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

In a series of posts, I have been exploring the "nuts and bolts" of D&O insurance. In this post, the seventh in the series, I examine the perennial questions of limits selection and program structure – that is, how much insurance is enough, and how should the insurance be structured? As explained below, these two questions are inextricably linked

Limits Selection

One of the most challenging questions for anyone that advises D&O insurance buyers is the question of what is the right amount of insurance The question inevitably involves a mixture of art and science, particularly because the analysis is affected by basic considerations of cost and risk tolerance. While there are certain objective benchmarks that can help to inform the process, the benchmarks must be considered in conjunction with relevant considerations that should also influence the analysis.

The question of D&O insurance limits selection is, of course, different depending on whether the buyer is a publicly traded company or is privately held. The difference in analysis between the two is not just in the total quantity of insurance purchased but also in how the limits selection question is analyzed. I discuss the question of limits selection for public and privately held companies separately below.

For publicly traded companies, there are some basic benchmark reference points and some additional considerations that every insurance buyer should asses.

Publicly traded companies will first want to approach questions surrounding limits selection from the perspective of basic limits adequacy, taking into account the company’s likely securities class action litigation settlement exposure. The securities suit settlement exposure is the appropriate starting place because for most companies in most circumstances, a securities suit represents the company’s largest management liability exposure. The company should be provided with information sufficient to allow it to assess the range and distribution of settlements for companies of its size and other characteristics.

A second benchmark publicly traded companies may want to consider are peer purchasing patterns – that is, how much D&O insurance do other companies like ours buy? Some buyers find this information reassuring, although care should always be taken to make sure that peculiar purchasing patterns, which sometimes can be industry-wide, do not inappropriately drive an important decision like limits adequacy.

In addition to these basic, relatively objective guidelines like settlement trends and peer purchasing patterns, there are additional considerations that should also be taken into account.

The first is that information about securities class action settlements, discussed above, does not take into account defense expense. Defense costs must be considered, because under most D&O insurance policies, defense costs erode the limits of liability. Every dollar of defense cost means one less dollar available for settlements or judgments. For a company to be sure that it has adequate limits of liability both to defend and to settle serious claims, appropriate consideration must be given to likely defense expenses as well as to settlement amounts. Along those lines, it is critical to note that both settlements and defense expenses have been escalating in recent years, much faster than the rate of economic inflation.

The other consideration that should be taken into account is that the most important value of D&O insurance is the protection it affords individual insureds in the event of a catastrophic claim. When things go seriously wrong, the D&O insurance may be the individuals’ last line of defense.

When these catastrophic type events occur, the company and the individual directors and officers may find themselves battling multiple legal proceedings simultaneously. In addition, the interests of the various defendants in the various proceedings may conflict dramatically, particularly when ousted former management is faulted for the company’s woes. Often when this occurs, each defendant will retain separate counsel. Under these circumstances, defense expenses can mount astonishingly quickly, causing the rapid depletion or even the complete exhaustion of the available insurance (for more about which, refer here).

The possibility of a catastrophic claim that could consume available limits underscores the importance of careful consideration of limits selection issues. Simply put, what other cases might have settled for in the past or how much insurance other companies buy may provide little guidance for the question of how much insurance a particular company might need in the future, particularly since the settlement and purchasing pattern data tend to be backward looking and incorporate historical patterns that may not be relevant to future requirements.

On the other hand, the difficulty of using a catastrophic claim scenario is that it may quickly lead to the rather unhelpful conclusion that no amount of insurance is enough to address the top end exposures. At some point, the analysis must shift from the quantity of insurance to the structure of the insurance, a question I address further below.

With respect to private companies, the issues are different, primarily because privately held companies do not typically face class action securities litigation risks. However, merely because private companies have no class action securities litigation exposure does not mean that private companies and their directors and officers do not face serious liability risks. I have in fact seen numerous private company D&O claims that have settled for millions of dollars. For that reason, an appropriate awareness of the possibilities should also inform private company D&O limits selection issues.

For private companies, the objective reference standards are peer purchasing patterns by company asset size. These peer data have the same benefits and limitations as they do for public companies, but many buyers find this data useful and reassuring in the insurance acquisition process.

The limits of liability for private company D&O insurance is, like public company D&O insurance, in most instances subject to erosion by defense expenses. so many of the same considerations concerning defense expenses should also be taken into account for questions of private company D&O limits selection.

One added consideration particular to private company D&O insurance is that the entity coverage available under a private company policy is quite a bit broader in the private company policy than is the entity coverage in a public company policy. (The public company policy is limited to securities claims; the private company policy is not so limited.)

The broader entity coverage available in the private company policy creates the possibility that the limits of liability could be eroded by the defense expenses and settlements of the entity, potentially leaving the individuals with less (or no) insurance remaining to defend themselves or settle claims. The broader entity coverage in the entity policy could influence some buyers to increase the D&O insurance limits of liability, as one way to protect against erosion or exhaustion of the limits by entity claims.

Program Structure

In light of the escalating average claims severity and of the catastrophic potential for defense expense to deplete policy limits, it may be necessary to reconsider commonplace concepts of limits adequacy. Increased limits alone, however, may not solve all of the problems.

Part of the solution has to be program structure. Clearly, one of the factors that can contribute to limits depletion or exhaustion is that so many different people are accessing the insurance, particularly when there are multiple simultaneous claims. One way that well-advised corporate officials can ensure they are not left without insurance to protect them as individuals is through supplemental D&O insurance structures dedicated solely to their own protection.

These supplemental structures might take any one of a number of different forms, including for example, excess Side A coverage for a specified group of individuals, or even through an individual D&O insurance policy (so-called IDL coverage). While there are a variety of ways this supplemental insurance might be structured, the possibility of catastrophic claims underscores the importance of addressing these issues as part of the insurance acquisition process.

The point of these supplemental insurance structures is to ensure that no matter what happens, the individuals (or some subset of them, for example, the non-officer directors) will have a pot of money with their name on it, as reassurance that the individuals will not be left with unresolved claims but no insurance remaining with which to defend themselves. For more about structuring D&O insurance to protect non-officer directors, refer here.

Moreover these alternative structures often have broader coverage than the "traditional" D&O insurance; for example, they often contain fewer exclusions. They also provide so-called "drop down" protection when they provide first dollar coverage, in the event, for example, that the underlying traditional D&O insurers have become insolvent or seek to rescind coverage. In addition, because these alternative insurance structures protect only specified individuals, the insurance cannot be siphoned off for the payment of entity claims or the claims of other individuals who are not insured under the structure.

The complexity of these limits selection and program structure issues underscore how indispensible it is that insurance buyers enlist knowledgeable and experienced advisors in their D&O insurance acquisition process. In particular, it is important that buyers ensure not only that their advisors have access to the data described above that is relevant to the limits selection process but also have the ability to explain the limitations of the data as we well as the additional considerations that should be taken into account. In addition the insurance advisor should be able to guide the company through the process of selecting the right insurance structure to ensure that the company and its directors and officers are adequately protected even in the event of a catastrophic claim.

Readers who would like to read the prior posts in this series about the nuts and bolts of D&O insurance should refer here:　

Executive Protection: Indemnification and D&O Insurance – The Basics　　

Executive Protection: D&O Insurance – The Insuring Agreement

Executive Protection: D&O Insurance—The Policyholder’s Obligations

D&O Insurance: Executive Protection – The Policy Application

Executive Protection: Private Company D&O Insurance 

Executive Protection: D&O Insurance Policy Exclusions

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The LexisNexis Top 25 Business Law Blogs of 2010, as selected by the members of the LexisNexis business law communities, have been announced, and I am pleased and honored to discover that The D&O Diary is among this year’s designees. The LexisNexis announcement, including the list of the 2010 Top 25 Business Law blogs, can be found here.

I am particularly happy to find my blog among the honorees because the list includes so many blogs that I follow and bloggers whose work I respect. I encourage everyone not only to take a look at the list, but also to visit the other sites, particularly those with which you might be unfamiliar.

Readers may note in the LexisNexis announcement that though the Top 25 blogs have been chosen, the voting is not yet finished. The voting for the Top Business Law Blog of 2010 will continue and the winner will be announced on November 5, 2010. I encourage all readers who are also members of a LexisNexis business law community to cast a vote for their favorite business law blog. I would be honored and humbled if anyone should choose to cast a vote for The D&O Diary.

Interested readers who are not familiar with the site may also want to take a look at the LexisNexis Corporate & Securities Law Community, which can be found here. The community site contains a wealth of resources, including links to blog posts and articles, case law and commentary, and podcasts.

My thanks to the members of the LexisNexis business law communities for voting for my site as a Top 25 Business Law Blog, and my congratulations to all of the honorees.

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Among the many cases filed as part of the subprime litigation wave are the numerous cases filed on behalf of holders of mortgage-backed securities against the firms that issued the securities. In many of these cases, the plaintiffs have not alleged that they have failed to receive payments due under the securities, but rather they have alleged that their investments have declined in value or are now riskier than when purchased.

As these cases accumulated in 2008 and 2009, observers questioned whether these investors’ claimed harms represented injuries cognizable under the federal securities laws, as I discussed in an earlier post.

In an October 14, 2010 decision (here), Southern District of New York Judge Miriam Goldman Cedarbaum held in a case filed on behalf of holders of certain asset-backed certificates issued by Goldman Sachs-related entities that, where the holders had not alleged that they had failed to receive payments due under the certificates, they had failed to allege injuries cognizable under the federal securities laws.

The investors had purchased the asset-backed certificates in 2007 offerings. The certificates entitled the holders to monthly distributions of interest, principal or both. The offering documents for the certificates warned investors that the offering underwriters "cannot assure you that a secondary market" for the securities will exist, and "consequently, you may not be able to sell your certificates readily or at prices that will enable you to realize your desired yield."

In its amended complaint, the plaintiff did not allege that it had failed to receive the monthly distributions. The harm the plaintiff claimed is that a hypothetical sale in the secondary market at the time of the suit "would have netted, at most, between 35 and 45 cents on the dollar." The plaintiff also claimed that it is exposed to "much more risk than the Offering Documents represented with respect to both the timing and absolute cash flow to be received."

In her October 14 ruling, Judge Cedarbaum noted that at a prior hearing she had previously denied the defendants’ motion to dismiss the plaintiffs’ claims based on Section 12 (a) (2) of the ’33 Act. However, she granted the defendants’ motion to dismiss plaintiffs’ Section 11 claims, holding that the plaintiffs alleged injuries were insufficient to state a claim.

In rejecting the sufficiency of plaintiff’s argument that that their certificates would have a diminished value in a hypothetical sale, Judge Cedarbaum noted that "the Certificates were issued with the express warning that they might be resalable." She concluded that because the plaintiff "made an investment that it knew might not be liquid, it may not allege injury based upon the hypothetical price of the Certificates on a secondary market at the time of the suit." She noted further that the complaint failed to allege that a secondary market for the certificates "actually exists" and also failed to allege "any facts regarding the actual market price" for the certificates at the time of the suit.

Judge Cedarbaum also rejected the sufficiency of the plaintiff’s allegations about the increased risk of diminished cash flow in the future, not that "Section 11 does not permit recovery for increased risk." She said that "to allege an injury cognizable under Section 11," the plaintiff must "allege the actual failure to receive payments due under the Certificates," adding that though the plaintiff has "had three opportunities to amend its complaint, it has never made the allegation."

Discussion

As far as I am aware, Judge Cederbaum’s ruling is the first in which mortgage-backed investors’ Section 11 claims have been dismissed for lack of cognizable injury based on a failure to allege that payments due under the securities had been terminated or interrupted. There were quite a few of these mortgage-backed securities lawsuits filed during 2008 and 2009, and Judge Cedarbaum’s decision potentially could be quite significant in these other cases, at least where the investors have not alleged that payments due under the instruments have failed.

One aspect of this decision is the presence in these instruments’ offering documents of precautionary language warning about the potential unavailability of a secondary market for the instruments. Investors in instruments with offering documents that lacked this precautionary language may still be able to try to argue establish a cognizable injury based on the diminished resale value of the securities. However, those other claimants would also have to be able to allege that there actually is a secondary market for their securities and will have to allege what the resale price would be in order to allege injury sufficiently.

In any event, Judge Cedarbaum’s ruling potentially could be sufficient in many of the other securities suits that mortgage-backed asset investors filed in 2008 and 2009.

Special thanks to Doug Henkin of the Milbank Tweed law firm for providing a copy of Judge Cedarbaum’s opinion. Doug is the co-author of a paper I cited in my earlier post raising the question of whether mortgage-backed asset investors would be able to satisfy the requirements under Section 11 to allege a cognizable injury. An updated version of the paper can be found here.

I have in any event added Judge Cedarbaum’s ruling to my running tally of subprime and credit crisis related dismissal motion rulings, which can be found here.

A Securities Litigator’s Guide to D&O Insurance: Readers of this blog may be interested to know about two articles written by Jack Cinquegrana and John R. Barankiak Jr. of the Choate Hall law firm. The articles, which can be found here, are entitled "A Securities Litigator’s Guide to D&O Insurance," provide a brief overview of D&O insurance basics and also discusses issues that frequently arise concerning payment of defense costs and settlements. The articles are relatively short but contain some interesting observations and comments.

Sorry: My blog hosting service experienced a variety of service outages and problems on Monday. Readers may have experienced delays in receiving email notifications and difficulty in accessing the most recently added content. I am assured the problems have been addressed. I apologize for the inconveniences yesterday.

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As has now become a familiar routine, this past Friday night the FDIC took control of several more commercial banks. The seven additional banks seized on Friday bring the year to date total number of failed banks to 139, and the total since January 1, 2008 to 304. At the same time, lawsuits involving failed and troubled banks are also accumulating, and on Friday, investors filed two more banking-related securities class action lawsuits. And as noted below, the jury trial in another banking related-securities class action lawsuit continues to go forward in federal court in Florida.

Recent Banking-Related Securities Suits

The first of the new lawsuits was filed on October 22, 2010 in the Northern District of Illinois against PrivateBancorp and certain of its directors and officers. As reflected in the plaintiffs’ lawyers’ October 22 press release (here), the Complaint alleges material misrepresentations in connection with the company’s June 4, 2008 and May 11, 2009 securities offerings. The complaint (which can be found here) alleges that the company’s share price fell over 37% in October 2009 after it announced that it held nearly $400 million in nonperforming loans.

The other recently filed banking-related suit was filed on October 22, 2010 in the Northern District of Iowa against Meta Financial Group and certain of its directors and offices. According to their October 22, 2010 press release (here), the Complaint (which can be found here) relates to the company’s October 12, 2010 announcement that the Office of Thrift Supervision was investigating the company in connection with its iAdvance credit origination program. The complaint alleges that the company’s shares declined over 40% on the news.

Statistical Review of Recent Banking-Related Litigation

Securities class action activity involving commercial banks represents a significant part of 2010 securities class action lawsuit filings. By my count, there have been at least ten securities class action lawsuits so far this year involving banking institutions, representing about seven percent of the approximately 143 securities suits filed year to date.

As noted in NERA’s August 2010 report on failed bank litigation, investor lawsuits involving failed and troubled banks have been a significant accompaniment of the current round of banking problems. According to the NERA report, private investor litigation "was not a notable feature of the S&L crisis litigation," but this time around "private litigation against D&Os has been widespread."

Among other statistics, the NERA report notes that of the 240 securities class action lawsuits filed against financial sector firms in 2008 and 2009, there were 45 against depositary firms. The report further notes that of the 20 largest failed banks prior to 2010, 13 involved publicly traded institutions, and eight were involved in securities class action litigation through the end of 2009.

Updated Overview of Bank Failures

Meanwhile the number of failed banks continues to mount. The 139 banks closed in 2010 through October 22 is nearly equal to the 140 banks closed in all of 2009. The seven banks closed this past Friday night includes two more failed banks in Georgia and Florida, respectively, as well as one more in Illinois. There three states – Georgia, Florida and Illinois – are the states with the highest numbers of failed banks, both this year and since January 1, 2008.

So far this year, Florida has the highest number of failed banks, with 27, followed by Georgia (16), Illinois (16) and California (10). These four states alone have combined for 69 bank failures this year, or just under 50% of all 2010 bank failures.

Though 39 states and Puerto Rico have each had at least on bank failure since January 1, 2010, the bank failures have predominately been concentrated in just a handful of states, again led by the same four states – with Georgia leading the way with 46 failed banks, followed by Florida (43), Illinois (38) and California (32). These four states together have had 159 bank failures, or about 52% of all failed banks since January 1, 2008. Other states with high numbers of failed banks during that period include Minnesota (14), Washington (13), Missouri (11) and Nevada (10).

The 2010 bank failures have largely been concentrated among smaller banks. 116 of the 139 bank failures, or about 83%, have involved institutions with less than $1 billion in assets. 32 (or about 29%) of the 2010 bank failures have involved banks with less than $100 million in assets. Of course, given that there are many more smaller banking institutions in the U.S. than there are larger banks, it may be unsurprising that there are so many bank closures involving smaller banks.

Discussion

While the bank closure statistics are striking, it is worth noting that the lawsuits described above, as well as much of the banking-related securities litigation, involves banks that remain in operation. In other words, the current level of banking-related securities litigation represents more than just the direct fallout from the high level of bank failures. Rather the litigation reflects the pressures and stresses more widely distributed throughout the entire U.S. banking industry in the wake of the credit crisis.

Even though we are well past the depths of the financial crisis (at least temporally), many banks remain under pressure, as reflected in the FDIC’s most recent quarterly banking profile (about which refer here). In many instances, this pressure has, among other things, led to litigation.

So while we continue to wait and see the extent to which the FDIC will, as a result of the current round of bank failures, become an active claimant against former directors and officers of failed bank, investors have pressed ahead with their own claims. Many of these investor claims have come in the form of securities class action lawsuits, the targets of which include a range of banking-related defendants, beyond just the failed institutions. The most recent filings suggest that we may continue to see more commercial banking-related securities litigation in the months ahead.

Meanwhile, BankAtlantic Securities Trial Continues: Among the banking-related securities cases filed in recent years is the securities class action lawsuit filed against BankAtlantic Bancorp and certain of its directors and officers, which recently became one of the very rare securities class action lawsuits to actually go to trial (about which refer here). The jury trial in the case is going forward in federal court in Miami, and as reflected in the October 22, 2010 post in the Southern Florida Business Journal Blog (here), the trial has among other things involved the plaintiffs’ introduction of inflammatory internal emails highly critical of the bank’s lending practices and processes.

According to informed sources, the plaintiffs are likely to conclude the presentation of their case some time during the upcoming week, and it will then be the defendants’ turn to present evidence and to introduce testimony.

Plaintiffs in the case are represented by Matthew Mustokoff and Andrew Zivitz of the Barroway Topaz firm and Mark Arisohn of Labaton Sucharow. The defendants are represented by Eugene Stearns of the Stearns Weaver Miller law firm.

Anatomy of a Failure: Those readers wondering how in the world we got into this current banking mess may want to take a look at the article entitled "Death of a Small Town Bank" in November 1, 2010 issue of Time Magazine (link currently unavailable) The article tells the story of Community Bank & Trust (CBT) of Cornelia, Georgia, which the FDIC closed on January 29, 2010.

Though CBT is just one of the 139 banks that have failed this year, its tale encompasses so many of the problems underlying the current crisis. All of the usual details are present, as a small town institution got caught up in the speculative fever caused by rapidly escalating real estate prices, compounded by administrative and procedural shortcomings (and possibly worse) that led to faulty and some improper loans. The sudden collapse of prices that accompanied the financial crisis left lenders unable to repay and the bank saddled with a portfolio of bad loans that ultimately caused the bank’s failure and left the town with a challenging future. The article makes for interesting, if sobering, reading.

For Those Looking for Something to Feel Good About: Those readers who have had just about enough of depressing stories about failed banks may want to take a look at the cover article from the October 24, 2010 issue of The New York Times Magazine entitled "The D.I.Y. Foreign-Aid Revolution." The article reports the stories of several individuals who have made it their personal responsibility to try to make the world a better place, and who actually have each found a way to actually do things that can make a difference. A really inspirational article about some really interesting and impressive people.

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The astonishing pace of legislative and judicial changes - just over the last few months alone - underscores how rapidly the liability exposures in the directors and officers arena can be transformed. In the latest issue of InSights (here), I take a look at the current hot topics in the world of directors’ and officers’ liability. There is much to discuss in the world of D&O, with further changes just over the horizon. The year ahead could be very interesting and eventful. The latest InSights article reviews what to watch now in the world of D&O.

The Latest Bulletin From Our San Francisco Bureau:  Our SF correspondent filed this report before last night's game (names removed to protect privacy, swear words modified to conform with the family-oriented approach of this blog):

So living with a wacko Giants fan is actually really fun right now. Yesterday {name removed} and her mom and godmother went kayaking outside the stadium and it sounds like SO MUCH FUN. I have added it to my to-do list of things while I live in the Bay.

Anyway, aside from kayaking (and drinking, and eating, and singing while kayaking) Giants fans wear these ugly fake beards to mimic the "rally beards" that the pitchers have (well, all the pitchers except Lincecum). And they have t-shirts that say "Fear the Beard." I have seem some television footage of very small children and very blonde women in beards. Very strange.

Also, just to prove that Tim Lincecum really could never play on any team except the Giants or the A's, everyone knows he smokes pot like it's his job, and the fans wear shirts that say "Let Timmy Smoke." I very much doubt that would be the public reaction ANNNYwhere else. Also he doesn't cover his mouth when he swears, so "F*ck Yeah" t-shirts are also very popular.

Unfortunately, I'm still not overly interested in the BASEBALL...just the funny things that San Franciscans do while they WATCH baseball.

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Among the most frequently recurring and arguably most vexatious D&O insurance coverage issues are the questions of the carrier’s obligation under the policy for defense expenses incurred either in connection with an informal SEC investigation or an internal investigation.

In an October 15, 2010 summary judgment ruling in insurance coverage litigation involving Office Depot, Southern District of Florida Judge Kenneth Marra, applying Florida law, denied coverage for both of these categories of defense expense. Though the decision is a direct reflection of the specific facts involved and the particular policy language at issue, the ruling provides an interesting insight into these recurring issues.

Background

In June 2007, Office Depot was the subject of news report suggesting the company had improperly disclosed material information to securities analysts in violation of Sec. Regulation FD. In a July 17, 2007 letter, the SEC advised Office Depot it was "conducting an inquiry" to determine whether the securities laws had been violated, and requested certain information from Office Depot "on a voluntary basis." Office Depot opted to voluntarily cooperate by providing documents and making its employees and officers available for sworn testimony. On July 31, 2007, the SEC requested that Office Depot preserve the records of numerous employees and offices, which it identified by job title.

Office Depot forwarded the letter to its insurers. Office Depot’s primary insurer accepted the letter as a "Notice of Circumstances" that may give rise to a claim.

In addition, in July 2007, before it received the SEC’s informal inquiry, Office Depot received an internal whistleblower letter raising concerns relating to the timing of recognition of Office Depot’s vendor rebate funds. Office Depot self-reported the whistleblower allegations to the SEC, which expanded its inquiry to include the whistleblower allegations. The company’s audit committee conducted its own investigation of the allegations, retaining lawyers, accountants and consultants for those purposes. The internal investigation resulted in Office Depot’s restatement of its 2006 financial statements.

In November 2007, two shareholder derivative lawsuits and two securities class action lawsuits were filed against the company. The shareholder suits alleged misrepresentations in connection with the company’s financial reporting of vendor rebates. In January 2010, the defendants’ motions to dismiss the securities class action lawsuit were granted. The dismissal is now on appeal. The plaintiffs in the derivative lawsuits voluntarily dismissed those cases.

In January 2008, the SEC issued a formal "order directing private investigation" and during the course of 2008 subpoened the company and at least eight current and former Office Depot officers and directors, including several who previously voluntarily testified. The notice did not name any individuals as wrongdoers. In November and December 2009, the SEC issued Wells notices to three Office Depot officers. In December 2009, the company reached an undisclosed settlement with the SEC staff.

Office Depot requested reimbursement from its D&O insurers of the over $23 million the company had incurred in responding to the SEC, indemnifying individuals against defense expenses, and conducting an internal investigation of the whistleblower allegations.

The primary carrier acknowledged its obligation to reimburse Office Depot for defense costs incurred by officers and directors after having been served with SEC subpoenas and Wells notices, and for the costs incurred in the four securities lawsuits. However, the approximately $1.1 million of acknowledged expenses did not exceed the policy’s $2.5 million retention. The primary insurer denied coverage for the other expenses, and Office Depot filed an action alleging breach of contract and seeking a judicial declaration of coverage. Office Depot’s excess D&O insurer intervened the action.

The parties filed cross motions for summary judgment.

The October 15 Ruling

The insurers argued that there is no coverage for Office Depot’s costs incurred in voluntarily responding to the SEC’s investigation and for the costs of Office Depot’s internal investigation of the whistleblower allegations because the costs did not arise either because of a "Securities Claim" against Office Depot or a "Claim" against an insured director or officer. All policy references below refer to the language of the primary policy.

The policy’s definition of Securities Claim contains threshold language that excludes from the term "an administrative or regulatory proceeding against, or investigation of, an Organization." However, the definition contains a "carve back" which specifies that the term Securities Claim "shall include an administrative or regulatory proceeding against an Organization, but only if and only during the time that such proceeding is also commenced and continuously maintained against an Insured Person."

Judge Marra found it significant that the threshold language excluded coverage for "an administrative or regulatory proceeding against, or investigation of" an Organization, but the carve back preserving coverage refers only to "an administrative or regulatory proceeding" – and thus the carve back does not refer to "an investigation" as does the threshold language. Judge Marra concluded that "the carve-back clause does not restore coverage for ‘an investigation of’ the Organization"

Judge Marra also found the policy’s definition of "Claim" distinguishes between "a proceeding for relief" and an "investigation of an insured person," specifying that an investigation constitutes a "Claim" only once the insured person has been notified in writing that he or she may be a target or after service of a subpoena.

In addition, Judge Marra rejected Office Depot’s argument that the term "proceeding" was broad enough to encompass the SEC’s informal and formal investigation of Office Depot. In reaching this conclusion, Judge Marra referenced the policy’s distinction between "proceedings against" and "investigations of" insured persons and organizations. Judge Marra said this distinction can only be given "any meaning" by giving the term "proceeding" its "plan meaning," which he defined as "a formal legal action or hearing conducted in a court of law or some official tribunal."

Judge Marra concluded therefore that the company’s costs of voluntarily responding to the SEC do not represent "loss of the Organization arising from a Securities Claim."

Judge Marra also concluded that the voluntary, pre-subpoena costs incurred on behalf of the individual directors and officers were not incurred in connection with a "Claim." In reaching this conclusion he specifically referenced the trigger required to bring an "investigation" within the definition of "Claim."

Office Depot had argued further that the policy’s "relation back" language brought all of the pre-claim costs within coverage when the claims finally did emerge. Office Depot made this argument in reference to the language in the policy’s notice provisions which provide that when a policyholder provides a notice of circumstances that could give rise to a claim, and a claim subsequently arises, the claim relates back to the time of the original notice.

Judge Marra ruled that the "relation back" language pertained solely to the question of when a "Claim" is first made for purposes of determining the appropriate claims made policy period. The relation back language, Judge Marra said, "simply serves to identify the policy period in which the ‘subsequent Claim’ was made; it does not operate to expand the Policy definition of ‘Claim’ to absorb any allegations of wrongdoing which happen to be related or similar to the wrongdoing described in the insured’s original Notice of Circumstances."

Judge Marra also rejected Office Depot’s related argument that the November 2007 securities lawsuit "relate back" to provide coverage for the company’s internal investigation. The company had argued that because the subsequent lawsuits were "subsequent claim," the Policy’s "relation back" language brought under the Policy’s coverage all defenses expenses incurred from the date of the Notice of Circumstances.

Judge Marra said that even if the securities suits were "subsequent claims" that relate back for notice purposes to the date of the original notice of circumstances, "it does not follow that any pre-suit investigation costs which may have related to and benefitted the defense of those suits…are transformed into a covered ‘loss’ which ‘arises from’ that securities litigation."

Finally, Judge Marra held that the Policy’s definition of covered Loss does not include the costs of investigating potential or anticipated claims, rejecting Office Depot’s argument that those costs are "arising from" the defense of a claim. He found that the "arising from" phrase "connotes a sequential relationship" between the Claim and the Loss that "arises from it" – that is, Loss that "follow sequentially in time." He said that covered loss "does not include related pre-suit or pre-claim investigation costs, regardless of how ‘related’ or ‘beneficial’ those costs may have ultimately proved to be in defending against the claim which ultimately materialized." He added that "while these costs may well have reasonably been incurred in contemplation of anticipated or potential litigation, that is not enough to meet the Policy’s requirement that the ‘resulted solely from’ the investigation or defense of a Claim."

UPDATE: In a subsequent October 27, 2010 order (here), Judge Marra rejected Office Depot's further assertion, based on the prior order, that the company was entitled to insurnace payment for all costs the company incurred in responding to the SEC after November 5, 2007, the date on which the first of the shareholder lawsuits was filed.

In his October 27 order, Judge Marra said that volunarary SEC response costs the company incrred after the shareholder suit was filed "may have followed the securities lawsuit sequentially in time, they did not 'grow out of' or 'flow from' the subject lawsuits, and therefore did not 'arise from'" those suits. Judge Marra added that even though the comany incurred SEC response costs after the shareholder suit was filed, that "does not transform the post-suit SEC response costs into covered 'Loss" ... even though some of those response costs may have been related to or had utility in Office Depot's defense of the securities lawsuit."

Discussion

Judge Marra’s analysis and conclusions are a direct reflection of the specific language at issue in the Office Depot case, and his analysis might or might not produce the same or similar outcome under different policy language. He seemed particularly persuaded that Office Depot’s primary D&O policy draws a clear distinction in how the policy responds to "investigations" on the one hand and "proceedings" in the other.

That said, Judge Marra’s analysis is quite detailed and represents a very thorough examination of what policyholders are entitled to under the policy before an investigation ripens into a formal administrative or regulatory proceeding. The opinion also represents a detailed examination of what insurers are responsible for before a claim has been made under the Policy.

Insurers will undoubtedly welcome this decision and will attempt to rely on it in other cases. As a district court opinion, the decision has limited precedential value, but the insurers will seek to rely on the decision for its persuasive value. The extent to which other courts will follow Judge Marra necessarily will depend on the policy language at issue in the other cases. Indeed, Judge Marra himself rejected Office Depot’s attempt to rely on prior decisions in which courts had held that an "investigation" is a "proceeding," stating that the policies involved in those other cases involve different language.

Notwithstanding Judge Marra’s decision, policyholders will continue seek coverage for defense costs incurred in informal investigations and for internal investigation, particularly where distinctions in policy language would seem to justify a different outcome. The sheer dollar costs involved alone (see, e.g., Office Depot’s $23 million in expenditures) ensure that policyholders will continue to agitate on these issues.

Given the perennial nature of these issues, the question arises of what are the practical lessons of Judge Marra’s opinion. The most important lesson seems to be that the policy’s wordings of "Securities Claim" and "Claim" are very important and the specific wording used with relation both to "investigations" and "proceedings" can be critically important. A particularly important issue for insurance buyers and their advisors to keep in mind is that a court may differentiate "regulatory and administrative proceedings" on the one hand and "investigations" on the other hand, and it is critically important to analyze coverage with respect to these two sets of considerations separately.

One final note relates to Judge Marra’s analysis of whether pre-claim defense expenses may be said to be "arising from" a subsequent claim. Judge Marra reduced this analysis to a question of temporal relation, in effect concluding that any particular item of defense expense can only "arise from" a claim if it comes later in time. I am not sure this analysis takes into account all of the possibilities, In particular, there are occasions when defense expenses are incurred earlier that would inevitably have been incurred later, the argument being the expenses "would have been incurred in any event" and the fact that they were incurred prior is an accident of timing. Arguably, Judge Marra’s analysis is not (or perhaps fairly ought not to be) preclusive of this argument. (Please refer to the Update above for further on this point).

It is probably worth noting that there have been recent innovations introduced into the D&O insurance marketplace designed to try to provide coverage for certain preclaim expenses incurred by or on behalf of individual directors and officers. The most recent formulations would not address the pre-claim expenses or internal investigative expenses of the insured entity itself, but it would at least provide direct or reimbursement coverage for costs incurred by or on behalf of individuals before a "Claim" has emerged.

These issues surrounding informal inquiries and internal investigations raise many points of contention, and policyholders and their insurers will continue to struggle with these issues. It seems probable that insurers facing these disputes will attempt to rely on Judge Marra’s opinion.

Special thanks to Steve Brodie of the Carlton Fields law firm for providing me with a copy of Judge Marr’s opinion. The Carlton Fields firm represented the primary insurer in the coverage litigation.

For discussion of a recent decision in which a court held that there was coverage under a D&O insurance policy for investigative expenses of a special litigation committee, refer here.

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In a series of posts, I have been exploring the "nuts and bolts" of D&O insurance. In this post, the sixth in the series, I examine the range of D&O insurance policy exclusions. Though some exclusions are found in most D&O insurance policies, others appear only occasionally , while yet other particular exclusions may only appear in specific policies or specific kinds of policies. For purposes of analysis, I have tried to group the various kinds of exclusions in separate categories below.

As a preliminary matter, it is important to note that while generalizations are possible about the kinds of exclusions that may appear in "most" or "many" policies, there are always exceptions. For example, one type of D&O policy, the so-called Excess Side A/DIC policy, often has fewer exclusions than the traditional D&O policies. In addition, more recently introduced D&O insurance policies may have different or narrower exclusions that are found in the typical policy. D&O insurance policies for financial institutions often have exclusions relating specifically to the type of financial activity in which the institution is engaged.

Any attempt to try to identify all of these exclusions and exceptions would be far beyond the scope of this post. For purposes of this introductory overview, I have limited my observations to what generally is the case, and in most cases, my observations relate to traditional D&O insurance policies.

Exclusions to Define the Policy’s Relation to Other Policies: In order to avoid overlapping policies or duplicate coverages, most D&O policies contain exclusions providing that coverage is precluded for matters that have been reported or the subject of notice under other policies. Consistent with the claims made nature of D&O policies, many policies also include exclusions precluding coverage for litigation that was pending prior to the policies inception.

Exclusions to Fit the Policy with Coverage Afforded by Other Types of Insurance: D&O insurance policies are built with the presumption that it is just a part of the policyholder’s overall program of insurance. With that in mind, most D&O policies contain exclusions to preclude coverage for claims that are typically covered by other types of insurance. Thus, most policies contain exclusions for loss arising from claims arising from bodily injury or property damage, as those hazards are typically insured under Commercial General Liability Insurance (CGL) policies. Similarly, most D&O policies exclude coverage for claims under ERISA and similar laws, as those claims typically would be covered under Fiduciary Liability Insurance policies.

Catastrophic Hazards: Many policies include separate exclusions for loss arising from catastrophic hazards, such as nuclear events, environmental damage and war. Some of these exclusions, particularly the environmental damage exclusion, will often have coverage coverage carve backs for shareholder claims or for loss for which the company is unable to indemnify individual directors and officers. In addition, in the wake of the events of September 11, 2001, and in compliance with the Terrorism Risk Insurance Act (TRIA), many policies will also contain specific provisions relating to acts of terrorism.

Refer here for an example of a coverage dispute arising in connection with the question whether or not a D&O policy’s pollution exclusion precluded coverage for a shareholder claim alleging pollution related misrepresentations and omissions.

Conduct Exclusions: Most D&O policies contain one or more exclusions precluding coverage for certain types of conduct. The conduct exclusions typically preclude coverage for two categories of conduct: first, for loss relating to fraudulent or criminal misconduct; and second, for loss relating to illegal profits or remuneration to which the insured was not legally entitled.

These exclusions can often have subtle wording differences that can significantly affect the availability of coverage. The most important wording variant is with respect what is required in order for the exclusion to be triggered. In recent times, these provisions usually require a prior "adjudication" that the precluded conduct has actually occurred in order for the exclusion to be triggered. Different variations of the adjudication requirement may require the adjudication to take place in the underlying claim, while other exclusions may allow the determination to be made in a separate proceeding (such as a declaratory judgment proceeding).

Another important aspect of these exclusions are the accompanying provisions defining when one insured person’s conduct may be attributed to another person or to the insured entity. In more recent times, many policies restrict the imputation of conduct among insurerds – policies with these provisions are said to have "full severability of conduct."

An example of a recent case illustrating the importance of the precise wording of the adjudication trigger in the fraud exclusion can be found here.

Insured vs. Insured Exclusion: Most D&O policies have exclusions precluding claims brought by one insured against another insured, in order to preclude coverage for collusive claims and for infighting among senior corporate officials. The Insured vs. Insured exclusion typically includes numerous exceptions (or "carve backs" as they are usually called). The exceptions preserve coverage for derivative claims, cross claims, certain employment practices claims, and claims brought by bankruptcy trustees.

The Insured vs. Insured exclusion (often referred to as the I v. I exclusion) has evolved over time, and so there are many variants both to the exclusion and to the carve backs. As others have noted (refer here), the Insured vs. Insured exclusion continues to be heavily litigated and is often at the heart of many coverage disputes. Insured vs. Insured disputes can often arise in the context of corporate bankruptcy, as noted here. More recently, whistleblower provisions in the Sarbanes Oxley Act and the Dodd-Frank Act have also potentially raise Insured vs. Insured concerns, if the whistleblower is also an insured person. Many insurers will agree to Insured vs. Insured exclusion carve backs designed to preserve coverage for whistleblower claims.

Particular Circumstances: In the course of insurance acquisition process, it sometimes happens that the insurance underwriter will identify a specific circumstance or event that represents a risk the underwriter is unwilling to accept. In that event, the underwriter will sometimes insist on an exclusion precluding coverage for the event or circumstance. While these kinds of specific event (or "laser" exclusions as they are sometimes called) are not uncommon, the typical insurance buyer that has an alternative will try to acquire a policy without the event exclusion.

Private Company D&O Insurance Policy Exclusions: As discussed in the preceding post in this series, the entity coverage available in a private company D&O insurance policy is quite a bit broader than the entity coverage in a public company D&O policy. In a public company policy, the entity coverage extends only to securities claims. The entity coverage available under a private company policy is not so restrictive, and in fact is quite comprehensive.

In order to protect themselves from the breadth of claims that otherwise might come within the entity coverage, many private company D&O insurers will include a number of exclusions applicable solely to the entity coverage. Some examples of entity coverage exclusions of this type include the contract exclusion (about which refer here), an exclusion precluding coverage for intellectual property claims, and an exclusion for antitrust and other competition related claims.

The antitrust or competition exclusion is not found in all private company D&O policies, and many insurers will remove or at least modify the exclusion upon request. There are a very limited number of insurers who insist on retaining this exclusion or at most allowing only defense cost coverage. In the current competitive insurance environment there are usually private company D&O insurance alternatives available that do not include the antitrust exclusion.

Since private company D&O insurers do not want to include the risks associated with public securities trading, most private company policies contain exclusions relating to public securities offerings and trading. It is important for these exclusions to be worded appropriately so that they do not preclude coverage for activities that might take place in advance of a planned public offering. If the planned offering does not go forward, the private company policy will have to respond to any claims, so it is important that the wording of the exclusion contemplates that possibility.

Miscellaneous and Anachronistic Exclusions: As the exclusion involved in the Stanford Financial coverage dispute demonstrates, there a many other kinds of exclusions out there in the insurance marketplace, some of them quite unusual. Among other exclusions that sometimes appears is the so-called "bump up" exclusion, precluding coverage for additional amounts paid to investors claiming inadequate consideration in a corporate buy out situation (about which refer here).

There are a host of other exclusions that have been around for a long time but that you just don’t see that much any more. An example of this kind of exclusion is the "failure to maintain insurance" exclusion (or FTMI exclusion, as it sometimes is called), precluding coverage for claims against corporate officials based on their negligent failure to obtain or maintain insurance.

Another example of this type of exclusion is the old "Commissions" exclusion The commissions exclusion, as typically worded, precludes coverage for loss incurred in connection with any claim "alleging, arising out of, based upon or attributable to payments, commissions, gratuities, benefits or any other factors to or for the benefit of" an agent or employee of any foreign government.

This exclusion was instituted after the Foreign Corrupt Practices Act was enacted in the late 70s. The exclusoin has largely fallen into disuse since that time, although you still see it on some policies from time to time. As discussed at greater length here, in an era of heighted FCPA enforcement activity, the Commissions exclusion is highly undesirable from the policyholder’s perspective.

As I noted at the outset, D&O insurance policies for companies in the financial sector sometimes contain exclusions particularly relevant to claims and exposures associated with the companies’ specific activities. An example of this kind of exclusion is the so-called regulatory exclusion sometimes found on policies issued to commercial banks. This exclusion became relative rare in the mid-90s and until recently, but as the number of failed banks began to rise a couple of years ago, the exclusion began to reappear in at least some commercial banks’ D&O insurance policies. Refer here for a brief overview of the regulatory exclusion.

A Final Note about Policy Wording: One final note is that language accompanying the exclusions can often be critically important. As discussed here, some exclusions are preceded by all-encompassing omnibus language, precluding all loss "based upon, arising out of, or any way relating to" the excluded conduct or matter. In other instances, the exclusion is preceded only by the more limited "for" preamble. The broader preamble can substantially expand an exclusion’s preclusive effect, and accordingly it is critically important to consider not only what exclusions a policy contains, but also how the exclusions are worded and what terms and conditions accompany the exclusions.

Towers Watson Survey 2010: The 2010 version of the Towers Watson survey is underway, but the window is closing soon. This survey, which so many of us in the industry depend upon, queries companies about liabitliy issues and D&O insurance questions. Because we all depend on the survey results, and because the more survey responses the more complete the survey results will be, we all have an interest in as many respondents as possible completing the survey.

The survey, the questionnaire which can be accessed here, will close Friday October 22, 2010, so please have your clients and companies complete the survey form.

Prior Installments in the D&O Nuts and Bolts Series: Readers who would like to read the prior posts in this series about the nuts and bolts of D&O insurance should refer here:　

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In a public report that makes for some interesting reading, UBS on October 14, 2010 released a statement disclosing that though its own investigation had concluded that "what happened should not have been allowed to happen," the company will take no legal action against its former directors and offices for losses the company suffered during the U.S subprime meltdown that forced a government bailout of the company. The company’s write-down of mortgage related assets exceeded $50 billion.

The company’s October 14 statement can be found here and the report itself, which was undertaken pursuant to the May 2010 recommendation of the Swiss Federal Assembly, can be found here.

The report includes a number of critical findings, including an assessment that the company’s "growth strategy" was "not planned in a sufficiently systematic manner," which contributed to the bank’s losses. The management incentives at the time encouraged company officials to seek revenue "without taking appropriate consideration of the risks."

The report also concludes that there company lacked a "uniform approach" to risk and that risk control was "based too heavily on statistical models." As a result, and "despite warning," the company "falsely believed" that is U.S. real estate investments were both valuable and sufficiently hedged, though there was "no comprehensive or continuous assessment" of the overall risk profile of the cross-border wealth management business.

The report also concluded that there were "failures with regard to the training and instruction" of some employees, and that the company "did not implement an effective system of supervisory and compliance controls necessary to convey a clear and consistent expectation that full compliance with applicable internal controls and U.S. legal requirements."

Despite these shortcomings, the company’s Board concluded, as part of the reporting process, that it is not in the company’s interests to pursue legal claims against the former directors and officers.

In its October 14 statement, the company explains that among the reasons the Board decided not to pursue claims is that "the chances of any such proceedings being successful" is "more than uncertain." The Board also took into account that these kinds of actions "last many years, generate high costs, lead to negative informational publicity and thus hamper UBS’s efforts to restore its good name.’

The statement also notes that pursuing claims against "could weaken UBS’s legal position in pending cases, regardless of whether the former management is ever found to be liable." The report itself goes on to note that UBS is the subject of class action proceedings in the U.S. and that "by litigating against its former directors and officers inSwitzerland, UBS would negatively impact its position in these class action proceedings in the US, in particular because, under US rules, the US plaintiffs could claim that thisis an admission that they had in fact acted improperly."

The report emphasizes that there had been no findings of criminal misconduct. The report states finally that "the Board of Directors is opposed to any attempt by third parties to file actions against former directors and officers or to pursue actions at the company’s expense. In the event that individual shareholders were to propose a vote at the general meeting for a resolution in favor of filing a claim at the company’s expense, the Board would consider it its duty to recommend that such a proposal be rejected."

Finally, the report is accompanied by an external report prepared by University of Zurich Law Professor Peter Forstmoser, who concluded that though there is "a sufficient basis to initiate legal proceedings against former individual directors or officers," the Board’s decision not to pursue legal claims is not only "appropriate," but it is also "necessary," taking into account the overall interests of the company and its shareholders.

The Dow Jones Newswire October 14, 2010 article about the UBS report notes that two UBS executives have returned pay from the 2007 to 2009 time frame totaling $73.7 million. The article also quotes a representative of one shareholder group as "disappointed" that the UBS Board decided not to pursue a civil lawsuit against the former directors.

Discussion

I can imagine a school of thought amongst a certain type of investor who might be outraged that the company is doing nothing to pursue claims against the individual former directors and officers who were responsible for the operational shortcomings identified in the report as having caused the bank’s enormous losses. I can also imagine this same type of investor complaining that this is the type of cozy, protect-your-old-buddies mentality that allow problems to arise the first place.

But at the same time, there is something quite instructive and perhaps even refreshing in the report’s consideration whether the postulated claim would actually help or hurt the company. There is something to the idea that this type of litigation, which can drag on for years and can be enormously expensive, does more harm than good. Indeed, if all prospective corporate and securities litigation were forced to endure this same type of scrutiny, and had to withstand the question whether the lawsuit would help or hurt the company and its investors on whose behalf it supposedly is filed, there would almost certainly be significantly less corporate and securities litigation.

The report’s justification for taking no action against the former company officials is of course pertinent to the company and to investors who remain invested in the company and interested in the company’s future. Investors who lost money as a result of the events analyzed in the report and who are no longer invested in the company may continue to feel aggrieved, but they can hardly complain that the company has refused to pursue any claims since those investors would not have benefited either.

Where investors may be most concerned is the Board’s statement that the Board will oppose any shareholder proposals seeking claims against the former officials. That is really the point where this report and the Board’s conclusions do seem defensive. On the other hand, if the Board really believes it is not in the company’s interest for those kinds of claims to be pursued, then the Board’s statement on this issue is simply consistent with the overall conclusion about where the company’s interests lie.

The Hits Just Keep on Coming: One of the most distinct trends to emerge in connection with recent securities lawsuit filings was the sudden surge during 3Q10 in securities class action lawsuits filed against for-profit education companies. On Friday, October 15, 2010, plaintiffs; lawyers announced the filing of yet another securities suit involving a for-profit education company, in this case Strayer Education.

According to the press release, the Complaint, which was filed in the Middle District of Florida against the company and certain of its directors and officers, alleges that the defendants:

failed to disclose that: (i) the Company had engaged in improper and deceptive recruiting and financial aid lending practices and, due to the government’s scrutiny into the for-profit education sector, the Company would be unable to continue these practices in the future; (ii) the Company failed to maintain proper internal controls; (iii) many of the Company’s programs were in jeopardy of losing their eligibility for federal financial aid; and (iv) as a result of the foregoing, defendants’ statements regarding the Company’s financial performance and expected earnings were false and misleading and lacked a reasonable basis when made.

The allegations in the Strayer lawsuit are similar to the allegations in the actions previously filed against other for-profit educational institutions in recent months. As detailed further here, these cases all relate back to a congressionally-initiated investigation involving federally backed student loans.

By my count, a total of seven different for-profit education companies have been sued in securities class action lawsuits since mid-August. These seven securities suits represent about five percent of the roughly 136 securities class action lawsuits that have been filed so far in 2010.

Yet Another Mortgage Mess: The headlines on the business pages have been dominated recently with tales of the mortgage documentation mess that is choking the mortgage foreclosure process. But according to Felix Salmon’s October 13, 2010 post on his Shedding No Tiers blog, there is yet another mortgage-related mess, relating to disclosures surrounding the mortgage-backed securities that the investment banks sold to investors at the peak of the housing bubble.

According to Salmon, it "turns out that there’s a pretty strong case" that the investment banks "lied to investors in many if not most of these deals."

Salmon comments relate to a process the investment banks followed as they assembled the pools of mortgages for securitization. As the banks acquired mortgages, they relied on outside service providers to test the mortgages in effect reunderwriting the mortgages according to the standards the origination entities were supposed to have used in creating the mortgages.

In reviewing documents submitted to the Financial Crisis Inquiry Commission, what Salmon determined is that in reunderwriting the mortgages, the outside service providers sometimes rejected the mortgages at an astonishingly high rate – in the specific example Salmon cites, the reviewer rejected 45% of the mortgages reviewed.

It is what happened next that really troubled Salmon. According to Salmon, rather than telling the originator that the pool wasn’t good enough, the investment banks would instead renegotiate the amount of money they were paying for the pool. And, Salmon adds dramatically, "this is where things get positively evil."

Salmon contends that because the investment banks knew they would be selling the mortgages rather than keeping them, they "had an incentive to buy loans they knew were bad," because the banks could go back to the originator and get a discount. The advantage afforded the investment banks is that "the less money they paid for the pool, the more profit they could make when they turned it into mortgage bonds and sold it off to investors."

The "scandal," according to Salmon, is that "the investors were never informed of the results" of the outside service providers’ tests. The banks didn’t pass the discounts along to the investors, who were "kept in the dark" about the tests, about the poor results, and about the discounts. The banks, according to Salmon, were "essentially trading on inside information about the loan pool: buying it low (negotiating a discount from the originator) and then selling it high to people who didn’t have that crucial information."

Salmon followed up his initial provocative post with some an interesting follow-up post as well.

More Failed Banks: This past Friday night, the FDIC took control of three more banks, bringing the 2010 year-to-date number of failed banks to 132. The latest three were not in any of the real estate disaster areas like Georgia, Florida, Illinois or California, but rather involved banks in America’s heartland. Two of the three were in Missouri and the third was in Kansas.

Since January 1, 2008, there have been a total of 297 failed banks. During that period, there have been six bank failures in Kansas and ten in Missouri. The states that lead with the highest number of failed banks during that period are Georgia (44), Florida (41), Illinois (37) and California (32).

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The First Circuit has overturned a lower court’s decision holding that Genzyme’s D&O insurance policy did not provide coverage for additional amounts paid to claimants who asserted they had not received enough in a share exchange. Though the First Circuit reversed and remanded the case, the First Circuit did not invalidate the so-called bump up exclusion and indeed agreed that the exclusion precluded entity coverage for bump up amounts.

The First Circuit’s October 13, 2010 opinion can be found here.

Background

From 1993 to 2003, Genzyme’s capital structure included "tracking stock" to track the performance of three separate business units within the company. In May 2003, Genzyme’s board decided to eliminate the tracking stocks, and the company announced that it would exchange the business units’ tracking stock for a certain number of the company’s General Division’s shares.　

The ensuing exchange was unpopular among many Biosurgery Division shareholders, who subsequently initiated a securities class action lawsuit against Genzyme and certain of its directors and officers. The Biosurgery Division shareholders alleged that the defendants had schemed to depress the Division’s tracking stock so that Genzyme could fold the Biosurgery Division into the General Division at an exchange rate favorable to General Division shareholders. In August 2007, Genzyme agreed to settle the Biosurgery Division shareholders’ claim for $64 million. More detailed background regarding the lawsuit can be found here.

Genzyme sought to recover part of this settlement amount from its D&O insurer. The insurer denied coverage on two grounds: (1) that the settlement did not represent insurable "loss" under the policy; and (2) that coverage was precluded by the policy’s "bump up" exclusion. Genzyme initiated coverage litigation. The D&O insurer moved to dismiss.

As detailed here, in a colorfully written September 2009 opinion, District of Massachusetts Judge Nancy Gertner granted the insurer’s motion to dismiss. Judge Gertner based her decision on two separate grounds.

She concluded first that the settlement amount did not represent insurable loss as a matter of Massachusetts public policy because the settlement benefitted one group of shareholders at the expense of another. She also concluded that coverage for the settlement amount was precluded by the policy’s "bump up" exclusion, which provides that the carrier is not liable for "the actual or proposed payment by any Insured Organization of allegedly inadequate consideration in connection with its purchase of securities issued by any Insured Organization."

In her opinion, Judge Gertner expressly considered and rejected Genzyme’s argument that the "bump up" exclusion was limited by its own terms to the policy’s entity coverage and therefore did not apply to claims against individual directors and officers.

The First Circuit’s opinion

In an October 13, 2010 opinion written by Judge Timothy Dyk, a three judge panel of the First Circuit reversed in part Judge Gertner’s ruling, and remanded the case to the District Court for further proceedings.

As an initial matter, the First Circuit rejected Judge Gertner’s conclusion that coverage for the settlement would violate Massachusetts public policy, noting both that "the public policy rationale articulated by the district court finds no support in Massachusetts statutory or case law." Massachusetts recognizes "only a limited public policy exception" and applicable principles weigh against "creating amorphous public policy limitations on insurance policies."

The First Circuit concluded that not only does it "see no basis in Massachusetts legislation or precedent for concluding that the settlement payment is uninsurable as a matter of public policy," but also that "there are significant reasons why such an exception should not be created as a matter of public policy," noting that such an exception "have the effect of making it impossible to secure coverage for damages awards in routine securities litigation that charges the corporation with unfair or unlawful treatment of a class of securities holders."

The First Circuit then went on to agree with Judge Gertner’s conclusion that the bump up exclusion precluded coverage for the settlement. However, the Court noted that the exclusion by its own terms expressly limited its preclusive effect only to policy’s entity coverage clause. The court held that there was no basis in the policy language or under Massachusetts public policy for applying the bump-up exclusion to the policy’s other insuring clauses.

The First Circuit also referenced the policy’s allocation provisions, which the court found expressly recognized that there might be occasions on which the bump up exclusion operated to bar coverage under the policy’s entity insuring provision but in which the other insuring provisions would still provide coverage.

The court concluded that "we must remand the district court to consider the allocation question," adding that "if part of the Genzyme payment represented indemnification provided to officers and directors," then the payment would fall under the policy’s corporate reimbursement coverage provisions (as opposed to the entity insuring provisions) "and allocation of the total settlement is required under the policy."

With a final wink and a nod, the First Circuit acknowledged that because "the problems involved in allocation may be difficult," this might be a case "where settlement, rather than lengthy and costly litigation, might be worth consideration by the parties."

Discussion

On the one hand, we might assume that because the First Circuit reversed and remanded this case that insurers would score this as a loss. No doubt, the ruling arguably represents something of a setback for the specific carrier involved in this case. But the news for insurance carriers generally is not all bad here, and looked at from a certain angle, the overall news for the insurers may be relatively good, or at least acceptable.

First of all, the First Circuit affirmed that the bump up exclusion applied to the Genzyme settlement. Sure, the court also concluded that the exclusion only applied to preclude coverage under the Policy’s entity insuring provision, but that limitation is expressly stated in the exclusion itself. It was pretty slick for the insurer to have convinced Judge Gernter that the exclusion applied to other insuring provisions notwithstanding the express limitations in the exclusion, but insurers in general can hardly grumble that exclusions are to be applied according to their express terms.

And though the First Circuit may have taken away Judge Gertner’s public policy determination, I think the circuit court’s conclusion here may not be all bad from the insurer’s perspective.

In thinking about this public policy issue, it is worth drawing a contrast between the colorful prose of Judge Gertner’s district court opinion, which was full of humorous analogies and heavily freighted language, and the straightforward, workmanlike approach of the First Circuit’s opinion.

I noted at the time that not everyone was going to be equally impressed with Judge Gernter’s elaborate hypotheticals and her willingness to dispense with conventional case law formulas. I also noted the problems that that her judicial approach might prsent in the event other less intellectually agile judges were to try reasoning by analogy or from first principles rather than established case law formulas.

Back in the day when I was regularly representing D&O carriers in coverage disputes, I know which way I would have come down on the question whether I would have prefered a judicial decision maker that writes flamboyantly and dispenses with case law formulas, or a judicial decision maker that is unwilling to infer case decisive principles. Over the long haul, this latter approach to the decision making process is likelier to be preferable – in fact, preferable for all litigants, not just insurers.

All of that said, the parties must now go back to this district court to try to sort out the allocation issues, which the First Circuit correctly stated are likely to be difficult. The insurer probably did not appreciate the First Circuit’s friendly suggestion that perhaps settlement is the best approach. As someone who once represented carriers, I know that when a court suggests settlement, what they are really saying is – insurance company, get out your checkbook. I never considered that particularly helpful, actually.

But as I said, though Genzyme’s D&O insurer may not be happy with the way the First Circuit’s opinion impacts this specific case, I don’t think this is necessarily a bad decision overall for the insurers. As was said to me back when I was representing carriers, some days the bear eats you, some days you eat the bear.

I fully recognize that some readers may take strong exception to my interpretation of this decision, and those readers are strongly encourage to post their views to this blog using the site's comment feature. (I really do wish people would post their thoughts and reactions more often.)

Special thanks to the several loyal readers who send me copies of the First Circuit’s opinion, including Peter Welsh of the Ropes & Grey law firm. The Ropes & Grey law firm represented Genzyme before the First Circuit.

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Stanford Financial’s D&O insurers do not have to continue to advance the criminal defense attorneys’ fees of R. Allen Stanford and two other former Stanford related individuals, according to an October 13, 2010 ruling by Southern District of Texas Nancy Atlas.

The ruling, which can be found here, follows a four day evidentiary hearing in August 2010, the purpose of which was to determine whether or not to continue a preliminary injunction compelling the insurers to advance the defense fees. In her October 13 opinion, Judge Atlas granted the insurers’ motion to vacate the preliminary injunction.

The insurers had denied coverage in reliance on the D&O policy’s money laundering exclusion. The exclusion applies if insured persons took any of a number of specified actions with respect to "criminal property," which is a benefit the Plaintiff knew of suspected , or reasonably know or should have suspected was obtained through "criminal conduct."

The money laundering exclusion does not apply "until such time as it is determined that the alleged act or acts did in fact occur."

In a January 26, 2010 opinion, Southern District of Texas Judge David Hittner entered a preliminary injunction prohibiting the insurers from "withholding payment" of defense expenses, as discussed here. Judge Hitner required the insurers to continue paying the fees "until a trial on the merits in this case or such other time as this Court orders."

In a March 15, 2010 opinion (about which refer here), the Fifth Circuit reversed and remanded the case to the district court, concluding that the money laundering exclusion’s "in fact" wording required a judicial determination to establish whether or not the exclusion had been triggered, but also concluding that this determination can be made in a separate proceeding such as a coverage action.

As discussed at here, the purpose of the August 2010 evidentiary hearing was to determine whether or not the insurers had shown a substantial likelihood that one or more of the three individuals has engaged in money laundering as defined in the applicable insurance policies.

In her October 13, 2010 opinion, Judge Atlas concluded that the insurers met their burden of showing a substantial likelihood that "the preponderance of the evidence would demonstrate that the Money Laundering Exclusion applies to each Plaintiff and that coverage of defense costs in the Criminal or SEC Action or related litigation, for Plaintiffs is not required under the Policy," and accordingly she granted the insurers’ motion to vacate the preliminary injunction.

The October 13 opinion reflects a detailed review of the evidence presented at the preliminary injunction hearing; however, Judge Atlas also stressed that her "findings and conclusions are neither final findings of fact nor conclusions of law for use in the criminal or SEC cases pending against each Plaintiff."

Judge Atlas considered the facts as applicable to Allen Stanford separately from the other two individuals, Gilbert Lopez and Mark Kurht, who were, respectively, Stanford Financial’s chief accounting officer and global controller.

In concluding that the underwriters had carried their burden of showing by a preponderance of the evidence a substantial likelihood that Lopez and Kuhrt had violated the money laundering exclusion, she concluded that the two knew or reasonably should have known that the investment information they were provided, and that were included in annual reports and marketing materials, "were fictitious, or at the very least, were not accurate reflections" of Stanford Financial’s investment performance. The two individuals were also aware of but did not report personal loans to Allen Stanford of at least $1.7 billion.

In reaching a similar conclusion with respect to Allen Stanford, she concluded that he was aware that Stanford Financial’s affiliates were marketing certificates of deposit based on "important misrepresentations" about Stanford Financial’s assets, investment allocations and the performance of those investments. Stanford was also aware that the financial statements did not reflect the massive personal loans that had been made to him.

After having reached these conclusions, Judge Atlas reiterating that her ruling was "narrow," adding that

The Court does not reach the issue of whether the evidence supports a finding that Stanford personally engaged in criminal conduct. The ruling is limited to analysis of conduct found by a preponderance of the evidence on a necessarily restricted record.

Judge Atlas declined to enter a stay of her ruling pending appeal.

Discussion

Judge Atlas’s ruling is indeed narrow, since it was in the context only of the preliminary injunction. Because of this procedural context, her determinations represent only a conclusion that evidence presented established "a substantial likelihood" that the exclusion has been triggered, and therefore the continuation of a preliminary injunction until an ultimate determination on the merits is not appropriate.

There are other significant attributes of her ruling that would limit any potential general applicability. First and foremost is the money laundering exclusion itself which is an uncommon exclusion (you don’t see this exclusion in very many D&O policies).

In addition, many other D&O policy exclusions (including even other exclusions in Stanford Financial’s D&O insurance policy) specify that they only apply "after adjudication" that the prohibited conduct has occurred. The money laundering exclusion, by contrast, specified that it was triggered if "in fact" the prohibited conduct occurred. This distinction was critical in the Fifth Circuit’s consideration of these issues.

So, to recap, what we have is a procedurally narrow context, an unusual set of coverage issues, and some very case specific factual determinations. Moreover the factual determinations were made only pursuant for purposes of determining whether or not the preliminary injunction should remain in force – as Judge Atlas specifically stated, these determinations were not "final findings of fact."

Judge Atlas was accurate in stating that her conclusions were "narrow." But nevertheless, the determination, unless overturned on appeal prior to the criminal trial, will leave Allen Stanford and the other two individuals without insurance for their defense expenses as they prepare for their January 2011 criminal trial.

An October 13, 2010 Bloomberg article discussing Judge Atlas’s opinion can be found here. (Full disclosure, I was interviewed in connection with the article).

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Overall levels of corporate and securities litigation remained at elevated levels in the most recent quarter even as securities class action filing levels remained flat, according to the third quarter 2010 report of the insurance information firm, Advisen. The October 2010 report can be found here. 

Preliminary Notes 

The litigation analyzed in the Advisen report includes not only securities class action litigation, but a broad collection of other types of suits as well, including regulatory and enforcement actions, individual actions, derivative actions, collective actions filed outside the U.S. and allegations of breach of fiduciary duty.

In considering the Advisen report, it is critically important to recognize that the report uses its own unique vocabulary to describe certain of the litigation categories.

For example, the report uses the phrase "securities fraud" lawsuits to describe a combination of both regulatory and enforcement actions, on the one hand, and private securities lawsuits brought as individual actions, on the other hand; however, the category of "securities fraud" lawsuits does NOT include private securities class action lawsuits, which are in their own separate category (SCAS").

In addition, both "securities fraud" lawsuits and securities class action lawsuits, as well as all of the other categories of lawsuits described in the report, are subparts of the aggregate group of corporate and securities litigation the report refers to as "securities suits."

Due to these unfamiliar usages and the similarity of category names, considerable care is required in reading the report.

The Report’s Analysis

According to the Report, corporate and securities litigation "remained at inflated levels" in the third quarter. There were 284 "securities suits" in the third quarter, which is slightly higher than the 278 filed in 2Q10 and the 276 filed in the third quarter of 2009. The filings for the first three quarters of 2010 annualize to 1,024 lawsuits, by comparison to the 1,105 filed in 2009 and 928 in 2008. These annual figures are significantly above the roughly 800 per year lawsuits filed in 2007 and 2006.

The new lawsuit filings have remained at elevated levels even though the number of securities class action lawsuit and "securities fraud" action (that is, enforcement actions and individual securities suits) have remained essentially flat. The heightened litigation activity levels is largely due to the number of breach of fiduciary duty suits, which "have grown rapidly as a percentage of all securities suits," now representing 34 percent of all "securities suits," compared to as little as 8 percent as recently as 2004. These breach of fiduciary duty lawsuits "often are filed in the wake of a merger or an acquisition by shareholders of the acquired company who believe the directors did not obtain an adequate price."

Securities class action lawsuits as a percentage of all "securities suits" has, by contrast, declined in recent years and now represents less that 20 percent of all corporate and securities lawsuits. According to the Report’s counting methodology, there were 144 securities class action lawsuits filed in the first three quarters of the year, which annualizes to 192 lawsuits. This annualized number compares to the 234 securities class action lawsuits filed in 2009. According to the Report, there average number of securities class action lawsuit filings during the period 2004 to 2009 is 226.

The Report attributes the relative decline of securities class action lawsuit filings in 2010 to the drop in the number of new lawsuits related to the credit crisis. But though the credit crisis lawsuits have declined, financial firms remain the most frequently named in securities class action lawsuits. Overall, though, the securities class action lawsuit filings "were much more broadly dispersed than in previous quarters." The two largest categories of lawsuit defendants after financial firms are companies in the consumer discretionary and healthcare categories.

My own analysis of third quarter securities class action lawsuit filings can be found here.

Advisen's Third Quarter Litigation Overview: On October 15, 2010 at 11:00 a.m. EDT, I will be participating in an Advisen webinar reviewing the firm's third quarter securities litigation report. Other participants in this webinar include Steve Carabases of ACE, Adam Savett  of Claims Compensation Bureau and David Bradford of Advisen. The session will reveiw Advisen's analysis of third quarter 2010 securities litigation and discuss the implications for brokers, underwriters and risk managers. Information about the session, including registration information, can be found here.

In BofA/ Merrill Case, Judge Castel Denies Motion for Reconsideration and Immediate Appeal: In an October 7, 2010 order (here), Judge Kevin Castel denied the defendants’ motion for interlocutory appeal or for reconsideration of Judge Castel’s August 27, 2010 order denying in part and granting in part the defendants’ motions to dismiss. Refer here for background regarding his August 27 ruling, which as noted here, has proven to be controversial, to the extent it seemed to suggest that BofA could not be liable under the federal securities for omission allegedly made at the direction of Secretary of the Treasury Paulson. That aspect of Judge Castel’s ruling, which clearly favors the defendants, was the subject of defendants’ motion.

Rather, as discussed in Alison Frankel’s October 12, 2010 Am Law Litigation Daily article (here), the defendants relied on three specific issues: "Did BofA have a duty to disclose Merrill's (disastrous) interim financial results; do shareholders of an acquiring comany have causation claims; and are covenants of a private merger agreement actionable under federal securities laws? "

Judge Castel denied the request for interlocutory appeal, noting that granting the motion would "grind this action to a halt." He also held that the defendants had not presented sufficient grounds for reconsideration.

Welcome to the Blogosphere: I am pleased to note that my friend Joe Monteleone of the Tressler law firm has joined the blogosphere with his new blog, The D&O and E&O Monitor, which can be found here. The new blog is off to a great start and it looks like a worthy new addition to the blogosphere. All I can say is that Joe will soon learn that a blog is harsh mistress.

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The FDIC has authorized more than 50 lawsuits against former directors and officers of failed banks, according to an October 8, 2010 Bloomberg article. But merely because the lawsuits have been authorized does not necessarily mean we will see 50 lawsuits, as it appears that the FDIC approval was calculated in part to encourage pre-litigation settlements.

Since January 1, 2008, the FDIC has taken control of 294 banking institutions, as detailed here. The FDIC has been a very active litigant seeking to assert its rights of priority over other litigants’ claims against the directors and officers of failed banks, but the FDIC itself has filed only one lawsuit against the senior officials at a failed bank.

Though the FDIC has to date pursued relatively little litigation itself, it has asserted claims against individuals at failed banks. These claims have come in the form of demand letters nominally addressed to the individuals but also with copies to the failed institution’s D&O insurers.

For example, as discussed here, the FDIC filed a November 24, 2009 motion in the BankUnited Holding Company bankruptcy proceeding asserting its rights of priority to assert claims against Company’s bank unit’s directors and officer. Attached to the motion was a copy of a November 5, 2009 letter the FDIC’s attorneys sent to former directors and officers of BankUnited, in which the FDIC presented a demand for civil damages and losses. Copies of the letter were sent to the company’s primary and first level excess D&O insurers.

With its recent litigation authorization, the FDIC may now proceed to file more lawsuits against directors and officers of failed banks. However, the authorization (and surrounding publicity) may have been calculated to try to avoid litigation and encourage pre-litigation settlement in connection with some of the claims the FDIC has previously asserted in the form of demand letters like the one in BankUnited.

Along those lines, the Bloomberg article quotes an FDIC spokesman as saying that "the goal is to reach as many settlements as possible," adding further that "it’s both in our interest and theirs to try and settle this matter before it gets into court and we get into expensive litigation." Thus, it appears that the authorization and surrounding publicity is designed in part to encourage settlements before available funds have been reduced by defense expenses.

The article cites the FDIC’s estimate that the 50 authorized lawsuits would represent an effort to try to recoup more than $1 billion in losses. By way of comparison, and according to the NERA’ August 2010 report on failed bank litigation (about which refer here), during the S&L crisis, the FDIC recovered about $1.3 billion in D&O claims.

In terms of the number of lawsuits filed, the 50 currently authorized lawsuits would represent about 17% of the 294 banks that have failed since January 1, 2008. During the S&L crisis, the FDIC filed lawsuits in connection with about 24% of the 1.813 failed financial institutions -- meaning roughly 435 lawsuits. Because the institutions failing during the current banking crisis are larger than the institutions that failed during the S&L crisis, the potential litigation recoveries in connection with many of the current failed institutions are proportionately larger.

Even though the FDIC want to try to settle cases if it can, it seems probable that it soon will be filing lawsuits, perhaps many of them in the days ahead. The Bloomberg article quotes the FDIC’s spokesman as saying that "we’re ready to go," adding that "we could walk into court tomorrow and file the lawsuits."

As a loyal reader said, commenting on the reports of the FDIC’s litigation authorization, "Game on." Indeed.

UPDATE: In picking up this story, various news sources have clarified that the FDIC did not authorize 50 lawsuits but rather authorized lawsuits against 50 individuals. Refer for example here. At least one knowledgeable source I consulted confirmed that what the FDIC authorzied was not 50 separate lawsuits, but rather lawsuits against 50 indiviudals. The expectation then is that there might be 5 to 10 lawsuits, which is quite a bit different than 50 lawsuits. Hard to see how the FDIC plans to get to $1 billion in recoveries from that level of litigation activity.

Special thanks to the several readers who sent me copies of the Bloomberg article.

Morgan Keegan Funds ’33 Act Subprime-Related Claims Survive Dismissal: In a September 30, 2010 order (here), Middle District of Tennessee Judge Samuel H. Mays, Jr. granted the defendants’ motions to dismiss the ’34 Act claims but denied the motions to dismiss the ’33 Act claims in the Regions Morgan Keegan Open-End Mutual Fund securities class action litigation.

Plaintiffs are investors in three Morgan Keegan select mutual funds. The defendants are the funds themselves, their corporately affiliated asset manager, related corporate entities, as well as their corporate parent. The defendants include individual officers and directors of the funds and related entities.

The plaintiffs’ allegation is basically that the funds invested in CDOs and other illiquid subprime mortgage-backed investments in excess of stated restrictions on the funds’ investments. The plaintiffs contend that their investment losses are not the result of normal market factors, but rather are due to the funds investment in lower-priority tranches of asset-backed securities. When the market for the instruments began to decline in 2007, the funds found themselves holding assets that quickly declined in value and which they could not readily sell because of the limited market for such investments. Two of the funds declined in value over 70 percent, the third declined over 20 percent.

In reviewing the motions to dismiss, Judge Mays noted that the plaintiffs’ amended complaint "exceeds four hundred pages, comprising 766 paragraphs and six appendices." This extraordinary length may in the end have weighed against the plaintiffs. Judge Mays observed that "when it is possible to ask legitimately, after reading a four-hundred page Complaint, who is being sued for what on a particular count, Plaintiffs have not met the PSLRA’s pleading standards," adding that "it is not for the Court or for Defendants to ask who is ‘relevant’ to a particular count. It is the plaintiffs’ duty to state clearly against whom they seek damages." Judge Mays found that dismissal of the ’34 Act claims on this basis alone is sufficient.

Judge Mays went on, assuming for the sake of analysis that the plaintiffs claims had been pled with sufficient particularity, to hold that the plaintiffs had not sufficiently pled scienter. In attempting to establish scienter, the plaintiffs had relied on the "group pleading" doctrine. Judge Mays assumed for purposes of his opinion that group pleading had survived the PSLRA, but nevertheless concluded that "plaintiffs have failed to demonstrate that the inference of scienter is at least as compelling as any opposing inference of nonfraudulent intent."

But while Judge Mays granted the defendants’ motion to dismiss the plaintiffs’ ’34 Act claims, he denied the defendants motions to dismiss the plaintiffs’ ’33 Act claims, finding that the plaintiffs had adequately identified the allegedly misleading statements in order to state a claim.

I have added the Morgan Keegan ruling to my running tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.

Indian Summer: Wikipedia’s various supposed explanations for the origins of the phrase "Indian Summer" seem equally implausible and lack the ring of truth. Whatever the origin of the expression, the weather to which it refers is a delight and a balm in our weary world. In a few short weeks, the winds will howl and the snows will blow. But for now, a beneficent sun shines in an azure sky arching over the changing leaves' brilliant colors. It is enough to make your heart glad.

Horseshoe Lake, Shaker Heights, Ohio, October 9, 2010

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Yet another securities class action lawsuit against a non-U.S. company has been dismissed based on the U.S. Supreme Court decision in Morrison v. National Bank of Australia. In a decision that specifically addresses many of the questions that have been discussed in the wake of Morrison, Southern District of New York Judge John Koeltl, in an October 4, 2010 opinion (here), granted the defendants’ motion to dismiss the Swiss Re subprime-related securities class action lawsuit..

Though the case was dismissed, the opinion does suggest some alterative approaches plaintiffs may use to try to avoid Morrison’s preclusive effect.

As discussed here, the plaintiffs first sued Swiss Re and certain of its directors and officers in 2008. As Judge Koeltl later put it in his October 4 opinion. "the gist of many of the plaintiffs’ alleged misstatements or omissions is that Swiss Re failed to disclose that it had issued two [credit default swaps, of CDSs] that insured CHF 5.3 billion of assets… It eventually suffered a CHF 1.2 billion loss on these CDS when it suddenly wrote down the value of the CDOs and sub-prime securities that were insured by the CDSs."

After the Supreme Court issued its opinion in Morrison, the defendants in this case moved to dismiss, contending that the Exchange Act did not apply to the plaintiffs’ purchases of their Swiss Re securities, which had taken place on a non-U.S. exchange.

The plaintiff, Plumbers Union Local No. 12 Pension Fund, argued that Morrison did not preclude their claims, even though the transaction on which they had acquired their shares had taken place on a London-based subsidiary of the Swiss stock exchange. The plaintiffs argued that they had decided to purchase their Swiss Re shares in Chicago, and that the purchase orders were placed electronically by traders located in Chicago. The plaintiffs contended that the purchase occurred when and where an investor places a buy order.

Judge Koeltl, citing the several recent decisions, held that the term purchase "cannot bear the expansive construction plaintiffs propose, at least for purposes of Morrison’s transactional test." A contrary ruling, Judge Koeltl said "would require a fact-bound, case-by-case inquiry into when exactly an investor’s purchase order became irrevocable. It would also produce the multiplicity that the Supreme Court directed courts to avoid."

Accoringly, Judge Koeltl held that "a purchase order in the United States for a security that is sold on a foreign exchange is insufficient to subject the purchase to the coverage of section 10(b) of the Exchange Act." He acknowledged that there might be "unique circumstances in which an issuer’s conduct takes a sale or purchase outside this rule," but "the mere act of electronically transmitting a purchase order from within the United States is not such a circumstance."

Judge Koeltl also expressly rejected the suggestion that merely because the purchaser was domiciled in the U.S., that the U.S. securities laws applied to the transaction, noting that "a purchaser’s citizenship does not affect where a transaction occurs; a foreign resident can make a purchase within the United States, and a United States resident can make a purchase outside the United States.." Where the decision to purchase took place and even the location of the harm are also irrelevant. .

Having determined that the U.S. securities laws do not apply to the plaintiffs’ shares, Judge Koeltl then addressed the plaintiffs’ argument that even if they could not assert claims under the U.S. securities laws, they could assert their claims under state common law and the Court would have diversity of citizenship jurisdiction over such claims.

The parties had previously stipulated that if the plaintiffs’ claims under section 10(b) where dismissed under Rule 12 (b)(6) for failure to state a claim on which relief could be granted (as opposed to a dismissal under Morrison), the dismissal would also be dispositive of any common law fraud claims.

Judge Koeltl then proceeded to address the defendants’ motion to dismiss the section 10(b) claim and granted the motion to dismiss, finding that the plaintiffs had failed adequately to allege that the defendants had made materially or misleading statements. Judge Koeltl also found that the plaintiffs had failed adequately to allege scienter. Based on this determination, he concluded granted the defendants’ motion to dismiss, which was determinative not only of plaintiffs’ section 10(b) claims but also the plaintiffs’ claims for common law fraud.

Discussion

There are a number of interesting things about this opinion. The first is the specificity of Judge Koeltl’s analysis about what factors are or are not relevant to the post-Morrison analysis of whether or not the U.S. securities laws apply. His analysis seems to make clear that the location on the exchange on which the transaction took place is going to be determinative, and neither the citizenship nor location of the purchaser is relevant.

This view, which is consistent with the growing string of post-Morrison decisions, suggest that the so-called "f-squared" cases (that is, involving claims by U.S. claimants who purchased their shares in a non-U.S. company on a non-U.S. exchange) seem increasingly unlikely to have remain viable post-Morrison.

Judge Koeltl’s opinion does not address the more controversial question, raised sua sponte by Judge Berman in his recent opinion in the SocGen case (about which refer here), that under Morrison even the claims of purchasers who acquired ADRs in domestic transactions are precluded. Indeed, Judge Koeltl’s opinion is silent on the question of whether Swiss Re ADRs trade in the U.S.

But though Judge Koeltl’s opinion does not address the claims of domestic purchasers of ADRs, his analysis seems to suggest that he would not have gone as far as Judge Berman and concluded that the securities don’t apply to U.S. ADR purchases. First, he states that "Morrison held that a domestic purchase or sale is necessary (and as far as the opinion reveals, sufficient) for section 10b) to apply to a security that is not traded on a domestic exchange" -- which suggests that in Judge Koltl’s view, Morrison does not preclude claims even of domestic ADR purchasers who acquired their shares over the counter, rather than on an exchange.

The Swiss Re decision is the latest in a string of rulings suggesting that plaintiffs face significant hurdles in attempting to pursue securities claims against companies domiciled outside the U.S., particularly where the company’s share trade largely outside the U.S. However, the Swiss Re decision does suggest, albeit indirectly, some the ways the plaintiffs may attempt to circumvent these obstacles.

Thus, for example, even though Judge Koeltl’s ruling on the defendants’ motion to dismiss resulting in a dismissal of the plaintiffs’ common law claims, there was certainly nothing in his opinion that suggests that plaintiffs could not assert such claims. The fact is that Morrison only applies to claims under the Exchange Act. Although the plaintiffs’ common law claims were dismissed in Swiss Re, the clear suggestion is that in another case, sufficient allegations could survive a dismissal motion, in which circumstance the case would go forward, notwithstanding Morrison.

A footnote in the Swiss Re case suggests another possibility. In footnote 5, Judge Koeltl observes that "the plaintiffs also noted that they might have a claim under Swiss law, but they have not pursued that avenue." Whether the plaintiffs in fact would have had such a claim under Swiss law and whether the U.S. court would have had an appropriate jurisdictional basis for entertaining such a claim is not addressed in Judge Koeltl’s opinion. But at least the theoretical possibility is posed by the footnote. UPDATE: An October 6, 2010 Law.com article (here) reports that the plaintiff shareholdes in the Toyota securities class action lawsuit have amended their complaint to add allegations of violations of Japanese securities laws, which demonstrates that one way plaintiffs may attempt to circumvent Morrison is by asserting in a U.S. lawsuit alleged violations of the securities laws of the non-U.S. company's home country.

Whether plaintiffs’ lawyers might ultimately choose to frame their U.S. claims against foreign companies based on common law or foreign law rights of recovery remains to be seen. But if the present trend of decisions continues, these alternatives may begin to look more attractive.

I have in any event added the Swiss Re decision to my running tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.

Special thanks to the several readers who sent me copies of the Swiss Re decision.

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As discussed in an earlier post, the BankAtlantic subprime related securities lawsuit is headed to trial. According to an October 5, 2010 Law.com article (here), jury selection in the case will begin this Friday, October 8, 2010, in federal court in Miami.

The Law.com article suggests the case has become contentious as it has moved forward. Among other things, the article quotes defense counsel as saying that "I’m offended by this case," which he characterizes as "a completely made-up, frivolous claim." Defense counsel reportedly has moved for sanctions against the plaintiffs’ attorney. (The article does not mention that in connection with the motions for summary judgment, Judge Ursula Ungaro granted summary judgment for plaintiffs on the issue of falsity, as to certain of the allegedly misleading statements, as discussed here.)

If the case does proceed to trial it would represent one of one only a very small handful of securities class action lawsuits that have actually made it to trial since the enactment of the PSLRA in 1995.

According to information compiled by Adam Savett, the Director of Securities Class Actions at the Claims Compensation Bureau, since the enactment of the PSLRA, there have only been nine securities class action lawsuits based on post-PSLRA conduct that have actually been tried to a jury verdict. Another seven cases alleging post-PSLRA conduct went to trial but were compromised or otherwise resolved prior to verdict. An additional eleven securities cases have gone to trial post-PSLRA but involved pre-PSLRA conduct.

In other words, if the BankAtlantic case actually does go forward, it would represent only the 28^th case to go to trial since the enactment of the PLSRA, and only the 17^th case since the enactment of the PSLRA involving post PSLRA conduct to go to trial. If the BankAtlantic case actually goes to verdict, it would represent only the tenth securities class action lawsuit to go to verdict post-PSLRA involving post-PSLRA conduct.

For those who are interested to know how the nine post-PSLRA verdicts have turned out, the current tally (taking into account post-verdict proceedings and reflecting only the current status of post-verdict proceedings) is as follows: Plaintiffs 5, Defendants 4. (The scoreboard is subject to revision pending the outcome of additional proceedings in several of the cases.)

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With one lone exception, the FDIC has not yet itself pursued litigation against the directors and officers of a failed financial institution. However, the FDIC has already made it clear that it intends to assert its rights under FIRREA as the receiver of failed banks to take control of shareholders’ derivative lawsuits.

More recently, and perhaps more aggressively, the FDIC is now attempting to intervene in two direct shareholder actions where failed institutions’ aggrieved investors are asserting their own claims, rather than derivatively asserting those of the failed institution. These more recent moves may represent efforts not just to assert but to extend the FDIC’s litigation preclusion rights. The FDIC’s actions are interesting in and of themselves, but also for what the FDIC has claimed in asserting its rights.

The FDIC’s most recent move in this direction is its October 4, 2010 motion to intervene in the Haven Trust Bancorp securities class action litigation pending in the Northern District of Georgia. A copy of the FDIC’s memorandum in support of its motion to intervene can be found here. Haven Trust Bancorp was the parent corporation for Haven Trust Bank, a Duluth, Georgia failed bank of which the FDIC took control on December 12, 2008.

The FDIC has previously moved to intervene in the negligent misrepresentation lawsuit that individual investors had filed in Fulton County (Georgia) State Court against certain former directors and officers of Georgian Bancorp. A copy of the FDIC’s September 23, 2010 motion to intervene, and accompanying motion to remove the case to federal court upon grant of the intervention, can be found here. Georgian Bancorp was the corporate parent of Georgian Bank, of which the FDIC took control on September 25, 2010. My prior post about the Georgian Bancorp case can be found here.

Both of these lawsuits are direct, not derivative, actions. In each case the plaintiffs seek to recover damages in the form of their own lost investment interests. In asserting that it nevertheless has the right to intervene, the FDIC raises a number of interesting arguments.

First, in both cases, the FDIC asserts that both cases are basically just derivative lawsuits in disguise. Thus, for example, in the Haven Trust case, the FDIC asserts that "although Plaintiffs have attempted to frame their allegations of wrongdoing and damages in terms of securities fraud and misrepresentations …Plaintiffs’ alleged losses clearly emanate from the fact that the Bank, as sole asset of the Holding Company, became worthless upon the appointment of the FDIC as receiver for the Bank." In the Georgian case, the FDIC asserts that the plaintiffs’ claim is "in substance a derivative claim." The FDIC asserts, the shareholders’ claims are, in effect, "double derivative" claims.

Second, the FDIC asserts that as receiver of the respective banks, under 12 U.S.C. Section 1821 it has succeeded to "all rights, titles, powers, and privileges of the insured depository institution, and of any stockholder … of such institution with respect to the institution and the assets of the institution." In reliance on this provision, the FDIC asserts as an initial matter that it has priority rights to assert the claims presented in the respective plaintiffs’ complaints, because they are essentially derivative complaints.

The FDIC’s further argument in reliance on this statutory provision is with reference to the respective institutions’ D&O insurance policies. Thus, for example, the FDIC asserts in the Georgian case that among the assets with respect to which it assumed priority upon being appointed receiver was Georgian’s D&O insurance policy, which "provides limited and finite monies for claims covered by the Policy and may be the only source of recovery against the Defendants in this or any subsequent lawsuit."

The FDIC points out further that the D&O policy is a "wasting asset" that would be reduced by defending the plaintiffs’ claims. The FDIC has the right to intervene, it therefore asserts, because "its ability to recover in a subsequent lawsuit will be affected by any judgment in this action or protracted litigation."

The FDIC is even more explicit about the possibility of its pursuing claims in its intervention motion in the Haven Trust case. There the FDIC explicitly stated that its investigation includes examination of the "acts and/or omissions of the Bank’s former officers and directors in connection with their management of the Bank’s affairs." The FDIC states that after completing its investigation it will determine "whether claims should be brought against any individual or entity," noting that "several of the defendants in this case, as former officers and/or directors of the Bank, are potential targets."

There are a number of concerns with the grounds on which the FDIC is moving to intervene. First, the FDIC completely disregards the investors’ own legal right to assert their own claims for their own alleged financial injuries. Second, and perhaps more to the point, the investors are asserting their claims as shareholders of the parent holding companies of the failed banks, not of the failed banks themselves. The FDIC’s priority rights extend to its rights as receiver of the failed bank. Whether the FDIC can assert rights on behalf of the parent holding company of the failed bank is a potentially contentious proposition.

Section 1821 (d)(2)(A)(i), on which the FDIC relies to assert its priority rights, refers to the rights, titles, etc., of the "insured depositary institution, and of any shareholder …of such institution." However, the plaintiffs’ in this shareholder suits are not asserting rights as shareholders of the institution, but of the parent holding company. The FDIC may or may not be able to persuade a court to make the leap from its rights as receiver of the failed bank to the rights of the shareholders of the bank’s parent company, but the argument seems to strain the language of the provision.

Finally, the FDIC may indeed be interested in preserving the D&O policies, but there is nothing about Section 1821 that gives the FDIC priority to the proceeds of the policy, in preference to other prospective claimants. The insurance proceeds are not a cash fund like an investment account: rather, the proceeds are available only for payment of certain kinds of loss arising from claims. The policy itself may be an asset of the estate, but the proceeds are available only pursuant to the terms and conditions of the policy, only for payment of claims, and the rights of the insureds and the claimants to the proceeds of the policy are determined by the policy’s own terms.

Whatever else may be said about the FDIC’s actions in moving to intervene in these case, they do show both that the FDIC is actively considering pursuing its own lawsuits, and that it is will to move aggressively to preserve its own recovery prospects in the event it subsequently decides to pursue lawsuits. The pretty clear message is that the FDIC does intend to pursue lawsuits, too.

As if the prospect of competing lawsuits from both investors and regulators were not daunting enough for directors and officers of failed institutions (and their insurers), a lawsuit recently filed in South Carolina suggests yet another type of prospective claimant that may be asserting claims against failed banks’ directors and officers.

On September 29, 2010, the trustee for the estate of Beach First National Bankshares filed a lawsuit in the Bankruptcy Court for the District of South Carolina against certain directors and officers of the bankrupt company. A copy of the complaint can be found here. The company’s wholly owned subsidiary, First National Bank of Myrtle Beach, was closed on April 9, 2010 The Trustee’s complaint asserts claims for breach of fiduciary duty and negligence.

While the Trustee may have seized the initiative in this case, there would seem to be the possibility that the FDIC might yet seek to intervene in the Trustee’s case just as it did in the cases described above. Disappointed shareholders might also seek to assert their own claims for harm to their own investment interests, particularly since the First National holding company is a publicly traded company.

The possibility of claims asserted by these various prospective and active claimants underscores how one of the consequences of a bank failure may be a scramble for the proceeds of the insurance policy. The FDIC may well contend that under FIRREA it has certain priorities but other claimants are also highly motivated to circumvent the FDIC’s asserted rights.

Of course in the end the FDIC may establish its priority. But in the meantime, the scramble for the D&O insurance could become quite a circus. And in the center ring could be the directors and officers of the failed institutions – and their insurers – against whom the competing claimants will assert their claims. The likelihood for further D&O litigation involving failed banks’ directors and officers seems high.

One final thought about the FDIC's interventions in the two case discussed above -- there have been a fair number of shareholder class actions brought by investors in failed financial institutions. It will be interesting to see how far the FDIC goes with thie intervention tactic and whether it will seek to intervene in other cases involving larger financial institutions. Perhaps its initiatives in the two Georgia lawsuits are test cases that will determine whether it will seek to intervene elsewhere.

Many thanks to a loyal reader for providing copies of the various pleadings to which I linked above.

A copy of an October 3, 2010 Myrtle Beach Sun News article about the Beach First Trustee’s lawsuit can be found here. (Full disclosure, I was interviewed in connection with the article.)

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There was a flurry of subprime related securities lawsuit dismissal motion activity at the end of last week, and although in some cases the motions were granted and in other instances large parts of the cases were dismissed, in several instances enough of the cases survived for the plaintiffs to tally the rulings in the win column. Among the cases where the plaintiffs retained enough to live for another day were at least one high profile case and another interesting auction rate investor case.

Fannie Mae: In a September 30, 2010 order (here), Southern District of New York Judge Paul A. Crotty granted in part and denied in part the defendants’ motions to dismiss the plaintiffs’ ’34 Act claims in the Fannie Mae subprime-related securities class action lawsuit. (In a November 29, 2009 order, here, Judge Crotty had previously granted the defendants’ motions to dismiss the plaintiffs’ claims under the ’33 Act).

The plaintiffs’ ’34 Act claims involved three principal allegations: (1) that the defendants had misrepresented Fannie’s exposure to subprime and Alt-A mortgage markets and related risks; (2) that the defendants had misrepresented the quality of Fannie’s internal risk controls (3) that Fannie had filed materially inaccurate financial statements.

Judge Crotty granted the defendants’ motions to dismiss both as to the allegations that Fannie had misrepresented its subprime and Alt-A exposure and as to the allegations that Fannie has filed inaccurate financial statements. However, Judge Crotty denied the dismissal motions of the company itself, its CEO and its Chief Risk Officer, with respect to the allegations that the defendants had misrepresented the quality of Fannie’s internal controls.

In granting the motions to dismiss as to allegations concerning Fannie’s exposure to subprime and Alt-A mortgages, Judge Crotty ruled that Fannie’s public filings contained cautionary language that warned investors about the risks of Fannie’s subprime and Alt-A investments. He also held that the plaintiffs had failed to explain why the defendants’ statements regarding Fannie’s subprime and Alt-A investments were false. Finally, he held that the plaintiffs had failed to allege that the defendants had acted with scienter in making statements about Fannie’s subprime and Alt-A exposure.

In granting the motions to dismiss as to the allegations that Fannie filed inaccurate financial statements, Judge Crotty held that the plaintiffs had not alleged sufficient facts to establish that Fannie’s financial statements were false at the time they were issued. Judge Crotty also noted that Fannie’s regulators had never claimed that Fannie had committed any GAAP violations and had never asked for restatements of any of Fannie’s financial statements for the class period, but at the same time reported repeatedly that Fannie was adequately capitalized.

In denying the motions to dismiss as to the plaintiffs’ allegations that the defendants had misrepresented the quality of Fannie’s internal risk controls, Judge Crotty relied heavily upon three emails that had gone between the company’s Chief Risk Officer and its CEO. In these emails, the Chief Risk Officer complained, among other things, that the company "was not even close to having the proper control processes for credit, market and operational risk."

Judge Crotty said that these statements "show that Fannie may have been saying one thing while believing another" and are sufficient to survive a motion to dismiss. However, because the plaintiffs had not shown that two of the other individual defendants were aware of the emails, Judge Crotty granted these two defendants’ motions to dismiss, while denying the dismissal motions of the company, its CEO and the Chief Risk Officer.

Perrigo Company: As discussed here, the auction rate securities lawsuit filed against Perrrigo and certain of its directors and offices did not involve the usual allegations that an auction rate securities seller had misrepresented the securities in connection with the securities’ sale; rather, Perrigo was an auction rate securities investor, and the plaintiffs, Perrigo shareholders, alleged that the defendants had misrepresented the company’s own investment exposure to auction rate securities.

Essentially, the plaintiffs alleged that during a period in 2008 and early 2009, the company failed to write down the value of its auction rate securities investments, and also failed to acknowledge publicly that it has purchased its auction rate securities from Lehman Brothers, and was therefore not going to benefit from the same kind of redemption as had other auction rate securities investors who had purchased their securities from, for example, Merrill Lynch, Citigroup and UBS. On February 3, 2009, the company reported that it had incurred a significant charge related to the write down of the auction rate securities and also revealed the Lehman connection.

In his September 30, 2010 order (here) denying the defendants’ motions to dismiss, Southern District of New York Judge Thomas Griesa had that the "plaintiffs argue persuasively that the identical factors that caused Perrigo to drastically write down the value of the ARS on February 3, 2009 – increased credit and liquidity risks – were operative and evident to defendants at the time they issued the November 6, 2008 statements." Judge Griesa also found that the plaintiffs had sufficiently alleged materiality, scienter and loss causation.

WaMu Mortgage Pass-Through Certificates: In a September 28, 2010 order (here), Western District of Washington Judge Marsha Pechman granted in part and denied in part the dismissal motions in the securities class action lawsuit that had been brought by investors who had purchased interests in certain Washington Mutual Mortgage Pass-Through Trusts. The defendants in the case included Washington Mutual and certain of its subsidiaries, as well as certain officers of the subsidiaries who had signed the offering documents, and the rating agencies which had provided credit ratings for the investments.

Judge Pechman first ruled that the named plaintiffs lacked standing to assert claims with respect to 25 of the 36 offerings at issue because the plaintiffs had not purchased securities in connection with those 25 offerings. In addition, Judge Pechman also dismissed allegations as to three other offerings as time-barred.

With respect to the remaining offerings, Judge Pechman found that the plaintiffs had adequately alleged misrepresentation in connection with the offering documents’ statements about the underwriting guidelines used in connection with the origination of the underlying mortgages. She observed that "in essence, Plaintiffs allege the underwriting guidelines ceased to exist," adding that "the absence of underwriting standards could make the identified statements misleading."

However, she held that the plaintiffs had not alleged actionable misrepresentations with respect to the offering documents’ statements about appraisals and loan to value ratio, noting that the "allegations on this issue are simply too conclusory." With respect to the alleged failure to disclose the credit ratings alleged conflict of interest, she concluded that "because reasonable investors knew that the rating agencies were paid by the issuers, the alleged misrepresentation is immaterial.

Judge Pechman also rejected the defendants’ arguments that the plaintiffs had not adequately alleged economic loss, since the plaintiffs have not alleged that they failed to receive an income stream from the certificates. Judge Pechman said that plaintiffs allegations "give rise to the inference that the value of the security is much less that the purchase price," and the "mere fact that Plaintiffs may have difficulty substantiating the exact nature of their loss in an illiquid market does not necessitate dismissal."

Oppenheimer Auction Rate Securities: In a September 29, 2010 order (here), Judge Loretta Preska granted the defendants’ motion to dismiss the auction rate securities lawsuit that had been brought against Oppenheimer Holdings and one of its subsidiaries. The Oppenheimer lawsuit is one of the conventional auction rate securities lawsuits, in that it had been brought by auction rate securities buyers against the firm that sold them the investments.

The plaintiffs contend that in connection with their purchase of the securities they had been misled about the nature and safety of the securities as well as the nature and operation of the market for the securities. The plaintiffs allege that as a result of the failure of the auction rate securities market in February 2008, they are stuck holding illiquid securities for which there is no market.

In granting the motions to dismiss, Judge Preska found that the plaintiffs had not sufficiently alleged scienter. Specifically, she found that the plaintiffs allegations of motive and opportunity were insufficient and that the alleged circumstantial evidence of scienter were also insufficient.

Among other things, Judge Preska found that the inference of scienter that plaintiffs urged "is not at least as strong as the inference that Oppenheimer negligently or carelessly provided insufficient training to its financial advisors and was merely negligent in not detecting and disclosing the imminent market collapse." The "more compelling inference" is that "Oppenheimer did not predict that all broker dealers would withdraw from the ARS market en masse."

Countrywide Asset-Backed Certificates Trust: In a mortgage-backed asset securities case that was not brought as a class action, on September 28, 2009 Judge Kevin Castel granted the motion of defendants Countrywide Home Loans and related entities, as well as certain Countrywide directors and officers, brought by two individual investors who had purchased mortgage backed securities from Countrywide. A copy of the order can be found here.

The plaintiffs, who had purchased over $540 million of the securities in their initial offerings, alleged that the offering documents contained material misrepresentations regarding the underlying loans, regarding the underwriting guidelines used in connection with the origination of the underlying loans; as well as regarding the selection and servicing of the underlying loans.

Judge Castel noted at the outset that this is the unusual case where the plaintiffs acknowledge that they knew that the underlying loans were "risky" and that the borrowers were "credit-blemished," but claim that they were misled because the loans were riskier than they were led to believe.

Judge Castle concluded both that the plaintiffs had insufficiently alleged misrepresentation and that the plaintiffs had insufficiently alleged scienter.

Discussion

In one sense, these dismissal motion rulings described above just represent a random selection of rulings as the courts continue to grind through the mountain of pending subprime and credit crisis related lawsuits. However I have some observations about this group of rulings.

First, though some subprime cases are dismissed outright and there are many other cases where substantial parts of the cases have been knocked out, in a substantial number of these cases the plaintiffs are either prevailing on the dismissal motions or at least managing to scrape out just enough to live to see another day. Thus for example in both the Fannie Mae and WaMu cases discussed above, even though huge parts of the cases were dismissed, enough remains for the plaintiffs to be able to continue to fight and to try to work toward an eventual payday.

Second, among the cases surviving in whole or in part are many of the highest profile cases. The Fannie Mae case is just the latest illustration of this, following close on the heels of the dismissal motion survival of the AIG case (refer here) and the Merrill Lynch/BofA merger case (refer here). This follow along with many of the other high profile cases such as the Countrywide, New Century and Washington Mutual. subprime related securities suits. The point is that while many of the subprime cases may have been dismissed along the way, the biggest, highest-profile cases are generally going forward.

Third, as the cases grind through, some important issues are being worked out. Thus, for example, as suggested in the Oppenheimer case, courts are now working through the merits of the auction rate securities cases. Up to this point, many of the auction rate securities cases that had been dismissed were based on mootness grounds, based on the defendants’ entry into regulatory settlements that more or less made plaintiffs whole. In Oppenheimer, the court addressed the merits of the plaintiffs’ allegations and found the allegations to be insufficient.

The Oppenheimer ruling is not the first auction rate securities lawsuit dismissal on the merits (refer for example here with respect to the Merrill Lynch auction rate securities case) but it does represent another instance suggesting that the plaintiffs in these auction securities cases are not doing particularly well.

By contrast, in the Perrigo case, the court found the plaintiffs’ allegations against Perrigo as an auction rate securities investor to be sufficient. The claimants in other cases against auction rate investors have not been as successful – refer for example here with respect to the dismissal motion grant in the securities suit brought against Mind M.T.I. Even though the plaintiffs’ record in these auction rate investor cases may be mixed, the Perrigo case at least shows that plaintiffs are overcoming initial pleading hurdles in at least some of these cases.

Finally, and notwithstanding the cases where the plaintiffs did manage to overcome the dismissal motion phase at least in part, there are still a number of cases where the defendants are succeeding in getting the cases dismissed, as evidenced in the Countrywide and Oppenheimer cases discussed above.

I have in any event added these decisions to my running tally of subprime and credit crisis-related dismissal motion rulings, which can be accessed here.

Many thanks to the several readers who forwarded copies of these decisions to me.

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New securities class action lawsuit filings in the third quarter of 2010 remained below longer term historical averages, although consistent with filing levels in more recent quarters. There were 39 new securities class action lawsuits filed in the third quarter, bringing the 2010 YTD total number of new filings to 125, as of September 30, 2010.

The 125 new filings through the end of the third quarter compares with the 129 that were filed in the first three quarters of 2009, and implies a total of about 166 by year end 2010 (compared to 169 in 2009). The implied 2010 total is well below the annual average of 197 new securities class action lawsuits filed during the period 1996 to 2008.

Though the overall 2010 YTD filings levels remain below historical levels, new filings did turn up slightly in September 2010, when there were 21 new securities class action lawsuits filed, the highest monthly number of filings since 2008.

New filings against companies in the financial services sector remain an important component of new securities class action lawsuits. During the third quarter there were eight new filings in the 6000 SIC Code series (Finance, Insurance and Real Estate), and an additional three new filings involving firms without SIC Codes but that are financially related. These eleven total new filings against financially related firms represented about 28% of third quarter filings.

Subprime and credit crisis related securities class action lawsuits continue to be filed in the third quarter of 2010. Seven, or about 18%, of the third quarter filings were subprime or credit crisis-related.

While filings against financially related companies continue to predominate as they have since 2007, there were a number of other areas of concentration in the third quarter as well. As I have noted elsewhere, there was a proliferation of filings in the third quarter against for-profit education companies. A total of six for-profit educational companies were sued in the third quarter.

In addition, as has been the case over time, new filings against life sciences companies was also an important part of the third quarter filings. There were a total of seven new filings against companies in the life sciences sector, including four against companies in the 2834 SIC Code category (pharmaceutical preparations). .

For the first three quarters of 2010, there have been 26 new securities lawsuits filed against companies in the 6000 SIC Code series and another 15 against financially-related companies without SIC codes, for a total of 41 new lawsuits against financial companies, or about one third of all 2010 filings. 22 (or about 17.5%) of all 2010 filings have been subprime or credit crisis-related.

Filings against life sciences companies have also been a significant component of 2010 YTD filings. There have been 19 new securities lawsuits filed against companies in the life sciences industry, including 13 against companies in the 2834 and 2835 SIC Code categories. (SIC Code 2835 include in vitro and in vitro diagnostic substances).

There have been ten new securities class action lawsuits filed this year against foreign-domiciled companies, or about eight percent of the total. Interestingly, there have been four new securities class action lawsuits filed against foreign-domiciled companies since the U.S. Supreme Court issued its opinion in Morrison v. National Australia Bank.

Of the 125 YTD filings, 17 (or about 13.6%) represented so-called "belated filings" – that is, cases in which the filing date came more than a year after the proposed class period cutoff date. Though there have been a significant number of these belated filings this year, the number of these filings has slowed as the year has progressed. Only four of these 17 belated cases have been filed since June 30, 2010.

Apple Turnover: You may have missed it this past week, but the parties to the long-running Apple Computer options backdating-related securities class action lawsuit have reached a settlement, as reflected in their September 28, 2010 memorandum in support of their settlement stipulation. The Apple case is one of the last of the 39 options backdating related securities class action lawsuits to finally be resolved.

The Apple settlement incorporates a rather unusual feature. On the one hand, the parties have agreed to settle the case for two conventional settlement terms -- a payment of $14 million in cash for the benefit of the plaintiff class and the company’s agreement to adopt certain corporate governance reforms. But in addition, the company has agreed to make payments totaling $2.5 million to 12 educational institutions’ corporate governance programs.

These payments work out to approximately $208,333 for each of the twelve institutions. The memorandum in support of the parties’ settlement stipulation reports that the lead plaintiff selected the twelve institutions "after conducting a review of corporate governance programs nationally."

While these corporate governance programs undoubtedly represent worthy causes, you do have to wonder about this settlement feature, which arguably provides no benefit either to members of the class or to current Apple shareholders. It also raises questions about compelled corporate philanthropy at shareholders’ expense.

I have in any event added the Apple settlement to my running table of options backdating related case resolutions, which can be accessed here.

Advisen’s Third Quarter Litigation Overview: On October 15, 2010 at 11:00 a.m. EDT, I will be participating in an Advisen webinar reviewing the Third Quarter Securities Litigation. Other participants include Scott Meyer from ACE, Adam Savett of Claims Compensation Bureau, and Dave Bradford of Advisen. The session will review Advisen's analysis of third quarter 2010 Securities litigation and settlements and discuss the larger implications for underwriters, brokers and risk managers. Information about the free webinar, including registration instructions, can be found here.

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