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Securities: No Liability Under Securities Exchange Act

by Alvin Arnold

A pension fund brought a 10b-5 class action against reinsurers for securities fraud but a federal district court ruled that the reinsurer was not required to disclose its sub-prime risks in greater detail than it did and that the statement by an executive officer regarding the risk of its sub-prime related activities was not false or misleading.

In addition, allegations that the reinsurer misstated the value of its credit default swap (CDS) arrangements by failing to mark them to market value, did not provide sufficient particularity to state a 10b-5 claim. Plumbers’ Union Local No. 12 Pension Fund v. Swiss Reinsurance Co., 2010 WL 3860397 (S.D. N.Y. 2010)

Background

A reinsurer who identified sub-prime risks in the portion of its balance sheet dealing with invested assets, and disclosed that sub-prime risks were elsewhere in its balance sheet other than in invested assets, and that these included credit default swap (CDS) activity, was not required to disclose these risks in greater detail. There is no obligation under the Securities Exchange Act for an issuer to identify specifically every type of asset or
liability in possesses, so long as its disclosures are broad enough to cover all instruments that are relevant to the value of the issuer’s securities.

A statement by an executive officer of a reinsurer that its sub-prime related activities had significantly less risk than it was exposed to through its investments in sub-prime bond, was not false or misleading to support a 10b-5 claim for securities fraud. Statements by a reinsurer that it took a cautious stance regarding various risks, that it could manage volatility and that it engaged in active management of financial market risk, did not give rise to a claim for securities fraud. Such statements were no more than puffery and were too general to cause a reasonable investor to rely on them. The court also ruled that an allegation that a reinsurer repeatedly misstated the value of its credit default swaps (CDS) by failing to mark them to market value, did not provide sufficient particularity to state a 10b-5 claim in a class action brought by a pension fund against the reinsurer and two of its senior executives for securities fraud. When plaintiffs contend the defendants had access to contrary facts that they did not disclose as would give rise to a claim of securities fraud, they must specifically identify the reports or statements containing this information.

Credit Default Swaps

A credit default swap is a contract under which a purchaser makes a series of payments to the CDS seller in exchange for credit protection in the event that a particular credit instrument covered by the CDS experiences a defined event such as a default or credit rating downgrade. The occurrence of such an event triggers a payment by the CDS seller to the purchaser of the CDS. The CDS functions as a form of insurance because the buyer of the CDS makes periodic payments and in return receives a sum of money if one of the events specified in the contract occurs. When Swiss Re disclosed severe CDS losses, its shares dropped sharply, while analysts expressed surprise about Swiss Re’s involvement in the sub-prime CDS business.