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

LAST UPDATED ON February 24, 2010. With the arrival today of two more lawsuits against R. Allen Stanford and the Stanford Financial Group of companies, it may now be time to start keeping a table of the Stanford Group-related litigation. Given the magnitude of the losses and the publicity surrounding the Stanford scheme, there could well be a great deal more of litigation ahead.

My running tally of Stanford Group lawsuits can be found here. The document categorizes the suits into several tables, including a final table in which I have listed related proceedings. I will update the table as new cases arrive, and I will indicate the date of the most recent update at the top of this post.

The first of the two lawsuits to be added (that is, latest as of the time this post was originally created) today is the securities class action lawsuit filed on February 20, 2009 in the Middle District of Louisiana, in Baton Rouge. A copy of the complaint can be found here. This latest securities lawsuit joins two separate securities class action complaints previously filed in the Southern District of Texas, as well as the SEC enforcement proceeding filed in the Northern District of Texas. UPDATE: In addition to these cases, the plaintiffs in the first filed Southern District of Texas case have also filed a substantially identical complaint in the Nothern District of Texas as well, refer here.

The second of the two Stanford-related lawsuits to be added today is a lawsuit filed in Texas (Harris County) District Court by a trustee for the Rocky Mountain Trust. A copy of the trustee’s Original Petition can be found here. According to the Petition, the trust used its income to fund a foundation for "medical, dental and nutritional programs in Mexico and Central America." The Petition states that thousands of poor, including hundreds of Mexican orphans, have received assistance through the foundation. The defendants in the case include Stanford Group Company and related Stanford entities, as well as R. Allen Stanford and other individual Stanford directors and officers.

According to the Petition, the trustee was introduced to the Stanford group by acquaintances in Mexico. The trustee was persuaded to invest all of the trust’s assets in Stanford certificates of deposit. The trust is currently invested in three CDs, two of which total approximately $475,000 in face value and a third of which has a face value of about €202,000. Upon hearing of issues involving the Stanford CDs, the trustee unsuccessfully demanded return of the trust’s investment. The complaint asserts claims for common law fraud, violation of the Texas Securities Act, negligent misrepresentation, breach of fiduciary duty, aiding and abetting, conspiracy, and breach of contract. The complaint also seeks a temporary restraining order, and exemplary damages.

One common problem all of these cases will face is trying to get service of process on the elusive Mr. Stanford.

Hat tip to the Courthouse News Service (here) for the Louisiana and Texas state court complaints. Thanks to Adam Savett of the Securities Litigation Watch for the new Northern District of Texas complaint.

Other Stanford-Related Notes: The FCPA Blog has an interesting post today (here) questioning whether Stanford’s interactions with the Antiguan authorities could subject him to enforcement action under the Foreign Corrupt Practices Act.

Meanwhile, the February 24, 2009 Wall Street Journal is reporting (here) that a hedge fund run by Vice President Biden’s son and brother was exclusively marketed by companies controlled by R. Allen Stanford.

Finally, if you need a steady stream of news about the Stanford scandal, you will want to check out the Houston Chronicle’s Stanford Watch blog (here). Hat tip to the Daily Caveat for the link to the blog site.

For those readers who may not previously have seen it, I am also separately maintaining a list of litigation related to the Madoff scandal, which can be accessed here.

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In the lists of those supposedly responsible for the current financial mess, the rating agencies are among those usually featured prominently. Numerous investors have in fact sued the rating agencies claiming the ratings misled them into making their investment (about which refer, for example, here). Whether these investor actions will succeed remains to be seen, but in a recent ruling, at least one court has held that much of the subprime-related securities lawsuit brought against Moody’s by its own shareholders can go forward.

Background

In 2007, Moody’s shareholders sued the company and several of its directors and officers in a series of lawsuits that ultimately were consolidated in the Southern District of New York. (For the background of the case, refer here.)

The consolidated amended complaint alleged that the defendants had falsely claimed that the company was an independent and impartial body, while in fact the company’s arrangements for rating asset-backed securities and other structured investments put it in a conflict of interest and compromised its independence. The amended complaint also alleged that the company falsely claimed to have verified the quality of the underwriting practices at the loan originators whose mortgages were consolidated into the securities being rated.

The amended complaint further alleged that the company misrepresented that the rating scale used for the structured investments was equivalent, and reflected the same risk of default, as the company’s rating scale for traditional financial instruments. Finally, the amended complaint alleged that the defendants had falsely represented that the company derived its revenue from legitimate business practices.

The defendants moved to dismiss the amended complaint, arguing that the plaintiffs’ initial complaint had been filed after the statute of limitations had expired; that the amended complaint failed to adequately allege misrepresentations and materiality; and also that the amended complaint failed adequately to allege loss causation and scienter.

The Court’s February 18, 2009 Order

In a February 18, 2009 order (here), Judge Shirley Wohl Kram denied the motion in part and granted the motion in part, with leave to amend. The practical consequence of the court’s order is that a significant portion of the plaintiffs’ case will now be going forward.

The court first reached the defendants’ argument that the plaintiffs’ claims were barred by the statute of limitations. The defendants had argued that the plaintiffs were put on "inquiry notice" about the supposed fraud due to "storm warnings" as early as 2003. However, the court found that the statements on which the defendants sought to rely "refer to the credit rating industry in general terms and make no specific reference to Moody’s" and there is in any event "no mention of fraud." The court also found that Moody’s management’s "words of comfort preclude a finding of inquiry notice."

The court next determined that the amended complaint adequately alleged material misrepresentations in connection with Moody’s assertions of independence and also with respect to its statements about its assessment of the quality of loan originator underwriting as part of its ratings process.

However, the court found that the plaintiffs had not adequately alleged material misrepresentations in connection with the company’s statements about the equivalence of its structure finance rating system to its corporate finance rating system, and about the company’s statements concerning the sources of its revenue.

Even though the court found that the amended complaint’s "poor organization…dilutes Plaintiffs’ allegation of loss causation," the court found that the complaint alleges "sufficient corrective disclosure" to survive a motion to dismiss on the loss causation issue. The court also held that because the defendants failed to establish that Moody’s share price had declined as part of an industry-wide downturn, the defendants had failed to establish a "direct intervening cause" for the share price decline.

Finally, the court held that the amended complaint adequately pled scienter on the part of the company’s CEO as well as the company itself, finding that the CEO’s statements in a confidential slideshow were "revealing" of the CEO’s knowledge that the company "was not truly independent." With respect to the company itself, the court found that the plaintiffs had "alleged specific statements indicating that various top officials knew that Moody’s independence, ratings and methodology had been compromise," and that "consequently" the allegations of the amended complaint "sufficiently plead" the company’s scienter.

The court did however find that the amended complaint had not adequately pled scienter as to the other two individual defendants, the company’s COO and the Managing Director of the Asset Finance Group.

Regarding the claims and defendants with respect to which the motion to dismiss was granted, the court allowed plaintiffs leave to amend, directing them to file their amended complaint by March 18, 2009.

Discussion

The court’s opinion in the Moody’s case is significant in and of itself, as yet another subprime-related securities lawsuit that has survived the motion to dismiss, if only in part. Though the nature of the allegations against Moody’s may be somewhat distinct from those raised in many of the other subprime and credit crisis-related securities lawsuit, and though the dismissal motion was in fact granted in part, the outcome of the dismissal motion ruling nevertheless underscores that some of the many pending subprime and credit crisis-related securities lawsuits will be going forward.

The ruling, even if based on factual circumstances that arguably are specific to Moody’s, may be of particular significance to the separate securities lawsuits brought by the shareholders of McGraw-Hill (corporate parent of S&P) and by the shareholders of Fimalac (corporate parent of Fitch’s).

The more interesting question is what significance any of the court’s order in the Moody’s case may have for the many lawsuits brought against the rating agencies not by the agencies’ own shareholders but rather by investors who claim to have made their investments in reliance on the integrity and quality of the agencies’ ratings. These other investor lawsuits raise categorically different factual and legal issues that the suits brought by the agencies’ own shareholders.

Nevertheless, even given the differences between the two sets of claimants and the two categories of cases against the rating agencies, the ruling in the Moody’s case may at least provide some context for the investor lawsuits, particularly with respect to the court’s holdings that the shareholder plaintiffs adequately alleged that Moody’s had made material misrepresentations about its independence and processes, and had sufficiently alleged scienter as to the company’s CEO and the company itself. These particular holdings could be relevant in the separate investor lawsuits, at least on those issues.

I have in any event added the court’s February 18 ruling in the Moody’s case to my table of subprime and credit crisis-related securities lawsuit settlements, dismissals and dismissal motion denials, which can be accessed here.

A February 23, 2009 Reuters article regarding the court’s ruling in the Moody’s case can be found here.

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By now it is not news that the current credit crisis and related litigation wave have both spread far beyond the residential real estate sector in which they both first began. But the details surrounding the extension remain interesting and may even contain hints about what may lie ahead, as suggested by a recent lawsuit.

As reflected in their February 20, 2009 press release (here), plaintiffs’ attorneys have filed a securities class action lawsuit in the Southern District of New York against American Express and its CEO and CFO. The complaint (which can be found here) is filed on behalf of those persons who purchased the company’s securities between March 1, 2007 and November 12, 2008.

According to the complaint, American Express is the world’s largest issuer of charge cards. The complaint alleges that during the class period, the company "deviated from its historical strategy" of targeting the "premium market sector" and instead "engaged in riskier lending," while it "reassured investors and analysts that it did not engage in such riskier transactions."

The complaint alleges that the defendants "mislead investors by falsely representing American Express’s exposure to the riskiest credit card holders." The complaint alleges that the defendants repeated these reassurances to "artificially support" the company’s share price "as the building credit crisis in the market punished most companies that dealt with risky customers."

The complaint further alleges that as a result of the company’s "shift to risky card business," its brand has been "cheapened" and its stock has dropped over 65%. The complaint also alleges that the company won approval to convert to a bank holding company in order to qualify for TARP money – "a capital infusion required to save the Company from its risky endeavors."

On the one hand, it is hardly surprising in this environment that any credit lending facility should be experiencing difficulties or that those difficulties might result in litigation. But on the other hand, this new lawsuit does demonstrate both how far afield from the original subprime-related problems that triggered the current crisis, and how diverse the credit problems are that are now driving the related credit crisis litigation wave.

For some time now, the spreading subprime and credit crisis-related litigation wave has spread to encompass sectors of the credit marketplace beyond just subprime lending. Some time ago, for example, student lenders were drawn in (refer here), as were commercial construction companies (refer here). The involvement of a credit card company represents just another category of the credit marketplace to be drawn into the litigation wave.

But even though this new lawsuit may be just an extension of previously existing trends, it still has some ominous overtones. For one thing, American Express may be one of the largest providers of consumer credit, but it is far from the only one. Many businesses, other than just credit card companies, depend at some level upon the extension of consumer credit as part of their business model. The financial troubles these companies are now facing could also mean vulnerability to possible future litigation.

Another troubling note suggested by American Express’s woes is that a great deal of consumer debt, like the residential real estate debt, was packed into securities backed by the debt. The challenges facing the mortgage-backed securities market are at this point well known. Deteriorating conditions in the consumer credit arena could have significant implications for securities backed by the consumer debt.

In the meantime, American Express seems to be taking matters into its own hands to try to avoid further defaults as the recession deepens. According to February 23, 2008 news reports (here), American Express has offered to pay some cardholders $300 to pay off their outstanding balances and close their accounts by April 30, 2009. According to the news reports, analysts are concerned that credit card defaults could reach 11 percent by year end. One commentator is quoted as saying that what the company is trying to do is to "move to the front of the line in terms of getting paid back."

In any event, I have added the American Express complaint to my running tally of the subprime and credit crisis related securities litigation, which can be accessed here. With the addition of the American Express complaint, the current litigation tally now stands at 162, of which 19 have been filed so far in 2009. A spreadsheet reflecting the 2009 cases can be found here.

Special thanks to Adam Savett at the Securities Litigation Watch for the link to the American Express Complaint.

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As the difficulties and challenges from the global economic crisis continue to mount, one recurring question has been – how could things possibly have gone so wrong?

One way to try to answer this question is to look at the root causes – that is, the financial and economic conditions that produced the current circumstances. A February 19, 2009 memorandum by my friend Faten Sabry of NERA Economic Consulting and her colleague Chudozie Okongwu and entitled "How Did We Get Here?: The Story of the Credit Crisis" (here) does an excellent job explaining how "problems that first manifested in a relatively small part of the mortgage market" have "led to a contagion" that has "quickly spread to threaten the liquidity and possible solvency of may financial institutions around the world."

As alternative to looking for root economic causes is to try to determine who, rather than what, is responsible for the current mess. It is perhaps inevitable given the magnitude of the current crisis that attempts would arise to assign blame. Time Magazine’s recently published gallery (here) of the 25 persons most responsible for the financial crisis is just one manifestation of this inevitable fault finding process.

The supposed regulatory shortcomings of the SEC are among the contributing factors cited by some commentators.Indeed, former SEC Chairman Christopher Cox is among those whose names appeared on the Time Magazine list.

With the SEC under scrutiny and facing questions, the incoming agency leadership faces pressure to burnish the agencies’ supervisory credentials. It appears that this rehabilitative exercise may include in part the assignment of responsibility for the financial crisis, a process that apparently may target corporate boards.

According to a February 20, 2009 Washington Post article entitled "SEC to Examine Boards’ Role in Financial Crisis" (here), one of new SEC Chairman Mary Schapiro’s "first tasks" will be looking into "whether the boards of banks and other financial institutions conducted effective oversight leading up to the financial crisis," as part of an SEC effort to "intensify scrutiny at the top levels of management."

This process, described as an "inquiry into what went wrong at the board level," will examine boards that "signed off on the risks the companies took." The Post article quotes observers who note that "the boards of top financial firms had characteristics that promoted risky business practices and harmed shareholders." Among the characteristics the article cites are: board members overloaded with commitments to multiple boards; failure to separate the CEO and Chairman functions; and insufficient oversight of compensation issues.

To a certain extent, the Post article, and perhaps even the reported SEC initiative to scrutinize boards, reflects something of a faulty premise. The article states that "with few exceptions, boards have received little media attention as the country has sought explanations for financial firms’ taking on such perilous risks. Whether or not boards have received "media attention," they certainly have not escaped scrutiny, as the boards of numerous companies already have been subjected to extensive private securities class action litigation by shareholders. Were there to be an SEC initiative targeting boards, plaintiffs’ attorneys’ undoubtedly would be emboldened to bring even further litigation in the SEC’s wake.

To be sure, the Post article also cites comments by other observers who question whether boards should be "held culpable for a financial crisis that just about everyone missed." One commentator observes that the "universe of people who misread the risks…is very broad" and "could extend to rating agencies, managements and regulators." (The mention of regulators’ own potential culpability adds a certain ironic note here.) Regrettably, in the current environment, this observation about the broad dispersion of culpability may represent less of a statement of exculpation that a justification for enlarging the list of persons on whom blame might be cast for the present predicament.

The causes of the current situation may be myriad and the responsibilities widely dispersed. Nevertheless, for cultural reasons buried deep in the American psyche, particularized blame apparently must be assigned. The prospect of the SEC deliberately targeting financial institutions’ boards unquestionably elevates directors’ potential liability exposures. This heightened exposure extends not only to the boards of the high profile companies that have already failed, been bailed out or been merged out of existence. It also extends to the boards of the many other banks, insurance companies and other financial institutions, and even companies outside the financial sector, that are currently struggling.

The prospect of heightened board scrutiny inevitably leads to questions concerning the adequacy of the potentially targeted board members’ D&O insurance. Now more than ever, board members will want to ensure that they have appropriate insurance structures in place to protect themselves should they attract the unwanted attention either of regulators or plaintiffs’ attorneys.

Potential Liability of Other Professionals: Consistent with the suggestion cited above that a wide range of persons potentially culpable for misreading the risks, investors seeking to recover their massive losses are targeting numerous other "gatekeepers," in addition to the directors and offices of the troubled companies. These gatekeepers include companies’ outside professionals, many of whom have been named as defendants in the subprime and credit crisis-related securities lawsuits.

On February 24, 2009 at 2:00 p.m. EST, the Securities Docket will be hosting a webcast on the "Liability of Professionals in the Financial Crisis." In this free webcast, Stuart Grant of Grant & Eisenhofer and Michael Young of Wilkie Farr and Gallagher will be addressing questions surrounding the potential liability of professionals such as auditors, investment bankers, rating agencies, lawyers and others.

For further information about the webcast and to register, refer here.

Did the Media Fail Their Gatekeeper Function, Too?: Add the media to the list of gatekeepers that arguably failed in their gatekeeper responsibilities. In a February 21, 2009 interview in the Wall Street Journal (here), NYU Professor Nouriel Roubini observes that

in the bubble years, everyone becomes a cheerleader, including the media. This is the time when journalists should be asking tough questions, and I think there was a failure there. The Masters of the Universe were always on the cover, or the front page -- the hedge-fund guys, the imperial CEO, private equity. I wish there had been more financial and business journalists, in the good years, who'd said, 'Wait a moment, if this man, or this firm, is making a 100% return a year, how do they do it? Is it because they're smarter than everybody else . . . or because they're taking so much risk they'll be bankrupt two years down the line?"

And I think, in the bubble years, no one asked the hard questions. A good journalist has to be one who, in good times, challenges the conventional wisdom. If you don't do that, you fail in one of your duties.

There is, it seems, no shortage of blame to spread around. The question remains whether anyone in particular can or should be held directly responsible for failing to see what no one else saw – and if so, whom.

The Week Ahead: The PLUS D&O Symposium: This week, I will be in NYC to help co-Chair the annual Professional Liability Underwriting Society (PLUS) D&O Symposium, which will take place on Wednesday, February 25, 2009 and Thursday 26, 2009, at the Marriott Marquis hotel in Times Square. Details about the Symposium, including the agenda and registration information, can be found here.

I know that many readers will be attending the Symposium, and I hope readers at the conference will make a point of greeting me, particularly if we have not previously met. I look forward to seeing everyone in New York.

Because of the Symposium and related PLUS duties and functions, The D&O Diary will not be appearing according to its usual schedule. Regular publication activities will resume next week.

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Even after Merrill Lynch’s recent $550 million settlement of the subprime-related securities and ERISA lawsuits pending against the company (about which refer here), the consolidated subprime-related derivative lawsuit against the company’s directors and officers remained pending. By contrast to the massive settlements in those other lawsuits, the derivative litigation was recently dismissed, because of the company’s January 2009 acquisition by Bank of America.

In a February 17, 2009 opinion (here), Judge Jed Rakoff of the Southern District of New York granted the defendants’ motion to dismiss the derivative action. The defendants had argued that as a result of the Bank of America’s acquisition of Merrill in a stock-for-stock transaction, the plaintiffs are no longer Merrill shareholders and therefore lack standing to pursue the derivative actions as filed. Judge Rakoff granted the motion in light of the requirement under Delaware law for a derivative plaintiff to show "continuing ownership."

In his opinion, Judge Rakoff expressly noted that the dismissal "is without prejudice to plaintiffs’ filing with this Court, if and when they have standing, a renewed action, recast as a derivative action against Bank of America, or as a so-called ‘double derivative action, or otherwise, but based on the same underlying allegations as the actions here dismissed." (As reflected here, a "double derivative action" is a lawsuit in which a shareholder of a parent corporation brings an action on behalf of a wholly owned subsidiary for alleged wrongs to a subsidiary.)

The subprime-related derivative litigation involving Countrywide was also dismissed, following Bank of America’s acquisition of Countrywide, based on the requirement that derivative plaintiffs must demonstrated continuing ownership in order to have standing to assert the derivative claim, as reflected here and here.

Bank of America’s acquisition of Merrill is itself now the subject of extensive securities litigation, as discussed here.

A February 20, 2009 Law.com article discussing the dismissal in the Merrill subprime-related derivative litigation can be found here.

Second Stanford Financial Lawsuit Alleges Madoff Connection: As noted in a prior post (here), the same day as the SEC announced that it had launched a civil enforcement proceeding against R. Allen Stanford, the Stanford Financial Group and related entities and individuals, aggrieved investors also launched a securities lawsuit against many of the same entities and individuals in the Southern District of Texas.

A second lawsuit has now been commenced in the Southern District of Texas against the Stanford International Bank and related Stanford entities. Among other things, the second complaint expressly alleges a connection between the Madoff scandal and the new Stanford Financial scandal.

As reflected in the plaintiff’ lawyers February 19, 2009 press release (here), the action is brought "on behalf of purchasers of Stanford International Bank Ltd. ("SIB") certificates of deposit ("CDs") or shares in SIB’s Stanford Allocation Strategy proprietary mutual fund wrap program ("SAS") between February 19, 2004 and February 17, 2009."

According to the press release, the Complaint (which can be found here), alleges that the defendants

fraudulently peddled CDs that promised rates of return far above those available from other banks. Defendants claimed that these superior returns were possible because SIB invested its deposits rather than loaning them. To ensure that depositors could redeem their CDs, defendants assured them that SIB’s investments were liquid and diversified. In fact, nearly 80% of SIB’s investments were concentrated in just two high-risk, illiquid categories: private equity and real estate. Now that the real estate and private equity markets are in free fall, many of those who purchased SIB’s CDs have recently been informed that they cannot redeem them.

The complaint also alleges with respect to the defendants mislead investors about the SAS program. The complaint alleges that the defendants

picked a handful of mutual funds that had performed extremely well in 1999-2004 and claimed the returns of those high-performing funds as the historical returns of the SAS program. Defendants also inflated the claimed returns of the SAS program in 2006 and 2007. Investors, misled by defendants’ claims of historic returns, have fared very poorly in the SAS program.

The complaint also alleges that the defendants misled investors about SIB’s exposure to the Madoff scandal. The complaint alleges that the bank sent investors a letter

unequivocally stating that "Stanford International Bank did not have any exposure to the Madoff Fund." Just two days before this letter was sent, an SIB analyst informed all three of the individual defendants, including R. Allen Stanford ("Stanford"), that SIB had invested in Meridian, a New York-based hedge fund that used Tremont Partners as its asset manager. Tremont, in turn, had invested a portion of Meridian’s – and SIB’s – money with Madoff.

The two fraud schemes seem to have come together as if they were subatomic particles drawn by some unwritten law of physics.

The Sox First blog has an interesting post here on the parallels between the Madoff and Stanford scandal.

Yet Another Bank Closure: By contrast to the last several Friday nights in a row, the FDIC did not assume control of multiple banks following their closure by regulatory authorities. Rather than multiple banks, this Friday the FDIC announced that it had assumed control of just a single bank.

As reflected in its February 20, 2009 press release (here), the FDIC assumed control of Silver Falls Bank of Silverton, Oregon. Prior to its closure, the bank had assets of approximately $131.4 million.

The closure of the Oregon bank already brings the 2009 year to date total of bank failures to 14 (by contrast to the 25 banks that failed during all of 2008). As I have recently noted (here), the surging bank failure levels has some very troublesome implications, and the now standard Friday bank closure announcement is one more reflection of the current challenging financial circumstances.

Auction Rate Securities: Balance Sheet Valuation Concerns: With all the long-standing publicity surrounding the difficulties in the auction rate securities markets, and the extensive related litigation, you might expect that companies with balance sheet exposure to auction rate securities had long since adjusted the securities’ carrying values to reflect the current market conditions. But according to a recent study, many companies with auction rate securities exposure have yet to make any accounting adjustments.

As reported in a February 20, 2009 CFO.com article (here), a recent study of 625 corporate auction rate securities holders found that 186 of them, or nearly 30 percent, continue to report them at par value. The study’s author is quoted as saying that "there’s still an awful lot of companies out there that are not properly accounting for [the auction rate securities]."

These companies failure to recognize their balance sheet exposure to auction rate securities could represent a significant litigaton risk factor. There have already been at least one securities lawsuits against a nonfinancial company that included allegations based on the company’s alleged failure to disclose its exposure to auction rate securities (refer, for example here). Companies delaying their recognition of this exposure could be exacerbating an already serious concern. The delay potentially could represent a heightened litigation risk.

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In case you were wondering how long it would take, you should know that investors have already filed the first securities class action lawsuit in connection with the fraud allegations surrounding R. Allen Stanford and his Stanford Financial Group.

On February 17, 2009 -- the same day as the SEC announced its charges that Stanford had engaged in a "multi-billion dollar investment scheme" -- plainiff investors filed a securities class action lawsuit against Stanford and his related entites, as well as several other individual directors and  offficers, in the Southern District of Texas. The complaint, which can be found here, is filed on behalf of all persons who purchased securities and CDs from Stanford and affiliated selling agents from January 1, 2000 through February 17, 2009.

Though many of the Stanford investors reportedly are domiciled abroad (particularly in Latin America), the named plaintiffs in this initial lawsuit are all residents of the Houston area. The defendants include not only Stanford and his Houston-based firm but the affilated bank, based in Antigua.

The complaint describes the allegedly aggressive sales efforts undertaken to sell the affilated bank's CDs. The complaint alleges that the sales efforts misrepresented the safety and security of the CDs. The complaint also alleges that the Stanford affilated entitles misrepresented their performance and investment returns. The returns are alleged to have been "misleading and inflated."

Call it a hunch, but I suspect this complaint is only the first of many that will be filed in the days, weeks and months ahead.

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In a subprime-related lawsuit that highlights the advantages ERISA claimants may have over litigants seeking relief under the securities laws, a federal court has refused to dismiss the complaint filed under ERISA on behalf of benefits plan participants of NovaStar Financial.

In an opinion dated February 11, 2009 (here), Judge Nanette K. Laughrey of the Western District of Missouri denied the defendants’ motion to dismiss the action filed against the alleged fiduciaries of the NovaStar Financial 401(k) plan on behalf of plan participants. During the relevant time period, plan participants had the option to invest in a unitized stock fund that held NovaStar common stock.

The plaintiff’s complaint alleges that the defendants knew or should have known that investment in the company’s stock was imprudent, because of the company’s "serious mismanagement and improper business practices" The complaint alleges that the company was relying on subprime mortgage origination and servicing for revenue, while failing to maintain underwriting standards and appropriate risk management techniques. The complaint alleges that the company’s practices ultimately eliminated the company’s ability to elect to be taxed as a real estate investment trust, and that the company’s practices collectively caused the company’s financial statements to be misleading.

The plaintiff also alleges that the defendants knew about the company’s problems but did not disclose them to plan participants. The plaintiff also alleges that the defendants issued misleading statements to the plan participants, as a result of which the participants could not make informed decisions about their investments. Following revelations about NovaStar’s subprime-related difficulties, the company’s share price declined (approximately 99 percent from the beginning of the class period).

The complaint essentially alleges that the defendants breached their fiduciary duties in allowing plan participants to invest in company stock; by failing to monitor; and by issuing misleading communications.

The bulk of Judge Laughrey’s February 11 opinion relates to defendants’ arguments that the court should dismiss the complaint based on plaintiffs’ lack of standing. Suffice it to say here that the court concluded that the plaintiff alleged sufficient injury to support both statutory and constitutional standing, and the defendants’ motion to dismiss for lack of standing was denied.

Judge Laughrey also denied defendants’ motion to dismiss based on their argument that the defendants were not plan fiduciaries and in any event were entitled to a statutory presumption that they had acted with prudence. The court found plaintiffs’ allegations on which she contended that the defendants were fiduciaries to be sufficient. The court also found plaintiff’s allegation sufficient, at least at the pleading stage, to overcome the presumption of prudence, observing that the plaintiff has "pleaded facts indicating a precipitous decline in Novastar stock and that Defendants knew, or should have know, of NovaStar’s impending collapse."

Defendants further argued that the court should dismiss plaintiff’s allegations about the adequacy of communications to plan participants, contending that the allegations of insufficiency were inadequate and in any event that ERISA does not regulate the communications of which the plaintiff complaints. The defendants expressly cited the prior dismissal of the securities action concerning NovaStar stock (about which, more below).

In rejecting this argument, Judge Laughrey noted that the plaintiff had alleged "affirmative material misrepresentations to plan participants – as well as to the general public --- regarding the soundness of the NovaStar investment." The court specifically noted that "the heightened pleading requirements of securities laws do not apply to [the plaintiff’s] ERISA action," commenting further that the plaintiff "need not identify the author or specific content of each misrepresentation in order to survive a motion to dismiss."

Judge Laughrey’s recognition that ERISA class actions are not subject to the pleading requirements and other procedural hurdles to which class action securities claimants are subject highlights the advantages, at least in the initial stages, that an ERISA claimant may have over a securities plaintiff in seeking to recover alleged investment losses.

The advantages available even on more or less the same set of facts is underscored by the fact that the securities class action filed on behalf of NovaStar’s shareholders was, as Judge Laughrey noted, previously dismissed, with prejudice. (Refer here for a detailed discussion of the prior securities lawsuit dismissal.). The contrast in outcomes is even more noteworthy given how curt the prior court was in dismissing the securities action (among other things, in granting the dismissal motion in the securities case, the court noted that companies "are not expected to be clairvoyant" and that "bad decisions do not constitute fraud.")

By my count (refer here), there have been at least 22 ERISA class action lawsuits filed in connection with the current wave of subprime and credit-crisis related litigation. Whether or not these cases, or any one of them, ultimately will be successful remains to be seen. But if Judge Laughrey’s opinion is any indication, these cases may at least survive a motion to dismiss – or, rather, they may have a better chance of surviving the initial dismiss motion than their parallel securities lawsuit.

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In a recent post (here) discussing the New York state court lawsuit recently filed against Banco Santander and related entities on behalf of Madoff-related victims, I mentioned that among the claims asserted in the complaint is a cause of action under New York General Business Law Section 349. This item caught the attention of Albany Law School professor Christine Sgarlata Chung, who has a particular interest in the question whether Section 349 is applicable to securities claims.

At my invitation, Professor Chung has submitted the following brief guest post relating to the plaintiffs’ Section 349 claims:

I read with interest your recent post on the Madoff-related class action filed by the Coughlin Stoia firm.  As you note, the complaint asserts a variety of state law claims, including claims under §349 of the New York General Business Law.   This is an interesting approach, given the reluctance of some New York courts to apply §349 to securities transactions. 

 For example, in Gray v. Seaboard Securities, Inc., 788 N.Y.S 2d 471 (N.Y. App. Div. 2005), plaintiffs alleged that they opened accounts at Seaboard, purchased stock recommended by Seaboard, and paid full service brokerage commissions to Seaboard based on Seaboard’s promise to provide proprietary research.   Plaintiffs alleged that Seaboard engaged in a deceptive business practice within the meaning of §349 by failing to provide the promised investment advice.

The district court dismissed the plaintiffs’ claims on the grounds that §349 does not apply to securities transactions.  On appeal, plaintiffs argued that §349 does not contain a "wholesale exclusion" for securities transaction.  They also argued that their claims arose from Seaboard’s furnishing of services (i.e., investment advice) and not from securities transactions per se. 

The appellate court affirmed the dismissal of the plaintiffs’ claims, noting that the "vast majority of [New York] courts which have considered the issue have found general Business Law §349 inapplicable to securities transactions for essentially two reasons."   First, the court reasoned "individuals do not generally purchase securities in the same manner as traditional consumer products, such as vehicles, appliances or groceries, since securities are purchased as investments and not goods to be consumed or used."  Second, the court held that because the securities arena is highly regulated at the federal level, "it is questionable that the legislature intended to give securities investors an added measure of protection beyond that provided by securities acts." 

It is important to note that in 2001, a different department of the New York appellate court held that § 349 does not contain a blanket exception for securities transactions.   See Scalpe & Blade, Inc.  v. Advest, Inc., 722 N.Y.S. 2d (N.Y. App. Div. 2001).  Still, given Gray and its ilk, I am curious to see how the Coughlin Stoia plaintiffs fare with their § 349 claim.

Special thanks to Professor Chung for her interesting commentary on this issue. The D&O Diary welcomes guest posts from responsible commentators and we are always interested in submissions and contributions from readers.

Other Madoff-Related Notes: A February 18, 2009 Wall Street Journal article entitled "Accounting Firms that MIssed Fraud at Madoff May be Liable" (here) suggests that accounting firms for Madoff feeder funds could be "legally vulnerable to claims that they should have uncovered red flags, according to legal and accounting experts."

And a February 17, 2009 article in The (London) Times reports (here) that lawyers from firms in 21 different countries (including the U.S.) recently met in Madrid and formed a global alliance to represent claimants who lost money as a result of the Madoff scheme. Hat tip to the Securities Docket (here) for the linkl to the Times article.  

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Deteriorating economic conditions threaten a massive wave of corporate defaults. Corporate borrowers’ inability to fulfill debt obligations not only could prompt a bankruptcy filing surge, but also could result in a flood of ensuing lawsuits and claims as creditors and shareholders seek to recoup their losses. These claims could present a host of challenging D&O coverage issues.

The Growing Default Threat

According to a February 13, 2009 Wall Street Journal article entitled "Wave of Bad Debt Swamps Companies" (here), "the U.S. is entering a period likely to feature the most corporate-debt defaults, by dollar amount, in history." The article reports estimates that "U.S. companies are poised to default on $450 billion to $500 billion in corporate bonds and bank loans over the next two years."

In percentage terms, the default rate could "approach levels last seen in 1933." High yield default rates peaked around 15% in 1930. The Journal reports that S&P estimates that default rates will hit 13.9% this year "but could go as high as 18.5% if the downturn is worse than expected."

The "growing wave of souring debt" has already resulting in rising numbers of bankruptcies, including, just in the last few days, Muzak Holdings LLC; Pliant Corp.; Aleris International; and Midway Games.

However, as the Journal article observes, corporate defaults do not always result in Chapter 11 filings. Borrowers are sometimes able to restructure their debt outside of bankruptcy, and sometimes give creditors ownership stakes in exchange for reducing or elimination debt.

The Risk of Increased Numbers of Claims

In addition to the possibility of a growing number of bankruptcies, the prospect of surging corporate defaults also raises the possibility of an upsurge in claims against the directors and officers of the struggling or bankrupt companies.

Companies whose financial stability is deteriorating may as one consequence of their struggles get hit with a "going concern" opinion from their auditor. As the securities lawsuit filed against NextWave Wireless illustrates, the question whether a company can continue as a going concern alone can become an allegation in a shareholders’ class action complaint.

Claims may arise even when companies attempt a work out to try to avoid bankruptcy. These claims can come from shareholders, who may content that the workout resulted in a dilution of their interests, or it can even come from other bondholders, who may claim that their interests have been harmed or improperly subordinated, as demonstrated in the recent Station Casino bondholder claim (complaint here). Bondholders also recently filed a similar lawsuit against Harrah's Entertainment and certain of its directors and officers (refer here).

But a bankruptcy filing is particularly likely to be followed by claims against the bankrupt company’s directors and officers. These claims can come in the form of securities lawsuits brought against the individuals by the bankrupt company’s shareholders, as reflected for example in the recent cases filed against Pilgrim Pride’s corporate officials (refer here); against Britannia Bulk’s senior officers (here); or against the directors and officers of Charys Holding Company (here).

In addition, the Trustee in bankruptcy may also assert claims against the company’s directors and officers, as evidenced in the now infamous Just for Feet claim (about which refer here). As the Just for Feet bankruptcy also demonstrates, these various claims can arise simultaneously, which presents its own set of issues.

The Potential Coverage Issues

The advent of claims following bankruptcy presents a number of challenges in the context of any potentially applicable directors and officers’ liability insurance. Some of these challenges are a reflection of the size and structure of the insurance program; other challenges arise from the nature and extent of the coverage afforded.

With respect to the overall program, one critically important issue may simply be the amount of insurance available. The prospect for multiple simultaneous claims is increased dramatically when a company files for bankruptcy. The simultaneous prosecution of multiple claims presents the very real possibility that the insurance could be substantially depleted or even entirely exhausted. As demonstrated in the claims surrounding the Collins & Aikman bankruptcy (about which refer here), defense costs alone potentially could deplete the available limits.

And as demonstrated in connection with the multiple claims filed against the directors and officers of Just for Feet following that company’s bankruptcy, the proceeds of a traditional D&O insurance program alone may be insufficient to resolve all claims that can arise in the bankruptcy context. Both the Collins & Aikman and the Just for Feet examples have important implications for policy structure, as discussed below.

The interplay between the provisions of the Bankruptcy Code and the terms and conditions of the D&O policy may present certain specific challenges. As I discussed at greater length in a prior post (here), a recurring issue since so-called "entity coverage" has become a standard part of the D&O policy has been whether or not the D&O policy proceeds are property of the bankrupt estate under Bankruptcy Code Section 541(a) and subject to the automatic stay in bankruptcy under Bankruptcy Code Section 362.

A particularly good article discussing these questions regarding the D&O policy proceeds and the operation of the bankruptcy stay written by my good friend Kim Melvin of the Wiley Rein law firm can be found here.

Another frequently recurring D&O insurance coverage issue arising in the bankruptcy context is whether claims asserted by the Trustee or other receivers or liquidators against the company’s directors or officers funs afoul of the policy’s exclusion for claims brought by one insured against another insured. The "insured vs. insured" issue arises because of the concern that the Trustee or other claimant is "standing in the shoes" of a policy insured, the company itself.

Addressing the Insurance Concerns

A number of policy solutions to these recurring bankruptcy issues have developed in recent years. For example, a coverage carve-back to the insured vs. insured exclusion, now a standard provision in most policies, has continued to evolve over the years to address concerns about coverage for claims brought by Trustees and others.

In addition, many policies now contain "priority of payments" provisions as a way to try to address questions surrounding the availability of the D&O policy’s proceeds for the payment of defense expense or the resolution of claims notwithstanding the bankruptcy stay.

Perhaps even more importantly, to address concerns about the susceptibility of the policy proceeds to depletion or exhaustion from multiple simultaneous claims, particularly in the bankruptcy context, the D&O industry has developed a number of structural solutions designed to ensure that whatever may happen, a fund of money will remain available for specified individuals so they can defend and resolve claims against them. These structures might take any one of a number of forms, including a so-called Side A/DIC policy, or even an individual director liability (IDL) policy.

The complexity of these coverage and structural issues underscores the need to involve a skilled insurance professional in the D&O insurance acquisition process. Financial troubled companies in particular require the contributions of an informed and experienced advocate in structuring their coverage. The structure and the terms and conditions of a company’s insurance program could determine whether or not insurance coverage is available for individual directors and officers in the event of bankruptcy and related claims.

One final note about the likelihood of increasing corporate defaults. That is, the current deteriorating economic conditions not only present challenges for insurance buyers, they also present serious concerns for D&O underwriters. As the Journal article cited above notes, the defaults "will likely spread across many industries." Among the industries the article specifically mentions are "media, entertainment, casino and hotel companies, car makers and retailers."

Up to this point, the most significant consequences of the credit crisis have been concentrated in the financial sector. D&O underwriters have had the ability to segment risk arising from the credit crisis according to whether or not companies were financially related. However, with the growing threat of corporate defaults across many industry sectors, risk segmentation will be much more challenging. At a minimum, it will no longer be sufficient for underwriters to presume that risk is limited to the financial sector alone.

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In a February 12, 2009 FINRA Dispute Resolution Award, a panel of three arbitrators ruled that Credit Suisse must pay ST Microelectronics more than $400 million based on the company’s claims that Credit Suisse misled the company into buying subprime-exposed auction rate securities. A copy of the award can be found here.

The FINRA Award

As I detailed in an earlier post (here), ST Microelectronics had filed the FINRA claim against Credit Suisse (USA) LLC, while also separately filing a civil lawsuit against Credit Suisse Group, the U.S. affiliate’s Switzerland-based parent. The separate lawsuit complaint can be found here.

According to the February 12 Award, the FINRA complaint against the U.S. affiliate asserted claims under Section 10 of the ’34 Act and Rule 10b-5, alleging that the claimant "requested investments in student loan securities backed by U.S. government guarantees" but that instead their funds were invested in what the civil lawsuit complaint described as "illiquid, risky and unsustainable auction rate securities consisting of collateralized debt obligations and credit linked notes, some of which were backed by subprime real estate loans." (The separate complaint alleged that Credit Suisse had an "intentional strategy" of "dumping into the accounts of unsuspecting clients some of the worst ARS on the market.")

The Award makes no specific findings of fact but instead simply species the amounts to be awarded to ST Microelectronics. Credit Suisse is ordered to pay the claimant "compensatory damages" of $400 million, which is to be "paid immediately in exchange for Claimant’s entire portfolio." The award also orders the payment of certain of fees and costs, interest, and $3 million attorney’s fees.

Discussion

The FINRA award has a number of significant implications, the most immediate of which may be those relating to Credit Suisse itself. The separate lawsuit complaint filed against the Credit Suisse parent company alleges that "at least a dozen other multinational corporations are victims of the same scheme," carried out by two Credit Suisse brokers who, in fact, are the subject of a current criminal prosecution (about which refer here). The complaint alleges that the supposed scheme involves "more than $2 billion of these clients’ money."

A July 31, 2009 Wall Street Journal article (here) listed ten overseas companies (including ST Microelectronics) that have initiated arbitration proceedings against Credit Suisse-affiliated companies based on auction rate securities. The February 12 FINRA Award may bode ill for Credit Suisse in these other proceedings.

In addition, the outcome, magnitude and prominence of the February 12 Award could also spur similar claims by other aggrieved parties against other broker-dealers, particularly other aggrieved institutional investors. By and large, institutional investors were excluded from the massive auction rate securities regulatory settlements that have been announced to great fanfare. These excluded investors may be encouraged by ST Microelectronics’ success, and seek to pursue their own claims. A February 13, 2009 Bloomberg article (here) discussing the Award quotes one observer as saying "this decision will likely lead to either more arbitrations or settlements between investors and broker-dealers."

To be sure, the circumstances relating to Credit Suisse’s involvement with auction rate securities may be distinct. As noted above, criminal proceedings have arisen from its brokers’ activities. Other prospective claimants’ claims may not be as sympathetic.

It is important to emphasize that while the Award itself describes the relief granted as "compensatory damages," what it actually accomplished is a rescission of the underlying securities transaction. Credit Suisse basically has to buy back the company’s securities at face value. (In that regard, the Award itself noted that what the claimant had requested was "relief equivalent to rescission" – which appears to what the claimant got.) Though the Award provides for the payment of other fees and costs, it does not award any other type of damages. The Award expressly denied the claimant’s request for punitive damages.

The absence of the award of other damages potentially could affect other prospective claimants. That is, while these cases may provide an avenue of relief, there is nothing about this Award to suggest that that a claim of this type is going to produce some kind of a bonanza. On the other hand, for many prospective institutional investor claimants, the opportunity to return their auction rate securities for face value at this point would be more than enough incentive for them to pursue a claim.

The Award does provide one very particular kind of encouragement for these kinds of claims. The panel’s award of $3 million in attorneys’ fees undoubtedly will capture the imagination of many would-be claimants’ attorneys. The prospect of this kind of fee recovery undoubtedly will encourage many attorneys to seek out and pursue these claims.

It is unclear from the Award what preclusive or superseding effect the Award might have on the separate federal court lawsuit ST Microelectronics filed against the Credit Suisse corporate parent. It seems that the company secured the relief it sought. What reason or even opportunity there might be to continue to prosecute the civil case is not immediately apparent.

Hat tip to the WSJ.com Law Blog (here) for the link to the FINRA Award.

Don’t Tell Me How to Fix It, Just Tell Me Who to Blame: If you missed it, you may want to take a look at the list of the "25 People to Blame" (here) in the February 23, 2009 issue of Time Magazine. The magazine’s attempt to identify the individuals responsible for the current financial mess is actually kind of interesting, even thought provoking.

The list includes the usual suspects: Dick Fuld, Jimmy Cayne Angelo Mozillo and Stan O’Neill.( I agree that Angelo Mozillo of Countrywide also belongs on the list, although I don’t think I would have put him first, as Time Magazine did.) Time also included, correctly in my view, Fred Goodwin of Royal Bank of Scotland, whose ill-fated and ill-time take over assault on ABN AMRO is record setting in a number of extremely negative ways.

The list also recognizes others who rightfully should shoulder some of the blame, but who sometimes elude the harsh spotlight. In this category I would put Marion and Herb Sandler, whose Golden West Savings bank initiated the Option ARM mortgage. Sandy Weill also (correctly, in my view) appears on the list for the mess he made of Citigroup.

A couple of U.S. Presidents make the list -- Bill Clinton and George W. Bush. Alan Greenspan, Hank Paulson and Chris Cox are also there. There is also one former Prime Minister, Davíð Oddsson of Iceland, and one Premier, Wen Jiabao of China.

There are a several interesting names on the list. For example, John Devaney appears as a sort of a stand in for the whole hedge fund industry, and Lew Ranieri gets belated recognition for having fathered mortgage securitization. Kathleen Corbett, the former head of rating agency Standard & Poor’s also gets a nod for the plethora of triple-A rating on mortgage backed securities that encouraged so much misdirected investment. Joe Casano gets due recognition for basically taking down AIG.

There are others whom I think are misplaced on this list. For one thing, what is Bernie Madoff doing there? He may have been a big crook, but in the end he is just a crook.

There are also at least two very significant omissions from the list.

First and foremost, the U.S. Congress deserves to be recognized for its encouragement of housing policy that was misguided and disproportionate to the requirements and limitations of sound principles. Congress is great at holding hearings and making speeches when things go wrong. Their own abysmal record of implementing policies that prevent problems warrants its own set of hearings. I’d like to put some of them in the dock and subject them to the same kind of sneering cross-examination that they have been imposing on others in recent days. (To be fair to the list-makers, they did slot former Texas congressman Phil Gramm at No.2 on the list, which arguably is a Congressional designation by proxy.)

And finally, why isn’t the American Homebuyer on the list? Yes, the American Consumer is recognized, but I think we need to be specific here. Within the larger group of well-intentioned home buyers are those who were driven by some weird form of housing lust to buy gigantic houses they couldn’t afford. There also appear to have been some who were all too willing to hide or even misrepresent their true financial condition to secure credit. Sure, the lenders were complicit, but as long as we are assigning blame, let’s put some everywhere that it belongs.Of course, many homeowners who are now struggling had nothing to do with any of this kind of conduct, but there are also those who were involved.

When you come right down to it, there is no shortage of culprits. Sadly, there are many, many victims. Some of them are even the same people.

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In a case demonstrating the range of both the potential legal theories and the prospective litigants that could become involved in Madoff-related litigation, a pension fund has filed an ERISA class action against an investment advisory firm for the advisory firm’s investment of the pension fund’s assets in a Madoff "feeder fund."

On February 12, 2009, the Pension Fund for Hospital and Health Care Employees – Philadelphia and Vicinity filed an ERISA lawsuit against Austin Capital Management Ltd. in the Eastern District of Pennsylvania, on its own behalf as well as on behalf of all employee benefit funds for whom Austin acted as investment manager and whose assets were invested in whole or in part by Austin in any Madoff-related investment during the period February 12, 2005 to the present.

A copy of the complaint can be found here. A copy of the plaintiffs’ lawyers February 13, 2009 press release can be found here. A February 17, 2009 Law.com article describing the lawsuit can be found here.

The complaint alleges that in June 2008, the plaintiff’s investment consultant retained Austin "for the purpose of managing a portion of the [plaintiff’s] assets, to be invested in hedge funds." At the time, Austin, which is a wholly-owned subsidiary of Cleveland-based KeyCorp, had approximately $2.3 billion of assets under management.

In July 2008, the plaintiff’s investment consultant placed $10 million of the plaintiff’s assets with Austin for investment with the Austin Capital Safe Harbor Dedicated ERISA Fund, Ltd., an exempt corporation operating under the laws of the Cayman Islands. Austin is the investment manager for Austin Safe Harbor.

The complaint alleges that Austin invested a portion of Austin Safe Harbor assets in "Madoff-related investments, specifically funds managed by Tremont Holdings." According to a February 3, 2009 Bloomberg article (here), Tremont in turn "placed money through its Rye Select Broad Market Prime Fund, L.P.," which in turn invested with Madoff’s firm.

The complaint alleges that Austin was a fiduciary to the class of benefit funds, but that Austin failed to conduct adequate due diligence prior to recommending and investing monies in Madoff-related funds. The complaint also alleges that Austin ignored "red flags."

The complaint identifies several other public pension funds for which Austin acted as investment manager. The complaint states that Austin managed $170 million for the Massachusetts Pension Reserves Investment Management Board, of which $12 million was exposed to Madoff-related investment, and also managed $170 million for the New Mexico Education Retirement Board, of which $8-10 million was in Madoff-related investments. According to news reports (here), the Massachusetts pension fund recently voted to fire Austin due to the Madoff-related losses.

There are a number of interesting things about this lawsuit. The first is that it seeks relief under ERISA. So far as I am aware, this is the first Madoff-related lawsuit asserting claims under ERISA. The interesting thing about an ERISA class action, as opposed to a securities class action, is that the ERISA action is not subject to the PSLRA’s discovery stay and other procedural requirements. So the ERISA plaintiff is free to conduct discovery even while the dismissal motion is pending.

The opportunity under ERISA to avoid some of the challenges of litigating under the federal securities laws clearly was one of the plaintiffs’ attorney’s motivations in bringing the action. The Law.com article linked above quote the attorney as saying that ERISA provides "an easier and quicker route in repairing the damage."

By was of comparison, the attorney cites as the shortcomings (from his perspective) of seeking relief under the securities laws, the "high burden of proving fraud" and the "limitations on showing third parties were at fault." The attorney said that while Madoff may have been involved in fraud, "it would be much more difficult to prove that third-party investment funds that invested with Madoff were also defrauding clients."

The other interesting thing about the fact that this lawsuit was filed under ERISA is that it at least potentially draws into the mix yet another type of insurance. Up to this point, the likeliest source of insurance funds in connection with the prior Madoff-related lawsuits has been the target defendants’ D&O insurance or errors and omissions (E&O) insurance. A claim under ERISA at least potentially triggers coverage under applicable fiduciary liability policies (if any). The spread of Madoff-related insurance exposure to include fiduciary liability coverage may not have been among the factors considered in earlier estimates about aggregate Madoff-related insurance losses.

The final interesting thing about this lawsuit is what it says about just how broad the pool of Madoff-related defendants has become. The plaintiff pension fund in this lawsuit did not invest with Madoff. It did not even invest with a Madoff feeder fund. Instead, it invested with an investment advisor that invested with a feeder fund that in turn invested with Madoff. (Got that?) The sheer span of these increasingly remote connections required to establish the Madoff-related link underscores just how widespread the Madoff litigation may yet become.

I have in any event added the new lawsuit to my running tally of all Madoff-related litigation, which can be accessed here.

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The pace of bank failures is accelerating. This past Friday night the FDIC took control of four more banks, representing the largest number of bank closures yet on a single date and bringing the year to date total to 13 -- including ten just in the last three weeks alone.

On February 13, 2008, the FDIC announced that it had taken control of Riverside Bank of the Gulf Coast, of Cape Coral, Florida, which previously had assets of $539 million (about which refer here); Sherman County Bank of Loup City, Nebraska, which previously had assets of $129.8 million (refer here); Corn Belt Bank and Trust Co. of Pittsfield, Illinois, which had assets of $271.8 million (refer here); and Pinnacle Bank of Beverly, Oregon, which had assets of $73 million (refer here).

The geographic distribution of these banks, including the presence of three banks outside the most challenged real estate markets in California and Florida, together with the fact that these are smaller community banks, are both particularly troublesome notes.

The FDIC has now taken control of 34 banks just since July 1, 2008. (The FDIC’s failed bank list can be found here.) The accumulated effect of these regulatory actions is starting to strain the agency, as detailed in a February 14, 2009 New York Times article entitled "Failed Banks Pose Test for Regulators" (here). The article states that the agency is in the midst of a "military-style buildup as it undertakes one of the greatest fire sales of all times." The FDIC is, according to the article, "struggling to deal with a miserable stew of failed real estate projects, vacant land, boarded-up houses and loans to defunct or bankrupt businesses."

In all likelihood, the situation will only get worse for some time to come. To be sure, we are a long way from the dark days of 1989, when regulators took control of 534 lenders (including 327 savings and loans). But we could be headed in that direction.

According to a February 9, 2009 Bloomberg article (here), an RBC Capital Markets analyst has predicted that as many as 1,000 U.S. banks may fail in the next three to five years. The analyst said that most of the failures will probably occur at banks with less than $2 billion in assets as their commercial loans default.

Both the analyst’s emphasis on smaller banks and on the banks’ exposure to commercial loans are particularly disturbing observations. By and large, the worst (or at least the most public) consequences from the credit crisis have been concentrated among the largest banks and have arisen from problems involving residential real estate lending. The expansion of the meltdown’s ill effects to a wider variety of financial institutions and other types of credit could have serious implications – and not just for the threatened banking institutions, but for the economy as a whole.

In any event, the four bank closures this past Friday night is the most yet on a single day as part of the current wave of bank failures. The seven banks closed so far in February already represent the highest monthly total yet. Unfortunately it appears that many of these kinds of records will be established and broken in the weeks and months ahead.

Motley Fool, commenting (here) on the FDIC’s practice of announcing bank closures on Friday evening, observed that "evidently the U.S. head-in-sand department has decreed that all such unpleasant announcements should be made when the least people will read them." The Fool might be right; the FDIC could in fact be worried about what might happen if people were to focus too closely on the accumulating number of bank failures. It may or may not be a real concern (yet) that depositors might lose confidence in the banking system, but the FDIC might well have that possibility in mind.

Conduct Unbecoming of a Gentleman: As described in a February 13, 2009 Las Vegas Sun article (here), Station Casino bondholders have sued the company and certain of its directors and officers, as well as certain related entities, alleging that the company’s debt-reduction plan is unfair to some of the company’s bondholders.

While the claims themselves may seem commonplace, the bondholders’ complaint (here) displays a rather unusual literary flair. Among other things, in what is effectively a prologue, the complaint quotes Count Leo Tolstoy as having said: "A gentlemen is a man who will pay his gambling debts even when he knows he has been cheated." Perhaps even more flamboyantly, the complaint then goes on to state that the defendants are "not acting Gentlemanly."

Shocking bevior, indeed.

Hat tip to Courthouse News Service for the Station Casino complaint.

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Strangely, the Judge Couldn’t Be Found Inside the Mailbox at the UPS Store: According to the February 12, 2009 Atlanta Constitution (here), Fulton County deputies have yet to serve suit papers filed on December 12, 2008 against a Fulton County Superior Court Judge, even though the deputies and the Judge all work in the same courthouse building and even though the summons was addressed to the Judge at the courthouse. However, the deputies did attempt to serve the Judge at his campaign headquarters mailbox at a UPS store.  (Map courtesy of Fulton County deputies.)

Hell: According to a February 10, 2009 Minneapolis Star Tribune article (here), local police in Texas have seized 22 urine-soaked dogs found with their owner inside a locked station wagon. The ammonia level inside the car was measured as 23 parts per million. Humans reportedly start experiencing health issues at 12 parts per million. The article does not explain the simultaneous combination of owner, dogs, urine and locked station wagon.

Her Whole World Came to an End in an Instant: You might say, she broke a nail, big deal, right? However, Lee Redmond of Salt Lake City has not cut her nails since 1979. The total length of her nails in 2008 was over 28 feet, including a right thumbnail that measured nearly 3 feet long. She has appeared in the Guiness Book of World Records. The Associated Press reports (here) that she broke her nails after she was thrown from an SUV in a vehicle collision. She was hospitalized for serious injuries that are not considered life threatening – unless of course your life consists of being famous for having long fingernails. Everyone here at The D&O Diary hopes for the best for Ms. Redmond.

I Wonder, Did They Check Bernie Madoff’s Shoes?: According to a February 11, 2009 San Jose Mercury News article (here), a mortgage fraud suspect stopped at the Canadian border had $70,000 stuffed in his boots. (Don’t ask, of course they were cowboy boots.) He also had $1 million in Swiss bank certificates and four ounces of platinum valued at $1,420 an ounce. What an idiot. With the global economy in the tank, he probably could have written off the value of the certificates and gotten a tax loss carry forward for the next five years, and with commodities prices what they are, he was probably carrying the platinum at a loss too.

A Strange World, Indeed, Mr. Mum:  Ordinarily, I find material for my blog posts basically by roaming around the Internet and after a while someting worth writing about just kind of shows up. For whatever reason, last night, all I could find was a bunch of really weird stories. After a while, it occured to me, when life hands you lemons, or whatever, you basically just have to make a blog post out of it.

The hardest part was figuring out how to categorize this post. Categorization is a mandatory publication prerequisite within the blog software I use. I finally decided to put this post in the "SOX (Generally)"  category, because, after all, what is more absurd than the word "SOX"? 

All of this reminds me of the old comic strip, written by Irving Phillips, entitled "The Strange World of Mr. Mum." As shown in these examples, Mr. Mum was a silent but observant witness to all of the world’s absurdities. Many of the strips ended with Mr. Mum in a bar, contemplatively drinking a glass of carrot juice. (I just hope his dogs weren’t locked in the car outside.)

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 When the Madoff scandal news first broke, I thought it would be like so many other fraud controversies, dominating the headlines briefly and then fading into the background – as seemingly has happened with the Marc Dreier debacle. But perhaps as a result of the scale and breadth of the harm caused, the Madoff scandal story just seems to keep escalating.

Today’s headline revelation is the widely reported news (refer here), that Ruth Madoff, Bernard Madoff’s wife, allegedly withdrew a total of $15.5 million from a brokerage account just prior to Mr. Madoff’s now-famous confession to his sons and subsequent arrest.

This allegation first arose in a footnote of a complaint filed on February 11, 2009 by Massachusetts Secretary of State William F. Galvin to revoke the broker-dealer registration of Cohmad Securities Corporation. The complaint and related exhibits can be found here.

The Enforcement Section of the Massachusetts Securities Division of the Officer of the Secretary of the Commonwealth had "sought to determine whether the businesses of Cohmad and Madoff Investments were so intertwined that they could be viewed as a common enterprise, and not as separate entities, for purposes of imputing liability and obtaining investor relief." The complaint alleges that Madoff was one of Cohmad’s co-founders and directors.

As detailed in the complaint, Galvan contends that Cohmad "categorically refuses to discuss its actions with regulators" and therefore "has no right to continue to engage in the securities business in the The Commonwealth of Massachusetts."

As part of the complaint’s contention that Cohmad and Madoff’s securities firm are "so intertwined that they could be viewed as a common enterprise," Galvin cites, among other things (in footnote 4, on page 25 of the complaint) wire transfer records showing the "flow of funds" between the two enterprises, referring specifically to documents showing that "Ruth Madoff withdrew [from Madoff-related accounts at Cohmad] $5,500,000 on November 25, 2008 and withdrew $10,000,0000 on December 10,2008." Madoff was arrested on December 11, 2008.

The documents reflecting these two wire transfers can be found on the last two pages of Exhibit 16 (refer to pages 51 and 52, here).

A news wire story (here) quotes a spokesman from Galvin's office as saying "We're not accusing her of anything wrong." The spokesman added "Now, what someone in New York or the feds may think of it may be entirely different."

A Painful Situation: And under the general heading of marital complications related to the Madoff scandal, I reference the difficulties facing Steven Simkin, formerly married to Laura Blank. On February 3, 2008, Simkin filed a complaint in New York State (New York County) Supreme Court (here) against his former wife in connection with the Madoff-related investment the couple had maintained prior to their divorce.

According to the complaint, the couple entered a June 27, 2006 agreement providing for the division of their marital assets. The couple "mistakenly believed" that their largest asset was their account with Madoff Investment Securities, which they believed to be valued at $5.4 million. As part of the agreement, Simkin agreed to pay Blank half of the assumed account value in cash. (Ouch.)

The account is now "worthless, literally not worth the paper on which the parties’ valuation rested." Simkin’s complaint alleges that

As a result of the parties’ clear mistake of fact, Steven paid Laura millions of dollars believing, as did Laura, that it represented her share in the "Account" (as the parties understood it to be) and retained the "Account" as a portion of his equitable share of the couple’s assets. As a result, Laura obtained a windfall and Steven did not receive an equitable share of the couple’s joint assets. Accordingly, by this action, Steven seeks to reform the Agreement, which is grounded upon a material and mutual mistake respecting the couple’s assets at the time …and recover from Laura so as to accomplish the goal the parties intended by executing the Agreement.

Mr. Simkin, you have my sympathy.

Special thanks to the several readers who send me links to the Massachusetts Secretary of State’s complaint and to Jon Jacobson for help in finding the Simkin complaint. I have added the two complaints to my register of Madoff-related litigation, which can be accessed here.

A Clawshank Redemption?: And under the general heading of trying to recover previously paid out amounts, one issue that has gained a great deal of attention is whether the trustee in the Madoff liquidation proceeding can recover ("clawback") amounts paid out to fund investors who cashed out before the scandal was revealed. The Securities Docket has a post on the topic (here), discussing efforts that some of the investors who redeemed their shares to change the claims bar date in the Madoff liquidation proceeding out of concern for anticipated clawback efforts. .

In a February 2009 memorandum entitled "How Long and Strong is Trustee Piccard’s Claw?" (here), the Seyfarth Shaw law firm takes a detailed look at the trustees’ powers, and reviews the similar clawback efforts undertake in the Bayou funds scandal.

The memo concludes that the trustee’s ability to clawback redemption payments is "not unbridled" and that there are "powerful defenses that can and will be advanced, including the good faith defense that protected many redeeming investors in the Bayou case." The memo also notes that "additional defenses also are likely to be developed as the facts surrounding what Madoff did come into sharper focus."

Meanwhile, in Europe:  According to press reports (here), European investor rights group Deminor has initiated a legal proceeding in a Luxembourg court in order to compel two Luxembourg units of UBS to provide informatoin and materials relating to the entities' role in steering clients to Madoff-related investmens.

The action, which Deminor initiated on February 11, 2009, is filed against UBS S.A. and UBS Fund Services, as well as against the Luxalpha SICAV Fund, Luxembourg Third Party Management Company SA and Access Management Luxembourg SA.

According to the news reports, the action seeks information regarding contracts between the UBS units, Madoff, and Luxalpha, an investment fund that UBS allegedly promoted. Regulators closed Luxalpha last week for not complying with regulatory requirements. The action also seeks to obtain audit reports of the fund, prepared by Ernst & Young.

Deminor claims that it represents individual and institutional investors that had lost over $1.3 billion as a result of the Madoff scheme.

I would be very grateful to any reader who might be able to provide me with a copy of the new Luxembourg complaint.

Gender Issues: A February 11, 2009 Washington Post article entitled "In Banking Crisis, Guys Get the Blame" (here) raises the question whether the current global economic crisis is a result of the fact that the financial industry and its regulators are "overwhelmingly male-dominated."

The article quotes one commentator as saying that "you can argue that the men have made a right mess of it, and now the ladies should have a go." Another commentator observes that "maybe if we had some more women in the boardrooms, we may not have seen as much risk-taking behavior."

Finally, one commentator with an odd notion of human anatomy, commenting on London’s top financial sector officials, observed that "there are quite a lot of alpha males with testosterone steaming out their ears."

At least when it comes to relying on women to clean things up, Iceland "is leading the way," having appointed a female prime minister as well as two women to lead two of its major banks. The prime minister’s spokesperson is quoted as saying "Men, especially young men, made a mess of things. There is a strong discussion that women would have taken a more cautious approach in the financial sector."

And Finally: I have added a Twitter button in the right hand column. Readers interested in receiving Twitter updates (or "tweets" as they are known) between blog posts will want to click on the Twitter button and register to become a "follower" of my Twitter site. I also add "tweets" when I have added new blog posts. I have come to appreciate that there are many web denizens who prefer to receive their information as "tweets", so that is why this blog now has a Twitter button.

The New York Times has a nice February 11, 2009 article (here) with a good overview of what Twitter is all about.

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I have previously tried to anticipate the future direction of the credit crisis litigation wave (refer, for example, here), but what I failed to foresee is that as the credit crisis itself has entered the remedial phase – or what we all hope turns out to be the remedial phase – there also would be litigation arising from the administration of the remedies. A recent securities lawsuit demonstrates how circumstances surrounding the government’s bailout efforts can lead to litigation.

As reflected in their February 9, 2009 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the Middle District of Alabama against Colonial BancGroup and certain of its officers. Colonial is a bank holding company that operates Colonial Bank, N.A., which has 347 bank branches in Florida, Alabama, Georgia, Nevada and Texas, and over $26 billion in assets.

The lawsuit relates to Colonial’s efforts to obtain TARP money, and in particular to the company’s December 2, 2008 and January 27, 2009 press releases discussing the company’s TARP-related efforts. A copy of the complaint can be found here. Special thanks to Courthouse News Service for the complaint.

In its December 2, 2008 press release entitled "Colonial BancGroup Received Preliminary Approval from the U.S. Treasury for $550 Million in Capital" (here), Colonial announced that it had "received preliminary approval" to participate in the Treasury Department’s capital purchase program, pursuant to which Colonial "will receive $550 million from the Emergency Economic Stabilization Act of 2008."

In the December 2 press release, Colonial also stated that in exchange for its investment, the Treasury was to receive preferred shares paying a 5% dividend for the first five years. If the preferred shares are not redeemed within five years, the dividend rate increases to 9%. The press release also stated that the Treasury will also receive warrants to purchase shares of Colonial.

According to the plaintiffs’ lawyers’ February 9 press release, in response to Colonial’s December 2 announcement, Colonial’s share price "surged over 50 percent from its $2 per share close on December 1, 2008 to close at $3.08 per share on December 2, 2008."

However, the complaint alleges that the defendants failed to disclose that "Colonial would be required to raise additional outside capital of $300 million before it could receive the $550 million in TARP funding." The complaint further alleges that Colonial "belatedly disclosed" this requirement after the markets closed on January 27, 2009. The complaint alleges that in response to the company’s January 27 announcement, Colonial’s share price declined 45%, from $1.58 per share to $0.85 per share.

Colonial’s January 27, 2009 press release, which can be found here, stated that Colonial’s participation in TARP is "subject to Colonial’s increasing equity by $300 million." The January 27 press release also states that Colonial is "actively pursuing a variety of capital raising alternatives to increase equity by $300 million, which should satisfy this condition of the TARP preliminary approval."

As discussed in a February 6, 2009 Birmingham Business Journal article (here), Colonial’s announcement that it must raise $300 million of additional funds to qualify for TARP "is raising eyebrows among some banking analysts and banking experts." The article quotes one commentator as saying that this item represents "a pretty significant omission" on Colonial’s part in its announcement of the TARP funding. The article also quotes an analyst as saying she felt "deceived" by the bank because it "withheld important information."

The Colonial lawsuit is far from the first credit crisis-related securities lawsuit in which governmental intervention of one sort or another is involved. For example, the government’s role in brokering Bank of America’s acquisition of Merrill Lynch features prominently in the securities lawsuit recently filed against BofA (about which refer here). The need for governmental rescues has also featured in a number of other credit crisis-related securities lawsuits, including for example, the lawsuits filed against Fortis (refer here), ING (refer here), and the Royal Bank of Scotland (refer here). But so far as I know, the Colonial case is the first securities lawsuit where the allegations are tied directly to the TARP funding program.

I supposed that after more than two years of credit crisis litigation, as well as massive governmental involvement in the financial markets, it should come as little surprise that we have reached the point where lawsuits relating to the bailout efforts themselves are starting to arise. I suppose we should start getting ready now for the inevitable stimulus-related lawsuits which undoubtedly will follow not long after Congress finishes its current efforts.

The Colonial lawsuit does raise an interesting categorization issue, which is whether the case properly should be counted as credit crisis-related and grouped with the previously filed credit crisis-related securities lawsuits. After reviewing Colonial’s press releases and considering the reasons why the company needed TARP money in the first place, I have concluded that the lawsuit is related to the ongoing credit crisis and therefore it belongs in my running tally of credit crisis related securities lawsuits.

My running tally of the subprime and credit crisis-related securities lawsuits can be accessed here. With the addition of the Colonial lawsuit, the tally of subprime and credit crisis-related securities lawsuits that have been filed during the period 2007 through 2009 now stands at 156, of which 15 have been filed in 2009. A spreadsheet showing the 2009 credit crisis related securities lawsuits can be accessed here.

One final note about TARP -- the Bank Lawyer's Blog reports (here) that some banks in the Dallas area are advertising the fact that they haven't taken TARP money because they don't need to. That line of analysis could get awfully murky under the Treasury department's proposed updated bailout approach, under which banks will be "stress tested" and only the likeliest to survive will receive aid.

Madoff Update: Regular readers know that in addition to my running tally of the subprime and credit crisis-related securities lawsuits, I have also been maintaining a separate tally of Madoff-related litigation. The Madoff-related litigation register, which can be accessed here, is subdivided into multiple tables, reflecting the various types of litigation that has arisen out of the Madoff scandal.

I recently updated the Madoff lawsuit register by adding a number of new Madoff lawsuits, based on excellent information, materials and links provided by several readers, including in particular Jon Jacobson of the Greenberg Traurig law firm. My special thanks to all for the contributions.

And Finally: Describing it as "the beginning of a long process," the SEC Actions blog has a post (here) discussing the partial settlement that Bernard Madoff has reached with the SEC. The WSJ.com Law Blog also has a post here describing the partial settlement. A link to the SEC’s litigation release regarding the partial settlement can be found here.

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Even though Madoff victims previously filed a securities class action lawsuit against Banco Santander and other parties in the Southern District of Florida (as discussed here), a different group of claimants has now filed a separate lawsuit in the Southern District of New York against substantially the same set of defendants. However, the new lawsuit purports to represent a different approach, and also presents specific allegations pertaining to Banco Santander’s public offer (here) to compromise the Madoff-related claims.

On February 4, 2009, plaintiffs filed a purported class action lawsuit in the Southern District of New York "on behalf of all persons or entities who owned shares of Optimal Strategic U.S. Equity Ltd. on December 10, 2008." The defendants include Banco Santander S.A. and related entities; Optimal Investment Services; PricewaterhouseCoopers; several HSBC-related entities; and several individual defendants. A copy of the complaint can be found here.

Both the purported class and cast of defendants named in this new lawsuit are similar to the class and defendants named in the previously filed Southern District of Florida lawsuit (about which refer here). However, unlike the prior lawsuit, the most recent lawsuit does not assert any claims under the federal securities laws.

Even though the new lawsuit purports to involve a class action, it asserts, rather than alleged violations of the federal securities laws, common law claims against all defendants for negligent misrepresentation, breach of fiduciary duty, and unjust enrichment. The complaint also asserts a claim for aiding and abetting a breach of fiduciary duty claim against PricewaterhouseCoopers. In addition, the complaint asserts a claim against all defendants under Section 349 of the New York General Business Law.

What makes this class action complaint’s lack of securities law allegations noteworthy is that it was filed by one of the leading plaintiffs’ securities class action law firms. A number of possibilities suggest themselves as to the reasons for the omission of a claim based on the firm’s area of specialty.

The first is the possibility that the firm hopes to maintain its own lawsuit separately and without consolidation with the previously filed lawsuits.

Another more interesting possibility is that the law firm wants to avoid the discovery stay under the PSLRA. Indeed, press reports (here) relating to the lawsuit expressly noted that "unlike other Madoff-related cases, the suit does not contain a securities claim, meaning plaintiffs can receive relevant information about the case before any trial that could bring to light previously unknown details on the case."

A leading plaintiffs’ securities firm’s use common law claims as a tactical way to insert a discovery tentacle, possibly to support later amended securities claims, is a disturbing possibility that would represent a circumvention of the PSLRA’s intended protections. Of course, there is always the possibility that the plaintiff lawyers in fact intend to pursue the common law claims without later adding securities claims, which would represent an interesting development in and of itself.

Yet another reason the plaintiffs’ lawyers may have dispensed with a federal securities claim is suggested in the claim asserted against PricewaterhouseCoopers. Under Stoneridge, the plaintiffs have no aiding and abetting claim against the audit firm under the securities laws. The complaint nevertheless asserts an aiding and abetting claim against the audit firm, but for fiduciary duty violations, not Securities law violations, suggesting an attempt to avoid Stoneridge’s limitations.

The new complaint in any event expressly references Banco Santander’s public offer to compromise the Madoff-related claims (about which refer here). Among other things, the complaint describes Santander’s offer as "woefully inadequate," citing the fact that the offer "does not compensate Class members for any interest or gain their money would have earned," and asserting that the preferred stock Banco Santander is offering would be substantially discounted in the open market.

For their part, the plaintiffs in the action previously filed in the Southern District of Florida have filed an "emergency motion" to enjoin Banco Santander from contacting putative class members to try to secure a release from them of their claims. In the memorandum filed in support of the motion (a copy of which can be found here), the plaintiffs allege that Santander "has launched a misleading and coercive campaign to pick off class members one by one, by pressuring them to release their claims based on incomplete and misleading information."

The memorandum cites Santander’s supposed use of closed door meetings, in which class members are presented with "onerous conditions and take-it-or-leave-it terms with quick expiration dates." The memorandum also references Santander’s "failure" to inform the putative class members of the existence of the lawsuit that "seeks recovery in excess of the compensation proposed."

The motion seeks to enjoin Santander from contacting class members, in order to prevent an "end-run around the Court’s jurisdiction and power to preside over this Class Action."

Whatever else may be said about the multidirectional litigation, it seems fairly certain that Banco Santander is getting a quick indoctrination into the battlefield tactics of the U.S. plaintiffs’ bar.

I have in any event added the new lawsuit to my running tally of the Madoff-related litigation, which can be accessed here. The new lawsuit appears in Table IV, in which I have identified "additional lawsuits against related defendants" and that are distinct from the federal securities class action lawsuits separately listed in the document.

Special thanks to Adam Savett of the Securities Litigation Watch blog for a copy of the complaint of the new lawsuit.

More Bank Closures: The expanding wave of bank failures swelled again this past Friday night when the FDIC announced the closure of three more banks, bringing the number of 2009 year-to-date closures to nine.

The three latest bank closures are Alliance Bank, previously a $1.14 billion asset bank in Culver City, CA (about which refer here); County Bank, previously a $1.3 billion bank in Merced, California (refer here); and First Bank Financial, previously a $279 million asset bank in McDonough, Georgia (refer here). The FDIC’s complete list of failed banks can be found here.

The closure of nine banks already in 2009, including in particular the closure of six banks in just the last two weeks, is extraordinary in and of itself. It is also noteworthy in context, as the number of bank closures just in the opening weeks of this year already exceeds the total number of all bank closures during the four years between January 1, 2003 and January 1, 2007. Indeed, during the period January 1, 2000 to January 1, 2008, only one year (2002, with 11 closures) had more bank closures than the nine already in the first six weeks of the year.

As I recently noted (here), the increasing number of bank closures is a difficult and disturbing trend, Unfortunately, all signs are that the number of bank closures will continue to grow as the year progresses.

Event Registration Update: If you are planning on attending the PLUS D&O Symposium on February 25 and 26, 2009 at the Marriott Marquis hotel in New York but you have not yet registered, you may want to get your registration in at your earliest opportunity. Event registration is rapidly filling, and so you may want to register now before it is too late. Registration 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.

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The numbers are unambiguous – there were more securities lawsuits filed in the second half of 2008 than there were in the first half. Nevertheless commentators and observers continue to repeat the mistaken conclusion that there were fewer lawsuits filed in the second half, and even to try to discern some significance from a decline that never, in fact, occurred.

Here are the facts. As reflected on the Stanford Law School Clearinghouse Securities Class Action Clearinghouse website, which helpfully indexes the securities class action filings by quarter (here), there were 112 securities lawsuits filed in the first half of 2008 and 114 in the second half.

Not only were there more lawsuits filed in the second half of the year, but there were more lawsuits filed in the fourth quarter (65) than any other quarter during the year. Indeed, there were more lawsuits filed in December (30) than any other month during the year.

Clearly, the fact that securities lawsuit filings in fact accelerated at the end of 2008 potentially has far different implications for the future than the mistaken impression that lawsuit filings were declining.

The source of the impression that there were fewer lawsuits in the second half of 2008 is the year-end securities lawsuit filing Report jointly published by the Stanford Law School Clearinghouse and Cornerstone Research. The Report, which can be found here, considered only lawsuit filings through December 15, 2008. As I noted at the time the Report was first published (here), by omitting the last two weeks’ lawsuit filings, the Report not only excluded at least 12 lawsuit filings from its analysis, but it also reached a conclusion, inconsistent with the actual aggregate year-end data, that lawsuit filings had declined in the year’s second half. When lawsuit filing data through December 31 are considered, it is clear that the number of filings did not decline in the year’s second half.

What difference does it make whether or not lawsuit filings declined in the second half? Well, a discussion of the reasons for a lawsuit filing decline is a far different conversation that a debate over the reasons why lawsuit filings accelerated in the year’s final quarter and month. The repetition of the impression that lawsuit filings were declining when in fact they were accelerating not only perpetuates a misunderstanding of what actually happened, but it also allows the possibility that decisions could be made or conclusions reached based on a faulty premise.

Unfortunately the conclusion that securities lawsuit filings declined in the second half of 2008 continues to be repeated. As reflected in a February 9, 2009 Business Insurance article (here), industry observers continue to distract themselves and perhaps others as well debating the reasons for a lawsuit filing decline that never happened, when in fact the actual discussion ought to be the reason why lawsuit filings actually accelerated at the end of the year.

The danger from this mistaken conclusion is apparent in the remarks of one leading industry observer at a recent conference. As quoted in the Business Insurance article, the observer noted, in apparent reliance on the Cornerstone report, that “in this last quarter, there were actually fewer cases filed. It got better, not worse at the end of the year.” The world certainly looks a lot different if you think things recently “got better”; unfortunately, they didn’t get better, they got worse.

The D&O insurance industry has a hard enough time behaving rationally and making sense of what has actually happened. It would be extremely unfortunate if the industry were to become even further confused by a conclusion that unsupported by full-year data.

I entreat readers to do everything they can to make sure that the misimpression about securities lawsuit filing activity levels is not perpetuated. The industry faces too many other challenges to have to deal with the added burden of laboring under misimpressions.

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The credit-crisis securities litigation wave, which began with the filing of the first subprime mortgage-related lawsuits in early February 2007, is about to enter its third year. Though the wave has evolved during the intervening period, it shows no sign of slowing down. The more interesting question going forward will be whether the litigation, which up until now has largely been concentrated in the financial sector, will spread to encompass companies in the wider economy.

The Wave’s History – So Far

The current subprime and credit crisis-related securities litigation wave began on February 8, 2007, with the filing of a securities lawsuit against New Century Financial Corporation and certain of its directors and officers. (Refer here for my most recent post on the New Century case.) Two years later, there have been 152 separate subprime or credit crisis-related lawsuits filed against companies and other entities, as reflected in my running tally of the suit, which can be accessed here.

The initial cases during 2007 were largely filed against subprime loan originators, banks, mortgages companies, home builders and residential real estate investment trusts. However, by year end 2007, a number of lawsuits had also been filed against investment banks, investment advisors, and rating agencies.

During 2007, there were a total of 40 subprime-related securities lawsuits filed.

In 2008, the lawsuits against banks and other mortgage originators continued to mount, but the litigation activity spread beyond just residential mortgage and real estate issues. The litigation also involved student lenders, commercial construction companies, commercial real estate investment trusts, bond insurers, and mortgage guaranty insurers. As I noted at the time (refer here), by early 2008, the litigation activity was no longer just about the subprime meltdown but had by that time become a credit crisis litigation wave.

The litigation wave also picked up considerable momentum during 2008, driven in part by the onslaught of cases involving auction rate securities. A total of 21 separate auction rate securities lawsuits were filed in 2008, against broker dealers, security issuers and mutual funds, among others. There were also a significant number of separate securities lawsuits filed on behalf of preferred shareholders and subordinated debtholders, which represents a relatively unusual securities litigation development, as discussed here.

The crisis in the global financial markets during fall 2008 also significantly affected the litigation wave. As I noted here, as a result of the financial market turmoil, the litigation wave reached an "inflection point" during the third quarter of 2008, where companies began to find themselves exposed to litigation not because of their own direct vulnerability to the credit crisis, but because of the companies’ exposure to other companies that were experiencing credit crisis-related issues.

During 2008, a total of 101 subprime and credit crisis-related securities lawsuits were filed.

As 2009 has begun, the litigation wave has shown no sign of slowing down. Indeed, during January 2009 alone, there were eleven new credit crisis-related securities lawsuits. A spreadsheet of the 2009 cases can be found here.

One important consequence of the litigation wave’s evolution over time is that it has become increasingly difficult to maintain absolute definitional clarity about what should be included in the category. This challenge has become even more difficult now that the financial crisis basically encompasses the entire global economy. It has become progressively tricky to determine whether or not newly filed lawsuits logically ought to be group together with the earlier suits, or whether they represent something entirely different. This categorization challenge has made simply "counting" the subprime and credit crisis-related lawsuits increasingly more difficult over time.

Financial Sector Concentration

Though the litigation has evolved and become more diverse, the litigation activity has largely been concentrated in the financial sector. Of the 152 subprime and credit crisis-related securities lawsuits that have been filed as of February 4, 2009 and that involved companies or other entities that have assigned standard industrial classification codes (SIC Codes), fully 117 of them have involved companies or other entities with SIC Codes in the 6000 series (Finance, Insurance and Real Estate).

Moreover, the 18 entities that have been sued but that have no SIC Code designated are also almost exclusive concentrated in the financial sector. These entities include mutual funds, private equity firms, hedge funds, and foreign firms whose shares do not trade on U.S. exchanges (e.g., Fortis and Société Générale).

Of the financial companies, the SIC Code categories with the largest number of lawsuits were SIC Code 6021 (National Commercial Banks) and SIC Code 6798 (Real Estate Investment Trusts), both of which had 16 lawsuits. Other categories with a significant number of securities lawsuits include SIC Code 6211 (Security Broker Dealers), which had 13 lawsuits; SIC Code 6189 (Asset Backed Securities), which had 12 lawsuits; and SIC Code 6035 (Savings Institutions, Federally Chartered), which had 11 lawsuits.

Has the Wave Entered a New Phase?

But while the litigation activity has largely been concentrated in the financial sector, there has more recently been a "new wave" of credit crisis lawsuits, as discussed at greater length here. These new wave lawsuits involved companies exposed to some of the credit crisis casualties (Lehman Brothers, Fannie Mae, Freddie Mac, Washington Mutual, American International Group, etc); that made wrong-way bets on commodities or currencies; and companies outside the financial sector whose balance sheets are laden with auction rate securities or other troubled assets.

The interesting question these new wave cases present is how far outside the financial sector these kinds of cases will spread as we go forward.

How are the Cases Faring?

Even though the subprime and credit crisis-securities litigation wave is about to enter its third year, most of the cases are still only in their earliest stages. There has really been only one significant settlement, the recent massive $550 million settlement involving Merrill Lynch (about which refer here). The few other settlements have been considerably more modest (refer here).

Only a handful of these cases have even reached the motion to dismiss stage. Among the cases where dismissal motions actually have been addressed, there have been several notable cases in which the dismissal motions were denied – for example, the New Century case (refer here) and the Countrywide case (refer here).

On the other hand, there have also been a handful of cases in which the motions to dismiss have been granted, and at least some courts have seemed skeptical that the target companies financial woes were the result of fraud (about which refer here).

My complete list of subprime and credit crisis-related securities lawsuit settlements, dismissals and dismissal denials can be found here.

Looking Ahead

Even though the litigation wave is about to enter its third year, it is clear that we have still only just begun. With the cases already filed only in their earliest stages and with new lawsuits continuing to pour in, the subprime and credit crisis-related litigation wave is likely to continue to remain an important feature of the litigation landscape for years and years to come.

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The 2008 securities lawsuit filings were dominated by new lawsuits filed against companies in the financial sector, as has been well-documented elsewhere (refer here). But while lawsuits against financial companies were the most prominent feature of the 2008 securities filings, there were also a significant number of lawsuits filed against companies outside the financial sector. In particular, life sciences companies, which historically have experienced a heightened level of securities litigation exposure, suffered a significant level of litigation activity once again in 2008.

For purposes of this post, I am including under the heading "life sciences" companies any company either in SIC Code series 283 (Drugs) or in SIC Code series 384 (Surgical, Medical and Dental Instruments and Supplies). Reasonable minds could differ about whether additional categories should also be included within life sciences companies, but the interests of simplicity and consistency with my own prior analyses support this categorical definition.

A review of the 2008 securities lawsuit filings shows that, notwithstanding the primacy of litigation involving financial companies during the year, heightened securities litigation activity involving life sciences companies continued in 2008.

According to my analyses, during 2008, there were 15 new securities lawsuits filed against companies in the 283 SIC Code series, including nine in the 2834 SIC Code category (Pharmaceutical Preparations). There were also eight securities lawsuits filed against companies in the 384 SIC Code category, including five in the 3845 SIC Code category (Electromedical Apparatus).

The fact that there were 23 new securities lawsuits filed against life sciences companies in 2008 is quite remarkable given the predominance of the credit crisis litigation wave.

The total number of life sciences lawsuits is significant in relative terms as well. By way of comparison to the 23 new securities lawsuits filed against life sciences companies in 2008, there were 21 securities lawsuits filed against life sciences companies in 2007. (My detailed analysis of the 2007 life sciences securities lawsuits can be found here.)

The fact that the number of lawsuits filed against life sciences companies actually increased in 2008 is extraordinary in light of the extent of the surging credit crisis litigation wave.

The 23 securities lawsuits filed against life sciences companies in 2008 represents approximately 10% of the total of 226 new securities lawsuits overall that were filed in 2008, which is comparable to the 12% that life sciences lawsuits represented of 2007 securities lawsuit filings.

That this significant of a percentage of securities litigation activity is unrelated to the credit crisis litigation wave underscores a point I have previously emphasized (for example, here), that while the subprime and credit crisis-related litigation wave is a significant factor driving securities lawsuits filing activity, it is by no means the sole factor.

The lawsuits filed against life sciences companies in 2008 involved a wide variety of allegations. The most common allegation, asserted in five of the lawsuits, is that the defendant company misrepresented the results or progress of one or more of its clinical trials. Lawsuits filed against four companies alleged financial misstatements or improper revenue recognition.

Other lawsuits involved allegations relating to disclosures about product efficacy; manufacturing deficiencies or controls; merger integration issues; misrepresentations about an officer’s credentials; intellectual property concerns; and product commercial viability.

The attributes of these companies that most frequently attract litigation is the combination of their susceptibility to disruptive events and the vulnerability of their share prices. These kinds of setbacks are an almost inevitable attribute of the regulatory and scientific environment in which these companies operate. However, these kinds of risks are also often comprehensively disclosed.

As a result, though life sciences companies are frequently sued, they have not proven to be easy targets. As I noted here and here, lawsuits filed against life sciences companies are frequently dismissed. Nevertheless, life sciences companies continue to attract the unwanted attention of the plaintiffs’ lawyers.

Securities Litigation Survey: Readers interested in securities litigation topics under the year-in- review heading will want to take a look at  the January 2009 memorandum by the Skadden law firm entitled "Securities Litigation 2008 – Noteworthy Decisions" (here). The memorandum does a particularly good job briefly summarizing the eleven decisions discussed as well as identifying the significance of the decisions.

Early Registration Deadline Approaching: The early registration deadline for the C5 D&O Liability Insurance Conference is approaching. The Conference is scheduled to take place March 24 and 25, 2009 in London. As reflected in the program brochure, which can be accessed here, the program has a number of interesting speakers and will be addressing many of the current hot topics in D&O insurance. I will be participating in a panel entitled "Current Litigation Trends in Europe and the US: Are Class Actions on the Horizon?"

The early registration deadline for this conference is February 9, 2009, after which the registration fee becomes considerably more expense.

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The growing problems surrounding option adjustable-rate mortgages (Option ARMs) are a concern I have previously noted (here). But it now appears that the problems may be far worse even than previously feared. These problems not only represent a growing threat to borrowers and lenders alike, but the also present the increasing likelihood for further shareholder litigation.

According to a January 30, 2009 Wall Street Journal article entitled “Option ARMs See Rising Defaults” (here), nearly $750 billion in Option ARMs were issued from 2004 to 2007. Unfortunately, as of December 2008, 28% of Option ARMs were in default or foreclosure, and an additional 7% involved properties that have already been take back by lenders. A chart accompanying the Journal article shows that the Option ARM default rate is already far greater now than was the subprime default rate at the beginning of 2008.

Borrowers holding Option ARM mortgages now find themselves having to play a particularly unattractive hand. In particular, as a result of the way these loans are structured, borrowers that have been paying only the minimum have likely seen their principal amount due increase as a result of so-called “negative amortization.”

At the same time, housing values around the country have declined. The Journal article reports that more than 55% of borrowers with Option ARMs owe more than the current value of their homes.

Think that sounds bad? Things are about to get worse. A lot worse.

As detailed in a lengthy January 4, 2009 post on the Seeking Alpha blog (here), the interest rates on billions of dollars are due to reset in 2009 and 2010. The problems that likely will ensue “are expected to be more pronounced than the subprime crisis since the economy is already nearing its trough, the consumer confidence has slumped to an all time recent history low and financial markets are in a gridlock.”

In explaining why the problems associated with the Option ARM resets could be so bad, the Seeking Alpha blog post goes through a detailed analysis of the timing and likely magnitude of the resets. In explaining the problems that could follow, the author notes:

The potential average payment increase on the loans recast is 63%, representing an additional $1,053 due each month on top of the current average payment of $1,672. These large payment increases could cause delinquencies to increase, and increase dramatically, after the recast. The fact that only 65% of borrowers have elected (or are able) to make only minimum payments underscores the magnitude of the potential problem. The potential payment shock combined with the continuous deteriorating outlook for home prices and lack of refinancing opportunities could be a negative cause of concern for investors in Option ARM securities. Even more ominous, is pall cast upon the banks that hold these assets and are additionally exposed to other forms of consumer credit, ie. HELOCs, credit card debt and other unsecured loans.

As a result of these problems and possibilities, sources quoted in the Journal article estimate that more than half of all option ARMs outstanding will default, and that nearly 61% of options ARMs originated in 2007 will eventually default.

These looming problems not only represent a threat to borrowers, investors and lenders, but they also present the possibility for even further litigation.

Problems arising from Option ARM mortgages have already been the source of considerable securities litigation. The most recent lawsuit involves Triad Guaranty, which provides private mortgage insurance products to residential mortgage lenders and investors in the United States.

As reflected in their January 29, 2009 press release (here), plaintiffs’ attorneys have filed a securities class action lawsuit in the Middle District of North Carolina against Triad and certain of its directors and officers. According to the press release, the complaint (which can be found here), alleges that

beginning in late August 2007 and continuing throughout 2008, Triad began to acknowledge serious issues surrounding its exposure to anticipated losses and defaults related to its book of business for its Alt-A and pay-option adjustable rate mortgage (“ARM”) products written in 2006 and 2007 due to a failure to engage in proper underwriting practices, resulting in a decline in Triad’s stock price. Then, on November 10, 2008, Triad issued its financial results for the third quarter of 2008, reporting a net loss for the quarter ended September 30, 2008 of $160.1 million. On this news, Triad’s stock price dropped $0.11 per share to close at $0.70 per share on November 11, 2008.

The complaint further alleges that the defendants concealed from the investing public that:

(a) the Company was not adequately accounting for its loss reserves in violation of Generally Accepted Accounting Principles, causing its financial results to be materially misstated; (b) the Company failed to engage in proper underwriting practices for its book of business related to insurance written in 2006 and 2007, including the insurance related to its Alt-A and pay-option ARM products; (c) the Company had far greater exposure to anticipated losses and defaults related to its book of business related to insurance written in 2006 and 2007, including its Alt-A and pay-option ARM portfolios, than it had previously disclosed; (d) the Company lacked effective internal controls to detect fraud and misrepresentations in the underwriting process; and (e) the Company failed to disclose the true risks associated with its ability to continue to write new business and, given rating downgrades and capital limitations, the Company would be forced to liquidate its Canadian subsidiary and stop writing new insurance policies and transition the business to run-off.

Even before this recent lawsuit was filed against Triad, there had already been a number of securities lawsuits raising allegations concerning Option ARMs, including for example cases filed against Wachovia (refer here), Washington Mutual (refer here) and Downey Financial (refer here).

All of those prior lawsuits involved either companies that issued the Option ARMs or the issuers’ successors in interest. Triad, by contrast, is not an issuer but rather is a mortgage insurer. Triad’s involvement in a securities lawsuit raising Option ARM-related allegations highlights the potential for extensive further litigation, involving not just the issuers themselves but other types of companies as well.

I have in any event added Triad to my running tally of subprime and credit crisis-related securities litigation, which can be accessed here. With the addition of the Triad lawsuit, the current tally of subprime and credit crisis related securities litigation filed during the period 2007 through 2009 now stands at 150, of which eight have been filed in 2009. A spreadsheet reflecting the 2009 lawsuits can be found here.

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As detailed in a recent post (here), one of the more worrisome trends in an economic environment full of thing to worry about is the increasing number of bank failures involving community banks. This trend continued this past Friday night when the FDIC closed three more banks, brining the 2009 bank closure tally up to six.

The three banks closed on Friday were MagnetBank of Salt Lake City, Utah, which has assets of $292.9 million (and the details about which can be found here); the Suburban Federal Savings Bank of Crofton, Maryland, with assets of $360 million (refer here); and Ocala National Bank of Ocala, Florida, with assets of $223.5 million (refer here).

A particularly troublesome note regarding the Utah bank’s closure is that the FDIC was unable to find a buyer for the bank’s assets or deposits, which the Wall Street Journal described (here) as a “rare event and an ominous sign for regulators.” According to news reports (here), this is the first time in over five years that the FDIC has been unable to find a buyer for a failed bank’s assets. In the absence of a buyer, the FDIC will issue checks to the bank’s depositors, increasing the impact on the FDIC insurance fund.

The failure of the Suburban Federal Savings Bank was the first bank failure in Maryland since 1992. As detailed in the Washington Post (here), the bank’s failure was precipitated by mounting losses in the bank’s mortgage loan portfolio.

Perhaps even more noteworthy than the fact that the total number of bank failures in 2009 is already up to six banks is the fact that the total number of bank failures in the seven month period between July 1, 2008 and January 31, 2009 is 27. (The FDIC’s complete list of failed banks for the period October 2000 through the present can be found here.) That is a huge number and all signs are that these numbers will continue to grow as 2009 progresses. The Journal article specifically observed that regulators are “bracing for dozens of more lenders to collapse in the coming months.”

Along those lines, it is worth noting that in the FDIC’s Quarterly Banking Profile for the Third Quarter of 2008 (here), which is the FDIC’s most recent quarterly profile, the number of institutions on the FDIC’s problem list increased from 117 to 171, and the assets of the “problem institutions” rose from $78.3 billion to $115.6 billion. This is the first time since 1994 that assets from problem institutions have exceeded $100 billion.

The FDIC’s next quarterly banking profile, for the quarter ending December 31, 2008, will not be released until later in February (the reports are issued 55 days after each quarter end). It will be interesting to see how significant the deterioration was in the fourth quarter.

As I detailed in my prior post, both historically and more recently, an increase in the number of failed banks has meant an increase in failed bank litigation. As the bank failures continue to mount, the threat of increased bank related litigation will also continue to grow.

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