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In re PXRE Group

March 4, 2009

IN RE PXRE GROUP, LTD., SECURITIES LITIGATION


The opinion of the court was delivered by: Richard J. Sullivan, District Judge

OPINION AND ORDER

Lead Plaintiff Chad S. Condra is represented in this matter by Jeremy Alan Lieberman and Marc Ian Gross, Pomerantz Haudek Block Grossman & Gross LLP, 100 Park Ave, 26th Floor, New York, New York 10017. Defendant PXRE Group Ltd. is represented by Bruce Domenick Angiolillo, John Cummings Anderson, and Jonathan K. Youngwood, Simpson Thacher & Bartlett LLP, 425 Lexington Avenue, New York, New York 10017. Defendant Jeffrey L. Radke is represented by David Spencer Karp, Debevoise & Plimpton LLP, 919 Third Avenue, New York, New York 10022 and Jonathan Rosser Tuttle, Debevoise & Plimpton LLP, 555 13th Street, N.W., Washington, DC 20004. Defendant John M. Modin is represented by Justin Matthew Garbaccio and M. William Munno, Seward & Kissel LLP, One Battery Park Plaza, New York, New York 10004. Defendant Guy Hengesbaugh is represented by Brad Scott Karp and Jonathan Hillel Hurwitz, Paul, Weiss, Rifkind, Wharton & Garrison LLP, 1285 Avenue of the Americas, New York, New York, 10019.

Lead Plaintiff Chad S. Condra ("Plaintiff") brings this putative class action lawsuit against Defendants PXRE Group, Ltd. ("PXRE" or the "Company"), a Bermuda reinsurance corporation, and three of its officers, Jeffrey L. Radke ("Radke"), John M. Modin ("Modin"), and Guy Hengesbaugh ("Hengesbaugh").*fn1 Plaintiff alleges that Defendants engaged in a scheme to understate PXRE's losses arising out of the series of hurricanes that devastated the Gulf Coast in 2005. Plaintiff asserts that this scheme caused injury to himself and to all other purchasers of PXRE stock during the period from September 11, 2005 through February 22, 2006 (the "Class Period"), in violation of section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act"), 15 U.S.C. § 78j(b), Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder, and section 20(a) of the Exchange Act, 15 U.S.C. § 78t(a).

Before the Court are Defendants' motions to dismiss pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure and Plaintiff's motion to amend pursuant to Rule 15(a)(2) of the Federal Rules of Civil Procedure. For the reasons that follow, Defendants' motions are granted and Plaintiff's motion is denied

I. BACKGROUND

A. Facts

The following facts are taken from the Proposed Second Consolidated Amended Class Action Complaint ("PSAC") submitted by Plaintiff.*fn2 The Court also considers any written instrument attached to the PSAC, statements or documents incorporated into the PSAC by reference, legally required public disclosure documents filed with the Securities and Exchange Commission, and documents upon which Plaintiff relied in bringing the suit. See ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87, 98 (2d Cir. 2007). The Court assumes all alleged facts to be true for the purpose of deciding the motions before it, and construes all alleged facts in the light most favorable to Plaintiff. See Cleveland v. Caplaw Enters., 448 F.3d 518, 521 (2d Cir. 2006).

1. The Parties

Plaintiff purchased shares of PXRE stock during the Class Period, and brings this putative federal class action lawsuit on behalf of all purchasers of PXRE common stock during the Class Period. (PSAC ¶¶ 1, 16.) Plaintiff asserts claims against PXRE and the three individual Defendants, all of whom were officers of PXRE during the time period relevant to this action. (Id. ¶¶ 18-20.)

Defendant PXRE was a Bermuda corporation whose stock was publicly traded on the New York Stock Exchange. (Id. ¶¶ 14, 17.) PXRE is a reinsurance company, or an "insurer's insurer," providing insurance coverage both to primary insurers and to other reinsurance companies. (Id. ¶¶ 17, 27.)*fn3 PXRE provides reinsurance coverage to other property insurance companies (known as "cedents") that have sold policies to homeowners and businesses. (Id. ¶ 27.) By so doing, PXRE assumes the contractual obligations set forth in the cedents' underlying policies, and is bound to cover claims arising from losses occurring under those policies. (Id. ¶¶ 27-28.) Since 1987, PXRE has specialized in offering catastrophe and "risk excess" reinsurance related to, among other events, hurricanes. (Id. ¶¶ 17, 27.)

As noted, the three individual Defendants were all officers of PXRE during the relevant time period. Individual Defendant Radke was PXRE's President and Chief Executive Officer. (Id. ¶ 18.) Individual Defendant Modin was PXRE's Executive Vice President and Chief Financial Officer prior to his resignation on January 6, 2006. (Id. ¶ 19.) Individual Defendant Hengesbaugh was PXRE's Chief Operating Officer. (Id. ¶ 20.) Further, all of the individual Defendants were members of PXRE's "Ceded Reinsurance Underwriting Committee," which was allegedly responsible for "[a]ll underwriting decisions." (Id. ¶ 22.)

2. The Alleged Scheme

Beginning in August 2005, a series of hurricanes landed on the Gulf Coast. The first, and most devastating, was Hurricane Katrina, which hit the Gulf Coast on August 29, 2005, causing extensive and unprecedented damage to the city of New Orleans and the surrounding region. (See id. ¶¶ 32-33.) Much of the damage was caused by the fact that Hurricane Katrina resulted in a "storm surge," which overtopped the levees designed to protect New Orleans, culminating in the flooding of water from the Mississippi River into the city of New Orleans. (Id. ¶ 33.) As a result of the broken levees, river water submerged over eighty percent of New Orleans. (Id.) More than 1,800 people lost their lives in the wake of the storm, making Hurricane Katrina the deadliest United States hurricane since 1928. (Id. ¶ 32.)

Soon after, on September 24, 2005, Hurricane Rita arrived, "causing billions of dollars in damages along the Texas-Louisiana border." (Id. ¶ 34.) Finally, on October 23, 2005, Hurricane Wilma struck the Gulf of Mexico, killing at least sixty-three people and causing billions of dollars in damages to affected areas, including the Gulf Coast. (Id.) Through its reinsurance policies, PXRE "had exposure" for all three storms, with Hurricane Katrina providing the "largest exposure." (Id. ¶ 35.)

According to Plaintiff, PXRE, as a reinsurance company, was obligated to estimate losses arising from claims covered by its cedents' policies once any catastrophic event like Hurricane Katrina occurred. (Id. ¶ 29.) These loss estimates had to be prepared "even before actual claims were filed and processed." (Id.) Plaintiff asserts that such loss estimates were "closely watched" by rating agencies such as A.M. Best and Standard & Poor's, which issue ratings based on evaluations of whether a company has sufficient capital relative to potential claims and liabilities to support the sale of new policies. (Id. ¶ 30.) Plaintiff claims that "it was imperative that PXRE maintain a rating of A- or higher from the insurance rating agencies," because if PXRE's rating fell below A-, cedents were contractually bound not to purchase reinsurance policies from PXRE, and were also contractually entitled to cancel their reinsurance policies with PXRE. (Id. ¶ 31.) In other words, "[a]ny downgrades below A- would essentially put [PXRE] out of business." (Id. ¶ 75.)

Plaintiff further alleges that, "[a]t the outset of the Class Period, PXRE was especially vulnerable to a ratings downgrade," due to the exhaustion of PXRE's own retrocessional insurance policies*fn4 and due to the fact that PXRE's capital surplus was low relative to the initial estimates of the losses incurred by Hurricane Katrina. (Id. ¶¶ 74, 76.) "If PXRE's reported loss estimates from Katrina were too high relative to its capital surplus, [its] ability to pay claims would be deemed at risk, likely resulting in a ratings downgrade." (Id. ¶ 75.)

Plaintiff posits that because of this pressure to maintain an A- credit rating and to raise capital, "Defendants were motivated to materially understate PXRE's estimate of losses, as well as engage in a string of offerings to raise cash, which they did throughout the Class Period." (Id. ¶ 77.) In essence, Plaintiff alleges that the loss estimate reports created by PXRE in the wake of the three hurricanes that hit the Gulf Coast in 2005 were prepared in a reckless and/or willfully deceptive manner; that, as a result, the loss estimates issued in a series of press releases and public documents were false and misleading; and that Defendants disseminated these false and misleading reports with the intention of deceiving insurance rating agencies and investors as to the true extent of PXRE's losses arising from the three hurricanes.

Below, the Court details the factual allegations from the PSAC involving (1) the preparation of the loss estimate reports, and (2) the allegedly false and misleading statements issued during the Class Period.

i. The Preparation of the Loss Estimate Reports

Based on information allegedly provided by confidential informant ("CI") #2, PXRE's Vice President in charge of risk modeling,*fn5 Plaintiff alleges that PXRE's loss estimate reports were prepared by a team consisting of Radke, Hengesbaugh, Modin, and James Matusiak ("Matusiak"), PXRE's "Chief Actuary." (Id. ¶ 40.) Plaintiff further alleges that the losses were estimated on the basis of (1) "top down" computer modeling, whereby PXRE used software designed by outside risk modelers, as well as its own "proprietary software," to generate an estimate of PXRE's losses in relation to industry-wide losses; and (2) a "ground-up" contract-by-contract analysis of reinsurance contracts held by PXRE, whereby its underwriters would examine PXRE's own contracts in order to determine the extent of PXRE's exposure to losses. (Id. ¶ 41.) According to CI #2, individual Defendants Radke and Hengesbaugh allegedly "had the most influence over the final loss estimate figures and had the final say on the estimates that were disseminated to the public." (Id. ¶ 40.)

a. PXRE's "Top-Down" Modeling

In regard to the "top-down" analysis conducted by PXRE following Hurricane Katrina, Plaintiff asserts that PXRE's estimates "were based in part on industrywide projections of $30-$40 billion of insured losses arising from the Katrina catastrophe." (Id. ¶ 93.) However, Plaintiff alleges that in utilizing this industry-wide loss projection, Defendants "ignored the much higher estimates [of $40 billion to $60 billion in losses] published by [one modeling agency called Risk Management Solutions, Inc. (`RMS')] . . . a well-respected catastrophe modeler." (Id.) According to the PSAC, RMS allegedly included in its industry-wide loss projections "a significant amount of damages from commercial and covered residential flooding in New Orleans." (Id.)*fn6 Specifically, RMS estimated that "river flooding in New Orleans" was likely to result in $15 billion to $25 billion of those losses. (Id. ¶ 37 (emphasis in original).)

The PSAC does not specifically allege that PXRE's computer modeling system failed to account for commercial flooding in New Orleans. However, Plaintiff does assert, on the basis of information purportedly obtained from CI #2, that PXRE's "modeling system" had two specific flaws. (See id. ¶¶ 43-44.) First, Plaintiff claims that PXRE's proprietary software, as well as the software previously purchased by PXRE from outside risk modelers, was only capable of calculating losses due to ocean flooding, and was incapable of calculating losses incurred by river flooding. (Id. ¶ 43.) Second, Plaintiff asserts that PXRE's loss modeling system was "unreliable once loss estimates [arising from a storm] exceeded $35 billion, since the hurricanes [below] that threshold were fundamentally different from Katrina's trajectory and thus not predictive of the storm." (Id. ¶ 44.) Plaintiff alleges that this second flaw "effectively capped PXRE's estimate of industry losses at the $35 billion range." (Id.)

b. PXRE's "Ground-Up" Contract-By-Contract Analysis

In regard to PXRE's "ground-up" contract-by-contract analysis following Hurricane Katrina, Plaintiff alleges that, according to CI #2, PXRE's underwriters calculated loss estimates for each contract and reported those estimates to either Hengesbaugh, Radke, and/or Modin at both informal and formal meetings held in PXRE's Bermuda office. (Id. ¶ 42.) Plaintiff alleges that, although CI #2 neither participated in nor was "present" at these meetings, he "often heard the discussions that occurred" because the Bermuda office had an open floor plan and CI #2's desk was "right near the location of the meetings." (Id.) Based on CI #2's knowledge of these meetings, Plaintiff asserts that individual Defendants "Radke and Hengesbaugh exerted the most influence over the determination of the loss estimates." (Id.)

In addition, Plaintiff asserts that the "ground-up" contract-by-contract analysis conducted by PXRE failed to correct one of the flaws in PXRE's "top-down" modeling system - namely, the alleged lack of consideration given to PXRE's losses arising from "river flooding" in New Orleans. (Id. ¶ 45.) Therefore, although CI #2 "fully anticipated that significant upward adjustments would be made" to the "topdown" loss estimates prepared by PXRE's underwriters, the publicly available loss estimates "`closely matched the reports'" prepared by the top-down modeling system. (Id. (quoting CI #2).)

Plaintiff alleges that the defects in both PXRE's "ground-up" and "top-down" loss estimate reports were responsible for PXRE's inability "to account for the $15-$25 billion of industry wide commercial (and covered residential) flooding losses triggered by the breached levees in New Orleans." (Id. ¶ 46.)

ii. The Allegedly False and Misleading Statements Issued During the Class Period

During the Class Period, Plaintiff alleges that PXRE, relying on its loss estimate reports, made several false statements before and after engaging in a string of offerings to raise cash.

a. The September 11, 2005 Press Release

On September 11, 2005, within two weeks of Hurricane Katrina's arrival on the Gulf Coast, PXRE issued a press release (the "September 11 release") indicating that its preliminary estimate of net losses*fn7 arising from Hurricane Katrina was approximately $235 million, and that PXRE calculated this estimate, at least in part, on the basis of industry-wide loss estimates of $30 billion to $35 billion. (Id. ¶ 47.) According to the PSAC, PXRE stated that it expected to report a net operating loss of $85 million to $100 million for 2005. (Id. ¶ 48.)*fn8 PXRE indicated in the September 11 release that it calculated the preliminary estimate of its net loss from Hurricane Katrina on the basis of "extensive modeling, a ground-up review of all exposed reinsurance contracts and numerous discussions with PXRE's clients." (Id. ¶ 50.) Also in the September 11 release, individual Defendant Radke was quoted as stating, in relevant part, "[w]e expect that the unprecedented industry losses arising from Hurricane Katrina . . . are likely to have a significant impact on reinsurance pricing, . . . and we believe that we are well positioned to take advantage of the opportunities that are likely to present themselves in the wake of Hurricane Katrina." (Id. ¶ 49.)

The September 11 release also included the following cautionary language that was not quoted in the PSAC:

It is difficult . . . to accurately estimate losses in the immediate aftermath of any major catastrophe. The unique circumstances of Hurricane Katrina, including the unprecedented flooding, limited access by claims adjustors and the potential legal and regulatory issues, add even more uncertainty to the normal difficulties of estimating catastrophe losses. PXRE will continue to monitor the situation and provide updates if its current estimate changes materially.

(Anderson Aff. Ex. C (the September 11 release); see PSAC ¶¶ 49-50 (quoting the September 11 release).)*fn9

Plaintiff alleges that, as a result of Defendants' statements, the insurance rating agency A.M. Best gave PXRE a rating of "A" with "negative implications." (PSAC ¶ 52.) Plaintiff also claims that PXRE announced on September 15, 2005, "a shelf registration of up to $300,000,000 of debt securities, common shares, preferred shares, depositary shares, warrants, and trust preferred securities." (Id. ¶ 53.)

b. The September 19, 2005 Press Release

On September 19, 2005, PXRE issued a second press release (the "September 19 release"), updating its preliminary loss estimates for Hurricane Katrina. (Id. ¶ 54.) This new loss adjustment was based in part on a revised estimate of industry-wide losses of $30 billion to $40 billion, an increase from the previous industry-wide loss estimate of $30 billion to $35 billion. (Id. ¶ 55.) The updated loss estimates also indicated that PXRE would suffer a net loss from Hurricane Katrina in the range of $235 million to $300 million, resulting in an expected net operating loss of up to $165 million for 2005. (Id. ¶ 54.)*fn10

As with the September 11 release, the September 19 release indicated that the updated preliminary estimate was "based on extensive modeling, a ground-up review of all exposed reinsurance contracts and numerous discussions with PXRE's clients." (Id. ¶ 56.)

The September 19 release also included cautionary language similar to the language found in the September 11 release:

It is difficult . . . to accurately estimate losses in the immediate aftermath of any major catastrophe. Moreover, the unique circumstances of Hurricane Katrina, including the unprecedented level of flooding and limited access by claims adjustors, make our estimates subject to a higher level of uncertainty than normal. In addition, further uncertainty is created by potential legal and regulatory issues . . . . To date, the Company has only received a limited number of written loss notices. PXRE will continue to monitor the situation and provide additional updates as necessary.

(Anderson Aff. Ex. D (the September 19 release); see PSAC ¶ 56 (quoting the September 19 release).)

On September 23, 2005, A.M. Best issued a report regarding PXRE, indicating that: Further catastrophe losses in the short term may expedite A.M. Best's review and potentially result in a ratings downgrade. A.M. Best will continue to hold discussions with PXRE's management in order to assess the company's risk management capabilities and to reevaluate the level of capital necessary to support PXRE's profile.

(PSAC ¶ 58.)

c. The September 28, 2005 Press Release

Hurricane Rita made landfall on September 24, 2005. (Id. ¶ 59.) On September 28, 2005, PXRE issued a third press release (the "September 28 release"), indicating that its preliminary estimate of net losses arising from Hurricane Rita was in the range of $30 million to $40 million. (Id.) This raised PXRE's total expected net loss for the third quarter to the range of $230 million to $320 million. (Id.) PXRE also stated that it expected to report a net operating loss of $125 million to $200 million for 2005. (Id.)

Like the two earlier press releases, the September 28 release contained language explaining PXRE's reliance on "modeling and a review of all exposed reinsurance contracts" (id. ¶ 60), as well as cautionary language warning, inter alia, that "the ultimate impact of losses from Hurricane Katrina and Hurricane Rita on the Company's results of operations might . . . differ substantially from the Company's current estimates." (Anderson Aff. Ex. E (the September 28 release); see PSAC ¶ 60 (quoting the September 28 release).)

In response to these increased estimates, on September 30, 2005, A.M. Best and Standard & Poor's downgraded PXRE to a rating of "A-" with "negative implications." (PSAC ¶ 62.) On that same day, Defendants announced that PXRE intended to make a public offering of approximately $100 million of its common shares, and that it had agreed to sell $375 million of its series D perpetual preferred shares in a private placement. (Id. ¶ 63.) PXRE announced that it had completed both of these sales on October 7, 2005. (Id. ¶ 64.)

d. The October 17, 2005 Proxy Statement

On October 17, 2005, PXRE filed a Proxy Statement (the "October 17 Proxy Statement") calling for a Special General Meeting of Shareholders, at which it would seek shareholder approval of a proposal to convert the perpetual D shares recently offered by PXRE into regular common stock. (Id. ¶ 65.) The October 17 Proxy Statement also reiterated some of the statements made in the September 19 release. (See id. ¶¶ 65-66.) Specifically, it stated that on September 19, 2005, PXRE had increased its earlier loss estimates due to the net impact of Hurricane Katrina to the range of $235 million to $300 million. (Id. ¶ 65.) The October 17 Proxy Statement also noted that "losses from Hurricane Katrina will materially negatively impact third quarter financial results and shareholders' equity and PXRE Group expects to have a net loss for calendar 2005." (Id.) As with the previous press releases, the October 17 Proxy Statement also noted that the "estimates were based mainly on modeling, a review of exposed reinsurance contracts and discussions with certain clients." (Id. ¶ 66.)

e. The October 27, 2005 Press Release

On October 27, 2005, PXRE issued a fourth press release (the "October 27 release"), announcing results for the third quarter ending September 30, 2005. (Id. ¶ 68.) This announcement included revised loss estimates for Hurricane Katrina and Hurricane Rita. (Id.) Specifically, PXRE announced that the Company incurred net losses of approximately $349.9 million from the storms. (Id.) Of those losses, $330 million was attributable to Hurricane Katrina. (Id.) This raised PXRE's total expected net losses to $317.3*fn11 million. (Id.)*fn12

In the October 27 release, individual Defendant Radke was quoted as saying:

Hurricanes Katrina and Rita will make the third quarter of 2005 the most costly quarter in history for the reinsurance industry in terms of insured catastrophe loss. PXRE's loss for the quarter is correspondingly large but the storms again demonstrated the strength of PXRE's risk management, as our losses were within our expectations for such major events. . . . . The strategic market position we have earned over the past 23 years through our dedication to customer service and prompt claims payment gives us confidence in our ability to thrive in the wake of Hurricanes Katrina and Rita, and recent feedback from communications with brokers validates that confidence. Indeed, our recent ...


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