Ca Public Employees' Retirement System v. Chubb, 03-3755.

CourtUnited States Courts of Appeals. United States Court of Appeals (3rd Circuit)
Citation394 F.3d 126
Docket NumberNo. 03-3755.,03-3755.
PartiesCALIFORNIA PUBLIC EMPLOYEES' RETIREMENT SYSTEM, on behalf of itself and all others similarly situated; New York State Common Retirement Fund; The<SMALL><SUP>*</SUP></SMALL> Butler Wick Trust Company, The Executor of the Estate of John N. Teeple, Deceased, Appellants v. The CHUBB CORPORATION; Dean R. O'Hare; David B. Kelso; Henry B. Schram; Executive Risk Inc.; Stephen J. Sills; Robert H. Kullas; Robert V. Deutsch.
Decision Date30 December 2004

William S. Lerach, Eric A. Isaacson, (Argued), Lerach, Coughlin, Stoia, Geller Rudman & Robbins, San Diego, for Appellants.

Herbert Wachtell, (Argued), Jonathan E. Pickhardt, John F. Savarese, Wachtell, Lipton, Rosen & Katz, New York, Mary C. Roper, Drinker, Biddle & Reath, Philadelphia, for Appellees The Chubb Corporation; Dean R. O'Hare; David B. Kelso; Henry B. Schram; Executive Risk Inc.

William J. O'Shaughnessy, (Argued), McCarter & English, Newark, for Appellees Stephen J. Sills; Robert H. Kullas; Robert V. Deutsch.

Before SLOVITER, VAN ANTWERPEN and COWEN, Circuit Judges.

COWEN, Circuit Judge.

This is a securities class action lawsuit brought on behalf of shareholders of the Chubb Corporation ("Chubb") against Chubb, Executive Risk, Inc. ("Executive Risk"), and several Chubb and Executive Risk officers. Plaintiffs aver that Defendants defrauded investors by artificially inflating the value of Chubb's common stock through accounting manipulations and false statements designed to effectuate a stock-for-stock merger between Chubb and Executive Risk, and avoid an alleged hostile takeover attempt. The District Court granted Defendants' motion to dismiss Plaintiffs' Second Amended Complaint pursuant to Fed.R.Civ.P. 12(b)(6), the Private Securities Litigation Reform Act ("PSLRA"), 15 U.S.C. §§ 78u-4 et seq., and Fed.R.Civ.P. 9(b), and denied Plaintiffs leave to file a Third Amended Complaint. We will affirm.


In reviewing the factual background of this litigation, we accept as true the well-pleaded allegations in the Second Amended Complaint and consider the documents incorporated by reference therein. See In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1420, 1426 (3d Cir.1997).

Background to Class Period

Plaintiffs are investors who acquired Chubb common stock between April 27, 1999 and October 15, 1999 (the "Class Period"), including the former shareholders of Executive Risk who exchanged their Executive Risk shares for shares of Chubb stock pursuant to a merger of the companies that occurred on July 20, 1999. The Defendants are Chubb, Executive Risk, and their top former corporate officers, Chubb Chief Executive Officer ("CEO") Dean R. O'Hare, Chief Financial Officer ("CFO") David B. Kelso, Chief Accounting Officer Henry B. Schram, and Executive Risk CEO Stephen J. Sills, Board Chairman Robert H. Kullas, and CFO Robert V. Deutsch.

Chubb is a diversified insurance company headquartered in Warren, New Jersey, with local branch and service offices throughout North America and internationally. Chubb sells personal, standard commercial and specialty commercial insurance and is one of the largest national underwriters of directors' and officers' liability insurance. The claims in this securities class action concern Chubb's standard commercial insurance business, which accounts for approximately one-third of Chubb's total premiums.

Beginning in 1995 and continuing through 1998, Chubb's financial performance deteriorated. Chubb consistently cited the competitive standard commercial insurance market as the cause of its poor performance during this period. On February 2, 1999, Chubb reported disappointing fourth quarter 1998 and year-end results. Defendant O'Hare assured investors that "[w]e are taking aggressive steps to achieve adequate prices for this business, and we expect to see the impact of these actions as we move through the renewal cycle." (Compl. ¶ 17.)

O'Hare employed two strategies to address Chubb's flagging business. First, to combat the continuing diminution of Chubb's stock price and earnings-per-share ("EPS") in the latter half of 1998, O'Hare promulgated what Plaintiffs refer to as the "rate increase/policy non-renewal initiative" (hereinafter referred to as the "rate initiative"). Announced in October 1998 following the release of disappointing third quarter 1998 results, the rate initiative sought to revamp the standard commercial insurance operations by increasing premiums and refusing to renew unprofitable business. Second, in an effort to counter the difficulties in the standard commercial business and increase profitability, Chubb sought to acquire a profitable specialty insurance company. Accordingly, in 1998, Chubb targeted Executive Risk, a profitable insurance carrier specializing in directors' and officers' liability insurance, for acquisition. On February 6, 1999, following negotiations which took place between October and December 1998 and due diligence investigations conducted in January 1999, Defendants O'Hare and Sills publicly announced the merger agreement. The terms included a stock-for-stock acquisition at a fixed exchange ratio of 1.235 Chubb shares to each share of Executive Risk stock. On February 5, 1999, the agreed-to-ratio represented a premium of 63%, as Chubb stock was valued at $58 1/16 and Executive Risk stock was valued at $44. In addition, Plaintiffs contend that Executive Risk's Board members, including Sills, Kullas, and Deutsch, were given special benefits and payments for endorsing the transaction to Executive Risk shareholders. Final approval of the merger was subject to a vote of Executive Risk's shareholders.

Plaintiffs claim that the impending Executive Risk shareholder vote and fixed exchange ratio placed tremendous pressure on Chubb, O'Hare, Kelso, and Schram to halt the decline of Chubb's stock price,1 because any further decline would result in less consideration for Executive Risk shareholders and thereby jeopardize the merger vote. As such, Plaintiffs allege that the Chubb Defendants issued false and misleading statements representing that the rate initiative was ameliorating the problems in the standard commercial lines business, and that it was doing so more quickly than anticipated. This, Plaintiffs allege, artificially inflated the value of Chubb's stock and portrayed the merger as more beneficial to Executive Risk shareholders than it truly was. Plaintiffs also claim that the Chubb Defendants were motivated to continue to artificially inflate the price of Chubb's stock following consummation of the acquisition because Chubb was threatened with a hostile takeover.

False Statements and False Financial Results: First Quarter 1999

According to Plaintiffs, Defendants' allegedly fraudulent scheme to inflate the value of Chubb's stock began with the release of Chubb's first quarter 1999 results via a press release issued on April 27, 1999.

The first quarter 1999 results were better than expected, revealing an improved EPS and a combined ratio2 of 117.9% in the standard commercial insurance lines, down from 119.5% in the fourth quarter 1998 report. Plaintiffs claim that the Chubb Defendants intentionally falsified these results, including the calculation of the combined ratio, by violating generally accepted accounting principles ("GAAP") and SEC rules. In addition, Plaintiffs allege that in the days and weeks following the release of the first quarter 1999 results, the Chubb Defendants promulgated numerous statements falsely attributing the favorable first quarter 1999 results to the success of the rate initiative in turning around the standard commercial lines and forecasting even further improvement.

Plaintiffs assert that statements contained in Chubb's April 27, 1999 press release were false, as were statements made by individual Chubb Defendants in follow-up conversations and conference calls with analysts and investors. Chubb's April 27, 1999 press release stated that

[O]ur pricing strategy in standard commercial lines has begun to show the impact we are looking for in our renewal business. Month by month, renewal rate increases are building momentum, and we expect this trend to continue. Moreover, we have been successful in retaining business we want to keep at higher rates, while at the same time we are walking away from business where we can't obtain adequate pricing. By maintaining this profit oriented discipline, standard commercial lines will likely show a decline in premiums throughout the year and produce improved combined ratios. This decline in premiums should be offset by continued premium growth in personal and specialty commercial lines and by the benefits of a series of growth initiatives begun late last year.

It also represented that Chubb's standard commercial insurance combined ratio was 117.9%, down from the fourth quarter 1998 combined ratio of 119.5%. Plaintiffs claim that in a follow-up conference call held on April 27, 1999, and in follow-up conversations with individual analysts, money and portfolio managers, institutional investors and large Chubb shareholders, Defendants O'Hare and Schram maintained that

(a) the rate initiative was not only working, but was actually exceeding management's expectations, and this accounted in large part for Chubb's better-than-expected first quarter 1999 results;

(b) as a result of the successful turnaround of Chubb's standard commercial insurance operations, that part of Chubb's business would show 5 1/2% to 6% premium growth throughout 1999, as Chubb's rate increases for new or renewal standard commercial insurance policies were sticking;

(c) the momentum of rate increases in Chubb's standard commercial insurance operations was growing month by month;

(d) Chubb was successful at...

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