William Genschow

In Fulton County Employees Retirement System v. MGIC Inv. Corp.[1], the Seventh Circuit Court of Appeals held that mortgage insurance companies are not subject to liability for fraudulent statements about their holdings and future liquidity when they do not predict a large market crash, and have some substantial liquidity at the time the statements were made.  Additionally, the Seventh Circuit Court of Appeals held that companies are not liable when officers speak about a subsidiary when the company does not hold a majority share in their subsidiary.

Fulton County Employees Retirement System (FCERS) brought suit against MGIC Investment Corporation, a mortgage insurance company that survived the sub-prime mortgage crisis.  MGIC, like many of the mortgage insurance companies during the crisis, suffered massive losses when the mortgage security market collapsed, significantly devaluing MGIC’s holdings in its subsidiary, Credit–Based Asset Servicing and Securitization (CBASS), a company that packages and sells single-family home mortgages. FCRS brought suit under 15 U.S.C. §78u-4(b)[2], alleging that the MGIC made fraudulent statements about the holdings of MGIC’s subsidiary.

Prior to the market collapse, MGIC released a press statement that indicated the subsidiary still held “substantial liquidity” to cover any loss of securitized loan value.  At the outset of the year the company held $300 million in assets, but began to make payments to cover losses in securitized loans.  At the time of the press statement and a conference call where the statement of liquidity was made, the company had $150 million in assets and stated that the money might not last much longer.  Eleven days later, the MGIC investment in CBASS was written off as a loss.  The plaintiff alleged that MGIC had misled its investors because MGIC failed to mention specific numbers on CBASS’s holdings, that a statement of mere “substantial liquidity” was vague and misleading, and that the firm should have predicted the market crash and informed their shareholders of impending losses as a result.  The plaintiff also alleged that the company was liable for standing by and not revoking such a vague statement about a subsidiary’s finances when the statement is made by the company’s officers.

Chief Judge Easterbrook, writing for the Seventh Circuit Court of Appeals, found that the scienter requirement under 15 U.S.C. § 78u-4(b) was not satisfied by the plaintiff because MGIC’s “substantial liquidity” statement was essentially true.  The Court found that the ownership of $150 million in cash on hand with expenses of only $150 million in the last six and a half months leading up to the statement was enough money to constitute substantial liquidity.  Additionally, the Court held that the warning issued about CBASS was sufficiently non-generic in its attempt to balance optimism with reality.

The Court noted that companies need only distribute financial information relating to the individual company and do not have to disseminate information about the whole market and were thus not liable for not releasing information predicting a market crash.  In addition, the Court found that the company was not liable for the statements of its officers about the subsidiary.  The Court found that the individuals had “ultimate authority over their own statements” and that, while MGIC did not offer a correction to its language, MGIC did not have direct control or controlling shares of CBASS and therefore could not be liable.[3]

Ultimately, the Court found that a balance of factual indications of current company performance and optimism of future performance could never be considered fraud. Additionally, for a company to be held liable for the statements of individual officers about a subsidiary, that company needs to hold a controlling interest in its subsidiary.

[1] 675 F.3d 1047 (2012).

[2] See, 15 U.S.C. § 78u-4(b) (delineating misleading statement, scienter, and standing requirements while stating that the misleading statement must be the cause of the plaintiff’s loss).

[3] Fulton County Employees Retirement System v. MGIC Inv. Corp., 675 F.3d 1047, 1051 (2012).

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