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.
Originally published by Shearman & Sterling, August 2020
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