Corporate Governance

In re: American Express Co. Securities Litigation

By Rachel Taylon

In a case that may become increasingly important as the market crisis continues, the Southern District of New York in In re: American Express Co. Sec. Litig., 02 cv 5533 (S.D. N.Y. Sept. 26, 2008) dismissed a shareholder complaint that alleged Amex fraudulently misrepresented its high risk - high yield investments. Plaintiffs, who bought common stock between July 1999 and July 2001, brought a securities class action lawsuit against American Express (“Amex”) and seven of its officers claiming securities fraud under section 10(b).

In their complaint, Plaintiffs alleged three categories of fraud: (1) false and misleading statements regarding adoption of risk managements procedures; (2) failure to comply with Generally Accepted Accounting Procedures (“GAAP”) concerning losses from the High Yield Debt investments; and (3) mischaracterizations regarding 2001 investment developments.           

Securities fraud requires proving statements or omissions of material fact made with scienter. In securities fraud statutes, scienter is a mental state that requires the intent to deceive, manipulate, or defraud or at least knowing misconduct. Allegations that someone “ought to know” is not enough to plead scienter. A court must take into account all the facts alleged collectively and find a strong inference of scienter and not infer scienter solely from an individual event. Plaintiffs may establish scienter by proving the defendants intentionally acted fraudulently to benefit personally, deliberately participated in illegal behavior, knowingly did not disclose inaccuracies in company financial statements, or recklessly failed their duty to monitor.           

Plaintiffs claimed the incentive to increase compensation motivated Defendants and that Defendants should have known of the fraud based on their positions within the company. The court reasoned that a desire to increase executive compensation is insufficient to plead scienter because that desire can be imputed to all corporate officers and pleading one “should have known” is a “boilerplate” allegation. Therefore, the court dismissed these claims because under well established law an allegation that defendants were motivated by compensation or alleging defendants should have known of fraud based on their positions within a company are insufficient claims to plead scienter.

Furthermore, the Plaintiffs claimed that if Defendants did not know of the status of the High Yield Debt, they were reckless in not being aware. Under 10(b) a reckless claim requires completely unreasonable conduct that is an extreme departure from ordinary care such as a defendant “shut[s] their eyes to the facts.” The court dismisses Plaintiffs’ allegations of recklessness as being purely “conclusory” because Plaintiffs failed to plead specific acts constituting recklessness.            

The complaint also relied on allegations made by confidential sources. A complaint may rely on confidential sources if the sources provide a foundation for believing the defendants made false statements and the sources are in a position to properly posses the information. Plaintiffs’ complaint did not meet this standard because the confidential sources did not state that any particular Defendant had information or access to information regarding valuation, inadequate risk control, GAAP violations, or information that contradicted the 2001 reports. Plaintiffs showed that Defendants were aware of risks associated with high yield investments but not that they failed to monitor the risks or were incorrectly valuing the portfolio. In addition, Plaintiffs provided no proof that the confidential sources had any contact with Defendants or possessed knowledge of what Defendants knew at that time.          

Plaintiffs claimed two directors received information that should have alerted them that the public statements were false or misleading. The directors received an email regarding the deterioration of the High Yield Debt portfolio but the court found that knowledge of the deteriorating portfolio does not demonstrate that either Amex’s 2001 filings or the director’s previous statements regarding unexpected losses were false or misleading. The court noted the fact that Defendants put together a team to analyze the High Yield Debt and reported the results was evidence that Defendants were not attempting to deceive but rather trying to quantify the problem. In addition, because Defendants did put together this analyst team, the court determined Defendants upheld their duty to monitor and that this precluded any inference of recklessness.           

Since the Plaintiffs failed to plead scienter by showing Defendants mental state consisted of the intent to deceive, manipulate, or defraud, the court granted Defendants motion to dismiss the § 10(b) claim.

The primary materials for this are available on the DU Corporate Governance website.

Full post as published by The Race to the Bottom on November 05, 2008 (boomark / email).