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

With the United Nations Climate Change Conference set to begin December 7, 2009 in Copenhagen, activists and observers are dialing up the volume both with calls for reform and with updated reports of the projected risks that global warming threatens. Among the long-standing initiatives advocates are now seeking to advance is the petition before the SEC calling for the adoption of climate change disclosure requirements.

These renewed calls for disclosure reform, as well as the release of additional data regarding insurance industry exposure to climate change, are clearly intended to coincide with the upcoming UN conference. One question, however, is how much recent email revelations of climate change researchers’ practices will affect the current dialog.

First, with respect to climate change disclosures, on November 23, 2009, a coalition of twenty public pension funds, public officials and environmental groups filed a "Supplemental Petition on Interpretive Guidance" (here) renewing their call for the SEC to "act promptly to clarify that existing disclosure requirements apply to climate change." Background regarding the group’s initial September 2007 petition can be found here.

As described in their November 23, 2009 press release (here), the group has renewed its call for climate change disclosure reform because of the "spate of recent regulatory, legislative and scientific developments – including the Environmental Protection Agency’s new mandatory greenhouse gas reporting rule – and the new economic opportunities that dramatically change the landscape of corporate climate change disclosure."

In a separate development, a November 23, 2009 report issued jointly by Allianz and the World Wildlife Fund entitled "Major Tipping Point in the Earth’s Climate System and Consequences for the Insurance Sector" (here) asserts that rising sea levels due to global warming could put trillion of dollars of U.S. assets at risk. Among other things, the report states that the planet’s atmosphere is close to dangerous atmospheric thresholds or "tipping points" that could cause dire environmental and economic consequences. The World Wildlife Fund’s November 23, 2009 press release regarding the report can be found here.

In addition to rising sea levels, the report also cites three additional "tipping points" that likely to have an impact: an increasingly arid climate in California; disturbances in the summer monsoon in India and Nepal; and reduction to the Amazon rainforest due to drought.

At the same time, the upcoming Copenhagen conference is clearly creating pressure for governmental action, as suggested by the announcements last week that both Chinese and U.S. officials will arrive at the conference with various country-level carbon emissions goals (as discussed here).

This same pressure could increase the likelihood of implementation of reforms such as the proposed climate change disclosure requirements, as these types of initiatives afford governmental officials the opportunity to show they are taking actions without at the same time requiring theme to address proposals that could directly affect economic activity or that could prove politically more controversial.

However, one wild card that has been played in the midst of all of these developments is the recent revelation of email communications amongst climate change researchers. These emails have been portrayed as suggesting that the researchers manipulated data to support their findings of climate change and that they suppressed contrary points of view. The question arises of how much these disclosures will undermine the perception of trustworthiness of the scientific conclusions on which so much of the current dialog is premised.

One example of the way in which the email revelations can affect perceptions is the joint Allianz/WWF report described above. Two of the three individual authors of the report are affiliated with the Tyndall Centre for Climate Change at the University of East Anglia, which is the institution form which the hacked emails were obtained. While the report’s authors’ affiliations would hardly have occasioned comment previously, now these institutional associations will inevitably raise the question whether the report and its conclusions reflect trustworthy and objective scientific analysis, or something else.

Climate change skeptics and reform opponents are already attempting to seize on the email disclosures to try to suggest that, due to the damage to the perception of trustworthiness of the climate change science, reform initiatives are doomed.

There is no doubt that the email disclosures have affected the dialog. At the same time, events such as the upcoming Copenhagen conference carry their own inertial dynamic. President Obama’s commitment to address the conference certainly will reinforce this dynamic. In this context, reform initiatives, such as the proposed climate change disclosure application, could acquire a certain inevitability. That is certainly the hope of the initiative’s proponents.

The prospect for increased climate change-related disclosure requirements, and the continuing agitation of climate change activists, will put increased pressure on public companies to address climate change issues in their public filings. As I recently noted (here), investor interest in climate change-related disclosures, along with the effects of voluntary initiatives (such as the NAIC’s climate change disclosure project, about which refer here), may separately create their own independent pressures for corporate climate change disclosures.

As these disclosure expectations become more generalized, the possibility of investor litigation relating to climate change disclosure also increases. As I recently noted (here), litigation developments in other areas of the law have moved the possibility of climate change-related disclosure litigation one step closer.

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Bankruptcy cases filed in the U.S. federal courts continued to surge in the twelve months ended September 30, 2009, according to statistics released on November 25, 2009 by the Administrative Office of the U.S. Courts. The statistical release, which can be found here, shows that for year ending on September 30, 2009, there were 58,771 business bankruptcy filings, up 52 percent from the 38,651 business filings in the 12-month period ending September 30, 2008.

Data accompanying the release show that the number of filings has increased in the 12-month periods preceding the quarter end for each quarter since the end of the third quarter of 2006.

Though the twelve-month data show a rising number of bankruptcy filings, the quarterly data for the most recent quarter show a slightly different picture, suggesting that the number of bankruptcy filings may have peaked earlier this year, and that during the most recent months the number of business-related bankruptcy filings may even have begun to decline slightly, at least from their 2009 year-to-date highs.

Thus, according to the Administrative Office’s monthly filing data (which can be found here), there were 15,177 business-related bankruptcies in the third quarter of 2009, compared to 16,098 during 2Q08, which represents a third quarter filing decline of about 5.7%. The highest monthly total during 2009 was in April 2009, when there were 5,621 business-related bankruptcy filings, compared to 4,853 in September 2009.

But while the 3Q09 business filings were down slightly from the preceding quarter, the third quarter filings nonetheless remained at very high levels. Thus, by way of comparison, the third quarter business bankruptcy filing total of 15,177 filings is considerably higher than the quarterly totals in 4Q08, when there were 13,021 filings, and in 1Q04, when there were 14,425 filings.

Whether or not bankruptcy filing peaked earlier this year, the number of bankruptcy filings remains significant. The possibility of bankruptcy remains a significant threat for financially troubled businesses. As I have previously noted (here), among the events that often follows after the filing of a bankruptcy petition is the arrival of claims against the bankrupt firm’s directors and officers.

Bankruptcy associated-claims present a host of complications, not least of which is the intricate way that D&O insurance policies respond in the bankruptcy context. One recent development illustrating the difficulties that can arise in the bankruptcy context was the July 2009 decision in the Visitalk case (about which refer here), in which the Ninth Circuit upheld the carriers’ denial of coverage for a lawsuit brought by a company as debtor in possession against former directors and officers of the company, as a result of the policies’ insured vs. insured exclusion.

These kinds of complications underscore the need for D&O insurance policies to be closely scrutinized for their ability both to withstand and to respond to claims arising in the context of bankruptcy.

Hat tip to the SOX First blog (here) for the link to the bankruptcy statistics.

More About FCPA Enforcement and Pharmaceutical Companies: As I recently noted (here, scroll down), both the DoJ and the SEC have indicated that Foreign Corrupt Practices Act enforcement has a high priority and that FCPA enforcement in the pharmaceutical industry is a particular focus.

A November 24, 2009 memo from the Latham & Watkins law firm entitled "U.S. Department of Justice Announces Stepped-Up Criminal Enforcement of Foreign Corrupt Practices Act Against Pharmaceutical Industry" (here) takes a closer look at these prosecutorial priorities.

The memorandum explains that among other reasons for the new focus on pharmaceutical companies is that "many foreign health systems, are regulated, operated and financed by government entities, and competition is intense, which creates more opportunities to ‘pay off foreign officials for the sake of profit.’" Of particular concern is the fact that it may not always be obvious which medical functionaries are "foreign officials" within the meaning of the FCPA.

The article includes a variety of suggested practical steps that pharmaceutical companies can take in light of these concerns.

Special thanks to Adam Savett of the Securities Litigation Watch for providing a copy of the law firm memo.

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The FDIC’s latest Quarterly Banking Profile (here) shows that as of September 30, 2009, the country’s commercial banks are continuing to struggle, and that as a result of the banks’ woes the FDIC’s Deposit Insurance Fund (DIF) is $8.2 billion in the red. The rising numbers of "problem" institutions suggests both that the number of failed banks could continue to grow and that the DIF could remain under pressure – although as discussed below, the DIF situation may not be quite as dire as the headline details might otherwise suggest.

The FDIC report states that the number of banks on the FDIC’s "problem" institution list rose during the third quarter to 552 from 416 at the end of 2Q09, and that the total assets of "problem" institutions increased from $299.8 billion to $345.9 billion. If assets at "problem" institutions of a third of a trillion dollars sound bad, that’s because it is. The FDIC reports that both the numbers and assets of "problem" institutions are "now at the highest level since the end of 1993."

The FDIC defines "problem" institutions as "those with financial, operational or managerial weaknesses that threaten their continued financial viability." To be classified as a "problem," an institution would have to be ranked as either a "4" or a "5" on the FDIC’s "scale of 1 to 5 in ascending order of supervisory concern." The FDIC does not provide the names of the "problem" institutions, nor does it specify how many of them are rated "4" and how many are rated "5."

To put the number (552) and assets ($345.9 billion) of the third quarter-end "problem" institutions into some perspective, there were "only" 171 "problem" institutions as of the end of 3Q08. In twelve months, the number of "problem" institutions more than tripled, and the assets at "problem" institutions more than doubled.

Along with the growing numbers of "problem" institutions have come an escalating number of bank failures. During the third quarter of 2009, "fifty insured institutions with combined assets of $68.8 billion failed," which represents "the largest number [of bank failures] since the second quarter of 1990 when 65 insured institutions failed." As of the September 30, 2009, 95 banks had failed, and as of November 20, 2009, the 2009 YTD total number of bank failures stood at 124.

This wave of bank failures has taken its toll on the Deposit Insurance Fund (DIF). During the third quarter, the DIF decreased by $18.6 billion, to negative $8.2 billion, "primarily because of $21.7 billion in additional provision for bank failures."

Although these DIF figures sound disastrous, there is more to the story than just the reported negative figure. The FDIC’s November 24, 2009 press release accompanying the report (here) explains that the negative balance reflects a $38.9 billion "contingent loss reserve that has been set aside to cover estimated losses over the next year." In addition, the DIF balance is not the same as the FDIC’s cash resources, which stood at $23.2 billion as of the end of the third quarter.

To further bolster the FDIC’s cash position, on November 12, 2009, the FDIC’s board voted to required insured institutions to prepay three years’ of deposit insurance premiums – worth about $45 billion – at the end of 2009. The press release on the prepayment assessment can be found here.

With the increase in the number of "problem" institutions and the obvious relationship between rising numbers of "problems and the likely number of future bank failures, signs are that we could continue to see significant numbers of bank failures as we head into 2010. While I still don’t think we are going to see 1,000 failed banks by the end of 2010, we are clearly going to be seeing a lot more failed banks.

As bad as all of this is, the Quarterly Banking Profile hints at the possibility that all of the bad news might not even be out in the open yet. Among any other details, the Quarterly Banking Profile also reports that "growth in [loan loss] reserved continued to lag the rise in noncurrent loans, and the industry’s ratio of reserves to noncurrent loans declined for a 14^th quarter, from 63.6 percent to 60 percent."

In terms of what all of this means for the economy, perhaps the most significant detail in the document is its report that "loan balances declined by the largest percentage since quarterly reporting began in 1984." The FDIC’s press release quotes FDIC Chairman Sheila Bair as saying that "there is no question that credit availability is an important issue for economic recovery. We need to see banks making more loans to their business customers."

Europeans Worried About Proposed U.S. Investor Protection Law: According to a November 23, 2009 Financial Times article (here), the European Commission is worried about legislation currently before Congress that would specify the circumstances under which investors could sue foreign domiciled companies in U.S. courts.

As I discussed in a prior post (here), Section 215 the Investor Protection Act of 2009 is addressed to "Extraterritorial Jurisdiction" which would amend the ’33 Act, the ’34 Act and the Investment Advisors Act of 1940 to specify that U.S. courts could properly exercise jurisdiction in any action involving "conduct with the United States that constitutes significant steps in furtherance of violation, even if the securities transaction occurs outside the United States and involves only foreign investors," as well "conduct outside the United States that has a foreseeable substantial effect in the United States."

Under the first of these two prongs, U.S. based conduct alone would be sufficient jurisdictional basis, even with respect to foreign purchasers of who purchased their shares of foreign-domiciled companies on foreign exchanges (so-called "f-cubed claimants").

The article quotes the former director of litigation for Bank of America as saying that "if this legislation passes, there will be greater opportunity for foreign companies to be hauled into U.S. courts." The article also reports that Charlie McCreevy, the European Union Commission for Internal Markets as having "expressed concern over the measure."

All-Time Worst E-Mail Faux Pas?: The title of the Clusterstock’s post (here) pretty much says it all: "Cornell Business School Employees Accidentally Email Everyone with Their Dirty Email Love Notes." Clusterstock observes that the "this might set some kind of record for the worst email mistake anyone has ever made."

Due to the family-oriented nature of this blog, The D&O Diary will not reproduce any examples of the couple’s inadvertently forwarded emails.

The good news is that the two employees involved are married. The bad news is that they are not married to each other.

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One of the more interesting securities class action lawsuit filing patterns that has developed as 2009 has progressed is the number of securities suits that have been filed long after the end of the purported class period cut-off date, as I have previously noted here. A November 21, 2009 National Law Journal article entitled "Securities Fraud Suits Resurface" (here, registration required) examines these patterns and reports that as plaintiffs’ lawyers turn away from credit crisis-related cases and turn back to "traditional securities suits," the plaintiffs are "slapping public companies with securities class actions months or years after the fraud came to light."

According to the article, eight of the 23 securities class actions filed against public companies in October and November 2009 "define the class as investors who bought or acquired the company’s stock during some time between 2006 and the first half of 2009." My prior posts (here and here) demonstrate that this pattern of filings with the class period cut-off date well in the past emerged well before October.

The article attributes a statement to Sam Rudman of the Coughlin Stoia law firm to the effect that "he’s working through a backlog of potential targets." The explanation for the backlog is that "lawsuits related to subprime mortgages and financial instruments consumed much of Coughlin Stoia’s energy in recent months," but the new subprime and credit crisis-related filings are "waning." The article quotes Rudman as saying about the subprime and credit crisis cases that "we’re busy litigating cases, but not a lot of new ones are being started," so now the firm is looking at cases "we kind of backburnered for two years."

As a result, the firm is "putting many prior stock drops under the microscope before the statute of limitations runs out." Rudman is quoted as saying about the number of cases the firm is looking at, "my list is long."

As I noted in my prior posts about the backlog, the plaintiffs’ efforts to work off the backlog poses a challenge for D&O underwriters, because it means that companies with long distant stock price drops could still find themselves involved with securities litigation long after the event. As a result, it is hard for underwriters to be sure when a company is "out of the woods."

Another consideration as the backlog cases come in is that the new cases are more broadly distributed across the economy than was true for the filings during at least the last couple of years. Since mid-2007, the new lawsuits have largely been concentrated in the financial sector. But in the second half of 2009, there have been fewer cases against financial companies and the cases that have been filed have hit a much broader variety of industries, as I recently noted in detail here. This filing shift may require a recalibration of risk distribution and, consequently, risk selection.

Lawyers tell me that these older cases pose a problem for the companies too. The target companies may have new management that is unfamiliar with the events that gave rise to the prior stock price drop. The company may also be involved in M&A activities, and the overhang of a past stock price drop can, for example, present an uncertainty to an acquirer.

One challenge plaintiffs may face with these lawsuits is that in some cases they brush right up against the applicable statute of limitations for securities fraud suits, as was the case with the new lawsuit filed on October 28, 2009 against Pitney Bowes, where the suit was filed one day short of the two-year statute of limitations (as I discuss further here, scroll down).

Some of these recent cases have even been filed seemingly after the statute of limitations period has passed, as Adam Savett noted on his Securities Litigation Watch blog (here), with respect to the complaint against Avanir Pharmaceuticals, which was filed three years after the proposed class period cut-off date.

There’s delayed, and then there’s stale. In at least a few instances, these cases are being offered up after the sell-by date.

Arkansas Securities Plaintiff Attorney Sentenced: Readers may recall the courtroom drama earlier this year when Arkansas-based securities class action attorney Gene Cauley took the Fifth in response to questions from Southern District of New York Judge Jed Rakoff about $9.3 million missing from the funds escrowed in connection with the settlement of the Bisys Group securities class action lawsuit. Shortly thereafter, Cauley agreed to plead guilty to wire fraud and criminal contempt for misappropriating the escrowed funds.

Today, Cauley was sentenced to 86 months in prison, and ordered to pay $8.8 million in restitution, in addition to the $500,000 he previously paid, as reported here on the WSJ.com Law Blog.

An earlier WSJ.com Law Blog post reported (here) that Cauley was in fact a protégé of Bill Lerach. Today’s article on Bloomberg (here) about Cauley’s criminal sentencing notes that Cauley joins a growing list of plaintiffs’ securities class action attorneys who have "been jailed for felonies," including Bill Lerach himself and his former law partners, Mel Weiss, Steven Schulman and David Bershad, and including even Marc Dreier.

These gentlemen of course made their living for many years accusing corporate officials of fraud. Ahem. Yes, well…isn’t ironic, don’t you think?

Welcome: The D&O Diary would like to welcome the latest new addition to the blogosphere, the CyberInquirer blog. The blog is maintained by Rick Bortnick and Pam Pengelley of the Cozen O’Conner firm and is devoted to "news and views on recent developments in Cyber Law and Insurance." The blog looks promising and looks like a great new source of new and information about insurance and law issues relating to Cyberspace. I look forward to following future posts and wish the site’s authors great success. They appear to be off to a great start.

Speaker’s Corner: Next week, I will be co-Chairing the American Conference Institute’s 15^th Annual Advanced Forum on D&O Liability in New York. The faculty for this event includes an all-star cast of insurance industry professionals and leading attorneys. The conference will be held on November 30 and December 1, 2009 at The Carlton Hotel in New York. The event website can be found here and the agenda, including a complete list of speakers and topics, can be found here.

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On November 20, 2009, Ohio Attorney General Richard Cordray announced (here) the filing of a lawsuit in the Southern District of Ohio on behalf of five Ohio pension funds against Standard & Poor’s, Moody’s and Fitch. According to his press release, the complaint, which can be found here, charges the rating agencies with "wreaking havoc on U.S. financial markets by providing unjustified and inflated ratings of mortgage-backed securities in exchanged for lucrative fees from securities issuers."

During the period January 1, 2005 through July 8, 2008, the plaintiff pension funds purchased a variety of asset-backed securities all of which had "false and misleading" ratings of AAA or equivalent. The complaint alleges that while the ratings purportedly were objective and independent, "in truth, the Rating Agencies subverted those principles and negligently provided unjustified and inflated ratings in exchange for the lucrative fees the ABS issuers paid the Defendants for not only rating the securities but also for helping to structure them."

The complaint makes liberal use of the rating agencies’ internal communications that the SEC disclosed following its own investigation of the firms, and also quote extensively from the SEC’s investigation report (about which refer here).

The complaint asserts that "when the housing and credit markets collapsed, the flaws in the Defendants’ AAA ratings gradually became clear." The value of the pension funds’ investments "dropped precipitously" which, the complaint alleges, caused the funds to lose over $457 million, as "these purportedly safe investments became obvious for what they were – high risk securities that both the issuers and the Rating Agencies knew to be little more than a house of cards." The complaint asserts claims for relief under the Ohio Securities Act and for negligent misrepresentation.

The Ohio action follow the similar action that Calpers filed in July 2009 against the rating agencies, as discussed here.

As I have previously discussed on this blog, the rating agencies have proven to be a popular target for investors angry about losses they sustained on mortgage-backed securities and other investments following the subprime meltdown. But as I have also previously noted, these investor actions could face significant hurdles, particularly with respect to the rating agencies’ constitutional defenses. Significant case law supports the rating agencies’ position that their ratings opinions are protected by the first amendment.

In attempting to overcome these arguments, the Ohio funds will undoubtedly seek to rely on Judge Shira Scheindlin’s September 2009 opinion in the Cheyne Financial case, in which she rejected the rating agencies’ argument that their rating opinions were entitled to immunity under the First Amendment.

But as I noted in my prior post discussing Judge Scheindlin’s opinion, the extent to which these plaintiffs will be able to rely on her opinion may be limited. First, as a district court opinion, it will be of at most persuasive but not precedential value. Moreover, Judge Scheindlin’s conclusions were made in the context of an action made under New York’s fraud laws, which may or may not be relevant to an action under Ohio’s laws.

In addition, Judge Scheindlin’s ruling in the case was limited by its own terms. In disallowing the first amendment defense, she said "where a rating agency has disseminated their ratings to a select group of investors rather than to the public at large, the rating agency is note afforded the same protection." To the extent the ratings the Ohio funds’ allege to be misleading were not made to a select group of investors, as was the case with respect to the investments involved in the Cheyne Financial case, Judge Scheindlin’s ruling arguably may not be relevant.

But despite the obstacles, Cordray appears enthusiastic about the case. In fact, he seems to have decided in general that he can extract significant political value by pursing securities litigation. On November 20, 2009, he wrote on his blog, Speak Out Ohio, that "my office is aggressively pursuing Wall Street corporations and executives that harm investors here in Ohio and around the world." (Yes, the Ohio Attorney General has a blog. Doesn’t everybody?) Among other things, he also references in his blog post the recent $400 million settlement in the Marsh contingent commission securities class action lawsuit, in which his office participated.

Just to underscore how enthusiastic he is about pursing securities class action litigation, Cordray also separately published on November 20, 2009 a detailed report of the securities class action lawsuits his offices has pursued or is pursuing.

The political value that Cordray thinks he can gain by initiating securities litigation may be discerned from the tenor and tone of some of his remarks in his blog. For example, with respect to the rating agency lawsuit, he says that:

This case goes to the heart of what’s wrong with Wall Street today. Ohio workers—including our families, friends and neighbors – work hard to create wealth in our economy. Then Wall Street corporations and executives manipulate that wealth, for their benefit, and they do so with total disregard for our life’s work and the importance of our retirement savings. Ordinary people throughout Ohio are hurt by this kind of misconduct. And we won’t stand for it.

If you are wondering whether Cordray’s litigation endeavors are producing their intended results (that is, by generating favorable publicity for Cordray, who clearly has higher political aspirations), you will be interested to know that the filing of the rating agency lawsuit made the front page of the business section of Saturday’s Cleveland Plain Dealer. Since the only thing in Cleveland worse than the Cleveland Browns is the Cleveland economy, the paper’s business section is actually widely read, for same morbid reasons that people gawk at traffic accidents.

Ben Hallman of the Am Law Litigation Daily has an interesting November 20, 2009 profile of Cordray and of the ratings agency case here. Among other things, Hallman notes that Cordray is a former five-time undefeated Jeopardy! champ. Hallman also (correctly, in my view) notes that Cordray is "making a strong bid to be the Midwest’s answer to Andrew Cuomo."

On the Other Hand, Securities Litigation Could Also a Scam Worse Than Bernie Madoff’s: While Cordray is convinced that he is helping to protect the little guy by pursuing securities suits against Wall Street, Lawrence W. Schonbrun, the executive director of Class Action Litigation Watch, asserts that securities class action litigation is "a financial rip-off worse than Bernie Madoff."

In a November 21, 2009 editorial in The Buffalo News (here), Schonbrun takes on the plaintiffs’ securities class action bar, asserting that class action securities litigation is "skimming hundreds of millions of dollars from investors in U.S. corporations." Using Judge Rakoff’s rejection of the SEC’s settlement of the BofA/Merrill Lynch bonus action as a starting point, Schonbrun argues that:

In a typical year, more than 200 securities class action lawsuits are filed against American companies, with an average settlement of more than $100 million each; that adds up to a staggering $20 billion a year! Over nearly 40 years, that means that the system has drained upward of $800 billion of shareholder wealth, not just from people who directly trade securities but from all Americans who own mutual funds, or have pension funds or other types of investments. Kind of dwarfs Madoff’s $65 billion, doesn’t it?

Schonbrun is rather obviously playing fast and lose with the numbers, since there has never yet been even one year when class action lawsuits settlements average $100 million, and there certainly have not be 40 years’ worth of average settlements of $100 million.

But his rant does raise an interesting question, which is -- who is actually helped and who is actually hurt by the class action lawsuits? It is true that when class action settlements are funded in whole or in part by defendant corporations, it is shareholders that are hurt. As Schonbrun points out, among the most significant shareholders are the very kinds of pension funds on whose behalf Cordray is busy filing lawsuits. Schonbrun’s intemperate screed didn’t quite get there, but there is a very interesting question about whether the kinds of lawsuits Cordray is busy congratulating himself for filing (at least to the extent they are filed against publicly traded companies, as opposed to the rating agencies) actually benefit the pension funds over the long haul.

So here’s my idea: Let’s have a public debate between Cordray and Schonbrun. Call it "Class Action Smackdown" or something like that. To enhance the entertainment value, the rules of engagement could specify (drawing on Cordray’s Jeopardy! experience) all of the contestants’ statements would have to be expressed in the form of a question. That could be quite a spectacle.

And Speaking of Class Action Litigation: Meanwhile, back at the Southern District of New York courthouse, the Vivendi securities class action lawsuit trial is now in its sixth week. The trial disappeared from the radar screen for a while, but it was back in the news again this week, as former Vivendi CEO Jean-Marie Messier took the stand.

According to news reports, he told the jury that he might have made mistakes but her never misled shareholders. The AP newswire story quotes him as saying "Some of my management decisions turned out wrong, but fraud? No. Never. Never. Never." According to the AmLaw Litigation Daily account of his testimony, Messier also called the allegations in the case "blatant lies, infamous lies." Messier’s testimony reportedly will continue for several days.

And Speaking of Liability Exposures: I have been involved with D&O claims, one way or another, for well over 25 years. After such a long period observing the havoc of lawsuits against directors and officers, I never ceased to be amazed by corporate officials who are convinced they don’t need management liability insurance. To me, that attitude as foolhardy and dangerous as that of the soldier who is convinced he doesn’t need a helmet because he is sure that he is never going to get hit.

One product I have been particularly surprised that corporate officials often must be convinced they need is Fiduciary Liability Insurance. This insurance, which is quite inexpensive given the extent of the protection it affords, is designed to protect plan fiduciaries against claims by employee plan participants or beneficiaries that the fiduciaries breached their duties.

On November 19, 2009, CFO.com had a particularly good article entitled "Fiduciary Liabilities: Are you Covered?" (here) which describes Fiduciary Liability Insurance and explains why it is an indispensible part of every company’s insurance program. I commend the article for anyone involved in advising companies about their management liability insurance.

And Finally: So which country do you think has the most English speakers, India or China? You might might be tempted to say India. But you would be wrong. Correct answer? China. I guess if you start with a billion people, having the most of anything is a lot simpler.

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Pop quiz: the law of which jurisdiction should govern a coverage dispute arising under D&O insurance policies issued by U.S-domiciled insurers to an NYSE company incorporated in Delaware with its headquarters in Oregon? If you find the answer "British Columbia" as surprising as I do, read on. The court decision discussed below could have important implications for the typical U.S. D&O policy, with its extension of "worldwide coverage," particularly as both commerce and litigation become increasingly global.

Background

Now-bankrupt forest products company Pope and Talbot, Inc. was incorporated in Delaware and had its corporate headquarters in Portland, Oregon. Until its bankruptcy, its shares traded on the NYSE. Pope and Talbot conducted business through several operating subsidiaries, the largest of which was P&T Ltd., a Canadian federally chartered company with its principal operations in British Columbia. The bulk of Pope and Talbot’s operations ran through P&T Ltd. and the bulk of Pope and Talbot’s employees were employed by P&T Ltd.

P&T Ltd. is now in receivership. PricewaterhouseCoopers is the receiver for P&T Ltd. PWC, in its role as receiver, has instituted an action in British Columbia seeking a judicial declaration of coverage under the parent company’s D&O insurance policies for claims against P&T Ltd.’s directors and officers brought by former P&T Ltd employees under the Canadian Business Corporations Act for unpaid wages.

Pope and Talbot’s D&O insurance program was structured in several layers, involving three U.S. domiciled insurers. The negotiation and placement of the policies took place in the United States.

In a prior ruling, British Columbia Supreme Court Justice Paul Walker determined that the British Columbia court had jurisdiction over PWC’s declaratory judgment action. The insurers then sought a declaration that Oregon law would govern the dispute.

The November 12 Opinion

In his November 12, 2009 decision (here), Justice Walker determined that British Columbia law is the proper law to be applied to the interpretation of the policy.

He began with the determination that the parties intended different laws to apply to different parts of the policy (a choice of law principle known as dépeçage). In reaching this conclusion, Justice Walker referenced several different parts of the policies at issue, including in particular the primary policy’s definition of "Loss," which contained a provision specifying that the policy’s coverage for punitive and exemplary damages would be determined under the law most favorable to the insured. Justice Walker also referenced the policy’s Oregon state amendatory endorsements, which specified that Oregon law would govern any disputes regarding alleged misrepresentations in the insurance application.

Justice Walker determined that given these clause-specific choice of law provisions, and given the absence from the policies of any general choice of law provisions, the "proper law" governing the disputes arising under other policy provisions "is left to be determined by the court hearing the dispute to find based on the application of its own laws, taking into account the directing language in the policies."

Reviewing these circumstances in this light, and discounting the policies’ various connection to jurisdictions in the United States, and applying British Columbia choice of law principles, Justice Walker concluded that "the policies have the closest and most substantial connection with BC," and therefore BC law governs the coverage dispute presented by the receiver.

In substantiating this decision, Justice Walker stated that given the importance of the Canadian subsidiary, "most of the claims could be expected to arise from Canadian operations," and he stressed that the P&T Ltd. employees’ wage claims are "unique to Canadian operations" and have "no equivalent in Oregon," as a result of which Justice Walker concluded that "the proper law of the policies to determine the carriers’ coverage obligations for these claims is BC law."

He added that the parties "would reasonably have expected BC law to apply to determine the insurers’ coverage obligations."

Discussion

Suffice it to say that I have concerns with Judge Walker’s analysis. He managed to blow right past the fact that all of the acts involved with the formation of the insurance contracts took place in the U.S. and that insurance contracts were formed between a U.S.-domiciled company and U.S.-domiciled insurers, and that the key risks insured against and for which the policy was purchased were U.S.-based.

Justice Walker simply jumps to the conclusion that given the size of the P&T Ltd’s operations, the insurance contracts were primarily designed to protect against Canadian exposures. However, the company that purchased the policy was the parent company, a U.S.-domiciled company whose shares traded on a U.S. securities exchange. Is there any possible doubt that the most important reason the company bought the policy – and the reason the policies cost so much in U.S. currency – is because the company and its directors and officers wanted protection against corporate litigation in U.S. courts under U.S. law?

Of course the policies do provide "worldwide coverage" and, yes, of course substantive local law governs the local claims wherever the claims might arise. But Justice Walker seems to have telescoped the primacy of local law regarding the underlying dispute into a determination that local law should govern questions of policy interpretation, which analytically are two completely different issues.

All of that said, there are a couple of points in Justice Walker’s analysis that do give me pause. In particular, the considerations on which he relied in concluding that principles of dépeçage control the choice of law issue are by no means far-fetched. His consideration of the "law of the most favorable venue" wording in the provisions relating to coverage for punitive and exemplary damages is interesting and raises issues I had not previously considered. He may have a point that this language could be interpreted to suggest that the parties intended the laws of different jurisdictions to apply to different parts of the policy.

Where his analysis goes off track, in my view, is having found that different jurisdictions’ laws may apply to different policy provisions, he concluded both that BC choice of law principles should determine which law should apply, and he applied these BC choice of law principles in a blunderbuss way to conclude that BC law governed interpretation of the policy (see, e.g., his assertion that the likeliest claims to arise under the policies were Canadian claims.)

But the most significant aspect of Justice Walker’s decision is the unmistakable message that if a policy provides "worldwide coverage," the policy not only applies to claims wherever they may arise, but courts in those far flung jurisdictions may push ahead and apply their own local laws to questions of coverage relating to the local claim.

In the increasingly global economy, many businesses have significant operating subsidiaries in many countries. And as the rest of the world become increasingly litigious, too, the possibility of claims arising in these multifarious jurisdictions is increasingly likely. But while the U.S. D&O insurance industry has long noted the increasing possibility of claims arising outside of the U.S., I suspect it may come as a big surprise to many U.S. D&O insurers that local will law will not only govern the local claim itself, but the local court could also determine that local law governs questions of policy coverage for the local claim.

I have no idea what the insurance coverage laws are in vast smorgasbord of countries outside the U.S. Who knows what a court in, say, Vietnam or Slovakia or Gabon might conclude about a U.S-issued D&O insurance policy’s coverage for a local claim? I doubt that many domestic U.S. D&O insurers do either, and I suspect they have little interest in finding out.

On that score, it should be noted that Justice Walker repeatedly recognized the right of the parties to choose the law that would govern the interpretation of the policies, and it was only the absence of any such a provision that allowed him to conclude that BC law should govern.

All of which suggests to me that we may have reached the point where, at least from the carriers’ perspective, it may be time to for U.S.-based D&O insurers to consider the inclusion of a general choice of law clause in their policy. The inclusion of a choice of law clause would have the advantage of predictability and certainty, and it would spare the parties from a post-claim surprise discovery that, for example, the parties reasonably expected that BC law would govern the interpretation of these policies. (I am sure it was news to these carriers to learn that they had "expected" the interpretation of these polices to be governed by the law of British Columbia.)

Given the increasingly global nature both of commerce and of litigation, the inclusion of a choice of law clause arguably could be the reasonable next step in the evolution of the U.S. D&O insurance policy. Many international contracts in many contexts (including the insurance and reinsurance context) as a matter of course specify which jurisdiction’s law should govern the interpretation of the contract. Indeed, the typical D&O policy, with its "worldwide coverage" provision, really is itself an international contract, and to that extent it may be anomalous that U.S. D&O policies often do not have choice of law provisions.

Of course, were general choice of law clauses to be included in D&O insurance policies, the clauses would have to be carefully coordinated with other policy provisions, including in particular the most favorable venue wording relating to coverage for punitive and exemplary damages.

I recognize that both my analysis of Justice Walker’s opinion and my suggestions about the inclusion of choice of law language in U.S. D&O insurance policies could be controversial. I can well imagine D&O professionals who advocate for policyholders arguing that the local law ought to govern policy coverage issues. I can also imagine some insurance professionals objecting that whatever benefit a choice of law clause might produce in the international context, it might produce some unexpected and even unwanted results in the domestic context.

I am very interested in readers’ views, particularly those who may have a perspective different than mine regarding Justice Walker’s opinion and also with respect to my suggestions about choice of law provisions.

Very special thanks to loyal D&O Diary reader Raymond Sieh, whom I just met for the first time at last week’s PLUS International Conference, for providing me with a copy of the opinion.

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Beginning with the corporate scandals earlier in this decade and continuing with the more recent financial meltdown and Ponzi scheme revelations, these has been a widespread push toward corporate governance reform. In some European countries, these developments have been accompanied by the implementation of mechanisms to provide some form of relief to the victims of corporate misconduct.

These legal trends have in turn had a significant impact on the European D&O insurance marketplace, as discussed at length in the November 2009 Advisen report entitled "European D&O Insurance Market to Benefit from Governance and Legal Reforms" (here, $ required).

As discussed in the report, Europe has had its own share of accounting scandals, as a result of which "governments across Europe have passed laws requiring new disclosures, enhanced shareholder protections, and greater transparency." There have also been actual or proposed changes to litigation procedures, many of which represent moves toward the development of various forms of collective action. Though the progression of these changes varies by country, the "clear trend" is toward a "more collective-friendly civil legal system"

As a result of these developments (both the scandals and the legal reform), "the number of shareholder suits filed in European courts is substantially up."

In discussing this European litigation, the report uses its own terminology, and in particular, the report (apparently – the report does not expressly define the term as used in connection with the European litigation) uses the expression "securities suits" to describe both actions initiated by private litigants as well as regulatory enforcement actions.

With this specific use of the phrase "securities suits," the report states that since 2005, "32 large securities suits were filed in European courts against European companies." (The report does not specify what is meant by "large.") Of these 32 "large securities suits," 18 were filed in the first half of 2009 alone. In addition, of the 32, 29 were collective action suits. For cases settled since 2005, the average settlement per case was a "staggering" 117 euros ($155 million).

In addition, European companies have become increasingly susceptible to "securities suits," as the report uses that term, in U.S. courts as well. Claims against European companies doing business in the U.S., particularly those whose shares trade on U.S. securities exchanges, have "mushroomed" in recent years. The number of "securities suits" against European companies increased from 10 in 2005 to 37 in 2008, and to 23 in the first half of 2009.

Many of these "securities suits" against European companies in U.S. courts hare securities class action lawsuits – of the 113 "securities suits" filed against European companies in U.S. courts since 2005 (through mid-2009), 54 are securities class action lawsuits. The remainder of "securities suits" apparently includes enforcement actions, individual lawsuits and derivative actions.

The average settlement of "securities suits" against European companies in U.S. courts during the period 2005 through mid-2009 is 55 million euros ($78 million).

These litigation developments have amplified the risks to corporate directors and officers, and according to the report have affected the perceived need for D&O insurance as well. Most large European companies carry some amount of D&O insurance, although the "perceived level of D&O insurance coverage need varies among countries." Many small to mid-sized European public companies do not purchase D&O insurance at all. This relatively low penetration, together with the changing legal environment that could encourage more companies to purchase D&O insurance, represents a "once-in-a-lifetime growth potential" for D&O insurers.

The report estimates that the European D&O insurance market represents 2008 written premium of 1.37 euros ($2.0 billion), up from about 1.01 billion euros ($1.25 billion) in 2004. By contrast, the Advisen report estimates, the 2008 U.S. D&O insurance marketplace was worth about $6.8 billion.

The European market has grown in recent years at a compound between 2004 and 2008 of about 7.9 percent, but due to improved product take-up rather than to rate increases. The report projects that the European D&O insurance market is likely to continue to grow, though the growth is likely to vary from country to country, commensurate with the countries’ changing levels of legal reform.

The report contains a detailed overview of the specific legal developments in the U.K., German, Netherlands, Italy and France, and also includes summaries of legal developments in Austria, Denmark, Finland, Norway, Spain, Sweden and Switzerland.

The report is interesting and timely, and provides a thorough overview of European legal developments and the way they will impact the European D&O insurance marketplace.

My prior post on the development of collective action procedures in Europe and the contrast of these procedures with the U.S. class action system can be found here. My previous discussion of current D&O insurance issues in Germany can be found here. The state of securities litigation exposures for directors and officers of Japanese and Canadian companies, respectively, can be found here and here.

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One interesting thing about the most recently filed securities class action lawsuits is what they have in common – that is, that while the companies sued are drawn from a surprising diversity of industries, none of them are in the financial services sector. The absence of new securities suits against financially related companies is quite a contrast to the lawsuits that were being filed a year ago, and for that matter that were being filed in the first few months of 2009. There is an increasingly strong suggestion that after more than two and a half years, the subprime and credit crisis-related litigation wave may have finally just about played itself out.

The latest securities lawsuit is representative. That is, on November 17, 2009, plaintiffs’ lawyers announced (here) that they had filed a lawsuit in the District of Rhode Island against CVS Caremark and certain of its directors and offices. The complaint, which can be found here, alleges that the defendants failed to disclose operating problems the company was having in its pharmacy benefits management (PBM) business, which the company acquired in 2007. On November 5, 2009, the company disclosed (here) the PBM problems and also disclosed that the company was the subject of an FTC investigation into the company’s drug benefits practices.

Whatever else might be said about the new CVS lawsuit, the suit clearly was not filed against a financial services company and the allegations appear unrelated to the financial crisis.

The several new securities cases filed over the last two weeks share both these traits. That is, the defendant companies are outside the financial sector and the allegations generally do not appear to specifically relate to the global financial crisis.

A case in point is the lawsuit filed last week against The Boeing Corporation and certain of its directors and officers. The plaintiffs’ lawyers’ November 13, 2009 press release (here) describes the securities suit that was filed in the Northern District of Illinois. According to the press release, the complaint (which can be found here) alleges that the company misrepresented the production timeline and anticipated delivery dates of the company’s Dreamliner 787 commercial aircraft.

Similarly, on November 6, 2009, plaintiffs’ lawyer initiated a securities class action lawsuit against jewelry retailer Zale Corp. (about which refer here) alleging that the company had improperly recorded certain prepaid advertising expenses and intercompany accounts receivable.

Other examples include the November 10, 2009 action against Hemispherix Biopharma, (refer here) alleging misrepresentations in connection with the new drug application of one of the company’s clincal stage products; the action filed on November 6, 2009 against STEC, Inc.(refer here), the memory drive manufacturer, which is alleged to have overstated demand for one of its products; and the November 6, 2009 action filed against specialty women’s clothing retailer Limited Brands (refer here), which is alleged to have made misrepresentations regarding the company’s direct-to-consumer ecommerce initiative.

Again, none of these cases involve financial companies and none are directly related to the financial crisis.

To be sure, all along as the subprime and credit crisis litigation wave unfolded over the last two and a half (actually nearly three) years, there have been cases that didn’t involve financial companies and that were unrelated to the credit crisis. However, this recent collection of cases, particularly the absence of any financial related suits, seems to represent a categorically different filing pattern.

At the same time, there are still some cases being filed that unquestionably reflect back to the credit crisis. Indeed, late last week I noted (here) that a credit crisis-related lawsuit had been filed against VeraSun Energy. Even though the company itself is not financially related, the claims in the complaint relate to the company’s alleged problems arising from the company’s wrong way bets on certain financial derivative hedging contracts.

There undoubtedly are other cases yet to come like that filed against VeraSun, where the allegations reflect back on the events of the financial crisis – particularly, as was the case with the VeraSun filing, if the plaintiffs’ lawyers’ continue to file suits where the proposed class period cutoff date is well in the past, and accordingly the lawsuits involved long past events. As I noted in my post about VeraSun, those kinds of cases could continue to arrive for some time to come.

But while there could and likely will be further additional cases relating to or arising from the financial crisis, it seems increasingly likely that the mix of cases will be much more diverse that has been the case for almost three years now. This may entail some adjustment for D&O insurance underwriters, who have been very defensive against financial company risks, but much more agreeable to accepting other kinds of risks. The pattern over the last few weeks suggest that securities litigation risk may once again be dispersed across a wide variety of sectors and industries, and a more generalized underwriting approach to risk selection may be required going forward.

So What About Bernard Madoff’s Insurance?: If you are like me, you have probably wondered since the very beginning of the Madoff scandal what kind of insurance his firm carried. It turns out that, other than a bond, his firm didn’t carry professional liability insurance.

As reflected in Susan Sclafane’s November 17, 2009 National Underwriter article (here), Madoff apparently had for years refused to buy D&O insurance, and instead carried only a $25 million financial institutions bond because he was required to do so by participants in his legitimate clearing trade business. (The bond carrier, which reportedly was on the risk for 15 years, apparently has filed a rescission action.)

Not that the D&O insurance would have gone very far, even if there had been D&O insurance in place, in view of the massive scale of the losses. For that matter, given Madoff’s guilty plea, coverage for claims against Madoff or his firm would have been excluded under most D&O policies anyway.

Perhaps it was Madoff’s awareness that of the unlikelihood of coverage that convinced him not to squander his ill-gotten gains on insurance designed to protect his victims.

Special thanks to a loyal reader for providing the link to the National Undewriter article.

Today’s Grammar Question: Observant readers may have noticed that in discussing the recent securities filings I used the plural form of the verb "to be" in connection with my use of the noun, "none" – as in, "none of them are," rather than "none of them is."

While I have no particularly strong feelings on the question of the proper verb form to be used with the noun "none," a little bit of Internet research convinced me there are quite a number of people who feel quite strongly on the subject.

I also am persuaded that the plural verb form is generally proper (as discussed here), and that even for those who feel that either usage is proper, the plural form is in any event most appropriate when the word "none" is used in the sense in which I used it – that is, to mean "not any, " in reference to plural entities (about which refer here).

If there are any readers out there who have a strong reaction to my resolution of this grammatical issue, I suggest that the best response is either a long walk or a short drink. (Or if you prefer, a short walk and a long drink. Better yet, skip the walk.)

Further Apologies: I apologize to everyone for continuing service problems with this site, particularly with respect to the delivery of email notifications. LexBlog, my blog hosting service, is continuing to suffer ill effects from a sustained spambot attack a few days ago. Along with everyone else, I sure hope things return to normal soon, if for no other reason than for the sake of my sanity.  

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According to its November 13, 2009 press release (here), Marsh & McLennan has agreed to pay $400 million to settle the consolidated securities class action lawsuit pending in the Southern District of New York against the company, its insurance brokerage unit, and certain former officers of the company. The company also agreed to pay $35 million to settle the related ERISA class action suit filed on behalf of the company’s employees. Both settlements are subject to court approval.

As reflected in the press release, the company expects that $205 million of the $400 million securities settlement and $25 million of the $35 million ERISA settlement will be covered by the company’s insurance.

The securities suit settlement stipulation can be found here. The settlement stipulation in the ERISA suit can be found here.

These two consolidated class action lawsuits were both initiated in October 2004, in the wake of then-New York Attorney General Eliot Spitzer’s announcement that he had launched a fraud lawsuit against Marsh and others alleging that Marsh had engaged in bid-rigging, price-fixing and had accepted payoff from insurers in the form of "contingent commissions."

As reflected in greater detail here, the investor plaintiffs in the subsequently filed securities suit alleged that the defendants had failed to disclose that "the Company had implemented and executed an unsustainable business practice whereby the Company designed and executed a business plan under which insurance companies agreed to pay so-called ‘contingent commissions’ in return for Marsh to steer them business and shield them from competition." The securities suit further alleged that "the Company's revenues and earnings would have been significantly less had the Company not engaged in such unlawful practices."

The ERISA suit alleged that the defendants had breached their fiduciary duties by "imprudently permitting" the company’s benefit plans to invest in and hold MMC stock, despite the fact that defendants knew or should have known that the company or its subsidiaries were engaging in bid-rigging and other illegal activities. As a result, it was alleged, the plan’s investment in MMC stock was no longer prudent and appropriate.

Based on the data reflected in the most recent Risk Metrics Group table of the 100 largest securities class action settlements (here), the $400 million securities lawsuit settlement, if approved, would represent the twenty-fourth largest securities largest securities settlement ever. The $35 million ERISA settlement would also be among the larges all-time ERISA class action settlements, as reflected in my table of ERISA case settlements, which can be accessed here.

The Marsh lawsuits were among several that were filed in the wake of Spitzer’s "contingent commission" investigation. And though some of these other cases also resulted in settlements, none were any near as large as the recent Marsh settlements.

For example, AON paid a comparatively modest $30 million to settle its contingent commission-related securities suit (about which refer here). The contingent commission-related securities suit filed against Hilb, Royal & Hobbs (about which refer here) was actually dismissed, and while the plaintiffs appeal was pending the parties negotiated a stipulation of dismissal.

The massive size of the Marsh settlements is impressive, but similarly noteworthy is the extent to which both of these settlements exceeded the amount of insurance available. One of the perennial questions in D&O insurance placement is the issue of "limits adequacy" – that is, the question of how much insurance is enough. The significant extent to which these settlements exceeded the available insurance underscores the dramatic potential for catastrophic claims to exceed the limits of even very large D&O insurance programs.

A smart-alecky observer might be tempted to try to extract some irony from the fact that an insurance advisor like Marsh was caught short with insurance limits that proved insufficient. The reality is that very serious claims of the kind filed against Marsh have the terrible potential to exceed any realistically available amount of insurance. As a practical matter, as some level, there is no available and affordable amount of insurance that could be sufficient to ensure limits sufficiency for every possible claim. In any insurance program, even one that is very large, there will always be some risk that the costs associated with serious claims could exceed the available limits.

This inherent potential for limits inadequacy underscores the extraordinary importance of limits selection issues. Well-advised insurance buyers will want to purchase limits calculated to reduce the risk of limits insufficiency as much as practicable, consistent with competing concerns regarding affordability and insurance availability.

As the same time, the inherent risk of limits inadequacy highlights the need for well-advised insurance buyers to consider program structure issues as well program limits. A well-constructed insurance program should incorporate not only appropriate limits of liability, but should also include appropriate alternative insurance structures, such as Excess/Side A DIC insurance and perhaps even independent director liability insurance, as a way to try to reduce the possibility that individuals might face further potential liability without insurance available to protect them.

One final note is that there have now been a couple of dozen securities class action settlements of $400 million or greater. While settlements of this enormous size are still noteworthy, the fact is that it is becoming increasingly common for securities class action settlements to exceed any theoretically available amount of insurance. This troublesome fact has significant risk management implications. Simply put, insurance alone may be insufficient to fully protect against liability exposures under the federal securities laws. There is a longer essay for another day here, but the unmistakable conclusion is that corporate risk management must address far more than just insurance-related issues.

The November 13, 2009 press release of Ohio Attorney General Richard Cordray relating to his office’s role in negotiating the Marsh settlement on behalf of various Ohio pension funds can be found here. A post on the 10b-5 Daily blog discussing the settlement and linking to various rulings in the underlying securities suit can be found here. Ben Hallman's November 13, 2009 AmLaw Litigation Daily article discussing the attorneys involved in the settlement can be found here.

DoJ Targets Pharma Company FCPA Violations: Earlier this week, I linked to a recent Business Insurance article suggesting the Foreign Corrupt Practices Act-related claims could produce increasing claims costs for D&O insurers. But knowing that there could be growing numbers of FCPA claims does not tell D&O insurance underwriters which of their policyholders or prospective policyholders are likeliest to produce these kinds of claims.

Recent comments by a DoJ official suggest at least one industry that could prove to be a significant source of FCPA-related losses. According to a November 12, 2009 Blog of the Legal Times article (here), Assistant Attorney General Lanny Breuer recently told a pharmaceutical industry conference that the application of the FCPA to the pharmaceutical industry will be a priority in the "months and years ahead."

The particular concern is that government involvement in foreign health care systems means that health care and medical officials in many countries are government officials, creating a "significant risk that corrupt payments will infect the process." Breuer and others emphasized that their enforcement actions will not be limited to corporate actors, but where facts warrant will also include criminal actions against individuals.

Dick Cassin has a post on his FCPA Blog (here) with a link to a complete copy of Breuer’s remarks, as well as Cassin’s own comments on the prospects for increased FCPA enforcement activity in the pharmaceutical industry.

And in This Week’s Ponzi Scheme News: I was struck by the news late last week that prosecutors had brought criminal charges against two computer programmers for aiding Bernard Madoff’s fraudulent investment scheme. I think we all suspected that a fraud as massive as Madoff’s could not have been sustained without the complicity of other individuals. Of course there were individuals like these programmers, who apparently were actively complicit – along with those like the regulators and other gatekeepers who may have been passively complicit.

The latest Ponzi scheme story involving Florida lawyer Scott Rothstein is all too familiar. The November 14, 2009 Wall Street Journal’s front-page story about Rothstein reflects all of the now-standard features, including large boats, expensive homes and fast cars – all of the accoutrements of accomplishment, where all that had been accomplished was deception. The Miami Herald reports that investigators "do not believe this was a one-man show." That is, the Rothstein scheme may have had other features in common with other Ponzi schemes, including the complicity of others.

The Journal’s account of Rothstein’s fraudulent scheme brought home to me that these schemes require yet another kind of complicity --- that is, the complicity of investors seeking outsized returns. It would be unduly harsh (not to mention smug) to presume to blame the investors for their losses. They were, after all, actively misled. By the same token, however, the schemes would have gone nowhere if investors had not been willing to accept the schemes’ unconventional investment proposition in exchange for the promise of returns unavailable from conventional sources. A November 9, 2009 Fort Lauderdale Sun Sentinel article examining this angle of the Rothstein story can be found here.

We can bemoan the failure of regulators and other gatekeepers that allowed the schemers to escape detection. But at the same time, a healthy skepticism, including in particular a suspicion of consistently market-beating returns, may be something that no investor can afford to do without. I do not mean to suggest that the victims of these schemes are to blame for their own losses. Rather, I am saying that the rest of us can learn from these events, and with benefit of the lessons from these examples perhaps avoid  these kinds of losses in the future.

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As the dramatic events in the financial marketplace during fall 2008 recede further into the past, the wave of related litigation activity has also clearly started to slow. But a newly filed lawsuit arising directly from the financial crisis suggests that there may still be further credit crisis cases yet to come, particularly as plaintiffs’ lawyers continue to initiate class action litigation with proposed class period cut-off dates well in the past.

As reflected in their November 10, 2009 press release (here), plaintiffs’ lawyers have launched a securities class action lawsuit in the Southern District of New York against certain former officers VeraSun Energy Corp., a of South Dakota-based ethanol producer that filed for bankruptcy on October 31, 2008.

According to the press release, the complaint (a copy of which can be found here) alleges that the defendants failed to disclose that:

(i) VeraSun was, in part, a speculative commodities trader in addition to an ethanol producer; (ii) VeraSun engaged in speculative and risky derivate transactions that exposed the Company to substantial financial and liquidity risk; (iii) VeraSun experienced substantial loses on speculative derivative transactions causing margin pressures on the Company; (iv) as a result of margin pressures from bad speculative derivative transactions, the Company sold out of a large short position in corn and incurred substantial losses; (v) the Company entered into highly risky "accumulator" contracts that obligated VeraSun to purchase increasing amounts of corn after the price of corn fell in price per bushel; and (vi) VeraSun’s financial condition and especially its liquidity were negatively impacted as a result of speculative commodity transactions, ultimately causing the Company to file for bankruptcy.

The complaint further alleges  that:

On September 16, 2008, VeraSun announced that it commenced a public offering of 20 million shares of its common stock to raise money for "general corporate purposes." The true purpose of this public offering was to raise capital in an effort to prevent a disastrous impact from the huge losses experienced by the Company as a result of its speculative trading and risky bets on the price of corn.

Not only are these events all well over one year ago, but the proposed class period also covers a segment of time that is also well past -- the complaint purports to be filed on behalf of a class of persons who purchased VeraSun shares between March 12, 2008 and September 16, 2008.

The complaint’s allegations resemble the facts and circumstances alleged in a number of credit crisis-related cases that were filed last fall, where (as described here) the defendant companies were alleged to have suffered significant financial reverses due to wrong way bets on commodities or currencies, often (as was the case with VeraSun) in connection with hedging transactions. In each case, the sudden and dramatic events in the financial markets during September and October 2008 produced a magnified impact on financial condition of these companies.

The prior lawsuits generally were filed closer in time to the events involved, while the VeraSun case has only just been filed. The lapse in time between the events alleged and the VeraSun lawsuit filing is, however, consistent with the filing pattern that has emerged during 2009, where (as noted here) numerous newly filed complaints have proposed class period cutoff dates that fall well before the filing date.

I have previously speculated that these seemingly belated filings may perhaps reflect a filing backlog that developed as plaintiffs’ lawyers were caught up in the rush of credit crisis related lawsuits and Madoff related litigation. The VeraSun case filing suggests that this apparent backlog may even include yet to be filed credit crisis-related lawsuits, which in turn suggests that there there may be more credit crisis suits yet to come.

The VeraSun case is also the latest example of a securities class action lawsuit arising in the wake of a corporate bankruptcy. The surging numbers of business-related bankruptcies may further contribute to the further instigation of securities class action litigation. The possibility of these kinds of cases arising, like the VeraSun case, well after the bankruptcy date suggests these cases could continue to arrive for some time to come.

All of which suggests to me that, even of the pace of new credit crisis-related securities lawsuit filings have declined, the litigation fallout from the global financial crisis is likely to continue to accumulate in the months ahead.

I have in any event added the VeraSun case to my list of credit crisis related cases, which can be accessed here.

Another Options Backdating-Related Securities Suit Settlement: Another one of the remaining options backdating-related securities lawsuits has settled. As reflected in their October 15, 2009 stipulation of settlement (here), the parties to the Sonic Solutions options backdating-related securities suit have agreed to settle the case for $5 million.

A complete list of the options backdating-related lawsuit resolutions can be accessed here.

Adam Savett of the Securities Litigation Watch blog has been tracking (here) the options backdating related settlements.Adjusting his data to take account of the Sonic settlement would mean that 30 of the 39 options backdating-related securities class action lawsuits have now been resolved, with nine of these cases having been dismissed and twenty-one of them having been settled. Prior to the Sonic settlement, the average settlement amount was $77.8 million – or $33.23 million if the outsized UnitedHealth settlement is disregarded.

UPDATE: The Securities Litigation Watch has updated its options backdating settlement tally and analysis to reflect the Sonic settlement, here.

My Dinner with Bill: I am in Chicago this week at the PLUS International Conference, where the keynote speaker was none other than Bill Clinton. Let me just say that he though he is now "only" a former President, he retains all of his rhetorical powers. His speech was entertaining, thought-provoking, funny and serious, and impressive.

During the Q&A, one of the questions he was asked is a rather conventional parlor game question: if you could have dinner with any historical figure, who would you choose and why? Perhaps because it was a conventional question, he gave a rather conventional, almost undergraduate-approval-seeking type answer. And being a politician, he couldn’t name just one person – he named three: Socrates, Jesus, and Genghis Kahn. Clinton had his reason for each of the three.

I will grant you that Genghis Kahn is an interesting answer, but the other two are safe, predictable and, well, kind of boring. I will stipulate that everyone if they had a chance would want to meet Jesus. Socrates is pretty much in the same category. (Same with Gandhi and Winston Churchill) So if we all agree that Jesus and Socrates (and Gandhi and Churchill) are not available, which historical figure would you want to have dinner with?

Because Clinton gave himself three choices, I am going to give myself three as well.

First, I would choose Charles Maurice de Talleyrand-Perigord, also known as the Bishop of Autun. Talleyrand lived through some of the most interesting events in all of human history and somehow not only managed to be involved in them all, but what is perhaps a more impressive feat, to have survived them all. He was involved in the French revolution from the start and even acted as foreign minister to the revolutionary government. He later managed to become a key advisor to Napoleon, until they fell out over policy. Ultimately, he became one of the key players in the Bourbon restoration. Though often reviled as unprincipled and cynical, I believe he may have been one of the most interesting people in the grand march of history, and he certainly led one of the most interesting lives.

Second, I would choose Moshe ben Maimon, now known as Maimonides, the Jewish theologian, physician and philosopher. He also lived at an incredibly interesting time, having been born in Islamic Spain in the twelfth century and then fled persecution through Northern Africa. His wisdom, scholarship and knowledge of languages have shaped European thought up until this very day. He was among the first Europeans both to appreciate and advocate Aristotle. His rationalist philosophy would still appeal to most moderns, which to me is a reflection of what an original and powerful thinker he was.

Having chosen two historical figures, I feel I should be a little bolder and unconventional with my last choice. So my third selection is John Lennon. He was a radical advocate for peace whose art and originality touched the lives of millions.

A dinner with all three of these persons simultaneously would be chaos. But a dinner with any one of them (language and cultural issues aside) would be fascinating.

So, now you have Bill Clinton’s choices and my choices. Who would you choose? And why? If you are attending the conference and you have views on this question, I hope you will stop me and let me know your thoughts. And if you are not at the conference, I hope you will use the comment function on this blog to let me and other readers know what you think.

The one final thought I have to add is that , after having heard Bill Clinton speak today, honestly, I think a dinner with him would be pretty damn interesting, too.  I suspect we could talk about Talleyrand and Maimonides and even John Lennon or Genghis Kahn and it would be memorable and entertaining.

UPDATE: My friend and former colleague Marty Hacala provided the following e-mail answer to my dinner guest question: 

I agree that Clinton's answer was boring and conventional. We are after all talking about a dinner party and not a lecture. Who wants to listen to a failed carpenter and a suicidal Greek talk about the hereafter while picking at their food? Genghis Khan is an interesting choice if only because he might tire of the conversation and dispatch the first two before dinner has even begun.

My invitations would go to Oscar Wilde, Abraham Lincoln and Groucho Marx. (I could substitute Churchill for Lincoln, but I fear the alcohol wouldn't last and so the meal would end on an unhappy note.) Just imagine the stories they would tell? I see myself sitting there mesmerized listening to Wilde and Marx trade high and low-brow barbs, while Lincoln tells long stories of how they remind him of mostly made up characters from his youth. It would be an evening to remember. 　

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There are certain constant issues in the D&O insurance marketplace, but at the same there is always a steady stream of critical issues that emerge and dominate the dialog. In the latest issue of InSights (here) entitled "What to Watch Now in the World of D&O," I take a closer look at the current hot topics affecting the marketplace for D&O insurance.

Bribery Probes and D&O Insurance: Regular readers know that I have written frequently on this blog (most recently here) about the increasing concerns about  the rising number of Foreign Corrupt Practices Act enforcement actions, including possible threats arising from follow on civil actions. The problems that issues may present for D&O insurers is discussed further in an article by Zack Phillips in the November 9, 2009 issue of Business Insurance entitled " Rise in Bribery Probes May Hit D&O Insurers" (here). Special thanks to a loyal readers for sending along a link to this article.

On a related note, Frederick Bourke, Jr., the individual mentioned in the Business Insurance article as having been convicted on criminal FCPA charges, was sentenced yesterday to one year in prison. Refer here for Andrew Longstreth's November 10, 2009 AmLaw Litigation Daily article.

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The onslaught of bank closures continues. The FDIC’s closure of five more banks this past Friday night brings the 2009 YTD total number of bank failures to 120 – including twenty-one in just the last three weeks alone. There are a variety of reasons for the growing number of bank failures, but clearly one important reason is the continuing deterioration of commercial real estate loans.

As I noted in a prior post (here), there may be further bank failures ahead as commercial real estate mortgages come due or default. A November 5, 2009 BusinessWeek article entitled "The Commercial Loan Nightmare Facing U.S. Banks" (here) suggests that banks’ commercial real estate loan problems may be worse even than may be currently apparent.

According to the article, "many banks have been forestalling the day of reckoning" by using an approach the article described as "extend and pretend," which consists of allowing "temporary extensions to trouble borrowers on maturing commercial loans to give them, and the bank, some breathing room."

The problem for the banks is that "surging delinquencies and defaults will eventually catch up with them." Many banks are currently showing no charge-offs, but as much as $500 billion in commercial real estate loans will mature within in coming months, while commercial real estate values have declined as much as 40 percent since the beginning of 2007. As these issues catch up with the banks, according to the article, more banks could fail.

The article includes a list of the 30 publicly traded banks that may have the most exposure to commercial real estate. The 30 banks have more than 50 percent of their loan portfolios in commercial real estate loans. To be sure, the banks’ heavy concentration in real estate loans is not the same as being burdened with bad loans, but it does mean that the listed banks "have more exposure to the commercial real estate sector."

Among the bank closed this past Friday night was the California-based United Commercial Bank, as reflected in this November 6, 2009 FDIC Press Release (here). The bank's parent holding company, UCBH, and certain of its directors and officers, were already the subject of a securities class action lawsuit, as I discussed in a prior post, here. The UCBH lawsuit and the failure of the bank operating company may represent examples of the ways in which the growing numbers of troubled banks could lead to an increased amount of litigation arising from the banks' woes.

Another Subprime Securities Suit Dismissal: In an October 6, 2009 order (here), District of Massachusetts Judge Nathaniel Gorton granted the defendants’ motion to dismiss the complaint that had been filed against the commercial construction firm, Perini Corporation and certain of its directors and officers. Judge Gorton’s dismissal ruling granted the plaintiffs leave to amend, but he warned that if the amended complaint is deficient, "dismissal will be with prejudice."

As reflected here, the plaintiffs had alleged that Perini had failed to disclose that the developer on a major Las Vegas construction project was experiencing financial difficulties, including difficulties in obtaining project financing for the Las Vegas project. The complaint further alleged that as a result of these difficulties the Las Vegas project faced possible delays and that the developer faced a risk of default. The complaint further alleged that the Las Vegas project represented as much as 20% of the Perini company’s construction backlog and that as a result of the difficulties the company’s ability to maintain its profit margins was in doubt.

As Judge Gorton later summarized, the "crux" of the plaintiffs’ complaint is that the company knew about the developer’s financial troubles, "which rendered statement that, in essence, all was well at Perini, false and misleading."

In his October 6 ruling, Judge Gorton found that the plaintiffs had failed to adequately allege scienter. He said that even assuming the defendants were aware of the developer’s financial difficulties "the complaint fails to attribute the requisite high level of culpability to them. To the contrary, the complaint sets forth facts showing that the defendants were actively and ultimately successfully, working to ensure that any difficulties of [the developer] did not impact Perini."

The court found that the non-fraudulent inferences from the defendants’ conduct and statements to be "more compelling that any inferences of culpable scienter." Moreover, Judge Gorton found further that the plaintiffs had failed to "plead adequately that the defendants were even ‘aware of’ [the developer’s] financing difficulties in the first instance."

Finally, Judge Gorton found that even if the plaintiffs had adequately alleged scienter, the allegedly fraudulent statements do not provide a basis of liability. He found that most of the statements came within the safe harbor for forward looking statements and that the few remaining statements that were not forward looking were not otherwise actionable

I have added the Perini decision to my running tally of subprime and credit crisis-related dismissal motion resolutions. The tally can be accessed here.

Special thanks to Adam Savett of the Securities Litigation Watch (here) for providing copies of the Perini ruling.

Another FCPA-Related Civil Lawsuit Settlement: Regular readers know I have written frequently about civil litigation that can follow in the wake of Foreign Corrupt Practices Act (FCPA) investigations and enforcement actions. (Refer for example here.) In the latest resolution of this kind of follow on civil action, on November 6, 2009, Nature’s Sunshine Products announced (here) that the court had preliminarily approved the settlement of the lawsuit in which the company had agreed to pay $6 million.

As reflected here, the plaintiffs in the securities lawsuit had alleged in connection with the improper payments that the company lacked appropriate internal controls and that the company’s books and records did not reflect the foreign transactions. As noted here, the court had denied the defendants’ motions to dismiss.

The company’s FCPA-related problems received additional attention earlier this year when (as noted here), the SEC brought control person liability charges against the company’s CEO and CFO, even though the individuals were not alleged to have had any involvement in or even awareness of the company’s allegedly improper payments.

The company’s $6 million securities class action settlement is just the latest in a line of settlements in securities cases following in the wake of FCPA-related investigations and enforcement actions. My prior overview of FCPA-related follow-on civil litigation can be found here.

The Financial Crisis and D&O Insurance: A wide variety of litigation has arisen out of the global financial crisis, much of which has implicated the D&O insurance of the defendant companies. The involvement of the companies’ D&O coverage in turn has underscored the importance of the applicable policies’ coverage and in particular the sufficiency of the policies’ terms and conditions.

A recent memo entitled "Directors’ and Officers’ Coverage Priorities in the Financial Crisis: A Seven-Point Inspection for Your D&O Policy" (here) by Ernest Martin Jr. and Micah Skidmore of the Haynes and Boone law firm presents a comprehensive overview of the critical D&O insurance issues arising from the current financial crisis. The article is thorough and timely.

Apologies: Due to a massive spambot attack directed at the "Comment" function of blog sites hosted by the LexBlog network (on which The D&O Diary is hosted), there have been a variety of service and performance disruptions on this site over the last several days. Among other things, the comment function has been disabled and the email notification system was interrupted. I have also had intermittent difficulties just adding new content.

I apologize to readers for any difficulties you may have had accessing this site, posting comments, or receiving email notifications. I am hopeful that the problems are now or will soon be completely resolved.

My special thanks to everyone at LexBlog for the courteous and attentive service while managing this crisis.

This Week: The D&O Diary’s publication schedule during the week of November 9 will be disrupted because I will be in Chicago for the annual PLUS International Conference. I know many readers will also be there and I hope readers who see me there will be sure to say hello and, if we have not met before, to introduce themselves. I look forward to seeing everyone in Chicago.

Upcoming Conference: On November 30-December 1, 2009, I will be co-Chairing the American Conference Institute’s Fifteenth Annual Advanced Forum on D&O Liability in New York. This event will include presentations from the leading figures in the D&O insurance field, and the program will address the most critical issues facing the D&O insurance industry today. The program agenda, including registration information, can be found here.

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The D&O Diary is pleased to present the following guest blog post, written by Angelo Savino (pictured),  a partner at the Cozen & O’Connor law firm. Angelo is resident in the firm’s New York office. Angelo’s guest blog post follows:

As noted in prior posts (here), the U.S. Supreme Court is considering whether to grant certiorari in the National Australia Bank ("NAB") case, which involves foreign-cubed or f-cubed litigation. At the Court’s invitation, the Solicitor General and the SEC have now weighed in with the government’s position by submitting a joint brief.

Oddly, as noted by 10b-5 Daily, the government argues that (1) every Circuit Court that has considered the extraterritorial reach of the federal securities laws since Judge Friendly’s 1975 decision in Bersch has focused on the wrong issue and (2) there is currently a conflict among the Circuits regarding the standard to be applied to foreign-cubed cases under the cause test, but that the Court should nevertheless deny certiorari. Ironically, the government’s position may increase the likelihood that the Court will grant cert.

Background

NAB involved claims on behalf of a class of foreign purchasers of stock in NAB, an Australian corporation, on foreign exchanges. The complaint alleged accounting irregularities at NAB’s Florida mortgage servicing subsidiary, Homeside, that were transmitted to NAB headquarters in Australia and incorporated into NAB’s financial statements, which were then disseminated from outside the U.S. The District Court dismissed the claim for lack of subject matter jurisdiction and the Second Circuit affirmed.

In considering the extraterritorial reach of the U.S. securities laws, the Second Circuit applied the cause test, which the Court articulated as follows: "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 losses to investors abroad." Relying on two 1975 decisions by Judge Henry Friendly – Bersch v. Drexel Firestone Inc. and IIT v. Vencap Ltd., the Court sought to identify which actions constituted the fraud and directly caused harm, or as the Court stated elsewhere in the opinion "what is central or at the heart of a fraudulent scheme."

Applying the above standard, the Court held that subject matter jurisdiction did not exist because NAB, not Homeside, was the publicly traded company and its executives at the Australian headquarters were primarily responsible for the company’s public filings, relations with investors, and public statements. Thus, the conduct that directly caused any loss occurred outside the U.S.

Thereafter, the plaintiff petitioned for cert. and the Supreme Court invited the government to submit its view on the petition. Although the SEC had previously submitted an amicus brief to the Second Circuit siding with the plaintiff and asserting that subject matter jurisdiction existed in the case, its current brief urges the Supreme Court to deny cert. because, although the Second Circuit analyzed the wrong issue, it reached the correct result.

Discussion

The most striking aspect of the government’s analysis is the assertion, contrary to the jurisprudence of the last 34 years, that "the geography of an alleged fraudulent scheme – i.e., whether it was conceived and executed in whole or in part outside the United States – is irrelevant to the district court’s subject-matter jurisdiction." Instead, the government would engraft a geographical component onto the 10b-5 cause of action. The government notes that in cases of transnational fraud, a private plaintiff should be required to demonstrate a direct causal link between his injury and the U.S. portion of the alleged scheme. The government concluded that, in this case, the link between Homeside’s accounting numbers and the harm to the plaintiffs was too attenuated because, as the Second Circuit explained, the numbers had to pass through numerous checkpoints manned by NAB’s Australian personnel before reaching investors.

In an action by the SEC, however, the government asserts that the transnational nature of a fraudulent scheme is relevant only insofar as it has a sufficient connection to the United States to bring it within section 10(b)’s substantive prohibition. This begs the question what is a sufficient connection. The government’s answer this time is to characterize Homeside’s conduct as integral to the overall scheme and, therefore, sufficient to support an SEC enforcement action.

So after trashing the analytical method applied by every court to consider the extraterritorial reach of the securities laws over the last 34 years, the government next concludes that the conduct at Homeside is insufficient for foreign private plaintiffs but sufficient for an SEC action. This tends to give the government’s analysis the appearance of intellectual gymnastics designed to preserve or extend its own ability to bring cases. It seems more analytically satisfying to accept the traditional jurisdictional analysis as correct, and require foreign-cubed plaintiffs to satisfy the cause test while requiring the SEC to demonstrate satisfaction of the effects test, which focuses on harm to U.S. investors and U.S. markets. Moreover, to the extent that the SEC seeks, in a given case, to prevent export of fraud from the U.S., it should rightly bear the burden on a motion to dismiss of demonstrating that the resources of U.S. courts are appropriately being used, as it would if the issue is jurisdictional, but not if it is part of the 10b-5 cause of action. The government’s analytical model would shift that burden for private plaintiffs as well, making it more likely that they would bring more actions in U.S. courts.

The government’s brief also recognizes the existence of a split among the Circuits, but characterizes it as "much less pronounced than petitioners contend." Different Circuits have in fact articulated different formulations of the cause test, as noted in the brief. Add to that calculus, the Eleventh Circuit’s recent decision in the CP Ships case, affirming a District Court’s finding of subject matter jurisdiction in a case that, like NAB, involved alleged accounting irregularities at the Florida subsidiary of a foreign company whose stock traded predominantly on foreign exchanges. The apparent inconsistencies among the Circuits, of course, may simply be the product of the fact-intensive inquiry inherent in analyzing causation regardless of how courts articulate the cause test. But even then, it would be preferable to have a single nationwide standard. Nevertheless, the government concludes that NAB is not a suitable vehicle for resolving the conflict because the petitioners identify no case indicating that any other Circuit would allow their suit to go forward.

Conclusion

The government’s arguments seem motivated by a concern that analyzing foreign-cubed cases as a jurisdictional issue and using the Second Circuit’s short-hand formulation of the cause test (where did the heart of the fraud occur?) could prevent the SEC from bringing enforcement actions in certain cases. The government’s reasoning, however, seems to miss the mark. The cause test will have an impact primarily, if not solely, in the foreign-cubed context where there is a foreign plaintiff. The SEC will be bringing cases generally when it perceives an effect on U.S. investors or markets and may, therefore, be evaluated under the effects test. Alternatively, it will need to justify invoking the power of the U.S. courts to protect primarily foreign interests by demonstrating domestic conduct that directly caused the losses. In any event, the jurisdictional analysis rightly places the burden of demonstrating that the action should proceed on the party bringing the case, which the government’s suggested analytical model would not, at least at the motion to dismiss stage.

Despite believing that courts have been misanalyzing the issue for over three decades and despite recognizing a split in the Circuits, the government urges the Court to deny cert. By stressing these issues in its brief, however, the government may very well persuade the Court of the need to resolve these questions in an era of increasing globalization of the capital markets and increasing incidence of foreign-cubed litigation.

The D&O Diary is very grateful to Angelo Savino for submitting this article for publication on this site. I welcome draft proposed guest posts from other authors. Anyone interested in submitting a proposed guest post should just drop me a note using this blog’s contact function (see the Contact link in the right hand column, above).

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Where securities class action lawsuits are concentrated tends to vary over time. At various times over the past several years, companies in the high tech sector, telecommunications category and, more recently, in the financial services industries, have found themselves for a period to be the most popular targets for plaintiffs’ securities class action attorneys. However, beginning in August of this year and accelerating since then, exchange-traded funds (ETFs) appear become among the hottest new targets for securities class action lawsuits. Signs are that there could be more ETF-related securities suits ahead.

By my count there have been at least eight or nine and arguably as many as eleven (or more) new securities class action lawsuits filed against ETFs since August. (See my note below about the difficulty in counting these cases.) Though these lawsuits are separate and are separately filed on behalf of separate investors against separate ETFs, the allegations of these suits are quite similar – indeed, in many cases, virtually identical.

Two recent cases filed against ProShares Ultra Short Dow 30 Fund (refer here) and Direxion Shares Daily Financial Bear 3X Fund (refer here) illustrate the nature of this category of securities suits. The lawsuits overall, like these two, generally are filed against some variation of the funds themselves, the funds’ investment advisors or managers as well as the funds’ distributors, and the funds’ individual trustees. The ETFs themselves allegedly were designed to provide some multiple of the return (or of the inverse of the return) of some benchmark index or measure.

The complaints basically allege that the defendants failed to disclose to investors the risks associated with the investments, and in particular allegedly did not disclose the significant likelihood of losses to the value of the funds’ shares if held over time or even just for more than a single day, nor did the funds disclose the extent to which the funds’ results would likely diverge from their benchmark over time.

Though there have been many of these ETF-related securities lawsuits filed recently, there may be many more yet to come. Among other things, as inevitably seems to happen when plaintiffs’ lawyers start racing to stake out their piece of a hot property, at least one plaintiffs’ firm has issued a press release (here) announcing that it is investigating a whole raft of ETFs – indeed, the particular plaintiffs’ firm’s press release lists 75 different ETFs the firm is investigating.

Whether these cases will ultimately succeed or fail of course remains to be seen, but the plaintiffs’ firms’ actions clearly suggest that they think they are on to something.

These lawsuits already represent a significant part of the total number of securities class action lawsuits this year (depending on how you count, between five and ten percent of the total). If as seems likely at this point new ETF-related cases continue to be filed, the ETF cases will not only represent an even more significant portion of the total number of new securities cases this year, but they could also produce a material increase in the overall number of lawsuits that are filed this year.

But whatever the ultimate number of ETF-related cases ultimately proves to be, I believe that we have already reached the point where these cases represent their own separate phenomenon and therefore worthy of tracking on that basis.

Accordingly, I have created a separate list of the ETF lawsuit filings, which can be accessed here.

It is entirely possible that this list is incomplete, and I would be grateful if readers would let me know about any cases I may have missed. I will be updating this list as new ETF-related cases come in.

I should add that trying to keep track of these cases and to tell them apart is a particularly vexing task. Many of the ETFs have bewilderingly similar names, and some of the lawsuits purport to file claims on behalf of investors in multiple ETFs. Figuring out which suits are separate and which are duplicates is a considerable challenge. For each case presented separately on this list there have been multiple other apparently duplicate other filings that I have not listed. Some of these cases do overlap and there may well be consolidation of some (or, who knows, perhaps many or all) of these cases before all is said and done. I have tried as best as I can to identify separate cases separately. I welcome readers’ observations and comments about the list.

Though there have been a number of these suits, and though there could be many more, most of these suits are filed against ETFs within one single fund family. As a result, the extent of the contagion effect from this lawsuit outbreak so far has been relatively isolated. This concentration of many suits within a single fund family may diminish the insurance impact of this category event, as the single fund family likely carried only a single insurance program for all of the funds in the family. I stress that I have no direct knowledge one way or the other, but it is relatively unlikely that each new lawsuits represents a significant new insurance related loss or loss exposure.

Perhaps the Theory is "Better Late Than Never"?: In recent posts (most recently here),  I have noted another trend, which is the apparently belated filing of securities class action lawsuits, where the date of the proposed class period cut off is well in the past. For example, the new suit filed on October 28, 2009 against Pitney Bowes (refer here) has a proposed class period cut off date of October 29, 2007, suggesting that the case was filed just prior to the expiration of the two-year statute of limitations cut off date.

Well, if the cases I previously discussed could fairly be described as "belated," then the securities class action filed in the Southern District of California on October 30, 2009 against Avanir Pharmaceuticals and certain of its directors and officers can only be described as superannuated. Or more succintly, old. Perhaps even stale.

The actiion purports to be filed on behalf of persons who acquired shares of the company's stock between July 1995 and October 31, 2006. That is, the complaint (a copy of which can be found here) was not filed until nearly three years after the proposed class action cutoff date.

There is no way of telling from the face of the complaint how the plaintiffs intend to try to overcome the rather obvious statute of limitations objection that the defendants will raise, expecially given that the complaint expressly alleges that the company's true condition was revealed in an October 31, 2006 disclosure.  It will be interesting to see how the plaintiffs attempt to respond to the statute of limitations defense.

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As a result of a November 2, 2009 ruling (here) by Northern District of California Judge Susan Illston, the PMI Group securities class action lawsuit is the latest subprime-related securities suit to survive a renewed motion to dismiss following plaintiffs’ filing of an amended complaint after the motion to dismiss their initial complaint had been granted. As was the case with respect to the recent ruling in the Washington Mutual subprime-related securities class action lawsuit (about which refer here), the PMI Group lawsuit plaintiffs overcame the shortcomings of their initial pleading with an amended complaint reliant upon added confidential witness allegations.

Background

The PMI Group, a residential mortgage insurer that also owns a controlling interest in bond insurer Financial Guaranty Insurance Corporation, as well as certain of PMI’s directors and officers, were first sued in a securities class action lawsuit in March 2008 (about which refer here). As discussed here, on July 1, 2009, Judge Illston granted in part and denied in part the defendants’ motion to dismiss the plaintiffs’ consolidated complaint.

In her July 1 order, Judge Illston held that the plaintiffs had adequately alleged material misrepresentation and loss causation, but she granted the motion with leave to amend on the grounds that the consolidated complaint did not adequately allege scienter. Among other things, Judge Illston observed that the complaint "falls short of showing that the defendants were aware that the statements were false and misleading when made."

On July 24, 2009, the plaintiffs filed their first amended complaint and the defendants renewed their dismissal motions.

November 2 Ruling

In her November 2 decision, Judge Illston denied the renewed dismissal motion. She noted that the plaintiffs’ amended complaint "differs from the original complaint in a number of ways." Among other things, she noted that the plaintiffs had "supplemented their allegations regarding previous confidential witnesses and added three new confidential witnesses." The plaintiffs also added additional allegations regarding admissions the defendants had allegedly made, as well as allegations PMI itself had made in a lawsuit against a third party, among other things.

Based on these amended allegations, Judge Illston found that the plaintiffs had "cured the deficiencies" in the prior complaint and that the amended complaint "sufficiently alleges a strong inference of scienter." Among other things, Judge Illston referenced the amended complaints’ allegation, through the confidential witnesses, of the defendants’ awareness of the alleged problems in PMI’s credit risk assessments, as well as rising defaults.

Discussion

Judge Illston’s denial of the renewed motion to dismiss in the PMI Group case follows the October 27, 2009 ruling in the Washington Mutual subprime-related securities suit in which the renewed motion to dismiss following an initial dismissal similarly was granted. In both cases, the plaintiffs’ amended complaint overcame the pleading shortcoming found in their initial complaint.

If nothing else, these cases demonstrate that it is possible for plaintiffs to overcome an initial dismissal. Though not all plaintiffs will be able to muster sufficient confidential witness testimony and other allegations to cure the initial pleading shortcomings, these rulings at least show that plaintiffs who are able to muster enough can overcome the initial pleading hurdles and survive the motion to dismiss, even if the initial motions were granted.

And though two case decisions alone may represent far too little data from which to generalize, the success of these plaintiffs on renewed dismissal motions following pleading amendments does suggest that it might have been mature for some commentators (including me perhaps) to suggest that plaintiffs are not faring well in the subprime-related securities class action lawsuits.

Even though a number of dismissal motions have been granted in these cases, many of the motions were granted without prejudice. The recent rulings in the PMI Group and WaMu subprime-related securities suits suggest that a certain number of these initially dismissed cases may well survive renewed motions, and so the scoreboard could look different, perhaps quite a bit different, when all the initial pleading processes in these cases have fully played out.

I have in any event added the November 2 ruling to my register of dismissal motion rulings in the subprime-related lawsuits. The register can be accessed here.

It is probably worth noting that another significant corporate investor in the Financial Guaranty Insurance Corporation, The Blackstone Group, has also been sued in a subprime-related class action lawsuit in connection with the company’s write-down of its investment in bond insurer, about which refer here.

Another Subprime Lawsuit Settlement: It appears that I may have missed an earlier settlement of a subprime-related securities class action lawsuit. As reflected here, on September 2, 2009, the parties to the Hovnanian Enterprises subprime-related securities suit entered an agreement to settle the case for $4 million. I have added this settlement to my list of subprime-related lawsuit case resolutions, here.

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While I have long predicted (refer here) the possibility of litigation against directors and officers of public companies concerning global climate change-related disclosures, to date the lawsuits have not materialized. Which is not to say that there have not been relevant developments – to the contrary, there have been many, as discussed below. There just haven’t been any disclosure lawsuits.

However, recent case law developments in the Second and Fifth Circuits, though relating to an entirely different area of the law, suggest that there may be a new environment for climate change-related lawsuits, as a result of which climate change disclosure lawsuits have moved one step closer.

The Recent Decisions

As summarized in an October 29, 2009 memorandum entitled “Judicial Climate for ‘Global Warming’ Claims Getting Worse?” (here) by Theodore Howard and Jeremiah Galus of the Wiley Rein law firm, the two recent case law developments are the Second Circuit’s September 21, 2009 decision in Connecticut v. American Electric Power Co. (here) and the Fifth Circuit’s October 16, 2009 decision in Comer v. Murphy Oil USA (here).

In each of these cases, a variety of claimants asserted claims based on nuisance and other tort theories against a variety of utilities and energy related companies, claiming that the defendants’ carbon emissions had caused (or increased) the plaintiffs’ claimed harm. The claimants in the Comer case are victims of Hurricane Katrina, who basically claim the defendants’ activities exacerbated the hurricane damage. In each case, the district court held the plaintiffs’ claims could not surmount initial justiciability and standing hurdles.

However, in both cases, the appellate courts determined that the plaintiffs did have standing to assert their claims and held that their claims do not present non-justiciable political questions.

As the law firm memo notes, these rulings “may have removed significant hurdles from the paths of plaintiffs seeking to hold corporate emitters of greenhouse gases liable for harms allegedly caused by global warming.” But though the decisions “may signal a shift in the way courts view tort-based global warming claims,” it is “still too early to project the decisions’ significance.”

Among other considerations the memo notes as suggesting that the decisions’ significance ultimately may be reduced is the fact that at least one district court case already has expressly declined to follow the Second Circuit’s analysis in the American Electric Power case. The memo also notes that the “plaintiffs undoubtedly still face the potentially insurmountable task of proving how and to what extent a particular corporation’s contribution to global warming proximately caused a particular plaintiffs’ injuries.”

For these reasons, the memo notes, it “remains to be seen” whether the cases “pose a serious risk of liability exposure for corporate defendants,” but the corporations – and their insurers – “should be paying close attention to further developments in these cases.”

Discussion

On at least one level – and arguably on all levels – these developments have little to do with the possibility of claims against corporate directors and officers for climate change-related disclosures. These lawsuits raise claims only on tort and nuisance theories. Moreover, it does, as the law firm memo notes “remain to be seen” whether these cases will result in any liability even on those claims.

Nevertheless, I believe these cases represent potentially significant developments with respect to the possibility of climate change disclosure litigation. First, as the memo notes, these cases “may signal a shift in the way in which the federal courts view tort-related global warming claims.” The extent to which judicial perspectives have been changed and to which hurdles have been removed may not be limited just to the context of tort-related cases.

The context within which all climate change related cases are considered may have changed, particularly to the extent these courts “newfound willingness” to consider these cases is, as the memo suggests, “derived from a perceived failure on the part of the legislative and executive branches to address the issue.” If prospective plaintiffs believe that climate change-related claims may be more likely to receive a receptive hearing, they may be encouraged to bring further claims, whether based on tort or based on other theories.

Some readers may regard my generalization of these tort case developments to the world of D&O claims as analytically unwarranted, and they may be right. However, I think this recent case decisions are most properly viewed as the just the latest in a series of developments that have brought the climate change debate ever closer to the courts.

The first development in this chain was the U.S. Supreme Court’s 2007 decision in Massachusetts v. EPA (about which refer here). The chain continued with New York AG Andrew Cuomo’s climate change disclosure subpoenas to several utilities, which resulted in several of the utilities agreeing to certain disclosure principles (refer here). There have been several other extensions of the chain, including the National Association of Insurance Commissioners’ promulgation of climate change disclosure principles for insurance companies, as well as the EPA’s April 2009 endangerment finding (about which refer here). Similarly, there have been a variety of Congressional and other initiatives toward mandating climate change related disclosures (refer here).

These appellate decisions are just the latest event in this continuing chain of developments. In addition,  there are other reasons why I think we can expect to see disclosure related litigation. Among other things, the pattern for the kind of disclosure related case that may yet arise is already established. As I noted in a recent post (here), there is already a pattern for disclosure-related cases based on alleged misrepresentations or omissions related to environmental liabilities and contingent litigation exposures.

Moreover, there is an extensive network of activists who are politically motivated to bring these kinds of claims. Andrew Cuomo was attempting to appeal directly to this network when he filed the disclosure-related subpoenas against the utilities, and there are countless others whose political agenda would be served by similar initiative, including litigation. As the chain of developments outlined above continues to lengthen, these motivated actors, who already have demonstrated their willingness to pursue litigation to advance their goals, may well target concerned players concerning their climate change-related disclosure.

I know from prior communications with readers that there is some significant skepticism about the prospect for climate change-related disclosure litigation any time soon. These skeptics could well be right, since there that kind of litigation is unlikely to arise in the absence of a significant share price decline from a company’s disclosure of some climate change or greenhouse gas emission related issue. But I still think the possibility of these kinds of claims arising is merely a question of when, not if. (Some people I am sure assume I am afflicted with some unbreakable curse that compels me to make these predictions at least once every quarter.)

A Couple of Securities Class Action Settlement Notes: The long-running securities class action lawsuit involving Adams Golf and certain of its directors and officers has finally settled. The case, which was went all the way through discovery and which suffered from delays owing to judicial vacancies,  was first filed in June 1999 and related to the company's July 1998 IPO. More details about the case can be found here.

According to the company's November 3, 2009 press release (here), the settlement provides for a payment to the plaintiff class of $16.5 million, of which Adams Golf itself has agreed to contribute $5 million.

Readers of this blog may be interested in the statement in the press release that Adams was "forced" to contribute the $5 million "because one of its former insurers refused to contribute to teh settlement based on the alleged late notice of the claim." The press release states that Adams has commenced coverage litigation against the former insurer and against its former insurance broker. The settlement requires Adams to pay the class action plaintiffs the first $1.25 million of any recovery, net of fees and expenses, that Adams recovers in the ongoing litigation with the former insurer and former broker. Further details about the settlement and the coverage litigation can be found on Adams Golf's November 3, 2009 filing on Form 8-K (here).

In a separate development, in a November 3, 2009 press release (here), Quest Software announced that it has settled the options backdating related  securities class action lawsuit that had been filed against the company and certain of its directors and officers. The case settled for $29.4 million. Background regarding the case can be found here. I have added the Quest Software settlement to my running tally of options backdating related settlements, which can be found here.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing the information about the Quest settlement.

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In an October 29, 2009 order (here, Hat Tip: Am Law Litigation Daily), Ontario Court of Justice judge Paul Perell ruled that the direct involvement of the U.S.-based law firm Milberg LLP was permissible in the securities class action lawsuit filed against Timminco Limited and pending before the court.

Timminco had been sued in two separate proposed class actions under Part XXIII.1 of the Ontario Securities Act. The first filed action (about which refer here) was brought by Toronto-based Kim Orr Barristers P.C. The second was brought later (refer here) by the London (Ont.)-based Siskinds law firm. Each of the respective law firms filed cross-motions to stay the other action. (The motions were presented as "carriage motions," the purpose of which is "to stay all other present and future class proceedings relating to the subject matter.")

The Kim Orr law firm argued that because of its association with Milberg, which it described in its motion papers as "a pre-eminent American class action firm," it is "in the best position to prosecute the action." In a response that the Ontario court characterized as "unkindly," the Siskinds law firm drew attention to the "serious stain on the reputation of Milberg LLP," and also raised concerns about the American law firm’s involvement in an Ontario class action.

Calling it a "very difficult decision and a very close call," the Ontario court ruled in favor of the Kim Orr firm and stayed the Siskinds action.

The court did observe that the Siskinds firm is "one of the pre-eminent class action firms in Canada." The Kim Orr firm, founded in January 2008 was formed by attorneys from other firms that the court described as "pre-eminent."

The Ontario court did note the criminal misconduct in which certain Milberg partners had been involved, but also noted that all of the criminally charged attorneys had left the firm. He further noted that the two Milberg attorneys proposed to be involved in the Timminco case were "untainted" by the wrongdoing.

The two Milberg attorneys are Michael C. Spencer (currently involved in the trial of the Vivendi securities class action lawsuit in New York) and Arthur Miller (who among other things is an NYU law professor and previously a law professor at Harvard Law School). In support of its motion to lead the Timminco case, a Kim Orr partner submitted an affidavit stating that Milberg’s "experience and resources will greatly enhance our ability to prosecute the case."

In reaching its decision to allow the Kim Orr firm action to proceed, the court said it found the involvement of the Milberg firm to be a "neutral factor." The court observed that Milberg "does not bear the mark of Cain," and the two Milberg attorneys "have fine reputations and excellent credentials."

The court also noted that while "one can posit examples where the involvement of an American law firm would be grounds for disqualifying an Ontario firm," this is not one of those cases. The court found that Milberg’s proposed role of providing "investigative services, document management services, and strategic advice" not to be disqualifying.

After a detailed review of the two law firms’ respective class action claims, the court decided to favor the application of the Kim Orr firm and granted its motion to stay the Siskinds action.

An October 30, 2009 Am Law Litigation Daily article about the ruling can be found here.

Over the past several years, many of the leading U.S. plaintiffs’ securities class action law firms have launched various initiatives to expand their practice internationally. (Refer, for example, here.) As the Timminco case appears to demonstrate, one consequence seems to be the export to other countries of U.S.-based securities class action experience and expertise.

These developments not only seem to be producing an expanded universe of opportunities for the U.S. law firms, but also, given that what the U.S. firms are contributing is their "experience," seem to threaten the possible overseas extension of many attributes of U.S.-style securities class action litigation.

The decision in the Timminco case discussed above underscores that there are limitations for U.S. attorneys’ involvement. Indeed, the Am Law Litigation Daily article linked above describes a prior case in which the purely financial involvement of the U.S.-based Motley Rice law firm in a prior Ontario class action lawsuit was disallowed. But the fact that Milberg firm will be participating in the Timminco case does suggest that U.S. plaintiffs’ securities class action attorneys may and sometimes will play a role in the prosecution of securities actions outside the U.S., a development that undoubtedly will be unwelcome for the potential litigation targets in other countries.

These developments will also be unwelcome to the potential targets’ D&O insurers as well. Along those lines, it is worth noting that in the October 29 opinion in the Timminco case, Judge Perell expressly noted that "the Timminco directors carry insurance policies that may be available to partially compensate class members if the litigation is resolved in their favor."

Timminco’s D&O insurance limits would potentially exposed whether or not the Milberg firm was involved in the case. But the prospect of U.S.-based securities class action plaintiffs’ attorneys aiding securities class action litigation outside the U.S. does seem to present some unwelcome additional possibilities, both in this case as well as other cases yet to come, in Ontario or elsewhere.

To be sure, the local attorneys appear highly motivated to develop their own securities class action practices, and it could be, as Judge Perell observed in the Timminco case, that the U.S. plaintiffs’ attorneys presence or involvement really is just a "neutral factor." From my perspective, though, the U.S. securities plaintiffs’ attorneys’ involvement could represent an additional force advancing the development of securities class action litigation outside the U.S.

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In what is the largest number of banks closed on a single day in years, this past Friday night the FDIC seized nine related lending institutions. The nine banks, based in California, Illinois, Texas and Arizona, had been owned by FBOP Corp., a privately held Illinois-based bank holding company. U.S. Bancorp agreed to assume all of the combined banks assets of $19.4 billion and deposits of $15.4 billion.

The latest round of closures brings the 2009 YTD total number of bank closures to 115, already the highest annual total since 1992, when 181 lending institutions failed during the S&L crisis. 31 banks failed just in September and October 2009 alone, more than the 25 banks that failed during all of 2008. Indeed, the FDIC has closed 16 banks just in the last two weeks. The FDIC’s complete list of failed banks can be found here.

Though certain states have seen higher numbers of bank failures this year, the current banking woes are not contained to just one state or region. The failed banks are quite dispersed geographically. 31 different states have had at least one bank closed this year. The states with the highest numbers of bank failures are Illinois (20), Georgia (19), California (13), Texas (5) and Minnesota (5). The Wall Street Journal has a nifty interactive map of the U.S. showing the location of the bank failures, with scaled markers indicated the relative size of each failed bank.

One of the banks closed this past Friday night was California National Bank. With assets of $7.8 billion and $6.2 billion in deposits, CNB is the fourth largest bank to fail this year, according to the Los Angeles Times (here).

The FBOP banks had their share of troubled loans, but the collapse of FBOP’s banks was, according to the Chicago Tribune (here), the result of "an abrupt reversal of fortune last year when the government takeover of Fannie Mae and Freddie Mac exposed the holding company’s large concentration of Fannie and Freddie preferred stock." According to the Los Angeles Times article linked above, the holding company had owned $855 million in preferred Fannie and Freddie shares that became worthless when the government placed the companies in receivership in September 2008.

U.S. Bankcorp’s acquisition of the nine banks’ deposits and assets seems to be a pretty sweet deal. U.S. Bancorp acquired the assets under a loan-sharing plan with the FDIC, which will absorb 80% of the first $3.5 billion in losses and 95 percent of any additional losses.

The swelling numbers of failed banks is certainly worrisome, particularly as the pace of bank closures seems to have quickened recently. This year’s aggregate numbers are starting to rival those for the later years of the S&L crisis.

There are, however, important differences between the current circumstances and the earlier era. The first is the geographic dispersion of the bank failures. During the S&L crisis, many of the failed institutions initially were concentrated in the southeastern part of the country, although as the bank crisis evolved, the bank closures moved up the coast to the northeastern states. By and large, the rest of the country experienced relatively few bank failures.

Another significant difference is the cause of many of the current bank failures. During the S&L crisis, bad loans caused most of the bank failures. Bad loans are clearly a significant factor in many of the current closures as well. But a significant contributing cause of many of the current closures is the presence of troubled assets in the failed banks’ investment portfolios. FBOP’s problems from its soured investments in Fannie and Freddie represent one example where troubled investment assets triggered a bank closure. Similarly, as discussed at length here and here, some banks that have failed this year were weighed down by their investment in other banks’ trust preferred securities.

Another difference is that this time around – at least so far – there does not seem to have been the same surge of FDIC-led failed bank litigation. Of course, it remains to be seen whether the FDIC will once again unleash a wave lawsuits against the former directors and officers of the failed institutions. There has been a certain amount of investor driven involving banks that have failed (refer for example here), but so far at least the FDIC has not been prominently pursuing litigation.

The one thing that seems for certain is that, particularly in light of the recent acceleration of the pace of bank closures, the number of failed banks seems likely to grow as this year ends and we head into next year.

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