Pleading Fraud with Scienter under Heightened Pleading Standards: IBEW Pension Fund v. AMEX Fraud Complaint Dismissed

In Local No. 38 IBEW Pension Fund v. Am. Express Co., 2010 WL 2834226 (S.D.N.Y. July 19, 2010), the United States District Court held Plaintiff did not adequately plead scienter under the Private Securities Litigation Reform Act’s heightened pleading standards for its securities fraud claim against American Express (“AMEX”).

Plaintiff  alleged that from 2007 to 2008, AMEX and two of its officers, CEO Kenneth Chenault (“Chenault”) and CFO Daniel Henry (“Henry”), made false and misleading statements about the company’s charge and credit card portfolio’s credit quality, underwriting guidelines, and loss reserves, even as the portfolio’s quality significantly deteriorated.

Between 2004 and 2007, AMEX pursued an aggressive growth strategy, significantly expanding its lending portfolio.  In 2007 and 2008, Chenault and Henry repeatedly made public statements asserting that the credit quality of AMEX’s charge and credit card portfolio was strong, that the company had not lowered underwriting standards, and that the portfolio’s loss reserves were adequate.  Plaintiff alleged these statements were deceptive because the company relied on 0% balance transfers for growth, while its portfolio concurrently experienced increased delinquency rates.  In support of these allegations, Plaintiff relied on information from confidential witnesses, including a credit analyst, executives, and managers who were privy to various company practices and performance data that contradicted defendants’ public statements.

Under Rule 10b-5 of the Securities Exchange Act of 1934, a plaintiff must allege that the defendant “(1) made misstatements or omissions of material fact, (2) with scienter, (3) in connection with the purchase or sale of securities, (4) upon which the plaintiff relied, and (5) that the plaintiff's reliance was the proximate cause of its injury.”  In this case, the court focused primarily on scienter.  

To properly show scienter under the PSLRA, a plaintiff must state with particularity facts that collectively create a strong inference that the defendant “embrac[ed] intent to deceive, manipulate or defraud.” The inference must be "'at least as compelling as any opposing inference of nonfraudulent intent.'" Id. (quoting Tellabs v. Makor, 551 U.S. 308, 319 (2007)). 

Such an inference exists when a defendant benefits in a “concrete and personal way” from fraud, or shows a “reckless disregard for the truth.”  To establish a concrete and personal benefit, a plaintiff must prove that a defendant’s motivation for such a benefit is particular; a general motive that would be possessed by any officer or insider is insufficient.  To establish reckless disregard, a plaintiff must identify with specificity reports or statements that contradict a defendant’s representations and were known to that defendant.

The only allegation of a benefit was the desire to maintain a strong credit rating.  The court reasoned, however, such a motive is "possess[ed] by nearly every corporate executive."  Importantly, Plaintiff identified no other benefits that flowed to Defendants.  The court, therefore, found that Plaintiff pled no “concrete and personal” benefit.

To show reckless disregard for the truth, a plaintiff must identify specific reports or statements that contradict Defendants public utterances.  The court found that Plaintiff’s confidential witnesses did not specifically identify any such reports or statements; rather, they provided general assertions about the information they believe executives should have known.  

Only one of the twelve confidential witnesses even had contact with Defendants, and this witness did not identify a specific report that Defendants might have seen.  Another confidential witness asserted that Risk Management performance data was reported up the company hierarchy.  However, the mere “existence of channels” through which information might flow is insufficient to demonstrate an executive has actual knowledge of that information.  Ultimately, the court found the confidential witnesses’ statements to be general and speculative, and thus not sufficient to establish Defendants’ reckless disregard for the truth. 

The court concluded that the complaint, though long and “hydra-like,” did not plead a concrete and personal benefit or a reckless disregard for the truth.  Consequently, Plaintiff failed to create a strong inference that Defendants’ public statements were made with scienter. 

Lacking such an inference of scienter, the court granted Defendants’ motion to dismiss for failure to state a claim on which relief may be granted.

The primary materials for this case may be found on the DU Corporate Governance Website.