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

On Friday June 26, 2009, in the highest number of bank closures on a single day since 1992, the FDIC assumed control of five more banks, bringing the YTD total number of failed banks to 45, compared to 25 for all of 2008. In addition, at the same time as bank closures surge, there are growing signs that both private litigants and the FDIC intend to pursue claims against the former directors and officers of the failed institutions.

The five banks closed on Friday are Mirae Bank of Los Angeles, California, which prior to its closure had assets of $456 million (and about which refer here); MetroPacific Bank of Irvine, California, which prior to its closure had assets of $80 million (refer here); Horizon Bank of Pine City, Minnesota, which had assets of $87.6 million (refer here); Neighborhood Community Bank, of Newnan, Georgia, which had assets of $221,6 million (refer here); and Community Bank of West Georgia, Villa Rica, Georgia, which has assets of $199.4 million (refer here).

The closure of the two Georgia banks continues the pattern of a high concentration of bank failures in that state. With the addition of these two latest closures, the number of bank failures in Georgia since January 1, 2008 now stands at 14, the highest number of any state. There have been nine bank closures in Georgia already so far in 2009. My prior post discussing the Georgia bank failures at greater length can be found here.

The closure of the two California banks brings the total number of failed banks in California since January 1, 2008 to eleven. There have been seven bank failures in Illinois and four in Florida since the beginning of 2008. The FDIC’s complete list of all banks that have failed since October 2000 can be found here.

The relatively small size of all five of the banks closed this past Friday night continues the concentration of bank failures in the community banking sector. Of the 45 bank failures so far this year, 39 have involved institutions with assets under $1 billion. Only eleven of the 45 had assets over $500 million.

Some litigation against the directors and officers of these failed banks has already begun to emerge. As I previously noted (here), from among the six of the 25 banks that failed in 2008 have become involved in securities class action litigation, even though only eleven of the 25 were publicly traded.

Shareholders of failed banks are also starting to file shareholders’ derivative and individual litigation against the directors and officers of failed banks. For example, on May 28, 2009, a shareholder of Meridian Bank of Madison County, Illinois, which regulators closed on October 10, 2008 (refer here), filed a complaint (here) in Madison County (Illinois) Circuit Court against the former President of the bank and two former directors. The complaint combines derivative and individual claims. Among other things, the complaint alleges that the directors engaged in self-interested transactions and that the bank’s practices and procedures were detrimental, resulting in the bank’s closure by federal regulators and in damages to the bank’s shareholders.

In addition, according to a June 14, 2009 article in the FinCri Advisor (here, registration required), the FDIC is currently assessing whether to pursue claims against the former directors and officers of failed financial institutions. According to the article, the FDIC has begun the process of potentially suing directors and officers, by sending claims letters to ousted officials advising them of the FDIC’s intent to pursue claims.

Because the FDIC typically assumes control of failed banking institutions after the close of business on Friday evenings, it seems relatively unlikely that there were be any further bank closures in June 2009. However, the 45 closures in the first half of the year alone already represent an 80% increase over the total number of closures during all of 2008.

With the continued stress in the general economy, the deteriorating condition of the commercial real estate sector, and the elevated levels of unemployment, the likelihood is that the number of bank closures will continue to grow as the year progresses. Indeed, In the FDIC’s most recent Quarterly Banking Profile (as of March 31, 2009), the FDICcounted 305 institutions with assets of $220 billion on its Problem List. The Problem List is up from 252 institutions with $118 billion in assets at the end of the third quarter of 2008, which in turn was up from 117 institutions with $78.3 billion in assets as of the end of the second quarter. (The FDIC does not identify the problem banks by name.)

At the same time, there would appear to be a growing likelihood of claims against the former directors and officers of at least some of the failed banks. As I have previously noted (here), these developments have already registered in the D&O insurance marketplace for community banks, which has quickly become characterized by rising prices and narrowing terms and conditions.

Hat tip to the Courthouse News Service (here) for the Meridian Bank complaint.

Children’s Place Settles Securities Suit: In a June 26, 2009 filing on Form 8-K (here), The Children’s Place Retail Stores announced the settlement of the consolidated securities class action litigation that had first been filed against the company and certain of its directors and officers in the Southern District of New York in September 2007. Background regarding the securities lawsuit can be found here.

According to the 8-K, in the settlement, the company agreed to pay $12 million for a release of all claims. The cost of the settlement, according to the 8-K, “is covered by the Company’s insurance.”

Securities Suit Against FX Energy Dismissed: In an order dated June 25, 2009 (here), District of Utah Judge Clark Waddoups granted the defendants’ motion to dismiss the securities class action lawsuit that had been filed against FX Energy Corporation and certain of its directors and officers. Background regarding the case can be found here.

As summarized in the June 25 opinion, the plaintiffs alleged that the defendants had made two essential sets of misrepresentations. First, the plaintiffs alleged that in press releases and in a slide presentation the defendants had falsely represented that the decision to drill for gas at two sites was “based on well-established scientific and geological data,” while the defendants had in fact (the plaintiffs alleged) used only two-dimensional (2D) seismic data while suggesting that they had used three-dimensional (3D) data. Second, the plaintiffs alleged that the defendants had touted the proximity of the Sroda-5 and Lugi-1 sites to other successful wells as a significant factor indicating that gas could be located at one of the two sites, knowing that this representation was untrue.

With respect to the allegedly misleading statements regarding the type of seismic data used, the court found that reading all of the allegedly misleading statements, it “cannot find any statements that reasonably imply that FX Energy was using 3D seismic data.” To the contrary, the court found “the non-specific references to 2D and 3D in these documents give one the impression that FX Energy was generally using 2D but had plans to use 3D at some future time.” Accordingly, the court found with respect to the first set of allegations that the plaintiffs had not sufficiently pleaded fraudulent statements or omissions.

With the second set of alleged misrepresentations, the court found that the plaintiffs had adequately alleged that the defendants’ statements implied that the Lugi-1 and Sroda-5 wells would have a higher chance of success given the success of other wells in the vicinity. However, the court found plaintiffs allegations were still insufficient to establish a claim for securities fraud due to the complaint’s failure to properly plead scienter.

Specifically, the court found that there was a plausible opposing explanation for defendants’ statements, which is “that the Defendants actually believed that they were true.” The court found that it did not believe that a reasonable person would conclude that that the plaintiffs’ allegations that the defendants acted with scienter was at least as compelling as the opposing inference.

As the court said, “to accept Plaintiffs’ allegations, one would have to believe that Defendants knew that their information on Lugi-1 or Sroda-5 was unreliable and actually had strong information that those wells were dry, but nonetheless planned to drill there, repeatedly publicized those plans, and they expended significant resources to actually drill there, all on the chance that taking these actions might artificially inflated stock prices.” The court also found that the plaintiffs’ reliance on the testimony of confidential witnesses and on the defendants’ trading in their share in company stock were unavailing.

Accordingly the court granted the defendants’ motion to dismiss the plaintiffs’ complaint.

Hat tip to Adam Savett of the Securities Litigation Watch (here) for the link to the Children’s Place 8-K and to the June 25 opinion in the FX Energy case.

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One of the most striking things I have found when talking to corporate officials about D&O insurance is how different the conversation can be when talking to non-officer directors compared to talking to corporate officers. Without meaning to over-generalize, the two groups sometimes have different questions and concerns. And indeed there are very good reasons why the insurance needs and interests of non-officer directors should be analyzed differently from those of the corporation and its officers.

By way of background, these issues arise in the context of the traditional D&O insurance policy, which may have potential conflicts of interest built right into its frame. By way of illustration, after I recently made a recent presentation about D&O insurance to a group of noninsurance professionals, one of the audience members (an economist) came up to me to express his astonishment that both a company’s inside officers and its non-officer directors would be insured under the same policy of insurance. When you think about it, it may not make much sense, but that is the way the insurance typically is structured.

Not only are there two potentially conflicting sets of individuals yoked together in the traditional D&O insurance policy, but since the mid-90s, the traditional D&O insurance policy has also incorporated so-called “entity coverage” for securities claims, providing the company with balance sheet protection and representing yet another potential conflict within the policy with respect to the interests of the non-officer defendants.

In recent years, the insurance marketplace has developed and materially improved a variety of alternative insurance vehicles designed to ensure a dedicated source of insurance protection for the individuals insured under the D&O insurance program. These alternative approaches include excess Side A insurance, which effectively provides catastrophe insurance for the protection of individual directors and officers, and individual director liability insurance (IDL), which protects a single individual. These products can be further customized to protect a specific group of individuals – for example, the non-officer directors.

Not every company wants, needs or can afford to acquire these alternative products in addition to their traditional D&O insurance. But every company should consider them. And these days, an increasing number of companies do purchase some form of these alternative products, typically Side A excess insurance. But both with respect to the companies declining to purchase these products and with respect to many of the companies that do, the assessment of these alternative or supplemental structures often is not taken from the perspective of the needs and interests of the non-officer directors.

It is this conversation topic – the one about the non-officer board members’ interests in the structure of the D&O insurance program – that represents the heart of the difference that arises between speaking about D&O insurance to outside board members compared to talking about these issues to corporate officers.

In my experience, outside board members are keenly interested in learning more about the protection afforded by these alternative products and the ways the D&O insurance program can be structured to maximize their protection. In particular, non-officer directors want to know about the ways the insurance program can be structured so that there is dedicated insurance set aside that cannot be eroded or exhausted by the defense expenses and indemnity obligations of the company or the company’s officers. They want as much reassurance as they can get that no matter what happens, they will not have to go out of pocket in any way.

Corporate officers, even those who recognize the theoretical value of these products, often are most concerned with considerations pertaining to cost. Even officials persuaded of the need for the company to acquire excess Side A insurance to protect the individual directors and officers may not be susceptible to persuasion of the need for separate limits set aside just for the outside board members, and frequently the stumbling block to further consideration of these issues is an unwillingness to incur additional D&O insurance expense.

These issues recur with sufficient frequency that it is my universal recommendation to non-officer board members that they request a separate presentation directly to the board about the company’s D&O insurance, to afford all of the board members a separate opportunity to inquire about their interest and the level of insurance protection available to them.

Another step I have found an increasing number of concerned board members requesting is a separate review of their company’s D&O insurance program by an outside and independent insurance professional, on behalf of the board. An independent review not only facilitates a separate determination whether or not the non-officer board members’ needs and interests are appropriately addressed, but it also facilitates a separate inquiry whether the terms, conditions, and structure of the program adequately addresses all of the interests insured.

This latter point bears emphasizing – that is, there is considerable value in having the D&O insurance program separately and independently reviewed. D&O insurance is of course only one part of the company’s overall insurance program, but from the outside board members’ perspective, the D&O insurance is the only insurance the company has that insures them directly, so they are highly motivated that the insurance program is the best available.

Though both the company’s officers and its board members are equally interested in ensuring the adequacy of the D&O insurance program, my own experience is that a separate insurance audit on behalf of the non-officer board members frequently discloses a variety of ways the overall D&O insurance program might be improved, sometimes materially.

Another constituency that may have an interest in having an independent insurance review is the board of a corporate subsidiary, particularly where the subsidiary’s board is separately constituted from the parent company’s board. Though the corporate parent’s D&O insurance typically will provide protection for the subsidiary’s directors and officers, there are occasions when the subsidiary board’s interests are sufficiently distinct that the subsidiary’s board would be well advised to at least consider whether or not to acquire a separate policy dedicated to their own protection. These interests are particularly noteworthy for subsidiaries of large financial services companies, when the subsidiary board may have its own distinct liability exposures as well as a separate interest in the availability of insurance limits dedicated to their protection.

As I noted above, the interests of a wide variety of insureds are yoked together in a single D&O insurance program. But that does not mean that the various constituencies’ interests cannot be considered separately. A separate consideration of competing and sometimes conflicting interests can sometimes result in the selection of different insurance structures. In addition, as noted above, an independent insurance audit can provide an opportunity for the separate review of the adequacy and appropriateness of the terms and conditions in the applicable policies.

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On June 19, 2009, the Fifth Circuit, in a per curiam opinion (here) written by a panel that included retired Supreme Court Justice Sandra Day O’Connor sitting by designation, reversed and remanded the district court’s denial of class certification and entry of summary judgment in defendants’ favor in the Flowserve securities class action lawsuit.

CORRECTION: The original version of this post suggested that Justice O'Connor herself had written the June 18 opinion. In light of  reader comments (please see below) I have revised this post to reflect the fact that the Fifth Circui's decision was in the form of a per curiam opinion that does not indicate which member of the panel authored the opinion. The entire staff here at The D&O Diary apologizes for any confusion our original post may have caused.

With respect to the class certification issue, the Fifth Circuit vacated the district court’s refusal to certify the class based on what the Fifth Circuit found was the district court’s application of an erroneous standard on the loss causation issue, and remanded the case for further proceedings. In addition, the Fifth Circuit reversed the district court’s entry of summary judgment, essentially on the ground that the district court’s analysis on the loss causation issue for class certification purposes was not in any event dispositive of the loss causation issue on the merits, and therefore was not the appropriate basis for entry of summary judgment.

The Fifth Circuit’s opinion is noteworthy for a number of reasons. First, it represents a rare occasion where securities class action plaintiffs have succeeded, even if only provisionally and for the time being, in a circuit that is generally perceived as heavily defense oriented. It should be noted that there is nothing in the Fifth Circuit’s opinion that precludes the district court from ruling against the plaintiffs on either issue on remand; even with application of what the Fifth Circuit described as the correct legal standard, the district court could nonetheless again rule in the defendants’ favor.

Second, the Flowserve case represents the latest example of the Fifth Circuit’s struggles with the question of the proper consideration of loss causation issues at the class certification stage. These same or similar issues are presented in both the Belo securities case (about which refer here) and the Halliburton securities case (here), both of which are now also pending before the Fifth Circuit. Given the continuing controversy on these issues, it seems increasingly likely that these issues could wind up before the U.S. Supreme Court.

Finally, the opinion is perhaps most interesting for the final commentary provided in the opinion's concluding paragraph:  

To be successful, a securities class-action plaintiff must thread the eye of a needle made

smaller and smaller over the years by judicial decree and congressional action. Those ever higher hurdles are not, however, intended to prevent viable securities actions from being brought.

Whether or not these remarks perhaps represent an expression of concern with how far the pendulum had swung in the Fifth Circuit in these kinds of cases, these words undoubtedly will be repeated by plaintiffs’ counsel in future filings, both inside and outside the Fifth Circuit, in support of the claims.

Very special thanks to a loyal reader for providing a copy of the Fifth Circuit’s Flowserve opinion.

Speakers’ Corner: During the period June 21-23, 2009, I will be in Palo Alto, California, where I will be participating as a faculty member at the Stanford Law School Directors’ College. A summary agenda for the event can be found here.

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Various blogs and news articles expressed surprise and astonishment at the $2.876 billion judgment entered against Richard Scrushy in the HealthSouth state court derivative lawsuit, but a review of the June 18, 2009 memorandum opinion (here) that accompanied the final judgment shows that Jefferson County (Alabama) Circuit Court Judge Alwin E. Horn III actually ruled that the total amount of the damages to be the even more eye-popping amount of $3.115 billion. It was only the application of $239 million credit for judgments entered against other defendants that brought the number down to the $2.876 billion figure ultimately entered against Scrushy and other individual defendants.

It may well be wondered how on earth the court could have come up with these astronomical figures, whether before or after the application of the judgment credit. Part of the answer is the fraud itself, with Judge Horn described as “remarkable and perhaps unique in its duration, size and scope.”

Judge Horn’s opinion details what he describes as HealthSouth’s fraudulently reported net income during the period 1996 through 2002. The annual figures stated in the opinion, when added up, suggest that HealthSouth’s fraudulently reported net income exceeded its actual net income by over $3.138 billion.

However, Judge Horn’s damage calculation was not directly related to the massive scale of the fraud. Rather, it was calculated based on a variety of separate categories of damages including: excess bonuses paid to Scrushy ($10.4 million); amounts Scrushy gained on inside trades ($147.4 million); amounts the company spent on remediation, reconstruction and restatement of its financial records ($457.6 million); amounts the company spent during the period 2004 to 2006 on excess debt, consent fees, bond and credit payments as a result of the fraud ($1.147 billion);salaries and bonuses paid to fraud participants ($26.5 million); excess payments and loans to Scrushy-related enterprises ($260 million) and HealthSouth’s overpayment of taxes ($169.6 million).

These amounts, as staggering as they are, add up “only” to $2.2 billion. The total damages Judge Horn calculated reached $3.115 billion by the application of nearly one billion dollars in prejudgment interest. In determining the amount of interest, Judge Horn calculated the applicable interest rate in varying amounts over time, applying Delaware law and using the standard of five percentage points above the Federal Discount Rate, resulting in interest rates applied in some cases of as much as 10%.

Judge Horn’s opinion does not state whether post-judgment interest will also accrue, but presumably there are provisions for this interest under applicable law.

Whether or not further proceedings or appeals ultimately will substantiate all of these damage amounts and interest assessments, Judge Horn’s analysis represents a fascinating catalog of the harm caused to the company as a result of the fraud, as well as the ways that Scrushy himself profited. It should probably be noted that the possibility of an appeal may be complicated by the rather interesting question of how Scrushy could post an acceptable and adequate appeal bond.

Judge Horn’s opinion makes for interesting reading in other respects as well, particularly the ways that Judge Horn went about reaching factual conclusions despite having to deal with competing and conflicting testimony from witnesses he described as “six testifying felons.”

Among other things, Judge Horn relied on Scrushy’s own testimony in a prior case (the MedPartners case), in which Scrushy testified about what financial information a CEO must receive. Judge Horn described Scrushy’s testimony as an “unwitting confession,” because it showed that “for a fraud of even a billion dollars to occur over a period of years, the CEO had to know of the fraud.”

Assuming for the sake of argument that the massive judgment against Scrushy withstands further review, if any, the question will then become what if anything can be recovered on the company’s behalf. Though at one time he was a wealthy man, years of litigation and the panoply of claims against him undoubtedly have greatly reduced his former wealth. He may have a multibillion dollar judgment against him, but that does not make him a multibillion dollar man. Nor does it seem likely that the company’s recovery will ever remotely approach the amount of the judgment.

A June 19, 2009 Law.com article by Ben Hallman providing the backstory on the state court derivative lawsuit can be found here.

From Those Incredibly Large Amounts to Some Incredibly Small Numbers: After working with figures in the billions, it is hard focus on a dispute involving only very small fractions of a dollar, but that is what is involved in the securities class action lawsuit filed on June 18, 2009 in the Eastern District of Arkansas against Shearson Financial Network and certain of its directors and officers.

As reflected in the their June 19, 2009 press release (here), the plaintiff’s purported class action complaint (which can be found here) alleges that the defendants

caused a press release to be issued on May 7, 2009, that stated the Company had emerged from bankruptcy. In the press release, the Company used the ticker symbol, SHSNQ to identify itself, which was the ticker symbol belonging to the Company’s old stock which would ultimately be cancelled. However, at the time the Company issued the press release the stock listed under the ticker symbol SHSNQ was still trading and had not been cancelled. As a result of defendants’ false and misleading statements, Shearson’s securities traded at artificially inflated prices during the Class Period, reaching a high of $.039 on May 8, 2009.

On May 11, 2009, the Company issued a press release stating among other things that the stock trading under the ticker symbol SHSNQ would be cancelled and that Shearson’s new stock would trade under a different ticker symbol.

The complaint alleges that following the issuance of the May 11 press release the share price fell to $.0097 on trading volume of over 27.6 million shares. (That is, the share price decline three cents per share). Later, all shares traded under the symbol SHSNQ were canceled, meaning holders of those shares “were left with nothing but losses.”

The plaintiff, who bought his shares at $.039 per share on May 8, 2009, purports to represent a class of purchasers who bought the SHSNQ shares during the five-day period between May 7, 2009 and May 12, 2009.

I know that there have been class periods shorter than five days. But I suspect there have been very few classes brought on behalf of share price declines as small as three cents a share. I was unable to determine how many of the SHSNQ shares actually traded on the open market, but even assuming a three cent per share loss on all of the 27.6 million SHSNQ shares that traded on May 11, the market cap decline was $810,000. Obviously, not everyone selling bought their shares at the peak and some sold before the entire three cent share decline accumulated, so the actual losses on those trades is almost certainly quite a bit below that amount.

The relatively small amount in dispute is of course no reason to forebear from filing the lawsuit; however, the absence of any allegations of scienter of any kind, in combination with the small amount in dispute, would have been enough to discourage most self-interested plaintiffs’ attorneys from enlisting in this case.

More Bank Closures: After the close of business on June 19, 2009, the FDIC announced the closure of three more banks, bringing the year to date total number of bank closures to 40. The FDIC’s complete list of failed banks, including the latest three to be added, can be found here. The three banks all had assets under $1 billion dollars, continuing the trend of closures in the community banking sectors.

One of the three banks was located in Georgia, bringing the total number of Georgia banks to fail during 2009 to seven, and the total since January 1, 2008 to 12.

My recent overview of the growing number of bank closures and the implications for the D&O insurance marketplace can be accessed here.

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As the credit crisis litigation wave has evolved, an increasing number of related lawsuits have “targeted asset management firms and involved complex financial instruments,” according to a new study from NERA Economic Consulting. The June 15, 2009 study, written by Dr. Faten Sabry with her colleagues Anmol Sinha and Sungi Lee, is entitled “An Update on the Credit Crisis Litigation: A Turn Toward Structured Products and Asset Management Firms,” and can be found here.

The study provides an update of what the study describes as “credit crisis filings,” which category includes not only securities cases (i.e. those involving allegations pertaining to the purchase, ownership or sale of securities) but also includes ERISA claims, shareholder derivative actions, individual state and federal cases, and international cases. The category excludes predatory lending, mortgage loan repurchase disputes and actions involving consumer finance.

The study reports that this broad category of “credit crisis filings” increased by 172% in 2008 compared to 2007. The study, which reports data through March 17, 2009, notes that the filing activity shows no sign of slowing in 2009, with 46 “credit crisis filings” through March 17 of this year, compared with 188 in all of 2008 and 69 during 2007.

Though the study reports on a broad category of kinds of filings, even within this broad category, the study found that the percentage of filings that name individual directors and officers as defendants is high – 62% in 2008 and 72% in 2009.

The study found that within the broad category of “credit crisis filings” that while claims against shareholders involved 57% of filings in 2007, they represented only 37% in 2008 and 33% in 2009. The filings over time increasingly have involved other claimants, including auction rate securities investors, non-ARS investors, plan participants, and other plaintiffs. The non-ARS investors include those who invested in preferred securities, corporate bonds, mortgage-backed securities, mutual funds, and money-market funds.

Just as the type of claimants has shifted over time, so too has the type of claim target. The study reports that as the credit crisis has moved from the mortgage-related markets to the overall credit markets, “the focus of the related litigation has also shifted towards more complex financial instruments and different market participants.”

Among other things, the study reports that asset management firms and issuers/underwriters now represent the majority of the defendants named. The percentage of lawsuits involving asset managers more than doubled between 2007 and 2008.

The study includes a particular examination of lawsuits involving collateralized debt obligations (CDOs). As CDOs have experienced increasing numbers of “events of default,” the lawsuits have followed. The CDO-related lawsuits generally allege failures to disclose proper valuations and misrepresentations about the quality of the underlying collateral.

In addition, as the financial crisis has continued, the underlying debt and the indices that are used as reference entities for credit default swaps have declined in value and the providers of CDS protection have experienced significant losses, also resulting in litigation. A key allegation in the CDS lawsuits is the failure to pay the protection promised following the occurrence of certain credit events.

The study notes that though there have been some reported resolutions of the credit crisis cases, which the report describes generally, most cases remain in their earliest stages.

The report concludes by noting that “as the losses continue to mount, it is not clear that the litigation will slow down,” adding that the lawsuits remain in their early stages and the credit crisis story is far from over.”

The study’s update of the credit crisis litigation wave provides useful and interesting analysis of the evolving litigation. Indeed, perhaps as a result of the depth of interesting information and analysis in the study, a variety of additional interesting questions that the data might also answer follows from reading this study.

The study’s aggregation of a wide variety of kinds of claims into a larger category denominated “credit crisis filings” does raise the question of what portions within this larger category each of the included types of claims represents. It would be interesting to see a breakdown within the larger category of “credit crisis filings” how many and what percentage each of the constituent subcategories represents and how they have changed over time. By way of illustration, how many of the “international cases” have there been, and when were they filed?

Similarly, within the category of claims identified in the study as having been filed against directors and officers, it would be interesting to know how these claims break down by lawsuit type.

It would also be interesting if the study’s descriptive analysis of the claims involving CDOs and CDS, which included also descriptions of some representative cases, also included aggregate numerical analysis of claims involving these financial instruments – that is, over time, how many claims have there been involving these kinds of financial instruments, and how have the numbers changed?

The study also specifies that the authors identified a category of claims involving non-ARS investors. It would be interesting to know specifically how many of these claims by each of these kinds of investors have been filed over time. For example, with respect to claims involving investors in preferred or subordinated investors, which I have noted (here) is an increasingly important part of securities lawsuit filings, how many filings have there been? How have the filing numbers changed over time?

Finally, while the report intentionally and by its own terms intends to describe and analyze lawsuit filings trends broader than those just involving securities class action lawsuits, that filing subcategory is generally an area of widespread interest and it would be interesting to have the benefit of the authors’ analysis of this specific subcategory.

All of that said, the study provides an interesting and important overview of the way that the credit crisis litigation wave has evolved over time. We can all hope that the authors will continue to track the filings and to provide further updates as the credit crisis litigation wave continues to evolve.

A complete list of the credit crisis-related securities lawsuit filings is accessible here, and a table reflecting credit-crisis related securities lawsuit case resolutions is accessible here.

Speakers’ Corner: During the period June 21-23, 2009, I will be in Palo Alto, California, where I will be participating as a faculty member at the Stanford Law School Directors’ College. A summary agenda for the event can be found here.

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In a June 17, 2009 opinion (here), the Eleventh Circuit upheld the district court’s entry, in connection with the $445 million partial settlement of the HealthSouth securities action, of a bar order that extinguished Richard Scrushy’s contractual claims both for indemnification of any settlement he may enter in the case as well as for advancement of his legal defense costs. The opinion raises interesting and important issues and arguably includes some troublesome analysis, particularly with respect to the advancement issues.

Background

In 1994, Scrushy and HealthSouth had entered an agreement requiring HealthSouth to indemnify Scrushy to the fullest extent permitted by law. The agreement also entitles Scrushy to receive advancement of attorneys’ fees as they become due, provided he agrees to repay the amount advanced if it is later determined that he is not entitled to be indemnified.

In 2003, HealthSouth, Scrushy and several other HealthSouth officials were sued in a series of securities class action lawsuits that were later consolidated. Refer here for background regarding the case. In 2006, HealthSouth and several of the officials reached a partial settlement agreement in which HealthSouth and its insurers agreed to pay the plaintiffs $445 million. (The insurance carriers paid $230 million of this settlement amount.) Scrushy was not a party to this settlement, and he has still not settled.

The parties’ stipulation of settlement proposed several bar orders for the court’s approval. Among other things, the proposed bar order extinguished any non-settling party’s claim for contribution against settling parties. The contribution bar order is reciprocal (that is, HealthSouth’s contribution claim against Scrushy is also barred), and is also balanced by a judgment credit, under which a future judgment against non-settling party is to be credited by the amount of the settlement.

The district court entered the bar order over Scrushy’s objections that the order extinguished his contractual indemnification and advancement rights. Scrushy appealed to the Eleventh Circuit.

The Opinion

Scrushy raised several arguments against the bar order, contending first that the mandatory contribution bar in the PSLRA was exclusive, and therefore the bar could extend only to his rights to contribution, but not to his separate contractual rights of indemnification and advancement. The Eleventh Circuit held that the PSLRA’s contribution bar was not exclusive, and in fact was enacted against a background of established case law which had approved bar orders precluding indemnification claims.

Scrushy also argued that under case law and the PSLRA if he were to be deprived of valuable rights in a contribution bar order, he is entitled to compensation. The Eleventh Circuit held that the judgment credit represented very valuable compensation, since if Scrushy were to take the case to trial, the plaintiffs "will recover nothing at all from Scrushy and other non-settling defendants unless the verdict exceeds $445 million." The court also noted that Scrushy should be able to use that fact as "a very significant bargaining chip" in settlement negotiations with plaintiffs.

Scrushy argued further that depriving him of his indemnification rights would be contrary to public policy under Delaware law designed "to encourage qualified individuals to serve as corporate officers." The court said that these considerations must be "balanced against countervailing policies in favor of settlement." The court also referenced extensive case law that indemnification of securities violations is inconsistent with policies underlying the securities laws. The court concluded that the bar order’s elimination of Scrushy’s indemnification right was not against public policy.

The court then turned to Scrushy’s argument that the bar order’s elimination of his advancement rights was inappropriate. Scrushy argued that his rights of advancement were independent of any liability he might have to plaintiffs, and therefore it inappropriate in a settlement involving plaintiffs’ liability claims to strip him of his independent contractual rights.

The court conceded that "no circuit court… has addressed this issue" and acknowledged that the injury to Scrushy with respect to his advancement rights is not measured with respect to amounts Scrushy might have to pay to the plaintiffs. However, the court said that "the attorneys’ fees are nonetheless paid on account of liability to the underlying plaintiffs or risk thereof." The court found that the claim for attorneys’ fees "clearly cannot be considered to be independent of his liability to the underlying plaintiffs" because it is "so close in nature of the claims which established case law holds are appropriately barred" that so holding is "a minimal and reasonable extension thereof."

Scrushy raised a separate public policy argument with respect to his advancement rights, arguing that Delaware law "supports advancement of litigation fees for officers and directors to ensure that they will resist unjustified claims, and to encourage qualified individuals to serve."

The court recognized that in the absence of fee advancement "an innocent officer might have difficulty proving his innocence, and thus might have difficulty realizing a prevailing status." But the court said these considerations have to be balanced by policies in favor of settlement. It noted that HealthSouth might well have been reluctant to settle if "it would continue to be liable for endless legal fees to fund Scrushy’s individual defense" as that would constitute "limited peace." The Eleventh Circuit also said (and I want to take care to quote this carefully here) "advancement of legal fees might be inconsistent with the policies underlying the securities laws."

The court rejected Scrushy’s argument that he was not compensated in the bar order for the elimination of his advancement rights; the court said the "overall compensation was adequate" given the judgment credit.

Accordingly the Eleventh Circuit held that the district court to not abuse its discretion in entering the bar order.

Discussion

At one level, the outcome of this dispute is hardly surprising, as it is particularly difficult to meet the "abuse of discretion" standard applicable to the Eleventh Circuit’s review of the district court’s entry of the bar order.

On the other hand, the Eleventh Circuit’s apparent commitment to upholding the settlement and to rejecting Scrushy’s claims seems to have driven their consideration of these issues, and whether or not the outcome ultimately is appropriate, there are parts of the court’s analysis that I find less than comfortable.

Although I also have issues with respect to the court’s analysis of indemnification issues, my real concerns relate to the court’s holding regarding Scrushy’s advancement rights.

In particular, the court gave very short shrift to Scrushy’s public policy arguments regarding advancement. True, the court did concede that an innocent officer "might" have difficulty proving his innocence if his advancement rights are eliminated, and (the court delicately added) "might have difficulty realizing a prevailing status."

A fair assessment of these points would not be written in the conditional sense -- there is no "might" about it. The reality is that company official whose advancement rights are cut off is pretty much screwed unless he or she has individual resources to defend him or herself. (I am setting insurance issues to the side here, in order to concentrate on the advancement issues).

I also think the court strained very hard but not very convincingly to substantiate its conclusion that Scrushy’s advancement rights are not independent of the plaintiffs’ liability claims against him.

My overwhelming impression of this opinion is that the outcome was dictated by the identity of the appellant. The fact that it was the notorious and reviled Richard Scrushy before the court clearly seems to have had an impact, and in particular a presumption of Scrushy’s liability for the violation of which he is accused pervades the Eleventh Circuit’s opinion. For example, the Eleventh Circuit said that "Scrushy made no showing in the district court that he was merely an innocent bystander with respect to the violations at issue here."

The court also noted, approvingly, that "a party in HealthSouth’s shoes might well have been more willing to leave extant the contractual claims for advancement of fees on the part of an outside director who could adduce evidence of excusable ignorance of the violations."

The unmistakable message seems to be that it is OK for the bar order to extinguish Scrushy’s advancement rights because we all know that he is a bad guy. Indeed, the popular consensus is that Scrushy is a bad guy and even that he did all the stuff that plaintiffs allege. But in our system, we generally require these kinds of things to be proven before they can serve as the basis for depriving someone of their contractual rights. Scrushy was in fact acquitted in the criminal trial relating to these allegations, though later convicted on unrelated bribery and racketeering charges. The entry of the bar order did not follow a trial, it followed only a fairness hearing. (Readers who feel I am disregarding some important findings of fact in connection with these proceedings are invited to let me know if I am overlooking something.)

Several days ago I defended Bank of America’s advancement of Angelo Mozilo’s defense fees (see my prior post here), and many of the things I said there seem applicable here. In reflecting on these issues, I find myself wondering about the Eleventh Circuit’s consideration of public policy under Delaware law. I can’t help but find the contrast overwhelming between the outcome of the Eleventh Circuit’s analysis on the advancement issue here, and the ruling of the Delaware Chancery Court in the Sun-Times case (linked in my earlier post about Mozilo) that the company had to continue to advance defense costs even though the former officers had been convicted of crimes, had been sentenced and were in jail.

It seems to me that the right way to think about the advancement issue is to forget that the appellant here was Richard Scrushy and imagine instead that we are talking about some poor anonymous sucker that got cut out of a settlement and now faces a panoply of securities law allegations by himself. Imagine further that unlike Scrushy the poor sucker has no independent resources with which to defend himself. Perhaps the outcome on the question of the appropriateness of a bar order extinguishing advancement rights might be the same for the poor sucker as it was here. But I find the impression overwhelming that the outcome of this case had to do with the fact that it was about Scrushy and not some anonymous poor sucker.

My final concern about this opinion is that in its zeal to uphold the settlement against Scrushy’s challenge the court managed to say some things that simply don’t stand up. The worst example is the court’s statement (which I quoted carefully above) that "the advancement of legal fees might be inconsistent with the policies underlying the securities laws." I really cannot explain or understand this statement, but it seems to be a very radical suggestion to even pose the possibility that it is against public policy for companies to advance defense fees on behalf of corporate officials who have merely been accused of securities laws violations.

I feel confident that this is a proposition that would elicit no assent in any quarter, but if it were an accurate statement of the law, I think we would see a wave of mass resignations as no one would voluntarily undertake the kind of risks that this proposition implies.

I have said some strong things here. I hope readers who disagree with my view of this case will take the time to add their comments to this post.

Many thanks to a loyal reader for providing me with a copy of the Eleventh Circuit opinion.

UPDATE: On June 18, 2008, a Jefferson County (Alabama) Circuit Court judge entered a $2.8 billion judgment against Richard Scrushy following a bench trial in a derivative lawsuit filed against him. Although there are no findings of fact in the Final Judgment (copy here), the order clearly represent a finding that Scrushy engaged in the alleged misconduct. This ruling obviously puts the Eleventh Circuit's decision in a different light. However, this ruling had not yet been issued at the time the Eleventh Circuit issued its decision, so I think many if not all of my questions raised above remain valid given the record before the Eleventh Circuit at the time it ruled.

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A frequent securities class action lawsuit accompaniment is a companion ERISA stock drop lawsuit brought on behalf of employee participants in the defendant company’s benefit plan. These ERISA lawsuits have in recent years resulted in a string of impressive settlements, although the plaintiffs have not fared as well in the few cases that have actually gone to trial. In a ruling that could have significant implications for other cases, on June 1, 2009, the court in the latest of these cases to go to trial – the high-profile Tellabs ERISA case – entered a sweeping ruling (here) in defendants’ favor. 

Because the court in the Tellabs ERISA case ruled in defendants’ favor following trial both with respect to the “prudence” and the “disclosure” issues, and because the disclosures at issue involve many of the same alleged misrepresentation issues as are raised in the much-chronicled Tellabs securities class action (about which refer here and here), the defense ruling in the Tellabs ERISA case could proved to be particularly significant.

Background

The Tellabs ERISA case relates to issues raised by participants in Tellabs’ retirement and savings plan. During the class period of December 11, 2000 through July 1, 2003, the plan offered participants twelve different investment choices, including one fund that was invested exclusively in Tellabs stock. 

Tellabs itself had a record year in 2000, but beginning in the first quarter of 2001, Tellabs began to experience a downturn in product demand as well as increased costs. As the year progressed, senior company officials (many of whom were plan fiduciaries and who were subsequently defendants in both the securities lawsuit and the ERISA lawsuit) made a number of statements about the company’s business performance and business prospects. The company along with the rest of the telecommunications industry continued to face business challenges during 2002 and 2003. During the class period, Tellabs share price declined from $63.19 to $6.58 per share.

In their lawsuit, the plaintiffs contended that Tellabs and the individual plan fiduciaries breached their duties under ERISA. Among other things, the plaintiffs contended that the defendants breached their fiduciary duty of prudence by allowing and holding instruments in the Tellabs stock fund. The plaintiffs also alleged that the defendants breached their duty to honestly disclose material information.

The case was tried in an eight day bench trial in late April and early May 2009, and on June 1, 2009, Northern District of Illinois Judge Matthew Kennelly issued his findings of fact and conclusions of law, which can be found here.

The Court’s Rulings

Judge Kennelly found for the defendants on essentially all points. With respect to the issue whether the defendants violated the duty of prudence by allowing the plan to continue holding and investing in Tellabs stock, the court found that the defendants demonstrated “procedural prudence.” He found that “by virtue of their roles as high level executives,” they had extensive discussion of Tellabs’ business and future prospects “albeit outside the context of investment and administrative committee meetings.”

The court added that “though it would have been wise for defendants to conduct a more formal review of the Tellabs stock funds and to document that review, its absence does not mean they were imprudent in light of their intimate knowledge of Tellabs.”

Judge Kennelly further held, on the issue of so-called “substantive prudence,” that the “evidence shows that a reasonably prudent individual in similar circumstances who undertook such an examination would not have sold the Plan’s stock or removed it as an investment options,” notwithstanding the business challenges that the company was facing. Based on his review of how the business issues unfolded and how the defendants’ responded, Judge Kennelly concluded that “a reasonable fiduciary in similar circumstances would not have concluded that the Plan should have divested its Tellabs stock or ceased offering it to participants as an investment option.”

With respect to the plaintiffs’ allegations about the inadequacy of defendants’ disclosures about Tellabs and its financial results and prospects, the court concluded that the defendants did not make any material misrepresentations, adding that “Defendants certainly made a number of predictions about Tellabs and the communications industry that turned out to be wrong,” but the “evidence does not demonstrate that defendants misrepresented either the facts or their expectations when they made these statements.”

Finally, Judge Kennelly also ruled in the defendants’ favor on statute of limitations issues. The defendants had argued that the plaintiffs’ claims were barred by the three year statue of limitations. Plaintiffs had argued that due to defendants’ concealment of the fraud, a six-year statute of limitations should apply and therefore the claims were not time-barred. In a pretrial ruling, Judge Kennelly had found that there were disputed issues of fact on the question of concealment. But following trial, he concluded that there was no evidence of concealment and therefore that the three-year statute applied and accordingly the plaintiffs’ claims also failed because they are time-barred.

Discussion

It is not just that Judge Kennelly’s rulings represent a clean sweep for the defendants. It is that this is the latest of the high profile post-Enron ERISA stock drop cases in which the defendants have prevailed following trial. Other high profile examples include the DiFelice v. U.S. Airways case, in which the defendants’ trial court victory was affirmed in 2007 by the Fourth Circuit (refer here). In addition, in 2008, the Seventh Circuit affirmed (here) the defense verdict in the Nelson v. Hodowal ERISA stock drop case (albeit in a narrow ruling).  

Trials in these cases are rare, but the track record of defense verdicts at some point may begin to tell, both with respect to which cases get filed and with respect to how the cases settle. In particular with respect to settlement, a demonstrated defense willingness to take a case to trial could begin to have a downward effect on settlements.

Chuck Jackson of the Morgan Lewis firm, who successfully represented the defendants at trial in both the Tellabs ERISA case and in the earlier DiFelice case, wrote (here) with his colleague Christopher Wells following the DiFelice case that:

a plaintiff’s knowledge that an insured and insurer are willing to go through trial if necessary should have the effect of driving down settlements to more properly correspond to the merits of the particular claims, rather than simply fixing a price based on perceived trends, the limits of the insurance polices and a mushy ‘what if’ analysis based on Rule 12(b)(6) rules.

These points seem even more valid in light of the outcome of the Tellabs ERISA case.

The DiFelice case has rightly been viewed as significant because the court ruled in the defendants’ favor on the prudence issue, even thought the company wound up in bankruptcy. The Tellabs ERISA case may be even more significant because the court ruled in defendants’ favor on both the prudence issue and on the disclosure issue.

Plaintiffs are often attracted to ERISA stock drop cases because they can allege disclosure shortcomings without having to plead or prove scienter, as they would in trying to make a claim for securities fraud. Plaintiffs also try to insinuate in settlement negotiations that the court will be predisposed to favor their claims because the plan participants have seen their retirement funds substantially or entirely diminished.Judge Kennelly ruled in the defendants favor notwithstanding and seemingly without regard to these presumed plaintiffs’ advantages.

Judge Kennelly’s rulings on the disclosure issues may also be significant because of the prominence of the virtually identical disclosure allegations in the high profile Tellabs securities case. The Supreme Court opinion and the subsequent Seventh Circuit opinion in the Tellabs securities case were based solely on plaintiffs’ allegations, which were taken as true due to the procedural posture of the case.

However, Judge Kennelly made specific findings of fact based on an evidentiary record. . Judge Kennelly clearly credited he testimony of the Tellabs witnesses. His conclusion that the defendants did not make any material misrepresentations suggests that the securities plaintiffs’ allegations also ultimately may be unsustainable. Judge Kennelly’s conclusions that the defendants did not misrepresent either the facts or their assessments provide an important context for subsequent proceedings in the case.

Judge Kennelly’s final ruling on the statute of limitations issues may be significant in another way, as it seems to be one more basis on which the ruling could withstand appellate scrutiny. Adding the statute of limitations ruling at the end of his findings and conclusions seemingly another way for the appellate court to adopt the district court’s rulings.

Many of these ERISA stock drop cases contain very similar allegations to those in the Tellabs ERISA case. That is, as in the Tellabs case, the plaintiffs allege that the defendants were imprudent in allowing plan assets invested in company stock and that the defendants failed to disclose to plan participants what the defendants knew about the company’s business results and prospects. According to Jackson, Tellabs counsel in the ERISA trial, the detailed findings of fact and conclusions of law provide “a blueprint for how to try this kind of case.” The court’s findings and conclusions certainly show the challenges plaintiffs face in trying to substantiate these kinds of allegations and also show how defendants can go about refuting the allegations.

To be sure, there may not be a sudden rush of trials in these kinds of cases. These cases can be notoriously expensive to litigate, and costs and uncertainty of litigation will undoubtedly continue to motivate parties to these cases to seek settlement. But the outcome of the Tellabs ERISA case will hearten those who want to fight these kinds of allegations, and may increase the likelihood that the cases settle for reasons related to the merits.

Our congratulations to Tellabs’ trial counsel, Chuck Jackson of the Morgan Lewis firm, for his great victory in this case, as well as in the DiFelice case. Jackson has clearly staked out a very clear specialty in trying these kinds of cases. His track record certainly is solid. 

Special thanks to a loyal reader for providing a copy of the findings and conclusions.

Seinfeld on Risk Management: George Costanza has to read a risk management textbook, takes advice from a blind man, winds up lecturing (unintentionally) about Ovaltine. Hat tip to the Insurance Journal for the video link.

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In the latest twist in the long-running options backdating saga, and in what appears to be a significant milestone in the options backdating-related gatekeeper claims, on June 15, 2009, Vitesse Semiconductor announced (here) that it had reached a settlement with its former auditor, KPMG LLP, in connection with the option backdating related allegations. In the settlement KPMG agreed to pay $22.5 million and to forgive past indebtedness.

As discussed at greater length here, in June 2007,Vitesse sued KPMG in Los Angeles County Superior Court alleging that KPMG had been negligent in auditing the company’s stock option grants and financial statements during the years 1994 to 2000. Vitesse later amended the complaint to include the years 2001 to 2004.

Vitesse itself had been the subject of an options backdating-related securities class action lawsuit in the Central District of California, as described here. Vitesse settled that lawsuit for a payment $10.2 million in cash, $8.75 million of which came from the company’s D&O insurance carrier, and the balance in payments from individual defendants. The settlement also included the transfer of shares of Vitesse stock from Vitesse and from the individual defendants.

The plaintiffs in the options backdating securities lawsuit had also sued KPMG and as reflected here, on June 16, 2008, the parties to the securities lawsuit filed a stipulation of settlement in which KPMG agreed to contribute $7.750 million toward the class settlement.

KPMG’s recent $22.5 million settlement of Vitesse’s own lawsuit is in addition to KPMG’s separate $7.750 million contribution to the settlement of the securities class action lawsuit.

As I recently noted (here), the options backdating securities class action lawsuits themselves appear to be winding down, but until word circulated of KPMG’s settlement with Vitesse, I had not heard of the resolution of any cases that companies themselves had filed against their outside professional advisors.

Even if there were prior outside gatekeeper settlements that I missed, the KPMG settlement with Vitesse has to be the most significant settlement between an outside gatekeeper and a company with respect to the options backdating scandal. It will be interesting to see whether the final stage of the options backdating saga includes further significant gatekeeper claim resolutions. Given the magnitude of the KPMG settlement, it would certainly seem that there could be other significant settlements and perhaps even the assertion of additional claims.

I would be very interested to know if readers are aware of the resolution of any other cases that companies have filed against their outside professionals in connection with the options backdating scandal.

As noted here, KPMG is also the subject of a trustee’s claim in connection with the New Century Financial Corp. bankruptcy proceeding. KPMG also remains a defendant in the New Century subprime-related securities class action lawsuit, after its motion to dismiss in that case was denied, as discussed here.

How Will GM Sell Cars Now?: General Motors certainly faces a daunting challenge trying to sell cars as a bankrupt company. I have posted a video link below of an irreverent but particularly funny take on what a bankrupt GM’s ads might look like. The spoof ad does a great job ripping conventional car ad clichés, which clearly won’t work now (if they ever did).

Hat tip to the Planet Money blog for the link to the video. Warning, the ad contains language some might consider offensive.

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Most reasonably sophisticated consumers understand that the cheapest running shoes may be no bargain, that the least expensive cellular plan may have big gaps, and that selecting legal counsel based on which attorney charges the least is fraught with peril. Yet when it comes to D&O insurance, these same buyers are often only concerned with which is the lowest cost alternative, without complete consideration whether the cheapest coverage fully addresses their insurance needs.

The assumption behind many insurance purchasing decisions is that the various alternatives are basically equivalent, and the only relevant variable is price. Whether or not this assumption would be valid for personal insurance like home or auto, for which the insurance is generally issued on standard forms, it definitely is not true with respect to D&O insurance.

There is no standard D&O insurance policy form; to the contrary, the various carriers’ base forms vary significantly, and many of the key terms are negotiable, particularly with respect to public company D&O insurance.

So the assessment of D&O insurance alternatives often involves – or rather should involve – careful comparison between a host of relative advantages and disadvantages, among which price is one of many important factors to be considered.

Despite the many subtle but nonetheless critically important differences between D&O insurance alternatives, many insurance buyers, even those who otherwise qualify as very sophisticated, ultimately make their selection based solely upon price, even though they would never depend solely on price alone when selecting, say, a pair of running shoes, a cellular plan, or an attorney to represent them.

When it comes to running shoes, cellular plans or attorneys, consumers both understand what these goods and services are for and they also fully expect to use these goods and services. When it comes to D&O insurance, however, the same buyers are unconsciously assuming that they will never actually need to use the product, and that the insurance acquisition is nothing more than a box-checking exercise. D&O insurance? Yep, got that.

The one subset of insurance buyers who do not need to be reminded when selecting among D&O insurance alternatives of how important it is to consider all issues, and not just price, are company officials who have previously been involved in a D&O claim. These individuals fully understand what D& O insurance is for, and they often have a deep appreciation of the way that seemingly small difference in policy language can have a significant impact on the extent of coverage in the event of a claim.

After over a quarter of a century of involvement with directors’ and officers’ liability issues, I have seen hundreds of claims involving thousands of individual director and officer defendants. I have seen highly regarded individuals, who have amassed a lifetime’s worth of wealth and prestige, have everything they worked for their entire careers come crashing down around them. I have seen formerly powerful executives taken away in handcuffs. I have seen grown men cry. None of these individuals ever thought they would ever find themselves in these circumstances – but they did. I guarantee you that not one of them, finding themselves caught up in these circumstances, thought to themselves “Boy, I sure am glad we got the cheapest D&O insurance we could find.” .

The D&O insurance acquisition process cannot be built on the assumption that those things might happen, but not to my company and certainly not to me.  The entire acquisition process has to be built on the assumption that these things will happen to this company.

Of course, not all D&O claims are catastrophic, but the one thing I know for sure about D&O claims is that, whether or not they are catastrophic, the quality of the D&O insurance available at the time of the claim is critically important. The time to analyze whether or not the D&O insurance program is built to respond to the range of possible claims circumstances is not when the claim comes in, but when the insurance is purchased.

Cost is of course an indispensible consideration and price considerations should always be taken into account. In fact, I have many times recommended to clients that they select an alternative that is the lowest cost option. But when I make that recommendation, price alone is neither the sole nor the most important criterion.

D&O insurance buyers whose advisors recommend the lowest priced alternative need to consider whether (a) the advisor is recommending the lowest priced alternative because it really is the best option for the company based on full consideration of all relevant factors; (b) the advisor is recommending the lowest price alternative because he or she thinks that is what the buyer wants to hear and that’s what it will take for the advisor to get or keep the business, and he or she doesn’t have the guts to provide an independent and fully considered recommendation; or (c) the advisor doesn’t have a clue what the important differences are between the available alternatives and the only distinction the advisor can explain is the cost difference.

I am often asked to review public companies’ D&O insurance programs. In many cases, the companies have insurance programs that are more or less matched to their requirements and circumstances. But in a surprising number of cases, the programs I review lack critically important features that could dramatically affect the availability of coverage in various claims circumstances. Sometimes these underserved policyholders are also over-paying for their insurance, which has its own set of implications. But more often, the company itself has selected into an inadequate insurance program because they chose their insurance based solely on price.

Price considerations alone are not enough to allow a buyer to select the best running shoes, cellular plan or legal counsel. Price considerations are important of course, because no one should overpay for something. Often the way to make the optimal purchase is to get assistance from someone who knows more about the products and services.

Insurance buyers may never have to use their D&O insurance, but policyholders don’t want to find out when a claim arises that the cheap insurance they bought was no bargain. That is why it is indispensible to have a skilled and experienced insurance advisor involved in the D&O insurance transaction, one that understands and can explain the differences between the insurance alternatives and that can recommend the alterative that will best meets the company’s needs and finances.

Where are You Going, Al? Can’t You Read?: Any alpaca having the temerity to disregard this sign will find itself in very serious trouble.

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In what has become a weekly ritual as 2009 has progressed, each Friday evening after the close of business, the Federal Deposit Insurance Corporation (FDIC) announces the names of the banks it has taken over that week. The current number of year-to-date bank closures stands at 37, which already represents the highest annual total since 1993, the end of the last era of failed banks. All signs are that the number of bank failures will continue to grow in the months ahead, a prospect that is affecting the D&O insurance marketplace, even for smaller community banks.

In the latest issue of InSights (here), I take a look at the background regarding the current wave of bank closures and examine the D&O insurance marketplace’s reaction to these developments.

One of the issues discussed in the article is the surprising number of failed banks in Georgia. The June 10, 2009 Wall Street Journal has an article entitled "Failed Banks's Dot Georgia's Vista" (here) discussing the reasons for the high number of bank failures in that state.

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A variety of news articles and blogs have expressed surprise and even outrage that Bank of America is advancing the legal expense that former Countrywide CEO Angelo Mozilo is incurring in defending against the various claims that have been raised against him, including the recent SEC enforcement action.

There is no particular reason for me to bestir myself to justify BofA’s action, particularly since Mozilo has done such an effective job making himself look like a cartoon villain (as I discussed here). But under Delaware law and under the legal understandings that BofA reached when it acquired Countrywide, BofA has a legal obligation to advance Mozilo’s expenses. The only outrage would be if BofA refused to do so.

Countrywide was a Delaware Corporation. BofA is a Delaware Corporation. Under Section 145(e) of the Delaware General Corporation Law, companies are permitted to advance expenses directors and officers incur in defending claims brought against them for actions undertaking in their capacities as directors and officers. Most companies’ by-laws make these advancement requirements mandatory, which I presume would have been the case for Countrywide. Mozilo may even have had a separate advancement and indemnification agreement; many senior executives do. In addition, as reflected in a June 9, 2009 Bloomberg article (here), the two companies’ July 1, 2008 merger agreement specified that Bank of America would maintain Countrywide’s existing indemnification rights for six years.

There is a very good reason for the legal formality surrounding advancement and indemnification; that is, the question of entitlement to these rights usually comes up only after serious allegations have arisen. Accordingly, it is important to lock down rights and obligations at a calmer time, so that duties and expectations are clear if questions later do arise. Having entered these agreements, companies are not at liberty to dispense with the commitments simply because they later find it distasteful or repugnant to honor the commitments.

Mozilo may well be one of the most unpopular figures in the United States right now, and a lot of people want to make him the poster child for everything that went wrong with our financial system. But as reviled as some might perceive him to be, that does not deprive him of his legal rights nor does it relieve BofA, as Countywide’s successor-in-interest, of its legal obligations.

Keep in mind that Mozilo has not been convicted of anything (yet?) – indeed, though he is one of the subjects of an SEC civil enforcement action, no criminal charges have been brought against him. Nor has he yet been found liable in any of the many civil actions against him.

Indeed, even if criminal charges had been brought, Mozilo would nonetheless retain the right to advancement of his defense expenses. In considering the extent of Mozilo’s rights, it is important to recall the July 30, 2008 Delaware Chancery Court opinion (here) in which Vice Chancellor Leo Strine held that the Sun-Times Media Group had to continue to advance the defense expenses of four former officers, including Lord Conrad Black, even though: 1) the four had been convicted of various criminal offenses; 2) the four had already been sentenced; 3) the convictions had been upheld on appeal; and 4) the company had already advanced $77 million in defense expenses for the four. Vice Chancellor Strine held that under Delaware statutory law and the applicable by-law provisions, requiring advancement until "final disposition," the obligation to advance expenses continued until the "final, non-appealable conclusion" of the criminal action, which had not yet been reached.

Whatever else may be said, advancement rights are enforceable and durable. (I will leave aside the problem created by the Schoon v. Troy case, about which refer here, which did seemingly permit the retroactive elimination of advancement rights, the Delaware legislature recently created a statutory remedy for that bobble.)

BofA is of course entitled to obtain from Mozilo an undertaking to repay the expenses advanced if it is later determined that he did not act in "good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation." Mozilo is a very wealthy man, wealthy enough that if the statutory standard for repayment is triggered, BofA can try to recover the amount advanced – that is if there’s anything left at that point.

I understand that the main objection to BofA’s advancement of Mozilo’s defense expenses is that BofA has accepted $45 billion in bailout money. The objection is that taxpayers are effectively paying Mozilo’s legal fees, or something like that.

One might try to argue that, because taxpayers shouldn’t have to foot the bill, companies accepting bailout funds ought to be required to terminate advancement or indemnification rights of former officers and directors, but as far as I know there were no such requirements imposed in connection with the bailout money provided to BofA. Moreover, even though Congress has a pretty impressive record of trying to impose retroactive conditions on bailout recipients -- without the slightest regard for the requirements of binding contracts -- there are still some very good policy reasons why even Congress would have to hesitate to retroactively superimpose a bailout condition like that.

In any event, the objection about Mozilo’s defense expenses is not to advancement of defense expenses as a general matter, but to advancement for Mozilo in particular. There is no principled basis on which to isolate one individual, no matter how unpopular he may be, and single him out as the one person retroactively disentitled to his otherwise enforceable rights. To put it another way, if Mozilo is not entitled to advancement, then no current or former director or officer from an entity receiving bailout funds should be entitled to advancement. I suspect that even the most thick-skulled, grandstanding member of Congress would see the policy concerns with taking that position.

There is an added component to this question – that is, the extent to which Countrywide’s D&O insurance may be reimbursing BofA for its advancement of Mozilo’s defense expense. Countrywide undoubtedly carried D&O insurance, likely with limits of liability in the tens and perhaps in the hundreds of millions of dollars. The Countrywide insurance program may have had a significant self-insured retention, but that has likely been satisfied even if it is many millions of dollars.

The problem with D&O insurance as a source of reimbursement for defense expenses is that there are so many lawsuits against Countrywide and its directors and officers in so many different courts that the insurance limits could quickly be depleted or even exhausted, assuming for the sake of discussion that the carriers have not asserted defenses to coverage.

To the extent not reimbursed by insurance, BofA will have to advance Mozilo’s defense expenses. For those who still just find this too much to swallow, here’s one final thought – even if BofA is obliged to pay Mozilo’s defense expense due to an undertaking the merger documents, BofA appears to be making money from the Countrywide acquisition. According to Bloomberg (here), BofA reported mortgage-banking income in the first quarter of $3.71 billion, compared to $1.52 billion in the first quarter of 2008, "because of surging demand for home loan refinancings." This is a significant form of consolation for the fact that BofA is on the hook for Mozillo’s defense expenses.

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Remember options backdating? There is still a raft of unresolved options backdating cases out there, but at least one of the remaining options backdating related securities class action lawsuits has now been settled.

On June 9, 2009, Marvell Technology announced (here) that it has reached an agreement to settle the case for a payment to the class of $72 million. I have added the Marvell case to my table of options backdating case resolutions, which can be accessed here.

With the addition of the Marvell case, 27 of the 39 options backdating-related securities class action lawsuits have now been resolved. Nine have been dismissed and eighteen have been settled. Twelve of the 39 have not yet been resolved. A complete list of the options backdating lawsuits can be found here.

According to the Securities Litigation Watch "Options Backdating Scorecard" (here), the average options backdating class action settlement (including the Marvell settlement) $82.5 million, but if the $895 million UnitedHealth Group settlement is excluded, the average settlement (again including the recent Marvell settlement) $34.71 million, which suggests that the Marvell settlement was well above the prior adjusted average options backdating securities class action lawsuit settlement.

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Something hit me this past week as I was reviewing the latest Madoff-related complaint to cross my desk. The class action complaint (here), was filed on May 29, 2009 in the Middle District of Florida by a Florida physician who had a Swiss Life variable annuity policy that was invested in the Platinum All Weather Fund (the "Fund"), a mutual fund offered by Nomura. The Fund in turn was invested in certain other investment vehicles that had simply turned their assets over to Madoff. According to the complaint, the entire Fund has now been written down to zero.

The Madoff-related losses alleged in the complaint are all too familiar, but what struck me as I reviewed these latest allegations is what an incredibly far-flung, diverse and many-tentacled monster the Madoff fraud scheme was. And as diverse and dispersed as the consequences of the Madoff scandal have been, so too is the wave of litigation that has followed in the wake of the scheme’s collapse.

When I first started tracking the Madoff-related litigation last December, it seemed like a relatively straightforward undertaking. But now the list of Madoff-related lawsuits (which can be accessed here) runs to some 18 pages, and the lawsuits continue to pour in. In reviewing this now-lengthy and growing catalog of claims, the most striking thing is what a varied assortment of lawsuits the Madoff scandal has produced. Even though there is a great deal of duplication among the claims, the list encompasses a spread and scope of lawsuits that defied brief summarization.

At first, the stream of lawsuits involved the money managers that ran the now-infamous rogues’ gallery of Madoff-related "Feeder Funds," such as Walter Noel, Stanley Chais and Ezra Merkin. Lawsuits involving these individuals and their associated firms continue to come in. But as the lawsuits have piled up, the claims have targeted an ever-broadening array of individuals and entities, as demonstrated by the lawsuit described above against a Swiss insurer and a Japanese investment management firm.

The list of litigation targets includes Spanish and Austrian banks, Cayman Island hedge funds, Irish investment custodians, private banks based on Gibraltar, investment management firms in Luxembourg, and many other individuals and entities spread across the entire globe. The overall impression from this geographically diverse mix of defendants is that until the scheme collapse, the entire world seems to have gone completely Madoff.

Several other recently filed complaints highlight the geographic dispersion of defendants targeted in the Madoff-related lawsuits.

For example, on May 15, 2009, an investor filed a derivative complaint (here) in New York (New York County) Supreme Court against Kingate Global Fund Limited, a British Virgin Island fund, as nominal defendant, as well as against related Kingate entities and individuals. The complaint alleges that the fund was a Madoff feeder fund with substantially all of its assets invested with Madoff or his firm. (On April 17, 2009, Irving Picard, the liquidator of Madoff’s firm, separately filed an action, here, in the Southern District of New York bankruptcy court against Kingate and related funds.)

On May 7, 2009, investors who had purchased limited partnership interests in investment funds offered and managed by Swiss bank Union Bancaire Privée (UBP) and related entities filed a class action complaint (here) in the Southern District of New York against UBP and associated entities and individuals, alleging that the defendants had invested a "material amount of the investment capital of the UBP funds" with Madoff’s firm.

On May 29, 2009, the R.W. Grand Lodge of Free and Accepted Masons of Pennsylvania filed a complaint (here) in the Eastern District of Pennsylvania against Meridian Diversified Fund, a Cayman Island "fund of funds" that had invested in the Rye Select Broad Market XL Fund managed by Tremont Partners, which in turn had invested significant assets with Madoff. (The Meridian funds have themselves initiated a separate action, here, against Tremont and related entities.)

The claim diversity is not merely geographic. In looking over the lengthy list of lawsuits, some of the claims seem to have taken their inspiration from the theater for the absurd. For example, there is the pro se complaint (which can be found here and that is described in greater detail here), in which the plaintiff purported to sue, among others, Brittney Spears and Kevin Federline, on Bernard Madoff’s supposed behalf, alleging among other things that Spears had "secret affairs with Madoff in return for Saks Fifth Avenue gift certificates."

Some of the lawsuits reveal the private pain that has accompanied Madoff victims’ losses, as shown for example in the lawsuit (here) filed in New York (New York County) Supreme Court by Steven Simkin against his former wife Laura Blank, in connection with the Madoff-related investment the couple had maintained while married. It appears that in their divorce, Simkin had paid millions to buy out his wife’s share of the Madoff investment, which is now worthless. Simkin’s suit seeks reformation of the agreement in which the couple had divided the marital assets. A tough situation for Mr. Simkin, no doubt; one can only wonder about his former wife’s sympathies for his plight.

So much of this Madoff-related litigation is like that of Mr. Simkin, a desperate bid to salvage something from the losses on now worthless investments. Some of these lawsuits, particularly those against solvent, deep-pocketed defendants potentially could result in substantial recoveries. But in far too many of the other lawsuits, there may be no assets against which to recover, even if the claims are otherwise successful.

In some instances, the defendants may have insurance that these claims could implicate. However, the costs of litigation may erode or even deplete the available limits long before any claimants have a chance to access the policy proceeds. Moreover, in many cases, the same defendants have been targeted so many times by so many different claimants that whatever assets or insurance the targets may have are likely to satisfy only a very small amount of the various plaintiffs’ claims.

Despite these obvious difficulties, the Madoff-related lawsuits continue to pile up. In most instances, the complaints are salvage operations fueled by anger and frustration. The one thing that is clear is that the collapse of Madoff’s fraudulent scheme will be keeping lawyers occupied for years and years to come.

I would be remiss in closing this post if I did not recognize the contributions of the many loyal readers who have provided me with copies of complaints or alerted me to lawsuits that were missing from my list. The list truly is a product of this blog’s community of readers. My very special thanks to all who have contributed.

A Classical Allusion: Readers of a certain age may recognize the title of this post as an allusion to the 1963 movie, It’s a Mad, Mad, Mad, Mad World. The movie, whose all-star ensemble cast included, among others, Jimmy Durante, Spencer Tracey, Phil Silvers, Sid Caesar, and Jonathan Winters, involves the mad scramble of various drivers to recover the hidden loot revealed in the dying words of the automobile accident victim whose death they all witnessed.

Cherished memories of my childhood enjoyment of this movie motivated me to buy a DVD of the movie for my own children. Suffice it to say that both movie-making and kids’ taste in comedy have changed dramatically in a generation. Even I have to admit that by contrast to the pace of today’s movies, the pace of this movie classic is absolutely glacial. And the slapstick humor I remembered enjoying so much in my youth failed to amuse my kids. After the scene in which an enraged Jonathan Winters destroys a filling station with his bare hands, which I had remembered as hilarious, my then-eight year old son said, "Why would anyone think that is funny?"

Due to this failed attempt to take my family down my own memory lane, my access to the family’s movie queue on Netflix has been permanently barred. And whenever anyone in the house wants to veto a proposed movie, all they have to say is "It’s a classic!" and they can be sure no one will want to watch that particular film.

All of that said, a reference to the 60’s movie and its portrayal of an every-man-for-himself race to try to recover hidden and possibly nonexistent funds seemed particularly apt in connection with a discussion of the Madoff-related litigation scrum.

Even though my kids panned it, I still think the movie is funny. Readers unfamiliar with but curious about the movie may want to watch this trailer which captures the level of the movie’s humor (check out Jimmy Durante "kicking the bucket")

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In its most significant enforcement action yet related to the subprime meltdown, on June 4, 2009, the SEC filed a civil securities fraud complaint (here) in the Central District of California against Angelo Mozilo, the former CEO of Countrywide Financial Corp., as well as the company’s former COO and CFO. The complaint alleges that the defendants mislead investors by misrepresenting the company’s loan origination standards and practices and by hiding the company’s deteriorating financial condition. The complaint also contains allegations of improper inside trading against Mozilo for initiating Rule 10b5-1 trading plans to sell shares while he was aware of material nonpublic information about the company’s deteriorating loan practices.

As discussed in its June 4, 2009 press release (here), the SEC’s complaint charges that from 2004 through 2007, Countrywide engaged in "an unprecedented expansion of its underwriting guidelines and was writing riskier and riskier loans, which these senior executives were warned might curtail the company’s ability to sell them" to investment bankers and other mortgage buyers.

The complaint alleges that while the company was issuing reassuring statements to investors, Mozilo "internally issued a series of increasingly dire assessments of the various Countrywide loan products and the risks to Countrywide in continuing to offer or hold these loans."

One of the more interesting aspects of the SEC’s press release about the suit is the accompanying document (here) in which the SEC summarizes email messages from Mozilo in which he delivered some of his "increasingly dire assessments." Among other things, an email attributed to Mozilo is quoted as saying that "we are flying blind on how these loans will perform in a stressed environment." Another email is also quoted as saying, with respect to the company’s subprime 80/20 loans, that "in all my years in the business I have never seen a more toxic prduct [sic]."

In other emails, Mozilo refers to the company’s 100% subprime second mortgages as "poison" and says that the 100% loan-to-value subprime mortgage is "the most dangerous product in existence and there can be nothing more toxic."

All of these statements attributed to Mozilo allegedly were made before Mozilo established several Rule 10b5-1 trading plans during the period October through December 2006. In December 2006 and February 2007, as the company’s share price was rising to record highs, he adjusted several previously established plans to allow him to sell even more shares. Pursuant to these plans and during the period November 2006 through August 2007, Mozilo exercised over 51 million stock options and sold the underlying shares for total proceeds of over $139 million.

Among other things, the complaint alleges that Mozilo approved his October 2006 trading plan one day after sending the email quoted above about "flying blind" on how the loans would perform. The complaint also alleges that five days before executing his December 2006 trading plan he circulated a memorandum to all managing directors and to the company’s board of directors noting a number of substantial concerns about the company’s subprime loan origination processes and noting that Countrywide expected its 2006 subprime loans to be the worst performing on record.

While many of these same kinds of allegations also appear in the pending Countrywide securities class action litigation (about which refer here), the SEC’s allegations nonetheless represent a significant development. SEC officials have been saying for over two years (as noted here, for example) that the agency would be cracking down on alleged Rule 10b5-1 trading plan abuses. Indeed, as discussed here, in an October 8, 2007 letter (here) to then-SEC Chairman Christopher Cox, North Carolina Treasurer Richard Moore had specifically asked the SEC to examine Mozilo’s stock trading pursuant to his Rule 10b5-1 plans.

With the SEC’s public commitment to cracking down on Rule 10b5-1 abuses and with the bull’s-eye drawn so specifically on Mozilo’s trading, it may have simply been a matter of time before some version of this complaint was filed. (Indeed, Alison Frankel’s June 4, 2009 American Lawyer article about the SEC’s complaint, which can be found here, is entitled "SEC (Finally) Charges Former Countrywide CEO Angelo Mozilo.") The SEC’s action nevertheless is a significant development, if for no other reason than the prominence of the company and of Angelo Mozilo and because of the nature and specifics of the allegations.

The more interesting question is the extent to which the SEC will be targeting other officials, whether for Rule 10b5-1 plan abuses or for disclosures relating to subprime loans and other lending practices. Given the continuing current public need to assign blame for the current crisis, the prospect for further enforcement activity in these areas seems likely.

Indeed, according to a June 4, 2009 Washington Post article (here), new SEC Chairman Mary Schapiro has specifically said that as part of her plan to try to rebuild the SEC’s tarnished reputation, she intends to step up enforcement efforts and to push cases related to the financial crisis. As a result, the Countrywide complaint may be only the first in a series of SEC enforcement actions designed to assign blame for the meltdown while also demonstrating that the SEC is "tough" again.

The World Was So Much Nicer Before Aggrieved Homeowners Had Access to Counseling Services:  Mozilo’s email practices got him in hot water even while he was still CEO of the company. In May 2008, Mozilo drew media attention (refer for example here) when he accidentally hit the "Reply" button rather than "Forward" after calling a homeowner’s plea for help "disgusting."

The borrower’s email had come from Daniel Bailey, a homeowner who was trying to stay in his home of 16 years. Bailey signed an adjustable rate mortgage and was told at the time that he could refinance after one year, before the payments became unaffordable. In drafting his note, Bailey had relied on suggested language from an Internet website that provided coaching services for troubled borrowers.

The email response Mozilo inadvertently sent Bailey said "Most of these letters now have the same wording. Obviously they are being counseled by some other person or by the Internet. Disgusting."

Mozilo seems to have had a deep commitment to ensuring that he would later look like a cartoon villain. I mean, here’s a guy who had just made a cool $140 million, yet when one of the suckers stuck with one of the loans that Mozilo himself described as "toxic" has the audacity to ask for relief, all Mozilo can think about is how "disgusting" it is that all of the losers stuck with these loans have the same grievances.

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There is no question that the Amsterdam Court of Appeals’ May 29, 2009 action authorizing Royal Dutch Shell to begin funding the April 2007 securities settlement represents a landmark development. Under the ruling (a copy of which can be found here, in Dutch), Shell will begin paying a total of $381 million to a foundation that represents over 150 institutional investors in 17 European countries, Canada and Australia, in settlement of their securities fraud claims arising from allegations that Shell had overstated its oil and gas reserves.

A June 1, 2009 Law.com article describing the court’s action can be found here. The foundation’s May 29, 2009 press release describing the court’s action can be found here.

But while the court’s approval of the settlement unquestionably is a significant development, it remains unclear what this development implied about the likelihood of further collective settlements of the same kind, and in the short term it seems unlikely to overcome non-U.S. investors’ interest in pursuing relief in U.S courts, at least when that option is available.

Background

Royal Dutch Shell and certain of its directors and officers were first sued in a U.S.-based securities lawsuit in the District of New Jersey on January 29, 2004, following the company’s January 9, 2004 announcement that it was writing down its "proved" oil and gas reserves by 20%. Background regarding the U.S. securities suit can be found here. The class on whose behalf the U.S. action was initially brought purported to include European investors who had purchased their shares on exchanges outside the U.S.

In July 2005, Netherlands enacted the Dutch Act on Collective Settlements of Mass Damages, which, subject to considerations discussed below, allows for collective settlement of the claims of the members of a class who do not opt out.

Shell and its biggest investors are located in the Netherlands. As discussed at length in a January 7, 2008 American Lawyer article (here), the Dutch Act gave Shell and its European investors a way to settle "on their home turf." On April 11, 2007, Shell agreed to pay $352.6 million, plus administrative expenses, to Shell investors who purchased their shares and resided outside the U.S. (As explained in the foundation’s May 29 press release linked above, the amount of the settlement was later increased to align the Non-U.S. shareholders’ settlement with the settlement Shell had reached in the U.S action with U.S. investors.) A detailed description of the settlement can be found here.

The settlement was contingent on its approval by the Amsterdam Court of Appeals, which the court granted in its May 29 declaration. The Dutch Court’s approval is likely enforceable throughout Europe based on the European regulation on jurisdiction and recognition of judgments.

Discussion

The Dutch court’s refusal to approve the settlement would have represented a significant setback for the prospect of future similar settlements, as would the court’s refusal, for example, to approve the participation in the settlement of non-Dutch investors.

But while the court’s approval avoided these setbacks and while the settlement itself clearly provides an example of a way in which European investors were able to resolve their grievances against a European company in a European court, that does not mean that the Amsterdam Court of Appeals is now about to be inundated with these kinds of settlements. Indeed, given the clear advantages to proceeding in U.S. courts under the U.S. securities laws, aggrieved non-U.S. investors are likely to continue to attempt to pursue their claims in U.S. courts, as long as and to the extent that U.S. relief and remedies are available to them.

First, while the Dutch Act allows for collective settlements of the type involved in the Shell claim, it does not allow for collective damages claims. Indeed, as stated in the American Lawyer article linked above, the "innovative solution" involved in the Shell settlement was that Shell and the European investors used the Dutch Act to settle the European investors’ U.S.-based damages claims. While this allowed the European investors to "settle litigation on their home turf," it depended on the existence of the U.S. lawsuit on the front end, in order for there to be a Dutch settlement on the back end.

The Shell settlement basically represented an innovation, but the ability for other litigants to use the Shell settlement itself as a model will largely depend on the existence of a similar combination of circumstances. It is far likelier that the next set of European investors to try to use the Dutch Act will need to establish their own "test case" rather than simply modeling off of the Shell settlement. In other words, change in the form of a European collective action remedy for aggrieved investors has been and appears likely to continue to be episodic and incremental, rather than categorical.

In the meantime, the U.S. courts continue to offer potential claimants, even those located outside the U.S., with a host of potential advantages. The U.S lacks a loser pays rule; it allows contingency fees; it uses a jury system for civil cases; and it has a well recognized and understood class action mechanism. It also has a highly motivated, entrepreneurial plaintiffs bar. Its courts recognize the fraud on the market theory, which spares claimants from having to prove that the relied on alleged misrepresentations.

Of course, many potential claimants would prefer a remedy in their home country if one were available. However, the reason for which non-U.S. investors would seek to resort to non-U.S. courts is less likely to be due to the availability of possible alternatives like the Dutch Act and more likely to be due to jurisdictional constraints on their access to U.S. courts. Non-U.S. investors in Non-U.S. companies who bought their shares outside the U.S. – so-called "foreign cubed" or "f-cubed" claimants – who have jurisdictional access to the U.S courts are likely to continue to take advantage of it, at least as long as and to the extent that the access remains available. A detailed comment on ClassActionBlawg.com about the interaction between U.S. jurisdiction for f-cubed claims and the possibility of further Shell-type settlements can be found here.

As discussed in a recent post (here), last October, the Second Circuit declined to rule that U.S. courts could never exercise jurisdiction over the claims of f-cubed claimants. In the National Bank of Australia case, the Second Circuit held that subject matter jurisdiction exists if "activities in this country were more than merely preparatory to a fraud and culpable acts or omissions occurring here directly caused the losses abroad." However the court declined to find jurisdiction in that specific case.

The petition of the plaintiffs in the National Australia Bank case for a writ of certiorari case to the U.S. Supreme Court is pending. The 10b-5 Daily blog (here) reported earlier this week that the Supreme Court has asked the Solicitor General to present her views on the petition. A June 1, 2009 Bloomberg article discussing the Supreme Court’s request for the SG’s views in the NAB case can be found here.

There is of course no way of knowing now, but it is at least possible that the f-cubed jurisdiction issue will soon wind up in front of the U.S. Supreme Court. In the meantime, the Second Circuit’s decision continues to allow for the possibility of subject matter jurisdiction in f-cubed cases, at least under certain circumstances.

All of that said, the movement toward the development of collective remedies in jurisdictions outside the U.S. is now well-established and the Dutch Court’s approval of the Shell settlement undeniably represents another step in support of that movement. We are likely to continue to hear in the weeks and months ahead about the growing threat of collective investor actions outside the U.S. What remains to be seen is where the next "test case" will come from and how it will be framed.

My prior post comparing and contrasting in detail European and U.S. collective action procedures and approaches can be found here.

Very special thanks to Werner R. Kranenburg (who can be found on Twitter, here) for a copy of the Dutch Court’s ruling.

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The high-profile bankruptcies of two of the country’s leading auto companies have dominated recent headlines, but for all their size, complexity and notoriety, the GM and Chrysler bankruptcies are only part of the recent wave of bankruptcies that have swept through economy. Numerous other companies have also found themselves in bankruptcy court. As these bankruptcies have spread, bankruptcy-related securities lawsuits against the bankrupt companies’ directors and officers have followed. Unlike much of the credit crisis-related litigation thus far, these latest bankruptcy-related securities lawsuits are not concentrated in the financial sector.

The most recent example of bankruptcy-related securities litigation is the securities class action lawsuit that was filed on June 1, 2009 in the Eastern District of Arkansas against the CEO, CFO and Chairman of Charter Communications. Charter, which filed for bankruptcy on Marsh 27, 2009, was not named as a defendant. The complaint, which can be found here, purports to be filed on behalf of all persons who acquired Charter shares between October 23, 2006 and February 12, 2009.

The complaint alleges that during the class period the defendants made a series of statements that misled the investing public about the company’s ability to service its debt, about its need to refinance or recapitalize, and about its cash resources. As reflected in plaintiff’s counsel’s June 1 press release (here), the plaintiff contends that "defendants failed to disclose, among other things, that Charter would not be able service its debt to September 2010, but rather Charter would file bankruptcy in March of 2009. Also, the Defendants issued misleading statements about Charter’s potential for mergers. As a result of defendants’ false and misleading statements, Charter’s securities traded at artificially inflated prices during the Class Period."

A second recently filed bankruptcy-related securities lawsuit is the action filed on May 18, 2009 in the Southern District of New York against the former CEO and former CFO of Nortel Networks. Nortel, which filed for bankruptcy on January 14, 2009, is not named as a defendant. The complaint, which can be found here, purports to be brought on behalf of persons who acquired Nortel shares between May 2, 2008 and September 17, 2008.

According the plaintiffs’ counsel’s May 19, 2008 press release (here), the complaint alleges that the defendants "failed to disclose material adverse facts about the Company’s true financial condition, business and prospects." Specifically, the complaint alleges that the defendants failed to disclose that

(i) that demand for the Company’s products was declining as carriers cut back their capital expenditures and other customers deferred purchase decisions; (ii) that the Company’s financial results were materially overstated as the Company was failing to properly write-down its goodwill; (iii) that the Company’s restructuring was not meeting with success as the Company was struggling to cut costs and improve profitability; (iv) and as a result of the foregoing, defendants lacked a reasonable basis for their positive statements about the Company, its business, operations, earnings and prospects.

These two actions join the bankruptcy-related securities lawsuits recently also recently filed against the directors and officers of Idearc (about which I previously wrote here) and MRU Holdings (about which I wrote here).

In addition to the common element of bankruptcy, and the fact that as a result of the bankruptcy in each of the cases the company was not names as a defendant in the lawsuits, the recent actions against Charter, Nortel and Idearc also share something else in common, which is that each of these companies is outside the financial sector.

As has been well-documented elsewhere (refer, for example, here), the securities litigation arising out of the credit crisis has to this point largely been concentrated in the financial sector. However, these recent actions suggest that the spread of adverse financial consequences from the current economic crisis will not only result in an increasing number of bankruptcies but also in an increasing number of bankruptcy-related securities lawsuits.

These bankruptcy-related securities lawsuits, like the ones described above, are likely to arise in a wide variety of business sectors, not just in the financial sector. Indeed, because the bankruptcies are and are likely to continue to be spread throughout the larger economy, it seems increasingly likely that going forward the litigation arising from the current economic crisis will not be concentrated just in the financial sector.

Whether or not these most recent lawsuits will be successful of course remains to be seen. The scienter allegations in the Charter and Nortel complaints are not overwhelmingly detailed. Neither complaint contains insider trading allegations; rather, the scienter allegations depend on assertions about what the defendants knew or must have known, without further elaboration showing that the defendants had contrary knowledge at the time of the allegedly misleading statements.

The other interesting detail about the Charter complaint is that a number of the allegedly misleading statements on which the plaintiff relies were actually made by a UBS media analyst. Neither UBS nor the analyst is named as a defendant; rather, the plaintiff alleges that the analyst was "directed" to make "statements related to Charter by the Defendants." The complaint further alleges that after making these statements and recommending Charter’s stock, the analyst "became Charter’s primary banker."

Allegations that securities litigation defendants misled the investing public through statements by third party analysts are certainly not unprecedented, but as a result of Regulation FD and other developments, these kinds of allegations have become relatively rare, particularly in private securities lawsuits. Whether and to what extend these allegations in the Charter case serves as the basis of liability will be interesting to monitor.

In a recent issue of Insights (here), I discuss at greater length the likelihood that more bankruptcies could result in increased securities litigation, and the D&O insurance issues that bankruptcy-related securities lawsuits could present.

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One of Congress’ goals when it instituted the "lead plaintiff" provisions of the PSLRA was to encourage institutional investors to become more involved in controlling and monitoring securities class action lawsuits. But now that institutional investors are indeed more involved in securities lawsuits, the question has become – what difference has it made? A recent academic study suggests that institutional investor involvement in securities litigation not only enhances investors’ success in seeking financial recovery, but also improves the quality of the defendant companies’ corporate governance. The authors conclude that securities litigation is an effective corporate monitoring tool for institutional investors.

A January 2009 paper entitled "Institutional Monitoring through Shareholder Litigation" (here), by Agnes Cheng of LSU, Henry He Huang of Prairie View A&M University, Yinghua Li of Purdue, and Gerald Lobo of University of Houston, examined all securities lawsuits that were filed from January 1, 1996 to July 20, 2005 and that had been resolved by June 1, 2006. 1,811 lawsuits met these selection criteria, of which 1,525 lawsuits were led by individual lead plaintiffs, 178 lawsuits were led by at least one public/union pension fund or mutual fund, and 108 lawsuits were led by other categories of institutions.

Among other things, the authors found a "trend of increasing institutional involvement in securities litigation." The percentage of lawsuits with institutional investor lead plaintiffs has more than doubled from less than 15% in 1996 to more than 30% in 2004.

The authors were most concerned in determining the effect of institutional investor involvement in case outcomes. Prior research had already shown (as reflected in my prior post, here) that cases with institutional investor lead plaintiffs result in larger settlements, primarily because institutional investors tend to become more involved in the larger, more serious cases.

In order to be able to control for the differences due to the kind of case in which institutional investors become involved, the authors identified the "determinants" that affect institutional investor involvement and used these factors as control variables. The authors identified a range of variable associated with the increased likelihood of institutional investor involvement, including merit and potential damages, size of the defendant company, and prior performance of the defendant company.

Among other things, the authors found that institutional investors are more likely to be involved when the case does not involve an IPO, when accounting issues are present, and when accounting firms are involved. The cases also tend to involve longer class periods, more significant investor losses and companies with higher levels of institutional shareholdings.

The authors used a multivariable regression analysis to control for these case differences, in order to be able to determine the impact attributable to having an institutional investor as the lead plaintiff. The authors found that after controlling for the determinants of having an institutional investor lead plaintiff, "lawsuits with an institutional lead plaintiff are less likely to be dismissed and have significantly larger settlements."
 

Specifically, the authors found that "institutional plaintiffs play a significant role in defeating the defendant firm’s motion to dismiss," finding that "an institutional lead plaintiff can reduce the dismissal probability by 38.2%" The authors found this relationship held even when tested against control variables relating to the possibility that the institutional lead plaintiffs simply selected the most meritorious cases.

The authors also found that the presence of an institutional lead plaintiff "can increase the total settlement amount by approximately 59.8%," when controlling for all the various factors that might be due to the type of case in which institutional investors tend to become involved. The authors concluded that "having an institutional investor lead plaintiff is associated with both a statistically and an economically larger impact on the settlement amount than having an individual lead plaintiff."

Finally, the authors also found that within three years of the lawsuit filing, defendant companies that faced institutional investor lead plaintiffs experienced greater improvement in board independence than those facing individual lead plaintiffs.

To measure this impact, the authors looked at changes in three variables within three years of the lawsuit filing: percentage of independent boar members in the full board, percentage of independent audit committee members, and whether there is a lead director. The authors found that the presence of an institutional lead plaintiff was associate with more significant reform in these three areas, from which the authors concluded that "the impact of securities class action on governance change depends on the type of lead plaintiff."

From these various observations, the authors conclude that "institutional investors’ involvement in securities litigation enhances not only investors’ success in seeking financial recovery, but also the quality of the defendant firms’ corporate governance." From this, the authors further conclude that "institutional investors could use litigation as a mechanism to discipline management and to secure the long-term health of the firm"

The authors noted the increasing incidence of institutional investors choosing to opt out of certain class settlements, which the authors note suggests that some investors may find opting out and filing individual lawsuits to be a stronger monitoring tool that leading the class action. The authors, citing recent research by Columbia Law Professor John Coffee (about which refer here), observed that "while the reasons for institutions opting out are interesting, our empirical sample limits our ability to study that issue." The questions surrounding institutional investors’ willingness to opt out raises a host of interesting issues, not the least of which is the relative importance on a continuing basis of class action litigation of a monitoring tool along the lines the authors suggest. The authors note that this is an interesting question for another day.

One final observation about the authors’ interesting study is that their article, like an increasing amount of legal literature, depends on the application of sophisticated mathematical tools to problems arising in the legal context. While this approach unquestionably has its value, it does make for some daunting presentations and some impenetrable analyses.

I certainly am in no position to question (much less fully appreciate) the validity of the authors’ quantitative approach. I confess that I must simply take it on faith that the authors’ regression analyses are both suitable and properly applied. The more critical approach I generally prefer to take is simply not an option for me when it comes to considering this type of quantitative analysis. I am uncomfortable taking so much on appearances – the authors’ work certainly appears to be rigorous – but without undertaking a massive self-reeducation project, I am hardly in a position to do anything differently.

At least I understand and appreciate the authors’ conclusions. Like a docile and uncritical church congregation, I know when to say "Amen."

A post on the Harvard Law School Forum on Corporate Governance and Financial Regulation blog about the authors’ paper can be found here.

Inspiring Words: While reading Ronald C. White, Jr.’s literary biography of Abraham Lincoln entitled The Eloquent President (here), I had occasion to re-read Lincoln’s First Inaugural Address, including the speech’s stirring final paragraph:

I am loath to close. We are not enemies, but friends. We must not be enemies. Though passion may have strained it must not break our bonds of affection. The mystic chords of memory, stretching from every battlefield and patriot grave to every living heart and hearthstone all over this broad land, will yet swell the chorus of the Union, when again touched, as surely they will be, by the better angels of our nature.

It is easy for us now to admire the eloquence of these words at the remove of nearly a century and a half and with the luxury of time for quiet reflection, but the words are even more impressive when considered in the context of the circumstances in which they were first delivered. At the time of the inauguration, seven states had already seceded; the very next day, Lincoln would receive word from the commander of Fort Sumter that his supplies were nearly exhausted. Lincoln’s optimistic words reflect an earnest but nearly impossible hope for reconciliation at one of our nation’s darkest hours.

Reading Lincoln’s words filled me with the same feelings I had when listening to Winston Churchill’s "Battle of Britain" speeches while I was touring the War Cabinet Rooms in London earlier this year. Both examples underscore the powerful potential of words to illuminate and inspire, even in desperate and hopeless times.

One of the more interesting details about this paragraph of Lincoln’s speech is that it was the result of an unlikely collaboration between Lincoln and his Secretary of State, William Seward. As well-told in Doris Kearns Goodwin’s excellent book, Team of Rivals, Lincoln and Seward would go on to become political allies and close friends, but at the outset of Lincoln’s presidency, they were political rivals who hardly knew each other and who had never worked together. Lincoln set aside his ego and not only asked Seward to review his draft speech, but he adopted most of Seward’s suggestions.

The most fascinating part of this collaboration is how Lincoln adopted Seward’s suggestions. White’s book puts Seward’s suggestions and Lincoln’s final text in side by side columns, which highlights how Lincoln transformed Seward’s proposed language, sometimes in subtle, sometimes in powerful ways. For example, Seward did indeed suggest the phrase "mystic chords" but Lincoln rendered the phrase as "mystic chords of memory." Seward suggested "the guardian angel of the nation," which Lincoln changed into "the better angels of our nature." Lincoln turned Seward’s well-intentioned prose into meaningful, musical poetry, with words that still resonate and inspire.

The transformative power of Lincoln’s use of language was not lost on Seward; he came to appreciate the power of Lincoln’s words perhaps as much as anyone. Though Seward presumed to make six pages of suggestions to Lincoln’s First Inaugural Address, his presumptions changed as he came to know Lincoln better. Three years later, when asked if he had helped Lincoln write the Gettysburg Address, Seward said, "No one but Abraham Lincoln could have made that address."

One of the more remarkable things about Lincoln’s powerful use of language is that he had less than one year of formal education. For some reason, in our own time, we have restricted higher office eligibility to individuals who acquired at least a part of their higher education at one of two elite Eastern universities. Indeed, the current President and his three immediate predecessors all share this common educational connection. I am not sure why this peculiarly narrow form of educational elitism now predominates our politics, but the danger is that something vital and fundamentally American could be lost as a result.

One interesting note about Lincoln’s first inauguration is that Lincoln was the ninth President for whom Chief Justice Roger Taney administered the oath of office, a feat of longevity and endurance that so unlikely that is seems incomprehensible. Given our current Chief Justice’s relative youth, one can wonder whether he might eventually swear in as many Presidents as Taney. Perhaps in future inaugurations, Chief Justice Roberts will actually administer the Oath’s required words correctly, on the first try.

In our time, the Gettysburg Address, the Emancipation Proclamation and even Lincoln’s Second Inaugural Address may all be better remembered than the speech Lincoln delivered at his first inauguration. Lincoln’s words in his other speeches are indeed memorable. But it seems to me that in our time as throughout our history, the mystic chords of memory unite us to our past and our aspirations now more than ever and the prayerful hope for the influence of the better angels of our nature remain as strong as ever.

Lincoln’s words remind us that our nation’s history includes days that were darker than even those today, but even in those desperate times, we never lost hope and we did persevere — as Lincoln might have said, with God’s help.

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