The opinion of the court was delivered by: Laura Taylor Swain, United States District Judge
This Document Relates To: All Actions
Lead Plaintiff State of Michigan Retirement Systems, as custodian of the Michigan Public School Employees Retirement System, the State Employees Retirement System, the Michigan State Police Retirement System, and the Michigan Judges Retirement System ("Lead Plaintiff"), brings this action on behalf of a putative class of investors ("Plaintiffs") who purchased or otherwise acquired publicly traded securities issued by American International Group, Inc. ("AIG" or the "Company"), between March 16, 2006, and September 16, 2008 (the "Class Period"). Plaintiffs principally allege that Defendants violated the federal securities laws by materially misstating the extent to which AIG had accumulated exposure to the subprime mortgage market through its securities lending program and its credit default swap ("CDS") portfolio. That exposure, which placed the Company at risk in ways that Defendants allegedly declined to disclose, ultimately led to a liquidity crisis that required an unprecedented bailout by the United States Government.
Plaintiffs assert claims under the federal securities laws against AIG and various current or former AIG executives, directors, accountants, and underwriters (collectively, "Defendants").*fn1 Specifically, in the Consolidated Class Action Complaint ("CCAC" or "Complaint"), Plaintiffs assert the following claims: (i) against AIG and the "Section 10(b) Defendants" (defined below) for alleged violations of Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b) ("Section 10(b)"), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 ("Rule 10b-5 "); (ii) against the "Executive Defendants" (defined below) for alleged violations of Section 20(a) of the Exchange Act, 15 U.S.C. § 78t-1 ("Section 20(a)"); (iii) against AIG, the "Signing Executive Defendants" and the "Director Defendants" (defined below) for alleged violations of Section 11 of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77k ("Section 11 "); (iv) against the "Underwriter Defendants" (defined below) for alleged violations of Section 11; (v) against PricewaterhouseCoopers LLP ("PwC") for alleged violations of Section 11; (vi) against the Underwriter Defendants for alleged violations of Section 12(a)(2) of the Securities Act, 15 U.S.C. § 77l(a)(2) ("Section 12(a)(2)") ; and (vii) against the Executive Defendants for alleged violations of Section 15 of the Securities Act, 15 U.S.C. § 77o ("Section 15"). The Court has jurisdiction of the claims pursuant to 28 U.S.C. § 1331.
Plaintiffs group the defendants in the following manner in the Complaint, and the Court uses the same nomenclature for the purposes of this opinion: Sullivan, Bensinger, Cassano, Forster, Herzog and Lewis are named as the "Section 10(b) Defendants." (CCAC ¶ 50.) All of the Section 10(b) Defendants occupied executive-level positions at the Company and were privy to material non-public information concerning AIG and AIGFP. (CCAC ¶ 553.) Moreover, Plaintiffs allege, all of the Section 10(b) Defendants "prepared, approved, signed, and/or disseminated" the documents and statements that contain the material misstatements and omissions upon which Plaintiffs' 10(b) claims are predicated. (CCAC ¶ 552.)
The Section 10(b) Defendants and Frost are named as the "Executive Defendants." (CCAC ¶ 49.) Plaintiffs allege that all of the Executive Defendants exercised control over AIG and/or AIGFP during the Class Period through the key management roles they played and their direct involvement in the Company's day-to-day operations, including its financial reporting and accounting functions. (CCAC ¶ 566.) Sullivan, Bensinger and Herzog are named as the "Signing Executive Defendants." (CCAC ¶ 608.) Tse and the "Outside Director Defendants" are named as the "Director Defendants." (CCAC ¶ 70.)
The following twelve defendants or groups of defendants, comprising all of the served defendants,*fn2 have moved to dismiss the claims asserted against them:
(i) AIG, a holding company which, through its subsidiaries, engages in a wide range of insurance and financial service activities in the United States and abroad (CCAC ¶ 40);
(ii) Martin J. Sullivan, President and Chief Executive Officer of AIG from the beginning of the Class Period through his resignation on June 15, 2008, who signed the Company's Registration Statements and Forms 10-Q and 10-K throughout the Class Period, and made many of the statements Plaintiffs allege to have been false or misleading (CCAC ¶¶ 41, 485);
(iii) Steven J. Bensinger, Executive Vice President and Chief Financial Officer of AIG throughout the Class Period, who signed the Company's Registration Statements and Forms 10-Q and 10-K throughout the Class Period, participated in the preparation of the allegedly false press releases and public filings at issue, and participated in the investor conference calls at issue as well (CCAC ¶¶ 42, 489);
(iv) Joseph Cassano, who was President of AIG Financial Products ("AIGFP"), the division that managed the CDS portfolio that is at the center of this action, from the beginning of the Class Period through his resignation on February 29, 2008 (CCAC ¶ 43);
(v) Andrew Forster, Executive Vice President of the Asset Trading & Credit Products Group of AIGFP during the Class Period, who was responsible for managing AIGFP's global credit division (which contracted to sell the CDSs at issue) and who gave investor presentations concerning the Company's management of the CDS portfolio (CCAC ¶¶ 44, 124, 346);
(vi) Alan Frost, Executive Vice President of AIGFP during the Class Period, who headed AIGFP's business and marketing efforts in the United States (CCAC ¶ 45);
(vii) David L. Herzog, Senior Vice President, Comptroller, and Principal Accounting Officer of AIG throughout the Class Period, who signed the Company's Forms 10-Q and 10-K throughout the Class Period and participated in the Company's calls with research analysts throughout the Class Period (CCAC ¶¶ 46, 491);
(viii) Robert Lewis, Senior Vice President and Chief Risk Officer throughout the Class Period, who signed off on each of the CDS contracts and gave investor presentations concerning the Company's exposure to the mortgage market (CCAC ¶¶ 47, 311, 329);
(ix) 34 financial institutions that served as underwriters of AIG offerings of notes, debentures, and common stock during the Class Period (the "Underwriter Defendants") (CCAC ¶ 51);*fn3
(x) 15 former and current outside directors (the "Outside Director Defendants") who signed various registration statements and annual reports filed with the U.S. Securities and Exchange Commission ("SEC") (CCAC ¶¶ 54-66, 68-69);
(xi) Edmund S.W. Tse, a Board Member and Senior Vice Chairman for the Life Insurance Division of AIG throughout the Class Period (CCAC ¶ 67); and
(xii) PricewaterhouseCoopers LLP, which served as an Independent Registered Public Accounting Firm for AIG and audited the Company's financial statements throughout the Class Period (CCAC ¶ 71).
Plaintiffs have moved to strike certain exhibits submitted by Defendants in support of their motions to dismiss. The Court has reviewed thoroughly all of the parties' submissions, including multiple notices of supplemental authority. For the reasons that follow, Defendants' motions to dismiss are denied. In light of the resolution of the motions to dismiss, Plaintiffs' motion to strike is moot.
For the purposes of these motions, the Court takes as true the following facts drawn from the Consolidated Class Action Complaint, the documents incorporated by reference therein, and public filings of which the Court may take judicial notice.*fn4 Plaintiffs' 284-page pleading details Plaintiffs' allegations as to the causes of AIG's liquidity crisis, as well as their allegations regarding attendant material misstatements and omissions on Defendants' part. The Court assumes the parties' familiarity with the record and limits the following summary of Plaintiffs' factual allegations to matters that are material to the Court's legal conclusions.
A. The Genesis of AIG's Exposure to the Subprime Mortgage Market
AIG was founded as an insurance agency in Shanghai, China, in 1919. The Company moved to New York in 1949 and, under the leadership of Maurice "Hank" Greenberg, became a publicly held company in 1969. AIG eventually grew into one of the world's largest insurance and financial services companies. (CCAC ¶ 81.)
Greenberg initiated AIG's foray into "swap" transactions in 1987 through a joint venture, called AIG Financial Services, which entered into contracts in which one party paid its counterparty a fee to assume the risk of a referenced transaction. (CCAC ¶ 82.) The joint venture was highly profitable and it became a division of AIG (AIGFP) in 1993. (CCAC ¶¶ 83-85.) In 1998, AIGFP, while led by Tom Savage, began entering into credit default swaps, in which AIGFP received regular premium payments in exchange for assuming the risk that an underlying debt security would not perform. (CCAC ¶ 86.) Savage rigorously analyzed each credit default swap transaction until he retired from AIGFP in 2001, at which time Cassano succeeded Savage as the President of AIGFP. (CCAC ¶ 87.) In the early years of Cassano's tenure, the division was scrutinized closely by AIG's management. (CCAC ¶ 88.)
A series of accounting scandals that occurred at AIG between 2000 and 2004 (arising out of misconduct unrelated to AIGFP) led to SEC and Department of Justice ("DOJ") investigations of the Company; AIG's disclosure of internal control failures and recognition of a $3.9 billion overstatement of reported income; AIG's payment of an $80 million fine and restatement of years of financial statements; a downgrade of AIG's AAA credit rating; and, in 2005, Greenberg's forced retirement. (CCAC ¶¶ 89-91). Following Greenberg's departure, AIG's senior management weakened or eliminated the risk controls that Greenberg had put in place to supervise AIGFP. (CCAC ¶ 129.) Sullivan, Greenberg's replacement as CEO, cancelled bi-weekly meetings with AIGFP and excepted AIGFP from AIG's rigorous company-wide control procedures. (CCAC ¶¶ 129, 133.)
At approximately the same time that Greenberg retired, AIG's loss of its AAA rating curtailed AIGFP's ability to engage in certain types of investments. The credit default swap market, however, remained available. AIGFP decided to expand considerably its underwriting of credit default swaps, particularly those in which it sold protection on Collateralized Debt Obligations ("CDOs"). (CCAC ¶¶ 91-93.)
CDOs are structured products created by a manager that has purchased asset-backed securities, typically pools of residential mortgages (including subprime mortgages) bundled into Residential Mortgage Backed Securities ("RMBS"), which serve as the underlying collateral for the security. The CDOs are divided into tranches such that the highest tranche (often referred to as the "Super Senior" tranche) suffers losses only after the collateral pool has been impaired to such an extent that all of the lower tranches have been wiped out. In a financial alchemy that has been much maligned, the highest tranches of CDOs composed of subprime RMBS were assigned much higher credit ratings than the underlying collateral. AIGFP only sold protection on the highest tranche. (CCAC ¶¶ 92-102.)
AIGFP wrote approximately 220 new CDS contracts in 2005, which exceeded the total number of such contracts it had written in the previous seven years combined. By the end of 2005, AIGFP had written, in the aggregate, approximately $80 billion of credit default swaps relating to CDOs comprised of pools of securities backed by subprime mortgages. (CCAC ¶ 102.)
Senior executives at AIGFP recognized signs in late 2005 that the Company's increased exposure to the subprime mortgage market carried greater risks than they had previously realized. American General Financial Services, an AIG division in the mortgage lending business, "had become alarmed by the rapidly growing use of subprime mortgages" and "word spread from American General to AIGFP that the subprime business was a minefield." (CCAC ¶ 108.) Eugene Park, who managed AIGFP's North American credit derivative portfolio, declined the opportunity to be placed in charge of marketing AIGFP's CDSs (which would have entailed a promotion) after concluding that the swaps were unacceptably risky. (CCAC ¶¶ 108-09.) Most importantly, AIGFP executives realized that the model they were using to evaluate the risk involved with the CDSs (the "Gorton model," constructed by Professor Gary Gorton) "was not adequate to deal with the subprime mortgage debt underlying the insured CDOs." (CCAC ¶¶ 111, 483.) In fact, AIGFP executives Frost and Forster did not even provide Gorton with all the data he would have needed to develop a comprehensive model, even if it were possible to do so. (CCAC ¶ 483.)
AIGFP decided at the end of 2005 to stop entering into new credit default swaps that provided protection on CDOs. (CCAC ¶ 112.) According to a confidential witness who was an AIGFP executive in 2005 with knowledge of this decision, the factors that led AIGFP to stop underwriting new CDSs -- the declining quality of underwriting standards for subprime loans and the correlation between the types of collateral in the CDOs (which were supposed to be composed of diverse, non-correlated assets) -- were already present in the majority of the CDSs that AIGFP had entered into in 2005. (CCAC ¶ 112.) AIGFP did not, however, extricate itself from any of those contracts, nor did it hedge against the increased risk of those contracts. (CCAC ¶¶ 116, 124.) Rather, defendants Forster, Frost and Cassano rejected suggestions from other AIGFP personnel that AIGFP should hedge the CDS portfolio. (CCAC ¶ 351(d).) Although AIG stated in its public filings that it had the ability to hedge its positions (CCAC ¶ 259), and defendant Forster stated at a May 2007 investor conference that hedging the CDS portfolio was unnecessary due to its conservative profile, AIG actually declined to hedge because it would not have been economically feasible to do so. (CCAC ¶ 126.)
The CDS portfolio put the Company at risk in three ways. Most obviously, AIG would have to make large payments in the event that a significant proportion of the underlying reference securities defaulted, a risk known as "credit risk." Additionally, if AIG's credit rating were downgraded, or if the market value of the reference securities declined -- due, for example, to a market perception that the mortgage-backed securities within the CDOs were increasingly likely to fall short of providing the expected cash flows because of increasing defaults on the underlying mortgages -- AIG would be forced to post collateral to its counterparties to provide security that it could make good in the event of a default, a risk known as "collateral risk." Morever, in such a scenario AIG would be required to mark-to-market the declining value of the CDS assets in its financial statements. Such marking to market would cause it to recognize a loss on paper even before it experienced an actual economic loss, a risk known as "valuation risk." (CCAC ¶¶ 117-22.)
Despite the multitude of risks presented by the CDS portfolio, AIGFP did not subject these investments to strict control procedures. Cassano presided over weekly meetings with AIGFP executives (including defendants Forster and Frost) where risk management issues across AIGFP's businesses were discussed, yet he deliberately excluded key risk management personnel from reviewing the Asset/Credit Group (which engaged in the CDS transactions). (CCAC ¶ 133.) Cassano also did not subject the CDS investments to the rigorous risk analysis process to which the other business units at AIGFP were routinely subjected (CCAC ¶¶ 136-38), and Forster and Frost made valuation and risk management decisions with respect to AIGFP while controlling the flow of relevant information within the Company (CCAC ¶ 480).
AIGFP's CDS portfolio was not the only major source of exposure to RMBS at AIG. The Company's securities lending program, which was housed within AIG Investments (a separate division from AIGFP), was intended to earn additional return on long-term financial assets by lending securities to banks and brokerage firms in exchange for cash collateral. In an ambitious effort to generate additional income, it became significantly exposed to the subprime mortgage markets as well: by year-end 2005, the program was investing up to 75% of all the collateral it received from borrowers in RMBS and other mortgage-backed securities.*fn5 (CCAC ¶ 219, 244-45, 266(g).) The securities lending program's exposure to RMBS was particularly risky given that the program was obligated to repay or roll over most of its loans every 30 days. Therefore, investing its collateral in this manner created the risk that a freeze in the RMBS market might quickly precipitate a liquidity crunch for AIG. (CCAC ¶ 245.)
In 2006, as has been widely documented, the previously soaring housing market faltered, leading to rising mortgage default rates, falling home values, failures of hedge funds that had long positions in the mortgage market, and bankruptcies of many subprime mortgage lenders. These events continued throughout 2006 and 2007. (CCAC ¶¶ 140-48.) In light of growing investor concern regarding exposure to the subprime mortgage market, AIG, on August 8, 2007 (during the second quarter 2007 investor call), November 8, 2007 (during the third quarter 2007 investor call), and December 5, 2007 (during a special investor meeting) gave three investor presentations addressing its own exposure. (CCAC ¶ 150.) These presentations, along with the Company's public filings and press releases, are the focus of many of Plaintiffs' allegations of material misstatements and omissions.
Plaintiffs' securities law claims are based principally on the contention that AIG consistently misled the market by failing to disclose the valuation and collateral risk of the CDS portfolio (which ultimately caused the Company's liquidity crisis) while emphasizing instead what AIG characterized as the "extremely remote" nature of the portfolio's credit risk. Plaintiffs also allege that AIG consistently trumpeted its risk controls and its careful structuring of its CDS portfolio despite its awareness that its risk controls were inadequate and its models were unable to evaluate the extent of the risk. (CCAC ¶ 152.) Plaintiffs allege as well that ...