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Wednesday, May 29, 2024 | Back issues
Courthouse News Service Courthouse News Service

MGIC Dodges Claims of Misleading Investors

CHICAGO (CN) - Finding no evidence of fraud, the 7th Circuit tossed claims that a mortgage insurance company inflated its share price through false and misleading statements.

Though the price of its securities fell substantially, MGIC was one of a small number of private mortgage insurance companies to survive the economic turmoil caused by subprime mortgage prices.

"Precisely because it survived a steep fall in the price of its securities, MGIC is an attractive target for litigation," Chief Judge Frank Easterbrook wrote for the federal appeals court.

Four class actions against MGIC under the Securities Exchange Act were consolidated in the Eastern District of Wisconsin. The shareholders say MGIC fraudulently concealed the financial peril of one of its businesses in a quarterly earnings report on July 19, 2007.

The Credit-Based Asset Servicing and Securitization LL, or C-BASS for short, was a securitization business in which MGIC owned a 46 percent interest. Another insurer called Radian Group owned a separate 46 percent of shares, and the remaining 8 percent belonged to C-BASS managers.

C-BASS bought and packaged single-family residential-mortgage loans, most of which were subprime, using borrowed money. The packages provided security for the loans, but creditors were allegedly protected from losses through a contractual right to make margin calls. Lenders could thus demand that C-BASS either repay the loans or provide additional collateral to boost the ratio of the collateral's value to the outstanding balance.

When the packages' value became apparent, lenders began making margin calls. C-BASS made most payments from its cash reserves, which totaled $300 million at the beginning of 2007. By July 19, the company told investors that it just $150 million remained in those reserves. The report claimed that $150 million was "substantial liquidity" for its operations.

Within two weeks of the July 19 update, C-BASS received an additional $470 million in margin calls through internally generated cash and additional investments from MGIC and Radian.

But MGIC stopped pumping cash into C-BASS on July 23, declaring the investment "materially impaired" and essentially writing it off as a loss.

The shareholders say MGIC should have seen the loss coming, and the July 19 report was materially misleading.

A federal judge dismissed the consolidated complaint, however, and the 7th Circuit affirmed last week.

"The District Court wrote (and we concur) that the 'substantial liquidity' statement was true, both absolutely ($150 million is a lot of money) and relative to the needs of C-BASS's business," Easterbrook wrote (parentheses in original).

"Since C-BASS had depleted reserves by only $150 million in meeting 6 ½ months of margin calls, managers could say that the remaining $150 million was 'substantial' liquidity without demonstrating bad intent," he added.

Easterbrook also pointed out that the July 19 announcement included warnings about the potential instability of the company.

MGIC's report said: "Our income from joint ventures could be adversely affected by credit loses, insufficient liquidity or competition affecting those businesses."

Easterbrook noted that "the goal of this paragraph was to let investors know about the trouble without painting too gloomy a picture. A balancing act of that nature cannot sensibly be described as fraud."

MGIC's continued contributions to C-BASS after the July 19 announcement further weaken the fraud case.

"If it had seen the cliff, it would have stopped contributing capital to C-BASS before July 23, when it turned off the spigot," Easterbrook wrote. "Until then MGIC thought that C-BASS was going to pull through and backed that belief with cash, as did Radian Group."

MGIC had once valued C-BASS at $516 million.

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