Fulton County Employees’ Retirement System v. MGIC Investment Corp.: Another Subprime Fraud Case Dismissed

In Fulton County Employees’ Retirement System v. MGIC Investment Corporation, No. 08-C-0458, 2010 WL 601364 (E.D. Wis. Feb. 18, 2010), the Federal Court of the Eastern District of Wisconsin dismissed a stockholder fraud claim alleging misstatements "designed to mask the true impact of the [subprime] crisis on the companies’ businesses."  The court found that statements by executives at MGIC that the company engaged in “focused underwriting” were not attributable to the company and were too vague to be material.

Plaintiff, Fulton County Employees’ Retirement System (“Fulton”), an institutional investor, purchased MGIC common stock between October 12, 2006, and February 12, 2008.  Defendants, MGIC Investment Corporation and its executives (“MGIC”), through its principal subsidiary, insured residential home mortgages.  During the relevant period, it insured a number of subprime mortgages and other risky mortgages.  MGIC also owned 46% of C-BASS, a joint venture between MGIC and another mortgage insurer, Radian Group Inc. (“Radian”).  Radian also owned a 46% interest in C-BASS.  C-BASS specialized in purchasing subprime, single-family residential mortgages for packaging into mortgage-backed securities.

In this consolidated class action, Fulton alleged that Defendants committed securities fraud in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Securities and Exchange Commission (“SEC”) Rule 10b-5.  Fulton alleged that as the subprime crisis began to unfold, MGIC made statements (directly and through analysts) designed to assure the market that MGIC employed “superior” underwriting practices, and that these statements were misleading because MGIC’s underwriting standards were in fact risky.  

The court found that the statements did not imply that MGIC employed “superior” underwriting practices.  See Id.  ("None of the statements uses the word 'superior' or any other adjective that would cause a reasonable investor to believe that, MGIC’s underwriting was better than the underwriting employed by others in the industry."). 

Other statements were made by analysts and not management.  As a result, there was doubt whether the statements could be attributed to the company.

• The second statement was not made by MGIC or its executives. Instead, analysts made this statement in a report they prepared after meeting with Culver and another executive of MGIC who is not a defendant in this case. Most of this statement consists of conclusions that the analysts drew after meeting with Culver, rather than direct quotes from Culver, and thus this statement may not be attributable to Culver or MGIC.

Even to the extent the statements were attributable to the company, the court found that they were not misleading. 

Other alleged misrepresentations were dismissed for failure to plead a strong inference of scienter.  Plaintiff claimed that MGIC masked the delinquency rates of books of insurance by combining older, more conservatively written vintages with newer, riskier vintages.  The court found this argument problematic because the manner in which MGIC published its delinquency rates was not suspicious. 

MGIC had reported its delinquency rates on an aggregate basis all along, and switched to reporting rates by type and vintage year in the third quarter of 2007, suggesting that when it realized a certain segment of its business was responsible for its large losses, it thought investors would be interested in statistics related to that specific segment.  As the court concluded:  "the only cogent inference is that no one realized the extent of the problem until the third quarter of 2007. Plaintiff’s suspicion that defendants had internal data showing alarming trends prior to this time is pure speculation and does not give rise to a strong inference of scienter."

Lastly, Fulton alleged MGIC made misleading statements about C-BASS by failing to disclose C-BASS had paid $145 million in margin calls and had represented that it "maintains substantial liquidity to cover margin calls."  The court concluded that the statement about sufficient liquidity was not misleading.  Id.  (MGIC "still had $150 million in cash remaining. $150 million in cash is substantial liquidity. Although this proved to be inadequate to cover the ensuing margin calls, MGIC did not say that C-BASS had enough
liquidity."). 

As for the failure to disclose the $145 million in margin calls, the precise amount was not material.  As the court reasoned:

• And because defendants disclosed that liquidity was a concern, stated that C-BASS had been subject to increasing margin calls, and made truthful statements regarding the amount of cash that remained available, Draghi’s failure to also disclose the precise dollar amount of the margin calls that C-BASS had received during the opening days of the third quarter cannot reasonably be considered an omission that rendered his statement about the amount of cash remaining misleading.

As a result, the court dismissed the case but indicated that the plaintiff, if it believed it could "cure the problems identified" could file an amended complaint, with defendants having an opportunity to respond. 

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