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November 27, 2002


The opinion of the court was delivered by: Amy J. St. Eve, District Judge.



I. The Parties

A. The Liquidator

Nathaniel S. Shapo is the Director of Insurance of the State of Illinois. (R. 1-1, Compl. ¶ 10.) He became Liquidator of the Alpine estate on June 28, 2000, by order of the Circuit Court of Cook County. (Id.) As Liquidator, he brings this action on behalf of the Alpine estate to recover to recover property and damages allegedly sustained by Alpine as a result of the Defendants' alleged misconduct. (Id. ¶ 11.)

B. Alpine and Transco

Alpine was a stock property and casualty insurance company. It was organized under the laws of Illinois and it maintained its principal place of business in California. (R. 1-1, Compl. ¶ 3.) Before the order of liquidation, Alpine principally wrote excess and surplus lines coverage for commercial casualty liability and ocean marine coverages. It also specialized in underwriting professional liability coverage for architects and engineers on a claims-made basis. (Id. ¶ 3.)

On December 31, 1996, Alpine assumed the assets and liabilities of Transco, its corporate parent. (Id. ¶ 4.) Before then, Transco was an excess and surplus lines carrier that was incorporated in Illinois. (Id.) Transco was once a member syndicate on the Illinois Insurance Exchange. (Id.) Defendants O'Shaughnessy, Exstar Financial Corporation ("Exstar"), and ultimately TCO Holdings, Inc. wholly owned Transco from time to time. (Id.)

C. The Defendants

The Defendants can be grouped into one of two categories. They are either (1) corporations related to Alpine and Transco or (2) directors and officers of Alpine, Transco, and the corporate defendants (the "individual defendants"). The corporate defendants consist of Exstar, TCO Insurance Services, Inc., TCO Insurance Services, and TCO Holdings, Inc. The individual defendants are Peter O'Shaughnessy, Steven Shinn, Craig Rice, and John Clark.

1. Corporate Defendants

Exstar, an insurance holding company, is a publicly held Delaware corporation headquartered in California. (R. 1-1, Compl. ¶ 18.) Two of its subsidiary operating companies were Alpine and Transco. (Id.) TCO Holdings, Inc. is a Delaware corporation that was, at various times, Transco's parent. (Id. ¶ 20.)

TCO Services, Inc. ("TCO Illinois") is an Illinois corporation. (Id. ¶ 19.) TCO Illinois performed marketing, underwriting claims, management, investment, and general administrative functions for the various corporate defendants. (Id.) TCO Insurance Services ("TCO California") is a California corporation. (Id.) TCO California performed administrative services for TCO Illinois pursuant to a servicing agreement. (Id.) Together, TCO Illinois and TCO California acted as an affiliate underwriting manager and as the managing general agent for Alpine and Transco. (Id. ¶ 3.)

2. Individual Defendants

Peter J. O'Shaughnessy and Steve Shinn are residents of California. (R. 1-1, Compl. ¶¶ 12, 14.) Craig Rice is a New Jersey resident, (Id. ¶ 16), while John Clark resides in Illinois. (Id. ¶ 17.) O'Shaughnessy, Shinn, Rice, and Clark had various roles with Alpine, Transco, and the corporate defendants. O'Shaughnessy was also the controlling shareholder of Alpine, Transco, Exstar, TCO Illinois, and TCO California (collectively, "TCO entities") through his interest in their ultimate parent, TCO Holdings. (Id. ¶ 2.)

The Complaint alleges that the individual defendants were executives and directors of the corporate parties as follows:

Individual Alpine Transco Exstar TCO Companies
O'Shaughnessy Director 1986-96 Director 1985-96 President 1988-93 CEO Chairman 1988-96 President 1985-93 CEO 1988-2000 Director Exec. VP 1986-92 Chairman 1988-2000 (various dates) Director 1988-2000
Shinn Exec. VP 1992-95 Sr. Vice President President 1993-95 President of TCO Director 1992-95 Exec. Vice President Exec. VP 1992-93 1993-95 President 1996 President Director 1992-93 Exec. VP of TCO (various dates) 1992
Rice Director 1989-95 VP 1988-93 Director 1992-96 CFO 1991 CFO 1989-95 Asst. Treas. 1988-93 CFO 1992-96 Exec. VP 1989-95 Controller 1988-89 Treasurer 1992-96 Treasurer 1989-95 Exec. VP 1992-96
Clark President 1992-96 President 1992-96 Sr. VP 1992-95 President 1992-96 CFO 1992-96 Asst. Treas. 1992-95 Director 1992-96

(Id. ¶¶ 12-17.)

II. Substantive Allegations

The Complaint alleges a course of illegal conduct that was purportedly masterminded by O'Shaughnessy and facilitated by Shinn, Rice, and Clark from 1987 until 1996. (R. 1-1, Compl. ¶ 2.) This conduct was effectuated through a series of complex financial transactions that resulted in $19 million being illegally transferred out of Alpine and Transco. (Id. ¶ 6.) Because these funds were transferred out of Alpine and Transco, they were not available for the payment of policyholder and creditor claims. (Id. ¶ 21.) These transactions took three forms: (1) diversions from premium fund trust accounts; (2) filters of Transco funds through stock swaps; and (3) transfers of money through bogus loans and real estate deals. Each of the individual defendants allegedly profited from the schemes. (Id.)

A. Premium Fund Trust Account Diversions

Pursuant to agreements with Alpine and Transco, TCO Illinois and TCO California were responsible for the administration and safekeeping of Alpine and Transco policyholder premiums. (R. 1-1, Compl. ¶ 22.) Alpine entered into an Amended and Restated Management Agreement with TCO Illinois that was effective January 1, 1991. (Id. ¶ 25.) Alpine's Board of Directors — comprised of Defendants O'Shaughnessy, Shinn, Clark, and Rice — executed a written consent of the agreement on November 15, 1991. (Id.) Shinn and Rice also executed the agreement as officers of TCO Illinois. (Id.) The first paragraph of this agreement provided that:

[TCO Illinois] shall maintain a trust fund account in a bank that is a federally or state chartered bank and that is a member of the Federal Deposit Insurance Corporation. All premiums and other monies collected or received on behalf of [Alpine] promptly shall be deposited into such bank account.

(Id. ¶ 26.)

Transco entered into a similar agreement with TCO Illinois that was effective July 1, 1993. (R. 1-1, Compl. ¶ 27.) Paragraph J of that agreement required TCO Illinois to "maintain a trust fund account into which all premiums and other monies collected or received . . . shall be deposited." (Id.) Along with TCO Illinois' contractual requirements, TCO California was also obligated to deposit premiums or other funds received in separate and segregated fiduciary accounts to be held on behalf of Alpine and Transco. (Id. ¶ 23.) Even outside these contractual obligations, Illinois and California law required TCO Illinois and TCO California to create and maintain separate segregated premium fund trust accounts for premiums collected in those states. (Id. ¶¶ 29-33.)

TCO Illinois and TCO California never established or maintained separate and segregated trust accounts as required by the agreements and by state law. (R. 1-1, Compl. ¶¶ 23, 28.) Instead, the Defendants permitted the Alpine and Transco premiums to be commingled with TCO Illinois and TCO California funds. (Id. ¶ 34.) Additionally, the Defendants diverted almost $9 million in premium fluid trust money to other affiliates over a period of several years. (Id.) The individual defendants diverted these funds in order to subsidize the operating losses of O'Shaughnessy controlled affiliates and to enrich the Defendants. (Id. ¶ 35.)

At various times during this commingling and diversion, Alpine and Transco were financially unstable and illiquid, as were the other O'Shaughnessy controlled entities. (Id. ¶ 36.) O'Shaughnessy, however, caused himself to be paid more than $5 million of the premium fund money that had been wrongfully misappropriated. (Id. ¶ 37.) Additionally, O'Shaughnessy improperly used hundreds of thousands of dollars of Alpine and Transco premiums for various personal expenses. (Id.)

B. Stock Swap with Jeffrey Beresford-Wood

In December 1989, the individual defendants caused TCO Holdings, Inc., Transco and Exstar to enter into a series of financial transactions that were designed to effectively divert and upstream Transco funds to its then parent, TCO Holdings. (R. 1-1, Compl. ¶ 57.) Beresford-Wood was the sole shareholder of JBW & Co., as well as other insurance companies. JBW & Co. controlled Concord General Corporation ("Concord"), a privately held insurance holding company. (Id. ¶ 58.)

O'Shaughnessy and Beresford-Wood agreed to swap preferred stock in insurance holding companies. (Id. ¶ 60.) The exchanges were illusory since the preferred stock of each entity was of little or no value. (Id. ¶ 59.) The benefit was that their respective parent companies were paid approximately $19 million each from the other's subsidiary. For the Defendants, Beresford-Wood was necessary to consummate the transaction. Had Transco directly paid this money to its parent companies, regulatory oversight would have been triggered. (Id. ¶ 61.)

The swap took the following form: Beginning in late 1989, O'Shaughnessy caused Transco to purchase $15 million of preferred stock in Concord. (Id. ¶ 60.) Simultaneously, First Horizon Insurance Company, Beresford-Wood's insurance entity, purchased $15 million of preferred stock in Exstar. (Id.) The net effect was that Exstar ended up with $15 million in liquid cash, while Transco's cash reserves were depleted by the same figure. (Id.) Transco's only showing for the $15 million was ownership of Concord preferred stock that had minimal value. (Id. ¶¶ 59, 61.)

The stock transaction scheme, however, did not end there. The Defendants created a dividend and redemption scheme to circulate another $4 million to TCO Holdings. This was accomplished through a Transco dividend that was worth four times the value of the stock itself. (R. 1-1, Compl. ¶ 62.) On December 12, 1990, O'Shaughnessy, acting unilaterality for the Transco Board of Directors, executed a Unanimous Written Consent in Lieu of a Board Meeting. (Id.) This consent authorized Transco's payment of a $4.00 per share dividend. (Id.) TCO Holdings was Transco's sole shareholder at the time, owning $1 million shares. (Id.) Transco then transferred to TCO Holdings $4 million worth of Concord preferred stock by way of dividend. (Id.)

Although the Concord stock really had questionable value, TCO Holdings sold the shares back to Concord for $4 million in April 1991, when Concord redeemed exactly $4 million in preferred shares. (R. 1-1, Compl. ¶ 62.) O'Shaughnessy applied the redemption entirely to shares owned by TCO Holdings and none to the $11 million in shares still owned by Transco. (Id.) This dividend scheme therefore allowed TCO Holdings to receive the entire value for the shares acquired by the Transco dividend. This redemption further depleted the value of the shares of Concord still owned by Transco.

Beresford-Wood received his end of the dividend and redemption scheme just two months later. In June 1991, O'Shaughnessy caused Exstar to redeem $4.25 million of the preferred stock that it had previously issued to First Horizon. (Id.)

From 1990 to 1994, Transco received dividends totaling $5,946,625 on its remaining $11 million in preferred Concord stock at the stated rate of 11.3%. (Id. ¶ 63.) Transco did not receive any dividends in 1995. (Id.)

In 1992 and 1993, Exstar and Concord planned initial public offerings. (R. 1-1, Compl. ¶¶ 64, 65.) If Concord became a public corporation, however, it would have seen an increase in market value and regulatory scrutiny. (Id.) In order to continue with the illicit scheme, O'Shaughnessy, Shinn, and Clark caused the Concord preferred stock to be exchanged in late 1993 for preferred stock in JBW & Co. that was essentially worthless. (Id. ¶ 66.) The Defendants planned to convert the Concord preferred stock into debt of JBW & Co. (Id.)

In December 1995, the stock of JBW & Co. was exchanged for a secured promissory note, pursuant to written documents that were executed by JBW & Co., Concord, Beresford-Wood, and Transco. (R. 1-1, Compl. ¶ 67.) The promissory note was secured by 81% of the outstanding stock of Classic Fire & Marine Insurance Company, an Indiana Insurance corporation that was a wholly owned subsidiary of Concord. (Id. ¶ 68.) At the same time Classic Fire & Marine Company's surplus was reduced by approximately fifty-percent due to a restructuring. (Id.) This restructuring dramatically reduced its ability to repay the loan to Transco. As a result, Transco's potential to support its reinsurance obligation to Alpine was also lessened. (Id.)

Classic Fire & Marine Insurance Company is in liquidation, after being placed in rehabilitation in 1998. (Id.) In December 1997, the promissory note was discharged in consideration of Alpine's receipt of $2,260,252. At the time, the total outstanding principal and interest was $14,037,533. (Id. ¶ 69.)

C. The Illicit Transfers of Alpine Premium Fund Money to O'Shaughnessy

The individual defendants caused Alpine, Transco and TCO Holdings to enter into numerous fraudulent transactions that were designed to transfer money to O'Shaughnessy under the guise of secured loans and real estate transactions. (R. 1-1, Compl. ¶ 72.) At the same time that these corporations were providing money to O'Shaughnessy as part of these schemes, Alpine, Transco, and TCO Holdings were experiencing severe liquidity difficulties and were in desperate need of the money they were transferring to O'Shaughnessy. (Id.) O'Shaughnessy understood at the time that the purported collateral was or would be essentially worthless. He entered into the loan agreements never intending to repay the money. (Id.)

As of December 1996, O'Shaughnessy owed TCO Holdings $4,797,904. (R. 1-1, Compl. ¶ 73.) The only collateral for this debt was O'Shaughnessy's personal guarantee and the capital stock of TCO Holdings and its subsidiaries. (Id.) That stock was of questionable value because the Defendants had looted the companies. (Id. ¶ 72.) The loan proceeds came from the wrongfully commingled insurance premiums of Alpine and Transco. (Id. ¶ 73.) O'Shaughnessy never paid down his loan and the other Defendants never pursued his payment. (Id. ¶ 74.)

From 1991 to 1996, Transco and Alpine purchased $4,794,000 in real estate from O'Shaughnessy. (R. 1-1, Compl. ¶ 75.) The transactions included Transco's purchase of O'Shaughnessy's personal residence for $2.5 million in 1991. (Id. ¶ 76.) After the purchase, O'Shaughnessy leased back the home for approximately $3,000 per month. (Id.) In July 1995, Transco purchased eight lots for residential construction from O'Shaughnessy for a little more than $1 million dollars. (Id. ¶ 75.) These real estate transactions were intended to help resolve O'Shaughnessy's personal liquidity problems. (Id.)

D. False Statements Submitted to the Illinois Department of Insurance

1. Non-Resident Insurance Producer Applications

O'Shaughnessy submitted and caused to be submitted a series of knowingly false Non-Resident Insurance Producer Applications to the Illinois Department of Insurance for the years 1989 to 1996. (R. 1-1, Compl. ¶ 38.) O'Shaughnessy, who signed these applications under penalties of perjury, falsely stated that premium fund trust accounts were being properly maintained. (Id.)

2. Annual Statements

Additionally, O'Shaughnessy, Clark, Shinn, and Rice caused annual statements of Alpine and Transco to be submitted to the Illinois Department of Insurance and the Illinois Insurance Exchange through 1995. (R. 1-1, Compl. ¶ 39.) These annual statements were knowingly false in several ways. First, they listed substantial agents' balances as admitted assets. (Id.) The individuals knew, however, that TCO Illinois and TCO California were insolvent and that those balances were uncollectible because the funds had been used to underwrite losses incurred by O'Shaughnessy's affiliated companies. (Id.) Second, the annual statements falsely portrayed the preferred stock transactions with Beresford-Wood as legitimate by including them as admitted assets. (Id.) Third, the 1992 through 1995 annual statements represented that all assets of the companies were exclusively under the insurance companies' control. (Id.) These assets were under the control of O'Shaughnessy, however, and were being misappropriated by him, with assistance from Rice, Clark, and Shinn. (Id.) Fourth, the 1995 annual statement reflected the collateral loan as an asset. (Id.) The individual defendants, however, knew this loan was worthless. (Id.)

O'Shaughnessy and Clark signed the 1991 and 1992 Annual Statements of Transco. (R. 1-1, Compl. ¶ 70.) Clark signed the 1993 and 1994 annual statements. (Id.) Rice, Clark, and Shinn knew of the falsity of the annual statement filings, but did nothing to correct the violations or to inform appropriate authorities. (Id. ¶ 40.)

E. The Schemes are Uncovered

In 1996, the liquidity problems that Alpine and Transco were experiencing came to light both internally and externally. These discoveries caused the Illinois Department of Insurance to issue a Corrective Order.

1. Alpine's Controller expresses concerns

On January 19, 1996, Alpine's Controller, David Gay, expressed concern about the diversion of Alpine's premium fund money by TCO Illinois and TCO California. Gay sent a memorandum to Defendants Rice and Clark regarding the diversion of these funds:

I can't stress enough the seriousness of the situation. I don't see how TCO is going to pay the insurance companies the $6.4 million in 1995 premium collections on a timely basis or how Alpine's intercompany balances are going to be cleared. I was disappointed to hear the Illinois Director of Insurance was not informed about the cash flow situation. I shudder to think of the consequences when the Illinois Director of Insurance begins their [sic] audit in the Spring and discovers the situation. That's assuming we are able to get KPMG to sign off under these conditions.

(R. 1-1, Compl. ¶ 42.) On April 27, 1996, Gay reiterated his concern over Alpine's finances:

I am writing to document our conversation today and on April 19, 1996. On April 19, 1996 I called you expressing my continued concern over the cash flow situation, whereby operating expenses for the TCO/Exstar Group are being paid from premium belonging to Alpine Insurance Company . . . . You also said that the company will be meeting with the Department of Insurance on May 6 to fully disclose so called out of trust situation. I think the Department of Insurance should be notified immediately about the situation as it is apparent that TCO doesn't have the capability to pay back the money it owes Alpine, and the situation continues to deteriorate. Under the circumstances, I don't feel comfortable approving wire and transfers from Alpine Insurance Company. I request that you approve these wires.

(Id. ¶ 43.)

2. Alpine's rating is ...

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