PHILLIP WOOLGAR, individually and on behalf of all others similarly situated, Plaintiff, v. KINGSTONE COMPANIES, INC., BARRY GOLDSTEIN, DALE A. THATCHER, VICTOR J. BRODSKY, AND BENJAMIN WALDEN, Defendants.
No. 19-CV-5500 (RA)
UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK
August 10, 2020
USDC-SDNY DOCUMENT ELECTRONICALLY FILED DOC#: DATE FILED: 8/10/2020
RONNIE ABRAMS, United States District Judge:
Lead Plaintiff Donald Fitzherbert brings this federal securities class action against Kingstone Companies, Inc. (“Kingstone” or the “Company“), as well as Kingstone‘s Chief Executive Officer Barry Goldstein, former Chief Executive Officer Dale Thatcher, Chief Financial Officer Victor Brodsky, and Chief Actuary Benjamin Walden (collectively, “Defendants”1), alleging that, from March 14, 2018 to April 29, 2019, Defendants committed securities fraud in violation of
I. Factual Background
The following facts are drawn from Plaintiff‘s Amended Class Action Complaint (the “CAC” or “Complaint“), Dkt. 36, and are assumed to be true for the purpose of this motion. See Stadnick v. Vivint Solar, Inc., 861 F.3d 31, 35 (2d Cir. 2017).
A. The Parties
Defendant Kingstone is the parent and holding company of Kingstone Insurance Company (“KICO“), its wholly owned subsidiary. CAC ¶¶ 2, 22. KICO is a “property and casualty insurance company” that provides “insurance products for individuals and small to mid-size businesses in the northeast,” and “distributes its insurance products through an independent agent and broker network.” Id. ¶ 2. Kingstone is incorporated under the laws of the state of Delaware. Id. ¶ 22. Both Kingstone and KICO are headquartered in New York. Id. ¶ 2. Kingstone trades on the NASDAQ under the ticker symbol “KINS.” Id. ¶ 22.
Defendant Barry Goldstein is Kingstone‘s current CEO and President, and has been since July 19, 2019. Id. ¶ 23. Goldstein also served as Kingstone‘s CEO and President from March 2001 to December 31, 2018. See id. In addition, Goldstein is the Executive Chairman of Kingstone‘s Board, as well as the CEO, President, and Chief Investment Officer of KICO, Chairman of KICO‘s Board, and Chairman of KICO‘s Executive Committee. Id. ¶¶ 23-24. Previously, Goldstein was the Chairman of Kingstone‘s Board from March 2001 to December 31, 2018, Kingstone‘s CFO from March 2001 to November 2007, Kingstone‘s Treasurer from May 2001 to August 2013, KICO‘s CEO from January 2012 to December 31, 2018, KICO‘s President from January 2012 to March 2018, and KICO‘s Treasurer from March 2010 to September 2010. Id.
Defendant Dale Thatcher is the former President and CEO of Kingstone and KICO. Id. ¶ 25. He served as Kingstone‘s President and CEO and as KICO‘s CEO from January 1, 2019—and as
Defendant Victor Brodsky is Kingstone‘s CFO and Treasurer, as well as KICO‘s CFO, Executive Vice President, and a director of its Board. Id. ¶ 26. Previously, Brodsky was Kingstone‘s Chief Accounting Officer from August 2007 to July 2009, its Principal Financial Officer “for SEC reporting purposes” from November 2007 to July 2009, and its Secretary from December 2008 to August 2013. Id. Brodsky was also previously KICO‘s Senior Vice President from January 2012 to February 2017 and KICO‘s Treasurer from September 2010 to December 2011. Id.
Defendant Benjamin Walden is Kingstone‘s and KICO‘s Chief Actuary and KICO‘s Executive Vice President. Id. ¶ 27. He previously served as KICO‘s Senior Vice President from January 2015 to February 2017, and as KICO‘s Vice President from December 2013 to January 2015. Id.
Lead Plaintiff Donald Fitzherbert (“Plaintiff“) acquired Kingstone securities during the Class Period, and allegedly did so “at artificially inflated prices” and thus suffered damages as a result of Defendants’ alleged securities violations. Id. ¶ 21. Plaintiff brings this federal securities class action on behalf of both himself and a class of “all persons who purchased or otherwise acquired Kingstone securities” between March 14, 2018 and April 29, 2019 (the “Class Period“). Id. ¶ 164.2
B. Overview of Kingstone and KICO‘s Business
Kingstone “offers property and casualty insurance products” through KICO, its wholly owned subsidiary. Id. ¶ 30. Its “primary source of revenue” comes from the “premiums paid to KICO” for
During the Class Period, KICO‘s product lines included “personal, commercial liability, [and] livery physical damages” lines. Id. ¶ 36. KICO‘s personal line is the company‘s largest, and consists of “homeowners and dwelling fire multi-peril, cooperative/condominiums, renters, and personal umbrella policies.” Id. KICO‘s commercial liability line consists primarily of “small business retail, service, and office risks with limited residential exposure,” as well as “liability policies for small independent contractors” and “special multi-peril policies for larger and more specialized risks,” and “umbrella policies for each of these.” Id. ¶ 37. Its livery physical damage line covers “vehicle physical damage for car service vehicles and taxicabs.” Id. ¶ 38. Its other policies include “canine legal liability policies and participation in the mandatory state joint underwriting associations.” Id.
C. Kingstone‘s A.M. Best Rating
Plaintiff maintains that, for at least four years prior to the start of the Class Period, Kingstone “saw ever increasing net premiums, revenues, and net income.” Id. ¶ 39. Prior to the Class Period, Kingstone also apparently “received an A.M. Best upgraded financial strength rating.” See id. ¶ 103. In particular, Kingstone was upgraded to an A- rating. See id. ¶ 104; see also ¶ 32 (alleging that in April 2017, KICO “achieved its long-standing goal of becoming an A-rated carrier” when its rating was upgraded from “B++” to “A-“). According to the Company‘s SEC filings, “rating agencies such as A.M. Best review the financial performance and condition of insurers” on an “ongoing basis,” and a “downgrade” in the Company‘s “financial strength rating from A.M. Best could have a material
D. Kingstone‘s Loss Reserves
According to the Complaint, “[i]nsurance companies like Kingstone” are required to maintain and record loss reserves in order to “ensure adequate liquidity to pay policy claims.” Id. ¶¶ 3, 40. The “loss reserve” is “an estimate of the value of claims not yet paid,” which “directly impacts” a company‘s net income as it is “recorded as a balance sheet liability.” Id. ¶ 3; see also id. ¶ 40 (“Loss reserves are balance sheet liabilities[.]“). Plaintiff alleges that Kingstone‘s “loss reserves directly impact income and are the largest expense on the Company‘s income statement.” Id. ¶ 44.
Loss reserves are intended to “reflect the estimated cost of future amounts the company will be required to pay on claims for policies written at or before the balance sheet date,” and are for “both known and unknown losses which have been incurred as of the financial reporting date on all previously written policies, both current and expired.” Id. ¶ 40. Loss reserves fall into two categories. First, “case reserves” are reserves for “known but unpaid claims,” including “reserves for the claims and [loss adjustment expenses (‘LAE‘)], expenses for settling or adjusting the claims.” Id. ¶¶ 3, 41. Plaintiff asserts that when Kingstone receives an insurance claim, the “case reserve,” or “estimated amount of its ultimate settlement and its estimated loss expenses,” is established based on the “then-known facts about the claim,” and that each reported claim may subsequently be increased or decreased based on “developing additional facts.” Id. ¶ 41. According to Plaintiff, “a company‘s case reserves must accurately reflect the cost of known but unpaid claims.” Id. ¶ 3. Second, “‘incurred but not reported’ loss reserves,” or “IBNR reserves,” are reserves that consist of “the IBNR
The basis of most of Plaintiff‘s allegations is that Defendants materially understated the Company‘s loss reserve estimates. According to the Complaint, Kingstone‘s “under reporting” of its loss reserves ultimately “came to light” at the end of the Class Period, when Defendants were “forced to take a reserve charge in the amount of $5 million.” See id. ¶ 5. Specifically, on April 29, 2019, Kingstone “shocked the market” by “announcing a $5 million loss reserve charge,” comprised of $2.5 million to case reserves and $2.5 million to IBNR reserves. Id. ¶ 8; see also id. ¶ 84. In the press release announcing the $5 million reserve charge, the Company also stated that it had “engaged a consultant to do a comprehensive review of [its] claims operations,” and that “[that] report conclude[ed] that Kingstone should adopt and implement ‘a number of industry best [] practices including the need to acquire more skilled and experienced staff.‘” Id. ¶ 8. As a result of this news, Kingstone‘s stock price dropped $2.02 per share. See id. ¶¶ 9, 85.
Since the end of the Class Period, Kingstone has taken additional reserve charges, for a total charge of over $11 million. See id. ¶¶ 5, 16. In particular, Kingstone took a $1.6 million reserve charge on August 8, 2019, see id. ¶ 92, as well as a $5.1 million reserve charge—$4.4 million of which was “related to the commercial lines“—on November 11, 2019, see id. ¶¶ 14, 94. When the Company took the November 2019 reserve charge, it also announced that it expected to report “a material weakness in internal control,” which related to “the establishment of case reserve levels.” See id. ¶ 95. Plaintiff maintains that the Company‘s need to “take loss reserve charges totaling over $11
E. The CWs’ Allegations
According to six confidential witnesses (“CWs“), “a culture of failing to accurately underwrite policies and set adequate loss reserves prevailed at [Kingstone] and was well-known, if not encouraged, by the Individual Defendants.” Id. ¶ 55. Plaintiff maintains in particular that Defendants “permitted [such] risky underwriting of policies and insufficient claims reserving for those poorly underwritten policies” in order to increase the Company‘s business. See id. The CWs, all of whom are former employees of the Company, describe various issues that purportedly existed at Kingstone during the Class Period.3
First, the CWs reported issues in the Company‘s underwriting department. CW1 described a “risky underwriting culture” at the Company, in which “management continually overrode underwriters and granted unwarranted exceptions leading to the undervaluation of properties.” Id. ¶ 60. CW1 maintained that all “certain agents” had to do “was complain to management, especially [D]efendant Goldstein, when an underwriter would decline business and the decision [would be] overridden.” Id. With respect to underwriting, CW1 also asserted: “If you didn‘t do what they wanted, you were going to get fired. They were very controlling. The bottom line is that the top are going to have the final say in it. They will override you every step of the way.” Id. ¶ 61. CW1
CW3 similarly maintained that the Company‘s policies “defied good underwriting guidelines and should not have been written.” Id. ¶ 67. CW5 asserted that “something was definitely ‘off’ with regards to underwriting” at the Company, and that “a lot of business was written for both personal and commercial properties that should not have been written.” Id. ¶ 69. As an example of how Kingstone “took whatever they could get,” CW5 recalled a “specific instance” of a “high value home” that was “left unattended for the winter where the pipes burst causing millions of dollars of damage.” Id. In that case, Kingstone allegedly “had not properly reserved for the claim, or possibly had no reserve for it, and had to pay out millions.” Id. (emphasis omitted). Additionally, some of the CWs suggested that the Company became more concerned with “volume,” as opposed to quality. See, e.g., id. ¶ 68 (CW4 asserted that “the focus” of the Company “became volume as opposed to quality“). CW3 asserted further that “concessions were made to certain insurance agencies depending upon the volume of business they brought to the Company.” Id. ¶ 67.
The CWs also described a culture of secrecy and a general lack of transparency at the Company. CW2, for instance, maintained that everything at Kingstone was “secretive,” and that there was “no sharing of information” and “no transparency.” Id. ¶ 59. CW1 and CW2 reported that there was a “lack of communication” between departments at Kingstone, which, among other things, had an “adverse effect on the underwriting process” at the Company. See id. ¶¶ 58-59. According to
CW1 also reported that, in addition to the Company‘s underwriting department, “Kingstone‘s claims department [] had concerns.” Id. ¶ 70. To exemplify these issues, CW1 pointed to the fact that there were “at least five different claims managers during CW1‘s five-year tenure,” and maintained that “[i]f you didn‘t play the game, they got rid of you.” Id.; see also id. ¶ 57 (CW1 described issues with employee retention in the Company‘s claims department). CW1 asserted further that Walden, Kingstone‘s Chief Actuary, had “no business being an actuary at an insurance company” because he did not “understand insurance” and “was constantly giving exceptions.” See id. ¶ 71.
CW2 raised concerns about under-valuations at Kingstone. Specifically, CW2 claimed that Kingstone was “definitely undervaluing all their homes,” and did not have “proper reserves.” Id. ¶ 64; see also id. ¶ 72 (CW2 asserted that Kingstone “did not have proper reserves set and it was very hush-hush when there was a big loss“). From CW2‘s perspective, the under-valuations were “significant,” and CW2 thus “brought up” concerns about “undervaluing Kingstone‘s books and putting the Company at risk” “over and over.” See id. ¶ 65 (alterations omitted). CW2 recalled discussing under-valuations with some of the Individual Defendants. For instance, CW2 apparently “discuss[ed] the book being undervalued” “multiple times” with Goldstein, Thatcher, and Walden. Id. ¶ 66. CW2 asserted that Goldstein‘s response to “the undervaluation concerns” was that CW2 was “making something of nothing, calling it a red herring, and eventually trying to avoid having conversations with CW2 altogether.” Id. CW2‘s “topic of conversation” was nonetheless “the undervaluation of the books, and how it would impact [the Company] if there was a catastrophic
Lastly, CW6 set forth concerns about the Company‘s loss reserves. In particular, CW6 contended that “a lot of [Kingstone‘s] files were under reserved, particularly the larger accounts.” Id. ¶ 73. According to the Complaint, “[i]t was CW6‘s job to calculate what the reserves should be, but CW6‘s recommendations were ignored by upper management at least 50% of the time on the larger accounts.” Id. The Complaint also alleges that when “CW6 requested reserve increases, [those] requests were declined.” See id. Additionally, CW6 recalled that commercial claims were “under-reserved as well,” including “one case where an excess verdict was obtained and the amount awarded was in excess of the policy.” See id.
F. Goldstein‘s Stock Sales
Plaintiff alleges that during the Class Period, Goldstein sold 79,286 shares of Kingstone stock, “reaping net proceeds of over $1.3 million.” See id. ¶ 115. Goldstein sold these shares pursuant to a 10b5-1 plan, which was apparently entered into on November 14, 2018. See id. ¶ 115 n.4. Goldstein allegedly made these sales between January 2, 2019 and January 25, 2019. See id. ¶ 115. According to Plaintiff, Goldstein “had only sold shares of Kingstone stock once prior in the preceding ten years.” See id (emphasis omitted).
On July 19, 2019, almost three months after the end of the Class Period, Kingstone announced that Thatcher had resigned his positions as CEO and President of Kingstone and KICO, and as a director on the Boards of both companies. See id. ¶ 90. Goldstein “resumed the positions as President and CEO of Kingstone and KICO” as a result of Thatcher‘s resignation. See id. Plaintiff contends that Thatcher‘s “resignation” was “sudden” and “suspicious” because, at the time he left the Company, Thatcher was only seven months into his three-year employment contract. See id. ¶ 105. Moreover, according to CW3, Thatcher was actually fired. See id.
II. Procedural Background
On June 12, 2019, Plaintiff Phillip Woolgar filed this putative securities class action against Defendants Kingstone, Goldstein, Thatcher, and Brodsky. Dkt. 1. On October 3, 2019, the Court appointed Donald Fitzherbert as Lead Plaintiff, approved his selection of counsel, and authorized the filing of an amended complaint. Dkts. 25, 26. Plaintiff filed the amended class action complaint—the operative complaint—on December 17, 2019, adding Defendant Walden as a named defendant. Dkt. 36. On February 18, 2020, Defendants moved to dismiss pursuant to
III. Materially False and Misleading Statements Alleged in the Complaint
Plaintiff alleges that Defendants made materially false and misleading statements and omissions during the Class Period regarding Kingstone‘s loss reserves and “loss reserve practices,” the effectiveness of Kingstone‘s internal controls, and Kingstone‘s underwriting and risk practices, including by “materially misstat[ing] Kingstone‘s financial results” such as its “loss reserves, net income, loss ratio, and combined ratio.” See id. ¶ 116. By making such false and misleading
A. Kingstone‘s Loss Reserves
First, Plaintiff alleges that, throughout the Class Period, Defendants falsely represented that Kingstone‘s loss reserves were “adequate,” “strong,” and/or “solid.” See, e.g., id. ¶ 7. For instance, the March 14, 2018 press release announcing the Company‘s quarter and year ended December 31, 2017 financial results stated that “[t]he Company‘s reserve position remains strong,” and that Kingstone had “built a dedicated and highly capable claims team that is clearly having a positive impact on financial results.” Id. ¶ 132. During the investor conference call held the next day, Walden echoed this sentiment, stating that the Company‘s “year-end internal and external actuarial reviews confirmed the strength of [its] reserve position,” and that its “financial results for the quarter and the year are not materially affected by changes in the adequacy of [Kingstone‘s] reserves.” Id. ¶ 133; see also id. (the Company‘s “reserving philosophy lends stability to [its] results, even in times of short term volatility“); id. ¶ 134 (“Apart from the winter catastrophe events, underlying results remained solid.“); id. ¶ 135 (the Company‘s “reserves remained solid“); id. ¶ 136 (the Company‘s “reserve levels remained strong with a small amount of favorable development recorded during the quarter“).
Defendants also allegedly “manipulated Kingstone‘s loss reserves” throughout the Class Period, causing the reserves to be “materially lower than they should have been.” See id. ¶¶ 4, 54. Plaintiff asserts that Defendants did this by intentionally and/or recklessly undervaluing properties at the underwriting and claims phases, and by “failing to follow industry best practices in [the Company‘s] claims department.” See id. ¶ 54. Plaintiff alleges further that Defendants “intentionally under-reserved” and understated Kingstone‘s loss reserves in order to “inflate the Company‘s net income and overall financial strength, especially in light of the Company‘s recent A.M. Best rating upgrade which was bringing in more business.” See id. ¶¶ 4-5. Plaintiff thus contends that Kingstone “should have increased its loss reserves” during the Class Period, but that it did not adequately do so. See id. ¶¶ 5-6. By “materially understat[ing]” its loss reserve estimates on its income statement, Plaintiff alleges, Kingstone overstated its net income during the Class Period, thereby violating generally accepted accounting principles (“GAAP“). See id. ¶ 75.4
More broadly, Plaintiff alleges that Defendants falsely reported Kingstone‘s financial results during the Class Period because they “represented that the financial information [contained in the reports] was a fair statement of the Company‘s financial results and that the results were prepared in
B. Kingstone‘s Internal Controls
Next, Plaintiff alleges that each of Kingstone‘s quarterly and annual financial reports filed during the Class Period “contained materially false and misleading [statements] regarding the Company‘s internal controls.” See id. ¶ 147. Specifically, these reports contained statements indicating that “[t]here was no change in [the Company‘s] internal control over financial reporting during [its] most recently completed fiscal quarter that ha[d] materially affected, or [was] reasonably likely to materially affect, [its] internal control over financial reporting.” See id. (2017 10-K and 2018 10-K); id. ¶ 148 (1Q18 10-Q, 2Q18 10-Q, and 3Q18 10-Q). Defendants allegedly misrepresented that Kingstone “maintained effective internal controls that enabled the Company to accurately account for loss reserves, among other things.” See id. ¶ 52. Moreover, Goldstein, Thatcher, and Brodsky “certified the effectiveness of Kingstone‘s internal controls such that the Company‘s financial statements were accurate, prepared in compliance with [GAAP] and fairly represented the Company‘s financial condition in each of the financial reports issued” during the Class Period. See id.; see also id. ¶ 149 (alleging that Goldstein or Thatcher and Brodsky “certified to the effectiveness of the Company‘s internal controls in each of Kingstone‘s annual and quarterly filings
C. Kingstone‘s Underwriting, Risk Management, and Reserving Practices
Finally, Plaintiff alleges that Defendants made false and misleading statements regarding the Company‘s underwriting, risk management, and claims reserving practices. In describing the Company‘s “underwriting and risk management practices” in its 2017 10-K, for instance, Kingstone stated that its “underwriting process evaluates and screens out certain risks based on property reports, individual insurance scoring, information collected from physical property inspections, and driving records,” that it “maintain[s] certain policy exclusions that reduce [its] exposure to risks that can create severe losses,” that it “target[s] a more preferred risk profile in order to reduce adverse selection from risks seeking the lowest premiums and minimal coverage levels,” that its “underwriting philosophy is to target niche risk segments for which [it has] detailed expertise and can take advantage of market conditions,” and that it “monitor[s] results on a regular basis,” including by reviewing “selected producers” on “at least a quarterly basis.” See id. ¶ 121. The 2017 10-K also provided that Kingstone “carefully underwrite[s] [its] business” using certain “risk underwriting tools,” and that the Company‘s “claims and underwriting expertise” enables it to “profitably write personal lines business in all the territories in which [it] writes[s].” See id. Plaintiff asserts that Kingstone‘s 2018 10-K “included the same, or substantially identical, false and misleading statements relating to the Company‘s underwriting and risk management practices and loss reserve practices and procedures as the 2017 10-K.” Id. ¶ 130.
The Company also allegedly made false and misleading statements regarding its process of regularly reviewing and updating its reserves estimates. Plaintiff alleges that Kingstone‘s SEC filings during the Class Period falsely stated, for instance, that the Company‘s loss reserve process “used ‘standard actuarial reserving methodologies,’ considering ‘all information known to [the Company]
D. Reasons Why Statements Were Allegedly False and/or Misleading
According to Plaintiff, the statements in the Company‘s annual and quarterly financial statements were “materially false and/or misleading and/or failed to disclose” that (1) “properties were significantly under-valued creating greater credit risk and a greater chance that the loss reserves were not adequate,” (2) “Defendants fostered a culture which prevented communications between underwriters and other departments, including the claims department, requiring underwriters to underwrite inaccurately or be fired, and acquiescing to the demands of agents and brokers,” (3) “the claims department was not following industry best practices,” (4) “as a result, loss reserving procedures were insufficient or not being performed correctly,” and (5) “as a result the Company‘s loss reserves, net loss ratio, and net combined ratio were materially understated and net income
Plaintiff also contends that the statements in the 2017 10-K and the corresponding March 14, 2018 press release were materially false and misleading because the Company allegedly admitted that “Kingstone was not following industry best practices” and because “Kingstone should have reported materially higher reserves and ratios and lower net income” for this period. See id. ¶ 118. Similarly, Plaintiff alleges that the statements in the 2018 10-K and corresponding March 13, 2019 press release were materially false and misleading for the same reason—the Company was allegedly not following industry best practices—and because, again, “Kingstone should have reported materially higher reserves and ratios and lower net income.” See id. ¶ 120; see also id. ¶ 119 (alleging that the statements in “each of the press releases and Forms 10-Q were also materially false and misleading” in light of the numbers reported for the Company‘s loss reserves, net loss ratio, combined ratio, and net income).
Additionally, as to the challenged statements about Kingstone‘s internal controls in particular, see, e.g., id. ¶¶ 147-48, Plaintiff asserts that those statements were “false and misleading when made because throughout the Class Period, Kingstone‘s internal controls suffered from a material weakness.” See id. ¶ 150.
LEGAL STANDARDS
I. Motions to Dismiss Under Federal Rule of Civil Procedure 12(b)(6)
To survive a motion to dismiss under
II. Motions to Dismiss Under Federal Rule of Civil Procedure 9(b) and the PSLRA
In addition to the requisite Rule 12(b)(6) pleading standards, the CAC is also subject to the heightened pleading requirements of
The PSLRA expands on Rule 9(b) and requires “that securities fraud complaints specify each misleading statement; that they set forth the facts on which a belief that a statement is misleading was formed; and that they state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” Id. (quoting Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 345 (2005)) (internal quotation marks omitted). Nevertheless, “even with the heightened pleading standards of Rule 9(b) and the PSLRA, the Court ‘[does] not require the pleading of detailed evidentiary matter[s] in securities litigation.‘” Galestan v. OneMain Holdings, Inc., 348 F. Supp. 3d 282, 302 (S.D.N.Y. 2018) (quoting New Orleans Emps. Ret. Sys. v. Celestica, Inc., 455 F. App‘x 10, 15 (2d Cir. 2011)).
DISCUSSION
I. Whether Plaintiff Adequately Alleges a Section 10(b) Claim
To state a claim under
Under Rule 10b-5, it is unlawful to (1) “make any untrue statement of a material fact,” or (2) “omit to state a material fact necessary in order to make the statements made . . . not misleading.”
For a statement to be actionable under
As to materiality, “there must be a substantial likelihood that a reasonable person would consider the fact misstated or omitted important in connection with a contemplated securities transaction.” In re Lululemon, 14 F. Supp. 3d at 572; see also Freudenberg v. E*Trade Fin. Corp., 712 F. Supp. 2d 171, 181 (S.D.N.Y. 2010) (“A misrepresentation or omission is material when a reasonable investor would attach importance to it in making an investment decision.“). However, “whether a reasonable investor would find a particular misrepresentation or omission ‘material’ to an investment decision is usually a matter reserved for the trier of fact.” In re Inv. Tech. Grp., Inc. Sec. Litig., 251 F. Supp. 3d 596, 610 (S.D.N.Y. 2017) (citation omitted). Therefore, “a complaint may not properly be dismissed on the ground that the alleged misstatements or omissions are not material unless they are so obviously unimportant to a reasonable investor that reasonable minds could not differ on the question of their importance.” Ganino v. Citizens Utils. Co., 228 F.3d 154, 162 (2d Cir. 2000) (citation omitted).
To demonstrate the purported falsity of the challenged statements—as well as Defendants’ fraudulent intent, which is discussed below—Plaintiff relies heavily on the reports from the six CWs. Where a plaintiff relies on allegations from confidential witnesses, as here, those sources must be “described in the complaint with sufficient particularity to support the probability that a person in the position occupied by the source would possess the information alleged.” Novak v. Kasaks, 216 F.3d 300, 314 (2d Cir. 2000). “It is well-established, however, that generic and conclusory allegations based upon rumor or conjecture are undisputedly insufficient to satisfy the heightened pleading standard of
First, the majority of the CWs are alleged to have worked within the underwriting side of the business, and their allegations relate largely to the Company‘s property liability lines, not its commercial liability lines. See, e.g., CAC ¶ 56 (CW1 was a Personal Lines Underwriter from March 2014 to March 2019); id. ¶ 67 (CW3 was a Personal Lines Underwriter until some point in 2016)6; id. ¶¶ 68-69 (CW4 and CW5 were both Underwriting Assistants until approximately July 2019), id. ¶¶ 59, 64 (CW2 was the “Director of Sales for High Value Homes” from September 2017 to October 2018, and primarily asserted issues regarding the undervaluing of homes). Only CW6 is alleged to have knowledge of Kingstone‘s reserving practices. See Tr. at 6; cf. CAC ¶¶ 56, 59, 67-69. Indeed, aside from CW6—who is described in the Complaint without reference to any specific job title or dates of employment, but rather simply as someone who “worked in the claims department during the Class Period” and had the job of calculating “what the reserves should be,” CAC ¶ 73—none of the
Furthermore, despite Plaintiff‘s assertion that “in a Company of only 101 employees, an underwriter could surely have knowledge of unwarranted exceptions in both personal lines and commercial lines,” see Opp‘n at 11, the Complaint does not actually allege that the CWs were in positions in which they had particular knowledge about the Company‘s commercial liability lines—i.e., the lines from which the increased reserves were ultimately taken, see Tr. at 6; see also Reply at 2 (explaining that the “vast majority of the Company‘s loss reserve adjustments applied to commercial liability claims“). In fact, the CWs mention “commercial liability claims” only twice, and neither reference demonstrates that any Defendant was aware of specific information that contradicted their public statements. See CAC ¶ 69 (CW5 reported that “a lot of business was written for both personal and commercial properties that should not have been“); id. ¶ 73 (“CW6 recalled commercial claims being under-reserved as well, mentioning one case where an excess verdict was obtained and the amount awarded was in excess of the policy.“).7
Second, the CWs’ allegations fail to plausibly allege that any of the Individual Defendants received specific, contradictory information demonstrating that their public statements were false or misleading at the time they were made. The majority of the CWs are not alleged to have had any direct contact with the Individual Defendants at all, let alone know what information they possessed. In fact, only CW2 is alleged to have had personal contact and/or conversations with the Individual
Moreover, although Plaintiff asserts that Defendants received “reports detailing significant undervaluation found on the books” and/or attended “meetings about the reports,” see Opp‘n at 15, “a complaint must allege more than the mere existence of contradictory information to support a securities fraud claim; it must allege particularized facts that suggest that the defendants knew of and disregarded such information.” Okla. Firefighters Pension & Ret. Sys. v. Student Loan Corp., 951 F. Supp. 2d 479, 497-98 (S.D.N.Y. 2013). The Complaint here is thus different from that in Freudenberg v. E*Trade Fin. Corp., 712 F. Supp. 2d 171 (S.D.N.Y. 2010), for instance, where the plaintiffs had “pled with particularity the knowledgeable positions occupied by each of the CWs, . . . many of whom had first-hand interactions with the Defendants concerning the matters alleged in the Complaint.” See id. at 196. In Freudenberg, “the Complaint ma[de] reference to sixteen CWs, who provide[d] accounts of what they told Defendants, what Defendants knew, and/or what was discussed internally that is alleged to be contrary to Class Period statements.” Id. at 198. No such allegations are present here.8
Even CW2‘s allegations are insufficient in this regard. The Complaint alleges that CW2 submitted “monthly reports” to “all management,” including Goldstein and Thatcher, and that these reports were discussed in meetings with “at least” Goldstein and Walden. See CAC ¶ 66. CW2 also allegedly discussed, in particular, “the book being undervalued multiple times” with Goldstein,
Third, and related to the above discussion, Plaintiff does not establish how any of the CWs’ allegations are inconsistent with the challenged statements. Even assuming, for instance, that there were communication issues among and within Kingstone‘s underwriting and claims departments, see CAC ¶¶ 57-59, that the underwriting department suffered from missing paperwork, see id. ¶ 63, that the underwriting guidelines changed every few months, see id. ¶ 62, and/or that the Company had issues with “employee retention,” see id. ¶¶ 56-57, none of these allegations demonstrate that the
Fourth, despite Plaintiff‘s contention that the CWs were “employed during the Class Period, which is all that is required to show the timing of the knowledge,” Opp‘n at 12, such vague references as to timing do not establish that the CWs have “provide[d] an adequate basis for believing that the defendants’ statements were false.” See Novak, 216 F.3d at 314. While many of the CWs were employed at Kingstone during the Class Period, they were also employed before and after it, making it unclear whether the purported issues they discuss actually existed during the Class Period. And one CW—CW3—was not even employed during the Class Period. See CAC ¶ 67. In any event, the critical deficiency is that the CWs’ allegations are largely undated, not their dates of employment. Without approximate dates as to when the CWs had—or raised—certain concerns, their allegations do not plead contemporaneous falsity. The one case that Plaintiff cites for the proposition that “all that is required to show the timing of the knowledge” is that the CWs were employed during the Class Period, City of Omaha Police & Fire Ret. Sys. v. Evoqua Water Techs. Corp., No. 18-CV-10320 (AJN), 2020 WL 1529371 (S.D.N.Y. Mar. 30, 2020), specifically noted that “courts must pay particular attention to the timing of anonymous allegations and the CWs’ bases for making such allegations.” See id. at *15. The Complaint here contains no indication as to when any of the issues
Finally, Plaintiff asserts that the CWs describe “an environment of fear of firing if management‘s desires were not followed,” see Opp‘n at 12, as well as a “corporate culture . . . indicative of knowledge that the underwriting and claims practices at the Company were risky at best,” see id. at 16. Plaintiff points to Kingstone‘s “small size,” the “restrictive rules” in place at the Company, and the fact that “there were five claims managers within five years,” as support for the contention that “when employees refuse to play along with Defendants’ demands, they are fired.” See Opp‘n at 16-17. These assertions, however, are plainly insufficient to demonstrate the falsity of Defendants’ public statements. Nor does Plaintiff provide particularized allegations from which it could be inferred that such a culture was anything more than the CWs’ own individual, subjective opinions, or that the Individual Defendants were aware of any of these general concerns. For instance, while CW1 stated that “[i]f you didn‘t do what they wanted, you were going to get fired,” CAC ¶ 61, and that “[i]f you didn‘t play the game, they got rid of you,” id. ¶ 70, none of the CWs actually allege instances of someone being terminated because they disagreed with the Company‘s management or “didn‘t play the game.”
B. Kingstone‘s Loss Reserves
Turning now to the categories of challenged statements, Plaintiff first asserts that Kingstone materially understated its loss reserve estimates, which caused it to overstate its net income in violation of GAAP. See Opp‘n at 14. Plaintiff also alleges that Defendants made material misstatements about the Company‘s reserves by falsely representing that they were “adequate,”
As an initial matter, loss reserves are statements of opinion. See, e.g., Fait v. Regions Fin. Corp., 655 F.3d 105, 113 (2d Cir. 2011) (holding that “statements regarding the adequacy of loan loss reserves” are statements of opinion); Chapman v. Mueller Water Prods., Inc., No. 19-cv-3260 (LJL), 2020 WL 3100243, at *10 (S.D.N.Y. June 11, 2020) (“Under Fait, accounting estimates that depend on management‘s determination or assumptions are ‘subjective’ opinions and ‘not matters of objective fact‘“) (quoting Fait, 655 F.3d at 110-11); Sjunde AP-Fonden v. Gen. Elec. Co., 417 F. Supp. 3d 379, 395 (S.D.N.Y. 2019) (“There is no dispute that, because there is no ‘objective standard for setting [] reserves,’ . . . such statements are to be analyzed as opinions.“) (citations omitted); In re Signet Jewelers Ltd. Sec. Litig., No. 16 Civ. 6728 (CM), 2018 WL 6167889, at *13 (S.D.N.Y. Nov. 26, 2018) (“Loan loss reserves are statements of opinion, as they reflect management‘s belief about the number of uncollectible loans in a company‘s portfolio.“); In re CRM Holdings, Ltd. Sec. Litig., No. 10 Civ. 975 (RPP), 2012 WL 1646888, at *28 (S.D.N.Y. May 10, 2012) (concluding that “[r]eserves are opinions” and explaining that “[i]nsurance reserves are, by their nature, extremely conjectural, and may need adjustment as time passes and their accuracy can be tested in retrospect.“) (internal quotation marks and citations omitted). In Fait, for instance, the Second Circuit explained that “determining the adequacy of loan loss reserves is not a matter of objective fact,” but rather, “reflect[s] management‘s opinion or judgment about what, if any, portion of amounts due on the loans ultimately might not be collectible.” See id. at 113. The “determination is inherently subjective,” and such estimates “will vary depending on a variety of predictable and unpredictable circumstances.” Id.; see also In re NovaGold Res. Inc. Sec. Litig., 629 F. Supp. 2d 272, 294 (S.D.N.Y. 2009) (“[T]he word
Statements of opinion may give rise to liability under
Second, “opinions, though sincerely held and otherwise true as a matter of fact, may nonetheless be actionable if the speaker omits information whose omission makes the statement misleading to a reasonable investor.” Sanofi, 816 F.3d at 210 (citing Omnicare, 575 U.S. at 194). A reasonable investor “expects not just that the [speaker] believes the opinion (however irrationally), but that it fairly aligns with the information in the [speaker‘s] possession at the time.” Omnicare, 575 U.S. at 188-89. To sufficiently allege that a statement of opinion was false or misleading through the omission of material information, a plaintiff “must identify particular (and material) facts going to the basis for the [speaker‘s] opinion—facts about the inquiry the [speaker] did or did not conduct or
Accordingly, “[s]tatements of opinion are not actionable unless subjectively false — the speaker does not believe what [he] says — or objectively false — the speaker misrepresents or omits existing material facts in support of [his] belief.” In re Signet Jewelers, 2018 WL 6167889, at *13; see also In re CIT Grp., Inc. Sec. Litig., 349 F. Supp. 2d 685, 690 (S.D.N.Y. 2004) (“[S]tatements about defendants’ belief in the adequacy of loan loss reserves could be actionable if it is alleged that defendants did not actually believe that loan loss reserves were adequate, or if defendants had no reasonable factual basis for their belief.“). The plaintiff “bears the burden of pleading particularized facts going to the basis of the speaker‘s opinion.” In re Signet Jewelers, 2018 WL 6167889, at *13. Here, Plaintiff fails to sufficiently allege that the loss reserve estimates were false at the time they were made, or that Defendants did not honestly believe those estimates to be true and accurate. Nor
The Complaint is devoid of allegations demonstrating—or even plausibly suggesting—that Defendants did not honestly believe their opinions regarding the strength or adequacy of the Company‘s loss reserves, or that they believed those estimates to be false. Courts in this Circuit have rejected claims based on similar allegations regarding a company‘s reserves. See, e.g., Chapman, 2020 WL 3100243, at *10 (rejecting claims that defendants materially understated the company‘s warranty reserves because plaintiffs failed to allege “facts plausibly showing that Defendants held anything other than an ‘honest belief’ that the warranty reserves were adequately stated,” “that [the company] ‘was experiencing or internally predicting losses exceeding their set reserves,‘” “that Defendants ‘knew that the . . . evidence on which they relied’ required them to take a larger reserve,” or “that the Company‘s officers ‘understood that the publicly reported numbers were at odds with [their] internal analyses‘“) (citations omitted); Student Loan, 951 F. Supp. 2d at 497 (finding that plaintiffs failed to allege any “basis for concluding that [the company‘s] loan loss reserves reflected anything other than management‘s opinion—based on a variety of subjective determinations—as to the likelihood and magnitude of future losses,” nor any facts “to support their argument that defendants did not honestly believe their loan loss reserves were adequate when made“); Malin, 499 F. Supp. 2d at 165 (explaining that while “statements regarding the adequacy of the loss reserves may be actionable under the theory that defendants did not actually believe them to be true or had no reasonable basis for such a conclusion, . . . they would not be actionable under the securities laws if they simply represented a failure on the part of defendants to correctly gauge the adequacy of the loan
As another court in this Circuit has aptly explained, “Plaintiff[] must do more than allege that Defendants could not have actually believed that [] loss reserves were adequate because they later increased reserves.” Malin, 499 F. Supp. 2d at 148. Rather, Plaintiff must plausibly allege “other indicator[s] that the results reported by Defendants were inaccurate at the time reported, or that Defendants had knowledge of any inaccuracy.” Id. Indeed, similar to In re CIT Group, Inc. Sec. Litig., 349 F. Supp. 2d 685 (S.D.N.Y. 2004), where “plaintiffs argue[d] that defendants could not have actually believed that [] loss reserves were adequate, . . . because defendants decided to increase loan loss reserves just three weeks after the IPO,” Plaintiff here “provide[s] no additional facts from which to infer that defendants did not believe that reserves were adequate or had no reasonable basis for such a belief.” See id. at 690. Furthermore, “[t]hat defendants later decided to revise the amount of [] loss reserves that it deemed adequate provides absolutely no reasonable basis for concluding that defendants did not think reserves were adequate at the time [of the challenged statements].” See id. at 690-91.13
Here, Plaintiff places substantial weight on the fact that on April 29, 2019—at the very end of the Class Period—Kingstone announced a $5 million loss reserve charge, and that it subsequently announced additional reserve charges in the ensuing months, totaling over $11 million. See, e.g., CAC ¶¶ 5, 8, 11, 16, 74, 84, 116-18, 120, 145, 154. Plaintiff seems to argue that, because the Company increased its loss reserves in 2019, its prior reserve estimates must have been fraudulent when originally made. The Court disagrees. The Complaint contains no factual allegations “support[ing] an inference that Defendants thought the reserves were inadequate prior to when these charges were
Nor do the CWs’ statements support Plaintiff‘s allegations regarding Kingstone‘s loss reserves. When asked at oral argument to identify factual allegations in the Complaint demonstrating that Defendants did not believe their opinions regarding the strength or adequacy of the Company‘s reserves at the time of their public statements, Plaintiff‘s counsel pointed primarily to the CWs’ statements. See Tr. at 16-17. In his opposition, Plaintiff similarly contends that Defendants “did not honestly believe the loss reserves were adequate” because they were “directly made aware of the insufficiency of the loss reserves” through the “receipt of reports detailing significant undervaluation found on the books,” as well as their “attendance at meetings about the reports,” and because the Individual Defendants themselves “were the primary actors in making the decisions to under reserve.” See Opp‘n at 15. As discussed above, however, the CWs generally consist of former employees who worked within Kingstone‘s underwriting business, many of whom worked on the Company‘s personal
Even CW6‘s statements—that “[s]ome of the claims [CW6] handled should have had” higher reserves, that CW6‘s “recommendations were ignored by upper management at least 50% of the time on the larger accounts,” and that CW6‘s requested reserve increases were denied, see CAC ¶ 73—appear only to demonstrate a disagreement between the CWs and Kingstone‘s “upper management” as to what the loss reserves should be, which is not uncommon in the context of reserves. See Fait, 655 F.3d at 113. At worst, such statements allege inactionable mismanagement. See Hinerfeld v. United Auto Grp., No. 97 Civ. 3533 (RPP), 1998 WL 397852, at *7 (S.D.N.Y. July 15, 1998) (“The
That management allegedly did not accept some of CW6‘s reserve recommendations—or some of the other CWs’ opinions that certain homes were undervalued—does not demonstrate that Kingstone engaged in risky reserving practices, had insufficient reserves, intentionally understated its reserves, or failed to adjust reserves levels when it was necessary to do so. Although Plaintiff argues repeatedly that reserve recommendations were ignored by Defendants “at least 50% of the time,” see Opp‘n at 9, 15, 16, 20, 22, 25, it is nonetheless plain from the Complaint that that allegation applies only to one CW‘s recommendations—that of CW6—and appears only to relate to “the larger accounts.” See CAC ¶ 73.15
C. Kingstone‘s Internal Controls
Plaintiff also challenges Defendants’ statements about the effectiveness of Kingstone‘s internal controls, including statements that management concluded that “internal control over financial reporting was effective” as of December 31, 2017 and December 31, 2018, CAC ¶ 147; statements in the Company‘s annual and quarterly reports that there was “no change” in its “internal control over financial reporting during [its] most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, [its] internal control over financial reporting,” id. ¶¶ 147-48; and Goldstein, Thatcher, and Brodsky‘s certifications regarding the design and effectiveness of the Company‘s internal controls over financial reporting, id. ¶ 149.
Plaintiff‘s allegations with respect to Kingstone‘s internal controls seem to rest entirely on Kingstone‘s “post-Class Period admission” that there was a material weakness as of September 30, 2019. See Tr. at 17-18. In Kingstone‘s Form 10-Q for the quarter ended September 30, 2019—filed with the SEC on November 12, 2019—the Company disclosed that, based on an evaluation of the effectiveness of its “disclosure controls and procedures,” it had identified a material weakness in its internal controls, which existed as of September 30, 2019. See CAC ¶ 97 (“Our management concluded that, as of September 30, 2019, our internal control over financial reporting was not effective. Management determined there was ineffective oversight over the process of setting
Additionally, as with its reserve estimates, Kingstone‘s independent auditor reviewed the effectiveness of its internal controls and concluded that the Company “maintained effective internal control over financial reporting.” See Mot. at 6. According to Defendants, Kingstone‘s independent auditor also “issued unqualified opinions throughout the Class Period attesting to the effectiveness of the Company‘s internal controls,” and was “unable to identify a material weakness in the Company‘s internal controls” during that period. See Mot. at 27-28. The Court agrees that these facts “undermine[] any inference that Defendants must have been aware of such a weakness during the
D. Kingstone‘s Underwriting, Risk Management, and Reserving Practices
Plaintiff next challenges Defendants’ statements regarding the Company‘s underwriting, risk management, and reserving practices. Plaintiff asserts in particular that Defendants knowingly and falsely claimed to have “conservative” and “strong” underwriting and risk management policies, as well as a “high quality insurance portfolio.” See Opp‘n at 9. Defendants also represented, for instance, that the Company‘s underwriting process “evaluate[d] and screen[ed] out certain risks based on property reports, individual insurance scoring, information collected from physical property inspections, and driving records,” CAC ¶ 121, that the Company maintained “certain policy exclusions that reduce[d] [its] exposure to risks that can create severe losses,” id., that it “carefully underwr[ote] [its] business” and “tighten[ed] certain underwriting criteria,” id. ¶¶ 121, 144, that it “target[ed] a more preferred risk profile in order to reduce adverse selection from risks seeking the lowest premiums and minimal coverage levels,” id. ¶ 121, and that it “maintained a sensible conservative level of risk taking,” id. ¶ 137. As to the Company‘s claims reserving process, Defendants stated that Kingstone‘s practices were “designed to set reserves that, in the aggregate, are adequate to pay all claims at their ultimate settlement value,” id. ¶ 122, that claims reserves were “closely monitored and [] recomputed periodically using the most recent information on reported claims and a variety of statistical techniques,” id. ¶ 125, that the Company had a “highly capable claims team,” id. ¶ 132, and that it “constantly monitor[ed] individual claims and ma[de] adjustments
Relying heavily on the CWs’ allegations, Plaintiff argues that such statements were false and misleading because, in reality, “Kingstone was engaged in risky underwriting practices with missing documentation, improper policy reviews, and a lack of inspections.” Opp‘n at 8.19 In particular, Plaintiff asserts, based on the CWs’ allegations, that Defendants “continually permitted underwriting exceptions for agents who brought in a large amount of business,” resulting in undervaluing of properties and thus under-reserving, as well as “prevented” the “underwriters and claims departments from communicating and sharing information,” thereby “making an adequate review of claims and the ‘monitoring’ of claims impossible.” Opp‘n at 8-9.
Statements about Kingstone‘s underwriting, risk management, and reserving practices fail for similar reasons as those above: the Complaint is devoid of particularized allegations demonstrating the falsity of these challenged statements. For the reasons already explained, none of the CWs’ allegations—all of which are assumed to be true—demonstrates the contemporaneous falsity of the challenged statements. See In re Lululemon, 14 F. Supp. 3d at 571 (noting that, “without contemporaneous falsity, there can be no fraud“). The CWs do not set forth specific, contradictory information of which Defendants were aware. Nor do they provide facts that make Defendants’ public statements about the Company‘s underwriting, risk management, or reserving practices false,
II. Whether Plaintiff Adequately Alleges that Defendants Acted with Scienter
Not only does the Complaint fail to sufficiently plead that Defendants made any false or misleading statements, but also it fails to sufficiently plead that any Defendant acted with the requisite scienter. “Scienter is the mental state embracing an intent to deceive, manipulate, or defraud by the maker of a statement.” In re Lululemon, 14 F. Supp. 3d at 573 (citing Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 319, 323 (2007)). The “scienter requirement is met where the complaint alleges facts showing” either (1) a “motive and opportunity to commit the fraud,” or (2) “strong circumstantial evidence of conscious misbehavior or recklessness.” Emps.’ Ret. Sys. of Gov‘t of the Virgin Islands v. Blanford, 794 F.3d 297, 306 (2d Cir. 2015) (citation omitted); see also Kalnit v.Eichler, 264 F.3d 131, 138 (2d Cir. 2001). To adequately plead that the statements were made with the requisite scienter, a plaintiff must plead facts that, “taken together[,] give rise to a strong inference that the makers of the statements . . . knew that their statements were false or misleading when made, or recklessly disregarded that possibility.” In re Lululemon, 14 F. Supp. 3d at 581 (citing Tellabs 551 U.S. at 323-24 and Novak, 216 F. 3d at 308-09). The question is thus “whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard.” Tellabs, 551 U.S. at 323.
At the motion to dismiss stage, “[t]o determine whether the plaintiff has alleged facts that give rise to the requisite ‘strong inference’ of scienter, a court must consider plausible, nonculpable explanations for the defendant‘s conduct, as well as inferences favoring the plaintiff.” Tellabs, 551 U.S. at 323-24. “In other words, it is not enough to set out facts from which, if true, a reasonable person could infer that the defendant acted with the required intent.” In re Advanced Battery Techs., Inc., 781 F.3d 638, 644 (2d Cir. 2015) (internal quotation marks and citation omitted). Rather, the scienter requirement is met “only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.” Tellabs, 551 U.S. at 324. The court must therefore ask: “When the allegations are accepted as true and taken collectively, would a reasonable person deem the inference of scienter at least as strong as any opposing inference?” ECA, 553 F.3d at 198 (quoting Tellabs, 551 U.S. at 326). The PSLRA likewise requires that a plaintiff “state with particularity facts giving rise to a strong inference” of scienter.
Plaintiff argues that the Complaint pleads a strong inference of scienter under both the “motive and opportunity” theory and the “conscious misbehavior or recklessness” theory. See Opp‘n at 20-24. The Court again disagrees, and holds that under either theory, he has failed to sufficiently plead scienter.
To allege scienter under the “motive and opportunity” theory, generally, a plaintiff must show that the defendant “benefitted in some concrete and personal way from the purported fraud.” Novak, 216 F.3d at 307-08; see also In re Lululemon, 14 F. Supp. 3d at 573 (“Motive and opportunity require plausible allegations that the maker of a statement could, and had the likely prospect of, realizing concrete benefits by the misstatement.“). It is undisputed that the Complaint adequately alleges that the Individual Defendants—former and current executives of the Company—had the “opportunity” to commit the alleged fraud by virtue of their executive positions at Kingstone. See Nguyen v. New Links Genetics Corp., 297 F. Supp. 3d 472, 492 (S.D.N.Y. 2018). The Complaint fails to plead, however, sufficient facts to show that any Individual Defendant had a “motive” to do so.
“Motives that are generally possessed by most corporate directors and officers do not suffice” for purposes of scienter. Kalnit, 264 F.3d at 139 (citing Novak, 216 F.3d at 307-08). “[I]nstead, plaintiffs must assert a concrete and personal benefit to the individual defendants resulting from the fraud.” Id. Plaintiff argues that Defendants had the “motive” to commit the fraud based on three theories: first, based on the Individual Defendants’ “exorbitant compensation,” as well as the fact that their bonuses were “tied to the Company‘s income and combined ratio,” which was “directly impacted by loss reserves,” see Opp‘n at 23; second, based on the Individual Defendants’ desire to maintain the Company‘s upgraded A.M. Best rating, see id. at 24; and third, based on Goldstein‘s “substantial sale of stock” during the Class Period, see id. The Court addresses each of these theories in turn.
As to the Individual Defendants’ compensation and bonuses, it is well established that “[m]otives that are common to most corporate officers, such as the desire for the corporation to appear profitable and the desire to keep stock prices high to increase officer compensation, do not constitute ‘motive’ for purposes of this inquiry.” ECA, 553 F.3d at 198; see also Kalnit, 264 F.3d at 139. As to allegations of defendants inflating stock prices in order to increase their own compensation, the
As to Kingstone‘s A.M. Best rating, the Court agrees with Defendants that a desire to maintain a favorable rating from A.M. Best similarly does not establish motive. See Mot. at 21. Courts in this Circuit have held that “a motive to maintain a financial rating to protect the viability of the Company is not sufficient, under the law of this Circuit, to establish a motive to commit fraud.” Coronel v. Quanta Capital Holdings Ltd., No. 07 Civ. 1405 (RPP), 2009 WL 174656, at *16 (S.D.N.Y. Jan. 26, 2009) (rejecting plaintiff‘s allegations of fraud “based on the Company‘s desire to maintain an ‘excellent’ rating from A.M. Best“); see also, e.g., Novak, 216 F.3d at 307 (“Plaintiffs could not proceed based on motives possessed by virtually all corporate insiders, including . . . the desire to maintain a high corporate credit rating[.]“); San Leandro Emergency Med. Grp. Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 814 (2d Cir. 1996) (noting that a “company‘s desire to maintain a high bond or credit rating” does not qualify as a sufficient motive); Malin, 499 F. Supp. 2d at 157 (“A company‘s desire to maintain high credit and bond ratings, along with other similarly generalized motives, have been found to be insufficient, because such desires can be imputed to all companies.“).
Lastly, Goldstein‘s stock sales do not establish motive to commit the fraud for several reasons. As an initial matter, even a significant stock sale by a corporate insider is generally insufficient, without more, to support an inference of fraudulent intent. See In re Bristol-Myers Squibb Sec. Litig., 312 F. Supp. 2d 549, 561 (S.D.N.Y. 2004). Rather, only “unusual” stock trading by an executive, “under some circumstances[,] may give rise to an inference of [scienter].” Id. (citation omitted); see also Acito v. IMCERA Grp., Inc., 47 F.3d 47, 54 (2d Cir. 1995). An insider‘s stock sales may thus support an inference of fraudulent intent where the trades are “unusual or suspicious in timing or amount.” See In re Oxford Health Plans, Inc. Sec. Litig., 187 F.R.D. 133, 139 (S.D.N.Y. 1999). A plaintiff bears the burden of demonstrating that a defendant‘s stock sales are “unusual.” See Acito, 47 F.3d at 54.
The Court cannot conclude that Goldstein‘s Class Period sale of 79,286 shares of Kingstone stock, “reaping net proceeds of over $1.3 million,” CAC ¶ 115, was “unusual” or “suspicious,” even if it is true that Goldstein had only sold shares of Kingstone stock once before in the preceding ten years, see id. As to the timing, Plaintiff merely asserts that Goldstein “sold his stocks almost immediately after being taken out of the position to control the disclosure timing.” See Opp‘n at 24 n.20. Nonetheless, according to the table included in the Complaint, Goldstein‘s stock sales all occurred between January 2 and January 25, 2019. See CAC ¶ 115. It is thus undisputed that
As to the amount or other circumstances surrounding Goldstein‘s sales during the Class Period, Plaintiff has failed to sufficiently allege why such activity was “unusual.” In this determination, courts typically consider factors such as “the amount of profit from the sales, the portion of stockholdings sold, the change in volume of insider sales, and the number of insiders selling.” Evoqua, 2020 WL 1529371, at *25 (quoting In re Scholastic Corp. Sec. Litig., 252 F.3d 63, 74-75 (2d Cir. 2001)). Aside from alleging that Goldstein made “net proceeds” of approximately $1.3 million, CAC ¶ 115, the Complaint is silent with respect to “the portion of stockholdings sold,
Finally, it is uncontested that Goldstein‘s stock sales were made pursuant to a
In sum, the allegations regarding Goldstein‘s stock sales are insufficient to conclude that such sales were “dramatically out of line with prior trading practices at times calculated to maximize the personal benefit from undisclosed inside information.” Malin, 499 F. Supp. 2d at 150. For all of these reasons, Plaintiff has failed to plausibly allege that any Defendant had a “motive” to commit the fraud.
B. Conscious Misbehavior or Recklessness
Absent a showing of motive, a plaintiff may demonstrate scienter through allegations regarding conscious misbehavior or recklessness, but “the strength of the circumstantial allegations must be correspondingly greater.” ECA, 553 F.3d at 199 (quoting Kalnit, 264 F.3d at 142). “Conscious misbehavior,” on one hand, “generally consists of deliberate, illegal behavior.” In re Lululemon, 14 F. Supp. 3d at 573 (citing Novak, 216 F.3d at 308). Recklessness, on the other hand, can be adequately pleaded where the allegations show that defendants’ conduct was “highly unreasonable” and constituted “an extreme departure from the standards of ordinary care to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it.” S. Cherry St., LLC v. Hennessee Grp. LLC, 573 F.3d 98, 109 (2d Cir. 2009) (quoting In re Carter-Wallace, Inc. Sec. Litig., 220 F.3d 36, 39 (2d Cir. 2000)) (emphasis in S. Cherry St.). In other words, the recklessness required to plead scienter is “conscious recklessness—i.e., a state of
Circumstantial evidence can support a strong inference of scienter, under the “conscious misbehavior or recklessness” theory, where defendants: “(1) benefitted in a concrete and personal way from the purported fraud; (2) engaged in deliberately illegal behavior; (3) knew facts or had access to information suggesting that their public statements were not accurate; or (4) failed to check information they had a duty to monitor.” Blanford, 794 F.3d at 306 (citation omitted). Here, Plaintiff points to several circumstances that purportedly lead to an inference that the Individual Defendants engaged in “conscious misbehavior or recklessness.” The Court finds none of these to be persuasive.
First, Plaintiff argues that the Complaint sufficiently alleges that Defendants “knew facts or had access to information” suggesting that “Kingstone‘s portrayal of its underwriting practices, risk management practices, and loss reserving practices,” as well as its “loss reserves and related financial results,” were “not accurate.” See Opp‘n at 21. Under this prong, recklessness may be sufficiently pled where there are “[p]lausible allegations that a defendant had facts at his disposal contradicting material public statements, but then ignor[ed] such facts or proceed[ed] despite them.” In re Lululemon, 14 F. Supp. 3d at 574 (citing Novak, 216 F.3d at 308-09). Plaintiff asserts this purported knowledge based on the CWs’ allegations, including “CW6‘s frequently rejected loss reserve recommendations and refused reserve increase requests,” as well as the monthly reports that CW2 submitted and the “numerous meetings and discussions surrounding those reports.” See Opp‘n at 20. Where plaintiffs allege that defendants knew about or had access to contrary facts, however, “they must specifically identify the reports or statements containing this information.” Novak, 216 F.3d at 309. “An allegation that a defendant merely ought to have known is not sufficient to allege recklessness.” In re Lululemon, 14 F. Supp. 3d at 574 (citation omitted). As such, “Second Circuit cases uniformly rely on allegations that [1] specific contradictory information was available to the
As noted above, Plaintiff has failed to adequately plead that Defendants were aware of any specific, contradictory information at the time they made the allegedly false and misleading statements regarding loss reserves or reserving practices, underwriting practices, or risk management practices. See, e.g., In re SLM, 740 F. Supp. 2d at 559 (rejecting CWs’ allegations where plaintiff did not “identify any contemporaneous internal document showing that the loan loss reserves were improperly calculated or that [a defendant] made a statement without foundation,” and where “none of the CWs claim knowledge of how the loan loss reserves were calculated“); Malin, 499 F. Supp. 2d at 161 (rejecting CWs’ allegations in part because the complaint “fail[ed] to reference any actual reports reviewed by any specific individuals, including the Individual Defendants, at [the company] on any specific date that indicated that [the] loss reserves were not sufficient“). In fact, aside from CW2, Plaintiff has “failed to allege any facts showing that the confidential sources . . . had any contact with the Individual Defendants or would have knowledge of what they knew or should have known during the Class Period.” In re Bausch & Lomb, 592 F. Supp. 2d at 342; see also Malin, 499 F. Supp. 2d at 141-42 (holding that the “information collected from the CWs” was insufficient to support an inference of scienter because, among other things, “none of the CWs present[ed] any evidence that they communicated any of the alleged problems detailed above to any of the Individual Defendants or that the Individual Defendants otherwise knew about these issues“). And although CW2 references “monthly reports” and “meetings,” the Complaint does not plausibly allege what information was actually included in those reports or discussed at those meetings. Put simply, Plaintiff fails to plead “specific contradictory information” that was available to any Defendant at the time they made any
Moreover, the fact that Kingstone‘s independent auditor and independent actuary were unable to identify any material inaccuracies or weaknesses undermines a finding of recklessness on Defendants’ part. See, e.g., In re UBS AG Sec. Litig., No. 07 Civ. 11225 (RJS), 2012 WL 4471265, at *18 (S.D.N.Y. Sept. 28, 2012), aff‘d sub nom. City of Pontiac Policemen‘s & Firemen‘s Ret. Sys. v. UBS AG, 752 F.3d 173 (2d Cir. 2014) (“[T]he fact that UBS‘s outside independent auditor . . . did not require a restatement of UBS‘s financials significantly undercuts Plaintiffs’ allegations of recklessness[.]“); In re Bausch & Lomb, 592 F. Supp. 2d at 341 (“It is noteworthy that B & L‘s outside auditor[] did not question B & L‘s accounting practices.“); In re JP Morgan Chase Sec. Litig., No. 02 Civ. 1282 (SHS), 2007 WL 950132, at *13 (S.D.N.Y. 2007), aff‘d, 553 F.3d 187 (2d Cir. 2009) (explaining that the fact that the auditor had not required a restatement demonstrates that “reasonable accountants could differ as to whether [a particular accounting rule] applied to the . . . transactions—an inference that defeats plaintiffs’ claims of recklessness“).
Second, Plaintiff asserts that the fact that the Individual Defendants made “detailed public statements” as to the adequacy of Kingstone‘s loss reserves, as well as the fact that some of the Individual Defendants signed the Company‘s SOX certifications thereby attesting to the Company‘s internal controls over its reserves, supports an inference of scienter. See Opp‘n at 21-22. As a preliminary matter, this argument fails because Plaintiff has not sufficiently pleaded falsity as to any of the challenged statements for the reasons discussed above. The Complaint does not contain
Third, Plaintiff argues that Defendants’ violation of GAAP supports an inference of scienter. See Opp‘n at 22. But the “mere fact” that Kingstone‘s financial reporting may have been inaccurate, even if true, does not establish scienter. See In re Bausch & Lomb, 592 F. Supp. 2d at 341. The Second Circuit has made clear that “allegations of GAAP violations or accounting irregularities, standing alone, are insufficient to state a securities fraud claim. . . . Only where such allegations are coupled with evidence of corresponding fraudulent intent . . . might they be deemed sufficient.” Novak, 216 F.3d at 309 (internal quotation marks and citations omitted) (emphasis added); see also Evoqua, 2020 WL 1529371, at *26 (“The Second Circuit has long applied this standard, repeatedly holding that violations of GAAP are by themselves insufficient to state scienter.“) (collecting cases). Accordingly, there must be some showing that Defendants “intentionally and deliberately” refused to comply with GAAP to adequately plead scienter. See Novak, 216 F.3d at 311 (finding that plaintiffs adequately pleaded scienter where they alleged that defendants “intentionally and deliberately” refused to follow internal accounting policies). To succeed on this theory, Plaintiff must “put forward evidence of corresponding fraudulent intent, separate and apart from the accounting violations themselves.” Evoqua, 2020 WL 1529371, at *26 (internal quotations and citation omitted). Because Plaintiff has failed to plead facts demonstrating fraudulent intent, the alleged GAAP violations do not support an inference of scienter.
Finally, Thatcher‘s “sudden resignation” in July 2019 does not support an inference of scienter. See Opp‘n at 23. Terminations or resignations of corporate executives are insufficient alone to establish an inference of scienter. See Das, 332 F. Supp. 3d at 815. Indeed, “there are any number of reasons that an executive might resign, most of which are not related to fraud.” Id. (citation omitted). “[A]bsent additional factual allegations linking [an executive‘s] resignation . . . to the alleged fraud, such allegations are insufficient to raise a strong inference of scienter.” In re UBS, 2012 WL 4471265, at *18 (internal quotation marks and citations omitted). While Plaintiff contends that Thatcher‘s resignation was “highly suspicious” because he was “only seven months into his lucrative three-year employment agreement” at the time, see Opp‘n at 23 (emphasis omitted); see also CAC ¶ 105, he cites no authority for the proposition that an executive‘s early resignation during a period otherwise covered by an employment agreement constitutes “highly suspicious” circumstances. That allegation alone is thus insufficient to establish an inference of scienter. See, e.g., In re DRDGold Ltd. Sec. Litig., 472 F. Supp. 2d 562, 575 (S.D.N.Y. 2007) (rejecting allegations as to a director‘s resignation “after being in the position just three weeks” because the complaint did not “state any facts to indicate that his departure was a result of any knowledge of alleged fraudulent activities at [the company]“); In re BISYS, 397 F. Supp. 2d at 447 (“[A]bsent any alleged facts linking the two resignations and the alleged fraud, the resignations of [two former executives] do not support an inference of conscious misbehavior or recklessness.“).
The Court therefore concludes that Plaintiff has not pled facts giving rise to a strong inference of scienter. To the contrary, the more plausible inference—based on the facts alleged in the Complaint—is a “nonculpable” one: any inadequacy in Kingstone‘s loss reserves or the effectiveness of its internal controls were, at the most, a result of inactionable corporate mismanagement. And it
III. Whether Plaintiff Adequately Alleges a Section 20(a) Claim
Lastly, under
Control person liability under
For the reasons set forth above, Defendants’ motion to dismiss the Amended Class Action Complaint is granted. In light of his request, the Court will, however, permit Plaintiff to amend the complaint to cure the deficiencies identified in this Opinion, to the extent he has a good faith basis to do so. Plaintiff‘s amended complaint, if any, shall be filed no later than September 11, 2020. If he chooses to amend his complaint, Plaintiff shall also submit a redline demonstrating the changes between the current complaint and the new complaint, as well as a letter brief explaining why such changes should alter the Court‘s analysis. The Clerk of Court is respectfully directed to terminate the motion pending at Dkt. 45.
SO ORDERED.
Dated: August 10, 2020
New York, New York
Ronnie Abrams
United States District Judge