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

In its latest failed bank lawsuit, the FDIC, in its capacity as receiver of the failed County Bank of Merced, California, has filed a complaint against five former officer of the bank. The FDIC’s complaint was filed in the United States District Court for the Eastern District of California on January 27, 2012, just short of three years from the date of the bank’s closure. A copy of the FDIC’s complaint can be found here.

County Bank failed on February 6, 2009 and the FDIC was appointed as its receiver. The FDIC’s lawsuit has been filed against five former officers of the bank, each of whom served on the bank’s Executive Loan Committee. The complaint alleges claims against them for negligence and breach of fiduciary duty, in connection with 12 loans the bank made between December 2005 and June 2008, which the FDIC says caused the bank losses in excess of $42 million.

The FDIC alleges that the five defendants caused or allowed the bank to make “Imprudent real estate loans, typically for the construction and development of residences.” The complaint alleges that the bank’s real estate lending represented “significant departures from safe and sound practices.” The complaint further alleges that the bank’s management “disregarded the Bank’s credit policies and approved loans to borrowers who were not credit worthy and/or for projects that provided insufficient collateral and guarantees for repayment.”  The complaint further alleges that the bank’s management “unwisely continued risky commercial real estate lending in a deteriorating market even after becoming aware of the market decline.”

The FDIC filed its complaint only days before the third anniversary of the bank’s closure – that is, just before the expiration of the statute of limitations period within which the FDIC could bring its claims. Up until this point during the current bank failure wave, the FDIC has been proceeding very deliberately, in most cases filing lawsuits only after two years or more has elapsed since the date of bank closure.

The FDIC’s filing of this action just before the end of the limitations period is reminder that notwithstanding the FDIC’s deliberate pace in filing these lawsuits, the FDIC does face certain absolute time deadlines. Moreover, this particular bank’s closure occurred at a time when the number of bank closures began to escalate rapidly. The FDIC took control of increasing numbers of banks as 2009 progressed and on in to early 2010, which means that the limitations period within which the FDIC will have to file lawsuits will be about to run out for a host of failed banks in the coming months.

There were a total of 140 bank failures in 2009, ten in February 2009 alone, after only 25 bank failures in all of 2008. The numbers of bank closures escalated even further after February 2009. Indeed, there 95 bank failures in the last six months of 2009. In other words, as we move through 2012, the FDIC will be approaching the statute of limitations deadline for increasing numbers of banks.

In light of the approaching limitations deadline the 2009 bank failures, it seems likely that over the next few months we will see a surge in case filings, many, like the complaint here, filed at the very end of the applicable limitations period.

In any event, the FDIC’s action in the County Bank case represents the twenty-first failed bank action the agency has filed so far as part of the current bank failure wave, and already the third so far in 2012. The FDIC’s first two actions this year, both of which were filed in Puerto Rico, are described here.

Year End Securities Litigation Review Webinar: On February 1, 2012 at 11:00 am EST, I will be participating in a year-end securities litigation review webinar sponsored by Advisen . The webinar will be moderated by Advisen’s Jim Blinn and will also include my good friend David Williams of Chubb. The webinar is free. To register and for additional information, refer here.

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One feature of the recent changing mix of corporate and securities litigation has been the rise in the filing of follow-on derivative lawsuits in the wake of securities class action lawsuit filings. As Wilson Sonsini partner Boris Feldman recently noted, “like a moth drawn to a candle,” the derivative bar watches class action filings and “just cannot resist cribbing the class action complaints, even though the company’s setback does not suggest any breach of fiduciary duty.”

The rise in the number of follow-on derivative lawsuits seems to be attributable to the efforts of smaller or newer plaintiffs’ firms to try to get a piece of the action. The problem with these kinds of cases is that they just compound the defendant company’s litigation expense and threaten distraction from or even prejudice to the company’s defense in the class action suit – all as a result of a derivative action supposedly brought on the company’s behalf.

One way to try to reduce at least some of the potential evils associate with these follow-on suits would seem to be to stay the derivative suit until the securities suit has concluded. In many cases, the derivative plaintiffs agree to a stay. The question whether the court itself should order a stay of one of these follow-on suits was addressed in a January 27, 2012 Delaware Chancery Court opinion (here) in a derivative action involving SunPower Corporation.

The litigation arose after SunPower announced that it would have to restate its prior financials due to the underreporting of expenses at its Philippine manufacturing operations. Following these announcements, the company and several of its directors and officers were named as defendants in securities class action lawsuits (later consolidated) in the Northern District of California. The consolidated class action case was initially dismissed without prejudice, but the class action plaintiffs’ amended pleading survived the defendants’ renewed motion to dismiss. The court’s December 19, 2011 denial of the defendants’ renewed motion to dismiss can be found here.

Following the filing of the securities class action lawsuits, additional plaintiffs filed five derivative lawsuits in California state court, seeking indemnification from the individual defendants for any expenses the company incurs in the class actions. Those five California derivative actions were stayed by agreement.

However, yet another plaintiff filed a separate derivative action in Delaware Chancery Court, after having first exercised his rights to inspect the company’s books and records. The Delaware plaintiff contended that his access to confidential company documents has shown that the company had incurred million of dollars of costs, even before the class action lawsuits were filed, due to the accounting issues with the company’s Philippine operations.

The defendants moved to stay the Delaware plaintiffs’ action, arguing that proceeding with the derivative suit would prejudice the company’s defense in the securities suit. The defendants also argued that because the relief the Delaware derivative plaintiff seeks is largely contingent on the outcome of the securities suit, it would be premature for the derivative suit to proceed. The derivative plaintiff argued that because his filings were under seal, the defendants overstated the prejudice, He also argued that the because of the $8 million in expenses the defendants had already incurred in connection with the restatement, there were noncontingent damages ripe for adjudication.

In granting the defendants’ motion for a stay, Vice Chancellor Donald F. Parsons, Jr. concentrated on the overlap between the factual allegations in the class action lawsuit and in the derivative lawsuit. Both actions accused the individual defendants of having knowledge of the alleged wrongdoing or having ignored red flags. But, Parsons noted, the derivative plaintiff “makes these arguments on behalf of the corporation while the Securities Class Action plaintiffs make them against SunPower.”

Parsons said that “it is not practical for two actors … to pursue divergent strategies in two simultaneous actions on behalf of the same entity.” As a result, “simultaneous prosecution of both actions” would be “unduly complicated, inefficient and unnecessary.” The prosecution of the derivative suit would involve “taking actions designed to refute the merits of the Company’s defense of the Securities Action and vice versa.” This creates a “significant risk that the prosecution of [the derivative suit] will prejudice SunPower.” Parsons notes there is also a significant risk of inconsistent rulings.

Parsons also rejected the plaintiffs’ argument that the derivative suit was ripe for adjudication because at least a portion of the claimed damages are not contingent. Because the fill extent of the alleged damages cannot be known until the class action is resolved, “the wisdom as a practical matter of treating the indemnification claims as unripe until the liability for which the indemnification is sought is determined is plain.” Because the derivative claims cannot be adjudicated in full, the sensible ordering of events is for the class action to go first.

Accordingly, Parsons ordered the derivative suit to be stayed indefinitely, allowing the plaintiff to seek to have the stay lifted upon the earlier of the final dismissal of the securities class action or December 31, 2012.

Discussion

As discussed in a January 27, 2012 memorandum from the Morrison Foerster law firm (here), Vice Chancellor Parsons ruling provides “the clearest articulation to date of the danger follow-on derivative actions poste to corporations on whose behalf they are supposedly brought.” The ruling, according to the memo, “should prove a valuable guide to courts” trying to manage simultaneous derivative and class action litigation in the future.

The larger context for the problems Vice Chancellor Parson addressed is the increasing proliferation of conflicting litigation surrounding any type of corporate event. The phenomenon of multiple class action lawsuit filings following a stock drop has long been part of the corporate and litigation scene. These kinds of cases are more easily consolidated and managed. What has changed is increasing numbers of follow on derivative lawsuits, often, as here, filed in multiple jurisdictions, and which are not so easily consolidated or coordinated.

Just to quantify this problem and to proviide a little bit of historical context, in its 2011 securities class action litigation report, NERA Economic Consulting reported that the number of settled securities class action cases that were accompanied by parallel derivataive lawsuits has grown dramatically in recent years. NERA reports that prior to 2002 (when the Sarbanes-Oxley Act was enacted) the number of settled cases that were accompanied by a parallel derivative action ranged between 11 and 22 percent a year. However, from 2007 through the first half of 2011, the range was from 56 to 65 percent.

The threat of prejudicing the defense of the securities class action lawsuit is only one of the problems associated with the increase in follow-on derivative litigation. The proliferation of multiple simultaneous suits in multiple jurisdictions imposes a costly and vexatious burden on the companies involved. The SunPower case provides a good illustration of these problems. The Delaware derivative plaintiffs alleges that the company “is largely self-insured so that expense, settlements or damages in excess of $5 million in these actions will not be recoverable” under insurance. The costs associated with the derivative plaintiffs’ action simply add to this burden. As NERA noted in its year-end securities litigation report, in commenting on the phenomenon of folllow-on derivative lawsuits, "to the extent [the individual defendants] have indemnification agreements or continue to hold board or management positions, derivative litigation may prove expensive for the issuer." 

Unfortunately for the company, the derivative action has merely been stayed, not dismissed, which raises the question of what will happen in the future. The likelihood is that the class action lawsuit will settle at some point. (Yes there is a chance that it will be resolved on summary judgment, and an even smaller chance that it will be resolved at trial, but the greatest likelihood is that it will be settled.) Given the apparent limited amount of insurance available, the class action settlement will likely be modest. And if the case settles, the stipulation undoubtedly will include the usual defense disclaimers of liability or wrongdoing.

At that point, the stayed derivative litigation will finally be ripe. But at that point, the remaining insurance will almost certainly be gone. The derivative plaintiffs, without the benefit of any factual findings in the class action suit, will have to try to establish liability, forcing the individual defendants to incur additional defense expenses (which almost certainly would be advanced to the defendants under the company’s indemnification provisions), all to try to extract some payment out of the personal assets of the individual defendants. Given these factors, it seems highly probable that any ultimate recovery in the derivative suit – and therefore any benefit to the company – would be slight. But in the meantime, the company and its senior management are forced to endure the burden and expense of continued, redundant litigation.

There may be (infrequent) occasions where this kind of liltigation-about-litigation is not burdensome, vexatious and wasteful. Nevertheless, it is very hard to observe the expansion of this kind of follow-on derivative litigation with anything but alarm. If, as seems likely at least for now, this kind of litigation is going to continue to increase, it is going to be increasingly important for courts to develop rules of the road, if for no other reason to make sure that these suits do not further harm the very companies on whose behalf they supposedly are brought. That is the reason I think Vice Chancellor Parsons ruling is important, because it represents a practical recognition that the courts are going to have to police things to prevent the whole process from getting out of control.

I know that the plaintiffs’ attorneys behind these cases will argue that the cases are necessary to protect companies from the expenses the corporate defendants are forced to incur when alleged management misconduct leads to shareholder litigation. Other observers might perhaps more accuratey characterize these cases as nothing more than a vehicle by which the plaintiffs' firm involved is seeking to extract a fee.  I would argue that a better way to address the cost of litigation problem is through a prudent risk management approach including a comprehensive program of D&O insurance. If the company has an appropriate D&O insurance program in place, the class action litigation costs would not fall on the company, and there would be no even theoretical need for (or indeed any justification for) these types of follow-on lawsuits in most circumstances.

At least from the allegations Vice Chancellor Parsons recites in his opinion, it appears that this company carried only nominal amounts of D&O insurance. The amount and extent of litigation in which this company has become involved underscores the fact that in this day and age, well-advised firms should carry more than minimal amounts of insurance. Indeed, this case shows that in a changing litigation environment, traditional notions of limits adequacy may no longer be sufficient. The possibility that companies may have to be prepared to fund a multi-front defense suggests that companies may need more insurance than in the past in order to be fully protected.

A Dated Debate: We generally refer to the year 1901 as “nineteen-oh-one.” Similarly, 1909 is “nineteen-oh-nine.” But we refer to 1910 as “nineteen-ten” not “nineteen-and-ten.” My point here is that conversational conventions eventually tend toward to simplest and most economical expression.

In our current century, 2001 is referred to as “two thousand and one.” 2009 is referred to as “two thousand nine.” I suspect the convention will shift as the century progresses. For example, when we finally reach 2020 (if we do in fact make it that far), I feel quite certain the year will be referred to as “twenty-twenty” and not as “two thousand twenty.” Similarly, 2021 will be “twenty-twenty-one,” not “two thousand twenty one.”

Which brings me to the current year, 2012. Why do we refer to it as “two thousand twelve” rather than “twenty twelve”? I am not sure why, but “twenty twelve” is not in widespead usage. I feel quite certain that eventually we will all shift to the “twenty – “ formulation, just as a century ago, usage shifted to the “nineteen –“ custom.

Maybe it won’t be until 2020, but the “twenty –“nomenclature will eventually be the conversational way to refer to years during the current century. It may be too late now to change the way we refer to the current year, but it still may be possible to make some progress on this now.

As part of our forward-looking mission here at The D&O Diary, we would like to propose that we all get an early start on the rest of the century. Specifically, and with next year still a good eleven months off, we would like to respectfully suggest that everyone make a mutual commitment to refer to next year as “twenty-thirteen” rather than as “two thousand thirteen.” Why wait until 2020 to get on with the future?

I am sure many of you are wondering why I am so concerned about this. Here at The D&O Diary, we consider it part of our job to worry about these things so you don’t have to. Now remember, its “twenty thirteen,” not “two thousand thirteen.” O.K., everybody back to work.

There’s Nothing Quite Like a Real Book: Ironically, I first saw this video on my iPad. Ironically, it is a video about the magic of books. Irony notwithstanding, it is still a pretty cool video.

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The changing mix of corporate and securities litigation is a recent phenomenon on which I have frequently commented on this blog. While identifying the fact of the change is relatively straightforward, explaining it is more challenging. According to a January 11, 2012 article in The Review of Securities & Commodities Regulation entitled “Shareholder Litigation After the Fall of an Iron Curtain” (here), written by Boris Feldman of the Wilson Sonsini law firm, the changing pattern in corporate and securities litigation filings is a result of changes in the plaintiffs’ securities litigation bar – particularly, the elimination of a dominant plaintiffs’ firm. These changes, according to Feldman, have resulted in the five recent securities litigation trends he identifies in his article.

For many years, according to the article, the Milberg Weiss law firm was the “dominant securities plaintiffs’ law firm.” Even after it split into two separate law firms on the East and West Coasts, it was, according to Feldman, “the 800-pound gorilla of the shareholder litigation jungle.” In addition to dominating the litigation, the firm “exercised some discipline” on the rest of the plaintiffs’ securities bar, demonstrating “substantial influence over smaller firms and parvenus.”

Now, “for reasons of retirement and incarceration,” the familiar patterns of the past have been disrupted. Feldman analogizes this disruption in the standard order of the securities litigation world to the disruptions that followed in the political world in the wake of the fall of the Iron Curtain.

Without a dominant firm, smaller firms are now “free agents,” and new entrants have appeared. These smaller and newer players are “less predictable (and often less rational).” According to Feldman, these changes in the plaintiffs’ bar explain five trends in shareholder litigation he identifies in his article.

First, Feldman notes the recent rise in multi-jurisdiction litigation, where a single company can face multiple suits in different jurisdictions arising out of the identical factual circumstances. Feldman notes that although this might have happened from time to time in the past, when it did, the plaintiffs firms worked things out among themselves. But this is far less common now. Instead, firms that have “decided they have a better shot at participating in the litigation” have consciously chosen to file outside the company’s home jurisdiction, particularly in connection with shareholder derivative litigation. This multiplication of litigation has forced corporate defendants to have to defend themselves in multiple courts, resulting in added expense and uncertainty.

The second trend Feldman notes is the proliferation of demand letters. In the past, plaintiffs would bypass this statutory prerequisite to the filing of derivative litigation, out of a concern that the demand represented a concession that demand was not futile. More recently, however, demand letters have become “fashionable,” as secondary players, eager “to get in on the action,” will submit a demand even if derivative litigation has already been filed. Feldman notes that this may “actually be advantageous to defendants,” as courts will often stay derivative litigation while the defendant company considers the demand.

Third, Feldman notes the rise of derivative litigation paralleling shareholder class action lawsuits. In the past, the type of stock drop that would trigger a 10b-5 class action would not also spawn a derivative suit, at least in the absence of a major accounting problem and restatement. Now, parallel derivative suits are “de rigeuer.” The plaintiffs bar now “just cannot resist cribbing the class complaints,” even though the company’s setback does not suggest any breach by the company’s board. This change is attributable to a simple explanation: “different suits for different folks.”

The fourth trend Feldman notes is the automatic filing of litigation when a merger is announced. When “giants roamed the earth,” there was merger objection litigation, but not every single time a merger was announced. Now the litigation is pervasive and it follows a standard pattern of an initial suit alleging a breach of fiduciary duty after the deal is announced, followed by an amended complaint alleging disclosure violations after the proxy has been filed. The other change Feldman notes about this litigation is that in the past, the litigation went away once the deal closed, as the defendants defeated the preliminary injunction seeking to block the deal. Now the merger suits are increasingly surviving the closing, based on amended allegations that “range from weak to laughable.” Though few of these suits result in a payout, the plaintiffs’ lawyers “persist,” seeking “a place in the sun.’

Finally, Feldman notes the rise in actions under Section 220 of the Delaware Code seeking to inspect the corporate defendant’s books and records. Feldman says there has been more of this litigation in the past year than in all prior recorded history. In part this rise is due to encouragement from members of the Delaware judiciary. But this rise is also attributable to a cottage industry of plaintiffs’ firms eager to “get in on the action.” Defendant companies find these suits impossible to avoid; whatever they produce, the plaintiffs ask for more until they have “created an impasse and gotten a ticket to sue.” Feldman suggests that this “epidemic” of Section 220 litigation is “unlikely to be solved without intervention by the Delaware legislature.”

Feldman closes by suggesting that in the current, rapidly changing world, the “more fragmented world of plaintiffs’ securities lawyers will continue to amaze and surprise us with their innovation and resilience.”

Very special thanks to Boris Feldman for sending me a link to his article.

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In the FDIC’s latest lawsuit filed in its role as receiver of a failed bank, the FDIC not only named as defendants nineteen former directors and officers of the failed bank, but also included as defendants seventeen of their spouses and the failed bank’s D&O insurer. A copy of the FDIC’s January 18, 2012 complaint, filed in the agency’s capacity of receiver of the failed R-G Premier Bank of Puerto Rico, can be found here. UPDATE: See also the note below regarding the separate actoin filed in the District of Puerto Rico, involving the directors and officers of teh failed Westernbank Puerto Rico, which also involves D&O insurer defendants.

As discussed here, R-G Premier Bank failed on April 30, 2010. According to the FDIC’s complaint, its closure represented “one of the largest bank failures in Puerto Rico’s history, costing the Deposit Insurance Fund over $1.46 billion in losses.”

In its complaint, the FDIC asserts claims for gross negligence against certain former directors and officers of the failed bank, alleging that the bank’s losses and ultimate failure arose from the bank’s aggressive commercial lending. The complaint alleges that the commercial lending operations were essentially unsupervised, even though the commercial lending department “recklessly” pursued “explosive commercial loan growth.” The complaint alleges that the director and officer defendants “ignored numerous warnings from multiple sources about serious problems” in the bank’s management and lending operations.”

The complaint alleges that the director and officer defendants “exacerbated and accelerated” the bank’s loan losses “by robotically approving virtually any loan request that crossed their desks, even though such loan requests had been processed through the obviously deficient lending structure they had created at the Bank.” The FDIC bases its claims against the directors and officers on the individuals’ alleged “grossly negligent failure to exercise due care and any business judgment”; “grossly negligent failure to inform themselves about and to exercise adequate oversight over the Bank’s lending functions” and on the allegations that the defendants “knew or should have known” that the alleged problem loans identified in the complaint “were extremely unlikely to be paid back, and also the equally clear risks of injury to the Bank from the Bank’s inappropriate lending structure.”

The FDIC seeks to recover damages “in excess of $257 million” the bank allegedly incurred “as a result of the breaches of fiduciary duties and gross negligence” of the director and officer defendants in connection with 77 transactions identified in the complaint. The claims against the 17 spouses and conjugal partners who are also named as defendants “are based on their legal relationship to the Directors and Officers.”

The complaint also names as a defendant the insurer that issued two D&O liability insurance policies to the bank’s holding company. The two policies consist of a primary $25 million policy and a $10 million excess policy, both issued by the same insurer. Both policies are alleged to have had policy periods running from November 30, 2008 to December 30, 2009, with an optional extension period until December 30, 2010. The FDIC alleges in its complaint that the optional extension period was exercised on December 29, 2009. The complaint also alleges that on December 23, 2010, the FDIC sent a demand for civil damages to the directors and officers, with a copy of the demand also sent to the D&O insurer.

In Count III of the complaint, which is denominated as a “Claim for Direct Relief,” the FDIC alleges that its claims against the directors and officers “fall within the coverage provided” under its policies, and that the insurer is “liable” for “$35 million in damages caused to the Bank by the gross negligence of the Defendants.” The complaint seeks a judgment against the insurer “for at least $35 million.”

Discussion

In prior posts discussing the FDIC’s litigation against former director of failed banks, I have suggested that the real battleground for many of these suits may be the FDIC’s coverage disputes with the failed bank’s D&O insurer. This case, in which the FDIC named the D&O insurer as a defendant along with the former directors and officers, seems to make that aspect of these circumstances explicit.

This is not the first occasion on which the FDIC has directly named a failed bank’s D&O insurer as a defendant in a liability action. (For a prior example, refer here). Those readers uncertain how the FDIC is purporting to proceed directly against the insurer without first obtaining a judgment against the individual insureds may be interested to know that, at least according to sources I have reviewed online, Puerto Rico has a direct action statute, allowing those claiming injury from a torfeasor’s action to proceed directly against the tortfeasor’s liability insurer. At least based on my quick review of the subject, that would seem to explain the FDIC’s move of including the D&O insurer as a defendant in the suit.

Without being able to go behind the scenes it is hard to know for sure what the basis of the coverage action may be. Just based on the date on which the D&O policies originally incepted, it is not unlikely that the policies when issued included a regulatory exclusion. Some insurers have also taken the position that the insured vs. insured exclusion found in most D&O policies precludes coverage for claims brought by the FDIC as receiver, which is an issue that undoubtedly will be litigated heavily in connection with many of these failed bank coverage disputes.

It is also possible that the D&O insurer is asserting coverage defenses arising from the fact that the bank did not fail and the FDIC did not assert claims against the directors and officers until after the inception of the policies’ extensions. The insurer may be asserting defenses based on the timing of these various events relative to the policies termination dates and reporting deadlines. At least according to the FDIC’s recitation in the complaint, it appears that the FDIC did assert its claim against the directors and officers prior to the expiration of the extension.

The FDIC’s assertion of claims against the spouses and conjugal partners are obviously designed to allow the FDIC to be able to enforce any judgment against property jointly held by the individual directors and officers and their spouses. This is not the first occasion on which the FDIC has asserted claims against spouses of failed bank directors and officers. For example, in connection with the FDIC’s lawsuit against the certain former officers of Washington Mutual, the FDIC also asserted claims there against two of the officers’ spouses. The FDIC’s assertion of claims against the spouses is an illustration of the importance of the language found in many D&O policies which extends the definition of the term “Insured Persons” to include the spouses or domestic partners of the insured entity’s directors and officers, but only to the extent the spouses or partners is a party to a claim as a spouse to the director or officer.

One anomalous feature of the bank’s D&O insurance structure is that the both the bank’s primary D&O insurance policy and its excess D&O insurance policy were both  issued by the same D&O insurer. That is an unusual arrangement for many reasons, not the least of which is that many insurers would be reluctant to have such concentrated exposure to any one risk. The extent of the insurer’s exposure is one more reason I suspect that the insurer may considered its insurance of this risk as well defended, for example through the inclusion of a regulatory exclusion or even perhaps the preclusion of coverage for acts that incurred prior to the policies’ November 30, 2008 inception.

Of course, I could be wrong about the presence of these defensive features, but I still think it is unusual that the insurer would have take a full $35 million exposure to one financial institution, especially given the events that were taking place in the global financial marketplaces at that time.

The FDIC’s lawsuit against the former directors and officers of R-G Premier Bank of Puerto Rico is the nineteenth lawsuit the FDIC has filed in connection with the current wave of bank failures, and the second so far during 2012. The FDIC undoubtedly will be filing many more suits in the months ahead. Indeed, on the FDIC’s website page providing information about the agency’s litigation efforts, the FDIC states that as of January 18, 2012, the FDIC has authorized suits in connection with 44 failed institutions against 391 individuals for D&O liability with damage claims of at least $7.7 billion. This includes 19 filed D&O lawsuits (2 of which have been dismissed after settlement with the named directors and officers) naming 161 former directors and officers. In other words, even just looking at the suits authorized so far, there are many law suits yet to come. And the FDIC has been authorizing increased numbers of suits every month, so the likelihood is that many more lawsuits will be authorized and filed as we head forward in 2012 and beyond.

UPDATE: Following my initial publication of this post, a loyal reader provided me with a copy of the January 20, 2012 Amended and Restated Complaint in Intervention that the FDIC filed in the District of Puerto Rico in an action involving both the former directors and officers of the failed Westernbank and certain of their spouses, as well as the D&O insurers for Westernbank's holding company. A copy of the FDIC's complain can be found here.

Regulators closed Westernbank on April 30, 2010, which according to the FDIC's complaint, cost the insurance fund $4.25 billion. In October 2011, certain of the former Westernbank directors and officers had sued the bank's primary D&O insurer in state court in Puerto Rico. The FDIC as receiver for Westernbank moved ot intervene in the state court action, and on December 30, 2011, removed the state court action to the District of Puerto Rico. On January 20, 2012, the FDIC filed its amended complaint in intervention, in which it named as defendants certain additional directors and officers, as well as the excess D&O insurers in the bank's D&O insurers program. The FDIC expressly asserts its claims against the D&O insurers under Puerto Rico's direct action statute. Certain of the individual direcrors and officers have moved to remand the action back to state court.

The FDIC's action against the former directors and officers of Westernbank represents the twentieth action that the agency has filed so far as part of the current wave of bank failures, and also represents yet another example of a case where the real battleground may be the D&O insurance coverage dispute.

The First Bank Closures of 2012:  This past Friday night, the FDIC also took control of the first three failed banks of 2012, as reflected here. The FDIC closed banks in Florida, Pennsylvania and Georgia, the first three banks to fail in over a month. The presence of a Georgia bank among the first group of bank failures is hardly a surprise, as the bank’s 74 bank failures during the period January 1, 2008 through December 31, 2011 is by far the highest total for any state during the period. Florida, with 58 bank failures during that period, has the second highest total.

Is Morrison the "Global Securities Case of the Decade"?: In a very interesting and thorough January 20, 2012 article on the Am Law Litigation Daily (here), Michael Goldhaber asks the qustion whether or not the Supreme Court's 2010 decision in Morrison v. National Australia Bank is the Global Securities Case of the Decade (so far, at least). Among other things, Goldhaber reviews the wide swath that Morrison has cut through cases pending in the district courts, noting that "perhaps no other precedent has ever cut down so many claims of such value so rapidly." The article details the effects that the Morrison opinion has had and is likely to continue to have.

Teaching Fellowship at UCLA Law School: Some readers of this blog may be very interested to know that the Lowell Milken Institute for Business Law and Policy at the UCLA Law School is now accepting applications for the Lowell Milken Institute Law Teaching Fellowship. The fellowship is a full-time, year-round, one or two-year academic year-position beginning in July 2012. The position involves teaching, research and writing, as well as other duties. Applicants must already hold a JD. The application deadline is March 1, 2012. Further information about the fellowship program can be found here.

Now for Something Different: For today’s musical interlude, and as a complete contrast to the North Korean Kindergarten Guitar Quintet whose oddly disturbing video I posted a few days ago, here is a video of a very different kind of guitar quintet, involving as it does one guitar and ten hands. I understand this video and the song are both very popular in certain circles. I suspect it would not catch on in North Korea. The song is “Somebody That I Used to Know” by the group Walk Off the Earth.

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Securities class action filings rise slightly in 2011 compared to the prior year but remained below historical averages according to the annual study of Cornerstone Research, prepared in conjunction with the Stanford Law School Securities Class Action Clearinghouse, which was released today. A copy of the report can be found here, and Cornerstone Research’s January 19, 2012 press release can be found here. My own analysis of the 2011 securities class action lawsuit filings can be found here.

According to the report, there were 188 securities class action lawsuit filings in 2011, compared to 176 in 2010, and compared to the 1997 to 2010 average annual average number of filings of 194. The two largest factors in the number of 2011 filings were the heightened number of M&A-related filings (43) and the elevated number of filings involving U.S.-listed Chinese companies. (33).

The Cornerstone Research report contains a number of insights about the 2011 filings beyond those that have appeared in previously published analysis of the filings. Among other things, the report notes that three percent of companies listed on the three major U.S. exchanges (NYSE, NASDAQ and Amex) were sued in securities suits in 2011. This represents the highest annual percentage since 2004 and is above the 1997 to 2010 annual average percentage of 2.4 percent.

On the other hand, in 2011 only 3.2 percent of S&P 500 companies were sued, “making it the least litigious year for S&P 500 companies since 2000.” Historically, larger companies have been more likely to be sued in a securities class action lawsuit, and that trend continued in 2001. Thus, while only 3.2 percent of the S&P 500 companies were sued in 2011, those companies represented 5.1% of the S&P 500 market capitalization.

This year’s Cornerstone Research report also contains a number of new analyses, including an analysis of the number of private securities class action lawsuits filed between 1996 and 2011 involving Foreign Corrupt Practices Act allegations. The report shows that there were four such filings in 2011, the highest annual number of filings since 2006 (when there were also four filings).

The report also contains a new analysis of the experience of the judges handling securities class action lawsuits during the period 1996 to 2011. The analysis shows that while there are a relatively small number of judges that handled more than ten cases during that period (65), a much larger number of judges (329) handled only one case, and the vast majority of judges (582) handled only three or fewer cases. The inference is that many securities cases are being handled by judges who are relatively inexperienced with securities cases – although there is also a smaller number of judges that are very experienced with these types of cases.

The report also reflects some interesting insight about the plaintiffs’ law firms’ involvement in these cases. The report sets out which law firms are selected most often as lead counsel in securities class action cases that do not involve M&A related allegations and then separately lists the firms most often selected as lead counsel in the M&A cases. The interesting thins is that the lineup of law firms leading the M&A cases looks very different than the lineup for the other cases. These differences shed some light on the changing mix of corporate and securities lawsuits and the growth in the number of M&A cases, suggesting that among other things the rising M&A related litigation activity may reflect dynamics within the securities’ plaintiffs’ bar.

Speaking of M&A related cases, Cornerstone Research has also recently released a separate companion report specifically focused on M&A related litigation, which can be found here.

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Investors have a number of rights under federal and state law which they can enforce through litigation, including for example the right to file individual or class actions for damages. But can investors be required to submit these kinds of claims to binding arbitration in lieu of litigation? That is the question posed by a two different initiatives corporate reformers are currently pursuing.

One of the basic features of our system of corporate laws is that aggrieved shareholder can enforce their rights or seek damages by filing a lawsuit. But at the same time, our litigation system is costly and court processes can be both time-consuming and burdensome. For that reason, there have been many proposals over the years to provide for the arbitration of shareholder disputes. For example, in its November 2006 report (here), the Committee on Capital Markets recommended that public companies be allowed to have shareholder votes on the use of arbitration to resolve shareholder claims.

A couple of different developments are bringing these issues to the forefront now. First, on January 10, 2012, the Carlyle Group, an investment partnership preparing to conduct a public offering, submitted to the SEC an amended filing on Form S-1 that, among other things, specifies that its partnership agreement will provide that all limited partners must submit any claims to binding arbitration.

 A January 18, 2012 Bloomberg article by Miles Weiss entitled “Carlyle Seeks to Ban Shareholder Lawsuits Before IPO” (here) discusses the mandatory arbitration provisions described in Carlyle’s filing. Susan Beck’s January 18, 2012 Am Law Litigation Daily article about the Carlyle filing can be found here.

The Carlyle offering is a little unusual, because the firm does business as a limited partnership and the securities in the planned offering will consist of limited partnership units. The rights acquired with the units are defined by a limited partnership agreement. According to the company’s filing, the partnership agreement will provide that every limited partner “irrevocably agrees” that “any claims, suits, actions or proceedings arising out of or relating in any way to the partnership agreement or any interest in the partnership…shall be finally settled arbitration.” The filings explain that the kinds of actions to which this dispute resolution provision apply include without limitation disputes under the Delaware Limited Partnership Act and the federal securities laws. The filing also explains that the dispute resolution provisions specify that the each limited partner “irrevocably waives” any objection he or she may have to arbitration. (The filing’s disclosures relating to the partnership agreement’s dispute resolution provisions can be found here.)

The arbitration requirements reported in the filing are quite detailed. The dispute resolution provisions specify that the arbitration must take place in Wilmington, Delaware. The arbitration proceedings must be confidential and the amount of any award will not be disclosed. The provisions further specify that the person bringing the claim may only pursue arbitration in an individual capacity “and not as a plaintiff, class representative or class member,” and the arbitrators may not consolidate more than one person’s claim.

UPDATE: As discussed in Victor Li's February 3, 2012 Am Law Litigation Daily article (here), Carlyle Group has announced that in response to pressure from the SEC and others, it as decided to withdraw its proposed provision requireing investors to arbitrate claims.

A separate unrelated development involves the efforts of certain investors to put a proposal on 2012 proxy ballots to require shareholder claims to be arbitrated. According to information provided to me by University of Michigan Law Professor Adam Pritchard, shareholders at Pfizer and Gannett are currently seeking to have proposals included on upcoming proxy ballots that would amend the companies' corporate charters to require the arbitration of shareholder disputes.

The companies are seeking SEC authorization to omit the shareholder arbitration proposals from their proxy ballots, arguing that the arbitration requirement would violate both state and federal law. The companies contend that the arbitration requirement would violate Delaware law, which they contend provides shareholders with the right to litigate claims in the Delaware Court of Chancery absent a clearly expressed intent to arbitrate. The companies also argue that the arbitration requirement would violate Section 29 of the ’34 Act, which voids any contractual provision that would seek to waive any right under the statute. Finally, the companies contend that the SEC itself historically has taken the position that a mandatory arbitration charter provision would be against public policy.

Advocates for the shareholders seeking to introduce the shareholder proposals argue that there is liberal federal policy favoring arbitration agreements and that there is no support for the argument that an arbitration requirement would violate state law. They contend that Delaware law allows the use of corporate charters to embody agreements between a corporation and its shareholders.

They also argue that the Supreme Court has dealt with anti-waiver clauses in federal statutes and has consistently supported arbitration. In its January 10, 2012 opinion in CompuCredit v. Greenwood, the Court held that a right to sue provision in the federal consumer credit statute does not prohibit the enforcement of an arbitration agreement. The advocates for the shareholders argue the antiwaiver clause in Section 29 prohibits the waiver only of substantive rights, not procedural rights and is not a barrier to the enforcement of an arbitration requirement. The advocates (who include Professor Pritchard) contend that arbitration would not undermine the remedial and deterrent purposes of the federal securities law, arguing in further reliance on the CompuCredit case that the Supreme Court has said that arbitration is the equivalent of litigation.

Each of these initiatives is poised to be addressed shortly. The SEC will be called upon to respond to the Carlyle Group’s offering document and decide whether the offering may go forward with the dispute resolution requirement unchanged. Among other things, the SEC will have to determine whether or not Carlyle’s partnership ownership structure is a differentiating consideration. According to the Bloomberg article linked above, in 1990 the SEC refused to allow the offering of a savings and loan to go forward until the firm removed the arbitration clause from its corporate charter.

The SEC will also have to determine whether or not Pfizer and Gannett can omit the shareholder proposals from their proxy ballots. With deadlines for proxy mailings approaching, the SEC will have to reach a decision in time to allow the companies to prepare their proxy ballots. Of course even if the shareholder initiatives are included on the proxy ballots, a majority of shareholders would have to vote in favor of the proposals in order for them arbitration requirements to come into force.

Discussion

The motivations behind these efforts to require shareholder disputes to be arbitrated rather than litigated are perfectly understandable. Anyone who has ever been involved in any way in a material shareholder lawsuit knows that they are terribly costly and that they impose enormous burdens on all of the litigants. Taken collectively, shareholder litigation imposes an enormous cost on corporations in our country.  Reducing these costs is a highly desirable objective.

On the other hand, requiring shareholders to arbitrate their corporate claims would represent a massive change in the way that investor rights are addressed. Even if the U.S. Supreme Court thinks arbitration is equivalent to litigation, the fact is that in arbitration certain procedures are unavailable – like, for example, the ability to appeal.  And there are features of the Carlyle requirements that are clearly designed to ensure that arbitration would not be equivalent to litigation (for example, the prohibition against claimants proceeding collectively).

A change of this magnitude that has at least been approved by a shareholder vote has more of a sympathetic appeal. But even if the Carlyle offering is allowed to go forward with its offering with the dispute resolution procedures in its partnership agreement, or if Pfizer or Gannett have a mandatory arbitration shareholder proposal on this year’s proxy ballot, it would remain to be seen what would happen and how the arbitration provisions would be enforced when claims arise later. Court would then have to determine whether or not the provisions were valid and enforceable.

If any of these initiatives are permitted to go forward, it will be interesting to see what happens next. If Carlyle were able to include the mandatory arbitration provision in its charter (and if the reason Carlyle is permitted to do so is not linked to the fact that it is a partnership), it would seem likely that other companies would seek to implement similar provisions in the charters prior to their initial public offerings. And if the activist shareholders are successful in getting the mandatory arbitration issue on the Pfizer or Gannett proxy ballots, it seems likely that shareholders at other companies would pursue these same initiatives.

Though I could see these kinds of initiatives quickly spreading to other companies, these initiatives may not be popular with all shareholders. Indeed, I could easily imagine many shareholders actively opposing these types of efforts, taking the view that the opportunity to resort to the courts to seek redress of grievances is a basic and important right and an important tool to ensure that corporate officials abide by their legal duties.  The plaintiffs’ securities bar undoubtedly would become actively involved in resisting efforts to introduce these kinds of changes elsewhere.

Thus even of these current initiatives succeed, we would still be a very long way from the elimination of our current system of shareholder litigation. Nevertheless, it will be very interested to see where these current initiatives lead. The possibility for the adoption of a requirement for the mandatory arbitration of shareholder claims presents at least the theoretical chance for a radial revision on our current system of shareholder litigation.

One final note. The arbitration provision in the Carlyle partnership provision is far from the only restrictive aspect of the Carlyle structure. As Ohio State Law Professor Steven Davidoff notes in a January 18, 2012 post on the Dealbook blog (here), Carlyle "is propsing the most shareholder-unfriendly corporate goverance structure in modern history."  He notes that under the Carlyle structure shareholders have no right to elect directors and the company will not hold annual meetings of shareholders. In light of thse constraints and the arbitration provision, "the real question is whether prospective shareholders protest and refuse to participate in Carlyle's IPO because of the governance issues."

Thanks to the several readers who sent me links to the Bloomberg article and very special thanks to Professor Pritchard for sending me the information about the Pfizer and Gannett shareholder proposals.

Jobs Link: One of the great blogs that I follow closely is The FCPA Professor blog, which is written by Butler University Law Professor Mike Koehler. Professor Koehler’s posts are always interesting and well written. Now there is another reason to visit the site. Professor Koehler has added a Jobs link to his site (here), in which he will post job openings in his field. Great to see a fellow blogger expanding the universe of blogging possibilities.

The M&A Litigation Problem: In the latest issue of InSights, entitled “Why Mergers and Acquisitions Related Litigation is Such a Serious Problem” (here), I take a look at the issues arising from the growing levels of litigation surrounding M&A transactions.  These kinds of cases are becoming increasingly common and increasingly costly, both of which pose significant problems for companies and for D&O insurers. 

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On January 17, 2012, in a development with important implications for the evolution of post-Morrison remedies for non-U.S. investors, a Dutch court has held for the first time that a collective securities settlement is legally binding. Of even greater significance, the decision arose in a circumstance where none of the liable parties and few of the claimants were domiciled in the Netherlands. The court’s action suggests the possibility of a potentially important mechanism for aggrieved investors who bought shares outside the U.S. to obtain compensation.

A January 18, 2012 memorandum from the De Brauw, Blackstone and Westbroek law firm describing the Dutch court’s ruling can be found here. A January 18, 2012 memo from the Deminor Group about the ruling can be found here.

Background

The Non-U.S. investor proceedings in the Netherlands follow the settlement of related proceedings the U.S. As discussed at length here, Converium investors first filed a securities class action in the Southern District of New York in October 2004. The plaintiffs alleged Converium and certain of its officers and directors, as well its corporate parent, Zurich Financial Services, had made misleading statements about Converium’s financial condition, including the adequacy of its loss reserves for its North American business during the class period. (Converium had spun out of Zurich in a 2001 IPO.)

In 2007, while the U.S. case was pending, SCOR Holding (Switzerland) acquired the voting rights of Converium pursuant to a tender offer.

In rulings dated March 6 and March 19, 2008 (refer here and here, respectively) Southern District of New York Judge Denise Cote, applying pre-Morrison standards for determining the reach of the U.S. Securities laws, certified a class consisting of all persons who purchased Converium American Depositary Shares on the NYSE, and all U.S residents who purchased their Converium Shares on a non-U.S. exchange. Excluded from the class were investors who had purchased their shares on any non-U.S. exchange who were not U.S. residents at the time of their purchased.

The U.S. action ultimately settled for a total of $84.6 million, consisting of $75 million from SCOR and $9.6 million from Zurich. The Southern District of New York approved this settlement and entered final judgment on December 22, 2008.

As detailed here, in July 2010, two groups acting on behalf of the non-U.S. Converium investors entered settlement agreements with Scor and Zurich. The total amount of the two settlements is $58.4 million, of which $40 million is to come from SCOR and $18.4 million is to come from Zurich. The SCOR settlement agreement can be found here and the Zurich settlement agreement can be found here. The two groups acting on the investors’ behalf were Stichting Converium Securities Compensation Foundation, Dutch foundation formed for the purpose of seeking recoveries on behalf of the Non-U.S. Converium investors. Dutch investors in particular were represented by Vereniging VEB NCVB.

Pursuant to the Dutch Collective Settlement of Mass Damages Claims Act (known as WCAM), enacted in 2005, the parties then petitioned the Amsterdam Court of Appeals for approval of the settlement. An English translation of the parties’ petition, as amended, can be found here. The Act basically allows parties to seek court approval for collective settlement of mass actions entered for the benefit of class members who do not opt out.

On November 12, 2010, the Amsterdam Court of Appeals entered a provisional judgment acknowledging its right to recognize the settlements and scheduling a hearing for interested parties to appear and present their arguments with respect to the petition. Interestingly, the November 12 order specifically references the U.S. Supreme Court’s Morrison decision and the impact the decision has on the ability of Non-U.S. investors to pursue securities claims in U.S. courts.  The hearing to determine whether the settlement agreements will be binding was held on October 3, 2011.

On January 17, 2012, the Amsterdam Court of Appeals issued its ruling holding the settlements to be binding. As discussed in the De Brauw law firm memo, there two principal objections to the non-U.S. settlements. First, the objectors contended that the amount of the settlement was unreasonable because the benefit amount under the U.S. settlement was relatively greater than was the case under the non-U.S. settlement. The objectors also took exception to the amount of fees awarded to U.S. counsel was unreasonable.

In its January 17 ruling the Amsterdam Court rejected these objections. The rejected the objection about the settlement amount because the legal position of the non-U.S. investors was weaker than that of U.S. investors because the non-U.S. investors had been rejected from the U.S. class action. In dismissing the objection about the U.S. lawyers’ plaintiffs’ fees, the Court noted that much of the work in support of the settlement had been carried out in the U.S. by U.S. law firms, and that what was considered customary in the U.S. could be taken into account by the Dutch court.

Discussion

The significance of the Amsterdam court’s decision to accept the settlements as binding is that it represents the first time that the Amsterdam Court has approved a settlement “regarding the securities of a company which is not based in the Netherlands and whose securities are not traded on an exchange in the Netherlands.” At least in principle all EU member states, as well as Switzerland, Iceland and Norway will have to recognize the Amsterdam court’s ruling as binding.

The Court’s acceptance of the settlement, particularly given the limited connection of the settlement to the Netherlands, is particularly significant in light of the fact that the Netherlands is “the only European country where a collective settlement can be declared binding on an entire class on an ‘opt out’ basis.” As the DeBrouw law firm’s memo states, the Dutch courts not only have the power to declare the settlement to be binding but “it has the appetite to facilitate such settlements even if the parties to the settlement and the class members only have a limited connection to the Netherlands.” The decision confirms that the Netherlands is “Europe’s most attractive venue for facilitating international settlements.”

As a more general level, as the Deminor memo notes, the settlement also shows that “there is a legally binding settlement mechanism available in Europe that can help to solve complex securities litigation in Europe in an orderly way.”

These settlements represent the latest occasion when the new Dutch procedures have been used to reach settlements on behalf of non-U.S. investors in connection with securities claims that were also the subject of U.S. securities class action lawsuit claims and settlements.

The first and highest profile of these prior settlements was the $381 million settlement on behalf of non-U.S. Royal Dutch Shell investors. As discussed here, in May 2009, the Amsterdam Court of Appeals approved the settlement and authorized payment to Non-U.S. investors. The Dutch settlement followed an earlier settlement of a parallel U.S. securities class action lawsuit settlement on behalf of U.S. investors and arising out of the same factual allegations.

The Royal Dutch and the Converium settlements illustrate possible means by which, even in the wake of Morrison, non-U.S. investors can obtain recoveries for their investment losses. As plaintiffs’ attorneys cast about for alternatives for non-U.S. investors to pursue in the wake of Morrison, the use of settlements under the Dutch procedures may provide a possible remedy.

On the other hand, there are limitations on the usefulness of the Dutch procedure for investors. Only court authorized representatives can pursue claims on behalf of investors, and representatives cannot seek damages. Instead, the Dutch courts can only certify the class and approve out of court settlements. In addition, while the judgment of the Dutch court is in principle enforceable in courts outside the Netherlands, it remains to be seen whether or not other courts will in fact recognize the judgment.

But those limitations notwithstanding, the decision of the Dutch court to recognize the settlements as binding represents a significant step in the evolution of remedies for non-U.S. investors in the wake of Morrison. There is some irony that one of Morrison’s consequences is that has spurred investors to seek remedies elsewhere and thereby advance the development of remedial mechanisms outside the U.S Indeed in its preliminary ruling in the case the Dutch court specifically cited the advent of the Morrison decision as one reason that it should provide relief. In the one of Morrison’s consequences may be the encouragement of the process for developing investor remedies outside the U.S.

Special thanks to the several good friends who alerted me to this development and who sent me links to the law firms’ memos.

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For policyholders whose interests are insured in London, it can be critically important to understand the Lloyd’s claims processes. In the following guest post, my good friend Perry Granof  (pictured) takes a look at recent changes to the Lloyd’s claims processes effective January 1, 2012 that will affect a wide variety of professional liability claims.  Perry is Managing Director of Granof International Group LLC, an insurance consulting and claims service firm specializing in global executive, professional and financial institutions liability. He is also also Of Counsel at the Williams Kastner law firm in Seattle, Washington.

Many thanks to Perry for his willingness to publish his article here. I welcome guest posts from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly.

Here is Perry's guest post.  

I travelled to London in late November 2011 where I met with Lloyd’s claims representatives and first learned about the Lloyd’s Claims Transformation Programme (CTP). According to Lloyd’s, CTP is intended to provide improved customer service and greater flexibility for managing agents.

CTP was introduced to the Lloyd’s market on January 1, 2010, as a pilot program for marine hull, property, and casualty treaty classes of business. The pilot was deemed successful, achieving a 40% average improvement in claims transaction time.  According to Market Bulletin Y45221, dated September 30, 2011, the program was expanded to new claims in Financial Institutions (FI), Professional Indemnity (PI), which includes D&O, and medical malpractice, to be effective as of January 1, 2012.

CTP is intended to modernize, add quality and streamline the Lloyd’s claims handling process. However, it may give way to new disputes and potential opportunities for conflict resolution. Among the various procedural guidelines introduced by CTP is a streamlining of the triage categories from three to two. They are now “Standard” and “Complex” claim categories. The threshold is a specified dollar amount of exposure plus a sundry of other factors such as a potential or actual denial of coverage or allegations of fraud.

All complex claims, unlike Standard claims under the new Lloyd’s protocol, additionally have a second tier lead Managing Agent called a “Second”, which functions in conjunction with the “Lead” Managing Agent. Previously the Second underwriter only played a claims agreement role in certain circumstances, and an oursourced service provider represented the interests of the followers on every claim. The Second helps to ensure that an appropriate strategy is in place to help facilitate a proper resolution of the claim and that the other Managing Agents on the slip that make up the following market are fully represented and kept abreast of developments.

The Second  reviews the documentation and other considerations, which the Lead relied on in its recommendations to the market, and confers with the Lead in connection with: the “Handling of the Claim”; the “Ongoing management of the Claim”; the “Contingent Financial Planning (Reserves, Costs, etc.)”; Experts” and the “Settlement Process." The protocol also makes it clear that the “Followers”, are entitled to “contact the Lead (or Second) to raise queries or share their views on the proposed strategy to resolve the claim.”

A review of the relevant Market Bulletins, in particular Ref: 4522 and 4531, certainly justifies Lloyd’s optimism in touting the advantages of CTP. CTP will lead to an open and more effective claims handling regime among syndicates engaged in the adjustment of Complex claims. However, it could also lead to an increase in conflicts arising between the Lead, the Second and the Follower Lloyd’s syndicates, by giving non-Lead syndicates more voice and responsibilities.

Under the CTP, non-Lead syndicates clearly have standing to raise queries and share their views and can offer platforms for followers in which to dissent to positions offered by Lead carriers. Some emerging conflicts that I can foresee, especially in the PI/FI and D&O classes of business include drop down issues. When an exposure potentially exceeds the available insurance program, a lead insurer may propose a drop down arrangement to save policy limits for itself and possibly throughout the entire tower of coverage. A Second or Follower may respond arguing that the Lead must fully exhaust its coverage before the rest of the market begins contributing to the resolution of the claim. This issue has recently been addressed in the case of Citigroup, Inc. v. Federal Ins. Co., 10-20445, 2011 U.S. App. LEXIS 16316 (5th Cir. Aug. 5, 2011). In Citigroup, the Court held that the excess policies unambiguously required that the primary carrier pay its full policy limit as a condition precedent to the excess carriers filling the gap by dropping down and providing coverage. Still, Citigroup is only binding in the 5th Circuit and the case was determined by the specific policy wordings at issue.

Another source of conflict could involve situations where a Lead, a Second or Followers disagree over the placement of claims in an insurance tower covering one particular policy year, over another. This may become contentious where participating insurers have different reinsurance treaties covering different policy years, impacting their net exposures. Also, if the exposure is significant, it can become a dispute, which may not be easily soluble.

A third source of conflict could involve situations where Second and Followers may perceive a given policy limits claim, directed by the Lead resulting in disproportionate and inequitable payments of insurance proceeds, constituting a waste, and possibly giving rise to extra - contractual damages.

All of these situations, and others that I am unable to currently foresee, may require an efficient and effective dispute resolution mechanism to insure that disagreements among the syndicate companies to a tower are resolve quickly cheaply and confidentially. In reviewing Section 5.0 "Resolution of Disagreements" under Market Bulletin Ref: Y4531, which describes the 2010 “Claims Scheme Process Guidelines," there does not appear to be any mention of a disputes resolution process, other than a meet and confer provision. Also Lloyd’s underwriters are required to use their best endeavours to reach a consensus under Market Bulletin Ref: Y4522 which also makes reference to a mediation and arbitration process as "prescribed by Lloyd's from time to time". These provisions are designed to make it easier for Lloyd’s co-insurers as opposed to non-Lloyd’s co-insurers to resolve issues amongst themselves without recourse to formal dispute resolution proceedings. Although it represents an effort to address future disputes among Lloyd’s co-insurers, this may not entirely avoid the risk of formal proceedings, especially considering the types of disputes that could arise from the issues I set forth above.

The CTP may require a new and expedited regime to resolve FI, PI & D&O coverage disputes among Lloyd’s carriers, quickly, quietly and efficiently, minimizing any disruptions of the claims handling process. This may ultimately give rise to mediation and arbitration opportunities in the United States and abroad to resolve disputes among Lloyd’s syndicates in connection with US and non-US venued claims.

Cornerstone Releases M&A Related LItigatoin Study: Iin a recent post (here), I previewed a then-forthcoming study from Cornerstone Research with regard to M&A related litigation. Cornerstone Research has now released its study, entitled "Recent Developments in Sharholder Litigation Involving Mergers and Acquisitions" (here). The final report contains additional information beyond the specific items I reviewed in my prior blog post. Special thanks to Cornerstone Research for sending me a link to the final report.

The North Korean Kindergarten Quintet: For today’s music interlude we are featuring a video that is simultaneously impressive and deeply disturbing. Watch these children perform and see if, in addition to being slowly but completely creeped out, you don’t find yourself gaining a little insight into the reason there were real tears when Kim Jong-Il died in December. The more basic question is why they aren’t crying all the time.

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There seems to be a general consensus that the amount of M&A-related litigation is increasing. The question of how to quantify the increase has attracted quite a bit of attention lately. In a recent post, I previewed a forthcoming report from Cornerstone Research that will provide detailed statistic analysis of the M&A litigation phenomenon.

My post attracted considerable commentary, and also drew a communication from NERA Economic Consulting, which has released its own statistical analysis of M&A-related litigation, and which they shared with me.

In addition, this week I separately received from Ohio State University Law Professor Steven Davidoff a copy of the January 1, 2012 paper that he and Notre Dame Finance Professor Matthew Cain have written entitled “A Great Game: The Dynamics of State Competition and Litigation” (here), in which they analyze M&A related Litigation from 2005-2010., with particular attention to the question of whether or not there is now competition between the states for this type of corporate litigation. Davidoff should be familiar to many readers as The Deal Professor from the New York Times Dealbook blog.

These two reports add substantial additional quantitative and analytic support for the general observations surrounding the growth in M&A-related litigation. Both of these reports corroborate the explosive growth in M&A-related litigation in recent years. I examine both of these reports below, starting first with Professors Davidoff and Cain’s analysis.

Professors Davidoff and Cain’s Paper

The Professors’ primary interests relate to the question of whether or not the states are competing for corporate litigation. Their interest in this question is driven in part by recent analyses suggesting that Delaware may be losing “market share” for this type of litigation. In order to determine how “both attorneys and courts interact in this game,” the authors examine state court merger litigation. The authors analyzed 955 merger transactions that took place between 2005 and 2010 and having a transaction value great than $100 million.

The authors found that 49.7 percent of transactions during that period attracted at least one shareholder lawsuit, and that the litigation rate increased “sharply” during the period, with only 38.7 percent of the transactions incurring litigation in 2005, compared to 84.2 percent in 2010. In addition, merger transactions increasingly are attracting multiple lawsuits. In 2005, only 8.6 percent of the deals attracted litigation in more than one jurisdiction, compared to 46.5 percent in 2010.

The authors found that during the sample period, 69.8 percent of cases settled, while 30.2 percent were dismissed. Only 4.9 percent of the settlements involved in increased in the amount of the transaction consideration, while 52.1 percent of the settlements involved only the disclosure of additional information. The average plaintiffs’ attorneys’ fee for settled suits is $1.4 million. Cases that settled for additional disclosure only pay the lowest level of attorneys’ fees (average attorneys' fees of $793,000) while settlements involving an increase in the deal consideration  pay the most (average attorneys fees $8.5 million)

The authors used this information to calculate an expected dismissal and attorneys’ fee baseline, as a way to measure “unexplained” dismissal rates and attorneys fees. The authors used these unexplained amounts as an “indicator for state competition.” The authors found significant variation across states, with certain states awarding higher fees than others. Delaware awarded fees $400,000 to $500,000 higher while dismissing a greater portion of cases than other states.

The authors found some statistical support for the claims that Delaware is losing the state court litigation competition, but they also found that “the game” is complex and that the dynamic varies depending on which states are compared. The authors also found evidence that Delaware’s courts are responsive to this competition, concluding that Delaware’s courts award” higher attorneys’ fees to compensate for a higher dismissal rate,” and adjust “dismissal rates down when it loses prior cases to other jurisdictions.” The authors cite the recent $300 million award in the Southern Peru Copper case as an indication that Delaware is” competing more overtly in this game.”

The NERA Economic Consulting Presentation

In a December 6, 2011 presentation done in conjunction with the Wilson Sonsini law firm and entitled “Merger Objection Litigation” (here), NERA provided a detailed statistical review of M&A-related litigation. The NERA study is based on the firm’s examination of the 731 merger transactions it identified as having been announced between 2006 and 2010 and that were completed by February 28, 2011, and that had a value equal to or greater than $100 million. NERA found that 285 of those transactions were challenged in a state or federal lawsuit, through June 20, 2011. NERA also found that litigation settlements had been reached in connection with 162 of the deals.

The NERA study found that while there were fewer deals overall in the last three years of the 2006-2010 study period, the incidence of M&A related litigation escalated significantly in those three later years. Thus, while only 26.1% of the 2006 deals and only 21.9% of the 2007 deals attracted litigation, 45.4% of the 2008 deals, 78.6% of the 2009 deals, and 60.7% of the 2010 deals attracted litigation. Though the 2010 figure represent a slight decline from the prior year, the 2010 level of litigation still represents a significant increase compared to the earlier years in the study period.

The NERA study also found that throughout the 2006-2010 period, the litigation rate increased as the size of the deal increased. Thus, only about 25% of the deals under $500 million attracted litigation, but 38.7% of the deals between $500-$999 million, 40.8% of the deals between $1 billion and $1.9 billion, 53.0% of the deals between $2 billion and $4.9 billion and 70.1% of the deals equal to or greater than $5 billion attracted litigation.

Merger objection litigation can be expected to arise fairly quickly after the deal is announced. The NERA study shows that a third of the litigation arrives in the first two days after the deal is announced and about 60% arrived in the first week. 81% of the merger litigation arrives within the first thirty days after the deal is announced. Although the takeover target is consistently named as a defendant in this litigation, 70% of the time the named defendants also include the acquirer.

The vast majority of the litigation is filed in state court only. 83% of the deals that were litigated attracted only state court litigation. Another 14% attracted both state and federal litigation. Only three percent of the deals attracted only federal court litigation.

The NERA study suggests that many of the deals that attract litigation are attracting litigation outside Delaware. Of the deals that were litigated, 20% were litigated only in Delaware and another 13% were litigated in both Delaware and another state. So about one third of the deals that attracted litigation were litigated at least in part in Delaware. The remaining two thirds of the deals were litigated only outside Delaware. However, the presentation does not show how many of the deals that were litigated only outside Delaware involved target companies that were incorporated in Delaware. The presentation also does not show whether or not the prevalence of litigation outside Delaware changed during the 2006-2010 study period.

With respect to the M&A-related lawsuits in the study period that had settled, the NERA report found that the vast majority of the settlements involved cash payments of less than $1 million. 106 of the 154 settlements in the settlement analysis (nearly 69%) settled for less than $1 million. Another 33 out of the 154 in the settlement analysis settled for less than $10 million. Only 15 of the 154 settlements in the analysis settled for amounts of $10 million or greater, including only 4 with settlements between $100 million and only one with a settlement greater than $1 billion. (The NERA presentation includes a detailed list of the largest settlements at slide 19.)

Thus, while the settlement period included a few very large settlements, the vast majority of the settlements were for less than $10 million, and more than two-thirds were below $1 million.

In fully 87% of the litigated deals that had settled, the only beneficiary from the monetary settlement was the plaintiffs’ attorneys. In only 9% of the settlements did the beneficiaries include both the plaintiffs’ attorneys and class members. Thus the vast majority of monetary settlements pay only for the plaintiffs’ attorneys’ fees and expense, and the “benefits” to the class, although occasionally monetary, more often take another form, such as reduced target company termination fee; fuller disclosure; or improved corporate governance.

Discussion

The information in these two studies provides valuable additional perspective on the increasingly important M&A-related litigation phenomenon. The two studies corroborate that in creasing numbers of M&A transactions are attracting litigation. The NERA data also provides some interesting additional information that has not been a part of other statistical perspectives on this litigation phenomenon, including in particular the data showing how quickly the lawsuits arrive and the information showing the range of settlement outcomes.

The Professors’ report provides additional information about the increasing prevalence of multi-jurisdiction litigation, as well as average attorneys’ fees and dismissal rates. Perhaps most significantly, the Professors’ study provides important insight into the question of state competition for corporate litigation.

The data in these studies are directionally consistent with the previously released studies, including the information I previewed in a recent post about the forthcoming Cornerstone Research report. They are also directionally consistent with each other, while differing somewhat in their details. The two reports also differ somewhat from the Cornerstone Research data I previously reviewed.  (The Cornerstone Research analysis suggests a higher litigation rate both in 2007 and in 2010 than the analysis in either of the two studies discussed above, although all three of the analyses agree that that the litigation rate increased between 2007 and 2010.)

The difference between the analyses may be attributable to the differing data sources used in the studies. There may have been methodological differences as well. For those of use who are studying and trying to understand the growing M&A-related litigation phenomenon, it will be important to understand these differences. We can certainly hope as the various research sources release their analyses that they will help the rest of us understand not only where their data came from and how it was analyzed, but how the approach they used may differ from other analyses that have been published.

In any event, no matter how you slice it, the level of M&A related litigation is growing. The defense expenses and settlement amounts associated with this litigation represent a growing problem as well. All signs are that this phenomenon will remain a significant part of the corporate and securities litigation landscape for the foreseeable future. For that reason it will remain important to understand what this litigation means. The willingness of NERA and of the Professors to share their analysis is extraordinarily helpful in that regard. Along those lines, I would like to express my deep thanks here to NERA and to Professor Davidoff for their willingness to share their presentations with me.

Seven Nation Army: Even though I was not even really focusing on it, I had noticed recently that marching bands and sporting fans everywhere have picked up the same tune, as a rallying cry, as a communal chant, as basic crowd background noise. But if you had asked me to focus on it, I still might not have been able to name the tune. A January 13, 2011 article on Deadspin identified the tune, and also explained how it managed to take over the sportworld.

The song is “Seven Nation Army,” a 2003 tune from the alternative rock band, The White Stripes. Just in case you don’t think you know the tune, I have included a video below of the band performing the song. (I guarantee you if you listen to it, you will say – “Oh yeah, that song. I always wondered what that was.”) I was on the alert for it this past weekend, and I noticed that both the San Francisco crowd at the 49ers/Saints game and the west London crowd at the English Premier League game between Chelsea and Sunderland were chanting the tune during their respective games on Saturday. All very odd for an alternative rock song. But I guess it isn’t any weirder than that fact that a lot of marching banks have also picked up “Carmina Burana” from classical composer Carl Orff.

In any event, for today’s musical interlude, here’s The White Stripes performing “Seven Nation Army.” Now you will know what the heck all of those fans are trying to chant. (My apologies to all of those rock music aficionados – most half my age -- who think I am an idiot for not knowing the song before; please consider my age, location and occupation, and I think you will see how unlikely it is that I would be fully versed in the contemporary alternative rock scene.)

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In a January 12, 2012 opinion that quotes from (and relies upon) former Treasury Secretary Henry Paulson’s credit crisis memoirs, Southern District of New York Judge Richard Holwell granted in part and denied in part the motion to dismiss in the subprime and credit crisis related securities class action lawsuit that investors had filed against General Electric, certain of its directors and officers, and its offering underwriters. A copy of Judge Holwell’s opinion can be found here.

Background

As discussed in greater detail here, the plaintiffs first filed their action in March 2009, alleging that the company had failed to disclose information regarding the company’s health and the health of its financial subsidiary, GE Capital, at the height of the financial crisis. As Judge Holwell summarized it, the plaintiffs allege that “during a time when the financial markets were crumbling and companies across the United States were scrambling to disclose their holdings in subprime loans, GE withheld information regarding its substantial holdings in subprime and non-investment grade loans and touted GE as safe in comparison to its competitors, despite the fact that GE was also feeling the impact of the financial crisis.”

Specifically, the plaintiffs allege that GE made misstatements about its ability to fund itself through commercial paper; the quality of its loan portfolio; its ability to maintain its dividend; and its projected 2009 profits. The plaintiffs also alleged that GE violated GAAP by improperly recharacterizing certain of its assets from short-term to long term and by maintaining inadequate loan loss reserves. The plaintiffs allege that the defendants made misleading statements on these topics throughout the class period from September 25, 2008 to March 19, 2009, in violation of the Section 10 (b) of the ’34 Act; and in connection with GE’s October 7, 2008 stock offering, in violation of Section 11 of the ’33 Act.

Three particular alleged statements on which the plaintiffs sought to rely proved to be particularly important in Judge Holwell’s rulings on the motion to dismiss. First, with respect to the plaintiffs’ allegations regarding the company’s ability to rely on commercial paper as the credit crisis peaked in September 2008, the plaintiffs’ rely on statements in Henry Paulson’s book, On the Brink, in which Paulson states that GE CEO Jeffrey Immelt called Paulson at least twice that month  allegedly to report that the company was finding it very difficult to sell its commercial paper for any term longer than overnight.

Second, the plaintiffs’ relied on Immelt’s statements in December 2008 with respect to the company’s $1.24 annual dividend: “What can you count on? You can count on a great dividend,” specifically referencing the $1.24 dividend level. The company later cut its quarterly dividend for the second half of 2009 from 31 cents a quarter to ten cents per quarter.

Third, according the plaintiffs, throughout the class period the defendants made statements describing their loan asset portfolio as “very high quality” and using various similar descriptions. The plaintiffs contrasted this with GE’s March 2009 release in which it specified that 42% of GE Capital’s $183 billion in consumer loans were made to non-prime borrowers and at least $145 billion of its $230 billion commercial lending and leasing portfolio consisted of loans to non-investment grade companies.

Judge Holwell’s Opinion

In his January 12 opinion, Judge Holwell held that the plaintiffs had adequately alleged falsity as to their allegations about the GE’s ability to access the commercial paper marketplace; as to the quality of its loan asset portfolio (and in particular its exposure to subprime credits); and with respect to the reliability of the company’s annual dividend. He concluded that the plaintiffs had not adequately alleged falsity as to the other allegations.

In concluding that the plaintiffs had adequately alleged that Immelt had acted with scienter, Judge Holwell found, in reliance on the statements from Paulson’s book, that the plaintiffs had adequately alleged that Immelt himself made “contradictory statements to Henry Paulson.” With respect to Immelt’s December 2008 statements about the reliability of GE’s dividend, Judge Holwell rejected the competing inference that Immelt made the statements while struggling to come to terms with a rapidly changing environment:

Immelt’s categorical statements that investors could “count on” a dividend and that GE was having “no difficulties issuing commercial paper are not the sort of cautious statements one would expect of a CEO attempting to come to grips with the effects of the economic crisis on his company. Instead, it can be argued that Immelt was attempting to convince the public that the economic crisis was not affecting GE too drastically and that they should continue to invest in GE. Of course, a CEO is allowed to convince the public to invest in his company, but not at the expense of providing it with accurate information about the company’s financial health.

In concluding that GE’s CFO Keith Sherin acted with scienter with respect to certain statements about the quality of the company’s loan asset portfolio, Judge Holwell essentially said that the plaintiffs had adequately alleged that Sherin should have known the extent to which GE Capital had made extensive loans to lower quality borrowers. Judge Holwell said “it is highly improbable that Sherin, the CFO of a company 50% of whose revenues were derived from financial services in 2008, would not inquire whether his company was exposed to the subprime consumer borrower and its counterpart in the commercial sector.”

Significant parts of the plaintiffs’ ’33 Act claims also survived the motion to dismiss, including in particular plaintiffs’ allegations about the company’s ability to access commercial paper and the quality of the company’s loan asset portfolio and its exposure to subprime credits. Judge Holwell found that the plaintiffs’ remaining ’33 Act allegations were insufficient, but his denial of the motion to dismiss with respect to at least some of plaintiffs’ allegations means that the offering underwriter defendants remain in the case.

Victor Li’s January 13, 2012 Am Law Litigation Daily article about Judge Holwell’s ruling can be found here.

Discussion

At least a part of plaintiffs’ case would have survived the defendants’ motions to dismiss even without the benefit of Henry Paulson’s statements in his book about his September 2008 telephone conversations with Jeffrey Immelt. But Paulson’s account of the conversations clearly had an impact. At a minimum, Judge Holwell referenced the Paulson’s account of the conversations several different times in his opinion.

I am not aware of a prior case where the statements of a former cabinet secretary in his or her memoirs has provided even a partial basis for the denial of a motion to dismiss in a securities class action lawsuit. The plaintiffs’ reliance on Paulson’s memoirs has to qualify as one of the more unusual ways that plaintiffs have established (at least for pleading purposes) that there was a difference between what the company was saying publicly and what its officials were saying behind closed doors. (The defendants will of course argue that there was no difference or if there was it is entirely explainable, which of course are arguments they will raise as the case goes forward.)

It is interesting to reflect on the sheer fortuity of the fact that Paulson chose to report on those conversations in his book, and that his book was published at a time that allowed the plaintiffs to be able to rely on those statements in their amended complaint. Of course, all of this does mean that as (or perhaps if) the case goes forward, Paulson’s deposition in this case would appear to be inevitable. (Of course, this case is not the only one in which the underlying narrative involved Paulson; Paulson’s conversations with BofA CEO Ken Lewis in December 2008 also play a central role in the securities class action lawsuit arising out of the BofA/Merrill Lynch merger.)

It is also interesting to reflect that in the middle of one of the worst financial crises in the country’s history, Immelt could pick up the telephone and call the Treasury Secretary to tell him about the problems his company was having. The CEOs of a vast number of companies were also going through crises at that very moment, but very few of them had the option to call the Treasury Secretary to complain to him about their companies’ problems. It is rather remarkable, even given how large a company GE is, that Immelt had this option. Indeed, given what we know about what else Paulson had on his plate during September 2008 (i.e., avoiding the collapse of the entire  global financial system), it really is kind of astonishing that Immelt could just call him up and that Paulson could take his call.

In any event, this case will now be going forward. Given the size and prominence of the company, and the fact that the case has now survived the motion to dismiss, this case has to be added to the list of pending high-profile subprime and credit crisis-cases worth watching. Very few of these cases go to trial; most settle. In this and some of the other high profile credit crisis cases – Citigroup; the BofA/Merrill Lynch merger case; Bear Stearns; AIG – it will be very interesting to see how the likely settlements of these cases will unfold. Without knowing for sure how any one of them ultimately will turn out, there undoubtedly will be some very interesting settlements from among these cases.

I have added Judge Holwell’s ruling to my tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.

More About the $40 Million Lehman Brothers Mortgage Backed Securities Settlement: The news that the parties to the Lehman Brothers mortgage-backed securities case had settled the suit for $40 million was announced in November 2011 (refer here). But the complete papers related to the settlement have only just been filed in the court docket. The papers reveal a few interesting details about the settlement.

First, the $40 million settlement is to be funded in two ways; $31.7 million of the settlement is to come from the company’s D&O insurance and $8.3 million is to come from Lehman Brothers Holdings itself. As the January 13, 2012 memorandum in support of the plaintiffs’ unopposed motion for preliminary approval of the settlement states, the bankruptcy court supervising the Lehman bankruptcy has approved the release of funds for these purposes.

Second, the parties’ settlement stipulation contains in interesting detail about the source of the D&O insurance funds for the settlement. The stipulation states (at page 15) that the $31.7 million insurance contribution to the settlement is to be paid by “certain insurers (‘Insurers’) that issued directors and officers insurance policies to LBHI, for the 2007-2008 and 2008-2009 policy periods.” What is interesting about this statement is that it suggests that the funds for this settlement are coming from two different policy periods.

In an earlier post (here), in which I discussed the $90 million settlement of the securities suit involving former Lehman executives, I had determined that the $90 million amount, together with defense expenses and other amounts, exhausted about $200 million of the applicable $250 million insurance tower. Based on that analysis of Lehman’s insurance, I would have assumed that the $31.7 million insurer contribution was drawn from what was left of the $250 million tower.

However, the reference in the parties’ settlement stipulation to the two different policy years suggests that a second tower of insurance has been broached and is being drawn upon in payment of losses arising from Lehman’s collapse.

In an earlier post (here) about how rapidly defense expenses were eroding Lehman’s D&O insurance, I had determined that during the 2007-08 policy period, Lehman carried a total of $250 million in insurance. I had noted that, though Lehman did not file for bankruptcy until September 2008, the May 2007-May 2008 insurance tower was the one implicated, because the first of the securities class action lawsuits was filed during that policy period and the subsequent matters related back to that initial filing (or so the insurers) argued. I noted that Lehman carried a separate $250 million tower of insurance for the May 2008 to May 2008 policy period, but that up to that point the losses had accumulated only with respect to the earlier of the two insurance programs. When I later analyzed the $90 million settlement on behalf of the directors and officers, I assumed for purposes of analysis that only a single $250 million tower was available for all purposes in connection with the Lehman collapse.

The cryptic note in the parties’ settlement stipulation in connection with the $40 million Lehman Brothers mortgage-backed securities settlement suggests, for the first time to my knowledge, that the second tower of insurance had been drawn in and is funding losses attributable to the events surrounding Lehman’s collapse. It would certainly change things (for example, the way that the prior $90 million settlement looks) if there were to be two insurance towers totaling $500 million potentially available in connection with these matters, rather than only a single $250 million tower.

If there were to be two towers rather than just one, the losses from the Lehman debacle could wind up being far more costly for the D&O insurance industry than has been assumed (depending of course on how extensive the second tower’s involvement ultimately proves to be). I suspect there are a number of readers out there who may have additional insight on these issues. I welcome additional perspective that any reader may be willing to provide (anonymously if that is the preferred approach).

In any event, this settlement is just further corroboration for a point I have long made about the litigation arising out of the subprime meltdown and credit crisis – that is, when all is said and done, this litigation, taken collectively, will prove to have been a massive loss event for the D&O insurance industry.

The Totally Awesome Sledding Crow: Here at The D&O Diary, we never, ever waste our time looking at Internet videos of animals doing amusing things. Just the same, we were distracted by this video of a crow that to all appearances is engaged in trying to perfect his snowboarding style. Watch this video carefully. The crow, standing at the apex of a snow covered roof, slides down the incline on a plastic lid. The crow then picks up the lid and tries to slide down another part of the roof. But when that doesn’t work, the crow picks up the lid, returns to the original spot, and slides down the roof again.

A scientific discussion of the crow’s behavior can be found in this January 13, 2012 article in The Atlantic (here). While science cautions against ascribing anthropomorphic explanations for animal behavior, I find myself imagining that as the crow is sliding down the roof, he is singing to himself “If everybody had an ocean/across the U.S.A./then everybody’d be surfin’/like Caiforn-Aye-Yay…”

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The tone public companies use in their disclosure statements can affect the companies’ susceptibility to securities class action litigation, according to a recent academic study. The authors found that firms hit with securities litigation generally used more optimistic language in their disclosure statements than did firms that were not sued. Based on these findings, the authors conclude that managing “disclosure tone” could provide “a straightforward means of reducing litigation risk.”

In their November 2011 paper “Disclosure Tone and Shareholder Litigation” (here), University of Chicago Business School Professors Jonathan Rogers and Sarah L.C. Zechman and Ohio State Business School Professor Andrew Van Buskirk set out to determine whether or not corporate managers’ use of optimistic language increases litigation risk. Using statistical techniques, they examined the extent to which differences in qualitative language are systematically related to differences in litigation risk.

The authors began by examining a range of plaintiffs’ complaints, in order to determine which disclosure channels are likeliest to affect the probability of litigation. Based on their review, the authors determined that the earnings announcements are the most consistently cited type of communication referenced in plaintiffs’ complaints.

The authors then used dictionary-based measures of optimism to analyze the tone used in the portions of earnings announcement that plaintiffs chose to quote in their class action complaints. In order to determine whether or not the sued firm’s disclosures were “unusually optimistic” the authors compared the tone of the sued firms’ earnings announcements to the tone of disclosures made my non-sued firms at the same time, in the same industry and experiencing similar economic circumstances. The authors concluded that the firms that are hit with securities class action lawsuits use “substantially more optimistic language in their earnings announcements than do non-sued firms.”

The authors also took a look at the combined effect of optimistic language and insider trading. The evidence they reviewed “is consistent with optimism and insider selling jointly affecting litigation risk.” The interaction between optimism and “abnormal insider selling” is “associated with an increase probability of being sued.” The authors found no evidence that insider selling on its own exposes the company to increased litigation risk; insider selling is “only associated with litigation when firm disclosures are optimistic.”

The authors’ conclusions suggested to them some ways that companies can try to mitigate litigation risk. That is, though disclosure tone “is certainly not the sole determinant of litigation,” disclosure tone “is both associated with litigation risk and under the discretion of management.” All of which led the authors to conclude that “monitoring and adjusting disclosure tone could provide a straightforward means of reducing litigation risk” – that is, “managers can reduce litigation risk by dampening the tone of disclosure.” On the other hand, the authors also note that shareholder litigation can be “an effective ex post mechanism” to assure investors that managers “are not simply engaging in cheap talk when they use positive language.”

One final note about the authors’ methodology. In order to quantify the tone used in firms’ disclosures, the authors used a form content analysis that relies on a pre-specified word list. The analysis simply counts the occurrence of words characterized defined as optimistic or pessimistic based on prior research and linguistics theory. However, rather than relying on a single categorization, the authors used three different libraries of words, each of which was used to study firm disclosures. The word counts using the three measures were then compared against a benchmark standard that was based upon a control group of non-sued firms. The sued firms “optimism” was then compared against the benchmark standard. The authors also applied control variable to isolate the effect of a firm’s optimism that is driven by management discretion, rather than by the firm’s economic circumstances.

Discussion

On the one hand, the authors’ analysis might seem simply confirm a common sense proposition that companies that are hype-ish with their disclosures are likelier to get sued. But a closer reading of the authors’ analysis suggests that the authors have established a more specific and more important conclusion. That is, the authors’ analysis establishes that there is a direct statistical relationship between a firm’s use of unusually optimistic language and the likelihood of the firm being sued. This statistical relationship has two important implications.

First, the existence of this relationship could have important D&O insurance underwriting implications. D&O insurance underwriters interested in selecting away from companies that are likelier to be sued in securities class action lawsuits will want to develop tools to help them identify disclosure statements that are unusually optimist. The key here is that the predictive relationship is based on the use of unusually optimistic language. That is, in order for an underwriter to use the existence of the relationship as a risk selection tool, the author would have to have a developed ability to determine what constitutes unusual optimism.

In connection with the D&O underwriting implications of the authors’ analysis, it is also significant to note the added relationship the authors found about the interaction of optimistic disclosure and unusual insider trading. The two factors together had a combined predictive effect. In other words, the presence of insider selling in combination with overly optimistic disclosure is particularly predictive of securities litigation risk.

The other significant implication of the authors’ analysis has to do with their conclusions about how companies might mitigate their securities litigation risk. There is definitely some good news in the authors’ report. That is, companies that are interested in trying to control their securities litigation risk exposure can reduce their litigation risk by managing their disclosure language. The authors’ conclusion in this regard are consistent with larger messages that many of us who advocate securities litigation loss prevention have been preaching for year – that is, that companies can control their securities litigation exposure by managing the disclosure process, in order to avoid the kinds of statements that attract the unwanted attention of class action securities lawyers.

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The SEC has commenced an enforcement action against a private company and its former Chairman and CEO in connection with the company’s repurchase of company shares from company employees and others prior to the company’s acquisition.

The action involves Stiefel Laboratories, which prior to its April 2009 acquisition by GlaxoSmithKline for $68,000 a share, was, according to the SEC “the world’s largest private manufacturer of dermatology products.”  On December 12, 2011, the SEC filed a complaint (here) in the Southern District of Florida alleging that the company and Charles Stiefel, its former chairman and CEO, defrauded shareholders by buying back their stock at “severely undervalued prices” between November 2006 and April 2009. The SEC’s December 12, 2011 press release about the enforcement action can be found here.

The company had an Employee Stock Bonus Plan through  which employees gained ownership of company shares. The company also engaged in direct share transactions with other shareholders. Because the shares did not trade on public markets, company share purchases were essentially the only way for shareholders to liquidate their shares of company stock.

The price for company share purchases was set through an annual l third-party share valuation each March. The company relied on a third-party accountant to perform the valuation. However, the SEC alleges that the accountant “used a flawed methodology and was not qualified to perform the valuations.” In addition, the SEC alleges that that shareholders were not told that after the valuation process, the defendants “discounted the stock by an additional 35%.”

In addition, beginning in 2006, the company began a series of conversations that culminated in the April 2009 sale of the company to Glaxo Smith Klein. During the course of these various discussions, the defendants received a series of valuations that were significantly higher than the third party valuation used for share repurchase purposes. The company did not advise employees or the accountant who performed the annual share price valuation of these much higher valuations. In addition, the company not only did not inform the employees about the ongoing negotiations, but repeatedly indicated that the company would remain private.

While these discussions were going forward, the company continued to repurchase company shares at valuations that were significantly below both the valuations that the prospective company buyers were using and that were also well below the ultimate sale price of $68,000 per share. Thus between November 2006 and April 2007, the company purchases 750 company shares at $13,012 a share. Between June 2007 and June 2008, the company purchased more than 350 additional shares at $14,517 a share, and bought an additional 1,050 shares from shareholders outside the Plan at an even lower stock price. Between December 3, 2008 and April 1, 2009, the company purchased more than 800 shares of its stock from shareholders at $16,469 per share.

The SEC alleges that shareholders lost more than $110 million from selling their shares back to the company based on the misleading share valuations. The SEC alleges that the defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, by repurchasing the shares at undervalued prices and in reliance on undisclosed material information, including both the higher valuations and the possibility of the company’s sale. The SEC’s complaint seeks declaratory relief, permanent injunctive relief, an officer and director bar, disgorgement and civil penalties.

Discussion

The allegations against the company and its former Chairman involve alleged misconduct that took place when the company was still a private company. I suspect that many readers will be surprised to learn that an SEC enforcement action against or in connection with the actions of a private company.

As explained in a January 10, 2012 memorandum from the Stites & Harbison law firm (here), Rule 10b-5 “prohibits, in connection with the purchase or sale of any security (public or private) making any untrue statement or omitting to state a material fact necessary in order to make the statements not misleading.” The allegations against the defendants here present a “cautionary tale for any private company,” underscoring the fact that federal and state securities laws govern even private company securities transactions and “restrict small closely held firms no differently than they restrict large, publicly-held corporations.” 

The law firm memo emphasizes that a private company in possession of material nonpublic information that is under a contractual obligation to consummate a transaction involving its own securities could face a dilemma -- for example, a pending transaction may put the company in a position where it may neither disclose pending negotiation nor abstaining from repurchase obligations under stockholder or similar agreements. The memo’s authors observe that private companies should “thoughtfully scrutinize the structure of a transaction in its own securities and would be well served to tailor corporate policies to ensure compliance with securities law obligations.”

The SEC’s allegations here present a cautionary tale in another sense as well. Some private company D&O insurance policies may be procured or written based on the assumption that, because the company is privately held, the company and its directors and officers face no potential liability under the federal securities laws. Or at a minimum, D&O insurance policies may be structured with insufficient awareness about the possibility that even a private company potentially could fact liability under the federal securities laws. This case shows that a company and its officials can fact potential liability under the securities laws in connection with transactions involving the companies own securities, even if the company’s shares are not publicly traded.

Of particular concern here is the securities offering exclusion found in many private company D&O policies. The wordings of these exclusions vary widely. Depending on the wording used in any particular private company policy, the exclusion might potentially preclude coverage for the type of claim presented here. The best versions of these types of exclusions specify that they do not apply unless the company has conducted an initial public offering. But as this case highlights, a private company D&O policy could be called upon to respond to an action alleging a securities law violations; indeed, it could be called upon to respond to an SEC enforcement action even where, as here the company’s shares are not publicly traded and where there has been no IPO. There might ultimately be no coverage under the policy for amounts representing disgorgements or fines or penalties, but the question of whether or not there is coverage for defense expenses (which could be quite substantial) could well depend on the wording of the securities exclusion.

All of which means, at a minimum, that the wordings of the securities offering exclusion in private company D&O insurance policies need to be reviewed closely with an eye toward the possibility of claims of this type.

Don’t Be That Guy: According to a January 12, 2011 Wall Street Journal article (here), Alan Gilbert, the conductor of the New York Philharmonic, brought a performance of Mahler’s Ninth Symphony to a halt when the orchestra’s performance of the music piece’s final movement – a sonorous rumination on the meaning of mortality – was interrupted by a persistent cellphone ringtone the article described as having a xylophone sound with a marimba beat. The cellphone’s owner apparently was seated in the front row at the performance at Avery Fisher Hall. 

I suspect that the next time the cellphone owner is asked to turn off their cellphone, he or she will actually make sure the phone is powered down.

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The number of publicly traded companies that filed for bankruptcy protection under either Chapter 7 or Chapter 11 declined in 2011, compared to the year prior, although the 2011 bankrupt companies collectively  listed greater amounts of pre-petition assets than 2010 bankrupt public companies did, according to data recently released by BankruptcyData.com (here).

According to the report, 86 publicly traded companies filed for bankruptcy protection in 2011, compared to 106 in 2010, and compared to 211 in 2009. The number of 2011 filings represents a 17% decline from the prior year, and nearly a 60% decline from 2009. Though the number of public companies filing for bankruptcy declined in 2011, the 2011 public company bankruptcies represented aggregate pre-petition assets of $104 billion, compared to $89.1 billion in assets in 2010. The 2009 public company bankruptcies represented $281 billion in assets.

The company average pre-petition assets rose to $1.2 billion in 2011 from $840 million in 2010. The increase in aggregate and average assets that the 2011 bankruptcies represent is largely a factor of two very large public company bankruptcies during the year: the $40.5 billion asset MF Global bankruptcy and the $25 billion AMR Corporation bankruptcy. Those two bankruptcies alone represented more than close to two thirds of all of the aggregate 2011 asset value. The MF Global bankruptcy represents the eighth largest U.S. bankruptcy of all times. None of the bankruptcies in 2010 are among the top ten. The two large 2011 public company bankruptcies had the effect of driving up the average bankruptcy size during the year.

The report notes that the increase in aggregate and average pre-petition asset size during 2011 is “all the more striking considering the low number of financial company bankruptcy filings” during the year. Bankruptcies in the Banking & Finance industry “typically reflect a higher pre-petition asset figure than other industries.” But there were only four public company bankruptcies in the sector during 2011, compared with 2010, when 21 of the 106 public traded bankruptcies involved companies in the Banking & Finance sector.

The sector with the largest number of 2011 bankruptcies was Health Care & Medical, which had a total of 11 bankruptcies; followed by Technology and Energy which each had nine filings each.

Though the number of public company bankruptcies has declined in each of the last two years, the public company bankruptcies remained at elevated levels. The 86 public company bankruptcies in 2011, though below the annual totals in 2010 and 2009, are above the totals in the years preceding the credit crisis and going all the way back to 2005, when there were also 86 public company bankruptcies.

In terms of what may lie ahead, the report includes the comments of one observer, George Putnam III, the founder of New Generation Research, BankruptcyData.com’s parent company, as saying that, “I expect to see an increase in bankruptcies in 2012 as some of the massive amount of debt that was issued before 2008 begins to come due.” These comments about the likely bankruptcy levels are consistent with other public commentaries (refer here) that have also suggested that 2012 could be a busy year for business bankruptcies.

A January 10, 2012 Los Angeles Times article about the public company bankruptcy data can be found here.

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In several recent posts (most recently here), I have written about the problems associated with the growing wave of M&A related litigation. In writing about this topic, I have tried to marshal the evidence supporting my position, but for many reasons my analysis has been more descriptive than statistical. However, I have been provided with advance access to some of the data from a forthcoming Cornerstone Research publication to be entitled “Recent Developments in Shareholder Litigation Involving Mergers and Acquisitions.” The data provide interesting additional statistical perspective on the recent M&A-related litigation trends.

UPDATE (as of Jan. 17, 2012): Cornerstone has now released its report, entitled "Recent Develpments in Shareholder Litigation Involving Merger and Acquisitions" (here) online. The full report iincludes additional information beyond what is discussed in this blog post.

In their preparation of the report, Cornerstone Research reviewed SEC filings related to acquisitions of U.S. public companies valued at $100 million or greater and announced during 2010 and 2011. For purposes of historical comparison, Cornerstone Research also collected information on litigation related to deals announced in 2007 valued at $500 million or greater.

Based on their review, Cornerstone Research identified 789 lawsuits filed in connection with U.S. public company acquisition transactions valued at $100 million or greater and announced in 2010 and 696 lawsuits for deals of that size announced in 2011.

Cornerstone Research found that litigation arose in connection with 91% of all deals announced during the 2010-2011 period with values greater than $100 million. The average number of lawsuits per deal announced during that period was 5.1. Both of these figures grow relatively larger as the size of the deals grows larger. Thus for deals announced in 2010-2011 with valuations between $100 million to $500 million percentage of deals involving litigation is 85%, and the average number of lawsuits per deal is 4.1, while 96% of all deals valued over $1 billion during that period attracted litigation, and averaged 6.1 lawsuits per deal.

Certain deals announced during the 2010-2011 proved to be particularly litigation attractive. For example, Blackstone’s $600 million acquisition of Dynegy attracted 29 lawsuits. Express Scripts’ $29.3 billion acquisition of Medco Health Solutions attracted 22 lawsuits. Attachmate’s $2.2 billion acquisition of Novell attracted 19 lawsuits. Overall, there were nine deals during that period valued at $100 million or greater that attracted 15 or more lawsuits.

To provide historical perspective, Cornerstone Research compared M&A litigation in 2007 and in the 2010-2011 periods, by comparing deals valued greater than $500 million announced in each of those two periods. There were 289 lawsuits in connection involving deals of that size in 2007 and 557 involving deals of that size in 2010, representing a 92% growth in the absolute number of lawsuits between the two periods. There were 473 lawsuits involving deals of that size that were announced in 2011, which is 63% higher than in connection with deals of that size announced in 2007.

Obviously, this growth in the absolute number of lawsuits might be attributable to an increase in the level of M&A activity involving deals greater than $500 million. In fact, there were 195 deals valued over $500 million that were announced in 2007, but only 108 and 80 deals valued over $500 million that were announced in 2010 and 2011, respectively.

The Cornerstone Research analysis shows that only 50% of the deals valued at $500 million or greater announced in 2007 attracted litigation, whereas 95% of the comparably sized deals announced in 2010 attracted litigation, and 96% of such deals announced in 2011 attracted litigation. In other words, the litigation activity was both absolutely and relatively greater for deals valued at $500 million or greater in the 2010-2011 period compared with comparably sized deals announced in 2007.

In addition, the number of lawsuits filed per deal has also increased. Deals valued at greater than $500 million announced in 2007 attracted an average of 2.8 lawsuits, whereas deals of that size announced in 2010 attracted an average of 5.4 lawsuits, and deals of that size announced during 2011 attracted an average of 6.1 lawsuits.

One of the recurring questions associated with the increase in M&A-related litigation has been whether or not courts in Delaware, traditionally the forum of choice for this type of litigation, has been losing “market share” to other jurisdictions that may be perceived as more plaintiff-friendly. The Cornerstone Research analysis suggests that Delaware’s courts are not in fact losing market share, at least with respect to deals meeting Cornerstone’s criteria.

Cornerstone Research’s analysis of this issue compares deals involving Delaware incorporated companies that were valued at greater than $500 million announced in 2007, on the one hand,  to deals involving Delaware incorporated companies where the deal was valued at greater than $500 million and announced in 2010-2011, on the other hand.

The Cornerstone Research analysis shows that in terms of where the lawsuits were filed in the two respective periods, in 2007, 34% of the lawsuits were filed in Delaware, while in the 2010-2011 period, 41% of the lawsuits were filed in Delaware.

This analysis is reinforced when the lawsuits are looked at on a per deal basis. Looking at the venue of lawsuits in which acquisitions involving Delaware incorporated companies were being challenged, the Cornerstone data show that 29 of the 2007 deals involved at least one lawsuit filed in Delaware, and 32 of the deals involving only litigation outside Delaware. By comparison, in 2011, 41 of the deals had at least one lawsuit filed in Delaware, and just nine of the deals involved litigation only outside Delaware. In other words, in the later period, a much greater portion of the deals involved litigation in Delaware, either exclusively or in combination with litigation in other jurisdictions, and a much smaller proportion of the deals involved only litigation outside Delaware.

Discussion

The Cornerstone Research data tend to corroborate many of the points I have made in recent posts on this blog – that is, M&A litigation is increasing, on both an absolute and relative basis; that a much higher percentage of deals is attracting merger objection litigation; and the average number of lawsuits per deal is also increasing.  The Cornerstone Research analysis is particularly interesting with respect to the number of deals that are attracting unusually higher numbers of lawsuits.

The data in the Cornerstone Research report are directionally consistent with many other data sources I have cited in prior blog posts on this topic, but the Cornerstone figures appear to differ in certain specific details. For example, the Cornerstone Research analysis suggests that a much higher percentage of deals attract merger objection lawsuits than the figures in other reports have suggested (refer here, for example).

There likely are many explanations for the differences in the details between the Cornerstone Research data and other reports, but one particular aspect of the Cornerstone analysis should be kept in mind. That is, the Cornerstone Research analysis for the 2010 and 2011 period involves only M&A transactions with announced values greater than $100 million. Deals involving smaller valuations and the related litigation are not a part of the Cornerstone Research analysis. By the same token, Cornerstone Research’s historical analysis refers only to deals announced in the 2007 period with valuations greater than $500 million, which omits an even broader range of deals (and related litigation) based on the size of the deal valuations. These data set definitions could result, at a minimum, in differences between the Cornerstone Research data and other analyses of comparable time periods.

But in any event, the Cornerstone Research analysis makes a very important contribution to the consideration of these issues. The Cornerstone Research report clearly shows that M&A related litigation is becoming a more significant issue. With the increasing average numbers of lawsuits per deal, M&A-related litigation is becoming an increasingly more costly problem, as the increased numbers of lawsuits in multiple jurisdictions means both procedural complications and increased defense expense.

The Cornerstone Research analysis of the Delaware court “market share” issue could prove to be particularly interesting. The question whether or not litigants are self-selecting away from Delaware is and will be a very hot topic. The stakes are high, as the continued involvement of Delaware courts in corporate and securities litigation could determine whether or not Delaware’s courts continue to play a leading role on legal issues in these areas. And on a more practical level, if Delaware’s courts are not losing market share after all, there is no reason for its judges to be as concerned with attempting to curry favor with the plaintiffs’ bar in order to preserve market share.

The Cornerstone Research data certainly offers a variety of interesting statistical perspectives on the issues surrounding the growth of M&A litigation. We can all look forward to the forthcoming publication of Cornerstone Research’s complete report on these issues.

Very special thanks to Cornerstone Research for their willingness to share this data with me and with readers of this blog.

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Back in February 2007, when investors in New Century Financial Corporation filed a securities class action lawsuit against the company and certain of its directors and officers, there was little reason to suspect at the time that problems at the company represented the leading edge of a looming financial crisis or that the case itself was the first lawsuit in what ultimately grew to become a mountain of subprime and credit crisis-related litigation. But even now, five years later, the litigation wave continues to churn through the system, though we are now mercifully well past the depths of the financial crisis.

As reflected below, though many of the cases have now been resolved, many more remain pending, and the likelihood is that the litigation will continue for years to come.

In the five years since the first of the credit crisis lawsuits was first filed, there have been nearly 230 subprime and credit crisis related lawsuits filed, including four in 2011. A list of all of the filings can be accessed here. 2008 was the peak year of the financial crisis and also the peak year for credit crisis related lawsuit filings, when there were 102 subprime and credit crisis-related cases filed. After that, the filings began to diminish. There were 62 credit crisis related securities class action lawsuit filings in 2009, and only 23 in 2010. Maintaining a precise count over time has been challenging, as cases have been consolidated, removed, transferred, and so on. The count of 230 lawsuits should be viewed as indicative of the total number of filings, rather than an exact representation. For analytic purposes below, I have used the 230 figure, but it should be kept in mind that all calculations are approximate.  

Dismissal Motion Rulings

By my reckoning, about 144 of the cases, or about 63%, have reached the motion to dismiss stage. A list of all dismissal motion rulings can be accessed here. As time has passed it has become increasingly complicated to track the dismissal motion rulings, as well. Several cases have had multiple rulings and there have even been a handful of cases that have made their way up to the appellate courts.

For purposes of counting the dismissal motion rulings, I have counted as dismissals all cases in which a dismissal motion was granted, whether or not the dismissal was with prejudice. However, I did not count cases in which the dismissal motion was initially granted but in which the motion was denied on subsequent rehearing. If any part of the plaintiffs’ case survived the dismissal motion, I counted the ruling as a dismissal motion denial, even if the ruling may have resulted in the dismissal of a substantial part of the plaintiffs’ case.

One particularly complicated variant that I have tried to factor in my analysis are the rulings in which a dismissal with prejudice was granted as to some but not all the parties. I have tried to factor those rulings out of my analysis here. In addition, I have counted cases in which dismissal motions were reversed on appeal as dismissal motion denials. Finally I have counted summary judgment grants in my tally of dismissals.

Using these principals to categorize the dismissal motion rulings, and disregarding the small handful of cases that were voluntarily dismissed and not refilled,  it appears that dismissal motions have been granted in 76 cases, or slightly more than half of the cases in which dismissal motions have been heard (that is, about 52%).

Although this dismissal rate is slightly higher than the historical rate of all securities class actions, which runs about 40%, it is important to keep in mind that I have included dismissal without prejudice in the tally.  Some of the dismissed cases may yet survive renewed dismissal motion, as was the case with a number of cases in which dismissal motions were initially granted – for example, the Washington Mutual case (here), the Credit Suisse case (here), the New Century Financial case (here), PMI Group (here), and IndyMac (here). The inclusion of summary judgment grants may also inflate the apparent dismissal rate somewhat as well.

In addition, appellate courts proceedings could also affect the dismissal rate calculation. In at least two cases, Nomura Asset Acceptance Corporation (about which refer here) and Blackstone Corporate (here), appellate courts reversed the dismissals granted in the lower courts. There may well be other reversals on appeal, which could affect the dismissal rate calculation, at least marginally. To be sure, the dismissals of a number of other cases has been affirmed on appeal, including the dismissal in the NovaStar Financial case (refer here), Centerline (here);  Impac Mortgage (here); Home Banc Corporation (here); Regions Financial Corp./Trust Preferred Securities (here); Morgan Keegan Asset Management (here); General Electric (here); American Express (here); and Fremont General Corporation (here).

Finally, it should be noted that dismissal motions are still yet to be heard in over a third of the subprime and credit crisis-related lawsuits. With further proceedings yet to unfold in many cases and with so many other cases yet to be heard, it would be premature to make any definitive pronouncements about whether or not the subprime and credit crisis cases are being dismissed at a greater rate than securities class action lawsuits generally.

40 Settlements and a Trial

So far 40 of the subprime and credit crisis related securities class action lawsuits have settled, representing $4.419 billion in the aggregate. It is interesting to note that of these 40, 23 of the settlements were announced in 2011, representing $2.48 billion total. The pace of settlement quickened considerably in the year just ended, as more of the earlier cases reached the settlement stage. It seems likely that we will see even more settlements in 2012.

The average of the settlements so far is about $110 million. However, the largest settlements are pulling this average upward. If the four largest settlements (the $627 Wachovia Preferred Securities settlement, the $624 Countrywide Settlement; the $475 Merrill Lynch settlement and the $415 Lehman Brothers Offering Underwriter settlement) are removed from the calculation, the average drops to about $63 million.

Not every case that survives dismissal settles; though it is very rare in the securities class action lawsuit context, some cases still do go to trial. In November 2010, a jury in the Southern District of Florida entered a plaintiffs’ verdict in the securities class action lawsuit filed against BankAtlantic Bancorp and certain of its directors and officers. (It is interesting to note that this case is one of the cases mentioned above in which the dismissal motion was initially granted but was denied on reconsideration.) However, as noted here, in April 2011, Southern District of Florida Judge Ursula Ungaro granted the defendants’ motion to have the jury verdict set aside. The plaintiffs have appealed Judge Ungaro’s ruling to the Eleventh Circuit.

Observations

Even if subprime and credit crisis-related dismissal rate may be running ahead of historical norms so far, it seems that the highest profile cases are surviving the dismissal motions. Thus, for example, the dismissal motions were denied in the Lehman Brothers case (about which refer here), in the Bear Stearns case (here), in the BofA/Merrill Lynch merger case (here), as well as in the Citigroup case (here), the AIG case (here) and the Washington Mutual case (here).

One particular subset of the cases that presents some particularly interesting issues, and where the plaintiffs lawyers have seen large parts of their cases dismissed, are the cases that have been brought on behalf of mortgage-backed securities investors. From fairly early on these cases, courts have granted the dismissal motions as to specific mortgage-backed securities offerings in which the named plaintiffs had not purchased the securities. A more troublesome standing challenge has arisen in cases in which the courts have held that the named plaintiffs can only represent investors that purchased securities in the same investment tranches, but not investors who purchased securities in other tranches in the same securities offering. Rulings along these lines have been granted in the Washington Mutual mortgage- backed securities case (about which refer here), in the Countrywide Mortgage-Backed securities case (here), and in the J.P. Morgan mortgage-backed securities case (here). These rulings have dramatically narrowed the potential scope of these cases. If the line of analysis were to be followed in other mortgage backed securities cases, it could substantially diminish the potential value of these cases for the plaintiffs.

At the same time, during 2011, there were a couple of attention- grabbing settlements of mortgage-backed securities cases. The first of these was the $125 million settlement of the Wells Fargo mortgage backed securities case, which represented the first settlement of any of the mortgage backed securities cases. This settlement was followed in December with the $315 million settlement of the Merrill Lynch mortgage-backed securities case. These settlements demonstrate that the mortgage backed securities cases potentially have substantial value. However, it will be interesting to see how the rulings involve tranche standing described in the preceding paragraph affect these cases going forward.

There were a number of other interesting aspects of the subprime and credit crisis securities class action lawsuits that settled in 2011. Among other things, the year’s settlements included the largest settlement yet as part of the wave of litigation, the $627 million settlement in Wachovia Preferred Securities Litigation. The settlements also included the rather unusual resolution in the Wachovia Equity Holders’ action, which settled for $75 million while the case was on appeal from its dismissal in the lower court. This latter settlement underscores the fact that looking at the current dismissal rate of these cases may not reveal everything there is to know about these cases.

It is not a mere coincidence that the two cases I noted in the preceding paragraph involve Wachovia, which was acquired in December 2008 by Wells Fargo. In fact, a very large part of the aggregate amount for which the cases have settled so far has come from just two companies, Wells Fargo and Bank of America, due to the two firms’ acquisitions of companies that were at the center of many of the key events in the subprime meltdown and credit crisis.

Take Bank of America, for instance. So far, the settlements on BofA’s tab include the $624 Countrywide settlement; the $475 million Merrill Lynch settlement; the $150 million Merrill Lynch bond action settlement; and the$315 million Merrill Lynch mortgage-backed securities settlement. For those of you keeping score at home, that adds up to a cool $1.56 billion, or nearly 30 percent of the aggregate settlement dollars so far.

By the same token, Wells Fargo had some large bills to pay, too. The settlements on its tab include the $627 Wachovia Preferred Securities settlement and the $75 million Wachovia equity investors’ settlement mentioned above, as well as the $125 Wells Fargo mortgage backed securities settlement. Those three settlements add up to $827 million.

The total of the settlements funded or to be funded by BofA and Wells Fargo collectively add up to $2.38 billion -- or more than half of the aggregate $4.419 billion of subprime and credit crisis-related settlements so far.

It is interesting to contrast these mammoth settlements, involving as they do a solvent surviving entity, with the smaller settlements in cases in which the target company did not involve a surviving entity. Even though the Washington Mutual collapse was the largest bank failure in U.S. history, the securities case settled for $208.5 million, of which $103.5 million was contributed on behalf of the underwriter defendants and the company’s auditor. And even though the failure of Lehman Brothers was the central event of the credit crisis, the securities case against the former Lehman executives contributed settled for $90 million. (Separately, the Lehman Brothers offering underwriters agreed to a $417 million settlement.) Obviously both of these settlements are very substantial, but still stand in contrast to the much larger settlements I n which a solvent surviving entity was involved.

The WaMu settlement and the Lehman executive settlements do illustrate one critical aspect of the resolution of the subprime and credit crisis-related securities class action lawsuits and that is the importance of D&O insurance to the settlement of many of these cases. Insurance likely was not much of a factor in the larger cases involving BofA and Wells Fargo. D&O insurance was also likely not much of a factor in the $417 million Lehman Brothers offering underwriter settlement. But D&O insurance has been a significant factor in many of the other settlements.

For example, the $105 million settlement on behalf of the individual defendants as part of the $208.5 million WaMu settlement was funded entirely by D&O insurance. Similarly the $90 million settlement on behalf of the Lehman executives was funded by D&O insurance (a settlement that largely exhausted the company’s $250 million D&O insurance tower). D&O insurers will contribute $68.25 million of the recent $79 million settlement of the E*Trade case. $30 million of the $37.5 Popular Inc. securities class action settlement is to be funded by D&O insurance, as discussed here. Other important settlements also obviously involve substantial D&O insurer contributions, even if the exact amount is not entirely clear – see here for example with respect to the $68 million MBIA settlement.

In other words, D&O insurance has been a critical part of many of these settlements. Taken together these cases have been enormously costly to the D&O insurance industry, particularly when the fact that D&O insurance is also funding a substantial portion of the costs of defending these cases as well. Taking into account that many more cases are yet to be resolved, it is clear that by the time all is said and done, the subprime and credit crisis-related litigation wave taken collectively will prove to have been a major event for the D&O insurance industry. With only a small portion of the cases resolved to date, the ultimate magnitude of the industry’s losses from this event is still yet to be told.

SEC Modifies Its Policy – A Little Bit: Many readers may have been surprised as I was to learn on Friday that the SEC no longer would be accepting the “neither admit nor deny” settlements. This aspect of the disputed Citigroup enforcement action has been the subject of heater controversy before Southern District of New York Judge Jed Rakoff (as discussed here).

However, the policy modification turns out to amount to substantially less than first appeared. As Alison Frankel explains in a January 6, 2011 post on Thomson Reuters News & Insight (here), the new policy only applies where the enforcement action target has admitted guilt or been convicted in a related criminal action. As Frankel puts it, “in other words, defendants whose guilt has already been established under the higher standard of criminal law can no longer deny civil charges. Which leads, of course, to the question of why it took the SEC 40 years to change such a ridiculous policy.”

No matter how you look at it, this change “does not represent a major change in policy,” as one commentator noted on the WSJ.com Law Blog (here). It should have no effect on the pending Citigroup controversy.

The Chevron Ecuador Environmental Lawsuit: I confess that I have not been closely following the long-running lawsuit that was filed against Texaco (now part of Chevron) on behalf of Ecuadorians in connection with Texaco’s oil production operations in that country. Over time, the case seemed to represent the absolute embodiment of litigation run amok and I long ago lost interest.

Nevertheless, I have to say that I found Patrick Radden Keefe’s January 9, 2012 The New Yorker (here) article about the case entitled  “Reversal of Fortune” in to be absolutely fascinating. The story about the case is full of outsized characters, including in particular the crusading lead plaintiffs’ counsel Steve Donzinger. The tale is worthy of a John Grisham novel. The case, which is no closer to resolution than it has ever been, has taken on a very peculiar life of its own. Though the case does very much represent litigation run amok, the story of the case makes for some very interesting reading.  

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As a result of developments during 2011, there is a “growing sense of urgency amongst FCPA practitioners as to the direction the statute will take in the coming years,” according to a law firm’s year-end FCPA report. The January 3, 2011 memo from the Gibson Dunn law firm, entitled “2011 Year-End Update,” can be found here. Whatever else might be said, according to the report, “these are interesting times for the FCPA.”

According to the report, FCPA enforcement activity remains near all time highs. In terms of FCPA enforcement actions initiated by the Department of Justice and the SEC, 2011 “was the second most prolific ear in the history of FCPA enforcement.” The 23 DoJ actions and the 25 SEC actions are “outmatched only by the juggernaut that was 2010.” However, the report notes, the 2010 statistics were “elevated substantially” by the 22-defendant SHOT  show arrests.

The report notes a number of interesting FCPA enforcement trends during 2011, including the increasing practice of U.S. regulators to pursue enforcement actions against individual defendants after negotiated settlements with the individuals’ employer. As an example, the report cites the recent enforcement actions brought against seven former Siemens executive and two former Siemens third-party agents. Among other things the report notes, the nine targeted individuals are all foreign nationals. In other words, the parent company, the alleged wrongful activity and the targeted individuals all took place or are domiciled outside the United States, which illustrates the U.S. regulators’’ willingness to “polic conduct beyond [U.S.] borders that it perceives as affecting U.S. markets.

The report also referenced the SEC’s willingness to bring unsettled FCPA enforcement actions as evidence of the agency’s “more aggressive enforcement stance.” In the past the agency “has not been known to file many FCPA cases absent an advance agreement to settle the matter.” But during 2011, the SEC brought 10 unsettled FCPA enforcement actions, more than in the previous 33 years of FCPA enforcement combined.”

FCPA enforcement actions during 2011 also reinforced the “imperative that acquisitive companies conduct thorough pre-acquisition due diligence and equally robust post-acquisition compliance integration.”

The report also notes the DoJ’s recent initiative to pursue foreign government officials who received the bribes paid by FCPA defendants. The FCPA itself does not criminalize the receipt of bribes by foreign officials, but the Department of Justice has tried to use two tools to reach the recipients: money laundering statutes and civil forfeiture actions. These aggressive efforts are still in their early stages.

The report notes that though the FCPA itself does not provide for a private right of action, “enterprising plaintiffs have circumvented the FCPA’s lack of a private redress mechanism by filing derivative lawsuits, securities fraud actions, tort and contract law claims, employment lawsuits, and private actions under the Racketeer Influenced and Corrupt Organizations (RICO) Act.” Among other cases the report cites is the FCPA-related derivative lawsuit involving Avon Products (refer here, footnote 5 to the financial statements), and the FCPA-related derivative lawsuits involving Bio-Rad Laboratories (refer here) and Tidewater, Inc. (refer here). Avon is also the subject of an FCPA-related securities class action lawsuit as well (refer here).

The report also canvasses the various pending legislative and policy developments that could lead to changes to the FCPA itself or its enforcement during 2012. The report also catalogues global anti-corruption enforcement developments. Overall, the report is interesting and well-written, and well worth reading in its entirety.

Readers of this blog will be most interesting in the report’s commentary about FCPA-related civil litigation. The follow-on litigation provides what I have called in the past the link to the D&O insurance policy. There would not be coverage under the typical D&O policy for the fines and penalties imposed in connection with an FCPA enforcement action, although defense fees incurred in connection with the action potentially could be covered under many policies, depending on the policy wording. But the filing of a civil lawsuit against members of the board of directors, as a follow on to the FCPA action, is an event much more directly linked to the D&O policy and much more likely to give rise to covered loss under the policy.

As the escalating levels of FCPA enforcement actions continues to increase, this type of potential Board liability exposure will continue to be a growing concern for Boards, their advisers, and their D&O insurers.

Those readers who want a more comprehensive overview of both the historical and current state of FCPA enforcement will want to refer to the Shearman and Sterling law firm’s mammoth 692-page January 3, 2011 “FCPA Digest” (here). The Shearman and Sterling report has a more detailed statistical overview and an exhaustively detailed case summarization. The Shearman & Sterling report also sets out in specific case detail a catalog of follow-on civil actions arising out of FCPA enforcement activities (refer to pages 538 through 620 of the report). The value of the Shearman & Sterling approach is that it is not limited just to actions filed or pending in 2011, but is historically all-encompassing – although some readers may find the report’s sheer size intimidating.

The Morrison  Foerster law firm has a January 5, 2012 client alert (here) detailed the fines and penalties assessed under the FCPA in 2011. A January 6, 2011 Corporate Counsel article reviewing the Gibson Dunn and Shearman & Sterling memos can be found here.

Readers interested in the phenomenon of FCPA follow-on civil litigation will want to read the very interesting post on the FCPA Professor Blog (here) about the $45 million settlement that Innospec in an antitrust lawsuit brought by a competitor following Innospec’s $25.3 million settlement of an FCPA enforcement action. Professor Mike Kohler has some very provocative observations about the case and the settlement.

Finally, for reference purposes, The FCPA Blog has a comprehensive list (dated January 4, 2012) of all severity-eight companies that have disclosed in their respective SEC filings currently pending FCPA investigations.

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On December 29, 2011, in what appears to have been the final year-end step as the FDIC ramped up its failed bank litigation activity during 2011, the FDIC filed a civil lawsuit in the Western District of North Carolina in is capacity as receiver of The Bank of Ashville, of Ashville, North Carolina, against seven former directors and officers of the bank. Though this lawsuit is only the latest in a series of failed bank actions the agency has filed, there are some interesting aspects to the case, as discussed below.

The Bank of Ashville was closed on January 21, 2011, and the FDIC was appointed receiver (about which refer here). The FDIC’s complaint in the recently filed action alleges that during the period June 26, 2007 through December 24, 2009, the defendants, “enticed by the ‘bubble’ in the real estate sector of the Bank’s lending markets,” caused the bank to pursue a growth strategy concentrated in “higher risk, speculative commercial real estate loans.” This focus resulted in rapid growth during the period.

The complaint alleges that that the defendants’ all but one of who lacked previous banking experience were “ill-equipped to manage the risks associated with the nature and extent of the Bank’s growth,” and that they increased the Bank’s risks by “implementing policies and procedures void of the most basic lending controls and neglecting to adequately supervise inexperienced and under qualified lending personnel.” The complaint further alleges that the defendants’ “failures to establish and to adhere to sound policies and procedures resulted in the approval of poorly underwritten and structured real estate dependent loans.”  The complaint also alleges that the defendants ignored regulatory and audit warnings.

As the problems in the real estate market began to emerge in 2008 and 2009, the defendants allegedly “took actions that masked the Bank’s mounting problems,” including approving additional loans or advances to borrowers on nonperforming loans.

The complaint asserts claims against the defendants for negligence, gross negligence and breaches of fiduciary duty, and seeks to recover $6.8 million in losses that the bank suffered on thirty commercial real estate and business loans.

At one level, there is nothing particularly striking about the allegations in the complaint. The amount of the alleged losses in the grand scheme of things is relatively modest, at least by comparison to those alleged in connection with other failed banks.  There are no particularly egregious facts alleged, such as self-dealing or even person enrichment. There are no provocative aspects of the complaint, like the inclusion of the failed bank’s D&O carrier as a co-defendant (as was the case here), or the inclusion of the bank’s outside lawyer as a defendant (as was the case here).

On the other hand, it could be that the lower level temperature of the case it itself noteworthy. It is possible that the FDIC’s willingness to initiate a lawsuit even in these circumstances suggests a certain level of aggressiveness on the FDIC’s part. This suggestion is further reinforced by the fact that the FDIC has brought this action relatively quickly after the bank’s failure, at least by comparison to other situations where the FDIC has pursued litigation. In most of its other lawsuits so far, the FDIC has only filed its lawsuit after the lapse of two years or more from the date of the failed bank’s closure. The modest amount of the damages sought together with the relatively accelerated filing date makes me wonder whether or not there is a context for the lawsuit filing.

The litigation activity of the FDIC as receiver is essentially a salvage operation. The FDIC is trying to reduce, or at least offset, the failed banks’ losses. The salvage operation often consists of an effort to capture the proceeds of the failed bank’s D&O policy. (Indeed, even the FDIC’s lawsuit against three former officers of Washington Mutual, the largest bank failure in U.S. history, turned out to be largely about the D&O insurance, as discussed here.) More than one of the FDIC’s lawsuits has looked like negotiation with the D&O carriers pursued by other means (consider this prior case involving the First National Bank of Nevada, here).

All of which makes me wonder whether this latest lawsuit, particularly given its timing and the quantum of damages sought, might be directed at  the failed bank’s D&O carrier. I do not mean to suggest that I am questioning the merits of the FDIC’s lawsuit, as I have no basis one way or the other to assess the merits. I am simply saying that the motivations for the lawsuit’s filing could have a lot to do with the failed bank’s D&O insurance – as in, the FDIC felt it needed to make a little noise to get the D&O carrier’s attention.

In any event, this latest filing represents the FDIC’s 16^th lawsuit of 2011, brining the total number of failed bank lawsuits the FDIC has filed during the current bank failure wave to 18, involving 17 different institutions. Based on the number of lawsuit authorized (as disclosed on the FDIC’s website) there clearly will be many more lawsuits to come during the New Year.

Goal Kick, For Real: In what has to be one of the most insane soccer goals ever, in a January 4, 2012 match, Everton goalie Tim Howard (a U.S. national who was the goalie for the U.S team at the 2010 World Cup) scored a wind-blown goal on a field-length kick. Sadly it was not enough for his team as Bolton would go on to beat Everton, 2-1.

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Securities class action lawsuit filing activity seems to have picked right up in the New Year where last year’s filings left off, as what appears to be the first filed case of 2012 involves a U.S.-listed Chinese company. Camelot Information Systems, a Chinese-based company whose American Depositary Shares (ADS) trade on the NYSE, and certain of its directors and officers have been sued in a securities class action lawsuit dated January 5, 2012. A copy of the plaintiff’s complaint can be found here.

Camelot is a provider of IT business solutions. Unlike many of the other U.S.-listed Chinese companies that have been sued in securities suits involving Chinese companies, Camelot did not obtain its listing by way of a reverse merger; it actually conducted a full IPO, in July  2010. The company also conducted a secondary offering on December 9, 2010. 

The company was the subject of an August 15, 2011 article on Seeking Alpha entitled “Extremely Cautious on Camelot Information Systems” (here) that questioned the company’s statements regarding its employees, revenue and other key business components. The company’s ADS price declined. On August 19, 2011, the company released its fiscal second quarter results and also lowered its guidance for fiscal 2011. Its ADS price declined further.

According to the plaintiffs’ lawyers’ January 5, 2012 press release (here), the complaint alleges that the defendants concealed from investors that:

(a) the Company’s IT professionals were not a competitive advantage to the Company and many were dissatisfied with Camelot, which would adversely affect Camelot’s ability to retain its customers; (b) the Company was suffering from undisclosed attrition of employees, which was having a negative impact on the Company’s ability to attract new customers; (c) Camelot did not have the large numbers of highly trained professionals at its disposal that it had represented; and (d) Camelot’s contract with its most important customer, IBM, was not as solid as represented, and would not be renewed on the same terms.

The complaint also names as defendants the offering underwriters that conducted the companies ADS offerings.

As I recently noted (here), lawsuits against U.S.-listed Chinese companies were one of the most significant parties of 2011 securities suit filings. The 39 lawsuits filed against Chinese companies represented nearly one fifth of all 2011 securities class action lawsuit filings. Although these filings were weighted to the first half of the year, there were 13 in the year’s second half, including two in December.

Eventually this filing trend will go away, as the plaintiffs’ lawyers sooner or later run out of additional Chinese companies to sue. But for now the filing trend appears to have carried over into the New Year, with the filing of this new lawsuit involving Camelot Information Systems.

Deloitte Must Produce Longtop Financial Documents: In an interesting development in connection with the SEC's investigation of Longtop Financial Technology, a Chinese companies who had been delisted from a U.S. exchange, on January 4, 2012, a Magistrate Judge for the U.S. District Court for the District of Columbia ruled that Deloitte Touche Tohmatsu Ltd. must appear in court ad produce documents on work the firm did for Longtop. The Magistrate ruled that Deloitte could be compelled to appear even though it had not been served with a show-cause memorandum. A copy of the Maistrate's january 4, 2012 order can be found here. A January 4, 2012 Blog of the Legal Times article discussing the ruling can be found here.

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The year just ended was eventful in many ways. Earthquakes, hurricanes, tornadoes, floods, blizzards and droughts were scattered across the globe, and political unrest shook many countries. In a year filled with such significant developments, events in the world of D&O liability pale by comparison. But even if there were no earth-shaking events, 2011 was nevertheless an eventful year in the directors and officers’ liability arena. Here is my selection of the top ten stories from the world of D&O.

1. M&A Litigation Becomes the Lawsuit of Choice for Plaintiffs’ Securities Attorneys: The traditional focus for any discussion of D&O litigation exposure has been federal securities class action litigation. But in recent years, there has been a shift in the mix of corporate and securities litigation filings. Taking into account both federal and state lawsuit filings, M&A-related lawsuits now outnumber federal securities lawsuit filings and M&A-related litigation is now the lawsuit of choice for many plaintiffs’ securities attorneys.

As a result of legislative changes and U.S. Supreme Court case law developments, “dispossessed plaintiffs’ lawyers” (as one academic recently put it) have been forced to seek an alterative business model. And M&A litigation appears to be an attractive business model for many plaintiffs’ lawyers. Corporate defendants, eager to complete the underlying business transaction, often are keen to settle these cases quickly. Settlements often include a not insignificant provision for plaintiffs’ fees.

The attractions of this business model is drawing competition, as increasingly each merger transaction is attracting  multiple separate lawsuits, often filed in differing jurisdictions. The jockeying between the plaintiffs’ lawyers in the competing cases in multiple jurisdictions has led to procedural complications and rapidly increasing costs of defense. Delaware, the traditional forum for this type of litigation, arguably now faced with “market share” competition, is according to some under pressure to show that it is not inhospitable to these kinds of lawsuits, and even to support plaintiffs’ fee awards (about which see more below).

Not only are both defense expenses and plaintiffs’ fee awards in merger objection suits mounting, but it is increasingly common for M&A-related cases to result in cash settlements on an order of magnitude often seen only in traditional securities class action lawsuits. Thus, the Kinder Morgan case, settled in August 2010 for $200 million (refer here); the Del Monte case settled in September 2011 for $89 million (refer here); the May 2010 ACS settlement was $69 million (refer here); and the 2011 Intermix Media settlement was $45 million (refer here).

The new M&A litigation model represents both a high frequency and a high severity risk. The severity risk is particularly acute given the exacerbating effects of escalating defense expenses and rising plaintiffs’ attorneys’ fees. The bottom line is that it is no longer sufficient to focus just on federal securities class action litigation. M&A related litigation is an increasingly important part of the overall mix of corporate and securities litigation. For anyone whose tasks include understanding the risks and exposures associated with corporate and securities litigation, this is an important development with significant implications. 

2. Chinese Take-Out: U.S.-Listed Chinese Companies Hit With Class Action Securities Litigation: Every year there seems to be one group or sector of companies that draws the unwanted attention of plaintiffs’ securities attorneys. During 2011, the hot sector was U.S.-listed Chinese companies. There were 39 different U.S.-listed Chinese companies hit with securities class action lawsuits during 2011, representing nearly one-fifth of all securities class action lawsuit filings during the year. Since January 1, 2010, there have been securities class action lawsuits filed against 49 different Chinese companies.

This surge of litigation involving Chinese companies has arisen out of accounting scandals, many of which were first revealed by online analysis, many of whom have short positions in the companies they are attacking. The Chinese companies have attempted to deflect the assertions by charging that the attacks are merely rumors started by interested parties with a financial incentive to drive down the companies’ shares prices. Fair or not, the online reports seem to be leading directly to shareholder litigation, as in many cases the shareholder plaintiffs’ are simply quoting the online analysts’ reports in their complaints.

Obviously not all of these cases are meritorious and indeed some of them have been dismissed (refer for example here). On the other hand, other cases have survived the initial dismissal motions (refer for example here). Even in those cases in which the plaintiffs’ claims survive the initial pleading threshold, their claims stiff face substantial challenges, not the least of which are problems involved with effecting service of process and in conducting discovery in China, as well as deriving from the geographic distances and language issues involved. (Refer here).

Eventually the plaintiffs’ lawyers will simply run out of Chinese companies to sue, but for now the phenomenon shows no sign of letting up. During the second half of 2011, there were a total of 13 Chinese companies sued in securities class action lawsuits in the U.S., including two in December alone.

The recent litigation against the U.S.-listed Chinese companies is a reminder of circumstance-specific events that can drive securities class action lawsuit filings. Countless things determine litigation activity levels, many of which cannot be captured or predicted in historical filing data. Simply put, the numbers vary over time, because, for example, contagion events and industry epidemics happen.

3. Massive Settlements Emerge as the Subprime and Credit-Crisis Litigation Wave Slowly Plays Out: The subprime and credit crisis-related litigation wave is about to enter its sixth year. Though there were additional credit crisis-related lawsuit filings during 2011, the arrival of new cases seems to have largely come to an end. However, there is still a massive backlog of cases filed over the last five years that is yet to be resolved. During 2011, a number of these cases were settled, and in some cases the settlements were massive.

The 2011 settlements include the largest so far in subprime and credit crisis-related cases, the $627 million Wachovia bondholders settlement, about which refer here. Other settlements include the following: Merrill Lynch Mortgage Backed Securities, $315 million (refer here); Lehman Brothers offering underwriters settlement, $417 million (refer here); Washington Mutual, $208.5 million (refer here); Wells Fargo Mortgage Backed Securities, $125 million (refer here); National City, $168 Million (refer here); Colonial Bank, $10.5 million (refer here); and Lehman Brothers executives, $90 million (refer here) and E*Trade, $79 million (refer here).

If you include the Lehman Brothers’ offering underwriters’ settlement, the various subprime and credit crisis lawsuit settlements total about $4.432 billion. The average settlement so far is about $110 million, although that figure is clearly driven upward by the largest settlements. If the Countrywide, Wachovia bondholders and Lehman offering underwriters’ settlements are removed from the equation, the average settlement drops to about $74.7 million.

As impressive as these settlement numbers are, there are still many more cases pending. Of course, a certain number of the pending cases will ultimately be dismissed. But many will not, and eventually those remaining cases will be settled. Although it is impossible to conjecture how large the total tab for all these cases ultimately will be, the implication from the cases that have settled is that the total amount will be massive. 

The possibilities here may have significant implications for D&O insurers. Of course, not all of these amounts will be covered by D&O insurance. But a significant chunk will be. Indeed, a number of the recent settlements will be funded entirely or almost entirely by D&O insurance, including the D&O portion of the WaMu settlement, the Colonial Bank settlement, the E*Trade settlement and the Lehman Brothers executives’ settlement. Interestingly, the Lehman executives’ settlement will come close to exhausting what is left of Lehman’s $250 million insurance tower.

In other words, the D&O insurers have had some very large bills to pay. Signs are that there will be further amounts due in the months ahead.

4. Costs Incurred in Connection with Informal SEC Investigation Held Not Covered: One of the perennial D&O insurance coverage questions is whether or not a D&O insurance policy provide coverage for defense expenses and other costs incurred in connection with an informal SEC investigation. In October 2011, in a case that was closely watched in the D&O insurance industry, the Eleventh Circuit  issued a per curiam opinion affirming a lower court holding that costs Office Depot had incurred in connection with an informal SEC investigation and investigating an internal whistleblower complaint were not covered under its D&O insurance policies.

The sheer dollar value of the costs for which Office Depot had sought coverage underscores the extent of the problems involved. Office Depot had incurred tens of millions of dollars in expense before the SEC investigation became formal. Under the circumstances presented and based on the policy language at issue, the district court held and the Eleventh Circuit affirmed that Office Depot did not have insurance coverage for these costs. The holding was a reflection of the specific policy language at issue, but D&O insurers undoubtedly will try to rely on the holding in other circumstances in which coverage is sought for costs incurred in connection with informal SEC investigations.

Meanwhile, the insurance marketplace has evolved in recognition of policyholders’ interest in having insurance coverage for the costs of informal SEC investigations. Recently, some carriers have been willing to provide coverage for costs individuals incur in connection with informal SEC investigations. In addition, at least one carrier now offers a separate insurance product that provides coverage for costs that the entity itself incurs in connection with an informal SEC investigation. Although this entity protection for informal SEC investigative costs is subject to a large self-insured retention and to coinsurance, the fact remains that if such a policy had been available to Office Depot and if Office Depot had had such a policy in place, at least a significant part of Office Depot’s costs of responding to the informal SEC investigation might have been covered.

Policyholder advocates undoubtedly will take the position that the Eleventh Circuit’s opinion in the Office Depot case does not represent the final word on the question of D&O insurance coverage for costs incurred in connection with informal SEC investigation. In making these arguments, the policyholder advocates undoubtedly will seek to rely on the Second Circuit's July 2011 opinion in the MBIA case, in which the court held that costs incurred in voluntarily responding to a governmental investigation are covered. (The MBIA case is itself also a reflection of the policy language involved and circumstances presented, including in particular the fact that most of the costs at issue were incurred after the SEC had issued a formal investigative order, by contrast to the Office Depot case, where most of the costs were incurred before the investigation was formalized.)

These questions undoubtedly will continue to be disputed and even litigated. But it will be interesting to see how the marketplace continues to evolve as the industry continues to try to craft solutions to this recurring problem.

5. FDIC Litigation Against Failed Bank Directors and Officers Slowly Emerges: Since January 1, 2008, there have been 414 bank failures, including 92 in 2011 alone. Though the number of bank closures this past year represents a decline from the prior year’s total of 157, the likelihood is that there are further bank failures ahead in 2012, albeit at a reduced pace from recent years. (The January 3, 2012 Wall Street Journal comments that “failures will be a part of the landscape for many months, maybe years, as weak banks take a long time to recover or fail.”) But even if the number of new bank failures may finally be starting to decline, the FDIC’s pursuit of litigation against the directors and officers of failed banks may just be getting started.

During 2011, the FDIC stepped up its failed bank litigation activity. The FDIC filed 15 lawsuits against directors and officers of failed banks in 2011, bringing the total number of FDIC failed bank lawsuits to 17. Signs are that the number of FDIC lawsuits will continue to grow in the months ahead. According to the FDIC’s website, as of December 8, 2011, the FDIC has authorized suits in connection with 41 failed institutions against 373 individuals for D&O liability for damage claims of at least $7.6 billion. These figures representing the authorized lawsuits contrast starkly with number of lawsuits that the agency has actually filed: So far, the agency has filed only 17 lawsuits against 135 former directors and officers of 16 failed financial institutions. Given the discrepancy between the number of suits authorized and the number of suits filed, there clearly are many more suits in the pipeline, with even more lawsuits likely to be authorized in the months ahead.

As the FDIC’s failed bank lawsuits have begun to emerge, settlements of these cases are also slowly developing. The most noteworthy of the settlements so far is the well-publicized resolution of the FDIC’s lawsuit against three former WaMu officers. Although widely reported as having a value of $64.7 million, the cash value of the settlement was actually about $40 million, as discussed here. All but a very small portion of the cash component was paid for out of WaMu’s directors and officers’ insurance coverage. Although it is interesting that the individual defendants were called upon to contribute out of their own assets toward the settlement, the fact is that D&O insurance represented almost all of the cash component of the settlement.

The point here is that as the FDIC failed bank lawsuits accumulate in the coming months and as the filed cases move toward resolution, D&O insurers could be called upon to contribute amounts toward defense and resolution of these cases that in the aggregate could be massive.

6. Eurozone Crisis Includes Corporate Liability Exposures: The financial crisis gripping the European economic community has many dimensions. As governments wrestle with concerns about sovereign debt of Eurozone countries, as well as unemployment and unrest, companies exposed to European sovereign debt face perils of their own. As the fallout from the collapse of MF Global demonstrates, the hazards these companies face include, among many other concerns, liability exposures stemming from the companies’ investments in European sovereign debt.

Among the many disturbing features of MF Global’s demise is the speed of its collapse. And inevitably its collapse was immediately followed by an onslaught of securities class action lawsuit filings against the firm’s directors and officers. MF Global collapsed because of its exposure to European sovereign debt. The company is of course far from the only enterprise exposed to European debt. A host of other financial institutions and banks are also exposed and many more enterprises are exposed to the companies with European debt exposure. The possibility of sovereign debt rating downgrades or even debt write-offs looms over the firms carrying these assets on their balance sheets. 

Though the larger problems for the global financial marketplace clearly are of a much higher order, these issues also pose a challenge for D&O insurance underwriters. As noted above, there is not just the question of whether or not a company is exposed to European sovereign debt. There is also the far more difficult to discern question of whether or not a company is exposed to a company that is exposed to European sovereign debt. If the European difficulties were to evolve from a crisis to a disaster  – for example, though the withdrawal of one or more countries from the Euro – the aftereffects could be even more widespread. As MF Global’s rapid demise illustrates, these kinds of concerns are sufficient to quickly send a company into bankruptcy.

There is no way to know for sure, but I suspect strongly that as the New Year progresses, there will be a lot more to be said about European sovereign debt risk, at both the global and individual company levels.

7. Whistleblower Rules Go Into Effect, Whistleblower Lawsuits Emerge: The SEC issued its implementing regulations with respect to the Dodd-Frank whistleblower provisions in August 2011. In November 2011, the agency released its first report to Congress, as required by the Dodd-Frank Act, on whistleblower activities, as of the end of the 2011 fiscal year end on September 30, 2011.

Though the SEC’s report reflected only a seven week time period, it revealed a heightened level of whistleblower reporting. In just the first seven weeks, the program recorded 334 whistleblower reports, which implies an annualized level of nearly 2,500 reports. Interestingly, about 10 percent of all whistleblower reports during the period reflected in the study originated outside the United States. The SEC made no whistleblower bounty payments during the period reflected in the study, as permitted under the Dodd-Frank Act. It seems likely that as the agency makes bounty payments additional whistleblowers will be motivated to come forward.

With the implementation of provisions for potentially rich whistleblower bounties under the Dodd-Frank Act, there have been concerns that the incentives will not only lead to increased numbers of reports and increased enforcement activity, but that the regulatory action will in turn generate follow-on civil litigation.  As discussed here, a December 2011 securities class action lawsuit filed against Bank of New York Mellon give a glimpse of how heightened whistleblower activity could lead to increased follow-on civil litigation.

The lawsuit followed whistleblower reports that the company engaged in a scheme to fraudulently overcharge its customers for foreign currency exchange transactions. Although the whistleblower allegations first emerged in separate whistleblower lawsuits, the foreign currency exchange allegations are also the subject of whistleblower reports to the SEC. In addition to the securities class action lawsuit, the whistleblower allegations have also triggered multiple regulatory actions. The train of events that the BNY Mellon whistleblower allegations set in motion shows how the revelation of whistleblower allegations can lead not only to significant regulatory action but also to significant follow on civil litigation.

Given the substantial bounties for which the Dodd-Frank Act provides, it seems likely there will be increased numbers of reports to the SEC, which in turn could mean increased levels of enforcement activity. Along with all other concerns these possibilities present, there is also the concern that the increased number of reports and increased enforcement activity could, following the same sequence illustrated in connection with the BNY Mellon whistleblowers, lead to a surge in follow-on civil litigation. As we head into 2012, we will have to watch whether increased whistleblowing will lead to increased follow-on civil litigation, similar to the suit against BNY Mellon.

8. Aggrieved Overseas Investors Seek Litigation Alternatives Outside the United States: For many years, the United States was the forum of choice for aggrieved investors to seek redress, regardless of whether or not the investors purchased their shares in the United States. However, the U.S. Supreme Court’s June 2010 decision in Morrison v. National Australia Bank abruptly and unexpectedly eliminated access to U.S. courts for investors who purchased their shares outside the U.S. As a result, these investors increasingly are seeking alternative means to pursue their claims. Though we are still in the earliest days following the Morrison decision, there seem to be significant indications that aggrieved investors are developing a new playbook that includes resort to non-U.S. courts.

Investors’ pursuit of claims outside the United States was not long in coming after the Morrison decision and as its implications began to emerge in the lower U.S. courts. For example, in January 2011, after investors’ claims in U.S. court against Fortis were dismissed based on the Morrison decision, investors filed an action in Dutch court seeking remedies under Dutch law, but raising the same allegations that previously had been asserted in U.S. courts. Similarly, in December 2011, hedge funds and other investors whose action against Porsche had been dismissed from U.S. courts based on Morrison filed an action raising the same allegations against the company and its management in a German court.

Developments in other jurisdictions also reflect investors’ efforts to develop alternative remedies in the absence of access to U.S. courts. Among other things, at least two class actions pending in Canadian courts have not only survived dismissal motions but have had global classes certified. As discussed here, investors have also shown a willingness to pursue claims in a variety of other countries, including, for example, Germany and Australia. Recent statutory amendments in other countries (including, in particular, Mexico) may lead to investors in those countries to seek to pursue claims there.

Increased litigation and regulatory exposure outside the United States has a variety of implications, not the least of which concerns D&O insurance. As companies and their directors and officers face increased exposures on a global basis, D&O insurance policies will be called upon to respond in new and unusual situations. These developments in turn will require policies that are well adapted to the changing circumstances.

9. Judge Rakoff Rejects Settlement of SEC Enforcement Action Against Citigroup: Southern District of New York Judge Jed Rakoff’s November 2011 rejection of the $285 million settlement of the SEC’s enforcement action against Citigroup was not the first occasion on which Rakoff rejected a proposed SEC settlement. But this latest rejection has caused quite a stir, and not only because of the sharp rhetoric he used in rejecting the settlement (among other things, he derided the settlement because it “shortchanged” investors.) The most significant aspect of Rakoff’s rebuff is his refusal to accept a settlement in which Citigroup neither admitted nor denied the SEC’s allegations.

The SEC, perhaps stung by the Rakoff’s sharp words, and even more concerned about the possibility that it might be constrained from the entry into future no admit/no deny settlements, has appealed Rakoff’s ruling to the Second Circuit.  The SEC is right to be concerned about the implications of Judge Rakoff’s ruling. Following Judge Rakoff’s ruling, at least one other court has questioned a proposed SEC settlement that contained the “neither admit nor deny formulation.”

The problem for the SEC is that if proposed settlements cannot be approved unless the target defendants admit to wrongdoing, it may become significantly more difficult to settle cases and the SEC will be forced to take more enforcement actions to trial. This would not only put an enormous strain on the agency’s resources, but it could result in an overall reduction in the agency’s enforcement reach as it is forced to concentrate both more time and means on fewer enforcement actions.

The inability to enter into a no admit/no deny settlement presents a highly unattractive picture for target defendants as well. If fewer enforcement actions settle and more enforcement actions are forced to trial, the costs of defending an SEC enforcement action could escalate substantially. Target defendants unable to avoid the risks and uncertainty of trial without admitting wrongdoing will have to consider the possible effects of any admission on separate private civil actions. Any admissions in the enforcement actions could undermine their defenses in the separate civil actions. Moreover, depending on what is admitted, the admissions could have the further also undermine the target defendant’s insurance coverage by triggering a conduct exclusion on the defendant’s insurance policy.  

For these and a host of other reasons, the SEC’s appeal of Judge Rakoff’s ruling to the Second Circuit will be very closely watched. Crucially, however, the Second Circuit has not yet agreed whether or not it will actually hear the appeal of Judge Rakoff’s ruling. In additiona, there is always the possibility that Citigroup and the SEC will reach an agreement that Judge Rakoff finds acceptable (a footnote in his opinion rejecting the initial settlement does lay out a schematic for a settlement that would be acceptable to him, as I discuss here). Depending on how it all finally goes down, this case has the potential to be one of the top stories of 2012, as well.

10. A Big Fee Award in Delaware Gets Everybody’s Attention: Sometimes in litigation, a case that results in a big number is interesting in and of itself. And on that score, Delaware Chancellor Leo Strine’s October 2011 post-trial damages award of $1.263 billion in a lawsuit arising out of Grupo Mexico’s 2005 sale of Minerva Mexico to Southern Peru Copper Corporation certainly qualifies as interesting. (The later addition of pre-judgment and post-judgment interest increased the amount of the award to $2 billion). But what really has drawn attention to the case is Strine’s award to the plaintiffs’ of fees amounting to 15% of the damages and interest – that is, $300 million. A December 28, 2011 Wall Street Journal article entitled “Christmas Comes Early for These Lawyers” (here) describes the award.

As noted in a December 28, 2011 WSJ.com Law Blog post (here), the $300 million fee award may be the largest fee award ever in a shareholders’ derivative suit. Indeed it appears to be one of the largest fee awards in any corporate or securities case, approaching in order of magnitude the awards in the massive Enron and World Com cases (where the fees awarded were $688 million and $336 million, respectively).

Grupo Mexico undoubtedly will appeal both the damages award and the fee award. Whether or not the $300 million award ultimately withstands scrutiny, there are reasons to be concerned about the award. As noted above with respect to M&A litigation, Delaware’s courts are facing competition and appear to have been losing “market share” for corporate litigation. At least some interpreters have concluded, as reported in the Journal article linked above, that the plaintiffs’ fee award is a not-so-subtle signal to plaintiffs’ lawyers that Delaware’s courts are “open for business.” Other interpreters suggested that the fee award represents a “message to the plaintiffs’ bar.”

It is an obvious concern if Delaware’s judges feel obliged -- in order remain competitive in the jurisdictional competition and to try to preserve declining corporate litigation market share -- to prove that plaintiffs’ lawyers will be rewarded for resorting to the state’s courts.

Bloggers of the World, Unite!: Everyone here is pretty much reconciled to the fact that writing a blog is not exactly accorded equal dignity with, say, writing for The New Yorker. So we were all very gratified by the article in December 31, 2011 issue of The Economist entitled "Marginal Revolutionaries" (here), in whch the magazine reports that "the financial crisis and the blogosphere have opened up mainstream economics to new attack." Among other things, the article cites "the power of blogging as a way of getting fringe ideas noticed." The article recounts the experiences of the "invisible college of bloggers" whose revolutionary economic analyses have moved from the fringe to become part of the central economic dialog of our times.

In the immortal words of  the theme song of revolutionaries everywhere , "Allons enfants de la patrie, Le Jour de gloire est arrivé!" 

Perspective: Those worried about the troublesome events of the day may want to spend a few minutes contemplating "The Hisory of the Earth as a Clock" (here). In the grand scheme of things, the current crises are a mere passing cloud. (Source: UW-Geoscience).

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Surging levels of M&A-related litigation and a wave of lawsuits involving U.S.-listed Chinese companies drove federal securities class action lawsuit filings during 2011 to the highest levels since 2008. However, due to the growing wave of M&A-related litigation, much of which is filed in the state courts, the federal securities lawsuit filing statistics, while interesting, represent only a part of the overall corporate and securities litigation story. State court litigation, particularly state court M&A-related litigation, represents an increasingly important part of the picture.

According to my count (about which see more below), there were 218 securities class action lawsuit filings in 2011, well above the 176 filed in 2010, and also above the 1997-2009 average number of filings of 195, but below the 2008 credit crisis fueled total of 223. The 2011 filings were fairly evenly balanced throughout the year, with 113 in the year’s first half and 105 in the year’s second half.

The single largest factor driving the increase in 2011 filings were merger-related lawsuits. Sixty-one of the 218 filings during 2011 (or about 28%) were merger-related. By way of comparison, the M&A-related lawsuits represented slightly less than 20% of all 2010 filings, While these federal court filings represented an important part of the year’s overall federal securities class action lawsuit filings, these federal court filings represented only a fraction of all M&A-related litigation, most of which was filed in state court. Taking all of the cases, state and federal, into account, the number of M&A related lawsuits now greatly exceeds the number of federal securities class action lawsuits that are not merger-related. As discussed further below, the counts and relative comparisons can get tricky.

A second significant factor driving the 2011 securities class action lawsuit filings is the number of filings against non-U.S. companies, particularly U.S.-listed Chinese companies. 55 (or about 25%) of the 2011 federal securities filings involved non-U.S. companies.  The targeted non-U.S. companies are domiciled in 12 different countries. 39 of these 55 foreign companies are U.S.-listed Chinese companies (or U.S. listed companies that have their executive offices or principal places of operation in China). These 39 alone represent about 18% of all 2011 filings. Though the 39 lawsuit filings involving Chinese companies were heavily weighted to the first part of the year, there were still 13 in the year’s second half (which is more the 10 total filed against U.S.-listed Chinese companies during all of 2010) -- including two in December.

At one level, the fact that a quarter of all 2011 securities class action lawsuit filings involved non-U.S. companies is surprising, given that it seemed probable that the U.S. Supreme Court’s decision in the Morrison v. National Australia Bank case would result in a reduction in litigation involving non-U.S. But the 2011 actions involving non-U.S. companies either (like the cases involving the Chinese companies) involved firms with shares or ADRs listed on U.S. exchanges – and that therefore come within the requirements of Morrison – or were filed only on behalf of shareholders who purchased their shares in the U.S. The November 2011 action on behalf of the very few Olympus Corporation shareholders who purchased their Olympus ADRs over the counter in the U.S. is a good example of this latter kind of case. The Olympus case, which involves only a very small fraction of the company’s shareholders, show that Morrison is still having a very significant impact on filings, notwithstanding the number of filings involving non-U.S. companies.

The merger cases and the cases involving U.S.-listed Chinese companies together represented 100 of the 218 securities class action lawsuit filings during 2011, or nearly 46% of all filings. Clearly these two lawsuit phenomena were significant factors in driving 2011 filings, and more than account for all of the increase in 2011 filings compared to filing levels in 2010 and 2009.

The companies targeted in the 2011 securities class action lawsuit filings were very diverse, representing 114 Standard Industrial Classification (SIC) code categories. Unlike recent years in which filings against companies in the financial services industries predominated, filings against companies in the 6000 SIC code category (Finance, Insurance and Real Estate) represented only about 12% of all filings, compared to 2010, when filings against companies in that group represented about 20% of all filings, and 2009, when suits against financial companies accounted for over half of all filings.

This decline in the percentage of cases involving financial companies is largely due to the winding down of the subprime and credit crisis-related litigation wave. But while the wave is fading, it is not yet completely gone. There were still four new subprime relates securities class action lawsuit filings in 2011. However, none of these were filed during the year’s second half, which suggests that we could be very close to the end of the litigation wave, at least in terms of new filings.

There really was no SIC code classification that predominated in the 2011 filings. However, as always seems to be the case, there were a large number of cases involving companies in the life sciences sector. The SIC code classification with the single largest number of filings was SIC Code classification 2834 (Pharmaceutical Preparations), in which there were 11 lawsuits in 2011. Overall there were 13 lawsuits in SIC Code Group 283 (Drugs). There were another 5 companies sued in SIC Code classifications 3841 (Surgical and Medical Instruments) and 3845 (Electromedical and Electrotheropeutical Apparatus), meaning that overall there were 18 new lawsuits filed against life sciences companies, or about 8% of all 2011 filings. These 2011 figures were down from filings against companies in the SIC Code categories in 2010, when there were 27 lawsuits against companies in these sectors, representing about 15% of all filings.

Another sector that had a significant number of filings was SIC Code Group 737 (Computer Programming, Data Processing and Other Computer-Related Services). There were a total of 21 lawsuits involving companies in this group. There were also another 11 lawsuits filed against companies in SIC Code Group 367 (Electrical Components and Processors), including nine in SIC Code classification 3674 (Semiconductors) alone. Together, these various technology categories accounted for 32 of all 2011 filings, or about 15%. 

The 2011 securities class action lawsuits were filed in 47 different federal district courts, although a few courts accounted for most of the filings. 48 of the filings, or about 22%, were in the Southern District of New York (both the merger filings and the lawsuits against Chinese companies helped to swell the number of filings in this judicial district). The Central District of California accounted for 33 of the filings (again swollen by filings involving Chinese companies), and the Northern District of California accounted for 16, largely as a result of the number of lawsuits involving technology companies. These three districts together accounted for 97 of the 2011 filings, or nearly 45% of the total.

Discussion

My tally of the 2011 securities class action lawsuit filings will differ from other published counts of the 2011 lawsuits. My count is larger than the tally of the Stanford Law School Securities Class Action Lawsuit Clearinghouse, because I included all federal court merger objection lawsuits while the Stanford web site chose to omit some. My count is smaller than that of NERA Economic Consulting (about which refer here) for a number of reasons, primarily because I count multiple lawsuits involving a corporate defendant only once, whereas NERA will count multiple lawsuits in multiple jurisdictions involving the same company multiple times, unless the separate lawsuits are consolidated in a single case in a single jurisdiction.

The differences in counting the M&A lawsuits underscores a recurring general difficulty with trying to count federal securities class action lawsuits. There is an inevitable definitional issue, as deciding whether or not to “count” individual cases presents recurring questions abut exactly what it is that you are trying to count. The M&A related cases present a particularly challenging category of cases, because increasingly a single merger transaction will give rise to multiple lawsuits in multiple different jurisdictions, sometimes based on a differing legal theories. Because there cases are sometimes filed in different states’ courts, or in both federal and state courts, there are recurring and vexing issues involved with trying to count these cases, all of which is compounded by the fact that it can be very difficult to accurately track the state court filings.

Though I have elected to include all federal court M&A-related lawsuit filings in my tally, these filings represent only a fraction of all M&A-related lawsuit filings in 2011. The vast majority of 2011 corporate and securities lawsuits – particularly the merger objection cases – were filed in state court. The fact that my 2011 count, like most of the published securities class action lawsuit filing counts, is based on federal filings necessarily means that it omits numerical recognition and analysis of the state court filings. At least from a frequency standpoint, the exclusively federal court focus could lead to a distorted impression of corporate and securities litigation activity levels.

At the same time, my inclusion of the federal merger objection lawsuits could result in a distortion the other way as well. There is a very legitimate argument that these cases should not be included, or at least many of them should not be included, in a tally of federal securities class action lawsuit filings. Some of them may not allege a breach of the U.S. securities laws. For that reason, the Stanford website omits some of these cases. I decided to go ahead and include all of them and not just some of them, first, because it can become extraordinarily difficult to make selections at the individual case level. The categorical distinctions are not always apparent. But the larger reason I decided to include these is that I felt that without including these cases, the overall levels of federal court litigation might appear understated.

There is another significant way in which the federal court litigation may be understated, at least as a matter of analysis. That is, most analysis of federal securities lawsuit filings levels focus exclusively on the absolute numbers of filings. Though the absolute number of annual filings has fluctuated over the years, they have generally held pretty steady, even allowing for the occasional annual blip up or down. But a simple focus on the absolute numbers of filings levels does not consider the relative filing levels – that is, the number of filings relative to the number of public companies.

The fact is that there are significantly fewer public companies than there were only a few years ago, due to bankruptcies and mergers, along with declining numbers of IPOs. As I discussed here, by one estimate, there are 40% fewer public companies than there were in 1997, yet the annual number of new securities class action lawsuits is more or less consistent with that earlier time. All of which supports the argument that because absolute filing numbers have held steady while the number of publicly traded companies has declined, overall filing levels have actually increased over time. In any event, regardless of what you make of this argument, I think that consideration of relative filing levels is a part of the analysis that is routinely omitted from the consideration of the changes in annual litigation activity.

Looking ahead to 2012, it seems probable that the wave of new lawsuits involving Chinese companies will wind down, since sooner or later the plaintiffs’ lawyers will simply run out of companies to sue. However, there seems to be no reason to expect that the surge of M&A-related litigation will not continue to grow. The procedural and substantive barriers to traditional securities litigation and the prospects for quick settlements and attorneys’ fee recoveries in the M&A suits have encouraged many of the smaller plaintiffs’ securities firms to adapt M&A litigation as their new business approach. The vexing problems this type of litigation presents will increasingly challenging in the New Year. My own view is that the growth in M&A litigation represents a secular rather than a merely cyclical change.

The bottom line is that with growing levels of M&A-related litigation and relatively greater frequencies of federal securities class action lawsuit filings, the likelihood that any particular public company will get hit with a serious corporate or securities lawsuit has never been greater (as I analyze in greater detail here).

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