UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK
Master File No. 02-CV-5533 (WHP) IN RE AMERICAN EXPRESS CO. Lead Case SECURITIES LITIGATION JURY TRTAL DEMANDED
CONSOLIDATED SECOND AMENDED CLASS ACTION COMPLAINT
MILBERG WEISS & BERSHAD LLP SANFORD P. DIJMAIN (SD-8712) KENT A. BRONSON (KB-4906) JOSHT.JA KELLER (JK-4882) One Pennsylvania Plaza New York, N Y 10119-0165 Telephone: 212/594-5300 Facsimile: 212/868-1229 (fax)
LOVELL STEWART HALEBIAN LLP CHRISTOPHER LOVELL (CL-2595) IMTIAZ SIDDIQUI (IS-4094) 500 Fifth Avenue New York, NY 10110 Tel: 212/608-1900 Fax: 212/719-4677 (fax)
Co-Lead Counsel for Plaintiffs TABLE OF CONTENTS
Page
I. NATURE. OF TI lE ACTION ...... 1
11. SUMMARY OF THE ACTION ...... 4
JURISDICTION AND VENUE ......
TV THE PAR I'IES ...... 15
V. CLASS ACTION ALLEGATIONS ...... 24
VI SUBSTANTIVE ALLEGATIONS ...... 25
A. BACKGROUND - AMERICAN EXPRESS AND ITS SUBSIDIARY AEFA...... 5
B. AMERICAN EXPRESS, THROUGH AETA, GORGES ITSELF ON HIGH -YIELD DEBT TO MEET THE COMPANY ' S AGGRESSIVE FINANCIAL TARGETS ...... 26
1. AEFA Implements an Unsound and Risky Business Model Dependent on Investment In Volatile High-yield 'Junk'Bonds and High-Risk Structured Investments ...... 26
2. Defendants ' Creation of a Meltdown Waiting to Happen : AEFA's Over-Investment in Volatile High-yield Debt , Coupled With a Lack of Adequate Risk Controls or Proced ures to Monitor or Accurately Value These Investments, Results in a Catastrophe ...... 32
a. The Additional Risks Posed by the High-yield Debt Investments Themselves ...... 32
b. American Express's and AEFA's Complete Failure Lo Properly Value and Monitor the Risks of AEFA's High- yield Debt Investments During the Class Period ...... 34
c. The Iligh-yield Debt Portfolio Issues Were Well-Knox^n Within AEFA and the Company ...... 40
C. DEFENDANTS ' MATERIAL MISREPRESENTATIONS DURING THE CLASS PERIOD IN VIOLATION OF THE FEDERAL SECURITIES LAWS ...... 42
1. Defendants ' Materially False and Misleading Representations Concerning the Risk Controls , Policies and Procedures with Respect to its High-yield Debt Investments ...... 48
1 2. American Express's Materially false and Misleading Statements Concerning the Value of AEFA's High-yield Debt Investments, the Methods of Valuation of 'i hose Investments, and its Failure to Comply with GAAP as a Result Thereo r...... 56
3. During the Class Period Defendants Concealed the Extent of American Express's High- Yield Exposure ...... 73
4. Defendants Persist in Materially Misrepresenting the T' acts Even as They Are Forced to Belatedly Divulge Portions of American Express's High-Yield Debt Debacle ...... 81
D. THE FULL TRUTH IS FINALLY REVEALED...... __ ...... 92
1. Analyst, Rating Agency and Business Press Reactions to American Express's High-yield Debt Debacle: A "Serious Credibility Problem" ...... 95
E. THE AFTERSHOCKS: SHAREHOLDERS PAY FOR DEFENDANTS' FRAUD A SECOND TIME, DEPARTURES AT THE COMPANY, AND AMERICAN EXPRESS FINALLY TAKES STEPS TO MONITOR, MANAGE AND CONTROL THE RISKS ASSOCIATED WITH ITS HIGH-YIELD DEBT ...... 96
F. SUMMARY OF DEFENDANTS' FALSE AND MISLEADING STATEMENTS DURING THE CLASS PERIOD ...... 98
I. Defendants ' Risk Controls and Strategy Regarding AEFA ...... 98
2. American Express's Financial Statements Concerning the Valuation of AEFA's high-yield Debt Holdings and Compliance with GAAP ...... 100
3. Defendants' Characterization oI Developments in 2001 ...... 100
VII. APPLICABILITY OF PRESUMPTION OF RELIANCE: FRAUD-ON-THE- MARKET DOCTRINE ...... 142
VIII. LOSS CAUSATION ...... 103
IX. ADDITIONAL ALLEGATIONS OF SCIENTER ...... 107
X. NO SAFE HARBOR ...... 1 I I
COUNT I Violation Of Section 10(b) Of The Exchange Act Against And Rule I Ob-5 Promulgated Thereunder Against All Defendants.. 111
COUNT lI Violation Of Section 20(a) Of The Exchange Act Against the Individual Defendants ...... 115
11 XI. CLAIMS FOR RELIEF...... -- ...... 116
XII. JURY TRIAL DEMANDED ...... 117
iii UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK
Master File No. 02-CV-5533 (WHP) IN RE AMERICAN EXPRESS CO. Lead Case SECURITIES LITIGATION JURY TRIAL DEMANDED
CONSOLIDATED SECOND AMENDED CLASS ACTION COMPLAINT
Plaintiffs, by and through their attorneys, bring this action on behalf of themselves and all others similarly situated, on personal knowledge as to themselves and their activities, and on information and belief as to all other matters, based on investigation conducted by counsel, including , inter alias review of United States Securities and Exchange Commission ("SEC") filings by American Express Co . ("American Express" or the "Company"); press releases and
other public statements issued by the Company; securities analysts' reports and advisories about
the Company; newspaper articles and reports from the media, including news reports reflecting
interviews with knowledgeable Company insiders and current and former executives, including
several of the Defendants themselves ; and direct interviews with former employees familiar with
many of the facts and circumstances surrounding the allegations set forth below , including a
Pricing Analyst and a former Vice President who worked for American Express Financial
Advisers Inc. ("AEFA"), the Company subsidiary at issue here.
1. NATURE OF THE ACTION
2. This is a securities fraud class action on behalf of a class of all persons who
purchased or otherwise acquired the common stock of American Express (the "Class") between July 26, 1 999 and July 17 , inclusive (the "Class Period"), seeking to pursue remedies under the Securities Exchange Act of 1934 (the "Exchange Act"). This action arises out of the materially false and misleading representations and omissions contained in the public statements of American Express and made by its senior officers and directors and those of its subsidiary
AEFA. As set forth below, such fraudulent conduct effectively disguised, inter cilia, the
Company's true operating results, business and financial condition, future prospects, lack of adequate internal and management controls, and significant losses suffered in very risky high- yield debt investments held by AEFA, including junk bonds, collateralized debt obligations
(.CDOs") and "toxic waste" obligations. )
Simply stated, during the Class Period, American Express and the other
Defendants planned and embarked on a fraudulent scheme to artificially inflate the Company's financial performance and its common stock price by investing heavily in volatile high-yield
debt instruments. This high-yield debt investment strategy: (1) allowed the Company to achieve
its extremely aggressive financial targets; (2) enabled AEFA and its affiliates to outbid its
competitors for its insurance and financial products by charging extremely low prices it would
not otherwise have been able to charge; and (3) enriched Defendant Harvey Golub ("Golub," at
' AEFA' s high-yield debt investments specifically included risky, directly held, below- investment-grade bonds ("junk bonds") and structured investments such as high-yield collateralized debt obligations ("CDOs") . Junk- bonds are bonds often issued by companies without long track records of sales or earnings , or by companies with questionable credit strength . One sub-category ofjunk bonds are called "fallen angels ," consisting of bonds that were investment grade at the time they were issued , but have since declined in quality or fallen below investment grade. CDOs are diversified collections of bonds that are sliced into tranches of vary ing risks and sold as securities . The riskiest portions of such CDOs are the bonds whose issuers are most likely to default , and are sometimes referred to as "toxic waste ." Such toxic waste was included in AEFA.' s high-yield holdings. Indeed, American Express invested in a range of risky high-yield debt instruments , such as bonds issued by struggling movie theater chains and companies that were financially crippled by asbestos liability. See also IT 71-86, infto. relevant times American Express's Chairman and Chief Executive Officer ("CEO")), Defendant
David R. Hubers ('Hubers," at relevant times the President and CEO of AEFA), and other
Company and/or AEFA executives by improperly and artificially inflating the Company's and/or
AEFA's financial condition and/or performance, and in tum their own incentive compensation awards.
4. Along the way, American Express and the other Defendants materially misrepresented the nature and extent of the risks and the Company's exposure associated with
AEFA's high-yield debt investments and investment strategy ; the Company' s exposure in connection with AEFA 's high-yield debt portfolio; and the nature, existence, and implementation of the Company' s management and risk controls, including its policies and procedures to monitor and assess the risks , health , value and performance of these extremely risky and speculative high-yield debt instruments during the Class Period . As a result, the value of these investments was continually and grossly Overstated during the Class Period.
S. Only in July of 2001, well after Defendant Golub announced his retirement, and had already received substantial incentive compensation payments of millions of dollars for 1999 and 2000 (based in significant part upon American Express's inflated income resulting from the fraud outlined herein), was it revealed that these highly volatile investments, coupled with
American Express's lack of management controls, resulted in total losses of over $1 billion to the Company for 2001 alone to the substantial detriment to the Plaintiffs and other Class members. 'these staggering losses represented approximately 38% of American Express's annual expected income, and nearly one-tenth of the Company's book value. IT. SUMMARY OF THE ACTION
Beginning in 1997 and 1998, as part of a drive to dramatically increase revenues and meet the Company's pre-determined, publicly -announced earnings targets, AEFA's life insurance division began to accumulate significant amounts of extremely risky high-yield debt securities. According to news reports quoting current and former AEFA executives, this strategy of increased investments in risky high-yield debt securities was implemented in direct response to Defendant Golub's demands for dramatically higher earnings growth and improved financial performance . These executives stated that Defendant Golub specifically demanded that AEFA meet a return-on-equity growth target of 20% - a very aggressive target for AEFA's line of business . Essentially, American Express was relying on AEFA's high-yield debt portfolio to make up for shortfalls in the performance of its other divisions AEFA in essence became
American Express's "cash cow" helping to drive the success of its financial performance.
7. William Dudley, a former AEFA Vice President, was quoted in a July 31, 2001
The Wall Street Journal Asia news article, entitled Risky Securities Cause a Major Loss at
American Express - A Gamble in One Unit Surprises the New Boss -A Huge Alarm Ringing,'
as stating that "[t]here were always pressures to use the corporate portfolio . . . to meet the return
objectives the [Company] was asking us to meet." This article also reported another former
AEFA executive as stating:
[t]he problem was that portions of AEFA's main business of financial advice, money management and insurance weren't growing enough to meet the targets. "The insurance business was very sluggish at the time," says Peter Anderson, the former chief investment officer of the Minneapolis investment group [AEFA], who retired May 1. "We needed the incremental income."
This intense desire to use AEFA' s investment portfolio as a vehicle to achieve
higher financial results for American Express ultimately resulted in AEFA's (and American
4 Express's) dramatic over-investment in, and over-exposure to, an extremely risky portfolio of high-yield, high-risk debt securities, which ultimately collapsed under its own weight into a growing series of write-downs totaling over $1 billion. Indeed, AEFA's over-investment in these volatile and complex securities was especially stark when compared with other industry competitors at the time. As was reported on July 31; 2001 in The Wall Street Journal Asia:
AEFA decided to raise the junk bond portion of its portfolio to what at its peak would become 12% of a 532 billion pool of investments it manages for itself, from around 8%. That shift in strategy put the company much deeper into the junk bond game than most of its blue-chip competitors, whose junk bond mix remained in the single digits. [2]
Nevertheless , AEFA maintained this large relative percentage of high-yield debt investment in its overall portfolio during the Class Period, and American Express continued to report large amounts of income therefrom, despite record and sustained rates of default for high- yield debt instruments like those owned by AEFA. These alarming elevated default rates
impacted the high-yield debt tuarket as well as AEFA's portfolio in particular, causing mounting
(but largely undisclosed) losses therein throughout the Class Period.
10. Shockingly, notwithstanding this volatile new investment strategy, a few months
later A1cr'A's head of high-yield debt investments recommended that the firm also begin
investing in even more intricate financial derivatives, namely CDOs. As reported in the Wall
Street Journal Asia on July 31, 2001, Defendant Hubers and Mr. Anderson, AEFA's former
Chief Investment Officer, were behind this plan, despite the fact that neither had any significant
experience in risky and speculative bond investing. Moreover, Defendant Hubers was motivated
2 AEFA's 10-12% allocation to high-yield securities contrasted sharply with most insurance companies and other peer companies , which limited their high-yield holdings to approximately 7% of their portfolios . See infra, at ¶T{ 77-80. to push AEFA to invest in more of these higher yield debt instruments because his bonus was based directly upon AEFA's returns on its investments, including the high-yield debt investments at issue here.
It. That said, AEFA was soon heavily involved in CDO investments . In fact,
American Express reportedly entered into 60 separate deals specifically involving CDOs, including 12 internally-created CDC] transactions, which generated management fees for the
Company.
1.2. However, while AEFA was recklessly loading up its portfolio with more and more volatile high-yield debt, American Express was at the same time materially misleading
investors as to the level of its exposure to risk associated with these investments and this
investment strategy, as well as the existence, extent and nature of AEFA's management controls,
as well as the true value of these investments.
13. For example, during the Class Period, American Express continually represented
that risks related to Company and AEFA investments were monitored and managed within the
Company according to well-defined, Board-approved risk management policies and controls.
However, these statements were materially false and misleading because, according to former
employees with personal knowledge of AEFA 's practices, as well as the facts revealed after the
massive $826 million high-yield debt write-down in July of 2001, no such effective policies
were actually in place at AEFA. Moreover, those responsible for the adoption, implementation,
management and oversight of these highly volatile high-yield debt investments were advisors
and internal executives who were in many cases themselves unfamiliar with the investment
characteristics, volatility, and risks of these securities.
6 14. In sum, despite its contrary representations, American Express (and AEFA) were effectively "flying blind," with no real or ef'f'ective policies, practices or procedures in place to monitor or assess the risks presented by, or the true values of, the risky high-yield debt investments that AEFA chose to make and/or hold.
15. Defendants were in fact aware that AEFA 's attempts to monitor the performance of, and to value, its high-yield debt investments were haphazard at best, and fraught with unreliability. Further, AEFA often relied entirely on the off-the-cuff recommendations and outdated and unreliable prices improperly provided solely by securities brokers or CDO managers to assess the value of the high-yield debt instruments in its portfolio.
16. Because many of these high-yield debt securities were relatively illiquid and had no ready market valuation information available, AEFA often took the path of least resistance in valuing these securities . This meant that at times AEFA simply failed to update the carrying values of these investments at all, even after severe declines in the high-yield bond market. See infra at 99-107. While market events repeatedly indicated, at a minimum, a high probability of substantial reduction in the values with respect to AEFA's high-yield debt holdings, AEFA would fraudulently fail to record any of these reductions in the value of these assets, instead keeping them propped up at falsely inflated valuations.
17. Nonetheless, during the Class Period, American Express still reported large amounts of income from AEFA (particularly driven by its high-yield investment strategy), and portrayed itself and AFFA's portfolio as being carefully.managed, closely scrutinized, and offering sustainable indeed, steadily improving - income. In reality, however, virtually no control or oversight was exercised over the pertinent investments. 18. AEFA's absence of management risk controls and improper valuation methods, with respect to its high-yield debt investments, resulted in the Company's issuance of a continued stream of false and misleading financial statements. During the Class Period, AEFA's reported operating results were based in large part on its valuation of its investments, including the risky junk bonds and CDOs at issue here. However, these results were materially false and misleading, because AEFA failed to update the values of many of these investments, some over a period of months or even years, despite the fact that the high-yield bond market was in severe decline well before and during the Class Period. In fact, newspaper reports quoting insiders at the Company reference significant problems being discussed within the Company about AEFA's high-yield debt investments as of at least the summer of 2000.
19. Moreover, Defendants were well aware of the state of the high-yield debt investment market during the Class Period, and they certainly knew, by the end of 2000, at the very latest, that high-yield debt prices were plummeting, causing credit downgrades among many of AEFA's junk bond and CDO investments, which should have been revalued, but were not.
Quite simply, Defendants knew that AEFA's high-yield debt portfolio was riddled with defaults and rapidly declining in value as a result. However, even for those high-yield investments that were revalued, the Company improperly, and in contravention of generally accepted accounting principles ("GAAP"), fraudulently marked losses as "unrealized" and, thus, failed to recognize properly the impact of the losses in its income statements.
20. In very early 2001, Defendant Chenault belatedly ordered a"very hard look" at the total $3.5 billion junk-bond portfolio and the higher-risk CDO investments, after realizing that the Company registered a fourth quarter 2000 loss of $49 million, and full year 2000 losses of well over $100 million, solely attributable to high-yield debt investments. Chenault ordered this "hard look" because despite American Express's reported overall income growth for the year
2000, the Company ultimately realized a total of $123 million losses attributable to these
investments for that year. However, the $123 million figure would very shortly be revealed to be
materially understated, as would the subsequent figures reported as having to be written down
for the first quarter of 200 1.
21. Also around this time, Defendants Crittenden and Chenault received, in
Crittenden's own words, a "huge alarm ringing" in late February 2001 concerning the "rapid
deterioration" of AEFA's high-yield debt portfolio. This "alarm" came in the form of an email
from AEFA CEO Stuart Sedlacek, to Defendant Crittenden, who in turn immediately informed
Defendant Chenault of this grave situation.
22, In fact, despite the $123 million write-down for high-yield debt investment losses
in 2000, American Express's 2000 Annual Report on Forn, 10-K, filed on March 30, 2001,
stated that corporate debt securities classified as "'held to maturity" across all American Express
operating segments had actually appreciated over 2000, so that the "cost" of such securities was
listed as $5.304 billion, while the fair value was listed as $5.312 billion. Incredibly, only days
later, on April 2, 2001, American Express would announce a $185 million write-down (described
below).
23. Specifically, on April 2, 2001, American Express issued a press release
announcing that its earnings for the first quarter of 2001, the period ending March 31, 2001,
would decline 18% from the same period in the prior year. As described in the press release, the
loss was attributed to "pre-tax losses of about $185 million from the write-down and sale of
certain high-yield securities held in the investment portfolio of its subsidiary, American Express
Financial Advisors (AEFA)." The press release further stated that: "Total losses on these
9 investments far the remainder of 2001 are expected to be substantially lower than in thefirst quarter." [Emphasis added.]
24. Even after American Express had acknowledged some of AEFA's high-yield debt losses in the spring of 2001, Defendants, using "damage control" spin tactics to try to mitigate the fallout impact on the Company's stock price, continued to mislead the market by misrepresenting the condition and the magnitude of the impairment to AEl g's high-yield investment portfolio. For example, after writing off $185 million in the first quarter of 2001,
Defendants took it upon themselves to expressly and repeatedly assure the market that any further write-domns for the remainder of 2001 would be far less than those in the first quarter, when they were well aware (or at the very least reckless in not being aware) that these assurances were baseless.
25. These empty "worst is over' assurances continued until at least May 15, 2001, when American Express filed its form 10-Q for the first quarter 2001, and by which time at least two of the Defendants (Defendants Cracchiolo and Chenault) had been told oFmore severe
problems with, and deterioration of, AEFA's high-yield debt investments. Defendants therefore
knew, or at a minimum were recklessly ignorant, of the fact that further write-downs would
likely be necessary in amounts Well above the $185 million already recorded for the first quarter
of 2001. There were significantly more problems with these investments that had not been
disclosed to the market, and the Defendants knew it, having been given contrary information.
However, Defendants remained silent and left unsuspecting investors in the dark.
26. Just a few months later, an July 18, 2001; the full truth was finally revealed.
American Express shocked investors and wialysts alike when it announced a massive write-down
for high-yield debt investments of $826 million, more than. four times the amount written-dotivn
10 in the first quarter (this despite its April 2, 2001 announcement that "total losses on these investments for the remainder of 2001 are expected to be substantially lower than in thefirst quarter."). On that date, before the market opened, American Express disclosed information that confirmed that its reassurances throughout the Class Period that it had a great team of risk professionals whose members were purportedly among the "best in the business;" that it was closely scrutinizing the health and performance of its and AEF'A's high-yield investments; that
AEPA had "significantly scaled back" its activity with respect to highly risky structured investments such as CDOs; and that the majority of the losses from AEFA's high-yield debt investments had already been absorbed and disclosed to investors were not true at all and were,: in fact, false and misleading.
27. The Company' s rather bizarre confession revealed that AEFA had in truth remained heavily exposed to these same types of high-yield debt investments, including structured investments and CDOs, and that the Company had failed to "comprehend" the risks presented by these investments. As a result, the Company was facing another round of huge write-downs.
28. The Company reported that its earnings for the quarter would most likely decline a whopping 76% from its earnings in the same period of the prior year, in part, because of an
$826 million pre-tax charge ($537 million after tax) to recognize "additional write-downs in the high- yield portfolio at AEFA and losses associated with rebalancing the portfolio towards lower-
risk securities."
29. Not only was the $826 million write-down more than four times the size of the
write-down for the first quarter, it was almost seven tinges the size of the write-down taken for all
of 2000. According to the Company' s statements, oIthc %826 million, almost half of the losses
11 ($403 million) were tied to the very structured Investments (including CDQs) which, as far back
as February, the Company and Chenault had claimed it had "significantly scaled back." An
additional $344 million represented sales and write-downs of directly held junk bonds, or "lower rated securities [sold] to reduce the level of [AEFA' s] high -yield portfolio ." With respect to this
$344 million portion, the Company added: "[a]dditional securities within the remaining high-
yield portfolio will be sold to allocate holdings towards stronger credits and reduce the
concentration of exposure to individual companies and industry sectors." The remaining
$79 million of the $826 million charge was allegedly attributable to "write down the value of
certain other investments to recognize losses during the second quarter."
30. Coupled with the write-downs in the first quarter, American Express's total write-
downs for high-yield bonds in the first half of 2001 alone represented nearly one tenth of the
Company's total book value.
31. The Defendants disingenuously attempted to pass off this massive melt-downs in
AEFA' s high-yield debt portfolio as a sudden , unexpected phenomenon, claiming:
The decision to rebalance the AEFA portfolio follows a re-examination of its overall risk profile and an assessment of likely performance in a prolonged economic downturn. During the second quarter, default rates rose to historically high levels. The company's analysis indicated that the economic benefit of continuing to own certain of the high-yield investments in its portfolio was not sufficient to compensate for the underlying risk during difficult market cycles.
32. However, this excuse was a false attempt to cover up the Defendants' own
fraudulent conduct in intentionally and/or recklessly failing to properly implement controls,
policies or procedures in order to monitor or manage the risks associated with AEFA 's high-
yield debt investments, or to properly value those investments. Defendants failed to take these
steps despite making repeated false and misleading representations to the contrary throughout the
Class Period.
12 33. Defendants were continually aware, or. at the very least, were reckless in not
being aware, that persistent, record high, and ascending default rates among high-yield debt
instruments existed much earlier in the Class Period than July of 2001. Indeed, Defendant
Chenault stated during a February 7, 2001 conference call that "fd]efault rates within the high-- yield sector ofthe market as we enter 2001 are at higher levels than a year ago." According to
available data from New York University 's Salomon Center, default rates on j unk bonds had
stepped up significantly during 1999 and 2000 from prior periods and continued climbing
afterward. Default rates had reportedly spiked to approximately 6 % by the third quarter of
1999, doubling from the prior year. Subsequently, defaults remained at that elevated 6% level,
and then began to rise even higher by the third quarter of 2000. The Company's Annual Report
on Form 10-K for the year 2000, filed with the SEC on March 30, 2001, also admitted that
`[d]efault rates within the high-yield sector of the market enter 2001 at higher levels than a year
ago "
34. The Company also expressly recognized a "deterioration in the high-yield bond
sector on directly owned bonds and low grades in other structured investments" in the fall of
2000, when it filed its third quarter 2000 Form 10-Q with the SEC on November 13, 2000.
35. Immediately following the July 18, 2001 announcement, American Express's
share price dropped 3.3%, representing an astonishing and rapid loss of $1.7 billion in market
capitalization.
36. Quite simply, American Express's materially false statements during the Class
Period misled investors as to the risk associated with its high-yield debt investments, its
investment strategy of loading up on these volatile investments, and its supposed internal risk
analysis controls, policies and procedures. Further, the Company's materially false statements
13 also deceived investors as to the true nature and value of AEFA's high-yield debt investment portfolio. Spurred by the intense pressures and expectations placed on AEFA to meet Golub's and American Express's extreme financial targets, the falsity of the Company's statements allowed American Express to record earnings, meet earnings targets, convey sustainable earning power, and portray a false picture of the high-yield investment portfolio of AEFA. This in turn artificially inflated American Express's stock price, and then, again in turn, served to inflate the incentive compensation of American Express and AEFA executives, including Defendants
Golub and Hubers.
37. When all was said and done, a number of securities analysts and commentators shrewdly assessed the entire debacle after Defendants' fraudulent scheme was fully revealed to the public in July of 2001. First Union Securities Analyst Meredith Whitney aptly labeled the episode one of "massive transition and questioned credibility ." Peggy Cagan of Zurich IC
Squared described American Express as suffering from a "serious credibility problem" in the wake of the revelation of the full truth on July 18. Moody's Investors Service's David Hamilton observed that "[s]omething as simple as taking a look at the credit ratings would have saved them from devastating losses..." Finally. A.G. Edwards' Joel Houck summed up his disbelief
as to Defendants' purported "lack of comprehension" explanation, considering that one of the
Company's core business activities (managing investments) was involved by pointing out
simply: "ftJhat's the business j4merican Express] is in."
III. JURISDICTION AND VENUE
38. Plaintiffs bring these claims pursuant to Sections I0(b) and 20 (a) of the Exchange
Act [15 U.S.C. y§§ 78j(b) and 78t(a)] and Rule lOb- 5 promulgated thereunder by the SEC [17
C.F.R. § 240.101-5].
14 39. This Court has jurisdiction over the subject matter of this action pursuant to 28
U.S.C. § 1331 and Section 27 of the Exchange Act [15 U.S.C . § 78aa].
40. Venue is proper in this District pursuant to Section 27 of the Exchange Act, and
28 IJ S.C. § 13 91(b), as many of the acts and practices complained of herein occurred in substantial part in this District.
41. In connection with the acts and conduct alleged in this Complaint, Defendants, directly or indirectly, used the means and instrumentalities of interstate commerce, including, but not limited to, the mails, interstate telephone communications and the facilities of the national securities markets.
IV. THE PARTIES
42. Lead Plaintiffs Adam Craig Slayton, Andrew Keith Slayton, and Glickenhaus &
Co., purchased American Express shares during the Class Period at artificially inflated prices, as
set forth in the certifications filed with the Court in this case, incorporated herein by reference,
and have been damaged thereby.
43. Plainti Fl' Atlas Equities purchased American Express shares during the Class
Period at artificially inflated prices, as set forth in the certifications filed with the Court in this
case, incorporated herein by reference, and has been damaged thereby.
44. Plaintiff Brown Family Trust purchased American Express shares during the
Class Period at artificially inflated prices, as set forth in the certifications filed with the Court in
this case, incorporated herein by reference, and has been damaged thereby.
45. Plaintiff Julie Dross purchased American Express shares during the Class Period
at artificially inflated prices, as set forth in the certifications filed with the Court in this case,
incorporated herein by reference, and has been damaged thereby.
15 46. Plaintiff Malka Rubin purchased American Express shares during the Class
Period at artificially inflated prices, as set forth in the certifications filed with the Court in this case, incorporated herein by reference, and has been damaged thereby.
47. Plaintiff Yvette Yeideman purchased American Express shares during the Class
Period at artificially inflated prices, as set forth in the certi.lications filed with the Count in this case, incorporated herein by reference, and has been damaged thereby.
48. Plaintiff Scott Barrentine purchased American Express shares during the Class
Period at artificially inflated prices, as set forth in the cerli (cations filed with the Court in this case, incorporated herein by reference, and has been damaged thereby.
49. Plaintiff William M. Palese purchased American Express shares during the Class
Period at artificially inflated prices, as set forth in the certifications tiled with the Court in this case, incorporated herein by reference, and has been damaged thereby.
50. Plaintiff Shiraz Sidi purchased American Express shares during the Class Period at artificially inflated prices, as set forth in the certifications filed with the Court in this case, incorporated herein. by reference, and has been damaged thereby.
51. Plaintiff Sam Wietschner purchased American Express shares during the Class
Period at artificially inflated prices, as set forth in the certifications filed with the Court in this case, incorporated herein by reference, and has been damaged thereby.
52. Plaintiff Charles Hovanesian purchased American Express shares during the Class
Period at artificially inflated prices, as set forth in the certifications filed with the Court in this
case, incorporated herein by reference , and has been damaged thereby.
16 53. Plaintiff Loretta Arzu purchased American Express shares during the Class Period at artificially inflated prices, as set forth in the certifications filed with the Court in this case, incorporated herein by reference, and has been damaged thereby.
54. Defendant American Express is a New York corporation with its principal place of business located at 200 Vesey Street, New York, NY 10787_ The Company is engaged primarily in the business of providing travel-related, financial advisory, and international banking services throughout the world. One of the Company's principal subsidiaries, AEFA, the subsidiary at issue here, provides a variety of financial products and services to individuals, businesses, and institutions. During the Class Period, AFFA accounted for more than one-third of American Express's total net income.
55. The following individual Defendants arc or were executive officers and/or directors of American Express and/or AEFA at relevant times .hereto, and certain of them, as outlined herein, received substantial compensation, including, inter cilia, incentive-based
compensation tied to the financial performance and results of the Company and/or AEFA during the Class Period:
(a) Defendant Golub served, at all relevant times, as American
Express's CEO and a Director until his resignation in late 2000. Defendant Golub signed the
Company's Form 1 d-Ks for the years ending December 31, 1999 and December 31, 2000, As a
result of his high level positions with the Company, Golub knew of the falsity of American
Express's statements, or was otherwise reckless in refusing to see the obvious, or to investigate
the doubtful, concerning statements that related to one of American Express's core operations, or
managing its investments. Defendant Golub received incentive compensation for 1999 that
included $2.4 million in cash due. inter cilia, to American Express's reported increase in income
17 and earnings per share for that year. That total award 1--ad a final value of 2.7 times his annual incentive award guideline. Defendant Golub also received an "incentive award" for 2000 that included $3.2 million in cash due, inter ulia, to American Express's reported increase in income and earnings per share for that year. again totaling 2.7 times his annual incentive award guideline.
(b) Defendant Kenneth 1. Chenault ("Chenault") served , at all relevant times, as American Express's President, Chief Operating Officer ("COO") and a Director until his appointment as the Company's CEO in January 2001 and as Chairman of the Company's
Board in April 2001. Defendant Chenault signed the Company's Form 10-Ks for the years ending December 31, 1999 and December 31, 2000. Due to his high level positions with the
Company, Chenault knew of the falsity of American Express's statements, or was otherwise reckless in refusing to see the obvious, or to investigate the doubtful, concerning statements that related to one of American Express's core operations, managing its investments. According to a former AEFA Vice President, Defendant Hubers, who had engineered AEFA's high-yield debt
investment strategy, reported directly to Chenault. Thus, apart from Chenault's own
representations to shareholders that he was familiar with AEFA's strategies, Chenault was also
familiar with AEFA's practices by virtue of direct reports from Defendant Hubers.
(c) Defendant Richard Kart Goeltz ("Goeltz") was, at all relevant
times, American Express's Vice Chairman and Chief Financial Officer ("CFO") until his
resignation in June 2000. Defendant Goeltz signed the Company's Form 10-Qs for the periods
ending June 30, 1999, September 30, 1999, and March 31, 2000 and signed the Company's Form
10-K for the year ending December 31, 1999. Due to his high level positions with the Company,
Goeltz knew of the falsity of American Express's statements, or was otherwise reckless in
is refusing to see the obvious, or to investigate the doubtful, concerning statements that related to one of American Express's core operations, or managing its investments.
(d) Defendant Gary L. Crittenden ("Crittenden") has served as
American Express's CFO and as Executive Vice President since June 2000. Defendant
Crittenden signed the Company' s Form 10 -Qs for the periods ending June 30, 2000, September
30, 2000, and March 31 , 2001 , and signed the Company' s Form 10-K tnr the year ending
December 31, 2000. Due to his high level positions with the Company, Crittenden knew of the falsity of American Express's statements , or was otherwise reckless in refusing to see the obvious, or to investigate the doubtful, concerning statements that related to one of American
Express's core operations, or managing its investments.
(e) Defendant Daniel T. I lenry ("Henry' ') was, at all relevant times,
American Express's Senior Vice President and Comptroller. Defendant Henry signed the
Company's Form 10-Qs for the periods ending June 30, 1999, September 30, 1999, March 31,
2000 and June 30, 21)00 and signed the Company's Form 10-Ks for the years ending December
31, 1999 and December 31, 2000. Due to his high level positions with the Company, Henry
knew of the falsity of American Express's statements, or was otherwise reckless in refusing to
see the obvious, or to investigate the doubtful, concerning statements that related to one of
American Express's core operations, or managing its investments.
(f) Defendant Hubers served at times relevant hereto as the President
and CEO of AEFA. As President and CEO of AEFA, Hubers knew of the falsity of American
Express's statements, or was otherwise reckless in refusing to see the obvious, or to investigate
the doubtful, concerning statements that related to one of American Express's core operations, or
19 managing its investments. Defendant Hubers' bonus was calculated and based directly upon
AEF'A's returns on its investments, including the high-yield debt investments at issue here.
(g) Defendant James M. Cracchiolo ("Cracchiolo") served at times relevant hereto as the President of Global Financial Services and the President, CEO, and
Chairman of AEF'A. In his position as head of Global Financial Services, Cracchiolo, inter alia, was responsible for actively identifying and implementing "expense and revenue synergies that cross American Express Bank, [AEFA]," and various other divisions of the Company.
Moreover, due to his high level positions with AEFA, Cracchiolo knew of the falsity of
American Express's statements, or was otherwise reckless in refusing to see the obvious, or to investigate the doubtful, concerning statements that related to one of American Express's core operations, or managing its investments.
(h) Defendants Chenault, Golub, Crittenden, Goeltz, Henry, Hubers,
and Cracchiolo are referred to collectively herein as the "Individual Defendants."
56. Because of the Individual Defendants' executive and managerial positions with
the Company and/or AEFA, they had access to the adverse, non-public and undisclosed
information about the Company's business, operations, operational trends, financial statements,
investments, markets and present and future business prospects particularized herein, inter alia,
the following: access to internal corporate documents (including the Company's operating plans,
budgets and forecasts, and reports of actual operations compared thereto, as well as internal
emails and faxes from employees reporting to them, certain of which advised of problems and/or
potential problems with, inter alia, the valuation and monitoring of perthrmance or risk
associated with the Company's and/or AEFA's high-yield investments); conversations and
connections with other corporate officers and employees, which included discussions
20 concerning, inter alia, problems and/or potential problems with the valuation and monitoring of the risks, performance, and/or valuation of the Company 's and/or AEFA 's high-yield. investments; attendance at management and/or Board of Directors meetings and committees thereof, and/or via other information provided to them in connection therewith.
5 7. By reason of their management positions and their ability to make (and making of) public statements in the name of American Express and AEFA, the Individual Defendants were and are controlling persons, and had the power and influence to cause (and did in fact influence and cause) American Express to engage in the unlawful conduct complained of herein.
58. It is appropriate to treat the Individual Defendants as a group for pleading purposes and to presume that the false, misleading and incomplete information conveyed in the
Company's public filings, press releases and other publications as alleged herein are the collective actions of the narrowly defined group of Defendants identified above. Indeed, each of the above officers of American Express, by virtue of their high-level positions with the
Company, directly participated in the management of the Company, was directly involved in the
day-to-day operations of the Company at the highest levels and was privy to confidential
proprietary information concerning the Company and its business, operations, growth, financial
statements, investments, and financial condition, including, without limitation, detailed
information concerning the internal controls monitoring with respect to condition, performance,
risks, and value of the Company's and/or AEFA's high-yield investments, as alleged herein.
Further, said Defendants were involved and participated in drafting, producing, reviewing and/or
disseminating the false and misleading statements and information alleged herein, Defendants
were aware, or recklessly disregarded, that the false and misleading statements were being issued
21 regarding the Company and/or AEFA and its financial condition and prospects, and approved or ratified these statements, in violation of the federal securities laws.
59. As officers and controlling persons of a publicly-held company whose common stock was, and is, registered with the SEC pursuant to the Exchange Act, and was traded on the
New York Stock Exchange (`NYSE"), and governed by the provisions of the federal securities laws, the Individual Defendants each had a duty to promptly disseminate accurate and truthful information with respect to the Company's and/or AEFA's financial condition and performance, growth, operations, financial statements, business, investments, markets, management, earnings and present and future business prospects, and to correct promptly any previously-issued statements that had become materially misleading or untrue, so that the market price of the
Company's publicly-traded securities would be based upon truthful and accurate information.
As a result of their failure to do so, the price of the Company' s common stock was artificially inflated during the Class Period, damaging Plaintiffs and the Class.
60. The Individual Defendants also participated in the drafting, preparation, approval and/or signing of the various public, shareholder and investor reports and other communications complained of herein and were aware of, or recklessly disregarded, the misstatements contained therein and omissions therefrom, and were aware of their materially false and misleading nature.
Because of their Board membership and/or executive and managerial positions with American
Express and/or AEFA (and as further outlined in ¶ 55 above), each of the Individual Defendants
had access to the adverse undisclosed information about American Express's business prospects,
investments, and financial condition and performance as particularized herein and knew (or
recklessly disregarded) that these adverse facts rendered the positive representations made by, or
22 about American Express and its business, and which were issued or adopted by the Company, materially false and misleading.
61. The Individual Defendants , because of their positions of control and authority as officers and/or directors of the Company and/or AEFA, were able to and did control the content of the various SEC filings, press releases and other public statements pertaining to the Company and/or AEFA during the Class Period. Each Individual Defendant was provided with copies of the documents alleged herein to be misleading prior to or shortly after their issuance and/or had the ability and/or opportunity to prevent their issuance or cause them to be corrected.
Accordingly, each of the Individual Defendants is responsible for the accuracy of the public reports and releases detailed herein and is therefore primarily liable for the representations contained therein.
62. Lastly, each of the Defendants is liable as a participant in a fraudulent scheme and course of business that operated as a fraud or deceit on purchasers of American Express common stock by disseminating materially false and misleading statements and/or concealing material adverse facts. The fraudulent scheme and course of business was designed to, and did:
(i) deceive the investing public regarding American Express's (and AEFA's) business, operations, and management, the quality, risks and condition of the Company's (and AEFA's) highly volatile high-yield debt investments, and the Company's cxposurc with respect to said investments, the policies, practices, procedures, and efforts (or lack thereof) undertaken to monitor and assess the risk associated with that portfolio, and the intrinsic value of American
Express common stock; and (ii) cause Plaintiffs and other members of the Class to purchase
American Express common stock at artificially inflated prices during the Class Period, and suffer
23 damages as a result of declines in the price o t' stock as the Defendants' conduct was revealed to the public.
V. CLASS ACTION ALLEGATIONS
63. Plaintiffs bring this action as a class action pursuant to Federal Rule of Civil
Procedure 23(a) and (b)(3) on behalf of a Class, consisting of all those who purchased or otherwise acquired the common stock of American Express between July 26, 1999 and July 17,
2001, inclusive, and who were damaged thereby. Excluded from the Class are Defendants, the officers and directors of the Company and/or AEFA, at all relevant times, members of their immediate families and their legal representatives, heirs, successors or assigns, and any entity in which Defendants have or had a controlling interest.
64. The members of the Class are so numerous that joinder of all members is impracticable. As of July 31, 2001, there were approximately 1.3 billion shares of American
Express issued and outstanding. Throughout the Class Period, American Express common
shares were actively traded on the NYSE, an active and efficient market. While the exact
number of Class members is unknown to Plaintiffs at this time and can only be ascertained
through appropriate discovery, Plaintiffs believe that there are hundreds or thousands of
members in the proposed Class. Record owners and other members of the Class may be
identified from records maintained by American Express or its transfer agent and may be notitied
of the pendency of this action by mail, using the form of notice similar to that customarily used
in securities fraud class actions.
65. Plaintiffs' claims are typical of the claims of the members of the Class as all
members of the Class are similarly affected by Defendants' wrongful conduct in violation of
federal law that is complained of herein.
24 66. Plaintiffs will fairly and adequately protect the interests of the members of the
Class and has retained counsel competent and experienced in class and securities litigation.
Further, Plaintiffs have no interests that are contrary to, or in conflict with, the members of the
Class which Plaintiffs seek to represent.
67. Common questions of law and fact exist as to all members of the Class and predominate over any questions solely affecting individual members of the Class. Among the questions of law and fact common to the Class are:
(a) whether the federal securities laws were violated by Defendants' acts as alleged herein;
(b) whether statements made by Defendants to the investing public during the Class Period misrepresented or omitted material facts about the business, operations, investments, and management of American Express; and
(c) to what extent the members of the Class have sustained damages and the proper measure of damages.
68. A class action is superior to all other available methods for the fair and efficient
adjudication of this controversy since joinder of all members is impracticable. Furthermore, as
the damages suffered by individual Class members may be relatively small, the expense and
burden of individual litigation make it impossible for members of the Class to individually
redress the wrongs done to them. There will be no difficulty in the management of this action as
a class action.
VI. SUBSTANTIVE ALLEGATIONS
A. Background --- American Express and its Subsidiary AEFA
69. American Express consists of three principal operating segments. One such
segment is AEFA, which includes the American Express Financial Corporation ('AFT, C") and
its affiliates and subsidiaries. AEFA has three primary financial service distribution channels:
25 retail, institutional, and third party. AEFA's retail channel operates through a sales force of financial advisors who offer clients a variety of financial planning and advisory services. AEFA advisors recommend and sell to clients investment and insurance products, some of which are products that are owned by American Express, and some of which are owned by other parties.
70. AEFA's insorance business is primarily carried out by IDS Life Insurance ("IDS
Life"), a wholly-owned subsidiary of AEF'C. IDS Li.te, operating through subsidiaries, sells different types of insurance, including fixed dollar insurance and annuities. AEFA, in addition to managing and investing funds for clients through its proprietary investment products, typically uses the premiums paid on the fixed dollar and other products to invest in and for its own
account, and the revenues generated by such investments are used to pay the benefits owed under
those contracts. Thus, under normal business conditions, AEFA would have to carefully
calibrate the premiums on such contracts, as well as their expected returns on any investments, in
order to match or exceed the guaranteed benefits payable to its clients.
B. American Express, Through AEFA, Gorges Itself on High -yield Debt To Meet the Company 's Aggressiv e Financial Targets
1. AEFA Implements an Unsound and Risky Business Model Dependent on Investment In Volatile High-yield "Junk" Bonds and High-Risk Structured Investments
71. In 1997 and 1998, Defendant Golub began to push for extremely aggressive
earnings growth for American Express, and for greatly increased performance for its business
units in order to feed that growth. As a result, the Company, and Defendant Golub, demanded as
much as an 18-210% return on equity, and 12-15% earnings per share growth each year. These
highly aggressive targets (for the Company and relative to the industry), and benchmarks, along
with other factors discussed below, put extraordinary pressure on AEFA, and demanded that it
engage in exceptionally risky investment strategies.
26 72. Not surprisingly, AEFA caved in to these pressures, readily obliging the wishes of its parent Company and Defendant Golub. News reports quoting current and former AEFA executives following the end of the Class Period confirm that as part of a drive to increase revenues and meet the Company's pre-determined, publicly-announced earnings targets, AEFA's life insurance division began to over-invest in extremely risky high-y ield debt securities.
According to these former AEFA executives, this strategy of increased investments in risky high- yield debt securities was in response to Defendant Golub's demands, which were communicated throughout the Company and AEFA, for a steep ramp-up in earnings growth which could not be produced organically.
73. According to a financial advisor who worked at AEFA's headquarters throughout most of the Class Period, and has personal knowledge of the activities of the Company and
AEFA during that time, AEFA's drive to .increase earnings growth also resulted in the under- pricing of its insurance products to beat out its competitors. Because AEFA's insurance products were indiscriminately sold at extraordinarily low premiums, the only way for AEFA to remain profitable or give the appearance of earnings growth, was to significantly drive up the yields on its own investments. As a result, AEFA caused its investment portfolio to become increasingly
skewed towards extremely risky high-yield debt investments, including junk bonds and CD Os.
According to this same financial advisor, there was a also big push at AEFA to induce people to
buy life insurance, usually under the guise of selling "financial plans." This financial advisor
was personally told by IDS Life executives that IDS Life could beat the premiums quoted by any
life insurance competitor because of the high returns of AEFA's high-yield debt investments.
74. Additionally, another high-ranking executive, a former Vice President who left
AEFA in 1998, stated that Defendant Hubers himself encouraged investment in larger and larger
27 CDO instruments in order to try and increase returns on AEFA's investments, and in turn lift
Company earnings . According to this AEFA Vice President, one AEFA portfolio manager warned Hubers of the inherent risks involved with these speculative financial products, but
Hubers disregarded these warnings and insisted that the investments continue nonetheless.
75. Yet another former AEFA Vice President stated in this connection that " [t]here were always pressures to use the corporate portfolio ... to meet the return objectives [the
Company] was asking us to meet." As was reported in The Wall Street Journal Asia on July 31,
2001:
[t]he problem was that portions of AEFA's main business of financial advice, money management and insurance weren't growing enough to nieet the targets. "The insurance business was very sluggish at the time," says Peter Anderson, the former chief investment officer of the Minneapolis investment group [AEFA], who retired May 1. "We needed the incremental income."
Indeed , according to Company and AEFA insiders, that "'incremental income" was to come, and, for a time, did in fact come from inflated returns on extremely risky AEFA high-yield debt investments.
76. As a result of this furious push to meet American Express's financial targets through the pursuit of higher expected returns on extremely risky debt investments, AEFA's
investment portfolio became extraordinarily bloated with these securities. At its high point,
AEFA increased its level of investment in these speculative securities by approximately 50%
over previous levels and over the proportions typically held by other companies in the industry.
See infra at'flI 77-80. As was reported in The Wall Street Journal Asia:
AEFA decided to raise the junk bond portion of its portfolio to what at its peak would become 12% of a S32 billion pool of investments it manages for itself, from around 8%. That shift in strategy put the company much deeper into the junk bond game than most of its blue-chip competitors, whose junk bond mix remained in the single digits.
2S 77. Specifically, during the Class Period, AEFA maintained an investment portfolio with a 10-12% allocation to high-yield securities; by contrast, most insurance companies limited their high-yield holdings to about 7% of their portfolios. UBS Warburg"s John McDonald noted, after the Company was forced to disclose the massive write-downs at the end of the Class Period, that "[wjith the $182 million and $826 million] write-downs and early sales, high-yield instruments now account for 7% of AEFA's investment portfolio, down from 11% at the end of the first quarter and 13% at the end 2000. This action bring AEFA's investment portfolio closer to its peer average of 5%-6%."
78. In order to gauge just how far AEFA had departed from industry trends with respect to its level of investment in high-yield debt securities, not to mention its representations of careful risk monitoring, analysis and management during the Class Period, it is also instructive to compare AEFA's high-yield investments specifically with those of some similar companies.
Such a comparison reveals that AEFA had invested in such securities to a far greater degree than other financial service companies filing financial statements under the same SIC Code (6199).'
79. For instance:
At year-end 2000, First Data Corporation reported that 7,1 °.o of its investments were in corporate bonds, only some of which, if any, would have been high-yields. By contrast, AEFA consistently allocated 10-12% of its portfolio toward hiahyields during the Class Period.
By year-end 2001, Morgan Stanley reported a decline in income from 2000 of 7% of pre-tax earnings, only some of which would represent losses due to high-yield debt. By contrast, American Express would ultimately report a decline in its net income by over 38% due to higlayield debt in 2001.
3 SIC Codes are Standard Industrial Classification Codes that appear in a company's disseminated EDGAR filings and which i.^;dicate the company's type of business. The SIC Code for financial services companies is 6199.
29 Sanders Morris Harris Group reported that by year-end 2000, only 2.1 %, of its holdings involved corporate debt, only a portion of which. if any, would have involved high-yield debt. [Emphasis added].
80. It is also helpful to compare AEFA to a large financial subsidiary, GMAC, of a more diverse company, General Motors:
General Motors Acceptance Corp. [GMAC], a subsidiary of General Motors, also reported minimal losses on corporate debt for years 2000 and 2001, suggesting virtually no investment in high- yield debts. []
81. In short, American Express reported large amounts of income from these high- risk debt instruments during the Class Period, despite mounting undisclosed losses in the value of these instruments, losses that the Defendants either were aware of and actively concealed, or willfully or recklessly ignored. Moreover, this gross over-indulgence exposed the portfolio to disproportionate material risk in the foreseeable, even likely, event of a further stock market downturn, as explained in greater detail below at ¶¶ 86-90.
82. Along with American Express, Defendant Golub himself also profited handsomely from this new Company goal and strategy, which was adopted and implemented under his watch and largely at his behest. However , Defendant Golub conveniently announced his retirement , before this scheme to meet American Express's financial targets by overloading
AEFA with risky high-yield debt investments finally collapsed in a wave of belatedly recognized
defaults and write-downs.5
4 Although GMAC is not registered as a financial services company under SIC Code 6199, it is helpful to compare AEFA with a large financial subsidiary.
Defendant Golub relinquished his Chief Executive position in January 2001 and his Chairmanship of the Board of Directors in April 2001, just as the truth was beginning to be revealed.
_^[l 83, Specifically, Defendant Golub received an annual "incentive award" for 1999 that included $2.4 million in cash due, inter alga, to American Express's reported increase in income and earnings per share for that year. That total award had a final value of 2.7 times his annual incentive award guideline. Remarkably, the financial rewards kept coming in 2000 for Golub, when he received another "incentive award" for 2000 that include $3.2 million in cash due, inter alia, to American Express's reported increase in income and earnings per share for that year.
That total award also had a final value of 2.7 times his annual incentive award guideline.
84, The Company would eventually register well over $1 billion in write-downs due to losses in these volatile high-yield debt investments, beginning with a relative trickle in the fourth quarter 2000 (a loss of $49 million), and full year 2000 losses of over $123 million, solely attributable to high-yield debt investments. Soon afterward, on April 2, 2001, American Express
announced that it would be writing off $185 million in losses on high-yield debt securities for the
first quarter of that year. Then, in July 2001, American Express announced that it would write
off an additional $826 million, bringing its total high-yield debt losses for the first half of 2001 to just over $1 billion.
85. Defendant Hubers, among others, was behind the notion that the firm should
invest in the risky financial derivatives that were CDOs, as part of this overall strategy of
generating greater returns through higher yielding, riskier investments. As was reported in the
Wall Street .Journal Asia on July 31, 2001, both Defendant Hubers as well as Mr. Anderson,
AEPA's former Chief Investment Officer, sanctioned this plan, although neither had significant
experience in bond investing, much less investing in volatile high-yield debt instruments.
Following the decision to invest in these types of high risk securities, in the time just before or
during the Class Period, American Express reportedly entered into approximately 60 separate
31 deals involving CDOs, including 12 CDO deals created internally in exchange for management fees.6
2. Defendants' Creation of a Meltdown Waiting to Happen : AEFA's Over-Investment in Volatile High-yield Debt, Coupled With a Lack of Adequate Risk Controls or Procedures to Monitor or Accurately Value These Investments , Results in a Catastrophe
a. The Additional Risks Posed by the High-yield Debt Investments Themselves
86. As set forth above at ¶ 2, note 1, AEFA's high-yield debt investments included risky, directly held, below-investment-grade bonds, or junk bonds, as well as structured investments such as high-yield CDOs, or collateralized debt obligations. CDOs are diversified collections of bonds that are sliced into tranches of varying risks and sold as securities, some of which also contain features referred to as "toxic waste" due to their especially high likelihood of default. Such toxic waste was included in AEFA's high-yield debt holdings. See, e.g. ¶T 9-12.
American Express invested in a wide range of risky high-yield investments, ranging from bonds issued by struggling movie theater chains and companies that were financially crippled by asbestos liability.
87. Statement of Position 93-1, Financial Accounting and Reporting for Highyield
Debt Securities by.lnve.strnent Companies ("SDP 93-1 ") defines high-yield debt securities, or junk bonds, as corporate and municipal debt securities having a lower than investment-grade
credit rating (BB +- or lower by Standard & Poor's or Ba or lower by Moody's). Because these
6 Not only did the Company purchase high-yield debt instruments from other issuers, it also packaged its own CDOs for sale to outside parties through other investment firms. In so doing, the company generated management fees, and in the process also retained some of the "toxic" portions of the investments for its own account.
32 securities are inherently different than investment-grade issues, they present additional credit, liquidity and market risks for all participants. For example;
Market Risk In contrast to investment-grade bonds (the market prices of which change primarily as a reaction to changes in interest rates), the market prices of high-yield bonds (which are also affected by changes in interest rates) are influenced much more by credit factors and financial results of the issuer and by general economic factors that influence the financial markets as a whole,
Liquidity Risk - The market risk is often heightened by the absence of centralized high-yield bond exchanges and relatively thin trading markets, which makes it more difficult to liquidate holdings quickly and therefore increases the volatility of the market price.
Credit Risk Issues of high-yield debt securities are more likely _o default than issues of investment-grade securities.
88. Thus, the risk of loss upon default by an issuer is significantly greater for high-
yield debt securities of the kind that AEFA invested in than with investment grade debt
securities , for multiple reasons. For instance , such high-yield securities are generally unsecured
and are usually subordinated to other creditors of the issuer. Also, issuers of high-yield debt
typically have higher levels of indebtedness and are more sensitive to adverse economic
conditions than investment grade issuers.
89. Furthermore , high-yield bond values have increased sensitivity to fluctuations in
equity markets than investment grade bonds due to several factors including: (i) the higher
coupons? typically found in high-yield bonds demand higher earnings, and earnings is a prime
driver of equity values; and (ii) the safety of high-yield bonds can be improved by the issuer
restructuring its finances, which typically involves an equity offering.
7 The "coupon" is the interest rate on a debt security that the issuer promises to pay to the holder until maturity, expressed as an annual percentage of face value.
33 90. In addition to these aforementioned risks, AEFA' s reliance on Junk bonds and
CDOs presented additional and extreme risk to American Express because AEFA's other sources of revenue also generally depend on the strength of equity markets . Unlike a standalone insurance company, AEFA has other sources of revenue besides its own investments and the premiums paid on insurance products . Specifically. AEFA's other revenue largely is derived through fees charged for its management and advisory services. Those fees are in turn based on the value of the underlying investments and thus the strength of the equity markets. By choosing an investment strategy for its insurance products that relied on high-yield debt instruments
(which , unlike investment grade bonds, also depend on the strength of the equity markets),
AEFA essentially left itself extraordinarily exposed in the event of a downturn in the equity markets by investing in these especially risky securities.
b. American Express's and AEFA's Complete Failure to Properly Value and Monitor the Risks of AEFA's High-yield Debt Investments During the Class Period
91, In order to properly account for the risks and exposure involved in its speculative investment strategy and to make reasoned decisions regarding how to implement such a strategy, it was necessary that AEFA obtain reliable, accurate information about its investments and the nature of the high-yield debt investment market. Exacerbating this precarious investment strategy and the dangers posed by these high-risk investments, AEFA utterlyfailed to adequately monitor and evaluate the extent of its exposure during the Class Period, or to even implement or utilize anything remotely resembling adequate risk monitoring or management controls, policies or procedures in order to do so, despite representing otherwise during the
Class Period. In sum, AEFA failed to take any necessary steps to accurately gauge, monitor or manage the amount of risk it had assumed, or the changes in the risks presented by these volatile investments, going forward through the Class Period.
34 92. Indeed, Defendants appear to have failed to even attempt to conduct even the most basic review, much less any kind of thorough analysis or monitoring of AEFA 's high-yield portfolio until very late in the Class Period , after being told that these investments were already in a rapid, extreme and irreversible state of collapse . Nevertheless , Defendants continued to issue materially false and misleading statements concerning the value of AEF.A 's high-yield. debt investment portfolio as well as the Company' s financial condition, performance and prospects.
Moreover, Defendants continued to make these misstatements even after they were aware, or at the very least recklessly ignorant, of the fact that the value of that portfolio was, worth hundreds of millions of dollars less than American Express had publicly claimed.
93. Moreover, according to a former AEFA Pricing Analyst who worked at AEFA headquarters in Minneapolis during the Class Period, and had personal knowledge of AEFA's business operations, AEFA' s analysts were often entirely unfamiliar with the bonds underlying
their investments and instead merely relied on brokers' representations as to the securities' value
(assuming a given security even had any remaining value).
94. Unfortunately, unfamiliarity with these types of high-yield, high risk investments ran from top-to-bottom at AEFA during the Class Period. As The IVail Street Journal Asia
reported, even those officers at the higher levels behind the investment plans and implementation
thereof, including Defendant Huhers, had at best sparse experience in bond investing, much less
any expertise investing in more volatile debt instruments like junk bonds and CDOs.
95. Contrary to its representations to shareholders (described more fully below),
AEFA failed to analyze and monitor the prices, values, and performance of such high-yield
investments. For example, as was observed by analyst Penny Cagan, head of research at Zurich
IC Squared, an independent risk consulting subsidiary of the Zurich Financial Services Group:
35 "American Express's investment team ... did not account for steadily increasing default rates and the volatility of the junk bond component of its holdings."
96. As set forth above, the market for many high-yield debt investments is relatively illiquid and, thus, lacks simple methods of valuation. Because market prices are not readily available, value can be estimated several ways depending on the nature of the instrurnent and the manner in which it is traded . However, such valuation must comply with C}AAP.
97. Management's best estimate (under the direction of the board of directors) of fair value should be based on the consistent application of a variety of factors in accordance with the valuation policy followed by the fund or entity involved. All relevant factors should be considered in selecting the method of estimating the fair value of each kind of security.
According to the SEC's Financial Reporting Codification ("FRC") 404.03, in determining the fair value assigned to a particular financial instrument, a company should, take into consideration all indications of fair value that are available, including, but not limited to:
(a) financial standing of the issuer; (b) business and financial plan of the issuer; (c) cost at date of purchase; (d) size of position held and the liquidity of the market; (e) contractual restrictions on disposition; (1) pending public offering with respect to the financial instrument; (g) pending reorganization activity affecting the financial instrument (such as merger proposals, tender offers, debt restructurings, and conversions); (h) reported prices and the extent of public trading in similar financial instruments of the issuer or comparable companies; (i) ability of the issuer to obtain needed financing; 6) changes in the economic conditions affecting the issuer; (k) a recent purchase or sale of a security of the company; (1) pricing by other dealers in similar securities; and (m) financial statements of investees.
98. Although there is no universally accepted single method for determining fair
value, at the very least, the company should be satisfied that the methods used to determine fair
value are reasonable and appropriate and that the resulting valuation is fair. Here, Defendants
36 fell far astray from these parameters, or any reasonable method of valuing the high-yield debt investments in AEFA' s portfolio.
99. AEFA' s shoddy and in some cases non-existent methods for valuing its high-yield debt holdings were a distant cry from the foregoing standard procedures. For example, one former Pricing Analyst explained that pricing for these securities when it was obtained at all
was obtained merely by calling sales persons at the various brokers (i.e., Salomon Smith
Barney, JP Morgan, Deutsche Bank) who had previously sold them the securities to try to get price quotes, because it was not possible to simply look to a real-time market price. The Pricing
Analyst described the procedure as a futile one, because the brokers themselves did not know the price and often had to be pressured into providing one. Another former Pricing Analyst in
AEFA's Corporate Actions and Valuations department confirmed this scenario, stating that high- yield securities were valued periodically simply by calling the brokers who sold them to AEFA.
He stated: "Yeah, whatever price you got from the broker. You definitely would enter it into the system, and it would feed all the rest of the systems."
100. Contemporaneous news reports confirmed this practice, describing a scenario during the Class Period with respect to the especially risky CDO investments in which:
American Express bad largely been relying on the reports of outside CDO managers to evaluate the health and performance of the investment-grade pieces it held. It wasn't uwtil .Illessrs. Berman and Yowan [two high level Company executives charged with conducting an internal assecsment] sat down with the portfolio fin May or June 20011, along with American Express's in-house analysts, that the company began to draw its own conclusions about all 8,500 bonds that underpinned the securities.
July 31, 2001 Wall Street Journal Asia article (emphasis added). It was this belated "in-house" monitoring and internal assessment, and reliable valuation, which investors had been falsely led to believe was being undertaken at AEFA all along. This eleventh-hour internal evaluation
37 ultimately revealed the true extent of the dramatic deterioration in AE:FA 's high-yield portfolio, resulting in American Express's announcement of an $826 million after-tax charge in July 2001.
101. Notwithstanding the fact that brokers typically act on behalf of an issuer, and not as independent appraisers as to the value of a bond or security, the Company' s sale (if not blind) reliance on brokers and similar outsiders, without an independent investigation of the value of these high-yield debt securities, was at best a highly reckless and extremely improper strategy and practice.
102. Moreover, although some audit procedures permit the reliance on outside pricing services for valuation of illiquid securities, AEFA's unquestioning and single-minded dependence on the estimates of individual brokers was improper because:
(a) audit procedures are inherently different from valuation, and solely done to corroborate a valuation, not to establish one; and
(b) audit procedures permitting reliance on estimates by outside parties require that the price be provided by an "independent pricing service," (emphasis added) and note that many auditors prefer to use nvo services in order to he certain of the accuracy of the valuation. See SOP 93-1.
103. According to the AEFA Pricing Analyst who worked in Minneapolis , part of
AEFA's standard operating procedures was that if a current price could not be obtained on an
AEFA high-yield debt investment at a given time, the price would simply be left alone and
unadjusted. Thus, during the Class Period, many securities were held at cost, without any
updates to their valuation . Indeed, many of AEFA's portfolio of such securities were not
revalued,for periods of 'up to several years, because ongoing pricing was unavailable and there
was no knowledge of the corresponding underlying assets.
104. Because of these woefully deficient and haphazard valuation procedures, some
AEFA investments were curried at cost without any adjustment for deteriorating market
38 conditions, while others were revalued according to improper procedures, almost entirely dependent on inadequate brokers' representations, with no independent verification or "checks" on the valuations. Moreover, according to the AEFA Pricing Analyst, even when a broker provided a price, sometimes there would be a delay ofseveral months between the request for the valuation information on a security and the tine it was ultimately received.
105. Quite simply, AEFA's failure to employ reliable or consistent controls, policies or procedures for monitoring its holdings made it impossible for AEFA to monitor the degree of risk inherent or present at any given time in the high-yield debt investments in its portfolio.
Similar flaws simultaneously made it impossible for AEFA to accurately account for the value of the portfolio in American Express's publicly filed fnancial statements with any real measure of accuracy, thus rendering those financial statements false and misleading, and creating a situation ripe for the dramatic over-valuation of AEFA's high-yield investment portfolio, and the massive write-downs and charges that ultimately came to pass.
106. By the end of 2000, AEFA had invested $3.7 billion in below investment grade
securities. Incredibly, AEFA and the Company described these investments, which encompassed these massive, volatile, extremely risky and (at the very least) highly recklessly managed,
monitored and valued high-yield debt investments, as "dependable" and portrayed them as
closely scrutinized and controlled for risk.
107. Furthermore, prior to and during the Class Period, Defendants represented that the
Company had strong internal controls in place which monitored the Company's risk exposure on
an ongoing basis. For example, American Express's Report on Forni 10-K for 1998, filed with
the SEC on March 30, 1999 and which remained active throughout the Class Period, assured
investors under a section titled "Risk Management" that:
39 Management establishes and oversees implementation of Board-approved policies covering the company's funding, investments and use of derivative financial instruments and monitors aggregate risk exposures on an ongoing basis. The company's objective is to realize returns connnensurate with the level of risk assumed while achieving consistent earnings growth. [Emphasis added].
These representations were made even though neither American Express, AEFA, nor any of the other Defendants could be said to have been reliably "'monitoring" (much less "'managing" or
"controlling") the financial health or performance of these investments, or to have known with any degree of accuracy the actual value of these high-yield debt investments. In addition, at the same time American Express and AEFA were employing haphazard, inconsistent, and often non- existent methods of valuation, thus obscuring American Express's true financial position to outside investors.
C. The High -yield Debt Portfolio Issues Were Well-Known Within AEFA and the Company
108. While the investing public was being kept in the dark, it was well-known within
American Express that AEFA's high-yield debt investment portfolio had serious problems. For example, the Pricing Analyst who was based in the Minneapolis Headquarters of AEFA throughout the Class Period stated that during the Class Period "[w]e knew that the junk market was getting bad." Yet another former employee who worked with bonds in AFFA, and as a
Portfolio Manager throughout the Class Period, indicated that "from the perspective of someone
in the Investment Department - and [who] knows ,"That was going on in the markets at that time
- I don't know why anyone in New York at corporate would have been surprised by any
charges that came out of a high-yield portfolio, you know, at that time." In fact, another former
employee who was CIO for the Equity Advisory Group and was employed at AEFA throughout
the Class Period indicated that he had understood that senior management had been warned that
the Company was "hanging itself' with its huge stake in junk bonds, and that another senior
40 employee had even gone so far as to put memos together to provide warnings of the problems with the junk bonds.
109. Given this collapse, it is not surprising then that senior management felt pressure to do whatever it took to keep AEFA and its high-yield debt portfolio afloat. Underscoring this pressure to grow, a former employee who was a Portfolio Manager of the Fixed Income
Department throughout the Class Period, indicated that AEFA had been an ever-present
"solution" that American Express seemed to turn to when it needed help meeting its financial targets. Although AEFA had previously helped fuel the Company's financial performance, during the Class Period AEFA was in desperate need of help, and needed to be propped up financially. One former employee who worked for American Express throughout the Class
Period (as American Express Director of Electronic Payments Strategy, working in the insurance department of AEFA in Minnesota and later in New York in the credit card business) stated that early 2001 would have been a very bad time to write down these assets and take a charge to earnings, because American Express's credit card business was in a tailspin; credit card profits were off by so much that they threatened American Express's ability to attain earnings in line with estimates.
110. Indeed, this same employee staled that there was pressure to conceal the
impairment of AEFA' s CDOs because any mark down in value of these investments would have
meant that AEFA (as a broker dealer under state insurance regulations) would have to take the
dramatic step of acquiring additional assets or decrease liabilities to maintain its required asset to
liability ratio. Such an event would have been devastating to the Company's ability to continue
to use AEFA and its high risk, high-yield debt investments to help drive its impressive financial
results quarter after quarter.
41 111. Further, not only were American Express's problems with respect to AEFA's high-yield debt portfolio widely known within the Company, but also, according to one former employee who was a Financial Advisor with AEFA during the Class Period in Minneapolis, there was a focused attempt to put a positive "public relations" spin on the situation. According to the former Portfolio Manager of the Fixed Income Department, `... Hubers had been goosing the numbers to look like a hero and also tried to make Golub look good."8
112. Unfortunately, although not surprisingly, Defendants' deception misled some
AEFA employees as well. Indeed, in this regard, one such former employee who worked at
AEFA throughout the Class Period stated that employees were also simply "lied to" about
AEFA's situation and problems with its high-yield debt investment portfolio.
C. Defendants' Material Misrepresentations During the Class Period in Violation of The Federal Securities Laws
113. AEFA reported materially false and misleading quarterly income growth during
1999 and 2000, due to the .failure to properly account for the risks and the values of its holdings.
AEFA's quarterly income statements during the Class Period, filed on Form 10-Q, issued and discussed in press releases, and also discussed on investor and analyst conference calls each reported increased revenue and income compared to the prior year period. For the reasons set forth earlier in ¶^ 141-170 each of these reports was materially false and misleading.
114. Serendipitously, in each successive fiscal quarter, American Express reported approximately a 14% increase from net income over the prior year's quarter. Defendants'
6 Apparently, as indicated by the former Director of Electronic Payments Strategy, Hubers had possessed the motive to make AEFA grow at all costs as his bonus was directly dependent upon AEFA.'s returns on its investments, including the high-yield debt investments at issue here.
42 fraudulent conduct outlined herein materially contributed to the Companys ability to achieve these impressive financial results.
115. For example, at the start of Class Period, on July 26, 1999, for the second quarter of 1999, Defendants reported net income of $646 million, as compared with net income of
$578 million in the same quarter of the prior year. American Express also reported that its "held to maturity" investments, which included most of AEFA's high-yield debt holdings as well as other "held to maturity" investments carried by AEFA and the other operating segments, had appreciated by $217 million. AEFA reported quarterly net income of $242 million, a 14% increase from net income of $212 million in the prior year. American Express's financial results for the second quarter of 1999, the period ending June. 30, 1999, were repeated in the Company's
Report on Form 10-Q filed with the SEC on or about August 13, 1999, which was signed by
Defendants Goeltz and Henry.
116. On October 25, 1999, American Express issued a press release announcing its financial results for the third quarter of 1999, the period ending September 30, 1999. For the quarter, Defendants reported net income of $648 million, as compared with net income of
$574 million in the same quarter of the prior year. American Express also reported that its "held to maturity" investments had appreciated by $137 million. AEFA reported quarterly net income of $240 million, a 14% increase from net income of $211 million in the prior year. American
Express's financial results for the third quarter of 1999, the period ending September 30, 1999, were repeated in the Company's Report on Form I O-Q filed with the SEC on or about November
15. 1999, which was signed by Defendants Goeltz and Henry.
117. On January 24, 2000, American Express issued a press release announcing its
financial results for the full year 1999, the period ending December 31, 1999. For the year,
43 Defendants reported net income of $2.48 billion, as compared with net income of $2, l4 billion in the prior year. American Express also reported that its "held to maturity" corporate debt investments had depreciated by only $3 million. AEFA reported net income for the year 1999 of
$935 million, yet another 14% increase from net income of $818 million in the prior year.
American Express's financial results for the full year 1999, the period ending December 31,
1999, were repeated in the Company's Report on Form 10-K. filed with the SEC on or about
March 27, 2000, which was signed by Defendants Goeltz, Golub, Chenault and Henry, among others. -
118. On April 24, 2000, American Express issued a press release announcing its financial results for the first quarter of 2000, the period ending March 31, 2000. For the quarter,
Defendants reported net income of $656 million, as compared with net income of $5 75 million in the same quarter of the prior year. American Express also reported that its "held to maturity" investments had depreciated by only $18 million. AEFA reported quarterly net income of
$245 million, a 15% increase from net income of $214 million in the prior year. American
Express's financial results for the first quarter of 2000, the period ending March 31, 2000, were repeated in the Company's Report on Form IO-Q filed with the SEC on or about.May 15, 2000, which was signed by Defendants Goeltz and Henry.
119. On July 24, 2000, American Express issued a press release announcing its financial results for the second quarter of 2000, the period ending June 30, 2000. For the quarter,
Defendants reported net income of $740 million, as compared with net income of $646 million in the same quarter of the prior year. American Express also reported that its "'held to maturity"
investments had depreciated by only $55 million. AEFA reported quarterly net income of
$275 million, another 14% increase from net income of $242 million in the prior year. American
44 Express's financial results for the second quarter of 2000, the period ending June 30, 2000, were repeated in the Company's Report on Form 10-Q filed with the SEC on or about August 11,
2000, which was signed by Defendants Crittenden and Henry.
120. On October 23, 2000, American Express issued a press release announcing its financial results for the third quarter of 2000, the period ending September 30, 2000. For the quarter , Defendants reported net income of $737 million, as compared with net income of
$648 million in the same quarter of the prior year. American Express also reported that its "held to maturity" investments had appreciated by $10 million. AEFA reported quarterly net income of $269 million, a 12% increase from net income of $240 million in the prior year. American
Express's financial results for the third quarter of 2000, the period ending September 30, 2000, were repeated in the Company ' s Report on Form 10-Q filed with the SEC on or about November
13, 2000, which was signed by Defendant Crittenden.
121. On January 22 , 2001, American Express issued a press release announcing its financial results for the full year 2000, the period ending December 31, 2000. For the full year
2000, Defendants reported net income of $2.81 billion, as compared with net income of
$2.4 billion for the prior year. American Express reported that corporate debt securities classified as held to maturity had appreciated by $8 million. For the fourth quarter of'2000,
AEFA reported net income of $242 million, a 2% increase over $238 million in the prior year.
American Express's financial results for the full year 2000, the period ending December 31,
2000, were repeated in the Company's Report on Form IO-K filed with the SEC on or about
March 30, 2001, which was signed by Defendants Crittenden, C]olub, Chenault and Henry,
among others.
45 122. As described above, each of these financial statements in ¶¶ 196-202, above, was materially false and misleading and presented a false impression of the financial health and the internal controls of the Company and its subsidiary AEFA. See ¶j 141-170, infra. Because these financial statements suffered from numerous accounting improprieties, Defendants caused
American H'xpress's reported financial results to violate not only their own representations regarding the existence of internal controls on accounting, but also, among other things, the following provisions of CRAP for which each Defendant is responsible:
(a) The principle that financial reporting should provide information that is useful to present and potential investors in making rational investment decisions and that information should be comprehensible to those who have a reasonable understanding of business -and economic activities. (FASB Statement of Concepts No. 1, 34);
(b) The principle of materiality, which provides that the omission or misstatement of an item in a financial report is material if, in light of the surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item. (FASB Statement of Concepts No. 2, IF 132);
(c) The principle that financial reporting should provide information about how management of an enterprise has discharged its stewardship responsibility to owners (stockholders) for the use of enterprise resources entrusted to it. To the extent that management offers securities of the enterprise to the public, it voluntarily accepts wider responsibilities for accountability to prospective investors and to the public in general. (FASB Statement of Concepts No. 1, ^ 50);
(d) The principle that financial reporting should provide information about an enterprise ' s financial performance during a period. Investors and creditors often use information about the past to help in assessing the prospects of an enterprise. Thus, although investment and credit decisions reflect investors' expectations about future enterprise performance, those expectations are commonly based at least partly on evaluations of past enterprise performance . (F ASB Statement of Concepts No. 1, ¶ 42);
46 (e) The principle that financial reporting should be reliable in that it represents what it purports to represent. The notion that information should be reliable as well as relevant is central to accounting. (FASB Statement of Concepts No. 2, ¶¶ 58-59);
(f) The principle of completeness, which means that nothing is left out of the information that may be necessary to ensure that it validly represents underlying events and conditions. (FASH Statement of Concepts No. 2, ¶ 80);
(g) The principle that conservatism be used as a prudent reaction to uncertainty to try to ensure that uncertainties and risks inherent in business situations are adequately considered. The best way to avoid injury to investors is to try to ensure that what is reported represents what it purports to represent. (FASB Statement of Concepts No. 2, ¶¶ 95.97); and
(h) The principle that contingencies that might result in gains are not reflected in accounts since to do so might be to recognize revenue prior to its realization and that care should be used to avoid misleading investors regarding the likelihood of realization of gain contingencies. (SFAS No. 5, .4 ccountingfor Contingencies).
123. In addition. Defendants falsely and/or recklessly failed to disclose the existence of known trends, events or uncertainties that they reasonably expected would have a material unfavorable impact on American Express's operating results or that were reasonably likely to result in the Company's liquidity decreasing in a material way, in violation of Item 303 of
Regulation S-K under the federal securities laws (17 C.F.R. 229.303).
1.24. These failures rendered the Company's Class Period financial statements and
Forms i0-K and IO-Q materially false and misleading.
125. The results outlined above were materially false and misleading because they did not properly- account for the significantly declining value of AEFA's high-yield debt investments. nor did American Express's financial statements disclose AEFA's utter lack of adequate risk controls or any policies or procedures in place to monitor the performance of its liigh-yield debt investments. As explained in more detail below, these financial results:
47 (a) materially overstated the value of AEFA's investments by failing to write off losses incurred by virtue of a marked downturn in the high-yield bond markets;
(b) falsely represented that the Class Period Form l0-Qs were prepared in accordance with GAAP; and
(c) omitted that, contrary to the Company's representations in its Report on Form l 0-K for the year ending Deceniher 31, 1998, the Company had failed to implement any controls, policies or procedures for assessing, analyzing or managing the risks associated with AEFA's investment portfolio.
1. Defendants ' Materially False and Misleading Representations Concerning the Risk Controls , Policies and Procedures with Respect to its High-yield Debt Investments
126. Despite ATP A's increasingly unbalanced portfolio, which became more and more bloated with v latilc high-yield debt.investments, American Express and the Individual
Defendants continued their false portrayal of AEFA as having strong and effective controls, policies and procedures in place to adequately monitor the risk and performance of its high-yield portfolio. American Express repeatedly presented itself and AEFA as operating in an environment wherein high-yield debt and other investment risks were carefully monitored, managed and controlled by strong and thorough American Express safeguards, policies and procedures.
127. Furthermore, prior to and during the Class Period, Defendants persistently represented that the Company had strong internal controls in place which closely monitored the
Company's risk exposure from. its investments on an ongoing basis. For example, American
Express's Report on Form 10.K for 1998, filed with the SEC on March 30, 1999 and which remained active throughout the Class Period, assured investors under a section titled "Risk
Management" that:
Management establishes and oversees implementation ofBoard- approved policies covering the company's .funding, investments
48 and use of derivative financial instruments and monitors aggregate risk exposures on an ongoing basis . The company's objective is to realize returns commensurate with the level of risk assumed while achieving consistent earnings growth. [Emphasis added.]
128. Further, in its Annual Report to Shareholders for 1999, incorporated by reference into its Report on Form 0-K Ihr 1999 (tiled March 30, 2000, and signed by Defendants Goeltz,
Golub, Chenault, and Henry), American Express falsely represented that:
Management establishes and oversees implementation ofBoard- approved policies covering the company's funding, investments and use ofderivativefinancial instruments and monitors aggregate risk exposures on an ongoing basis . The company's objective is to realize returns commensurate with the level of risk assumed while achieving consistent earnings growth. Individual business segments are responsiblefor managing their respective exposures within the context ofBoard-approved policies.
AEFA's owned investment securities are, for the most part, held by its life insurance and investment certificate subsidiaries, which primarily invest in long-term and intermediate-term fixed income securities to provide their clients with a competitive rate ofreturn on their investments while minimizing risk. Investment in fixed income securities provides AEFA with a dependable and targeted margin between the interest rate earned on investments and the interest rate credited to clients' accounts. AEFA does not invest in securities to generate trading profits for its own account.
AEFA's life insurance and investment certificate subsidiaries' investment committees regularly review models projecting different interest rate scenarios and their effect on the profitability of each subsidiary. The committees ' objectives are to structure their investment security portfolios based upon the type and behavior of the products in the liability portfolios to achieve targeted levels ofprofitability and to meet contractual obligations . [Emphasis added.]
129. Using similar language in its Annuual Report to Shareholders for 2000,
incorporated by reference into its Report on Form 10-K (filed on or about March 3d, 2001, and
signed by Defendvrts Crittenden, Golub, Chenault and Henry) American Express stated:
49 Management establishes and oversees implementation of Board- approved policies covering the company 'sfunding, investments and use of derivativefinancial instruments and monitors aggregate risk exposures on an ongoing basis. The company's objective is to realize returns commensurate with the level of risk assumed while achieving consistent earnings growth. The company 's treasury department is responsible for overseeing the individual business segments ' management of their respective exposures within the context of Board-approved policies.
AEFA's owned investment securities are, for the most part, held by its life insurance and investment certificate subsidiaries, which primarily invest in long-term and intermediate-term fixed income securities to provide their clients with a competitive rate ofreturn on their investments while controlling risk. Investment infixed income securities provides AEFA with a dependable and targeted margin between the interest rate earned on investments and the interest rate credited to clients ' accounts. AEFA does not invest in securities to generate trading profits for its own account.
AEFA's life insurance and investment certificate subsidiaries' investment committees regularly review models projecting different interest rate scenarios and their effect on the profitability of each subsidiary. The committees ' objectives are to structure their investment security portfolios based upon the type and behavior of the products in the liability portfolios to achieve targeted levels ofprofitability and to meet contractual obligations. [Emphasis added.]
130. The foregoing statements were materially false and misleading. For example, as detailed from and supported by the personal knowledge of the AEFA Pricing Analyst, the deficient procedures used for evaluating AEFA's high-yield debt holdings made it impossible to monitor and gauge the risks accurately on its high-yield debt investments, and no real risk monitoring or analysis was taking place with respect to AEFA' s high-yield debt investment portfolio.
131. Additionally, Defendants consciously and/or recklessly disregarded the risks inherent in AEFA's strategy and its utter lack of controls by falsely characterizing its high-yield
50 junk bonds and the very riskiest CDOs as "fixed income securities" capable of providing a
"dependable and targeted [investment ] margin. " This characterization was false because AEFA lacked the risk analysis and controls that American Express had represented.
132. By describing AEFA' s holdings with characterizations as conservative as were applicable under the circumstances, AEFA downplayed the risk to its own income presented by these volatile high-yield debt investments and the strategy to pile them into AEFA's portfolio, as well as the lack of any risk controls , monetary or effective valuation of these securities, AEFA represented 35% to 40% of American Express's total income throughout the Class Period.
133. Thus, American Express falsely described its policies and also misled shareholders into believing that (1) risks were being thoroughly monitored, gauged and evaluated on an ongoing basis by American Express and ALFA executives, when, in fact, nothing of the sort was happening; and (2) they were investing in a company with the goal of, inter alia, "provid[ing] [j clients with a competitive rate of return on their investments" while simultaneously "controlling risk" and "minimizing risk." In truth, Class members' investments were in much.more precarious positions than they were led to believe, due to AEFA's deliberate over-reliance on these high-risk investments, with respect to which neither the Company nor
AEFA made any real attempt to "minimize" or "control" risk.
134. Remarkably, Defendant Chenault essentially admitted as much after the Class
Period when he stated on July 18, 2001 that it had become "apparent" that American Express's
"analysis of the. portfolio at the end of thefirst quarter 120011 did notfully comprehend the risks that underline these structured investments during a period ofpersistently high default rates." Despite Chenault's belated and weak attempt to mitigate the force of this confession by trying to limit it to the prior quarter, it sums up to a great degree the story of American Express's
71 and AEFA's disastrous dance with high-yield debt. Defendants' continually represented throughout the Class Period that they were on top of the situation using effective internal controls, strict monitoring, and, as Chenault himself put it, a risk management team that ranked
,among the best in the business," and that American Express "continually improved [its] processes over the years," when in fact none of this was true.
135. Even as AEFA. increased its high-yield debt exposure and failed to implement the risk controls or monitoring safeguards that it had represented to investors were already in place. a downturn in the equity markets occurred and persisted, and American Express's risky high-yield debt portfolio was, and continued to be, extremely hard hit. According to data from New York
U niversity's Salomon Center, default rates on junk bonds had stepped up significantly during
1999 and 2000 from prior periods. Default rates had reportedly spiked to approximately 6% by the third quarter of 1999, doubling from the prior year. Subsequently, defaults remained at that elevated 6% level, and then began to rise even higher by the third quarter of 2000.
136. In light of these ominous developments in the high-yield debt markets, and
AEFA's exceptionally high concentration of high-yield debt investments relative to other similar
companies, AEFA's insistence on holding these securities without taking significant charges
throughout 1999 and 2000 reflected its failure to thoroughly or carefully monitor or analyze the
performance and impact of these investments and the utter lack of any proper risk controls in
place. Such conduct hardly constitutes an attempt to "control" or "'manage" risk, as American
Express had repeatedly represented was its approach to investing in its public filings. Instead,
under the circumstances, this was much closer to a casino-style of investing a highly reckless,
close-your-eyes, roll-the-dice and hope-for-the-best strategy - especially in handling such
volatile investments. It is probably much better described as a risk maximization strategy.
52 Under these circumstance, American Express's representations that AEFA's risk was carefully and properly managed and analyzed on a continual basis are demonstrably false and materially misleading.
137. In light of these developments in the high-yield markets and AEFA.'s high concentration of high-yield investments relative to other companies , AEFA' s insistence on holding these securities without taking significant charges throughout 1999 and 2000 could in no way be characterized as "dependable" or reflective of a careful analysis , proper risk controls, or carefully managed returns. Thus, American Express's representations to shareholders that
AEFA's risk was properly managed and analyzed are demonstrably false.
138. Thus, although AEFA disclosed to investors the amount of money it had invested in high-yield securities throughout the Class Period, it continually misled shareholders into believing that AEFA made reasonable, considered, informed and expert judgments regarding the prudence of its investment strategy, when in fact, AEFA's haphazard and unreliable procedures made it impossible for AEFA to exercise any judgment at all. Under these circumstances, the falsity of American Express's representations regarding risk analysis and risk management procedures is beyond dispute.
139. Moreover, American Express continually misled shareholders into believing that
American Express and AEFA had in place consistent, solid and reliable controls, along with well-understood and well-used policies and procedures for monitoring and valuing these volatile
securities . However, in fact, AFTA' s policies, procedures, and practices ranged from the haphazard and unreliable to the non-existent and underutilized, making it virtually impossible for
AEFA to exercise any real oversight, evaluation or judgment at all with respect to the true performance and value of the investments in this portfolio.
53 140. In light of these circumstances, the falsity of American Express' s representations regarding risk analysis and risk management procedures was not only material, it was critical, as those misreprescntations succeeded in creating a public perception of close scrutiny and reliability in terms of the monitoring and valuation of these investments, which was ultimately exposed as an illusion on July 18, 2001.
141. Indeed, it was only when Defendants began to realize that the charade would soon have to end, that Defendants finally began to attempt to live up to their representations that they had maintained thorough risk controls and protocols and monitored their high-yield debt investments carefully. For example:
(a) According to news reports, Defendant Chenault did not to ask for a thorough analysis of AEFA's approximately $3.5 billion j urik- bond portfolio and the higher-risk CDO investments until the beginning of 2001. and this was only after the Company registered a fourth quarter 2000 loss of $49 million, and full year 2000 losses of $123 million, attributable to high-yield debt investments, and despite widespread knowledge in the industry, and at American Express, that junk-bond prices were plummeting and defaults had sharply risen. Defendants knew, or were recklessly ignorant of the reality that these trends were having a marked impact on AEFA's high-yield debt investments, as well as the high-yield debt portfolios of other companies.
(b) Despite this supposed "hard look" at AEFA's entire high-yield investment portfolio in early 2001, the Company still failed to perform any substantial internal evaluation of these assets, and instead, continued to rely largely on outside brokers and CDO .managers alone to evaluate the value, health and performance of many of its high-yield investments.
(c) American Express finally took steps to perform an internal assessment of these assets in approximately May or June of 2001. This belated in-house review was only prompted by another explicit warning in early May of 2001 (prior to filing its first quarter 2001 Form 10-Q with the SEC) by AEFA's CFO that the highyield debt impairment problems werefar from over, and that the amount that the Company planned to write down for the first quarter of 2001 was likely sign fcantly below the actual amount that should and would have been written down. This
54 situation was a direct result of American Express's knowing and/or reckless failure to fulfill its promises to investors throughout the Class Period concerning AEFA's risk controls and valuation procedures vis-a-vis its high-yield debt investments.
(d) At that time, in May/June 2001, the Company assigned two high- level executives to head up a team of in-house analysts to thoroughly examine AEFA's high-yield debt portfolio investment- by-investment, conducting a serious "crunch the numbers" review to attempt to get to the bottom of the mis-valuation issues the Company was facing with respect to this portfolio. Such a review had apparently rarely- if ever been done before. The result of this eleventh-hour scrutiny was an initial estimate of $400 million more in necessary write-downs, which eventually ballooned to a total of $826 million in write-downs, for total charges of more than $1 billion taken in the first half of 2001.
(e) Only after this massive charge was taken, shocking the investing public, did AEFA announce, on August 28, 2001, that it had hired a new "Vice President of Investment Risk Management," to be, inter cilia, "responsible for overall management of American Express Financial Advisors' risk management function, including risk management policies and procedures" and a new strategy created to provide American Express executives with the centralized risk control authority (by creating a "Corporate Risk Management Committee" (CRMC)) that had been falsely represented to have existed and been exercised throughout the Class Period. See e.g., 71[107,1.25-27.
142. Unfortunately, American Express's creation of these measures was far too little and too late to protect Plaintiffs and Class members. Class members had already been falsely led to believe during the Class Period that American Express and the other Defendants, along with a
risk management team that ranked "among the best in the business," were actively monitoring, managing, "minimizing" and "controlling" the risks associated with American Express's and
AEFA's investments, including the high-yield debt portfolio. As was ultimately and fully revealed on July 18, 2001, nothing could have been further from the truth.
55 2. American Express's Materially False and Misleading Statements Concerning the Value of AE.FA's High-yield Debt Investments, the Methods of Valuation of Those investments, and its Failure to Comply with GAAP as a Result Thereof
143. In addition to AEFA recklessly failing to monitor its investments and properly to analyze and control for its risk, see ¶¶ 125-140, AEFA failed properly to value its higli-yield investments for the benefit of the Company's shareholders and markets.
144. AEFA, and American Express, also failed to properly value AEFA's high-yield debt investments, to the great detriment of Plaintiffs and the Class. Throughout 1999 and 2000,
American Express falsely attributed approximately 35% to 40% of its net income to AEFA, with ever-increasing revenue over prior years. It should come as no surprise then that American
Express should refuse for so long to, and tight so hard against, appropriately lowering the value of its high-yield investments through AEFA. Throughout 1999 and 2000, American Express continued to meet the earnings targets set by Defendant Golub and repeated to the public in numerous press releases that American Express provided an 18-20%, return on equity, and 12-
15% earnings-per-share growth each year, in part by relying on the outsized returns provided by
AEFA's bloated and continually over-valued high-yield debt investments.
145. Notwithstanding the rapid and persistent deterioration of the high-yield bond market, and the consequent and parallel deterioration of American Express's own Sunk bond and
CDO portfolio (both of which began to NN itlher even before the Class Period and continued to do so throughout) during the Class Period AEF'A failed to adequately account for its snowballing losses due to these failing high-yield investments. According to the former AEFA Vice
President who left AEFA in 1999, AF?FA's strategy of inflating earnings by over-investing in high-yield debt instruments began in 1997 and 1998, and ultimately resulted in Ameri can
56 Express's issuance of false and misleading financial statements in 1999 and 2000, due to the significant overvaluation of AEFA's high-yield debt holdings.
146. AEFA's failures in this regard included both its failure to choose its investments according to any kind of defined and strategic policy, and its failure to properly monitor and value its investments according to market fluctuations.
147. For instance, with respect to its choice of investments, AEFA invested in collections of risky derivative instruments such as CDOs. According to a former AEFA Pricing
Analyst who worked at AEFA headquarters in Minneapolis during the Class Period, and had personal knowledge of AEFA's business operations, AEFA's analysts were entirely unfamiliar with the bonds underlying their investments and instead merely relied on brokers' representations that the securities had value.
148. AEFA not only selected and continued to hold its investments in a reckless manner, but also, contrary to its representations to shareholders (described more fully below),
AEFA failed to analyze and monitor the prices and performance of such investments. For example, as was explained by analyst Penny Cagan, "-American Express's investment team .. did not account for steadily increasing default rates and the volatility of the junk bond component of its holdings."
149. Moreover, as set forth in greater detail above, and as stated by the former AEFA
Pricing Analyst with personal knowledge and experience, AEFA often obtained values for its high-yield debt securities - when it obtained them at all - solely by calling sales persons at the various brokers who had sold them the securities to try to obtain a price. See, e.g., ¶j 99.
Moreover, other securities were allowed to go months or even years without their recorded values being reviewed or adjusted at all, or properly. See, e.g., ¶' 103-104.
57 150. During the Class Period, American Express also falsely represented that its financial statements were prepared in accordance with GAAP (which are recognized principles by the accounting profession and the SEC as the uniform conventions necessary to define accepted accounting practices at a particular time). These statements were false and misleading because the Company's financial reporting veered far from GAAP requirements in multiple material ways. By so doing, the Company knowingly or recklessly disregarded, and materially misstated, the true value of AEFA's holdings, and used improper accounting practices in violation of SEC reporting requirements to falsely inflate AEFA's balance sheet and to falsify reported income and financial results in the Company's interim quarters and fiscal years during the Class Period.
151. Specifically, as discussed herein, Defendants caused the Company to violate
GAAP in the following ways:
(a) Defendants utilized improper, inconsistent and often non-existent valuation approaches for AEFA's high-yield debt.
(b) AEFA often improperly relied largely on outside brokers (i.e., Salomon Smith Barney, JP Morgan, Deutsche Bank) and CDC managers as the sole service for valuations of their high-yield investments, such as junk bonds and CDOs and were unfamiliar with the underlying assets of certain investments.
(c) Defendants knew or recklessly disregarded adverse news, trends, or events, which included significant defaults, increasing and persistently high default rates, and bankruptcy filings that negatively impacted the high-yield debt market, and which took place before and during the Class Period.
(d) Defendants knew or recklessly disregarded the current and near- term projected financial condition and performance of the issuers of the high-yield debt in which AEFA invested.
(e) Defendants willfully and/or recklessly ignored the inherent risks related to high-yield debt securities.
58 152. As set forth in Financial Accounting Standards Board ("FASB") Statements of
Concepts ("Concepts Sta(ement") No. 1, one of the fundamental objectives of financial reporting is that it provide accurate and reliable information concerning an entity's financial performance during the period being presented. Concepts Statement No. 1, paragraph 42, states:
Financial reporting should provide information about an enterprise's financial performance during a period. Investors and creditors often use information about the past to help in assessing the prospects of an enterprise. Thus, although investment and credit decisions reflect investors' and creditors' expectations about future enterprise performance, those expectations are commonly based at least partly on evaluations of past enterprise performance.
153. As set forth in SEC Rule 4-01(a) of SEC Regulation S-X, "[flinancial statements filed with the [SEC] which are not prepared in accordance with [GAAP] will be presumed to be misleading or inaccurate." 17 C.F.R. § 210.4-01(a)(l ). Management is responsible for preparing financial statements that conform with GAAP. As noted by the American Institute of Certified
Public Accountants' ("AICPA") professional standards:
financial statements are management's responsibility .... Management is responsible for adopting sound accounting policies and for establishing and maintaining internal control that viill, among other things, initiate record, process, and report transactions (as well as events and conditions) consistent with management's assertions embodied in the financial statements . The entity 's transactions and the related assets, liabilities, and equity are within the direct knowledge and control of management . . . . Thus, the fair presentation offinancial statements in conformity with [GAAPJ is an implicit and integral part of management 's responsibility. [Emphasis added.]
154. As is detailed more fully below, American Express 's management failed in its responsibilities and materially misled investors, because the Company's improper accounting violated the fundamental and relatively simple GAAP principle that financial statements must give anaccurate representation of a company's finances. Moreover, American Express violated several specific rules of GAAP reporting with respect to valuing assets.
59 155. To understand the errors in American Express's financial statements, it is first necessary to understand how American Express classified its investments. American Express's financial statements for most of the Class Period accounted for investments as either "held to maturity" or "available for sale," Securities classified as "held" were valued at amortized cost.
Securities classified as "available" were (theoretically) carried at fair market value, and thus periodically revalued to match their current market price ("marked to market").
156. As Defendant Chenault would eventually disclose during a conference call in
February 2001, the bulk of AEFA's high-yield securities were among those investments classified as "held to maturity." This meant that AEFA's high-yield debt securities were valued at amortized cost, despite the increasing divergence before and during the Class Period between cost and fair market value. Consequently, no matter how low the value droppedfor each of these securities, or how high default rates became, AEFA still reported these securities as having a value equal to the cost of the security. Such reporting had the inevitable effect of artificially inflating the value of AEFA's holdings because, by definition, drops in the value of these investments were simply ignored, and therefore obviously not reported or reflected in
AEFA's (or American Express's) balance sheets or Financial results. Thus, each of American
Express's financial statements released during the Class Period significantly overstated the value of AEFA's holdings. Or, as described by Ms. Cagan, head of research at Zurich IC Squared,
American Express's accounting for and valuation of its high-yield debt investments "did not account for steadily increasing default rates and the volatility of the junk bond component of its holdings."
157. As described below in. See, e. g-, «i 159-171, such accounting both materially misstated the value of the high-yield debt securities, and violated the GAAP principle that
60 impairments in the value of an investment must be accounted for, even when the investment is normally carried at cost.
158. Even when American Express did purport to mark its high-yield debt instruments to market, Defendants employed measures that resulted in crucial accounting errors and manipulations that resulted in overvaluation. Such high-yield debt instruments were purportedly marked to market for three reasons: (1) some amount of high-yield securities were classified as
"available for sale," and thus, according to American Express's discussions of its own accounting, were supposed to be carried at market value; (2) American Express's financial statements throughout the Class Period purported to show the difference between the carrying values of securities that were "held to maturity" and,their fair market value; and (3) beginning in
2001, American Express eliminated the "held to maturity" category entirely, and purported to value all of its investments at market.
159. Each of these attempts at market valuation was improper and rendered the
Company's financial statements materially false and misleading because:
(a) as described from personal knowledge by the Pricing Analyst in See, e.g., ¶J 99, 103-04, AEFA's methods for determining fair market value were woefully inadequate, and, in fact, on the Company's financial statements, "held" securities were mostly displayed as appreciating during the Class Period, despite deteriorating high-yield debt market conditions and higher default rates;
(b) even when a mark resulted in a determination that the value of a security had eroded, American Express improperly failed to recognize the loss, either on "held" securities or on thnse that were available for sale, thus leaving its bottom line unaffected and maintaining the illusion that AEFA 's high yield debtportfolio was worth much more than. it truly was;
(c) even a shareholder or analyst diligent enough to read every column in the balance sheets would still have been unable to determine where the high-yields were represented, because American
61 Express'sfinancial statements did not disclose that high yield securities were largely classified as "held to maturity';
(d) American Express only accounted for the "fair market value" of its "held" investments by lumping together all such investments, including investments held by operating segments other than AEFA, thus making it impossible to determine the amount of deterioration ofAEFA's investments; and
(e) American Express did not separately account for its high-yield debt sectuities, instead lumping its corporate debt securities together in one group, making it impossible to determine the amount of deterioration in the highyields alone -which facilitated their ability to knowingly and/or recklessly conceal the crumbling portfolio.
160. In fact, according to the AEF'A Pricing Analyst, the basic reason that the
accounting was changed at all, and why Defendants were finally forced to admit that their high-
yield investments were worth far less than they had been publicly reporting, was because
Defendants and AEFA finally began to monitor these securities as closely as they had
previously represented to shareholders and the investing public that they had been doing all
along. In doing so, they revealed that AEFA had been carrying "garbage securities " at cost for years.
161. In addition to portraying an overall materially false and misleading picture of the
value of American Express's investments, these methods of accounting violated a number of
specific GAAP rules, as described below.
162. Staff Accounting Bulletin No. 59 ("SAB 5 9"), Accounting]br Noncurrent
-Marketable Equity Securities, specifies that declines in the value of investments in marketable
securities caused by general market conditions or by specific information pertaining to an
industry or an individual company, "require further investigation by management." In this
regard, SAB 59 states: "[a]cting upon the premise that a write-down may be required,
management should consider all available evidence to evaluate the realizable value of its
62 investment." Therefore, in conducting its investigation, management should consider the possibility that each decline may be other than temporary and reach its determination only after consideration of all available evidence relating to the realizable value of the security.
163. SAB 59 states that the "other than temporary" standard does not mean
permanent" impairment. Unless evidence exists that the amortised cast. a[ a debt security should be realized, a write-down accounting for realized loss should be recorded. Thus, the point at which management deems the decline to no longer he temporary triggers the obligation to write-down the investment. Logically, this point may well precede any determination that an investment is permanently impaired.
164. The determination that an impairment is "other than temporary" should be based on subjective as well as objective factors, including knowledge and experience about past and current events and assumptions about future events . The following are examples of such factors:
(a) Fair value is significantly below cost and the decline is attributable to adverse conditions specifically related to the security or to specific conditions in an industry or in a geographic area;
(b) The security has been downgraded by a rating agency;
(c) The financial condition of the issuer has deteriorated;
(d) Scheduled interest payments have not been made; or
(e) The entity recorded losses from the security subsequent to the end of the reporting period.
165. Despite the persistent and ongoing negative events permeating the high-yield bond market, and continued high default rates during (and dating prior to) the Class Period, which impacted junk bonds and CDOs (including those in AEFA's high-yield debt portfolio),
American Express and AEFA improperly and fraudulently failed to write down the value of
63 these investments, therefore maintaining the appearance of a Company with financial condition, performance, and prospects all flying high. American f?xpress and the other Defendants violated
GAAP, which requires that for all securities, even those held to maturity, the company shall determine whether a decline in fair value below amortized cost is "other than temporary." If the decline in fair value is judged to be other than temporary, then the cost basis of the individual security shall be written down to fair value as a new cost basis and the amount of the write-down shall be included in earnings. In sum, it is impermissible for a Company to simply decide that it will carry an investment at cost, with an utter disregard of its market price or the rapidly deteriorating likelihood that the investment will pay out at maturity. As is provided in FASB
Statement of Concepts No. 5 ("CONS"), "[ajn expense or loss is recognized if it becomes evident that previously recognized future economic benefits of an asset have been reduced or eliminated .... "
166. As these standards demonstrate, American Express could not cure this defect simply by declaring that it would account for certain securities at cost, because GAAP requires that fair value be used when "cost" diverges significantly from the market price. In this regard, it is helpful to compare American Express's policies to those of other corporations during the same period:
AXA Financial Inc.'s December 31, 2000 10-K, filed on March 30, 2001 explained:
Fixed maturities identified as available for sale are reported at estimated fair value. Those fixed maturities which AXA Financial has both the ability and the intent to hold to maturity, are stated principally at amortized cost. The amortized cost of fixed maturities is adjusted for impairments in value deemed to be other than temporary.
Equitable Life Assurance Society ofthe United States, a subsidiary of AXA Financial Inc., on December 31, 2000 10-K, filed March 30, 2001 explained:
64 Fixed maturities identified as available for sale are reported at estimated fair value. Those fixed maturities which the Company has both the ability and the intent to hold to maturity, are stated principally at amortized cost. The amortized cost of fixed maturities is adjusted for impairments in value deemed to be other than temporary.
MetLife, Inc.'s 10 -K, for the period ending December 31, 2000 filed March 14, 2001, explained:
The Company's fixed maturity and equity securities are classified as available-for-sale and are reported at their estimated fair value. Unrealized investment gains and losses on securities are recorded as a separate component of other comprehensive income (loss), net of policyholder related amounts and deferred income taxes. The cost of fixed maturity and equity securities is adjusted for impairments in value deemed to be other than temporary. These adjustments are recorded as investment losses.
John Hancock Mutual Life Insurance Co.'s December 31, 2000 10-K, filed March 30, 2001 explained:
Bonds and mortgage-backed securities which the Company has the positive intent and ability to hold to maturity are classified as held- to-maturity and carried at amortized cost. Fixed maturity investments not classified as held-to-maturity are classified as available-for-sale and are carried at fair value. Unrealized gains and losses related to available-far-sale securities are reflected in shareholders equity, net of related amortization of deferred policy acquisition costs, amounts credited to participating pension contract holders and applicable taxes. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income. The amortized cost of fixed maturity investments is adjusted for impairments in value deemed to be other than temporary.
167. GAAP also requires that, even in the absence of a certain loss, serious probabilities of loss must be disclosed and accounrted for. 'thus, GAAP provides that an estimated loss from a contingent loss "shall be accrued by a charge to income" if:
(i) information available prior to issuance of the financial statements indicated that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial
65 statements; and {ii} the amount of the loss can be reasonably estimated. SFAS No. 5, at ¶ 8.
SFAS No. 5 also requires that financial statements disclose contingencies when it iv at least reasonably possible (e.g.. a greater than slight chance) that a loss may have been incurred. The disclosure shall indicate the nature of the contingency and shall give an estimate of the possible loss, a range of loss or state that such an estimate cannot be made.
168. In fact, the SEC considers the disclosure of loss contingencies to be so important to an informed investment decision that it promulgated Regulation S-X, which provides that disclosures in interim period financial statements may be abbreviated and need not duplicate the disclosure contained in the most recent audited financial statements, except that, "where material contingencies exist, disclosure of such matters shall be provided even though a significant change since year end may not have occurred." 17 C.F.R. § 210.10-01.
169. The Company violated GAAP by failing to specifically detail the probabilities of loss occasioned by its high-yield debt investments.
170. The Company further violated the requirements of GAAP by failing to take a provision for losses in its high-yield debt portfolio in its interim financial statements, as required by APB Opinion No. 28, ¶ 17, Interim Financial.Reporting:
The amounts of certain costs and expenses are frequently subjected to year-end adjustments even though they can be reasonably approximated at interim dates. 1. o the extent possible such adjustments should be estimated and the estimated costs and expenses assigned to interim periods so that the interim periods bear a reasonable portion of the anticipated annual amount.
171. Defendants violated GAAP by failing to write-down the Company's investments in its high-yield debt portfolio when there was a significant adverse change in the business climate surrounding said investments. During the Class Period the Defendants knew or recklessly disregarded that the -underlying assets in the portfolio were experiencing deteriorating
66 financial conditions, as exhibited by the continued record high corporate default levels. These violations of GAAP were made and concealed to mislead the investing public and portray
American Express ' s financial performance , results, condition and prospects in a materially false and misleading light.
172. Moreover , American Express ' s failure to ensure that AEFA maintained adequate controls for valuing its investments constituted a violation of § 13(b)(2) of the Exchange Act, which requires a company to "(A) make and keep books, records, and accounts, which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer; and (B) devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances that - (i) transactions are executed in accordance with manageme nt's general or specific authorization ; [and] (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with [GAA.P] ...." As described herein, American Express entirely failed to control AEFA' s accounting for its high-yield debt investments.
173. American Express also misled shareholders about the adequacy of its valuation methods, and the compliance of those methods with GAAP, in its Annual Report to Shareholders for 2000:
The management ofAmerican Express Company (the company, is responsible for the preparation andfair presentation of its Consolidated Financial Statemen is, which have been prepared in confbrmity with accounting principles generally accepted in the United States, and include amounts based on the best judgment of management. The company 's management is also responsible for the accuracy and consistency of otherfinancial information included in this anneal report.
In recognition of its responsibility for the integrity and objectivity of data in the,fnancialstatements, the company maintains a system of internal control over financia l reporting which is designed to provide reasonable, but not absolute,
67 assurance with respect to the reliability of the company's financial statements. The concept of reasonable assurance is based on the notion that the cost of the internal control system should not exceed the benefits derived.
The internal control system is founded on an ethical climate and includes: (i) an organizational structure with clearly defined lines of responsibility, policies and procedures; (ii) a Code of Conduct; and (iii) the careful selection and training of employees. Internal auditors monitor and assess the effectiveness of the internal control system and report theirfindings to management and the Board ofDirectors throughout the year. The company's independent auditors are engaged to express an opinion on the year-end financial statements and, with the coordinated support of the internal auditors. review the financial records and related data and test the internal control system over financial reporting.
The Audit Committee of the Board of Directors, which has only outside directors, meets regularly with the internal auditors, management and independent auditors to review their work and discuss the company 's financial controls and audit and reporting practices. The independent auditors and the internal auditors independently have full and free access to the Committee, without the presence of management, to discuss any matters which they feel require attention. [Emphasis added.]
174. The foregoing statements were also materially false and misleading because
Defendants knew or recklessly disregarded that the internal controls and methods used in assessing and valuing AEFA' s high-yield securities were inconsistent and severely deficient, if not nonexistent. For example, according to contemporaneous news reports , the statements of former employees, and Plaintiffs ' investigation:
(a) AEIFA knew or recklessly disregarded that its internal control policies and procedures were inadequate to analyze, monitor, and evaluate the extent of its high-yield debt exposure;
(b) AEFA knew or recklessly disregarded that its internal control policies and procedures were inadequate to analyze and capture downward trends in its high-yield debt portfolio, despite severe negative changes in economic conditions;
(c) .AEFA knew or recklessly disregarded that its valuation policies and procedures were often premised on insufficient, incomplete or skewed data about a security, almost entirely dependent on
68 brokers' or other outsiders' representations, with no internal independent valuations until very late in the Class Period, and that when a thorough and accurate internal valuation was finally performed, the result was a massive write-down and an $826 million charge announced in July of 2001; and
(d) AEFA knew or recklessly disregarded that it chose and continued to hold its investments in a manner that was contrary to its publicly slated investment philosophy, controls, policies and procedures.
175. As explained above, the value of American Express's holdings during the Class
Period, as well as the risks involved in AEFA`s strategy of investing in high-yield debt securities, depended on the movements of the high-yield bond market as well as on the specific financial information of the companies issuing the bonds, including, infer cilia, default rates.
Given the deterioration in the high-yield market during this period, American Express's failure to properly revalue AEFA's high-yield debt holdings or to develop appropriate controls, policies or procedures to examine their valuations eviscerated any hope of: (l) proper analysis and management of risk; and (2) proper valuation and accounting.
176. American lixpress's delay in taking a charge for high-yield debt investments during this period was not only devastating , but also unique. In contrast to American Express's utter disregard and fraudulent failure to record for its high-yield debt portfolio losses, other comparable companies with exposure to similar high-yield debt investments began taking charges to account for the deterioration in their high-yield debt portfolios much earlier than
American Express . For instance , according to AXA Financial Inc .' s December 31, 1999 10-K, filed on March 29, 2000:
Write-downs on fixed maturities, principally below investment grade securities, aggregated $226.5 million, $191.6 million and $15.2 million in 1999, 1998 and 1997, respectively. The increases in write-downs on fixed maturities in 1999 and 1998 were primarily attributable to rill increased level of defaults in high-yield and emerging market securities. [Emphasis added.]
69 177. Similarly, according to the Form 10-K, filed on March 29, 2000, by Equitable
Life Assurance Society of the U.S., (a subsidiary of AXA), for the period ending December 31,
1999:
Management defines problem fixed maturities as securities (i) as to which principal and/or interest payments are in default or are to be restructured pursuant to commenced negotiations or (ii) issued by a company that went into bankruptcy subsequent to the acquisition of such securities. The amortized cost of problem fixed maturities was $154.0 million (0.6% of the total amortized cost of this category) at December 31, 1999 compared to $94.9 million (0.4%) at December 31, 1998 and $31.0 million (0.1 %) at December 31, 1997. In 1999, additions to problem fixed maturities were concentrated in domestic highyield and emerging market securities and were related to an increased level of defaults in these securities during the year.
178. In contrast, American Express's Annual Report to Shareholders for the year 1999
contained a Letter to Shareholders signed by Defendants Chenault and Golub that actually
trumpeted AEFA's 'improved investment performance," an achievement that was repeated
throughout financial data incorporated by reference into its 10-K filing for that year. However,
as described above, default rates were steadily and persistently rising, and remained extremely
high during the Class Period, on the same high-yield bond investments and CDOs on which
AEFA's entire business model and achievement of its financial targets largely depended. This
rendered the Company's "investment performance," in reality, anything but successful.
179. Unable to continue this charade indefinitely, conditions forced American Express
to reveal part of its dire situation in 2000, but the Company simultaneously attempted to mitigate
the damage by lulling the markets with calming statements. Specifically, American Express
mentioned minimal "deterioration" in the high-yield debt portfolio, without providing any
meaningful and accurate quantification regarding the magnitude of the problem, its actual impact
on AEFA or American Express's financial condition or results. The Company also failed to
reveal the truth concerning American Express's and AEFA's complete lack of risk monitoring or
70 risk controls, or reliable, consistent or proper policies or procedures for the proper valuation of these investments.
180. Such statements appeared in American Express's Reports on Form 8-K, filed
April 24, 2000, July 24, 2000, and January 26, 2001, in which American Express continued to
misrepresent materially AEFA's asset quality as "strong." 'these representations were materially
false and misleading for the reasons stated in, inter cilia, ¶T 133 and 150-171, above.
181. Moreover, American Express's accounting methods, described above, had the
effect of disguising the magnitude of its high-yield tosses from shareholders. So, for instance, by
that time, despite the fact that extremely high default rates for high-yield bonds had persisted for
at least over a year, American Express's Report on Form 10-Q for the se-;ond quarter of 2000
listed only that all of the "held to maturity" investments (the classification that included high-
yields) across all of the American Express operating segments (not just AEFA, but also
American Express's other divisions), had a "cost" basis of $8.821 billion, and a fair value of
$8.766 billion, and thus under-reported total deterioration of only $55 million.
182. These statements, and the similar ones that appeared throughout American
Express's financial reports during the Class Period, were materially false and misleading
because:
(a) As Plaintiffs allege above, the financial statements and reported financial condition, including, inter alia, the Company's reported earnings and earnings growth, simply were not accurate because of AEFA's selfserving, inconsistent, inadequate, unreliable, and/or non-existent valuation methods with respect to its high-yield debt investment portfolio;
(b) American Express failed to account for the dramatically increased and persisting default rates and the volatility of the junk bond and CDO components of AEFA's holdings;
(c) Even if the valuations had been accurate, American Express's choice to report only consolidated figures without reporting figures
71 for individual segments had the effect of collapsing deteriorations in AEFA's investments with any appreciations due to American Express's other operating segments' investments, thus unfairly disguising the problems at AEFA with its high-yield debt investments, and undermining any other insubstantial disclosures as to such problems, which at best dramatically understated the issues and the problems facing AEFA and American Express, and were thus so hollow as to be practically useless; and
(d} Where market valuation resulted in a loss, American Express's treatment of such losses as "unrealized" (and continuation to carry its high-yield investments at cost) had the result of leaving its income unaffected and conveying the false impression that the loss was somehow non-existent or "temporary," rather than due at least in part to the persistent and severe collapse of the high-yield debt markets.
183. In sum, American Express and the Defendants were aware or were reckless in not being aware that, because of these haphazard, inconsistent, deficient and/or non-existent
valuation reporting methods, American Express' s minimal disclosures that the high-yield
investments had experienced some deterioration were inadequate to inform shareholders of the
true value and extent of the deterioration of AEFA's high-yield investment portfolio, and therefore, the true condition of American Express ' s reported earnings and earnings growth.
184. Amidst American Express' s reported overall income growth for the year 2000,
American Express ultimately realized a total of $123 million losses attributable to high-yield
debt investments for that year. Howvever, the $123 million figiue would be revealed to be
materially understated, as would the subsequent even larger figure of $185 million reported as
having to be written down for the first quarter of 2001.
185. Despite the $1.23 million write-down taken for losses on AEFA's high-yield
during the year 2000, American Express's 2000 Annual Report on Form 10-K stated that
corporate debt securities classified as "held to maturity" across all American Express operating
segments had actually appreciated over 2000, so that the "cost" of such securities was listed as
72 $5.304 billion, while the fair value was listed as $5.312 billion. This 2000 Form 10-K was filed with the SEC on March 30, 2001, even though only days later, on April 2, 2001, American
Express would announce a $185 million write-down (described below).
186. Barely one month later, in early May, 2001, before American Express filed its
Form l0.-Q for the first quarter of 2001, Defendants Cracchiolo and Chenault were informed that the $185 million first quarter 2001 write-down was likely just the tip of the iceberg. Then,
approximately three months later, the Company finally revealed the true scope of the
deterioration in AEFA's high-yield portfolio, in the form of a massive $826 million write-down
for the second quarter of 2001. These statements contained in the 2000 Form 10-K were materially false and misleading for the reasons stated in See, e.g., 150-171. American
Express's Report on Form 10-K for 2000 was signed by Defendants Crittenden, Golub,
Chenault, and I lenry, among others.
187. Ignoring the crashing market surrounding it, AEFA continued the charade of
profitability when, in a presentation to the financial analyst community that was filed on Form 8-
K on February 3, 2000, Defendant Hubers disregarded the precarious position of AEFA's
finances and, instead, insisted that AFFA's "diversification" of its "asset base" had "allowed
AEFA to weather market dislocations by helping to mitigate the impact on AEFA's earnings
from market volatility." In fact, precisely the opposite was true - AEFA's overinvestment in
risky highyield bonds rendered it uniquely vulnerable to market volatility.
3. During the Class Period Defendants Concealed the Extent of American Express's High -Yield Exposure
188. In American Express's Annual Report to Shareholders for 1999, a Letter to
Shareholders signed by Defendants Chenault and Golub trumpeted AEFA's "improved
investment performance," an achievement that was repeated throughout financial data
7.7 incorporated by reference into its 1 Q-IC filing for that year- In fact, as described above, default rates were steadily rising on the very investments on which AEFA's entire business model depended, thus rendering its "'investment performance " anything but successful.
189. Unable to continue the charade indefinitely, AEFA lulled the markets with calming statements during 2000. American Express mentioned minimal `deterioration" in the high-yield portfolio, without providing meaningful and accurate quantification regarding the magnitude of the problem. Such statements appeared on American Express's Reports on form
8-K filed April 24, 2000, July 24, 2000, and January 26, 2001, in which American Express continued materially to misrepresent AEFA's asset quality as "strong." These representations were materially false and misleading for the reasons stated in See, e.g., TIJ; 133, 150-171, above.
190. Moreover, American Express's accounting methods, described above, had the effect of disguising the magnitude of its high-yield losses from shareholders. So, for instance, despite very high default rates for high-yield bonds that had persisted for over a year, American
Express's Report on Form 10-Q for the second quarter of 2000, listed only that all of the "held to maturity" investments (the classification that included high-yield debt) across all of the
American Express operating segments (not just AEFA, but also American Express's other divisions), had a "cost" basis of $8.821 billion, and a fair value of $8.766 billion, and thus a disclosed total deterioration of only $55 million.
191. These statements, and the similar ones that appeared throughout American
Express's financial reports during the Class Period, were materially false and misleading because:
(a) As Plaintiffs allege herein, the numbers simply were not accurate because of AEFA's self-serving and unreliable valuation methods,
(b) American Express did not account for steadily increasing default rates and the volatility of the junk bond component of its holdings;
74 (c) Even if the valuations had been accurate, American Express's choice to report only consolidated figures without reporting figures for individual segments had the effect of collapsing the deterioration in AEFA's investments with any appreciation due to American Express's other operating segments' investments, thus disguising the problems at AEFA and the problems with the high- yields, and undermining any disclosures as to such problems; and
(d) Where market valuation resulted in a loss, American Express's treatment of such losses as "unrealized" (acid instead to continue to carry its high-yield investments at cost) had the result of leaving its income unaffected and conveying the false impression that the loss was somehow nonexistent or "temporary," rather than due at least in part, to the persistent collapse of the high-yield markets.
192. Separately, because of its deficient valuation reporting methods, American
Express's minimal disclosures that the high-yield investments had experienced some deterioration were inadequate to inform shareholders of the true value of AEFA' s portfolio and the true condition of American Express's reported earnings and earnings growth.
193. Additionally, American Express's constant reassurances to investors of the measures it had taken to analyze and control the risks associated With AEFA' s investments had the effect of portraying to shareholders that AEFA's investment in high-yield debt securities, was, in the Company's considered, informed and expert judgment, an appropriate investment strategy. These statements were false because, as alleged above, American Express knew that no such judgment had been exercised.
194. Amidst American Express's reported overall income growth for the year 2000,
American Express ultimately realized a total of $123 million in high-yield losses for the year.
However, the $123 million figure would very shortly be revealed to be materially understated.
195. In fact, despite the $123 million write-down, American Express's Report on Form ld-K for year 2000 stated that corporate debt securities classified as held to maturity across all
American Express operating segments had actually appreciated over 2000, so that the "cost" of
75 such securities was listed as $5,304 million, while the fair value was listed as $5,312 million.
This report was filed with the SEC on March 30, 2601, even though only days later, American
Express would announce a $185 million write-down (described below), and only months later, the Company would announce an $826 million write-down. These statements were materially
false and misleading for the reasons stated in, inter (ilia, ¶T 159-171. American Express's Report on I~orm 10-K for 2000 was signed by Defendants Crittenden, Golub, Chenault, and Henry, among others.
196. Due to the failure to properly account for the risks and the values of its holdings,
AEFA reported materially false and misleading quarterly income growth during 1999 and 2006.
AEFA's quarterly income statements during the Class Period, filed on Form 10-Q and issued in press releases, each reported increased revenue compared to the prior year period. For the reasons set forth earlier in, inter cilia, ¶[¶ 159- 171, each of these reports were materially false and
misleading. Serendipitously, in each quarter American Express reported approximately a 14%
increase from net income over the prior year's quarter.
197. For example , for the second quarter of 1999 , Defendants reported net income of
$646 million, as compared with net income of $578 million in the same quarter of the prior year.
American Express also reported that its "held to maturity" investments, which included most of
AEFA's high-yield holdings as well as other "held to maturity" investments carried by AEFA
and the other operating segments, had appreciated by $217 million. AEFA reported quarterly net
income of $242 million, a 14% increase from net income of $212 million in the prior year.
American Express's financial results for the second quarter of 1999, the period ending June 30,
1999, were repeated in the Company's Report on Form ld-Q filed with the SFC on or about
August 13, 1999, which was signed by Defendants Goeltz and Henry.
i6 198. On October 25, 1999. American Express issued a press release announcing its financial results for the third quarter of 1999, the period ending September 30, 1999. For the quarter, Defendants reported net income of $648 million, as compared with net income of
$574 million in the same quarter of the prior year. American Express also reported that its "held
to maturity" investments had appreciated by $137 million. AEFA reported quarterly net income of 5240 million, a 14% increase from net income of $211 million in the prior year. American
Express's financial results for the third quarter of 1999, the period ending September 30, 1999 were repeated in the Company's Report on Form 10-Q filed with the SEC on or about November
15, 1999, which was signed by Defendants Goeltz and Ilenry.
199. On January 24, 2000, American Express issued a press release announcing its
financial results for the full year 1999, the period ending December 31, 1999. For the year,
Defendants reported net income of $2.48 billion, as compared with net income of $2.14 billion in
the prior year. American Express also reported that its "'held to maturity" corporate debt
investments had depreciated by only $3 million. AEFA reported net income for the year 1999 of
$935 million, a 14% increase from net income of $818 million in the prior year. American
Express's financial results for the full year 1999, the period ending December 31, 1999, were
repeated in the Company's Report on Form 10-K filed with the SEC on or about March 27,
2000, which was signed by Defendants Goeltz, Golub, Chenault and Henry, among others.
200. On April 24, 2000, American Express issued a press release announcing its
financial results for the first quarter of 2000, the period ending March 31, 2000. For the quarter,
Defendants reported net income of $656 million, as compared with net income of $575 million in
the same quarter of the prior year. American Express also reported that its "held to maturity"
investments had depreciated by only $18 million. AEFA reported quarterly net income of $245
77 million, a 15% increase from net income of $214 million in the prior year. American Express's
financial results for the first quarter of 2000, the period ending March 31, 2000, were repeated in the Company's Report on Form 10-Q filed with the SEC on or about May 15, 2000, which was
signed by Defendants Goeltz and Henry.
20.1. On July 24, 2000, American Express issued a press release announcing its
financial results for the second quarter of 2000, the period ending June 30, 2000. for the quarter,
Defendants reported net income of $740 million, as compared with net income of S646 million in
the same quarter of the prior year. American Express also reported that its "held to maturity"
investments had depreciated by only $55 million. AEFA reported quarterly net income of
$275 million, a 14% increase from net income of $242 million in the prior year. -American
Express's financial results for the second quarter of 2000, the period ending June 30, 2000, were
repeated in the Company's Report on Form I0-Q filed with the SEC on or about August 11,
2000, which was signed by Defendants Crittenden and Henry.
202. On October 23, 2000, American Express issued a press release announcing its
financial results for the third quarter of 2000, the period ending September 30, 2000. For the
quarter, Defendants reported not income of $737 million, as compared with net income of
$648 million in the same quarter of the prior year. American Express also reported that its "held
to maturity" investments had appreciated by $10 million . AEFA reported quarterly net income
of $269 million, a 12%% increase from net income of $240 million in the prior year. American
Express's financial results for the third quarter of 2000, the period ending September 30, 2000,
were repeated in the Company ' s Report on Form 1 O-Q filed with the SEC on or about November
13, 2000, which was signed by Defendant Crittenden.
78 203. On January 22, 2001, American Express issued a press release announcing its financial results for the full year 2000, the period ending December 31, 2000. For the full year
2000, Defendants reported net income of S2.81 billion, as compared with net income of
$2.4 billion for the prior year. American Express reported that corporate debt securities classified as field to maturity had appreciated by $8 million. For the fourth quarter of 2000,
AEFA reported net income of $242 million, a 2% increase over $238 million in the prior year.
American Express's financial results for the full year 2000, the period ending December 31,
2000, were repeated in the Company's Report on Form l 0-K filed with the SEC on or about
March 30, 2001, which was signed by Defendants Crittenden, Golub, Chenault and Henry, among others.
204. As described above, each of these financial statements in, inter aliu, ¶^ 197-242,
above, was materially false and misleading and presented a false impression of the financial
health of the Company. See, e.g., ¶`[ 159-171. Because of these accounting improprieties,
Defendants caused American Express's reported financial results to violate not only their own
representations of the existence of internal controls on accounting, but also, among other things,
the following provisions of GA AP for which each Defendant is necessarily responsible:
(a) The principle that financial reporting should provide information that is useful to present and potential investors in making rational investment decisions and that information should be comprehensible to those who have a reasonable understanding of business and economic activities. (FASB Statement of Concepts No. 1, Or, 34);
(b) The principle of materiality, which provides that the omission or misstatement of an item in a financial report is material if, in light of the surrounding circumstances, the magnitude of the item is such that it is probable that the judgment of a reasonable person relying upon the report would have been changed or influenced by the inclusion or correction of the item. (FASB Statement of Concepts No. 2, ^, 132);
79 (c) The principle that financial reporting should provide information about how management of an enterprise has discharged its stewardship responsibility to owners (stockholders) for the use of enterprise resources entrusted to it. To the extent that management offers securities of the enterprise to the public, it voluntarily accepts wider responsibilities for accountability to prospective investors and to the public in general. (t- ASB Statement of Concepts No. 1, ¶ 50);
(d) The principle that financial reporting should provide information about an enterprise's financial performance during a period. Investors and creditors often use information about the past to help in assessing the prospects of an enterprise. Thus, although in-vestment and credit decisions reflect investors' expectations about future enterprise performance, those expectations are commonly based at least partly on evaluations of past enterprise performance. (FASB Statement of Concepts No. 1, ¶ 42);
(e) The principle that financial reporting should be reliable in that it represents what it purports to represent. The notion that information should be reliable as well as relevant is central to accounting. (FASB Statement of Concepts No. 2, TO 58-59);
(t) The principle of completeness, which means that nothing is left out of the information that may be necessary to ensure that it validly represents underlying events and conditions. (FASB Statement of Concepts No. 2, ¶ 80);
(g) The principle that conservatism be used as a prudent reaction to uncertainty to try to ensure that uncertainties and risks inherent in business situations are adequately considered. The best way to avoid injury to investors is to try to ensure that what is reported represents what it purports to represent. (FASB Statement of Concepts No. 2, IT 95, 97); and
(h) The principle that contingencies that might result in gains are not reflected in accounts since to do so might be to recognize revenue prior to its realization and that care should be used to avoid misleading investors regarding the likelihood of realization of gain contingencies . (SFAS No. 5, Accoun [ingfor Contingencies).
205. In addition, Defendants falsely failed to disclose the existence of known trends, events or uncertainties that they reasonably expected would have a material unfavorable impact on its operating results or that were reasonably likely to result in the Company's liquidity
8o decreasing in a material way, in violation of Item 303 of Regulation S-K under the federal securities laws (17 C.F.R. 229.303).
206. These failures rendered the Company's Class Period financial statements and
Forms 10-K and 10-Q materially false and misleading.
4. Defendants Persist in Materially Misrepresenting the Facts Even as They Are Forced to.Belatedly Divulge Portions of American Express's High-Yield Debt Debacle
207. On February 7, 2001, Defendant Chenault and Al Kelly, President of American
Express's U.S. Consumer and Small Business Services, delivered presentations concerning
American Express to the financial analyst community. Those presentations were filed on Form
8-K with the SEC on February 8, 2001. Although Defendant Chenault acknowledged in that presentation that AEFA had some issues with its high-yield investments, particularly in the
fourth quarter of 2000, Chenault reassured investors that AEFA's exposure had diminished because "we have significantly scaled back our activity" in "structured investments, such as
collateralized debt obligations." This statement falsely implied (if not expressly stated) that
American Express had substantially reduced its exposure to CDOs when, in fact, AEFA
remained substantially exposed to such investments, as would be revealed to investors when
$403 million worth of CDOs alone was written off in July 2001.
208. During that February 7, 2001 presentation, Defendant Chenault further reassured
American Express investors. analysts and the investing public that the Company had a handle on
any future losses with respect to AEFA's high-yield debt portfolio, through careful, constant and
close scrutiny of these investnm.ents, their performance and risks, stating that:
(a) the Company had "planned for a range of economic conditions" and that continued "[p}otential deterioration in the high-3yield portfolio" at AE1~A "does not represent a problem with our fundamental husiness mode[ "
81 (b) "[c]losely linked to our earnings expectations for 2001 are the priorities I have i dentified for the company. ...1w/e will closely monitor ourfinancial results so that resources can be appropriately reallocated."
(c) '-[o]ur operations people, and specifically our risk management staff, are among the best in the business. They axe highly skilled and experienced, and have continually improved our processes over the years."
(d) "[b]ecause of our breadth, there are a number of business levers we can pull and adjust as the year progresses and circumstances change. ... Investment spending in one business can be reprioritized to counter weakness in another ... while our geographic scope allows us to reallocate resources on a timely basis when certain markets slow, or others improve ... In addition to having levers to pull, we have also implemented, as I mentioned, a monitoring process that guides us on when to pull them. Our diversity provides flexibility. Andflexibility is the single most important attribute for a company as economic cycles change.
(e) "[i]n terms of AEFA overall, the fundamental business model is sound. The model provides us with a number of significant advantages relative to our peers , and we believe it continues to position us tivell for future growth in the long-term."
(f] "[s]ine we hold our investments, we recognize losses based on impairment analyses, which we evaluate on an ongoing basis."
[Emphasis added.]
209. At approximately this time, Chenault himself ordered a "very hard look," at
AEFA's high-yield portfolio in early 2001. which specifically included the same higher-risk
CDO investments that he reported to analysts on February 7. 2001 that AEFA had supposedly
"significantly scaled back" on. Moreover, just a few weeks later, in late February, 2001,
Cbenault was advised by Defendant Crittenden of the "huge alarm ringing," which was set off by
AEFA CFO Sedlacek's email to Crittenden warning that AFEA's high-yield portfolio was
"deteriorating rapidly."
82 210. After American Express had reported another write-down of $185 million for the first quarter of 2001 associated with its high-yield debt investments, but had not yet filed its
Form 10-Q for that quarterly period with the SEC, Defendant Chenault was informed by
Defendant Cracchiolo in early May, 2001 (again, acting on a written message from Mr.
Sedlacek) that the $185 million, and other amounts in prior losses already booked by American
Express due to deterioration of its high-yield investments, was likely an understatement of the true extent of the problem. Moreover, Chenault vas informed that much of the additional deterioration was attributable to CDO investments, the very type of structured investments
Chenault represented during the presentation in February 2001 had been "significantly scaled buck." As a result of the subsequent comprehensive internal Company review and analysis of the deterioration of its CDO investments, it was ultimately determined and fully revealed in July 2001, that well over $400 million in losses were attributable to the deterioration in these CDO investments alone.
211. In the same February 7, 2001 presentation, Chenault further characterized as
"soand" AEFA's "fundamental business model." These statements were materially false and misleading because AEFA's business model, as set forth above, contrary to the Company's public representations, had no effective controls, policies or procedures to monitor or assess risk or to accurately value its high-yield debt investments on an ongoing basis.
212. These "sound business model" statements were also materially false and misleading because, as the former financial advisor explained, AEFA's business model with respect to IDS Life was explicitly premised on the dramatic under-pricing of insurance products so as to gain a competitive pricing advantage over competitors while snaking up the difference with high (and artificially inflated) returns on junk bonds, CDOs and "toxic waste" investment.
83 However, AEFA was not analyzing ancb"or monitoring the risks of these investments as represented, and the value of which AEFA and American Express were dramatically over- estimating.
213. According to a former AEF'A Vice President , Defendant Huhers, who had participated in, engineered and sanctioned this strategy, reported directly to Chenault. Thus, apart from Chenault's own representations to shareholders that he was familiar with AEFA's strategies, Chenault was also familiar with AEFA's reckless and haphazard practices by virtue of reports from Defendant Huhers.
214. Defendant Chenault also misled investors when he stated that American Express had 'accepted" that the high-yield investments brought greater returns at greater risk, thus falsely implying that American Express had rationally considered the benefits of such exposure and had made a careful investment decision. In fact, the opposite was true because, as explained herein,
American Express had failed to implement any reliable risk management or monitoring controls, policies, practices or procedures, much less those that it represented were in place.
215. Chenault also made material misrepresentations and omissions when he indicated
to American Express investors that the Company actually understood and appreciated its high-
yield debt investments because its "risk management staff [was] among the best in the business.
They are highly skilled and experienced, and have continually improved our processes over the
years." This statement was materially false and misleading because:
(a) according to former AFFA employees with personal knowledge and as alleged herein, American Express had failed to implement the risk management controls, policies or procedures it had represented with respect to AEFA;
b) no proper risk management team existed at the time that Chenault made the statement; indeed, American Express only performed any kind of thorough monitoring or analysis of the performance and risk of its high-yield portfolio very late in the Class Period, well
84 into the year 2001 at the earliest, and no real "risk management team" was created until after the massive July 2001 write-downs were revealed. See e.g., ¶y!j 249-250; and
(c) Chenault later attempted to backtrack from his earlier statement by claiming that it was now apparent" that American Express's "analysis of the portfolio at the end of the first quarter did not fully comprehend" certain risks with respect to AEFA's high-yield debt investments. .this admission in fact was indicative of American Express's failure to `fully comprehend," monitor or analyze the risks associated with these investments throughout the Class Period, and flew in the face of the Company's public representations indicating that it was thoroughly and actively monitoring said risks.
216. Chenault's attestation as to the strength of American Express's risk management team was additionally misleading because it fraudulently induced the market to believe that
AEFA had made, and was continuing to make, careful and considered valuations of its CDOs and junk bond holdings, and investment decisions, based on similarly careful and considered analyses of the risks presented, even though this was anything but the case. See, e.g., T,209-
217. On or about March 30, 2001, American Express filed its Report on Form 10-K for
2000. Just days after the l0-K was filed, and less than two months after Chenault represented that AEFA had "significantly scaled back" its riskier holdings, American Express announced that it would be taking an additional write-down of $185 million for high-yield losses in the first quarter of 2001 9
218. On April 2, 2001, American Express issued a press release announcing that its earnings for the first quarter of 2001, the period ending March 3 1, 2001, would decline 1891'0 from the same period in the prior year. As described in the press release, the loss was attributed to "pre-tax losses of about $185 million from the write-down and sale of certain high-yield
9 Although the press release and oral statements referred to a $185 million loss, the Company's Report on Form l. 0-Q for the first quarter 2001 quantified the loss at $182 million.
85 securities hold in the investment portfolio of its subsidiary, American Express Financial Advisors
(AEFA). " The press release further stated that:
The high-yield debt portfolio deteriorated in the latter part of 2000 and write -downs in the fourth quarter of last year totaled $49 million (pre-tax).
AEFA's high-yield investments are expected to be approximately $3.5 billion at quarter end, or about 11 percent of its total portfolio. Total losses on these investments for the remainder of2001 are expected to be substantially lower than in thefirst quarter.
[Emphasis added.]
219. This was not the last time the Company would attempt to soothe the market with a falsely optimistic statement about the storm having passed. The looming massive $185 million write-down for a single quarter, exceeding losses taken for the entire prior year of 2000, resulted in an 80% decline in earnings for AEFA. Finally, American Express rescinded its earlier projection that it would meet earnings targets for 2001. Incredibly, however, Defendants continued thereafter to understate the extent of the damage by falsely assuring the investing public that "[t]otal losses on these investments for the remainder of 2001 are expected to be substantially lower than in the first quarter." This statement was materially false and misleading for numerous reasons:
(a) according to the former AEFA financial advisor, at the time of these bold and affrnnative representations, AEFA had not "significantly scaled back" its activity with respect to structured investments, such as CDOs, as the circumstances and internal conversations with Company employees also soon revealed, and as the eventual $826 million second quarter write-down would soon reveal;
(b) according to the former AEFA Financial Advisor, A.1;FA was aware that the portfolio was still highly unbalanced and overvalued at that time due to junk bonds and risky CDOs;
86 (c) by this time, the Company had adopted an accounting change (motivated in part by awareness that AEFA's high-yields had been materially overvalued) requiring high-yields to be marked to market, thus necessitating a closer examination of the market value of high-yield securities that had previously been carried at cost, and which had never been closely scrutinized before in terms of ongoing risk assessment or accurate valuation, despite the Company's representations to the contrary;
(d) there was no significant change in the high-yield bond market between April 2001 and the ultimate write-down of $926 million in July 2001, thus demonstrating that the final write-down was not due to sudden changes between April and July 2001; and
(e) Chenault and the other Defendants knew by at least May 2001, before American Express filed its first quarter 2001 Form 10-Q, or were certainly reckless in not being aware, that the $185 million write-down being reported for the first quarter 2001 materially understated the amount by which the value of AEFA's high-yield portfolio had in fact deteriorated during the first quarter of 2001. Thus, Defendants were aware that they had no reasonable basis upon which to continue to make this representation.
220. The April 2001 write-down, even though it materially under-reported the true damaged condition of AEFA's high-yield portfolio, shocked investors , analysts, and the market, as they had been under the impression that American Express had completed its high-yield bond write-downs at the end of 2000. News of the write-down resulted in a 3.8% drop in American
Express's share price by the market's close on April 2, 2001, representing a staggering loss of more than $2 billion in market capitalization.10 Moreover, the Company's stock price fell from a closing price of $41.30 per share on Friday, March 30, 2001, to $37.95 per share when the market next opened on Monday, April 2 and then went up to $39.71 per share by the time of the
April 2 market close. On the next day, Tuesday, April 3, 2001, as the news of the write-down
(which was in conflict with the 10-K filed only one business day earlier) reverberated across the
10 According to analysts, the drop would have been even steeper but for a simultaneous rumor of an upcoming merger between American Express and Citigroup.
87 market, the Company's stock price continued to fall to a closing price of $37.99 per share. On
Wednesday, April 4, 2001, the Company's share price closed at $36.20.
221. In sum, the Company's common stock price plunged $5.10 per share, or an astounding 12.3 %, for total market capitalization losses of approximately $6.7 billion, over the three days froze April 2 (when news of the $185 million write down was publicly released) to
April 4, 2001, from the March 30, 2001 closing price of $41.30 per share down to close at
$36.20 on April 4.
222. Again, although conditions had forced American Express to partially reveal the truth, the Defendants continued in conference calls the day of the announced write-down on
April 2, 2001 to materially mislead investors. Defendants did their best to assuage the market with even more false assurances that the situation was now in hand and that the worst of the storm was over, and they could see clear skies ahead.
223. For example, during a conference call on April 2, 2001, Defendant Cracchiolo promised that, after the $185 million loss, "'we are constantly reviewing this portfolio" and that
"we will be managing it very closely as we move forward." Cracchiolo further explained that
American Express "put significant amount of the exposure behind us," and that "we expect [] total losses on these investments for the remainder of 2001... to be substantially lower than [the
$18 5 million] in the first quarter ...."
224. During this April 2, 2001. conference call, Defendant Cracchiolo also attempted to
conceal the fact that large unreported losses had been amassing at AEFA over the past two years
by implying that the bulk of the problem had originated in the first quarter of 2001. For instance,
Cracchiolo explained that the write-down had been necessary in part because of "asbestos
problems and fallen angels that were in the better graded areas that came about rather quickly,"
88 thus falsely implying that American Express had been on top of the situation and that the problem was a new and unexpected one.
225. In another conference call on April 2, 2001, Defendant Cracchiolo repeated the earlier misrepresentation by Defendant Chenault that AEFA had significantly shed its risky structured investment holdings. During the same call, Crittenden repeated the false statement that after the April 2001 write-downs, "we've gotten substantially most of this issue taken care of in the first quarter and that the losses we will see in the remaining quarters of the year should be less."
226. Cracchiolo's statements were false and misleading as alleged in, inter alga,
¶T 221-224, above, because:
(a) as Defendants knew or recklessly disregarded, by that time, AEFA's losses were far greater, and AEFA remained heavily exposed to CDOs and had not "significantly scaled back" in these types of investments;
(b) the deterioration in value that had necessitated the write-down had actually occurred much earlier, after the high-yield bond markets collapsed in late 1999 and default rates remained at historically high levels;
(c) Cracchiolo would later be reported in the St. Paul Pioneer Press on July 28, 2001, to have admitted that AEFA's high-yield debt problems existed at least as far back as the third quarter of 2000, rather than, as represented in April 2001, having originated due to unexpected defaults in the first quarter of 2001; and
(d) Cracchiolo knew or recklessly disregarded that AEF'A had not been following the publicly represented risk analysis and control procedures.
227. Defendant Chcnault later explained that .AEV'A had earlier misrepresented the
risk/value of its portfolio when he stated in July 2001 that "our analysis of the portfolio . . . did
not fully comprehend the risks that underline these structured investments during a period of
persistently high de fault rates."
89 228, On April 23, 2001, American Express issued a press release announcing its financial results for the period ending March 31, 2001. For the first quarter of 2001, Defendants reported net income of $538 million, as compared with net income of $656 million in the same quarter of the prior year. American Express's Financial results for the first quarter of 2001, the period ending March 31, 2001, were repeated in the Company's Report on Form 10-Q -fled with the SEC on nr about May 15, 2001, which was signed by Defendant Crittenden.
229. By falsely assuring the market that the bulk of the problems had been disclosed,
Defendants continued to recklessly and materially misstate and overvalue AFTA's holdings.
Nevertheless, Defendants maintained the facade that the issues with AEFA's high-yield debt portfolio had largely been resolved, misrepresenting the financial condition, prospects and performance of American Express and AEFA and artificially inflating American Express's stock price, even as Defendants were aware of facts and circumstances that strongly indicated otherwise, and also discovered additional information that directly contradicted these public misrepresentations.
230. On April 23, 2001, American Express issued a press release announcing its
financial results for the period ending March 31, 2001. For the first quarter at2001, Defendants
reported net income of $538 million, as compared with net income of $656 million in the same
quarter of the prior year. American Express's financial results for the first quarter of2001, the
period ending March 31, 2001, were repeated in the Company's Report on Form 10-Q,
referenced above in 11227, filed with the SEC. on or about May 15, 2001, and signed by
Defendant Crittenden. The Form 10-Q stated that 'itJotal losses on these investments for the
remainder of 2001 are expected to be substantially lower than in the first quarter" when, as
90 explained below , the Company and the other Defendants had no basis for making this representation because at that time they were aware of contradictory information.
231. Specifically , in early May, 20 01, before American Express had filed its Form
10-Q with the SEC for the first quarter of 2001, Defendant Crittenden received a fax from
AEFA's CF[) advising him that American Express was facing additional losses on its high-yield debt investments beyond those already honked. Defendant Chenault was specifically advised of this situation a day later, during a visit to AEFA's Minneapolis headquarters, and was informed that the deterioration of the high-yield debt portfolio was so had that even the investment grade
CDOs held by American Express were likely damaged, due to the fact that defaults in underlying
bonds had increased so sharply.
232. As a result, the Company brought in former.American Express Treasurer Walter
Berman, who had rejoined the Company, and Senior Risk Management Vice President David
Y owan, working with a team of in-house American Express analysts, to assess the damage.
233. However, this represented the first time American Express or AEFA had
performed a comprehensive internal valuation of these high-yield CDO investments. Previously,
they had largely relied on outside parties such as CDO managers to evaluate those instruments.
Messrs. Berman and Yowan estimated a necessary $400 million in additional necessary write-
do,v s, a figure that understated the real picture by another $426 million.
234. Incredibly, however, despite the fact that Defendants Chenault and Cracehiolo
had been expressly informed in early May 2001 that the $185 million first quarter write-down
did not reflect the true magnitude of the deterioration of AEFA's high-yield debt portfolio,
American Express nevertheless included the following statement in its first quarter 2001 Form
Ia-Q filed on May 15, 2001: "Total losses on these [highyield] investments for the remainder
91 of 2001 are expected to be substantially lower than in the first quarter (of 20011. " Defendants failed to correct or qualify this statement over the next two months, leaving investors in the dark until American Express shocked the market in mid-July 2001 with an $826 million write-down of AEFA's high-yield debt investments.
1). The Full Truth is Finally Revealed
235. The Class Period ends on July 17, 2001. The next morning, on July 18, before trading began, American Express revealed information that finally' fully alerted investors that they were being mislead throughout the Class Period. Thus, up until this point, investors had been mislead to believe, among other things, that American Express had a great team of risk professionals who were among the "best in the business" who were closely scrutinizing the health and performance of American Express's and AEFA's high-yield debt investments, that
AEFA had "significantly scaled back" its activity with respect to highly risky structured investments such as CDCs; and that the majority of the losses from AEFA's high-yield debt
investments had already been absorbed and disclosed to investors. In fact, none of this was true.
236. American Express issued a press release on July 18, 2001 announcing its earnings
for the second quarter of 2001, the period ending June 30, 2001. The Company reported that
earnings for the quarter would most likely decline 76% from the same period of the prior year, in
part, because of an $826 million pre-tax charge to recognize 'additional write-downs in the high-
yield debt portfolio at [AEFA] and losses associated with rebalancing the portfolio towards
lower-risk securities.""
11 According to UBS Warburg's John McDonald, the Company's earriings per share would have been $0.53, if not for the $826 million write-down, instead of $0.13 for the second quarter 2001.
92 237. The $826 million write-down was more than faun times the size of the write- down for the first quarter, and almost seven times the size of the write-down taken for all of
2000. According to the Company's statements, of the $826 million, almost halfof the losses
($403 million) were tied to the very structured investments (including CDOs) in which, as far back as February, the Company and Chenault had claimed it had "significantly scaled hack"
An additional $344 million represented sales and write-downs of directly held junk bonds, or
"lower rated securities [sold] to reduce the level of [AEF'A's] high-yield portfolio." With respect to this $344 million portion, the Company added: "[a]dditional securities within the remaining high-yield portfolio will be sold to allocate holdings towards stronger credits and reduce the concentration of exposure to individual companies and industry sectors." The remaining
$79 million of the $826 million charge was allegedly attributable to "write down the value of certain other investments to recognize losses during the second quarter."
238. According to the Pricing Analyst who worked in AEFA headquarters during the
Class Period, the problems with AEFA's high-yield debt investments, many of which were accounted for at cost, mandated an accounting change in 2001 that required all investments to be carried at fair value. It was this revaluation, in turn, that was responsible for much of the belated write-down. Despite this accounting change dating from the beginning of 2001, Defendants still failed to disclose the size of the deterioration of AEFA's high-yield debt portfolio until more than half-way through the year.
239. Coupled with the write-downs in the first quarter, American Express's total write- downs for high-yield bonds in the first half of 2001 represented nearly one tenth of the
Company's total book value.
93 240. In a conference call following the July 18, 2001 announcement, Chenault announced that the Company would now be scaling back high-yield debt investments to approximately 7%.12 With regard to the large charge to earnings, Defendant Chenault admitted:
We took on securities that didn 't have the appropriate balance for us between risk and reward. [The Company is now looking for] -better quality, less volatile securities. [Enm.phasis added.]
241. Incredibly, Chenault made these statements despite: (1) ordering a "very hard look" at AEFA's entire high-yield debt portfolio in early 2001, at least in part to assess the risk exposure it presented to AEFA and American Express; (2) representing to investors that
American Express had "significantly scaled back [its] activity" in "structured investments, such as collateralized debt obligations"; and (3) stating repeatedly to investors, even after being directly confronted with information that indicated otherwise, that losses on high-yield debt investments for the remainder of 2001 were expected to be "substantially lower than in the first quarter" of 2001.
242. Moreover, Chenault's admission in 239 exposes the falsehood of American
Express's repeated representations during the Class Period that AEFA was investing in long-term and intermediate-term fixed income securities to "provide their clients with a competitive rate of return on their investments while "minimizing risk" or "controlling risk." Rather, Chenault essentially confessed that AEFA, and, by extension, the Company, were not acting at all adequately to "monitor," "minimize," or "control" risk, as the Company repeatedly represented throughout the Class Period, but rather were engaged in speculative and risky high-yield debt
12 As noted by UBS Warburg's John McDonald, "[w]ith [the 5182 million and $R6 million] writedowns and early sales, high-yield instruments now account for 7% of AEFA's investment portfolio, down from 11% at the end of the first quarter and 13% at the end 2000. This action bring AEFA's investment portfolio closer to its peer average of 5%-6%."
94 investing with lax, if any, oversight in an attempt to maintain consistent earnings growth for
American Express.
243. On July 23, 2001, American Express issued a press release announcing its financial results for the second quarter of 2001. The Company reported a drop in net income from the prior year of 76%, and a drop in AEFA' s net revenue of 85%.
244. In its Form 10-K for 2001, American Express reported that AEFA's net income
for the entire year was down 95% from the prior year, and that the high-yield debt losses alone were responsible for an 87% loss of income from the prior year.
Analyst, Rating Agency and Business Press Reactions to American Express's High-yield Debt Debacle: A "Serious Credibility Problem"
245. Reacting to the July 18, 2001 announcement, credit rating agency Fitch lowered
its ratings on American Express and certain of its subsidiaries.
246. According to the Wall Street Journal on July 19, 2001, the w7rite-down came as a
"particularly nasty surprise for investors because the company took a similar pretax charge of
182 million three months ago, and said then that the move would avoid potentially bigger losses
down the road."
247. Although Chenault consistently attributed the additional write-downs to American
Express's somehow misunderstanding the "risk" and "reward" of the instruments in which it had
invested, rfinancial analysts questioned how American Express could not have known the risks or
have misunderstood those investments as it claimed to have done. For instance, David Hamilton
of the well-respected Moody's Investors Service observed:
Something as simple as taking a look at the credit ratings would have saved them from devastating losses. .. Those bonds had low single-B ratings ... They were risky corning out of the gate.
248. Joel Houck, an analyst at A.G. Edwards Inc., noted:
95 What I find very alarming about the whole thing is Chenault's comment that they didn't understand what they were doing. That's the business they're in. [Emphasis added.]
249. First Union Securities Analyst Meredith Whitney correctly summed up the
Company's entire situation: `[T]his story is one of massive transition and questioned credibility.'' [Emphasis added]. Another analyst, Peggy Cagan of Zurich IC Squared, recognized American Express's credibility problems as essentially market-wide: "Analysts are concerned that American Express is currently experiencing a serious credibility problem."
E. The Aftershocks: Shareholders Pay For Defendants' Fraud A Second Time, Departures at the Company, and American Express Finally Takes Steps to Monitor, Manage and Control the Risks Associated with its High-yield Debt
250. Shortly after announcing its disastrous results for the second quarter of 2001, the
CFO of AEFA, Stuart Sedlacek, abruptly left the company. His departure followed that of Peter
Anderson, former chief investment officer of AEFA, who had departed in May 2001. In
Sedlacek's place, American Express announced on August 2S, 2001 that it had hired Steve Lobo
as Vice President of Investment Risk Management. The press release stated:
In his new role, Lobo will be responsible for overall management of American Express Financial Advisors' risk management function, including risk management policies and procedures. He will also oversee AEFA's investment risk monitoring process and recommend investment strategies. Lobo will be an integral member of American Express Company's overall risk management team that assesses activities across the company.
251. The Annual Report to Shareholders for 2001, incorporated by reference into the
Company's Report on Form 10-K for 2001 , also announced the creation of an actual risk
management strategy and committee, which replaced the non-existent strategy and team that had
prevailed during the Class Period, and prior to the over $1 billion in high-yield debt investment
write - downs. The new strategy purported to vest centralized oversight authority in an American
Express Corporate Risk Management Committee (CMRC):
96 In the second half of 2001, the company established the [CRI 1C] to supplement the risk management capabilities resident within its business segments by routinely reviewing key market, credit and other risk concentrations across the company and recommending corrective action where appropriate. The CRMC promotes a rigorous understanding of risks across the company and supports senior management in making risk-return decisions.
252. The irony of this new attempt to centralize risk assessment and management oversight is that this was a responsibility that American Express and AEFA had ostensibly undertaken, but intentionally or, at the very least recklessly, failed miserably to fulfill, even prior to the announcement of the high-yield debt investment portfolio meltdown in the second quarter of 2001. For instance, the Company's 2000 Annual Report on Form 1 d-K represented:
[American Express] Management establishes and oversees implementation ofBoard-approved policies covering the company's funding, investments and use of derivative financial instruments and monitors aggregate risk exposures on an ongoing basis . The company's objective is to realize returns commensurate with the level of risk assumed while achieving consistent earnings growth. The company 's treasury department is responsible for overseeing the individual business segments' management of'their respective exposures within the context of Board-approved policies. [Emphasis added.]
253. In part, it was the Defendants' complete and utter failure to live up to these earlier representations with respect to AEFA's high-yield debt portfolio, which caused the Company to dramatically overstate the value of that portfolio. and, in turn, American Express's own financial condition and performance during the Class Period, until the full truth finally came out in July of
2001.
254. Finally, in ,American Express's Report on Form id-K for 2001, the Company disclosed that even after the write-down, it had placed a majority of its CDOs hacked by high- yield bonds, with a combined book value of $905 million . into a securitization trust that was sold for $120 million cash, and retained an interest with a book value of .5785 million. This
97 transaction would have allowed American Express to avoid writing-down any further impairment it might have determined were necessary for the individual CDOs. American
Express's third quarter Report on form 10-Q for 2001 explained that the transaction "allow[s] recognition of the investment return related to the overall performance of the portfolio. The ability to evaluate future cash flows at the portfolio level, rather than on a security-by- security basis, should increase the predictability of future performance."
255. This statement also suggests the unfortunate truth about AEFA's, and by extension American Express's, high-yield debt portfolio during the Class Period: name] y that before these volatile investments were packaged in this "protective" vehicle, and certainly without any thorough or consistent monitoring, analysis, oversight or understanding of the investments, neither the Company nor its subsidiary effectively had no ability to evaluate the risks, performance or value of the investments in the portfolio on a consistent or reliable basis.
F. Summary of Defendants' False and Misleading Statements During The Class Period
1. Defendants' Risk Controls and Strategy Regarding AEFA
256. During the Class Period, Defendants portrayed that AEFA had adopted policies
for risk management and adhered to certain risk management policies adopted by American
Express's Board. Specifically. Defendants represented to shareholders that:
(a) AEF'A's investment analysis and strategies conformed with "Board approved" policies of American Express regarding risk management (See, e.g., ¶¶ 106, 126-29);
(b) AEFA invested in "fixed income securities" in order to "minimize" and "control " risk and provide a "dependable" margin (See, e.g., 'T 126-29);
(c) AEFA "regularly review[ed]" models regarding the projected profitability of its investments (See, e.g., `^4j 126-29);
98 (d) AEFA's diversified investments protected it against market downturns (See, e.g., 11187);
(e) American Express had made a rational, considered decision to invest in high-yield debt securities, despite the risks, because it had reasonably determined that the likely benefits outweighed those risks (See, e.g.. 1213); and
(1) American Express had a capable, attentive risk management staff (ranking among the `best in the business") focused on the high- yield debt investments (See, e.g., ¶ 214).
257. These statements were materially false and misleading because, as set forth in more detail at See, e.g., ¶' 91-107, AEFA's high yield investment strategy and high yield debt portfolio was characterized by an absence of any significant or consistent risk control or monitoring policies or procedures. The absence of such controls was even admitted by Chenault, when he explained that as of the first quarter of 2001, "[O]ur analysis of the portfolio at the end of the first quarter [of 20011 did not fully comprehend the risks that underline these structured investments during a period of persistently high default rates." Indeed, this admission is also clearly indicated by other facts and circumstances described above, including, inter alga, the fact that Chenault decided to closely examine AEFA's high-yield debt portfolio in early 2001, and that there was apparently no substantial in-house assessment of American Express's CDO investments until May or June of 2001. See, e.g. ¶¶ 100-141.
258. The absence of any such risk controls was further demonstrated by American
Express's creation of a new centralized risk management committee in the wake of the write- downs, to assume duties that were already supposed to have been, and were represented as being, performed by American Express and AEFA See, e.g. `^I 249-52.
259. Defendants' misrepresentations were materially misleading because they
encouraged shareholders to rely on Defendants' judgment in evaluating, choosing, and monitoring high-yield debt investments, when in fact such judgment was not exercised.
99 2. American Express ' s Financial Statements Concerning the Valuation of AEFA's High-yield Debt Holdings and Compliance with GAAP
260. Defendants' failure to properly account for AEFA's mounting investment losses violated GAAP and materially misled shareholders. Specifically, Defendants' financial statements, filed with the SEC:
(a) employed haphazard procedures and methods in valuing AEFA.'s holdings (See, e.g., =j^ 91-104), and in some cases employed no valuation procedures or methods at all (See, e.g., ¶¶ 103-104);
(b) failed to update the values of some of AEFA's investments, over periods of months and sometimes even years (See, e.g. ¶T 100- 103);
(c) failed to recognize and take into account during the Class Period losses to income incurred as a result of necessary re-valuations of AEFA's holdings (See, e.g., CT 155-59, 165, 177-82); and
(d) falsely represented the existence of internal controls on American Express's reporting procedures (See, e.g., ¶ 173).
261. These errors violated the GA AP requirements that financial statements reflect the true value of the company, and that impairments in the value of investments be recognized. As a result of these errors, the value of AEFA's investments was materially overstated during the
Class Period.
3. Defendants ' Characterization of Developments in 2001
262. Once it became clear that AEFA's high-yield debt investments had exploded into huge liabilities for the Company, Defendants began to merely trickle out information about the severity of the situation and its impact on American Express. However, even then, Defendants persisted in minimizing the amount of damage to AEFA's portfolio with a series of misleading
"damage control" statements designed to reassure the market. For example, beginning in
February 2001 and continuing through the end of the Class Period, when American Express took
100 its unprecedented $826 million write-down in July of 2001, Defendants, either individually or through Company statements, made the following material misrepresentations:
(a) AEFA had significantly reduced its exposure to structured investments and CDOs (See, e.g., ¶ 207);
(b') AE A's fundamental business model was "sound," even though that model depended on risky, high-yield debt investments that Defendants would later admit had caused staggering losses (See, e.g., ¶ 212);
(c) that further large write-downs following the charge for the first quarter of 2001 would be unnecessary, a statement that was repeated in American Express's first quarter 2001 SEC filing even after Defendants became aware of information indicating that this would most likely not be the case (See, e, g, % 218-220, 224, 226);
(e) that the write-downs in the first quarter of 2001 were the result of failures in the bond market in that particular quarter, rather than a result of persistent deterioration in AEFA's holdings due to market conditions and extraordinarily high default rates stretching back well over a year, and as far back as 1999 (See, e.g., ¶ 225); and
(t) that it expressly recognized a "deterioration in the high-yield bond sector on directly owned bonds and low grades in other structured investments" in the fall of 2000, when it filed its third quarter 2000 Form 10-Q with the SEC on November 13, 2000. (See, e.1-., j 34)
263. As a result of these statements, American Express attempted to, and did, minimize the impact of its prior partial disclosures regarding high-yield debt losses. Thus, the Company misled the market into believing that the relatively smaller losses were non-recurring aberrations and immaterial impairments to AEFA's investment portfolio, rather than alerting shareholders to the fact that the disclosures of losses due to AEFA's high-yield debt investments up until that point were, in fact, only the tip of the iceberg.
101 VIL APPLICABILITY OF PRESUMPTION OF RELIANCE- FRAUD-ON-THE-MARKET DOCTRINE
264. The market for American Express's common stock was open, well-developed and efficient at all relevant times. As a result of the materially false and misleading statements and failures to disclose, detailed herein, Americzui Express's common stock traded at artificially inflated prices during the Class Period. Plaintiffs and other members of the Class purchased or otherwise acquired American Express common stock relying upon the integrity of the market price of American Express's securities and market information relating to American Express, and have been damaged thereby.
265. During the Class Period, Defendants materially misled the investing public, thereby artificially inflating the price of American Express's common stock, by publicly issuing false and misleading statements and omitting to disclose material facts necessary to make
Defendants' statements, as set forth herein, not false and misleading. Said statements and omissions were materially false and misleading in that they failed to disclose material adverse information and misrepresented the truth about the Company, its business and operations, as alleged herein.
266. Plaintiffs will rely upon the presumption of reliance established by the fraud-on- the-market doctrine. The market for American Express common stock was, at all times during the Cass Period, an efficient market for the following reasons, among others:
(a) American Express common stock traded on the NYSE, which is a highly efficient and automated market. The average weekly trading volume throughout the Class Period was approximately $27.8 million shares;
(b) As a regulated issuer, American Express filed periodic public reports with the SEC and the NYSE;
(e) American Express was followed by various analysts employed by major brokerage firms, including A.G. Edwards, Inc., First Union
102 Securities, and UBS Warburg, among others, who wrote reports, which were distributed to the sales force and certain customers of their respective 'brokerage firms. Each of these reports was publicly available and entered the public marketplace;
(d) American Express regularly communicated with public investors via established market communication mechanisms, including through regular disseminations of publicly available press releases, which were released into the market, on the national circuits of major newswire services and through other wide-ranging public disclosures, such as communications with the financial press and other similar reporting services; and
(e) The market price of American Express common stock reacted efficiently to new information entering the market.
267. As a result of the foregoing, the market for American Express's common stock promptly digested current information regarding American Express from all publicly available sources and reflected such information in American Express's stock price. Under these circumstances, all purchasers of American Express's common stock during the Class Period
suffered similar injury through their purchase of American Express's common stock at artificially inflated prices and as a result of Defendants' conduct alleged herein, and a presumption of reliance applies.
VIII. LOSS CAUSATION
268. At all relevant times, the material misrepresentations and omissions particularized
in this Complaint, and the ultimate disclosures thereof, directly or proximately caused or were a
substantial contributing cause of the damages sustained by Plaintiffs and other members of the
Class.
269. As described herein, during the Class Period. Defendants made or caused to be
made a series of materially false or misleading statements about American Express's financial,
investment and business condition, results, prospects and operations. These material
103 misstatements and omissions had the cause and effect of creating in the market an unrealistically positive assessment of American Express and its financial, investment and business condition, results, prospects and operations, thus causing the Company's common stock to be overvalued and artificially inflated at all relevant times. Defendants' materially false and misleading statements during the Class Period were widely disseminated to the securities markets, investment analysts and to the investing public, and resulted in Plaintiffs and other members of the Class purchasing the Company's common stock at artificially inflated prices.
270. Moreover, upon the revelation to the market and the investing public of the truth concerning the failure of American Express to implement or utilize internal controls, policies or procedures to monitor the risks, health, performance. and value of AEFA's high-yield debt investments, and the failure to implement or utilize any procedures or methods to accurately value said investments, and failure to inform investors concerning the true extent of the
Company's exposure to its high-yield debt portfolio and investment strategy, the market price of
American Express's common stock declined substantially, resulting in the decline of the value of the investments of the Plaintiffs and other Class members.
271. Had the truth about American Express and AEFA been revealed to the market earlier, including the facts that Defendants: (i) knowingly or recklessly misrepresented the nature and extent of their control, polices, practices and procedures for monitoring and analyzing the health, risk and performance of AEFA's high-yield debt investments; (ii) knowingly or recklessly grossly overstated the value and condition of AEFA's high-yield debt portfolio,
Plaintiffs and the Class would not have purchased American Express common stock or would have purchased the stock only at dramatically lower prices; (iii) knowingly or recklessly
concealed from investors the true extent of the Company exposure with respect to AEFA's high-
104 yield debt portfolio; and (iv) knowingly or recklessly concealed from investors the true nature and extent of the risks associated with the Company's and AEFA's high-yield debt investment strategy.
272. On March 29, 2001, the day before the Company filed its Form 10-K for the year
2000, the Company's stock price closed at $38.96 per share, on trading volume of approximately
5.6 million shares.
273. On March 30, 2001, the Company filed its Form 10-K for the year 2000, which stated, among other things, that corporate debt securities classified as "held to maturity" across
all American Express operating segments had actually appreciated over 2000, so that the "cost" of such securities was listed as $5.304 billion, while the fair value was listed as $5.312 billion.
Based on this filing, the Company's stock price opened at $41.75 on March 30, 2001 and closed
at $41.30. Trading volume on that day was over 1.35 million shares.
274. On April 2, 2001, American Express issued a press release partially revealing the
problems with AEFA's high-yield debt investments by disclosing the need for a write-down of
approximately $185 million for the first quarter of 2001. As a result, the stock price fell from a
closing price of $41.30 per share on Friday, March 30, 2001, to $37.95 per share when the
market next opened on Monday, April 2, and then to went up to $39.71 per share by the time of
the April 2, 2001, market close. On the next day, Tuesday, April 3, 2001, as the news of the
write-down. (which was in conflict with the 10-K filed only one business day earlier)
reverberated across the market, the Company's stock price continued to fall to a closing price of
$37.99 per share. On Wednesday, April 4, 2001, the Company's share price closed at $36.20. In
sum, the Company's common stock price plunged 55.10 per share, or 12.3%, over the three days
105 from April 2 (when news of the $185 million write down was publicly released) to April 4, 2001, from the March 30, 2001 closing price of $41.30 per share down to close at $36.20 on April 4.
275. When the truth about American Express was finally fully revealed on July 18,
2001, the artificial inflation that had been caused by Defendants' false and misleading statements
(and omissions) was eliminated from the price of American Express's common stock, causing significant losses to Plaintiffs and the Class. Specifically, on July 18, 2001, when the market learned the true extent of the severe devaluation of AFPA's high-yield debt portfolio, American
Express's common stock price fell from a closing price of $38.78 per share, on trading volume of approximately 3.9 million shares, to $37.50 per share, a drop of 3.3%, on almost double the prior day's volume, or 7.5 million shares.
276. Moreover, the drops in American Express's common stock price listed in paragraphs `yj^ 269-276 above, and the resulting losses suffered by Plaintiffs and the Class, are directly attributable to the market' s reaction to the disclosure of information that had previously been misrepresented or concealed by Defendants, and to the market's adjustment of American
Express's stock price to reflect the newly emerging truth regarding the value and condition of
AEFA's high-yield debt investments.
277. In sum, from the end of 2000 through July 18, 2001, American Express stock dropped by nearly 32%, or $17.44, from a closing price of $54. 94 on December 29, 2000, to a close of $37.50 on July 18, 2001 . This 32% decline, and the resulting losses suffered by
Plaintiffs and the Class are directly attributable to the market's reaction to the leakage and
disclosure of information that had previously been misrepresented or concealed by Defendants,
and to the market's adjustment of American Express's stock price, the price of which had still
106 been inflated until the end of the Class Period, to reflect the newly emerging truth regarding the value and condition of AEFA's high-yield debt investments.
278. Defendants' conduct, as alleged herein, proximately caused foreseeable losses to
Plaintiffs and the other members of the Class.
IX. ADDITIONAL ALLEGATIONS OF SCIE NTER
279. Throughout the Class Period, Defendants, through improper valuations, violated relatively simple GAAP rules and also ran afoul of American. Express's own stated policy of following GAAP principles. In doing so, Defendants knowingly or recklessly disregarded that the losses from its high risk investments should have been realized much earlier.
280. In addition to Defendants' failure to comply with GAAP, the staggering magnitude of the belated \,xite-downs (over $ 1 billion dollars) and pervasiveness and repetitiveness of these violations (which continued throughout the Class Period) as well as the
fact that such GAAP violations concerned a major part of American Express's business, further
demonstrates that Defendants acted intentionally, or at least recklessly.
281. Furthermore, Defendant Hubers' bonus was calculated and based directly upon
AEFA's returns on its investments, including the high-yield debt investments at issue here.
282. According to a AFFA Vice President, Defendant Hubers, who sanctioned and
engineered AEFA's high-yield debt investment strategy, reported directly to Defendant
Chenault. Thus Chenault was made aware of AEFA's practice of increasing its earnings through
its accounting for high-yield investments.
283. Moreover, because of their executive and managerial positions with American
Express, each of the Individual Defendants had access to the material adverse non-public
information about the investment strategy of AEFA and its lack of procedures for managing risk
107 and valuing its holdings. Such access to, and awareness of, AEFA's lack of internal controls is further evidenced by the Company's Reports on Form 10-K for 1999 and 2000. Both reports state that American Express has adopted "Board-approved" policies for risk management that guide the internal controls of the various subsidiaries, and both reports warrant that management exercises control over the internal accounting .for American Express.
284. Moreover, Defendants Huher and Cracchiolo, in their roles as President and Chief
Executive of AEFA, were personally responsible for the implementation of American Express's risk management policies with respect to AEFA, and thus were fully aware that no such policies had been put into effect.
285. Defendants had a duty to promptly disseminate accurate and truthful information with respect to AEFYs investments and financial condition, or to cause and direct that such information be disseminated. Asa result of their failure to do so, the price of American Express shares was artificially inflated during the Class Period, damaging Plaintiffs and the Class.
286. All of the Defendants had motives to pursue a fraudulent scheme in furtherance of
their common goal, i. e., inflating the reported profits of American Express and the trading price
of American Express shares by making false and misleading statements and concealing material
adverse information. The fraudulent scheme and course of business was designed to and did:
(i) deceive the investing public, including Plaintiffs and other Class members; (ii) artificially
inflate the price of American Express shares during the Class Period; (iii) cause Plaintiffs and
other members of the Class to purchase American Express shares at artificially inflated prices;
and (iv) conceal and cover tip the Individual Defendants' fraudulent scheme.
287. Defendants also had a motive to artificially inflate the price of American
Express's stock because Defendant Golub's incentive payments were tied to American Express's
108 financial performance , and it was Defendant Golub who pressured American Express segments to drastically increase earnings . Only after the "transition" and Defendant Golub ' s retirement did American Express recognize its high-yield losses. Due to such belated recognition ofjunk bond losses, American Express management had a `-down year" in 2001 for incentive compensation.
288. Defendants also demonstrated severe recklessness in their dealings with AEFA.
Because AEFA's revenues were based on the underlying values of its investments, any report of its revenues required a valuation of those investments. Without such valuations, or with valuations conducted with an irrational optimism with respect to the prospects of those investments, Defendants' revenue reports were unreliable and recklessly made. Defendants were further reckless in falsely representing the existence of risk management protocols and internal controls over valuation procedures.
289. Defendants repeatedly and baselessly assured investors during the first four months of 2001 that the problems had largely been accounted for and the junk bonds cleared
from their books. Such misrepresentations demonstrated further instances of Defendants' refusal to properly value AEFA's holdings.
290. Defendants promised, both in their 2000 Annual Report to Shareholders and in
their statements in April, 2001, that they would carefully monitor AEFA's investment portfolio.
Defendants further presented to shareholders in their 1998, 1999, and 2000 Reports on Form 10-
K that they had policies in place to manage investment risk appropriately . Given Defendants'
false representations that the write-downs in the first quarter of 2001 represented the bulk of their
high-yield losses, either no such monitoring occurred or, alternatively, the nionitoring was
grossly inadequate to the task.
109 291. Additionally, several of the Individual Defendants personally represented to the public that they had knowledge of AEFA's investment strategies and processes for valuing its holdings, and thus admitted awareness of the facts alleged herein. For instance, Defendants
Chenault, Cracchioio, Hubers, and Crittenden all presented analysts with information about
AEFA's finances purported to be personally known to them.
292. Moreover, based on information provided by a former Vice President, Defendant
Hubers personally engineered AEFA's strategy of generating earnings through increased high- yield investments; thus, Defendant Hubers was aware of and responsible for AEFA's false reports of earnings.
293. According to this former Vice President, Defendant Hubers, who sanctioned and engineered AEFA's high-yield debt investment strategy, reported directly to Defendant
Chenault. Thus, Chenault was made aware of AEFA's practice of increasing its earnings through its accounting for high-yield investments.
294. As alleged herein, Defendants acted with scienter in that Defendants knew or recklessly disregarded that the public documents and statements issued or disseminated in the name of the Company were materially false and misleading; knew or recklessly disregarded that such statements or documents would be issued or disseminated to the investing public; and knowingly and substantially participated or acquiesced in the issuance or dissemination of such statements or documents as primary violations of the federal securities laws. As set forth elsewhere herein in detail, Defendants, by virtue of their receipt of information reflecting the true facts regarding American Express, their control over, and/or receipt and/or modification of
American Express's allegedly materially misleading misstatements and/or their associations with
110 the Company, which made them privy to confidential proprietary information concerning
American Express, participated in the fraudulent scheme alleged herein.
X. NO SAFE HARBOR
295. The statutory safe harbor provided for forward-looking statements under certain circumstances does not apply to any of the allegedly false statements pleaded in this Complaint.
Many of the specific statements pleaded herein were not forward looking, but were instead false representations of the current value of American Express's holdings and false representations of
American Express's internal risk management policies. Additionally, many of the statements were included in documents that were claimed to have been prepared in accordance with GAAP, thus excluding them from the safe harbor. To the extent there were any forward-looting statements, any cautions provided to investors were inadequate to warn of the precarious state of
American Express's investment portfolio. Moreover, Defendants are liable for those false forward-looking statements because at the time each of those forward-looking statements was made, the particular speaker knew that the particular forward-looking statement was false, and/or the forward-looking statement was authorized and/or approved by an executive officer of
American Express who knew that those statements were false when made.
COUNT I
Violation Of Section 10(b) Of The Exchange Act Against And Rule lOb-5 Promulgated Thereunder Against All Defendants
296. Plaintiffs repeat and reallege each and every allegation contained above as if fully
set forth herein.
297. During the Class Period, Defendants carried out a plan, scheme and course of
conduct which was intended to and, during the Class Period, did: (i) deceive the investing public,
Ill including Plaintiffs and other Class members, as alleged herein; and (ii) cause Plaintiffs and other members of the Class to purchase American Express's common stock at artificially inflated prices. In furtherance of this unlawful scheme, plan and course of conduct, Defendants, and each of them, took the actions set forth herein,
298. Specifically, Defendants: (u) employed devices, schemes, and artifices to defraud; (b) made untrue statements of material fact and/or omitted to state material facts necessary to make the statements not misleading; and (c) engaged in acts, practices, and a course of business which operated as a fraud and deceit upon the purchasers of the Company's common stock in an effort to maintain artificially high market prices for American Express's common stock in violation of Section 10(b) of the .Exchange Act and Rule lOb-5. All Defendants are sued either as primary participants in the wrongful and illegal conduct charged herein or as controlling persons as alleged below.
299. Defendants, individually and in concert, directly and indirectly, by the use, means or instrumentalities of interstate commerce and/or of the mails, engaged and participated in a continuous course of conduct to conceal adverse material information about the business, operations and future prospects of American Express as specified herein.
300. These Defendants employed devices, schemes and artifices to defraud, while in possession of material adverse non-public information and engaged in acts, practices, and a course of conduct as alleged herein in an effort to assure investors of American Express's value and performance and continued substantial growth, which included the making of, or the participation in the making of, untrue statements of material facts and omitting to state material
facts necessary in order to make the statements made about American Express and its business operations and future prospects in the light of the circumstances under which they were made,
112 not misleading, as set forth more particularly herein, and engaged in transactions, practices and a course of business which operated as a fraud and deceit upon the purchasers of American
Express common stock during the Class Period.
301. Each of the Individual Defendants' primary liability, and controlling person liability, arises From the following facts: (1) the Individual Defendants were high-level executives and/or directors at the Company during the Class Period and members of the
Company's management team or had control thereof; (ii) each of these Defendants, by virtue of his responsibilities and activities as a senior officer and/or director of the Company was privy to and participated in the creation, development and reporting of the Company's internal budgets, plans, projections and/or reports; (iii) each of these Defendants enjoyed significant personal contact and familiarity with the other Defendants, and other Company insiders, and was advised of, and had access to, other members of the Company's management team, internal reports and other data and information about the Company's finances, operations, and sales at all relevant times; (iv) each of these Defendants was aware of the Company's dissemination ofinformation to the investing public which they knew or recklessly disregarded was materially false and misleading; and (v) each of the Individual Defendants either signed the materially misleading statements or personally made materially misleading statements to the public.
302. The Defendants had actual knowledge of the misrepresentations and omissions of material facts set forth herein, or acted with reckless disregard for the truth in that they failed to ascertain and to disclose such facts, even though such facts were available to them. Such
Defendants' material misrepresentations and/or omissions were done knowingly or recklessly and for the purpose and effect of concealing American Express's operating condition and future business prospects from the investing public and supporting the artificially inflated price of its
113 common stock. As demonstrated by Defendants' overstatements and misstatements of the
Company's business, investments, operations and earnings during the Class Period, Defendants, if they did not have actual knowledge of the misrepresentations and omissions alleged, were reckless in failing to obtain such knowledge by deliberately refraining from taking those steps necessary to discover whether those statements were false or misleading.
303. As a result of the dissemination of the materially false and misleading information and failure to disclose material facts, as set forth above, the market price of American Express's common stock was artificially inflated during the Class Period. In ignorance of the fact that market prices of American Express's publicly-traded common stock were artificially inflated, aid relying directly or indirectly on the false and misleading statements made by Defendants, or upon the integrity of the market in which the common stock trade, and/or on the absence of material adverse information that was known to or recklessly disregarded by Defendants but not disclosed in public statements by Defendants during the Class Period, Plaintiffs and the other members of the Class acquired American Express common stock during the Class Period at artificially high prices and were damaged thereby.
304. At the time of said misrepresentations and omissions, Plaintiffs and other members of the Class were ignorant of their falsity, and believed them to he true. Had Plaintiffs and the other members of the Class and the marketplace known the truth regarding the problems that American Express was experiencing, which were not disclosed by Defendants, Plaintiffs and other members of the Class would not have purchased or otherwise acquired their American
Express common stock, or, if they had acquired such securities during the Class Period, they would not have done so at the artificially inflated prices which they paid.
114 305. By virtue of the foregoing, Defendants have violated Section 10(b) of the
Exchange Act, and Rule lOb-5 promulgated thereunder.
306. As a direct and proximate result of Defendants' wrong [hi conduct, Plaintiffs and the other members of the Class suffered damages in connection with their respective purchases and sales of the Company's common stock during the Class Period.
COUNT 11
Violation Of Section 20(a) Of The Exchange Act Against the Individual Defendants
307. Plaintiffs repeat and reallege each and every allegation contained above as if fully set forth herein.
308. The Individual Defendants acted as controlling persons of American Express within the meaning of Section 20(a) of the Exchange Act as alleged herein. By virtue of their high-level positions, and their participation in and/or awareness of the Company's operations and/or intimate knowledge of the false financial statements filed by the Company with the SEC
and disseminated to the investing public, the Individual Defendants had the power to influence
and control and did influence and control, directly or indirectly, the decision-making of the
Company, including the content and dissemination of the various statements which Plaintiffs
contend are false and misleading. The Individual Defendants, because of their positions with
American Express, controlled the contents of quarterly and annual reports, press releases and
presentations to securities analysts. Each Individual Defendant either signed documents alleged
herein to have been misleading, or personally made public statements alleged to have been
misleading. Each Individual Defendant was provided with copies of the reports and press
releases alleged herein to be misleading prior to or shortly after their issuance, and had the ability
and opportunity to prevent their issuance or cause them to be corrected. Because of their
115 positions and access to material nonpublic information available to them, each of these
Defendants recklessly disregarded that the true value of AEFA' s holdings , and the effect such losses would have on American Express, had not been disclosed to, and were being concealed from, the public and that the positive representations that were being made were false and misleading.
309. In particular, each of these Individual Defendants had direct and supervisory involvement in the day-to-day operations of the Company and, therefore, is presumed to have had the power to control or influence the particular transactions and statements giving rise to the securities violations as alleged herein, and exercised the same.
310. As set forth above, Americ an Express and the Individual Defendants each violated Section 10(b) and Rule lOb-5 by their acts and omissions as alleged in this Complaint.
By virtue of their positions as controlling persons, the Individual Defendants arc liable pursuant to Section 20(a) of the Exchange Act. As a direct and proximate result of Defendants' wrongful conduct, Plaintiffs and other members of the Class suffered damages in connection with their purchases of the Company's common stock during the Class Period.
Xx. CLAIMS FOR RELIEF
WHEREFORE. Plaintiffs pray for relief and judgment, as follows:
(a) Declaring this action to be a class action pursuant to Rule 23(a) and (b)(3)
of the Federal Rules of Civil Procedure on behalf of the Class defined herein;
(h) Awarding compensatory damages in favor of Plaintiffs and the other Class
members against all Defendants, jointly and severally, for all damages sustained as a result of
Defendants' wrongdoing, in an amount to be proven at trial, including interest thereon;
116 (c) Awarding Plaintiffs and the Class prejudgment and postjudgment interest, as well as their reasonable costs, fees and expenses incurred in this action, including counsel fees and expert fees; and
(d) Such other and further relief as the Court may deem just and proper.
XII. JURY TRIAL DEMANDED
Plaintiffs hereby demand a trial by jury.
Dated: New York, New York MILBERG WEISS & BERSHAD LLP January 11, 2007
Sanford P . Dumain (SD-8712) Kent A. Bronson (KB-4906) Joshua Keller (JK-4882) One Pennsylvania Plaza New York, NY 10119 Tel: (212) 594-5300 Fax: (21 2) 868-1229
LOVELL STEWART HALEBIAN LLP ; '- Christ pher Lovell CL-2595) Imtiaz Siddiqui (13-4090) 500 Fifth Avenue . New York. NY 10110 Tel: (212) 609-1900 'Fax: (212) 719-4677
Co-Lead Counselfor Plain tiffs
117 Of Counsel:
Lawrence Soicher LAW OFFICES OF LAWRENCE SOICHER 110 East 59th Street, 25th Floor New York, NY 10022 Tel (212) 883-8000 Fax (212) 355-6900
Laurence Paskowitz PASKOWITZ & ASSOCIATES 271 Madison Avenue New York, NY 10016 Tel (212) 685-0969
Joseph V. McBride RABIN & PECKEL LLP 275 Madison Avenue, Suite 420 New York, New Yo'k 10016 Tel (212) 880-3722 Fax (212) 980-3716
Mel E. Lifshitz (ML-2616) Gregory M. Egleslon (GE-1932) Robert J. Berg (RB-8542) BERNSTEIN LIEBHARD & 1.TFSHITZ, LLP 10 East 401h Street New York, NY 10016 Tel (212) 779-1414
Mark S. Henzel LAW OFFICES OF MARC S. HENZEL 273 Montgomery Avenue, Suite 202 Bala Cynwyd, PA 19004 Tel (610) 660-8000
Joseph H. Weiss (JW-4534) Jack I. Zwick (.T7.-2514) WEISS & LURIE 551 Fifth Avenue, Suite 1600 New York, NY 10176 (212) 682-3025
118 Jules Brody (JB-91 5 1) Aaron Brody (Af3-5850) Tzivia Brady (TB-7268) STULL, STULL & BRODY 6 East 45th Street New York, NY 10017 (212) 687-7230
Peter D. Bull (P13-9118) Joshua M. Lifshitz (3L-9172) BULL & LIFSHITz, LLP 1 S East 4 1st Street New York, NY 10017 Tel (212) 213-6222 Fax (212) 213-9405
Robert 1. 1 Iarwood (RH-3286) Jeffrey M. Norton (3N-482.7) WECHSLER HARWOOD LLP 488 Madison Avenue, 8th Floor New York. NY 10022 Tel (212) 935-7400 Fax (212) 753-3630
Patrick A. Klingman SCHATZ NOBEL IZARD, P.C. One Corporate Center 20 Church Street Hartford, CT 06103 Tel (860) 493-6292
119 CERTIFICATE OF SERVICE
I, Joshua Keller, hereby certify that a true and correct copy of the CONSOLIDATED
SECOND AMENDED CLASS ACTION COMPLAINT was served by hand delivery on the following counsel of record on January 11, 2007:
Robert E. Zimel, Esq. Skadden, Arps, Slate, Meagher & Flom LLP Four Times Square New York, NY 10036
Dated: January 11, 2007 New York, New York
Joshua Keller