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

Broadcom Corporation, which previously settled its options backdating related derivative suit for $118 million, announced on December 29, 2009 (here) that it had settled the separate options backdating related securities class action lawsuit pending against the company and certain of its directors and officers in exchange for its agreement to pay $160.5 million. The settlement is subject to court approval.

Because the company provided its D&O insurers with complete releases in connection with the prior derivative settlement, Broadcom apparently is funding the class action settlement entirely out of its own resources. Broadcom’s press release states that it will be recording the settlement amount as a one time charge in its fourth quarter 2009 financial statements.

Broadcom’s option backdating issues were of course recently in the news in connection with Judge Cormac Carney’s dramatic December 15, 2009 dismissal of the criminal indictments that were pending against several individual former directors and officers of the company. With the dismissal of the criminal charges and the settlements of the derivative and class action cases, Broadcom seems one step closer to finally putting its option backdating issues to rest. Judge Carney also dismissed the options backdating-related SEC enforcement action as well, though the SEC action dismissal was without prejudice. Judge Carney did also "discourage" the SEC from refilng its complaint.

In light of the circumstances surrounding Judge Carney's dismissal of the criminal indictments, the size of the class action settlements is interesting. It certainly seems that given the concerns that Judge Carney noted in dismissing the indictments that the class action plaintiffs might face some formidable obstacles on key aspects of their case, including in particular in establishing that the defendants acted with scienter.

The dismissal of the criminal indictments doesn't seem to have prevented a very substantial settlement of the class action, however. Indeed, the timing of the class action settlement, coming just two short weeks after the indictments were dismissed, seems to suggest that the elimination of the criminal case somehow opened the way for the class action settlement. Who knows, perhaps with the prosect of finally putting the options backdating woes in the past, the company moved quickly to get the class action case settled so that it might move on.

The Broadcom class action settlement is the third largest of the options backdating-related class action settlements, after the UnitedHealth Group settlement ($925.5 million) and the Comverse Technology settlement ($225 million). The Broadcom settlement, at $160.5 million, is just slightly larger than the $160 million Brocade Communications class action settlement.

With the addition of the Broadcom settlement, 32 of the 39 options backdating-related securities class action lawsuits that were filed have now been resolved. 23 of the cases have been settled and nine have been dismissed. My complete list of options backdating related lawsuit resolutions can be accessed here.

According to data that Adam Savett of the Securities Litigation Watch has been maintaining (here) , and with the addition of the Broadcom class action settlement, the 23 options backdating related settlements total approximately $1.94 billion. The average options backdating class action settlement has been $84.3 million, but if the massive UnitedHealth Group settlement is taken out of the equation, the average drops to about $44.1 million.

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In a December 28, 2009 press release (here), the plaintiffs’ lawyers announced the settlement of the Comverse Technology options backdating-related derivative lawsuit. This derivative lawsuit settlement is separate from, but related to, the previously announced $225 million settlement of the Comverse Technology options backdating-related securities class action lawsuit (about which refer here).The bulk of the derivative lawsuit settlement consists of the previously disclosed agreement of Comverse’s former CEO Kobi Alexander to pay Comverse $60 million to be applied to the class action lawsuit settlement.

The derivative lawsuit stipulation of settlement (which can be found here), is dated December 17, 2009, the same day as the class action lawsuit settlement was announced. The settlement consists of a number of different components, the most significant of which is Alexander’s agreement to pay the $60 million to Comverse. As reflected in the company’s December 18, 2009 filing of Form 8-K (here), Alexander is to pay the $60 million into the derivative settlement fund and then the amounts are to be transferred to the class action settlement fund.

Alexander, as readers will no doubt recall fled to Namibia to evade options backdating charges, where he remains a fugitive. Due to his absence in Namibia, the arrangements for his payment of the $60 million are complicated, and are set out in a separate agreement (here). Among other things, Alexander has agreed to transfer certain investment accounts, real estate assets, insurance policies and other assets. Among other things, Alexander also agreed to relinquish his counterclaims against the company.

The company’s former General Counsel, William Sorin (who previously pled guilty to options backdating related criminal charges), also agreed to make two payments for the benefit of Comverse totaling $1 million, in addition to the more than $3 million he previously paid to the SEC. He also agreed to relinquish his counterclaims against Comverse seeking $2.2 million in damages relating to deferred compensation, lost wages and cancelled or revoked options and restricted stock.

The company’s former CFO, David Kreinberg, agreed to pay $75,000 for the benefit of Comverse, in addition to the $2.39 million he previously paid to the SEC. Kreinberg also agreed to relinquish his counterclaims for $4.3 million in damages relating to deferred compensation, lost wages, and cancelled or revoked options or restricted stock, as well as an additional $1 million in attorneys’ fees for which he had been seeking indemnification.

Comverse’s auditor during the time of the backdating scheme, Deloitte & Touche, agreed to pay the company $275,000.

Several individual defendants who had served on Comverse’s compensation committee will also collectively forfeit 155,000 in unexercised stock options.

The derivative lawsuit settlement stipulation also provides that "Comverse shall cause Comverse’s insurance carrier, on behalf of the Individual Defendants except for Mr. Alexander, Mr. Sorin, and Mr. Kreinberg, to pay to Comverse $1 million" by the later of either August 30, 2010 or thirty days after the derivative lawsuits and class action lawsuits are finally dismissed.

Finally, Comverse agreed to adopt or to keep in place certain corporate governance reforms.

Neither the company’s 8-K nor the plaintiffs’ lawyers’ press release mentions it, but the derivative suit’s stipulation of settlement also provides that Comverse will pay the plaintiffs’ attorneys’ fees of $9.35 million. Neither the settlement documents nor the company’s 8-K specify whether this amount will be offset in whole or in part by the payment of insurance.

Given the fact that insurance is expressly mentioned in the stipulation in connection with the $1 million payment, the inference is that, other than with respect to the $1 million payment, insurance funds are making no other contributions to the settlement. (There is also nothing in the documents expressly confirming that the carrier has agreed to pay the $1 million amount.)

In the absence of insurance payments (other than with respect to the $1 million payment), the $9.35 million in plaintiffs’ attorneys’ fees seems like a heavy burden to impose on the company, which may explain why neither the plaintiffs’ lawyers’ press release nor the company’s 8-K mentioned this amount.

It is complicated to calculate the relation between the burdens the derivative lawsuit imposed on the company compared to the benefit to company from the lawsuit. On the one hand, the plaintiffs in the derivative suit would cite Alexander’s agreement to pay the $60 million as benefit the derivative suit produced. I hope some of us can be forgiven for being confused about which lawsuit produced the $60 million payment.

Setting the $60 million aside, the other benefits to the company from the derivative settlement appear, at least relative to the size of the derivative plaintiffs’ $9.35 million attorneys’ fees, relatively modest. 

That said, the plaintiffs’ lawyers’ undoubtedly would argue that the $60 million settlement contribution should not be set aside but rather represents a very significant benefit to the company from the derivative lawsuit, and that benefit is the context within which the $9.35 million attorneys’ fees should be assessed. The size of Alexander's $60 million settlement contribution is noteworthy, but Alexander's fugitive status and location in Namibia, as well as the complex state of his financial affairs given his fugitive status, unquestionably add an extraordinary degree of difficulty to the negotiation of his contribution.

Another insurance question arises from the settlement’s requirement that Kreinberg relinquish his claim for indemnification of $1 million in attorneys’ fees. The agreement appears to be silent on the question whether Kreinberg can, notwithstanding his indemnification relinquishment, still seek payment of his attorney’s fees from the company’s D&O insurance carrier.

Kreinberg might contend (assuming for the sake of argument that policy funds remain) that he is entitled to have his fees paid under Side A of the policy, relating to amounts for which indemnification is unavailable. An interesting question is the extent to which the policy’s presumptive indemnification clause would presume indemnification notwithstanding Kreinberg’s indemnification relinquishment, which the carrier might assert as a basis to assert that Side A has not been triggered. (I suspect the carrier might well assert other defenses to coverage as well.)

I have in any event added the Comverse derivative settlement to my register of options backdating-related lawsuit resolutions, which can be accessed here.

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Beazer Homes has announced in its December 22, 2009 filing on Form 8-K (here) that it has settled the subprime-related shareholder’s derivative lawsuit that had been filed against the company, as nominal defendant, and certain of its directors and officers. According to the filing, the case has been settled in recognition of the corporate governance reforms the company has enacted and in exchange for the agreement to pay the plaintiff’s attorneys’ fees of $950,000. As reflected below, this appears to be the first settlement of a subprime-related derivative lawsuit.

The Derivative Lawsuit and Settlement

The plaintiff had filed a shareholders’ derivative complaint in Northern District of Georgia in April 2007. (A separate complaint filed in Delaware was later dismissed.). According to the plaintiff’s amended consolidated derivative complaint (here), the individual defendants breached their fiduciary duties and violated the federal securities laws by ignoring "numerous and obvious ‘red flags’ existing even prior to 2006 that alerted them or would have alerted them had they not consciously disregarded such red flags, to a plethora of improper loan practices at Beazer." The loan practices "eventually led to a vast amount of foreclosures and other problems, materially impacting the company’s stability."

The amended complaint also alleges that the defendants’ mismanagement has led to investigations of the company’s mortgage and accounting practices by the IRS, the Department of Justice, the FBI, HUD, and the SEC.

As part of the settlement and as reflected in the parties’ October 30, 2009 stipulation of settlement (here), Beazer acknowledged "that the commencement, prosecution and settlement of the Derivative Action were material contributing factors in causing the Company to agree to adopt and/or implement the corporate governance reforms and remedial measures" described in an attachment to the stipulation.

In addition, the stipulation provides that "Beazer and the individual defendants shall pay, or cause their insurers to pay, upon Court approval, an aggregate amount of $950,000 to Plaintiff’s Counsel for their attorneys’ fees and reimbursement of expenses."

There is nothing in the agreement to indicate that the company’s insurers have affirmatively agreed to pay these amounts.

Related Litigation

Beazer Homes and certain of its directors and officers had also been separately sued in a securities class action lawsuit, that later resulted in a $30.5 million settlement (here), that was, according to the company’s press release at the time, to be funded from insurance proceeds." Subsequent to the class action settlement, certain mutual fund investors in Beazer elected to opt out of the class action settlement and in September 2009 filed their own separate opt-out complaint in the Northern District of Georgia.

Beazer is now engaged in coverage litigation with its third level excess D&O insurer, as reflected in the declaratory judgment complaint that Beazer filed against the carrier on December 17, 2009, in the Northern District of Georgia. According to the coverage lawsuit, Beazer’s third level excess carrier "wrongfully denied coverage for Beazer Homes in connection with the Opt-Out Litigation." The complaint goes on to recite that the carrier’s "sole ground" for denying coverage "is the assertion that Beazer Homes purportedly breached a so-called ‘warranty letter.’" (My recent post discussing "warranty letters" can be found here.}

Discussion

With Beazer’s top level excess carrier denying coverage and engaged in coverage litigation with the company, it is unclear whether or to what extent insurance is presently available to fund the cash portion of the Beazer derivative settlement, even assuming insurance would otherwise apply to an agreement to pay the plaintiff’s attorneys’ fees.

But setting aside the issues surrounding the availability of insurance to fund the payment of the plaintiff’s attorneys’ fees, there is the overall question of the benefit of litigation that is settled in "recognition of" remedial actions that the company has already taken, undoubtedly due to the onslaught of regulatory and legal problems the company has encountered.

To be sure, the stipulation recites that the derivative litigation was a "material contributing factor" in causing the reforms to be initiated. Some observers may question whether the reforms would have been enacted in any event regardless of the derivative lawsuit, and might even question the social utility of a process the most tangible result of which is the transfer of monies to the plaintiffs’ lawyers who initiated the process. Those same observers would likely also note that the stipulation’s concession about the role of the derivative suit in the implementation of the governance reforms was simply a price the defendants had to pay to put an end the derivative suit, the same as the agreement to pay plaintiffs’ attorneys’ fees.

By my count, there were twenty seven subprime and credit crisis related derivative lawsuits filed, as reflected here. As far as I can determine, the Beazer Homes derivative settlement is the first of the subprime and credit crisis-related derivative suit to settle. There undoubtedly will be other settlements ahead.

Though Beazer Homes derivative suit is not options backdating related, it reflects the same settlement pattern as many of the options backdating derivative suits. As shown on my table of options backdating related derivative lawsuit case resolutions (which can be found here), many of the backdating derivative cases resulted in settlements comprised of an agreement to adopt corporate therapeutics and governance reforms, together with the payment of plaintiffs’ attorneys’ fees.

It remains to be seen whether others of the subprime and credit crisis related derivative suits will settle on the same or similar grounds. The plaintiffs’ lawyers that make their living off of these kinds of cases will have to accept that there will be questions about the value for shareholders and for society from this process, where the most visible thing that is accomplished is the plaintiffs’ lawyers collection of their fees. Of course, the plaintiffs’ lawyers themselves will cite the corporate reforms, a point which in the interest of balance, I acknowledge here.

I have in any event added the Beazer Homes derivative settlement to my tally of subprime and credit crisis related lawsuit resolutions, which can be accessed here.

Break in the Action: The D&O Diary will be on a short break over the next few days. We will resume the "normal" publication schedule after the holidays.

But before I go, I wanted to leave something to make you smile. Here, if you have not yet seen it, is Jill and Kevin’s Wedding Dance. Enjoy. (My oldest daughter says: "I like the bridesmaids’ dresses. They seem like people I would like, too --they dance the same way I do.")

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Since the sole remaining Friday in December is also Christmas Day, the seven banks the FDIC closed last Friday night may represent the last bank failures of 2009. Of course, there is no legal requirement that Friday is the only day of the week on which the FDIC can close a bank. The FDIC could close additional banks on any of the few remaining business days left this year. But given the holiday season, the 140 year-to-date number of bank failures seems likely to be where we will end the year.

The 140 bank closures were both widely dispersed and narrowly concentrated. The FDIC took control of banks in 32 different states, but the closures were particularly clustered in four states: Georgia (with 25 closures), Illinois (21), California (17), and Florida (14). These four states alone account for 77 of the bank failures this year, more than half of the year to date total. Indeed, no other state had double digit numbers of bank failures. The next closest states were Minnesota (6), Texas (5) and Arizona (5).

Though the bank closures have been geographically dispersed, certain regions have been spared. For example, there were no 2009 bank failures in the New England states of Maine, Vermont, New Hampshire, Massachusetts, Connecticut or Rhode Island, and only one each in New York and Pennsylvania. And though Georgia and Florida have seen high numbers of bank failures, much of the rest of the South has been relatively untouched – there were no 2009 bank failures in West Virginia, South Carolina, Tennessee, Mississippi, Arkansas and Louisiana, and only one each in Virginia, Kentucky and Oklahoma.

Among the banks that failed in 2009 were some of the country’s largest, including Colonial Bank (with assets of $25 billion), Guaranty Bank ($13 billion), and BankUnited ($12.8 billion). However, these banks all are smaller than two of the larger banks that failed in 2008, Washington Mutual ($307 billion) and IndyMac ($32 billion).

But though there the list of failed banks includes these larger banks, the list of bank closures really has been predominated by smaller banks. Of the 140 banks that failed in 2009, 112 (80%) involved institutions with less than $1 billion in assets. Indeed, 97 of the 140, or about 69%, had assets of under $500 million. 21 of the 2009 failed banks, or 15%, has assets of under $100 million.

Lest anyone might optimistically hope that with the end of 2009 we have put these sad tidings in the past, the 2009 bank closure timeline seems to suggest to the contrary. Of the 140 banks that closed in 2009, 95 (or about 68%) closed in the second half of the year, compared to 45 in the first half of the year. Though the highest monthly total was in July (when 24 banks were closed, nearly as many as the 25 banks that failed in all of 2008), there were significant numbers of closures in October (20) and December (16).

The FDIC’s latest Quarterly Banking Profile stated that as of September 30, 2009, it graded 552 banks as "problem" institutions (about which refer here), which suggests there could be many bank closures yet to come – which helps explain why FDIC Chairman Sheila Bair last week proposed to increase the agency’s budget and staff, in order for the agency to be able to deal with the anticipated increasing numbers of banking failures in 2010.

I have previously commented the high numbers of bank failures in Georgia, which has been referred to as the "bank failure capital of the world." In that regard, it is noteworthy that there were as many 2009 bank failures in Georgia (25) as there were in the entire country in 2008. In the two year period, Georgia has a total of 30 failed banks, as detailed here.

Who Might Sue When Banks Fail: In prior posts (for example, here), I have noted developments in claims being asserted against directors and officers of failed financial institutions by disappointed investors and by banking regulators. But in addition to these two groups that potentially might assert claims against the directors and officers of failed banks, another group of potential claimants also has recently emerged – the employees of the failed banks.

For example, as reflected in their December 17, 2009 press release, plaintiffs’ attorneys filed a class action lawsuit in the Western District of Washington against Venture Financial Group, the parent of Venture Bank, which regulators closed on September 11, 2009. The lawsuit is filed on behalf of the participants in the bank’s retirement plans. The defendants include the holding company’s directors and officers, some of whom also served on the bank’s board, as well as the individual members of the plans’ administrative committees.

The complaint, which can be found here, alleges that the bank engaged in "a number of large, high-risk and inappropriate investment practices." These practices, "combined with its hazardous lending practices produced more than $200 million losses" and "exposed the retirement plans," which included investments in the holding company’s stock, and which allegedly sustained more than $12 million in losses. The complaint seeks to recover damages on behalf of the plan participants under ERISA.

On December 16, 2009, the same plaintiffs’ firm also announced (here) that it is investigating the possibility of a similar ERISA class action behalf of participants in the benefits plans of Sterling Financial Corporation, which, though it is not among the banks that the FDIC has closed,  was also recently hit with a securities class action lawsuit.

This new lawsuit and the plaintiffs’ lawyers’ investigation announcement underscore that in the wake of a bank failure there are a variety of constituencies might consider initiating claims against the failed institution’s directors and officers. This is all just one more reason I think that one of the key litigation trends we will see in 2010 is an upsurge in litigation against the directors and officers of failed banks.

The Receiver’s Right to Stay Failed Bank Litigation and Require Exhaustion of Administrative Remedies: Though other constituencies may seek to assert claims, the FDIC has rights to seek a stay of the other claimants’ lawsuits under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA), as reflected in a December 10, 2009 order in the Northern District of Texas lawsuit involving Millennium State Bank. Millennium failed on July 2, 2009 (refer here). Investors who had purchased Millennium stock filed a state court action against the bank, its directors, its auditors and its offering underwriter. The investors claimed they had been provided incomplete and inaccurate information about the bank. The investors alleged violations of Texas securities law and common law, and they sought to rescind their investment traction and/or damages.

The FDIC moved to intervene in the state court suit and then removed the case to the Northern District of Texas. The FDIC then filed a motion under FIRREA, arguing that the investors’ case should be stayed and that the plaintiffs’ and intervenors’ claims must be "exhausted under the administrative claim procedure of FIRREA."

The court granted the motion, holding that the FDIC was entitled to the stay, saying that "the law is well established that a stay is mandatory for any claim subject to FIRREA, if the receiver requests one." The court rejected the investors’ argument that the FDIC was not entitled to a stay because they had not named the bank as a party. The court found that "the mandatory stay applies to all claims against the bank and any related third parties" and found further that under FIRREA the "stay is required as to all parties."

The court quoted case authority from the prior era of failed banks to the effect that refusing to grant a stay "would largely defeat FIRREA’s purpose of allowing the agency to evaluate claims in a streamlined administrative procedure."

The court granted the stay until the earlier of the date on which the FDIC as receiver disallows the claims or until the 180-day administrative review period has expired.

In other words, though there may be many constituencies that may seek to pursue claims in the wake of a bank’s failure, the FDIC has rights under FIRREA to sort out which claims will go forward. It seems likely one consideration that might affect whether the FDIC will allow a claimant’s case to go forward would be whether the FDIC intends to pursue its own claims as receiver against the defendants (and, it should probably be added, to try to maximize its own recovery from D&O insurance proceeds). As I previously noted (here), the FDIC has already established that it is going to be aggressive in asserting its priority rights to assert claims against the directors and officers of failed financial institutions.

So if, as I expect, there will be an upsurge in failed bank litigation in 2010, the FDIC is going to call the shots.

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In a December 4, 2009 order (here), Southern District of Ohio Judge Michael H. Watson granted the defendants’ motion to dismiss the consolidated subprime-related securities class action lawsuit against Huntington Bancshares. Judge Watson granted the motion based on his findings that plaintiffs had failed to adequately allege both falsity and scienter. The dismissal is with prejudice.

Background

In December 2006, Huntington and Sky Financial announced their plans to merge. In July 2007, Huntington’s $3.3 billion acquisition of Sky closed. For many years, one of Sky’s clients had been Franklin Credit Mortgage Corporation. Franklin originated subprime mortgage loans, some of which it sold in the secondary mortgage market. For seventeen years, Sky made loans to Franklin that Franklin used to finance its mortgages. In July 2007, Sky had $1.5 billion exposure to Franklin.

On November 16, 2997, Huntington alerted its investors that Franklin recently announced the deterioration of its mortgage portfolio. Huntington announced that because of Franklin’s announcement, it (Huntington) would be taking a fourth quarter after-tax charge of $300 million to build up its allowance for loan losses. Huntington also stated that it expected to report a fourth quarter loss. On this news, Huntington’s share price declined from $16.08 to $14.75.

Plaintiffs filed a securities class action lawsuit on behalf of investors who purchased Huntington shares between the date of the merger and November 16, 2007. Plaintiffs allege that Huntington’s acquisition of Sky subjected Huntington to significant subprime exposure because of Sky’s relationship with Franklin. The plaintiffs allege that Huntington misled investors regarding its ability to weather the deteriorating real estate and subprime mortgage market. The defendants moved to dismiss.

The December 4 Order

In his December 4, Judge Watson granted the defendants motion to dismiss, on the grounds that the plaintiffs had failed to adequately allege falsity and scienter.

In reaching the conclusion that the defendant had not adequately alleged falsity, Judge Watson noted that:

The Complaint does not allege any specific facts that Huntington’s disclosures were incompatible with any reports, data, or signs that Franklin would be unable to pay its loans to Huntington, nor does the Complaint do anything more that allege Defendants should have known the continuing erosion of the real estate market would render the loan portfolio precarious. Significantly, Huntington’s public statements all address the faltering real estate market, … increases in delinquencies in the industry, and the prospect of increases of allowances for loan and lease losses. No information suggests Huntington knew of Franklin’s situation prior to Franklin’s own announcement that it was having problems.

Even though Judge Watson concluded that the plaintiffs’ failure to allege falsity was a sufficient basis on which to dismiss the complaint, he separate analyzed the scienter issue as "an alternative basis" for his ruling.

After reviewing the plaintiffs’ allegations, Judge Watson found that the Plaintiffs "fail to establish a strong inference of scienter." He noted that:

Viewed in their aggregate, Plaintiffs’ allegations do not give rise to a "cogent" inference that Defendants possessed the requisite knowing or reckless intent to manipulate, deceived or defraud. The allegations concerning Huntington’s alleged knowledge after the due diligence period during the acquisition, the self-interested motives of Defendants, and the closeness in time of the supposed fraudulent statements and later disclosures, all lack the factual particularity that would support an inference of fraudulent intent that is "at least as compelling as any opposing inference."

Judge Watson’s dismissal ruling was with prejudice.

I have added the Huntington Bancshares dismissal to my register of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.

Special thanks to Adam Savett of the Securities Litigation Watch blog for providing me with a copy of the Huntington Bancshares ruling.

Amended Complaint Survives Former IndyMac’s CEO’s Dismissal Motion: In a contrary development in a high profile west coast subprime-related lawsuit, on December 11, 2009, Central District of California Judge George Wu’s denied the motion of former IndyMac CEO Michael Perry to dismiss the plaintiffs’ Fifth Amended Complaint. Judge Wu’s minute order entry of his ruling can be found here.

The tortured procedural history of the IndyMac case, which among things led up to the filing of five amended complaints, can be found here. As a result of this twisted procedural path and Judge Wu’s December 11 ruling, this IndyMac suit will now go forward solely as to Perry.

Judge Wu’s December 11 ruling adds the IndyMac case to the now growing list of subprime lawsuits that were initially dismissed but that following amended pleading survived renewed motions to dismiss, including, for example, the WaMu case (here) and the PMI Group case (here).

I have in any event also added the December 11 ruling in the IndyMac case to my tally of dismissal motion rulings, linked above.

Apology: I sincerely apologize for the faulty link to the transcript of the hearing in the Broadcom case in yesterday’s blog post. Readers who were frustrated because they could not access the transcript can find a correct link to the transcript here. I have also corrected the link on the blog post.

Again, I apologize for the error, which is just one of those things that can happen with late-night blogging.

Sometimes I really wish I had a fact-checker or editor following along behind me to protect against blogging boo-boos like that.

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According to a December 17, 2009 press release from the lead plaintiff’s attorneys, the parties to the Comverse Technology options backdating related securities lawsuit have agreed to settle the case for $225 million dollars. A particularly noteworthy feature is that the settlement amount includes a $60 million individual contribution from the company’s former CEO, Kobi Alexander, who famously fled to Namibia after the options backdating allegations surfaced.

The $225 million settlement represents the second largest of settlement of an options backdating-related securities class action lawsuit. The only larger backdating settlement is the mammoth $925 million settlement of the UnitedHealth Group options backdating securities suit (about which refer here and here). A complete list of options backdating settlements and case resolutions can be found here.

According to data compiled by Adam Savett of the Securities Litigation Watch, and taking into account this latest settlement, of the 39 options backdating related securities class action lawsuits that have been filed, 22 have now settled, along with nine that have been dismissed, meaning that there are still nine of the securities suits yet to be resolved. The $225 million settlement far exceeded the prior average options backdating securities suit settlement of about $74 million (or $31.82 million if the outsized UnitedHealth Group settlement is dropped out of the equation). The aggregate amount of all the options backdating securities suit settlements is, with the Comverse settlement, now up to $1.785 billion. UPDATE: The Securities Litigation Watch has updated its analysis to reflect the Comverse settlement, here.

Alexander’s extraordinary agreement to contribute $60 million to the settlement out of his own funds represents something of a milestone. The plaintiffs’ lawyers press release says that the amount "one of the largest recoveries from a former executive to settle a federal securities class action." By way of comparison, former UnitedHealth Group CEO William McGuire agreed to pay $30 million in settlement of the securities class action claims against him, as well as to have certain unexercised options grants canceled.

Regardless of where the amount falls in terms of size of individuals’ settlement contributions, it undoubtedly is the largest contribution by an individual defendant while simultaneously evading extradition. Alexander’s getaway to Namibia provided one of the more interesting subplots of the entire options backdating episode. You do kind of wonder exactly how he is going to handle the currency transfers. UPDATE: The parties' agreement regarding this settlement, which can be found here, specifically references various investment accounts of Alexanders that were seized by the U.S. Marshall's service. The agreement indicates (see page 17-19) that Alexander will cooperate and facilitate in the forfeiture of those accounts.

In addition, none of the information available to date about the securities class action settlement reveals whether the settlement resolves or even addresses the separate lawsuit that Comverse filed against Alexander and the firm’s former General Counsel, in which the company sought to recover $70 million in damages. Nor does the available information disclose whether or not the settlement resolves or addresses the separate lawsuit that Alexander filed against Comverse for more than $72 million of severance and other compensation.

The details surrounding the settlement contributions from Comverse itself are not entirely clear, either As of the time and date of this blog post entry, the parties have not yet filed their settlement agreement with the court, not has the company made any disclosures about the settlement. The information publicly available about the settlement does not disclose whether or not insurance will make any contribution to the settlement. However, at least one media story about the settlement suggests that the company will make its contribution in a number of payments during 2010, which, at least to the extent of those payments, seems inconsistent with funding for the settlement from insurance. UPDATE: According to Ben Hallman's December 18, 2009 article in the AmLaw Litigation Daily (here), Comverse intends to finance its $165 million share of the settlement by selling auction rate securities back to UBS, and if that doesn't work it will cover the amount with a a mix of cash and stock. Under the settlement agreement, Comverse's payments are to be paid into the settlement escrow account in a series of staged payments during 2010 and 2011.

Clearly there are still some details yet to be revealed about the settlement. I will supplement this post if I am able to unearth more details about the settlement.

One final note about the Comverse Technology options backdating issues is that this is one case that has resulted in a successful criminal prosecution. Even though the company’s former CEO is still evading extradition in Namibia, prosecutors did secure a criminal guilty plea from the company’s former General Counsel. In the wake of the dismissal of all of the individual indictments in the Broadcom case that I blogged about yesterday, it is notable that this is one case where the criminal charges stuck – again, notwithstanding Alexander’s evasion of arrest.

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There has been widespread news coverage of the dramatic December 15, 2009 decision of Central District of California Judge Cormac Carney to throw out the options backdating related criminal charges against Broadcom co-founder Henry T. Nicholas III and CFO William Ruehle, based on prosecutorial misconduct.

But even though many of press accounts have reproduced some of Judge Carney's harshest words – particularly his statement that the government’s treatment of a third defendant, Henry Sameuli, was "shameful and contrary to American values of decency" – the excerpts do not come close to capturing the depth and breadth of the Judge’s condemnation of the prosecutor’s conduct.

The transcript of the December 15 hearing at which Judge Carney delivered his ruling can be found here. I strongly recommend taking a few minutes and reading the entire transcript (it is relatively short), because only a complete reading truly conveys the extent of Judge Carney’s censure.

His reproach of the prosecutors is comprehensive, extensive and scathing. Judge Carney dropped a bomb on the prosecution. Not by accident, as if he got a little angry and then got carried away. No. Judge Carney clearly and consciously intended to summon every molecule of the power of his position and marshalled every tool in the arsenal of language. Judge Carney's decision is a case-hardened, bunker-buster, heat -seeking bomb -- that hit the bulls-eye.  

Among other things, he cites the prosecutors for "intimidating and improperly influencing" witnesses, which "compromised the truth process and compromised the integrity of the trial"; for making improper leaks to the media; for improperly pressuring Broadcom to terminate Samueli; for obtaining an "inflammatory indictment" of Samueli; and crafting "an unconscionable plea agreement" with Samueli.

Assistant U.S. Attorney Andrew Stolper, the lead prosecutor in the case, received particularly sharp criticism. Among other things, Judge Carney said that "the lead prosecutor somehow forget that truth is never negotiable." Of the case against Ruehle, Judge Carney said that to submit it to the jury "would make a mockery of Mr. Ruehle’s constitutional right to compulsory process and a fair trial."

In addition to the sheer potency of Judge Carney’s rhetoric, there are several other interesting aspects to Judge Carney’s rulings, some of which have not been fully noted in press reports.

The first is that Judge Carney’s decision to dismiss the case against Nicholas came during Ruehle’s trial. Nicholas was to be tried separately later. There was not even a motion on behalf of Nicholas pending. Moreover, Judge Carney’s dismissal of the indictment of Nicholas came just days after Judge Carney dismissed Samueli’s prior guilty plea, following Samueli’s testimony at Ruehle’s trial. Judge Carney’s decisions to first dismiss Samueli’s guilty plea and then to dismiss the case against Nicholas shows the extent of the concerns that were raised in Judge Carney’s mind as Ruehle’s trial unfolded.

Second, Judge Carney not only dismissed the criminal cases, he dismissed the SEC’s options backdating related enforcement action without prejudice –again, even though that SEC enforcement action was not formally before Judge Carney at the time. Judge Carney allowed the SEC thirty days to file an amended complaint, but he did also "discourage" the SEC from proceeding further, since "the government’s misconduct has compromised the integrity and legitimacy of the case" and the evidence during Ruehle’s trial "established that the SEC will have great difficulty proving that the defendants acted with reckless scienter."

Judge Carney also ordered the government to show cause why the separate drug distribution-related indictment against Nicolas should not be dismissed, and scheduled a date in February 2010 for the matter to be heard. Among concerns Judge Carney noted about the drug indictment is "government’s threats to issue a grand jury subpoena to Dr. Nicolas’ 13-year old son and force the boy to testify against his father."

Third, as part of discouraging the SEC from refiling its complaint, Judge Carney raised fundamental questions that go to the heart of the entire options backdating brouhaha --immediately after he had said that the SEC will have difficulty proving scienter. He said:

The accounting standards and guidelines were not clear, and there was considerable debate in the high-tech industry as to the proper accounting treatment for stock option grants. Indeed, Apple and Microsoft were engaging in the exact same practices as those of Broadcom.

These remarks suggest that, in addition to all of Judge Carney’s other concerns about the prosecutor’s misconduct, he also has fundamental concerns about whether there could possibly have been a culpable state of mind in connection with backdating. His reference to the uncertainty of the applicable standards and extent of the practices (even Apple and Microsoft!) certainly seems to raise questions about whether any criminal prosecution or even enforcement action is appropriate, not just the one against the Broadcom defendants.

Judge Carney clearly is quite sure that there was something wrong with the prosecutor’s actions in prosecuting the case, but he doesn’t seem to be sure at all whether or not there is actually anything wrong with backdating itself. Could these two points be related? Hmmm...

Indeed, this fundamental problem with the backdating allegations may explain why prosecutors have had so much trouble obtaining and retaining backdating convictions. Thus, for example, the conviction of former Brocade Communications CEO Gregory Reyes was overturned, again for prosecutorial misconduct (based on improper statements prosecutors made to the jury), and McAfee’s former general counsel, Kent Roberts, was acquitted.

It does sort of make you wonder whether Kobe Alexander might  now having second thoughts about his decision to flee to Namibia rather than face the criminal charges for alleged options backdating at Comverse.

Though the Broadcom criminal indictments have been dismissed and the SEC enforcement action has also been dismissed, possibly for good, an enormous amount of damage has been done. There is not only the terrible toll that the legal actions took on the lives of the individual criminal defendants. There is the almost unbelievable cost that all of these actions imposed on the company and its insurers.

As I noted in a prior post (here), Broadcom agreed, as part of the settlement of the options backdating-related shareholders’ derivative lawsuit, to settle its claims against its directors’ and officers’ liability insurers for $118 million, all of which represented a payment to the company in reimbursement of defense expenses incurred in connection with the various backdating-related legal proceedings. In the recitals to the insurance settlement, the parties stated that at point Broadcom’s cumulative legal expenses exceeded $130 million.

It is very hard not to conclude that entire sorry options backdating scandal has been an enormous waste, of time, talent and money.

There have been a number of interesting blog posts about Judge Carney’s dismissals of the Broadcom indictments, including items on the SEC Actions blog (here) and on the Ideoblog (here). The WSJ.com Law Blog has a post (here) comparing Judge Carney to Judge Rakoff.

Special thanks to Nancy Adams of the Mintz Levin firm for forwarding me a copy of the hearing transcript.

Even More Failed and Troubled Banks Next Year?: According to yesterday’s Wall Street Journal (here), the FDIC is looking to increase its budget by 35% next year and to add 1,600 new staffers, as the agency struggles to deal with the complications from the wave of failed and troubled banks. Among the reasons that agency Chairman Sheila Bair cited to justify moves is that the increases  "will ensure that we are prepared to handle an even larger number of bank failures next year, if that becomes necessary, and to provide regulatory oversight for an even larger number of troubled institutions"

The suggestion that the FDIC must be prepared for even more failed and troubled banks in 2010 is disturbing. There have already been 130 failed banks this year, and at the time of the FDIC’s last Quarterly Banking Profile, the FDIC reported that there were 552 Problem Institutions as of September 30, 2009, as noted here. Put simply, the FDIC thinks in order to be prepared for 2010, it has to be ready to deal with more than 130 additional bank failures next year and more than 552 troubled institutions.

Clearly, the banking industry’s problems are deep and continuing. The problems associated with failed and troubled banks are among the most significant concerns as we head into 2010.

Goodbye to All That: The blogosphere is losing one of its most talented and esteemed members. Yesterday, our friend, law-school compatriot and fellow blogger, Mark Herrmann, of the incomparable Drug and Device Law Blog, announced that he is retiring from blogging. Alas.

Herrmann, who has been a partner at Jones Day since before dinosaurs roamed the earth, is leaving Big Law to go be a client -- I mean , to become Vice President and Chief Counsel - Litigation at AON Corporation. As a result, Herrmann no longer thinks he will have as much time to write about legal issues surrounding medical drugs and devices -- go figure. 

Herrmann is moving on to do God's work, defending against unscrupulous types who would presume to sue insurance brokers. But as a result, the blogosphere is losing one of its most intelligent, cantankerous and amusing voices. Have no fear, his blogging partner (A blogging partner! What a concept! I should have thought of that!), Jim Beck, will be carrying on the fine tradition of the Drug and Device Law Blog.

Everyone here at The D&O Diary wishes Herrmann every success at AON. May the force be with you, Mark. Welcome the world of insurance brokerage, dude.

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On December 15, 2009, NERA Economic Consulting released its annual study of securities class action litigation trends. The study, entitled "Recent Trends in Securities Class Action Litigation: 2009 Year-End Update," and written by my friends Stephanie Plancich and Svetlana Starykh, can be found here. The study concludes that, notwithstanding the decline in credit crisis related filings in the second half of 2009, the projected year-end filing levels will be within historical norms. Average and median securities class action settlements are also consistent with recent trends.

According to the study, credit crisis related filings, which predominated class action filings during 2007 and 2008, "gradually declined" as 2009 progressed. Despite this decline, the total number of securities suit filings has not dropped off, "as other types of cases replaced credit crisis filings."

Based on NERA’s own counting methodology (which, as is explained in footnote 2 of the report, counts separate filings in separate circuits as separate lawsuits until the cases are consolidated), NERA counted 215 securities class action lawsuit filings through November 30, 2009, which projects to 235 filings by year end. Though the projected total of 235 would be below the 2008 level of 253 filings, it is well within the 1997-2004 average of 231 annual filings.

Although the 2009 filing levels look as if they will fall within historical levels, the 2009 filings were swollen by at least a several phenomena that may be short lived. Thus, for example, 36 of the 2009 filings involve Ponzi schemes. Though there may continue to be Ponzi scheme revelations as we head into 2010, it does seem likely that there may be fewer of those stories ahead.

Similarly, the 2009 filings were also increased by 13 new cases related to leveraged ETFs. (My prior post about ETF-related lawsuits can be found here). Though there may be further ETF cases yet to come, this group of cases seems likely to decline, as virtually all of these filings relate to a single family of funds and all relate to a single set of disclosures about the funds’ performance over time.

A third filing pattern that may not continue going forward is the number of cases in which the filing date falls well after the proposed class action cutoff date. (My most recent post about these apparently belated securities suit filings can be found here.) The NERA study shows that during the second half of 2009, the average time between the end of the class period and the date of the first filing lengthened to 279 days (versus a period of 161 days for suits filed during the preceding three years). The NERA study speculates that this may be a reflection of the fact that plaintiffs firms have been "focused on the large credit crisis cases over the last two years," but that they are "now able to focus on bringing other, non-credit-crisis cases with older class periods."

The NERA study reports that cases in 2009 continued to be clustered in the financial sector, with 53% of all filings naming a defendant in the finance sector. Another sector that has continued to see substantial activity is the health technology and services sector.

As far as case resolutions, the NERA study reports that for cases that were filed in 2000, 36% have been dismissed and 61% have settled, but that "even almost a decade after filing, there are still approximately 3% of cases that have yet to reach a final resolution," which underscores the fact that in some instances these cases can take as much as a decade or more to resolve.

Of course, the majority of cases filed in recent years remain pending. For these most recent cases, a higher proportion of resolutions have been dismissals rather than settlements, which the NERA study notes "is unsurprising, as motions to dismiss are usually fled relatively early in the litigation process, often before settlement discussions commence." Ultimately however, the NERA study comments, "we expect that a higher proportion of these recent filings will result in settlements."

With respect to the credit crisis cases, the NERA study notes that over 80% of the cases remain pending, with only 15% of the cases dismissed compared to only 4% (nine cases that have settled.) My running tally of subprime case resolutions can be accessed here. The NERA report comments that this pattern is consistent with observed patterns in which early on more cases are dismissed but that ultimately over time a large proportion of cases settle than are dismissed.

As far as settlements, the NERA study reports that the average securities class action settlement in 2009, if the IPO laddering settlement is removed from the equation, was $42 million, which is substantially above the 2003-2009 average of $29 million, but which is consistent with the overall trend, which is that "there has been a general increase in the average settlement values since 1996."

But though the average settlements continue to increase, median settlements have held relatively steady. In 2009, the median settlement was $9 million, similar to the medians in 2007 ($9.4 million) and 2008 ($8.0 million).

Over the past several years, the ratio of settlement to investor losses has held steady at around 2.5%. The NERA study speculates that because this ratio has held reasonably steady and because investor losses historically have been correlated with settlement values, the fact that investor losses in cases filed during 2007 and 2008 were significantly higher than prior years may be "a signal of potentially higher settlements in the future," as the 2007 and 2008 cases move toward settlement.

As always, the 2009 version of the NERA study provides interesting and thorough analyses. It is worth noting that, because the NERA study "counts" separate filings in separate circuits as separate filings as separate cases, the NERA filing will differ from (and almost certainly be higher than) the figures that other commentators may report in their year end reports.

One thing about the average and median settlement figures that I think all observers should keep in mind is that these figures do not include defense expense, which can be considerable and in many cases can represent a significant percentage of the settlement amounts. In addition, these class settlement figures do not reflect the value of any separate opt-out settlements, nor do they reflect the amounts of other litigation settlements, such as might be incurred in connection with parallel derivative or ERISA class action lawsuits.

My point is that as impressive as the settlement figures reflected in the NERA report are, they represent only a portion of the litigation exposure that the affected companies may have faced, and therefore represent only a partial and incomplete measure, for example, of what insurance limits may be sufficient to protect companies and their directors and officers from their claim exposures.

NERA’s December 15, 2009 press release regarding the 2009 study can be found here.

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In a landmark development for private securities litigation in Canada, a Justice of the Ontario Superior Court has ruled that a proposed securities suit against IMAX under Ontario’s new statutory provisions allowing private securities litigation may proceed. The court separately certified a global class of IMAX investors on whose behalf the case will now proceed.

According to a December 14, 2009 National Post article (here), Ontario Superior Court Justice Katherine van Rensberg, in two separate orders, granted the plaintiffs leave to bring the case and certified the action as a class suit, allowing plaintiffs to proceed with their case against several IMAX directors and officers over disclosures in the company’s 2005 financial statements. Justice van Rensberg's December 14, 2009 opinion granting the plaintiffs' motion for leave can be found here. Her December 14, 2009 opinion granting the plaintiff's motion for class certification can be found here.

Justice van Rensberg’s decisions are, according to the Post article “groundbreaking” because the case is the first to test recent revisions to the Ontario Securities Act that potentially made it easier for disappointed investors to bring actions for civil liability against directors and officers of public companies for misrepresentations in public disclosure documents. 

These statutory provisions, which became effective in December 2005,  were first passed by the Legislative Assembly of Ontario in legislation now referred to simply as Bill 198, which is codified as Section XXIII.1 of the Ontario Securities Act. The provisions provide for the liability of certain specified individuals for misrepresentations in companies’ public disclosure documents.

Section 138.8 (1) of the statute specifies, however, that a liability action cannot be commenced "without leave of court granted upon motion with notice to each defendant." The court is to grant leave only "where it is satisfied" that the action "is being brought in good faith" and there is a "reasonable possibility" the plaintiff will prevail at trial.

The significance of Justice van Rensberg’s decision in the IMAX case is that, according to Justice van Rensberg, the IMAX case represents "the first .case in Ontario in which the court has been asked to grant leave in such an action." She also observed that the statutory provision "has never been interpreted previously" adding that there is no other statutory similar statutory provision in force in any other Canadian jurisdiction.

In granting the plaintiffs' motion for leave to proceed, Justice van Rensberg held that "she is satisfied that the action is brought in good faith and that the plaintiffs have a reasonable possibility of success at trial in pursuing the statuory claims against all ... parties" other  than with respect to two individual outside director defendants.  

Of particular significance is Justice van Rensberg's conclusion that the standard to be used in determining whether a case should proceed is relatively low. With respect to the first part of the test, she said that "there is no reason to read in a 'high' or 'substantial' onus requirement for good faith in this type of proceeding." She also ruled against a more onerous threshold for the "reasonable possibility of sucess" part of the test, stating that "a threshold that is too difficult may have little deterrent value" and that an onerous threshold "may unduly lengthen and complicate the leave procedure." 

In a portion of the ruling that is of particular significance for outside directors serving on the boards of Canadian corporations, Justice van Rensberg specifically held that the statutory thresholds had been met with respect to several outside director defendants who served on the audit committee to the board or who otherwise had oversight responsibilties for the company's disclosure documents. 

Justice van Rensberg also separately held that the plaintiffs had satisfied the requirement for the certification of a global class to assert both the statutory claims and certain common law claims that the plaintiffs had raised.  The approved class included both plaintiffs who had bought there IMAX shares on the TSX as well as those who had bought their shares on the NASDAQ exchange.

In certifying the class, van Rensberg specifically rejected the defendants' arguments that the court could not include within the class the 80 to 85% of IMAX shareholders who resided in the U.S. or were otherwise non-Canadian. The defendants argued that it would be "extraordinary" for the court to recognize a class where most of the class members resided outside the jurisdiction. The defendants also argued that given the pendancy of the separate securities lawsuit pending in the U.S., it would be "premature" for the court to certify a worldwide class.

In rejecting the defendants' arguments against certification of a worldwide class, Justice van Rensberg took particular note of the arguments that the defendants had raised in opposing class certification in the U.S. securities lawsuit, in which they had also argued against the certification of a global class in that case as well. The defendants in particular had urged the superiority of the Canadian action, leading van Rensberg to conclude that the defendants were trying to have it both ways.

Justice van Rensberg went on to conclude that the court had authority to certify an international class, noting that the case had a real and substantial connection between the claims asserted on behalf of the foreign class members and the jurisdiction. She also specifically rejected the argument that that the existence of the parallel U.S. proceeding represented a reason not to certify a global class in Canada.

The Post article quotes two leading Canadian plaintiffs’ class action securities attorneys, who predictably find much to like with the court rulings. Dimitri Lascarias, of the Siskinds law firm, who is co-lead counsel for the plaintiffs in the case, is quoted as saying the decisions represented a “huge undertaking” for the court because there are “no parallels.” He is also quoted as saying that “it’s a very good day for the investing public in Canada. For a long time it’s been difficult for them to advance their claims in a class action setting. Finally, there’s relief on the class-action horizon.” (The other co-lead counsel on the case was Jay Strosberg of the Sutts Strosberg firm.)

UPDATE: Dimitri Lascaris emailed me the following additional comment on the IMAX case: "We are obviously pleased with the decision, and are particularly gratified that the court certified a global class. Insofar as canadian issuers are concerned, the proper place for the rights of their shareholders, whether foreign or domestic, to be adjudicated is this country. "

I previously wrote about the IMAX case here in a post in which I raised the question about whether an action in Ontario might be used as a way to obtain discovery that could be used to support a parallel securities action pending in the United States. While that concern may remain, it may be likelier in light of these rulings that litigants may seek to pursue claims in Ontario not to support litigation elsewhere, but for its own sake and purposes, without reference to litigation in the U.S. or elsewhere. That said, the principles reflected in these rulings will be most compelling with respect to Canadian based corporations, suggesting that it is unlikely that the Ontario courts will be flooded with securities litigation involving companies from outside Canada.

With respect to Canadian companies, these rulings in the IMAX case unquestionably represent significant developments, and they suggest that there potentially could be significant additional litigation to come in the Ontario courts. Both Justice van Rensberg's ruling that a low threshold should apply on a motion to leave and that an Ontario court may certify a worldwide class, if followed by other courts, could make Ontario an attractive jursidiction in which to pursue securities litigation, at least with respect to Canadian companies if not with respect to companies domiciled or based elsewhere.  

Julie Triedman has a December 15, 2009 article on the Am Law Litigation Daily (here) about the IMAX decisions that among other things quotes Lascaris as saying that the court certified of global class "and the door is now open for foreign investors to benefit from that protection."

UPDATE: Loyal reader and blog friend, Dave Williams of Chubb, sent me an email reminder that he will be chairing a panel on Securities Litigation developments in Canada at the PLUS D&O Symposium in New York on February 3-4, 2010. Background infromation regarding the Symposium can be found here. Speakers at the panel will include Justice Colin Campbell and Dimitri Lascaris, among others.

Very special thanks to Dimistri Lascaris for providing me with copies of Justice van Rensberg's opinions in the IMAX case.  

I welcome comments on this blog from readers on these developments, particularly from my many friends north of the border that I know regularly read this blog.

Book Note: While I am in a Canadian mode, I want to recommend a recent excellent biography of Samuel de Champlain, the French explorer, navigator and mapmaker. In his splendid book Champlain's Dream, author David Hackett Fischer (who also wrote the excellent book, Washington's Crossing) tells Champlain's extraordinary story.

Fischer convincingly argues that the success of French attempts to explore and colonize  North America were largely the result of Champlain's persistent and courageous efforts. The portrait that emerges is one of a man of uncommon bravery and intelligence, who mastered not only the arts required for voyages of discovery but also the tact and finesse required to maintain necessary relations at court during the reigns of several French monarchs.  

Fischer also argues that Champlain was a noble and perhaps even heroic figure, in part because of his insistence that the Native Americans the French settlers encountered should be treated with dignity and respect. As a result, the French were able to establish far more amicable relations with the locals than were the English, Dutch and Spanish colonists.

A particularly good review of Fischer's book from the October 31, 2008 New York Times can be found here.

What Passes for Humor These Days: My 16-year old son: “What’s brown and sticky?” Me: “I don’t know, what’s brown and sticky?” My son (after a pause): “A stick.” 

He told me that one right after he asked me, “What do you call cheese that isn’t yours?” Me: “I don’t know, what do you call cheese that isn’t yours?” My son: “Nacho Cheese.” (You might have to repeat that last one out loud a couple of times.)

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Though the year-to-date tally of failed banks is, as of Friday night, now up to 133, the much-anticipated wave of FDIC litigation against the directors and officers of the failed institutions has been slower to emerge. As I recently noted, however, the signs are that the FDIC is now starting to assert itself. Along those lines, a demand letter from the FDIC to the former directors and officers of BankUnited FSB, filed in the bankruptcy proceedings of BankUnited’s corporate parent company, shows that the FDIC is prepared to assert claims and demonstrates what those claims will look like.

On May 21, 2009, in a rare Thursday night action, the FDIC took over BankUnited, about which refer here. At the time of its closure, BankUnited has assets of over $12 billion, but as a result of the loss share arrangement the FDIC reached with the investors that purchased BankUnited’s assets, the FDIC estimated that the bank’s failure would cost the FDIC $4.9 billion.

On May 22, 2009, BankUnited’s parent company, BankUnited Financial Corporation, and related entities filed a petition for bankruptcy in the bankruptcy court for the Southern District of Florida.

According to court filings in the bankruptcy proceedings, BankUnited carried $50 million in directors’ and officers’ liability insurance, arranged in four layers. The program’s extended reporting period had a November 10, 2009 expiration date.

On November 24, 2009, the FDIC filed a motion with the bankruptcy court regarding the FDIC’s rights to assert claims against the BankUnited’s former directors and officers. A copy of the motion can be found here. In essence, the FDIC’s motion sought to establish the FDIC’s right to assert its claims in priority over the claims against the bank’s former directors and offices that committee on unsecured creditors and others sought to assert.

As part of its motion, the FDIC attached a copy of a November 5, 2009 letter that the FDIC, as BankUnited’s receiver, had sent to fifteen former directors and officers of the bank, in which the FDIC presented its "demand for civil damages arising out of losses suffered as a result of wrongful acts and omissions committed by the named Directors and Officers." The letter explains that the demand for civil damages is "based on the breach of duty, failure to supervise, negligence, and/or gross negligence of the named Directors and Officers."

Though the letter is nominally addressed to the fifteen individuals, copies of the letters also were sent directly to the bank’s primary and first level excess D&O insurers. The FDIC’s motion papers explain, in footnote 4, that the FDIC sent the letter to the bank’s primary and first level excess D&O insurers, but not to the second and third level excess D&O insurers, because the second and third level excess insurer’s policies "contain a regulatory exclusion."

In its November 5 letter, the FDIC states that its demand is based on damages "arising out of losses suffered due to wrongful acts committed in connection with the origination and administration of unsafe and unsound residential real estate loans." The letter cites in particular the individuals’ alleged wrongful acts in connection with "pursuing an overly aggressive grown strategy focused primarily on the controversial Payment Option ARM product (the ‘Option ARM’)." The letter asserts that by the end of 2007, Option ARM mortgages represented 70% of the bank’s residential loan portfolio and 60% of its total loan portfolio, and by 2008 represented 575% of the bank’s capital.

The letter asserts that individuals failed "to implement adequate credit administration and risk management controls failed to heed warnings and/or recommendations of bank supervisory authorities and bank consultants." The letter also states that the "inherent risk" of Option ARM loans was "coupled with deficiencies in the Bank’s underwriting, appraisal process and credit administration."

As the FDIC summarized in its November 24, 2009 motion, the letter asserts that the bank’s directors and officers:

(i) adopted an overly aggressive and reckless growth strategy by investing most of the Bank's assets in "Option ARM" lending products;

(ii) failed to provide the Bank with adequate reserves for potential loan losses resulting from its investments in Option ARM lending products;

(iii) engaged in reckless, high-risk, and limited scrutiny lending;

(iv) failed to oversee the Bank's affairs, including the failure to monitor the rising volume of loan delinquencies and to establish lending policies that would adequately protect the Bank; and

(v) failed to provide adequate personnel and administrative capacity to appropriately monitor loan appraisals and to carry out diligent underwriting reviews.

Among the FDIC’s more colorful allegations, the letter accuses the directors and offices of "encouraging an extremely liberal and aggressive lending mentality to 'make the loan as long as the borrower has a pulse.'" The letter also accuses the individuals of "engaging in reckless, high-risk, and limited-scrutiny lending to fuel the bank's aggressive and rapid growth — in direct contradiction to public representations of the bank's conservative lending and strict underwriting policies."

In addition, the letter accuses the individuals of "approving and putting in place a compensation structure that drove the bank's directors and officers to pursue recklessly risky lending and business practices."

The letter asserts that these "breaches of their fiduciary duties" caused the bank to suffer loan losses between January 1, 2006 and May 21, 2009 of over $227 million. In addition to these losses, the FDIC recognized a $4 billion loss to pay off liabilities the Bank used to fund its lending activities. The FDIC’s letter concludes with the note that its investigation is continuing and that it will supplement its demand as appropriate as its investigation progresses.

The FDIC’s demand letter demonstrates not only its willingness and intent to assert claims against the former officials of failed lending institutions, but also show that it is highly aware of the D&O insurance requirements relating to those claims. The timing of the FDIC’s November 5 demand letter (sent just prior to the insurance program’s expiration), coupled with the fact that no demand was sent to the excess carriers whose policies contain regulatory exclusions, shows that the FDIC claims approach is keyed to the failed financial institutions’ D&O insurance program.

So the signs are that the claims against the directors and officers of failed banks are coming, and that one of the principal purposes of the exercise is to try extract recoveries from the banks’ D&O insurance policies. Seems just like old times…

A December 11, 2009 Palm Beach Post article about the FDIC’s demand letter can be found here. Special thanks to a loyal reader for providing a copy of the Palm Beach Post article.

More Troubled Bank Litigation: In yet another sign that litigation involving troubled banks could be an increasingly important part of D&O claims activity in the weeks and months ahead, on December 11, 2009, plaintiffs filed a purported securities class action lawsuit in the Eastern District of Washington against Sterling Financial Corporation and two of its officers.

As reflected in the plaintiffs’ lawyers’ December 11 press release, the complaint, which can be found here, alleges that the defendants failed "to disclose the extent of seriously delinquent commercial real estate loans and construction and land loans" and that the defendants "failed to adequately and timely record losses for its impaired loans, causing its financial results and its Tier 1 capital ratio to be materially false."

According to the press release, the complaint further alleges that:

(a) defendants’ assets contained hundreds of millions of dollars worth of impaired and risky securities, many of which were backed by real estate that was rapidly dropping in value and for which Sterling had failed to record adequate loan loss reserves; (b) defendants failed to properly account for Sterling’s commercial real estate loans and construction and land development loans, failing to reflect impairment in the loans; (c) Sterling had not adequately reserved for loan losses such that its financial statements were presented in violation of Generally Accepted Accounting Principles ("GAAP"); (d) Sterling had not adequately accounted for its goodwill or its deferred tax assets such that its financial statements were presented in violation of GAAP; (e) Sterling had not adequately reserved for loan losses such that its Tier 1 capital was presented in violation of banking regulations; and (f) the Company’s capital base was not adequate enough to withstand the significant deterioration in the real estate markets and, as a result, Sterling would be forced to consent to a cease and desist order from the Federal Deposit Insurance Corporation directing it to raise $300 million in capital.

What makes the FDIC’s demand letter to the BankUnited officials and the shareholders’ complaint against Sterling Financial noteworthy is not that the banking activities to which the allegations relate are unique; to the contrary, it seems particularly important to note that during the period of the these banks’ alleged misconduct, many other banks were involved in the same or similar banking activities. This fact together with the growing number of failed banks and the significant additional numbers of troubled banks suggests that in the weeks and months ahead there could be many more demands and lawsuits along the lines of the ones described above.

I don’t think I am going out on a limb to say that litigation involving failed and troubled banks could be one of the most important litigation trends in 2010.

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On December 11, 2009, the U.S. House of Representatives approved by a 223-202 vote "The Wall Street Report and Consumer Protection Act of 2009," H.R. 4173 (here). The sprawling 1279-page Bill, which must be reconciled with competing financial reform legislation pending in the Senate, would institute a number of reforms and initiatives that would have a dramatic effect on the financial services industry.

In addition to the many higher profile institutional reforms, the Bill also incorporates a number of revisions and amendments that could significantly impact both SEC enforcement actions and private securities litigation.

The House Financial Services Committee’s two-page summary of the Bill can be found here. The Committee’s three page list of the Bill’s "highlights" can be found here.

The Bill’s high profile reforms include, among other things, the creation of a Consumer Financial Protection Agency; the creation of a Financial Stability Council to identify large, interconnected firms that could put the financial system at risk; the creation of a single federal banking regulator; and the introduction of various regulatory reforms regarding financial derivatives and credit default swaps. The Bill also required hedge funds and private equity funds to register with the SEC.

As reflected on the RiskMetrics Corporate Governance Risk & Governance Blog (here), the House Bill also introduces a number of corporate governance reforms, including an annual "say on pay" mandate and authorization for the SEC to issue a proxy access rule. The bill includes a permanent exemption for small issuers (those with less than $75 million in market cap) from the outside auditor attestation requirements of the Sarbanes-Oxley Act.

In addition to these higher profile initiatives, the House bill also incorporates variety of legislative revisions to the federal securities laws that could affect securities litigation. Some of these initiatives were the subject of separate legislative proposals that have now been incorporated into the larger financial reform legislation.

The House Bill’s provisions that potentially could impact securities litigation include the following:

1. Credit Rating Agencies (Section 6003): Clarifies the pleading standard applicable to private securities actions under the ’34 Act against "a nationally recognized statistical rating organization" by specifying that "it shall be sufficient for purposes of pleading any required state of mind for purposes of such action that the complaint shall state with particularity facts giving rise to a strong inference that the nationally recognized statistical rating organization knowingly or recklessly violated the securities laws."

The Section also specifies that NRSRO’s credit rating opinions "shall not be deemed forward looking statements."

2. Mandatory Arbitration (Section 7201): Gives the SEC authority to "prohibit, or impose conditions or limitations on the use of, agreements that require customers or clients of any broker, dealer, or municipal securities dealer to arbitrate any future dispute between them arising under the Federal securities laws."

3. Whistleblower Incentives and Protection (Section 7203): Gives the SEC authority to "pay an award or awards not exceeding an amount equal to 30 percent, in total, of the monetary sanctions imposed in the action or related actions to one or more whistleblowers who voluntarily provided original information to the Commission that led to the successful enforcement of the action."

4. Aiding and Abetting Liability (Section 7207): Amends the ’33 Act and the Investment Company Act of 1940 to provide that for purposes of an action brought by the SEC, "any person that knowingly or recklessly provides substantial assistance to another person in violation of a provision of this Act, or of any rule or regulation issued under this Act, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided."

Section 7215 also clarifies that recklessness is a sufficient basis on which to impose aiding and abetting liability under the ’34 Act

5. Extraterritorial Application of the Federal Securities Laws (Section 7216): Amends the ’33 Act, the ’34 Act and the Investment Advisors Act of 1934 to clarify that federal court jurisdiction for securities cases includes cases that involves "conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors" or "conduct occurring outside the United States that has a foreseeable substantial effect within the United States."

6. Deadlines for Enforcement Investigations and Compliance Examinations (Section 7209): Introduces, subject to certain specified exemptions, certain time requirements within which the SEC must complete enforcement investigations and compliance examinations. Among other things, the Section provides that, other than with respect to certain "complex action," within 180 days after serving someone with a Wells Notice, the SEC must either initiate an action against the person or provide notice that it does not intend to file an action.

The House Bill also dramatically increases SEC funding, doubling the agency’s budget in five years. The Bill also expands the agency’s subpoena powers and its ability to share and access information gathered by other regulatory and investigative bodies and agencies.

Readers of this blog will also be interested to know that Section 8802 of House Bill also creates a Federal Insurance Office within the Treasury Department. The new Federal Insurance Office would not replace state regulation of insurance. Rather, the new agency would monitor the insurance industry; designate insurers for stricter oversight; assist in the administration of TRIA; coordinate on international insurance regulation; and consult with states on insurance matters of national importance.

It remains to be seen whether any of these provisions will survive the forthcoming legislative process and actually become law. The Wall Street Journal’s front page article about the House Bill (here) indicates that Democratic leadership in the Senate has committed to having a reconciled agreement in principle about the financial reform legislation by the end of December, to have a bill enacted in the first half of 2010.

While the legislation that finally emerges will undoubtedly reflect further changes, it is interesting to observe even at this preliminary stage how some of the proposed initiatives have fared.

For example, though it contains provisions addressing the SEC’s authority to enforce aiding and abetting liability under the ’33 Act and under the Investment Advisors Act, the House Bill, at least, does not contain any provisions along the lines of those proposed last summer by Senator Arlen Specter to overturn Stoneridge. Nor does the House Bill contain any provisions reflecting Senator Specter’s initiative to overturn Iqbal. Of course, because those initiatives originated on the Senate side, they may still be incorporated into the Senate version of the financial reform bill and perhaps even in the final version of the reform legislation that ultimately emerges.

As noted above, the House Bill does incorporate suggested provisions that would clarify federal court jurisdiction in matters involving companies or persons outside the U.S. These provisions mirror the proposed legislation that Representative Paul Kanjorski introduced earlier this fall (as discussed in a prior post, here.) This jurisdictional provision, if enacted, could make the National Australia Bank case, on which the U.S. Supreme Court recently granted a petition for writ of certiorari, of considerably less potential significance, as jurisdictional issues raised in the case would be controlled in future by the new statutory provisions.

Given the current political climate, it seems probable that some form of financial reform legislation will be enacted prior to the 2010 congressional election. The ultimate version may be far different that the Bill approved by the House on Friday. However, if the House Bill is any indication of what might finally emerge, there could be some enormous changes ahead, including among other things significant changes relating to securities litigation and enforcement.

Random Thought: Is there anything more unintentionally ironic and completely self-negating than the phrase "This Page Intentionally Left Blank"? (This Internet being what it is, there is actually a website devoted to the phrase, here.)

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In a provocative statement suggesting the unlikelihood of "damage awards" against subprime lenders’ directors and officers, XL Capital Ltd. CEO Michael McGavick yesterday told a Goldman Sachs Group conference that "being collectively stupid is not a basis for a lawsuit," according to a December 9, 2009 Bloomberg article (here).

As reflected in the article, McGavick indicated that investors have little chance of extracting damages awards from executives and board members at firms that lost money, as the article put it, "betting on subprime mortgages." McGavick is quoted as saying that its "very hard to pick out the management team that did something wrong to the level that the law requires."

McGavick’s comments have already kicked up controversy, as reflected in Ross Todd’s December 9, 2009 article on Am Law Litigation Daily, entitled "Are Directors and Officers Safe from Securities Fraud Suits Because They Were ‘Collectively Stupid?’" (here).

However, it is difficult to tell from the Bloomberg article how comprehensive McGavick’s comments were intended to be. Was he talking only about companies that invested in subprime mortgages or was he talking about a larger group of companies, including subprime lenders and other companies that were brought down or seriously damaged by the subprime meltdown?

Subject to that uncertainty about the scope of McGavick’s comments, I have several thoughts and comments in reaction to his remarks.

As an initial matter I note that while it may be true that "collective stupidity" hardly represents a legal theory on which liability might be based, it also is not a very promising defense. Even setting aside the colorful use of the word "stupidity," it is not a great defense to argue that everybody managed to get it wrong, as proved to be the case in the connection with options backdating, for example.

And to the extent that McGavick’s statement was intended to be broadly based and was meant to suggest generally that plaintiffs are unlikely to even file lawsuits based on the subprime meltdown, the facts suggest otherwise. Plaintiffs have already filed over 200 subprime and credit crisis securities class action lawsuits (as reflected in the attachment to this prior blog post), as well as over 25 derivative lawsuits and over 15 ERISA class actions. Clearly, the plaintiffs’ lawyers perceive what McGavick characterized as "collective stupidity" to be a litigation opportunity.

If McGavick’s statement was intended to suggest that plaintiffs will not succeed in the cases arising out of the subprime meltdown, I have to say that from my perspective it is far too early to make any sweeping statements about who will come out ahead generally from the subprime and credit crisis lawsuits.

Specifically, even though there have been over 200 subprime and credit crisis related securities class action lawsuits, only a small portion of those cases have made it through the dismissal stage as reflected in my running tally of the rulings on subprime lawsuit dismissal motions, which can be accessed here.

Although the defendants have prevailed in many of the motions so far, there have also been a number of motions on which plaintiffs have prevailed – for example in the New Century and Countrywide cases (as reflected here and here, respectively). Indeed, there have been cases, like the Washington Mutual case (refer here), where the initial motion was granted, but the cases survived the renewed motion after the complaint was amended.

And even though there have only been a handful of settlements in the subprime and credit crisis cases so far, the settlements so far collectively represent nearly a billion dollars. Even if the out-sized Merrill Lynch settlements are disregarded, the other settlements still represent some very significant numbers. (The settlement data can be accessed here). Even modest extrapolation against the entire population of lawsuits suggests that even if plaintiffs don’t extract "damages awards," they are likely to notch some significant settlements before everything is said and done.

With so many of the subprime and credit crisis cases yet to be resolved, I think the most that can be said with respect to the D&O insurance industry’s likely aggregate exposure to the subprime and credit crisis lawsuits is that it is too early to tell. I will say that if you take into account the aggregate expenses that the D&O industry will sustain in defending insureds, it is clear that by any measure that the subprime and credit crisis litigation wave will in the final analysis represent a significant event for the D&O insurance industry, no matter what happens.

My prior interim update on the subprime and credit crisis-related litigation wave can be found here.

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In many prior posts (refer here), I have suggested that FCPA-related losses could represent a growing D&O exposure. In a recent demonstration of just how significant these kinds of exposures can be, Siemens disclosed  earlier this week that it has reached a 100 million euro settlement with its D&O insurers in connection with the claims arising from the company’s bribery scandal. The filing, which incorporates the insurance settlement documentation, raises a number of interesting issues.

In its December 8, 2009 filing of Form 6-K (here), Siemens reports that on December 2, 2009, the company reached a settlement agreement with its D&O liability insurers, while simultaneously announcing that it had also reached settlements with a number of its former directors and officers against whom it has asserted damages claims arising out of the bribery scandal. The settlements include the agreement of the company's former CEO Heinrich von Pierer to pay 5 million euros, and of his successor, Klaus Kleinfeld, to pay 2 million euros. Other former board members agreed to pay amounts ranging from 1 million euros to 3 million euros.

The filing explains that Siemens had a total of 250 million euros of D&O insurance coverage, arranged in five layers of 50 million euros each. Each layer had a lead insurer as well as participating coinsurers. The settlement agreement, which can be found in Annex 10 to the filing, identifies the lead insurers and the participating coinsurers for each layer.

The insurance settlement requires a payment to Siemens of up to 100 million euros, consisting of two parts: a payment of 90 million euros (against which prior defense payments of 5.5 million euros are to be credited) and as well as the payment of an additional fund of 10 million euros. The 10 million euro fund is to be maintained for the defense of future claims as well as for the satisfaction of "justified claims." that are asserted against former Board Members based on the bribery allegations or that have no connection with bribery allegation but for which coverage would have otherwise have been available under the D&O insurance program.

All of the layers in the Siemens D&O insurance program participated in the settlement, with each successive layer contributing a proportionately smaller percentage of the layer's 50 million euro limit.. (The percentage participations applicable to each layer are specified in the settlement agreement.) The 10 million euro fund is to be managed by the lead insurer on the primary layer on behalf of all the insurers.

The settlement agreement recites that the insurance settlement was the result of "intensive discussion" and that the Insurers had previously indicated that coverage might be denied on the grounds of, among other things, "pre-contractual knowledge and/or fraudulent/intentional violations of duties, and/or certain rights by unilateral declaration [that] can be exercised, which would lead to retroactive rescission of the D&O insurance." The parties reached the settlement in order to avoid the need to litigate these issues as well as to avoid the need for Siemens to pursue an action against … former Board Members who settled with Siemens in order to establish their liability as a precondition for the obligation to provide coverage."

Siemens’ SEC filing also reflects the settlement agreements reached separately with various former company officials. The filing recites that in connection with the individual settlements the individuals have agreed "not to draw on the D&O insurance coverage" in connection with their agreed payments to the company.

The agreement is subject to shareholder approval, which will be determined at the company’s January 26, 2010 shareholder meeting. (The shareholders will also vote on the individual settlements as well). The agreement clarifies that upon the effectiveness of the settlement, the insurance policies will be "retroactively terminated."

If it is "determined by a non-appealable court decision that individual Former Board Members intentionally or knowingly … violated their duties," then the Insurers shall be entitled to ask for reimbursement of defense costs paid to the respective former Board Member. The lead primary insurer is designated to administer this portion of the agreement.

There are a host of interesting things about this settlement.

The first is the marginal note accompanying the settlement stating that Michael Diekmann, a member of Siemens’ Supervisory Board, is the chairman of the Management Board of the parent holding company of the lead insurer on Siemens’ primary D&O insurance policy. The filing states that "Mr. Diekmann did not participate in the consultations and decisions pertaining to the Coverage Settlement." Call me cynical, but even if he didn’t participate in the consultations, this connection didn’t exactly impede the settlement either, if you take my meaning. To me this fact seems like it might help explain how there was any settlement at all, rather than the mother of all European D&O coverage lawsuits.

The second interesting thing is the way the D&O insurance policies are responding. The insurers are making a claims payment directly to the company, for claims that have been asserted by the company against its former officers. Unless the company’s European-issued insurance policies lack the kind of Insured vs. Insured exclusion that is standard in D&O policies issued in the U.S., there is something very peculiar about this payment. Even if the company itself is not an insured under the policy, it would seem like there would be an exclusion to protect against the possibility of collusive claims. Of course, there might have been such as exclusion in Siemens program and it was simply compromised as part of the settlement. (Readers who can help rationalize this apparent Insured vs. Insured problem are cordially invited to clarify, using this blog’s comment function.)

UPDATE: A knowledgeable European reader who prefers anonymity sent me a note with the following observation:"Regarding the payment towards the company we usually don´t carry IvI-exclusions over here in Germany. Most of the claims are made by the companies against individual directors and officers, word is that it´s around 80% or more of the times. We are basically still in the fledging stages of D&O litigation over here, D&O coverage was allowed in 1986, distribution really didn´t took off until the end of the 90s. The mentality over here regarding the pursue of claims against your directors and officers is totally different than in the US. Until the middle of the 90s, courts hadn´t even ruled on supervisory boards being forced to pursue claims against directors and officers."

The other thing about the insurers’ 90 million euro payment (less defense expenses previously paid) is the question of what exactly it represents. Simultaneously with the insurance settlement, Siemens settled its claims against most of the former company officials. So those claims have been resolved by individual payments for which the individuals are prohibited from seeking insurance. There are remaining claims against other individuals, but that is what the 10 million euro fund is for. So what exactly is the 90 million euro (less prior defense expense) payment for? Of course, the company has incurred literally billions of costs, expenses, fines and penalties in connection with the bribery scandal, but I don’t think the insurers are paying for the company's own scandal related expenses. 

The settlement agreement recites that, among other things, the insurance settlement relieved the company of the need to file and pursue actual lawsuits against former board members. I guess the internal logic of the settlement agreement is that the company could have pursued the lawsuits, and if they did, each would have to be litigated and separately settled, and the insurer would have to pay (assuming the claims were covered). The insurance settlement in effect says that we are just going to cut out all the intervening steps and compromise everything for a single payment.

The third feature is the way the settlement incorporates a settlement fund for future losses. It is on the one hand an escrow fund, but on the other hand it is more like insurance, or perhaps the residue of insurance with certain insurance-like attributes (e.g., it only applies to "justified" claims) The insurers are in effect providing a limited amount of insurance, but in a bargained down amount, with many fewer conditions.

Fourth, to the extent the insurance policies provided any type of insurance coverage for securities claims, the compromise and termination apparently precludes the availability of insurance in connection with the securities class action lawsuit filed in the Eastern District of New York last week, in which the plaintiffs alleged violations of U.S. securities laws solely against Siemens. (The $10 million fund would not be available in connection with this claim, because the claim was filed solely against the company, but the fund was set up only for claims asserted against former board members.)

Finally, I wonder what this settlement and the company’s settlements with the individual former company officials do to the derivative lawsuit that was filed in New York earlier in connection with the bribery scandal (refer here, see page 18). It is entirely possible that that case fell by the wayside earlier on, or that it was preempted by the claims the company itself asserted against the individuals. But it is an interesting question what impact these developments would have on the New York derivative lawsuit if it were still an active case. (Readers who may have any insight into the status of the derivative lawsuit are encouraged to provide updated information via the comment feature of this blog.)

Whatever else may be said about the settlement, it clearly represents a massive hit to the European D&O insurers. Hits on this scale may have become almost commonplace in the U.S., but this type of loss is still represents an extraordinary D&O insurance development in Europe. I wonder if this settlement is a game changer for the European D&O insurance community. UPDATE: Readers have advised me that massive D&O settlements on this scale are unfortunately becoming all too common in Europe as well; one example cited is the recent 57.5 million euro settlment involving EM.TV.

Finally, it is worth noting that the massive amount of the insurance settlement underscores the extent of the exposure that bribery-related claims represent. Though the Siemens case is extraordinary on many levels, the kind of insurance losses on claims related to bribery-related allegations are becoming increasingly common. As the Siemens insurance settlement demonstrates, the exposures are clearly not limited just to the United States.

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On December 7, 2009, NERA released its most recent update on trends in the numbers and values of settlements of SEC enforcement actions. The latest study, which is as of September 30, 2009 and complete through the end of the SEC’s 2009 fiscal year, shows that the number of settlements during the year declined for the second straight year, but the average settlement amount increased, and the median settlement amount held steady. NERA’s December 7 press release regarding the study can be found here.

As the report notes, because the 2009 settlements largely relate actions initiated in earlier periods, they may or may not be indicative of what reasonably may be expected in the SEC’s current heightened enforcement environment.

In addition, the reports observations about the high frequency of individual participation in the settlement of SEC enforcement actions may provide important additional context for Judge Rakoff’s recent high profile rejection of the proposed settlement of the SEC’s enforcement action involving the Merrill Lynch bonuses.

First, with respect to the numbers of settlements, the report shows that there were 626 settlements in fiscal 2009, compared to 673 in fiscal and 717 in fiscal 2007. Among other things, the report notes that fiscal 2009 was a year characterized by staff turnover and transition for the agency’s top leadership, which may be relevant to understanding the relative decline in the numbers of settlements.

Monetary payments were a component of 58.6% of company settlements and 58.9% of individual settlements for FY 2009. The average monetary SEC settlement during fiscal 2009 was $10.7 million, compared to only $4.7 million in fiscal 2008, but the increased 2009 average is largely a reflection of several very large settlements during fiscal 2009, including, for example, the $350 million Siemens paid in settlement of the FCPA enforcement action the agency filed against the company. Removing the settlements in excess of $100 million reduces the FY 2009 average to $4.4 million.

By contrast to the average, the median SEC enforcement settlement was about $1.0 million, about equal to the prior fiscal year’s median.

Among largest source of SEC enforcement actions are cases involving alleged misstatements. In an interesting analysis of the relationship between individual and corporate settlements in misstatement cases, the report notes that between the enactment of SOX and the end of FY 2009, the SEC had reached settlements in 353 cases involving alleged misstatements by corporate companies. Of these 353 settlements, 62 involved only the company, 99 cases involve only individual directors or employees, but the remaining 192 cases involved both the company and individuals.

In other words, individuals participate to a greater or lesser extent in the vast majority of SEC enforcement actions involving misstatements. As the report points, this pattern presents interesting additional context for Judge Rakoff’s high profile rejection of the SEC’s proposed settlement of the Merrill Lynch bonus enforcement action. Judge Rakoff faulted the proposed settlement because it fined the company (and its shareholders) but not the supposedly blameworthy individuals.

The report notes that this outcome is likely to spur the SEC to pursue individuals with "renewed vigor" and indeed SEC officials have made statements to that effect. The SEC’s own settlement patterns show that in general it is the agency’s practice to involve individuals in settlement of restatement cases.

The report reflects a number of different interesting findings, and also contains some helpful and interesting tables, including lists of the ten largest corporate and individual post-SOX settlements, as well as interesting data showing relating to the number of insider trading settlements – somewhat unexpectedly, the number of inside trading settlements hit a post-SOX low during fiscal 2009.

The report concludes with the observation that the full impact of the reforms that the SEC has only just begun to initiate "is likely yet to be seen." The report suggests that the trends observed in the most recent report are likely to change in the periods ahead.

SEC Files Enforcement Action Against Former New Century Officials: Perhaps as a reflection of the newly more active SEC, on December 7, 2009, the SEC filed an enforcement action in the Central District of California against three former New Century Financial Corporation officials.

The SEC’s complaint, which can be found here, alleges that the three defendants violated the securities laws failed to disclose important negative information, including dramatic increases in early loan defaults, loan repurchases, and pending loan repurchase requests. Defendants knew this negative information from numerous internal reports they regularly received, including weekly reports ominously referred to internally as "Storm Watch." The SEC’s December 7 litigation release about the action can be found here. 

The timing of the SEC's enforcement action against the three New Century officials stands in interesting contrast to the private securities class action lawsuit filed against certain former New Century officials. The private securities, which was the first of the subprime related securities class action lawsuits when it was first filed in February 2007, is nearly three years old. The court denied the defendants' motion to dismiss almost exactly a year ago.

 The more interesting question is whether the filing of the New Century action represents the first in a series of enforcement actions related to the subprime meltdown and credit crisis. In light of the new environment at the agency and the pressure it is under to reestablish its regulatory credentials, there may well be further actions yet to come.

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More than three years have passed since the first blockbuster revelations about corrupt payments at Siemens, yet litigation arising from the scandal continues to emerge. On December 4, 2009, plaintiffs’ lawyers filed a securities class action lawsuit in the Eastern District of New York against Siemens, based on alleged misrepresentations following initial revelations of the improper payments. The complaint, which can be found here, has a number of interesting features and it potentially raises complicated issues.

As reflected in a prior post (here), the bribery scandal at Siemens hit the front pages of the world’s financial papers in late 2006 after more than 200 German police raided the offices and homes of over 30 current and former Siemens employees. The ensuing investigation and enforcement action culminated in the December 15, 2008 announcement (here), that Siemens had agreed to pay a total of $350 million in disgorgement to the SEC, a criminal fine of $450 million to the U.S., and a fine of 395 euros to the office of the Prosecutor General in Germany.

The recently filed securities suit refers extensively to the SEC’s enforcement complaint against the company. But though the class action complaint is inextricably linked to the company’s bribery revelations, the complaint is not about the bribery disclosures as such. Rather, the complaint purports to be based on company statements about its business prospects and its ability to compete without making improper payments.

That is, the complaint alleges that the company claimed that it "had cleaned up [the] corporate-wide scandal and that it would meet its publicly announced revenue and earning projections" – but, the complaint further alleges, "Siemens ability to generate revenues and achieve earnings expectations was clearly dependent on its corporate-wide bribery activities."

Consistent with the theory that the complaint is not about the bribery itself but about the company’s claims about how it would fare as a bribery-free competitor, the proposed class period does not commence at some time prior to the bribery revelations. Instead, the proposed class period begins more than a year after the scandal first emerged, in November 2007, when new management projected significant growth for the company.

During the class period, the complaint alleges, management sought to dispel concerns that the lingering bribery investigation would have an adverse impact on the company’s ability to meet its earnings projections. The proposed class period ends at the end of the company’s 2008 second fiscal quarter, when the company announced a sharp drop in second quarter profits.

So while the plaintiff’s complaint consists almost exclusively of a detailed recounting of the bribery scandal and its regulatory aftermath, the complaint isn’t about the bribery or even the revelations about the bribery at all; instead, the plaintiffs seek damages based on what the company allegedly said about whether it could meet its goals now that it was no longer getting business by paying bribes.

Plaintiffs will obviously face certain challenges demonstrating that their claimed damages are due to these statements about Siemens’ prospects without bribing officials, as opposed to ongoing revelations concerning the bribery investigation – which continued both during and after the proposed class period. Indeed, the class period ends at the same time as the company disclosed certain findings of the law firm the company had hired to investigate the bribery allegations.

In one sense it seems as if the plaintiffs arguably are trying to have it both ways with respect to damages. They do not allege what harm was due to the company’s supposedly misleading projections; rather they allege only that "as a result of defendant’s fraud and misconduct, Siemens’ shareholders have suffered, and will continue to suffer, billion of dollars of damages." These broad damages claims are arguably at odds with the complaint’s relatively narrow class period and narrow range of alleged misrepresentations.

The complaint may also be susceptible to challenges that it does not sufficiently allege scienter. In that regard, it is interesting to note that the sole defendant named is the company. No individuals are named as defendants. Without any individual defendants, the possibility for the complaint to survive a dismissal motion will depend on some kind of "collective scienter," based on the supposed knowledge or recklessness of responsible corporate officials.

Critically, for the plaintiff’s complaint to succeed, they will have to show that during the class period, senior company officials knew (or were reckless in disregarding) that the company could not make its earnings targets without resorting to bribery. To put it as neutrally as I can, it is unclear from the complaint what allegations the plaintiffs intend to rely upon to show that the company’s senior officials knew during the class period that without improper payments Siemens could not meet its earnings projections.

The complaint could also face certain hurdles with respect to the claims of so-called "f-cubed" claimants. The proposed class period is not limited solely to the claims of investors who purchased their Siemens securities on the NYSE. To the extent the class purports to include the claims of foreign-domiciled investors who bought their shares in Siemens on a foreign exchange, the complaint could present the same kinds of jurisdictional issues as were raised in the National Australia Bank case, in which the U.S. Supreme Court recently granted a petition for writ of certiorari.

Perhaps in anticipation of these kinds of concerns, the new class complaint quotes liberally from the SEC’s allegations concerning the "nexus" between the improper payments and the U.S. However, the misleading statements that are the basis of the new class action complaint clearly appear from the face of the complaint to have been made in Germany. It is therefore possible that the claims of "f-cubed" class members could be susceptible to jurisdictional challenge.

In any event, and at a minimum, this case presents yet another concrete example of the way in which regulatory or enforcement investigations into corrupt payments can lead to civil litigation, which many readers will recognize as a recurring theme on this blog.

The fact that no individuals are named as defendants in the lawsuit is unusual, and could generate any number of interesting D&O coverage issues. For example, at least in the early days when company coverage first began to be added to insurance policies that previously only protected individuals, the company’s coverage was only available if there were also claims against individuals. These co-defendant requirements largely have fallen by the wayside over time, but the policy’s bias towards protecting individuals in preference to the company still survive in a various respects.

A related question about the company’s coverage is whether or not the company’s various admissions in connection with the prior regulatory or other settlements would trigger the conduct exclusions found in most D&O policies. I suppose that if the exclusion is sufficiently narrow, the company could argue that whatever else the company may have admitted, it did not make any admissions about the statements alleged in this complaint to be fraudulent. However, if the exclusion has a broader preamble, a carrier might well argue that the wrongful acts alleged in this complaint arise out of, related to or are based upon improper conduct to which the company as admitted.

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In its December 3, 2009 filing on Form-10-Q (here), Dell disclosed that on November 20, 2009, it had entered a written agreement to pay $40 million to settle the consolidated securities class action lawsuit pending against the company and certain of its directors and officers.

What makes the $40 million Dell settlement noteworthy is not its amount but its timing – the settlement comes not only after the securities lawsuit had been dismissed with prejudice at the district court level, but following oral argument on the plaintiffs’ subsequent appeal to the Fifth Circuit.

On September 13, 2006, the first of four securities class action lawsuits were filed in the Western District of Texas against Dell and four individual defendants, as well as against the company’s outside auditor. The plaintiffs’ 340-page Consolidated Amended Complaint (here) alleges that the company had a "culture of deception" and that it had used "fraudulent accounting" to inflate its revenues by $463 million for fiscal years 2003 through the 2006.

The plaintiffs further alleges that the individual defendants took advantage of the company’s inflated share price to unload millions of dollars of their personal holdings in the company stock – indeed, in the case of company founder, Michael Dell, the plaintiffs alleged that he had sold billions of dollars of company stock.

In an opinion dated October 6, 2008, Judge Sam Sparks granted the defendants’ motions to dismiss, with prejudice. The plaintiffs appealed to the Fifth Circuit. According to Dell’s most recent 10-Q, oral argument on the appeal took place before the Fifth Circuit on September 1, 2009. Thereafter, and while the appeal was still pending, the parties reached the settlement agreement described above. The parties jointly request that the Fifth Circuit remand the case so that the district court could consider the proposed class settlement.

As surprising as it is for a case to have settled following dismissal and while appeal was pending, this peculiar settlement timing is not entirely unprecedented. Most notably, the parties to the Bristol- Myers Squibb securities class action lawsuit agreed to settle that case for $300 million while the case was on appeal to the Third Circuit following the district court’s dismissal.

But even though it may have happened before for a securities case to be settled while on appeal following dismissal, the timing of the $40 million Dell settlement – coming as it did shortly after oral argument – does leave you wondering why the case settled when it did.

In her blog Footnoted (here), Michelle Leder, who was the first to note and report on the Dell settlement disclosure, speculates that the appeal "had to have gone really poorly" for the company to settle after securing dismissal in the court below. To a certain extent, Leder’s speculation seems plausible. Why else would the company agree to pay $40 million to settle a case that it had already managed to get dismissed?

There are some other possibilities. The first is that the company just wanted the case gone. Old cases, even those that are going reasonably well, don’t get better with age. More that one litigant has thrown money at a case just to get rid of it, and for a company with annual revenues of $12.9 billion and third quarter earnings of $337 million, the $40 million settlement (to the extent not funded by insurance) could represent a regrettable but relatively small cost of doing business.

Another possibility is that the plaintiffs are the ones for whom oral argument had gone poorly, and that thereafter for the first time they were willing to negotiate in a range that Dell was willing to consider.

Whatever the reason for the odd settlement timing, the fact that the parties were able to settle a case while on appeal and after oral argument shows that in a securities lawsuit, the possibility for a deal is always somewhere on the table.

Very few securities suits go to trial – in general, the cases either are dismissed or they settle. And, as the Dell case shows, sometimes a case can be both dismissed and settled.

Readers who have insight they can share about why the Dell case settled when it did are cordially invited to pass that information along. If I learn anything interesting from readers, I will add it to this post. Anonymity for those who need it will be scrupulously protected.

UPDATE: Alison Frankel has a very interesting December 7, 2009 post on the Am Law Litigation Daily (here) about the Dell settlement, including additional procedural history and statements from the plaintiffs' counsel about the settlement.

In closing, I should add a note of appreciation for the Footnoted blog. Michelle Leder consistently reports nuggets she has unearthed by digging through companies’ SEC filings. As a result of her diligence, she regularly reports perceptive and interesting things that no one else has noticed. Her site demonstrates the incredible value and power of a really good blog. Footnoted, everyone here at The D&O Diary salutes you.

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With 124 failed banks so far in 2009, and more likely to come in the weeks and months ahead, one recurring question has been whether the FDIC will be as aggressive in pursuing claims against directors and officers of failed lenders as it was during the S&L crisis. While we are awaiting the arrival of the seemingly inevitable regulator lawsuits, it is worth reviewing what the FDIC’s receivership litigation rights look like.

A recent decision out of the Northern District of Georgia arising from the 2008 failure of Integrity Bank and citing the body of case law the FDIC developed during the last failed bank era examines the FDIC’s litigation rights and also strongly reinforces the impression that the FDIC has D&O claims on its agenda.

Background

Integrity Bancshares is the parent holding company of Integrity Bank of Alpharetta, Georgia. On August 29, 2008, Georgia banking regulators closed Integrity Bank and the FDIC was appointed as receiver. On October 13, 2008, the holding company filed for Chapter 7 bankruptcy.

In February 2009, the bankruptcy trustee filed a damages action against four individual directors and officers for breach of fiduciary duties and negligence. Though some of the individual defendants were directors and officers of both the holding company and of the bank, the trustee’s claims are based solely on the individual defendants’ capacities as officers of the holding company and the bank. The trustee also filed an action against the bank’s D&O insurer seeking a judicial declaration of coverage for the damages action.

The trustee’s damages action alleges that the individual defendants harmed the now-bankrupt holding company and imperiled the capital that the holding company raised for and provided to the bank, by negligently managing the bank’s operations. Among other things, the trustee alleges that the bank’s lending practices, for which the individual defendants were responsible, were deeply flawed and were characterized by loans to speculative developments made at substantial variance to the bank’s putative lending requirements.

The FDIC intervened in the trustee’s damages action to assert that the trustee lacks standing to bring the damages claims, because the essentially derivative claims the trustee has brought belong to the FDIC as receiver of Integrity Bank. The individual defendants and their D&O insurer also moved to dismiss the declaratory judgment action based on the absence of an actual case or controversy.

The Court’s Opinion

In a November 30, 2009 opinion (here), Judge Richard W. Story granted the FDIC’s motion to dismiss, holding that under the Financial Institution Reform, Recovery and Enforcement Act of 1989 (FIRREA) all derivative claims against the officers and directors of Integrity Bank belong to the FDIC.

Judge Story observed that to have standing, the trustee would have to allege that the defendants caused direct and unique harm to the bankrupt holding company. But, Judge Story found, all of the alleged misconduct took place at the bank level. The allegations relate "only to actions taken in the Defendants’ roles as Bank officers." The harm to the holding company alleged is in its capacity "as a shareholder to the Bank," and the alleged harm is "secondary and predicated upon injury to the Bank."

Judge Story found that

Once the FDIC-R became the receiver of the Bank, the Debtor [i.e, the bank’s parent holding company] no longer had the ability to bring derivative claims against the officers of the Bank, because the FDIC-R succeeded to those claims. The fact that the Debtor subsequently declared bankruptcy did not create in the Trustee any standing that the Debtor did not already possess. Therefore, the Trustee does not have standing to bring the derivative claims alleged in the Damages Complaint.

Judge Story also found that though the complaint stated that the Trustee alleged "direct and unique harm," these allegations represent mere conclusory allegations insufficient to satisfy threshold pleading requirements under Iqbal.

Finally, Judge Story granted the motion to dismiss the declaratory judgment action as moot, essentially ruling that the court cannot rule on coverage issues until the underlying claims have been addressed.

Discussion

I literally have not had occasion to write or type the acronym "FIRREA" for over 15 years. Reading Judge Story’s opinion really is like déjà vu all over again. All of the key cases Judge Story cites are over 15 years old. This all has an uncannily familiar feel.

But there’s no nostalgia here.

No one should miss the obvious implication from the FDIC’s intervention in the Integrity case that if anybody is going to sue the directors and officers, it is going to be the FDIC. The FDIC’s assertion of its successor rights to derivative claims is not a mere academic exercise. The FDIC’s intervention looks like a blocking tactic calculated to preserve its ability to pursue its own claims as receiver.

All of this makes me feel like Harry Potter revealing the awful truth to his fellow students at Hogwarts – Voldemort is back, after a 14 year absence. (We still bear the scars from our last encounter, which quite nearly killed us, too.)

So it may be time to retrieve all those old files out of storage, because it looks like its dead bank litigation time again. Indeed, with the return of the regulatory exclusion on many financial institutions D&O policies, this may well and truly be déjà vu all over again.

To end where I began, with 124 failed banks this year, I think it is only a matter of time before we see the FDIC pursuing many claims against the directors and officers of failed financial institutions. As the Integrity Bank case makes clear, the FDIC as receiver has rights under FIRREA to pursue derivative claims against the Ds and Os of the failed banks.

Strap on your helmets.

Very special thanks to Henry Turner of the Turner Law Offices for providing me with a copy of Judge Story’s opinion.

More About Iqbal: Judge Story's reference to Iqbal reminds me to advise readers that the Senate Judiciary Committee held a hearing today on Senator Specter's bill to set aside Iqbal. The Witness Testimony and Members' Statements can be found on the Committee's Hearings page, here. The Blog of the Legal Times has a short summary of the hearings, here. The short version is that the Democrat members ot the Committee think Iqbal is bad.

Those readers interested in the intellectual debate over the merits of Iqbal will want to refer to the Drug and Device Law blog, where the authors have agreed to engage in a point/counterpoint on the Iqbal decision with Univesity of Pennsylvania Law Professor Stephen Burbank. The first volley in the exchage can be found here.

Vanity Fair on Goldman: If you have not yet seen it, you will want to take a look at the article about Goldman Sachs by Bethany McLean in the January 2010 issue of Vanity Fair, entitled "The Bank Job" (here). The article reviews Goldman's perspective on the its role in the global financial crisis and its aftermath. It also does a good job capturing the widespread outrage regarding Goldman's compensation, as well as the conspiracy theories about Goldman's various connections to official Washington. Basic theme: storied but aggressive bunch of capitalists has managed to draw a huge target on its own back.

Bethany McLean is an old hand at reporting on arrogant corporations, having co-authored Enron: The Smartest Guys in the Room.

Speakers' Corner: On Thursday December 3, 2009, I will be presenting at Skadden's Annual Securities Litigation and Enforcement Seminar.

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Courts in the financial center of New York and the tech hotspot of California tend to be where much of the headline grabbing securities law action usually takes place. But this week, the most significant action is in  Washington, D.C., as the Supreme Court and Congress are weighing into several of the hottest topic under the U.S. securities laws.

First, on Monday, November 30, 2009, the Supreme Court granted the petition for writ of certiorari in the National Australia Bank case. As a result of taking the case, the Supreme Court is likely to confront generally the question of extraterritorial application of the U.S. federal securities law and will address specifically the question of when U.S. court can properly exercise jurisdiction over securities law claims of so-called "f-cubed" claimants (that is, foreign investors who bought their shares in foreign-domiciled companies on foreign exchanges.) Background on the NAB case can be found here.

Second, and also on Monday, November 30, the U.S. Supreme Court heard oral argument in the Merck Vioxx case, in which the Court will address the question of what is required in order to establish "inquiry notice" sufficient to trigger the two-year statute of limitations for private securities lawsuits under the ’34 Act. Background on the Merck case can be found here.

Third, on December 2, 2009, the Senate Judiciary Committee is scheduled to hold a hearing on Senator Arlen Specter’s proposed legislation entitled "The Notice Pleading Restoration Act of 2009," which is calculated to set aside the U.S. Supreme Court’s holdings in the Twobley and Iqbal cases. These cases define standards for threshold pleading issues in all federal civil cases, including securities cases. A discussion on the background on the significance of the Iqbal decision for securities cases can be found here.

A link for the Senate Judiciary Committee session, which is entitled "Has the Supreme Court Limited Americans’ Access to Justice?," can be found here. The Committee hearing will be webcast and a link of the webcast can be found on the Committee’s hearings webpage.

Each of these developments has potential to work sufficient alterations to important aspects of the securities laws or to their application.

The NAB case potentially could represent a very significant milestone on the issue of the overseas reach of domestic securities laws in a global economy. The Merck case, though focused on a technical statute of limitations issues, could have important practical consequences (particularly these days when for whatever reason plaintiffs’ lawyers increasingly seem to be filing cases belatedly). Finally, Senator Specter’s bill could produce significant changes on the threshold pleading standards for all civil cases, including securities cases.

A November 30, 2009 Law.com article (here) suggests that the Supreme Court showed substantial skepticism that there were sufficient "storm warnings" earlier on that would have put plaintiffs on "inquiry notice" sufficient to trigger the running of the statute of limitations. Ashby Jones also has an interesting post on the WSJ.com Law Blog (here) about the oral argument.

Soon Everyone Will Have a Blog: A column in yesterday’s Wall Street Journal reports (here) that Iranian President Mahmoud Ahmadinajad maintains a blog, called "Mahmoud Ahmadinajad’s Personal Memos." (No link supplied here, it just seems ill-advised to visit the site). Not only does Ahmadinajad have a blog, but his blogging experience is one to which many bloggers – including your humble correspondent -- can relate. The column reports that Ahmadinajad "allots himself 15 minutes a week to write his blog, but admits that at times, he exceeds this limit."

Yes, it really is hard finding time when you have important things to blog about, particularly when that pesky day job can interfere with important blogging activities. (For the record, I allot myself more than 15 minutes a week for blogging.)

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In a series of recent rulings in coverage litigation arising out of the 2007 collapse of Brookstreet Securities Corporation, a California-based securities broker-dealer, Central District of California Judge Cormac Carney addressed the claims of several claimants to the proceeds of a professional liability insurance policy that had insured the defunct company. Though the rulings are narrow and tied to the specific facts presented, the issues in dispute are likely to recur in claims arising from the subprime meltdown and accordingly the rulings may be of more general interest on that basis.

Background

Brookstreet provided broker dealer services nationwide until mid-2008 when the company experienced a financial collapse. The company ceased operations in June 2007 and is now insolvent.

Brookstreet was insured under a Securities Broker Dealer Professional Liability Insurance Policy for the period November 8, 2006 to November 8, 2007. The policy provides coverage for claims made against Insured Persons for actual or alleged Wrongful Acts in the rendering of "Professional Services." The policy had limits of $3 million.

The policy is an express "claims made and reported" policy, requiring in order for coverage to apply both that the claim be made within the policy period and that notice of claim be given within thirty days and during the policy period.

The insurer brought an action for interpleader and posted a $3 million bond. The insurer then filed three separate motions for summary judgment as to certain separate groups of interpleader defendants, all of whom are in turn claimants against Brookstreet or certain of its former directors, officers or employees.

Judge Carney’s Rulings

In a three separate rulings, Judge Carney addressed each of the insurer’s summary judgment motions.

Claims Made/Late Notice Issues: First, in a November 20, 2009 opinion (here), Judge Carney addressed the insurer’s motion for summary judgment as to the defendant claimants who had not made their claim against Brookstreet prior to the policy’s expiration or with respect to whose claims Brookstreet had not provided notice of claim to the insurer prior to the policy’s expiration.

Judge Carney quickly granted the insurer’s motion as to the claimants whose claims were made after the policy’s expiration, or with respect to whose claims Brookstreet had not provided notice of claim to the insurer during the policy period.

The more interesting questions about notice sufficiency arose with respect to the claimants who had made their claims during the policy period and with respect to whose claims Brookstreet had provded notice of claim during the policy period, but with respect to whose claims Brookstreet had not provided notice within the 30-day period required under the policy.

Judge Carney, enforcing the policy’s notice requirements strictly, found that the insurer was entitled to summary judgment even as to this latter group of claimants. Judge Carney found that the 30-day notice requirement was a "condition precedent" to coverage and that "to force" the insurer to have to demonstrate prejudice in order for the notice provision to be enforced "would be to rewrite the insurance contract, and the Court is unwilling to take this step."

Derivative Claim Exclusion: The insurer had also moved for summary judgment as to those claimants whose claims arose out of or were based on transactions involving Collateralized Mortgage Obligations (CMO). The insurer relied upon a policy exclusion precluding coverage for claims "based upon, arising out of or attributable to the sale, attempted sale, or servicing of … any type of …derivative." Relying on this exclusion, the insurer argued that the CMOs are derivatives, and therefore the policy precluded coverage for claims relating to the CMOs.

In a November 20, 2009 ruling (here), Judge Carney concluded, based on extensive material provided by the insurer, that CMOs are "derivatives" within the meaning of the policy. Accordingly, he granted summary judgment as to those claimants whose claims were based on CMOs.

Interrelated Acts: The insurer had also moved for summary judgment as to a claimant who asserted that a Brookstreet employee had mismanaged her investments, through a pattern of "churning, making unauthorized trades, buying and selling high risk stocks, and failed to advise [her] of investment losses" during the period 1996 though June 2006.

The insurer argued that her claim arose out of an Interrelated Wrongful Act that first occurred prior to the policy’s September 10, 2002 retroactive date. The insurer further argued that the pre- and post-September 10, 2002 conduct constituted a single, non-covered Interrelated Wrongful Act. The claimant asserted that each of the improper acts was a separate Wrongful Act, and that each time Brookstreet failed to supervise its employee, it also committed a new and discrete Wrongful Act.

In a November 18, 2009 ruling (here), Judge Carney held that while he "does not discount the possibility that [the employee’s] actions may have constituted an Interrelated Wrongful Act …there are genuine issues of material fact as to whether the acts after September 10, 2002 were interrelated with those occurring before that date." Because a "reasonable jury could conclude" that each time the employee "made an unauthorized trade, churned [the claimant’s account] or bought and sold high risk stocks" each was a separate Wrongful Act.

Discussion

Judge Carney’s rulings are interesting in and of themselves, but they are also interesting for what they suggest more generally.

First, his holding that the claims based on CMOs were precluded from coverage under the Brookstreet policy’s exclusion for derivatives claims is a reminder that the way insurance policies respond to many of the current claims based on complex financial instruments could involve a host of complicated insurance issues.

Although the exclusion that the CMO claims triggered in the Brookstreet case is peculiar to the specific type of insurance policy involved in that case, similar questions could arise under other policies in connection with other claims relating to complex investment securities and other financial instruments.

Many of the types of recurring claims asserted in the current litigation wave (e.g., the auction rate securities suits and the Madoff feeder fund lawsuits) present allegations of the type for which professional liability policies like that involved in the Brookstreet case were designed to respond. However, as the Brookstreet case shows, there potentially could be a host of complex coverage issues associated with many of these claims, depending on the facts alleged and the specific policy language involved.

Second, Judge Carey’s ruling on the interrelatedness issue is a reminder of how difficult interrelatedness questions can be. The term "interrelated" is neither defined in the typical policy nor is it self-defining. At a certain level of generalization, everything in the universe is interrelated, and at the same time, at another level, nothing is interrelated. What makes something interrelated for insurance coverage purposes can become quite situational and subjective, which leads many judges, like Judge Carney here, to want to leave interrelatedness questions to the jury.

Many of the cases in the subprime and credit crisis litigation wave present interrelatedness questions. Different complaints against the same or similar defendants in different policy periods raise the question whether one or several policies have been triggered. Judge Carney’s ruling in this case shows how difficult it may be for carriers seeking to rely on interrelatedness arguments. My own experience, consistent with Judge Carney’s ruling, is that courts tend to resolve interrelatedness questions in a way that maximizes the amount of insurance available.

Finally, Judge Carney’s rulings on the claims made and late notice issues are largely unremarkable, except as pertains to the question of the timeliness of notice for notices provided within the policy period but beyond the 30-day notice period. Judge Carney strictly enforced the policy’s 30-day notice requirement, and declined to even consider arguments based on the absence of prejudice.

Judge Carney’s literal enforcement of the notice requirement is is particularly noteworthy in that his ruling operated to preclude coverage for the claims of claimants where were in no way themselves involved with or responsible for the late provision of notice. ‘

In any event, Judge Carney’s rulings present an interesting case study. Special thanks to a loyal reader for providing me with copies of Judge Carney’s rulings.

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