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From Securities Regulation Daily, May 4, 2015

Fraud claims against long-term care insurance company live on

By Amanda Maine, J.D.

A federal court refused to dismiss a class action securities fraud complaint against an insurance company and two executives.  Shareholders alleged that the company, its CEO, and its CFO made statements regarding a comprehensive review of the adequacy of the company’s reserves for its long-term care insurance business that contradicted later statements that the review was not nearly as intensive as previously indicated.  These allegations were sufficient in establishing falsity and scienter to survive the defendants’ motion to dismiss (In re Genworth Financial Inc. Securities Litigation, May 1, 2015, Spencer, J.).

Background. Genworth Financial, Inc. is an insurance company whose core business is long-term care (LTC) insurance, which generally provides coverage for individuals’ basic long-term care needs, including in-home care and stays at nursing homes and assisted living facilities. The financial health of LTC insurance companies depends on the adequacy of their reserves. GAAP also requires that LTC insurance companies review their experience data often and that they use current data and account for known trends in updating their reserves.  Between July 30, 2013, and March 3, 2014, Genworth and its CEO Tom McInerney and CFO Marty Klein made several statements about the company’s reserves, including that an intensive, broad, and deep review of its LTC insurance business was being undertaken and later completed.

On July 29, 2014, the head of Genworth’s LTC division resigned, and the company announced that its operating net income was 85 percent less than each of the prior three quarters. In statements thereafter, Genworth, McInerney and Klein admitted that the last time the company had done a major reserve review was in 2012. By November 2014, Genworth’s stock price had dropped more than 50 percent since October 30, 2013, as the company’s revealed actual reserves resulted in a $360 million loss in in net operating income. Investors filed a class action complaint alleging that Genworth, McInerney, and Klein committed securities fraud by misleading investors about the profitability of the company’s LTC insurance business and understating necessary reserves. The defendants moved to dismiss.

False and misleading statements. The court found that the plaintiffs had successfully alleged that the defendants made material misstatements or omissions. McInerney and Klein had told investors numerous times about the company’s “intensive, broad review of all aspects of the LTC business,” but later made statements that a deep review had not been performed. This was sufficient to demonstrate a reasonable belief that their earlier statements on the scope of the review were false or misleading. The complaint also adequately alleged that Genworth had used out-of-date current claim data, contrary to the assertions by the defendants. Due to these factors, the defendants also had no reasonable basis to believe that Genworth had adequate reserves for its LTC insurance operations, despite their statements otherwise.  In addition, the plaintiffs had, for the most part, sufficiently pleaded that the defendants had made false and misleading statements relating to certain GAAP violations and Genworth’s internal controls, the court found.

Scienter. The defendants argued that facts outlined by the plaintiffs were not sufficient to demonstrate scienter because a more cogent and compelling explanation of those facts was that the underlying assumptions the company used in the third quarter of 2012 held up under hindsight and testing until Genworth observed adverse claim experience in the second quarter of 2014.  Undertaking a holistic analysis, the court disagreed, finding that several factors taken together made the plaintiffs’ allegations sufficiently probative of scienter. These included: (1) the fact that the LTC insurance business was part of Genworth’s core operations; (2) McInerney’s and Klein’s “intimate involvement in the reserving process and review”; (3) bonuses totaling $4.5 million for 2013 between the two of them could establish motive and opportunity; and (4) the magnitude of the discrepancy, such as the $360 million loss of net operating income, a reduction of 2,156 percent for its LTC business.  Taken together, the plaintiffs had established that the defendants’ intent to deceive investors was at least as compelling as any competing inference suggested by the defendants.

Safe harbor and controlling person claims. The defendants contended that their allegedly false and misleading statements fell under the PLSRA’s safe harbor for forward-looking statements. The court noted that several of the statements at issue were made in the present tense, which could indicate that they would not qualify for the safe harbor. However, it concluded that at this stage in the litigation, it could not determine whether cautionary language accompanying the statements was meaningful.

The court also allowed the plaintiffs’ Section 20(a) controlling person claims to proceed as they had adequately pleaded a primary violation under Section 10(b).

The case is No. 3:14-CV-682.

Attorneys: Susan R. Podolsky (The Law Offices of Susan R. Podolsky) for Her Majesty the Queen in Right of Alberta, Fresno County Employees' Retirement Association, and City of Pontiac General Employees' Retirement System. Brian Emory Pumphrey (McGuireWoods LLP) for Genworth Financial, Inc.

Companies: Fresno County Employees' Retirement Association; City of Pontiac General Employees' Retirement System; Genworth Financial, Inc.

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