Southern District Of New York Dismisses Exchange Act Claims Against Specialty Insurance Underwriter For Failure To Plausibly Allege Falsity Or Scienter
12/24/2024
On December 12, 2024, Judge Lewis A. Kaplan of the United States District Court for the Southern District of New York granted a motion to dismiss a putative securities class action asserting claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) against an insurance underwriter (the “Company”) and certain of its former and current executives (the “Individual Defendants” and, with the Company, the “Defendants”). Police & Fire Ret. Sys. City of Detroit, et al. v. Argo Grp. Int’l Holdings, Ltd., et al., 22-cv-8971 (S.D.N.Y. Dec. 12, 2024). Plaintiffs allege that defendants made materially misleading statements about the Company’s claims reserves and the success of its construction-related underwriting business. The Court dismissed the action without prejudice, holding that plaintiffs failed to identify any actionable misstatement and found, in the alternative, that plaintiffs failed to allege a strong inference of scienter.
The Company, an insurance underwriter, that allegedly specializes in “niche,” high-risk insurance products, including coverage for commercial and residential contractors for liability arising from defective building components, design, materials, or workmanship, also known as “construction defect claims.” Historically, the Company’s construction-related underwriting allegedly was spread across several lines of its business that focused on high-risk insurance products, generally. But in June of 2018, the Company allegedly launched a stand-alone business line formed to exclusively underwrite construction-specific policies, including construction-defect claims.
In February of 2022, the Company announced it had discovered that its reserves related to construction-defect claims had been underfunded for the years 2017 and earlier, and that it needed to substantially increase its aggregate loss reserves. The Company also allegedly disclosed for the first time that it had created a task force at the end of 2017 “to examine its construction underwriting guidelines,” which led to the decision to create the Company’s construction segment. The Company’s stock price allegedly declined in response to these alleged disclosures. Plaintiffs commenced suit, alleging that defendants made numerous alleged misstatements about the strength of its reserves and the financial success of the Company’s construction business between 2018 and 2022.
The Court granted defendants’ motion to dismiss, concluding that plaintiffs failed to adequately allege the falsity of a single alleged misstatement in their complaint. In so holding, the Court found it to be significant that the gravamen of plaintiffs’ Exchange Act claims centered around the premise that the Company’s creation of a task force in 2017 to “tighten underwriting guidelines and exposures going forward” for its construction-related business suggested both that defendants misstated the sufficiency of the Company’s claims reserves and the success of its construction segment, and that defendants knew those alleged misstatements were false when they were made. The Court concluded that the connection plaintiffs sought to draw was a “logical fallacy,” holding that plaintiffs failed to allege any facts showing that the task force related to or even addressed the issues plaintiffs claimed defendants had misstated. In the Court’s view, the fact that the Company changed its underwriting guidelines “was not equivalent to” the proposition that its existing construction defect reserves were inadequate or that the Company’s construction-related business had not performed as well as reported.
Although the Court concluded plaintiffs failed to allege falsity, it nevertheless addressed the scienter element of plaintiffs’ Exchange Act claims. Plaintiffs principally sought to prove scienter by alleging that Individual Defendants’ compensation packages motivated them to misstate the Company’s financial performance. The Court was unmoved, holding plaintiffs failed to plead any connection between the Individual Defendants’ compensation and any aspect of the alleged fraud. Furthermore, the Court concluded that a handful of Individual Defendants’ alleged sale of common stock during the relevant period also did not raise a strong inference of scienter. The Court found it to be significant that plaintiffs failed to plead Individual Defendants earned a significant profit from the sales, that they depleted a sizeable portion of their stockholdings, or that a significant number of the Individual Defendants engaged in such sales.
Finally, having found plaintiffs failed to plead a predicate violation under Section 10(b), the Court summarily dismissed plaintiffs’ Section 20(a) claim. The Court’s dismissal was without prejudice.