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In re Converium Holding AG Securities Litigation

December 28, 2006


The opinion of the court was delivered by: Denise Cote, District Judge

This Document Relates to:


This action pertains to a dramatic drop in the stock price of Converium Holding AG ("Converium"), a Swiss reinsurance company. Plaintiffs, who bring their claims on behalf of a putative class of investors who purchased the company's stock between the initial public offering in December 2001 (the "IPO") and the collapse of Converium's North American business unit in September 2004, claim that defendants intentionally manipulated Converium's finances in order to disguise profound problems with the business. These problems were revealed when Converium was forced to take hundreds of millions of dollars in charges to cover previously undisclosed liabilities.

Plaintiffs bring claims under the Securities Act of 1933 (the "Securities Act") and the Securities Exchange Act of 1934 (the "Exchange Act") against Converium, certain of its officers and directors, and its former parent company. They also bring Securities Act claims against the lead underwriters of Converium's initial public offering. In three separately filed motions, the defendants have moved to dismiss all of the claims against them. The motions brought by the former parent company, the underwriters, and the directors are granted. The motions brought by Converium and its officers are granted in part.


The following facts are taken from the amended complaint filed on September 23, 2005 and the documents to which it refers, unless otherwise noted. Prior to its December 2001 IPO, Converium was a wholly owned subsidiary of defendant Zurich Financial Services ("ZFS"), a Swiss corporation. As a multinational reinsurer, Converium's business is, in basic terms, to provide insurance to other insurers. Converium collects premiums in exchange for exposure to claims made by the insured companies, or "ceding insurers." It sets aside a portion of these premiums as "loss reserves," which represent the amount the company estimates it will have to pay to cover the ceding insurers' claims under the policies that have been written to date. Loss reserves for a given policy are established when the contract is signed, and later revised as claims are submitted and more detailed information becomes available about the likely amount the reinsurer will have to pay under the policy. Loss reserves are the largest expense item on Converium's income statement. Here, the thrust of plaintiffs' claim is that defendants knew -- and hid from the investing public -- that Converium's loss reserves were hundreds of millions of dollars less than they needed to be to cover the company's exposure.

I. The Pre-IPO Business

According to the amended complaint, the problems were centered in the North American business unit of Converium, which did business as Zurich Re (North America) prior to the IPO.*fn1

Zurich Re (North America) and Converium North America were by far the largest business units of ZFS and Converium, respectively. In 1998, when defendant Dirk Lohmann ("Lohmann") became the CEO of ZFS's reinsurance business, there were indications that losses under policies written by Zurich Re (North America) for the 1996 and 1997 policy years were significantly higher than expected and that the premiums being charged for those policies were insufficient to cover the claims. Zurich Re (North America) monitored its business through quarterly loss reserve studies that were presented to defendants Lohmann, Martin Kauer ("Kauer"), Converium's CFO, and Richard Smith ("Smith"), the CEO of Converium North America.*fn2

According to plaintiffs, at the end of 2000, these studies showed a reserve shortfall of at least $100 million. And by early 2001, it had become clear that there had been significant underpricing in the 1998, 1999, and 2000 policy years as well, and that Zurich Re (North America)'s reserve deficiency was a severe problem.

As a result, ZFS decided to exit the reinsurance business. In order to determine how to do so, it hired Tillinghast-Towers Perrin ("Tillinghast"), an actuarial consulting firm, to provide an independent estimate of the company's loss reserves. Tillinghast performed separate studies of the North American and German businesses of Zurich Re and in April 2001 determined that Zurich Re (North America) was under-reserved by $350 million.*fn3

According to the amended complaint, the Officer Defendants knew that they could not conduct a sale or public offering of their reinsurance business with such a large deficit, nor could they increase the reserves by that amount, as it would undermine market confidence in the company's business.

Lohmann and Kauer decided that the maximum reserve increase that they could afford to make was $125 million, and they embarked on a campaign to "convince" Tillinghast that this would be sufficient. Over the next few months, executives "pulled out every stop" and "worked [Tillinghast] to death." In response, Tillinghast's estimate of the reserve deficit did indeed come down. By the summer, it had dropped to $186 million, but "the Company's senior management knew that Tillinghast's original 'best estimate' of $350 million was accurate."*fn4

Through a press release of September 6, 2001, Converium*fn5 announced that ZFS would be spinning off Converium in an initial public offering, stating that ZFS had selected this method for exiting the reinsurance business "following consideration of a number of alternatives." The release also noted that Converium had added to its reserves earlier in the year:

During the second quarter of 2001, following an independent actuarial review, Converium undertook reserve strengthening amounting to $112 million. As a result, Converium's loss reserves at Dec. 31, 2000 correspond to the consulting actuaries' best estimate of provisions for net loss and loss adjustment expenses.

The strengthening consisted of a $125 million increase in North American reserves and a $13 million decrease in European reserves.

Converium was legally registered as an independent entity on October 1, 2001. As part of the "road show" presentation to potential investors in the months that followed, Converium stated that its loss reserves had been "thoroughly examined by Tillinghast" and booked "at Tillinghast's 'best estimates.'" It also cited its high credit ratings -- "A" from Standard & Poor's and "A" from A.M. Best. The prospectus prepared for the IPO (the "Prospectus") echoed the claim that the loss reserves were consistent with Tillinghast's best estimates, and stated that the $112 million strengthening -- which had been undertaken in response to "adverse loss development across several lines of [Converium's] business mainly related to general liability and umbrella policy business underwritten in 1996 through 1999" --was sufficient to maintain the reserves at adequate levels:

[The] reserve strengthening discussed above was determined in accordance with our loss reserving policies ... and was recorded in accordance with our established accounting policies as described in Note 2(c) of our historical combined financial statements.

Our revised estimate of reserves, based mainly on the new ceding company reported data, was in line with Tillinghast's principally top-down reserve estimate within its range of estimates.

The Prospectus assured investors that Converium established its reserves "on the basis of facts available at the time" and that its reserves "were reasonable estimates based on the information known at the time [the] estimates were made." Investors were warned, however, that the stated reserves might "prove to be inadequate to cover our actual losses." The registration statement filed with the SEC in connection with the Converium IPO (the "Registration Statement") incorporated the Prospectus and was signed by each of the Officer Defendants and each of the Director Defendants except Clarke.


The IPO, which was conducted on December 11, 2001, resulted in the sale of 35 million shares of Converium stock at a price of 82 Swiss Francs per share, or $24.59 per American Depository Share ("ADS").*fn6 The IPO generated approximately $1.76 billion in proceeds -- the largest IPO of a reinsurance company in history. The two lead underwriters of the IPO, Merrill Lynch International ("Merrill Lynch") and UBS AG ("UBS") (collectively, the "Underwriter Defendants"), sold more than 11 million shares each and, along with the other underwriters, shared fees of approximately $54 million. On January 9, 2002, ZFS issued a press release stating that it had sold its remaining 5 million shares of Converium stock to the Underwriters. This move brought the total number of shares on the market to 40 million, and left ZFS with no ownership stake in Converium.

III. Post-IPO Problems

Following the IPO, the North American business continued its downward spiral. Just 20 days after the offering, Converium North America experienced an $80 million "adverse loss development," meaning that, without further strengthening of reserves, its reserve deficiency would grow by that amount. In each of the following quarters of the financial year, Converium's actuaries identified additional adverse loss developments. This information was reported to Smith and passed along to Lohmann and Kauer, who, despite being based in Switzerland, directly reviewed and approved decisions regarding North American reserves. Although the Officer Defendants authorized a total of $176 million in reserve increases for Converium North America in 2002, plaintiffs contend that they were aware that the reserve shortfall was in fact much greater. One internal Converium study concluded that at the end of 2002, Converium North America's loss reserves were still $293 million below the necessary level. During the Class Period, Converium North America maintained reserves of approximately $2 billion.

By the spring of 2003, Converium's board had grown concerned with the reserving issues and retained B&W Deloitte ("Deloitte"), an actuarial consulting group, to conduct an independent study of Converium's loss reserves as of the end of 2002. In May 2003, Deloitte presented its preliminary results, which showed that Converium North America had a $437 million deficit in its reserves. This figure did not take into account certain problematic policies that required high reserves, and thus the company's true deficiency was likely even higher than Deloitte's initial estimate. Even at the $437 million level, Deloitte's study indicated that Converium North America was carrying nearly 20% less in loss reserves than it should have. If Converium had disclosed this shortfall and increased its reserves by $437 million, it would have wiped out all of the company's net income for 2002 and 2003 and resulted in a $145 million loss for that period.

Converium received additional bad news when, during the first half of 2003, Converium North America experienced a $340 million adverse loss development. According to plaintiffs, this meant that Converium North America was under-reserved by $777 million as of June 30, 2003. Instead of addressing these problems, Converium executives set out to disguise them. In the second half of 2003, Converium announced that it would no longer report results by geographic segments, but by business segments. This, according to plaintiffs, was an attempt to disguise the worsening fortunes of Converium North America. In addition, Lohmann had some of Converium North America's worst policies transferred to Converium Zurich's books, and he increased the company's loss reserves by $155 million without public disclosure. Plaintiffs claim that, notwithstanding these efforts, Converium North America was still under-reserved by at least $500 million at the end of 2003.*fn7

IV. Post-IPO Public Statements

Plaintiffs contend that, despite evidence that the outlook for Converium North America was dire, Converium and its executives publicly painted a very different picture of the company's finances during this time. In early 2002, Converium made public its financial results for the year ending December 31, 2001. The company reported a net loss of $367 million, but downplayed the figure as being symptomatic of industry-wide issues caused in large part by the September 11 attacks and the Enron debacle. In its 2001 annual report, Converium announced that it had "recorded an addition of $11.6 million of net adverse loss reserve development." The press release in which the results were reported claimed that Converium nonetheless had "a very solid balance sheet" and had "substantially improved [the] underlying adjusted non-life" business in 2001.*fn8

On July 29, Converium issued a press release announcing its financial results for the first six months of 2002. It reported significant improvement over the previous year: Net income for the period was $32 million, compared to a net loss of $61 million during the same months during the prior year. The company touted the results and asserted that Converium was maintaining "[s]trong reserve levels." With respect to Converium North America, the company also reported improvement: The business unit booked a net loss of $18 million, compared to a loss of $81 million during the same portion of the prior year. This included a net adverse loss development of $20 million, which represented the lion's share of the company's overall $24 million addition to its loss reserves. On the same date, Converium filed a Form 6-K with the SEC containing the same financial results reported in the press release. Lohmann's letter to shareholders, included in the Form 6-K, stated that the company was continuing "to closely monitor the adequacy of our reserves for losses and loss adjustment expenses to uphold high reserving standards."

On September 6, Standard & Poor's issued a press release announcing that it had affirmed Converium's A rating and forecast "a significant improvement in operating performance" for the full 2002 year. On October 28, before trading in Switzerland or New York opened, Converium issued a press release announcing its financial results for the third quarter of 2002. It reported a net loss of $6 million and noted that during the quarter, Converium had increased its loss reserves by $60 million, $47 million of which was recorded by Converium North America. Converium also stated that, in light of the ongoing effects of the "soft market period of 1997-2000," it would be conducting further actuarial studies and anticipated adding up to $75 million to its reserves in the fourth quarter. In a press release, Lohmann addressed the reserve adjustments:

Our situation is not much different from that of the rest of the market and many of our competitors face the same issues. The question is how long they can avoid or hide the truth. I firmly believe that this step will prove to be the precursor of further adjustments within the industry.

Converium is facing pressure from prior years and contracts that from an underwriting standpoint we left long behind us. However, it is the nature of our business that problems surface with a significant time lag. We are proactively addressing the issues, and taking the pertinent measures to solve them.

In a conference call with analysts that day, Lohmann stated:

I do also feel that we have turned the corner on the reserve thing with this further study ... I really feel very strongly that [in] 2003 you are not going to see this sort of development impairing our good performance in the business year 2003, and the improvements that we had hoped would flow through fully in the bottom line of 2002 will flow through in 2003.

The announcement of the reserve adjustments impacted the market: The ADSs had closed the previous trading day at $22 and dropped more than 10%. A similar slide was seen in the Swiss shares.

On November 19, 2002, Converium issued a press release stating that it had "finalized" its reserve analysis and would increase reserves by $70 million as a result. The company said that the reserve increase was due to "the continued emergence of increased reported losses versus ...

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