On September 5, 2017, Judge Richard M. Berman of the United States District Court for the Southern District of New York dismissed a putative class action against Ambac Financial Group, Inc. (“Ambac”), asserting claims under Section 10(b) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rule 10b-5 promulgated thereunder. Wilbush v. Ambac Fin. Grp., Inc., No. 16 Civ. 5076 (RMB), slip op. (S.D.N.Y. Sept. 5, 2017), ECF No. 41. Plaintiff alleged that Ambac, an insurer, concealed its true credit risk and loss exposure to more than $10 billion in Puerto Rican bonds it insured. The Court held that plaintiff failed to adequately allege actionable misstatements, and further that plaintiff’s allegations of scienter were insufficient, given that there was no indication that defendants had access to non-public information contradicting their public statements.
Plaintiff alleged that Ambac’s SEC filings were misleading because Ambac reported net par outstanding for the bonds but did not report additional interest exposure, and also because Ambac assigned an ambiguous below investment grade internal rating to the bonds. The Court found these allegations insufficient because the complaint failed to allege a violation of Generally Accepted Accounting Principles or any other industry standard. In this regard, the Court noted that a review of SEC filings from other bond insurers, and an article cited in the complaint itself, indicated that Ambac’s net par reporting was typical of the industry and that, similarly, Ambac’s use of the “below investment grade” rating was consistent with industry standards.
The Court also rejected plaintiff’s misstatement allegations based on Ambac’s statements respecting the historical experience of its public finance portfolio, management’s stated belief that its reserves were adequate, and statements concerning Ambac’s risk management practices. As to Ambac’s historical experience, the Court observed that Ambac did not indicate that the same results would occur in the future, and a number of Ambac’s SEC filings contained specific cautionary language that the portion of the portfolio relating to Puerto Rico could pose a risk greater than Ambac’s reserves. With respect to management’s beliefs regarding loss reserves, the Court noted that the complaint failed to allege that management did not honestly hold those beliefs, or that Ambac at the time had information showing the reserves were inadequate. Similarly, statements regarding risk management practices were not actionable because they were merely generalizations upon which no investor could have reasonably relied.
As an independent bar to plaintiff’s claims, the Court found that plaintiff failed to adequately allege a strong inference of scienter. The Court rejected plaintiff’s allegations that defendants were motivated to commit fraud to increase Ambac’s credit rating and improve their own individual bonuses, reasoning that these motives would exist at nearly every company. Plaintiff also argued that scienter based on “conscious misbehavior and recklessness” could be “inferred” from the fact that defendants reviewed Ambac’s Puerto Rico exposure, attended meetings and discussions regarding that exposure, and communicated with the Puerto Rican government regarding loss mitigation strategies. But the Court held that these allegations were insufficient because plaintiff failed to “allege that defendants had access to non-public information contradicting their public statements.” Slip op. at 24-25 (emphasis in original). The Court also rejected plaintiff’s arguments that scienter could be inferred from executive resignations, explaining that in order to raise a strong inference of scienter, the resignations must be highly unusual or suspicious, but in this case none of the resignations occurred at or about the time the alleged fraud was disclosed.
This case demonstrates that disclosure practices consistent with well-known industry standards will be difficult for plaintiffs to challenge as misleading, and is a useful reminder that optimistic opinion statements are not actionable under the Exchange Act where they are honestly held and not contradicted by non-public information.
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