The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

The recent news about the eleventh hour award of nearly $4 billion in bonuses to Merrill Lynch employees is only the latest in a series of events exciting enthusiasm for "clawbacks" of allegedly excessive or undeserved Wall Street bonuses. Reports that New York City financial firms disbursed $18.4 billion in cash bonuses is 2008 added further fuel to the fire.

Senator Chris Dodd stated, with particular reference to executives receiving bonuses from financial institutions benefiting from government bailouts, "I’m going to look at every possible legal means to get that money back," adding "I’m going to be urging – in fact not urging, demanding—that the Treasury Department figures some way to get the money back."

President Obama, for his part, referred to the award of bonuses during a recession and while financial companies are seeking financial help to be "shameful" and the "height of irresponsibility."

The idea of compelling executives to disgorge compensation has been a recurring part of the public discussion surrounding the current economic crisis. The suggestion that the government should clawback financiers’ prior compensation has been a rallying cry for academics (here) and commentators (here) alike.

Indeed, the Dealbook blog reports (here) from Davos that a discussion of the topic of executive compensation turned a conference session into " a bit of a lynch mob, Davos-style" in response to a proposal to force those financiers who benefitted from the boom to "disgorge some of the money they ‘earned’ in bonuses based on profits that have since vanished."

This lynch mob mentality is familiar to those who recall the public outcry that accompanied the last era of corporate scandals. In fact, the perceived compensation excesses at Enron and Tyco, among others, resulted in a statutory provision specifically designed for the purpose of clawing back unwarranted compensation, Section 304 of the Sarbanes Oxley Act.

Section 304 has in fact been used to recover executive compensation, in the noteworthy options backdating settlement involving UnitedHealth Group (about which refer here). However, the fact that over six years’ after the enactment of the statutory clawback provision that there is only one noteworthy example of its utilization underscores the provision’s limited usefulness.

Simply put, and as discussed in detail here, Section 304 has several critical limitations: the provision lacks a private right of action; the provision’s language is poorly written; and it can only be used against the CEO and the CFO, limiting its use against other executives.

Moreover, as discussed in a December 24, 2008 CFO.com article (here), a federal district court recently ruled that the provision cannot be enforced against a company’s CEO or CFO if the company did not restate its financial results, even if the company had accounting discrepancies. The restriction clearly could further limit the provision’s usefulness and could constrain the government’s attempt to use the provision to recover the recent controversial bonus payments.

There are, however, other legal avenues that litigants might pursue to try to recover executive compensation, as discussed in the January 29, 2009 New York Law Journal article entitled "Limiting, Clawing Back Executive Pay in the Wake of the Financial Bailout" (here) by David Pitofsky and Matthew Tulchin of the Goodwin Proctor law firm.

The authors note that while the business judgment rule traditionally has shielded compensation decisions "shareholders seeking equitable rescission and restitution via derivative suits have been successful in recovering ill-gotten gains, even in the absence of compelling proof of personal impropriety." The authors cite as an example the recovery of $40 million in bonuses from HealthSouth CEO Richard Scrushy.

The authors also reference the mixed results presented in recent attempts to use state corporate governance laws to recoup executive compensation. On the one hand, they note the unsuccessful regulatory efforts to recoup a $187 million compensation package from former NYSE Chairman Richard Grasso (about which refer here).

On the other hand, the authors also note the more recent and successful use of New York’s fraudulent conveyance laws by current New York Attorney General Andrew Cuomo, who obtained AIG’s agreement, in response to the Attorney General’s demand letter, to freeze salaries and eliminate bonuses for certain former top AIG executives. (An October 15, 2008 New York Times article discussing Cuomo’s letter can be found here.)

University of California law professor Jesse Fried, among others, suggests (here) that the New York fraudulent conveyance laws, upon which Cuomo relied in his efforts involving AIG, might be used to recover unwarranted bonuses. Fried points out that the statute applies to all firms in New York, even those that have not applied for bankruptcy, and gives creditors the right to recover payments made to insiders under certain circumstances.

Provisions regarding executive pay were in fact a part of the federal bailout bill enacted by Congress last fall. However, amendments specify that the provision only applies to firms that receive government bailout funds by selling assets to the government in an auction. Because the bailout funds have not been deployed as originally intended to buy assets, the compensation recoupment provision may prove "toothless," as discussed in a December 18, 2008 Washington Post article (here).

Nevertheless, the lynch mob mentality in evidence at Davos is likely to continue to arise elsewhere, and in all likelihood, popular interest in recouping executive compensation will continue as a prominent topic while Congress continues to grapple with the current economic crisis.

Among other things, we can also expect continued discussion on whether or not Congress should enact a legislative limit on executive pay, as discussed in Robert Frank’s January 3, 3009 New York Times column (here).

In addition we can expect increasing pressure on companies to adopt their own clawback provisions, either as part of their incentive compensation plan, as governance policy, or as a statement of intent. My prior post discussing corporate clawback policies can be found here.

Whenever the issue of possible litigation against corporate officials comes up, the question arises concerning who will bear the costs. Obviously, the amounts of any compensation clawed back or disgorged would not be covered by the typical D&O policy. However, under the wording of the typical policy, a corporate official that is the target of a compensation clawback lawsuit would have substantial grounds on which to argue that his or her costs of defending against the suit should be covered.

To the extent that current popular sentiment for compensation recoupment translates into litigation, the resulting defense expense could become yet another area of growing claims expense for increasingly beleaguered insurers.

The Heat is On: Banco Santander started it, with its offer to make good on its clients' Madoff related losses. The word is out now, and at least some other banks have gotten the message.

As reported in the January 29, 2009 Financial Times (here), the National Bank of Kuwait has fully reimbursed all of its clients that lost money on the Madoff-related Ponzi scheme -- full reimbursement meaning both the clients initial investment as well as "the gains, thought to be ficticious, that they thought they had made."

As the Financial TImes article notes, the NBK move "puts pressure on other banks and fund managers whose clients lost money in Mr. Madoff's alleged fraud." (I wonder why the FT found it necessary to add the work "alleged.") The article goes on to note that NBK had the advantage of relatiively small losses to cover

Proud to Be a ‘KM Pick’: Knowledge Mosaic, the online subscription information service for attorneys, regulators, journalists and academics, offers a number of excellent services, including a weekly newsletter entitled Wired Mosaic. A feature of the newsletter is the KM Pick, in which the newsletter highlights a legal-oriented blog.

I am proud to report that in the January 29, 2009 issue of the newsletter (here), The D&O Diary is featured as the KM Pick. Modesty prevents me from reciting here the blush-inducing words of the newsletter's glowing encomium, but suffice it to say that I sure hope everyone will take a look at the item (right hand column, scroll down).

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A recurring theme on this blog has been the growing threat of civil litigation following in the wake of increased Foreign Corrupt Practices Act enforcement activity. (Refer for example, here.) A recent study both establishes both the overall scale of FCPA enforcement activity and quantifies the magnitude of the FCPA follow-on securities litigation.

The January 28, 2009 NERA Economic Consulting study, entitled "FCPA Settlements: It’s a Small World After All" (here) reports that since 2002, SEC and DOJ litigation and class actions involving the FCPA have "increased steadily," with over "$1.2 billion in settlements and penalties involving more than 30 countries during that period."

While this impressive number is inflated by the $800 million penalty and disgorgement recently imposed on Siemens, it also apparently does not include the pending $559 million settlement to which Halliburton recently agreed.

The Report, which draws on a database of all FCPA settlements between 2002 and 2008, includes a list of the ten largest regulatory settlements (again, not including the pending Halliburton settlement), which range between $16 million and $800 million. These figures include settlements with both the SEC and the DOJ.

What makes this Report really interesting is its analysis of settlements of securities class action lawsuits based on FCPA-related allegations.

The Report states that in securities fraud class action lawsuits arising from alleged FCPA violations a total of $84.4 million has been paid in settlements between 2002 and 2008. The Report further notes that if the outsized Siemens settlement is removed from the analysis, the settlements related to securities class action lawsuits represent 21% of all of the total FCPA-related civil and regulatory settlement by public companies during the period 2002 through 2008.

Based on the author’s review of several recently settled FCPA-related class action settlements, the Report concludes that "the behavior connected to the alleged FCPA violation can sometimes have a lasting impact on the company’s business." The class action settlements demonstrate "the link between alleged FCPA violations, ongoing revenue and the potentially large impact on firm value."

The Report also contains a table reflecting the market-adjusted price reactions to FCPA-related news and announcements. Analysis of the data shows that "the majority of companies that exhibited statistically significant price reactions at the 5% level to FCPA-related news had resulting 10b-5 actions filed against them."

The Report concludes by stating that as a result of globalization trends, coordinated regulatory activity and record-keeping requirements, FCPA enforcement is a growing priority around the world, and states that "as FCPA-enforcement against domestic and foreign issuers increases, it is likely that related securities litigation will be an issue in many of these cases."

The NERA Report’s detailed analysis is very interesting and is also quite consistent with my own analysis of the growing liability threat that FCPA enforcement activity represents. The Report also provides statistical support for my view, expressed here, that "the proliferation of this type of litigation activity and the significant involvement of the leading plaintiffs’ firms suggests that this category of emerging litigation may represent an increasingly important area of potential liability to directors and officers."

This growing liability exposure also raises a number of potentially significant D&O insurance coverage issues, which I discussed at length in the June/July 2008 issue of InSights, which can be found here.

My  recent post analyzing the opinion in the InVision case, in which the Ninth Circuit affirmed the dismissal of a securities class action lawsuit that had been based on FCPA-related allegations, can be found here.

A recent post with a year-end 2008 FCPA update can be found here.

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2008 was a remarkably eventful year, from the dramatic developments during the fall that rocked the financial markets to the changing of the guard in the Presidential election.  Many of the events had a profound impact in the world of D&O insurance.  In all likelihood, significant developments will continue to emerge during 2009 that will have implications for the D&O insurance marketplace.

In the latest issue of InSights (here), I review the past year’s most noteworthy events in the context of the D&O insurance marketplace.  The article’s first section reviews the top ten developments in the world of D&O insurance during 2008.  The article concludes with a perspective on what may lie ahead in 2009, including, in particular, a consideration of the impact that last year’s events could have on D&O pricing and coverage. 

A separate addendum to the InSights article takes a closer look at the 2008 securities class action lawsuit filings.As the addendum details, the pace of shareholder lawsuit filings increased significantly in 2008. There were 224 new securities lawsuits filed in 2008 , which represents a 30% increase over the 172 securities lawsuits filed in 2007, and an 88% increase over the 119 filed in 2006.

The 2008 filing total also represents the highest annual filing total since 2004. Further, all signs seem to indicate that the heightened filing levels will continue into 2009.

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Banco Santander, the Spanish bank whose customers may have suffered as much as $3.1 billion in Madoff-related losses, is reportedly offering some clients compensation for their losses. Reports of this compensation proposal follow one day after investors filed a securities class action lawsuit against Banco Santander and related entities in federal court in Miami.

According to a January 27, 2009 Wall Street Journal article (here), Banco Santander is offering its private banking clients up to $1.79 billion in compensation for losses from the Madoff scheme. The offer would not apply to institutional investors.

According to the Journal, the bank has approached its Latin American clients, offering them preferred stock with a 2% coupon in exchange for an agreement not to sue and an agreement to keep their deposits with the bank. (The great majority of Santander customers who suffered Madoff losses were Latin American, perhaps as many as 70%.) UPDATE: Banco Santander's January 27, 2009 statement regarding the proposed compromise can be found here.

Meanwhile, according to their January 27, 2009 press release (here), on January 26, 2009 plaintiffs’ lawyers initiated a Madoff-victim securities class action lawsuit in the Southern District of Florida.

The class action complaint (which can be found here) was filed by a Chilean company and an Argentinean individual. Both named plaintiffs claim they lost money through their investment in the Optimal Strategies U.S. Equity Fund, a subfund managed by Optimal Investment Services ("Optimal SUS") and marketed by Banco Santander S.A. in the United States. The complaint alleges that substantially all of the Optimal SUS fund was invested with Madoff’s firm.

The complaint is filed on behalf of persons who owned Optimal SUS shares on December 10, 2008 or who purchased shares of Optimal SUS between January 23, 2004 and December 10, 2008.

The complaint names as defendants Banco Santander S.A., Banco Santander International, Optimal Investment Services S.A. (Santander’s Geneva-based hedge fund unit) and certain individuals related to Optimal.

In addition, the complaint also names as defendants PricewaterhouseCoopers, whose Dublin office serves as the Optimal Fund’s auditors. The complaint also names as defendants two related HSBC entities, HSBC Securities Services (Ireland) Ltd. and HSBC Institutional Trust Services (Ireland) Ltd., which acted as administrator, registrar, transfer agent and custodian for the Optimal Funds.

According to the press release, the complaint alleges that the defendants violated the U.S. securities laws by

issuing materially false and misleading statements about their due diligence and oversight of Madoff and BMIS. Among the allegedly false statements made in the Explanatory Memorandum dated January 7, 2008, that was distributed to investors, was the assurance that Optimal "bases its investment decisions on a careful analysis of many investment managers." The complaint further asserts that had the Defendants conducted a reasonably "careful analysis" of Madoff and BMIS, Defendants would not have lost billions of dollars belonging to the investors.

In addition to the securities claims, the complaint also alleges common law causes of action including breach of fiduciary duty, negligence, negligent misrepresentation, and unjust enrichment. The complaint also alleges professional negligence against PricewaterhouseCoopers.

The new Banco Santander lawsuit is similar in many respects to the other securities class action lawsuits that have been filed against Madoff "feeder funds." What makes the case interesting is that both the named plaintiffs and the defendants are foreign domiciled (or at least owned by a foreign parent company). To be sure, one of the named plaintiffs, the Chilean company, specifically alleges that it invested in the Optimal SUS subfund through a Banco Santander International bank account in Miami, Florida.

Notwithstanding the lawsuit’s international flavor, the class action against Banco Santander may be unsurprising, as the bank has disclosed that its clients’ exposure to Madoff through the Optimal SUS fund was as much as $3.1 billion, which the Journal reports is the largest loss by any single bank. (Only investment companies Fairfield Greenwich and Tremont, both of which already face securities litigation, had larger losses).

It remains to be seen where Santander’s proposed compromise leaves the newly filed lawsuit. At least according to the Journal’s account, the proposed compromise does not apply to institutional investors. The Journal also reports that "some of those who have privately received the offer were unhappy with its terms and vowed to hold out for a better deal."

The Journal does report that the Spanish law firm that joined in bringing the suit is scheduled to meet with bank officials on February 6, 2009. Bloomberg quotes the Spanish attorney (here) as saying that the Santander offer is " a step in the right direction"; he added, however, that "at first sight, it looks insuficient."

In any event, I have added the Banco Santander suit to my list of Madoff-related securities class action lawsuits, which can be accessed here. According to my tally, there have now been eleven Madoff-related securities class action lawsuits filed.

Special thanks to the several readers who forwarded me copies of the Banco Santander complaint.

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Among the many lawsuits that have flooded in as part of the subprime and credit crisis litigation wave has been a profusion of lawsuits against the mortgage-backed securities issuers and their securities offering underwriters. These lawsuits, typically filed under the ’33 Act and alleging misrepresentations in the offering documents, claim that investors who purchased securities in the offering have been harmed due to the deterioration in the performance of the underlying mortgages.

As discussed below, questions about the damages claimed in these lawsuits could present serious hurdles as the cases go forward.

Background

A recent example of the class action securities litigation filed on behalf on investors in these mortgage-backed securities investments may be found in the January 26, 2009 press release (here) in which the plaintiffs’ lawyers described the lawsuit they filed in the Eastern District of New York against Deutsche Alt-A, Inc., and certain other defendants in connection with the offering of mortgage-backed pass-through securities by 32 mortgage loan trusts.

As described in the press release, the complaint (here) alleges that the offering documents failed to disclose that:

sellers of the underlying mortgages to Deutsche Alt-A were issuing many of the mortgage loans to borrowers who: (i) did not meet the prudent or maximum debt-to-income ratio purportedly required by the lender; (ii) did not provide adequate documentation to support the income and assets required to issue the loans pursuant to the lenders’ own guidelines; (iii) were steered to stated income/asset and low documentation mortgage loans by lenders, lenders’ correspondents or lenders’ agents, such as mortgage brokers, because the borrowers could not qualify for mortgage loans that required full documentation; and (iv) did not have the income or assets required by the lenders’ own guidelines necessary to afford the required mortgage loan payments, which resulted in loans that borrowers could not afford to pay.

The complaint alleges as the underlying mortgages have deteriorated, "the Certificates are no longer marketable at prices anywhere near the price paid by plaintiff and the Class and the holders of the Certificates are exposed to much more risk with respect to both the timing and absolute cash flow to be received than the Registration Statement/Prospectus Supplements represented."

This case is only one of several recent lawsuits in which the same or similar allegations have been raised. Plaintiffs’ lawyers have raised similar allegations against, for example, mortgage-backed pass through certificates sponsored by JP Morgan Acceptance Corporation (refer here); mortgage backed securities sponsored by GS Mortgage Securities Corp. (refer here); mortgage pass-through certificates sponsored by Washington Mutual (refer here); and mortgage-pass through certificates sponsored by Residential Asset Securitzation Trust (refer here). By my count, there have been more than a dozen of these types of lawsuits filed in connection with the current subprime and credit crisis-related litigation wave.

Like many of these cases, the Deutsche Alt-A case was originally filed in state court, and removed by defendants to federal court. (The removal petition, which accompanies the complaint, can be found here.) The federal court subsequently denied the plaintiffs' motion to have the case remanded to state court, in this case on the relatively narrow and specific ground that that one of the entities that originated the underlying mortgages, American Home Mortgage Corporation, is in bankruptcy in the federal court in Delaware, and the securities case is related to the bankruptcy proceeding. A copy of the January 8, 2009 opinion denying the remand motion can be found here.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the removal petition and complaint in the Deutsche Alt-A case.

Damages Analysis

In each of these cases, the harm claimed is similar to that alleged in the Deutsche Alt-A case; that is, that as a result of problems associated with the underlying mortgages, the securities are "no longer marketable at prices near the price paid" and the holders are exposed to much more risk with respect to the timing and absolute cash flow."

These allegations raise some interesting and perhaps novel questions, as discussed in a January 2009 article from the Milbank Tweed law firm entitled "Subprime Litigation Against Issuers and Underwriters of Mortgage-Backed Securities—Where are the Actual Losses?" (here).

As the memo notes, these lawsuits embody "the relatively untested assumption" that the current paper value of these securities is "the appropriate reference point" for determining whether the investors have "suffered a loss that is ripe for litigation (and the extent of any such loss)."

The authors note that these securities are not listed on any public exchanges, but rather all trades are privately negotiated. The securities themselves are essentially contracts that entitle the owner to certain portions of principal and interest from the pools of mortgages that serve as collateral for the securities. The securities also have various forms of credit enhancement, such as overcollateralization, subordination and excess spreads, so that defaults on the underlying mortgages will not necessarily trigger a default on the payment obligations on the securities themselves.

As a result, an investor could continue to receive payments under the securities as scheduled, even if GAAP accounting might require the carrying value of the securities to be reduced.

These circumstances lead the authors to ask

Is the fear that certain tranches of the [mortgage backed securites] might not be paid in full a sufficient basis for brining a claim under the ’33 Act? Is such a claim a ripe case or controversy for the courts? And is the fact that some "paper measure of price" for the [mortgage backed securities] tranche has declined since the time of purchase enough to overcome these hurdles?

In considering these questions, the authors note that the typical offering documents for these kinds of securities expressly warn that a secondary market for the securities may not exist and that investors may not be able to sell the securities at the price they hope to obtain. For most investors in these types of securities, this consideration is generally of less concern, because the investors "expect to make money by holding the bond through maturity and receiving the income stream they bargained for, not by trading on a secondary market."

Nevertheless, the lawsuits relating to these securities claim damages based on the decline in their valuation and the fears that payments may be at "risk" in the future. The memo reviews the well-publicized difficulties associated with valuing these securities, and notes the probable lack of valuation uniformity among holders of these securities, given the flexibility of the relevant accounting standards. As a result, the securities holders may face challenges in establishing with sufficient certainty that they have suffered an "economic loss," as the securities laws arguably require. These difficulties are particularly where, as is the case with many of these securities, the investors continue to receive all payments due to them.

The authors suggest that generally there is no basis in law for seeking damages where the damages cannot be quantified and may never come to pass. They suggest that defendants in these cases will attempt to argue based on these principles that investors "who continue to be paid the full amount of any principal and interest payments due to them may have little choice but to ‘wait and see’ whether feared, modeled, or projected losses…come to fruition (i.e., become ‘clear and definite’) before being able to state claims under the securities laws."

The authors add that this argument may be particularly compelling where "intervening events such as legislative or executive action….could drastically alter the future payment outlook for many mortgage-backed securities."

These lawsuits against the issuers of mortgage-backed securities represent a significant number of the subprime securities lawsuits. Plaintiffs’ lawyers seem inclined to file these lawsuits, undoubtedly in part due to the degree of investor concern about their investments. Whether and to what extent these cases ultimately will succeed remains to be seen. As the law firm memo demonstrates there may be a host of questions surrounding these lawsuits. At a minimum it will be interesting to see what the courts make of these cases, and in particular the alleged damages, as the lawsuits proceed.

A more academic overview of many of these issues may be found in the paper Harvard Law School professor Allen Ferrell and Babson Business School Professors Jennifer Bethel and Gang Hu entitled "Legal and Economic Issues in Litigation Arising from the 2007-2008 Credit Crisis" (here).

Largest FCPA Penalty Ever Against U.S. Company: Fast on the heels of Siemens recent agreement to pay $800 million to settle bribery allegations (about which refer here), Halliburton has now agreed to pay $559 million to settle charges that one of its former units bribed Nigerian officials during the construction of a gas plant.

According to Halliburton’s January 26, 2009 press release (here), Halliburton has agreed to pay $382 million to the U.S. Department of Justice in eight installments over the next two years. In addition, Halliburton agreed to pay the SEC $177 million in disgorgement. Both settlements are subject to final approval by the relevant authorities.

As reported on the WSJ.com Law Blog (here), the Halliburton penalty is by far the largest ever for a U.S. company, far surpassing the prior record of $44 million by Baker Hughes in 2007. More detail about the Halliburton agreement can be found on The FCPA Blog (here).

The Halliburton settlement is further evidence of a point I have made numerous times on this blog, that FCPA enforcement activity represents a growing area of concern. As I discussed most recently here, an important part of this exposure is the threat of civil litigation that frequently follows on after the enforcement proceeding. The sheer magnitude of the Siemens and Halliburton settlements suggest that potential FCPA liability could represent a significant exposure for corporations and their directors and offices.

Blast from the Past: Another Options Backdating Settlement: The options backdating cases are a vestige from another time and place, yet they remain, like so much cosmic dust, reminders of a distant catastrophe. In a recent development in one prominent case, the Delaware Chancery Court has approved a settlement that is noteworthy in at least a couple of respects.

As reflected in a January 2, 2009 opinion by Chancellor William Chandler in the Ryan v. Gifford case (here), the court has approved the settlement of the options backdating case involving Maxim Integrated Products, over shareholder objections. Under the settlement, which is detailed in the opinion, the defendants agreed to pay a total of $28,505,473 in cash. In addition, the defendants agreed to cancel, reprice or surrender claims with respect to certain options they continued to hold. The company also agreed to certain corporate governance reforms.

The settlement is noteworthy in a couple of respects. The first is simply that it involves the Ryan v. Gifford case, in which Chandler had written an influential and important February 2007 opinion denying the defendants’ motion to dismiss (as discussed here). Because of this opinion, the case is among the more prominent of the options backdating cases.

The other noteworthy aspect of the settlement is the individual defendants’ significant contribution toward settlement. Of the $28.5 million settlement amount, $21 million was paid by insurance. The balance of the cash was paid by the individual defendants. John Gifford, the company’s former CEO, agreed to make his own cash payment of $6 million to Maxim, even though, as the Court noted, he was "covered by insurance." The court’s statement in this respect seems to suggest that there were additional insurance funds available to fund this amount, but that as part of the settlement Gifford nevertheless agreed to pay this amount out of his own assets. Other individuals agreed to pay lesser amounts.

It is not entirely clear whether the insurance would in fact have covered the amounts of these individual payments. For example, in connection with the payments by the individuals other than Gifford, the court noted that the amounts paid "represent the entire amount that they were alleged to have benefitted from the exercise of backdated stock options." To the extent these amounts represent disgorgement or return of ill-gotten gains, the policy’s coverage would not apply. The court’s opinion is not as specific with respect to Gifford’s payment, but to the extent his contribution also represents his return of benefits from the exercise of backdated options, the insurance coverage similarly would not likely apply.

In any event, the size of the settlement, the prominence of the case and the significance of the individuals’ contributions make this a noteworthy settlement. I have added the settlement to my list of options backdating lawsuit settlements, dismissals and dismissal motion denials, which can be accessed here.

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As a result of recent legislative changes, Canadian securities litigation filings increased substantially in 2008, according to a January 26, 2009 Report by NERA Economic Consulting entitled "Trends in Canadian Securities Class Actions: 1997-2008" (here). A January 26, 2009 press release describing the report can be found here.

According to the Report, plaintiffs filed a record nine new securities class action lawsuits in Canada during 2008, which represented an 80% increase over the previous annual maximum and a 125% increase over the prior year.

This level of filing activity is still "miniscule" compare to the securities litigation filings in the U.S., even allowing for the fact that the Canadian securities markets are in the aggregate much smaller than those in the U.S.

However, in recent years, four Canadian provinces have introduced "continuous disclosure" regimes and have enacted civil liability provisions as well. These provisions include certain "gate keeping" mechanisms (including, for example the requirement that the plaintiffs seek leave of court to pursue a class action), but plaintiffs nevertheless seem interested in pursuing relief under these new statutory regimes.

For example there have now been a total of twelve new securities lawsuits filed in Ontario since the 2006 revisions to the relevant laws. (The Ontario Securities Act, as amended, can be found here.)

One of these Ontario cases involves IMAX Corporation, which is also the subject of a U.S. securities lawsuit. As I discussed in a prior post (here), the prospect for Canadian securities actions may have, as the NERA Report puts it, "received a boost" with a ruling in the IMAX case, which permitted the plaintiffs in that case to conduct a certain amount of discovery at the pre-approval state.

As NERA Report observes, "for parallel US-Canada actions, the IMAX ruling may enable plaintiffs to do an end-run around the discovery stay provisions of the PSLRA by brining an action north of the border."

The NERA report also observes that the recent filing in Ontario of a class action against AIG may be an example of this tactic. My prior post discussing the Ontario securities action against AIG and its possible tactical purposes can be found here.

The NERA Reports that among the Canadian filings are cases demonstrating the impact of several trends that have also driven U.S. securities litigation. That is, the 2008 cases include lawsuit filings related to the credit crisis (against CIBC and AIG), as well as cases based on allegations of options backdating.

Nearly one-quarter of the Canadian class actions involve companies in the financial sector, and nearly one fifth involve resources companies.

The Report states that there have been twenty securities class action settlements, but only one (the Southwestern Resources case, which settled for CAN$15.5 million) involved a case brought pursuant to new securities legislation. The Report shows that cross-border cases tend to result in larger settlements than Canadian-only cases.

Overall the Report notes that while the plaintiffs’ bar is "more active than ever" and filed a record number of new lawsuits in 2008, "it remains to be seen whether the gate-keeping aspects of the new amendments to the legislation, as interpreted by the courts, will meaningfully hinder the ability of plaintiffs to prosecute class actions in Canada."

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In recent days, all eyes have been on two of the world’s largest banks. Commentators have questioned, for example, whether Citigroup should be nationalized (refer here) or if the Merrill Lynch-related losses might cost Bank of America CEO Kenneth Lewis his job (refer here). These institutions’ enormous size makes their problems predominant.

But while the woes of the financial titans are undeniably deeply troublesome, I have found myself increasingly concerned about the problems involving three much smaller banks: First Centennial Bank of Redlands, California; Bank of Clark County of Vancouver, Washington; and National Bank of Commerce of Berkley, Illinois.

My concerns about these banks are not about their business prospects – it is too late for that, as these three banks have already failed. Regulators closed First Centennial after the close of business this past Friday, January 23, 2009 (about which refer here), and Bank of Clark County and the National Bank of Commerce were closed the preceding Friday, on January 16, 2009 (refer here and here).

My concerns relating to these banks have to do with the facts and circumstances surrounding their closures, as well what the closures may portend.

1. The Number and Pace of Bank Failures: The closure of three banks on two successive Fridays in just the first few weeks of the New Year shows that the pace of bank failures, which accelerated as 2008 progressed, has continued unabated as we have headed into 2009. In 2008, there were a total of 25 bank closures (complete list here), of which 21 were in the second half of the year. With three closures already this year, signs suggest the heightened level of bank closures at year’s end has carried forward into 2009.

2. Community Banks are Not Immune After All: All three of these banks fall within a standard definition of "community banks" – that is, they had assets below $1 billion. National Bank of Commerce had assets of $430.9 million; Bank of Clark County had assets of $446.5 million; and First Centennial Bank had assets of $803.3 million. The community bank sector has largely been viewed as less affected by the worst of the current credit crisis. However, these three banks’ failures, and their geographic dispersion, suggest that the problems in the community bank sector could be more widespread than previously perceived.

3. Is the Worst Yet to Come?: These three bank failures are likely only the first of many yet to come in 2009. A January 23, 2009 Wall Street Journal article entitled "Banks Die Too Fast for Regulators" (here) reports that "federal regulators are bracing for more than 20 bank failures in the first quarter of this year," which were it to happen would mean nearly as many bank failures in the first quarter as during all of 2008 (which in turn was the most active year for bank failures since 1994).

Moreover, the Journal article specifically noted that the banks "are failing with accelerating speed, exposing holes in the regulatory infrastructure designed to catch collapsing institutions."

A vexing related issue is the apparent intervention of politicians on behalf of troubled banks. A January 24, 2009 Wall Street Journal article entitled "Politicians Asked Feds to Prop Up Failing Banks" (here) describes the efforts of two Illinois politicians on behalf of the National Bank of Commerce prior to its failure. As the article notes, politicians’ efforts "recall the savings and loan turmoil of the late 1980s, when members of Congress pressured the government to go easy on struggling thrift institutions." As one commentator cited in the article stated, these kinds of things "made the saving-and-loan debacle into a political scandal as well as a financial scandal."

4. Dead Banks Mean More Dead Bank Litigation: Both historically and more recently, failing banks have meant failed bank litigation. The Cornerstone Research Report on the 2008 securities litigation activity specifically observed that "five of the 25 banks that failed in 2008 were named in federal securities class actions filed in 2008," even though "only 11 of the 25 banks that failed were publicly traded."

Indeed, already in 2009, another one of the 25 banks that failed in 2008 has been sued in a securities class action lawsuit. As noted here, on January 5, 2009, plaintiffs initiated a securities lawsuit against PFF Bancorp and certain of its directors and officers, whose banking subsidiary was closed on November 21, 2008 (about which refer here). This 2009 lawsuit suggests the likelihood of even further "dead bank" litigation ahead, especially of the heightened level of bank closures persists.

5. Will Asset Woes Afflict More Banks – And Other Kinds of Companies?: There is a specific aspect of the National Bank of Commerce failure that I find particularly troublesome. As noted in much greater detail in a January 23, 2009 American Banker article entitled "Failure Over Securities Losses Sets Off Alarm" (here, registration required), the National Bank of Commerce failed not because of liquidity issues (the usual reason for bank failures) but "because it suffered such massive losses on its investments in Fannie Mae and Freddie Mac stock that it had negative capital levels." As the article notes, the bank’s failure "heightens concern about the fate of some other banking companies that had heavy securities losses."

The American Banker article also specifically notes that similar problems indirectly led to the failure of PFF Bancorp, the banking company noted above as having been sued in 2009. PFF apparently had agreed in June 2008 to sell itself to FBOP Corp. of Oak Park, Illinois, but after FBOP wrote down at the end of the third quarter $936 million of investment securities, the $17-billion asset bank found itself undercapitalized and regulators refused to approve the pending deal. Undoubtedly other banks face similar challenges in their investment portfolios.

Concerns about banks’ troubled asset portfolios were the original basis for TARP, but the American Banker article noted that TARP money wouldn’t have been sufficient to save the National Bank of Commerce, as "the bank would have been eligible for a maximum of $12 million but needed at least $26 million to become well-capitalized again."

Financial institutions’ exposures to troubled assets could be widespread and could become significantly worse as the credit crisis continues to spread. In particular, the number of assets that are troubled continues to grow. They included not only all of the toxic mortgage-backed assets, but also securities and other assets related to Fannie Mae and Freddie Mac, and also assets related to a growing list of other institutions, including Lehman Brothers, Washington Mutual, American International Group, and the Icelandic banks.

More recent financial turmoil has made this list even longer. For example, just in the past few days, Aflac’s share price fluctuated sharply and the company’s financial strength rating was downgraded because to the company’s exposure to debt securities issued by the Royal Bank of Scotland, Barclays and other troubled European banks.

The Aflac example shows that the asset issues that capsized the National Bank of Commerce stretch far beyond the banking sector. Indeed, a January 24, 2009 Washington Post article entitled "Life Insurers Take a Hit" (here) cites Aflac and states, among other things, that "financial markets downward spiral has drawn the nation’s life insurers into its vortex, reducing the already depressed value of its stock by a third since early this month." The article specifically notes concerns that life insurance companies’ balance sheets and financial statements might not "fully reflect the reduced value of the investments they hold."

Nor are these concerns limited just to the banking and life insurance sectors. The Wall Street Journal’s January 24, 2009 Heard on the Street column (here) notes balance sheet concerns involving reinsurer Swiss Re.

The various companies’ balance sheet vulnerabilities arising from their exposure to the securities of other failed or failing financial institutions is precisely the circumstance to which I was referring when I asserted (here) that the credit crisis and its related litigation wave had reached an "inflection point" – that is, companies are getting punished in the financial marketplace (and also getting sued) not necessarily because of their own direct credit crisis-related problems but rather because of their exposure through their investment portfolios to other companies’ credit crisis woes.

Whether or not a revitalized TARP program would be sufficient to remediate these problems for troubled banks is a question our political leaders must decide. But in the interim, the widespread balance sheet exposure to trouble assets will continue to burden a wide variety of companies, including but not limited to banks.

Moreover as the list of companies whose related assets are toxic continues to grow (now including Royal Bank of Scotland with others yet to come), the number of companies struggling with toxic balance sheet assets will also grow. One inevitable consequence undoubtedly will be further litigation, both in the banking sector and elsewhere as well.

A Case of Earlier Indigestion: Concerns surround the most recent financial institution mergers, such as the Bank of America’s acquisitions of Merrill Lynch and Countrywide; Wells Fargo’s acquisition of Wachovia; and PNC Banking Corporation’s merger with National City Corporation.

But a recently filed lawsuit is concerned not with these recent deals, but rather a transaction froman earlier era – Wachovia’s ill-fated $25 billion acquisition of Golden West, which at the time was the nation’s second largest savings and loan.

The new lawsuit was filed in California (Alameda County) Superior Court on January 21, 2009. The complaint, which can be found here, alleges that as a result of the Golden West acquisition, Wachovia acquired a $120 billion portfolio of Option ARM (or "Pick-A-Pay" loans as they were called) which the complaint alleges were not properly underwritten, inadequately capitalized, and became delinquent at very high rates. Within two years of the Golden West transaction, the complaint alleges, Wachovia "ultimately collapsed under the delinquencies and defaults on the Pick-A-Pay loans."

The complaint alleges that Wachovia, certain of its directors and officers, and its offering underwriters failed to disclose these risks to investors who purchased Wachovia’s shares in various securities offerings between 2006 and 2008. The compliant alleges that when the concerns were "ultimately revealed" the company was "forced into a fire sale by the FDIC that finally revealed to investors what had been misrepresented for months, if not years, as a result of its toxic subprime assets, Wachovia was a shell of a corporation that could not exist independently."

The plaintiffs’ lawyers have chosen to file their lawsuit in state court in express reliance on the concurrent jurisdiction provisions of Section 22 of the ’33 Act. I have previously discussed the plaintiffs’ lawyers’ possible forum selection (shopping?) motivations for filing federal securities lawsuits in federal court, here. As I also discussed in a recent post (here), the federal courts are split on whether SLUSA or CAFA preempted the concurrent jurisdiction provisions in the ’33 Act, although the law is most favorable to a finding of state court jurisdiction in the Ninth Circuit.

In any event, I have added the new securities suit to my list of subprime and credit crisis-related cases, which can be accessed here. With the addition of this case, there have now been a total of 147 subprime and credit crisis-related securities cases filed during the period 2007 through 2009, of which seven have been filed already in 2009. A spreadsheet of the 2009 cases can be accessed here.

A Word to the Wise: Those of you who may be planning on attending the 2009 PLUS D&O Symposium, to be held February 25 and 26 at the Marriott Marquis in New York, will want to know that the early registration discount is about to expire. The registration fee for those registering prior to January 30, 2009 is $845 for PLUS members and $1,045 for nonmembers. For after January 30, the fee will rise to $975 for members, and $1,175 for nonmembers. Registration and agenda information can be found here.

This year’s conference promises to be particularly interesting and informative. I am co-Chairing this year’s Symposium with my good friends, Chris Duca of Navigators Pro and Tony Galban of Chubb. The key note speakers include former Secretary of States Madeline Albright and New York Insurance Superintendent Eric Dinallo. Other panelists and speakers include a number of noteworthy individuals, including Stanford Law Professor Joseph Grundfest, Wilson Sonsini partner Boris Feldman and many others.

The Symposium will also feature a reprise of the excellent video, first shown at the PLUS International Conference in November, of "The Life and Times of Bill Lerach." The Securities Docket recently featured a trailer of the video, here.

And Finally: On January 28, 2009, the Securities Docket will be sponsoring the latest in its series of free webinars on securities related topics. The upcoming webinar is entitled "FCPA Enforcement: The Paradigm Shift" and will feature F. Joseph Warin of the Gibson Dunn law firm. Further information can be found here.

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As has been well-publicized, within a matter of weeks of closing its acquisition of Merrill Lynch, Bank of America announced previously undisclosed 4Q08 operating losses at Merrill of $21.5 billion that required BofA to obtain an emergency $20 billion cash injection from the U.S. Treasury, as well as an additional $118 billion asset backstop. BofA’s stock market valuation has dropped more $100 billion since the day before the merger was announced through the company’s January 16 earnings release.

As the Wall Street Journal reported (here), questions immediately arose following BofA’s announcement of the Merrill losses, such as why BofA’s CEO Kenneth Lewis "didn’t discover the problems prior to the Sept. 15 deal announcement" and "why he didn’t disclose the losses prior to the vote on the Merrill deal on Dec. 5 or before closing the deal on Jan. 1."

With these kinds of questions circulating, it comes as no surprise that plaintiffs’ attorneys have initiated litigation. There were actually two different lawsuits announced on January 21, 2009 relating to these circumstances. Both of the lawsuits purport to be filed on behalf of persons who held BofA securities on October 10, 2008, the record date for the December 5, 2008 special meeting of shareholders to approve the merger.

The first of these two lawsuits was filed in the Southern District of New York, as described in the plaintiffs’ lawyers’ January 21 press release (here). The second was filed in the Northern District of Georgia, as described a separate January 21 press release (here). The complaint in the N.D.Ga. action can be found here.

Both complaints name as defendants Bank of America and certain of its directors and officers. The S.D.N.Y. action also names Merrill’s CEO John Thain as a defendant as well. Both lawsuits allege that the defendants made materially false and misleading statements in the proxy materials in order to secure sufficient proxies to approve the merger. The defendants are alleged to have known that excessive losses at Merrill should have been disclosed to allow shareholders a well-informed vote on the merger.

Of all the interesting issues surrounding these circumstances, the most significant is the question of when BofA became aware of the magnitude of Merrill’s losses. (A related question is when Merrill became aware of the losses, but don’t expect any Merrill shareholders to raise the concern, as the completion of the merger was clearly in their best interest.)

The Journal article linked above reports that BofA now asserts that it learned of the magnitude of Merrill’s losses after the Dec. 5 shareholder vote, and that by Dec. 17, Lewis was so alarmed by the losses, which he reportedly characterized as "monstrous," that he traveled to Washington for an emergency meeting with Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson.

What happened at this Dec. 17 meeting presents its own interesting set of issues. Paulson and Bernanke apparently told Lewis that, according to the Journal, "failing to complete the Merrill acquisition would be disastrous" and would "further destabilize markets" and "hurt the bank" and potentially set off a "ripple effect that would exacerbate a fragile situation." The government officials also promised Lewis the backstop protection if the losses proved to be as significant as Lewis feared.

The meeting raises a host of questions, as discussed in the January 20, 2009 Wall Street Journal article entitled "BofA’s Merrill Deal Exposes Myth of Transparency" (here). The article suggests that "by most any reasonable measure, if the Merrill losses were concrete enough to seek a government lifeline, they were concrete enough to report to the company’s shareholders." The question is whether Lewis kept mum about the losses and the promised lifeline at Bernanke and Paulson’s request; the article asks whether perhaps the government was "complicit in nondisclosure."

While there may have been a marketplace interest in keeping the deal on track, there is no existing law that would relieve the company of its disclosure duties for the benefit of larger marketplace interests. The January 20 Journal article raises the question whether "a new legal standard could eventually emerge, sort of a ‘national interest’ doctrine absolving companies of governance actions that may be potentially harmful, but are important to an economic or defense emergency."

These are interesting questions. However, it should be noted that they arguably are irrelevant to the recently filed lawsuits, as the December 17 meeting took place well after the December 5 shareholder vote. There is of course always the possibility of a separate lawsuit on behalf of persons who acquired BofA shares, for example, between the December 17 meeting and before the company’s recent announcement of the Merrill-related losses. UPDATE: In the day immediately after I added this post, additional lawsuits came flooding in, including at least one (here) that is filed against, among others, a subclass of claimants who purchased Bank of America securities between January 2, 2009 and January 16, 2009.

Regardless whether or not other lawsuits in fact emerge, two questions will be paramount: when did the magnitude of the Merrill losses become apparent, and when did BofA have a duty to disclose this information to its shareholders?

Whatever else might be said about these circumstances, the certainly do underscore the magnitude of the problems confronting the economic and banking systems, as well as the challenges facing the incoming administration as it struggles to address these problems while taking up the reins of government.

These circumstances also raise serious questions about whether or not there are or should be exceptions to the transparency principles on which our entire system of securities and market regulation is based. It doesn’t require much imagination to picture the bedlam that could have ensued if the Merrill deal had fallen apart just before Christmas. The system can ill afford any more of the kind of chaos that enveloped the markets in September and October last year.

On the other hand, BofA’s shareholders might well feel that any analysis concluding that information was properly withheld from them for the sake of the overall market improperly negates their rights and expectations as shareholders.

It may or may not get addressed in a court in connection with the litigation involving the Merrill deal, but the question whether or not there is "national interest" exception to the standard disclosure principles is surely a very interesting question.

Professor Larry Ribstein discusses the question whether there is a national interest exception to the securities laws in his Ideoblog, here.

I have in any event added the Bank of America/Merrill Lynch litigation to my running tally of the subprime and credit crisis-related securities lawsuits, which can be accessed here. With the addition of this new litigation, the current tally of these cases now stands at 146, of which five have been filed in 2009.

More Madoff Litigation: The Madoff-related litigation wave has also continued to roll on. For example, on January 21, 2009, plaintiffs’ lawyers announced (here) that they had initiated a class action lawsuit in the Southern District of New York on behalf of persons who purchased between 2003 and the present variable universal life insurance issued by Tremont International Insurance Limited or Argus International Bermuda Limited.

The complaint (which can be found here) alleges that the insurer, an entity owned by Tremont Capital Management had breached its duties by offering Tremont-related funds as investment options for the variable investment account component of the policies. The complaint further alleges that the Tremont-related funds were heavily invested in Madoff funds.

The complaint alleges that the defendants violated a number of legal duties. The complaint does not, however, assert a violation of the federal securities laws. As a result I have included in the list of "other" litigation in my table of the Madoff-related litigation, which can be accessed here.

This latest lawsuit not only demonstrates that the Madoff litigation continues to roll in. It also shows what an incredible diversity of individuals and investors were harmed by losses from Madoff’s fraudulent scheme. It also shows how incredibly complicated it all is going to be to unwind this whole mess.

And Finally: Readers who registered the question posed on my preceding blog post whether President Obama had completed the oath of office as required by the Constitution will be relieved to know that the issue has been resolved.

On the apparent theory that there is nothing in the Constitution against do overs, Obama and Chief Justice reprised their roles in another rendition of the oath of office in a considerably less formal ceremony at the White House on the evening of January 21, 2009, as reported here.

That certainly is a load off my mind.

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The question of coverage for fees and costs incurred in connection with responding to subpoenas is a perennial D&O insurance issue. Policyholders are sometimes surprised and disappointed when their D&O insurer takes the position that their policies do not cover these amounts.

Whether or not there is coverage for fees incurred in connection with a subpoena often critically depends both on the specific facts and circumstances surrounding the subpoena and the specific language of the applicable policy. The critical issue under the policy is whether or not the subpoena comes with the applicable policy’s definition of the term "Claim."

A January 21, 2009 memorandum from the Lowenstein Sandler law firm entitled "Does a Subpoena Constitute a ‘Claim’ for Purposes of D&O Insurance Coverage" (here) takes a detailed look at several recent case decisions exploring these issues. As the memorandum notes, the cases show that these issues "are fact intensive as to both the wording of the definition of ‘claim’ and the particular facts surrounding the subpoena."

The cases discussed in the memo show a number of things in connection with the question whether a subpoena is a "Claim."

First, the wordings of the policy definition of the term "Claim" vary substantially between policies and the precise wording used can be determinative.

Second, in addition to the wording of the policy, the nature of the subpoena involved also is critically important. A court may well have a different perception of, say, a grand jury subpoena, compared to an administrative subpoena, for example.

Third, courts apparently have been willing to consider outside factual matter (for example, the affidavit testimony of one of the attorneys involved regarding the nature of the investigation surrounding the subpoena), which can be highly relevant to a fact intensive inquiry.

Fourth, in addition to the definition of the term "claim," the presence of allegations of a "Wrongful Act" can also be an important determinant in the inquiry whether the fees and costs incurred in connection with a subpoena are covered. The typical D&O policy provides coverage for loss arising from a "Claim" based on an "actual or alleged Wrongful Act." As the memo shows, whether or not a subpoena represents a "Claim," there may still be a question whether an actual or alleged Wrongful Act is involved.

The question of what constitutes a "Claim" may be one of the most frequently recurring coverage issues under a D&O policy, and the actual wording used is critical. As the memo notes, "often seemingly minor differences can be coverage-determinative."

In that regard, in summarizing the lessons from the cases, the memo notes several truths about the D&O insurance coverage placement process with which I heartily concur:

it is essential that the insurance broker or consultant be expert in D&O policies and negotiate with the insurer for the best possible definition of claim. All D&O insurance policies are not created equal. More expensive D&O policies frequently provide better coverage than less expensive ones. Optimally, the insurance broker or consultant should not simply present the insured with a policy, but a consideration of different policies, so that the insured can perform a cost/benefit analysis.

The memo concludes with an observation of the need to provide timely notice.

And If SEC Subpoenas Are Involved: In many instances, the subpoena that is the source of the coverage dispute has been issued by the SEC. Readers who find themselves dealing with the issue of whether or not there is coverage under a D&O policy for fees and costs incurred in connection with an SEC subpoena may find it helpful to refer to the SEC’s Enforcement Manual, which can be found here.

The Manual, which was only recently made public, describes the SEC’s enforcement practices and policies in detail, and may prove useful in trying to understand what various SEC actions and processes may represent.

A Related Issue: An issue that also frequently occurs in conjunction with the question of coverage for fees and costs incurred in responding to a subpoena is the question of coverage for fees and costs incurred in connection with a criminal investigation. In a recent post (here), I reviewed the issues surrounding the question of coverage under a D&O policy for expenses incurred in connection with a criminal investigation.

Eleventh Circuit Affirms Options Backdating Lawsuit Dismissal: Although they may seem but a distant memory, the options backdating cases continue to grind through the courts. In a January 9, 2009 opinion (here), the Eleventh Circuit affirmed the lower court’s dismissal of the securities class action lawsuit filed in connection with the options backdating allegations involving Witness Systems. Background regarding the case can be found here.

The lower court had dismissed the case in reliance on the Supreme Court’s decision in the Tellabs case, holding that the complaint did not satisfy the PSLRA’s requirements for pleading scienter. The trial court dismissed the case without allowing the plaintiffs leave to amend, though the plaintiffs had requested leave in a footnote to an opposition brief.

A copy of the district court’s opinion can be found here. My prior blog post discussing the dismissal can be found here.

The Eleventh Circuit, after noting that as a result of the options backdating the company had "minimally overstated earning" between 2004 and 2006, affirmed the dismissal.

Among other things, the Eleventh Circuit noted that the complaint contained no allegation that the company’s CEO "had any knowledge of the accounting principles relating to stock options," and observed that the inference that the CEO "knew that backdated options in 2000 and 2001 had led to overstated earnings during the class period in 2004 to 2006 is not as compelling as the competing inference that he was unaware that backdated options had affected financial statements several years later."

The court specifically noted that the "de minimus change" in the financial statements was not a "glaring ‘red flag’" that the company was overstating earning.

The Eleventh Circuit also affirmed the district court’s denial of leave to amend, because the plaintiffs’ request for leave to amend was "imbedded within an opposition memorandum."

I have updated my table of options backdating securities lawsuit settlements, dismissals and dismissal motion denials in order to reflect the Eleventh Circuit’s decision. The table can be accessed here

A January 15, 2009 memorandum from the Carlton Fields law firm discussing the Eleventh Circuit’s decision can be found here. Special thanks to Dave Leonard of the Carlton Fields firm for sending along a link to the memo.

You Decide: Article II, Section 1 of the U.S. Constitution specifies with respect to an incoming President of the United States as follows: "Before he enter on the execution of his office, he shall take the following oath or affirmation:--‘I do solemnly swear (or affirm) that I will faithfully execute the office of President of the United States, and will to the best of my ability, preserve, protect and defend the Constitution of the United States.’"

Which raises and interesting question: Did Obama actually complete the oath as required by the Constitution? Roll the tape and decide for yourself. (Hat tip to the WSJ.com Law Blog for the link to the YouTube video.) Ask yourself as you watch whether or not it is relevant that Obama, while serving in the Senate, was one of 22 Democratic senators to vote against Roberts' confirmation. This was, by the way, the first time that a Chief Justice has sworn in a President that voted against him.

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They aren’t the first subprime lawsuit settlements, but the two massive settlements Merrill Lynch announced this past Friday are unquestionably the largest subprime subprime securities lawsuit settlements so far, and they certainly suggest the enormous stakes that may be involved in the mass of subprime and credit crisis-related litigation cases that remain pending.

In a January 16, 2009 filing on form 8-K (here), Merrill Lynch announced that the Lead Plaintiff, the Ohio State Teachers’ Retirement System, had accepted Merrill Lynch agreement to pay $475 million cash in settlement of the consolidated securities class action settlement pending against the company and certain of its directors and officers. As reflected more fully here, the consolidated case involved the claims of a variety of claimants, the basic allegations in the litigation were that the defendants

knew or recklessly disregarded that (i) the Company was more exposed to CDOs containing subprime debt than it disclosed; and (ii) the Company’s Class Period statements were materially false due to their failure to inform the market of the ticking time bomb in the Company’s CDO portfolio due to the deteriorating subprime mortgage market, which caused Merrill’s portfolio to be impaired.

My initial post about the filing of the Merrill Lynch subprime-related securities class action lawsuit can be found here.

In addition to the consolidated securities settlement, Merrill Lynch also announced on January 16 that it had entered into a proposed settlement of the class action brought on behalf of Merrill Lynch employees who invested in or held Merrill Lynch stock in their retirement plans. Merrill Lynch will pay $75 million in cash under the terms of this settlement.

Both consolidated cases focused primarily on Merrill Lynch’s subprime-related losses and related disclosures during the class period, and both settlements are subject to court approval.

The $475 million securities class action settlement ranks among the largest ever; according to a review of RiskMetrics data, it appears to be in the top 20 securities class action settlements of all time. The $75 milion settlement of the employees' claims is also one of the largest ERISA class action settlements ever; based on my informal survey, it may be among the top five largest of all time.

But the significance of the Merrill Lynch settlements may not be what they represent in and of themselves, but rather what their size may suggest for the remaining mass of subprime and credit crisis-related litigation.

To be sure, many of these cases may not be anywhere near the magnitude of the Merrill Lynch case, and many of the cases will be winnowed out through motions to dismiss. Yet among the over 140 subprime and credit crisis related securities lawsuits are many others that also involve huge shareholder losses, and many cases will survive the winnowing process of the motions to dismiss. If it is any indication of what may be yet to come, the Merrill Lynch settlements suggest the aggregate settlements of these cases could represent a staggering sum.

There are a couple of interesting things about the Merrill Lynch settlements. The first is that they came before any ruling on the many pending motions to dismiss in the consolidated cases. While the timing of the settlements, prior even to a ruling on the motions to dismiss, might be due to any number of factors, one likely possibility is that Merrill’s new owner, Bank of America, moved quickly to put the litigation in the past.

The other interesting thing about these settlements is that the 8-K does not mention the involvement of insurance money. That of course does not mean for sure that there will be no insurance contribution toward the settlements, but it does seem at least to make that suggestion. As I have noted elsewhere (here, for example), due to the insurance structures that many large banks have employed in recent years (some of which include only Side A insurance, which would not be triggered in many of these cases), insurance may not be a factor in many of the subprime and credit crisis-related cases involving the larger banks, which is a consideration that may mitigate the overall losses to the insurance industry from these lawsuits.

A January 16, 2008 Bloomberg article describing the Merrill Lynch settlement can be found here. Hat tip to the Securities Docket (here) for first highlighting the settlements.

In any event, I have added the Merrill Lynch settlement to my table of subprime and credit crisis related securities lawsuit settlements, dismissals, and dismissal denials, which can be found here.

And Finally: The January 18, 2009 Washington Post has an article entitled "Livid Investors Launch a Volley of Lawsuits" (here) that describes how investors angered by their investment losses are turning to the courts to seek recompense. (Full disclosure: I was interviewed in connection with the article.)

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In order to assign responsibility in connection with the enforcement of public welfare objectives, courts have developed the "responsible corporate officer doctrine," which in recent years has been applied with increasing frequency in environmental enforcement. A California appellate court recently applied the doctrine to enforce civil liability on the officers of a family run business. The case, and indeed the doctrine itself, raise important concerns about the potential liability of directors and officers.

Background

John and Ned Roscoe were officers, directors and shareholders of a family company that had a underground storage tank. The tank leaked 3,000 gallons of gasoline. A company employee notified the county and hired a consultant to clean up the leak. However, as the appellate court later put it, cleanup "did not proceed timely and adequately," and though regulators sent multiple notices to the company, no one from the company "attempted to make sure the problems were addressed."

The county filed a civil lawsuit against the Roscoes and their family company for failure to remediate and to file certain reports as required by law. Following a bench trial, the court found the Roscoes and their company jointly and severally liable for $2.4 million in "civil penalties."

The trial court specifically found that the Roscoes had "overall authority" for the company, could have remediated the problems, but did not "exercise their responsibilities and power to use all objectively possible means" to remedy the problem. The Roscoes appealed.

The Appellate Ruling

In a December 26, 2008 opinion (here), the California Court of Appeal for the Third Appellate District applied the "responsible corporate officer doctrine" and affirmed the trial court.

As the appellate court noted, the responsible corporate officer doctrine was developed by the U.S. Supreme Court in the 1943 case of United States v. Dotterweich, to hold corporate officers in responsible positions of authority personally (and in that case, criminally) liable for violating strict liability statutes protecting the public welfare.

Though the Dotterweich case involved a criminal proceeding, the California court in Roscoe applied the doctrine to uphold the imposition of civil liability. The Roscoe court described the doctrine as "a common law theory of liability separate from piercing the corporate veil or imposing personal liability of direct participation in tortious conduct."

The appellate court in the Roscoe case held that the trial court properly applied the doctrine to the Roscoes because they had "overall authority," they "could have prevented or remedied promptly the problem," and because they did not "exercise their responsibilities and power to use all objectively possible means" to remedy the problem.

Discussion

Typically, the corporate veil doctrine would shield corporate officers or shareholders from direct personal liability for legal violations of the corporation, consistent with long-developed notions of the distinct and separate legal identity involved with the corporate form.

But the "responsible corporate officer doctrine" expands the power of government to impose liability on individuals, seemingly in disregard of the corporate form, and apparently without requirement of participation in the wrongful conduct or even the requirement of a culpable state of mind, in the name of protecting public health and welfare.

I understand from reviewing a variety of articles online (refer for example here) that there arguably may be nothing new about the California court’s invocation of the responsible corporate officer doctrine. It apparently has been applied in any number of states (refer for example here) and seems to be most frequently used in connection with environmental enforcement actions.

Indeed, the doctrine is embodied in the statutory wording of several fundamental federal environmental statues and has now found its way into the environmental statutes of many states that modeled the statutory scheme on the federal laws. I understand from conversations with an environmental attorney (I happen to be married to one) that this is a recognized and well-established doctrine in environmental law.

That the doctrine may have a lengthy pedigree behind it does not make it any less troubling to me. The idea that liability could be imposed on an individual for corporate misconduct, in apparent disregard of the corporate form and without even a requirement for a culpable state of mind, seems inconsistent with my (perhaps not fully informed) assumptions about the way the law ought to work.

To my mind, this doctrine seems to impose liability for nothing more than a person’s status. The word "responsible" in the responsible corporate officer doctrine’s name does not mean that the individual was responsible for the misconduct, but only that the individual was responsible for the corporation.

The California court did specify prerequisites that could circumscribe the doctrine’s application; that is, the court indicated that "there must be a nexus between the individual’s position and the violation in question such that the individual could have influenced the corporate actions" and that "the individual’s actions or inactions facilitated the violations." But while these requirements could constrain the doctrine’s application, they also seem to relate more to an individual’s position or status, rather than the individual’s actual state of mind or even direct culpability.

It appears that other courts have considered knowledge of the violation a prerequisite to the imposition of liability based on the responsible corporate officer doctrine, which to me seems like a minimal requirement for the doctrine’s application to be consistent with traditional notions of justice and fair play.

In any event, the typical directors and officers liability insurance policy would not likely respond to provide indemnification for these kinds of awards, for at least two reasons. The first is that most policies contain a broad form pollution exclusion. The second is that most policies will not cover fines and penalties.

While the typical D&O policy would not cover these kinds of penalties, I can imagine an argument that there should be insurance for these kinds of exposures. The fines are imposed on individuals essentially because they occupied a corporate office – that is, by reason of their status, seemingly without regard to actual fault. (It may well be that there are separate environmental liability insurance policies available in the marketplace that are designed to respond to these very exposures, an issue on which I invite readers’ comments and observations.)

A public policy advocate might well argue that individuals should have to pay these amounts out of their own resources, in order that the liability threat will deter future violations and motivate compliance. These kinds of arguments seem most compelling to someone who is secure in the knowledge that they will never have to worry about having liability imposed on them for conduct of which they might have been completely unaware.

A January 14, 2009 memorandum from Foley & Lardner law firm discussing the Roscoe case can be found here.

Special thanks to Damien Brew for providing a copy of the Roscoe opinion. I hasten to add that the views expressed in this post are exclusively my own.

Climate Change Disclosure: In prior posts, I have noted a variety of developments that are increasing pressure on publicly traded companies to increase their disclosure on climate change related issues. For example, I noted here the Petition for Interpretive Guidance on Climate Risk Disclosure filed with the SEC on September 18, 2007 by the Coalition for Environmentally Responsible Economies (CERES) and others. In another post (here), I discussed the settlements that Xcel Energy and others reached with the New York Attorney General regarding climate change risk disclosure.

These developments raise the question whether these and other circumstances have changed public companies' disclosure practices regarding climate change issues. In a January 15, 2009 memorandum (here), the McGuire Woods law firm reports the results of its survey of the of the 2008 10-K filings of approximately 350 companies in order to determine the state of SEC disclosure practices regarding climate change.

What the law firm found was that "very few companies made any type of 10-K disclosure regarding [greenhouse gas, or GHG] emissions or climate change." Only 42 of 350 companies reviewed, about 12.2% made any disclosure whatsoever regarding GHG emissions or climate change. Unsurprisingly, the largest concentration of companies making some disclosure on these issues was among utility companies, particularly large utilities. Of the 26 non-utility companies making some disclosures, the next largest concentrations were in the energy and industrial sectors.

The memorandum observes that "very few companies outside the energy and utilities industries made any type of GHG emissions or climate change-related disclosures" in 2008. The memo goes on to predict, however, that "this state of affairs is likely to change in 2009," as a result of the change in administration and the changing political climate, as well as changing regulator and investor expectations.

The report concludes that "each company that does not currently provided GHG or climate change disclosures will need to carefully evaluate whether that is a reasonable approach given the kinds of risks, and opportunities, that GHG and climate change issues present." The report ends by noting that "we expect the number of public companies that make GHG and climate change disclosures in their SEC reports will increase in 2009."

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On January 12, 2009, in the first dismissal motion ruling among the many subprime and credit crisis-related securities lawsuits pending in the Southern District of New York, Judge Shira Scheindlin granted the defendants’ motion to dismiss in the Centerline Holding Company securities case, with leave to amend. A copy of the opinion can be found here.

Background

As detailed more fully here, the plaintiff’s complaint basically alleges that the company and four individual defendants concealed from the investing public that they were structuring a sale of the company’s $2.8 billion portfolio of tax-exempt mortgage revenue bonds to a third party. When the company announced the sale, it also announced that it would be cutting its dividend from $1.68 per share to only 60 cents a share.

The company also disclosed at the same time that it had entered into a related party transaction with a company controlled by its Chairman, Stephen Ross, and its Managing Trustee, Jeff Blau, whereby this separate company agreed to provide Centerline with $131 million in financing in exchange for 12.2 million shares of newly-issued convertible stock that will pay an 11% dividend.

Upon the announcement of this news, the company’s share price declined 25% and the lawsuits followed.

The Motion to Dismiss Ruling

The defendants moved to dismiss the complaint on the ground that the plaintiff had not adequately pled scienter. Judge Scheindlin agreed. Specifically, she concluded that the plaintiff had neither alleged sufficient facts showing that defendants had the motive and opportunity to commit fraud nor adequately pled that defendants acted with recklessness.

The plaintiff had alleged that defendants Ross and Blau were motivated to "engineer" the related party transaction to increase their voting control of the company from 17% to almost 30%; to be paid an 11% coupon rate, "thereby diverting a material portion of the Company’s income to insiders…to the great detriment of shareholders"; and to have the opportunity to nominate an individual trustee.

Judge Scheindlin said that these allegations "do not explain why Ross and Blau would have wanted to fraudulently conceal the news" of their investment or of the bond portfolio sale. She also said that "if they had any motive, it would have been to disclose information about the bond sale and dividend cut sooner," since their preferred shares are only convertible at $10.75 a share, yet after the announcement of the bond sale, the company’s share price declined to $7.70 a share.

The court noted that if Ross and Blau had wanted a "sweetheart" deal, "the would have been motivated to cause information related to the sale of the bond portfolio and dividend cut to be disclosed sooner so that they could have negotiated a lower conversion price."

Judge Scheindlin also found insufficient the allegations that the other two individual defendants were motivated by reason of their high salaries, bonus compensation, equity awards or continued employment.

Judge Scheindlin also held that the plaintiff had not alleged facts sufficient to establish conscious misbehavior or recklessness. Specifically, she noted that "the Complaint does not allege any facts to show that defendants knew they should have disclosed information of the transactions prior to the date of the announcement, but recklessly failed to do so."

The defendants cited an SEC rule (promulgated in implement Section 409 of the Sarbanes Oxley Act) specifying that companies are required to disclose material definitive agreements within four business days of entry into the agreement, and argued that the plaintiff had not alleged that the company had failed to comply with the rule. The plaintiff argued that whether the defendants complied with the SEC’s rule, the company had failed to disclose information about the pending sale information about the pending sale and dividend cut while the company was making other disclosures on those topics, which made those other disclosures "false, inaccurate, incomplete or misleading."

Judge Scheindlin said that even if it were assumed that the statements were misleading, the defendants’ compliance with the SEC’s rule "suggests that Lead Plaintiff has failed to show defendants acted recklessly in omitting such information." She added that defendants conduct cannot be described as "highly unreasonable" when "it is arguable that they did not have a duty to disclose such information before they actually did."

Because she found that the plaintiff had not presented facts to make the Section 10 claims "plausible," Judge Scheindlin dismissed the claims, but she allowed plaintiff 30 days in which to file an Amended Complaint.

Discussion

The significance of Judge Scheindlin’s opinion is that it is the first dismissal motion ruling in a subprime and credit crisis-related case in the Southern District of New York. A very large number of the subprime and credit crisis-related securities lawsuits overall have been filed in the S.D.N.Y because the financial services industry is concentrated there. By my count, as many as 54 of the 101 subprime and credit crisis-related securities lawsuits that were filed in 2008 were filed in the Southern District of New York.

However, any inferences about the other cases that might be drawn from Judge Scheindlin’s grant of the dismissal motion in the Centerline case probably need to be heavily discounted because the opinion depends so heavily on case-specific allegations and the specifics of the transaction involved. For that reason the case may offer relatively little insight into the prospects for other cases pending in the S.D.N.Y., except to the extent that it illumines the legal standards that will be applied to scienter issues in other cases.

In any event, the ruling was without prejudice, and it remains to be seen whether or not the plaintiffs will be able to amend their pleadings sufficiently to survive a renewed motion to dismiss.

Those readers who may have had the thought, as I did, while reading about this case that the allegations really lend themselves more to a derivative lawsuit alleging breaches of the duty of loyalty and care will want to know that there was a separate derivative lawsuit filed in the S.D.N.Y. against Centerline, as nominal defendants, as well as certain of its directors and officers. A copy of the derivative complaint can be found here.

I have added the recent Centerline opinion to my table of subprime and credit crisis-related securities lawsuit dismissals, dismissal motion denials and settlements, which can be accessed here.

Another 2009 Credit Crisis Lawsuit: In their January 14, 2009 press release (here), plaintiffs’ lawyers announced their initiation of a securities class action lawsuit in the Western District of Washington on behalf of investors who purchased certain WaMu Mortgage Pass-Through Certificates. The Complaint (which can be found here) was filed against the various series of certificates, as well as Washington Mutual bank, WaMu Acceptance Corporation, and certain individuals.

According to the press release, the complaint alleges that the "defendants made material misstatements and omissions in connection with the offerings regarding the collateral underlying the certificates."

The new WaMu case is already the third subprime and credit crisis-related lawsuit filed so far in 2009. Because I thought that some readers might like to separately track the 2009 credit crisis securities lawsuits, I have created a separate spreadsheet (that can be accessed here) on which I will separately track the 2009 credit crisis cases. I will update the spreadsheet as new credit crisis cases are filed.

The addition of the WaMu case brings the total number of subprime and credit-crisis related securities lawsuits that have been filed since 2007 to 144. My list of all of the subprime and credit crisis securities cases can be accessed here.

Special thanks to Adam Savett of the Securities Litigation Watch for providing a copy of the WaMu complaint.

More about Social Networking: In a recent post, I revealed my New Year’s resolution to become more familiar with and involved in the various professional social networking sites, including LinkedIn and Twitter. The prior post elicited a promising initial response, but because I suspect that many readers may not have seen my prior note, I am reprising the message here.

Many readers may be interested to know that between the times when I enter new blog posts, I often add quick notes and links on Twitter. My Twitter site can be accessed here. It is relatively simple to register.

I also remain interested in trying to better develop my LinkedIn network. The LinkedIn button in the right hand margin above will take you to my LinkedIn profile. I am interested in trying to bring readers of this blog into my LinkedIn network, so please let me know if you would like to "connect." I am still learning what I might be able to accomplish with the network, but I proceeding on the theory that the only way to figure it out is to plunge in and try to make it work.

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We are barely into the New Year, but all signs are that two of the critical securities litigation trends of 2008 – the subprime/credit crisis related litigation wave and the Madoff-related litigation wave – remain significant factors and apparently will continue to drive new lawsuit filings as we head into 2009, as the recent lawsuit filings discussed below suggest.

The New RBS Lawsuit

First, with respect to the credit crisis litigation, on January 12, 2009, plaintiffs’ lawyers issued a press release (here) stating that they had initiated a securities class action lawsuit in the Southern District of New York on behalf of purchasers of Series S American Depositary Shares (ADSs) of the Royal Bank of Scotland Group and related entities and certain directors and officers. The complaint also names as defendants the offering underwriters that conducted the June 2007 offering of the shares.

The Complaint (which can be found here) alleges misrepresentations and omissions in the offering documents, which incorporated the Company’s 2004, 2005 and 2006 financial statements. The Complaint alleges that the company "ultimately announced huge multi-billion pound impairment charges associated with its exposure to debt securities, including mortgage-related securities tied to the U.S. real estate markets, causing the price of RBS’s Series S ADSs issued in the Offering to decline." The ADSs, which were originally offered at $25/share, now trade around $10/share.

According to the Complaint, the offering documents omitted that:

(a) defendants’ portfolio of debt securities was impaired to a much larger extent than the Company had disclosed; (b) defendants failed to properly record losses for impaired assets; (c) the Company’s internal controls were inadequate to prevent the Company from improperly reporting its debt securities; (d) the Company’s participation in the consortium which acquired ABN AMRO would have disastrous results on the Company’s capital position and overall operations; and (e) the Company’s capital base was not adequate enough to withstand the significant deterioration in the subprime market and, as a result, RBS would be forced to raise significant amounts of additional capital.

RBS is actually the second company from the ill-fated consortium that was the "successful" bidder in the ABN AMRO buyout to get dragged into U.S. securities litigation.

As I noted here, another consortium member, Fortis, was also hit with a securities class action lawsuit in October 2008. As I noted in that prior post, "it is one more of those amazing things about the current circumstances that, despite the size of the ABN AMRO calamity, it is effectively just background noise in the larger cataclysm." (An abridge version of the ABN AMRO debacle can be found here.) Both RBS and Fortis have also been the recipients of massive bailout efforts from their respective governments.

The ABN AMRO losses to RBS continue to amount. For example, on January 12, 2009, Bloomberg reported (here) that, as a result of loans RBS acquired as part of the ABN AMRO deal, RBS is the biggest lender to bankrupt U.S. chemical maker Lyondell Chemical Co., and may face losses on its $3.47 billion of loans. The loans were part of the $20.5 billion raised to finance Bassell AF’s 2007 leveraged buyout of Lyondell.

More Madoff Litigation

According to their release (here), on January 12, 2009, plaintiff’s counsel initiated another Madoff-related securities class action lawsuit in the Southern District of New York on behalf of investors in the Herald USA Fund, Herald Luxemburg Fund, Primeo Select Funds, and Thema International Funds, against the Funds, Medici Bank, Bank Austria Creditianstait, Unicredit S.A., Pioneer Alternative Investments, HSBC Holdings plc and Ernst & Young LLP, as well as Medici Bank’s founder Sonja Kohn and its former CEO Peter Scheithauer. A copy of the complaint in the case can be found here.

Austrian regulators took control of Bank Medici after the bank revealed that it had invested as much as $3.2 billion in funds managed by Bernard Madoff and his firm. Bank of Medici is 25% owned by Unicredit. As reported here, one of the Bank’s largest customers was Unicredit’s Pioneer Investments, which invested as much as €805 with the Funds. Further background can be found here.

According to the press release, the Complaint alleges defendants caused the Funds "to concentrate almost 100% of their investment capital with entities that participated in the massive, fraudulent scheme perpetrated" by Madoff and his firm.

Run the Numbers: With the addition of the RBS case, the total number of subprime and credit crisis-related securities lawsuits going back to 2007 now stands at 143, of which two have been filed already in 2009. My updated tally of the subprime and credit crisis-related cases can be accessed here.

The new lawsuit on behalf of the Bank Medici Funds investors brings the total of Madoff-related securities class action lawsuits to eight, as reflected on my running tally of the cases, which can be accessed here.

Keeping Count: In my analysis (here) of the recently released Cornerstone/Stanford Clearinghouse report regarding the 2008 securities litigation, I noted that the report’s count of new 210 securities lawsuit filings through December 15, 2008 contrasted with my own count of 224 securities lawsuits through December 31, 2008. As I noted in my analysis, the additional lawsuits filed between December 15 and December 31 were critically important in understanding fully 2008 filing trends, as they significantly affect relative and absolute filing numbers during the year.

The Stanford Law School Securities Class Action Clearinghouse website has now updated its count through year’s end, bringing their 2008 tally to 226. The Stanford website can be accessed here.

On further review of their figures, my account appropriately should be adjusted from 224 to 226.

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Investors whose fortunes were tied to Bernard Madoff and his firm have already been counting (and mourning) their losses. But for the insurers that provided coverage for financial firms targeted in the Madoff-related litigation, the losses have only just begun to accumulate.

How high the insurance losses ultimately may run remains to be seen, but early estimates suggest that that the insurance losses, even just for defense expenses, could be significant.

A January 9, 2008 Bloomberg article (here) reports that Madoff-related claims "may cost insurers who cover financial institutions more than $1 billion as they pay legal costs for investment managers who gave client money to Madoff." Indeed one respected industry participant is quoted as saying that a total of $1 billion "feels a little low to me."
 

The losses could well affect not only D&O insurers, but also insurers offering"error and omissions" E&O insurance. For many of the kinds of investment firms involved in these cases so far, the type of insurance protection they would most likely purchase provides both coverages within a single package.

The article correctly points out that how large the insurance losses ultimately turn out to be depends on how many of the Madoff "feeder funds" and other litigation targets actually have purchased these kinds of insurance. As one observer quoted in the article notes, hedge funds and other investment vehicles "often don’t buy coverage."

There are a variety of other factors that also could affect the total cost to insurers of the Madoff-related claims. The first is the question of who is insured under the policies. In many of these Madoff-related lawsuits (a complete list of which can be accessed here), the plaintiffs have named a laundry list of related defendants, often including not only investment managers and advisors, but also investment funds, offshore entities, and a squadron of associated individuals.

These claims are going to stress-test the insurance policies involved. The policyholders will find out how well put together the policies were, in light of the entities’ related structures and operations. There may well be instances where the entire family of advisors, managers and funds were not fully yoked together under the coverage umbrella.

But an even more important set of issues that potentially could affect the scope of insurance losses are the potential coverage defenses the carriers may seek to assert. In particular, insurers will be looking closely to see whether the allegations raised in these lawsuits trigger one of more of the standard conduct exclusions, particularly the personal profit and the fraud exclusions.

The conduct exclusions typically are written on an after adjudication basis, meaning that the only apply to preclude coverage only after an adjudicated determination that the prohibited conduct actually took place (as I recently noted in my discussion of the potential coverage insurance issues arising in connection with the Satyam scandal, here).

Moreover, at this point the fraud involved appears to involve misconduct of Madoff himself, rather than the feeder funds, although obviously investigators are probing the potential complicity of a wide variety and number of persons associated with Madoff.

The personal profit exclusion may prove to be the more relevant. A typical exclusion precludes coverage for loss "based upon, arising from, or in consequence of … an Insured having gained any profit, remuneration or advantage to which such Insured as not legally entitled, if a judgment or final adjudication in any proceeding establishes the gaining of such remuneration or advantage."

Investors have already claimed that the feeder funds inappropriately exacted management fees or other compensation without conducting appropriate due diligence or otherwise earning their fees. However, an adjudicated determination of these allegations would be required for the profit exclusion to preclude coverage.

Although there is currently no reported reason to suggest that the "feeder funds" were aware of Madoff’s scheme, insurers will also be looking closely at who know what and when, looking for possible bases to rescind coverage based on alleged misrepresentations in the policy application.

Yet another factor that could restrict the total insurance losses is the limitation on the amount of insurance potentially involved. In my experience, many investment advisory firms and hedge funds buy relatively lower limits of insurance coverage. Thus, in many cases, the available insurance involved could be relatively slight and could quickly be exhausted by defense costs alone. As a result, a portion of the potential defense expense and the amount of some settlements could wind up being uninsured.

I suspect that as a result of the Madoff-related events, many investment advisory firms, hedge funds and other financial firms will now need far less persuading of the value of this type of insurance or that more than just minimal limits could well be advised. Unfortunately, for the firms acquiring this insight for the first time now, this type of coverage could well become much more expensive even if otherwise available.

As noted in a December 31, 2008 publication of the Lloyd’s insurance market entitled "Madoff Scandal Poses Challenges for Directors" (here), the "sheer scale of the fallout from Madoff could seriously affect the financial insurance market’s dynamics, affecting the availability and cost of both professional indemnity and directors and officers coverage." The article quotes one source as stating with respect to this type of coverage that "prices are going to increase and cover will be restricted."

More Madoff Lawsuits: Meanwhile, the Madoff-related lawsuits continue to flood in. For example, on January 8, 2009, Pacific West Health Medical Center, Inc. Employees Retirement Trust sued Fairfield Greenwich Group and related entities and individuals in the Southern District of New York on behalf of all persons who purchased shares of the Fairfield Sentry funds, alleging that the defendants breached their fiduciary duties. The defendants are also accused of negligence, unjust enrichment and breach of contract.

A copy of the Pacific West complaint can be found here. A copy of a January 9, 2009 Bloomberg article describing the complaint can be found here.

It also looks as if overseas investors are about to get involved in Madoff litigation, which may be unsurprising give that, as the Financial Times reports (here), as much as half of the Madoff losses have been borne by non-U.S. investors.

According to a January 8, 2009 Reuters story (here), investment activist group Deminor is readying to sue UBS, HSBC, Hyposwiss and others in courts in Luxembourg and Ireland in connection with the Madoff scandal. The charge is that the defendant banks acts as depositories for sponsored funds that invested clients’ money in Madoff-related vehicles. The allegation is that the depository banks were responsible for the sponsored funds and negligently failed to check what was inside the clients’ portfolios.

According to an earlier Financial Times article (here), UBS at least sought to exculpate itself from any responsibility for clients’ assets through the subscription documents it used.

In any event, I have updated my running tally of the Madoff-related litigation, which can be accessed here.

Special thanks to David Demurjian for the link to the Bloomberg article, and to a loyal reader who prefers anonymity for the Reuters and Financial Times articles.

Can Madoff Losses Be Recovered?: In addition to all of the factors noted above that could diminish the aggregate Madoff-related insurance losses, there is also the question whether the investors’ claims are meritorious. That is, do the claimants actually have a legitimate basis upon which to try to recover their losses from the Madoff "feeder funds" and others?

These questions will be addressed in a webinar entitled "Madoff Litigation: Can the Lost Billions Be Recovered?" to be hosted by Securities Docket on January 14, 2009 at 2:00 P.M. The speakers include Gerald Silk of the Bernstein Litowitz firm, Brad Friedman of Milberg LLP, and Fred Dunbar of NERA Economic Consulting. Further background regarding the webinar can be found here. Registration for the webinar can be accessed here.

A replay of a prior Securities Docket webinar entitled "2008: A Year in Review" can be accessed here. (I was one of the speakers at this prior session.)

"Hitler Previews the Cubs’ Winter Meeting": This video is in questionable taste, contains foul language, and is very very funny, at least for those having some acquaintance with the Chicago Cubs. (The humor is more accessible if, for example, you know who Kerry Wood is.) Special thanks to a loyal reader for sending along a link to this video.

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Seventh Circuit Weighs In on State Court ’33 Act Jurisdiction and Removal: A January 5, 2009 Seventh Circuit decision in the Katz v. Gerardi case (here) may make it more difficult for plaintiffs to pursue ’33 Act litigation in state court, at least in the Seventh Circuit -- and possibly elsewhere, too.

As I detailed in a recent post (here), plaintiffs’ lawyers have proven keenly interested in pursing subprime and credit crisis-related litigation in state court, apparently for forum shopping type reasons. Defendants generally have sought to remove these cases to federal court, relying, among other things on the Class Action Fairness Act of 2005 (CAFA) and the Securities Litigation Uniform Standards Act of 1998 (SLUSA).

However, this past summer, the Ninth Circuit held in the Luther v. Countrywide case that the nonremoval provision in Section 22 of the ’33 Act (which provides concurrent state and federal court jurisdiction for ’33 Act cases) effectively trumps the more recently enacted SLUSA and CAFA because it more specifically relates to securities lawsuits. My discussion of the Luther v. Countrywide case can be found here.

An October decision in the Second Circuit in the New Jersey Carpenters’ Fund v. Harborview Mortgage case had refused to remand to state court a ’33 Act case, as is more fully discussed on the 10b-5 Daily blog (here). The Harborview decision was primarily based on the fact that the underlying securities lawsuit did not involve "covered securities" for which SLUSA created an explicit removal exception; because the exception did not apply, the case could appropriately be removed to federal court notwithstanding the nonremoval provision in Section 22.

In the recent Seventh Circuit opinion, Judge Frank Easterbrook wrote that the provisions of the more recently enacted statutes, particularly CAFA, trump Section 22. Judge Easterbrook expressly rejected Luther v. Countrywide’s conclusion that the more specific securities statute prevailed. However, Judge Easterbrook’s opinion, like the Second Circuit opinion in Harborview, also depended in part on the fact that the investment instruments involved are not "covered securities" (i.e., do not trade on a national exchange), and therefore did not come within one of CAFA’s removal exceptions.

In addition, Judge Easterbrook’s opinion does seem to have been influenced significantly by the fact that the plaintiff in the case was really a seller of the investments involved, rather than a buyer, and therefore lacked a legal basis to assert a ’33 Act claim. Although the opinion nevertheless examined the removal/jurisdictional issues as if the plaintiff had a legal right to assert the claim, the opinion’s starting point arguably influenced the outcome of its analysis.

In any event, the Seventh Circuit’s recent opinion, together with the Second Circuit’s Harborview opinion, clearly could create substantial jurisdictional hurdles (at least outside the Ninth Circuit) for the numerous plaintiffs now seeking to pursue ’33 Act claims in state court. Many (if not all) of the various subprime and credit crisis-related cases filed in state court related to investment instruments that are not traded on national exchanges and therefore are not "covered securities." Accordingly, contrary to the title of one of my prior posts, Section 11 cases may not be "coming soon to a state court near you" after all.

A January 12, 2009 Law.com article discussing the Seventh Circuit opinion can be found here.

Collins & Aikman Defendants Criminal Charges Dropped: On January 9, 2009, prosecutors dropped securities fraud and other criminal charges against former Collins & Aikman CEO David Stockman and three others. As reported in the January 10, 2009 Wall Street Journal (here), the U.S. Attorney’s office said further prosecution "wouldn’t be in the ‘interests of justice’ following a renewed assessment of the case."

While the individuals involved undoubtedly are relieved to have the prosecutorial threat removed, the government’s action comes only after the now-defunct company’s directors and officers insurance was entirely exhausted by defense fees, as I discussed at length in a prior post (here). Unfortunately for these individuals, they continue to face SEC enforcement proceedings as well as civil litigation (about which refer here), now without any further insurance available to fund their defense in these proceedings, not to mention any settlements or judgments that may follow.

A criminal prosecution has such an enormous potential to cause harm. On the one hand, it is commendable that the government was willing to reassess the case and to drop it before any further harm was done. On the other hand, even though the prosecution is over, it has done material damage to the individuals who were unfortunate to be subject to a prosecution that lacked an adequate basis. It is extremely regrettable when the government uses its enormous power when it is unwarranted. In this instance the government can drop the case and walk away without so much as an apology, but the unfortunate consequences of an unjustified prosecution continue for the individuals involved.

University of Denver law professor Jay Brown has extensively covered the Collins & Aikman criminal prosecution on the Race to the Bottom blog (here), including in particular his discussion (here) of how the criminal prosecution exhausted the company’s D&O insurance. The SEC Actions blog has a good summary description (here) of the criminal case and raises the question whether the SEC will proceed with the civil enforcement proceeding in light of the discontinuance of the criminal case. All of the key pleadings in the criminal case can be found on the University of Denver Law School’s corporate governance website, here.

2008 Delaware Case Law in Review: Francis Pileggi of the Delaware Corporate and Commercial Litigation Blog has released the2008 installment of his annual review of key Delaware opinions. Pileggi’s report, which is must reading for anyone who wants an overview of important legal developments in Delaware’s court’s during 2008, is entitled "Selected Key Corporate and Commercial Delaware Decisions in 2008" and can be accessed here.

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As the details about the Satyam Computer Services scandal have emerged and the U.S. securities lawsuits have begun to flood in, questions have also arisen about Satyam’s D&O insurance. At least some of the questions are answered in a January 8, 2009 article in The Economic Times (India’s largest financial daily) entitled "Satyam Scam Triggers Biggest D&O Claim" (here).

According to the article, Satyam carries a $75 million D&O insurance program led by Tata AIG, which is a joint venture of Tata Group and American International Group. The article also states that the Satyam claim "could trigger one of the largest Directors and Officers insurance claims in India."

Of course, knowing the limits of liability under Satyam’s insurance program does not necessarily tell you how much insurance ultimately will be available to defend and indemnify Satyam and its directors and officers. In a case where the company’s Chairman has publicly admitted fraud, the applicable terms and conditions will be absolutely critical. I discuss below a couple of issues that seem likely to arise.

The Fraud Exclusion

Without knowing more about the specific terms applicable under Satyam’s D&O insurance program, it is difficult to say anything with certainty. However, at least in the U.S., D&O insurance policies do not cover fraudulent, criminal or intentional misconduct.

But, again in the U.S., these exclusions typically do not kick in until there has been an "adjudication." Even though Satyam’s Chairman has admitted cooking the books, he has not (yet) been convicted of anything, so to the extent the policy’s exclusions have an "adjudication" requirement, the exclusions would not apply, at least in the interim.

Moreover, a well-constructed U.S. policy would also contain a "severability of exclusions" provision so that even if an exclusion would apply to preclude coverage based on the Chairman’s misconduct, it would not apply to others who were uninvolved in the conduct. Of course, many questions are now being asked about who else at Satyam might have been involved in the fraudulent accounting. The Chairman’s letter sought to establish that other board members were unaware of the fraud.

A prior post discussing the "adjudicated fraud" exclusion can be found here. A separate post discussing an interim decision in the Refco matter and relating to the interaction of the exclusion and the funding of defense costs can be found here.

Application Misrepresentations?

Another insurance issue that likely will be raised is the question of policy rescission. Given the magnitude of the fraud and the apparent length of time during which it was going on, the question may be asked whether the policy was procured through misrepresentations in the application process.

Under the typical current D&O policy in the U.S., application misrepresentations can serve as a basis on which the carrier can rescind the policy only as to persons with knowledge of the misrepresentations and as to persons to whom that knowledge is imputed. A well-constructed U.S. policy will limit "imputation" so that innocent persons do not risk rescission of their coverage because of another’s misrepresentation. The imputation language used in Satyam’s policy could well be critical.

A prior post discussing D&O insurance policy rescission issues can be found here (refer especially to my "final thoughts" toward the end of the post).

I welcome any insight readers can provide about the provision of the typical D&O insurance policy in the Indian market, as well as any additional information anyone can supply about the Satyam program, particularly any additional carriers involved.

Very special thanks to loyal reader Aruno Rajaratnam for providing a copy of The Economic Times article as well as other information about Satyam.

Global Accounting Outlook = Bleak: Fitch's Ratings has issued a January 8, 2009 report entitled "Accounting and Financial Reporting: 2009 Global Outlook" (available here, registration required) with some very interesting observations about the year ahead for public company accountants. As the report states in its opening line, "these are indeed interesting times for accounting."

Among other things, the report notes the following with respect to the "going concern" questions that many companies and their accountants will face as the companies prepare their year-end 2008 financial statements:

The sharp decline in global debt and equity securities values and a very difficult credit environment have presented a unique set of chllenges to the interpretation and implementation of some pervasive accounting issues. An immediate question facing some companies preparing their full-year 2008 financial statements, is how best to justify a "going concern" basis, given the doubts some have about their abiltiy to refinance. Management statements on this issue should be required reading for investors and analysts. The determination of impairment charges on debt securities and the lack of clear-cut rules on the subject have pitted some issuers against their auditors. This is a particularly sensitive issue because profitability and regulatory capital adequacy are at state for many financial institutions.

Obviously, insurance companies are among the companies for whom the determination of impairment charges will be particularly sensitive. And among others who will want to read companies' managers' statements on the "going concern" issue, in addition to investors and analysts, are D&O underwriters.

A news article describing the Fitch report can be found here. Special thanks to a loyal reader for sending along the news article and a link to the report.

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I encourage those that questioned my inclusion of FCPA issues in my list of top ten 2008 development to refer to the January 5, 2009 memo from the Gibson Dunn law firm entitled "2008 Year-End FCPA Update" (here).

As the memo puts it, 2008 was ‘by any measure …a monster year in Foreign Corrupt Practices Act (‘FCPA’) enforcement." The memo goes on to note that "2008 saw the FCPA’s enforcement regime mature like never before," adding that "there were no unimportant FCPA enforcement actions this year."

The memo highlights several enforcement trends. First, with particular emphasis on the recent massive Siemens FCPA fine, the report notes the trend toward escalating corporate financial penalties.

The memo reports that the Siemens fine eclipsed the prior record FCPA fine by nearly twenty times; in fact, the memo notes, the Siemens fine substantially exceeds "the aggregate of every dollar collected by the U.S. government in connection with FCPA settlements over the statute’s thirty-one year history." The memo also emphasizes the staggering costs that Siemens incurred in connection with the investigation. The memo notes that the company’s investigation and corporate remediation costs exceeded $1 billion.

To show that "enormous foreign prior settlements are certain not to be a fluke of 2008," the memo cites ABB’s recent announcement that it has reserved $850 million for potential costs associated with the continuing investigation of alleged improper practices.

The memo also addresses a theme I have frequently sounded (most recently here), that FCPA enforcement actions increasingly are accompanied by follow-on civil litigation. The memo notes that FCPA investigations increasingly have "spurred a variety of collateral civil suits, including securities fraud actions, shareholder derivative suits, and lawsuits initiated by foreign governments or business partners." Companies "can no longer assume that making peace with DOJ and the SEC will end the pain associated with their alleged FCPA violations."

With respect to securities litigation following on after FCPA investigations, the memo notes that "in recent years, courts have been trending towards finding that plaintiffs adequately alleged false or misleading statements, thereby meeting the heightened pleading standard under the PSLRA." However, as I noted in a recent post (here), the Ninth Circuit in the InVision Technologies case made it clear that "there are limits on the types of allegations that will meet this threshold."

The memo also reproduces an interesting bar graph showing the foreign jurisdictions having the "dubious distinction of being the most-referenced setting for FCPA allegations." Among the top countries are Nigeria, Iraq, China, Vietnam and Ecuador.

The memo, which is detailed and interesting, identifies a number of other important trends, including the increased internationalization of foreign anti-corruption endorsement.

Answer: Less Than One Day: In my January 7, 2009 post (here) regarding the accounting scandal dramatically disclosed at the Indian technology company Satyam Computer Services, I raised the question of how long it would take for plaintiffs’ lawyer to initiate a securities class action lawsuit against the company in a U.S. court.

The answer is – less than a single day.

Even before the close of business on January 7, plaintiffs’ lawyers announced (here) that they had filed a securities class action lawsuit in the Southern District of New York on behalf of purchasers of the company’s ADRs (which are traded, or at least were traded, on the NYSE) against the company and certain of its directors and officers. A copy of one of the Satyam complaints that has been filed can be found here.

The well of scandal is an ever-flowing stream, providing the plaintiffs’ bar with a constantly replenished source of new litigation targets. So much for the notion that the pool of potential securities litigation defendants is "fished out."

New Year’s Resolution: Some people resolve lose more weight, other people resolve to get more exercise. Even though I need to spend more time fooling around with technology like I need a hole in my head, my New Year’s resolution is to try to get more plugged into the new social media.

Along those lines, you will note that I have added a button in the right hand sidebar that links to my LinkedIn profile. I encourage everyone to check out my profile by clicking on the button. I would also like to strongly encourage other readers that are active on LinkedIn to "connect" with me. I am still trying to figure out what the site will lead to, but at least if readers of this blog start connecting we can try to work through it together.

In addition, I have recently signed up for Twitter. Again, I am still feeling my way along with the new technology, but I will say that I have used Twitter several times over the past couple of days to alert "followers" (in effect, subscribers) to developments before I had a chance to get a post up on my blog. For example, as soon as I saw the link to Cornerstone’s year end report, I posted a "tweet" on Twitter. I also added a "tweet" about the new Satyam lawsuit as soon as I learned about it. I encourage readers who may also be active on Twitter to sign up for future updates.

Finally, I welcome readers’ thoughts and comments on these new media. As I said, I am still trying to figure all of this out, and I am particularly interested in thoughts and comments about how best to take advantage of these new technologies.

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Because of the dramatic events in the financial and credit markets, 2008 will undoubtedly go down in history as a dark and difficult year. 2008 was a challenging year for bloggers, too. So much happened of such significance that trying to find the time to comment and the words to express it all were almost overwhelming blogging challenges.

But dramatic headline events do not always make the best blog posts, because high profile events are exhaustively reported in the mainstream media. The blog posts that stand out in retrospect are those that analyze a specific detail of larger events reported elsewhere; that draw connections between otherwise disparate events; or that highlight developments that otherwise would be lost in the noise.

I have set out below my own list of The D&O Diary’s Top Ten Blog Posts of 2008. I have used a simple standard in determining which posts to include; I listed posts that stand up best to re-reading now. The Top Ten posts are presented chronologically.

1. "CDO Squared" Securities Lawsuit Hits MBIA (January 13, 2008): MBIA is only one of several bond insurers to get caught up in the subprime litigation wave. But the lawsuit against MBIA arose at a time when all of us were still just becoming acquainted with some of the complex financial instruments that have caused so much trouble.

This post attempted to explore the then-unfamiliar CDO-squared instruments, incorporating into the exercise both a detailed study of Warren Buffett’s condemnation of derivative securities as "financial weapons of mass destruction," as well as a reflection of the possible lessons for the current crisis from the near-collapse of Long Term Capital Management ten years earlier.

Little did I suspect at the time how relevant my observations about derivative securities or the lessons of LTCM would become later in 2008. (As an aside, I must note how instructive I found it to reread now all of January 2008’s posts. What an astonishing year 2008 was.)

2. Auction Rate Securities: The Next Subprime Litigation Wave? (February 13, 2008): This post commented on "a developing breakdown in an obscure corner of the credit market involving debt instruments called ‘auction rate securities.’" The post accurately foresaw the coming wave of auction rate securities litigation, which according to my tally involved at least 21 companies in new securities lawsuits during 2008. (My subprime and credit crisis-related litigation tally, which includes auction rate securities litigation, can be found here.)

Litigation involving auction rate securities remained one of the top securities litigation stories throughout 2008 (as reflected here, for example), and the lawsuits were a significant factor in the upsurge in new securities filings in 2008. My complete overview of the 2008 securities filings can be found here.

3. A Single "Toxic" CDO, A Multitude of Subprime Lawsuits (March 9, 2008): So many of 2008’s dramatic events were so large and their effects were so sweeping that they defy easy comprehension. An alternative way to try to understand what happened is to look at a single investment vehicle – in this case, a collateralized debt obligation (CDO) called "Mantoloking" – and examine the difficulties and litigation that has followed in its wake.

The extent and magnitude of the problems from just this one investment structure (among other things, it played a role in Bear Stearns’ demise) helps put some context around the problems now besetting the global financial marketplace.

4. D&O Insurance: Defense Expense and Limits Adequacy (June 2, 2008): Every now and then a set of circumstances come along that helps illustrate one of the perennial problems in D&O insurance. In this instance, the case involved was the criminal prosecution arising from the collapse of Collins & Aikman. The particular problem involved was the possibility that defense costs alone threatened to exhaust the company’s entire $50 million insurance program before the criminal case even went to trial.

As discussed in the post, the increasing possibility that defense costs could deplete or exhaust available insurance undermines traditional notions of limits adequacy and underscores the importance of issues involving program structure as part of the insurance acquisition process.

5. Section 11 Lawsuits: Coming Soon to a State Court Near You (July 21, 2008): One of the more interesting (yet little noted) features of the subprime and credit crisis-related litigation wave has been the frequency with which plaintiffs’ lawyers in reliance on the ’33 Act’s concurrent jurisdiction have chosen to file Section 11 lawsuits in state court rather than federal court.

As I speculated elsewhere (refer here), these state court lawsuits arguably represent an involved form of forum shopping. They also may represent an attempted end run around the PSLRA’s procedural requirements. But whatever the motivation may be, the plaintiffs’ bar has shown a heightened interest in proceeding in state court and have even has some success in opposing removal to federal court.

In the general hubbub of the current financial turmoil, this litigation development has not attracted nearly as much attention as it deserves. The anomalous phenomenon of federal class action litigation going forward – in significant volume – in state court represents a trend that deserves greater attention. As I have noted in this blog post, some "recalibration" may be required.

6. A Closer Look at the Fed’s $85 Billion AIG Bailout (September 17, 2008): Both the significance and consequences of the AIG bailout are still emerging, as reflected in Carol Loomis’s December 24, 2008 Fortune article (here). But in rereading a blog post written in the immediate aftermath of the first announcement of the AIG bailout, it appears that many of the continuing questions were immediately apparent.

7. WaMu: A Thrift Falls in the Forest: (September 28, 2008): It is one measure of the massive scale of this fall’s events that the largest bank failure in U.S. history is almost a footnote to the year’s events. Even though WaMu’s failure may be overshadowed by other events, that does not mean that the event lacks significance. Indeed, many of the consequences of WaMu’s collapse still have yet to emerge.

Moreover, WaMu was only one of 25 bank failures in the U.S. during 2008. Though overshadowed by other more dramatic events, these bank failures portend further difficulties in 2009.

8. More Damn Things to Worry About (September 30, 2008): So many things happened so quickly in September 2008 that we were all left wondering: what else could go wrong? This post embodies sheer frustration we felt at the time and the depth of the concern about what may lie ahead. Many of the specific fears expressed have indeed come to pass. Though written quickly and at a very late hour, the post withstands scrutiny now.

9. Reading the New Buffett Bio (October 8, 2008): In the midst of this Fall’s financial crisis, it was a reassuring pleasure to read about Warren Buffett’s life. I enjoyed Alice Schroeder’s new biography of Buffett, and I enjoyed writing about her book. Writing a book review is something of a departure for this blog, but it stands out perhaps for that very reason. Given everything that was happening at the time, it was a relief just to read a book.

10. The Evolving Credit Crisis Litigation Wave (December 3, 2008): As we head into 2009, it is critically important to understand that as 2008 progressed, not only did the credit crisis itself evolve into something much more extensive and dangerous, but so too did the related litigation wave. In an earlier post (here), I speculated that the litigation wave might have reached an "inflection point." Further lawsuit filings confirmed that the litigation wave has spread beyond the financial sector.

Because this litigation wave is likely to continue to spread in the weeks and months ahead, this development represents an important and noteworthy trend for the New Year.

And Finally: In addition to my favorite blog posts, I also had a favorite video of the year, the viral video Where the Hell is Matt? I not only smile every time I watch this video, I like it a little bit more with each viewing. YouTube reports that the video has been viewed over 16 million times. Matt’s website (here) reports that the video was shot in 42 countries and took 14 months to videotape and edit.

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2009 has barely just begun but the year’s first corporate scandal, which has quickly been dubbed the "Indian Enron," has already arrived. Your radar might not have picked this one up yet, but you may want to take a quick look at today’s news involving Indian information technology company Satyam Computer Services, Ltd.

As reported in articles on Bloomberg (here) and the New York Times website (here), Satyam’s Chairman, Ramalinga Raju, has sent a January 7, 2009 letter of resignation to the company’s Board of Directors, with copies the Bombay stock exchanges, in which he reveals, as the Times puts it, that "the company’s financial position had been massively inflated during the company’s expansion from a handful of employees into an outsourcing giant with 53,000 employees and operations in 66 countries."

It appears that as much as 53.6 billion rupees (or about $1.04 billion) in cash that the company reported as of the end of the second quarter that ended in September, was nonexistent. The company’s reported second quarter revenue was actually 21 billion rupees, rather than the reported 27 billion rupees.

The Chairman’s letter, which can be found here, is an absolutely extraordinary document.

With "deep regret and a tremendous burden," the Chairman details the specific balance sheet accounts that were inflated due to "non-existent cash." The letter further explains how the balance sheet "gap" came to exist – it is, the Chairman reports, "purely on account of inflated profits over a period of the last several years."

The letter states matter-of-factly that "what started as a marginal gap between the actual operating profit and one reflected in the books of accounts continued to grow over the years. It has attained unmanageable proportions as the size of the company operations grew." The letter goes on to describe how the company strained to maintain the gap over time." The letter further describes the company’s attempts to work out of its dilemma by merging with other companies, which the letter describes as the "last attempt to fill the fictitious assets with real ones." (The mergers fell through.)

It was, the letter says "like riding a tiger without knowing how to get off without being eaten."

In an apparent bid to exculpate himself, the Chairman notes that neither he nor the company’s Managing Director (or their spouses) sold any shares, nor have the taken "one rupee/dollar from the company" and they have not "benefitted in financial terms on account of the inflated results."

The Chairman graciously emphasizes that none of the past or present board members "had any knowledge of the situation in which the company is placed." After identifying each of these individuals by name, he states that none of them "were aware of the real situation as against the books of accounts."

The letter concludes with a description of the corrective actions the company will now take, an apology, and the Chairman’s resignation.

The company, whose name means "truth" in Sanskrit, trades its shares on the Bombay stock exchange and also has American Depository Receipts that trade on the New York Stock Exchange. Its shares also trade on the Euronext exchange.As of the close of trading on January 6, 2009, the company had a market capitalization of over $3 billion. However, the shares plunged 77% in trading on the Bombay exchange today.

The Times reports that the company is audited by PricewaterhouseCoopers.

According to a January 7, 2009 commentary on the Wall Street Journal’s website (here), Satyam’s scandal is already being called "India’s Enron." Perhaps that comparison was inevitable, but I think the scandal, particularly the Chairman’s extraordinary letter of confession, has overtones of the Madoff affair.

How long do you suppose it will be before a securities class action lawsuit is initiated in the U.S.?

UPDATE: The answer to this question is: less than one day. Plaintiffs' lawyers January 7, 2009 press release about their newly filed securities lawsuits agasint Satyam and certain of its directors and officers on behalf of purchasers of the American ADRs can be found here. The case was filed in the Southern District of New York.

FURTHER UPDATE: A copy of one of the Satyam complaints can be found here.

Special thanks to a loyal reader for supplying a copy of the Chairman’s letter.

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In recent posts discussing year-end trends, my observations included predictions that credit crisis related lawsuits would continue in 2009 and that increased levels of bank failures could lead to further "dead bank" litigation. As it turns out, 2009’s first-filed securities class action lawsuit appears to reflect both of these projected trends.

According to the plaintiffs’ attorneys’ January 6, 2009 press release (here), they have filed a securities class action lawsuit in the Central District of California alleging that PFF Bancorp and certain of its directors and officers issued false and misleading statements about the company’s financial condition and business practices in violation of the federal securities laws. Until the bank’s closure, PFF operated a community bank located in Pomona, California.

As the FDIC reported (here), on November 21, 2008, banking regulators closed PFF and its assets were transferred to U.S. Bankcorp. PFF is one of the twenty-five U.S. banks that failed during 2008. (The FDIC’s complete list of the failed banks can be found here.)

The only defendants named in the complaint (which can be found here) are the company’s former CEO and former CFO. According to the press release, the Complaint alleges that the defendants "concealed" the bank’s "improper lending to borrowers with little ability to repay the amount loaned and failed to inform investors of the impact of changes in the real estate market in San Bernardino and Riverside Counties."

Specifically, and according to the press release, the Complaint alleges that the defendants concealed that:

(a) PFF's assets contained hundreds of millions of dollars worth of impaired and risky securities, many of which were backed by real estate that was rapidly dropping in value; (b) prior to and during the Class Period, PFF had been extremely aggressive in generating loans, including being heavily involved in offering Home Equity Lines of Credit ("HELOCs"), which would be enormously problematic if the value of residential real estate did not continue to increase; (c) defendants failed to properly account for PFF's real estate loans, failing to reflect impairment in the loans; (d) PFF's business prospects were much worse than represented due to problems in the Inland Empire market, which was a key focus of PFF's business; and (e) PFF had not adequately reserved for loan losses on HELOCs and on other real estate-related assets.

In prior posts, I have speculated (most recently here) that the growing number of failed banks could lead to a wave of failed bank litigation. I also recently projected (here) the likelihood that credit crisis related litigation wave will continue in 2009. One case is obviously no basis from which to generalize, but it does at least indicate that the forces on which I based my speculations are at least at work.

The likely operation of these factors, as well as the Madoff litigation and the general turbulent conditions in the financial marketplace, are among the reasons that that 2009 could be a very active year for securities litigation.

The year has barely begun and the horizon is still wide open, but from my perspective we seemed to have picked up right where we left off.

In any event, I have added the PFF Bancorp case to my running tally of the subprime and credit crisis-related lawsuits, which can be accessed here. With the addition of the first-filed case of 2009 to the list, the number of subprime and credit crisis-related lawsuit filed during the period 2007 through 2009 now stands at 142.

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On January 6, 2008, Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse released their report on the 2008 securities class action lawsuit filings entitled "2008: A Year in Review." The Report can be found here and the accompanying press release can be found here.

According to the Cornerstone Report, through December 15, 2008, there were 210 securities class action lawsuits filed in 2008, which represents an 18% increase over 2007 and an 80% increase over 2006. The Report also found that the 2008 filing levels represented a 9% increase over the average annual filing level of 192 for the 11 years ending in December 2007.

As discussed below, the Report’s analysis of the 2008 filing levels is consistent with my own previously released analysis, which can be found here.

Cornerstone’s release of its annual securities litigation report is a much-anticipated event, and this year’s Report does not disappoint. It contains a veritable treasure trove of detailed observations, including a multitude of complex comments about the magnitude of financial losses involved in securities cases over time. The Report also has a host of other detailed comments about the specifics of the 2008 filings.

The Report merits a thorough and comprehensive reading. I briefly summarize the Report’s findings below and follow with my own comments.

The Cornerstone Report’s Findings

The Report observes that the period of heightened filing activity began in the second half of 2007. The 317 filings during the last 18 months represent a 71 percent increase over the 185 filings during the preceding 18-month period.

The Report finds that the 2008 filing activity was "dominated by a wave of litigation against firms in the financial sector" and that "litigation against firms closest to the on-going subprime/liquidity."

The 2008 Report introduces a truly nifty innovation called the Securities Litigation Heat Map, which graphically shows how concentrated the 2008 securities filing activity was in the financial sector. Among other things, the Map shows that nearly a third of all large financial firms were named defendants in a securities class action in 2008.

The Heat Map also shows how over the years different sectors have been variously targeted in securities lawsuits.

The Heat Maps confirm what practitioners in this area have long known, which is the litigation activity is strongly driven by sectors slides and contagion effects, as a result of which over time industry alone has proven to be a very poor predictor of likely future securities litigation activity. Simply put, the plaintiffs lawyers simply move on to then next hot trend.

The Report also includes the annual analysis of what it calls Disclosure Dollar Losses (that is, market capitalization losses at the end of each class period). The Report finds that these losses for 2008 class actions totaled $227 billion, which is 48 percent more than 2007 and 75 percent more than the annual average for the 11 years ending in 2007, and also represents the highest level since 2000.

In its review of the status of database cases, the Report finds that of resolved cases, 41 percent were dismissed and 59 were settled. The majority of cases were resolved after the first ruling on the motion to dismiss but before the rulings on summary judgments. For class actions filed between 1996 and 2002 and resolved by the end of 2008, the median time to resolution was 33 months, the median time to settlement was 37 months, and the median time to dismissal was 25 months. The Report also concludes that class action with higher shareholder losses take longer to resolve.

The Report also notes that the percentage of cases involving Section 11 claims increased to its highest level in 2008. The Report also noted that with respect to alleged violations of GAAP, there has been a shift from allegations related to income line statements to allegations related to balance sheet components. The Report also notes that seven of the 192 companies named in class actions in 2008 subsequently filed for bankruptcy, compared to two out of 172 in 2007 (although five of the 2007 companies filed for bankruptcy in 2008).

The Number of 2008 Filings

The Report’s tally of 210 new securities filings through December 15, 2008 is essentially consistent with my own report’s conclusion (refer here) that there were 224 new securities lawsuits through December 31, 2008, as there were 13 new securities lawsuits filed after December 15 and before December 31. The 13 additional lawsuits I included in my tally but that were omitted from the Cornerstone Report account for virtually all of the difference between the two analyses.

The arrival of 13 new securities lawsuits in the last two weeks of the year is unusual, as December is usually a slower month for new filings. The late December influx was largely but not exclusively due to the flood of Madoff- related litigation.

Cornerstone’s Report’s cutoff at December 15 is significant in other respects as well. For example, the Report states that lawsuit filings dipped in the second half of the year, and even relies on the supposed second half decline as one of the grounds on which it suggests that financial sector securities lawsuit filings may diminish in 2009. The Report also devotes a great deal of effort to trying to reconcile this supposed second half decline with observations regarding stock market volatility.

However, when all of the lawsuits filed through year end are included, it turns out that filings actually increased in the second half of the year. Not only that, but as I pointed out in my report on the 2008 filings, the securities lawsuit filing levels in the fourth quarter 2008 and in December 2008 represent, respectively, the highest quarterly and monthly totals in over five years.

Projected 2009 Filing Trends

The Report contains no predictions regarding likely overall 2009 filing levels, but the accompanying press release quotes Stanford Law Professor Joseph Grundfest to the effect that securities litigation against the financial sector may decline in 2009 because "virtually all the major financial services firms have already been sued," as a result of which "the pool of major financial services defendants might be getting fished out." In support of this conclusion, the Report among other things cites the fact that of the 15 largest financial services companies by market capitalization at the beginning of 2007, 12 of them have already been sued.

Professor Grundfest does not actually predict that overall securities lawsuit filings will decline in 2009; however, in the press release, he is quoted as saying that, because all of the major financial institutions have already been sued, "the supply of new defendants might be drying up." He also suggests that "litigation activity against the financial sector may decline next year," and in the Report adds that "it is unclear as to whether the wave of litigation will extend significantly beyond the larges financial firms in the near future."

My own view is that 2009 could well be a very active year for securities litigation. This view is based in part on the surge of litigation in the latter part of 2008, which shows every sign of continuing. The fact that there were thirty new securities class action lawsuits in December 2008, including ten new credit crisis-related lawsuits, strongly suggests that plaintiffs’ lawyers are finding no shortage of targets.

In addition, the credit crisis litigation wave long ago ceased to be just about the large financial institutions, if indeed it ever was just about that. As time has gone by, the wave has continued to spread and evolve. One attribute of this evolution is that as 2008 progressed, the credit crisis litigation has extended far beyond the financial services sector, as I noted most recently here.

In other words, the plaintiffs’ lawyers may or may not find new targets in the financial sector. (Although I strongly suspect that as a result of the Madoff scandal the plaintiffs’ lawyers will find innumerable new financial sector targets, but that is a separate issue.) The likeliest scenario, borne out by filing patterns that are already emerging, is that the plaintiffs will simply move on to other sectors, as they have numerous times in the past.

I note parenthetically that the probable movement of the litigation to a new sector is graphically foreshadowed by the Cornerstone Report’s Securities Litigation Heat Maps, which vividly show how quickly plaintiffs’ lawyers have moved from sector to sector in the past.

All of which I believe suggests that the heightened filing levels show every likelihood of continuing into 2009. Indeed, given the strong likelihood of additional Madoff victim litigation, as well as the likely continued spread of the credit crisis litigation wave outside the financial sector, the likeliest possibility is that 2009 will be a very active year for securities litigation.

The WSJ.com Law Blog has a January 5, 2009 post (here) discussing the 2008 securities lawsuit filings and quoting both from the Cornerstone Report and from my analysis of the 2008 filings.

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2008 was a remarkably eventful year, from the dramatic events that rocked the financial markets to the Presidential election that resulted in a change in national leadership. Virtually all of the significant events during 2008 also had an impact on the world of D&O insurance, one way or another. In all likelihood, significant developments will continue to emerge during 2009, with further implications for the D&O marketplace.

In a year as eventful as 2008, selecting as the most significant events is a challenging task. But with an eye toward the developments of greatest significance for the D&O industry, I have prepared the following list of the top ten stories of 2008.

1. Credit Crisis Becomes Global Financial Calamity: What began in 2007 as a subprime meltdown had by early 2008 become a credit crisis, which in turn evolved during Fall 2008 into a full blown global financial disaster.

Within the space of just a few short weeks, the government took control of Fannie Mae and Freddie Mac; the FDIC took over Washington Mutual, in the largest U.S. bank failure ever; Lehman Brothers collapsed, in the largest U.S. bankruptcy ever; Bank of America agreed to acquire Merrill Lynch in a government brokered deal; the government undertook a massive bailout of AIG; Congress enacted a colossal $700 billion bailout package; and Wells Fargo agreed to acquire Wachovia. And those events came after a raft of prior financial shocks, including the collapse of Bear Stearns, the seizure of the auction rate securities market, and the disintegration of U.S. residential real estate market.

Any one of these events on its own would be significant. Taken collectively these events represent an enormous upheaval, the full ramifications and consequences of which will only emerge over the months and years to come.

And those are just the headlines. In other developments reported "below the fold," companies around the world have grappled with a general business downturn, wrestled with the threat of their own insolvency or that of their customers or suppliers, and basically tried to maintain their ground in an increasingly hostile financial environment.

All of these developments have enormous potential significance, much of it yet to unfold. These events have not only fueled litigation, but they have also presented D&O underwriters with a dramatically altered underwriting environment. The perils involve not only the challenge of underwriting financially troubled companies, but also the trial of underwriting in the context of rapidly changing (and deteriorating) conditions in the financial and credit markets.

During 2008, the world became significantly more dangerous for D&O underwriters. All signs suggest the current perilous conditions will continue into 2009, and perhaps beyond.

2. Financial Market Disruptions Hit Major Insurers: The turmoil in the financial markets also battered three insurers that are major players in the D&O marketplace. AIG’s woes required an enormous government bailout. XL and Hartford both faced differing degrees of turbulence due to write-downs in their respective investment portfolios.

Each of one of these insurers is dealing with their own unique set of circumstances. Rating agencies have noted and responded to these developments. Insurance buyers remain anxious and wary. The implications of these developments, both for each of these insurers and for the marketplace as a whole, remain to be seen. At a minimum, these events have disrupted the D&O insurance marketplace and introduced a significant element of uncertainty. The disruptive impact from these developments is likely to continue to affect the D&O industry throughout 2009.

3. Subprime and Credit Crisis Litigation Wave Rolls On: The subprime litigation wave that began in 2007 continued to surge in 2008, as there were 101 new subprime and credit-crisis related securities lawsuits filed during 2008, bringing the two-year total to 141. My running tally of the subprime and credit crisis-related securities lawsuits can be accessed here.

As time has passed, the litigation wave has continued to evolve; for example, the 2008 subprime and credit crisis-related litigation included as many as 21 auction rate securities lawsuits all of which were filed in the earlier part of 2008. Later in the year, a string of lawsuits initiated by holders of preferred or subordinated securities emerged (as discussed here).

In February 2009, the subprime and credit crisis-related litigation wave will enter its third year, but the phenomenon shows no signs of abating. The credit crisis-related securities lawsuits continued to accumulate throughout 2008. Of the 101 subprime and credit crisis-related lawsuits filed in 2008, 45 were filed in the second half of the year, including ten in December alone.

The credit crisis lawsuit filings remained high as the year ended, suggesting that significant credit crisis litigation activity will continue well into 2009 and perhaps beyond.

4. Credit Crisis Litigation Spreads Beyond the Financial Sector: As massive as the subprime and credit crisis-related litigation wave has been, it had until recently been concentrated in the financial sector. But as 2008 wore on, and largely as a result of the dramatic events in the global financial markets during September and October 2008, the litigation wave spread beyond the financial sector.

The companies that have become involved in this extended litigation wave include, for example, those that had significant exposure to Lehman Brothers or other companies that collapsed this fall. (Refer here and here for discussion of these "new wave" credit crisis lawsuits). In addition, companies that have been drawn in include companies that made wrong way bets on commodities or currencies (about which refer here).

These developments suggest that the credit crisis-related litigation wave may have entered a dangerous new phase, as I discuss at greater length here. These developments also underscore the challenges for D&O underwriters in the current environment.

My complete rundown of all 2008 securities litigation can be found here.

5. Bank Failures Surge: Led by the FDIC’s assumption of control of Washington Mutual in the largest bank failure in U.S. history, bank failures surged in 2008. According to the FDIC’s website (here), there were 25 bank failures in 2008, the highest annual total since 1994, at the end of the last era of failed banks. Perhaps even more significantly, the pace of bank closures increased as the year progressed; 21 of the 2008 bank closures took place in the second half of 2008, 12 of them in the fourth quarter.

In many ways, other financial events have overshadowed this sudden surge in bank failures. Indeed, as I noted here, the WaMu failure, the largest in U.S. history, has largely been relegated to yesterday’s news pile. But the timing and pace of the bank closures during 2008 suggests that there are likely to be further bank failures ahead, carrying with it the threat of associated "dead bank" litigation, a possibility I previously discussed here.

6. Madoff Scandal Triggers Litigation Torrent: The revelation of the massive Ponzi scheme involving Bernard Madoff and his firm has triggered a wave of litigation as aggrieved investors scrambled to try to recoup their losses. The first Madoff-related lawsuits targeted Madoff and his firm. But given the unlikelihood of a significant recovery there, investors have quickly moved on to other targets. A running tally of the Madoff investor litigation can be accessed here.

The primary Madoff-related litigation targets are the so-called "feeder funds" that invested with Madoff on their clients behalf. Recent blog posts discussing these "feeder funds" lawsuits can be found here and here. Given the magnitude of the investor losses and the depth of investor outrage, these lawsuits are likely to continue to accrue for some time to come. Press reports (for example, here) suggest that lawyers are gearing up for a litigation onslaught.

7. Presidential Election Signals Changes: I don’t know whether you heard, but there was an election in November. The coming changes in the White House as well as the increased Democratic majority in Congress could signal significant future legislative and other developments.

The arrival of the new administration will likely mean a change in direction for judicial appointments. A more interesting question is whether the Democratic control of Congress and the White House could lead to legislative changes in the securities laws. As discussed at the PLUS International Conference in November (about which refer here), the current financial turmoil could be used as a justification for legislative reform efforts – for example, an attempt to overturn Central Bank and Stoneridge.

At a minimum, the coming changes in the leadership at the SEC, together with a different leadership interpretation of the meaning and value of regulation, could lead to a changed environment for the enforcement of the securities laws.

8. Largest-Ever Fine Underscores the Growing Significance of the FCPA: For some time now (most recently here), I have been writing about the growing importance of Foreign Corrupt Practices Act (FCPA) enforcement activity and associated civil litigation. The FCPA mounting significance was dramatically underscored recently when Siemens agreed to pay an $800 million fine.

The Siemens fine is the largest ever, dwarfing the previous record fine, paid by Baker Hughes, of $44 million (about which refer here). The outcome of the Siemens investigation is merely the latest development in a long chain of events highlighting the growing importance of the FCPA.

As I have previously noted (refer here), one of the usual accompaniments of an FCPA investigation is follow-on civil litigation. As the threat of FCPA-related exposure continues to grow, the threat of follow-on civil litigation will also increase.

The FCPA Blog has a detailed overview of 2008 FCPA enforcement activity here.

9. Defense Expense Tests Limits Adequacy: Companies ensnared in high stakes litigation may find themselves confronting an unexpected new challenge – the increasing likelihood that defense costs alone could exhaust the entire amount of available D&O insurance coverage. This threat was unfortuntately realized in connection with the Collins & Aikman bankruptcy and related criminal proceeding (about which refer here), where accumulated defense expense exhausted the company’s entire $50 million D&O insurance, before the criminal case even went to trial.

The possibility that escalating defense expense could entirely deplete available insurance presents a frightening prospect for individuals involved in a serious D&O claim, and also raises troubling questions about traditional notions of limits adequacy. In addition, the possibility of total limits exhaustion as the result of the requirements of multiple claims and multiple insureds underscores the need for insurance buyers to consider alternative insurance structures (such as, for example, separate insurance for an individual or a group of individuals) to ensure that segregated funds remain available in the event of a catastrophic claim.

10. Indemnity Developments Trigger Additional Insurance Structure Concerns: In the Schoon v. Troy case (about which refer here), the Delaware Chancery Court held that a board of directors properly could eliminate former directors' advancement rights retroactively. The possibility that former directors could lose their rights to advancement or indemnification comes as unwelcome news to many directors.

This case development, like the development about limits adequacy noted above, highlights the need to address program structure as part of the insurance acquisition process. In general, directors and officers have become more concerned about the availability of insurance protection when they need it most. As a result, interest in a wider variety of auxiliary insurance structures has increased. These structures can include new insurance solutions designed for the needs of retiring directors.

In a year as eventful as 2008, reasonable minds could differ about what events deserve to be included in any Top Ten list. I am very interested in readers’ views about the top stories, particularly those who feel that other events deserved to be included on the list.

More "Top" Lists: Making year-end lists seems to be a nearly universal phenomenon, and Top Ten lists abound. Time Magazine simplified things by creating "The Top Ten of Everything of 2008," which can be found here.

Then  there are always the lists of the "Bottom Ten," like Business Week’s list of the Ten Worst Predictions About 2008 (here). Fortune has a list (here) of the "dumbest" business decisions of 2008, but given the kind of year 2008 was, a list of just ten was not enough – the magazine’s targets 21 business decisions as "dumbest."

Perhaps the most entertaining "Top" list is VideoGum’s list of the Top Viral Videos of 2008, which can be viewed below. (Viewer discretion is advised as some persons may find some of the content offensive.)

PLUS D&O Symposium: Readers will also want to be sure to register for the annual PLUS D&O Symposium, which will be held on February 25 and 26, 2009, at the Marriott Marquis Hotel in New York. Information about the Symposium, including registration instructions, can be found here.

The Symposium will feature an all-star cast, including keynote speakers Madeline Albright and NY Insurance Department Superintendant Eric Dinallo. Wilson Sonsini partner Boris Feldman will once again be moderating the annual panel on securities litigation developments. The schedule also includes a panel on Bankruptcies and Bailouts, with panelists including VJ Dowling of Dowling & Partners Securities and David Bradford of Advisen.

The conference will also include a replay of the excellent video, "The Rise and Fall of Bill Lerach" (a movie trailer for which can be found here). Stanford Law Professor Joseph Grundfest will lead a panel discussion of the video. The video was shown at the PLUS International Conference in November 2008 and received rave reviews.

Readers with any questions about the Symposium should feel free to drop me a note or give me a call.

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Over the holidays, I added two blog posts that readers may find particularly interesting. To make sure that readers returning to their desks after the holidays do not overlook them, I have highlighted the two posts below, with links.

The List: Madoff Investor and Feeder Fund Litigation (December 26, 2008): This post is the access point to a table of Madoff Investor and Feeder Fund litigation. I have updated the litigation table numerous times since the initial publication, as several readers have helpfully provided relevant additional links and documents.

I will continue to update the table as new Madoff litigation arises. Readers are strongly encouraged to let me know of any new or additional information necessary to keep the table accurate and up to date.

A Closer Look at the 2008 Securities Lawsuits (January 2, 2009): As part of an annual feature on this blog, I reviewed last year’s securities lawsuit filings. As detailed in greater length in the post, the 224 new securities filings in 2008 represents the highest annual filing total since 2004.

The post also discusses the possible impact of the 2008 securities filing activity on the D&O insurance marketplace.

2008 Year in Review: On January 6, 2008, at 2:00 p.m. EST, I will be participating in a free webcast sponsored by the Securities Docket (here) entitled “2008 Year in Review: Securities Litigation and SEC Enforcement.”

The webcast will be moderated by Bruce Carton of the Securities Docket, and will feature several of my fellow bloggers, including Francine McKenna of the re: The Auditors blog (here); Tom Gorman of the SEC Actions blog (here); and Walter Olson of the Point of Law blog (here). Additional information about the webcast can be found here.

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In a development that attracted little notice at the time, on December 10, 2008, the parties to the subprime-related securities lawsuit pending in the Northern District of California against Luminent Mortgage Capital and certain of its directors and officers filed a Stipulation of Settlement (here), in which the defendants agreed to pay $8 million to settle the case.

As far as I am aware, the Luminent settlement is only the second of the subprime-related securities lawsuits in which the parties have reached a settlement.

As discussed at greater length here, the plaintiffs had alleged that in certain public statements in July 2007, the defendants has misrepresented Luminent’s liquidity, the quality of its mortgage backed securities (MBS) portfolio, and the safety of its dividend for the second quarter of 2007, payable August 8, 2007.

The plaintiffs’ Amended Complaint (here) alleged that the defendants failed to disclose margin calls on the company’s MBS portfolio, a write-down on its portfolio and significant exposure to subprime debt that negatively impacted the company’s liquidity. The company’s share price dropped over 75% after the company announced on August 6, 2007 that it was cancelling payment of the second quarter dividend.

As reflected in the Stipulation of Settlement, the parties reached an agreement to settle the case while the defendants’ motion to dismiss was pending. The settlement followed the parties’ agreement to attempt to resolve the case through court-appointed mediation. The settlement is subject to court approval. The settlement also includes defendants’ agreement to pay $100,000 administrative costs. The parties agree that plaintiffs’ counsel may apply for and receive a fee award of up to 25% of the settlement amount.

Though the Stipulation of Settlement was not filed with the court until December 10, it is dated September 10, 2008. On September 5, 2008, Luminent and its subsidiaries had filed for bankruptcy protection in the District of Maryland Bankruptcy Court. On October 3, 2008, Luminent filed a motion in the bankruptcy court to lift the automatic stay to permit the securities lawsuits settlement to be consummated and to approve the settlement as in the best interests of the debtor. On December 2, 2008, the bankruptcy court approved Luminent’s application and authorized the parties to proceed with the settlement.

The Luminent settlement follows the only other subprime-related securities lawsuit settlement of which I am aware, the $4.85 million WSB Financial Group settlement (about which refer here). I have added the Luminent settlement to my running table of subprime and credit crisis-related securities lawsuit settlements, dismissals and dismissal denials, which can be accessed here.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the Stipulation of Settlement. 

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As other commentators previously have noted (refer here), the pace of securities lawsuit filings increased significantly in 2008 compared to recent years. According to my tally, there were 224 new securities lawsuits filed in 2008. The 2008 total represents a 30% increase over the 172 securities lawsuits filed in 2007, and an 88% increase over the 119 securities lawsuits filed in 2006.

The 2008 filing total also represents the highest annual filing total since 2004. All signs seem to indicate that the heightened filing levels will continue into 2009.

My 2008 securities lawsuit filing tally reflects a lower number than the figures NERA Economic Consulting recently published (refer here), and in that regard I urge readers to refer to my comments below about the particular complications associated with "counting" securities lawsuits in 2008.

Overall Observations

The most significant factor in this year’s heightened securities litigation filing activity was the number of subprime and credit crisis-related securities lawsuit filings. Of the 224 new securities cases filed in 2008, 101 were subprime or credit crisis-related. As reflected on my running tally of subprime and credit crisis-related securities lawsuits, which can be accessed here, there have been 141 total of these cases filed overall during 2007 and 2008 combined.

One factor that increased the number of subprime-related lawsuit filings in 2008 was the influx of auction rate securities lawsuit filings (about which refer here). There were 21 of these auction rate securities lawsuits filed in 2008, largely in the first half of the year.

Another factor that increased the 2008 filings was the influx of Madoff-related litigation during December 2008. My running tally of the Madoff lawsuits can be found here. Investors have initiated Madoff-related securities class action lawsuits against at least seven distinct investment groups, and every sign is that this litigation will continue to flood in during the early weeks and months of 2009.

2008 Filings by SIC Code

The predominance of the subprime and credit crisis-related litigation during 2008 is borne out in the profile of the companies that were sued in securities lawsuits during the year. Though the companies targeted represent over 90 different Standard Industrial Classifications (SIC) Codes, fully 99 of the lawsuits hit companies with SIC Codes in the 6000 series (Finance, Insurance and Real Estate), including 19 in SIC Code 6021 (National Commercial Banks) and 20 in SIC Code 6211 (Security Brokers and Dealers).

There were a number of securities lawsuit defendants entities in 2008 that have no SIC Code designated. These defendants include mutual funds, private investment firms and other entities. By my count, there were as many as 23 new lawsuits filed in 2008 against entities that lack an SIC designation. In most cases, these entities are involved in investment or financial services-related businesses, which even further underscores the fact that much of the securities litigation activity in 2008 was concentrated in the financial sector.

But while securities suits against companies in the financial sector were a predominant factor in the 2008 securities lawsuits filings, there were other SIC Code categories that also saw significant litigation activity, including SIC Code 3674 (Semiconductors) which also saw ten filings; SIC Code 2834 (Pharmaceutical Preparations) which saw nine lawsuit filings; and SIC Code 3845 (Electromedical and Electrotherapeutic Apparatus) which had five.

In addition, while the credit crisis lawsuits hit the financial sector hard, the credit crisis litigation wave spread outside the financial sector as the year progressed and the financial turmoil spread. As I noted here, and as a result of the dramatic events in the financial markets during September and October 2008, a number of companies outside the financial sector were hit with credit crisis-related lawsuits, particularly those with exposure to Lehman Brothers, Fannie Mae and Freddie Mac, or those that made wrong-way bets on currencies or commodities.

State and Court Distribution of Filings and Defendants

The concentration of cases in the financial sector also affected the geographic distribution of the 2008 case filings. Though securities lawsuits were filed in 48 different federal district courts (as well as several state courts), 97 of the 224 securities filings in 2008 were filed in the Southern District of New York. The federal district with the second highest number of new lawsuit filings was the Northern District of California, where 12 new securities lawsuits were filed. Other districts with a significant number of filings include the District of Massachusetts (10), and the Central District of California (9).

Another factor contributing to the significant number of filings in the Southern District of New York was the number of lawsuits filed there against foreign-domiciled companies. Overall, there were 34 foreign companies sued in securities lawsuits in 2008, all but five of which were initiated in the Southern District of New York. The 34 foreign companies sued represented 17 different countries, with the largest number from Canada (8), China (5) and Switzerland (4).

The domestic U.S. companies hit with securities lawsuits were based in 31 different states, and the District of Columbia. The state with the largest number of new securities lawsuits was New York (42), followed by California (23), Massachusetts (13) and Ohio (10).

The Pace of Filings and Likely Future Trends

The pace of new lawsuit filings increased during the year, with 105 during the first half and 119 in the second half. The fact that the fourth quarter, with 67 new filings, was the most active quarter during the year, together with the fact that there were a significant number of filings (30) in December (typically a quiet month for securities lawsuit filings), suggests that the heightened level of securities filings will continue into 2009. Indeed, the filings in the fourth quarter of 2008 and during December 2008 represent, respectively, the highest quarterly and monthly totals in more than five years.

My conclusion that the increased securities litigation activity levels will continue in 2009 is reinforced by the likelihood that the credit crisis litigation wave will continue to spread outside the financial sector in 2009.

Some Comments about "Counting": One reason for the wide disparity in the various published versions of the 2008 securities lawsuit filings is that the seemingly simple task of counting lawsuits was particularly complicated during 2008.

One complication is that some companies were sued multiple different times by different sets of claimants, on different legal theories, or with respect to different sets of circumstances. For example, one historically unusual phenomenon that recurred during 2008 was the initiation of new securities lawsuits initiated by preferred shareholders or subordinate securities holders (about which refer here). The multiplication of lawsuits involving different claimants or different legal theories but related defendants raised a continuing series of questions whether or not a new action does or does not represent a separate lawsuit that should be separately counted.

This question whether or not a separate complaint represents a new lawsuit was particularly complicated with respect to the Madoff-related litigation that flooded in during the final weeks of December. As reflected in my running tally of these lawsuits, which can be accessed here, there have already been multiple lawsuits against related Madoff-feeder funds. Reasonable minds might well differ as to whether or not a particular complaint represents an entirely new lawsuit or simply a related or duplicate complaint.

Another attribute of this multiplicity of lawsuit filings is that the number of new lawsuits filed may be significantly different than the number of companies sued, as some companies were sued multiple times in multiple different lawsuits. As a result, there may be a certain amount of double counting associated with some of the lawsuit tallies or some of the analysis of lawsuit filings.

Yet another factor complicating the counting is that during 2008 plaintiffs initiated a number of securities class action lawsuits in state court (about which I previously commented here). In many instances these lawsuits are difficult simply to find. The inclusion of these cases, and the uncertainty around their numbers, could significantly affect the overall lawsuit tally.

As has been increasingly the case in recent years, it has become progressively more difficult simply to maintain definitional clarity about what exactly is being counted. To clarify what I have been tracking, I try to count class action lawsuits that allege violations of the federal securities laws. That said, I have excluded certain lawsuits that other reasonable minds might include. For example, I generally exclude merger objection lawsuits. In addition, I generally exclude lawsuits in which the securities allegation is simply that the defendants failed to register securities. On the other hand, I include lawsuits even if the defendant entity is not a publicly traded entity (for example, if the defendant is a private equity fund or a hedge fund.)

Because of these definitional issues, it is almost inevitable that various tallies of the 2008 securities lawsuits will differ.

UPDATE: The WSJ.com Law Blog has a January 5, 2009 post (here) regarding the 2008 securiteis class action filings. The Law Blog entry links to this post and includes comments from a number of commentators and practitioners in the field.

Impact on D&O Pricing?: The uptick in securities lawsuit filings in 2008 might well be expected to have an upward impact on D&O pricing, and indeed it may yet have that effect. But particular features of the 2008 filings might moderate that expected effect.

First, the concentration of the filings in the financial sector means that the impact from the heightened filing levels is not widespread throughout the D&O industry. D&O carriers are not yet experiencing the impact of the filing levels across their entire portfolio, and carriers that do not have significant financial industry exposure may not yet be experiencing elevated claims activity, although that likely will change as the credit crisis litigation wave spreads outside the financial sector.

Second, even with respect to the heightened activity levels, the impact is muted somewhat by the multiple different lawsuit filings against the same companies. The D&O impact from the third, fourth or fifth new lawsuit against the same company may not increase the aggregate losses to which insurance applies. Because the number of companies sued is less than the number of new lawsuits initiated, the aggregate claims frequency level is less than the overall filing levels might indicate.

Third, many of the defendant entities are not publicly traded companies. As I noted above, many of the defendant entities in new 2008 lawsuits were mutual funds, investment partnerships, hedge funds, or other investment vehicles. The incidence of litigation against these types of entities would have only an indirect impact at most on the market for public company D&O insurance.

Fourth, a significant amount of the securities litigation activity in 2008 involved claims likelier to create errors and omissions (E&O) insurance losses, rather than D&O losses. For example, the Madoff-related litigation and the auction rate securities litigation may or may not produce D&O insurance losses, but may well produce significant E&O losses. The spread of losses to other insurance lines could dilute the overall impact from the 2008 litigation on the D&O carriers.

Fifth, most of these cases are still in their earliest stages, and it will be some time yet before the losses begin to accrue. Until loss payments begin to mount, D&O pricing is unlikely to make dramatic changes (at least as a result of securities filing activity levels).

All of that said, the increase in litigation activity in 2008, together with the disruption involving market leader AIG and other leading carriers, as well as the prospect for continued significant litigation activity in 2009, are likely to create uncertain conditions in the D&O marketplace and could lead to increased carrier caution as 2009 progresses. Indeed, Advisen, a leading industry observer, is predicting that a hard market for insurance will develop toward the end of 2009 (about which refer here).

2008: The Year in Review: Readers interested in learning more about the 2008 securities litigation trends will want to the January 6, 2009 webcast sponsored by Securities Docket.

I will be participating in this free webcast, which will begin at 2 pm EST, along with a number of my esteemed fellow bloggers, including the Securities Docket’s own Bruce Carton; Walter Olson of the Point of Law blog; Tom Gorman of the SEC Actions blog; Francine McKenna of the Re: The Auditors blog; and Lyle Roberts of the 10b-5 Daily blog. Further information about the podcast can be found here.

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