The 11th Circuit Court of Appeals has held that an insurer of municipal bonds does not have standing to bring an action for federal securities fraud under Rule 10b-5 of the Securities and Exchange Act (“the Act”). Financial Security Assurance, Inc. v. Stephens, Inc., No. 04-14894, 2007 WL 2700280 (11th Cir. Sept. 18, 2007).
The Crisp County, Georgia Solid Waste Authority (“Authority”) sought bond financing for a regional solid waste processing facility. The bond underwriter prepared a Request for Proposal for various credit enhancers, including Financial Security Assurance (“FSA”). The RFP contained a disclaimer, warning all potential credit enhancers to perform their own due diligence. After performing little, if any, due diligence, FSA submitted a bid, which was conditioned on a full review of all legal documentation relating to the transaction. The Authority accepted FSA’s bid, and FSA insured the municipal bonds. Shortly after the facility opened, its cash flow proved insufficient. After exhausting its debt reserves, the Authority defaulted; it could not make the payments due on the bonds.
FSA paid the sums required under the insurance policy and acquired the bonds, then sued the underwriter and the civil engineering firm, which conducted the feasibility study for the facility. FSA alleged that the underwriter had committed federal securities fraud and the underwriter and engineering firm had made fraudulent and negligent misrepresentation under Georgia law. The district court dismissed FSA’s 10b-5 claim and subsequently granted summary judgment against FSA on the remaining counts.
On appeal, FSA advanced four bases for its standing to assert a 10b-5 claim: i) FSA was the true party at risk and, functionally, the purchaser of the bonds; ii) FSA was the guarantor of the bonds; iii) following default, FSA purchased the securities, pursuant to the terms of the insurance policy; and iv) FSA was subrogated to the rights of the individual bondholders.
Rejecting these arguments, the Eleventh Circuit affirmed the district court’s dismissal of the 10b-5 claim. The appellate court found that FSA did not have standing to bring a federal securities action because: i) FSA did not purchase securities within the meaning to the Act; ii) a guarantor is not a purchaser of securities; iii) when FSA acquired the bonds after the Authority defaulted , the bonds were no longer securities because they did not have the potential to generate profit; and iv) FSA failed to allege harm to the bondholders in support of its subrogation claim. The Court also affirmed the summary judgment on the state court claims because, under Georgia law, FSA did not conduct adequate due diligence before agreeing to insure the bonds.