Southern District Of New York Grants In Part And Denies In Part Motion To Dismiss A Putative Securities Fraud Class Action Against An Insurance Company In Connection With Delisting Of Preferred Stock
On August 14, 2020, United States District Judge Katherine Polk Failla of the United States District Court for the Southern District of New York granted in part and denied in part a motion to dismiss a putative securities fraud class action asserting violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 against an insurance company (the “Company”) as well as certain of its officers, who were members of the family that founded the Company and were long-time controlling stockholders. Martinek v. Amtrust Fin. Serv., Inc., No. 19 Civ. 8030 (KPF), 2020 WL 4735189 (S.D.N.Y. August 14, 2020). Plaintiff alleged that the Company made false or misleading statements and omissions about whether the Company’s preferred stock would continue to trade on the New York Stock Exchange (“NYSE”) following a proposed buyout of the common stock by the controlling stockholders. The Court largely denied defendants’ motion to dismiss, holding that plaintiff had adequately alleged scienter and the falsity of two categories of alleged misstatements.
In early 2017, the Company announced that a number of governmental agencies had conducted investigations regarding the Company’s accounting practices, and, that as a result of these investigations, the Company would need to restate its financial statements from 2013 to 2017. The announcement caused the Company’s stock price to decline by half, and a private equity firm specializing in management buyouts approached the controlling stockholders about taking the Company private through a proposed merger. Notably, this proposal only contemplated the acquisition of the Company’s common stock, not the Company’s preferred stock. The Company, in a series of proxy statements and other filings, stated that the preferred stock “will continue to be listed” and later stated that it “expected” that the preferred stock would remain listed on the NYSE after the merger. However, two months after the merger closed, the Company delisted the preferred stock, citing administrative costs associated with maintaining the listing. Plaintiff alleged that the Company’s statements that the preferred stock “will” continue to be listed and that it “expected” that the stock would remain listed were materially misleading. Plaintiff also alleged that other statements made by the Company were fraudulent, specifically that the Company “contemplated” that the preferred stock would remain outstanding and that this was a “key term” of the merger.
First, the Court held that the Company’s statement that the preferred shares “will continue to be listed” on the NYSE after the merger was actionable. The Court observed that (1) the fact that defendants delisted the preferred shares just two months after the merger for reasons knowable to defendants when they made the statements “strongly suggest[ed]” that defendants knew the statements were false when made, and (2) reasonable investors would have interpreted this statement to mean that defendants had made a reasoned determination to maintain the listing. The Court also rejected defendants’ argument that the alleged misstatement was a forward-looking statement protected by the Private Securities Litigation Reform Act, noting that the cautionary language contained only boilerplate and generalized warnings and that “it is questionable that a reasonable investor would have understood assurances that [the Company] ‘will’ take certain action within [its] control to be forward-looking.” Similarly, the Court held that plaintiff adequately alleged that the Company’s statement that it “expected” the preferred stock to remain listed after the merger was actionable. The Court noted that, by the time the Company made this statement, defendants had performed extensive due diligence and would have been aware of the costs of maintaining the listing. The Court also rejected the Company’s argument that the word “expectation” was itself cautionary language and, as a result, such a statement was necessarily a protected forward-looking statement. The Court noted that the Company’s proffered reason for delisting—the cost of maintaining the listing—was not among the risks disclosed in any of the Company’s public filings. Aside from these two categories of misstatements, the Court found that the remaining categories of alleged misstatements were not actionable because they did not suggest that the preferred stock would remain listed, they were too vague to induce reasonable reliance by an investor, or, in some cases, the alleged misstatements were made after the preferred stock had been delisted.
Second, the Court held that plaintiff had adequately alleged scienter. The Court was unimpressed with defendants’ argument that their motives were merely those of corporate officers, which are insufficient to establish scienter. The Court noted that plaintiff had adequately alleged that defendants benefitted in a “concrete and personal way” from the alleged fraud and therefore had established a motive. Specifically, a private buyout enabled the individual defendants to acquire a profitable Company at a historically low cost, eliminated the need for the Company to comply with reporting requirements under the Exchange Act, and foreclosed any derivative liability arising from the accounting scandal that would expose the individual defendants to significant personal liability. According to the Court, all of these benefits depended upon the Company delisting the preferred stock because (1) the Company remained exposed to reporting requirements and derivative liability as long as the preferred stock remained outstanding, and (2) simply buying back the preferred stock would have significantly increased the cost of taking the Company private.