The opinion of the court was delivered by: John F. Keenan, United States District Judge
Defendants move to dismiss with prejudice the consolidated amended class action complaint ("Complaint") in this securities fraud action for alleged violations of the Securities Exchange Act of 1934; § 10(b) ("10(b)"), § 20(a) ("20(a)"), and Rule 10b-5 ("10b-5") promulgated thereunder.*fn1 For the reasons discussed below, the Complaint is dismissed without prejudice.
Many of the allegations in the Complaint are supported by the recollections and opinions of six confidential witnesses ("CW"s), all of whom were employees or agents of Universal or its subsidiaries at all relevant times. (Compl. ¶ 21.) The action is brought on behalf of those who purchased the securities of defendant Universal American Financial Corporation ("Universal") between February 16, 2005 and October 28, 2005 (the "Class Period"). Plaintiffs allege that Universal, a health and life insurance company, issued false and misleading statements regarding the financial performance of its senior citizen health care segment ("Senior Segment") as part of a scheme to allow insiders to sell their privately held shares while the shares were artificially inflated.
Notably, Plaintiffs do not allege that any of the reported financial results for the company were false. Rather, Plaintiffs allege that Defendants' statements accompanying financial reports painted an overly optimistic and misleading portrait of the Senior Segment. As a result of this alleged scheme, Plaintiffs purchased inflated common stock that dropped in value after the company announced a decline in net income on October 28, 2005.
The Complaint contains three counts. Count I is brought against Defendants Universal, Barasch, Waegelein, and Bryant for violations of 10(b) and 10b-5. Count II is brought against Defendant Wehner for violations of 10(b) and 10b-5(c). Count III is brought against all of the individual defendants for violations of 20(a).
Defendant Universal and its subsidiaries sell insurance in the United States and Canada. Universal primarily sells Medicare Supplement,*fn2 Medicare Advantage,*fn3 fixed benefit accident and sickness disability insurance, senior life insurance, and fixed annuities. (Compl. ¶¶ 7, 28.)
Universal monitored its medical loss ratio ("MLR") at all relevant times to gauge the strength of its business. MLR measures the ratio of a company's collected premiums versus the expenses it incurs in providing health care. An increase in this ratio indicates that the company is growing less profitable. (Compl. ¶ 33.) Universal also monitored its level of Lapsation (non-payment of premiums by policyholders) and Rollover (sales agents transferring business to competitors). (Compl. ¶ 34.)
During all relevant times, Defendant Richard A. Barasch ("Barasch") was Universal's Chairman, President, and Chief Executive Officer ("CEO"). Defendant Robert A Waegelein ("Waegelein") was Universal's Executive Vice President and Chief Financial Officer ("CFO"). Defendant Gary W. Bryant ("Bryant") was Universal's Executive Vice President and Chief Operating Officer ("COO"). Defendant William E. Wehner ("Wehner") was director and President of Pennsylvania Life Insurance Company, a subsidiary of Universal. (Compl. ¶ 8.)
During the Class Period, Barasch "sold 160,000 shares of his personally-owned stock at artificially inflated prices, for gross proceeds of $3.24 million." Waegelein "sold 60,000 shares of his personally-owned stock at artificially inflated prices, for gross proceeds of $1.37 million." Bryant "sold 120,000 shares of his personally-owned stock at artificially inflated prices, for gross proceeds of $2.74 million." Wehner "sold 150,000 shares of his personally-owned stock at artificially inflated prices, for gross proceeds of $2.63 million." (Compl. ¶¶ 8, 96.)
According to the Complaint, these sales were made while each Defendant was in possession of private material adverse information "which they knew would negatively impact Universal stock once it was made public." (Compl. ¶ 96.) The sales were also allegedly unusual compared to Defendants' sales prior to the Class Period and represented a "significant portion" of each Defendant's holdings. (Compl. ¶ 96.)
1. February through March 2005
The Class Period begins on February 16, 2005, the day Universal issued a press release announcing "record" financial results for its fourth quarter ended December 31, 2004 and year end 2004. The press release reported net income of $17.4 million, earnings of $.30 per diluted share, and total revenue of $206.6 million. Plaintiffs do not allege that these reported financial results were false. Instead, Plaintiffs take issue with Defendant Barasch's comments in the report regarding Universal's Senior Segment:
We are especially pleased with our improved strategic position in the senior health insurance market. . . . As this market for individual senior health insurance grows, our company is well-positioned to offer the full range of needed products. . . . .
The Senior Solutions program is a key part of our efforts to increase senior market sales. We continue to emphasize recruiting and new office expansion, and we have begun to see the results in new sales. . . . .
For the full year, the loss ratio on our Medicare supplement business increased by 80 basis points to 69.1% from 68.3 percent in 2003 and segment income was 1% lower than last year. We have already begun to apply for and implement rate increases that should allow us to reverse this trend. (Compl. ¶ 47.) According to the Complaint, these statements were misleading because Defendants did not disclose that rate increases would be higher than expected and that the rate increases would hurt rather than help the company.
To support these allegations, the Complaint relies on Universal's application with the Department of Insurance in states in which it conducted business for a rate increase in its Medicare Business. These applications were made some time in early 2005, no later than April 2005. The applications, according to the Complaint, were not readily available to the public. Universal allegedly detailed in the applications "the condition of its business in an effort to justify the requested rate increase." (Compl. ¶ 36.) Plaintiffs assert that the condition of the business detailed in the applications was materially different from the condition of the business disclosed to the public.
Plaintiffs also rely on the opinions of the CWs to demonstrate the alleged falsity of Defendants' statement about the magnitude of the rate increases sought. In CW-1's opinion, "[Universal knew the that the loss ratio was going to go way up because of [the rate increase] -- they're not stupid."*fn4 (Compl. ¶ 38a.) According to CW-6, "universal executives, including Defendant Wehner, knew that the significant rate increase . . . would create a huge gap between Universal's premiums and those of the Company's competitors and, in effect, cause sizeable Lapsation, Rollover and loss of overall business." (Compl. ¶ 39c.)
CW-1 had attended a meeting led by Universal executives, including Defendants Barasch, Bryant, and Wehner, from January 8, 2005 through January 21, 2005 in Florida ("January 2005 Meeting"). (Compl. ¶ 38a.) At the meeting, CW-1 recalls being told, though it is not clear by whom, "that despite the Company's rate increase only three weeks earlier on January 1, 2005, there were already plans to implement further rate increases during 2005." CW-1 also recalls Universal's chief actuary saying "they were going to have a big rate increase." CW-1 was told, though again it is not clear by whom, that these changes were being made because Universal's "loss ratio is so terrible." At this meeting, according to CW-1, the Company's sales managers were shown a PowerPoint presentation in which "the Company's MLR was significantly higher than the MLR disclosed to the public in the Company's financial reports." (Compl. ¶ 38a.)
CW-2 also attended a meeting in Florida in early 2005, though it is not clear whether it was the January 2005 meeting attended by CW-1. At this meeting, "senior management told 'us that the claims losses were just horrendous' and that 'the claims losses were higher -- we're going to have big rate increases.'" (Compl. ¶ 38b.)
The day after the press release was issued, on February 17, 2005, Universal held a conference call with investors and analysts. On the call, Defendant Barasch stated as follows:
As [the senior] market grows and as more individuals within this demographic segment need to acquire some sort of health insurance coverage, our Company is an in [sic] position to offer the products that are needed whether on the indemnity side or the managed care side. . . . .
We're very optimistic about our ability to keep growing the senior health insurance business through our career agents. . . . As these new [22 Senior Solutions] offices take root, we expect that this branding of our product line will lead to better recruiting and higher sales in the near term. . . . .
[O]ur senior market brokered segment was somewhat disappointing this quarter as a result of higher than expected Med-Sup loss ratios. For the full year loss ratio in our Med-Sup asset business increased by 80 basis points to 69.1 percent up from 68.3 percent last year and consequently segment income was 1 percent lower than last year. We've already begun to apply for and implement rate increases that should allow us to reverse this trend through the course of 2005. . . . .
We're confident that this positive trend in new sales activity in the Medicare Advantage segment will continue. . . . .
But even with increases competition we think we are well-positioned to continue our pattern of growth. . . . .
With our existing strength in Medigap, our growing presence in the Medicare Advantage market . . ., we think we are in an excellent strategic position to benefit from the enormous opportunities that exist in the senior health insurance market. . . . .
[W]e anticipate earnings for 2005 in the range of $1.17 to $1.24 per diluted share excluding realized gains. . . . Keep in mind that Medicare supplemental loss ratios are higher in the first quarter as policyholders satisfy their Medicare deductibles and then the loss ratios trend lower through the balance of the year. (Compl. ¶ 49.)
The conference call included a question and answer session in which Jason Zucker, an analyst at Fox-Pitt, asked Defendant Barasch, "Can you talk about price increases that you've been getting on average . . . ?" Barasch answered, "we think they're going to be 8 or 9 -- between 8 and 10 percent going forward." (Compl. ¶ 51.)
Barasch's general characterization of the Senior Segment's current and future prospects was allegedly false and/or misleading, as was his predicted rate increase range. Barasch allegedly knew that Universal's Senior Segment was not healthy, that earnings-per-share would be lower than predicted, and that the rate increases would be higher than predicted. In CW-1's opinion, Defendants "would have known the negative impact that increasing rates would have on the Company's performance as rate increases would make it more difficult for the Company's agents to sell Universal's policies," which "would, in turn, lead to increased Lapsation and Rollover." (Compl. ¶ 39a.) In CW-5's opinion, "the market is competitive and people are inclined to move when the price increases." (Compl. ¶ 38c.)
As of the February 2005 press release, Universal stock was trading at approximately $16 per share.*fn5 On March 1, 2005. Universal's stock dipped down below $16 and was trading at approximately $15.83 per share. On this date, an "[i]nsider s[old] 20,000 shares for $316,552." (Compl. ¶ 46.)
On March 16, 2005, Universal filed a 10-K with the Securities and Exchange Commission ("SEC"), which reiterated Universal's financial results for the fourth quarter and year ended December 31, 2004. The report stated that Universal routinely monitored its MLR to ensure compliance with loss ratio standards required by state law, that the company requested rate increases when needed, that the company believed its prices, products, and customer service were competitive, and that Universal management "has not identified any material weaknesses in our internal control over financial reporting." (Compl. ¶ 53.) The 10-K was accompanied by certifications by Barasch and Waegelein, attesting to the accuracy and completeness of the reports. (Compl. ¶ 55.) This information was allegedly false and misleading because Barasch and Waegelein knew the reports were not complete or accurate.
Between April 1, 2005 and May 2, 2005, Universal's stock price fluctuated between approximately $16 and $18 per share. During this period, "Insiders s[old] 190,000 shares for $3,310,776." (Compl. ¶ 46.)
On May 3, 2005, Universal issued a press release announcing "record" financial results for its first quarter ended March 31, 2005. The company reported net income of $16.1 million, earnings per diluted share of $.28, and total revenues of $224.3 million. Again, Plaintiffs do not challenge the reported financial results, but instead take issue with Defendant Barasch's comments in the report about the Senior Segment:
Led by outstanding results in our Medicare Advantage segment, we are very enthusiastic about our strategic position in the senior health insurance market. To complement our Medicare supplement franchise, we are now building a Medicare Advantage business as well. As the market for individual senior health insurance grows, our company is well-positioned to offer the full range of needed products. . . . .
[R]esults in our Senior Market Health segment were negatively impacted by higher morbidity, primarily from the increase in the deductible for Part B coverage. Our Medicare supplement loss ratio increased 140 basis points . . ., leading to a 14% decrease in segment income for the quarter. We have already applied for and will implement rate increases that should allow us to reverse this trend. As we have discussed previously, first quarter results in the Medicare supplement business are impacted by loss ratios that are seasonal and predictably higher than in the succeeding quarters, and we expect to see improvement throughout the balance of the year.
Our senior market sales force continues to perform well. (Compl. ¶ 57.)
During a conference call with investors and analysts the next day, Barasch essentially repeated what was stated in the report. (Compl. ¶ 59.) The results were again repeated in Universal's 10-Q, filed with the SEC on May 10, 2005. (Compl. ¶ 61) The 10-Q was accompanied by certifications from Barasch and Waegelein attesting to the accuracy and completeness of the reports. (Compl. ¶ 63.) Plaintiffs allege that these statements were false or misleading because Barasch knew the MLR was affected by factors other than seasonality and because he knew the sales force was not performing well.
At some time in May 2005, CW-6 recalls "[w]e asked how can it be so bad when the stock is doing so well and [Wehner] said well, it hasn't gotten out to the stock yet and it's our job to keep the stock looking as good as it can as long as possible." According to CW-6, "[t]his was a direct quote from Bill Wehner who was the president of the company." (Compl. ¶ 43.) At some other point in time, not made clear in the Complaint, CW-6 recalls Wehner saying "why we're selling it is none of your business and yes, business is bad, so yes, of course, [shares are] going to go South." (Compl. ¶ 44.)
Between May 3, 2005 and June 1, 2005, Universal's stock fluctuated between approximately $17 and $19.5. On June 1, 2005, an "Insider s[old] 20,000 shares for $378,200"; for presumably $18.91 per ...