The opinion of the court was delivered by: Robert P. Patterson, Jr., U.S.D.J.
On July 16, 2007, Plaintiff Washington State Plumbing and Pipefitting Pension Trust ("WA Trust"), on behalf of those who purchased common stock between October 4, 2005 and April 3, 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 common 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. The Complaint additionally seeks recovery pursuant to Sections 10(b) (Rule 10b-5 promulgated thereunder) and 20(a) of the Exchange Act of 1934. See 15 U.S.C. §§ 78j(b), 78t(a); 17 C.F.R. 240.10b-5.
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 Public Documents*fn1
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.*fn2 (Compl. ¶¶ 26-27.) After raising approximately $550 million in startup capital through an August 2003 private equity offering, the Company began substantive operations in September, 2003.*fn3 (Compl. ¶¶ 26-27, 55-56.) On May 14, 2004, the Company registered the shares sold in the initial private offering and went public on the Nasdaq stock exchange, trading under the ticket "QNTA." (Compl. ¶ 27.)
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." (Compl. ¶¶ 55-56.) 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.)
Independent rating agencies ascribe ratings to insurance and reinsurance companies such as Quanta. (Compl. ¶ 60.) 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. (Compl. ¶¶ 61-62.) Specifically, a company's A.M. Best rating is derived from its "Best's Capital Adequacy Ratio" or "BCAR" score, which, in turn, is ascertained from an "in-depth evaluation of a company's balance sheet." (Compl. ¶ 66.) While taking into account other factors, the BCAR model primarily considers a company's "premium-to-surplus" ratio. (Id. ¶ 67.)
A.M. Best assigns one of 16 ratings to insurance companies, ranging from A and A (superior) and A, A- (Excellent) to B, B (Very good), down to F (in liquidation) and S (suspended). (Compl. ¶ 62.) From the time of its founding through March 2006, when Quanta was downgraded, A.M. Best awarded Quanta an "excellent" (A-) rating. (Compl. ¶ 63.) As Quanta described in a May 26, 2005 analyst presentation, if the Company let their premium-to-surplus ratio fall below 1.1-to-1, a ratings downgrade from A.M. Best would probably result. (Id. ¶¶ 68-69.) Hence the "amount of surplus dictated the amount of premiums Quanta could underwrite and still retain its 'excellent' rating." (Id. ¶ 71.)
Maintaining an A.M. Best "excellent" rating was of significant importance for Quanta. (Compl. ¶ 63.) In the Company's December 24, 2003 prospectus in connection with its Initial Public Offering, the Company wrote that "a significant ratings downgrade [from A.M. Best] would result in a substantial loss of business as policyholders and ceding companies purchase insurance or reinsurance from companies with higher . financial strength ratings." (Compl. ¶ 63.)
In the "Risk Factors" section of Quanta's October 27, 2005 Registration Statement for the preferred shares offering, Quanta reiterated these sentiments:
[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. ¶¶ 63-65; Ruffino Decl., Ex. E [Form S-3 filed 10/27/05] at 6.)
C. Losses from the 2004 Hurricane Season
Four hurricanes struck the United States during the third-quarter (July to September) of 2004. (Compl. ¶¶ 76-77.) In an October 7, 2004 press release, the Company reported $46 million in after-tax net losses from those hurricanes. (Id. ¶ 77.) This $46 million loss figure was confirmed one month later in a November 2, 2004 press release. (Id. ¶ 78.)
On November 3, 2004, the Company held a press conference at which it explained that it needed to stay within the "mandated 1.1-to-1" premium-to-surplus ratio necessary to maintain an A.M. Best "excellent" rating. (Compl. ¶ 79.) On December 22, 2004, the Company raised $40 million in a private placement offering, and on February 24, 2005, the Company raised an additional $20 million in a second private placement. (Id. ¶¶ 81-82.) This capital infusion enabled the Company to remain within the mandated 1.1-to-1 premium-to-surplus ratio, and A.M. Best reaffirmed Quanta's "excellent" rating.*fn4 (Id. ¶ 83.) In Quanta's year-end 2004 results released on March 14, 2005, the Company reported an additional $21.3 million in losses stemming from the four hurricanes that struck the United States during the third-quarter of 2004. (Id. ¶¶ 83-84.)
D. Loss Reserves for Pacific Energy's Oil Pipeline Leak
On May 3, 2005, Defendant Russ reported Quanta's first-quarter 2005 financial results in an analyst conference call. (Compl. ¶ 89.) During that call, Quanta revealed a $5 million increased loss reserve for that quarter, stemming primarily from a ruptured oil pipeline owned by Pacific Energy Partners, a company for which Quanta was the primary insurer. (Id. ¶¶ 89-90.) Because Quanta had purchased reinsurance, its net exposure for the ruptured pipeline, which had caused crude oil to spill into a lake, was 50% of the total loss (up to $25 million). (Id. ¶¶ 89-90, 94.) Due to this spill, the Company recorded a $5 million loss reserve for cleanup costs.*fn5 (Id. ¶ 90.)
On August 2, 2005, Quanta reported that it had increased the pipeline loss reserve by $2.5 million in the second-quarter of 2005, to a total of $7.5 million. (Compl. ¶ 95; Ruffino Decl., Ex. C [transcript of 08/02/05 conference call] at 11.) This increase resulted because even though the "oil that was cleaned up on the surface of the lake was believed to be all the oil that existed," some of that "oil apparently had dropped to the bottom of the lake and then later in the [second-quarter] reemerged," requiring additional clean up. (Ruffino Decl., Ex. C at 18.) The initial loss estimate projected by the Company on May 3, 2005 had been its "best estimate at the time." (Id.)
On November 1, 2005, in a conference call to discuss 2005 third-quarter results, Defendant Russ explained that the pipeline loss was the same as previously reported ($7.5 million), and that the spill cleanup was "substantially complete." (Compl. ¶¶ 94, 97-98.) The $7.5 million loss estimate was also included in the November 14, 2005 Form 10-Q the Company filed to report its third quarter 2005 financial results. (Compl. ¶ 98.) That same day, Pacific Energy filed its third-quarter 2005 financial reports with the SEC on Form 10-Q. (Id. ¶ 102.) In its filing, Pacific Energy reported that it had increased its own expected loss from the pipeline spill by $4.5 million, from $15.0 million in the second quarter of 2005 to $19.5 million in the third quarter.*fn6 (Id.)
In Quanta's December 5, 2005 common-stock offering Registration Statement, the Company wrote that "included in our expected ultimate losses during the nine months ended September 30, 2005 is $7.5 million related to damages from a ruptured oil pipeline in California which occurred during the first quarter of 2005." (Compl. ¶¶ 98-100; Declaration of George Borden, dated September 28, 2007 ("Borden Decl."), Ex. B [Registration Statement] at 60.) This loss estimate was based on a "detailed review of affected contracts." (Id. ¶ 99.) In a Form 10-Q released on January 10, 2006, Quanta acknowledged $4.9 million in additional net loss expenses related to the pipeline rupture. (Compl. ¶ 101.) The increase was due to "additional remediation costs at the site" and was based on "a specific remediation plan over an estimated period of time." (Ruffino Decl., Ex. M [Form 8-K filed 01/11/06]). The Company reminded investors that the reported losses from the pipeline rupture "remain[ed] an estimate," and that actual losses could "vary significantly from the estimate, for example, if the plan or its estimated time to completion change[d]." (Id.)
E. 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 material damages estimated at $16 billion. (Compl. ¶ 105.) 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. ¶¶ 106-108.) Quanta provided insurance and reinsurance coverage for properties in the areas affected by these hurricanes. (Compl. ¶¶ 104-07.)
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. (Compl. ¶ 109; 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.
The next day, on October 5, Kenneth Billingsley, an equity research analyst with BB&T, issued a "buy" recommendation for Quanta, writing that while "$84 million in hurricane related losses" was anticipated by the "market," the Company was reporting estimated losses of only $58 million. (Compl. ¶ 110.) In a report issued that same day, equity research analyst John Keefe of Ferris Baker noted that the Company's "losses [were] substantial enough that they will likely provoke rating concerns" from A.M. Best, but that such concerns could be "addressed via raising a modest amount of additional capital," which the Company "should be able to accomplish." (Compl. ¶ 111.) Keefe's suspicions were confirmed because also on October 5, A.M. Best placed the financial strength of Quanta, which was rated "excellent" (A-), under review with "negative implications." (Compl. ¶¶ 111-114.) The price of Quanta's common stock, which had traded at $7.34 on August 24, 2005, prior to the hurricanes, closed at $5.88 on October 5, 2005. (Compl. ¶¶ 112-13.)
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. ¶ 114; 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. ¶¶ 8-9, 104, 111.)
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, would be "approximately $68.5 million, including reinstatement premiums." (Compl. ¶ 116; Ruffino Decl., Ex. F [Form 8-K, Press Release dated 10/26/05]). Upon the release of this news, Quanta's common stock price, which traded at $4.35 on October 25, 2005, closed at $3.82 on October 27, 2005. (Compl. ¶ 117.) The press release emphasized that the aforementioned figures were still "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.)
That same day, Quanta filed a shelf-registration form for a preferred shares offering with the SEC. (Compl. ¶ 116; Ruffino Decl., Ex. E [October 27, 2005 S-3 Form], at 1.) The shelf-registration statement reiterated that the estimated net loss from hurricanes Katrina and Rita was $68.5 million (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 [the Company's] potential exposure to these events and [were] not based on actual reported losses." (Ruffino Decl., Ex. E at 7.) The shelf-registration form acknowledged that the hurricanes from 2004 and 2005 have had a "material adverse effect" on the Company's business, 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 [were] inherently difficult to predict" because the "property catastrophe market [was] inherently complicated." (Ruffino Decl., Ex. E at 8, 11.)
During the Company's November 1, 2005 third-quarter earnings conference call, Defendant Dodd, Quanta's CFO, reiterated that the Company's statements of "total loss impact for Katrina and Rita was $68.5 million." (Compl. ¶ 119.) In that call, Defendant Dodd stated that:
The estimates we have right now are our best estimates based on all the information we have to date. We've been naturally very conservative, continue to be very aggressive in getting a hold of information, which has proved difficult getting access into New Orleans and the various curfews and flood damages did make it difficult. We continually review where we're at. We're actively pursuing information. But we believe the numbers we have right now are solid. (Ruffino Decl., Ex. G at 23 [transcript of 11/01/05 earnings call].)
During that same call, Quanta explained that because it had been put on a "watch" list with negative implications by A.M. Best, it was working to reduce its "exposure to catastrophe," while also raising capital. (Compl. ¶ 119.) These steps were "intended to have [the Company's] current 'A-' rating reaffirmed." (Id.)
Two weeks later, on November 14, 2005, Quanta filed a third-quarter earnings report, listing the same "estimated net [hurricane-related] losses" of approximately $68.5 million. (Compl. ¶ 121; Ruffino Decl., Ex. H [Form 10-Q filed 11/14/05] at 24.) The report stated that this figure was subject to "significant uncertainty" because the Company had "received a limited number of claim notifications relating" to the hurricanes. (Ruffino Decl., Ex. H at 32, 35-36.) The $68.5 million amount was the "Company's best estimate of losses based upon information currently available," and it was derived from a "detailed review of affected contracts and discussion with clients, cedants and brokers" as well as "industry loss estimates." (Ruffino Decl., Ex. H at 13, 32, 35; Compl. ¶ 160.) The Company also stated, in numerous places, that the "actual amount of losses from the hurricanes may vary significantly from the estimate," and that the Company "participate[s] in lines of business where claims may not be reported for some period time after those claims are incurred." (Ruffino Decl., Ex. H at 32, 35-36, 39-40, 49, 56.)
On December 5, 2005, Quanta filed a Registration statement for the secondary offering of approximately eleven million shares of common-stock (Ruffino Decl., Ex. I [Registration Statement filed 12/05/05]), and on December 7, 2005, the Company filed an amended Registration Statement related to that same offering. (Ruffino Decl., Ex. J [S-3/A Statement filed 12/07/05].) Nine days later, on December 16, 2005, Quanta filed a "Definitive Prospectus Supplement" for the secondary offering of common stock (Ruffino Decl., Ex. K [Prospectus for Common Stock Offering filed 12/16/05]; Borden Decl., Ex. B [same]).
The offering documents repeated the $68.5 million "estimate" for the 2005 hurricane losses. (Compl. ¶ 122; Ruffino Decl., Exs. J at 14; K at 14.) The offering documents explained that the estimate was based upon "a combination of a review of in-force contracts and preliminary loss information from our clients, brokers and loss adjusters and the output of industry models," and were "not based on actual reported losses," but rather were "derived from a review of [the Company's] potential exposure to these events." (Ruffino Decl., Exs. J at 2, 17; K at 2, 17, 94.) The net estimated loss reserves figures took "into account the receipt of anticipated recoverable amounts under reinsurance and retrocessional agreements and the effects of reinstatement premiums." (Ruffino Decl., Ex. J at 17.) The Prospectus further explained that the Company's estimate of its: unpaid exposure to ultimate claim costs associated with these losses is based on currently available information, claim notifications received to date, industry loss estimates, output from industry models, a detailed review of affected contracts and discussions with clients, cedants and brokers. (Compl. ¶ 160.) And in the "Risk Factors" section of the Prospectus and Registration Statement, the Company stated that the:
Estimate of net losses is subject to a high level of uncertainty due to the unprecedented nature of the catastrophe, complex coverage and regulatory issues and the unknown impact of such losses on our reinsurers. Our actual losses from Hurricanes Katrina and Rita may differ materially from our estimated losses. If our actual losses from Hurricanes Katrina and Rita are materially greater than our estimated losses, our business, results of operations and financial condition could be materially adversely affected. (Ruffino Decl., Exs. J at 14, 49; K at 14, 94.) The offering documents further explained that:
We believe that we will not know our 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. As a result, our losses may vary significantly from our recorded estimates. (Ruffino Decl. Ex. K at 17, J at 40, 49, 86-87.) The Prospectus reiterated that "[s]ignificant periods of time often elapse between the occurrence of an insured loss, the reporting of the loss to an insurer and payment by the insurer of that loss." (Ruffino Decl. Ex. K at 16-17.) Thus, loss reserves were "only estimates," as estimating loss reserves was a "difficult and complex process involving many variables and subjective judgments.*fn7 (Id.) Further, the offering documents noted:
[T]here always exists a reporting lag between a loss event taking place and the reporting of the loss to us. These incurred but not reported losses are inherently difficult to predict. Because of the variability and uncertainty associated with loss estimation, it is possible that our individual case reserves for each catastrophic event and other case reserves are incorrect, possibly materially. (Ruffino Decl., Exs. J at 17; K at 17.)
On January 11, 2006, in the same Form 10-Q in which the Company reported additional losses related to the ruptured pipeline, the Company reported the "receipt of approximately $3.0 million in additional recovery" for losses related to Hurricane Rita. (Ruffino Decl., Ex. M.) This reinsurance recovery was recognized in the fourth quarter of 2006. (Id.) The Form 10-Q warned, however, that reported estimated losses would "continue to be estimates which are subject to a high level of uncertainty due to the unprecedented nature of the catastrophes, complex coverage and regulatory issues and the unknown impact of such losses to its reinsurers." (Id.) As a result, "actual losses from these hurricanes may differ significantly from estimated losses." (Id.)
On March 2, 2006, Quanta disclosed preliminary results for 2005 in a press release, which included "$10.2 million of additional (fourth-quarter of 2005) costs related to hurricanes Katrina and Rita," as well as $5.5 million related to a previously reported environmental loss and $8-13 million of additional general reserve strengthening. (Ruffino Decl., Ex. N [March 8, 2005 press release] at 2, 6); Compl. ¶¶ 157-59.) The hurricane related losses were approximately 15% higher than previously estimated.
(Ruffino Decl., Ex. N at 10.) As the Company explained in an analyst conference call that morning, the hurricane-related additional losses were due to a $17.4 million "business interruption claim from a single offshore energy account," which came to Quanta's attention in "early 2006." (Compl. ¶ 159; Ruffino Decl., Ex. N at 10, 15.) Subsequent to this disclosure, the Company's common stock price dropped from $4.73 to $2.83. (Compl. ¶ 165.)
The Company further explained that it was "difficult to get a handle on the business interruption," and that as of "Q3 and indeed through December 31," the Company had not "received any information on that account," and "applied actuarial estimates based on similar events in the past . proved to be not conservative enough." (Compl. ¶ 159.) The Company did see, however, "favorable development of $5.5 million" related to its "reinsurance property book and technical risk property book" stemming from the hurricanes. (Ruffino Decl., Ex. N at 15.)
In a March 2, 2006 conference call held to discuss the 2005 year-end results, investment analyst Ron Bobman argued that it was "hard to sort of establish confidence in new management" when the Company had held an investor road show in "late November" of 2005, and at that road show Company management had stated that the Company had "scrubbed the reserves," implying that it had taken a close look at the reported losses from the hurricanes. (Compl. ¶ 163-64.)
F. The December 2005 Registration Statement and Prospectuses
In the Registration Statement filed in connection with the common-stock offerings, the Company 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. J at 14-15, 21-22.) The Registration Statement also pointed out that the Company derived a "significant portion" of business "from a limited number of brokers, and that brokers rely on A.M. Best ratings to assess the quality of insurers with whom they might place business." (Id.) Further, the offering document acknowledged that the hefty losses incurred by Quanta due to the 2004 and 2005 hurricanes "have had, and future catastrophic events may have," a materially adverse effect on the Company's "ability to write new and renewal business and our results of operations and financial condition." (Ruffino Decl., Ex. J at 14-15.)
On December 16, 2005, less than two weeks before the end of the fourth-quarter, Quanta filed a Prospectus in connection with its offering of common-stock, and the Prospectus incorporated the Registration Statement for the offering in full.*fn8 (Compl. ¶ 122.) That day, the Company priced approximately eleven million shares of common stock at $4.75 per share. (Id. ¶¶ 124-25.) FBR, which in November 2005 owned 5% of Quanta's shares, was the lead underwriter of the offering and it performed a due diligence investigation of Quanta and participated in the preparation of the Prospectuses. (Compl. ¶ 42.) BB&T Capital was the co-underwriter of the offerings, and also performed a due diligence investigation of Quanta. (Compl. ¶ 43.)
In addition to the aforementioned warnings, the Prospectus stated that the common-stock offering would increase the Company's "available rated capital" and help "maintain [its] current rating with A.M. Best." (Ruffino Decl., Ex. K at 15-16.) The Prospectus reiterated the importance of A.M Best's rating to Quanta's business, stating that the rating was "an increasingly important factor in maintaining the competitive position" of Quanta's "insurance and reinsurance" businesses. (Ruffino Decl. Ex. K at 15.) The Company was "working closely with A.M. Best" to maintain its current "excellent" ...