The opinion of the court was delivered by: Robert P. Patterson, Jr., U.S.D.J.
On July 16, 2007, Plaintiff Harold Zirkin ("Zirkin") on behalf of those who purchased preferred stock between December 14, 2005 and March 2, 2006 (the "Class Period"), filed an amended Complaint ("Compl.") in the above-captioned class action against Defendants Quanta Capital Holdings Ltd. ("Quanta" or the "Company"), Quanta's individual officers and directors (James J. Ritchie, Jonathan J.R. Dodd, Robert Lippincott III, Michael J. Murphy, Nigel W. Morris, and W. Russell Ramsey), and the two underwriters (Friedman, Billings, Ramsey & Co. ("FBR") and BB&T ("BB&T")) who underwrote the December 14, 2005 preferred stock offering by the Company. The Complaint seeks recovery pursuant to Sections 11, 12(a)(2), and 15 of the Securities Act of 1933. See 15 U.S.C. §§ 77k, 77l, 77o.
On September 28, 2007 both Quanta (and its individual employees) and the underwriters each separately filed motions to dismiss pursuant to Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim upon which relief may be granted. Argument was heard by the Court on April 3, 2008. For the reasons that follow, Defendants' motions are granted, and the Complaint is dismissed.
1. The Complaint and Related Documents
Quanta was incorporated on May 23, 2003 as a Bermuda holding company formed to provide specialty lines of casualty insurance, reinsurance, risk assessment, and risk-consulting services.*fn1 (Compl. ¶ 28.) After raising approximately $550 million in startup capital through an August 2003 private equity offering, the Company began substantive operations in September 2003.*fn2 (Id. ¶ 28.)
The Company's primary business consisted of providing "specialty lines" of insurance and reinsurance for "risks that are often unusual or difficult to place and do not fit the underwriting criteria of standard commercial products." (Id. ¶¶ 29-31.) As a result, Quanta's products "require extensive technical underwriting skills and risk assessment resources and, in many cases, engineering expertise, in order to be profitably underwritten." (Declaration of Andrew Ruffino, dated September 28, 2007 ("Ruffino Decl."), Ex. O [Quanta's 2005 Annual Report] at 1, 4.)
Reinsurance policies are a "means by which an insurance company can protect itself against the risk of losses with other insurance companies." (Compl. ¶ 29.) Reinsurance can be written either through treaty or facultative reinsurance arrangements. (Id. ¶ 30.) Treaty reinsurance contracts provide for automatic reinsuring of a category of risk underwritten by the ceding company, while in facultative reinsurance contracts the ceding company cedes, and the reinsurer assumes all or part of a specific risk or risks. (Id.) Quanta wrote most of its reinsurance business on a treaty basis, with a limited amount of facultative reinsurance for property, casualty, marine and aviation exposures. (Id.)
Independent rating agencies ascribe ratings to insurance and reinsurance companies such as Quanta. (Compl. ¶ 34.) These ratings are a "critically important metric" with which to evaluate the "overall financial strength of the prospective insurer or reinsurer." (Id.) A.M. Best, an independent credit rating company "widely recognized as the preeminent rating agency within the insurance and reinsurance markets," bases its rating on a company's "available and required rated capital" to support its operations. (Id. ¶ 34.) From the time of its founding through March, 2006, when Quanta was downgraded, A.M. Best awarded Quanta an "excellent" (A-) rating. (Compl. ¶ 36.)
Maintaining an A.M. Best "excellent" rating was of "paramount" importance for Quanta. (Compl. ¶¶ 35-36.) In the "Risk Factors" section of Quanta's October 27, 2005 shelf Registration Statement for the preferred shares offering, Quanta explained that:
[a] ratings downgrade would adversely affect our ability to do business . would result in a substantial loss of business . and would also constitute a default under our credit facility and under certain other agreements . Additionally, ceding companies will have the right to terminate a significant portion of our reinsurance treaties below our current rating of A-. We intend to work closely with A.M. Best to maintain our current A.M. Best rating. In this regard, we are reviewing our capital structure, developing a capital raising plan and implementing plans to conduct an internal analysis of our technical risk property and property reinsurance lines of business and the efficacy of our catastrophe models over the next few months. (Compl. ¶ 36; Ruffino Decl., Ex. E [Form S-3 filed 10/27/05] at 6.)
C. Hurricanes Katrina and Rita -- Changes in Loss Estimates Over Time
Hurricane Katrina struck Louisiana, Mississippi, and Alabama on August 29, 2005, causing significant destruction with damages estimated at $16 billion. (Compl. ¶¶ 37-38.) On September 24, 2005, Hurricane Rita struck Texas and Louisiana, causing $4-$7 billion in damages, and in October 2005, Hurricane Wilma struck southern Florida. (Compl. ¶¶ 39-40.) Quanta provided insurance and reinsurance coverage for properties in the areas affected by these hurricanes. (Compl. ¶¶ 37-44.)
In an October 4, 2005 press release, Quanta issued its first loss projections related to the hurricanes, reporting that the "retained net losses from hurricanes Katrina and Rita [were] expected to be in the ranges of approximately $40 to $50 million and approximately $2 to $8 million, respectively," or $42-$58 million combined. (Ruffino Decl., Ex. D [Form 8-K, Press Release dated 10/4/05].) The press release cautioned that these numbers were only "estimates" based on a "review of [Quanta's] potential exposure to these events" and were not "based on actual reported losses." (Ruffino Decl., Ex. D.) The Company further warned that it would: not know our exact losses for some time given the uncertainty around the industry loss estimates, the size and complexity of hurricanes Katrina and Rita, limited claims data and potential legal and regulatory developments related to potential losses. As a result, our loss reserves may vary significantly from those disclosed above.
On October 5, A.M. Best placed the financial strength of Quanta, which was rated "excellent" (A-), under review with "negative implications." (Compl. ¶ 41.) The next day, Quanta responded to A.M. Best's decision to review the Company's rating by discontinuing the writing of new business in the "technical risk property and property reinsurance lines" pending an internal review. (Compl. ¶ 46; Ruffino Decl., Ex. D.) The Company also stated that it would review its "capital structure and develop[e] a capital raising plan" to fend off a potential ratings downgrade by A.M. Best. (Compl. ¶ 46.)
Three weeks later, on October 26, 2005, Quanta announced additional losses from hurricanes Katrina and Rita, stating that the Company's "total estimated net losses," which would be reflected in the Company's third-quarter results, were "approximately $68.5 million, including reinstatement premiums." (Compl. ¶ 51; Ruffino Decl., Ex. F [Form 8-K, Press Release dated 10/26/05]). The press release also emphasized that the aforementioned figures were "preliminary loss estimates." (Ruffino Decl., Ex. F.)
The change in our estimate for hurricanes Katrina and Rita arises out of increases in losses reported by our reinsurance customers and additional information from our loss adjusters in our primary insurance business . We note that there is still substantial uncertainty around all of these estimates and that we will not know our exact losses for some time. As a result, our loss reserves may move positively or negatively depending upon actual losses reported. (Id.)
The next day, on October 27, Quanta filed a shelf-registration form with the SEC, stating that it may issue "up to $125 million" of securities in the form of preferred shares and junior subordinated debt. (Ruffino Decl., Ex. E [October 27, 2005 S-3 Form], at 1.) The shelf-registration statement reiterated that the estimated net losses from hurricanes Katrina and Rita were $68.5 million. (Compl. ¶ 52; Ruffino Decl., Ex. E at 7.) These estimates were the Company's "best estimates based on all the information" the Company had "to date," and the estimates were "derived from a review of our potential exposure to these events and [were] not based on actual reported losses." (Compl. ¶ 53; Ruffino Decl., Ex. E at 7.) The Company warned that these losses "have had . a material adverse effect on [the Company's] ability to write new and renewal business and [the Company's] results of operations and financial condition." (Compl. ¶ 52; Ruffino Decl., Ex. E at 7.)
The shelf Registration Statement acknowledged that the hurricanes from 2004 and 2005 have had a "material adverse effect" on the Company's "ability to write new and renewal business and [the Company's] results of operations and financial condition," and it warned about reporting lags, stating that "there always exists a reporting lag between a loss event taking place" and "the reporting loss" to Quanta, and that these "reported losses are inherently difficult to predict" because the "property catastrophe market [was] inherently complicated." (Ruffino Decl., Ex. E at 7, 8, 11.) As a result, the Company would "not know [its] exact losses for some time given the uncertainty around the industry loss estimates, the size and complexity of Hurricanes Katrina, Rita, and Wilma, limited claims data and potential legal and regulatory developments related to potential losses." (Id. at 8.)
The shelf Registration Statement further warned investors that being "under review with negative implications" by A.M. Best was a risk factor, because this could lead to a ratings downgrade that would "materially and adversely affect our ability to execute our business strategy and our competitive position resulting in a substantial loss of business and business opportunities ." (Ruffino Decl., Ex. E at 4, 6, 12.) It also pointed out that the Company derived a "significant portion" of business "from a limited number ...