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IN RE AMERICAN EXPRESS CO.

March 31, 2004.

IN RE; AMERICAN EXPRESS CO. SECURITIES LITIGATION


The opinion of the court was delivered by: WILLIAM PAULEY, District Judge

MEMORANDUM AND ORDER

This consolidated class action combines twelve suits alleging securities fraud by American Express Company ("Amex" or the "Company") and several of its officers — Harvey Golub, Kenneth I. Chenault, Richard Karl Goeltz, Gary L. Crittenden, Daniel T. Henry, David R. Hubers and James M. Cracchiolo (the "Individual Defendants").*fn1 Plaintiffs are purchasers of Amex common stock between July 26, 1999 and July 17, 2001 (the "class period"). The Consolidated Amended Class Action Complaint (the "Amended Complaint" or "Amended Compl.") alleges violations of section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b) (2000), and SEC Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 (2000). Plaintiffs also assert a "control person" claim against the Page 2 Individual Defendants under Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a) (2000). Defendants move to dismiss the Amended Complaint pursuant to Rules 12(b)(6) and 9(b) of the Federal Rules of Civil Procedure, and Sections 21D and 21E of the Exchange Act, 15 U.S.C. § 78u-4, 78u-5 (2000). For the following reasons, defendants' motion is granted.

  BACKGROUND

  Amex is a publicly traded financial services corporation. (Amended Compl. ¶ 40.) Through its subsidiary, American Express Financial Advisors ("AGFA"), Amex provides a variety of financial products including insurance and annuities. (Amended Compl. ¶¶ 40-41.) IDS Life Insurance Company ("IDS"), an AEFA subsidiary, sells insurance products and invests the premiums on its own account in fixed income securities with a broad range of maturities. (Amended Compl. ¶ 41.) The returns generated from these investments are used to pay benefits under those insurance policies. (Amended Compl. ¶ 41.) According to plaintiffs, a direct correlation exists between the return on AEFA's investments and the premiums charged to the holders of IDS insurance policies: the higher the return, the lower the premium. (Amended Compl. ¶ 41.)

  Plaintiffs allege that, beginning in 1997 Golub set aggressive earnings targets for Amex. (Amended Compl. ¶ 42.) Page 3 Under pressure to meet Golub's publicly announced earnings goals, AEFA allegedly under-priced its insurance products to undercut competitors. (Amended Compl. ¶ 42.) To maintain profitability, AEFA relied increasingly on high-yield, high-risk instruments such as below-investment-grade, or "junk," bonds and collateralized debt obligations ("CDOs").*fn2 (Amended Compl. ¶¶ 47, 51.) In contrast to the typical insurance industry portfolio, where high-yield investments comprise approximately 7 percent of the total value, AEFA's high-yield holdings constituted approximately 10 to 12 percent of its portfolio. (Amended Compl. ¶ 46.)

  Plaintiffs assert that because AEFA's portfolio was heavily reliant on high-yield investments, it was exposed to volatility in the equity markets. (Amended Compl. ¶ 51.) Accordingly, plaintiffs contend that it was imperative for AEFA to monitor its investments to obtain accurate valuations for its holdings and gauge its risk exposure. (Amended Compl. ¶ 52.) Plaintiffs allege that AEFA did not monitor and evaluate the Page 4 extent of its exposure during the class period because it failed to take steps to obtain reliable information about its investments and the state of the market. (Amended Compl. ¶¶ 52, 54, 59-65.) For example, AEFA allegedly valued certain of its high-yield holdings based on estimates that brokers, who simply act as agents for issuers, assigned to those securities. (Amended Compl. ¶¶ 59-60.) Because AEFA did not employ reliable methods for valuing and overseeing its holdings, plaintiffs claim that it could not monitor the risk in its portfolio. (Amended Compl. ¶¶ 59-65.)

  Throughout the class period, AEFA disclosed to investors the amount of money it invested in high-yield instruments. (Amended Compl. ¶ 80.) Nevertheless, plaintiffs allege that various statements by defendants pertaining to the value and extent of AEFA's high-yield investments were materially misleading. Amex's 1998 10-K stated that "[t]he company's objective is to realize returns commensurate with the level of risk assumed while achieving consistent earnings growth." (Amended Compl. ¶ 66.) This statement was repeated in Amex's 10-K for 1999, which was filed with the SEC in March 2000 and signed by defendants Golub, Goeltz, Chenault and Henry. (Amended Compl. ¶ 72.) The 1999 10-K also stated:

  AEFA's owned investment securities are, for the most part, held by its life insurance and investment certificate subsidiaries, which Page 5 primarily invest in long-term and intermediate-term fixed income securities to provide their clients with a competitive rate of return on their investments while minimizing risk. Investment in fixed income securities provides AEFA with a dependable and targeted margin between the interest rate earned on investments and the interest rate credited to clients' accounts. AEFA does not invest in securities to generate trading profits for its own account.

 (Amended Compl. ¶ 72.) Amex's 2000 10-K repeated this and similar statements. (Amended Compl. ¶ 73.)

  Defendants also issued statements during the class period concerning the internal controls that Amex had in place to monitor its risk exposure. For example, in its 1998 10-K, Amex stated that:
Management establishes and oversees implementation of Board-approved policies covering the company's funding, investments and use of derivative financial instruments and monitors aggregate risk exposures on an ongoing basis.
(Amended Compl. ¶ 66.) Two years later, defendant Chenault told investors that Amex could weather the economic downturn in 2001 because its "risk management staff are among the best in the business. They are highly skilled and experienced, and have continually improved [Amex's] processes over the years."

  (Amended Compl. ¶ 140.) Plaintiffs assert that these statements were materially misleading because they misrepresented Amex's high-yield holdings as conservative and because Amex did not Page 6 have reliable risk management policies in place during the class period. (Amended Compl. ¶¶ 54-55, 62, 64, 75.)

  Beginning in the third quarter of 1999 and continuing through 2000, default rates in the high-yield bond market increased, thus eroding the value of high-yield securities held by AEFA. (Amended Compl. ¶ 76.) Despite these negative developments, Amex did not write down investments in its high-yield portfolio in 1999 or 2000. (Amended Compl. ¶ 102.) Plaintiffs allege, therefore, that Amex's financial statements were false and misleading because they significantly overvalued AEFA's holdings. (Amended Compl. ¶¶ 86, 102.)

  Plaintiffs further allege that defendants misled investors by representing that Amex's financial statements were prepared in accordance with generally accepted accounting principles ("GAAP"), which require companies to account for impairments in the value of an investment. (Amended Compl. ¶ 94.) Plaintiffs contend that defendants' statements to this effect were false and misleading because most of AEFA's high-yield investments were valued at amortized cost rather than written down in accord with GAAP. (Amended Complaint ¶¶ 87, 93, 102.)

  The Amended Complaint also alleges that defendants' statements concerning Amex's risk management and financial reporting were materially misleading because defendants knew or Page 7 recklessly disregarded that Amex's internal controls over the valuation of its high-yield securities were "severely deficient or non-existent." (Amended Compl. ¶ 111.) Plaintiffs claim, additionally, that such statements were materially misleading because defendants knew or recklessly disregarded that Amex continued to hold its investments "in a manner that was contrary to its publicly stated investment philosophy and controls." (Amended Compl. ¶ 111.)

  As the equity market downturn deepened, Amex began to disclose the existence of some "deterioration" in its high-yield portfolio. (Amended Compl. ¶ 117.) The Company issued successive statements to this effect in its Form 8-Ks, filed on April 24, 2000, July 24, 2000 and January 26, 2001. (Amended Compl. ¶ 117.) These Form 8-Ks, however, described AEFA's overall asset quality as "strong." (Amended Compl. ¶ 117.)

  In a presentation on February 7, 2001, which was later incorporated in a Form 8-K, Chenault acknowledged that the Company had had some problems with its high-yield investments, especially in the fourth quarter of 2000. (Amended Compl. ¶ 136.) During that presentation, Chenault stated that "we have significantly scaled back our activity" in "structured investments, such as collateralized debt obligations." (Amended Compl. ¶ 136.) Chenault also characterized AEFA's "fundamental business model" as "sound." (Amended Compl. ¶ 137.) Plaintiffs Page 8 claim that Chenault's statements were materially false and misleading because AEFA's practice of under-pricing IDS insurance policies and making up the difference with high-yield investments, which AEFA failed to monitor adequately, bore significant risk and was fundamentally unsound. (Amended Compl. ¶ 137.)

  Two months after Chenault's February 7 presentation, Amex announced that it would take a write-down of $185 million in losses on its high-yield portfolio for the first quarter of 2001 in addition to a $123 million loss realized on its high-yield investments for 2000. (Amended Compl. ¶ 144.) On April 2, 2001, Amex issued a press release announcing that its earnings for the first quarter of 2001 would decrease by 18 percent from its 2000 earnings period. (Amended Compl. ¶ 144.) Amex attributed this decline to a "pre-tax loss of about $185 million from the write-down and sale of certain high-yield securities held in the investment portfolio of its subsidiary [AEFA]." (Amended Compl. ¶ 144.) The press release also stated that "[t]otal losses on these investments for the remainder of 2001 are expected to be substantially lower than in the first quarter." (Amended Compl. ¶ 144.) These losses caused Amex to revise an earlier prediction that it would meet its earnings targets for 2001. (Amended Compl. ¶ 145.) News of this writedown resulted in a 3.8 percent drop in Amex's share price, Page 9 representing $2 billion in market capitalization. (Amended Compl. ¶ 147.)

  In the wake of this announcement, several of the Individual Defendants made statements that these losses were expected to be lower for the remainder of 2001 than they had been in the first quarter. (Amended Compl. ¶¶ 148-50.) Plaintiffs claim that these statements implied that the problems underlying those losses were sudden, when in fact they had roots as far back as 1999. (Amended Compl. ¶ 148.) Chenault, for example, stated "our analysis of the portfolio at the end of the first quarter did not fully comprehend the risk underlying these structured investments during a period of persistently high default rates." (Affidavit of Robert E. Zimet, dated February 14, 2003 ("Zimet Aff."), Ex. D at 2.)*fn3 Plaintiffs claim that such statements were false and misleading because: (1) AEFA Page 10 still remained exposed to risks from its high-yield holdings; and (2) the deterioration in the value of high-yield investments began in 1999, when default rates surged, not 2001. (Amended Compl. ¶ 151.)

  On July 18, 2001, Amex issued a press release announcing that its earnings for the second quarter of 2001 would likely decline 76 percent from the prior year, partly due to an $826 million pre-tax charge to recognize "additional write-downs in the high-yield portfolio at [AEFA] and losses associated with ...


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