318 F.3d 148 (2nd Cir. 2003), 02-7155, LC Capital Partners, LP v. Frontier Ins. Group, Inc.

Docket Nº:02-7155.
Citation:318 F.3d 148
Party Name:LC CAPITAL PARTNERS, LP, on behalf of itself and all others similarly situated, Plaintiff-Appellant, v. FRONTIER INSURANCE GROUP, INC., Harry W. Rhulen, Peter L. Rhulen, Mark H. Mishler, Patrick W. Kenny, Suzanne Rhulen Loughlin, Joseph P. Loughlin and Ernst & Young, LLP, Defendants-Appellees.
Case Date:January 28, 2003
Court:United States Courts of Appeals, Court of Appeals for the Second Circuit
 
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318 F.3d 148 (2nd Cir. 2003)

LC CAPITAL PARTNERS, LP, on behalf of itself and all others similarly situated, Plaintiff-Appellant,

v.

FRONTIER INSURANCE GROUP, INC., Harry W. Rhulen, Peter L. Rhulen, Mark H. Mishler, Patrick W. Kenny, Suzanne Rhulen Loughlin, Joseph P. Loughlin and Ernst & Young, LLP, Defendants-Appellees.

No. 02-7155.

United States Court of Appeals, Second Circuit

January 28, 2003

Argued: Oct. 16, 2002.

Page 149

Paul D. Young, New York, N.Y. (Mil-berg Weiss Bershad Hynes & Lerach, LLP, New York, N.Y.; Susan Liebhard, Bernstein, Liebhard & Lifshitz, LLP, New York, N.Y.; Gene Cauley, Cauley & Geller, LLP, Little Rock, Ark., on the brief), for Plaintiff-Appellant.

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Bruce M. Cormier, Washington, D.C. (Michael J. Crane, Ernst & Young, LLP, New York, N.Y.; Lawrence S. Robbins, Kathryn Schaefer Zecca, Robbins, Russell, Englert, Orseck & Untereiner LLP, Washington, D.C., on the brief), for Defendant-Appellee Ernst & Young, LLP.

Bruce G. Vanyo, Palo Alto, CA (Laurie B. Smilan, Michele Rose, Lyle Roberts, Wilson Sonsini Goodrich & Rosati, McLean, VA, on the brief), for Defendant-Appellee Frontier Insurance Group, Inc.

Before: MESKILL, NEWMAN and POOLER, Circuit Judges.

JON O. NEWMAN, Circuit Judge.

The issue on this appeal is whether plaintiffs, suing for stock fraud, were on inquiry notice that started the running of a statute of limitations early enough to render their suit time-barred. This issue arises in the context of an insurance company that took increasingly large reserve charges and did not disclose its continuing failure to establish adequate reserves. Plaintiff-Appellant LC Capital Partners, LP ("LC Capital") appeals from the February 7, 2002, judgment of the District Court for the Southern District of New York (Lawrence M. McKenna, District Judge), dismissing, for failure to state a timely claim, its class action against Frontier Insurance Group, Inc. ("Frontier"), its officers and directors, and its outside auditor, Ernst & Young, LLP ("E & Y").1 We conclude that the suit is time-barred and therefore affirm.

Background

LC Capital, acting on behalf of itself, other named consolidated plaintiffs, and a putative class, is an investor that purchased securities issued by Frontier between August 5, 1997, and April 14, 2000 ("the Class Period"). Frontier is an insurance holding company that, through subsidiaries, conducts business as a specialty insurer and reinsurer. During the Class Period, Frontier's shares were traded on the New York Stock Exchange.

Allegations of fraud. The Plaintiffs allege that during the Class Period, Frontier engaged in irresponsible and negligent insurance practices. The Plaintiffs focus on three areas of the Defendants' conduct. First, the Plaintiffs allege that the Defendants implemented reserve policies with the deliberate purpose and systematic effect of under-reserving for claims. Second, the Plaintiffs allege that the Defendants' information systems were grossly inadequate, such that reserves could not properly be recorded and claim histories necessary for responsible actuarial analysis were unavailable. Third, in order to cover the revenue shortfalls created by Frontier's failure to reserve adequate sums and price policies correctly, the company engaged in a "pyramid scheme": it rapidly expanded its business by acquiring other insurance companies, offered policies at predatory prices, and used the premium income thus generated to pay claims on existing policies. The Plaintiffs allege that the individual Defendants were aware that these policies were reckless, and that they ignored or fired employees and independent actuaries who raised concerns about these policies.

The Plaintiffs allege that the Defendants' policies gradually eroded the financial health of Frontier. During the Class Period, Frontier took a series of reserve

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charges: $17.5 million in 1994, $40 million in 1997, $139 million in 1998, and $136 million in 1999. The price of its common stock decreased from the Class Period high of $35,227 to $0,875 a share.

The Plaintiffs allege that, in a series of financial reports, press releases, and other public statements issued throughout the Class Period, the Defendants made false and misleading statements and material omissions to conceal Frontier's practices and their effects. Much of the language that the Plaintiffs take issue with is language that essentially says "all is well." For instance, Frontier's Form 10-Q for the quarter ended June 30, 1997, states, "The Company's subsidiaries maintain liquid operating positions and follow investment guidelines that are intended to provide for an acceptable return on investment while preserving the Company's capital, maintaining sufficient liquidity to meet their obligations and, as to the Company's insurance subsidiaries, maintaining a sufficient margin of capital and surplus to ensure their unimpaired ability to write insurance and assume reinsurance."

With respect to E & Y, the Plaintiffs allege that the accounting firm recklessly disregarded numerous warning signals to which it would have had special access as Frontier's auditor. The Plaintiffs allege that E & Y's opinions during the Class Period certifying Frontier's financial statements were materially false and misleading and in violation of federal securities law.

Potential storm warnings. In 1994, Frontier took a $17.5 million restructuring charge, apparently the first time that Frontier was required to take a charge since its founding in 1986. The charge was attributed to aggressive expansion into Florida's insurance market where the reserve models that the company had previously used turned out to be insufficient.

On February 17, 1998, Frontier announced it would take a $40 million charge and also announced a loss of $9.8 million for the fourth quarter of 1997. Frontier issued a press release describing this charge as a "reserve restructuring charge." Harry W. Rhulen, Frontier's CEO, stated that the charge was "attributable to the adoption of a more conservative reserving policy."

On December 16, 1998, Frontier announced that it would take a $139 million charge, which would result in a "loss for the year." Frontier described this charge...

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