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

Most of the cases filed in the subprime and credit crisis-related litigation wave are still in their earliest stages, but as the early returns have trickled in, one recurring question as been how the cases are faring. More than once (refer here for example) I have questioned whether the plaintiffs are doing poorly in dismissal motions in these cases, although more recently plaintiffs do seem to have been doing a little better (refer here and here).

My analysis of the plaintiffs’ success levels has been rather subjective and impressionistic. As an alternative to this unscientific approach, blogger Cliff Shnier on his eponymous blog (here) has applied more arithmetic rigor to the analysis and reached the conclusion that plaintiffs are in fact doing better on dismissal motions in recent months.

Using the data from The D&O Diary’s running tally of credit crisis securities lawsuit dismissal motion rulings, which can be accessed here, and applying the methodology similar to that used by blackjack players to count cards, Shnier has performed a quantitative analysis of the trend in credit crisis cases securities lawsuit dismissal motion rulings.

In order to perform the analysis, Shnier assigned a numeric value to each dismissal motion outcome, ranging from a score of minus one for a dismissal with prejudice to a score of plus one for a denial of a motion to dismiss, with intermediate values assigned for inconclusive outcomes such as dismissals without prejudice. Shnier then arrived at a running count by adding together all of the scores, and plotting the running count on a graph showing how the aggregate score has varied over time.

The resulting graph, shown on the left (a more legible image is linked on Shnier’s blog) shows that beginning in November 2007 and for the following twelve months “the running count started out in the negative numbers,” which is “favorable to defendants.” But the trendline crossed into positive numbers – more favorable to plaintiffs – and has stayed there ever since December 2008. Schnier’s conclusion? The “trendline is moving upward in favor of dismissals being denied.”

Shnier concedes that the outcome of this exercise may reflect the values he has assigned to various outcomes, particularly dismissals without prejudice. But even if more conservative values are assigned to these determinations, the trendline is still favorable to the plaintiffs.

There are of course many ways to analyze a range of case outcomes, and a numerical analysis is just one approach. And in any event, these cases are still mostly in their early stages, so any analysis at this point may be premature. Nevertheless, Schnier’s blackjack counting approach is interesting, and is certainly different, and it may have advantages over more subjective or impressionsitc approaches to the question. It will be interesting to continue to monitor Shnier’s analysis as the credit crisis-related securities cases continue to develop. 

The Infamous “Suzanne Researched This” Commercial (Circa 2006): How a lot of people wound up with more debt than they could afford and living in a house that is too big and beyond their means.

Clusterstock comments (here) that the “the commercial touts the fact that your Century 21 broker will team up with your browbeating wife and guilt you into buying the home you can't afford. It must be watched. We still think it kind of might be a parody.”

If it is a parody, it is a perverse kind of unconscious self-parody. All I know is that the words “You guys can do this” were used far too frequently in that era.

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Relatively few securities lawsuits make it to the U.S. Supreme Court, so for that reason alone it is a noteworthy development that on May 26, 2009, the U.S. Supreme Court granted Merck’s petition for a writ of certiorari in the securities class action lawsuit relating to the company’s disclosures about Vioxx, the pain medication Merck withdrew from commercial distribution in 2004.

The Supreme Court will address the question of what is required to establish "inquiry notice" sufficient to trigger the running of the two-year statute of limitations for private securities lawsuits. As discussed below, the question before the court is likely to produce an opinion that, while likely to be narrow and technical, could nevertheless have a great deal of practical significance for many cases.

Background

The first Vioxx-related securities class action lawsuit was filed on November 6, 2003. (Refer here for a detailed background on the case.) Though Vioxx was not finally withdrawn from commercial distribution until September 2004, the district court granted Merck’s motion to dismiss the consolidated class action based on the statute of limitations, finding that there was sufficient public information available prior to November 6, 2001 to trigger the plaintiffs’ duty to investigate the alleged fraud. A copy of the district court April 12, 2007 opinion can be found here.

On September 9, 2008, the Third Circuit, in an opinion (here) written by Judge Dolores Sloviter, and accompanied by a vigorous dissent from Judge Jane Roth, reversed the district court and concluded that no "storm warnings" of the alleged fraud existed for more than two years prior to the filing of the original complaint.

In order to determine whether or not there was sufficient publicly available information to trigger the statute, the Third Circuit reviewed several categories of information that the district considered to have constituted "storm warnings," including: various studies that raised concerns about Vioxx’s side-effects; an FDA warning letter that publicly criticized Merck for its misleading marketing of Vioxx; several consumer fraud lawsuits that were filed against Merck throughout 2001; and an October 2001 New York Times article that discussed Vioxx testing results and side effects.

Based on its detailed factual review of each of these various categories of information, the Third Circuit concluded that "the District Court acted prematurely in finding that [plaintiffs] were on inquiry notice of the alleged fraud." Among other things, the Third Circuit found it relevant that throughout the period Merck continued to issue reassuring statements that minimized the various public disclosures. The Third Circuit also considered it relevant that Merck’s share price did not react to the various disclosures and that the analysts following Merck did not alter their ratings in response to these developments.

In dissent, Judge Roth stated her view that there various categories of information provided sufficient "storm warnings" to put investors on inquiry notice, regardless whether or not there was any significant change in Merck’s share price or in analysts’ ratings.

The Cert Petition

In its petition for certiorari, Merck argued that the various Circuit courts have issued conflicting opinions on what is required to put a plaintiff on "inquiry notice" sufficient to trigger the running of the statute of limitations. Merck argued that the Third Circuit, together with the Ninth Circuit but in contrast to the other Circuits, had held that "no duty to investigate arises, and the statute of limitations does not begin to run, until the plaintiff receives specific evidence of the elements of its claim without the benefit of any investigation."

Merck argued that as a result of its "more lenient" standard, "the Third Circuit has excused an investor from asking a single question until it has evidence not just of scienter, but of materiality and loss causation as well." Merck contended that the Third Circuit’s standard "runs contrary to the fundamental purpose of inquiry notice – to encourage the timely filing of fraud claims by placing an affirmative burden on plaintiffs to investigate potential claims."

Merck argued that the existence of a split in the circuits on this question not only undermines the goal of the uniform application of the statute of limitations, but it encourages plaintiffs to forum shop, burdens the parties with uncertainty and leaves investors unsure of their obligations.

In their brief in opposition to the writ, the plaintiffs had argued that the Third Circuit had made a very fact intensive determination, and had simply held that on the record there were not sufficient facts to trigger the obligation to investigate potential claims. The plaintiffs argued that the purported split in the circuits pertained only to what a plaintiff must do once the duty to investigate has been triggered, which, plaintiffs contend and the Third Circuit found, had not happened in this case.

On May 26, the U.S. Supreme Court granted the writ, and the case will be argued in the court term that begins in October, possibly with a new Justice on the bench.

Analysis

The possible significance of this case will be even more apparent after the case has been fully briefed and argued, but based on the record so far, I note the following:

First, the court seems to have taken this case based on Merck’s argument that there is a split of authority among the Circuit courts on what it is that puts a securities plaintiff on inquiry notice. Under these circumstances, the likeliest outcome at the Supreme Court level is that the Court will articulate the standard to be applied and then remand the case back to the lower courts for further proceedings. (I am assuming here that it is unlikely that the Third Circuit will not simply be affirmed, because the Supreme Court didn’t have to grant cert in order for the Third Circuit’s ruling to stand.)

This prospect in turn suggests a couple of things to me. The first is that the statute of limitations question in this case likely will be, as it has been up to this point, ultimately be decided on a very fact intensive basis. In addition, it also seems likeliest that the Court will simply choose among one of the existing standards for what triggers inquiry notice, which in turn suggests that it is unlikely that the Supreme Court’s decision in this case will plow any new ground.

Both of these factors suggest strongly that the Supreme Court’s decision will be narrow, precise and technical – as might be expected in a dispute over standards for triggering the statute of limitations.

That said, even if the Supreme Court’s opinion plows no new ground, it could nevertheless have enormous practical significance in at least some individual cases. Depending on how the Court’s decision unfolds, it could answer a number of critical issues that could be outcome determinative in some cases, including the following:

1. In order for plaintiff to be put on "inquiry notice," must the plaintiff be aware of the probability that fraud may have occurred, or merely the possibility that fraud may have occurred?

2. Is the awareness of the probability or possibility alone enough to trigger the statute, or must it also be shown that plaintiffs would have discovered facts sufficient to actually bring suit?

3. What is the relevance to the analysis, if any, of the presence or absence of movement in a company’s stock price or in analysts’ opinions?

4. What is the relevance to the analysis, if any, of reassurances from the Company, and how does that affect the triggering of inquiry notice?

All of that said, though the outcome of this case is likely to be narrow and technical and will likely produce a narrow definition of a technical standard, the decision potentially could have practical significance on questions of the timeliness of many securities lawsuits.

The Gibson Dunn law firm has an interesting May 27, 2009 memo here explaining in detail the contours of the split in authority among the various Circuit courts on the question of what triggers the running of the statute of limitations.

Special thanks to the several readers who send me links to briefs and articles relating to the Supreme Court’s cert grant in this case.

About the Nominee: Speaking of the recent nominee to the U.S. Supreme Court, a May 27, 2009 memo from the While & Williams firm (here) suggests that in insurance coverage cases, Second Circuit Judge Sonia Sotomayor has a track record of ruling in favor of insurers. On the other hand, as the memo also notes, not that many insurance cases actually make it all the way to the Supreme Court. Hat tip to the Point of Law blog (here) for the link to the memo.

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As discussed in a prior post (here), at an April 1, 2009 hearing, Southern District of New York Judge Jed Rakoff had raised concerns that a proposed lead plaintiff’s law firm may have a "blatant, shocking conflict of interest," as a result of free portfolio monitoring services the firm performed for its client, the Iron Workers Local No. 25 Pension Fund. On April 25, 2009, Judge Rakoff entered an order (here) naming the Public Employees’ Retirement System of Mississippi (MissPERS) as lead plaintiff, stating that he would explain his reasons in a forthcoming opinion.

On May 26, 2009, Judge Rakoff entered his opinion (here) explaining his lead plaintiff selection in the case, which involves consolidated lawsuits relating to Merrill Lynch mortgage pass-through certificates. The opinion contains some interesting comments and observations about the two competing plaintiffs and their relations to their counsel

In his opinion, Judge Rakoff explained that because of "problematic relationships" between plaintiffs and their counsel, he was faced with a choice between "two less-than-perfect plaintiffs." He was particularly concerned with the relationship between the Iron Workers Fund and its counsel, because of testimony at the April 1 hearing showing that the Fund had a contractual arrangement with counsel whereby the law firm provided "free monitoring" of the Fund’s portfolio, in exchange for which if the firm recommended that the Fund pursue securities litigation, the firm would be retained on a contingency fee basis.

Judge Rakoff said that this arrangement goes "far beyond any traditional contingency arrangement" and creates a "clear incentive" for the firm to "discover fraud" and to recommend litigation, a practice that "fosters the very tendencies toward lawyer-driven litigation that the PSLRA was designed to curtail."

As the April 1 hearing, Judge Rakoff had questioned whether this arrangement was ethical. Following the hearing, the concerned law firm filed an affidavit from distinguished scholar Geoffrey Hazard, who opined that the arrangement did not create an improper conflict of interest. Among other things, Professor Hazard based his opinion on the conviction (speaking with respect to securities litigation) that plaintiffs’ lawyers had every incentive to proceed only if the claim is reasonably viable. He also noted that in contemporary practice, most plaintiffs are sophisticated and have access to sophisticated advisors.

Judge Rakoff noted that while he has "the very greatest respect" for Professor Hazard, he was not persuaded. First, the Professor’s statements about plaintiffs’ counsel’s incentives to pursue only viable claims are contrary to the concerns of Congress in enacting the PSLRA "regarding abusive lawyer-driven litigation."

And with respect to the supposed sophistication of plaintiffs and their access to sophisticated advisors, Judge Rakoff noted that the Iron Worker’s Fund’s administrator "was not particularly sophisticated in evaluating securities actions" and "only had a rough idea what this lawsuit was all about," and the "sophisticated advisors" on whom the Fund was relying were "the very lawyers who would be bringing suit."

Judge Rakoff concluded that he "need not determine whether there here exists a conflict of interest that violates ethical rules," since it is clear that the Iron Workers Fund is "in no position to adequately monitor the conduct of this complex litigation."

Which is not to say that MissPERS, the lead plaintiff he selected, is "without blemish," since it too relies on portfolio monitors and has very regularly served as a lead plaintiff. However, Judge Rakoff found that MissPERS relies on twelve different monitors, rather than a single monitor, and it employs a group of lawyers to evaluate litigation recommendations and "plainly had a sophisticated knowledge of such matters."

As for the objection that MissPERS was a "professional plaintiff" of the kind the PSLRA disfavors, Judge Rakoff noted that when the alternative plaintiff had little expertise, "the accumulated experience of MissPERS in pursuing multiple securities fraud actions seems a benefit more than a detriment."

In a final footnote, Judge Rakoff raised, but did not address, concerns about Pay-to-Play arrangements that could affect relations between plaintiffs’ firms and elected officials, but he declined to address the issue, which he said was not "presently before the Court in this case."

It is probably worth noting that the strong language Judge Rakoff used at the April 1 hearing has drawn considerable attention in other forums. For example, in a May 5, 2009 hearing before Central District of California Judge Andrew Guilford to determine the lead plaintiff in a case pending there, Judge Guilford noted (here) that because the same law firm was involved in the case before him as in the case before Judge Rakoff, he was "concerned" by Judge Rakoff’s observations at the April 1 hearing, and he noted further that his lead plaintiff "determination will benefit" from the analysis Judge Rakoff was to provide in his then-forthcoming opinion. Clearly, Judge Rakoff’s various statements and rulings could have significance outside the confines of the specific case in which they were delivered. Special thanks to a loyal reader for a copy of the May 5 opinon

On the other hand, it is relevant to note that in another recent lead plaintiff decision by a judge in same courthouse as Judge Rakoff did not consider the monitoring services this particular law firm provided to the lead plaintiff to even be a relevant consideration. In a  May 22, 2009 opinion (here), Southern District of New York Judge Barbara S. Jones rejected arguments that the law firm had a conflict of interest due to the portfolio monitoring servicves it provided to the proposed lead plaintiff. Judge Jones said that "the Court has been shown no reason why this monitoring system causes any issues or impediments to teh firm's representation," noting that the firm "has substantial experience in representing shareholders in securiteis class actions" and that she "believes the firm will serve the class adequately." Special thanks to a loyal reader for a copy of the May 22 opinion.

Andrew Longstreath’s May 27, 2009 Law.com article about Judge Rakoff’s opinion can be found here.

More Problem Banks: In prior posts (most recently here), I noted concerns regarding the increasing number of failed banks, and conjectured that banking closures were likely to continue to accumulate for the foreseeable future, citing the FDIC’s estimates of the number of "problem banks."

In its latest Quarterly Banking Profile, released on May 26, 2009 for the first quarter of 2009 (here), the FDIC increased the number of banks on its "Problem List" from 252 at year end 2008 to 305 as of March 31, 2009, and increased the total assets at problem institutions from $159 billion to $220 billion. (The FDIC does not identify the banks it has designated as "problems" by name.)

To put this increase in context, the number of banks on the Problem List as of the end of the third quarter of 2008 was only 171, and at the end of the second quarter of 2008, the count was only 117. In other words, the number of banks on the Problem List not only increased 21% from year end 2008 to the end of the first quarter 2009, but it has increased 160% in just nine months between the middle of 2008 and the end of the first quarter.

As I have said before, all signs are that the current banking woes are likely to continue for the foreseeable future.

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As governance ratings have become ubiquitous, they have also attracted an increasing about amount of attention, not all of it positive. As I noted in a prior post (here), one academic study questions the "predictive validity" of the governance ratings. A more recent academic study questions the applicability of uniform governance standards to disparate companies.

In any April 2009 paper entitled "Elusive Quest for Global Governance Standards" (here), Harvard Law Professor Lucien Bebchuk and Hebrew University of Jerusalem Professor Assaf Hamdani question whether the effort to establish uniform governance metrics suffers from a "basic shortcoming"; that is, the authors question whether certain corporate arrangements counted as good governance should be considered equally valuable for all companies.

In particular, the authors contend that the value of certain arrangements "depends considerably on companies’ ownership structure" and that "measures that protect outside investors in a company without a controlling shareholder are often irrelevant or even harmful when it comes to investor protection in companies with a controlling shareholder."

In elaborating on this perspective, the authors note that in the U.S. most public companies lack a controlling shareholder, by contrast to companies outside the U.S. that often have a controlling shareholder. Given the absence of a controlling shareholder, "for anyone approaching governance arrangement from a U.S. perspective finds it is natural to assume that the arrangements governing control contests are a key element in the governance of public companies." This kind of bias results in a preference for governance arrangements that, for example, relate to takeovers and proxy fights. However, for companies that have controlling shareholders, "the presence of arrangements providing protection against a hostile takeover or a proxy fight is neither good nor bad, but simply irrelevant."

In view of these differences deriving from this important ownership distinction, certain governance practices, the authors suggest, should be weighed in assessing governance according to whether or not companies have a controlling shareholder.

The authors reviewed the governance rating methodology of three governance rating systems: RiskMetrics’ Corporate Governance Quotient (CGQ); and two measures developed by academics, the Anti-Self-Dealing Index and the Anti-Director-Rights Index. The authors conclude that presumptions built into the measures reflect a "failure" to "properly take into account the relationship between ownership structure and corporate governance," which "substantially undermines the indices’ ability to serve as effective metrics for the quality of the governance at firms or countries worldwide."

The authors are not against the development of governance metrics; as they put it, they "do not question the feasibility of developing a methodology for large-scale governance assessments." Rather they argue that commentators and practitioners should "develop separate systems – one for controlled and one for widely held firms," so that the rating methodology "fits the company’s ownership structure."

The authors’ analysis makes an important contribution for the understanding and use of the now ubiquitous governance measures. In particular, it may be critical for those relying on these measures to understand their limitations in certain contexts. By the same token, it is worth emphasizing that the limitations the authors cite will be most relevant in connection with companies outside the Unites States. The authors apparently do not question the general usefulness of the measures for U.S.-domiciled companies that lack a controlling shareholder (or for that matter, for any company lacking a controlling shareholder).

The more interesting question may be whether or not there are other limitations on the one-size-fits all approach to corporate governance measurement. I have often been concerned that governance metrics applicable to larger companies may not be as applicable to smaller companies, or that governance requirements best suited for mature companies may not be the same as those suited, say, for a developmental stage company. I have also often wondered whether the standards should be applied the same to all companies in all industries.

All of which to me suggests that there could be room for additional research along the lines undertaken in this study, to examine whether or not there may be other ways in which governance metrics should reflect separate methodologies for assessing different categories of companies.

He’s At It Again: Some readers may recall the recent post (here) in which I reported on the lawsuit that purported to be brought on behalf of Bernard Madoff by federal prison inmate Jonathan Lee Riches against Brittney Spears. As reported in a May 23, 2009 article in the Spokane Spokesman-Review (here), Riches has now filed another lawsuit in the Eastern District of Washington seeking an injunction to stop the Guinness Book of World Records from naming him as the person who has filed the most lawsuits in the history of mankind. A copy of Riches’ latest complaint can be found here.

Riches contends that the Guinness Book plans to print false information about him, among other things apparently by undercounting the number of lawsuits Riches claims he has filed. He also objects to the names the Guinness Book intends to call him, including "Johnny Sue-nami," "Sue-per-man," "the Patrick Ewing of Suing" and the "the Lawsuit Zeus." He says that these phrases "hurt my feelings and violates my civil rights."

Riches filed his case in the Eastern District of Washington despite the February 23, 2009 order (here) entered in that court by Judge Justin Quackenbush, in a case in which Riches had sued the Peanut Corporation of America claiming to have been poisoned with Salmonella-tainted peanut butter. In the order, Judge Quackenbush had admonished Riches that his "ability to file future cases in this court will be enjoined" if Riches continue to filed cases that fail to state a claim or that are "deemed frivolous or malicious."

Among other things, in his latest lawsuit, Riches claims that the Guinness Book has "no right to publish my work, my legal masterpieces." Riches prior lawsuit targets include among others Somali pirates, Plato, Nostradamus, George Bush and New England Patriots Coach Bill Belichick. (Riches undoubtedly filed the Belichick lawsuit to prove that not all of his lawsuits are frivolous.) In his latest complaint, Riches says he has also sued Black History Month, the president of Iran and butter substitute "I Can’t Believe It’s Not Butter!"

Riches also asserts that "when I get out of prison, I’m going to start a Lawsuit 101 shop and teach Americans how to file pro se lawsuits." He also said "I will sell Jonathan Lee Riches T-shirts" saying "Watch out what you do, or I’ll sue you."

Hat tip to the Overlawyered blog (here) for the link to the Spokane Spokesman-Record article.

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Many of the subprime and credit crisis related securities lawsuits, particularly those filed in early in the subprime meltdown, involve subprime mortgage originators and financial institutions that pooled the mortgages into investment securities. A separate category of litigation distinct from that relating to originators and securitizers involves the companies that purchased the investment securities and that are alleged to have misrepresented the value of these assets on their balance sheet.

One company whose balance sheet exposure to toxic subprime mortgage backed assets resulting in securities litigation is the international money transfer and payment company MoneyGram International. Background regarding the MoneyGram securities lawsuit can be found here.

On May 20, 2009, District of Minnesota Judge David Doty issued a detailed opinion (here) substantially denying defendants’ motion to dismiss the plaintiff’s consolidated complaint in the MoneyGram case. Because many of the other credit crisis-related securities lawsuits contain allegations similar to the balance sheet toxic asset exposure allegations in the MoneyGram case, and because the parties’ arguments in the MoneyGram case reflect the battle lines that are likely to be drawn in many of these cases, Judge Doty’s opinion represents an interesting and potentially significant examination of the issues that may well recur in other cases.

Background

MoneyGram’s global payment and money transfer business requires the company to hold, transfer or to guarantee payments of large amounts of cash. To secure these payments and guarantees, MoneyGram maintains an investment portfolio. At the beginning of the class period in January 2007, the majority of MoneyGram’s $5.85 billion portfolio was held in asset-backed securities, mortgage-backed securities and collateralized debt obligations, backed in part by residential mortgages.

By the end of the class period in January 2008, the value of the portfolio had significantly deteriorated. In order to be able to maintain adequate capital, the company entered a substantial financing transaction that forced the company to recognize over $1 billion in losses in its investment portfolio. The company’s share price declined nearly 50%, and securities litigation ensued.

The consolidated complaint alleges that during the class period, the defendants made a series of misleading statements regarding the composition, valuation and quality of the company’s investment portfolio, and about its investment valuation processes, standards and controls.

The May 20 Opinion

Judge Doty’s May 20 opinion undertakes a detailed and painstaking review of all of the parties’ arguments. However, after having detailed the parties’ positions, he then in a few efficient paragraphs reduces the parties’ positions to two "competing narratives," as reflected on pages 67-68 of the opinion.

The "defendants’ narrative," Judge Doty writes, "maintains that at the beginning of the class period the eventual scope of the market failure was unforeseeable," but as 2007 progressed and the market decline became apparent, "defendants maintain that they proactively disclosed additional sufficient details" about the investment portfolio and its susceptibility to further declines.

The defendants further assert that their "increased recognition of unrealized losses and [other than temporarily impaired] securities accurately tracked the actual market decline." They also allege that they "made disclosures in good faith as reflected by the absence of insider trading allegations and financial restatements," and therefore they argue it is "improper to impose liability for failure to presage the nation’s worst economic meltdown in decades."

The "plaintiff’s narrative," on the other hand, argues that by the beginning of the class period "external ‘red flags’ reflecting the failure of the subprime and Alt-A markets were so apparent that defendants knew or should have know" that the investment assets were substantially impaired and could not be reliably priced. Moreover, the plaintiffs contend, the defendants "selectively and misleadingly released information about the investment portfolio," misleading investors into believing that the general market decline did not threaten MoneyGram.

In the meantime, the plaintiff alleges, the defendants were exploring bankruptcy and recapitalization options that were not revealed to the investing public, and rejected buyout overtures "to prevent revelation of [the company’s] financial problems." The plaintiffs allege that the defendants failed to disclose these problems "for fear of the market’s reaction."

Judge Doty found that "despite the shortcomings of some of lead plaintiff’s additional allegations of scienter," considering all of the circumstances "and with particular emphasis on the alleged misrepresentations and omissions, a reasonable person could find lead plaintiff’s fraud narrative to be cogent and at least as plausible as defendants’ opposing fraud narrative."

In finding that the plaintiff adequately alleged that the defendants had made material misrepresentations or omission, Judge Doty found that "the complaint connects the external ‘red flags’ with the defendants’ internal recognition of the effect of those flags," without which connection the allegations "would fail as prohibited hindsight claims." The complaint does not merely assert that "later disclosures should have been made earlier or that later-determined facts show that earlier statements were false," but rather allege why the statements may have been false when made or the omission should have been made earlier in light of the then-existing facts. Therefore, although "extensive, repetitive and occasionally abstruse," the complaint adequately alleges the existence of material misrepresentations.

Judge Doty concluded that the complaint’s allegations were sufficient to survive the motion to dismiss, except as to one individual defendant.

Analysis

In many ways, Judge Doty’s succinct presentation of the two competing narratives recapitulates the arguments that likely will be raised in many of the toxic asset balance sheet valuation securities cases that have been filed. The defendants will contend, as did the defendants in the MoneyGram case, that the plaintiffs’ allegations are simply fraud by hindsight, depending on later asset valuation declines or losses as supposed evidence of prior disclosure shortcomings.

Judge Doty’s opinion shows that in at least some instances plaintiffs will be able to overcome the fraud by hindsight "narrative." Significantly, Judge Doty found the plaintiffs’ narrative to be at least as compelling as the defendants, even in the absence of insider trading or a restatement.

To be sure, many aspects of Judge Doty’s ruling depend on specific allegations particular to this case. In particular, Judge Doty’s ruling on the scienter issue depended, for example, on allegations relative to a specific communication company officials had with an institutional investor in which defendants refused to disclose details of the company’s portfolio for fear the disclosures would be "disruptive," and on allegations that, contrary to the company’s public statements, the company’s securities were not of a higher quality and different vintage than those being downgraded by rating agencies.

Nevertheless, while Judge Doty’s ruling undeniably depended on factors specific to the case, the opinion does demonstrate that "fraud by hindsight" defenses may be overcome, a suggestion that is likely to hearten the plaintiffs in other cases. What seemed to matter, and what will likely matter in other cases involving toxic asset valuation disclosures, is not whether or not the company’s losses were greater than those of other companies, but rather what the company said or failed to say about its losses as they accumulated, as well as about the company’s exposure to losses before they occurred.

I have added the MoneyGram decision to my table of subprime and credit crisis settlements, dismissal and dismissal motion denials, which can be accessed here.

Securities Litigation and the Foreseeability of the Housing Decline: One of the critical issues imbedded in the MoneyGram case, and in many of the other cases in which plaintiffs seek to recover investment losses related to the subprime meltdown, is "the extent to which the downturn in the housing market and the resulting financial institutions’ writedowns and losses on securities with substantial real estate exposure was foreseeable earlier in time."

This question is examined in a May 6, 2009 paper entitled "Securities Litigation and the Housing Market Downturn" (here) written by Harvard Law Professor Allen Farrell and Atanu Saha of Compass Lexecon. The authors examined the question of foreseeability of the housing downturn (and related investment decline) beginning in 2006, as that is when the vast majority of class periods in the current wave of securities lawsuits begin, even though the bulk of the subprime investment writedowns took place in the fourth quarter of 2007 and the first quarter of 2008.

The authors posit that in order for disclosures prior to the massive writedowns to be actionable the possibility of these writedowns occurring had to be foreseeable. A company’s failure to disclose its exposure to certain asset valuation risks, or to create reserves for future losses on those assets, would be relevant only to extent it was foreseeable at the time of the disclosure that the valuation of the assets would decline. By the same token, the scienter element can only be established of senior managers’ actions were reckless in light of the foreseeable risks that the asset valuations would decline.

Based on their detailed review of housing price and interest rate data, the authors conclude that "there is little indication that the market was anticipating during the course of 2007 the serious market downturn that in fact occurred in the fourth quarter of that year." The authors conclude that "the evidence is consistent with the proposition that the serious housing market downturn was not generally foreseeable and was not foreseen by sophisticated market participants prior to the fourth quarter of 2007."

The authors’ paper provides substantial grist for the mill for litigants seeking to contend that class action plaintiffs’ securities lawsuit allegations constitute fraud by hindsight. Defendants can hardly be held liability for failing to anticipate or failing to disclose the risks of circumstances that not only were not foreseen but that were not foreseeable.

Unfortunately for defendants in these cases, these arguments may be unavailing. Very few of these cases ever go to trial; for most cases, the most critical stage is the determination of the dismissal motion. At the motion to dismiss stage, the plaintiffs’ allegations must be taken as true and the extensive factual data of the kind on which the authors rely is not considered or even relevant.

The presumption at the motion to dismiss stage that the plaintiffs’ allegations are true permits them to posit circumstances that might later prove to be demonstrably untrue. The authors’ paper may well establish that plaintiffs could struggle to prevail were they ever put to their proof. However, the name of the game for the plaintiffs is usually just to get past the dismissal motions, with the assumption that the case will settle long before the allegations are tested. It may not matter what the plaintiffs ultimately might be able to prove about forseeability; they are concerned rather only with what they can allege.

Special thanks to Kelly Rehyer for forwarding a link to the article.

A Reliable List of Tweeters: Within the world of Twitter are a few worthwhile notes dispersed in a deluge of noise. Filtering the notes from the noise requires identifying the tweeters worth following, a process that can be hit or miss. Fortunately, for those who want to identify reliable Twitter sources on securities litigation issues, Bruce Carton of the Securities Docket has developed a comprehensive list of the "15 People All Securities and Corporate Litigators Should Follow on Twitter" (here).

I commend Bruce’s list – I already follow everyone on Bruce’s list, and so I know it to be trustworthy and complete. Very special thanks to Bruce for including me in the company of illustrious tweeters.

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Amidst the current wave of credit crisis-related securities lawsuits have been a noteworthy number of cases involving various classes of subordinated or preferred securities investors, as I previously noted here. In particular, and just in the past several weeks, plaintiffs’ lawyers have filed several securities class action lawsuits involving banks’ "trust preferred securities." As discussed below, these hybrid securities have particular characteristics that make them particularly sensitive to the current financial turmoil, which, in turn, suggest that there could be further litigation ahead involving these securities.

Background

Trust preferred securities are hybrid securities that have characteristics of both equity and debt. Although any corporation could issue these securities, they have most popular with bank holding companies, due to a 1996 Federal Reserve Board opinion allowing the proceeds of a trust preferred offering to be treated as "Tier I" capital by the bank holding company. Under these Fed guidelines, up to 25% of a bank’s Tier I capital may be from funds raised through trust preferred securities offerings.

In anticipation of a trust preferred securities offering, the bank holding company creates a wholly-owned subsidiary organized as a trust. The holding company issues debt to the trust and the trust in turn issues securities to investors through an initial public offering. The holding company’s debt is the trust’s sole asset. In many instances, the trust preferred securities are traded on the public securities exchanges, with their own ticker symbol. The proceeds of the offering are transferred from the trust to the holding company, where the proceeds are treated as capital on the holding company’s balance sheet.

The advantage to the holding company from this transaction structure, in addition to the ability to reflect the transaction proceeds as regulatory capital, is that the holding company’s interest payments on the debt issued to the trust are tax deductible (unlike dividends on conventional preferred shares, which would come out of after-tax income).

Further background regarding trust preferred securities can be found here and here.

In recent years, these kinds of offerings were a popular way for bank holding companies to raise regulatory capital. According to a recent publication from the Federal Reserve Bank of Philadelphia (here), at the end of 2008, over 1,400 bank holding companies had approximately $148.8 billion in trust preferred securities outstanding. However, during 2008, there were relatively fewer of these offerings, as the market for these kinds of offerings "essentially dried up" due to "disruptions in the credit market."

Trust preferred securities offerings were an effective way for bank holding companies to bolster their regulatory capital when their financial performance was strong. However, when the holding company’s financial condition deteriorates and its regulatory capital declines, then, according to the Philadelphia Fed article, limitations the percentage of trust preferred securities that may be counted in regulatory capital and the restrictive covenants on the debt obligation "further exacerbate the institution’s financial problems and raise supervisory concerns."

In addition, concerns that the holding companies are more likely to defer interest payments on the securities as the economic crisis continues have resulted in ratings downgrades for the securities and significant declines in the valuation of the securities as well.

The Litigation

Given the combination of circumstances, it is hardly surprising that litigation involving these trust preferred securities has begun to appear. Just in the past few weeks, there have been several securities class action lawsuits brought on behalf of trust preferred securities investors who purchased their shares in the initial public offering of the securities.

For example, on May 4, 2009, a purported class action lawsuit was brought in the Northern District of Georgia on behalf of persons who purchased SunTrust Capital IX 7.875% Trust Preferred Securities of SunTrust Banks, in connection with the February 2008 initial public offering of the securities. The complaint (here) names as defendants SunTrust Banks; the trust itself; certain directors and officers of SunTrust; the offering underwriters; and PricewaterhouseCoopers.

The complaint alleges that there were material misrepresentations and omission in the offering documents in violation of the liability provisions of the ’33 Act. Among other things, the complaint alleges that:

(a) The Company's assets, including loans and mortgage-related securities were impaired to a greater extent than the Company had disclosed; (b) Defendants failed to properly record losses for impaired assets; (c) The Company's internal controls were inadequate to prevent the Company from improperly reporting its impaired assets; and (d) The Company's capital base was not as well capitalized as it had represented.

Other recent actions involving trust preferred securities include the action brought on April 1, 2009 involving Regions Financial Corporation’s 8.875% Trust Preferred Securities of Regions Financing Capital Trust III, which issued securities in an April 2008 offering. Background regarding the case can be found here.

Three different recent securities lawsuits target separate trust preferred offerings involving Deutsche Bank. These filings involve actions commenced on February 24, 2009 (refer here); March 19, 2009 (refer here) and March 30, 2009 (refer here). Each of these actions relate to separate trust preferred securities offerings sponsored by Deutsche Bank.

Each of these cases are brought under the ’33 Act, and each names as defendants the bank holding company, the trust, the holding company’s directors and officers, the offering underwriters, and in many cases the auditor. Each of cases raises factual allegations similar to those raised in the SunTrust case.

Subject to the possible constraint noted below, it seems likely that there will be more of these kinds of lawsuits ahead. The trust preferred securities, which were offered to investors under different economic circumstances, are now beaten down as a result of the current financial turmoil. Each of the hundreds of separate offerings involved a distinct and discrete class of investors, which in turn gives plaintiffs’ lawyers a series of separate points of access from which to target specific troubled financial institutions, as the multiple separate lawsuits against Deutsche Bank demonstrate.

Each of the offering also affords a separate potential opportunity to assert claims under the ’33 Act. Bringing an action under the ’33 Act, rather than under the ’34 Act, avoids the need to satisfy the heightened standards for pleading scienter. In addition, the issuing entity is "strictly liable" under the ’33 Act for material misrepresentations and omissions.

The ’33 Act’s relatively short one year/three year statute of limitations (refer here) may provide some constraint on the offerings that plaintiffs’ lawyers might now attempt to target. On the other hand, the looming time limitations may simply spur a host of filings before time expires.

One final note is that the litigation possibilities arising from problems surrounding these securities are not limited just to the bank holding companies that initiated the trust preferred securities transactions. Investors who suffered losses because of interest payment defaults on trust preferred securities have also been hit with lawsuits. For example, the securities class action filed against RAIT Financial Trust (about which refer here) arose after American Home Mortgage defaulted on its trust preferred securities interest payments obligations, which meant the loss to RAIT of $95 million in revenue.

Investors alleged that RAIT had failed to disclose its exposure to American Home and to adequately reserve against the possibility of American Home’s nonpayment. As noted here, on December 22, 2008, the court granted in part and denied in part defendants’ motion to dismiss the RAIT plaintiffs’ complaint.

Shareholders Win Japanese Class Action: According to news reports (here), on May 21, 2009, shareholder plaintiffs won a 7.6 billion yen ($81 million) securities class action verdict against Takafume Horie, the founder of failed Internet company Livedoor, and other Livedoor executives. 3,340 individual and corporate shareholders had brought the action, which alleged that the defendants "used stock swaps and other dubious maneuvers to pad Livedoor's books and inflate its share price."

Horie (who is popularly known as "Horiemon") is out on bail while he appeals his criminal conviction for securities fraud. Background regarding the fraud allegations can be found here.

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In an earlier post (here) in which I raised the question whether lawyers would find themselves the targets of gatekeeper blame from the subprime meltdown, I discussed a malpractice action that had been brought against the Cadwalader law firm by Nomura Securities, in connection with a commercial mortgage securitization transaction in which Cadwalader had acted as counsel.

According to Susan Beck’s May 21, 2009 Law.com article (here), Nomura’s lawsuit has survived Cadwalader’s motion to dismiss. As the article notes, the "backstory" on this case "is complicated." Cadwalader had been Nomura’s counsel in connection with the securitization. After one of the underlying commercial mortgages defaulted, LaSalle National Bank, the loan servicer, had sued Nomura. Nomura settled the LaSalle case for $67.5 million and then sued Cadwalader for malpractice in connection with the securitization documentation.

In his April 28, 2009 opinion (here) denying Cadwalader’s motion to dismiss, New York Superior Court Judge Melvin L. Schweitzer ruled that Nomura’s position in the LaSalle case that Cadwalader’s actions were proper did not preclude Nomura’s claims in the malpractice action, and that Cadwalader’s reliance on standard language from a Standard & Poor’s publication did not create a defense for a motion to dismiss.

Though the underlying securitization is from an era long ago (the transaction took place in 1997), the attempt to impose gatekeeper liability on the law firm raises the possibility that lawyers may find themselves among the targets in connection with more recent securitization transactions. The Nomura lawsuit’s survival of the initial motion to dismiss, though for reasons very specific to the particular case, may motivate other erstwhile plaintiffs to consider the possibility of targeting the transaction attorneys involved in the many securitizations now the subject of extensive litigation.

If the Nomura case is any indication, aggrieved parties may well attempt to seize on purported defects in the securitization documents to attempt to target the law firms that drafted the documents. To the extent law firms' clients and former clients are compelled to pay investor losses on securities they sold to investors, the clients and former clients may attempt to shift those losses to the lawyers that drafted the securitization documents.

Interestingly, according to the Law.com article, the attorney that initiated the Nomura lawsuit was none other than Marc Dreier, who recently pled guilty to a series of criminal actions that may be even harder to believe than they are to summarize. The Nomura case is being carried forward by two attorneys from Drier’s former law firm.

Florda Bank Becomes Larges Bank to Fail This Year:  In a rare Thurday night regulatory action, on May 21, 2009, BankUnited FSB became the thirty-fourth bank failure so far this year when regulators took control of the bank and sold its assets to a group of investors. According to news reports (here), the BankUnited closure is also the biggest bank failure so far this year. The failed bank had assets of $12.80 billion.

According to the Wall Street Journal (here), BankUnited's woes were due in part to its significant exposure to "nonresident alien" mortigage, which foreign domiciled individuals (primarily in Latin America) used the loans to acquire Flordia residential properties.

The DealBook blog has a lengthy description (here) of the private equity process that resulted in the transfer of BankUnited's assets.

In connection with prior bank closures this year, the FDIC had waited until after the close of business at the end of the week on Friday afternoon to announce its regulatory action. The FDIC’s Thursday afternoon action on BankUnited breaks this otherwise consistent pattern. Perhaps the banking regulators wanted to get ahead to allow them to get an early start on the upcoming holiday weekend.

The FDIC’s press release regarding the closure can be found here and additional background information from the FDIC can be found here. The FDIC’s complete list of failed banks can be found here. A helpful Wall Street Journal table regarding the recent bank closures can be found here.

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In prior posts (most recently here), I have noted the continuing litigation efforts of institutional investors excluded from the various auction rate securities regulatory settlements to try to compel their broker-dealers to buy back the investors’ ARS. In a complaint filed on May 13, 2009 in the Southern District of New York by Monster Worldwide against RBC Capital Markets (here), Monster raises the novel theory that RBC’s settlement-related offer to repurchase ARS from "eligible investors"is a "tender offer" that RBC must extend to all investors -- including institutional investors like Monster.

Between May 2007 and February 2008, Monster acquired $71.6 million of student loan backed ARS from RBC that Monster was left holding when the ARS market collapsed. In October 2008, RBC entered a regulatory settlement in which it agreed repurchase ARS from "its individual customers, charities, non-profits and government entities with less than $25 million on deposit." Pursuant to this arrangement, RBC will repurchase more than $850 million in ARS from "eligible investors." News reports regarding the regulatory settlement can be found here.

On December 1, 2008, RBC initiated an offer pursuant to the settlement to repurchase the ARS from eligible investors. Monster characterizes this repurchase offer in its complaint as a "tender offer," which offer was not extended to Monster and other institutional investors.

In its complaint, Monster describes its exclusion from RBC’s regulatory settlement as "arbitrary and unlawful," and alleges that RBC’s limitation of the "tender offer" only to "eligible investors" as a "clear violation" of Section 14(d) of the Exchange Act, giving rise to a claim for relief.

Monster also alleges that the repurchase offer violates SEC Rule 14d-10(a)1, the "All Holders" Rule, which provides that "No bidder shall make a tender offer unless … The tender offer is open to all security holders of the class of securities subject to the tender offer."

Finally, Monster alleges violations of the securities laws and common law in connection with RBC’s representations regarding the ARS.

Monster’s "tender offer" theory is unique and creative. By characterizing RBC’s repurchase offer, Monster seeks to secure for itself the benefit of a settlement from which it was excluded. The court will be challenged in addressing these allegations, because were the court to accept Monster’s theory, the floodgates could be opened for investors excluded from the other regulatory settlements to seek to bring themselves within the repurchase requirements. The critical question will be whether or note Monster is able to sustain its theory that RBC’s repurchase offer pursuant to the settlement is in fact a tender offer. This case will be very interesting to watch.

Special thanks to Thom Weidlich of Bloomberg for providing a copy of the Monster complaint.

Apologies: I would like to extend my deepest apologies to all readers who have experienced difficulties trying to access The D&O Diary over the last couple of days. A series of extended service outages at the blog’s hosting service has interrupted access to the site. I sincerely hope that these extremely annoying and frustrating service outages will not recur.

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Regular readers know that a recurring theme on this blog is the increasing prevalence of civil litigation following on in the wake of FCPA enforcement actions (refer for example here.) In the latest example of the phenomenon, on May 14, 2009, the Policemen and Firemen Retirement System of the City of Detroit has filed a derivative lawsuit in Texas (Harris County) District Court against Halliburton Company and KBR as nominal defendants, and against the companies’ present and former directors and officers, to recover civil damages, inter alia, in connection with the companies’ recent high-profile FCPA enforcement settlements.

By way of background, and as reflected here, on February 11, 2009, KBR and Halliburton agreed to pay $177 million in disgorgement in connection with SEC charges that KBR subsidiary Kelly Brown & Root LLC bribed Nigerian officials over a 10-year period in violation of the FCPA. In addition, Kelly Brown & Root agreed to pay $402 million to settle parallel criminal charges. Halliburton’s press release regarding the settlement can be found here.

The recently filed Texas civil action seeks "to hold Defendants responsible for the reign of terror their reckless failure to monitor the Companies’ internal controls permitted to take place at the Companies."

The plaintiffs’ Petition alleges that "the Companies were permitted to engage in conduct so notorious that the name ‘Halliburton’ has become virtually synonymous with corruption, just as Enron became the poster-child for fraud."

The complaint further alleges that KBR and its employees and agents "engaged in a course of conduct that includes bribery, gang rape, human trafficking, illegal operations in Iran, mishandling of toxic materials, and systemic overbilling."

The plaintiffs allege that the defendants were either complicit with or lacked oversight over these actions.

The increasing likelihood of civil litigation following on after an FCPA enforcement action, of which the new Texas lawsuit is but one example, represents a growing liability exposure for directors and officers of public companies and for their insurers. The fines and penalties in the underlying enforcement action would not be covered under the typical D&O insurance policy, although many of the costs of defending against allegations could well be covered. However, the costs of defense and in all likelihood any settlement of the follow-on civil litigation would be covered under most D&O policies. As a result, as I have discussed in prior posts, these kinds of lawsuits could represent a growing area of exposure for D&O insurers.

An AmLaw.com article regarding the lawsuit can be found here. A May 15, 2009 Bloomberg article regarding the lawsuit can be found here.

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In a pair of separate rulings late last week, district court judges took on the plaintiffs’ allegations in a couple of high profile lawsuits arising out of the subprime meltdown. The courts’ rulings make it clear that the plaintiffs’ allegations in these cases will be highly scrutinized, but that (in one of the two cases) the judicial hurdles are not entirely insurmountable.

First, in a May 15, 2009 ruling in the Washington Mutual Securities Class Action, Western District of Washington Judge Marsha Pechman granted the defendants’ motions to dismiss with respect to the plaintiffs’ ‘34 Act allegations, with leave to amend. She also granted the motion with respect to certain of the plaintiffs’ ’33 Act allegations, also with leave to amend, but she denied the motions to dismiss with respect to the plaintiffs’ ’33 Act allegations concerning the company’s October 2007 securities offering.

In granting the motions with respect to the ’34 claims, Judge Pechman was sharply critical of the clarity and organization of the plaintiffs’ consolidated class action complaint. She characterized the complaint as “verbose and disordered” and states that the plaintiffs’ allegations concerning the elements of the claim are “spread disjointedly” throughout the complaint, as a result of which the complaint “never offers a cohesive presentation of the required elements for securities fraud for each defendant.” Judge Pechman refers to the complaint as embodying “puzzle pleading.”

The opinion recounts that two days prior to oral argument on the dismissal motions, Judge Pechman had directed plaintiffs’ counsel to address the alleged misleading statements of each of the defendants and to connect the statement to the allegations allegedly showing that the defendant knew the statements were false. At the hearing, the opinion recounts, plaintiffs’ counsel “indicated that the relevant allegations were too numerous to identify even in three hours of argument.”

This response to her concerns clearly raised Judge Pechman’s ire; she said that she “remains mystified at counsel’s failure to allege cohesive claims, submit helpful briefing or prepare a response to the Court’s inquiry in advance of oral argument.” She added that counsel “cannot expect the Court to engage in the necessary analysis when counsel is not prepared to do so.” She added that if counsel is “unable to rectify the problems identified in this Order when they file the amended Complaint, the Court may be obligated to review whether counsel can adequately represent the proposed class.”

Given the attention-grabbing nature of Judge Pechman’s rebuke on the plaintiffs’ ’34 Act allegations, it might easily be overlooked that she denied the defendants’ motion to dismiss regarding plaintiffs’ ’33 Act claims relating to the company’s October 2007 securities offering. Judge Pechman specifically found that plaintiffs’ allegations with respect to the October 2007 offering were sufficient.

However, Judge Pechman granted the defendants’ motions to dismiss as to the company’s three offerings in August 2006, September 2006 and December 2007, because the plaintiff class lacked standing with respect to those offerings. The court allowed the plaintiffs’ leave to name additional plaintiffs to obtain standing as to the three other offerings. The court deferred consideration of the plaintiffs’ allegations with respect to these three offerings awaiting the plaintiffs’ efforts to establish standing. The court’s rulings with respect to the October 2007 offering raises the prospect that if the plaintiffs are able to establish standing, their ’33 Act allegations regarding these other offerings may also survive.

Though plaintiffs’ counsel cannot be happy with their rough treatment in Judge Pechman’s order, at least a portion of their complaint survive the motion to dismiss, and they now have the opportunity to try to amend the complaint to address the court’s concerns.

I have in any event added the May 15 ruling in the WaMu case to my table of subprime and credit crisis related dismissal motions grants and denials, which can be accessed here.

Andrew Longstreth’s May 18, 2009 Law.com article regaring the WaMu decision can be found here.

Cleveland Subprime Nuisance Case Dismissed: In a decision also dated May 15, 2009, Northern District of Ohio Judge Sara Lioi granted the defendants’ motion to dismiss in a case in which the City of Cleveland sought to hold 21 investment banks liable under Ohio nuisance law in connection with the banks’ securitization of subprime mortgages. The complaint alleged that the banks (which had not originated the mortgages) had facilitated the making of loans to subprime borrowers who could not afford the debt. After the borrowers defaulted, the lenders foreclosed. The city sought to hold the banks liable for its burdens and costs in maintaining the foreclosed properties.

My prior post criticizing the City of Cleveland for filing the lawsuit can be found here.

Judge Lioi granted the defendants motions to dismiss on four grounds: that the claims were preempted by Ohio law regulating mortgage lending; that the claim was barred by the “economic loss rule”; that the allegations failed to demonstrate that securitizing subprime loans constituted an “unreasonable interference with a public right”; and that the allegations were not sufficient to satisfy causation requirements – that is, the securitizers’ conduct had caused the City’s problems.

The opinion is interesting in a number of respect, perhaps first and foremost in connection with Judge Lioi’s holding that the securitizers’ conduct could not be deemed a public nuisance because the City had not alleged that the defendants had violated any laws. In reaching this conclusion, Judge Lioi extensively reviewed the panoply of governmental laws and regulations regarding mortgages, which she said were “specifically aimed at encouraging lending to traditionally underserved segments of the population.” From this Judge Lioi discerned a “picture” of “express governmental encouragement of the type of lending that forms the basis of the City’s claim.”

In holding that the banks can’t be liable for conduct that not only is not illegal but that the government expressly encouraged, Judge Lioi may implicitly be suggesting the true source of the City’s woes. It was, after all, governmental policy, for these kinds of loans to be made.

Judge Lioi’s extensive review (at pages 32 and 33 of the opinion) of the myriad of intervening causes that led to the City’s very real problems emphatically underscores the essentially foolishness of trying to hold the investment banks liable for the problems the City is facing because of its heavy load of foreclosed properties. As Judge Lioi observed, the “confluence of events certainly was no small problem given the large volume of foreclosures in Cleveland and the city’s budgetary constraints but under no circumstance can it be described as having been directly caused by Defendants’ conduct.”

A May 15, 2009 memorandum from the Skadden law firm analyzing Judge Lioi’s opinion can be found here. Plaintiffs’ counsel reportedly already has filed a notice of appeal.

Special thanks to Robert Rapp of the Calfee Halter law firm for providing a copy of Judge Lioi’s opinion.

Update: Readers may recall my recent post (here) about the questions surrounding the $9.3 million that was unaccounted for from the settlement of a settlement class action lawsuit. One of the plaintiffs’ lawyer, Gene Cauley, had asserted his rights under the Fifth Amendment at a April 20, 2009 hearing at which the court sought to establish the whereabouts of the money.

In a May 18, 2009 post (here), the WSJ.com blog reports that Cauley has now agreed to plead guilty to criminal charges and has also submitted a filing to the Arkansas Supreme Court in which he has agree to give up his law license. Unfortunately, the money itself is not yet accounted for, and according to statements of Cauley’s attorney cited in the blog post, may prove difficult to recover. 

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As the early returns have slowly accumulated for the subprime and credit crisis-related securities lawsuits, the question has arisen (refer here for example) whether or not these cases are faring poorly, in light of the numerous dismissal motions that have been granted thus far. Many of these dismissals have been granted, however, with leave to amend. And now at least one case in which a dismissal was granted with leave amend has survived a renewed motion to dismiss, suggesting that at least in the cases where dismissals were granted with leave to amend, it may be premature to write off the plaintiffs’ prospects.

As noted in a prior post (here), on December 11, 2008, Southern District of Florida Judge Ursula Ungaro granted defendants’ motion to dismiss, with leave to amend, in the BankAtlantic Bancorp subprime-related securities class action lawsuit. Judge Ungaro granted the motion on the ground that the plaintiff’s complaint failed to plead facts giving rise to a strong inference that the defendants acted with scienter in making the alleged misrepresentations and omissions.

On January 12, 2009, the plaintiff filed a first amended consolidated complaint (here), and the defendants’ renewed their motion to dismiss.

In a May 11, 2009 ruling (here), Judge Ungaro found that the amended complaint "cures the most pertinent deficiencies" that she had found in the earlier complaint. Thus, whereas the earlier complaint relied on confidential witnesses "about whom the Court knew nothing," and on allegations that were "vague and [that] failed to show what each of the individual defendants’ knew," Judge Ungaro found that the amended complaint "contains sufficient information regarding these confidential witnesses, including their employment duties, whether they were employed during the Class Period, and how they obtained direct knowledge of the facts they were reporting."

Judge Ungaro further found that the amended complaint "clearly states" how the individual defendants were reckless in not knowing the alleged misrepresentations regarding the bank’s lending practices.

Judge Ungar considered the defendants’ arguments for the court to consider competing inferences that might be drawn from the plaintiff’s allegations. Noting that the inferences of scienter "need not be irrefutable," she found that the facts alleged gave rise to a strong inference of scienter because the amended complaint "includes specific facts demonstrating that [the defendants] knew or were severely reckless in not knowing of the Company’s risk exposure, which was greater than they disclosed to investors."
 

With respect to defendants’ argument that the bank’s woes were due to the "deterioration in the real estate market," Judge Ungar said "whether or not Defendants’ alternative causation theory bars Plaintiff’s claim for damages is a question for another day."

Noting that the "pleading requirements under the PSLRA are stringent but are not insurmountable," Judge Ungaro concluded that plaintiffs had sufficiently alleged that the Defendants were "extremely reckless" in the company’s disclosure about the bank’s commercial loans, and so defendants’ renewed motion to dismiss was denied.

The amended complaint’s survival is most significant because it comes after the initial motion to dismiss had been granted, raising the possibility that even if the plaintiffs whose original complaints fails to survive dismissal motions may yet be able to file an amended complaint that can overcome the court’s concerns. It may be premature to count out the plaintiffs in the various other cases where initial motions to dismiss have been granted with leave to amend.

Judge Ungaro’s denial of the renewed motion to dismiss is also interesting because this case, perhaps by contrast to some other cases (such as the Countrywide and New Century cases) where dismissal motions have been denied, does not involve some of the more dramatic allegations involved in those other cases. For example, by contrast to the Countrywide case, allegations of insider trading were not a significant consideration in Judge Ungaro’s denial of the motion to dismiss in this case.

Plaintiffs’ lawyers may well find Judge Ungaro’s opinion as a positive development. Perhaps if the allegations in this case are sufficient, other cases may yet survive motions to dismiss as well. This impression is underscored by the fact that Judge Ungaro was not deterred by the general downturn in the real estate market or the economy.

In any event, I have added Judge Ungaro’s latest opinion to my running tally of settlements, dismissal and dismissal motion denials in the subprime and credit crisis-related lawsuits, which can be accessed here.

Special thanks to Chris Keller at the Labaton Sucharow law firm for providing me with a copy of Judge Ungaro’s latest opinion. The Labaton Sucharow represents the plaintiff in the BankAtlantic case.

Should He Stay or Should He Go?: In the recent Household Financial securities lawsuit jury trial (about which refer here), among the individual defendants who were found to have acted recklessly in making public disclosures was Household director William Aldinger. As a result, Aldinger not only faces the prospect of having to pay monetary damages; he also faces further questions about his continued service on other corporate boards.

As reflected in a May 12, 2009 Chicago Tribune article (here), Aldinger serves on the board of four other publicly traded companies: Illinois Tool Works; AT&T; Charles Schwab Corp.; and KKR Financial Holdings LLC. As the article notes, "the verdict raises the question of whether Aldinger should have to resign from the boards."

This is uncharted territory in many ways, because so few securities lawsuits actually go to trial. While the verdict does not "automatically disqualify" Aldinger from continued service on the other boards, according to one expert cited in the Tribune article, it certainly puts the boards of those other organizations in a difficult position. The article quotes governance commentator Nell Minow as suggesting that Aldinger should resign and save those other companies from embarrassment and shareholder scrutiny.

Aldinger had been CEO of Household prior to its 2003 acquisition by HSBC.

Special thanks to a loyal reader for the link to the Tribune article.

Speaker's Corner: On Thursday May 14, 2009, I will be in Los Angeles for the Professional Liabiltiy Underwriting Society Southern California Chapter eductional event. I will be participating as a panelist on a sesion discussion the State of the Insurance Market. Further information about the session can be found here. If you are attending the event, I hope you will make a point of greeting me and introducing yourself. 

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One byproducts of the turmoil that has swept over insurance giant AIG has been a cascade of litigation. But even before the company’s latest woes, it was locked in a series of hotly contested legal battles with its former Chairman and CEO, Maurice Greenberg. The latest front in this ongoing war apparently is a fight over the proceeds of the company’s primary D&O insurance policy, as a result of which the D&O insurer has now initiated an interpleader action to sort out whose claims to the policy proceeds should prevail.

As reflected in the complaint (here) that the insurer filed on May 8, 2009 in the Southern District of New York, the insurer issued a $15 million primary D&O insurance policy over a $10 million self-insured retention for the policy period May 24, 2004 through May 25, 2005. As the D&O insurer’s complaint notes, "AIG is at the center of a firestorm," as a result of which the company and its present and former directors and officers are the targets of numerous lawsuits. (The lawsuits themselves are not specified in the D&O insurer’s complaint.)

But as the insurer’s complaint observes, "even before the current issues at AIG became front page news, a very public split" occurred between AIG and Greenberg, as a result of which the company and Greenberg have "taken strongly adversarial positions" in the various lawsuits that have accumulated against AIG. Both AIG and Greenberg and his related entities have expended significant sums in their defense of the underlying litigation, and both AIG, on the one hand, and Greenberg and his related entities, on the other hand, have demanded that the D&O insurer advance to them the proceeds of the D&O policy, presenting the insurer with "competing adverse demands to the proceeds of the Policy."

According to the complaint, AIG was advancing Greenberg’s defense expenses until mid-2007, after which Greenberg’s defense expenses were advance by his various related entities. The D&O insurer’s complaint alleges that the defense expenses that AIG has incurred on Greenberg’s behalf and on behalf of other individual defendants in the underlying litigation exceed both the D&O policy’s $10 million self-insured retention and its $15 million limit of liability.

The D&O insurer’s complaint is filed in the form of an interpleader action under Rule 22 of the Federal Rules of Civil Procedure. Using this procedure, the insurer is basically disclaiming any right or interest in the policy proceeds, and tendering them to the court, for the court to sort out the competing interests to the policy proceeds.

The precipitating event that triggered the initiation of the interpleader action was the attempt by Greenberg to pursue arbitration, in reliance on the arbitration clause in the D&O insurance policy. While the policy does provide for arbitration, Greenberg did not join AIG as a party to the arbitration, while at the same time purporting on his own to select an arbitrator. The D&O insurer is concerned both that AIG must be a party to the arbitration, and that the Policy reserves to AIG rather than to individual insureds the right to select the arbitrator.

In light of this separate arbitration proceeding, the D&O insurer’s recently filed complaint seeks, in addition to interpleader, a judicial declaration whether or not Greenberg is entitled to use the arbitration procedure under the policy, and if so whether AIG is a necessary party to the arbitration, as well as whether or not AIG has the right under the policy to select the arbitrator. The D&O insurer also seeks a judicial declaration of the appropriate disposition of the policy proceeds pending the outcome of the arbitration.

Obviously one of the things that makes this new action interesting is the high profile of the litigants involved. But the case is also interesting as an illustration of the kinds of problems that can arise between current and former directors and officers – clearly, the disputes can even include vehement disagreement over the proper allocation and distribution of D&O insurance proceeds.

The arbitration dispute also demonstrates some the shortcomings that can arise in the application of arbitration provisions in a D&O insurance policy. The sequence of events here not only raises questions about who can initiate arbitration, but also who has what rights in the event of an arbitration. Individual insureds might well be concerned to learn that their company could reserve the exclusive right to select arbitrators in any dispute in which the individuals might become involved with the D&O insurer. (These issues illustrate one reason why I have always thought that the preferred approach to alternative dispute resolution clauses in an insurance policy is for the specified procedures to be at the option of the aggrieved insured, rather than mandatory.)

Another interesting note in this dispute is that it relates to a D&O insurance policy that incepted in 2004. Obviously, the hottest parts of the "firestorm" in which AIG is now engulfed arose well after the policy period for the policy that is in dispute in this case, raising the question of how many (if any) other policy years’ of coverage have been triggered by the various lawsuits in which AIG is involved. How many of the various lawsuits "relate back" to this policy year, and how many triggered policies that were in force in subsequent policy periods? The total amount of insurance potentially in play depends on the outcome of this question.

It is also worth noting that the interpleader complaint described above involves only the primary policy in AIG’s D&O insurance program for the policy period 2004-05. AIG undoubtedly carried significant additional amounts of insurance (i.e., excess insurance) during that same policy period. While the excess insurers in the program may be indifferent whether the primary policy is exhausted in payment of AIG’s or Greenberg’s defense expenses, once the primary policy is exhausted, the dispute between AIG and Greenberg will just move up to the first level excess carrier, and so on up the ladder.

So it is obviously important to the excess insurers to know how the present dispute is resolved, because the outcome potentially could dictate the excess carriers’ rights, obligations and interests.

One final point that the many claimants in the various lawsuits pending against AIG and its present and former directors and officers may well want to note is that the deluge of litigation in which AIG is involved is rapidly depleting whatever amounts of insurance may remain. At some point, the insurance could well be exhausted even just by defense expense alone, leaving only the assets of the now nationalized entity as the primary source of funds out of which to try to extract a settlement or judgment – putting the claimants’ interests in direct conflict with those of U.S. taxpayers.

The theoretical possibility that these claimants might be able to recover from the individual defendants out of the individuals’ own assets must be tempered by the awareness that these individuals, although once wealthy, had most of their net worth tied up in AIG stock. My point here is that well-advised claimants might want to focus on trying to figure out how to maneuver cases toward settlement as soon as possible with the least possible additional defense expense. Not that I have a dog in this particular fight, I’m just saying …

Bloomberg reporter Thom Weidlich has a May 11, 2009 article about the interpleader action, here.

Mayday, Mayday!: Readers may be interested to know that Hank Greenberg just celebrated his 85th birthday on May 4. Everyone here at The D&O Diary wishes Hank a belated Happy Birthday.

And speaking of May anniversaries, with a May 24 inception and expiration date for the insurance policy at issue in this dispute, is it possible that the AIG D&O insurance program is up for renewal once again in just a few days?

Pertinent to the possibility of an impending AIG D&O insurance renewal during the month of May, I note that, according to Wikipedia (here), the universal distress signal "mayday" is a derivation of the French expression "m’aider," short for "venez m’aider," meaning "(you) come help me."

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By now, it is well-established that the recent heightened securities lawsuit filing activity has been largely concentrated in the financial sector. However, litigation involving companies in other sectors has by no means gone away. In addition, recent filings suggest that while the plaintiffs’ lawyers have been concentrating on the financial sector, a backlog of actions against other companies may have been piling up, and that the plaintiffs’ lawyers are now getting around to working off the backlog by initiating long-deferred cases against companies outside the financial sector.

The most recent example of this apparently postponed activity against nonfinancial companies involved the online auction company, Bidz.com. As reflected in their May 7, 2009 press release (here), plaintiffs’ counsel has initiated a securities class action in the Central District of California against the company and one if its officers. Though the case was just launched this past week, the purported class period runs from August 13, 2007 to November 26, 2007. That is, the proposed class period ends more than a year and half before the case was filed.

The Bidz.com action joins several other recently filed securities class action lawsuits filed against nonfinancial companies where the end of the proposed class period is well before the date on which the cases were first filed.

For example, the securities class action first filed in the Southern District of New York on April 28, 2009 against fashion apparel company Liz Claiborne and certain of its directors and officers (about which refer here) has a proposed class period of February 28, 2007 through April 30, 2007. The proposed class period end is nearly two full years prior to the date on which the action was finally commenced.

In addition, in the securities action first filed on April 14, 2009 in the Southern District of New York against Coach, Inc., the fashion accessory and leather goods company, the class period proposed runs from January 23, 2007 to October 22, 2007 (refer here for background about the case).

These cases join other securities suits filed earlier this year against nonfinancial companies in which the filing date came considerably after the proposed class period end. The Sprint Nextel action (here), first filed on March 10, 2009, has a proposed class period of October 26, 2006 through February 27, 2008. The Rackable Systems case (here), first filed on January 16, 2009, has a proposed class period of October 30, 2006 through April 4, 2007.

At one level, there may be nothing remarkable about the timing of these actions’ filings, given the applicable statute of limitation (refer here), which allows actions to be brought up to two years after the discovery of the alleged fraud. These lawsuits are in that sense by no means "stale."

But as a practical matter, it is noteworthy that these lawsuits are only now arising, in some cases as much as nearly two years after the supposed revelation of the underlying events. Particularly when these cases are viewed collectively, there is a definite suggestion that these cases may have been deferred while plaintiffs’ lawyers were preoccupied with other things.

All of which raises the possibility that while the plaintiffs’ lawyers were caught up in the litigation frenzy concentrated in the financial sectors following the subprime meltdown and the credit crisis, they were also building up a backlog of deferred cases against other companies, to which they are now finally getting around.

Of course, this flurry of apparently belated activity against nonfinancial companies could be purely coincidental. Time will tell. The challenge in the interim for D&O underwriters is that the perennial problem of assessing the continuing litigation risk for a company that had some adverse news some time ago may be even trickier now. It is always difficult to know for sure when a company that has had a problem is "out of the woods," and with the possibility that plaintiffs’ lawyers may now be working off a backlog, this assessment may be dicier than ever.

The suggestion that plaintiffs’ lawyers may be working off a backlog of cases against nonfinancial companies raises the possibility that the focus of securities litigation activity in coming months may shift to companies outside the financial sector. And as I recently noted (here), the mounting number of corporate bankruptcies may also drive litigation activity outside the financial sectors. Of course, it remains to be seen whether or not these apparent trends will continue to emerge. But the prospect for increased securities litigation involving nonfinancial companies is certainly one of the critical issues to watch as the year progresses.

Climate Change and D&O Issues: Regular readers know that I have in the past written extensively (more recently here) about the possibility of a growing D&O exposure arising from climate change-related disclosure issues. My good friend Carol Zacharias, General Counsel of ACE Professional Risks, has written an article published in the Spring 2009 issue of The John Liner Review entitled "Climate Change is Heating Up D&O Liability" (here) that provides a comprehensive overview of the topic, including a review of related litigation that has already arisen.

Along with her many interesting observations, Zacharias concludes that "the question is no longer whether there will be actions arising out of how a company and its leadership assess, quantify, and disclose climate change risks, but rather how extensive the litigation will be and when it will be lodged against directors and officers."

Hat tip to Mason Power at MAPO Online (here) for the link to the article.

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Several of the lawyers for the plaintiffs in the Bisys Group securities lawsuit are concerned with the whereabouts of more than $9 million from the $65.8 fund established in connection with the settlement of the case. 

As reflected in the transcript of the April 20, 2009 hearing before Southern District of New York Judge Ned Rakoff (here), in response to a question from the court about the missing $9.3 million, counsel for plaintiffs’ attorney Gene Cauley (sole signatory on the settlement fund escrow account) reported that "the funds are presently unavailable to be delivered," and when asked why, counsel responded by saying that "if I go into anymore detail, I think I might violate a privilege against self-incrimination."

In response, Judge Rakoff said that "it appears not unlikely... that Mr. Cauley may have committed a crime or several crimes" and that "he may have committed disbarrable conduct in one or many ways." Judge Rakoff also said that he was drawing the inference from Cauley’s taking the Fifth that "Mr. Cauley has either misappropriated or otherwise misallocated these funds" and that because of that possibility, Rakoff "asked the U.S. Attorney to have someone here today." There was in fact an AUSA in the courtroom at the hearing, and Rakoff observed that "I trust there will be a prompt investigation of this matter by the U.S. Attorney’s office."

When the Bisys Group litigation settled in October 2006, Cauley’s former law firm, Cauley Bowman Carney & Williams, was a co-lead counsel in the case and appointed as custodian for the settlement fund. Cauley was designated as sole signatory on the escrow account in which the funds were deposited.

Rakoff had ordered distribution of the settlement funds to the class plaintiffs through a class action settlement administrator, AB Data. The class funds were to be provided to administrator in a series of payments, the last of which, in the amount of $9.3 million, was to have taken place on April 2, 2009. Apparently Cauley advised A.B. Data that the funds for the April 2 installment were invested in a 90-day Treasury bill and that the funds would be available by April 8. However, the $9.3  million is yet to be provided to A.B. Data.

On April 15, several of the lawyers from Cauley’s former firm, now part of a firm called Carney Williams, faxed Rakoff a letter advising him of the situation. Though Rakoff was out of the country at the time, he directed his law clerk to convene a joint conference call, in which Cauley apparently declined to participate. Rakoff then issued an order requiring Cauley’s appearance at the April 20 hearing.

At the April 20 hearing, Rakoff ordered the funds that have been deposited so far with the settlement administrator to be distributed to the plaintiff class.

In a WSJ.com Law Blog post about these remarkable circumstances here, Cauley’s counsel is quoted as stating with respect to the missing $9.3 million that Cauley is "working to be able to find the money and to pay it in 90 days." The lawyer also said that Cauley "expects to make everyone 100% whole."

Judge Rakoff closed the April 20 hearing with a brief peroration reflecting on the unusual circumstances in the Bisys Group case: "When I hear people cracking lawyer jokes, I always take umbrage and point out that the profession of Lincoln, the profession of Madison and Jefferson often represents the highest ideals in our society. But recent events give me pause about how true that is."

Cauley was the subject of a past, somewhat colorful WSJ.com Law Blog post (here), which makes for even more interesting reading in light of these more recent circumstances.

Special thanks to a loyal reader who also forwarded me a copy of the hearing transcript.

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On May 7, 2009, a jury in the Northern District of Illinois entered a mixed verdict finding in plaintiffs’ favor on several counts in the Household International securities fraud securities class action lawsuit, a long-running case with overtones of the current subprime meltdown. Background regarding the case can be found here.

The verdict form the jury entered (which can be found here) is quite complex and very detailed. The jurors were asked to make specific findings with respect to 40 allegedly false and misleading statements. The jury found in favor of the defendants with respect to 23 of the statements. However, the jury found in favor of the plaintiffs with respect to 17 of the statements. Table A to the verdict form identifies and assigns a number to each of the 40 statements.

As detailed in by Adam Savett of the Securities Litigation Watch blog (here), the jury found that all four defendants acted recklessly with respect to the 16 statements on which the jury found in favor of plaintiffs. In addition, with respect to an additional statement (Statement No. 14), two defendants (Household and former Chairman and CEO William Aldinger) were found to have acted knowingly, one defendant (Gary Gilmore, the former Vice-Chair of Consumer Lending was found to have acted recklessly, and one defendant (David Schoenholz, the former CFO and COO) was found not liable.

With respect to the recklessly misleading statements, the jury assigned 55% of the responsibility to Household; 20% to Aldinger; 20% to Schoenholz; and 10% to Gilmer.

The jury found that from March 23, 2001 (the date of Statement No. 14, with respect to which two of the defendants were found to have acted knowingly), the allegedly misleading statements inflated Household’s share price by as much as $23.94.As the class period progressed, however, the amount of inflation the jury found changed; it ranged between $23.94 a share and negative $4.66 a share. (Negative share inflation is a puzzling concept that I am sure will have to be sorted out at a later date.)

The available record does not explain how these findings will translate into damages. However, as discussed in press coverage at the time the trial commenced (here), the case was bifurcated with liability issues to be tried first and damages to be tried later if necessary. Apparently there will be further proceedings, based on the jury’s findings in the initial phase, the fix the amount of damages.

Significance for Current Subprime Cases?: The verdict in the Household case arguably has significance with respect to many of the cases filed in connection with the current subprime litigation wave. Even though the Household case was initially filed in 2002, it involved allegations in connection with representations about residential real estate lending practices.

In their complaint, the plaintiffs had alleged that during the class period, the defendants concealed that Household "was engaged in a massive predatory lending scheme." The plaintiffs had alleged that Household "engaged in widespread abuse of its customers through a variety of illegal sales practices and improper lending techniques." Household also reported "false statistics" that were intended to "give the appearance that the credit quality of Household’s borrowers was more favorable that it actually was." The plaintiffs allege that the "defendants’ scheme" allowed them "to artificially inflate the Company’s financial and operational results."

In the third quarter of 2002, the company took a $600 million charge and restated its financial statements for the preceding eight years, and in October 2002, the company announced that it had entered into a $484 regulatory settlement regarding its lending practices. On November 14, 2002, the company announced that it was to be acquired by HSBC Holdings. (In recent months, HSBC’s results have been significantly affected by losses in the subprime mortgage portfolio it acquired in the Household deal and its chairman has publicly admitted that "with the benefit of hindsight, this is an acquisition that we wish we had not undertaken.")

Securities Lawsuit Trials Are Very Rare: Trials in subprime related securities class action lawsuits are extremely rare. According to data compiled by the Securities Litigation Watch (here), only 21 cases have gone to trial since the PSLRA was enacted in 1995. Only seven of those 21 cases involved conduct that occurred after the PSLRA’s enactment.

Two recent high profile securities class action trials involved JDS Uniphase and Apollo Group. As noted here, on November 27, 2007, the jury in the JDS Uniphase trial returned a defense verdict. The Apollo Group trial initially resulted in a January 2008 plaintiffs’ verdict and an award of $277.5 million in damages, but as detailed here, on August 4, 2008, the judge granted the defendants’ motion for judgment as a matter of law, which set aside the jury verdict. A detailed discussion of the two cases can be found here.

Not only are verdicts susceptible to post-trial motions, but they are also susceptible to reversal on appeal, as happened in connection with the defense verdict in the Thane International case, where the Ninth Circuit overturned the jury verdict on appeal and ordered a new trial (about which refer here). The retrial in the Thane case resulted in a defense verdict.

With the inclusion of the Household International verdict and adjusting for the post-trial motion in the Apollo Group case and the post-appeal verdict in Thane, the scoreboard for the seven post-PSLRA trials – as adjusted for post-trial proceedings--  now stands at three wins for the plaintiffs and four for the defendants.

Analysis: While there are further procedures yet to go, the verdict in the Household case nevertheless represents a significant development. The subprime overtones in the case and the defendants’ connection to financial giant HSBC guarantee that the verdict will be very high profile, and it could well cast a shadow over the many other more recently filed cases where questionable lending practices are involved. It is unlikely that many other litigants will be encouraged to push their cases to trial, but the settlement potentially could influence settlement discussions in the other cases.

The way that plaintiffs might try to use the Household verdict in the current litigation can be clearly discerned in the statement from Patrick Coughlin, whose firm Coughlin Stoia Geller Rudman & Robbins represented the plaintiffs in the Household case. Coughlin states that “The jury’s verdict is a victory for the million of Americans suffering as a result of deceptive predatory lending practices and a victory for all investors fighting for greater corporate transparency, honesty and integrity. “

Andrew Longstreth of AmLaw Daily has a May 7, 2009 article about the Household verdict, here.

Securities Litigation Update: On Friday May 8, 2009, I will be participating in a webinar sponsored by Advisen in which Advisen’s finding regarding 1Q09 securities lawsuit filings will be discussed. The hour-long webinar, which is free, will begin at Noon EDT. Registration for the webinar is available here. Advisen’s report on first quarter filings can be accessed here.

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Though the subprime and credit crisis-related securities litigation wave is now well into its third year, relatively few of the cases have yet settled or otherwise finally been resolved. However, the parties to one of the securities lawsuits filed in the earliest stages of the litigation wave have announced that they have settled the case, in a development that potentially may have significance for the many other pending cases.

On May 5, 2009, Beazer Homes announced (here) the settlement of the securities lawsuit that had been filed in the Northern District of Georgia in March 2007 against the company and certain of its directors and officers. In the settlement, the plaintiffs agreed to dismiss the case with prejudice and release all claims against the defendants in exchange for the payment of $30.5 million. According to the press release, the settlement is to be “funded from insurance proceeds” on behalf of the Company and the individual defendants and “there will be no financial contribution by the Company.” The settlement agreement is subject to court approval.

As reflected in the May 5, 2009 memorandum the plaintiffs’ filed in support of their request for judicial approval of the settlement (here), the settlement apparently also applies to the company’s auditor, Deloitte and Touche, which had been named as a defendant in the case.

Beazer Homes is a residential home builder that also provided home loan and mortgage finance services to home buyers. As reflected at greater length here, in quick succession in March 2007, the company announced the resignation of its CFO and that the company had received inquiries regarding its mortgage lending practices. The company’s share price declined and plaintiffs filed several securities class action lawsuits. On May 12, 2008, Beazer restated its financial statements for the previous nine years.

As reflected in their amended complaint, the plaintiffs’ alleged that the audit committee of the company’s board concluded that the company’s mortgage practice violated certain federal and/or state origination requirements and also discovered accounting and financial reporting errors or irregularities that required restatement because of improper accumulation of reserves, improper revenue recognition and other accounting and financial misstatements. The plaintiffs allege that the company’s disclosures during the class period had misled investors about the company’s origination practices and financial condition.

Relatively few of the many subprime and credit crisis-related securities lawsuits filed to date have yet been settled or otherwise resolved to date. (A complete list of the subprime and credit crisis-related lawsuit settlements, dismissals, and dismissal motion denials can be accessed here.) The outsized Merrill Lynch settlement (about which refer here) is noteworthy for its sheer size, but otherwise may have relatively little to say about many of the other pending cases that involve relatively smaller companies, and relatively smaller investment losses. In this context then, the Beazer Homes settlement may be significant for a number of reasons.

First, the case appears to have been settled before the court had ruled on the plaintiffs’ motions to dismiss. Particular cases may settle for any number of reasons, so that fact that the Beazer Homes case settled prior to the dismissal motion ruling may or may not imply anything about other cases – but nevertheless, the settlement prior to dismissal motion ruling does at least raise the possibility for other cases. Along those lines it should be noted that the memorandum the plaintiffs filed in support of their request for settlement approval reports that the parties settled the case as a result of mediation in April 2009, while the dismissal motions were fully briefed by not yet argued.

The Beazer Homes case is also significant because it represents a substantial settlement funded entirely with proceeds of the company’s insurance. If the number of aggregate dollars required to resolve the many other pending subprime and credit cases is extrapolated out from the Beazer settlement, the implied resulting figure – even allowing for the likelihood that a substantial number of the cases will be dismissed – is potentially huge. There have in fact been some noteworthy estimates of the likely aggregate cost to the insurance industry required to resolve all of these cases; whether or not these estimates ultimately prove accurate, the Beazer settlement suggests at least for now that the final resolution of these cases could in the aggregate required some truly impressive sums from insurers.

All of that said, there are some material attributes of the Beazer case that might suggest that its settlement may not necessarily be representative of what to expect from other subprime and credit crisis cases. The first is that the company’s own audit committee concluded that it had violated certain applicable mortgage origination laws. The second is that (at least according to the amended complaint) the company remains under investigation from governmental and regulatory authorities, including the SEC. These circumstances may distinguish Beazer from many of the other cases that have been drawn into the subprime and credit crisis litigation wave, and to that extent at least the settlement may or may not provide a useful indication of likely future settlements in other cases.

I have in any event added the Beazer Homes settlement to my list of subprime and credit crisis-related lawsuit settlements and other case resolutions, which can be accessed here.

Delaware Amends Corporations Code to Address Indemnification and Advancement Concern: As I noted in an earlier post (here), in a March 2008 decision in the Schoon v. Troy case, the Delaware Chancery Court raised concerns when it held that a subsequent board may retroactively eliminate the advancement rights of a prior director.

As explained in the April 2009 issue of the Tressler, Soderstrom firm’s Special Lines Advisory (here, see page 3), the Delaware legislature has now amended Section 145 of the state’s General Corporation code to provide that “rights to indemnification may not be eliminated after the date an act giving rise to a claim takes place, unless a corporation’s indemnification provisions expressly preserve the right to retroactively eliminate the individual’s right to indemnification as permitted by the court in Schoon.“ The amendments are effective August 1, 2009.

Special thanks to my good friend Joe Monteleone for providing me with a copy of his firm’s memo.

Elliptically Speaking Awards (Euphemism Category): I might have considered this a bad parody if I had not seen for myself that this is an actual press release on the website of Nokia Siemens Networks. On November 11, 2008, the company announced (here) the following update on its “synergy-related headcount-adjustment goal.”

Nokia Siemens Networks has completed the preliminary planning process to identify the proposed remaining headcount reductions necessary to reach its previously announced synergy-related headcount adjustment goal. … To date, the company has achieved an adjustment of more than 6,000 employees and continues to expect a total synergy-related adjustment of approximately 9,000 employees. …Simon Beresford-Wylie, chief executive officer of Nokia Siemens Networks, [said] “With the successful completion of these plans, we will have the vast majority of the synergy-related headcount reductions completed and we can then start to put this chapter of our history behind us and focus on creating a world-class company.”

The proposed headcount adjustments are a result of merger-related synergies, including changes to the product portfolio; site optimization; streamlining of various functions; strategic, long-term R&D and workforce balancing; and other factors designed to build a competitive Nokia Siemens Networks. “We have now completed the preliminary planning necessary to identify the specific areas where we have additional synergy-related reduction needs,” said Bosco Novak, head of human resources at Nokia Siemens Networks. “It is our goal to engage constructively with employee representatives in Finland, Germany and other countries to quickly and fairly achieve these needed changes so we are able to remove the ongoing uncertainty that our employees have about synergy-related headcount reductions.”

Hat tip to Harper’s Magazine, which reproduced the press release in its May 2009 issue (here).

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As the subprime meltdown has become a more generalized economic crisis, the adverse consequences have moved far beyond the residential real estate sector where the trouble first began. Until recently, however, the worst effects were concentrated in the financial sector. But as Chrysler’s recent bankruptcy filing shows, the turmoil is no longer limited to the finance sector alone. The infiltration of the credit crisis into the larger economy not only threatens a rise in bankruptcies, but could also include increased bankruptcy-related securities litigation, much of which may be outside the financial sector.

An indication of how these developments might arise can be seen in the securities class action lawsuit filed in the Northern District of Texas on April 30, 2009, against certain former officers of Idearc, Inc. A copy of the complaint can be found here. Idearc "manages and delivers print, online and wireless publishing and advertising services on multiple platforms," including yellow and white pages, online directories and search services. Idearc itself filed for protection under the U.S. bankruptcy laws on March 3, 2009, and so is not named as a defendant in the securities lawsuit.

The complaint alleges that in 2006 and 2007, the company had "touted" its credit and collection policies and procedures, which it claimed had resulted in a steady decline in its bad debts. However, the complaint alleges, during 2007, the company "relaxed" its credit policies "in order to increase the dollar amount" of reported revenue.

The complaint further alleges that the company, "by selling to non-creditworthy customers, effectively reported tens of millions of dollars of sales that it otherwise would not have reported while accumulated tens of million of dollars of uncollectible receivables." However, the complaint alleges, in mid-2008, the company admitted that it had relaxed its credit policies in 2007, and "began to write off these uncollectible receivables in a piecemeal fashion over several quarters."

The complaint alleges that by year end 2008, the company had written off $47 million of receivables, which among other things "materially contributed to the company’s need to file for bankruptcy protection." The complaint alleges that investors were misled by the company’s disclosures regarding its credit and collection policies and procedures as well as by the piecemeal revelation of its company’s growing problems with receivables collections and reserve for bad debts.

As the economy sours, many companies – including companies outside the financial sector, like Idearc – are likely to experience increasing difficulties realizing the anticipated benefits from customer, vendor or counterparty obligations. By the same token, reduced economic activity may render many companies unable to meet their own obligations to their creditors, suppliers and others.

As these problems accumulate, other companies will find it necessary to seek protection under the bankruptcy laws. The officers and directors of many of these bankrupt companies, like those at Idearc, may find themselves the target of a post-filing securities class action lawsuit. Another recent example of a post-filing bankruptcy lawsuit involves former directors and officers of MRU Holdings, about which I previously wrote here.

The increase of these kinds of bankruptcy related lawsuits may be the means by which the current wave of subprime and credit crisis-related litigation spreads outside the financial sector. In its recent quarterly report on securities litigation (here), Advisen suggested that "it is likely that the wave of subprime-related suits, and in particular suits filed against financial services companies, will crest in 2009." The report goes on to suggest that "as bankruptcies rise through the economy, hitting all sectors, and securities suits are filed as a consequence, suits filed will become more dispersed …broadly affecting all sectors."

More Failed Banks: In what is now a standard weekend ritual, this past Friday evening the FDIC closed three more banks, bringing the year to date total number of failed banks to 32. The three banks closed this Friday night were: Silverton Bank of Atlanta, Georgia, which prior to its closure had assets of $4.1 billion, making it the fifth largest bank to fail since the beginning of 2008 (further details about the bank can be found here); Citizens Community Bank of Ridgewood, N.J. , which had assets of $45.1 million (refer here); and America West Bank of Layton, Utah, which had assets of $299.4 million (refer here).

Silverton is the sixth Georgia bank to be closed this year and the eleventh since January 1, 2008, the highest total for any state during either of those two periods.

In light of their relatively small size, both Citizens Community Bank and America West Bank qualify as community banks. As I recently noted (here), the 2009 bank failures have largely involved these kinds of smaller community banks. Indeed, 27 of the 32 banks that have failed so far this year have involved financial institutions below $1 billion in assets, which is one standard measure of community banks.

Silverton was quite a bit larger than these community banks, and it is also somewhat unusual in that Silverton did not take deposits from the general public or make loans to consumers. Silverton was a wholesale bank, providing services, according to the Wall Street Journal (here), to one in every five banks in the country. Silverton was known as the Bankers Bank until last year. Its customers, depositors and investors are all banks. Banks that had invested in Silverton will incur losses as a result of its failure, which could pose problems other banks.

The FDIC’s complete list of failed banks since October 2008 can be found here. The Wall Street Journal has a nifty interactive table of all the failed banks here, which can be sorted by name, closure date, asset and deposit size, and other factors. (The Journal’s list does not yet include Citizens Community Bank and America West Bank.)

Speakers’ Corner: On Monday, May 4, 2009, I will be in New Orleans at the spring meeting of the Casualty Actuarial Society, participating on a panel entitled "An Update on the Credit Crisis and Related Issues for D&O Insurers." The panel will be chaired by Joe Lebens of the Towers Perrin firm, and will include Stephanie Plancich from NERA Economic Consulting and David Bradford from Advisen. More information about the session and the conference can be found here.

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Securities class action lawsuits filings are on pace to make 2009 the most active for securities class action filings in years, according to Advisen’s May 1, 2009 Securities Litigation Quarterly (here). According to the report, there were 67 securities class action lawsuits in the first quarter of 2009, up from 56 a year earlier. The first quarter filings represent an annualized filing rate of 268 securities class action lawsuits, which would not only represent a significant increase over 2008 but would even be greater that the "relatively litigious year of 2004."

My own analysis of the first quarter 2009 securities class action filings can be found here.

The overall purpose of the Advisen report is to analyze "securities lawsuits" in the first quarter of 2009. As used in the Advisen report, the term "securities lawsuits" refers not just "securities class action lawsuits," but also includes SEC enforcement actions, state court fiduciary duty cases, and even lawsuits filed in non-U.S. courts.

In addition, the report uses yet a different term – "securities fraud lawsuits" – as a subset of "securities lawsuits," to describe SEC enforcement proceedings and other regulatory actions.

So in the report "securities class action lawsuits" and "securities fraud lawsuits" are each separate and distinct subcategories of the larger category of "securities lawsuits."

According to the Advisen report, filings in the broadest category -- "securities lawsuits" -- were up significantly in the first quarter of 2009, with 169 of these actions, compared with only 125 in the fourth quarter of 2008, and 134 in the first quarter of 2008. These filings (which, again, represent a broader category than just "securities class action lawsuits") were significantly increased by Madoff-related lawsuit filings, which represented 30% of all the "securities lawsuits" in the first quarter. The report notes that "2009 might end up as a year with a heavy front-end load of lawsuits" due to the "flurry of Madoff-related cases" in the first quarter.

Using its own categorization, the report notes that fewer of the "securities cases" plaintiffs are filing are "securities class action lawsuits," and that plaintiffs increasingly have been filing securities lawsuits alleging common law torts, contract law violations, and breach of fiduciary duties." The report speculates that plaintiffs’ counsel may be pursing these alternatives in order to be able to proceed in state court and to avoid having their case consolidated with the larger class action suit.

With respect to "securities lawsuits" other than "securities class action lawsuits," the enforcement and regulatory actions that the report categorizes as "securities fraud lawsuits" accounted for 34 suits filed in the first quarter, up from 19 in fourth quarter of 2008, but down from 54 in third quarter of 2008. The "securities fraud lawsuits" filed in first quarter of 2009 represent an annualized filing rate136 cases, flat with 2008 but down from 175 in 2007.

Other types of "securities lawsuits" other than "securities class action lawsuits" filed in the first quarter of 2009 were: breach of fiduciary duties (26), collective actions in non-US courts (20), derivative shareholder actions and other derivative cases (14), and others (8).

The Advisen report notes that suits against financial firms dominated the "securities lawsuit" filings in the first quarter. The report notes that 117 out of the 169 "securities lawsuits" filed (or 69%) in the first quarter involved financial services firms (including insurance companies). These financial services claims fall in four basic groups: the Madoff-related claims; subprime and credit crisis-related claims; specialist improper trading claims; and Stanford Group-related claims.

With respect to the subprime and credit crisis-related claims, the report suggests that these claims "will crest in 2009," adding that "as bankruptcies rise through the economy, hitting all sectors, and securities suits are filed as a consequence, suits filed will become more dispersed…broadly affecting all sectors."

The report notes that many of the cases will not only potentially trigger D&O insurance policies, but "may also trigger coverage under errors and omissions (E&O) and fiduciary liability policies" which is true with respect to may of the Ponzi scheme cases as well as with to some of the subprime and credit crisis-related cases.

First Quarter Report Webinar: On Friday May 8, 2009, at Noon EDT, I will be joining David Bradford and Jim Blinn of Advisen for a free one-hour webinar to discuss the findings in the Advisen quarterly report and to discuss the implications for the liability insurance market. Registration for this free webinar is available here.

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Several of the recipients of TARP funding have also been the targets of securities class action lawsuits and other litigation. In an April 29, 2009 post on the DealBook blog (here), Dan Slater, formerly of the WSJ.com Law Blog, raises the concern that TARP money could be used “to line the pockets of allegedly aggrieved shareholders and the lawyers who, wrapped in the flags of corporate governance, are in the process of making a billion-dollar cottage industry out of filing strike suits.”

As an example, Slater cites the case of Merrill Lynch, which, on the same day as its new corporate parent Bank of America announced that it was receiving an additional $20 billion in TARP money, announced that it would pay $550 million to settle a securities class action lawsuit and an ERISA lawsuit. (For further detail regarding the Merrill settlement, refer here.) Slater contends that as a result of the settlement either BofA will be less able to repay its TARP obligation or must cut its TARP allotment to settle up

Slater also notes that 19 of the 32 recipients of $1 billion or more of TARP money have since January 2008 been sued in securities class action lawsuits. “Put another way,” Slater states, “of the more than $300 billion that’s been paid out in TARP money, nearly $240 billion of it, or 78 percent, is subject to shareholder suits.”

Slater argues that while there has always been a circularity involved in the funding of securities lawsuit settlements, now, “in the world according to TARP,” the securities settlement money could be coming from taxpayers.

Slater raises an interesting point, and the example of Merrill Lynch is particularly telling. I think his analysis is incomplete, however, to the extent that it disregards the existence of D&O insurance, E&O insurance, and fiduciary liability insurance, which will be funding a very substantial amount for the defense and settlement of these lawsuits.

However, the Merrill Lynch settlement unquestionably raises the concern, given its sheer size, that the resolution of these cases could require funding that far exceeds that amount of insurance available. To that extent, at least, there arguably is a concern that TARP money could fund, or at least offset the cost of, securities class action settlements.

Slater’s points are, to that extent at least, well taken. I think it should be noted that plaintiffs’ lawyers are well aware of these concerns – many of the lawsuits to which Slater refers were filed before TARP was instituted, and since the TARP payments were first made, plaintiffs’ attorneys have had to take these kinds of concerns into account on deciding whether or not to file new cases.

These kinds of issues may also be part of the constellation of considerations that has been affecting courts’ reactions to the early motions to dismiss. As I have previously noted (most recently here), while it is still early, many of the subprime and credit crisis-related cases have not been faring particularly well in the courts at the motions to dismiss stage, and concerns like those that Slater has raised may be part of the reason.

An April 29, 2009 Am Law Litigation Daily post discussing Slater’s article can be found here.

Madoff Redemption Clawbacks?: One of the more interesting and complicated questions that has arisen lately is the extent to which Irving Picard, the trustee for the Bernard Madoff Investment Securities liquidation, wil be able to "clawback" amounts from BMIS investors who redeemed their investors who redeemed their investments prior to the firm's collapse. An April 28, 2009 paper by NERA Economic Consulting entitled "Clawbacks from Madoff Investors: Questions of Economics, Equity and Law" (here) takes a detailed look at the issues surrounding the extent of the trustee's ability to recover the amounts previously redeemed. As the paper reviews at length, there are a variety of competing considerations that will have to be balanced in determing the extent to which the trustee appropirately may clawback these amounts.  

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