Fulton v. MGIC: Limiting Duties that a Corporation Owes to its Shareholders

In Fulton Cnty. Emp. Ret. Sys. v. MGIC Inv. Corp., No. 11-1080, 2012 WL 1216314 (7th Cir. Apr. 12, 2012), the Seventh Circuit of the U.S. Court of Appeals affirmed the district court’s dismissal of the appellant’s derivative action for failure to meet the heightened pleading standard under the Private Securities Litigation Reform Act (“PSLRA”). 

According to the complaint, MGIC, a private mortgage insurance company, owned a 46% equity stake in Credit Based Asset Servicing and Securitization, LLC (“C BASS”).  C BASS securitized single-family residential mortgage loans.  C BASS bought mortgages on the secondary market that were mostly subprime, consolidated them into packages, and sold security interests in the packaged loans to investors.  This type of business structure required C BASS to keep the collateral of its loan packages at contractually specified levels.  If the collateralized level dropped too low, lenders demanded margin calls, which required C BASS to contribute large portions of its cash reserves into the loan packages to meet the margin call requirements.  On July 19, 2007, C BASS’s cash reserves were $150 million; however, between July 19 and August 2, C BASS received another $470 million in margin calls.  On July 30, 2007, MGIC decided to stop investing in C BASS, which was at one time worth $516 million, and MGIC declared that its investment in C BASS would be written off as a loss. 

Plaintiff, on behalf of a class, alleged that the defendants committed securities fraud in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5. On appeal, Fulton County Employees Retirement System (“Fulton”) reduced its complaint to a sole claim that MGIC Investment Corporation (“MGIC”) committed fraud during, and in connection with, its quarterly earnings call on July 19, 2007.  Plaintiff also contended that MGIC was vicariously liable for statements made by the CEO and COO of C BASS at the press release under § 20(a) of the 1934 Act because MGIC was the “controlling person” over C BASS management.  In upholding the dismissal of the case, the court held that the proposition that MGIC should have seen the cash reserve problem looming may have been sufficient for negligence, but did not reflect the state of mind required to prove fraud.  The court reasoned that the $150 million in cash reserves that C BASS had on July 19 was “substantial liquidity,” demonstrating that C BASS did not have bad intent.  Additionally, the press release disclosed multiple problems that MGIC encountered, including the liquidity risk at C BASS.  MGIC managers did not have any private information that they failed to reveal at the press conference.  The problem that MGIC and C BASS faced was market-wide, apparent to anyone who studied the markets, and “MGIC had no duty to foresee the future.”

With respect to the claim under § 20(a), the court held that MGIC’s 46% equity share did not allow MGIC to exercise unilateral control over C BASS and that the members of C BASS’s management acted as independent agents, speaking for themselves. 

Finally, the court declined to find MGIC liable for statements issued by managers of CBASS.  Plaintiff asserted that because these managers had been “invited” to speak, MGIC “effectively ‘made’ their statements.”  The court concluded that the argument could not be “squared” with the analysis in Janus.  As the court reasoned:  “We have explained why Williams and Draghi, not MGIC or its officers, had ultimate authority over their own statements. Janus Capital prevents treating MGIC as the statements' maker.”   Nor was there any obligation on the part of MGIC to correct any errors made by Williams and Draghi. 

The primary materials for this case may be found on the DU Corporate Governance website.