In re AMTRUST FINANCIAL SERVICES, INC. SECURITIES LITIGATION

REPLY MEMORANDUM OF LAW in Support re: 147 MOTION to Dismiss the Consolidated Second Amended Complaint. . Document

S.D.N.Y.January 23, 2019

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK IN RE AMTRUST FINANCIAL SERVICES, INC. SECURITIES LITIGATION C.A. No. 1:17-cv-01545-(LAK) REPLY BRIEF IN FURTHER SUPPORT OF AMTRUST’S, THE OFFICER DEFENDANTS’, AND THE DIRECTOR DEFENDANTS’ MOTION TO DISMISS GIBSON, DUNN & CRUTCHER LLP 200 Park Avenue New York, New York 10166-0193 Tel: (212) 351-2662 Fax: (212) 351-6362 Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 1 of 16 i TABLE OF CONTENTS Page INTRODUCTION .......................................................................................................................... 1 ARGUMENT .................................................................................................................................. 1 A. Plaintiffs’ Section 11 & 12(a)(2) Claims (Counts I & II) Should Be Dismissed ............ 1 B. Plaintiffs’ 10(b) Claim (Count IV) Should Be Dismissed. ............................................. 5 CONCLUSION ............................................................................................................................. 10 Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 2 of 16 ii TABLE OF AUTHORITIES Page(s) Cases Acito v. IMCERA Grp., Inc., 47 F.3d 47 (2d Cir. 1995) ..........................................................................................................6 City of Brockton Ret. Sys. v. Shaw Grp. Inc., 540 F. Supp. 2d 464 (S.D.N.Y. 2008) ........................................................................................6 In re CPI Card Group Inc. Securities Litigation, 2017 WL 4941597 (S.D.N.Y. Oct. 30, 2017) ............................................................................9 Dobina v. Weatherford Int’l, Ltd., 909 F. Supp. 2d 228 (S.D.N.Y. 2012) ........................................................................................6 In re DRDGOLD Ltd. Securities Litigation, 472 F. Supp. 2d 562 (S.D.N.Y. 2007) ........................................................................................3 Fait v. Regions Fin. Corp., 712 F. Supp. 2d 117 (S.D.N.Y. 2010), aff’d, 655 F.3d 105 (2d Cir. 2011) ...........................2, 4 Fresno County Employees’ Retirement Association v. comScore, Inc., 2017 WL 3261609 (S.D.N.Y. July 28, 2017) ............................................................................2 Freudenberg v. E*Trade Financial Corp., 712 F. Supp. 2d 171 (S.D.N.Y. 2010) ........................................................................................7 Garber v. Legg Mason, Inc., 347 F. App’x 665 (2d Cir. 2009) ...............................................................................................5 Glaser v. The9, Ltd., 772 F. Supp. 2d 573 (S.D.N.Y. 2011) ........................................................................................7 Hall v. The Children’s Place Retail Stores, Inc., 580 F. Supp. 2d 212 (S.D.N.Y. 2008) ......................................................................................10 Harris v. AmTrust Fin. Servs., Inc., 135 F. Supp. 3d 155 (S.D.N.Y. 2015) ........................................................................................8 Kalnit v. Eichler, 264 F.3d 131 (2d Cir. 2001).......................................................................................................7 Kalnit v. Eichler, 85 F. Supp. 2d 232 (S.D.N.Y. 1999) ........................................................................................10 Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 3 of 16 iii In re Kidder Peabody Sec. Litig., 10 F. Supp. 2d 398 (S.D.N.Y. 1998) ..........................................................................................7 Koplyay v. Cirrus Logic, Inc., 2013 WL 6233908 (S.D.N.Y. Dec. 2, 2013) .............................................................................7 Kuriakose v. Federal Home Loan Mortgage Corp., 897 F. Supp. 2d 168 (S.D.N.Y. 2012) ........................................................................................4 In re LaBranche Sec. Litig., 405 F. Supp. 2d 333 (S.D.N.Y. 2005) ........................................................................................7 In re Lehman Bros. Sec. & ERISA Litig., 2013 WL 5730020 (S.D.N.Y. Oct. 22, 2013) ..........................................................................10 In re Lehman Bros. Sec. & ERISA Litig., 799 F. Supp. 2d 258 (S.D.N.Y. 2011) ........................................................................................3 Litwin v. Blackstone Grp., L.P., 634 F.3d 706 (2d Cir. 2011).......................................................................................................5 In re Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347 (2d Cir. 2010).......................................................................................................3 In re Petrobras Sec. Litig., 116 F. Supp. 3d 368 (S.D.N.Y. 2015) ........................................................................................3 In re Petrobras Securities Litigation, 2016 WL 1533553 (S.D.N.Y. Feb. 19, 2016) ........................................................................3, 4 Ret. Sys. v. Lockheed Martin Corp., 875 F. Supp. 2d 359 (S.D.N.Y. 2012) ......................................................................................10 Rothman v. Gregor, 220 F.3d 81 (2d Cir. 2000).........................................................................................................6 In re Sanofi Securities Litigation, 155 F. Supp. 3d 386 (S.D.N.Y. 2016) ........................................................................................9 In re Silvercorp Metals, Inc. Securities Litigation, 26 F. Supp. 3d 266 (S.D.N.Y. 2014) ..........................................................................................6 Special Situations Fund III QP, L.P. v. Deloitte Touche Tohmatsu CPA, Ltd., 33 F. Supp. 3d 401 (S.D.N.Y. 2014) ........................................................................................10 Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 127 S. Ct. 2499 (2007) ........................................................................................5 Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 4 of 16 iv In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628 (S.D.N.Y. 2004) ........................................................................................3 Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 5 of 16 AmTrust, the Officer Defendants, and the Director Defendants (all capitalized terms herein as defined in Dkt. 148 (“Br.”)), submit this reply brief in further support of their motion to dismiss. INTRODUCTION AmTrust at all times made accounting judgments it believed were appropriate regarding two complex, subjective issues—the timing of warranty revenue recognition and discretionary bo- nus accrual—and the results of these judgments are non-actionable statements of opinion under Omnicare. Throughout their opposition brief (“Opp.”), Plaintiffs blithely ignore the reason AmTrust changed its accounting treatment of those issues, which resulted in its restatement of certain financial statements: it switched from the world’s fifth-largest accounting firm to a new, “Big 4” auditor, and its new auditor had a different approach to those specific, judgment-based accounting issues. Despite the absence of any factual support in the SAC, Plaintiffs speculate that Defendants were engaged in a years-long fraud that led them to knowingly misstate and inflate AmTrust’s financial results. But the most plausible inference from the facts alleged in the SAC, including that AmTrust received unqualified audit opinions for each of the years at issue and dis- closed the key accounting policies at issue in its SEC filings, is just the opposite. The claims should be dismissed. ARGUMENT A. Plaintiffs’ Section 11 & 12(a)(2) Claims (Counts I & II) Should Be Dismissed 1. The Two Accounting Changes Driving The Restatement Are Non-Actionable Statements Of Opinion Rooted In Accounting Judgments. AmTrust did not assert that “every financial metric” in a company’s financial statements is an opinion, contra Opp. 21, but rather that, under governing accounting guidelines, the two specific timing issues driving the Restatement here constitute subjective accounting judgments that qualify as opinions under Omnicare, see Br. 13-18. Tellingly, Plaintiffs fail to address the cited Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 6 of 16 2 accounting guidance at all. Although Plaintiffs concede that some financial metrics “do constitute opinion” statements under Omnicare and the law of this Circuit, Opp. 22-23, they attempt to cabin that concession to cases involving “estimates of future performance” (as opposed to “historical income metrics”), see id., but provide no support for such a bright-line distinction under Omnicare. Indeed, contrary to their unsupported theory, Plaintiffs acknowledge that this Court’s decision in Fait, affirmed by the Second Circuit, found that “representations of goodwill, which ‘reflected judgments as to values that were not objectively determinable’”—there, so-called historical met- rics—reflected opinions. Opp. 23 (quoting Fait v. Regions Fin. Corp., 712 F. Supp. 2d 117, 123 (S.D.N.Y. 2010), aff’d, 655 F.3d 105 (2d Cir. 2011)); see also Dkt. 118, at 34 (conceding at oral argument “that there are items in a financial statement that require subjective judgment”). Simi- larly, under the unrebutted accounting guidance, application of the two primary accounting deter- minations at issue here requires subjective judgments by management, including estimates and assessments of the probability of future occurrences. Br. 14-18.1 Plaintiffs’ cases do not suggest otherwise. For instance, in Fresno County Employees’ Retirement Ass’n v. comScore, Inc., 2017 WL 3261609 (S.D.N.Y. July 28, 2017), unlike here, the defendant expressly “admitted to wrongdoing” and tied its restatement to evidence of intentional misconduct. Id. at *3-4, *10-11 (misconduct was “primary driver behind the restatement”). That is what separated comScore from cases involving “complex accounting judgments over which rea- 1 In announcing the Restatement, AmTrust expressly discussed its “application” of relevant accounting guidance. SAC ¶¶ 112, 114. It matters not that AmTrust also included the words “error” and “incorrect” to describe the Restate- ment, see Opp. 22 (describing the use of the word “error” as “especially telling”), as it goes without saying that one can hold an erroneous or incorrect opinion. In other words, the mere existence of the Restatement, and AmTrust’s reference to “errors,” does not support Plaintiffs’ argument that the misstatements were factual. See also Dkt. 118, at 8, 48. Indeed, AmTrust explained that the “errors” were “based on management’s interpretation of accounting guid- ance related to multiple-element revenue recognition.” Ex. 11 (8-K (Feb. 27, 2017) at 8. Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 7 of 16 3 sonable minds can differ.” Id. at *11; see id. at *12 (distinguishing case involving incorrect appli- cation of accounting methodologies, as such misapplication “raised issues of subjective opinion”). In re Petrobras Securities Litigation, 2016 WL 1533553 (S.D.N.Y. Feb. 19, 2016), is similarly inapposite: it did not address the two specific accounting determinations at issue here, and instead dealt with the entirely different issue of asset carrying-value as a “fact-based estimate.” Id. at *4. The financials there were overstated not because of a subjective accounting judgment, but because the company included bribe payments and overcharges in the carrying-value of its fixed assets. Id.; In re Petrobras Sec. Litig., 116 F. Supp. 3d 368, 375 (S.D.N.Y. 2015).2 Moreover, AmTrust expressly disclosed its revenue recognition policy with respect to war- ranty revenue. See Br. 16.3 Plaintiffs’ strained misreading of that disclosure is untenable. They take the statement that AmTrust “recognizes revenue . . . at the time of the sale” but “defers a portion” of that revenue to later periods as indicating that AmTrust recognizes a minority portion of that revenue upfront, with the majority of the revenue deferred. See Opp. 25-26. This facially implausible interpretation injects the word “minority” into an unqualified statement about upfront recognition and ignores the plain meaning of the word “portion.” See Br. 15 n.13. Plaintiffs also misread Omnicare to suggest it applies only when opinion statements are explicitly introduced by expressions such as “I believe.” Opp. 23. Omnicare and its progeny say no such thing. To the contrary, “investors recognize opinions,” in Plaintiffs’ words, when, as here, 2 Although In re DRDGOLD Ltd. Securities Litigation, 472 F. Supp. 2d 562, 569 (S.D.N.Y. 2007), which was decided before both Omnicare and Fait, described certain misstated financials as “fact[s],” the court did so without analysis. 3 Plaintiffs’ cases do not suggest that the adequacy of a disclosure can never be decided at the pleading stage. See In re Lehman Bros. Sec. & ERISA Litig., 799 F. Supp. 2d 258, 282 (S.D.N.Y. 2011) (potential issues with “this disclo- sure” preclude judgment as a matter of law); In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628, 691-92 (S.D.N.Y. 2004) (questions of fact as to adequacy of specific disclosures). Plaintiffs’ analysis effectively concedes that courts can resolve this issue on the pleadings. Opp. 25 n.22. That those cases involved Exchange Act claims is of no moment, as the “definition of materiality is the same for [Sections 11 & 12(a)(2)] as it is under section 10(b) of the Exchange Act.” In re Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347, 360 (2d Cir. 2010). Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 8 of 16 4 they see reported financial results that “depend[] on” subjective accounting “methodology and assumptions.” Fait, 655 F.3d at 110-11; Br. 13-17.4 And Plaintiffs’ suggestion that this Court should reject the Omnicare argument because it “subvert[s]” an otherwise “strict liability offense,” Opp. 24, is nothing more than an argument that Omnicare and Fait were wrongly decided. Finally, Plaintiffs’ contention that the purported misstatements are actionable under Om- nicare’s embedded facts or material factual omissions prongs is meritless. See Opp. 27. First, Plaintiffs argue that “the very income metrics now admitted to be false” constitute false embedded facts regarding historical financial performance. Id. at 27. The sole case Plaintiffs cite on this issue addresses the issue of financial statements as embedded facts in an auditor opinion. Petrobras, 2016 WL 1533553, at *3. To the extent an audit opinion can include both opinions and embedded facts, that would not support Plaintiffs’ assertion that the relevant portions of the finan- cial statements at issue here—which are the direct result of subjective accounting judgments—are anything but non-actionable opinions. Second, Plaintiffs contend that Defendants failed to dis- close the “fact” that its accounting did not comply with GAAP. But this is just a backdoor attempt to evade Omnicare. The determination of GAAP non-compliance was made retrospectively, as a result of the change in subjective accounting judgments; it is not a pre-existing, “omitted [] fact,” 4 With respect to revenue recognition, Plaintiffs have no response to the subjectivity of AmTrust’s decision to apply “multiple-element” guidance, which itself involves probability determinations. Br. 15 n.12 (citing EITF 00-21). Sub- jective judgment is also required to evaluate the sufficiency of the historical evidence relating to when AmTrust in- curred costs for performing administrative services associated with warranty contract revenue. Br. 14-16. Plaintiffs assert only that Defendants lacked such historical evidence, Opp. 13, but this allegation is entirely conclusory, see Br. 15 n.11. As for the accounting for discretionary bonuses, Plaintiffs relegate their discussion of that issue to a footnote and effectively concede that it involves estimates as to future occurrences. Opp. 23 n.18. In attempting to distinguish Kuriakose v. Federal Home Loan Mortgage Corp., 897 F. Supp. 2d 168 (S.D.N.Y. 2012), Plaintiffs focus entirely on whether the future resolution of a contingency—here, bonus payments—will be within the defendant’s control. But the fact that AmTrust will in the future decide whether to make bonus payments says nothing about its present assessment of whether such payments are “probable,” nor does it convert that subjective assessment into an objective one. See Br. 17-18. Plaintiffs cite no authority to the contrary. Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 9 of 16 5 Opp. 27, and Plaintiffs provide no support to the contrary. They otherwise ignore—and thus im- plicitly concede—that the SAC fails to identify any omissions or duty to speak. In sum, this case does not involve false embedded facts or material factual omissions. 2. The Materiality Of The Remaining Adjustments Is Inadequately Pleaded. Plaintiffs effectively concede that they failed to plead facts suggesting that the Restate- ment’s “other adjustments” are material standing alone, i.e., once disaggregated from the non- actionable opinion statements. Opp. 18 n.13. Plaintiffs suggest that the mere inclusion of these adjustments within the Restatement establishes their materiality, but Defendants have already ex- plained why that is not the case. See Br. 19 n.17. Once a company is addressing material issues through a Restatement, it is expected to include even non-material issues as well, as AmTrust did here. Id. (citing SAB 99). Plaintiffs fail to address SAB 99. Their only other response—that materiality cannot be assessed at the pleading stage—is incorrect, as Plaintiffs’ own cases demon- strate. See Litwin v. Blackstone Grp., L.P., 634 F.3d 706, 717 (2d Cir. 2011) (discussing standard for dismissing claims on materiality grounds). Without any allegations speaking to the materiality of the “other adjustments” standing alone, the allegations are “too conclusory” with respect to materiality. Garber v. Legg Mason, Inc., 347 F. App’x 665, 669 (2d Cir. 2009) (affirming dismis- sal); see also Dkt. 118, at 10. Plaintiffs’ argument regarding the “magnitude” of the alleged mis- statements, again in the aggregate, Opp. 19, is unavailing for the same reason. B. Plaintiffs’ 10(b) Claim (Count IV) Should Be Dismissed Plaintiffs recognize the clear nonculpable inferences that can be drawn from the facts here: “The AmTrust Defendants[] . . . filed financial statements they believed were truthful, only to find out later their belief was unwarranted.” Opp. 60. This Court must consider not only possible inferences in Plaintiffs’ favor, see id. at 15, but also any “plausible opposing inferences,” and particularly all “nonculpable explanations for the defendant’s conduct,” Tellabs, Inc. v. Makor Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 10 of 16 6 Issues & Rights, Ltd., 551 U.S. 308, 323-24, 127 S. Ct. 2499, 2509-10 (2007). Under Tellabs, Plaintiffs’ hindsight scienter allegations fall flat.5 The most plausible inference is that the Restate- ment was the result of a change in auditors and accounting judgments, not fraud. 1. The SAC Fails To Adequately Allege Motive And Opportunity. Plaintiffs allege two motives, both of which are common to any corporate insider. They are therefore not indicative of fraud. Acito v. IMCERA Grp., Inc., 47 F.3d 47, 54 (2d Cir. 1995). First, Defendants’ strategy of “acquiring companies,” Opp. 42, does not support an infer- ence of scienter. Plaintiffs have not alleged that the acquisitions represent anything other than a reasonable business strategy, nor could they. Id. at 46 (recognizing importance of strategic acqui- sitions). Plaintiffs’ key case—like so many other cases they cite—is a pre-Tellabs opinion that does not compare culpable and nonculpable inferences. See Rothman v. Gregor, 220 F.3d 81, 93- 94 (2d Cir. 2000). The remaining cases Plaintiffs cite are likewise entirely distinguishable.6 Second, looking to “insider sales” and the context of those sales, any possible inference of scienter is not nearly as compelling as the available nonculpable inferences. Plaintiffs’ assertion boils down to this: a single executive, Ron Pipoly, sold stock during a four-year period, which they say was “suspicious and unusual” timing.7 Plaintiffs suggest that the size of these sales establishes 5 Plaintiffs cite a plethora of pre-Tellabs cases (see, e.g., Opp. 41, 42, 43, 44 n.38, 45, 47, 49, 58, 59), but these decisions did not compare the nonculpable and culpable explanations that could be drawn from the defendants’ con- duct, as Tellabs now requires this Court to do. See City of Brockton Ret. Sys. v. Shaw Grp. Inc., 540 F. Supp. 2d 464, 475 (S.D.N.Y. 2008) (recognizing shift in analysis post-Tellabs). 6 For instance, the allegations in In re Silvercorp Metals, Inc. Securities Litigation, 26 F. Supp. 3d 266 (S.D.N.Y. 2014), gave rise to a compelling inference of fraudulent intent because the transactions at issue there were fictitious. Id. at 276. Plaintiffs have not accused AmTrust of acquiring fake companies, and they would have no good-faith basis to do so. Moreover, Plaintiffs fail to allege a “unique connection” between any acquisition and any false statement. Opp. 43 (citing Dobina v. Weatherford Int’l, Ltd., 909 F. Supp. 2d 228, 242-43 (S.D.N.Y. 2012)). The sole “connec- tion” between acquisitions and purported misstatements is coincidental: Plaintiffs seek to tether any acquisition they can find to the nearest financial reporting date, Opp. 43, a task made easy (and entirely meaningless) given that AmTrust must periodically issue such reports. 7 Plaintiffs’ brief and the SAC also refer to stock sold by other executives (¶ 510), but there is no allegation those sales were suspiciously timed. The mere sale of shares is of course not enough to raise an inference of scienter. “[I]nstead [p]laintiffs must establish that the sales were ‘unusual’ or ‘suspicious.’” Br. at 23 (citation omitted). Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 11 of 16 7 fraudulent intent, whereas courts in this District post-Tellabs have identified at least seven factors that bear on whether stock sales can give rise to a strong inference of scienter, Glaser v. The9, Ltd., 772 F. Supp. 2d 573, 587 (S.D.N.Y. 2011); Br. 22-23, almost all of which Plaintiffs entirely ignore. The cases Plaintiffs cite are wholly distinguishable. For instance, the stock sales in Freudenberg v. E*Trade Financial Corp., 712 F. Supp. 2d 171 (S.D.N.Y. 2010), were deemed suspicious be- cause they occurred in close proximity to known or likely known “time bombs” (release of infor- mation) damaging to stock price. Id. at 200. Here, by contrast, Plaintiffs’ only assertion as to timing is that Pipoly started selling shares “eight months before the start of the Class Period,” and then sold stock at various times throughout that period. Opp. 41, 54-55. But the Class Period is an artificial period defined by Plaintiffs; its start date could not have had any significance to De- fendants at the time.8 And, unlike in Freudenberg, Pipoly’s stock sales began years before any release of the information that Plaintiffs allege negatively impacted the stock price. Plaintiffs also assert that the chart showing Pipoly’s increase in stock holdings is “incomplete” because it does not exactly match the Class Period. Opp. 54. But as the chart shows, Pipoly indisputably increased his holdings during the Class Period, which undermines any possible inference of scienter.9 8 Plaintiffs also fail to rebut the exculpatory value of the 10b5-1 plans with respect to the timing of stock sales, and instead claim that the 10b5-1 plans are “of little moment at this stage of the litigation” as they are “affirmative de- fense[s].” Opp. 41 & n.35. They are incorrect. This Court may consider documents pertaining to the 10b5-1 plans on a motion to dismiss. See Koplyay v. Cirrus Logic, Inc., 2013 WL 6233908, at *6 (S.D.N.Y. Dec. 2, 2013) (rejecting argument to the contrary and noting that “courts in this Circuit have regularly made reference to Rule 10b5-1 plans when considering scienter in securities fraud actions”). 9 Again citing exclusively pre-Tellabs cases, Plaintiffs assert that Zyskind’s executive compensation provides suffi- cient motive. See Opp. 54 (citing In re Kidder Peabody Sec. Litig., 10 F. Supp. 2d 398, 418 (S.D.N.Y. 1998), which Plaintiffs fail to mention was abrogated in part, see In re LaBranche Sec. Litig., 405 F. Supp. 2d 333, 351 (S.D.N.Y. 2005)). For its part, LaBranche concludes—even pre-Tellabs—that “allegations concerning the bonuses received by the Individual Defendants are inadequate to satisfy the scienter requirement.” Id. at 354. AmTrust’s insiders’ execu- tive compensation “motives” are common to all corporate insiders and fail to provide any “strong” inference of fraud, let alone one that is at least as compelling as any nonculpable inference. Id. at 353 (citing Kalnit v. Eichler, 264 F.3d 131, 140 (2d Cir. 2001) (“stating that incentive compensation can hardly be the basis on which an allegation of fraud is predicated” (citation omitted))). Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 12 of 16 8 2. Neither Intentional Misbehavior Nor Recklessness Is Adequately Pleaded. Plaintiffs’ allegations of fraudulent intent or recklessness fall flat. Plaintiffs admit that the nearly 100 paragraphs of the SAC—and numerous pages of their opposition brief—detailing the OIP with three former BDO auditors have nothing to do with AmTrust. See Opp. 56. Plaintiffs still rely on a purported “red flag” article and its progeny despite the holding of another court in this District that the article was “published by a short seller that [the plaintiff in that case] con- cede[d] may have been wrong in certain respects and has been proven wrong in others by the passage of time.” Harris v. AmTrust Fin. Servs., Inc., 135 F. Supp. 3d 155, 159 (S.D.N.Y. 2015) (footnotes omitted); see also id. at 173 n.30 (complaint in that action “acknowledges that the GeoInvesting Report was ‘mistaken’ about its ‘hypothesis’”). Contrary to Plaintiffs’ suggestion, Opp. 56-57 & n.47, Defendants are not claiming that Harris should have collateral estoppel effect in this case. Rather, Defendants assert that this Court can and should consider the Harris court’s determination that the supposed “red flag” article that Plaintiffs rely on heavily here was not cred- ible. One can plausibly infer from the allegations in the SAC that Defendants, consistent with the views of the Harris court and the unqualified audit opinions AmTrust received every year, con- sidered but did not credit the vague contentions in articles that were written by third-party short- sellers who had a financial interest in harming AmTrust and who were not privy to its financial and accounting records. This plausible inference is far more compelling than any inference of fraudulent intent. This is so even with respect to the internal controls allegation made in some of the articles that AmTrust later addressed. The relevant question is whether the allegations in the articles were credible at the time; the Restatement cannot retroactively confer credibility where none existed contemporaneously. Moreover, the “red flag” articles indisputably do not address the two main issues that drove the Restatement or suggest that AmTrust should have been on notice Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 13 of 16 9 of the potential for a difference of opinion between auditors on those two specific subjective ac- counting determinations.10 Plaintiffs’ remaining arguments cannot save their scienter allegations. First, they repeat their allegations about Warrantech despite the fact that “nothing in the complaint” says that any Defendants “knew anything about” that “ancient history.” Dkt. 118, at 14; compare Opp. 45-46, 58-60, with Br. 27-28. Second, Plaintiffs argue that the “length and magnitude” of the Restatement demonstrates scienter, Opp. 46-47, but there is a far more plausible nonculpable explanation: AmTrust and its prior auditor applied their own, honestly held interpretation of the relevant accounting standards, without any comments from the SEC’s Division of Corporate Finance, for at least the period of time covered by the Restatement. Third, the purported “temporal proximity” of the purportedly misleading statements to the “first corrective disclosure,” id. at 47-48, is not indicative of scienter here, where the far more plausible inference is that AmTrust simply had not made a decision to restate as of February 27, 2017. The temporal proximity point in In re CPI Card Group Inc. Securities Litigation, 2017 WL 4941597 (S.D.N.Y. Oct. 30, 2017) (Kaplan, J.), on which Plaintiffs rely, is wholly distinguishable: there the company admitted a few months after an initial public offering that sales had slowed. Id. at *4. That timing may have been suspicious, but Plaintiffs do not explain how Defendants would benefit from accounting for expected immaterial corrections to financial statements a few weeks before announcing a restatement. No 10 Plaintiffs’ assertion that alleged GAAP violations and internal control certifications evidence fraudulent intent similarly lacks merit. GAAP violations or lack of internal controls plus credible red flags may give rise to an inference of scienter—absent any nonculpable inferences to the contrary—as Plaintiffs’ cases note. Opp. 48-49. But where, as here, there were no credible red flags, later-discovered GAAP violations and internal control weaknesses do not give rise to an inference of scienter. The internal control certifications were in any event non-actionable “opinions.” See Opp. 60 n.52. While Plaintiffs purport to distinguish In re Sanofi Securities Litigation, 155 F. Supp. 3d 386 (S.D.N.Y. 2016), they focus on a specific pleading deficiency identified in that case and ignore the separate legal proposition for which Defendants cited it. Because the falsity of a statement “based on my knowledge” “is entirely dependent on what [the defendant] knew, not on what was objectively true at the time of the statement,” id. at 402 (alteration omit- ted), Plaintiffs’ failure to allege subjective falsity renders the internal control certifications non-actionable, see Br. 33- 34. Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 14 of 16 10 inference is more compelling than the nonculpable one: the corrections simply turned out to be more significant than Defendants anticipated on February 27. Finally, the fact that AmTrust replaced Pipoly as CFO, but retained him as an employee in another role, is likewise benign. This is a far cry from the cases Plaintiffs cite, where an officer was forced to resign and the defendants “failed to suggest a plausible opposing inference.” Hall v. The Children’s Place Retail Stores, Inc., 580 F. Supp. 2d 212, 233 (S.D.N.Y. 2008). Ultimately, the most plausible inference in this case is that Defendants did not intend to engage in fraudulent conduct: they reasonably believed that their financial statements were accu- rate at the time they were issued, a new auditor later recommended changes based on its subjective accounting judgments,11 and AmTrust complied with the new auditor’s recommendations.12 CONCLUSION For the foregoing reasons, and for the reasons set forth in Defendants’ opening brief, the SAC should be dismissed with prejudice. 11 Plaintiffs assert AmTrust was “instructed” to change auditors by a New York agency reviewing a particular trans- action. Opp. 54 n.44 (emphasis omitted). But AmTrust indisputably could have declined to enter into the transaction to avoid switching auditors, and surely would have if it had been engaged in a purported years-long fraud. It chose to switch because it was not. 12 Without any primary violations, Plaintiffs’ control-person liability claims (Counts III & V) necessarily fail as well. Br. 34-35. Those claims should also be dismissed because, while the general rule is that control-person claims can be pled in the alternative, Opp. 79, Plaintiffs’ “own theory” precludes such an approach in this case, Kalnit v. Eichler, 85 F. Supp. 2d 232, 246 (S.D.N.Y. 1999); accord City of Pontiac Gen. Emps.’ Ret. Sys. v. Lockheed Martin Corp., 875 F. Supp. 2d 359, 375 (S.D.N.Y. 2012). The secondary liability claims should likewise be dismissed because Plaintiffs fail to allege culpable participation. See Br. 34-35. They cite a case in which this Court found that Section 20(a) plaintiffs need not do so, Opp. 81, but they ignore this Court’s subsequent decision to the contrary, In re Lehman Bros. Sec. & ERISA Litig., 2013 WL 5730020, at *4 (S.D.N.Y. Oct. 22, 2013) (Kaplan, J.), which accords with “the majority of district courts in this Circuit,” Special Situations Fund III QP, L.P. v. Deloitte Touche Tohmatsu CPA, Ltd., 33 F. Supp. 3d 401, 437 (S.D.N.Y. 2014). Defendants explained why culpability is similarly required under Section 15, despite non-controlling authority to the contrary. Br. 35 n.29. Plaintiffs have no substantive response, and their acknowledgement that the Second Circuit has deferred resolution of this question belies their characterization of De- fendants’ position as “nonsensical.” Opp. 80 & n.70. While scienter allegations may satisfy culpability requirements, the scienter allegations here are inadequate for the reasons discussed above, and Plaintiffs in any case affirmatively disclaimed all scienter allegations for purposes of the Section 15 claim. See SAC at 44 n.6. Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 15 of 16 11 Dated: New York, New York January 23, 2019 GIBSON, DUNN & CRUTCHER LLP By: /s/ Lawrence J. Zweifach Mark A. Kirsch Lawrence J. Zweifach Caitlin J. Halligan 200 Park Avenue New York, New York 10166-0193 Tel: (212) 351-2662 Fax: (212) 351-6362 LZweifach@gibsondunn.com Attorneys for Defendants AmTrust Finan- cial Services, Inc., Barry D. Zyskind, Ronald E. Pipoly Jr., Donald T. DeCarlo, Susan C. Fisch, Abraham Gulkowitz, George Karfunkel, and Jay J. Miller Case 1:17-cv-01545-LAK Document 156 Filed 01/23/19 Page 16 of 16