In what may be the largest ever outside director securities lawsuit case settlement, on July 13, 2009, Southern District of California Judge Roger R. Benitez preliminarily approved the six settling outside directors’ $55.95 million settlement of the claims pending against them in the Peregrine Systems securities class action lawsuit. The July 13 order can be found here. As discussed further below, the directors’ settlement is the latest of a multiple settlements in the case, as a result of all of which former Peregrine outside directors have now agreed to pay a total of $61.55 million in settlements.
As reflected in greater length here, in May 2002 plaintiffs filed securities class action lawsuits against Peregrine and other defendants, including certain directors and officers of Peregrine. Peregrine itself filed for bankruptcy in September 2002 and was dropped from the lawsuit. On April 5, 2004, following an initial round of motions, the plaintiffs filed their first amended consolidated complaint.
The complaint alleges that Peregrine materially overstated its revenues and earnings during the class period due to the company’s failure to recognize revenue properly. Peregrine ultimately issued restatements of its financial statements for fiscal years 2000 and 2001. The restatement reduced previously reported revenue of $1.34 billion by $509 million, of which, according to the SEC’s separate civil enforcement complaint against Peregrine (here), "at least $259 million was reversed because the underlying transactions lacked substance." Several Peregrine officers, including the company’s CEO and CFO, entered guilty pleas in connection with the criminal investigations of Peregrine.
In July 29 2006, the parties to the class action lawsuit announced a partial settlement in the amount of $56.3 million on behalf of certain settling defendants. As part of the July 2006 settlement, and as reflected further here, Arthur Anderson agreed to pay $30 million; former officer Douglas Powanda agreed to pay $4.675 million; former director William D. Savoy agreed to pay $5.1 million; and former director Thomas Watrous agreed to pay $500,000. The July 2006 settlement also included certain amounts received in bankruptcy from the company. In November 2006, Judge Benitez approved the July 2006 settlement. The case proceeded against the non-settling defendants.
On February 9, 2009, the plaintiffs filed a motion (here) for approval additional settlements with the remaining individual defendants, six former outside directors (John J, Moores, Charles E. Noell III, Norris vandenBerg, Richard A. Horshey II, Christopher Cole, and Rodney Dammeyer), and four former officers (Stephen P Garner, Mattew C. Gless, Frederic B. Luddy, and Richard T. Nelson).
One of the settling directors, John Moores, was Peregrine’s chairman from 1990 to July 2000 and from May 2002 through March 2003. For a time, Moores owned the San Diego Padres major league baseball team. According to Wikipedia, here, during his years on Peregrine’s Board, Moores sold over $600 million worth of Peregrine stock.
Accompanying the February 9 motion were two settlement stipulations, one each with respect to the two groups of defendants. The settlement stipulation with respect to the outside director defendants, a copy of which can be found here, is dated December 2008 and reflects the six outside director defendants’ agreement to pay a total of $55.95 million toward settlement.
The settlement stipulation with respect to the four officer defendants can be found here and provides that defendant Luddy will pay $100,000 and defendant Nelson will pay $25,000. The stipulation provides further that defendants Gardner and Gless "shall note be required to pay any cash in light of their current financial condition and, as to Gardner, the fact that the forfeitures obtained from him in the criminal case … may be distributed" to claimants.
In Judge Benitez’s July 13 order, he preliminarily approved these two proposed settlement, subject to a final determination at a hearing scheduled for October 16, 2009.
I should emphasize that the foregoing description as well as the analysis below is based solely on the information available in the public record. If I have mischaracterized anything or misunderstood any of the events discussed above, I encourage readers to let me know so that I can correct any errors.
UPDATE: Andrew Longstreth's July 16, 2009 American Lawyer article about this settlement (here) includes a statement from counsel for one of the outside directrros that insurers did contribute toward the outside directors' settlement and the outside directors are pursuing payments from excess insurers. Counsel for the outside directrors also disputes that this is the largest ever settlement on behalf of outside directors, which could be true -- but this is still a very large settlement.
The Outside Directors’ Settlement
The outside directors’ settlement stipulation does not disclose the source of funds for the outside directors’ payments in the settlement. Given Peregrine’s bankruptcy, the payments obviously will not be funded by indemnification from the company. And in light of the extensive, years-long litigation, as well as the 2006 settlement, it seems probable that any potentially available D&O insurance was long ago exhausted; the stipulation itself does not indicate whether any portion of the outside directors’ settlement is to be funded by insurance.
There are however, certain indications in the stipulation suggesting that at least part of the outside directors’ settlement will be funded out of one or more of the directors’ personal assets. For example, of the directors’ total $55.75 million settlement contribution, $27.5 million is to be paid in the form of a note signed and payable by John J. Moores and Rebecca Ann Mores as individuals and as trustees of the John and Rebecca Ann Moores Family Trust. The stipulation also provides that the security for the note will be provided either by a letter of credit or by a security interest in JMI Holdings LLC’s economic interest in a San Diego hotel. These and other terms strongly suggest that at least a portion of the settlement will be funded out of one or more directors’ personal assets.
The six outside directors’ settlement, taken together with the $5.6 million in settlement amounts to which the two directors agreed as part of the July 2006 settlement, brings the total amount paid in settlement of claims against former Peregrine directors to $61.55 million, which exceeds any prior securities lawsuit solely on behalf of outside directors of which I am aware.
When I spoke as a panelist at the 2009 Stanford Law School Directors’ College last month, the number one concern of the directors attending the D&O insurance session was the possibility that their personal assets might be exposed in the event of a lawsuit against them arising out of their service as directors. Although relatively rare, there is in fact some danger that directors might have to pay settlement of claims against them out of their own assets, as the Peregrine settlement strongly suggests.
As I noted in a prior post (here) concerning the now infamous Just for Feet case, the possibility that directors might have to contribute personally toward settlement is materially increased in the bankruptcy context, when the defunct company is unable to fulfill its indemnification obligations. In the event of complex and serious claims following bankruptcy, there is danger that the available D&O insurance could be exhausted before all claims are resolved, potentially leaving directors exposed to additional claims without insurance, which is what happened in the Just for Feet case.
The threat of possible exposure of personal assets of outside directors raises the question whether there are insurance solutions that can be used to try to insure against these possibilities.
Many companies in recent years have secured so-called Side A/DIC coverage, which in effect provides catastrophic claim protection for company officials, particularly in the event of corporate bankruptcy. However, the typical Side A/DIC policy insures all company officials, including officers, raising the risk that even the Side A/DIC policy could be exhausted by defense expense or settlement payments on behalf of the officers, potentially leaving directors exposed without adequate insurance.
As discussed at greater length here, the best way for an individual director or a group of directors to ensure that a pool of insurance will be available to protect them regardless of what happens is to secure a policy solely for the protection of those individual(s). One possible solution is a separate Side A policy just for nonofficer directors. An alternative solution is an individual director liability policy (IDL) designed to provide insurance protection exclusively to a named individual or group of individuals.
The nightmare scenario suggested in the Peregrine Systems settlement, where outside directors may have been required to contribute massive amounts out of personal assets to extricate themselves from litigation arising from their service as directors, together with the availability of alternative insurance products that could address their exposure, are the reasons why I contend that outside board members should retain and consult an independent insurance advisor in connection with the company’s D&O insurance acquisition.
As I noted recently (here), in my experience outside directors are keenly interested in learning more about the protection afforded by these alternative products. A separate consideration of competing and sometime conflicting interests can sometimes result in the selection of different D&O insurance structures.