The D&O Diary

The D&O Diary


Bankruptcy Court Lifts Stay to Allow D&O Insurer to Pay Individuals’ Defense Expenses

Posted in D & O Insurance

idahoAs those involved in D&O Insurance claims well know, a recurring D&O insurance problem is the question of whether or not the D&O insurer for a bankrupt company can pay the costs of the bankrupt company’s former directors and officers incurred in defending claims against them. Disputes arise when the individuals seek to have the stay in bankruptcy lifted to allow the insurer to pay their defense expenses. Oftentimes creditors or the bankruptcy trustee will oppose lifting the stay, arguing that the D&O policy proceeds are assets of the bankrupt estate and should be preserved for the benefit of the estate or the creditors rather than expended paying the individuals’ defense costs.


These issues were discussed in a recent case in the Bankruptcy Court for the District of Idaho. In a succinct March 25, 2014 opinion (here), Bankruptcy Court Judge Jim D. Pappas rejected the arguments of the bankruptcy trustee and ruled that the stay should be lifted to allow the D&O insurer to pay the fees that certain former officers of Hoku Corporation incurred in defending claims against them. Hat tip to the Jones, Lemon & Graham’s D&O Digest Blog (here) for the link to the opinion. The D&O Digest’s April 21, 2014 blog post about the opinion can be found here.



Hoku Corporation was a subsidiary of Tianwei New Energy Corporation. On July 2, 2013, Hoku filed a Chapter 7 bankruptcy petition. On August 20, 2013, JH Kelly LLC, the prime contractor for Hoku in the construction of a polysilicon plant in Pocatello Idaho, sued Tianwei and several former directors and officers of Hoku, alleging fraud, racketeering and other misconduct while JH Kelly was constructing the plant.


The individual directors and officers filed a motion in the bankruptcy proceeding requesting the bankruptcy court to determine that the proceeds of Hoky’s D&O insurance policy were not property of Hoku’s bankrupt estate, or in the alternative, granting relief from the automatic stay in bankruptcy to allow the D&O insurer to pay the individuals’ costs of defending themselves in the JH Kelly lawsuit. The bankruptcy trustee filed an objection to the motion, arguing that the proceeds of the policy are assets of Hoku’s bankruptcy estate, and arguing further that payment of the individual’s defense fees would diminish the bankruptcy estate’s potential recovery of its own claims under the Policy.


Hoku’s D&O insurance policy, which had limits of liability of $10 million, included a so-called order of payments provision, specifying that


In the event of Loss arising from a covered Claim for which payment is due under the provisions of this policy, then the Insurer shall in all events:

(a) first, pay Loss for which coverage is provided under Coverage A and Coverage C of this policy; then

(b) only after payment of Loss has been made pursuant to Clause 22(a) above, with respect to whatever remaining amount of the Limit of Liability is available after such payment, pay such other Loss for which coverage is provided under Coverage B(ii) of this policy; and then

(c) only after payment of Loss has been made pursuant to Clause 22(a) and Clause 22(b) above, with respect to whatever remaining amount of the Limit of Liability is available after such payment, pay such other Loss for which coverage is provided under Coverages B(i) and D of this policy.

The bankruptcy or insolvency of any Organization or Insured Person shall not relieve the Insurer of any of its obligations to prioritize payment of covered Loss under this policy pursuant to this Clause 22. 


 The March 25 Ruling 

In his March 25, 2014 order, the Bankruptcy Judge granted the directors’ and officers’ motion based on his determination that the individuals had shown cause for relief from the automatic stay under Section 362(d)(1) of the Bankruptcy Code.


After first noting that the question of whether or not the proceeds of a D&O Insurance policy are assets of a bankrupt insured company’s bankruptcy estate is “an unsettled question,” the Bankruptcy Judge turned to the question of whether or not the stay should be lifted, saying that “assuming without deciding, the proceeds of the Policy are property of the bankruptcy estate, the Court concludes that good cause has been shown by the Movants under Section 362(d) for relief [from] the automatic stay.”


The Bankruptcy Judge determined that in considering whether or not the individuals had shown cause for lifting the stay that the Court should “balance the harm to the debtor if the stay is modified with the harm to the directors and officers if they are preventing for executing their rights to the defense costs.” The Bankruptcy Judge noted further that “clear, immediate and ongoing losses to the directors and officers in incurring defense costs trumps only ‘hypothetical or speculative’ claims by the trustee.”


The Bankruptcy Judge found that the individuals “are experiencing clear immediate and ongoing defense costs expenses,” adding that under the priority of payments provision in the policy, payments under other coverage provisions of the policy were “subordinate” to payment under the Side A coverage provision under which the individuals sought to have their defense fees paid.


By contrast, the Bankruptcy Judge found that the “potential harm to the estate suggested by the Trustee consist of hypothetical, indeed perhaps speculative claims he might pursue against the Movants.” The Bankruptcy Judge noted that other courts had criticized other bankruptcy trustees for seeking to prevent the payment of individual directors and officers defense fees under Side A.


“All things considered,” the Bankruptcy Court said, “the potential harm to the bankruptcy estate inherent in granting the Movants relief is negligible.” After noting that the policy’s $10 million limit of liability provided “ample coverage,” he concluded that the fees the individuals were incurring in defending the JH Kelly matter represented “a clear, immediate and actual harm that greatly outweighs any speculative and hypothetical harm to the bankruptcy estate.”



The kinds of issues discussed here have been a feature of the D&O insurance claims environment for many years, since coverage for the corporate entity became a regular part of the typical D&O policy. When the corporate entity files for bankruptcy, the question that arises is whether as a result of the D&O policy’s entity coverage the policy and its proceeds are assets of the estate. The practical solution that has evolved is that now when individuals want to have their defense fees paid, they will approach the bankruptcy court to obtain what has become known as a “comfort order” to allow the D&O insurer to pay the individuals’ defense fees (as discussed in greater detail here).


As I noted in a prior post (here), the granting of these types of comfort orders is now something of a “standard” procedure. However, even though these practices are now well established, and have been employed in such high profile proceedings as the Lehman Brothers bankruptcy (refer here) and the MF Global bankruptcy (refer here), trustees like the one here will continue to agitate on these issues.  (Admittedly, other problems arose in those high profile cases but not with respect to the question of whether or not a comfort order was appropriate.)


Nevertheless we still have situations like this one where Trustees try to throw up roadblocks to the payment of individuals’ defense fees based on the speculative notion that the policy proceeds need to be preserved for rights of recovery the Trustee not only has not established yet but even has not yet asserted. In that respect, I think there is something to the suggestion of the Bankruptcy Court here that bankruptcy trustees may warrant criticism for putting up these kinds of obstructions to the enforcement of contractual rights based on such speculative grounds.


I have always thought that these recurring problems are the result of a fundamental misconception of the D&O insurance policy. For obvious reasons, claimants and creditors want to establish that the D&O insurance policy exists for their protection and benefit. For less obvious reasons, some courts fall for this, which I have always found frustrating.


The fact is that insurance buyers purchase D&O insurance to protect the insured persons from liability. No one pays insurance premium as a charitable act for the benefit of prospective third party claimants. Liability insurance exists to protect insured persons from liability, not to create a pool of money to compensate would-be claimants. The very idea that claimants who have not even established their right of recovery from the insureds should be able to deprive the insureds of their right to use their insurance to protect themselves stands the entire insurance proposition on its head.


All of that said, there are recurring issues involved with the administration of these kinds of comfort orders, particularly, as discussed here, when court insist on asserting so-called “soft caps” on the amount of defense fees that can be paid or otherwise requiring ongoing Court supervision. 


Advisen Releases First Quarter 2014 Corporate and Securities Litigation Report

Posted in Securities Litigation

PrintOverall Filings of corporate and securities lawsuits during the first quarter of 2014 were at their lowest levels since before the financial crisis, according to the latest report from Advisen, the insurance information firm. The April 2014 report, which is entitled “D&O Claims Trends: 2014,” can be found here. As discussed below, the report will also be the subject of an Advisen webinar at 11:00 am EDT on Thursday, April 24, 2014.


It is important to note that unlike other regularly published reports in this area, the Advisen report analyses filings patterns for more than just securities class action lawsuits. The information in the report encompasses a broad range of corporate and securities lawsuits, including securities class action lawsuits but also including other types of lawsuits as well, including regulatory and enforcement actions; breach of fiduciary duty lawsuits; and securities lawsuits not filed as class actions. In addition, the Advisen reports includes litigation activity both inside the outside the United States. The Advisen report also uses its own “counting” protocols. These important characteristics of the Advisen report account for the signficiant differences between the statistics and information discussed in the Adivsen report and the information found in other published reports.


The first quarter traditionally is a busier period during the calendar year for the filing of corporate and securities lawsuits. However, according to the report, there was a 35 percent decline in the number of new corporate and securities lawsuits filed during the first quarter of 2014 compared to the same quarter a year ago and a 17 percent decline from the final quarter of 2013. The 238 first quarter filing “events” noted in the Adivsen report “represent the lowest quarterly total since prior to the financial crisis.”


Lawsuit filings were generally down across all categories of cases that Advisen follows during the first quarter. However, securities class action lawsuit filings were basically flat on a year-over-year quarterly basis, as there were 39 securities lawsuit filings in the first quarter of 2014, compared to 38 in the first quarter of 2013.  


With the decline of other types of suits and with securities class action lawsuit filings remaining flat, the proportion that securities class action lawsuit filings represent of all corporate and securities filings increased in the first quarter. During the first quarter of 2014, securities class action lawsuits represented 17 of all corporate and securities lawsuit filings, which is the highest quarterly percentage since the third quarter of 2009.  The report notes with respect to this percentage that “coming on the heels of two consecutive years of growth as a percentage of total events, this is a trend that is certainly worth following.”


Consistent with the overall downward trend, the report notes that M&A litigation, which had surged in recent years, was down in the first quarter of 2014 at least on an absolute basis. Indeed, the total number of M&A lawsuits peaked in 2011 and have decreased materially over the two years following. The report does not consider whether or not the decline in the absolute numbers of M&A lawsuits is due to a decline in overall M&A activity or how the numbers of M&A lawsuits filed compared to the varying levels of M&A activity over the time period under consideration.


The financial services sector “continues to be a lightening rod for D&O related litigation.” As has been the case in recent quarter, the financial services sector is the “leading target of new filings.” Companies in the financial services sector were the target of new filings in 29 percent of the total. Other active sectors included consumer discretionary at 17 percent and health care at 13 percent.




Long time observers of corporate and securities claims activity know that lawsuit filings in this arena ebb and flow over time, and that the filings trends play out across multiyear periods, not on a quarterly basis. The fact that filings in any given quarterly period are “up” or “down” compared to a prior quarter or a year prior quarter may or may not tell you what you need to know to identify filing trends.


There are obviously a number of factors involved here. We are still coming out of the very active litigation period following the credit crisis, and while there may be many fewer credit crisis related lawsuit filings, many of the credit crisis cases are still playing out. If you talk to plaintiffs lawyers, they will tell you they are as busy as they have ever been. The relative number of quarterly filings may not mean the plaintiffs are inactive, it may only mean they are busy with other things.


One thing to keep in mind about apparently lower filing levels is that there have been short periods of apparently decreased filing activity in the past. For example, during the period from mid-2005 to mid-2007, there was a so-called “lull” in new securities lawsuit filings. However, the lull ended abruptly when the early fallout from the credit crisis started to hit, and we then moved into a period of very active litigation activity that lasted for several years. The point is that during the first quarter 2014, there were no events driving litigation activity, but if an event were to occure, there would likely soon be a swift upswing in new filings activity. In other words, it would be dangerous for anyone to presume that the apparently quiet first quarter of 2014 represents some kind of permanent downshift in the corporate and securities litigation arena. You can be sure that as soon as the next bandwagon appears, the plaintiffs’ lawyers will be among the first to jump on.


The report itself supplies a number of possible explanations for the quarterly downturn, some of which that are consistent with my remarks here. For example, the report speculates that the quarterly decline is “likely due to a combination of factors” including the “continued wind down of credit crisis litigation, fewer U.S. public company targets, and a limited number ability to settle due to fewer mediators.” For sure, the wind down of the credit crisis litigation is a factor as is the historical decline in the number of publicly traded companies (there are 40 percent fewer public companies than in 1997).


There are a number of current factors that could point to an upswing in the future or that at least seem likely to drive future litigation activity. The first is the new Financial Fraud Task force that the new SEC commissioner has formed. The activities of this task force seem likely to drive not only increased enforcement activity, but also follow-on civil litigation as well. Another factor is the Dodd Frank whistleblower program, which also seems likely to produce increased enforcement activity and follow-on civil litigation. In addition, the upswing in IPO activity, which picked up steam in 2013 and has continued so far in 2014, is likely to lead to increased activity due to the heightened susceptibility of IPO companies to litigation activity.


A wild card in all of this is the Halliburton case now pending before the U.S. Supreme Court. Although based on the tenor of the oral argument it seems unlikely, it is still at least theoretically possible that the Supreme Court will throw out the “fraud on the market’ theory. If that were to happen, it could be much harder for plaintiffs to pursue their claims. But while that might result in fewer class action filings, it could actually result in an increase in the number of filings, as more claimants pursue their claims as individual lawsuits. However, if, as seems likelier at this point, the Court adopts some middle course and doesn’t throw out but instead modifies the way the fraud on the market presumption operates, that could have yet a different impact on securities class action lawsuit filings. Until we know for sure what the outcome of the pending case is, it is premature to speculate on what will change. It is possible that while are waiting, the plaintiffs are holding back – although there have been plenty of case filings while the Halliburton case has been pending and in fact securities class action filings during the first quarter of 2014 were level with the first quarter of 2013.


Quarterly Advisen Claims Seminar: At 11:00 am EDT on Thursday April 24, 2014, I will be participating in a webinar entitled “Quarterly D&O Claims Trends: Q1” to discuss the findings in the Advisen report and other important D&O claims trends. The panel will also include my good friends Steve Shappell of AON and Will Fahey from Zurich. Jim Blinn of Advisen will moderate the panel. For further information about the webinar and to register, please refer here.

D&O Policy Excluding “Receiver” Claims Bars Coverage for FDIC Failed Bank Lawsuit

Posted in Failed Banks

cali2In an interesting April 7, 2014 opinion (here), Magistrate Judge Stanley A. Boone of the Eastern District of California, applying California law, held that a D&O insurance policy’s insured vs. insured exclusion precludes coverage for claims brought against former officers of the failed County Bank of Merced, California by the FDIC in its capacity as the failed bank’s receiver. Because the magistrate judge’s ruling depended on an unusual wording not generally found in the typical insured vs. insured exclusion, the ruling may be of limited relevance to similar coverage disputes in other cases. However, the magistrate judge’s analysis may still be of interest notwithstanding the unusual wording because of the issues the magistrate judge considered in reaching his conclusion.



County Bank of Merced, California failed on February 6, 2009 and the FDIC was appointed as receiver. The FDIC asserted potential claims against the bank’s officers on February 5, 2009. The FDIC made a formal claim against the officers on November 16, 2009. The claim was submitted to the bank’s insurer, which had issued a policy calling itself an Extended Professional Liability insurance policy (confusingly referred to in the magistrate judge’s opinion as an “EPL policy.” Readers of this blog well know that an EPL Policy is something entirely different, so for clarity’s sake and because the relevant coverage sections of the policy at issue provide D&O insurance, I will refer to the policy in this blog post as a D&O policy.)


The insurer denied coverage for the claim in reliance on the D&O policy’s insured vs. insured exclusion. The relevant exclusion, Exclusion 21 to the Policy, provides in pertinent part that the policy does not cover loss arising from “a claim by, or on behalf of, or at the behest of, and other insured person, the company, or any successor, trustee, assignee or receiver of the company.” (The exclusion also contains several carve backs preserving coverage for certain kinds of claims otherwise precluded from coverage by the exclusion, but none of these carve-backs are relevant here.) The D&O insurance carrier took the position that the FDIC’s claims against the former officers were precluded from coverage under Exclusion 21 because the FDIC brought the claims in its capacity as receiver of County Bank.


On February 27, 2012, the FDIC filed a civil action against five former officers of the failed bank, alleging that the defendants had been negligent and had breached their fiduciary duties. On November 12, 2012, the FDIC and the former officers reached a settlement in the civil action in which the officers assigned their rights under the D&O insurance policy to the FDIC and consented to the entry of a default judgment. A default judgment in the amount of $48.5 million was entered.


In the separate coverage lawsuit, the insurer and the FDIC (proceeding as the individuals’ assignee) cross-moved for summary judgment on the question of whether or not the insured vs. insured exclusion precluded coverage for the FDIC’s lawsuit against the former officers.


The April 7 Opinion 

In an April 7, 2014 Opinion, the magistrate judge granted the D&O insurer’s motion for summary judgment and denied the FDIC’s cross-motion. The magistrate judge concluded that Exclusion 21 precluded coverage for the FDIC’s claim because the FDIC brought the claims against the former officers in its capacity as “receiver.” He rejected the FDIC’s argument that the exclusion’s reference to “receiver” referred only to a court-appointed receiver, saying that “while the FDIC attempts to differentiate itself from other types of receivers, it fails to identify any significant distinction that would justify an interpretation of Exclusion 21 that would treat the FDIC differently from any other type of receiver.”


The FDIC also sought to fashion an argument for coverage based on the fact that the insurer offered a separate “Regulatory Exclusion” – not included on County Bank’s policy – that expressly excludes coverage for claims brought by any federal or state regulatory agency. The FDIC argued that the existence of the two different exclusions demonstrates that the regulatory exclusion was intended to exclude FDIC claims and the insured vs. insured exclusion was not intended to exclude FDIC claims.


The magistrate judge rejected this argument in light of the FDIC’s dual capacity as federal insurer of deposits and as liquidating agent for the bank. The FDIC, he noted, stands in the shoes of the bank only in the latter capacity. Thus, “the existence of a regulatory exclusion is not superfluous in light of the insured versus insured exclusion; the regulatory exclusion would bar suits brought by the FDIC in its capacity as federal insurer, also known as its ‘corporate capacity,’ whereas the insured versus insured exclusion would only bar claims by the FDIC in its capacity as receiver.”


The FDIC also tried to argue that the “reasonable expectation” regarding the insured vs. insured exclusion is that it was in the policy to prevent collusive lawsuits, and therefore should not preclude coverage for claims by the FDIC as receiver because they are not collusive. The magistrate judge rejected this argument on two grounds: first, he found that the argument was flawed because it would apply to any type of receiver in any context, yet the FDIC did not explain why the exclusion would not apply to the FDIC and not to other type of receivers.


The second ground on which the magistrate judge rejected the FDIC’s “reasonable expectation” argument is interesting. He said that a suit by the FDIC against a failed bank’s directors and officers “has the potential for collusion just as a suit by a corporation against its own directors and officers.” While he was “not accusing the FDIC of collusion,” he noted that the interests of the FDIC as receiver “could be aligned with the interests of the directors and officers of a failed bank when an insurer is involved.” Accordingly, he said, “it is not too difficult to imagine a scenario of collusion between the FDIC and the directors and officers.” For that reason, he rejected the FDIC’s argument that excluding the FDIC’s claims would be inconsistent with the parties’ reasonable expectations.



It is important to note that that Exclusion 21’s express reference to a company’s “receivers” is unusual. Indeed, the magistrate judge expressly rejected the relevance of various cases on which the FDIC sought to rely in which courts had concluded that the insured vs. insured exclusion does not preclude coverage for the FDIC’s claims as receiver. Exclusion 21, he noted, “is materially different from the insured versus insured exclusion interpreted in the cases cited by the FDIC,” because Exclusion 21 specifically excludes claims brought be “receivers,” while the cases the FDIC cited did not include language expressly excluding claims brought by “receivers.”


Because of this policy wording difference, the holding in this case will be of limited value in the many other coverage disputes arising in connection with FDIC failed bank litigation and involving the question of whether more conventional insured vs. insured exclusions preclude coverage for the FDIC’s claims as receiver.  Just the same, though the insurance question here involved unusual policy wording, the magistrate judge’s analysis is nevertheless interesting and potentially even relevant to other cases.


His analysis of why the existence of the regulatory exclusion does not negate the argument that the insured vs. insured exclusion applies to the FDIC is interesting. The FDIC will often seek to argue that the absence of a regulatory exclusion means that a D&O insurance policy should cover claims brought by the FDIC notwithstanding the existence of the insured vs. insured exclusion. By reasoning that two exclusions apply to the FDIC in different ways – with the regulatory exclusion precluding coverage for FDIC claims in either of its dual capacities, and the insured vs. insured exclusion precluding coverage only for FDIC claims in its capacity a receiver of a failed bank – the magistrate judge showed how the absence of a regulatory exclusion does not mean that FDIC as receiver claims are covered or that the insured vs. insured exclusion was not intended to exclude FDIC claims.


The magistrate judge’s “reasonable expectations” analysis is also interesting, for its recognition that an FDIC’s claims as receiver presents at least the theoretical possibility of “collusion” and so represents the kind of dispute the exclusion was designed to address.


I will say that the FDIC’s dual capacity represents a confusing strain in many of these cases, both in the underlying liability lawsuits and in the coverage actions. In many of the FDIC’s failed lawsuits, the defendant directors and officers attempt to assert affirmative defenses against the FDIC for actions it took in its capacity as the bank’s regulator prior to its collapse. Whether or not these kinds of defenses can be asserted in an action the FDIC is bringing in its capacity as receiver is a hotly contested issue. As this case shows (and other cases have also shown) the question of the capacity in which the FDIC is acting can become a factor in coverage litigation as well.


As interesting as this case is, the question of the applicability of the insured vs. insured exclusion to claims asserted in its capacity as the receiver of a failed bank will continue to be litigated. The carriers, for their part, will try to rely on the rulings, such as the Northern District of Georgia Judge Richard W. Story’s August 2013 opinion (discussed here) that the insured vs. insured exclusion does preclude coverage for an FDIC lawsuit against a failed bank’s directors and officers, while the directors and officers will try to rely on rulings such as Northern District of Georgia Judge Robert Vining’s January 2013 ruling, discussed here, that the insured vs. insured exclusion doesn’t preclude coverage.


Special thanks to Joe Montelone, now of the Rivkin Radler law firm, for sending me a copy of the magistrate judge’s opinion.  


Flash Boys Litigation: High Frequency Traders, Brokers and Securities Exchanges Hit With Securities Suit

Posted in Securities Litigation

flash boysThe topic of high frequency trading has dominated the business headlines since the late March publication of Michael Lewis’s new book, “Flash Boys: A Wall Street Revolt.”  The SEC, the U.S. Department of Justice and the Federal Bureau of Investigation have confirmed that they are investigating high frequency trading, as has the New York Attorney General.  With all this media attention and regulatory scrutiny, it was perhaps inevitable that the one of the consequences of these events would include a securities suit.


On April 18, 2014, plaintiffs lawyers’ filed a securities class action lawsuit in the Southern District of New York against 42 defendants including fourteen brokerages, sixteen securities exchanges and twelve high-speed traders. The roster of defendants includes the major exchanges, such as the NYSE and NASDAQ, as well as trading platforms such as the BATS Global Markets; major banks, such as BofA, UBS and Barclays; and a long list of trading firms large and small. The complaint does not name any individuals as defendants.


The lawsuit, filed by the City of Providence, Rhode Island, is brought on behalf of an ambitious putative class; the action purports to be brought on behalf of all public investors “who purchased and/or sold shares of stock in the United States between April 18, 2009 and the present (the “Class Period”) on a registered public stock exchange (the “Exchange Defendants”) or a United States-based alternate trading venue and were injured as a result of the misconduct.” And yes, the complaint (which can be found here) contains multiple references to Michael Lewis’s book.


Interestingly, the complaint not only purports to be filed on behalf of a plaintiff class, but it also purports to be filed against a defendant class as well. The Brokerage Firm Defendants and High Frequency Trader defendants named in the complaint purportedly are sued both individually and as representatives of a defendant class consisting of all (1) financial firms whose brokerage divisions placed bids or offers and/or transacted for members of the Plaintiff Class on stock exchanges or alternative trading venues during the class period: (2)  financial firms that operated alternative trading venues for the anonymous trading of bids and offers and trading by brokers to members of the Plaintiff Class during the class period; and (3) financial firms that engaged in high frequency trading during the class period.


The complaint traces the history of securities trading in the United States since the early 70’s to try to explain the “bold new world” that characterizes current securities trading, a world that now includes “high frequency trading,” which the complaint defines as “a type of algorithmic trading” involving “the use of sophisticated technological tools and algorithms to rapidly trade securities.”


According to the plaintiff’s lawyers’ April 18, 2014 press release (here), the complaint alleges that defendants  “engaged in a scheme and wrongful course of business whereby the Exchange Defendants, together with a defendant class of the brokerage firms entrusted to fairly and honestly transact the purchase and sale of securities on behalf of their clients … and a defendant class of sophisticated high frequency trading firms … engaged in conduct that was designed to and did manipulate the U.S. securities markets and the trading of equities on those markets, diverting billions of dollars annually from buyers and sellers of securities to the defendants.”


The complaint alleges that certain market participants received material, non-public information so that they could use the informational advantage obtained to manipulate the U.S. securities market. The Exchange Defendants and those defendants that controlled alternate trading venues allegedly demanded and received substantial kickback payments in exchange for providing the High Frequency Trader defendants access to material trading data via preferred access to exchange floors and/or through proprietary trading products.


In exchange ‘hundreds of millions of dollars” in payments, the Brokerage Firm Defendants allegedly provided access to their customers’ bids and offers, and directed their customers’ trades to stock exchanges and alternate trading venues that the Brokerage Firm Defendants knew had been rigged and were subject to informational asymmetries as a result of defendants’ scheme and wrongful course of business. The Brokerage Firm Defendants allegedly sold “special access” to material data, including orders made by the investing public so that the high frequency trader defendants could then trade against them using the informational asymmetries and other market manipulation.


The complaint alleges that the defendants’ alleged conduct deprived investors of the “market integrity” on which all securities buyers and sellers rely, as a result of which the plaintiff and the plaintiff class have been “victimized by what can fairly be characterized as a crooked crap game.” (Citations omitted).


The complaint alleges three substantive claims. The first, asserted against all defendants, alleges violation of Section 10(b) of the Exchange Act and Rue 10b-5 thereunder. The second, filed only against the Exchange Defendants, alleges violation of Section 6(b) of the Exchange Act. (Section 6 of the Exchange Act provides for the existence of National Securities Exchanges and specifies certain requirements for the existence, including in particular a requirement that the exchanges operate in a fair and equitable manner). Count III, filed against the Brokerage Firm Defendants and the High Frequency Trading, alleges violations of Section 20A of the Exchange Act. (Section 20A specifies the liabilities to contemporaneous traders for insider trading.) The complaint seeks compensatory damages, equitable restitution, forfeiture and other injunctive or equitable relief.



This massive, sprawling lawsuit is nothing if not ambitious. Between the purported plaintiff class that includes everyone that traded in the U.S. securities marketplace during the last five years and an encyclopedia of defendants (including a purported defendant class) that includes just about every one of the financial firms that makes up the U.S. securities marketplace, this lawsuit basically tries to encompass the entire private U.S. securities arena and everything and everyone in it.


The plaintiffs’ lawyers’ ambition includes not only the size of their undertaking, but also the novelty of some of their approaches. I am very curious to know whether or not there is any history of private civil litigation under Section 6 of the Exchange Act and whether or not any other litigants have successfully pursued claims against the securities exchanges based on this statutory provision.


The plaintiff’s purported use here of a defendant class action is also interesting. The attempt to name a defendant class is not a new concept. Claimants have attempted to use this kind of procedural vehicle in a number of other kinds of lawsuits, ranging from patent litigation to product liability litigation against fire arms manufacturers. Still, as noted on the Class Action Countermeasures blog (here), defendant class actions are “rare beasts” because of definitional and procedural problems surrounding their use. Here, the plaintiffs will struggle to overcome some obvious problems with the seeming shapelessness of the defendant class and the problems associated with having class representatives that did not volunteer for the role.


Another challenge the plaintiffs may face has to do with the very subject of their lawsuit. For all of the adverse publicity surrounding high frequency trading, it is not (in and of itself) illegal – though of course, front-running, insider trading and other practices are or can be. However, it is a tall order to try to contend that everyone engaged in high frequency trading employed prohibited practices. Moreover, high frequency trading has its defenders. According to some, the presence of high frequency trading helps to narrow the gaps between bid and ask prices, which helps to reduce trading costs – a possibility that may highlight the kind of challenges the plaintiffs will face in pursuing these claims and in trying to show that all of the members of the purported plaintiff class were in fact damaged. As one author put it, high frequency trading may be “mysterious and secretive, but not at all evil.” 


And of course the plaintiff will face the hurdles that any private securities plaintiff faces – overcoming the heightened pleading standard under the PSLRA, presenting sufficient allegations of scienter as to each of the defendants – except that here all of those hurdles are magnified by the sheer number and diversity of the defendants involved.


If nothing else, this lawsuit looks like a full employment act for the securities defense bar. The dozens of defense law firms that will be involved undoubtedly will count on riding this baby for years. (Which of course underscores another aspect of the plaintiff’s lawyers’ audacity in brining this suit; that is, they are going to have to carry this massive lawsuit, which will be fiercely litigated for years, before they will realize any possibility of a recovery.)


Whenever there is massive new event-driven litigation like this I am asked what the litigation means for the D&O insurance industry. Here, I think this event means a variety of things. Many of the larger financial institution defendants are either self-insured, carry large self-insured retentions or only carry so-called Side A only insurance programs (which would not be triggered here). The involvement of these larger financial institution defendants in this lawsuit will have only a limited impact on the D&O marketplace.


Many of the other defendants, especially the smaller brokerage and trading firms, are likely to carry more traditional D&O insurance programs (although an interesting question is whether these claims would trigger their D&O insurance programs or the E&O insurance programs – or even perhaps both). The carriers insuring these other defendants are at a minimum going to be looking at some huge defense fee bills. Maybe not enough to change the overall marketplace, but maybe enough to substantially affect the D&O (and E&O) marketplace for these kinds of financial firms.


The real wild-card here, for the insurance carriers as well as for everyone else involved, is whether this case will get through to the point where there is a settlement or settlements, and importantly for insurance purposes, whether by that point there have been developments in the ongoing governmental investigations that might affect the availability of coverage (e.g., whether or not there have been any criminal guilty pleas or other admissions that might trigger coverage exclusions). In other words, at this early stage, it is far too early to try to conjecture how it might all play out. However, for better or worse, we will get to have the experience of watching this case unfold in the months ahead.


Many readers will recall that Michael Lewis spoke at the PLUS International Conference in Orlando last November. He was an engaging and entertaining speaker and he left the impression that he is an interesting, likeable person. Although it seems likely that this lawsuit will be referred to as the “high frequency trading securities lawsuit,” I kind of hope in an acknowledgement of Lewis that the lawsuit is known as the “Flash Boys lawsuit.” (I recognize that the defendants probably wouldn’t like that very much.)


Dinner at Edwin’s: On Saturday night, my wife and I joined another couple for dinner at a new and unusual restaurant in Shaker Square in Cleveland called Edwin’s. It is a high-end, white table cloth restaurant serving fine French food. The food was excellent, and the service was well-intentioned and enthusiastic, if not always perfect. But what made the meal interesting is Edwin’s mission:


Edwin’s Leadership & Restaurant Institute is a unique approach at giving formerly-incarcerated adults a foundation in the hospitality industry while providing a support network necessary for a successful reentry. Edwin’s goal is to enhance the community of Cleveland’s vulnerable neighborhoods by providing its future leaders. Our mission is to teach a skilled trade in the culinary arts, empower willing minds through passion for the hospitality industry and prepare students for a successful transition into the world of business professionals.


In recent years, there have been a string of restaurants in Shaker Square that have tried valiantly but failed. In fact, one of our favorite after-theater restaurants, the Wine Grotto, used to be located in the space now occupied by Edwin’s. For many reasons, it could be a tough road for Edwin’s, too.  But you just really want to see a project like this succeed. It was great to see that the restaurant was crowded and the large staff was busy. It makes such a difference to meet the staff members and to get a glimpse of the challenges they face – and of how hard they are willing to work to overcome the challenges.


The True Story of the Koy Panyee Southern Thailand Youth Soccer Club: A friend sent me a link to the video embedded below. The video tells the true story of how a group of boys figured out how they could find a place to play soccer in their water-surrounded floating fishing village in Thailand. The video is entertaining, heart-warming and inspiring. Do yourself a favor and take a couple of minutes to watch this video.


The Latest Stockpile of Readers’ Mug Shots

Posted in Blogging

mugshotBecause the latest round of mug shots is long overdue, quite a backlog of pictures has built up. The latest round of readers’ photos may be a bit late but it may also be one of the best collections yet.


Readers will recall that  almost one year ago, I offered to send out a D&O Diary coffee mug to anyone who requested one – for free – but only if the recipient agreed to send me back a picture of the mug and a description of the circumstances in which the picture was taken. In previous posts (here, here, here, here, here, here, here, here , here, here, here, here, here, here, and here), I published prior rounds of readers’ pictures. I have posted the latest round of readers’ pictures below.


The first pictures come to us from our friend Mark Gebhardt, the risk manager for the Southern Ute Indian Tribe Growth Fund. Mark took these pictures last summer but only recently sent them in. These pictures were taken above 10,000 feet in a remote part of the San Juan Mountains, near Durango, Colorado, where Mark lives. The second of the two pictures features Mark’s “friend and intrepid camper” Charlie holding a D&O Diary mug; about Charlie, Mark said “if I know Charlie, it ain’t filled with coffee.”


















The next picture, sent in by Rebecca Dutton of March, depicts the centerpieces of the FINPRO team’s Pi Day celebration. The picture does not quite include 3.1415 pies. (It does occur to me that a D&O Diary coffee mug might be a useful thing to have around on Pi Day.)












Our next picture, from Kent Paisley, the head of specialty lines for Darwin National in Canada, depicts Allied World’s new Toronto offices as the company prepares to launch its professional lines products in Canada.












This next picture was taken at Loyola Law School in downtown Los Angeles, where Phillip Reed of Willis (pictured) was asked to  “deliver a guest lecture on what lawyers should know about of liability insurance and its role in civil litigation.”   












And while we are on the West Coast, we should take a look at these pictures sent to us by Megge Van Valkenburg of the Bullivant Houser Bailey law firm in Portland, Oregon. The first picture was taken in front of the Voodoo Donut shot, which Megge reports is a local landmark. The next picture, a tribute to true Portlandia, depicts Megge in front of the sign showing the city’s unofficial motto – Keep Portland Weird.





















One of the most astonishing things I have learned over the years while maintaining this blog is just how far-flung this site’s readership is. As proof of this point, I am happy to publish this picture of the Moscow skyline, sent in to us by Alma Malysheva, the head of the Corporate Clients Liability division for Rosgosstrakh, which Alma reports is one of the three largest insurers in Russia.












And finally, we have these absolutely outstanding pictures taken in South Africa and sent in by our good friend Tracy Baughman, of Beazley in London. Seriously, if you are going to be hanging out with elephants and zebras in Africa, it is always a good idea to have a D&O Diary mug at the ready.





















I never cease to be amazed at the breadth and diversity of pictures that readers send in. I find it incredibly amusing that readers are carrying their mugs onto mountain tops and on safari, as well as to donut shops and office parties.  Thanks to everyone who has sent in pictures of their D&O Diary mugs. This has been such a great experiment. It may just look like a coffee mug, but it turns out to be a tool for self-expression.


Because I have shipped out the last of the mugs, I am afraid I can’t fulfill any more mugrequests. However, if other readers would like to send in pictures taken with their own firm’s mugs, I would be happy to publish the pictures. Of course, if there are D&O Diary mug recipients out there who still have not sent in mug shots, I would be happy to post those pictures as well.


Liability Exposures of Audit Committee Chairs

Posted in Director and Officer Liability

secOne frequently asked question is whether members of a corporate board’s audit committee face heightened liability exposures. Two recent SEC enforcement actions seem to underscore that audit committee chairs do face liability exposures. Though both cases involve somewhat unusual circumstances, they seem to suggest that the “gatekeepers” on which SEC has said it will be concentrating increased enforcement focus may include audit committee members.


Hat tip to Daniel Goelzer at the Baker & McKensie firm for his April 2014 memo entitled “Audit Committee and Auditor Oversight Update” (here) that brought these cases to my attention.


The Ag Feed Case: On March 11, 2014, the SEC filed an enforcement action in the Middle District of Tennessee against Agfeed Industries and certain of its current and former directors and officers. including K. Ivan Gothner, who served as chair of the company’s audit committee, and Edward Pazdro, who served for a time as the company’s CFO.


The SEC’s complaint, which can be found here, alleges that from 2008 through June 30, 2011, AgFeed, an animal nutrition and hog production company, overstated its revenue by $239 million. The fraud allegedly was orchestrated by the company’s Chinese management. The complaint alleges that in May 2011, Gothner and Pazdro learned that the hog production division had maintained two sets of books in China – a real set and a fake set. In June 2011, Gothner and Pazdro received a report from Chinese counsel at AgFeed which concluded based on witness statements and documents that AgFeed had maintained the two sets of books for the purpose of inflating revenue and profits, that the company’s former CEO and CEO had directed the fraud, and that the former CFO had ordered the destruction of the second set of books.


The complaint alleges that between June 2011 and September 2011, a period during which the company was engaged in an effort to raise capital, Gothner and Pazdro “engaged in a scheme to avoid or to delay disclosure of the fraud,” including failing to disclose the fraud to auditors and to key company personnel. With respect to Gothner, the audit committee chair, the SEC further alleges that he misrepresented to counsel that a third-party expert had been hired to analyze the USB stick on which the two sets of books were maintained when no expert had been hired. Both Gothner and Pazdro are alleged to have failed to “conduct further meaningful inquiries into the fraud even as additional red flags arose.” The complaint further alleges that their failure to act on the fraud allowed the company to file a false and misleading Form 10-Q in August 2011.


L&L Energy: On March 27, 2014, the SEC filed an administrative cease and desist order against Shirley Kiang, the firmer audit committee chair of L&L Energy, a Seattle-headquartered coal company with all of its operations in China. The order alleges that the company misrepresented in public filings that a person was serving as the company’s Acting Chief Financial officer when in fact that person never did.


The order alleges that  in May 2009 while Kiang was audit committee chair, the purported Acting Chief Financial Office became aware that she had been falsely represented as the company’s Acting CFO, and that the purported Acting CFO asked Kiang to investigate. Kiang advised the company’s chairman of the information; the chairman told Kiang that the person had never actually served as the Acting CFO and that Kiang should not share this information with anyone, including the company’s Board of Directors or the public.


In August 2009, the company filed its 10-K for the 2009 fiscal year. The 10-K contained the required certifications that any fraud involving management had been disclosed to the company’s auditors and audit committee. The SEC cease and desist order alleges that when Kiang signed this certification, she knew or should have know it was false.


The SEC’s cease and desist order charges that by withholding the information that the purported Acting CFO had not served as the actual Acting CFO and allowing the false certifications to be filed, Kiang “caused” L&L Energy to violate the reporting requirements of the securities laws. Kiang agreed to settle with the SEC without admitting or denying allegations (because the cease and desist order was filed in an administrative proceeding, no judicial approval was required). Kiang consented to the entry of an order directing her to cease and desist from any future violations.



As the Baker McKenzie memo notes, enforcement actions against audit committee chairs are rare, and these two cases involving as they do somewhat unusual fact patterns “may seem of limited significance.” However, these two enforcement actions come at a time when the SEC has already announced its intention to pursue “gatekeepers” and to hold them accountable.


It is noteworthy in that regard  that a March 11, 2014 Reuters article discussing the action against the AgFeed audit committee chair quotes SEC Enforcement Director Andrew Ceresney as saying that “today’s enforcement action is a cautionary tale about what happens when an audit committee chair fails to perform his gatekeeper function in the face of massive red flags.”


As the law firm memo puts it, “these cases seem to illustrate how the Commission intends to apply its gatekeepers program to audit committee members.” The Reuters article linked above quotes a leading defense attorney as saying that the AgFeed enforcement action represents “a warning shot across the bow” for public company audit committees,” and that the case is a reminder that “audit committees must follow up on red flags and seek outside counsel for assistance.”


At a minimum the cases should affect the way that audit committee members – particularly audit committee chairs – think about the liability exposure associated with their activities in those roles. These individuals will not only want to understand their exposures but also will want to inquire about the indemnification and insurance available to protect and defend them in the event they are hit with an action based on their service in those roles.


Special thanks to a loyal reader for sending me a copy of the Baker & McKenzie law firm memo.


The Beautiful Game: For many years, my wife and I have joked that when the Wall Street Journal or the New York Times decide to try to do some trend-spotting, they peek inside our house and then write about what we are doing. So it was this morning, when my wife handed me the Thursday Styles section of today’s Times, said, “They’re following us around again,” and pointed to an article entitled “Their Game, Now Ours,” (here), which in the print edition has the subtitle “Soccer emerges as the sport of the thinking class in the U.S.”


Regular readers undoubtedly are aware that I am an energetic fan of European soccer (sorry, to avoid confusion, I can’t call it football in this context), particularly English Premier League soccer. Some may even recall the short item in my post this past Monday about Liverpool’s dramatic 3-2 win over Manchester City on Sunday – a game that the Times article in fact references in its very first sentence. Among other things, the article states that soccer is a topic you can no longer ignore, which is “particularly evident in New York creative circles, where the game’s aesthetic, Europhilic allure and fashionable otherness have made soccer the new baseball – the go-to sport for the thinking class.”


I commend the Times article to anyone interesting in thinking about whether there actually is a trend here.  For myself, I think the current enthusiasm for the sport has less to do with Europhilic sensibilities and more to do with the sheer pleasure of watching the matches. It is, as is often said, a beautiful game – in fact, the beautiful game.


If you have any doubts about the game’s beauty, I recommend you watch the video below of the welsh soccer star Gareth Bale of Real Madrid scoring what proved to be the winning goal in Wednesday’s championship match in the annual  Copa del Rey soccer tournament, between Real Madrid and perennial rival Barcelona. It is one thing to watch the replay aware that you are about to see something special; at the time Bale scored the goal, the moment was absolutely electric. You will note in the video that when Bale’s breakaway run ended with his spectacular goal, Barcelona players collapsed onto the pitch as if they were literally thunderstruck. Watch this video, and you will see what the excitement is about. (When  the video begins, hit Skip Ad, and don’t worry when the video freeses momentarily about 49 seconds in, it starts up again).

Guest Post: Social Media and D&O Liability Exposures

Posted in Director and Officer Liability

danbailieyEarlier this week I published a post on this site about the employment practices liability exposures that the social media may present for employers. After seeing my post, D&O maven Dan Bailey of the Bailey Cavalieri law firm send me a note pointing out that the social media also present D&O liability exposures for companies and their directors and officers as well. Dan sent me a brief article he had written on the topic as well. Dan agreed to publish his article as a guest post on this site, and I have reproduced it below. I would like to thank Dan for his willingness to publish his article on this site. Responsible commentators who would like to submit a guest post on a topic of interest to readers on this site should contact me directly. Here is Dan’s guest post:  


One cannot overstate the important impact that social media is having on all aspects of our social and professional lives.  Evidence is growing that this phenomenon may also impact D&O liability exposures if it is not properly addressed within corporations.  The primary issue from a D&O perspective is whether social media posts by a company or its directors and officers of information that may be considered material to investors can serve as a basis for a securities claim either because the information was selectively disclosed to a few rather than to the entire market, or because the information was false or misleading.


On April 2, 2013, the SEC issued a report that provides guidance on the application of Regulation FD to the use of social media by public companies and their directors and officers.  The SEC stated in the report that social media channels may be used by companies to communicate material non-public information, as long as the company previously took appropriate steps to alert investors and the market to both the types of social media channels that the company may use to distribute such information, and the type of information that the company intends to disclose through those channels.  This guidance applies with respect to disclosures through company websites, blogs and social media sites such as Facebook, Twitter and YouTube.  If a company has not properly informed its investors and the market regarding the company’s intended use of social media sites to communicate company news or if the information disseminated by a company or its directors and officers through those sites is not truthful and complete, significant securities law violations may occur.


Social media risks can arise under other laws, as well.  For example, on January 17, 2013, the Federal Financial Institutions Examination Council issued proposed guidance on risk management for financial institutions impacted by social media.  The guidance addresses the application of various laws, regulations and policies to the social media activities of banks, savings associations, credit unions and other nonbank entities supervised by the Consumer Financial Protection Bureau.  The guidance seeks to promote institutional awareness of responsibilities to identify, measure, monitor and control social media-related risks.  Those risks include not only legal risks, but also reputational and operational risks.  Among other things, the guidance states that all financial institutions should have risk management programs for social media, including internal controls; policies for the use, monitoring and retention of social media communications, with specific regard to compliance with consumer protection laws; employee training; oversight and monitoring of all information posted on the financial institution’s own social media accounts; and compliance procedures and director/management reporting parameters.


Most companies today utilize social media platforms to support their business strategies, but many are not adequately managing the liability exposures which may arise from such activities.  Some suggested loss prevention concepts in this area to protect both the company and its directors and officers include the following:


a.            Company Policies.  Companies should adopt internal policies regarding the appropriate use of social media by its directors, officers and other employees, should train all personnel with respect to those policies, and should monitor social media sites for compliance with those policies.  The informal nature of social media communications may tempt people to abandon their normal discipline regarding appropriate communications when participating in social media sites, thereby creating potential exposures not only for themselves, but also the company and its management.


b.            Authorized Corporate Representatives.  Social media communications which purport to be by or on behalf of the company should be made only by a few select authorized persons who are trained in the various issues which can arise through social media communications.  Any unauthorized communication purporting to be by or on behalf of the company should be disclaimed by the company.


c.             Securities Law Compliance.  All social media communications by or on behalf of the company or its directors and officers should be carefully vetted to assure compliance with securities laws.  For example, one should assess whether the information is material and non-public and, if so, whether the communication is being made through a channel of distribution previously disclosed to investors.  Also, like any corporate disclosure, the communication should be truthful, not misleading, and free of hyperbole or spin.


d.            Inform Investors.  If the company intends to disclose material information through social media channels, the company should clearly inform investors to that intended practice and the specific channels of communication that are likely to be used, as well as the types of information that may be disclosed.  Investors should be notified of this information through alternative sources—such as SEC filings, press releases, and the company’s website—in order to increase the likelihood that all investors will have access to the information, thus giving all investors the opportunity to monitor the social media communications.


e.            Regularity.  If possible, companies should create a pattern or some regularity to its use of specific social media channels so that investors have a better opportunity to monitor all of the information disclosed by the company through social media.


If directors and officers directly participate in social media communications which violate either the securities laws or other legal standards, claims by regulators, shareholders or other third parties may be asserted against the directors and officers.  Likewise, directors and officers who fail to properly identify and manage a company’s social media risks may also be the target of claims by shareholders or regulators.  As the burgeoning world of social media continues to expand rapidly, these risks to directors and officers are likewise expanding.


Cornerstone Releases 2013 Study of M&A Lawsuit Settlements

Posted in Director and Officer Liability

cornerOnly two percent of M&A lawsuit that settled in 2013 involved a monetary payment to shareholders, according to the latest report on M&A lawsuit settlements from Cornerstone Research. The report, entitled “Settlements in Shareholder Litigation Involving Mergers and Acquisitions: Review of 2013 M&A Litigation” (here), is the second part of a two-part series on M&A litigation. Cornerstone’s earlier report on 2013 M&A lawsuit filings trends can be found here. Cornerstone Research’s April 15, 2014 press release about its latest report can be found here.


According to the report, monetary settlements related to M&A lawsuit were rarer in 2013 compared to prior years; only two percent of M&A lawsuits settled in 2103 involved a monetary contribution, compared to over five percent in prior years. In addition, there were only two M&A lawsuit settlements in 2013 for over $5 million (CNX Gas, $42.7 million; BMC Software, $12.4 million), compared to three in 2012 and six in 2011.


Supplemental disclosures remained the only shareholder consideration in the majority of 2013 M&A lawsuit settlements. Nearly 92 percent of M&A lawsuit settlements reached in 2013 includes additional disclosures or additional disclosures plus other terms. As in prior years, over 90 percent of the settlements were reached before the deal closing.


Interestingly, the fees the plaintiffs’ counsel are requesting are as a general matter declining, both with respect to M&A settlements taken as a whole and with respect to disclosure only settlements. Average fees requested by plaintiffs’ counsel declined to $1.1 million in 2013, compared to $1.4 million in 2011 and 2012. Average fees requested in disclosure only settlements declined in 2013 to $500,000, compared to $513,000, down from $953,000 as recently as 2008.


Over the last four years, the plaintiffs’ attorney’s fees requested in the Delaware Court of Chancery are slightly lower than in other courts. Over the same period, the Delaware Chancery Court approved, on average 80 percent of the requested fees, compared to 90 percent in other courts. Delaware Chancery Court granted less than the requested fees in 35 percent of settlements, compared with only 18 percent for other courts.


A number of specific factors affect the size of the fee award. Plaintiff attorney fee awards were higher in settlements with monetary consideration and with reduced termination fees. Between 2007 and 2013 plaintiffs fee awards were 22 percent higher in settlements involving a monetary fund. Fee awards were also higher in  settlements with higher than average number of lawsuits and in cases where settlements took longer than average to reach.  The reports analysis shows that attorneys fees awarded increased on average by $147,000 for each additional lawsuit above the average of five lawsuits per deal. On average, the attorneys fee award increased by $1,100 per additional day between lawsuit filing and settlement above the average of 113 days.


The press release accompanying the report quotes Dr. Lassaad Adel Turki of Cornerstone as saying “We’ve seen a steady decline over the last seven years in aver plaintiff attorney fees in disclosure-only M&A litigation settlements. This decrease may reflect the courts’ apparent growing skepticism for settlements where shareholders do not stand to benefit monetarily.”


PwC 2013 Securities Litigation Report Asks Whether There Are Changes Ahead

Posted in Securities Litigation

pwc2In its recently released annual analysis of securities class action litigation, PricewaterhouseCoopers observes that while 2013 may not have been a particularly noteworthy year in the securities class action litigation arena, “significant events and announcements in 2013 have set the stage for potentially sweeping changes in the future.” The PwC report, which is entitled “Are Changes on the Horizon?: 2013 Securities Litigation Study” can be found here. PwC’s April 11, 2014 press release about the report can be found here.


In making its suggestion that there may be significant changes ahead, the PwC report is relying on a number of factors, including first and foremost the U.S. Supreme Court’s reconsideration of the “fraud on the market” theory in the Halliburton case currently pending before the Court. The report cites a number of other factors as well, most particularly be the SEC’s July 2013 creation of the Financial Reporting and Audit Task Force.


The SEC’s new Task Force is dedicated to identifying and prosecuting those involved in accounting and financial reporting.  The Task Force’s efforts will be substantially aided by the many whistleblower reports flooding into the agency, as well as the analytic tools at the Task Force’s disposal, such the agency’s Accounting Quality Model. The PwC report notes that “an SEC Task Force dedicated to financial fraud, this is equipped with modern tools and a potential army of whistleblowers waiting in the shadows to report misconduct, will inevitably lead to a greater number of financial fraud cases.”


As companies announce their involvement in SEC investigations or enforcement actions, “securities litigation will inevitably follow.” The PwC report suggests that while there may be a delay before the litigation impact, “it may only be a matter of time before the number of accounting related cases returns to previous highs.”


The PwC report also notes that during 2013, there was an increase in the number of companies completing initial public offerings compared to the immediately preceding years and that many of the IPO companies are completing their listings by taking advantage of the JOBS Act provisions for Emerging Growth Companies. The PwC report states that the companies taking advantage of the JOBS Act provisions “may be at a heightened risk of becoming the subject of litigation.” The reduced level of financial information that EGCs are required to provide “may increase the potential for allegations of omissions and/or inadequate disclosures regarding factors detrimental to the current financial position and future prospects.”


According to the PwC report, there were 160 securities class action lawsuits filed in 2013, up from 149 in 2012 but below the annual average number of filings (179) since the enactment of the Private Securities Litigation Reform Act. The report also notes that in 2013 there were the fewest numbers of accounting fraud cases during the 18 years that PwC has been completing its annual securities litigation survey. The low levels of accounting fraud allegations held both with respect to the absolute numbers of accounting fraud filings (46) and to the percentage of all cases filed (29%).


The report notes that with respect to the accounting cases that were filed, allegations of internal control deficiencies are cited more frequently than any other type of allegation. In 2013, 70% of all accounting-related cases alleged inadequate internal controls, or controls that were inappropriately designed, overridden or ineffective. The 70% figure for 2013 accounting-related cases is higher than the 6) of accounting cases in 2012, and represents the highest percentage of accounting cases citing internal control allegations in over ten years.


The report also notes that companies should be wary of any notion that they are “too small “to attract the attention of the plaintiffs’ lawyers. According to the PwC report, in 2012 and in 2013 respectively, 61% and 67% of all companies named in securities class action lawsuits had market capitalizations under $2 billion.


As was the case in 2012, the industry that attracted the highest percentage of securities class action lawsuit filings was the health industry, which was hit with 23% of all filings in both 2012 and 2013. The report notes a number of factors that cause the health industry to attract litigation. First, at least with respect to pharmaceutical companies and medical device companies, “both are heavily dependent on the successful launch of new drugs and products.” Because of marketplace pressure to keep investors apprised of product developments throughout the produce development life cycle, inevitably if problems later emerge investors may question the accuracy of prior statements about the products.


The health industry is also heavily regulated by multiple government agencies. As the report notes, “from research and development, to manufacturing, marketing, selling and billing, companies in the health industry are under intense government scrutiny – with securities litigation as a bi-product if allegations of non-compliance with regulations are made or investigations are initiated.”


Of non-U.S. companies named in securities class action lawsuits in 2013, the country with the most companies sued was Canada. The report notes that this may be due to the fact that in general companies in the mining sector – an important part of the Canadian economy—attracted significant litigation activity in 2013.


The PwC report notes that the number of securities class action settlements in 2013 (69) was roughly the same as the number in 2012 (70). However, the average securities class action settlement in 2013 of $49.6 million was 32% greater than the 2012 average and 21% greater than the five year average. The 2013 average was pulled upward by a number of significant settlements during the year of large cases relating to the financial crisis. The report cautions that these larger settlement figures “should not be viewed as the new ‘normal’ by the plaintiffs’ bar and by mediators” and notes that as the financial crisis cases filter out “total settlement value and average settlement amount will likely decrease in coming years, barring any new trend or industry practice that leads to increases in case filings and the resulting settlements.”


While the average securities class settlement in 2013 was higher than in 2012 and when compared to the average of the preceding five years, the median settlement was unchanged. The median settlement in 2013 was $9.1 million, the same as in 2012, and above 2011 ($8.9 million) but below 2010 ($10.8 million). 

D.C. Circuit Strikes Down SEC Conflicts Minerals Rules in Part, Upholds Other Provisions

Posted in Conflicts Minerals

dccircuitIn an April 14, 2014 Opinion (here), the D.C. Circuit struck down a portion of the SEC’s conflicts minerals rules as violative of the First Amendment, while at the same time upholding the other challenged portions of the Rules. A majority of the appellate panel found that the rules’ requirement that companies must disclose in their SEC filings and on their website that their product is not “conflict free” – by compelling “an issuer to confess blood on its hands” – violates the First Amendment’s free speech protections.



As discussed here, Section 1502 of the Dodd Frank Act required the SEC to promulgate rules requiring companies to annually disclosure their of conflict minerals originating in the Democratic Republic of Congo (DRC) or an adjoining country. On August 22, 2012, the SEC adopted the conflict mineral disclosure rules. The SEC’s August 22, 2012 press release can be found here and the rules themselves can be found here.


The specific minerals at issue are tantalum, tin, tungsten and gold. The countries covered by the disclosure rules are, in addition to the DRC, Angola, Burundi, Central African Republic, the Republic of Congo, Rwanda, South Sudan, Tanzania, Uganda and Zambia. Companies are required to comply with the new disclosure rules for the calendar year beginning January 1, 2013, with the first disclosures due May 31, 2014 and subsequent disclosures due annually each year after that.


Several business organizations including the National Association of Manufacturers challenged the rules in Court, arguing that the way that the SEC adopted the rules violated the Administrative Procedures Act, the Exchange Act and the First Amendment. In July 2013, the district court granted summary judgment in the SEC”s favor, rejecting the various challenges to the rules. The business organizations appealed the district court ruling to the D.C. Circuit.


The April 14 Opinion 

On April 14, 2014, in an Opinion by Senior Judge A. Raymond Randolph for a three judge panel, the D.C. Circuit affirmed the district court’s ruling in part, but reversed the district court with respect to its ruling on the First Amendment challenge. Judge Sri Srinivasan wrote a separate opinion in which he concurred with the court’s opinion in all other respects but dissented from the majority on the First Amendment issue. Judge Srinivasan contended that the Court should have held the First Amendment portion of its opinion in abeyance while an en banc panel of the D.C. Circuit considered the same First Amendment issues in a separate case involving rules relating to the labeling requirements for meat products.  


All three judges on the panel agreed in rejecting the business groups’ challenges to the conflict minerals rules based on argument that the rules are “arbitrary and capricious” under the Administrative Procedure Act and the argument that the SEC had failed to establish that the benefits of the Rules outweighed the substantial costs they are likely to impose. Essentially the court upheld the rules’ requirements for companies to investigate whether their products include the minerals and file public reports on their investigations beginning in June.


However, with respect to the business groups’ contention that the rules’ requirement that issuers must in their SEC filings and on their websites list specific products as not “DRC conflict free” unconstitutionally compels speech in violation of the First Amendment, a majority of the appellate court upheld the business group’s arguments. The appellate court said:


The label “conflict free” is a metaphor that conveys the moral responsibility for the Congo war. It requires an issuer to tell consumers that its products are ethically tainted even if they only indirectly finance armed groups… By compelling an issuer to confess blood on its hands, the statute interferes with their exercise of the freedom of speech under the First Amendment.


The court held that the conflict minerals provisions of the Dodd Frank Act and the SEC’s rules violate the First Amendment “to the extent the statute and the rule require regulated entities to report to the Commission and to state on their website that any of their products have ‘not been found to be DRC conflict free.’” The appellate court remanded the case to the district court for “further proceedings consistent with this opinion.”


In a footnote, the majority opinion addressed the concurring opinion’s suggestion that the panel should have stayed the First Amendment portion of its ruling in order to allow the en banc consideration of the First Amendment issues in the meat labeling case. The majority opinion states that issuing the opinion rather than holding the First Amendment issue in abeyance, “issuing an opinion now provides an opportunity for the parties in this case to participate in the court’s en banc consideration of this important First Amendment question.”



The SEC’s conflicts minerals rules have been highly controversial. As discussed here, the rules could prove difficult for many companies to put into effect and the implementation of the rules could create a host of problems for companies, including in particular even litigation risks. However, though a portion of the rules was struck down, the other portions were upheld. 


The SEC now has some decisions to make, and in particular it will have to decide whether or not it wants to seek en banc review of the appellate court’s First Amendment ruling.  By the same token, the business groups will have to consider whether they want to seek en banc review of the portions of the appellate court ruling upholding the rules. Either way, an en banc review of the case could create procedural complications. Among other things, there is the question of whether or not the en banc panel, the district court or the SEC itself will stay in the implementation of the rules during the en banc review.  


The SEC will also have to consider whether, on remand to the district court, it wants to go forward now with implementation of the portion of the rules that the appellate court upheld, without the disclosure requirements that were a key component of the transparency objectives of the Dodd Frank conflict minerals provisions.


In an April 14, 2014 Reuters article about the D.C. Circuit’s ruling (here), at least one legal commentator suggested that the ruling and the current state of play will put pressure on the SEC’s to grant companies more time to comply with the rules. In any event, it seems like there is more of this story to be told before the court challenge phase is complete.


It would seem that in light of the fact that the appellate court upheld the other portions of the rules and that for now at least the implementation of the rules has not been stayed that companies should prepare themselves to meet the rules’ requirements and deadlines in all respects other than the specific portion of the rules that the appellate court struck down.


I welcome comments from any readers who can shed any further light on where things stand with the implementation of the conflicts minerals rules now given the D.C. Circuit’s rulings and the current procedural posture of the case.