Malin v. Xl Capital Ltd.

Decision Date26 July 2007
Docket NumberCivil No. 3:03cv2001 (PCD).
CourtU.S. District Court — District of Connecticut
PartiesHarold MALIN and Sandra Joan Harold Malin and Sandra Joan Malin Revocable Trust, Individually and On Behalf of Others Similarly Situated, Plaintiffs, v. XL CAPITAL LTD., et al., Defendants.

David A. Rosenfeld, Lerach Coughlin Stoia Geller Rudman & Robbins, LLP, Melville, NY, Eli R. Greenstein, James W. Oliver, Shawn A. Williams, Lerach Coughlin Stoia Geller Rudman & Robbins, San Francisco, CA, George Edward Barrett, Barrett, Johnstor & Parsley, Nashville, TN, Patrick A. Klingman, Sheperd Finkelman Miller & Shah, Chester, CT, Ramzi Abadou, Milberg Weiss & Bershad, San Diego, CA, Terence J. Gallagher, III, Day Pitney LLP, Stanford, CT, David Randell Scott, Scott & Scott, Colchester, CT, for Plaintiffs.

Howard G. Sloane, Leonard A. Spivak, Cahill, Gordon & Reindel, New York, NY, James F. Stapleton, Terence J. Gallagher, Thomas D. Goldberg, III, Day Pitney LLP, Stamford, CT, Dorit S. Heimer, Westport, CT, Jeremy L. Wallison, Peter N. Wang, Foley & Lardner LLP, New York, NY, for Defendants.


DORSEY, District Judge.

This action is a securities class action suit brought by various individual plaintiffs (collectively "Plaintiffs") on behalf of purchasers of XL Capital Ltd. ("XL" or the "Company") publicly traded securities from November 1, 2001 through October 16, 2003 (the "Class Period") against XL and several of its executive officers: Brian M. O'Hara, Jerry de St. Paer, Ronald L. Bornhuetter, Nicholas M. Brown, Jr., and Henry Charles V. Keeling (collectively, the "Individual Defendants"). Plaintiffs bring this action alleging that Defendants engaged in securities fraud in violation of § 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j (b), and SEC Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5, and that the Individual Defendants were "controlling persons" under § 20(a) of the Exchange Act, 15 U.S.C. § 78t(a), and therefore derivatively liable for the Company's fraudulent acts. The crux of Plaintiffs' allegations is that Defendants knowingly issued false and misleading statements regarding the Company's financial condition by failing to adequately reserve for losses in its NAC Re reinsurance operations in order to artificially inflate the price of the Company's stock and maintain the Company's financial strength and debt ratings.

Defendants are now renewing their motion, pursuant to 15 U.S.C. § 78u-4(b)(3)(A) of the Private Securities Litigation Reform Act of 1995 (the "PSLRA"), to dismiss the Second Amended Class Action Complaint (the "SAC") for violations of the Federal Securities Laws on the ground that the SAC fails to satisfy the pleading requirements of the PLSRA. Prior to the filing of this renewed motion, Plaintiffs moved to preclude Defendants from submitting documents and arguments inconsistent with judicial notice. For the reasons stated herein, Plaintiffs' Motion to Preclude Documents and Arguments Inconsistent with Judicial Notice [Doc. No. 150] is granted in part and denied in part and Defendants' Motion to Dismiss [Doc. No. 154] is granted.


XL is a Bermuda-based financial service holding company that provides reinsurance through its operating subsidiary, XL Reinsurance America, Inc. ("XLRA," formerly NAC Reinsurance Corporation or "NAC Re").2 (SAC ¶¶ 11, 13.) As a reinsurer, XL provides insurance to direct or primary insurers, or "ceding companies,"3 who transfer all or part of the risk they underwrite, pursuant to a policy or group of policies, to XL, as the reinsurer. The ceding companies pay premiums, in exchange for which the reinsurer agrees to indemnify the ceding insurer on the risk transferred. A portion of the premiums collected from the ceding companies are set aside as "loss reserves," which represent the amount a reinsurance company estimates it will have to pay to cover the ceding insurers' claims under the policies that have been written to date. Loss reserves are established when the insurance contract is signed and are later revised as claims are submitted and more information becomes available about the likely amount the reinsurer will have to pay under the policy. Here, Plaintiffs allege that XL and the Individual Defendants defrauded investors during the Class Period by knowingly and falsely representing that XL had sufficient loss reserves to cover the losses that fall within the coverage assumed. As a consequence of these alleged misrepresentations, Plaintiffs contend that the Company's shares sold at artificially inflated prices which later fell after the truth became known to the market. Plaintiffs' allegations are based on various SEC filings, analyst reports, press releases, "relevant Company documents" and interviews with four confidential witnesses ("CW1", "CW2", "CW3" and "CW4"), each of which is alleged to have been employed in various units at the Company.

XL acquired NAC Re in June 1999 for $1.2 billion. In connection with the merger, XL increased loss reserves by $95 million. It later became apparent, however, that the 1997 through 2000 accident years4 were developing adversely. A Report on Examination of the NAC Reinsurance Corporation covering the five-year period from January 1, 1995 through December 31, 1999 was published on May 31, 2002 by the New York Insurance Department ("NYID") ("NYID Report"). As set forth in the Report, the NYID found that the Company had, as of December 31, 1999, understated loss reserves by $189 million. (N.Y.ID Report 25, Ex. 2 to SAC.) In 2000, XL took another charge to income of $122 million to increase loss reserves for its NAC Re operations. During the Class Period, XL increased loss reserves three more times, taking additional charges of $180 million in 4Q01, $215 million in 4Q02 and $184 million in 3Q03. Following the October 17, 2003 announcement of the $184 million reserve shortfall, Defendant O'Hara, on behalf of the Company, announced in a press release that the Company would conduct "an intensive claims audit and review of the ceding company claims files," with the intention of "fully address[ing] [the Company's] exposure to the 1997 through 2000 North American casualty reinsurance book written by the former NAC Re so that it will not adversely affect [XL's] financial results in 2004 and beyond." The "comprehensive claims audit review" uncovered an additional $663 million reserve shortfall, which was taken in 4Q03 and announced on January 13, 2004. XL's loss reserve increases, taken together, totaled over $1.36 billion.

On January 14. 2004, the day after XL announced the $663 million reserve shortfall, various insurance ratings agencies lowered their ratings and downgraded XL. Specifically, S & P downgraded the financial strength ratings of XL's core operating subsidiaries to "AA-" from "AA" and removed them for CreditWatch, noting that "[t]he outlook is stable." Rating agency A.M. Best placed XL's "A+" (Superior) financial strength rating under review with negative implications, rating agency Moody's downgraded XL Re's financial strength rating to "Aa3" from "Aa2," with a stable outlook, and rating agency Fitch put XL's "AA" financial strength rating on Rating Watch Negativemainly due to uncertainty relating to capital raising. A.M. Best stated that the reserve charge "was larger than we had anticipated, cumulatively for the year," and S & P similarly stated that "[w]e have taken a rating action on XL group because charges were higher than we had anticipated." According to Moody's, "the charges, together with others taken in 2002 and at the time of the acquisition of XL Reinsurance America in 1999, called into question the quality of the underwriting and actuarial controls under the operation's former NAC Re control." A report issued by Deutsch Bank-North America on January 15, 2004 discussed managements' corrective actions to assure that further revenue shortfalls would not occur, stating: "Reserve review appears to be comprehensive.... Reserve charge appears extremely conservative.... The company appears to be taking a number of steps in its reserving process to reduce the possibility of reserving errors in the future."5

Also on January 14, 2004, XL announced the firing of two executives, namely C. Fred Madsen, President of NAC Re reinsurance operations, and Martha Bannerman, XL's General Counsel and Chief Administrative Officer of its NAC Re reinsurance operations. One week later, Defendant Brown, Chief Executive Officer of XL's insurance and formerly Chief of Reinsurance Operations at NAC Re, left the Company.

On May 18, 2001 and September 4, 2001 respectively, XL issued $1.01 billion principal amount at maturity of Zero Coupon Convertible Debentures ("CARZ") and $509 million principal amount at maturity of Liquid Yield Option Notes ("LYONs"). Each of the CARZ and LYONs debt securities gave bondholders the right to require XL to repurchase the bonds on predetermined dates ("put" dates) at predetermined values. During the Class Period, a put date for the CARZ was scheduled to occur on May 23, 2002 and for the LYONs on September 7, 2002 and September 7, 2003. The repurchase obligations were also subject to credit ratings assigned by S & P's bond rating agency, such that if XL's financial strength and credit ratings fell below the level of "BBB+," that too would trigger bondholders' rights to demand conversion into shares at 5.9467 shares per CARZ and 5.277 shares per LYONs.

The Individual Defendants named in this suit hold various positions at XL and XLRA. Brian M. O'Hara is and was, at all times during the Class Period,...

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