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Stanford University Law School - Securities Class Action Clearinghouse
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UNITED STATES DISTRICT COURT
EASTERN DISTRICT OF NEW YORK
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)
LUCIAN B. COX, III ) CIVIL ACTION NO. CV 97 6083
) [filed Oct. 22, 1997]
Plaintiff, )
) CLASS ACTION COMPLAINT
vs. ) FOR VIOLATION OF
) FEDERAL SECURITIES LAWS
CITYSCAPE FINANCIAL CORP., )
ROBERT GROSSER, and ) JURY TRIAL DEMANDED
ROBERT C. PATENT, )
)
Defendants. )
)
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Plaintiff, as and for his complaint, alleges the following
upon personal knowledge as to himself and his own acts, and upon
information and belief as to all other matters. Plaintiff's
information and belief are based, inter alia, on the investigation
conducted by his attorneys, including a review of public filings of
defendant Cityscape Financial Corporation ("Cityscape" or the
"Company"), reports, press releases and articles pertaining to
Cityscape, and consultation with an accounting expert.
JURISDICTION AND VENUE
1. This court has jurisdiction of this litigation under
Section 27 of the Securities Exchange Act of 1934 (the "Exchange
Act"), 15 U.S.C. Section 78aa.
2. The claims herein arise under Sections 10(b) and 20(a) of
the Exchange Act, 15 U.S.C. Sections 78j(b) and 78t(a), and Rule
10b-5 promulgated thereunder by the Securities and Exchange Com-
mission ("SEC") (17 C.F.R. Section 240.10b-5).
3. Venue is properly laid in this district pursuant to
Section 27 of the Exchange Act and 28 U.S.C. Section 1391(b). Many
violations of law complained of herein occurred in this district,
including the dissemination of statements alleged herein to be
materially false and misleading.
4. In connection with the conduct complained of herein,
defendants, directly or indirectly, used the means and instrumen-
talities of interstate commerce, including the mails and interstate
telephone communications and the facilities of a national securi-
ties exchange.
PARTIES
5. Plaintiff Lucian B. Cox, III purchased shares of Cityscape
common stock on March 25, 1997 at $18.25 per share.
6. Cityscape has it [sic] principal offices in this district at 565
Taxter Road, Elmsford, New York 10523. Cityscape is a consumer
finance company that, through its wholly owned subsidiaries,
Cityscape Corp. and Cityscape Mortgage Corp. Ltd. ("CMC"), is
engaged in the business of originating, purchasing, selling and
servicing mortgage loans in the United States and the United
Kingdom, secured primarily by one to four family residences.
Cityscape was founded in 1985 and is headquartered in Elmsford, New
York, with regional processing offices in California, Georgia,
Illinois and Virginia.
7. Defendant Robert Grosser ("Grosser") served as Chairman,
Chief Executive Officer and a director of Cityscape at all times
relevant to this Complaint.
2
8. Defendant Robert C. Patent ("Patent") was at all relevant
times Executive Vice President and a director of the Company.
9. The persons named as defendants above will sometimes be
referred to herein as the Individual Defendants.
CLASS ACTION ALLEGATIONS
10. Plaintiff brings this action as a class action pursuant
to Rules 23(a) and (b)(3) of the Federal Rules of Civil Procedure
on behalf of all persons (the "Class") who purchased or otherwise
acquired Cityscape common stock from November 4, 1996 to August 13,
1997 (the "Class Period"). Excluded from the Class are the defen
dants, the subsidiaries, affiliates, officers, and directors of
Cityscape, the heirs and the members of the immediate families of
the Individual Defendants, and the successors or assigns of any
defendants.
11. The members of the Class are so numerous that joinder of
all members is impractical. While the exact number of Class
members is unknown to Plaintiff at this time and can only be
ascertained through appropriate discovery, Plaintiff believes that
there are at least hundreds of members of the Class. As of April
17, 1997, there were 29,744,322 shares of Cityscape stock
outstanding, which stock traded in an open and efficient market on
NASDAQ.
12. Plaintiff's claims are typical of the claims of the other
members of the Class, and Plaintiff and all other members of the
Class sustained injuries arising out of defendants' wrongful
conduct complained of herein.
3
13. Plaintiff will fairly and adequately protect the inter-
ests of the members of the Class and has chosen counsel experienced
in class action securities litigation. Plaintiff has no interests
antagonistic to, or in conflict with, the other members of the
Class he seeks to represent.
14. The questions of law and fact common to the other members
of the Class, and which predominate over any questions affecting
individual members, are, inter alia:
(a) Whether the federal securities laws were violated by
defendants' acts as alleged herein;
(b) Whether documents, releases and/or statements dis-
seminated to the investing public and Cityscape shareholders during
the Class Period omitted and/or misrepresented material facts about
the business and financial condition of the Company;
(c) Whether defendants made materially misleading
statements during the Class Period about the business and financial
condition of the Company;
(d) Whether defendants acted knowingly and/or recklessly
in making materially false statements and omitting material facts
about the business and financial condition of the Company;
(e) Whether the market price of the Company's common
stock was artificially inflated during the Class Period due to the
non-disclosures and/or material misrepresentations complained of
herein; and
(f) Whether the members of the Class have suffered
damages and, if so, what is the proper measure of damages.
4
15. A class action is superior to all other available methods
for the fair and efficient adjudication of this controversy since
joinder of all members is impracticable. Furthermore, as the
damages suffered by the Plaintiff or any other individual Class
member may be relatively small, the expense and burden of indi-
vidual litigation make it impossible for the Class members
individually to redress the wrongs done to them. Plaintiff antici-
pates no difficulty in the management of this action as a class
action.
PARTICIPATION OF INDIVIDUAL DEFENDANTS
16. The Individual Defendants participated in the drafting
and preparation of the various public documents (shareholder
reports) and other communications complained of herein and were
aware of, or recklessly disregarded the misstatements contained
therein and omissions therefrom, and were aware of, or recklessly
disregarded, their materially misleading nature. Because of their
board membership and/or executive and managerial positions with
Cityscape, the Individual Defendants had access to the adverse non-
public information about Cityscape's business prospects and
financial condition. The Individual Defendants, by reason of their
stock ownership, management position, and/or membership on
Cityscape's Board of Directors, were controlling persons of
Cityscape and had the power and influence, and exercised the same,
to cause Cityscape to engage in the illegal practices complained of
herein.
5
CONTROL OF INDIVIDUAL DEFENDANTS
17. The Individual Defendants, because of their positions of
control and authority as officers and/or directors of the Company,
were able to and did control the contents of the various quarterly
reports, SEC filings and press releases pertaining to the Company.
The Individual Defendants were provided with copies of Cityscape's
press releases and SEC filings after their issuance, with the
opportunity to cause them to be corrected. Because of their board
membership and/or executive and managerial positions with
Cityscape, the Individual Defendants and Cityscape had access to
the adverse non-public information about Cityscape's business and
finances particularized herein via access to internal corporate
officers and employees, attendance at Cityscape's management and
Board of Directors meetings and committees thereof and via reports
and other information provided to them in connection therewith. As
a result, the Individual Defendants were responsible for the
accuracy of the public reports and releases detailed herein as
"group published" information, and are therefore responsible and
liable for the representations contained therein under Section
20(a) of the Exchange Act.
18. The Individual Defendants either knew or recklessly
disregarded the fact that the illegal acts and practices and mis-
leading statements and omissions described herein would adversely
affect the integrity of the market for Cityscape common stock and
would artificially inflate or maintain the price of those
securities. Each of the defendants, by acting as herein described,
6
did so knowingly or in such a reckless manner as to constitute a
fraud and deceit upon Plaintiff and the other members of the Class
who Plaintiff seeks to represent.
BACKGROUND ALLEGATIONS
19. On April 22, 1996, Cityscape announced sharply higher
mortgage originations and continued business expansion during its
first quarter ended March 31, 1996. The Company announced that net
income for that quarter rose to $9.3 million from just $1 million
for the first period of 1995. The first quarter also saw domestic
loan origination rise to $166.7 million from $60.8 million for the
comparable period in 1995. Cityscape's United Kingdom operations
showed loan originations of $27.4 million, a 37% increase over the
$20 million recorded for the fourth quarter of 1995. These
positive results were discussed by defendant Grosser in the press
release:
The strong performance this quarter reflects
continued penetration of the US and UK
markets. During the quarter, we originated a
total of 2,962 loans from our network of over
800 mortgage brokers and loan correspondents
on both sides of the Atlantic. We achieved
this growth by expanding our product
offerings, cultivating our broker and
correspondent relationships and broadening our
geographical presence. While achieving this
growth, I am pleased to report that there were
no loan charge-offs during the first quarter
of 1996.
This was a particularly eventful quarter for
City Mortgage Corporation Limited, our UK
subsidiary. We completed the first public
European securitization of loans originated by
City Mortgage, and we entered into a new
funding agreement that should enhance the
profitability of our UK business. We also
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positioned City Mortgage for further growth by
agreeing to acquire J&J Securities Limited.
20. On or about July 24, 1996, Cityscape reported its second
quarter results. Net earnings for that period had increased to
$34.8 million from $2.4 million. Domestic loan originations rose
74% as well. Cityscape's United Kingdom operations generated $41.4
million in loans for the second quarter, a 51% increase over the
prior quarter's volume. The Company's UK subsidiary, City Mortgage
Corporation, acquired total loan portfolios of $240.6 million
during the second quarter as a result of its acquisitions of
Heritable Finance Group and J&J Securities Ltd.
21. On August 20, 1996, the London-based newspaper the Daily
Mirror reported on Cityscape's practices in the UK. The article
noted the response of Britain's Office of Fair Trading when it was
confronted with consumer complaints about the Company's practices:
"The City Mortgage Corporation does hold a Consumer Credit Licence
and we would look at any evidence to suggest that they were unfit
to hold such a licence."
22. On or about September 5, 1996, The Wall Street Journal
reported on Cityscape's stock-market rise. It noted that this had
been aided by large increases in the Company's quarterly revenues
and earnings, which were, in part, the result of several large
acquisitions. The article noted that some analysts believed that
Cityscape's business of specializing in making mortgage loans to
homeowners with credit histories "has big growth potential due to
such national economic trends as layoffs from corporate downsizings
and rising consumer debt loads." It stated that a "recent report
8
by Montgomery Securities estimates that sub-prime lending volume
will grow at 10% to 15% annually over the next five years, about
twice as fast as the rate for prime-customer mortgage lending."
The article quoted an analyst with NatWest Securities who favored
Cityscape partly because of its recent expansion into the United
Kingdom, where higher interest rates and more favorable lending
rules than those in the US have resulted in higher per-loan profit,
although he noted that the sub-prime market generally was "clearly
becoming more competitive . . . ."
23. The September 5 article in The Wall Street Journal also
reported that short sellers were betting that past ties between
Cityscape consultant Jay Botchman and John Peter, a convicted
felon, would bring the Company's shares down some. The article
noted that Cityscape's shares had already been hit recently by
rumors, which the Company had recently confirmed, that it was
considering selling five million shares. Concerning this,
defendant Grosser was quoted as stating that a stock offering was
not "imminent necessarily" and that it would be part of normal
financing activities.
24. A September 30, 1996 article in Barron's stated that in
addition to considerable negative press in the United Kingdom over
its lending practices, Cityscape was the subject of negative
comments by a spokesman for the British Labor Party, "which is
expected to win general elections next spring":
These types of loans should be illegal. I
would not hesitate to bring in retrospective
legislation tearing up existing mortgage
contracts.
9
In response, David Steene, of Cityscape's UK subsidiary CMC, stated
that the Company was being treated unfairly by the British press
and that Cityscape is operating in what was a woefully underserved
market. He further noted that the Company's rates and terms were
better than those that many other lenders offer subprime borrowers.
25. On October 21, 1996, an Investor's Business Daily report
featured Cityscape and its expansion into the subprime home equity
loan business in the United Kingdom. With respect to the UK
business, the report said defendant Grosser had represented that
Cityscape enjoyed margins that were approximately four times larger
than those in the US. Grosser stated that "[i]n terms of raw
securitizations, we are doing significantly more in the U.S. But
from a revenue perspective, the UK loans are more profitable." The
report noted that the chief reasons for the profit gap were the
loan prepayment penalties in the UK, as well as longer payment
schedules. Additionally, the report noted, "with so few players in
the UK subprime market, companies there get higher rates on loans
. . . ." Defendant Grosser was quoted as stating that "[w]e really
feel we have a leadership role and pioneering role in exporting the
nonconforming loan sector to the UK." The report confirmed that by
the end of 1995, the Company had originated approximately $41
million in UK loans with another $68 million in the first half of
1996. Moreover, with the acquisitions of Heritable Finance Group
and J&J Securities Ltd., the Company then held approximately $240
million in loans in the UK. The report concluded that the UK
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business represents just under half of Cityscape's $153 million in
annual revenues.
SUBSTANTIVE ALLEGATIONS
Defendants' False And Misleading Statements
26. In a November 4, 1996 press release (which was
disseminated by Business Wire), Cityscape announced its financial
results for its third quarter ended September 30, 1996. The
Company reported net earnings of $14.9 million, a substantial
increase from the $3.8 million reported for the same period in
1995. These results were repeated in the Company's Form 10-Q for
its third quarter, filed with the SEC on or about November 19,
1996. In its November 4 press release, Cityscape attributed its
1996 results to "the continuing increases in both US and UK loan
originations. The company's rising volume is primarily due to the
ongoing expansion of its origination network, the introduction of
new lending products and the overall growth of demand in its
markets." Loan originations for the Company's UK operations were
$67.6 million, up 393% over the comparable quarter in 1995 and up
63% over the second quarter of 1996 (excluding the second quarter
loans acquired as a result of the J&J Securities Ltd. and Heritable
Finance Group acquisitions). With respect to Cityscape's UK
operations, defendant Grosser stated:
In addition to the continued success of our
domestic operation, our United Kingdom
subsidiary, City Mortgage Corporation Limited
("CMC"), has made many significant advances
during the quarter. . . . Earlier this year
CMC obtained from Parliament a special license
to provide financing for up to 4.5 million
Council tenants who qualify to buy their
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houses at a significant discount to market
value under the "Right to Buy" legislation.
Our Direct Marketing Division began operations
in July initially targeting two million such
households using direct mail and
telemarketing, and CMC recently created an
exclusive partnership with one of the UK's
leading finance brokers to market CMC loan
products through television advertising. . . .
our growing production capabilities as well as
the increasing acceptance of our products in
the UK enabled us to complete two UK
securitizations of $102 million and $189
million, respectively, subsequent to the close
of the third quarter.
27. Defendant Grosser's statements described above were false
and misleading because Cityscape knew, or recklessly disregarded
the fact, that the Company's loan practices were under threat in
the United Kingdom and, therefore, Cityscape knew that the high
revenues generated by its UK loans would not continue in the
future. Defendants knew that Cityscape's UK business represented
just under half of the Company's total annual revenues. They also
knew that one of the primary reasons the UK operations were so
profitable was the loan prepayment penalties the Company exacted on
borrowers in the UK. This practice was one of several that had
caused considerable public outrage in Britain and had caught the
attention of politicians there. For these reasons, defendants knew
that reserves would likely have to be substantially adjusted upward
to account for any limitations placed on its business practices by
the government in the UK as any such limitations would reduce the
Company's earnings substantially.
28. On November 11, a National Mortgage News Report noted
that some analysts expected spreads on Cityscape's highly
12
profitable UK business to narrow. This expectation arose both from
greater competition from other American companies entering the
market, as well as "the possibility of the British Parliament's
placing sharp (and possibly retroactive) restrictions on subprime
home equity lending, the centerpiece of the City Mortgage Co.
(Cityscape's London affiliate) business in the UK" (emphasis
added). Defendants again attempted to downplay any possible effect
to its UK operations. Tim Lembick, Cityscape's Chief Financial
Officer, stated that "the company sees 'no real prospect of
legislation' coming from the Parliament that would curb the
company's activities.'"
29. On November 19, 1996, the Dow Jones News Service reported
that Cityscape had revised its second and third quarter earnings
results in order to reflect certain additional changes in the
accounting treatment used in connection with the acquisitions of
British-based Heritable Finance Group and J&J Securities Ltd. in
the second quarter. Specifically, second quarter earnings were
revised to $11.1 million from $8.3 million while third quarter
earnings were revised to $14.4 million from $14.9 million. The
report noted that the accounting changes involved resulted from the
reclassification to goodwill of $5 million of restructuring charges
expensed and $17.3 million in deferred tax assets recorded in the
second quarter. The Company had noted that these changes resulted
in an increase in the amount of goodwill recorded in connection
with the acquisitions to $30.6 million from $10.6 million.
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30. The Company's repeated false statements that its
operations, including its UK operations, would continue to expand
profitably influenced analysts covering the Company's stock. For
example, on November 21, 1996, the Dow Jones News Service reported
that a NatWest Securities analyst had restarted coverage of
Cityscape with a "buy" rating. The analyst's research note said
the Company's management team was "stronger and wiser in light of
the company's difficulties." NatWest also noted that the Company's
position in the United Kingdom was increasingly valuable. A few
days later, in a November 25 Dow Jones News Report, it was reported
that Wheat First Butcher Singer had upgraded its rating of
Cityscape from "outperform" to "buy." The Dow Jones News Report
stated that in a research note Wheat First Butcher Singer said it
had "more confidence in Cityscape since accounting issues have been
resolved, and that the company's shares have less downside
volatility in the near term."
31. On or about March 31, 1997, Cityscape filed with the SEC
its Form l0-K for the year ending December 31, 1996 (the "l996 Form
10-K"). The 1996 Form 10-K was signed by among others, defendants
Grosser and Patent. Cityscape reported that in March of 1997, the
Company had received notice from the British Office of Fair Trade
(the "OFT") that in reviewing the Company's license the OFT would
consider whether the Company had engaged in inappropriate loan
practices. The Company implicitly admitted that it had engaged in
at least some of the wrongful conduct. The Company stated:
The majority of the stated business practices are either
(i) not applicable to [CMC's] operations or (ii)
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practices in which [CMC] engages and believes itself to
be in compliance or easily able to modify its operations
in order to comply with the OFT letter. The OFT letter,
however, questions the appropriateness of standard
concessionary rate structures1, as well as the
calculation of prepayments using the Rule of 78 method.2
The Company is reviewing and evaluating its practices
with respect to each issue raised in the letter. . . The
Company does not believe regulatory initiatives set forth
in the letter will have a material adverse effect on any
of its mortgage loans or to the continuance of its
licenses, although no assurances to that effect can be
given at this time. (Emphasis added).
The standard rate/concessionary rate structure utilized
in some of its loans products is enforceable under
English Law, and that providing for a Standard Rate that
can be reduced to a Concessionary Rate upon prompt
payment does not contravene the common law rule against
charging penalty interest. In addition the Company
believes that the provisions of such loans entitling the
Company to accelerate repayment upon the occurrence of
____________________
1 While the OFT, in the March 1997 letter to the Company, chose
not to contest the legality of certain loan covenants, in actuali-
ty, dual rate loans and the Rule of 78 method of calculating
interest rebates were thinly disguised methods of charging sub-
prime mortgagors penalty interest in direct contravention of
English and Common Law. The standard/concessionary dual rate
structure was CMC's attempt to circumvent the English and Common
law rule against charging late payment penalty interest by
assigning a dual rate structure to its loans whereby an extremely
high "standard rate" of interest was assigned, but a borrower would
be charged a lower, "concessionary rate" if payments were made when
due. However, the "standard rate" is actually a penalty because
(a) it is a substantially higher rate of interest than the
"concessionary rate," and (b) it is only effective in accompanying
late payments.
2 The "Rule of 78" is also an oppressive and deceitful attempt
by Cityscape and CMC to charge mortgagors penalty interest. The
Rule of 78 is a method by which CMC circumvented the English and
Common law rule against charging pre-payment interest penalties.
If a UK borrower redeemed his loan in full prior to the maturity
date (whether voluntarily or through default) the equivalent of an
early payment fee would be charged as a result of the borrower's
contractual obligation to pay a stated amount of interest under his
note. The majority of CMC's loans calculate the pre-payment fee by
calculating the total principal and interest due over the full term
of the loan then applying a rebate for the unexpired portion of the
loan term.
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specified events of default and calculate the interest
rebate using the Rule of 78 with a six month deferment
are not penalties. (Emphasis added).
32. The March 1997 letter further put defendants on notice by
the OFT that such practices by Cityscape would no longer be
tolerated. Defendants knew, or were reckless in not knowing, that
because of, inter alia, press reports in the Fall of 1996 and the
March 1997 OFT notification, the statements made in the 1996 Form
10-K were materially false and misleading, because in the 1996 10-K
it was reported that "the Company does not believe regulatory
initiatives set forth in the [OFT] letter will have a material
adverse effect on any of its mortgage loans." The Company knew, or
recklessly disregarded the fact that the high revenues generated by
UK loans would not continue in the future, and that reserves would
need to be substantially adjusted upward to account for this which
would reduce earnings substantially. In essence, the Company knew
and/or recklessly disregarded the fact that the OFT's regulatory
initiatives would have a material adverse effect on the Company.
33. On April 24, 1997, as reported in Business Wire,
Cityscape announced its first quarter results for 1997. Cityscape,
attempting to maintain an illusion of continuing growth, and in an
effort to maintain falling stock prices, reported record earnings
for the first quarter of 1997. Cityscape reported an 80.6 percent
increase in earnings on a 193.4 percent increase in revenues for
its first quarter ended March 31, 1997, compared with the same
period in 1996. Net earnings for the first quarter of 1997 were
reported to be $16.8 million or 50 cents per fully diluted share,
16
up from $9.3 million or 31 cents per share in the first quarter of
1996. Revenues reportedly increased to $84.5 million for the
quarter, from $28.8 during the same period in 1996. Domestic loan
originations totaled $388.1 million up 132.8 percent over the
$166.7 million originated in the first quarter of 1996. UK loan
originations were reported to total $99.2 million, up 262 percent
over the $27.4 million originated in the first quarter of 1996.
However, gain on sales of all Cityscape loans increased $36.6
million or 151.9 percent to $60.7 million in the first quarter of
1997. This increase was due primarily to the Company's UK gain of
$33.9 million on $117.4 million of loan sales in the first quarter
of 1997, compared to a gain of $12.2 million on the $27.4 million
of loan sales in the first quarter of 1996. While UK loan
originations accounted for roughly 25 percent of Cityscape's
overall loan volume, gain on sales of the UK loans was
approximately two times the gain on sale of U.S. loans.
34. On April 24, 1997, Business Wire reported defendant
Grosser's reaction to the first quarter results:
The first quarter results underscore the
Company's commitment to the fundamentals of
our business, sound underwriting practices and
aggressive servicing.
Furthermore, defendant Grosser went on to exclaim that,
"[Cityscape's] performance during the quarter reflects the
continued growth of our new products and the strength of our core
business, both in the U.S. and in the UK."
35. On May 12, 1997 Cityscape filed its Form l0-Q for the
first quarter ending March 31, 1997 which repeated the results
17
disseminated on April 24. Cityscape again acknowledged receipt of
the March 1997 letter from the OFT:
The Company anticipates that the UK gain on
sale margin will continue to decrease in the
future as a result of the introduction of such
new loan products and as a result of the
Company's intention to discontinue originating
unregulated loans that utilize the Rule of 78
method commencing in the early part of the
second half of 1997. . . . The Company does
not believe regulatory initiatives set forth
in the letter will have a material adverse
effect on any of its mortgage loans or to the
continuance of its licenses, although no
assurances to that effect can be given at this
time. (Emphasis added).
36. The first quarter results announced by the Company on
April 24, the statements made by defendant Grosser the same day,
and the first quarter Form 10-Q were materially false and
misleading because, inter alia, defendants, in violation of
Generally Accepted Accounting Principles ("GAAP") (as set forth
below) failed to record as a result of, inter alia, the OFT Notice,
a valuation allowance relating to mortgage prepayments and Rule of
78 computations. The Company's failure to take the valuation
allowance resulted in an overstatement in net earnings of $9.7
million after taxes and an overstatement in total revenues of $15
million. Furthermore, no steps were taken by the Company to
correct the earlier statements made by defendant Grosser that
growth would continue in 1997. Defendants failed to acknowledge
the economic impact of discontinuing these loan practices, which
related to a majority of loans made in the UK and which accounted
for a substantial amount of Company profits. By reporting record
earnings for the first quarter of 1997, Cityscape attempted to
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create the impression that growth would continue. By reporting
that regulatory initiatives would not have a material effect,
Cityscape mislead investors into believing that operations,
revenues and profits would not be materially adversely effected by
changes in UK lending policy.
37. The first quarter results announced by the Company on
April 24, 1997, the statements made by defendant Grosser the same
day, and the first quarter Form 10-Q were materially false and
misleading because defendants, in violation of the Company' [sic] own
revenue recognition policy (as set forth below) failed to record as
a result of, inter alia, the OFT Notice, a valuation allowance
relating to prepayment and Rule of 78 reforms. The Company's
failure to take the valuation allowance resulted in an
overstatement in net earnings of $9.7 million after taxes and an
overstatement in total revenues of $15 million. According to the
1996 10-K and the first quarter 1997 IO-Q, defendants were clearly
in violation of Cityscape's revenue recognition policy. In the
Notes to Consolidated Financial Statements, of Cityscape's first
quarter l0-Q for the quarter ended March 31, 1997, at note 2, the
Company stated:
The accompanying consolidated financial
statements and the information included under
the heading 'Management's Discussion and
Analysis of Financial Condition and Results of
Operations' should be read in conjunction with
the consolidated financial statements and
related notes of the Company for the year
ended December 31, 1996.
38. In Cityscape's "Notes to Consolidated Financial
Statements" contained in the 1996 10-K, Note 3, "Summary of
19
Significant Accounting Policies: Revenue Recognition," the Company
stated, among other things:
Gains and losses on sale of mortgage loans are
realized when mortgage loans are sold to
investors. . . . Gain on sale of loans is
recorded on the settlement date. Included in
gain on sale of loans is the present value of
the differential between the interest rate
payable by an obligor on a loan over the
interest rate passed through to the purchaser
acquiring an interest in such loan, less
applicable recurring fees including the credit
enhancements and trustee fees. . . . In the
case of UK securitizations, or a sale into a
loan purchase facility, the Company records a
mortgage servicing receivable. . . . Although
the Company believes it has made reasonable
estimates of the fair value of the interest-
only and residual certificates likely to be
realized, the rate of payment and the amount
of defaults utilized by the Company are
estimates and actual experience may vary from
its estimates. . . . Higher than anticipated
rates of loan prepayments or losses would
require the Company to write down the fair
value of the interest-only and residual
certificates, adversely impacting earnings.
(Emphasis added).
39. Defendant Grosser had no basis in fact to make such
optimistic statements about the future profitability of Cityscape
since he knew and/or recklessly disregarded the fact that Cityscape
should have recorded valuation allowances in the first quarter of
1997, due, inter alia, to the receipt of the March 1997 OFT letter.
The valuation allowance in the amount of $15 million was ultimately
recorded in the second quarter.
40. On May 25, 1997, the London-based newspaper The Times
reported the following account of CMC's "aggressive servicing"
techniques. The Times reported that, "CMC, a subsidiary of the
American firm Cityscape Financial Corporation, said it would
20
investigate allegations that one of its brokers had carried a
machete in his car when visiting clients and others forged clients'
signatures or inserted fees after the client had signed the
agreement."3
41. On July 15, 1997, The Times reported that six law firms
were planning to launch a class action suit on behalf of 1,200 CMC
borrowers. It said that attorneys for the class believe that the
Company's use of dual rate interest structures and exorbitant
redemption penalties are unfair loan practices made illegal by laws
introduced three years ago. By this time, a group calling itself
the "CMC Victims Association" had been formed, and a "CMC Victim
Support Group" had been founded. The article noted that if the
High Court does rule in favor of these plaintiffs, this could pave
the way for compensation claims from all 30,000 CMC borrowers.
42. On July 18, 1997, after an investigation of the practices
of CMC and other subprime lenders operating within the UK, and in
an effort to crack down on "deceitful and oppressive" loan
practices by such companies, the OFT announced Non-Status Lending
Guidelines consistent with its March letter which, among other
things, officially made explicit that which was implicit during the
Class Period -- that mortgage lenders would not be able to charge
substantial penalty interest fees or charge prepayment penalties.
The OFT warned that if lenders and/or brokers continued to engage
in such practices, it would take regulatory action against them.
____________________
3 On August 18, 1997, in an effort to discourage media criti-
cism, Cityscape announced that it had filed a libel suit against
The Times for comments made in its May 25, 1997, issue.
21
Among the practices again condemned by the OFT were (i) dual
interest rate structures involving a large differential between the
two interest rates and (ii) the Rule of 78's method of calculating
prepayments (prepayment penalties would be allowed but only to the
extent that they corresponded to the lenders actual costs and
expenses associated with a default or early redemption).
43. Also, on July 18, 1997, Parliament member Paul Flynn
blasted CMC, calling the Cityscape subsidiary a "mortgage from
hell" loan firm. Flynn said of CMC's loan practices: "[CMC]
offers a lifeline to people in financial difficulty which turns out
to be a noose." Flynn went on to ask the Government to withdraw
CMC's credit license and to remove CMC from its list of "right to
buy" lenders recommended to council tenants.
44. On July 29, 1997, the London-based newspaper The
Independent reported that CMC announced that it was withdrawing its
two-tier interest rate plans. According to Company director David
Steene, the two-tier rate plans would be replaced by single rate
plans.
45. On August 4, 1997, Cityscape shocked Wall Street by
announcing disastrous second quarter results. The Company reported
net earnings of $3.6 million or $0.08 per share, for the quarter
ended June 30, 1997. This compared to $11.1 million or $0.35 per
share in the second quarter of 1996, and down from $16.8 million or
$0.50 per share for the first quarter of 1997. Results were
reduced by two one-time charges, which lowered earnings by a
combined $0.44 per share. First, the Company had incurred an
22
after-tax charge of $4.7 million or $0.15 per share, related to the
induced conversion of $14 million of the Company's convertible
subordinated debentures. Second, in response to the final announ-
cement of the Non-Status Lending Guidelines issued by the OFT,
which merely made explicit what had been implicit during the Class
Period, the Company took a $15 million pre-tax (or $9.1 million
post-tax) valuation allowance against gain on sale to augment
reserves related to recorded mortgage servicing receivables.
Finally, almost five months after being formally notified of
problems by the OFT, the Company began to take action regarding its
UK loans.
46. On August 7, 1997, as reported in the American Banker,
Moody's investment ratings service downgraded Cityscape's debt
rating because of the Company's growing number of seriously
delinquent loans, and the expected inability of the Company to deal
with the rising delinquency rate because of insufficient reserves
and the likelihood that future revenues would be cut as a result of
UK loan regulation reforms.
47. By August 13, 1997, on heavy trading volume, the price of
Cityscape stock had fallen to a 52 week low of $8.625 per share.
In an effort to stop the free-fall in its stock price, the Company
announced in a press release on that day that it knew of no reason
for the unusual trading activity in its stock, adding further that
there had been no material changes in its operating results or
financial condition since June 30, 1997. In the same August 13
press release it also stated that on August 12, CMC had announced
23
that it "had undertaken a voluntary review of its outstanding UK
loans."
48. On August 14, 1997, Money Marketing reported that CMC
announced that it was carrying out an internal investigation of its
Company and brokers concerning the possibility of malpractice.
Cityscape again contended that it was reviewing all UK loans made
since 1995 to make sure that it had been fair in its dealings with
borrowers.
49. The extent to which defendants had deceived the investing
public about the likelihood that its lending practices in the UK
were under threat was demonstrated by an August 21, 1997 article in
Money Marketing. That article noted that in July, the OFT
published guidelines that give companies such as Cityscape "until
September to clean up their act. If they fail to, OFT director-
general John Bridgeman will seek High Court injunctions to prevent
lenders using unfair contracts or strip them of their credit
licenses." The article noted that the OFT's actions had "led the
biggest player in the market, the City Mortgage Corporation, to
abolish its product range 'voluntarily.' CMC also launched an
investigation into its operations and its brokers to check for the
possibility of malpractice two weeks ago."
50. The August 21 Money Marketing article noted that CMC had
received "the most flak from the public and MPs for its dual
interest-rate schemes and high charges." It went on to state:
CMC offered borrowers, prior to August 1, an
initial interest rate of 9.9 per cent which
then went up to 16 or 17 per cent (over twice
the current bank base rate) if they defaulted
24
on repayments three times. It has now
scrapped dual interest rates in line with the
OFT's guidelines and introduced a single
standard rate of up to 11.9 per cent.
CMC's parent company Cityscape UK has put
aside $15m for exceptional costs, including
the review.
UNDISCLOSED ADVERSE INFORMATION
51. The true adverse facts about Cityscape's loan policies
and practices and the resultant valuation allowance adjustment due
to the modification of late payment and pre-payment interest
penalties, were known to and/or recklessly disregarded by
defendants. These true adverse facts were in direct contrast to
the positive representations made by defendants during the Class
Period concerning Cityscape's business operations and practices,
its earnings, revenues and net income. These representations were
false and misleading and operated to artificially inflate or
maintain the market price of Cityscape's common stock during the
Class Period. Each of the statements particularized above, made by
defendants, as alleged herein, was or became materially false and
misleading and misrepresented and/or failed to disclose material
adverse information as follows:
(a) Defendants failed to disclose the likelihood that it
would be forced to change its highly lucrative lending practices in
the UK and that this would have a material adverse effect an its
existing mortgage loans and require the Company to take substantial
additional reserves;
(b) Defendants failed to amend valuation allowances and
take a sufficient adjustment in reserves for the first quarter of
25
1997, after being notified by the OFT in March of 1997, that
practices such as dual rate loans and Rule of 78 prepayment
penalties would not be tolerated by British officials;
(c) In violation of GAAP (as set forth below) and the
Company's own revenue recognition policy, defendants failed to
disclose that reported earnings per share and net income in the
first quarter of 1997 were materially overstated because a
valuation allowance, as required by the March 1997 OFT letter, was
not recorded in that quarter. Revenues and earnings for the first
quarter were materially false and misleading in that revenue was
overstated by $15 million because the Company failed to record as
a result of the OFT notice, a $15 million valuation allowance
relating to pre-payment and Rule of 78 reforms which resulted in an
overstatement in net earnings of $9.7 million after taxes. As a
result of the charge not being taken in the first quarter the
Company also overstated total revenues, reported at $50 million, by
$15 million. Clearly the $15 million and $9.7 million dollar
figures were material amounts within the reporting requirements of
GAAP, and based on GAAP and the Company's own revenue recognition
requirements, the Company had a duty to disclose these amounts and
take the reserve in the proper quarter; and
(d) Defendants failed to disclose that there was no
reasonable basis for defendant Grosser to state on April 24, 1997
that he was confident that the Company's ventures and investments
would keep revenue growth strong in 1997, since insufficient
reserves and the introduction of new loan products which were going
26
to target higher quality borrowers with lower initiation and
prepayment fees, would prevent the Company from achieving
profitability and growth in the second fiscal quarter of 1997.
52. The Company's financial statements for the first quarter
of 1997, issued during the Class Period over the wire services and
in its Form l0-Q filing for the quarter ended March 31, 1997
violated the following provisions of GAAP, among others:
(a) The Company's financial statements issued for the
quarter ended March 31, 1997 failed to comply with the accounting
principle of reliability, which requires that reported information
be reliable to the extent that users can depend on it to represent
the economic conditions or events that it purports to represent and
that such information is reasonably free from error or bias (FASB
Statement of Concepts No. 2 and APB Statement No. 4);
(b) The Company's financial statements issued for the
quarter ended March 31, 1997 failed to comply with the accounting
principle of completeness which requires that financial information
be complete and that it validly represents the underlying events
and conditions (FASB Statement of Concepts No. 2 and APB Statement
No. 4);
(c) The Company's financial statements issued for the
quarter ended March 31, 1997 failed to comply with the accounting
principle of conservatism, which requires that a conservative
approach be taken in the accounting for transactions and the early
recognition of unfavorable events (FASB Statement of Concepts No.
2 and APB Statement No. 4);
27
(d) The Company's financial statements issued during the
Class Period failed to comply with the accounting principle of
neutrality, which requires that there should be an absence, in
reported information, of bias intended to attain a predetermined
result (FASB Statement of Concepts No. 2); and
(e) The Company's financial statements issued during the
Class Period failed to comply with the accounting principle of
relevance, which requires that reported information should have the
capacity to make a difference in a decision by helping users to
from predictions about the outcomes of past, present and future
events (FASB Statement of Concepts No. 2).
53. As a result of the disclosure of the truth concerning
Cityscape's financial condition and operations, which began on
August 4, 1997 and continued through August 13, 1997 with the
Company's announced review of all UK loans, the price of Cityscape
stock (which had traded as high as $ 31 1/2 per share during the
Class Period) closed at $ 10 1/8 per share on August 13.
54. In ignorance of the adverse facts concerning Cityscape's
true business and financial condition, which were concealed by
defendants, Plaintiffs and the other members of the Class purchased
Cityscape common stock at artificially high prices, relying upon
the statements made and/or upon the integrity of the market and
were damaged thereby.
55. Had Plaintiff and the other members of the Class known of
the materially adverse information not disclosed by the defendants,
28
they would not have purchased Cityscape common stock at the artifi-
cially inflated prices that they did.
FIRST CLAIM FOR RELIEF FOR
VIOLATION OF SECTION 10(b) OF THE
EXCHANGE ACT AND SEC RULE 10b-5
56. Plaintiff repeats and realleges each and every allegation
contained in paragraphs 1 through 55 of the Complaint as if fully
set forth herein.
57. During the Class Period, the defendants engaged in a
course of conduct, described above, pursuant to which they
knowingly or recklessly engaged in acts, transactions, practices,
and a course of business which operated as a fraud upon Plaintiff
and the other members of the Class; made various untrue statements
of material facts and omitted to state material facts necessary to
make statements made, in light of the circumstances under which
they were made, not misleading to Plaintiff and the other Class
members; and employed manipulative and deceptive devices and con-
trivances in connection with the purchase of Cityscape securities.
58. The purpose and effect of the defendants' plan, scheme,
and course of conduct was to artificially inflate the price of
Cityscape common stock and then artificially maintain the market
price of the stock.
59. The Individual Defendants, through their positions as
directors and officers of the Company, had actual knowledge of the
material omissions and/or the falsity of the statements set forth
above, and intended to deceive Plaintiff and the other members of
the Class or, in the alternative, acted with reckless disregard for
29
the truth when they failed or refused to ascertain and disclose in
the aforementioned documents the true facts to Plaintiff and the
other members of the Class.
60. Defendants Cityscape and the Individual Defendants had
actual knowledge of the material omissions and/or the falsity of
the statements set forth above, and intended to deceive Plaintiff
and the other members of the Class or, in the alternative, acted
with reckless disregard for the truth when they failed or refused
to ascertain and disclose in the aforementioned documents the true
facts to Plaintiff and the other members of the Class.
61. The statements made by defendants during the Class Period
regarding Cityscape's future outlook, assets, earnings, revenues,
reserves and the effect of changes in UK loan policies were
materially false and misleading when they were made since, at the
time they were made, the defendants were aware, or recklessly
disregarded the fact that the Company had grossly under-reported
valuation adjustments and reserves. Indeed, the Company's August
4, 1997, announcement of the huge reserves that the Company was
going to take lead to a devastating second quarter which could not
have surprised defendants, and was not due to circumstances that
were unforseen to defendants if they had, as stated, periodically
and continuously assessed the value of all assets and necessary
reserves.
62. Throughout the Class Period, in knowing and reckless
disregard for the truth and/or as part of their common plan and
ongoing efforts to continue the illusion of Cityscape's business
30
success, expected substantial profitability and future business
prospects, the defendants continued to issue, and/or participated
in the issuance of, materially false and misleading statements to
the investing public as particularized above. Moreover, defendants
failed to correct said statements and omissions when, during the
Class Period, defendants knew or were recklessness in not knowing
that the statements they previously made or disseminated had become
materially false and misleading.
63. Pursuant to their aforesaid plan and scheme defendants
made or issued, among others, statements that were materially
misleading when made for the reasons set forth above and in that
they failed to disclose the aforementioned material, adverse facts
about Cityscape's business, financial condition and future business
prospects, which were known to and/or recklessly disregarded by
defendants.
64. As a result of the foregoing, the market price of
Cityscape stock was artificially inflated during the Class Period.
In ignorance of the materially false and misleading nature of the
misrepresentations, described above, made by defendants and the
deceptive and manipulative devices and contrivances employed by the
defendants, Plaintiff and the other members of the Class relied, to
their detriment, on the integrity of the market price of the stock
in purchasing Cityscape stock. Had Plaintiff and the other members
of the Class known of the material adverse information not
disclosed by the defendants, they would not have purchased
Cityscape stock at the artificially inflated prices that they did.
31
65. Plaintiff and the other members of the Class have suffer-
ed substantial damages as a result of the wrongs alleged herein.
66. By reason of the foregoing, defendants have directly or
indirectly violated Section 10(b) of the Exchange Act and Rule l0b-
5 promulgated thereunder, in that they: (a) employed devices,
schemes and artifices to defraud; (b) made untrue statements of
material fact or omitted to state material facts necessary to make
the statements made not misleading; and (c) engaged in acts,
practices and a course of business which operated as a fraud or
deceit upon Plaintiff and the other members of the Class in connec-
tion with their purchases of Cityscape stock during the Class
Period.
SECOND CLAIM FOR RELIEF FOR VIOLATION
OF SECTION 20(a) OF THE EXCHANGE ACT
67. Plaintiff repeats and realleges each and every allegation
set forth in paragraphs 1 through 66, as if set forth fully herein.
68. The Individual Defendants, by virtue of their offices,
directorships, and specific acts were, at the time of the wrongs
alleged herein, controlling persons of Cityscape within the meaning
of Section 20(a) of the Exchange Act. The Individual Defendants
had the power and influence and exercised the same to cause
Cityscape to engage in the illegal conduct and practices complained
of herein by causing the Company to disseminate to the public, or
through analysts, the materially false and misleading information
referred to above.
69. The Individual Defendants' positions made them privy to
and provided them with actual knowledge of the material facts con-
32
cealed from Plaintiff and the Class by Cityscape during the Class
Period.
70. By reason of the conduct alleged in the First Claim for
Relief, the Individual Defendants are liable for the aforesaid
wrongful conduct and are liable to the Plaintiff and the members of
the Class for the substantial damages which they suffered in
connection with their purchases of Cityscape common stock during
the Class Period.
JURY DEMAND
WHEREFORE, Plaintiff on his own behalf, and on behalf of the
other members of the Class, pray for judgment as follows:
A. Declaring this action to be a proper class action,
certifying the Plaintiff as a Class representative and his counsel
as Class Counsel;
B. Declaring and determining that the defendants violated
the federal securities laws by reason of their conduct as alleged
herein;
C. Awarding money damages against the defendants, jointly
and severally, in favor of the Plaintiff and the other members of
the Class for all losses and injuries suffered as a result of the
acts and transactions complained of herein, together with prejudg-
ment interest on all of the aforesaid damages which the Court shall
award from the date of said wrongs to the date of judgment herein
at a rate the Court shall fix;
33
D. Awarding Plaintiff his costs and expenses incurred in
this action, including reasonable attorneys', accountants' and
experts' fees; and
E. Awarding such other relief as may be just and proper.
Plaintiff demands a trial by jury on all issues.
Dated October 21, 1997.
STULL, STULL & BRODY
/s/
________________________
Jules Brody (JB 9151)
Mark Levine (ML 0180)
Michael A. Swick
6 East 45th Street
New York, NY 10017
(212) 687-7230
Steven J. Toll
COHEN, MILSTEIN, HAUSFELD
& TOLL, P.L.L.C.
1301 Fifth Avenue
Suite 2905
Seattle, WA 98101
(206) 521-0080
Mark S. Willis
COHEN, MILSTEIN, HAUSFELD
& TOLL, P.L.L.C.
1100 New York Avenue, N.W.
West Tower, Suite 500
Washington, D.C. 20005-3934
(202) 408-4600
Counsel for Lucian B. Cox, III
34
Source: Scanned paper copy of court-filed document