The D&O Diary

The D&O Diary


A Whole Bunch of Interesting Litigation and Enforcement Statistics and Analyses

Posted in Securities Litigation

graphicA single case may involve a host of interesting issues but sometimes the important lessons can only be discerned when many cases are considered collectively. This past week saw the release of some interesting analyses of aggregate litigation and enforcement statistics, each set of which told some interesting tales to tell and identified some important trends.


The SEC’s FY 2014 Enforcement Statistics

The first of these sets of statistics was presented in the SEC’s October 16, 2014 announcement of its Fiscal Year 2014 enforcement statistics. (The 2014 fiscal year ended on September 30, 2014.) The SEC reported that it filed a “record” number of enforcement actions in 2014 involving a “wide range of misconduct” and including a “number of first-ever cases.”


During FY 2014, the SEC filed 755 enforcement actions, which represented a 10% increase over the 686 enforcement actions filed in FY 2013. In FY 2014, the agency also obtained orders totaling $4.16 billion, compared to $3.4 billion in 2013. By way of comparison to the statistics for FY 2013 and FY 2014, in FY 2012 the agency filed 734 enforcement actions and obtained orders totaling $3.1 billion in disgorgement and penalties.


The agency identified at least two significant factors driving the increase in enforcement actions. The first was the agency’s use of “new investigative approaches and the innovative use of data and analytic tools” and the second was the agency’s expansion into a number of new areas based on “first time cases.”


With respect to the use of data and analysis, the press release quotes SEC Chair Mary Jo White as saying that “the innovative use of technology – enhanced use of data and quantitative analysis – was instrumental in detecting misconduct and contributed to the Enforcement Division’s success in bringing quality actions.”


The kinds of “first-ever cases” identified in the press release included “actions involving the market access rule, the ‘pay-to-play’ rule for investment advisers, an emergency action to halt a  municipal bond offering, and an action for whistleblower retaliation.”


The press release also quotes SEC Chair White as saying that “aggressive enforcement” will remain a “top priority” and quotes the head of the SEC Enforcement Division as saying that he expects “another year filled with high-impact enforcement actions.” Going forward, the SEC Enforcement head said, the agency will “continue to bring its resources to bear across the entire spectrum of the financial industry.” Ominously, for the clients of the readers of this blog, he noted that among other things the agency will focus on bringing “cases against gatekeepers.”


The SEC’s press release includes a detailed recitation of various enforcement initiatives and accomplishments during the year. Among other things, the press release notes that during FY 2014 the agency’s whistleblower program awarded nine whistleblowers with total awards of approximately $35 million (the bulk of which was a single $30 million award, the largest ever, as discussed here).


Among other accomplishments, the press release cites the agency’s success during the fiscal year in “holding gatekeepers accountable,” noting that during the year it “held attorneys, accountants and compliance professionals accountable for the important roles they play in the securities industry.” The report also highlights the fact that during the year the agency “obtained the highest-ever FCPA penalties against individuals.”


With respect to the agency’s new policy of requiring individual admissions of wrongdoing as a condition of settlement of cases involving “particularly egregious conduct,” the press release notes that during the fiscal year that it had “demanded and obtained acknowledgements of wrongdoing under the admissions policy announced in the previous fiscal year.”


Alix Partners 2014 Litigation and Corporate Compliance Survey

On October 16, 2014, the business advisory firm Alix Partners released the report of its 2014 Litigation and Compliance Survey. The report is the result of a June 2014 survey of general counsel and compliance officers at companies in the United States and Europe with annual revenues of $250 million or more. The report underscores the fact that companies of this size in both the US and Europe are experiencing increased levels of litigation activity and incurring increased litigation costs. The firm’s October 16, 2014 press release can be found here and the Survey Report itself can be found here.


According to the report, 32 percent of respondents reported an increase in the number of legal disputes in which their companies were involved in the 12 months preceding the survey. The five most frequent types of commercial disputes in which the respondents said their companies were involved in the preceding twelve months were: contract (58%); employment (50%); intellectual property or patent infringement (33%); accounting/financial reporting/disclosure (19%); and insurance (19%). (The results totaled greater than 100% because the survey allowed respondents to select multiple categories.)


A particularly interesting observation from the survey responses of the European respondents is that many companies are seeing increases in cross-border disputes, with 35% of European respondents reporting that the number of cross-border disputes had risen during the preceding 12 months.


Interestingly, 8% of all respondent and eleven percent of European respondents reported that their companies were involved in bet-the-company disputes during the preceding 12 months. The top five types of bet the company disputes in which the respondents reported that their companies were involved were: contract disputes (50%); intellectual property (38%); class action (38%); antitrust (31%); and securities (13%). (Results totaled greater than 100% because of the selection of multiple categories.) Among the European respondents reporting that their companies were involved in bet-the-company litigation, the most frequently reported categories were contracts (71%) and class actions (57%).


All of this litigation activity has led to an increase in litigation spending. 47% of all respondents reported that spending at their companies for litigation had increased in the past year and 38% reported that their litigation departments had grown in the past year. Among the European respondents, half said that their companies had increased spending and 37% reported an increase in the size of their companies’ litigation departments.


As a resulting of the growing litigation threats and the mounting litigation spending, many companies are implementing measures to try to detect potential problems. In particular, increased regulatory oversight has encouraged many companies to increase their focus on preventive measures.


Academics’ Review of Plaintiffs’ Firms Effectiveness in Merger Objection Litigation

Based on their review of M&A-related litigation over a ten year period, a trio of academics has concluded that the top plaintiffs firms obtain the best results for shareholders, because they aggressively litigate their cases. In their October 2014 paper entitled “Zealous Advocates or Self-Interested Actors?: Assessing the Value of Plaintiffs’ Law Firms in Merger Litigation” (here), Case Western Reserve University Professor C.N.V. Krishnan, U.Cal Berkley Law Professor Steven Davidoff Solomon, and Vanderbilt Law Professor Randall Thomas reviewed a sample of 1,739 merger objection class action lawsuits filed between 2003 and 2012, in order to assess the effectiveness of the plaintiffs’ law firms. The results of their analysis, summarized in an October 15, 2014 article on the Vanderbilt University Web Site entitled “Top Class-Action Law Firms Are Worth Hiring, Study Says” (here), showed, according to one of the study’s authors, that “the presence of one of the top plaintiffs’ law firms is significantly and positively associated with a higher probability of lawsuits success.”


The paper’s authors divided the plaintiffs law firms into groups they denominated “top-10” and “non-top-10” using “various reputation measures” The authors then further divided to top firms into “top-5 firms” based on their “popularity with informed plaintiffs and proven ability to obtain large attorneys’ fees awards” The authors then analyzed the results in the various lawsuits in their litigation database, from which they concluded that the involvement of one of the top five firms was very strongly correlated with what the authors described as lawsuit success. The authors said that these results hold even after controlling for selection bias – that is, the likelihood that the top law firms get to pick the better cases that have higher chances of success.


The authors concluded that the top plaintiffs’ law firms achieve the best results because the top firms are significantly more active in prosecuting cases than other plaintiffs firms, which adopt more passive strategies. The top firms’ more active prosecution of the cases is evidenced by the fact that they file more documents in their cases and the fact that they “have fewer cases dismissed, win more procedural motions and obtain more substantive settlements.”  The lower tier firms, by contrast, appear to file lawsuits “in hopes of generating a quick settlement and avoiding the expense of trial,” with the settlements of the type that “many times are believed to profit the law firms more than their clients.”


As one of the authors quoted in the Vanderbilt web site article puts it, “not all plaintiffs’ law firms are alike and lawmakers, judges and regulators should act accordingly.” The authors’ research, they state, should give courts “guidance about the appropriate method for selecting lead counsel in shareholder class action litigation.”


Special thanks to a loyal reader for sending me a link to the Vanderbilt web site.



The SEC’s statement that its filing of a record number of enforcement actions during the past fiscal year was attributable in part to the agency’s “innovative use of data and statistical tools” is interesting. Since the agency announced the initiation of financial reporting task forces and implementation of data analytic tools to detect indicia of potential accounting fraud (dubbed in the media as “Robocop,”  about which refer here), there has been speculation that these initiatives could lead to an upsurge in enforcement activity. Although the agency’s fiscal year report does not directly link the increase in the number of enforcement actions to these initiatives, the SEC”s press release certainly does suggest that these initiatives represent a significant part of the agency’s enforcement actions during the past year. It seems likely that there will be more of this in the months and years ahead.


The SEC report’s emphasis on its actions targeting individuals and gatekeepers is certainly ominous for the interests of this blog’s readers. The agency’s focus on individuals and gatekeepers could, among other things, represent a real threat to the public company officers and directors.


The Alix Partners survey report is interesting not just because it documents that many companies are experiencing increased litigation activity and litigation spending, but also because it shows that these developments are not limited just to the more litigious United States. The fact that an even greater percentage of the European respondents to the survey than U.S. respondents reported that their companies were involved in bet-the-company litigation is surprising, and the fact that the European reported that their companies are experiencing increased litigation activity and litigation spending at about exactly the same levels as the U.S. respondents strongly suggests that the forces shaping the litigation environment in the two arenas may be similar — and even perhaps that the natures of the two environments may be converging. If nothing else, it may become harder over time to contend that litigiousness is a curse unique to the U.S. business environment.


Finally the academics’ analysis of the plaintiffs’ law firms’ results in merger objection litigation may not be surprising – it is hardly unexpected that top law firms produce better results – but their analysis is nonetheless interesting. If nothing else, their analysis substantiates a point that many of the more prominent plaintiffs’ firms frequently make about how many of the litigation ills of which the business community so frequently complains are the results of the actions of the bottom feeder law firms. The academics’ analysis provides support for the argument that the frivolous lawsuits filed only to try to extract a quick fee are the handiwork of the lower tier law firms. The academics report also provides some support for the arguments that some of the top firms often make, which is that their efforts produce real shareholder value and provide real protection for shareholders. The problem of course is to eliminate the frivolous unproductive litigation without eliminating the lawsuit that produce real benefits for shareholders.

Advisen Releases Third Quarter Corporate and Securities Claims Trends Report

Posted in Securities Litigation

PrintContinuing an recent downward trend, corporate and securities litigation filings during the third quarter declined, both compared to the prior quarter and compared to the third quarter last year, according a new report from Advisen, the insurance information firm. In its report, entitled “D&O Claims Trends: Q3 2014” (available here), Advisen reports that corporate and securities litigation declined 18 percent compared to the second quarter and 48 percent compared to the third quarter of 2013. This year’s filings are on pace for the third consecutive year of declining filing activity, as the wave of litigation that followed the financial crisis recedes into the past. However, the report does note that securities class action filing activity rose during the third quarter compared to the second quarter.


Unlike other published litigation reports, the Advisen claims update attempts to track not just securities class action litigation activity, but all corporate and securities litigation filing activity. So, in addition to securities class action filings, Advisen seeks to track, for example, shareholder derivative litigation and securities enforcement litigation, among other things. The Advisen report also tracks securities litigation brought on behalf of individuals (rather than on behalf of a class) and also attempts to track corporate and securities litigation outside the U.S. as well. Because the Advisen report tracks litigation activity other than just securities class action litigation activity, the data reporting  and conclusions in the Advisen report will differ from other published reports.


The Advisen report states that during the third quarter all corporate and securities litigation filings declined for the second consecutive quarter, putting 2014 on pace for its third straight year of annual aggregate declines. Third quarter filings not only declined by almost one-fifth (18%) from the second quarter, but third quarter filing activity is nearly half of what it was during the third quarter of 2013. The 48% year over year quarterly decline is the largest since before the financial crisis.


Nearly all classes of litigation that Advisen tracks declined in the third quarter compared to the second quarter. One exception is securities class action litigation, which increased to 52 filings in the third quarter from 43 in the second quarter. Because securities class action litigation activity picked up while other types of litigation declined, the percentage of all corporate and securities litigation filings represented by securities class action litigation increased. Securities class action litigation represented 21 percent of all corporate and securities litigation during the quarter, which is the highest quarterly percentage of total cases since 2009 and which exceeds the annual average of 15 percent since 2004.


Companies in the financial services industry were the most frequent targets for corporate and securities lawsuits in the third quarter. Fully one third of all third quarter filings were against companies in the financial services sector. Other industries that were active in the third quarter were: information technology (15%); industrials (14%) and consumer discretionary (13%).


The absolute number of merger objection lawsuit continued to decline in the third quarter, continuing a trend that began in 2011. At the current pace, it appears that the number of merger objection lawsuits will decline for the third year in a row in 2014. But while the Advisen report tracks the number of merger lawsuits, it does not track the number of mergers, leaving open the possibility that the number of merger of lawsuits has declined because the number of mergers has declined. Another factor may also be at work; in the past, mergers often attracted multiple lawsuits. It is possible that the aggregate number of merger objection lawsuits is declining because the number of separate lawsuit filed with respect to each merger deal is declining. The more interesting statistic is the percentage of all merger deals that attract at least one lawsuit. In recent years, the percentage of deals attracting at least one lawsuit has approached 100%. Because the Advisen report discusses only the absolute number of merger lawsuits, it does not shed any light on the more important question of the percentage of all merger deals attracting at least one lawsuit.


The general message of the Advisen report is that overall corporate and securities litigation filing levels are declining. Certainly relative to the high water mark of financial crisis-related litigation in 2011, filing activity is down. But evaluating the relative levels of filing activity arguably is a matter of your point of reference. Exhibit 1 in the Advisen report, a bar graph showing annual filing activity, makes the point. The exhibit shows that while filing activity is down relative to the financial crisis-related peak it also has returned to pre credit crisis-related levels. So another way of looking at the filing activity levels is that –rather than saying that the filing activity levels are declining — the filing activity has returned to more normal levels after the huge surge of litigation that followed the financial crisis.


Advisen Quarterly Claims Trends Webinar: On Thursday October 16, 2014, I will be participating in Advisen’s Quarterly Claims Trend Webinar. This free event will take place at 11 am EDT. Also participating in the seminar, in which the panelists will discuss the important trends in corporate and securities litigation, will be Jed Melnick, a leading corporate and securities litigation mediator and Managing Partner, Weinstein Melnick LLC, and Joseph E. White III, Co-Founder & Attorney at the Saxena White law firm. The event will be moderated by Jim Blinn of Advisen. Information about the seminar, including registration, can be found here.


IPO Companies and Fee-Shifting Bylaws

Posted in IPOs

stockmarketticker2One of the more interesting recent developments in the D&O liability arena has been the emergence of issues surrounding fee-shifting bylaws. As readers will recall, in May 2014, the Delaware Supreme Court in the ATP Tours case upheld the validity of a non-stock corporation’s bylaw imposing attorneys’ fees on an unsuccessful claimant in an intra-corporate lawsuit. Legislation to limit the Court’s decision’s effect to non-stock corporations was quickly introduced in the Delaware legislature, but the proposed legislation has been tabled until the legislative session resumes in 2015. While the question of the validity of these kinds of bylaws under Delaware remains on hold, some companies have continued to press ahead. Among the companies adopting fee shifting bylaws is none other than Alibaba, the IPO superstory of 2014.


As discussed in a September 30, 2014 post by Denver Law School Professor J.Robert Brown on the Race to the Bottom blog (here), Alibaba’s Amended and Restated Memorandum and Articles of Association (which can be found here) provide in Article 173:


Unless otherwise determined by a majority of the Board, in the event that (i) any Shareholder (the “Claiming Party”) initiates or asserts any claim or counterclaim (“Claim”) or joins, offers substantial assistance to or has a direct financial interest in any Claim against the Company and (ii) the Claiming Party (or the third party that received substantial assistance from the Claiming Party or in whose Claim the Claiming Party had a direct financial interest) does not obtain a judgment on the merits in which the Claiming Party prevails, then each Claiming Party shall, to the fullest extent permissible by law, be obligated jointly and severally to reimburse the Company for all fees, costs and expenses (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses) that the Company may incur in connection with such Claim.


As Professor Brown points out, Alibaba is a Grand Cayman corporation, so the pending legislative developments in Delaware are irrelevant to the validity of Alibaba’s fee-shifting bylaw. In addition, as a Grand Cayman corporation, the company and its directors and officers are not subject to the same kind of state court litigation as domestic U.S. companies and their directors and officers. So it would seem that this bylaw is targeted at securities lawsuits. However, it should also be noted that the bylaw applies by its terms to claims against the company itself  (as opposed to its directors and officers) and that it requires only reimbursement of fees to the company by unsuccessful litigants.


Shareholders of Alibaba might well have reason to be concerned about this bylaw provision, because of the practical barriers it creates for any shareholder who might want to allege that the company misled investors and thereby violated the federal securities laws. However, for the shareholders to be concerned about the bylaw, they would have to know about it. As Professor Brown notes, the company’s IPO prospectus apparently neglected to mention the existence of this bylaw provision.


Nor is Alibaba the only recent IPO company to include a fee-shifting provision in its bylaw. As Alison Frankel discusses in her October 9, 2014 post on her On the Case blog (here), Smart & Final, a grocery store chain that went public last month, and ATD Corp, a tire distributor that in August filed to go public, have also adopted charter provisions that “shift the cost of defending shareholders’ claims to investors who sue and lose.” Interestingly, both Smart & Final and ATD Corp. are Delaware corporations, so the validity of their bylaw provisions will depend on the outcome of the pending legislative processes in Delaware. These companies join a number of other smaller public companies that have amended their bylaws to include fee-shifting provisions (as discussed here).


According to a Professor Brown’s September 28, 2014 post on the Race to the Bottom blog (here), the Smart & Final fee-shifting provision appears in the company’s articles of incorporation and expressly refers to actions against the company’s officers, directors and employees, so presumably it would apply to shareholders’ derivative lawsuits as well as other state court shareholder litigation.


As Frankel points out, the questions of the validity of these kinds of bylaw provisions may be different for IPO companies than for other publicly traded companies that amend their bylaws to include these kinds of provisions. For the publicly traded companies, shareholders may try to object that the bylaws were amended without their consent. For IPO companies, the defendants “will argue that their founding corporate documents told shareholders what to expect.” (Although that argument may carry less sway if, as seems to be the case with Alibaba, shareholders were not in fact informed about the existence of the provisions).


The more interesting question in all of this may be where the SEC was on these issues. In the past, the SEC seemingly at least, had been quite attentive to these kinds of initiatives. For example, as discussed here, when The Carlyle Group sought to go public in 2012 with, as was disclosed in its preliminary registration statement, a bylaw requiring the arbitration of shareholder disputes, the company ultimately was forced to revise its bylaw to remove the provision under pressure from the SEC. These prior events raise the question of how the various companies recently were able to complete their public offerings with fee-shifting bylaws, which in Alibaba’s case apparently were not even disclosed in the Prospectus


As Frankel notes in her blog post, even if the SEC has been quiet on these issues in the past, that may be about to change. The SEC’s Investor Advisory Committee apparently is taking up these issues. Among other things it may be expected that at least the agency will require companies to do a better job disclosing the existence of these kinds of bylaws.


In any event, it seems clear that these issues are going to continue to percolate, regardless of what the Delaware legislature ultimately does on the pending legislation. For starters, regardless of what the Delaware legislature does, these issues will continue to arise in connection with other companies – like Alibaba for example — to which Delaware’s laws do not apply. In addition, legislative and judicial developments in other jurisdictions could have their own impact; as I noted in a recent post, Oklahoma’s legislature recently adopted a provision authorizing Oklahoma corporations to extend loser-pays to all shareholder suits involving board members.


It remains to be seen where all of this well lead. I suspect that going forward there will be increased scrutiny on these issues for IPO companies and that companies with fee-shifting bylaws that are attempting to go public will likely be called out on the issue, assuming that is that the SEC continues to allow the IPOs of companies that have these kinds of bylaws to proceed.


The larger issue is whether or not the developments portend a significant revision of what is known as the American Rule, whereby it has been the practice in this country that each litigation party will bear its own costs. As companies increasingly seek to introduce their own form of litigation reform through revision of their own bylaws, and as courts and legislatures evolve their response to these kinds of bylaw provisions, there is a possibility that these developments could work a major change to the traditional American Rule on attorneys’ fees.  Which in turn could have a significant impact on the corporate litigation environment.

Book Review: The Global Directors and Officers Deskbook

Posted in Director and Officer Liability

global directors 2The increasing globalization of business and commerce presents significant opportunities and major complications. The complications run across a wide variety of issues. Among other things, the complications arising from an increasingly global economy include concerns relating to the liabilities of companies’ directors and officers across jurisdictions. These concerns can vary widely depending on the countries in which the companies are involved.


Assessing and allowing for the legal differences between different jurisdictions can be challenging. Among other things, the laws regarding indemnification vary widely in different countries. The availability and procedures for class action litigation are also very different in different countries. The types, availability and applicability of D&O insurance also varies as well.


Fortunately, a new resource is available to help those struggling to identify the important issues affecting the liability of directors and officers in different jurisdictions. The resource is a American Bar Association publication entitled “The Global Directors and Officers Deskbook,” (here) which was edited by my good friend Perry Granof, director of Granof International,  and Henry Nicholls, who is senor counsel at the Cohon & Pollack law firm. The book provides an overview of the directors and officer liability landscape in 28 countries, including the United States, Canada and 26 other countries


Each of the chapters in this timely and helpful book addresses a different country. Each chapter follows a common format; the topics addressed in each chapter are: Statutory and Regulatory Framework: Indemnification; Regulatory Proceedings and Shareholder Representative Actions; Insolvencies, Arbitration and Alternative Dispute Resolution; and Insurance Issues.


The 28 countries addressed in the book are arranged regionally, with five countries from Africa and the Middle East (including Egypt, Israel, Nigeria, Saudi Arabia, and South Africa); seven countries from Asia/Pacific (including Australia, China; Hong Kong; India; Japan; Singapore; and South Korea); eight countries in Europe (including France, Germany, Italy, Netherlands, Russia, Spain and the United Kingdom); six countries in Latin America (including Argentina, Chile, Brazil, Colombia, Mexico, and Peru), as well as Canada and the United States.


I know from reviewing several of the chapters that the overview provided by each of the chapters is very useful. For example, the chapter on India provides a helpful discussion of the new Companies Act of 2013, which recently replaced the Companies Act of 1956.Among other things, the new Companies Act has introduced the concept of shareholder class actions. These and similar kinds of important observations are provided in each of the various chapters.


I was very pleased to note in reviewing the book how many of the chapters were written by friends and professional acquaintances. The India chapter was written by Burzin Somandy, whom readers may recall was my host and tour guide during my recent visit to Mumbai. The book’s regional coordinator for Europe and co-author of the U.K. chapter is my good friend Nilam Sharma of the Ince & Co. law firm. The Israel chapter was co-authored by Rachel Levitan with whom I have had much professional contact over the years. The China chapter was co-authored by Arthur Xiao Dong, whom I met for the first time during my 2012 visit to China. Other chapters were written by industry colleagues whom I have been fortunate to meet through PLUS. From my perspective, the book is clearly the work of knowledgeable and experienced industry veterans.


I would like to thank Perry Granof for the opportunity to review this book. I know that just about everyone in the D&O liability insurance industry will find this book to be indispensable.


D&O Insurance: Insured vs. Insured Exclusion Applicability to FDIC Failed Bank Claim Held Ambiguous

Posted in D & O Insurance

caliAs I have previously noted on this blog, one of the recurring D&O insurance coverage issues arising during the latest bank failure wave has been the question whether the Insured  vs. Insured Exclusion precludes coverage for claims brought by the FDIC in its capacity as receiver for a failed bank against the failed bank’s former directors and officers. In denying coverage for these kinds of claims, the D&O carriers argue that because the only basis on which the FDIC has the right to assert these claims is that it “stands in the shoes” of the failed bank, the Insured vs. Insured (IvI) Exclusion precludes coverage. The FDIC and the individual directors and officers argue that the question whether exclusion precludes coverage for the FDIC claims is ambiguous, and therefore the exclusion cannot be applied as the carriers contend.


As these cases have unfolded in various courts across the country, the rulings have gone both ways – some courts have found that the exclusion applies, while others have found that it is ambiguous and does not apply.


In an October 8, 2014 Opinion (here), in the latest ruling on these issues, Central District of California Judge Andrew Guilford, addressing these issues in the coverage litigation filed in connection with the FDIC’s lawsuit against the former directors and officers of Pacific Coast National Bank, held that the question of whether the IvI Exclusion precludes coverage for claims brought by the FDIC in its capacity as receiver of the failed bank is ambiguous.



Pacifica Coast National Bank of San Clemente, California failed on November 13, 2009. In November 2012, the FDIC, as the failed bank’s receiver filed a civil action against five of the bank’s former directors and officers, alleging negligence, gross negligence and breaches of fiduciary duty in relation to various loans the bank had made ad that allegedly resulted in millions of dollars of losses to the bank. The individual defendants sought coverage for the claims under the bank’s D&O insurance policy. The D&O insurance carrier, in turn, filed an action seeking a judicial declaration that there was no coverage under the policy for the FDIC’s claims. The FDIC moved for summary judgment in the coverage litigation and the individual defendants jointed in the FDIC’s motion. The insurer filed a cross-motion for summary judgment.


In denying coverage, the insurer relied on two policy provisions, the IvI Exclusion and the Unpaid Loan Carve-Out. The IvI Exclusion provided in pertinent part that the policy does not provide coverage for any claim against an Insured “brought by or on behalf of any Insured or Company [including the Bank] in any capacity.” The exclusion had a carve-back that preserved coverage for “a Claim that is a derivative action brought or maintained on behalf of the Company by one or more persons who are not Directors or Officers and who bring and maintain such Claim without the solicitation, assistance or active participation of any Director or Officer.”


The Unpaid Loan Carve-Out provides that the Loss as defined in the policy does not include “any unrepaid, unrecoverable or outstanding loan, lease or extension of any credit to any Affiliated Person or Borrower.”


The October 8 Opinion

In his October 8, 2014 Opinion, Judge Guilford denied the insurer’s motion for summary judgment and granted the motion for summary judgment of the FDIC and of the individual directors and officers. Judge Guilford held that the two policy provisions on which the insurer relied are ambiguous and therefore cannot serve as a basis to deny coverage.


With respect to the IvI Exclusion, Judge Guilford said that the fact that the exclusion is ambiguous when applied to the FDIC in its capacity as receiver of a failed bank “is evidenced by the fact that courts considering this exclusion have reached varying conclusions.” Noting the many decisions that have similarly concluded that the exclusion is ambiguous, Judge Guilford said that “there can be little doubt that repeated disputes over the IvI Exclusion have placed insurers on notice that it is ambiguous.”


Judge Guilford went on to note that “the insurance company has the ability, as a repeat party to these contracts, to ensure that ambiguities are eliminated over time.” The insurer “had the opportunity to make clear in the Policy that the IvI Exclusion applied to the FDIC-R, and it could have done so with a simple statement.” Judge Guilford noted that, in fact, the carrier “provides an optional regulatory exclusion – not included on the policy here – that explicitly names the FDIC.”


Judge Guilford expressly rejected the insurer’s argument that the IvI Exclusion applies because the FDIC “stands in the shoes” of the failed bank for which it is acting as receiver.” Though the U.S. Supreme Court had said in the O’Melveny & Myers v. FDIC decision that the FDIC as receiver “stands in the shoes” of the failed bank, the question to be answered under the IvI exclusion is whether or not the FDIC acting as the receiver of a failed bank is acting “on behalf of” the failed bank; the Supreme Court’s decision “doesn’t tell us whether ‘on behalf of’ means the same thing as ‘stands in the shoes.’”


Judge Guilford also found an ambiguity on the question of whether or not coverage for this claim was in any event preserved by the derivative claim coverage carve-back to the IvI Exclusion. Judge Guilford noted that the FDIC as receiver also succeeds to the rights of the failed bank’s shareholders. Even if, as the insurer argued, the FDIC’s lawsuit technically is not a derivative action, the question remains of on whose behalf the FDIC brings the claims. Judge Guilford said that “even if the procedure by which the FDIC-R asserts the claims differs from the derivative action available to shareholders,” the policy should cover the claims “if the FDIC-pursues them under its authority to recover losses on behalf of shareholders.”


Finally, Judge Guilford rejected the insurer’s argument that the Unpaid Loan Carve-Out precluded coverage for these claims because the damages the FDIC sought in the underlying action were in the amount of unpaid loans. Judge Guilford said that Carve-Out does not unambiguously apply to cases where tortious conduct results in damages that might happen to be in the amount of unpaid loans.



Judge Guilford’s opinion in this case stands in interesting contrast with the August 19, 2013 decision of Northern District of Georgia Judge Richard W. Story in the Community Bank & Trust coverage action, in which Judge Story held that the Insured vs. Insured exclusion in the D&O insurance policy at issue in that case unambiguously precluded coverage for the FDIC’s lawsuit against the bank’s former directors and officers. Judge Story’s decision is discussed in greater detail here.


On the other hand, Judge Guilford’s opinion is consistent with an earlier ruling from a different judge in the same judicial district. On January 4, 2014, Northern District of Georgia Robert L. Vining, Jr. held in the Omni National Bank coverage action that because of the “multiple roles” in which the FDIC acts in pursuing claims against the former directors and officers of a failed bank, there is “ambiguity” on the question whether the FDIC’s lawsuit as the failed bank’s receiver triggers the insured vs. insured exclusion. For further background on Judge Vining’s decision, refer here.


Similarly to Judge Vining, in October 2012, District of Puerto Rico Judge Gustavo Gelpi declined to dismiss a direct action the FDIC had brought under the Puerto Rico direct action statute against the D&O insurer of the failed Westernbank, noting that the FDIC has authority under FIRREA to act on behalf of a number of different constituencies and therefore that “the FDIC”s role as a regulator sufficiently distinguishes it from those whom the parties intended to prevent from bringing claims under [the Insured vs. Insured] Exclusion.” (For more about Judge Gelpi’s decision, refer here.)


Judge Guilford not only acknowledged the existence of this split in the case authority but he expressly relied on  it in concluding that the exclusion’s application to claims asserted by the FDIC-R is ambiguous, observing that the fact that the exclusion is ambiguous “is evidenced by the fact that courts considering this exclusion have reached varying conclusions.” This argument, taken together with the increasing weight of the cases that have concluded that the exclusion’s applicability to the FDIC-R is ambiguous, may increasingly make it more difficult for insurers to argue that the exclusion is not ambiguous.


Judge Guilford’s observation that the carrier could have easily precluded coverage for claims asserted by the FDIC by the inclusion of a regulatory exclusion is interesting. It is true that in the process of policy placement, the question of whether or not there is “regulatory coverage” tends to focus on whether or not the policy has some form of regulatory exclusion. Policies that do not have regulatory exclusions are preferred over policies that do. This marketplace distinction between policies that have the regulatory exclusion and that do not would be meaningless if coverage for FDIC claims is nevertheless precluded by the IvI Exclusion, whether or not the policy has a regulatory exclusion. Given this practical dynamic in the day-to-day insurance marketplace, there is some merit to the argument that the carrier ought not to be able to preclude coverage indirectly for a claim it could have but did not exclude expressly.


I will say I am less persuaded by Judge Guilford’s conclusion that even if the IvI Exclusion operates to preclude coverage for the FDIC’s claims coverage is nevertheless preserved by the application of the exclusion’s carve-back for derivative claims. The carve-back clearly was meant to apply to derivative claims. The FDIC’s lawsuit is not asserted as a derivative claim; it is a direct action. Judge Guilford’s analysis of this issue seems forced to me and unnecessarily fuzzies up the issue.


As long as the D&O insurance carriers hold out the hope that they might be able to persuade a court to reach the same conclusion that Northern District of Georgia Judge Richard Story reached in his August 2013 decision in the Community Bank & Trust case – that is, that the IvI exclusion unambiguously precludes coverage for the FDIC’s claims as receiver of a failed bank against the bank’s former directors and officers – they will continue to try to contest coverage in reliance of the exclusion. However, with each decision that the exclusion’s applicability to the FDIC’s claims is ambiguous, the argument will get harder and harder for the carriers to sustain. At some point, the cumulative weight of the case decisions could reach the point where the argument simply becomes unsustainable – that is, of course, unless the insurers can notch up some victories for the contrary position.


Book Review: “Berkshire Beyond Buffett”

Posted in Warren Buffett

bbbWhat Warren Buffett has accomplished at the head of Berkshire Hathaway is nothing short of astonishing. Not only has he built a massive company, but he has done it while maintaining an unparalleled reputation for business integrity. The man is an American business icon. He is also mortal. Buffett is now 84 years old. The question of what happens to Berkshire after Buffett moves on has weighed on the company for years – indeed, the rating agency Fitch has long highlighted as a risk of the company that so much depends on Buffett, whose departure, they aver, can only diminish the company’s value. These kinds of questions will only grow in coming years as Buffett ages further. (In the interests of full disclosure, I should add that I am a Berkshire shareholder, so these questions are not mere idle concerns for me.)


Will all of magic really disappear once the Sage of Omaha is no longer at the helm? In his new book, “Berkshire Beyond Buffett: The Enduring Value of Values” (here), George Washington University Law Professor Lawrence Cunningham takes up this question with admirable enthusiasm. Based on his comprehensive overview of the incredible company that Buffett has built, Cunningham concludes that what makes Berkshire unique is not Buffett himself; rather, it is the culture of the company. Berkshire, according to Cunningham “has distinct features and a strong corporate culture that will endure beyond Buffett.’


Cunningham reaches this conclusion based on a wide-ranging inspection of the company’s many wholly owned subsidiaries. Based on this review, Cunningham concludes that the seemingly diverse collection of subsidiaries share a set of common traits that are “distinctive, durable – and unique to Berkshire” and that “will allow Berkshire to endure beyond Buffett’s departure.”


For “mnemonic power,” and with only a little strain to make it work, Cunningham has reduced the list of common traits to a nine-letter acrostic that just happens to spell out the word “Berkshire.” The traits are: Budget Conscious; Earnest; Reputation; Kinship; Self-Starters; Hands off; Investor Savvy; Rudimentary; Eternal. That is, Buffett has assembled a group of companies led by managers that share his commitment to thrift; that value the autonomy and long-term commitment involved in Berkshire’s ownership; and that share his commitment to maintaining a reputation for integrity.


Over several interesting and readable chapters, Cunningham examines various Berkshire subsidiaries to show how they exemplify these characteristic traits. Cunningham presents the subsidiaries’ stories as a series of case studies. The stories include the histories of many familiar Berkshire companies, such as See’s Candies and GEICO. The stories also include interesting descriptions of some companies that may not be as familiar, such as FlightSafety International, MiTek, and Forest River. The companies’ stories are presented as a series of short vignettes that read like parables – each one coming as it does with its own moral lesson.


Not that Cunningham’s review is simply a panegyric. Cunningham is careful to consider several notable stumbles that have occurred along the way. Cunningham closely examines problems that arose at Gen Re after the company was acquired by Berkshire. He is also critical of both Buffett’s and Berkshire’s handling of the unusual circumstances that led to the departure of David Sokol, after Sokol had made a massive investment in the shares of Lubrizol before recommending to Buffett that Berkshire consider buying the company. In Cunningham’s view, the stumbles represent circumstances where Berkshire or Buffett uncharacteristically strayed from the company’s fundamental principles – in the end, reinforcing how critical the fundamental principles are to the company’s value and success. 


Cunningham also optimistically suggests that some of the measures that Buffett has recently put in place have laid the groundwork for a smoother transition. For example, he notes that in recent  years Buffett has brought in Todd Coombs and Ted Wechsler as sub-portfolio managers, as one of several steps that Cunningham suggests provide “the promise of durability” that will ensure that Berkshire continues to thrive after Buffett is gone.


One particularly interesting part of Cunningham’s analysis is his consideration of the Marmon Group, which is a large industrial conglomerate that was founded by the Pritzker family. Berkshire took over ownership of the company in anticipation of the passing of the company’s long-standing leaders. As Cunningham notes, Marmon was not only a perfect fit for Berkshire, but the two companies were built in very similar ways. Both had grown by acquisitions, undertaken in a careful and controlled way. Both were founded and developed by powerful leaders who left an indelible mark on their companies.


While there are also important differences between the two companies, Marmon, Cunningham suggests, provides one potential model for the post-Buffett Berkshire Hathaway. Cunningham notes one particular step the Pritzkers took as they prepared their companies for their departure.They organized the company into sectors supervised by divisional Presidents, who could create and implement strategy across the business segments. Based on the Marmon example, there is, Cunningham asserts, “good precedent for believing that even such a vast and decentralized enterprise can endure well beyond its founders.”


Cunningham also makes an interesting point about the business activities of a number of the subsidiaries. While Buffett has many praiseworthy talents, his true genius is capital allocation. He has made an astonishing number of successful acquisitions. As a result, Berkshire represents a great collection of companies that will continue to produce revenue and profits long after Buffett is gone. My concern has always been that after Buffett is gone, his successors may be unable to repeat his incredible deal making acumen. Cunningham points out that a number of companies in Berkshire’s portfolio – companies as diverse as MiTek, Forest River and Lubrizol – have been very acquisitive since their own acquisition by Berkshire. The managers of these and several other companies in the Berkshire group have proven to be very successful dealmakers in their own right. Maybe there will never be anyone with quite the touch that Buffett has, but the company will still continue to be able to deploy its capital in ways that grow the company’s value and contribute to the company’s success, even after Buffett is no longer on the job.


The bottom line for Cunningham is that in Berkshire Buffett has assembled a set of businesses and business managers that will give the enterprise enduring value; as he puts it, you can take Buffett out of Berkshire, but you can’t take Berkshire out of the subsidiaries.


In the book’s Epilogue, Cunningham does sound notes of caution. He allows that after Buffett, we must accept that there will be “slippage.” He observes that: “Deals may not come Berkshire’s way. Offers Berkshire makes may not be on terms as agreeable as they have been. Negotiations may be less favorable.” But returns will not be disappointing, and there will be no justification for dismembering the company or taking other radical steps. In the end, Cunningham concludes, Berkshire transcends Buffett and the company will be his enduring legacy.


I have to say I found Cunningham’s analysis interesting and reassuring Just the same, I do worry what the future may hold for the company, both in the near and longer term. In the near term, I worry about the company as Buffett remains at the helm. My household happens to include an aging relative who is exactly the same age as Buffett. She could not be relied upon to organize a bowl of Wheaties even if you spotted her the bowl, the cereal box, the milk and the spoon. Buffett by contrast is aging well, but the years have their own weight and cannot be gainsaid. The transition to the post-Buffett era could prove difficult not because the change will take place abruptly; it could prove difficult because the pre-departure era could prove to be far longer than is good for the company.


I also worry about the ownership base. One of the keys to Buffett’s great success is that he managed to build a shareholder base for his company that shares his business philosophy, that is willing to take a long-term view, and that knows better than to insist that the company’s management meet various short term goals. The shareholders have been amply rewarded for acquiescing in these views. Will the shareholders be as patient with new managers who lack Buffett’s track record and credibility – particularly if the new managers feel compelled to go in new or different directions? Will the new managers feels constrained in the making the changes that different times may require?


For all of the company’s great past success, a period of uncertainty lies somewhere ahead for the company in the not too distant future. In reading Cunningham’s book, I was reminded of something that one of the Berkshire subsidiary Presidents once said to me. The individual said that when Buffett dies, the company’s share price could plunge, perhaps dramatically. When that happens, the individual said, raise all the cash you can and buy as many shares as you can, because once the dust has settled and some time has passed, the world will figure out that Berkshire will still be a great company, even after Buffett is long gone. I happen to believe that assessment is true. Cunningham’s interesting book provides the explanation why that is so.  


Readers who lilke me are particularly interested in Warren Buffett will want to note that Professor Cunningham is the author of the excellent topically indexed anthology of Buffett’s annual letters to Berkshire shareholders, “The Essays of Warren Buffett,” which I reviewed in an earllier post, here.



More Shareholder Litigation Involving Corporate Inversion Transactions

Posted in Shareholders Derivative Litigation

medtronicOne of the more distinctive business trends in recent months has been the surge of so-called corporate inversion transactions, in which a domestic U.S. company merges with a non-U.S. company, with the the successor company to be based in the foreign country in order to take advantage of a more favorable corporate tax regime. These transactions have drawn a great deal of criticism from Washington, and on September 22, 2014, the U.S. Treasury department issued regulations to deter companies from entering into these kinds of transactions.  But at least according to some press reports, while the new regulations may remove some of the benefits the transactions have offered in the past, may not end the transactions altogether.


While it might be expected that these transactions would be unpopular in Washington, you would think that shareholders would welcome these transactions, given the tax advantages that the transactions afforded. However, as I noted in a prior post, in some cases, the shareholders of some of these companies have filed lawsuits against the companies and senior management, complaining, for example about the immediate tax consequences for the individual shareholders that the transactions trigger.


Now a shareholder of Medtronic has filed another of these lawsuits, in connection with the company’s planned $42.9 billion merger with the Irish-based company, Covidien. As discussed in an October 6, 2014 St. Paul Pioneer Press article (here), on October 3, 2014, a Medtronic shareholder filed a derivative lawsuits against the company, as nominal defendant,  and certain of its directors and officers in connection with Medtronic’s planned “inversion” merger with Covidien.


In her complaint (here), the plaintiff asserts claims for breach of fiduciary duties, waste of corporate assets, and unjust enrichment. The crux of the plaintiff’s complaint is that the company’s board has agreed to make “gross-up” payments to certain officers and board members, in order to offset certain excise taxes these individuals will owe under the Internal Revenue Code as a result of the company’s inversion transaction. (The excise taxes are due under a revision to the Tax Code Congress enacted in 2004 to try to discourage inversion transactions.) The purpose of the gross up payments is to put the same position after tax that the individuals would have been in if the excise tax had not applied.


The plaintiff’s complaint alleges that the total cost to the company of these payments will total approximately $63 million, including $25 million to the company’s Chairman and CEO. Because the gross-up payments themselves represent taxable income to the individuals, and because the payments to the individuals includes further amounts to offset the additional  income tax expense, the cost to the company to provide the gross-up payments is far greater than the $32.7 million owed for the excise taxes.


The plaintiff alleges that the company has justified these payments on the ground that the affected individuals should not be discouraged from taking actions they believe to be in the best interests of the company because of their own personal tax situation. The plaintiff alleged that this justification showed that the Board was “incapable of acting in Medtronic’s best interests when their personal interests are at stake,” and therefore that a demand on the “self-serving” board would be futile.


The complaint seeks restitution from the individual defendants for all illicit and improper tax reimbursements, as well as corporate governance reforms to address what the plaintiff calls “self-dealing” by the board.


Lawmakers in Washington undoubtedly will continue to try to find ways to address concerns relating to these kinds of corporate inversion transactions. It remains to be seen whether other companies press ahead with these kinds of transactions after the latest round of regulatory changes out of the Treasury department. But if there are other transactions, companies engaging in inversion transactions not only risk attracting the ire of Washington lawmakers, but also may face the possibility of shareholder litigation, as this latest lawsuit shows.


Special thanks to a loyal reader for sending me a link to the news article about the lawsuit.


A Tale of Two FCPA Follow-On Securities Lawsuits

Posted in Foreign Corrupt Practices Act

judgmentI have frequently noted in prior posts that a frequent development after a company announces the existence of an FCPA investigation is the filing of a follow on civil action (refer, for example, here). But while plaintiffs’ lawyers often are eager to file these lawsuits, in many instances they prove to be unsuccessful (as discussed here). A recent ruling in the FCPA follow-on securities class action lawsuit involving Avon Products illustrates the hurdles companies face in trying to pursue these kinds of claim. At the same time, however, recent dismissal motion denial in the FCPA follow-on securities class action lawsuit involving Wal-Mart Stores illustrates what may be sufficient for these kinds of cases to survive the initial pleading hurdles.


Avon Products  

Avon, a beauty products company that earns much of its revenue from direct sales operations, derived significant sales revenue from direct sales operations in China. The Chinese direct sales operations were made possible by licenses granted by the Chinese government. On October 20, 2008, Avon disclosed in a SEC filing on Form 8-K that in June 2008 the company’s CEO had received a whistleblower letter suggesting that certain travel and entertainment expenses associated with the company’s operations in China may have violated the FCPA. The company also announced that it had launched an internal investigation.


Between October 2008 and October 2011, the company reported generally increasing sales through its Chinese operations. In October 2011, the company announced that the SEC had launched a formal investigation of the company. Later in 2011, the company announced that its CEO would step down from that role but would remain as Executive Chairwomen for two years. In early 2013, the company announced that its Chief Financial Strategy Officer had been terminated in connection with the ongoing bribery investigation.


In July 2011, plaintiff shareholders filed the first of several securities class action lawsuits against the company and certain of its directors and officers. The plaintiffs alleged that the company had failed to disclose prior to the October 2008 8-K filing that it allegedly had obtained its licenses for direct sales operations in China through bribery of Chinese officials and that in subsequent communications reporting the company’s growing revenues in China the company failed to disclose that the revenue was possible as a result of the allegedly improperly obtained licenses. The defendants moved to dismiss.


In a detailed September 29, 2014 opinion (here), Southern District of New York Judge Paul G. Gardephe granted the defendants’ motion to dismiss the plaintiffs’ consolidated complaint. He did grant the plaintiffs leave to file an amended complaint.


With respect to Avon’s disclosures prior to the October 2008 8-K filing, he found that the plaintiffs had failed to show that any of the misleading statements had been made with the knowledge or awareness of the existence of the allegedly improper payments. In particular, he found that the allegations that the company’s executives “must have known” or “had to have known” about the improper payments because of their senior positions and direct involvement in the negotiation of the Chinese licenses were insufficient to satisfy the state of mind pleading requirements. He found with respect to the statements after the October 2008 8-K filing that the plaintiffs had failed to show that the statements were materially false or misleading.



On December 8, 2011, Wal-Mart disclosed in an SEC filing that as a result of information disclosed in an internal review, the company had begun an internal investigation whether certain matters were in compliance with the FCPA, and that the company had engaged outside counsel in the investigation and had voluntarily disclosed the matter to the SEC and the DoJ. In the subsequent securities class action lawsuit, the shareholder plaintiffs alleged that the company had learned of suspected corruption in its Mexican operations as early as 2005 and had conducted an internal investigation in 2006. The plaintiffs alleged that the December 2011 filing was misleading because it left investors with the impression that Defendants had first learned of the suspected corruption at that time. In June 2012, when Wal-Mart disclosed the events in 2005 and 2006, its share price declined significantly.


The defendants moved to dismiss the plaintiffs’ consolidated complaint. In a September 26, 2014 order (here), Western District of Arkansas Susan O. Hickey entered an order adopting the report and recommendation of the Magistrate Judge in the case denying the defendants’ motion to dismiss. Judge Hickey expressly agreed with the Magistrate Judge’s conclusion that the plaintiff had sufficiently alleged that the omission from the 2011 statement of 2005-2006 events rendered the 2011 statement materially misleading. She further affirmed the Magistrate Judge’s finding that omission of the information concerning the 2005-2006 events could have left a reasonable investor with the impression that the defendants first learned of suspected corruption at the time of the December 2011 statement – “an impression that would be untrue.”


The defendants had argued that Magistrate Judge’s conclusion that the plaintiffs had satisfied the requirement to plead scienter were incorrect. Judge Hickey concluded that the plaintiff had sufficiently alleged that defendants knew or had access to information suggesting that the December 2011 statement was not entirely accurate. She noted that the plaintiff had alleged that in October 2005, a Wal-Mart attorney had had given the Vice Chairman of the company’s international operations a detailed report of the suspected corruption allegations and that the Vice Chairman had rejected calls in 2006 for an independent investigation and instead assigned the investigation to the very office implicated in the corruption scheme. The complaint alleges that the company only disclosed the 2005-2006 events after an article appeared in the New York Times discussing the circumstances. Judge Hickey said that “the inference that the Defendants intentionally omitted certain information is just as strong, of not stronger, than any competing plausible inference.”



The different outcomes of the two dismissal motions are obviously attributable to critical differences between the allegations in the two cases. Largely as a result of disclosures in the New York Times articles (and elsewhere) the plaintiff in the Wal-Mart case had a basis on which to allege that senior officials at Wal-Mart allegedly were aware of the alleged improper payments in Mexico prior to the SEC filing in December 2011, whereas the plaintiffs in the Avon case were able to allege only that the senior officials at the company must have known or should have known of the improper payments prior to the company’s October 2008 SEC filing.


The outcome of the dismissal motion in the Avon case shows that It will not be enough for securities class action plaintiffs to succeed for them to allege that the company was involved in significant bribery activities, and that even the existence of significant bribery allegations may not be enough to support a securities class action lawsuit, even where the revelation of the existence of bribery allegations results in a significant share price decline. To be sure, the plaintiffs in the Avon case have been given leave to amend their complaint, and their amended complaint may succeed in overcoming the initial pleading hurdles. But the ruling the case discussed above underscored how difficult it can be for plaintiffs to overcome the pleading hurdles.


The Wal-Mart case shows how significant and serious an FCPA follow-on lawsuit can be where the plaintiffs are able to present factual allegations sufficient to overcome the initial pleading hurdles. Of course, whether the plaintiff in the case ultimately will succeed remains to be seen. However, because surviving the initial pleading hurdles often is the name of the game for securities class action plaintiffs, the shareholder plaintiff in that case already has made it to a critical litigation milestone.


These cases are interesting in and of themselves. They are also interesting in the context of a changing global environment where a number of countries are becoming increasingly active in enforcing their own anti-bribery laws. Among other countries, Canada, China, Brazil, Italy and the UK have recently become more active in this area. For many years, anti-bribery enforcement had been an activity almost exclusively limited to U.S. authorities. As an increasing number of countries become active in this area, overall levels of anti-bribery activity will increase — a prospective development that could have a number of important implications.


Among these implications it the possibility that increase anti-bribery enforcement activity could lead to more of the kind of follow-on civil litigation these two cases exemplify – both here in the U.S. and perhaps even outside the U.S. as well. As the Avon case shows, it may be challenging for the plaintiffs in these follow-in civil lawsuits to succeed, but as the Wal-Mart case shows, with sufficient factual ammunition, the plaintiffs in these kinds of cases can raise sufficient allegations at least to survive initial pleading hurdles.  


Maybe This Really is the Last of the Mug Shots

Posted in Mug Shots

mugshot(4)As reflected in an August blog post (here), I had thought that the ever-popular D&O Diary mug shot series had finally come to end. But even after what seemed to be the final installment, I received even more mug shots from other readers. I have been holding onto these late-arriving pictures for a while in the hope that perhaps some other readers might send in even more pictures. But I don’t want the latest pictures to get stale, so I have published below this short form mug shot gallery. Although it remains to be seen, it is entirely possible that these pictures will truly be the last in the series.


Readers will recall that early last year, 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, here, here, here and here), I published prior rounds of readers’ pictures. I have posted the latest round of readers’ pictures below.


Our first picture comes to us from Claire Lofthouse, who is the Head of PIFI Claims at Catlin in London. I like how Claire cleverly arranged the mug and the object inside to depict an image of the statement “I love The D&O Diary.”




The next picture was sent in by Mary Margaret Fox of Clyde & Co.’s Toronto office. Mary Margaret took the picture at the Ladies’ Golf Club of Toronto, a venerable golf course in Toronto and North America’s lone women-only golf club. Although men are allowed on the course as guests during certain hours, the club has steadfastly maintained its exclusively distaff membership orientation throughout its storied history. The club was founded 90 years ago by pro women’s golfer Ada Mackenzie because of the discrimination women faced at traditional clubs. Golf Magazine had an article about the course earlier this year, here. (Rick Reilly wrote an amusing column in Sports Illustrated about the course a few years ago, but I couldn’t find a link to the actual article). Mary Margaret reports that she took this picture while at the club to play a round of golf with her Clyde & Co. colleague Paul Emerson, Chris Rain of Arch Insurance Canada and Warren Cooney of Axis Reinsurance (Canada).




The final pictures actually appeared previously on this blog, in the travel post about my recent visit to Singapore (here). As discussed in the post, I was in Singapore for a PLUS event, and while I was there, Ernest Heng, a financial lines underwriter with AIG, came up and introduced himself. Ernest had brought his D&O Diary mug to the event, and so he was able to take a mug shot with me. We also got another great picture with the mug and a number of younger brokers and underwriters from Singapore.



My thanks to everyone sent in a mug shot as part of this long-running series. It has been great fun receiving the pictures and seeing the amazing diversity of locations where people took their mug shots. There is still time for anyone who still wants to send along their own mug shot; nothing would make me happier than to be able to publish yet another round of pictures.  


Cheers to everyone who helped make this series so much fun. 


Fifth Circuit Reverses District Court, Holds Multiple Disclosures Establish Loss Causation Even if No Single Disclosure Alone Sufficient

Posted in Securities Litigation

fifcirsealA recurring question arising in class action securities litigation is what constitutes a “corrective disclosure” for purposes of satisfying the requirements for pleading loss causation. In the Amedisys securities class action litigation, the district court had examined the five partial disclosures on which the plaintiff sought to rely to establish loss causation and held that none of the five alone was sufficient to meet the loss causation pleading requirement. On that basis, the district court had granted the defendants’ motion to dismiss.


However, in an October 2, 2014 opinion (here), the Fifth Circuit held that a “corrective disclosure” does not need to involve a single disclosure; rather, it held, the truth can be gradually revealed through a series of disclosures and whether the disclosures taken collectively satisfy the loss causation pleading requirement is to be determined from the totality of the circumstances. Noting that sometimes the whole can be greater than the sum of the parts, the appellate court held here that the five partial disclosures taken collectively constituted a corrective disclosure and satisfied the requirements to plead loss causation.




Amedisys provides home health care services to patients with chronic health problems. In their securities class action complaint, the plaintiffs allege that the company made misrepresentations regarding its practices in connection with Medicare reimbursement. The plaintiffs contend that the truth about Ameidys’s misrepresentations became known through a series of five partial disclosures. The plaintiffs allege that as the truth leaked out about the company’s Medicare reimbursement practices, its share price declined.


The five partial disclosures on which the plaintiff relied are as follows: (1) an August 12, 2008 online report by Citron Research raising questions about the company’s Medicare billing practices; (2) the September 3, 2009 resignation of the company’s CEO and its CIO, who were reported to have left “to pursue other interests”; (3) an April 26, 2010 Wall Street Journal article reporting a detailed expert analysis of the company’s Medicare reimbursement data, and stating that the company might be “taking advantage of the Medicare reimbursement system”; (4) the announcement between May and September 2010 of investigations of the company by the Senate Finance Committee, the SEC and the DoJ; (5) the company’s July 12, 2010 announcement of disappointing operating results.


Between August 11, 2008 and September 28, 2010, the company’s share price declined from $66.07 per share to $24.02 per share, a drop of 63.6%.


The defendants moved to dismiss the plaintiff’s complaint. The district court granted the defendants’ motion to dismiss on the ground that the plaintiff had failed to adequately plead loss causation. The district court reviewed each of the five partial disclosures on which the plaintiff relied and found that each one was insufficient to constitute a corrective disclosure for purposes of pleading loss causation. The plaintiffs appealed.


The October 2 Opinion 

In an October 2, 2014 opinion written by Judge James Rodney Gilstrap for a three-judge panel, the Fifth Circuit reversed the district court and remanded the case to the district court for further proceedings, expressly holding that the plaintiff has adequately pled loss causation.


The appellate court opened its analysis by examining the question of the extent to which fraud must become known to the market before it can constitute a corrective disclosure. The court said that the plaintiff must prove when the “relevant truth” about the fraud began to leak out, causing the plaintiff’s economic loss, which begs the question about the meaning of “relevant.” The Court said the test for “relevant truth simply means that the truth disclosed must make the existence of the actionable fraud more probable than it would be without that alleged fact.” In other words, the relevant truth need not reveal the fraud, it only need make the existence of the fraud more probable.


The Court then said that a corrective disclosure need not be contained in a single disclosure; rather, the Court said, “the truth can be gradually perceived in the marketplace through a series of partial disclosures.” With respect to several of the five disclosures on which the plaintiffs relied, the court said that even any one of the specific disclosures did not make actionable fraud more probable than not, “it must be considered with the totality of all such partial disclosures.”


The Court then reviewed the five disclosures on which the plaintiff sought to rely and said that the disclosures “collectively constitute and culminate in a corrective disclosure that adequately pleads loss causation.” This holding can “best be understood by simply observing that the whole is great than the sum of the parts” In summing up, the Court said “when this series of events is viewed together and with the context of Amedisys’s poor second quarter earnings, it is plausible that the market, which was unaware of Amedisys’s alleged Medicare fraud, had become aware of the fraud and incorporated that information into the price of Amedisys’s stock.”


With respect to the plaintiff’s attempt to rely on the disclosure of the governmental investigations, the appellate court noted that in general the commencement of a governmental investigation of suspected fraud does not standing alone constitute a corrective disclosure. However the court said the disclosure of the governmental investigations of the company’s Medicare billing practices “must be viewed together with the totality of the other alleged partial disclosures.” The court added that the district court erred in “imposing an overly rigid rule that government investigations can never constitute a corrective disclosure in the absence of a discovery of actual fraud.”


The court’s observation with respect to the Wall Street Journal article is also noteworthy. The defendants had attempted to argue that the article could not represent a disclosure because the article’s content was based on information that was already publicly available. The court noted that while the Medicare data on which the article was based may have been publicly available, expert analysis was required to understand its significance. The court noted that “it is plausible that … the efficient market was not aware of the hidden meaning of the Medicare data that required expert analysis [which] may not be readily digestible in the marketplace.”  



At a very basic level, the Fifth Circuit’s ruling in this case is noteworthy because it is the Fifth Circuit’s ruling. The Firth Circuit is not exactly known as the most plaintiff-friendly of courts.


As for the substance of the ruling, the court’s opinion is noteworthy for its conclusion that a series of disclosures can satisfy the loss causation requirement even if no single one of the disclosures standing alone would be sufficient. The court’s observation that the whole can be greater than the sum of its parts is significant and consistent with the realistic understanding that sometimes the truth leaks out gradually rather than coming out all at once.


The Court’s ruling with respect to the potential relevance of the disclosure of governmental investigations is also significant. Among other things, it shows that it is not the case that the disclosure of a governmental investigation is never relevant to the loss causation inquiry in the absence of disclosure of actual fraud. The court’s analysis suggests that the existence of a governmental investigation can be taken into account as part of the totality of circumstances as part of the loss causation analysis.


By the same token the court’s analysis of the significance of the Wall Street Journal article is also interesting, particularly the court’s analysis of the fact that the Medicare data on which the article was based is publicly available. The appellate court’s analysis highlights the fact that information may be publicly available but it may not be understood, or at least that its significance may not be understood. While this observation makes sense, it does raise interesting questions about one of the basic assumptions of the fraud on the market theory – that is, that in an efficient market at any given point in time, the company’s share price reflects all of the publicly available information about the company. The example of the publicly available but not full understood Medicate information suggests that even in an efficient market a company’s share price may not in fact reflect all of the information that is publicly available about the company. Specifically, when there is publicly available information that is not understood by the marketplace, the company’s share price may not reflect that information. This is an interesting point when considering the theoretical underpinnings of the fraud on the market theory.


The court’s observation that the partially revelatory disclosures must be viewed collectively, in totality and in context suggests the possibility of a wide-ranging inquiry that potentially could encompass broad time frames and a multitude of statements or disclosures. While there is nothing in the court’s opinion that would necessarily sanction the approach, there might be some reason to be concerned that plaintiffs in other cases who lack a single obvious corrective disclosure on which to rely may try to satisfy the loss causation requirement by trying to build up a mosaic of many disclosures to create the desired picture. The danger with this type of approach is that it could encourage some plaintiffs to try to bootstrap a collection of unrelated or innocuous statements in order to try to argue that the totality of the statements taken collectively satisfy the loss causation pleading requirement.


It is probably worth noting that the court’s analysis took place in the context of a massive but gradual share price decline that accompanied the piecemeal revelation of the Medicare billing problems at the company. The existence of the steep price decline and its connection to the partial revelations helps to explain the appellate court’s conclusion here. It could be that another court might not be as receptive to the kinds of arguments raised here if the share price decline had not been as steep or if it did not track with the purported pattern of disclosures. Plaintiffs trying to satisfy the loss causation requirement in the absence of these factors may find it harder to argue that, in their case, the whole is great than the sum of the parts. In other cases where these factors are lacking a court might conclude that the whole is no more sufficient that the insufficient separate parts.


Special thanks to John Browne of the Bernstein Litowitz firm for sending me a copy of the opinion. Bernstein Litowitz represents the plaintiff-appellant in the case and John briefed and argued the case in the Fifth Circuit.


Ninth Circuit Affirms Nvidia Securities Suit Dismissal, Holds Item 303 Disclosure Duties Are Not Actionable: In an October 2, 2014 opinion written by Judge Beverly Reid O’Connell for a three-judge panel (here), the Ninth Circuit affirmed the district court’s dismissal of the Nvidia securities class action lawsuit, concluding that the plaintiffs had not adequately pled scienter. In a particularly interesting part of its opinion, the Ninth Circuit, joining the Third Circuit on this point, held that the district court did not err in failing to consider plaintiffs’ allegations of scienter in the context of Item 303 of Regulation S-K, because, the appellate court held, Item 303’s disclosure duty is not actionable under Section 10(b) and Rule 10b-5.


Among other things, Item 303 requires reporting companies to disclosure “known trends or uncertainties” in the Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) section of their SEC filings The plaintiff had asserted that Item 303 requires disclosure of specified information and that, if the information is material, failure to disclose the required information constitutes a material omission for purposes of Section 10(b) and Rule 10b-5.


In rejecting this argument, the Ninth Circuit cited with approval from a prior holding on the same issue by the Third Circuit, in which that court had said “Item 303’s disclosure requirement varies considerably from the general test for securities fraud materiality set out by the Supreme Court in Basic Inc. v. Levinson.” The Ninth Circuit added that “Management’s duty to disclose under Item 303 is much broader than what is required under the standard pronounced in Basic.” The court held that Item 303 does not create a duty to disclose for purposes of Section 10(b) and Rule 10b-5


For disussion of an interesting example where the Second Circuit arguably took a contrary position with respect to Item 303 disclosure duties in the Ikanos Communications securities litigation, refer here.The Ninth Circuit distinguised the Ikanos Communications case, primarily based on the fact that the Ikanos Communications, unlike the Nvidia case, arose under Section 11 of the ’33 Act rather than under Section 10(b) and Rule 10b-5.


I note as an aside that while Item 303 may not, as the Ninth Circuit held, create a duty to disclose, it does create an opportunity to disclose. Companies interested in avoiding the unwanted attention of plaintiffs’ lawyers can try to use the Management Discussion and Analysis section of their periodic filings as an opportunity to “bespeak caution.” I have long argued that the use of precautionary disclosure in the MD&A can be an important part of securities litigation risk management, because it provides a way for companies to try to avoid securities litigation altogether or to put themselves in a better position to defend themselves if securities litigation does arise.


Securities litigation loss prevention is a subject and dear to my heart but I am afraid it is a topic that is not always given the attention it deserves. While it may be a topic for another day, I would welcome the opportunity to reinvigorate the discussion of steps that well-advised companies can take to try to reduce their risks of securities litigation.