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