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Gamboa v. Citizens, Inc.

United States District Court, W.D. Texas, Austin Division

May 7, 2018

JUAN GAMBOA, INDIVIDUALLY AND ON BEHALF OF ALL OTHERS SIMILARLY SITUATED
v.
CITIZENS, INC., RICK D. RILEY, KAY E. OSBOURN, GEOFFREY M. KOLANDER AND DAVID S. JORGENSEN

          HON. ROBERT PITMAN, UNITED STATES DISTRICT JUDGE

          REPORT AND RECOMMENDATION OF THE UNITED STATES MAGISTRATE JUDGE

          ANDREW W. AUSTIN, UNITED STATES MAGISTRATE JUDGE

         Before the Court are Defendants' Motion to Dismiss (Dkt. No. 18); Plaintiffs' Memorandum in Opposition (Dkt. No. 19); and Defendants' Reply (Dkt. No. 20). The District Court referred the motion to the undersigned Magistrate Judge for report and recommendation pursuant to 28 U.S.C. §636(b) and Rule 1(c) of Appendix C of the Local Rules.

         I. GENERAL BACKGROUND

         Lead Plaintiffs Juan Gamboa and Correy Hemingway bring this class action lawsuit pursuant to Federal Rule of Civil Procedure 23(a) and (b)(3) on behalf of a class consisting of persons who purchased or otherwise acquired securities sold by Defendant Citizens, Inc. Citizens is a Colorado insurance company that sells whole-life insurance policies primarily to foreign customers in South America and Taiwan and maintains its headquarters in Austin, Texas.

         Plaintiffs allege that Citizens operates an independent network of 3, 000 foreign sales consultants who sell whole-life insurance policies to foreign customers in an effort to avoid regulation in the United States. Plaintiffs contend that Citizens trains its sales force to use unlawful growth projections regarding Citizens' stock to steer foreign policyholders into the Citizens Stock Investment Plan, where policy dividends are automatically used to purchase Citizens stock. Based on these promised outsized returns, the majority of the Citizens' common shares are owned by foreign policyholders who continue to purchase shares automatically under the Plan as dividends are paid on the policies, artificially propping up Citizens' stock price.

         For much of its history, Citizens' had claimed that its life insurance policy proceeds and dividends were exempt from U.S. taxes. In 2015, however, Citizens announced that a “substantial portion” of its life insurance policies “do not qualify for the favorable U.S. federal income tax treatment” under Section 7702 of the Internal Revenue Code. Accordingly, almost all of the life insurance policies Citizens sells to foreigners are now subject to U.S. laws and deemed taxable. Despite this, Plaintiffs allege that “Citizens continues to market and sell policies as tax-exempt to foreign customers because it requires, in Ponzi-like fashion, a constant influx of new foreign customers to purchase the Company's stock.” Dkt. No. 14 at ¶ 6. Plaintiffs reason that:

If Citizens sales force were to disclose to foreign customers that they will have to pay U.S. income taxes on their policy benefits, then none of these customers would purchase a policy, and existing customers would either abandon or cash in their policy. This, in turn, would reduce the artificially created demand for Citizen's stock through the Plan. Simply put, the scheme would end and Citizens' business would fail.

Id.

         Plaintiffs contend that since the Section 7702 tax issue was disclosed in 2015, Defendants have attempted to suppress, cover up and delay the fraudulent scheme. For example, Plaintiffs allege that Citizens fired its Chief Financial Officer three weeks into his tenure when he refused to sign off on Citizens' financial disclosures. Plaintiffs contend that Citizens failed to disclose to its investors that it was under investigation by the Securities and Exchange Commission and the Internal Revenue Service. Plaintiffs allege that Citizens' fraudulent scheme was uncovered on March 8, 2017, when Seeking Alpha published an article exposing Citizens' unlawful business practices, and noting that it was under SEC and IRS investigation. Citizens disclosed in its 2016 Annual Report that it was reconsidering the viability of selling policies in international markets. As a result, Citizens stock prices sharply declined.

         On March 16, 2017, Plaintiffs filed this proposed class action complaint against Citizens, Chief Executive Officers Harold E. Riley, [1] Rick D. Riley, Kay E. Osbourn and Geoffrey M. Kolander, and Chief Financial Officer David Jorgensen (the court will refer to all defendants collectively as “Citizens”). Plaintiffs' lawsuit alleges violations of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5. Plaintiffs also allege violations of Section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a).

         II. LEGAL STANDARD

         Citizens moves to dismiss, arguing that Plaintiffs' First Amended Complaint fails to meet the pleading requirements of the Private Securities Litigation Reform Act. The PSLRA requires a securities fraud plaintiff to meet a higher pleading standard than plaintiffs must meet in other cases. Among other things, the statute requires the plaintiff to “specify each statement alleged to have been misleading, the reason or reasons why the statement is misleading, and, if an allegation regarding the statement or omission is made on information and belief, the complaint shall state with particularity all facts on which that belief is formed.” 15 U.S.C. § 78u-4(b)(1)(B). The plaintiff must also “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” Id. at § (b)(2)(A). And because the complaint here alleges fraud, the requirements of Rule 9(b) apply to this case. That rule requires that allegations of fraud be made with particularity by identifying the “time, place, and contents of the false representations, as well as the identity of the person making the misrepresentation and what that person obtained thereby.” Tuchman v. DSC Commc'ns Corp., 14 F.3d 1061, 1068 (5th Cir.1994) (internal citation and alterations omitted).

         III. ...


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