their sub-prime-backed assets did not extend to the securities that Bear Stearns itself held, but failed to disclose that even prior to the $3.2 billion securitized financing agreement, Bear Stearns held large amounts of the Hedge Funds’ toxic debt as collateral. During a June 22, 2007 conference call, Molinaro made false statements with respect to asset value and stated that the value levels attributed to the collateral it had received from the Hedge Funds “are a reflection of the market value levels that we’re seeing from our street counterparties.” In fact, the market for such securities had become highly illiquid, providing no basis for Molinaro’s statements. (Sec. Compl. ¶¶ 205-209.) On June 26, 2007, Cayne denied any material change in the risk profile. However, because of worthless subprimebacked collateral, the risk exposure had grown substantially. (Sec. Compl. ¶¶ 210-211.) By the end of June 2007, asset sales had reduced the loan balance to $1,345 billion, but the estimated value of the collateral securing the loan had deteriorated by nearly $350 million, approximately the value of the loan Bear Stearns had given the High Grade Fund. Any further declines in the value of the assets that Bear Stearns held as collateral would be borne directly by Bear Stearns. Instead of immediately reflecting its assumption of the declining collateral in its books, the Company delayed for months, according to the OIG Report, “to delay taking a huge hit to capital.” (Sec. Compl. ¶¶ 212-213.) On July 18, 2007, Bear Stearns informed investors in the Hedge Funds that they would get little money back after “unprecedented declines” in the value of AAA-rated securities used to invest in subprime mortgages. The more than $1.3 billion in collateral drawn from the Hedge Funds’ subprime-backed assets, which the Company had effectively taken onto its books by assuming the assets as collateral just a month earlier, was nearly worthless as well. Bear Stearns did not make the actual book entries until the fall of 2007, months after the losses were actually incurred by the Company. The Company ultimately only wrote off a fraction of the worthless collateral it held and had originally valued at $1.3 billion. (Sec. Compl. ¶¶ 214-216.) 5. Valuation and Risk The valuation of assets is governed by Statement of Financial Accounting Standards No. 157, Fair Value Measurements (“SFAS 157”). Although SFAS 157 took effect on November 15, 2007, Bear Stearns opted to comply with the standard beginning January 2007. SFAS 157 required that Bear Stearns classify its reported assets into one of three levels depending on the degree of certainty about the assets’ underlying value. Assets traded in an active market were classified as Level 1 (“mark-to-market”). Level 2 (“mark-to-model”) assets consisted of financial assets whose values are based on quoted prices in inactive markets, or whose values are based on models, inputs to which are observable either directly or indirectly for substantially the full term of the asset or liability. Level 3 assets, thinly traded or not traded at all, have values based on valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. To value Level 3 assets, companies rely on models developed by management. The information supplied by valuation models is incorporated into other models used to assess risk and hedge investments, such as the models measuring VaR. (Sec. Compl. ¶¶ 94-99.) Before the Class Period began, the Company knew that declining housing prices and rising default rates were not reflected in the mortgage valuation models that were critical to the valuation of its Level 3 assets. According to the OIG Report, prior to the Company’s approval as a CSE in November of 2 005, “Bear Stearns used outdated models that were more than ten years old to value mortgage derivatives and had limited documentation on how the models worked.” As a result, during the 2005 CSE application process, TM told Bear Stearns that “[w]e believe that it would be highly desirable for independent Model Review to carry out detailed reviews of models in the mortgage area.” (Sec. Compl. ¶¶ 100-102.) According to the OIG Report, in November 2005, the SEC Office of Compliance Inspections and Examinations (“OCIE”) found that “Bear Stearns did not periodically evaluate its VaR models, nor did it timely update inputs to its VaR models.” (Sec. Compl. ¶ 123.) Bear Stearns was warned of these deficiencies in a December 2, 2005 memorandum from OCIE to Farber, the Company’s Controller and Principal Accountant. According to the OIG Report, “Bear Stearns’ VaR models did not capture risks associated with credit spread widening.” (Sec. Compl. ¶¶ 124-125.) In September 2006, TM concluded after a meeting with Bear Stearns risk managers that the Company still had failed to improve the accuracy of the models it used to hedge against risk. As the housing crisis spread during the Class Period, the Company knew that fundamental indicators of housing market decline, including falling housing prices and rising delinquency rates, were not reflected in the VaR figures it disclosed to the public. (Sec. Compl. ¶¶ 126-128.) According to the OIG Report, in 2006, Bear Stearns’ trading desks had gained ascendancy over the Company’s risk managers, TM found that model review at Bear was less formalized than at other CSE firms and had devolved into a support function and Bear Stearns reported different VaR numbers to OIG regulators than its traders used for their own internal hedging purposes. (Sec. Compl. ¶¶ 129-131.) Traders were able to override risk manager marks and enter their own, more generous, marks for some assets directly into the models used for valuation and risk management by manipulating inputs into Bear Stearns’ WITS system — which was the repository for raw loan data, including such crucial information as a borrower’s credit score, prepayments, delinquencies, interest rates and foreclosure history — and did so to alter the value of pools of loans to enhance their profit and loss positions. (Sec. Compl. ¶ 132.) According to TM memoranda, the risk management department was persistently understaffed, and the head of the Company’s model review program “had difficulty communicating with senior managers in a productive manner.” (Sec. Compl. ¶ 134.) According to the OIG Report, TM, in the fall of 2006, concluded that Bear Stearns’ “model review process lacked coverage of mortgage-backed and other asset-backed securities,” that “the sensitivities to various risks implied by the models did not reflect risk sensitivities consistent with price fluctuations in the market,” and that TM’s discussions with risk managers in 2005 and 2006 indicated that Bear Stearns’ pricing models for mortgages “focused heavily on prepayment risks” but that TM documents did not reflect “how the Company dealt with default risks.” (Sec. Compl. ¶¶ 103-105.) Though Cayne and Molinaro were aware of the SEC’s concerns about Bear Stearns’ risk management program, the Company made no effort to revise its mortgage valuation models to reflect declines in the housing market. The head of the Company’s mortgage trading desk was “vehemently opposed” to the updating of the Company’s mortgage valuation models. (Sec. Compl. ¶¶ 106-107.) As the housing market declined throughout 2007 and into 2008, Bear Stearns continued to rely on its flawed valuation models. Level 3 assets, including retained interests in RMBS and the equity tranches of CDOs, made up 6-8% of the Company’s total assets at fair market value in 2005, and increased to 20-29% of total assets between the fourth quarter of 2007 and the first quarter of 2008. According to the Company’s Form 10-K for the period ending November 30, 2007, the majority of the growth in the Company’s Level 3 assets in 2007 came from “mortgages and mortgage-related securities,” the assets that the Company was valuing using misleading models. As of August 31, 2007, the Company carried $5.8 billion in Level 3 assets backed by residential mortgages, a figure that grew close to $7.5 billion by November 30, 2007. (Sec. Compl. ¶¶ 110-111.) Risk is defined as the degree of uncertainty about future net returns, and is commonly classified into four types: (1) credit risk, relating to the potential loss due to the inability of a counterpart to meet its obligations; (2) operational risk, taking into account the errors that can be made in instructing payments or settling transactions, and including the risk of fraud and regulatory risks; (3) liquidity risk, caused by an unexpected large and stressful negative cash flow over a short period; and (4) market risk, estimating the uncertainty of future values, due to changing market conditions. The most prominent of these risks for investment bankers is market risk, since it reflects the potential economic loss caused by the decrease in the market value of a portfolio. Because of the crucial role that market losses can play in the financial health of investment banks, they are required to set aside capital to cover market risk. (Sec. Compl. ¶¶ 113-114.) VaR is a method of quantifying market risk, defined as the maximum potential loss in value of a portfolio of financial instruments with a given probability over a certain horizon. If the company’s VaR is high, it must increase the amount of capital it sets aside in order to mitigate potential losses or reduce its exposure to high risk positions. (Sec. Compl. ¶¶ 115-117.) The Basel Committee on Banking Supervision, an international banking group that advises national regulators (the “Basel Committee”), determined that investors and regulators needed more accurate ways to gauge the amount of capital that firms needed to hold in order to cover risks. The Basel Committee allowed Bear Stearns and other Wall Street figures to use their internal VaR numbers for this purpose. This use of VaR was incorporated into the requirements for CSE program participants when the CSE program was launched in 2004. Companies participating in the program were required to regularly supply their VaR numbers to federal regulators and to the public. (Sec. Compl. ¶¶ 118-121.) The resignation of the head of model review at the Company in March 2007 gave trading desks more power over risk managers and by the time a new risk manager arrived in the summer of 2007, the department was in a shambles and risk managers were operating in “crisis mode.” (Sec. Compl. ¶¶ 134-135.) By October 2007, the entire model valuation team had evaporated, except for one remaining analyst. (Sec. Compl. ¶ 136.) According to the OIG Report, it was not until “towards the end of 2007” that Bear Stearns “developed a housing led recession scenario which it could incorporate into risk management and use for hedging purposes.” The mortgage-backed asset valuation inputs to the VaR models employed by the Company were never updated during the Class Period and remained a “work in progress” at the time of the Company’s March 2008 collapse. (Sec. Compl. ¶¶ 106-109.) 6. False and Misleading Statements The Securities Complaint describes allegedly materially false and misleading statements with which the Director Defendants are charged. They include statements relating to fiscal year 2006 and fourth quarter 2006 (Sec. Compl. ¶¶ 589), including the December 14, 2006 press release (Sec. Compl. ¶¶ 590-591), the fourth quarter 2006 earnings conference call (Sec. Compl. ¶¶ 592-605), the Form 10-K for fiscal year 2006 (Sec. Compl. ¶¶ 589-629); statements relating to fiscal year 2007 and fourth quarter 2007, including the first quarter press release (Sec. Compl. ¶¶ OSO-OS?), the first quarter conference call (Sec. Compl. ¶¶ 638-645), the first quarter 2007 Form 10-Q (Sec. Compl. ¶¶ 646-661), the second quarter 2007 press release (Sec. Compl. ¶¶ 662-665), the second quarter 2007 conference call (Sec. Compl. ¶¶ 669-671), the June 22, 2007 press release (Sec. Compl. ¶¶ 672-675), the second quarter 2007 Form 10-Q (Sec. Compl. ¶¶ 676-695), the August 3, 2007 press release and conference call (Sec. Compl. ¶¶ 696-703), the third quarter 2007 press release (Sec. Compl. ¶¶ 704-710), the third quarter 2007 conference call (Sec. Compl. ¶¶ 711-715), the third quarter 2007 Form 10-Q (Sec. Compl. ¶¶ 719-735), the November 14, 2007 statements (Sec. Comp. ¶¶ 736-739), the fourth quarter and fiscal year 2007 press release (Sec. Comp. ¶¶ 740-748), the fourth quarter 2007 conference call (Sec. Comp. ¶¶ 749-754), and the fiscal year 2007 Form 10-K (Sec. Comp. ¶¶ 755-781); and the 2008 statements (Sec. Comp. ¶¶ 782-794). Beginning in early 2006, record numbers of subprime loans began to go bad as borrowers failed to make even their first payment (“First Payment Default” or “FPD”), or failed to make their first three payments (“Early Payment Default” or “EPD”). During 2005, only one in every 10,000 subprime loans experienced an FPD. During the first half of 2006, the FPD rate had risen by a multiple of 31; nationwide, about 31.5 out of every 10,000 subprime loans originated between January and June 2006 had a delinquency on its first monthly payment, according to Loan Performance, a subsidiary of First American Real Estate Solutions. (Sec. Comp. ¶¶ 138-140.) Bear Stearns was well aware of the growth in EPDs. In April 2006, Bear Stearns’ EMC Mortgage, reputed to be a primary EPD enforcer, sued subprime originator Mortgage IT over approximately $70 million in EPD buyback demands. (Sec. Comp. ¶ 141.) In May 2006, the California Association of Realtors lowered expectations for California home sales from a 2% decline (2006 sales vs.2005 sales) to a 16.8% decline. Between April and June 2006, the Company faced repeated crises in its United Kingdom subsidiary as a result of poor performance of U.K. loans due to weak underwriting standards. As a result, the Company was left holding some $1.5 billion in unsecuritized whole loans and commitments from this subsidiary. Management at Bear Stearns was deeply concerned about the U.K. developments, and Spector made calls to investigate the crisis. However, the Company did not “use this experience to add a meltdown of the subprime market to its risk scenarios.” (Sec. Comp. ¶¶ 141-145.) In May 2006, after recent data demonstrated dramatically slowing sales, the highest inventory of unsold homes in decades, and stagnant home prices, the chief economist for the National Association of Realtors (“NAR”), admitted that “hard landings” in certain markets were probable. The monthly year-over-year data provided by the NAR showed that by August 2006, year-over-year home prices had in fact declined for the first time in 11 years. Sales of existing homes were down 12.6% in August from a year earlier, and the median price of homes sold dropped 1.7% over that period. Sales of new homes were down 17.4% in August 2006. As 2006 progressed, data aggregated in the NAR’s monthly statistical reports on home sales activity, home sales prices, and home sales inventory revealed (1) accelerating declines in the numbers of homes sold during 2006, which continued and deepened throughout 2007; (2) steadily decreasing year-over-year price appreciation in early 2006, no year-over-year price appreciation by June 2006, and nationwide year-over-year price declines beginning in August 2006 and continuing thereafter; and (3) steadily rising amounts of unsold home “inventory,” expressed in the form of the number of months it would take to sell off that inventory, rising 50% by August 2006 and doubling by late 2007. (Sec. Comp. ¶¶ 145-147.) By the end of 2006, EPD rates for 2006 subprime mortgages had risen to ten times the mid-2006 FPD rate; 3% of all 2006 subprime mortgages were going bad immediately. The 2006 subprime mortgages from First Franklin Financial, Long Beach Savings, Option One Mortgage Corporation and Countrywide Financial had EPD rates of approximately 2%; those originated by Ameriquest, Lehman Brothers, Morgan Stanley, New Century and WMC Mortgage had EPD rates of 3-4%; and those originated by Fremont General had EPD rates higher than 5%. (Sec. Comp. ¶¶ 145-148.) On December 14, 2006, Bear Stearns issued a press release regarding its fourth quarter and year end results for the fiscal year 2006, which closed on November 30, 2006. The release reported diluted earnings per share of $4.00 for the fourth quarter ended November 30, 2006, up 38% from $2.90 per share for the fourth quarter of 2005. It stated that net income for the fourth quarter of 2006 was $563 million, up 38% from $407 million for the fourth quarter of 2005. It is alleged that the Company achieved these results by using valuation models that ignored declining housing prices and rising default rates. These inaccurate models enabled the Company to avoid taking losses on its Level 3 assets, thereby increasing revenues and earnings per share and allegedly falsely inflating the value of its stock. (Sec. Comp. ¶¶ 150-151.) At the time of the statements, the Company’s Level 3 assets represented 11% of its total assets held at market value, or a total of about $12.1 billion. Because these assets were highly leveraged, even a small decline in value would have been vastly magnified. Accordingly, the values the Company assigned to this large group of assets were significantly higher than they should have been, violating GAAP. (Sec. Comp. ¶¶ 589-596). Bear Stearns also announced its fiscal year 2006 results In the same press release, Bear Stearns reported that its earnings per share (diluted) for the 2006 fiscal year were a record $14.27, its net income was $2.1 billion and its net revenues were $9.2 billion. These figures were allegedly false and misleading for the same reasons set forth above. (Sec. Comp. ¶ 590). On December 14, 2006, Bear Stearns held its fourth quarter 2006 earnings conference call, conducted by Molinaro. During the call, Molinaro repeated the financial results set out in the Securities Complaint at ¶ 590 and made statements that are alleged to be materially false and misleading when made, because the Company understood that the unusually risky loans it continued to purchase through its EMC subsidiary were not limited to any particular “vintage.” (Sec. Comp. ¶¶ 598, 601). During a press conference on the same day, Molinaro was asked whether the increased defaults threatened to make the securitization of those mortgages, which were increasingly being originated by Bear Stearns, a risky business. Molinaro responded “Well, I don’t — no, it doesn’t. Because essentially we’re originating and securitizing.” This statement is alleged to be false, as the Company faced significant exposure through the retained CDO tranches it kept on its books and the agreements it maintained with counterparties and CDOs. Based on the Company’s artificially inflated results and the allegedly false assurances by Molinaro, the Company’s stock rose by $4.07, closing at $159.96. (Sec. Comp. ¶¶ 150-153.) Molinaro understated Bear Stearns’ exposure to increasing defaults in the subprime market because Bear Stearns retained on its books $5.6 billion of the riskiest tranches of subprime-backed RMBS on its books. (Sec. Comp. ¶ 65.) Bear Stearns’ underwriting standards were not higher in 2006 than in previous years, and the Company understood that the loans it was continuing to purchase through its EMC subsidiary during the latter part of 2006 and the beginning of 2007 were unusually risky, and in fact EMC was not tightening its underwriting standards. (Sec. Comp. ¶¶ 602-605.) The Asset Backed Securities index (“ABX”), launched in January 2006, and the TABX index, standardized tranches of ABX indices, introduced in February 2007, synthesized subprime mortgage performance, refinancing opportunities, and housing price data into efficient market valuation of CDOs’ primary assets — subprime RMBS tranches, via the ABX and mezzanine CDO tranches, via the TABX — providing observable market indicators of CDO value. In February 2007, the ABX, which tracked CDOs on certain risky sub-prime loans (those rated BBB), declined from above 90 in early February to 72,71 on February 22, 2007, and down to 69.39 on February 23, 2007. TABX tranches also materially declined upon launch, indicating that the value of many CDOs had plunged. The Senior TABX Tranche dropped from a price of nearly $100 in mid-February 2007 to around $85 by the end of February 2007. The TABX continued to fall significantly in the months after February 2007. (Sec. Comp. ¶¶ 154-157.) Nonetheless, Bear Stearns continued to expand its subprime business aggressively. On February 12, 2007, the Company completed its acquisition of ECC, a major originator of subprime loans. (Sec. Comp. ¶¶ 158-159.) On February 13, 2007, Bear Stearns filed its Form 10-K for the annual and quarterly period ended November 30, 2006. The 10-K was signed by, among others, Defendants Greenberg, Cayne, Schwartz, Speetor and Farber. It is alleged that the Form 10-K made misrepresentations regarding the Company’s financial results, risk management practices, exposure to market risk, compliance with banking capital requirements, and internal controls. Finally, the 2006 Form 10-K contained allegedly false and misleading statements by the Company’s auditor, Deloitte, relating to its review and certification of the Company’s reported financial results. As a result, on February 13, 2007, Bear Stearns’ stock closed at $160.10 per share, up from a close of $157.30 per share the day before. The following day, February 14, 2007, Bear Stearns’ shares closed at $165.81. (Sec. Comp. ¶¶ 606-607). The financial results, including revenues, earnings, and earnings per share reported by the Company in the Form 10-K for 2006 were misleading for the same reasons set forth above, relating to the Company’s announced results for fiscal year 2006. Moreover, the Company’s assertions about the value of assets corresponding to Level 3 were allegedly materially false and misleading. (Sec. Comp. ¶¶ 608-609). As set forth above, by the date of this statement, the Company’s Principal Accountant and Controller had already been informed that the models the Company used to value the mortgage-backed securities in this asset category failed to reflect dramatic declines in the housing market. (Sec. Comp. ¶¶ 606-610.) It is alleged that Bear Stearns’ 2006 Form 10-K also misled investors with respect to the Company’s use of its VaR models and the accuracy of its valuation models for assets linked to subprime mortgages. Bear Stearns’ 2006 Annual Report to Stockholders, attached as an Exhibit to the Form 10-K, misrepresented Bear Stearns’ risk control philosophy when it stated that “the Company’s Risk Management Department and senior trading managers monitor exposure to market and credit risk for high yield positions and establish limits and concentrations of risk by individual issuer.” (Sec. Comp. ¶¶ 611— 616). Bear Stearns’ 2006 Form 10-K also misled investors with respect to the Company’s risk management procedures by stating that “comprehensive risk management procedures have been established to identify, monitor and control [its] major risks.” (Sec. Comp. ¶ 617). Bear Stearns’ 2006 Form 10-K also stated that “[t]he Treasurer’s Department is independent of trading units and is responsible for the Company’s funding and liquidity risk management ... [m]any of the independent units are actively involved in ensuring the integrity and clarity of the daily profit and loss statements,” and that: The Risk Management Department is independent of all trading areas and reports to the chief risk officer ... [t]he department supplements the communication between trading managers and senior management by providing its independent perspective on the Company’s market risk profile.” As set forth above, in this period Bear Stearns’ risk managers had little independence from its trading desk, and no ability to rein in the Company’s accumulation of risk. (Sec. Compl. ¶¶ 619-620.) Because of the deficiencies in its VaR models, the Company’s representation in its 2006 Form 10-K that it had an aggregate VaR of just $28.8 million, which was far lower than its peers, was materially false and misleading. In fact, the Company knew that its VaR numbers failed to reflect its exposure to declining housing prices. (Sec. Comp. ¶¶ 160-161, 621-624.) In its 2006 Form 10-K Bear Stearns stated that “the Company is in compliance with CSE regulatory capital requirements.” This statement was allegedly materially false and misleading when made because the Company had misled regulators into believing that it was meeting capital requirements only by repeatedly violating banking regulations relating to the appropriate calculation of net capital. (See Sec. Compl. ¶¶ 427-452.) As set forth above, Defendants Cayne and Molinaro each made allegedly false and misleading statements when they executed Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”) certifications, annexed as an exhibit to the Form 10-K filing. The Company also asserted in its Form 10-K that it marked all positions to market on a daily basis and independently verified its inventory pricing and assessed the value of its Level 3 assets as $12.1 billion. The Company allegedly knew that the models it used to value its Level 3 mortgage-backed assets were badly out of date and did not reflect crucial data about housing prices and default rates and that its risk managers had little power to provide any independent review of these figures. Because of the failure to take appropriate losses on its Level 3 assets, the revenues and earnings per share it reported in its 2006 Form 10-K are alleged to be false and misleading. Cayne and Molinaro executed a certification of these statements, and knew of the Company’s improper risk management and valuation practices, and the harmful consequences this deception would have on investors. As a result of the Company’s continuing misrepresentations about its 2006 results and its VaR exposure, its stock rose $5.71 on February 14, 2007, to close at $165.81. (Sec. Comp. ¶¶ 168-171.) The Company’s auditor, Deloitte, certified Bear Stearns’ 2006 Form 10-K as required by the Sarbanes-Oxley Act and, in so doing, knowingly and recklessly offered a materially misleading opinion as to the financial statements’ accuracy. (Sec. Comp. ¶ 629.) On March 15, 2007, Bear Stearns issued a press release regarding its first quarter 2007 results. As a result, on March 15, 2007, Bear Stearns’ stock closed at