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

A legislative proposal to create a single federal Canadian securities regulator is unconstitutional, the country’s highest court has ruled. In a December 22, 2011 opinion (here), the Supreme Court of Canada ruled unanimously in an advisory opinion that the Act to create a single, unified securities regulator “as presently drafted” is not a valid exercise of the federal power to regulate trade and commerce. However, the Court expressly left the door open to a unified approach to securities regulation based on federal/provincial cooperation.

 

In 2010, following decades of review and study, the Canadian federal government prepared a draft act implementing proposals to create a single federal Canadian securities regulator. The Act itself contains a basic securities regulation framework, including registration requirements for securities dealers, prospectus filing requirements, disclosure requirements, specific duties for market participants, a framework for the regulation of derivatives, civil remedies and regulatory and criminal penalties pertaining to securities. Interestingly, the Act does not, according to the Supreme Court, “seek to impose a unified system of securities regulation on the whole of Canada.” Instead, “it permits provinces to opt in, if and when they choose to do so.”

 

On May 26, 2010, the Governor General in Council referred the draft Act to the Supreme Court for an advisory opinion on its validity under the Constitution Act of 1867. Canada and the provincial government of Ontario argued that “securities markets have undergone significant transformations in recent decades,” including changes that give rise to “systemic risks and other concerns that can only be dealt with on the national level.”

 

However, Alberta, Quebec, Manitoba, New Brunswick and other provinces opposed the Act, arguing that the scheme that the Act sets up falls under the provincial power over property and civil rights. The did not dispute that the financial markets have changed, but they argued that the Act goes beyond the regulation of a specific industry and extends to “all aspects of public protection and professional competences” – matters that, the provinces argued, remain “essentially provincial concerns.”

 

British Columbia and Saskatchewan also opposed the Act, but adopted what the Supreme Court called “a more nuanced approach,” contending that the goals the Act seeks to accomplish are “best achieved through an exercise of federal-provincial cooperation, similar to the cooperation” that has been adopted in other aspects of commercial activity.

 

In its December 22 opinion, the Supreme Court concluded on the basis of existing case law standards that the Act “cannot be classified as falling within the general trade and commerce power” of the Constitutional Act. The Act, the Court concluded, “overreaches genuine national concerns.” Though some characteristics of the securities marketplace “may in principle, support federal intervention that is qualitatively different from what the provinces can do,” these characteristics “do not justify a wholesale takeover of the regulation of the securities industry.” The “field of activity” that the Act “would sweep into the federal sphere simply cannot be described as a matter that is truly national in importance.” The basic nature of securities regulation “remains primarily focused on local concerns of protecting investors and ensuring fairness of the markets through regulation of the participants.”  

 

The Court stressed that in its ruling, it was not expressing an opinion on what would be the optimal form of securities regulation; it was merely addressing the question of whether the proposed Act represents an appropriate exercise of trade and commerce.

 

The Court went on to observe that while the Act is outside of Parliament’s general trade and commerce power, “a cooperative approach that permits a scheme that recognizes the essentially provincial nature of securities regulation while allowing Parliament to deal with genuinely national concerns remains available.” The “animating force’ of a “scheme” is “cooperation,” as “the federalism principle upon which Canada’s constitutional framework rests demands nothing less.”

 

As a mere south of the border observer, I necessarily must leave any analysis of the Court’s constitutional reasoning to those better informed about Canadian constitutional law. However, based solely on my acquaintance with the securities marketplace, it is difficult for me to see how the matters that Act would regulate are primarily a matter of local concern. There would certainly seem to be compelling reason to conclude that the types of systemic risk we have so recently witnessed warrant a unified national system of regulation. Of course, those observations are based on a policy bias, not on the jurisdictional framework that Canada’s federal system requires.

 

All of that said, the Court’s opinion did not close the door conclusively on some form of federal regulation of securities. The Court’s suggestion that a cooperative federal/provincial system might pass constitutional muster arguably shows the way for supporters of federal securities regulation to move forward. The challenge will be coming up with an approach that appropriately balances provincial concerns that at the same time addresses the concerns that warrant a unified national approach.

 

A December 22, 2011 Bloomberg BusinessWeek article discussing the decision can be found here. A Toronto Star article quoting remarks about the decision from a variety of Canadian commentators can be found here.

 

Special thanks to a loyal reader for forwarding a copy of the Court’s opinion.

 

Insuring Against Post-Deal Concerns: A recurring business concern is the possibility of the erosion of value following a merger transaction. A variety of insurance tools have arisen to address these concerns, including Representations and Warranties Insurance, Tax Indemnity Insurance and Contingent Liability Insurance. A recent article from the Dechert law firm entitled “Transaction Insurance: A Strategic Tool for M&A” (here) is designed to acquaint private equity professionals with these tools. The article, though brief, provides a good introduction to these insurance tools and to their usefulness.

 

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One of the primary purposes for which policyholders purchase D&O insurance is to provide directors and officers with defense cost protection in the event claims are made against them. However, a September 15, 2011 decision by a justice of the New Zealand High Court in Auckland (here) found that former directors of the defunct Bridgecorp companies are not entitled to advancement under the companies’ D&O insurance policies of the costs of their criminal defense where the companies’ liquidators and receivers have raised (but not yet proven or even filed) claims against them exceeding the policy’s limits of liability.

 

Though the decision reflects a peculiar feature of New Zealand law, it nevertheless may have some noteworthy implications, particularly in light of the larger D&O insurance industry’s ongoing efforts to develop insurance solutions that operate globally and respond locally.

 

Background

The Bridgecorp group operated as a real estate development and investment firm. (For more information about the Bridgecorp group and its demise, refer here.) When it collapsed in July 2007, the group owed investors nearly NZ$500 million. The group’s former directors face numerous criminal and civil claims arising out of the collapse. Trial on the criminal charges was to take place this fall. The accompanying civil charges have been stayed pending the outcome of the criminal claims.

 

Separately, the liquidators and receivers for the Bridgecorp group companies have advised the directors that they intend to initiate civil proceedings against them, alleging that the directors breached their statutory and common law duties, and seeking an order requiring the directors to pay more than NZ$450 million.

 

At the time of its collapse, the Bridgecorp group carried NZ$20 million in D&O Insurance. The group also carried $2 million of statutory liability defense cost protection (the “SL policy”), but the limits of the SL policy have already been exhausted in payment of the directors’ attorneys’ fees. The directors now seek to have the D&O insurance fund their continuing criminal defense, which they estimate will amount to NZ$3 million through trial, exclusive of any post-trial proceedings.

 

The Bridgecorp group liquidators and receivers advised the group’s D&O insurer that they assert a “charge” under Section 9 of the Law Reform Act of 1936, which they contend creates a priority entitlement in claimants’ favor over monies that may be payable under any insurance policy held by the person against whom the claim is made. The Bridgecorp group directors in turn initiated an action seeking a judicial declaration that Section 9 does not prevent the insurer from meeting its contractual obligation under the D&O policy to reimburse them for their defense costs.

 

The September 15 Ruling

On September 15, 2011, New Zealand High Court (Auckland Registry) Justice Graham Lang ruled in favor of the Bridgecorp group’s liquidators and receivers, ruling that the receivers’ and liquidators’ “charge” on the D&O insurance policy’s limits of liability under Section 9 “prevents the directors from having access to the D&O policy to meet their defence costs.”

 

Section 9 (which is set out verbatim in paragraph 19 of Justice Lang’s opinion) arises out of the personal injury context and gives the claimant a “charge” over liability insurance policy proceeds as of the date the claimant’s injury arose. As Justice Lang stated, the provision provides a “procedural mechanism” to ensure that a claimant can “gain direct access to insurance monies that would have been available to the insured.”

 

Justice Lang acknowledged that the Bridgecorp group’s receivers’ and liquidators’ “charge” on the D&O policy’s proceeds is “conditional” upon the need for the prospective claimants’ ability to establish that the directors are liable, as well as upon the need for the directors or the claimants to establish that the directors are entitled to coverage under the policy.

 

Notwithstanding the fact that the receivers and liquidators claim on the policy proceeds is merely “conditional,” Justice Lang nevertheless held that it operated to bar the payment of the directors’ immediate criminal defense expenses. Justice Lang reasoned that because the receivers and liquidators claims are “for a sum significantly greater than the amount of cover available under the D&O policy,” the insurer is “bound to keep the insurance fund intact.”

 

Though the result might be different where the amount claimed is less than the limit of liability, where as here the amount of the claims exceed the limits of liability, any payments the insurer makes “must be for the purposes of satisfying any liability the directors may have to civil claimants,” to the point that if the insurer were to pay any defense costs, it “would be liable to restore the amount of any such payment to the pool of money available under the policy” in order to meet the claims of any claimants.

 

Justice Lang acknowledged that this result “may be harsh” for the directors, produces some “unsatisfactory consequences,” and may “seem unfair.” But he nevertheless reasoned that this result was “clearly in accordance with the object and purpose of [section] 9.” He added that the outcome was “partly the result of the fact that the Bridgecorp companies elected to take out an insurance policy that provided cover for both defence costs and claims for damages and compensation,” and is a “direct consequence of the statutory regime the Act introduced nearly 80 years ago.”

 

Discussion

At one level, this decision represents nothing more that the application of a peculiar feature of New Zealand statutory law. Moreover, informed sources advise me that the decision in under appeal, so it may or may not stand even within its own jurisdiction.

 

But at another level, this decision does raise some noteworthy implications of wider significance. The first and foremost is that it shows the significant danger that both policyholders and insurers may face with respect to the scope of D&O insurance coverage available around the world in the many jurisdictions where the interpretive case law is as yet undeveloped.

 

The threat of D&O claims throughout the world has expanded significantly in recent years, and with this increased exposure the potential significance of D&O insurance protection has also grown. Global companies increasingly seek to put in place D&O insurance protection applicable in the various countries in which they operate. But as this decision shows, D&O insureds facing claims in jurisdictions where the interpretive case law is undeveloped may not always know how the local courts will interpret and apply their policy.

 

One possible solution to this concern might be the inclusion in the D&O insurance policy of a choice of law provision designed to ensure that the policy will be interpreted according to the laws of jurisdictions where the coverage interpretations are more developed and therefore more predictable. Of course, this solution may be dependent upon the willingness of the court’s in the forum jurisdiction to recognize and apply the choice of law provision as written, as well as the apply the specified law according to expectations and assumptions. (Refer here for more thoughts about the potential need for choice of law provisions in D&O insurance policies.)

 

As Justice Lang himself acknowledged, there is something particularly “unsatisfying” about an outcome where the mere inchoate and as yet unfiled claim of a prospective claimant can take priority over the insured persons’ immediate need for criminal defense cost protection under the policy, particularly where, as Justice Lang also acknowledged “the Bridgecorp companies took the policy out at least in part for that specific purpose.”

 

In that regard, it is worth noting that this policy does not appear to contain so-called “entity coverage” (see paragraph 14 of the opinion). Accordingly, this policy clearly was intended solely for the protection of the insured directors and officers. Yet even though the policy for the individual insureds’ protection, Justice Lang’s interpretations of Section 9 subordinates the insureds’ immediate entitlement to the policy proceeds to the mere unproven claims of prospective claimants. The consequences of this topsy-turvy inversion is not just “harsh,” but grotesque as it leaves these individuals facing serious criminal charges without the very protection the insurance was designed to provide.

 

Justice Lang acknowledge that this result might not apply where the amount of the claims do not exceed the D&O insurance policy’s limits of liability, which would seem to suggest even more perversely that the more serious the claims against the directors and officers, the less likely they are to be able to rely on the defense protection under their D&O insurance policy.

 

The solution for the protection of corporate directors and officers in New Zealand would seem to be to separate out their defense cost coverage from the liability protection under their D&O insurance policy. If the Bridgecorp case is affirmed on appeal, it would seem that the New Zealand D&O insurance marketplace will have to evolve to provide a policy that avoids that pitfalls that this case presents -- or seek to have Section 9 amended to recognize the need for corporate defendants to be able to rely on their D&O insurance to defend themselves.

 

One other possible solution to the problem presented by this case is to arrange for defense costs to be outside the limits of liabilty (that is, to structure the policy so that defense expenses do not erode the limit of liability). Although D&O insurance typically is not structured that way, it sometime is --- indeed, if I am not mistaken, in Quebec it is required by applicable regulations that defense costs must be outside the limits of D&O insurance policies.

 

One thing this decision shows is how early the D&O insurance industry is in the process of trying to provide comprehensive global D&O insurance policies that will operate predictably in the various jurisdictions in which it may be applied. The D&O insurance industry has been working hard in recent years to develop policies that will operate globally and respond locally. The Bridgecorp decision underscores the significant challenge that the industry faces in trying to ensure that D&O insurance will predictably be available at the local level, particularly in jurisdictions where the coverage interpretations are as yet undeveloped. 

 

Perhaps it is owing to its antipodal provenance, but it seems to me that Section 9 (at least as interpreted by Justice Lang) stands the very idea of liability insurance on its head. Liability insurance does not exist to protect claimants, it exists to protect the insureds. Insurance buyers procure the insurance to protect themselves from third party lawsuits. The very idea that a mere assertion of a prospective claim, no matter how spurious, is enough to strip the insured under a liabiltiy policy of the proection they procured for themselves is questionable in its very approach to teh insurance equation. I hope that the appellate court (or if necessary the New Zealand Parliament)  will give due consideration to the nature and purposes of liabiltiy insurance and vacate the ruling of this case.

 

An October 4, 2011 memorandum about the Bridgecorp decision from the  Minter Ellison Rudd Watts law firm can be found here. An October 2011 Bulletin from Willis New Zealand about the decision can be found here.

 

Special thanks to the several loyal readers who sent me links about this opinion.

 

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As numerous commentators have noted, one of the most distinctive litigation developments over the last twelve months has been the emergence of U.S. securities litigation against Chinese companies that obtained their listings on U.S. exchanges that a “reverse merger” with a publicly traded U.S. shell company.

 

Given the prominence of these issues, I am very happy to publish the following guest post from Anjali C. Das, who is a partner in the Chicago office of the Wilson Elser law firm. Many thanks to Anjali for her willingness to publish her 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 Anjali’s guest post:

 

D&O Spotlight on China: Claims Against China-Based Reverse Merger Companies: A Tempest in a Teapot of Gunpowder Green Tea?

 

 

Introduction

           

These days, nearly everything to do with China has grabbed the spotlight – not least of all the country’s extraordinary and seemingly unstoppable economic growth. Not surprisingly, many U.S. investors have been pouring millions of dollars into Chinese companies with the hopes of gaining super-sized returns. However, naysayers have long predicted a bursting of the China bubble. At least for investors in China-based issuers, perhaps that time is now. Not unlike the bursting of the internet bubble in the 1990s fueled by explosive growth and investment in “dot.com” companies, investors and regulators may now have reason to fear the rapid rise and fall of Chinese companies that have accessed U.S. capital markets through reverse mergers. While short-sellers are publicly denouncing the purported fraud at these companies (and making big bucks shorting the stock), U.S. regulators are investigating the rash of accounting scandals at these companies which have caused some auditors to abruptly resign. Meanwhile, D&O insurers have to contend with the collateral damage resulting from the multitude of claims against China-based issuers and their directors and officers. This article highlights the following topics involving Chinese reverse merger companies: 

 

 

PCAOB's Research Note on Chinese reverse mergers

SEC's investigation of China-based issuers and their auditors

NASDAQ's proposed new listing requirements for reverse merger companies

SEC's Investor Bulletin on reverse merger companies

Moody's "Red Flags" report on China-based companies

D&O insurance coverage issues for claims against China-based issuers

 

 

 

PCAOB Issues a Report on China Reverse Mergers

 

 

On March 14, 2011, the Public Company Accounting Oversight Board ("PCAOB") issued a report examining the audit implications for reverse mergers involving China-based companies. A copy of the report can be found here. As explained in the PCAOB report, a reverse merger is an acquisition of a private operating company by a public company shell company. While the public shell company is the surviving entity, the  private company's shareholders typically control the surviving company or hold publicly traded shares in the company.  A perceived benefit of a reverse merger is that it enables a company to become an SEC reporting company with registered securities without having to file a registration statement under U.S. federal securities laws.

 

 

 

The PCAOB report identified 159 companies from China that accessed the U.S. capital markets in a reverse merger transaction from 2007 through March 2010, representing 26% of all reverse mergers during the period. Reportedly, the market capitalization of these companies was $12.8 billion as compared to a $27.2 billion market cap of the 56 Chinese companies that completed initial public offerings in the U.S. during that same period. 

 

 

Reverse merger entities listed on U.S. exchanges are required to file audited financial statements with the SEC, and the auditors of the financial statements are required to be registered with the PCAOB. According to the PCAOB, U.S. firms audited 116 or 74% of the China-based reverse merger companies, while Chinese registered accounting firms audited 38 or 25 of companies. The PCAOB report raises concerns that some U.S. firms are not conducting proper audits of China-based companies, including handing off the audit work to a local Chinese accounting firm without verifying the accuracy of the results. The PCAOB has identified various "key considerations" to determine the appropriate level of oversight of firms that performs audits of foreign companies with the aid of assistants outside the firm, including:  the ability to supervise outside assistants; whether the outside assistants have appropriate language skills, and whether the auditor would have the ability to comply with the PCAOB's documentation requirements.

 

 

           

SEC Launches Investigation of China-Based Issuers and Auditors

 

 

In response to a congressional inquiry by House Representative Patrick T. McHenry, Chairman of the Committee on Oversight and Government Reform, SEC Chairman Mary L. Schapiro issued a letter on April 27, 2011 seeking to assure Congress and the public that the SEC "has moved aggressively to protect investors from the risks that may be posed by certain foreign-based companies listed on U.S. exchanges" -- particularly those companies based in China.  As SEC Chairman Schapiro noted in her letter, there has been a recent marked increase in China-based companies listed on U.S. exchanges through the process of a reverse merger.

 

           

Last summer, the SEC reportedly launched a "proactive risk-based inquiry into U.S. audit firms" which have a significant number of issuer clients based outside the U.S.  Among other things, the SEC has requested auditors to provide information concerning the firms' compliance with U.S. audit standards for foreign-based reverse merger companies based in China.  Since the SEC launched its investigation, dozens of China-based companies have disclosed auditor resignations and accounting problems.  Since February 2011, Big Four accounting firms have resigned or been dismissed from at least seven Chinese companies listed in the U.S., as reported here. These auditors have reportedly experienced difficulty obtaining independent bank confirmations of a company's bank accounts, balances, and transactions, as reported here.   In at least one case, the auditor purportedly received false information directly from the bank itself, prompting the auditor to resign. 

 

 

In an effort to protect U.S. investors, the SEC has reportedly suspended trading in several China-based reverse merger entities.  In addition, the SEC has revoked the securities registration of many other China-based reverse merger companies.  In some instances, the SEC is also pursuing these companies' auditors for improper audits.   As the SEC Chairman observed, the Dodd Frank Wall Street Reform and Consumer Protection Act ("Dodd Frank") has enhanced the SEC's ability to obtain audit documentation in connection with its investigations of issuers based in China and other countries. 

 

 

NASDAQ Proposes New Listing Requirements for Reverse Mergers

 

 

 

On June 8, 2011, the NASDAQ filed proposed rules with the SEC to adopt additional listing requirements for companies that become public through a reverse merger. Under the proposed rules, which can be found here, a company that is formed by a reverse merger shall only be eligible to submit an application for initial listing if the combined entity can satisfy the following conditions: 

 

 

traded for at least 6 months in the U.S. over-the-counter market, on another national securities exchange, or on a foreign exchange following the filing of all audited financial statements;

 

maintained a bid price of $4 or more per share for at least 30 of the most recent 60 trading days;

 

in the case of a U.S. domestic issuer, the company has timely filed its two most recent financial statements (i.e., Form 10-Q or 10-K);

 

in the case of a foreign based issuer, the company timely files comparable financial statements (i.e., Form 6-K, 20-F or 40-F) that includes an interim balance sheet and income statement presented "in English"

 

 

In support of its proposed enhanced listing requirements, the NASDAQ cited the "extraordinary level of public attention to listed companies that went public via a reverse merger," and "allegations of widespread fraudulent behavior by these companies, leading to concerns that their financial statements cannot be relied upon." The NASDAQ believes that these new listing requirements will protect investors and "discourage inappropriate behavior" by companies. 

 

 

SEC Issues an Investor Bulletin on Reverse Mergers

 

 

 

On June 9, 2011, the SEC issued a bulletin cautioning investors of the potential pitfalls of investing in reverse merger companies. The bulletin can be found here. Among other things, the SEC observed that many reverse merger companies ("RMCs") "either fail or struggle to remain viable following a reverse merger"; there have been instances of fraud and other abuses involving RMCs; and some RMCs have been using smaller U.S. auditing firms that may not have sufficient resources to conduct adequate overseas audits. The SEC bulletin also cited recent examples where it suspended trading of RMCs due to accounting irregularities and/or revoked the securities registrations of RMCs due to the companies' failure to timely file required periodic financial statements.

 

 

Moody's Issues its "Red Flags" Report on China-Based Companies

 

 

To address investors' increasing concerns with the quality of financial reporting from publicly listed Chinese companies, on July 11, 2011 Moody's credit rating agency issued a "Red Flags" report for China-based companies. The report examines 20 red flags grouped into five categories that identify possible governance or accounting risks for China-based companies, including:

 

 

            Weaknesses in corporate governance: short track record of operations and listing history,         murky shareholders' background, large and frequent related-party transactions;

 

            Riskier or more opaque business models: unusually high margins compared to peers,     concentration of customers, complicated business structures;

 

            Fast-growing-business strategies: very rapid expansion, big capital investments resulting         in large negative free cash flow and intangible assets;

 

            Poorer quality of earnings or cash flow: discrepancy between cash flows and accounting             profits, disjointed relationship between growth in assets and revenues, large swings in working capital, insufficient tax paid compared to reported profits;

 

 

            Concerns over auditors and quality of financial statements: a switch in auditing firm or    legal jurisdiction of auditor's office, delay in reporting, or adverse comments from      auditors.

 

 

Moody's applied its red flags analytical framework to 61 rated Chinese companies. According to Moody's report, due to the rapid growth of Chinese companies, nearly all Chinese high-yield issuers tripped red flags related to aggressive business and financial strategies and quality of earnings. Moody's observed that fast-growing companies put pressure on managerial and financial resources. Additionally, these companies may make large capital investments that could negatively impact cash flow for a prolonged period of time. Also, due to the prevalence of strong founding families, many Chinese companies tripped the red flag for concentration of family ownership which may reflect weaknesses in corporate governance.  Moody's also noted the so-called arms-length related-party transactions were not always transparent. Interestingly, according to Moody's report, concerns over auditors arose less frequently compared to other red flags. 

 

 

 

Shorts-Sellers Creating Havoc

 

 

 

Meanwhile, short-sellers are wreaking havoc on China-based issuers' stock and publicly accusing these companies of fraud. In several instances, detailed reports issued by short-sellers have triggered a wave of internal investigations, investigations by regulators, and shareholder litigation against companies. While some companies have gone to lengths to deny short seller's often unsubstantiated accusations, the damage is done when the investors get spooked and the company's stock price spirals downward. 

 

 

All of the negative publicity has impacted Chinese companies across the board, regardless of whether specific allegations of fraud have been asserted. Where investors were once rushing to dump huge sums of money into any business with ties to China, they are now rushing to liquidate their stock holdings at the slightest sign of any trouble. The fallout has had a devastating impact on the number of reverse merger transactions of Chinese companies. Not surprisingly, some Chinese companies have postponed plans to sell shares in the U.S., either through reverse mergers or initial public offerings ("IPOs"). As reported here, compared to 47 reverse merger transactions in the first half of 2010, there have been only 29 for the first half of 2011.  At least for now, Chinese companies are no longer the darling of Wall Street.

 

 

The Rise of Shareholder Litigation

 

 

Approximately 30 shareholder suits were filed in the first half of 2011 against China-based companies listed on U.S. exchanges and the companies' directors and officers. On the surface, many of these suits are classic securities class actions alleging securities fraud and violations of Section 10(b) of the Securities Exchange Act of 1934 ("1934 Act") for materially false and misleading financial statements and related derivative actions.  However, suits against China-based companies may pose unique hurdles and added expense to the defense of shareholder claims in the U.S. For one thing, many or most of the individual defendants, corporate documents, and key witnesses may reside in China. Moreover, testimony and documents may need to be translated from Chinese to English. As such, defense costs can escalate rapidly. Also, given the current regulatory climate and increased suspicion of China-based issuers, the company may also be the subject of parallel proceedings or investigations by the SEC and other regulators. In some situations, the company's Board may simultaneously launch an internal investigation – particularly if the company's outside auditor abruptly resigns without issuing a clean audit opinion. That could also trigger a wave of management departures, putting added strain on the company's already stretched resources. 

 

 

D&O Insurance Coverage Issues

 

 

 

Claims against China-based issuers and their directors and officers may raise a host of coverage issues under traditional Directors and Officers (“D&O”) liability insurance policies including, but not limited to: 

 

 

Reasonable and necessary defense costs

Coverage for parallel proceedings and investigations

Rescission

Known Claim exclusion

Fraud and personal profit exclusions

Severabiity of the policy exclusions and application

 

 

 

D&O policy limits for public companies are typically eroded by defense costs. This may occur more rapidly in suits against Chinese companies in light of the complexities of transnational discovery. As such, it is in the interests of D&O insurers and insureds alike to ensure that these claims are being defended with maximum efficiency to minimize the possibility that the D&O insurance is significantly impaired or even exhausted by defense costs alone. While many large defense firms now have outposts in China, it is still imperative to gain an understanding of the anticipated division of labor between the U.S. based lead defense attorneys and their colleagues in China with respect to discovery, document collection, witness interviews, and other matters. Additionally, there should be an objective assessment to determine whether it is cheaper and more efficient to outsource certain discovery-related tasks such as collection and translation of documents.

 

 

Shareholder litigation against Chinese companies may spawn multiple parallel proceedings and investigations by the government, regulators, the Board, a Special Litigation Committee, and others. A key issue is whether such investigations constitute covered Claims or Securities Claims under the D&O policy. Historically, many D&O policies narrowly limited the availability of coverage for investigations, such as formal investigations by the Securities and Exchange Commission (“SEC”) commenced by service of a subpoena on a director or officer. However, in the past few years, some D&O policies began to offer enhanced coverage, including coverage for both formal and informal investigations by regulators. Nowadays, the definition of a Securities Claim is less standard and may contain many subtle, yet critical nuances impacting coverage. Not surprisingly, there has been a significant amount of litigation and reported decisions with respect to coverage for investigations under D&O policies. However, many of these decisions are fact-specific and driven by now obsolete D&O policy language and definitions which continue to evolve. 

 

 

Recently, on July 1, 2011, the Second Circuit Court of Appeals issued an opinion in MBIA, Inc. v. Federal Ins. Co., 2011 U.S. App. LEXIS 13402 (2d Cir.), that sets forth a comprehensive analysis of coverage for various investigations under a D&O policy. In that case, the policy definition of a covered Securities Claim included “a formal or informal administrative or regulatory proceeding or inquiry commenced by the filing of a notice of charges, formal or informal investigative order or similar document.” First, the Second Circuit held that investigations commenced by the SEC and the New York Attorney General (“NYAG”) were covered under the policy definition of a Securities Claim. The court observed that the issuance of a subpoena by NYAG was, at a minimum, a “similar document” related to a “formal or informal investigative order”. The court also opined that requests for information by the SEC pursuant to oral requests and subpoenas were covered because they were connected to the SEC’s formal order of investigation. The court also concluded that fees incurred by an independent consultant retained by MBIA in the context of negotiating a settlement with the SEC and NYAG were also covered.

 

 

Second, the Second Circuit concluded that legal fees incurred by MBIA’s Special Litigation Committee (“SLC”) to determine whether to pursue or terminate pending shareholder derivative actions were covered and did not clearly fall within the policy’s sub-limit of liability for shareholder derivative demands. Prior to the filing of the derivative actions, a shareholder demand on MBIA’s Board had been made and ultimately rejected. After the shareholder derivative suits were filed, the SLC sought and obtained dismissal of the lawsuits. The Second Circuit determined that the legal fees incurred by the SLC arguably fell within the policy’s coverage for “costs ‘incurred in . . . investigating’ ‘Claims’ or ‘Securities Claims,’ respectively, each of which is defined to expressly include lawsuits.” The Second Circuit also determined that that the insurer had failed to carry its burden of proving that the SLC’s legal fees were not covered under the policy definition of Loss which excluded “any amount incurred by [MBIA] (including its board of directors or any committee of the board of directors) in connection with the investigation or evaluation of any Claim or potential Claim by or on behalf of [MBIA]”. 

 

 

           

To the extent claims against China-based issuers and their directors and officers allege accounting improprieties and false and misleading financial statements, D&O insurers might have a potential rescission argument if the policy was issued in reliance on these false financials. In some instances, D&O policies and/or applications contain a Known Claim Exclusion which might serve as a basis for denying coverage if an insured knew and/or failed to disclose a fact, circumstance, act, error, or omission that might give rise to a Claim under the policy. Also, standard D&O policies contain fraud and personal profit exclusions that might apply; however, these exclusions are usually restricted to a finding “in fact” or “final adjudication” that the insured committed fraud or unlawfully profited. In addition, both the application and the exclusions might be “severable,” such that the knowledge or wrongful acts of one insured cannot be automatically imputed to other insureds except in limited situations.

 

 

 

Conclusion

 

 

 

Some might conclude that the spotlight on China-based reverse merger companies is merely a tempest in a teapot, as compared to the global financial crisis precipitated by the subprime market meltdown and collapse of numerous financial institutions at home and abroad. Nonetheless, the reality is that many China-based issuers have been targeted by regulators and investors alike for purported securities and accounting fraud that could ultimately cost D&O insurers millions in losses. At least for now, this trend seems to be gaining traction. Until the pot is done brewing and the tea leaves are read, D&O insurers should tread carefully in handling claims against their China-based issuers.

 

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For the second time, a court has given investors leave to proceed and also certified a plaintiff class in a secondary market misrepresentations claim under the revised Ontario Securities Act. In an order dated March 1, 2011, Ontario Superior Court Justice Wolfram Tausendfreund granted leave to investors to proceed against Arctic Glacier Income Fund, its trustees and related entities and executives. A copy of Justice Tausendfreund’s order can be found here.

 

As discussed at length here, effective in 2005, Ontario revised its securities laws (in legislative provisions now generally referred to as Bill 198) potentially making it easier for disappointed investors to bring actions for civil liability against directors and officers of public companies for alleged secondary market misrepresentations.

 

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

 

In a "landmark" December 2009 ruling, discussed here, Ontario Superior Court Justice Katherine van Rensberg granted plaintiffs in the Imax securities class action lawsuit leave to proceed with their claims. Justice van Rensberg also granted the plaintiffs’ motion to certify a global class in that case. In a February 2011 order (discussed here), another Superior Court Justice denied the defendants’ motion for leave to appeal Justice van Rensberg’s rulings.

 

The March 1 ruling involved an action brought by investors who had purchased shares of the Arctic Glacier Income Fund. The Income Fund is an unincorporated mutual fund trust that is a reporting issuer in ten Canadian provinces. Interests in the Income Fund trade on the Toronto stock exchange. The Income Fund’s sole assets are shares of Arctic Glacier Inc., a corporation organized under Alberta law. The company and its wholly owned subsidiary, Arctic Glacier International, provide packaged ice to consumers in Canada and the United States.

 

In March 2008, the Income Fund announced that it had become aware of an U.S. Department of Justice antitrust investigation involving the packaged ice industry. In 2009, Arctic International pleaded guilty to a criminal, anticompetitive conspiracy in the U.S. In the plea agreement, Arctic International agreed to pay a US$9 million fine and admitted that it had participated in a conspiracy to suppress competition in the packaged ice business in Michigan between 2001 and 2007. Following the announcement of the investigation, Income Fund’s unit price declined. The plaintiffs initiated an action alleging that they had been misled in connection with the company’s alleged legal and regulatory compliance programs.

 

As required under the revised Ontario Securities Laws, the plaintiffs moved for leave to proceed. In order to determine whether or not the plaintiffs had met the statutory requirement in order to obtain leave – that is, that "there is a reasonable possibility that the action will be resolved at trial in favor of the plaintiff" – Justice Tausendfreund followed the analysis of Justice van Rensberg in the Imax case with respect to the requirements to meet this standard. After noting that he saw no reason to depart from her analysis, Justice Tausendfreund said that "the applicable standard is more than a mere possibility of success, but is a lower standard than a probability."

 

Justice Tausendfreund concluded that the plaintiffs had met this "leave test" under Section 138.8 and granted them leave to pursue statutory claims for misrepresentation in the secondary market. He also granted the plaintiffs’ motion to certify a class of all investors who had purchased the Income Fund units during the class period, declining the defendants’ request to narrow the class.

 

The significance of Justice Tausendfreund’s ruling is that now a second set of plaintiffs has been granted leave to proceed with a claim for secondary market misrepresentations under the revised Ontario Securities Laws. In addition, Justice Tausendfreund, like Justice van Rensberg in the Imax case, found that the showing required to satisfy the "leave test" is relatively low.

 

It would is possible to overgeneralize from just these two cases, but at least so far that the plaintiffs have been relatively successful in overcoming the initial procedural hurdles in pursing secondary market misrepresentation claims under the revised Ontario Securities Act.

 

In addition, the plaintiffs have also succeeded in having a broad class certified as well. The certification of a global class in the Imax case may be of greater significance, given that Imax shared traded on both the Toronto and New York stock exchanges, whereas the Arctic Glacial Income Fund shares traded only on the Toronto exchange. But nevertheless, the relatively low initial threshold for leave and the courts’ willingness to certify broad classes are positive developments for the plaintiffs in these cases, and may make the remedies available under the revised Ontario Securities Act more attractive to other claimants.

 

An interesting and detailed March 8, 2011 analysis of the Arctic Glacier decision by the Osler, Hoskin & Harcourt law firm can be found here. The law firm memo raises a number of interesting questions about the decision, particularly with respect to the class certificaiton ruling. A March 4, 2011 Globe and Mail article about the recent ruling can be found here.

 

We Are All One: In her fascinating article in the March 7, 2011 issue of The New Yorker entitled "The View from the Stands" (here) about soccer in Turkey, Elif Batuman reported the following comments of one fan of the BeÅŸiktaÅŸ team about the team and its followers (who are known as ÇarÅŸi):

 

He characterized BeÅŸiktaÅŸ as the team of the unexpected, the team of underdogs, and talked about ÇarÅŸi’s slogans, which are unveiled on giant banners during matches. “We are all Black,” proclaimed one banner, after rival fans had made references to the race of the French-Senegalese BeÅŸiktaÅŸ star Pascal Nouma. When [competitior] Fenerbahçe disparaged a BeÅŸiktaÅŸ manager whose father had been a janitor, there were banners saying “We Are All Janitors.” And when an international committee of astronomers removed Pluto from the list of planets ÇarÅŸi took up the cause: “We Are All Pluto.”

 

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Among the questions that followed in the wake of the U.S. Supreme Court’s Morrison v. National Australia Bank decision has been whether and to what extent plaintiffs’ lawyers will resort to courts outside the U.S. to pursue securities claims on behalf of investors who purchased the defendant company’s shares outside the U.S. The action recently filed in the Netherlands on behalf of non-U.S. investors in Fortis presents shows that plaintiffs’ lawyers will be pursuing these claims.

 

A recent announcement involving prior Dutch settlements underscores that efforts to obtain recoveries outside the U.S. on behalf of non-U.S. investors have actually been underway for some time. The settlements show how parallel (or at least sequential) proceedings can resolve the claims of both U.S. and non-U.S. investors, respectively. These procedures, which have been used before in the same way, may afford a means by which all investors – including even non-U.S. investors – potentially may obtain recoveries, notwithstanding the constraints of Morrison.

 

On March 3, 2011, the Stichting Converium Securities Compensation Foundation issued a Hearing Announcement in connection with the settlements totaling $58.4 million on behalf of investors who purchased shares of Converium Holding AG between January 7, and September 2, 2004 and who did not purchase their shares on a U.S. exchange and who were not residents of the U.S. at the time they purchased their shares. The hearing, to be held on October 3, 2011 in the Amsterdam Court of Appeals, will determine whether or not the settlements will be held binding.

 

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) 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 will take place on October 3, 2011.

 

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.

 

However, as Luke Green noted in a recent detailed post on the Risk Metrics Group Insights blog (here), there are a number of limitations on the usefulness of this Dutch procedure for investors seeking recoveries. First, only court authorized representatives can pursue claims on behalf of investors, and representatives cannot seek damages. Rather, the Dutch courts can only certify the class and approve out of court settlements. Green also notes that absent a chance in EU regulations, the class representative may have difficulty enforcing the settlement outside the Netherlands. A detailed discussion of the potential conflict between the Dutch Act and the laws of other jurisdictions can be found here.

 

In the circumstances where there is no prior U.S.-based settlement or U.S. action to provide both leverage and a path to settlement, the non-U.S. investors will have to try another approach – as was the case for the Fortis investors who recently filed an action in the Netherlands in which they seek to assert claims on behalf of investors who affirmatively joined the action. Of course, it remains to be seen how successful that approach will be.

 

In the meantime, it seems probable that investors will continue in the wake of Morrison to explore jurisdictional alternatives, in the Netherlands and elsewhere. As I recently noted (here), Canada could represent yet another alternative, at least to the extent the recent Ontario court certification of a global class in the Imax securities class action proves to represent the potential reach and applicability of the Ontario securities laws. Developments in yet other jurisdictions could present additional possibilities.

 

In any event, it is probably worth noting that post-Morrison, the class certified in the U.S. action would not have included the U.S. residents who purchased their Converium shares outside the U.S. Following Morrison, several district courts have ruled (e.g., refer here) that the claims of these so-called "f-squared" investors are outside the ambit of the U.S. securities laws. These investors would essentially be in the same boat with the non-U.S. investors who purchased their shares outside the U.S.

　

Is the SEC Targeting Outside Directors?: A March 3, 2011 memo from the Haynes and Boone law firm entitled "SEC Enforcement: Spolighting Outside Directors" (here) takes a look at a recent SEC enforcement action that specifically targeted outside directors for their allegedly failure to fulfill their responsibilities as Board member at a company that engaged in fraudulent misconduct.

 

The memo suggests that although the specific case involved "egregious" misconduct, the SEC’s actions signal "a new willingness to prosecute those directors who disregard or neglect their duties." The memo suggests a number of lessons from the case, including in particular that outside directors must respond to "red flags."

 

Another Sarbanes-Oxley Clawback Action: In a separate March 3, 2011 action (here), the SEC also entered a negotiated settlement with the former CEO of Beazer Homes, in which the CEO agreed to reimburse the company $6.4 million in cash and also various company securities the CEO had received as part of his incentive bonus compensation during 2006. The SEC alleged that the company had filed fraudulent financial statements during the period for which the CEO had been awarded the bonus compensation.

 

The SEC had asserted its right to compel the return (or to "clawback") the bonus compensation under Section 304 of the Sarbanes Oxley Act. Under Section 304, it is not necessary for the individual target to have participated or even to have been aware of the conduct resulting in the company’s misstatement. The Beazer Homes CEO neither admitted nor denied the SEC allegations.

 

This is not the first time the SEC has used Section 304 to clawback compensation. As noted here, the SEC has previously sought to clawback compensation from the CEO of CSK Auto. The SEC also previously entered a clawback settlement with the CEO of Diebold (refer here).

 

As I noted in a prior post (here), these kinds of clawback actions present a host of complex D&O coverage issues. In any event, we are likelier to see more clawback actions in the future, in light of the expanded clawback requirements in the Dodd-Frank Act.

 

Academy Awards Retrospective: In the academy awards ceremony last week, The King’s Speech carried away a host of trophies. And perhaps appropriately so. It is an entertaining movie with excellent acting. And as I noted in an earlier post when I saw it, the movie made excellent use of music.

 

But I agree with Joe Queenan’s February 20, 2011 column in the Wall Street Journal. For all of its finery and as good as it is, The King’s Speech is a formulaic movie. As at least one Internet reviewer before me has observed, it is The Karate Kid with a British accent and better costumes. Take nothing away from Colin Firth, who was excellent, but were it not for our general enchantment with British royalty, this movie would not likely have swept the statuettes.

 

For my money, True Grit was the best movie of the year. If you saw the movie, you will recall the dreamlike sequence after Rooster Cogburn rescues Mattie and races through the night on horseback to try to get her medical attention. An absolute stunning visual sequence that was all the more remarkable because you didn’t notice it until you thought about it later.

 

Not only that, but Haille Steinfeld deserved the Oscar for best supporting actress. Anyone who can portray a 14 year old hung upside down in a cave filled with a decaying corpse and poisonous snakes and manage to convey simultaneously both terror and a sense of self-control has to win the award. And if you really want to appreciate how fantastic Haille Steinfeld was as the most recent version of Mattie, you should see how Kim Darby in the same role in the older version absolutely killed the movie. (I ask you, how could anyone play Mattie as a whiny simp?)

 

I am sure that like me many viewers enjoyed the unusual characters, odd but amusing dialog and unexpected plot of True Grit. The recent version of the movie more faithfully reproduced the feel of the novel on which the movie was based. Charles Portis wrote book. I know this because Portis wrote another book which I would argue is one of the funniest books out there.

 

Ten years after he wrote True Grit, Portis published The Dog of the South, which is the story Ray Midge’s headlong plunge from Little Rock into Mexico and then Belize. Midge is chasing his friend, Dupree, who ran off with Midge’s wife and took his car. And Midge wants his car back. It would be hard to quickly summarize Midge’s meandering quest and the oddball assortment of characters he encounters. The book is full of curious observations and busted bicycle wheel conversations that somehow make sense and are always funny (albeit often incorrect politically). Here’s a short excerpt to give a flavor of the book:

 

In South Texas I saw three interesting things. The first was a tiny girl, maybe ten years old, driving a 1965 Cadillac. She wasn’t going very fast, because I passed her, but still she was cruising right along, with her head tilted back and her mouth open and her little hands gripping the wheel

 

Then I saw an old man walking up the median strip pulling a wooden cross behind him. It was mounted on something like a golf cart with two-spoked wheels. I slowed down to read the hand-lettered sign on his chest. "Jacksonville Fla or Bust."

 

I had never been to Jacksonville but I knew it was the home of the Gator Bowl and I had heard it was a boom town, taking in an entire county or some such thing. It seemed like an odd destination for a religious pilgrim. Penance maybe for some terrible sin, or some bargain he had worked out with God, or maybe just a crazed hiker. I waved and called out to him, wishing him luck, but he was intent on his marching and had no time for idle greetings. His step was brisk and I was convinced he wouldn’t bust.

 

The third interesting thing was a convoy of stake-bed trucks all piled high with loose watermelons and cantaloupes. I was amazed. I couldn’t believe that the bottom ones weren’t being crushed under all that weight, exploding and spraying hazardous melon juice onto the highway. One of nature’s tricks with curved surfaces. Topology! I had never made it that far in my mathematics and engineering studies, and I knew now that I never would, just as I knew that I would never be a navy pilot or a Treasury agent. I made a B in Statics but I was failing in Dynamics when I withdrew from the field. The course I liked best was one called Strength of Materials. Everybody else hated it because of all the tables we had to memorize but I loved it. I had once tried to explain to Dupree how things fell apart from being pulled and compressed and twisted and bent and sheared but he wouldn’t listen. Whenever that kind of thing came up, he would always say – boast, the way those people do – that he had no head for figures and couldn’t do things with his hands, slyly suggesting the presence of finer qualities.　

　

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In a February 14, 2011 order (here), an Ontario Superior Court Justice has denied the motion of the defendants in the IMAX securities lawsuit pending in Ontario for leave to appeal the December 2009 rulings of Ontario Superior Court Justice Katherine van Rensberg granting the plaintiffs leave to pursue securities claims in a class proceeding.

 

At its most basic the order is essentially just a ruling that the defendants have not satisfied the relevant standard to justify an appeal at this stage in the proceedings. However, the court’s explanation of its decision implicitly endorses Judge Van Rensberg’s prior decisions – including in particular her decision to certify a global class of all Imax investors. Overall, as detailed below, the February 14 ruling is quite favorable to the plaintiffs.

 

Background

As detailed here, in December 2009, in "groundbreaking" rulings representing the first application of Ontario’s newly revised securities laws, Judge van Rensberg entered two orders granting the plaintiffs leave to bring their case, as required under to proceed under the laws, and certifying the suit as a class action. These rulings allowed the plaintiffs leave to proceed with their case against several IMAX directors and officers over disclosures in the company’s 2005 financial statements.

 

Justice van Rensberg’s decisions were the first to test recent revisions to the Ontario Securities Act that potentially made it easier for disappointed investors to bring actions for civil liability against directors and officers of public companies for misrepresentations in public disclosure documents.

　

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

 

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

 

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

　

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

 

The defendants sought leave to appeal Judge van Rensberg’s rulings to the Divisional court.

　

The February 14 Ruling

Under applicable statutory provisions, leave to appeal may be granted at this stage in the proceedings, inter alia, when there is "good reason to doubt the correctness of the order." In his February 14 order, Superior Court Justice D.L. Corbett held that this standard had not been met and he denied the defendants’ motion for leave to appeal.

 

At its most basic, the order essentially just holds that the statutory standard has not been met. Indeed, throughout the February 14 order, Justice Corbett reiterates with respect to the various substantive issues presented that "appellate courts will be in a better position to address them on a full factual record, after trial."

 

However, in order to substantiate the ruling, Justice Corbett specifies the bases for the determination that "there is no good reason to doubt the correctness of the decision" – which is, as Justice Corbett specifically puts it, that "this is the sort of claim that ought to be permitted to proceed," adding, with respect to the plaintiffs’ substantive misrepresentation claims that "it seems that the plaintiffs have a good arguable case, one that is worthy of moving forward." As detailed in the Discussion section below, Justice Corbett's analysis in this regard is quite favorable to the plaintiffs, and to plaintiffs generally.

 

Justice Corbett’s determination is most interesting with respect to Justice van Rensberg’s certification of a global class. In holding that there is "no reason to doubt the correctness" of Justice van Rensberg’s decision on these issues, Justice Corbett noted:

 

It would be wrong, of course, to compel foreign investors to be bound by Canadian proceedings, if they prefer to have their claims adjudicated elsewhere. But similarly, it would be wrong to preclude the from participating in Canadian proceedings if they wish their claims to be pursued in Ontario

 

Justice Corbett specifically found there is no prohibition of overlapping class proceedings in different jurisdictions, holding that the separate proceedings should not be viewed as "competing." Rather the proceedings should be "complementary" so as to "achieve a proper vindication of the rights of plaintiffs, fair process for the defendants and the plaintiffs, respect for the autonomous jurisdictions involved and an integrated and efficient resolution of claims." This process does not "required balkanization of class proceedings, but rather sensitive integration of them"

 

Discussion

For the parties, Judge Corbett’s ruling essentially means that the case will now go forward in Ontario. The larger significance may be that another court has corroborated Justice van Rensbert’s approach and conclusions with respect to the application of the new statutory provisions to the IMAX case.

 

But the most interesting aspect of Justice Corbett’s ruling is the determination that the certification of a global class was not clearly in error. The practical effect is a global class action might now go forward in Ontario courts under Ontario law under circumstances in which a global class might not be certified in U.S. courts under U.S. law.

 

As it happens, on December 22, 2010, Southern District of New York Naomi Reice Buchwald denied the motion for class certification in the parallel U.S. IMAX securities suit, holding that various circumstances prevented the lead plaintiff from serving as class representative.

 

But in any event, the plaintiffs in the U.S. case had not sought to include in the class the investors who had purchased their shares in IMAX on the Toronto stock exchange, having amended their motion for class certification in light of the U.S. Supreme Court’s decision in Morrison v. National Australia Bank, to limit their proposed class to those investors who purchased their shares on NASDAQ. That is, the plaintiffs essentially conceded that under Morrison the class in the U.S. class action could not include investors who purchased their shares outside the U.S.

 

In other words, the class certified by the Ontario court is more encompassing than the one that could be certified by a U.S. court. And Judge Corbett’s recent decision found no reason to doubt the correctness of Justice van Rensberg’s determination of these issues.

 

One of the questions commentators have asked in the wake of the U.S. Supreme Court’s decision in the Morrison case is whether plaintiffs’ counsel may seek to pursued securities claims outside of the U.S. The recent action filed in the Netherlands on behalf of Fortis investors provides some evidence that the plaintiffs’ attorneys are indeed pursuing alternatives to litigating cases outside of the U.S.

 

The recent affirmation that Ontario’s courts are authorized to certify a global class in a securities liability suit, in circumstances where a U.S. court cannot, highlights the question whether plaintiffs’ attorneys may look to Ontario’s courts as an alternative securities litigation forum, particularly in light of Justice van Rensberg’s earlier ruling that the threshold for establishing the right to pursue a securities claim under Ontario’s new legal provisions is a low one. Ontario’s courts certainly could be an attractive form at least with respect to Canadian companies.

 

I should add that even beyond the class certification issues, the February 14 opinion is favorable to plaintiffs. Among other things, Justice Corbett stated (in paragraph 29) that fraud alleged do "not require the plaintiffs to adduce direct evidence of the state of mind of the defendants" which "may be 'inferred from all of the circumstances," which is "a common way of determining knowledge and intention." 

 

Justice Corbett also evinced his support (in paragraph 32) for the view that "a different standard of proof" applies to defendants affirmative defenses than is to be applied to plaintiffs to determine whether they should be permitted to proceed. The plaintiffs standard is "relatively low" while the defendants must establish their affirmative defenses "to a standard sufficient to grand summary judgment dismissing a claim." Indeed, Justice Corbett went on (in paragraph 37), the "constellation of facts" alleged "may well preclude the defendants' affirmative defenses."

 

Finally, Justice Corbett also supported the view that reliance be established by showing reliance on the market (in a manner similar to a fraud on ther market theory) rather than by individual reliance, if supported by the facts.

 

Special thanks to Daniel Bach of the Siskinds law firm for providing me with a copy of the February 14 decision. The Siskinds law firm and the Sutts, Strosberg law firm represent the plaintiffs in the IMAX case in Ontario.

 

The Sports Highlight of the Decade?: In a February 14, 2011 article, The Wall Street Journal asked the rhetorical questoin whether Wayne Rooney's game-winning goal in the 78th minute of Saturday's game between Manchester United (Rooney's team) and Manchester City is the "sports highlight of the decade." All I know is that when Rooney executed his amazing, backwards bicycle kick, I shouted so loud that my wife came downstairs to make sure I was alright. Best of the decade or not, it is simplty amazing. So here is the video footage -- be sure to watch the slow motion replay to really appreciate how amazing the goal is.　

　

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In today’s global economy, business increasingly is conducted cross-jurisdictionally. Company officials and their advisors increasingly must grapple with liability issues arising under the laws of multiple jurisdictions. These liability issues in turn can present complex indemnification and insurance questions. Simply identifying the operative legal considerations can present a significant challenge.

 

A newly updated legal resource may afford valuable information for those struggling with these issues. Information about the new volume, entitled Directors’ Liability and Indemnification: A Global Guide, Second Edition, can be accessed here. This new edition was edited by UK Insurance maven, Ed Smerdon of the Sedgwick Detert law firm.

 

The book’s separate chapters describe the essential legal principles in 38 different countries. This latest edition includes new chapters on China, the Czech Republic, Kazakhstan, South Korea and the United Arab Emirates, among others. Each chapter has been written by a leading law firm in the relevant jurisdiction. For example, the chapter on the United States was written by Dan Bailey and Darius Kandawalla of the Bailey Cavalieri law firm.

 

Each chapter provides a country-specific overview of the legal principles governing directors’ duties and obligations. The text also contains a description of the claims environment in each country, including the relevant considerations regarding criminal and regulatory liability. The information also includes the principles governing the availability of indemnification and insurance in each country, as well.

 

The information for each country is presented succinctly and provides more of an introduction to the critical legal considerations than it does a comprehensive dissertation. This volume will be most useful to those looking for a quick impression of the legal environment. For those looking for a deeper understanding, this volume at least provides some starting points.

 

It seems likely that legal challenges arising from the cross-jurisdictional conduct of business will only increase in the months and years ahead. This volume will likely prove a valuable resource for insurance advisors and others called upon to counsel companies in connection with the associated liability exposures and related insurance considerations. We can only hope that this book’s editors and authors will continue to update and expand this volume in the years ahead.

 

Many thanks to Ed Smerdon for providing me with an opportunity to review an advance copy of the book.

 

D&O Insurance Implications of Dodd-Frank: The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 introduced sweeping reforms to every aspect of the country’s financial system. In addition, many of the Act’s provisions – including in particular its new whistleblower bounty sections -- seem likely to lead to increased SEC enforcement activity. The enforcement activity could in turn lead to follow on civil litigation.

 

The Act’s potential enforcement and litigation implications also carry important D&O insurance implications. These considerations and implications are reviewed in detail in a February 2011 article entitled "Dodd-Frank, SEC Enforcement Activity, Whistleblowers and D&O Insurance" (here) by my friend Priya Cherian Huskins and her colleague Carolyn Polikoff of the Woodruff Sawyer firm. Among other things, the authors discuss particular problems that may arise in connection with the Dodd-Frank’s executive compensation clawback provisions, as well as D&O insurance concerns arising from the new whistleblower provisions. The article concludes with a list of eight D&O insurance recommendations.

 

My thanks to Priya for reaching out to me to include a link to the article on this site.

 

Failed Bank Litigation Resources: Most readers who are following the events surrounding the current failed bank litigation wave likely are already familiar with the FDIC’s Failed Bank List, which is updated every Friday evening to reflect the latest banks of which the FDIC has taken control.

 

Another page on the FDIC website of which readers may want to be aware is the FDIC’s Professional Liability Lawsuits page. I have previously linked to this page in prior blog posts, but the FDIC has been updating the page and it now has a number of additional useful features.

 

First, for some time now, the FDIC has been updating the page to reflect the latest number of former directors and officers of failed banks against whom civil actions have been authorized. The page has recently been updated to show that the FDIC has now authorized civil actions against 130 directors and officers. More importantly, it is clear that the FDIC will be regularly updating this page with new information as additional actions are authorized.

 

In addition, in the new feature that readers may find most useful, the FDIC has now provided specific details regarding each of the four civil actions it has filed so far against former directors and officers of failed banks. From the way the information is presented (at the bottom of the page), it appears that the FDIC intends to update this information as additional actions are filed. Accordingly, this page could prove to be a valuable resource over time as the number of FDIC actions grows.

 

I intend to continue to track -- and link to --the FDIC litigation on my own as it is filed, as reflected here. At least for now, the FDIC itself also seems to be committed to tracking and providing this information as well. Many readers may find the FDIC’s page to be a highly credible and (we can hope) timely resource on these issues. I will continue to provide links to the lawsuits.

 

And speaking of failed banks, the FDIC did take control of four additional banks this past Friday night, as is reflected on the agency’s Failed Bank List. These four new closures bring the 2011 year to date number of failed banks to 18.

 

The 18 bank failures have been spread across 12 different states, though the largest number of closures this year has been in Georgia (4), which has led the way with the largest number of bank failures since the current wave began. The 18 failures so far in 2011 bring the total number of failed banks since January 1, 2008 to 340.

 

It is interesting to note that the pace of bank closure so far this year is running slightly ahead of the pace in 2010, when the FDIC closed more banks than it had in a single year since 1992. The FDIC did not close its 18^th bank in 2010 until February 19.

 

Living in America: On Friday, the determination of peaceful demonstrators in Egypt resulted in the historic overthrow of their oppressive government, but the lead story in Saturday’s Cleveland Plain Dealer was that the Cleveland Cavaliers’ ended their 26-game losing streak on Friday night. The Cavs’ first victory since December also apparently merited a headline in larger type as well.

 

As a letter to the editor in Sunday's edition put it, "Your newspaper failed to explain why all those Egyptians were so excited about the Cavs game."  

 

Web Animation Video Phenomenon Even Reaches the Insurance Industry: I know that many of you were as interested as I was in the February 11, 2011 Wall Street Journal article about the increasing numbers of customized computer-generated animated videos, which anyone can make on web sites such as Xtranormal.

 

One sure sign of how widespread this new phenomenon has become is the animated Xtranormal video now circulating that takes a light-hearted look at the perennial conversation about business between brokers and underwriters. For those of you who have not already seen it, here is the "I Need New Business" video. (The views, attitudes and opinions expressed in the video do not necessarily reflect those of The D&O Diary or its author.)

 

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The number of outstanding securities class action lawsuits in Canada reached an all-time high during 2010 according to a January 31, 2011 report by NERA Economic Consulting entitled "Trends in Canadian Securities Class Actions: 2010 Update." The report can be found here. The report includes an appendix in which securities lawsuit trends in several other countries are summarized, including Australia, Japan, and Italy, as well as the United States.

 

According to the report, there were eight new securities class action lawsuits filed in Canada during 2010. The number of 2010 filings is one fewer than the nine new cases filed in 2009, and two fewer than the record ten filings in 2008. Allowing for the settlements in six cases during the year in which defendants agreed to pay a total of CAN$80 mm, there are now 28 active Canadian securities class action lawsuits.

 

A total of 25 lawsuits have now been filed under Bill 198, the relatively new secondary liability provisions of the Ontario securities laws. Of the nine Bill 198 cases that have settled, the average settlement is CAN$10.7 mm, with four cases settling for more than $10 million and three settling for less than CAN$3 million.

 

Interestingly, one of the 2010 filings involved a company – Canadian Solar – whose shares do not trade on a Canadian exchange (its shared trade on NASDAQ. This is the second Canadian securities suit involving a company whose share do not trade on a Canadian exchange (the first being the 2008 lawsuit involving AIG).

 

The report notes that it has become relatively common in recent years for Canadian companies to be subject to securities lawsuit in the United States. Between 1996 and 2010, Canadian-domiciled companies have been named as defendants in securities class action lawsuits in the U.S. Of these, 17 cases also had parallel class action lawsuits in Canada.

 

The report notes that the number of future filings in the US against Canadian companies may decline in future years owing to the U.S. Supreme Court’s holding in Morrison v. National Australia Bank. Indeed, Morrison could have an impact on at least some of the cases pending in the U.S. against Canadian companies. The report notes that the Morrison case comes at a time when Canada and even other countries may be expanding the reach of their collective action mechanisms. It is entirely possible that there may be an increase of lawsuits in Canada involving companies whose shares do not trade in Canada, particularly in light of the fact that at least one Canadian court has been willing to certify a global class of claimants.

 

The average settlement amount of the 37 U.S. cases involving Canadian companies that have settled is US$71.5 mm, but this average is skewed by two large settlements involving Nortel. The median of these settlements is US$6 mm. For the 14 US cases against Canadian companies that have settled since 2007 (i.e., after the Nortel settlements), the average settlement is U.S $20.5 mm and the median settlement is uS$6.2 mm.

 

This Week at the PLUS D&O Symposium: Weather permitting, this week I will be attending the 2011 PLUS D&O Symposium in New York City. I know that many readers of this blog will also be there. I hope that if you see me at the Symposium that you will take a minute to say hello, particularly if we have not previously met. I look forward to seeing everyone there, or at least everyone who can make it through the storm. Safe travels to all, good luck to all of us with the weather.

　

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In a prior post, I speculated how WikiLeaks-style disclosures might fuel claims against corporate officials, to the extent that the previously nonpublic information conflicted with public statements. The latest round of WikiLeaks disclosures includes revelations that provide a more specific example of this type of process at work.

 

The latest revelations are in the form September 2009 diplomatic cables from the U.S. Embassy in London, published in The Guardian on December 13, 2010. The cables can be found here. The cables summarize meetings held September 2-7, 2009 between two U.S. senators and three members of the House of Representatives and various Members of Parliament, U.K. government officials and leading banking executives.

 

The meetings largely involved the discussion of the causes and lessons of the global financial crisis.

 

Among the sessions summarized in the cables is a separate meeting between the three congressmen and RBS Chairman Philip Hampton. Hampton was appointed to the post by the U.K government in February 2009. In the meeting, Hampton commented on the involvement of RBS in the financial crisis.

 

The cables quote Hampton as having said that RBS "had made several enormous mistakes," the most significant of which were the bank’s "heavy exposure to the U.S. subprime market and the bank’s purchase of ABN Amro."

 

With respect to the ABN Amro purchase, Hampton commented that it had "occurred at the height of the market and without RBS doing proper due diligence prior to the purchase." Hampton commented that "the board of directors never questioned this purchase," which Hampton termed "a failure of their fiduciary responsibilities."

 

The timing of these revelations is awkward, to say the least, both for RBS and for the U.K. Financial Services Administration, coming as it does just days after the FSA announced that it had closed its RBS investigation and would take no further regulatory or enforcement actions.

 

In a December 2, 2010 statement (here), the FSA said it was closing its supervisory investigation of RBS, noting that while its investigations had revealed a number of "bad decisions" at the bank, the FSA had concluded that those "bad decisions" were "not the result of a lack of integrity by any individual." The FSA statement added that "we did not identify any instances of fraud or dishonest activity by RBS senior individuals or a failure of governance on the part of the Board."

 

A December 13, 2010 article in The Guardian (here) suggests that the latest WikiLeaks investigations could lead to "pressure" on the FSA to reopen the RBS probe. The Guardian article also attributes statements to attorneys that Hampton’s reported remarks "could be crucial for any shareholders trying to bring legal action for the losses they sustained on their shares." particularly with respect to losses shareholders sustained in connection with the company’s 12 billion pound share offering in March 2008.

 

Whether or to what extent these revelations will lead to new or augmented litigation involving RBS and its current and former directors and officers remains to be seen. But regardless of what might arise as a result of this specific disclosure, the event itself highlights the problems that companies may face as a result of WikiLeaks-type disclosures.

 

As I have previously noted, the WikiLeaks-type of disclosure of internal or confidential communications potentially could represent a new type of threat for corporate officials. There may be and likely will be WikiLeaks imitators willing to ambush companies and executives with undisclosed communications obtained in any number of ways, which could not only be embarrassing but could also subject them to claims.

 

"Structural Corruption": James Fallows has an interesting commentary in a December 10, 2010 post on his blog on the Atlantic Monthly website about the decision of former Office of Management and Budget director Peter Orzag to accept a senior position at Citibank, a financial institution that received substantial federal bailout support during the financial crisis.

 

Among other observations, Fallows notes the "structural corruption" Orzag’s move represents (drawing a distinction to "personal corruption) in that, which there may be nothing formally wrong with the move, it "says something bad about what is taken for granted in American public life.."

 

I think Fallows’ comments are worth contemplating. I am sure I am not the only one that found the depth of involvement of Wall Street insiders during the financial crisis more than a little disturbing. What Fallow describes as the structural corruption is the very thing that left so many Americans suspicious that the bailout was an inside job, meant to protect financial interest at the expense of American taxpayers. The certainty that Washington insiders can look forward to making millions on Wall Street merely reinforces this perception of corruption. And yet, as Fallows note, it is taken for granted.

 

Introduction to D&O Insurance: Many readers may be familiar with my series of posts on the Nuts and Bolts of D&O Insurance, which can be accessed by clicking on the link in the right hand column. Readers who are interested in the basics of D&O insurance may also want to read "Directors and Officers Insurance: An Overview" (here) by my friend David Gische of the Troutman Sanders law firm, and his colleague Meredith Werner. The article includes important historical background on the development of the insurance product.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

　

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

 

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

 

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The amount of damages awarded in 2009 Japanese securities cases exceeded "the aggregate amount of securities litigation damages determined by court decisions in Japan for the entire previous decade," according to a new study of Japanese securities litigation from NERA Economic Consulting. The report, dated August 2, 2010 and entitled "Trends in Japanese Securities Litigation: 2009 Update," and which can be found here, updates the NERA report released last year that surveyed Japanese securities litigation from 1998-2008.

 

According to the report, there were 39 total cases filed in 2009, of which 14 related to misstatements, the same number of misstatement cases as in 2008. The balance of the filings largely involve broker-dealer cases, of which there were 23 in 2009, 12 of which related to unlisted stock trading.

 

The most significant trend noted in the report has to do with damages awards. The total value of all 2009 securities lawsuit judgments was about 47.2 billion yen (just under $550 million), which is four times the 2008 total and the highest annual level ever. The average damage aware per judgment amount was also a record high of 1.9 billion yen, or about $22 million.

 

Both the 2009 filings and damage awards reflected matters involving two notable companies, Livedoor and Seibu Railway. Thus, of the 14 new disclosure cases filed in 2009, five each related to Seibu Railway and Livedoor. New cases "involving other companies and/or allegations were limited." Similarly, much of the damages awarded "were related to the Livedoor and Seibu Railway cases." The report specifically notes awards that approximately 25 billion yen in damages is attributable to just two awards involving those two companies in 2009.

 

The report acknowledges that as the Seibu Railway and Livedoor cases are resolved, there is like to be a decrease in the number of judgments and damages related to misstatements, but the report suggests that any such downturn will be "short-term."

 

The report attributes the historical trends of increased number of disclosure related lawsuits and increased damages to changes that were introduced in Japanese law in 2004. Among other things, these changes the plaintiffs’ burden for proving damages was decreased and the powers of the Japanese Securities and Exchange Surveillance Commission were increased. Increased disclosure burdens on companies and heightened institutional investor expectations "may lead to an increase in the number of misstatement cases in the [the] future."

 

Though the reasons for the phenomenon in Japan may have uniquely Japanese attributes, Japan is only one of several countries that has seen an increase in the number and severity of securities related lawsuits in recent years, largely as a result of relatively recent legal reforms. Prior NERA reports have detailed these trends in Australia (about which refer here) and Canada (about which refer here).

 

These trends, which are also emerging in other counties as well, seem likely to continue, both because of the evolving impact of legal reforms as well as because of increased expectations of institutional and other investors. Other factors, including the increasing availability of litigation funding, which has proved to be a significant factor in the growth of securities litigation in Australia and elsewhere, could also contribute to these developments.

 

Another factor that at least potentially could encourage these trends is legal developments in the United States, particularly the U.S. Supreme Court’s June 2010 decision in Morrison v. National Australia Bank (about which refer here and here). As a result of this decision aggrieved investors who purchased securities on non-U.S. exchanges will be unable to pursue remedies under the U.S. securities laws in U.S. courts. As a result, some foreign-domiciled investors who might have attempted to pursue claims in the U.S. may now seek to pursue claims in their own country – and even, to the extent they find the remedies or procedures in their own country to be unsatisfactory, to seek legislative.

 

In any event, as the authors of the recent study suggest, the developments in Japan seem to represent longer term trends, which seems to be true in other countries as well. Even though there are still many more securities lawsuits in the U.S. than elsewhere, the number and significance of the lawsuits outside the U.S. appear to be increasing.

 

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As a result of series of legal developments, securities class action lawsuits in Australia have become have become increasingly common in recent years, and signs are that these trends will continue, according to a comprehensive study of Australian securities class action litigation issued on May 7, 2010 by NERA Economic Consulting.

 

The report can be found here, and NERA’s May 7 press release can be found here. (Hat Tip to Adam Savett of the Securities Litigation Watch blog, who has a post about the NERA study here).

 

Although the Australian laws permitting securities class action litigation have been in place since 1992, there were only two cases filed prior to 2000. There were a total of five cases filed during the years 2000 to 2003, and the filings began to increase steadily during 2004 and thereafter. There were a record number of cases filed in 2009, when six securities class action lawsuits were filed. There were a total of 22 securities class action lawsuits filed during the period 2004 to 2009.

 

A number of factors have contributed to the growing numbers of lawsuits. The first is that, according to the NERA study, "following the high-profile collapse of a number of companies in the early 2000s … shareholders have demonstrated that they are increasingly willing to use class actions as a tool to protect themselves from harmful conduct, and to punish offenders."

 

In addition, there have been several key case law developments that have removed some impediments, including decisions clarifying that shareholders can seek damages when their loss is distinct from any loss suffered by the company, and other decisions clarifying the rights of shareholders suing for damages against companies that are under administration.

 

However, perhaps the most significant development behind the increase in securities class action litigation in Australia is the "emergence of commercial litigation funding." Because of the prohibition against contingency fees, as well as the risks of costs awards against unsuccessful litigants, there were substantial financial barriers against pursuing this type of litigation.

 

Seventeen out of the 24 Australian securities class action lawsuits that have been filed since 2004 have been financed by a commercial litigation funder. The Australian commercial litigation funding business is dominated by IMF (Australia) Ltd., the first publicly listed litigation funder in Australia. IMF has financed 14 securities class action lawsuits and has proposed financing in an additional three suits that have not yet been filed. Though IMF dominates, according to the NERA study, a number of new firms have recently entered the market.

 

(Readers who, like me, are fascinated by this concept of litigation funding may want to have a look at IMF’s website, linked above.)

 

The two primary causes of action in Australian securities class action lawsuits are "contraventions of the continuous disclosure rules" and alleged violations of the laws prohibiting misleading and deceptive conduct. A number of suits also allege breaches of fiduciary trust. The two most common allegations, asserted in 52% of cases, are inaccurate earnings guidance and improper accounting.

 

Despite the dominance of the materials industry in the Australian economy, suits against mining or other companies represent only 14% of all cases filed. Actions brought against issuers in the diversified financial, insurance and real estate industries account for slightly more than half of all filings.

 

Because so many of the securities lawsuits have been filed in recent years, only a small number of all suits have been resolved. Of the 12 that were resolved as of December 2009, eight were settled, although all five of the resolved cases that were filed after 2003 were settled. The NERA report suggests that the litigation funding arrangements may have contributed to this trend toward negotiated resolutions, as the litigation funders are likely to "promote the selection and subsequent filing of actions that are stronger and for which a greater proportion of potential class members have signed a funding agreement."

 

Though Australian securities class action lawsuit filings have increased in recent years, they are many fewer securities lawsuit filed there than in the United States even allowing for the differences in size of the two countries’ economies. The NERA report comments that the class action filing levels in the Australia are "broadly similar to the level seen in Canada, once adjusted for the respective size of each economy."

 

The report concludes with the observation about Australian securities class action lawsuits that "with a number of recent common law developments having resolved many areas of uncertainty, it is likely that the rate of growth of filings evident since 2004 wil continue into the future."

 

NERA is of course well known for its periodic studies of U.S. securities class action lawsuits. Their new study of Australian class action lawsuits is the third in a series of studies concerning securities class action lawsuit litigation outside the U.S., following on its studies concerning securities litigation in Canada (refer here) and Japan (refer here).

 

More About the Schwab YieldPlus Securities Class Action Lawsuit Settlement: In an earlier post (here), I reviewed the $200 million settlement in the Schwab YieldPlus subprime related securities class action lawsuit. As noted at the time, the settlement did not resolved the related state law claims that the plaintiffs had filed.

 

On May 5, 2010, the Charles Schwab Company announced (here) that it had resolved the remaining state law claims as well, in exchange for an agreement to pay an additional $35 million, brining the total value of the Schwab YieldPlus settlement to $235 million. I have adjusted my table of subprime-related securities lawsuit case resolutions accordingly.

 

Farewell Ernie Harwell: Everyone here at The D&O Diary was saddened by the news earlier this week of the death of Hall of Fame baseball announcer for the Detroit Tigers, Ernie Harwell. One of my fondest memories from my three years at University of Michigan Law School is of listening to radio broadcasts of Tiger games, and of Harwell’s friendly, welcoming voice bringing the games alive. Harwell is perhaps better known for his signature home run calls ("That one is long gone!), but I will always remember the way he began games by saying "Its another great day for Tiger baseball." It was always a great day for Tiger baseball when Harwell was in the booth.

 

Ernie, we will miss you.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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As a result of legislative reforms and a changing enforcement environment, the number of disclosure related securities cases in Japan has increased in recent years and is likely to continue to grow in the years ahead, according to a July 15, 2009 report from NERA Economic Consulting. The report, which was written by Makoto Ikeya and Satoru Kishitani, is entitled "Trends in Securities Litigation in Japan: 1998-2008" and be found here.

 

The report examines 249 criminal and civil actions alleging violation of the Japanese securities from 1998 through 2008. Because very few Japanese cases settle, the report analyzes cases that have resulted in a judgment following trial.

 

The 249 cases studied encompass a wide variety of kinds of matters. The vast majority of the 249 cases (79%) represent broker-dealer cases (reflecting, for example, suitability allegations as well as a variety of other issues). The list also contains other kinds of cases included "market manipulation" and "insider trading" cases. But a large and growing number of the cases involve allegations of "misstatement" – indeed, by 2008, the misstatement cases represented half of all of the cases.

 

The growth in the number of misstatement cases in recent years is attributable to changes in the liability provisions in the Japanese securities laws. One set of revisions lessened the plaintiff’s burden for proving damages. In addition, for fiscal years beginning April 1, 2008, misstatements in internal control reports are subject to civil liability. The introduction of new accounting standards, more rigorous audits and disclosure of quarterly reports has added disclosure responsibilities, "increasing the risk that companies may make misstatements and face suits." Finally, Japan’s Securities and Exchange Surveillance Commission has been strengthened and expanded.

 

The report’s data show that cases related to misstatements have increased significantly since 2005, although the numbers in part reflect that certain high profile scandals have attracted multiple suits in the absence of any provision in Japan for class action litigation. For example, there have been eleven cases filed against Seibu Railway and four against Livedoor.

 

The report also notes that cases alleging that auditors alleged failed to detect misstatements have been on the rise since 2006, with ten such cases from 2006 through 2008, compared to only two from 1998 through 2005.

 

The report also notes that the type and number of plaintiffs involved is changing. Institutional investors have been more involved in recent years; for example, pension funds and trust banks are the main plaintiffs in the cases against Livedoor and Seibu Railway. Plaintiffs attorneys have also started forming large groups of plaintiffs to file for damages; the Livedoor case involved 3.310 individual investors and similarly large plaintiff groups have formed in other cases.

 

The increased number of misstatement cases has also affected the damages trends. The 9.5 billion yen award in the Live Door case raised the average award in 2008 to 450 million yen. However, of the 25 civil cases alleging misstatements between 1996 and 2008, a high number resulted in no damages award, although eight of those sixteen involved audit firm defendants and four involved Seibu Railway litigation.

 

Excluding litigation against the audit firms, 44% of the civil misstatement cases resulted in damage awards that were more than half of the amount sought and the average judgment was 1.5 billion yen.

 

The report concludes by noting that given the changes in disclosure requirements and the current litigation environment, securities litigation in Japan is expected to gradually increase going forward. However, in light of the "fundamental differences" between the U.S. and Japan (for example, "the absence of class actions, fewer attorneys, and other social factors") it is "unlikely that the number of securities litigation cases in Japan will be comparable to the U.S."

 

An interesting January 2009 legal memorandum by the Anderson Mori & Tomotsune law firm on the topic of civil liability under Japanese law for false statements in securities filings can be found here.

 

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A recent German legislative action creates some interesting requirements for and limitations upon insurance for German corporate director liability. These legislative changes are designed to try to ensure greater director exposure to personal liability, as a deterrent to corporate misconduct. However, the legislative changes are susceptible to circumventions that may limit their intended effects.

 

As reflected in a July 1, 2009 memo by Anthony Menzires and Dr. Gunbritt Kammerer-Galahn of the Taylor Wessing law firm entitled “D&O Insurance in Germany – The New Legislation Arrives” (here), on June 18, 2009, the Bundestag enacted the new Act on the Adequacy of Managerial Salaries.

 

 

Among other things, this new Act will impose a new requirement that German Stock Corporations (Aktiengesetz) purchasing D&O insurance for their executives must impose a personal deductible to be borne by the directors in an amount equivalent to at least 10% of the relevant loss, up to an annual cap. Comments accompanying the Act specify that the annual cap must be set at not less than one and one half the annual fixed remuneration of the director.

 

 

These requirements are applicable to all stock corporations, whether listed or publicly owned.

The requirements will to into effect immediately following the Act’s ratification by the Bundesrat on July 10, 2009, with immediate effect on all D&O insurance policies formed after that date and with a further requirement that all existing policies must be amended to bring them into compliance by July 1, 2010.

 

 

According to the law firm’s memo, these new statutory requirements codify long-standing German governance guidelines that had encouraged companies to structure their D&O insurance with a deductible to be borne personally by the directors as a way to “motivate them to avoid claims arising.” The memo observes that many German corporations “circumvented” these voluntary requirements.

 

 

The elevation of these provisions into statutory mandates represents an apparent legislative attempt to try to use the threat of personal liability to deter corporate misconduct. The German legislature’s action raises a couple of questions: Will the statutory requirement be effective? And will other countries follow?

 

 

As for whether the requirement will be effective in deterring corporate misconduct, there are certain aspects of the statutory requirement that are worth considering. The first is that that under the German two-tier system of board governance, the requirements apply only to D&O insurance for the management board (Vorstand) and not to the non-executive supervisory board (Aufsichtsrat). At a minimum, then, the deterrent effect, if any, is limited solely to the management board and would not reach the supervisory board.

 

 

The other aspect of the statute that may affect its effectiveness is the fact that the Act does not prohibit the acquisition of separate insurance for the individual director’s deductible exposure, which presents a rather obvious new product opportunity for German D&O insurers. And while the premium cost would have to be borne personally by the director, there is, as the memo notes, nothing to prevent each director from “seeking a commensurate uplift in their remuneration to cover the outlay.” Furthermore, there apparently is no existing requirement that would compel the corporation to disclose this type of compensation arrangement.

 

 

Whether other countries might follow the German legislation and enact similar statutory requirements may depend on whether the German requirement proves to be effective in deterring corporate misconduct. While the results from the statutory requirement remain to be seen, the apparent ease with which the personal exposure could be insured may well limit the deterrent effects.

 

 

The obvious logical step, then, might be to suggest that other countries considering the German requirement add further specifications that the director cannot acquire separate personal insurance to protect against the required liability exposure. My own view is that there are several critical considerations that should be taken into account before these kinds of prohibitions are imposed.

 

The first is that directors ought to be able to defend themselves, and so there should be no prohibition for the insurance providing defense expense protection. The second is that fundamental fairness requires that the barriers should apply only if an adjudication has determined that the director actually violated liability standards, and accordingly the statutory prohibition should only apply to judgments.

 

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There is no question that the Amsterdam Court of Appeals’ May 29, 2009 action authorizing Royal Dutch Shell to begin funding the April 2007 securities settlement represents a landmark development. Under the ruling (a copy of which can be found here, in Dutch), Shell will begin paying a total of $381 million to a foundation that represents over 150 institutional investors in 17 European countries, Canada and Australia, in settlement of their securities fraud claims arising from allegations that Shell had overstated its oil and gas reserves.

 

A June 1, 2009 Law.com article describing the court’s action can be found here. The foundation’s May 29, 2009 press release describing the court’s action can be found here.

 

But while the court’s approval of the settlement unquestionably is a significant development, it remains unclear what this development implied about the likelihood of further collective settlements of the same kind, and in the short term it seems unlikely to overcome non-U.S. investors’ interest in pursuing relief in U.S courts, at least when that option is available.

 

Background

Royal Dutch Shell and certain of its directors and officers were first sued in a U.S.-based securities lawsuit in the District of New Jersey on January 29, 2004, following the company’s January 9, 2004 announcement that it was writing down its "proved" oil and gas reserves by 20%. Background regarding the U.S. securities suit can be found here. The class on whose behalf the U.S. action was initially brought purported to include European investors who had purchased their shares on exchanges outside the U.S.

 

In July 2005, Netherlands enacted the Dutch Act on Collective Settlements of Mass Damages, which, subject to considerations discussed below, allows for collective settlement of the claims of the members of a class who do not opt out.

 

Shell and its biggest investors are located in the Netherlands. As discussed at length in a January 7, 2008 American Lawyer article (here), the Dutch Act gave Shell and its European investors a way to settle "on their home turf." On April 11, 2007, Shell agreed to pay $352.6 million, plus administrative expenses, to Shell investors who purchased their shares and resided outside the U.S. (As explained in the foundation’s May 29 press release linked above, the amount of the settlement was later increased to align the Non-U.S. shareholders’ settlement with the settlement Shell had reached in the U.S action with U.S. investors.) A detailed description of the settlement can be found here.

 

The settlement was contingent on its approval by the Amsterdam Court of Appeals, which the court granted in its May 29 declaration. The Dutch Court’s approval is likely enforceable throughout Europe based on the European regulation on jurisdiction and recognition of judgments.

 

Discussion

The Dutch court’s refusal to approve the settlement would have represented a significant setback for the prospect of future similar settlements, as would the court’s refusal, for example, to approve the participation in the settlement of non-Dutch investors.

 

But while the court’s approval avoided these setbacks and while the settlement itself clearly provides an example of a way in which European investors were able to resolve their grievances against a European company in a European court, that does not mean that the Amsterdam Court of Appeals is now about to be inundated with these kinds of settlements. Indeed, given the clear advantages to proceeding in U.S. courts under the U.S. securities laws, aggrieved non-U.S. investors are likely to continue to attempt to pursue their claims in U.S. courts, as long as and to the extent that U.S. relief and remedies are available to them.

 

First, while the Dutch Act allows for collective settlements of the type involved in the Shell claim, it does not allow for collective damages claims. Indeed, as stated in the American Lawyer article linked above, the "innovative solution" involved in the Shell settlement was that Shell and the European investors used the Dutch Act to settle the European investors’ U.S.-based damages claims. While this allowed the European investors to "settle litigation on their home turf," it depended on the existence of the U.S. lawsuit on the front end, in order for there to be a Dutch settlement on the back end.

 

The Shell settlement basically represented an innovation, but the ability for other litigants to use the Shell settlement itself as a model will largely depend on the existence of a similar combination of circumstances. It is far likelier that the next set of European investors to try to use the Dutch Act will need to establish their own "test case" rather than simply modeling off of the Shell settlement. In other words, change in the form of a European collective action remedy for aggrieved investors has been and appears likely to continue to be episodic and incremental, rather than categorical.

 

In the meantime, the U.S. courts continue to offer potential claimants, even those located outside the U.S., with a host of potential advantages. The U.S lacks a loser pays rule; it allows contingency fees; it uses a jury system for civil cases; and it has a well recognized and understood class action mechanism. It also has a highly motivated, entrepreneurial plaintiffs bar. Its courts recognize the fraud on the market theory, which spares claimants from having to prove that the relied on alleged misrepresentations.

 

Of course, many potential claimants would prefer a remedy in their home country if one were available. However, the reason for which non-U.S. investors would seek to resort to non-U.S. courts is less likely to be due to the availability of possible alternatives like the Dutch Act and more likely to be due to jurisdictional constraints on their access to U.S. courts. Non-U.S. investors in Non-U.S. companies who bought their shares outside the U.S. – so-called "foreign cubed" or "f-cubed" claimants – who have jurisdictional access to the U.S courts are likely to continue to take advantage of it, at least as long as and to the extent that the access remains available. A detailed comment on ClassActionBlawg.com about the interaction between U.S. jurisdiction for f-cubed claims and the possibility of further Shell-type settlements can be found here.

 

As discussed in a recent post (here), last October, the Second Circuit declined to rule that U.S. courts could never exercise jurisdiction over the claims of f-cubed claimants. In the National Bank of Australia case, the Second Circuit held that subject matter jurisdiction exists if "activities in this country were more than merely preparatory to a fraud and culpable acts or omissions occurring here directly caused the losses abroad." However the court declined to find jurisdiction in that specific case.

 

The petition of the plaintiffs in the National Australia Bank case for a writ of certiorari case to the U.S. Supreme Court is pending. The 10b-5 Daily blog (here) reported earlier this week that the Supreme Court has asked the Solicitor General to present her views on the petition. A June 1, 2009 Bloomberg article discussing the Supreme Court’s request for the SG’s views in the NAB case can be found here.

 

There is of course no way of knowing now, but it is at least possible that the f-cubed jurisdiction issue will soon wind up in front of the U.S. Supreme Court. In the meantime, the Second Circuit’s decision continues to allow for the possibility of subject matter jurisdiction in f-cubed cases, at least under certain circumstances.

 

All of that said, the movement toward the development of collective remedies in jurisdictions outside the U.S. is now well-established and the Dutch Court’s approval of the Shell settlement undeniably represents another step in support of that movement. We are likely to continue to hear in the weeks and months ahead about the growing threat of collective investor actions outside the U.S. What remains to be seen is where the next "test case" will come from and how it will be framed.

 

My prior post comparing and contrasting in detail European and U.S. collective action procedures and approaches can be found here.

 

Very special thanks to Werner R. Kranenburg (who can be found on Twitter, here) for a copy of the Dutch Court’s ruling.

 

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As a result of recent legislative changes, Canadian securities litigation filings increased substantially in 2008, according to a January 26, 2009 Report by NERA Economic Consulting entitled "Trends in Canadian Securities Class Actions: 1997-2008" (here). A January 26, 2009 press release describing the report can be found here.

 

According to the Report, plaintiffs filed a record nine new securities class action lawsuits in Canada during 2008, which represented an 80% increase over the previous annual maximum and a 125% increase over the prior year.

 

This level of filing activity is still "miniscule" compare to the securities litigation filings in the U.S., even allowing for the fact that the Canadian securities markets are in the aggregate much smaller than those in the U.S.

 

However, in recent years, four Canadian provinces have introduced "continuous disclosure" regimes and have enacted civil liability provisions as well. These provisions include certain "gate keeping" mechanisms (including, for example the requirement that the plaintiffs seek leave of court to pursue a class action), but plaintiffs nevertheless seem interested in pursuing relief under these new statutory regimes.

 

For example there have now been a total of twelve new securities lawsuits filed in Ontario since the 2006 revisions to the relevant laws. (The Ontario Securities Act, as amended, can be found here.)

 

One of these Ontario cases involves IMAX Corporation, which is also the subject of a U.S. securities lawsuit. As I discussed in a prior post (here), the prospect for Canadian securities actions may have, as the NERA Report puts it, "received a boost" with a ruling in the IMAX case, which permitted the plaintiffs in that case to conduct a certain amount of discovery at the pre-approval state.

 

As NERA Report observes, "for parallel US-Canada actions, the IMAX ruling may enable plaintiffs to do an end-run around the discovery stay provisions of the PSLRA by brining an action north of the border."

 

The NERA report also observes that the recent filing in Ontario of a class action against AIG may be an example of this tactic. My prior post discussing the Ontario securities action against AIG and its possible tactical purposes can be found here.

 

The NERA Reports that among the Canadian filings are cases demonstrating the impact of several trends that have also driven U.S. securities litigation. That is, the 2008 cases include lawsuit filings related to the credit crisis (against CIBC and AIG), as well as cases based on allegations of options backdating.

 

Nearly one-quarter of the Canadian class actions involve companies in the financial sector, and nearly one fifth involve resources companies.

 

The Report states that there have been twenty securities class action settlements, but only one (the Southwestern Resources case, which settled for CAN$15.5 million) involved a case brought pursuant to new securities legislation. The Report shows that cross-border cases tend to result in larger settlements than Canadian-only cases.

 

Overall the Report notes that while the plaintiffs’ bar is "more active than ever" and filed a record number of new lawsuits in 2008, "it remains to be seen whether the gate-keeping aspects of the new amendments to the legislation, as interpreted by the courts, will meaningfully hinder the ability of plaintiffs to prosecute class actions in Canada."

 

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As the details about the Satyam Computer Services scandal have emerged and the U.S. securities lawsuits have begun to flood in, questions have also arisen about Satyam’s D&O insurance. At least some of the questions are answered in a January 8, 2009 article in The Economic Times (India’s largest financial daily) entitled "Satyam Scam Triggers Biggest D&O Claim" (here).

 

According to the article, Satyam carries a $75 million D&O insurance program led by Tata AIG, which is a joint venture of Tata Group and American International Group. The article also states that the Satyam claim "could trigger one of the largest Directors and Officers insurance claims in India."

 

Of course, knowing the limits of liability under Satyam’s insurance program does not necessarily tell you how much insurance ultimately will be available to defend and indemnify Satyam and its directors and officers. In a case where the company’s Chairman has publicly admitted fraud, the applicable terms and conditions will be absolutely critical. I discuss below a couple of issues that seem likely to arise.

 

The Fraud Exclusion

Without knowing more about the specific terms applicable under Satyam’s D&O insurance program, it is difficult to say anything with certainty. However, at least in the U.S., D&O insurance policies do not cover fraudulent, criminal or intentional misconduct.

 

But, again in the U.S., these exclusions typically do not kick in until there has been an "adjudication." Even though Satyam’s Chairman has admitted cooking the books, he has not (yet) been convicted of anything, so to the extent the policy’s exclusions have an "adjudication" requirement, the exclusions would not apply, at least in the interim.

 

Moreover, a well-constructed U.S. policy would also contain a "severability of exclusions" provision so that even if an exclusion would apply to preclude coverage based on the Chairman’s misconduct, it would not apply to others who were uninvolved in the conduct. Of course, many questions are now being asked about who else at Satyam might have been involved in the fraudulent accounting. The Chairman’s letter sought to establish that other board members were unaware of the fraud.

 

A prior post discussing the "adjudicated fraud" exclusion can be found here. A separate post discussing an interim decision in the Refco matter and relating to the interaction of the exclusion and the funding of defense costs can be found here.

 

Application Misrepresentations?

Another insurance issue that likely will be raised is the question of policy rescission. Given the magnitude of the fraud and the apparent length of time during which it was going on, the question may be asked whether the policy was procured through misrepresentations in the application process.

 

Under the typical current D&O policy in the U.S., application misrepresentations can serve as a basis on which the carrier can rescind the policy only as to persons with knowledge of the misrepresentations and as to persons to whom that knowledge is imputed. A well-constructed U.S. policy will limit "imputation" so that innocent persons do not risk rescission of their coverage because of another’s misrepresentation. The imputation language used in Satyam’s policy could well be critical.

 

A prior post discussing D&O insurance policy rescission issues can be found here (refer especially to my "final thoughts" toward the end of the post).

 

I welcome any insight readers can provide about the provision of the typical D&O insurance policy in the Indian market, as well as any additional information anyone can supply about the Satyam program, particularly any additional carriers involved.

 

Very special thanks to loyal reader Aruno Rajaratnam for providing a copy of The Economic Times article as well as other information about Satyam.

 

Global Accounting Outlook = Bleak: Fitch's Ratings has issued a January 8, 2009 report entitled "Accounting and Financial Reporting: 2009 Global Outlook" (available here, registration required) with some very interesting observations about the year ahead for public company accountants. As the report states in its opening line, "these are indeed interesting times for accounting."

 

Among other things, the report notes the following with respect to the "going concern" questions that many companies and their accountants will face as the companies prepare their year-end 2008 financial statements:

 

The sharp decline in global debt and equity securities values and a very difficult credit environment have presented a unique set of chllenges to the interpretation and implementation of some pervasive accounting issues. An immediate question facing some companies preparing their full-year 2008 financial statements, is how best to justify a "going concern" basis, given the doubts some have about their abiltiy to refinance. Management statements on this issue should be required reading for investors and analysts. The determination of impairment charges on debt securities and the lack of clear-cut rules on the subject have pitted some issuers against their auditors. This is a particularly sensitive issue because profitability and regulatory capital adequacy are at state for many financial institutions.

 

Obviously, insurance companies are among the companies for whom the determination of impairment charges will be particularly sensitive. And among others who will want to read companies' managers' statements on the "going concern" issue, in addition to investors and analysts, are D&O underwriters.

 

A news article describing the Fitch report can be found here. Special thanks to a loyal reader for sending along the news article and a link to the report.

 

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There no longer seems to be a question whether European countries will adopt some form of collective action procedures. The questions now are what form the collective action mechanisms will take and to what extent will the processes will adapt or reject features of the U.S. class action model.

 

A November 6, 2008 article by NYU law professors Samuel Issacharoff and Geoffrey Miller entitled "Will Aggregate Litigation Come to Europe?" (here) takes a look at these questions and examines whether current European reforms are, in light of the extent of the aversion to the U.S. model, "likely to be effective in realizing their stated aims."

 

The authors begin their analysis by noting that while class actions were long "decried as the perversity of rapacious Americans," class actions are now "the focus of significant reforms in many European countries and even at the level of the European Union." Indeed, a "consensus" has emerged that "aggregate litigation will soon be the norm" in Europe. But by the same token, there is also a consensus that the European model of aggregate litigation "will not replicate American class action litigation with its domination of entrepreneurial plaintiffs’ attorneys."

 

The European movement toward aggregate litigation models has advanced because of the "need to create ex post accountability mechanisms" and the create mechanisms for the "efficient resolution of numerous intertwined claims." Aggregate litigation also mobilizes "efforts to foster prevention through the prospect of civil litigation."

 

The authors note that the criticisms of the U.S. model in many ways correspond with concerns raised inside the U.S. But the authors also ask whether or not the categorical aversion to the U.S. model may leave European reform efforts without the means to achieve desired results.

 

In order to assess whether the European rejection of the U.S. model sweeps too broadly, the authors examine the recurring criticisms of U.S. class action litigation. Among other things, the authors suggest that by framing the debate this way, the discussion will reflect both the weaknesses and the strengths of the U.S. approach and allow the reform process to benefit from the beneficial aspects of the U.S. approach.

 

The four criticisms of U.S. class action litigation on which the authors focus are:

 

(1) the danger that mass settlements may overgeneralize, by treating differently situated claimants as if they were similar, particularly where "an unsolicited and effectively unsupervised" agent resolves the case on behalf of absent class members;

(2) the most significant recovery is "often by successful class counsel, not by any class member;

(3) the uneasy relation between entrepreneurialism and avarice (as evidenced most recently by the criminal pleas of leading plaintiff securities attorneys); and

(4) the manipulation of the judicial forum for litigation gain (particularly through serial exploitation of "judicial hellholes").

 

The authors observe that what unifies these four controversies is "the role of private entrepreneurial lawyers" – which, the authors note, is "precisely what troubles Europeans about American class action practice." Nevertheless, motivated lawyer action is the "engine that fuels American aggregate practice." The authors ask whether the comprehensive rejection of the U.S. model "throws the baby out with the bath water" and whether "the controversies that arise in a system build on self-interest can be mitigated without disabling the entire undertaking."

 

In order to examine these questions, the authors look at the common features of European collective action reform efforts. While the legal reforms represent a broad spectrum of initiatives, there are three common features: (1) the tendency to allow only organizations to represent consumers in class actions; (2) the interaction between rules on litigation funding and class action procedures; and (3) the preference for "opt-in" rather than "opt-out" systems.

 

The authors find that there are potentially significant limitations to each of these unifying features. The authors also note that the evolving European efforts attempt to realize the benefits of collective action, but are "limited in their conception of how these processes will be realized."

 

The threshold issue that current European reform efforts must address is who will "organize, fund and lead the collective efforts." Both the strength and weakness of the American collective approach has been the "willingness to entrust a great deal of social regulation to private initiative and common law forms of adjudication." The authors express their concern that the European "cultural revulsion" to "accepting the reality of legal enforcement as entrepreneurial activity may leave the reforms without the necessary agents of implementation."

 

Discussion

The excesses of the U.S. class action system are a familiar hobby horse for social critics, both in the U.S. and abroad. Nevertheless aggrieved parties continue to pursue relief and redress through class litigation -- and not just consumers whose interests critics contend are hijacked by self-interested lawyers, but also well-financed institutional investors that are fully informed about their interests and fully able to act independently.

 

While Europeans disdain the excesses of the U.S. model, there have been periodic outbursts over the past several years where the need for collective action mechanisms has been so obvious that the local legal systems had to respond. Among the various corporate scandals that came to light earlier this decade were several instances where large group of aggrieved European investors were adversely affected and collectively sought redress. The current credit crisis underscores these issues. The further European development of collective action mechanisms does, as the authors note, seem to be inevitable.

 

On the other hand, the limitations of the U.S. model have been painfully apparent lately. The criminal sentencing of the leading plaintiff securities attorneys certainly highlights the corrupting potential of class litigation where the agent controls or even selects the principal.

 

There is also recent evidence that aggrieved parties involved in U.S-based litigation increasingly may perceive their interests to be best served outside of class litigation. Significant securities class action opt-out actions, in which would-be class members proceed independently to maximize their recovery and even to reduce counsel fees (about which refer here), suggest deep concerns about the utility of class litigation.

 

The authors may be correct that class litigation is most effective if it is driven by motivated entrepreneurs who can drive the process and maximize class results. Nevertheless, the lessons of the recent past in the U.S. highlight clearly how important it is for strict controls over class counsel.

 

The recent lessons also suggest the need for some modesty in advocating the U.S. class counsel model to Europeans. Indeed, rather than expecting the success of the European reforms to depend on European’s willingness to adopt aspects of the U.S model (such as the involvement of entrepreneurial counsel), perhaps it will be the case that the improvement of the current flawed U.S. model will depend on the adoption in the U.S. of existing or yet-to-emerge European innovations that develop as part of current European reform efforts.

 

Hat tip to the Point of Law blog (here) for the link to the article.

 

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In a recent post (here), I raised concerns about the possibility of U.S.-domiciled companies becoming subject to securities litigation under the Ontario Securities Act. Now, a recent decision by an Ontario Superior Court judge interpreting the Act’s provisions suggests the possibility of litigants using a parallel Ontario proceeding to circumvent the PSLRA’s discovery stay.

 

The decision arose in connection with the prospective securities action that claimants seek to pursue in Ontario court against IMAX and certain of its directors and officers. Under the provisions of Bill 198, enacted in 2005 and codified in Section XXIII.1 of the Ontario Securities Act (which can be found here), a preliminary procedure is required to determine whether a liability action under the Act can proceed.

 

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

 

The procedure specified for this determination is that the plaintiff and each defendant are to serve affidavits "setting forth the material facts upon which each intends to rely." The affiant may be "examined" on the affidavit "in accordance with the rules of the court."

 

The issue addressed in the recent decision in the IMAX case is the breadth of the examination that is to take place in connection with this authorization proceeding. In addressing this question, Madame Justice Katherine van Rensberg issued a ruling that potentially could compel defendants to answer questions under oath about a broad range of issues, even issues the claimants have not initially raised. A November 18, 2008 Globe and Mail article regarding the decision can be found here.

 

Justice van Rensberg wrote that the Act itself "provides no guidance as to the interpretation of the threshold test and what type, quality and quantity of evidence the court is to consider." IMAX had urged her to restrict examination to publicly available information. However, she found that shareholders seeking leave to proceed under the Act have "special powers" generally not available otherwise and she held that anyone being examined must answer questions that have a "semblance of relevance" even if it "might also reveal some other potential issues or wrongdoing not currently contemplated by the statutory claim."

 

The "semblance of relevance" test Judge Van Rensberg used is the threshold used in connection with discovery, the procedures with respect to which ordinarily apply once a case is underway. In effect, the Judge’s ruling permits discovery in the precertification stage, before the case has even been authorized to proceed. As comments quoted in the article note, defense advocates had militated in favor of inclusion of the precertification procedure in the Act as a way to bar frivolous claims, but now it appears that procedure can be used to compel defendants "to disclose evidence relevant to the merits."

 

This development, if it stands, not only seems to authorize plaintiffs to use the procedure to conduct a fishing expedition, it also could be used as a way to aid a parallel proceeding filed in U.S. courts, by allowing shareholders to examine company officials, even as to matters not raised either case.

 

As Adam Savett points out on his Securities Litigation Watch blog (here), this procedure, pursued in parallel with a U.S. filed lawsuit, could permit claimants to use the Ontario procedure to circumvent the PSLRA’s stay of discovery. Savett points out that IMAX itself is not only subject to the Ontario action but also to a separate action under the U.S. securities laws in the Southern District of New York, in which a motion to dismiss is pending. Savett observes that the Ontario court’s IMAX ruling "raises the specter of cases being filed cooperatively in Canadian and U.S. courts, with discovery in the Canadian action possibly being allowed to be used in the U.S. action."

 

This possible PSLRA discovery stay end-around takes on even greater potential significance in combination with the possibility of U.S.-domiciled companies and their directors and officers getting hauled into securities litigation in the Ontario courts. As I noted in my prior post (here), discussing the Ontario securities lawsuit recently filed against AIG, the prospect for U.S. companies of securities litigation outside the U.S. is unattractive. But perhaps even more unwelcome is the possibility of litigants using a parallel Ontario case against a U.S. company as a way to try to get material to be used to support a separate U.S. proceeding against the company.

 

If the recent IMAX ruling stands, U.S. securities litigators might have to become a great deal more familiar with Ontario’s securities laws and procedures.

 

Special thanks to Mark Renzel for providing me a link to the Globe and Mail article.

 

More about the AIG Lawsuit: A couple of interesting items about the AIG lawsuit appeared after I wrote my recent post about the case.

 

First, in a Guest Column on the Securities Docket (here), Dimitri Lascaris of the Siskinds law firm provides interesting additional detail about the "substantive and procedural advantages" offered to aggrieved claimants under the Ontario Act, as well as the potential damages available. The Siskinds firm is lead counsel in the Ontario proceedings filed against both AIG and against IMAX.

 

Lascaris also wrote in his column that "for a long time, America has largely dictated the standards by which issuers are obliged to conduct themselves in a globalized capital market. Like much else that is coming to an end in today’s capital markets, that era may be over. "

 

Second, Law.com has a November 19, 2008 article (here) about the case against AIG filed in Ontario. Among other things the article quotes Lascaris as saying that the AIG action is the first use of the use of the liability provisions of the Ontario Securities Act against a non-Canadian company.

 

And Finally: I would like to thank all of the many Canadian readers who commented to me about the AIG case. Numerous readers provided me with helpful additional information about the Ontario Act and about securities litigation in Canada. In that respect, several readers added helpful and interesting comments to the blog post about the AIG case, and I commend those comments to everyone's attention.

 

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Questions surrounding the susceptibility of foreign domiciled companies to U.S. securities laws and to the jurisdiction of U.S. court are frequently recurring issues, as I noted most recently here. However, a new case filed in Ontario under Ontario’s securities laws presents an interesting variation on these questions.

 

The Ontario Action Against AIG

According to its November 13, 2008 press release (here), the Siskinds law firm has filed a class action application and accompanying statement of claim in the Ontario Superior Court of Justice under the Ontario Securities Act against American International Group, American International Group Financial Products, and ten current or former AIG directors and officers. According to the press release, the claim is brought on behalf of Canadian investors who bought AIG securities between November 10, 2006 and September 16, 2008.

 

A copy of the application and statement of claim can be found here. According to the press release, the statement of claim alleges as follows:

 

The AIG class action arises out of AIGFP's credit default swaps and the crippling decline in AIG's stock price when the true effect of those credit default swaps became known to the investing public. The AIG disclosures out of which the class action arises are currently the subject of investigation by law enforcement authorities, and are alleged in the class action to have caused massive losses to Canadian investors.

 

The Ontario Securities Act

The action is brought under the investor protection provisions in Part XXIII.1 of the Ontario Securities Act. (Refer here for the provision of the Act.) The statutory provision specifies the liability standards in connection with "secondary market disclosure."

 

Section 138.3 of the statute provides a cause of action for damages on behalf of persons who trade in a company’s security -- "without regard to whether the person or company relied on the misrepresentation" -- where "a responsible issuer or a person or company with actual, implied or apparent authority to act on behalf of a responsible issuer releases a document that contains a misrepresentation."

 

The persons against whom the action may be brought are specified to include, among others, the issuer, "responsible" directors and officers, as well as persons who "knowingly influenced" the issuer or responsible persons.

 

Jurisdictional Issues

The plaintiff’s statement of claim takes great pains to emphasize that the action has "a real and substantial connection with Ontario." Indeed, in paragraph 155, the statement of claim alleges that the financial disclosures that are the basis of the action were "disseminated in Ontario"; that "a substantial proportion of the Class Members reside in Ontario"; that AIG "carries on business in Ontario"; that AIG considers its Canadian revenue as "domestic" for accounting purposes"; that "key AIG personnel charged with oversight of the above conduct were domiciled in Ontario and undertook part of that effort from Ontario."

 

The pains taken in the statement of claim to specify the claim’s connection to Ontario suggests an anticipation of a question whether the case properly belongs in Ontario courts. AIG is, after all, domiciled outside of Canada, and its shares do not trade on Canadian securities exchanges (or at least the plaintiff does not so allege). The alleged misstatements were prepared and issued outside of Canada.

 

On the other hand, the statement of claim does allege misconduct, harm and damages within Ontario. Without presuming the outcome, allegations of this type are of the kind that at least some U.S. courts have found a sufficient basis for the exercise of jurisdiction and the application of U.S. securities laws on companies domiciled outside the U.S.

 

Discussion

Setting aside these subject matter jurisdiction issues, and disregarding potential personal jurisdiction issues, there are some larger questions about this case. AIG faces extensive litigation in the U.S. on similar or related issues. Should any particular jurisdiction’s court have priority? Should courts defer to another jurisdiction’s courts?

 

These kinds of questions have come up before, for example, in connection with the Royal Dutch Shell cases, where there were also parallel proceedings in different countries (refer here). The way that these proceedings should coordinate is very much an evolving issue. But the noteworthy difference between that prior example and this instance is that here the target company is a U.S.-based company. It will be interesting to see whether that distinction makes a difference and how the respective cases unfold.

 

I also have these vague, unformed questions whether or not it makes a difference that AIG is now effectively owned by U.S. taxpayers. The taxpayers’ highest priority right now is getting repaid for the astonishing obligations to the U.S. treasury that AIG has recently undertaken. I haven’t worked it all out yet, but there does seem to be something inconsistent with the U.S. taxpayers’ interest in having the company’s limited resources siphoned off to defend and possibly to pay damages in a foreign jurisdiction. Canadian investors probably don’t care much about that, I suppose.

 

Of course, it might be argued that U.S. courts have been doing similar things to other countries’ companies (including Canadian companies) for some time now. Indeed, the plaintiff’s lawyers’ press release quotes one of the plaintiff’s attorneys as saying:

 

for many years, Canadian corporations have had to confront the long arm of America's justice system. But with the enactment of Part XXIII.1 of the Ontario Securities Act, Canadian investors can finally pursue remedies in our own Courts against American corporations that fail to respect Canada's securities laws. Canadian investors are entitled to have Canadian Courts hear their claims.

 

The one thing that is clear is that a class action under the Ontario securities laws is a serious matter. As I noted in a prior post (here), a prior class under the Ontario securities laws against FMF Capital recently settled for over CAN$28 million. This settlement apparently represents the largest securities class action settlement in Canada, and while the amount may seem small compared to some of the massive U.S. settlements, the amount did represent a very significant percentage of the investors’ claimed investment loss.

 

At a minimum, the FMF Capital settlement suggests that a claim under the Ontario securities laws represents a serious potential liability exposure. Along those lines, it should be noted that the press release states that the plaintiff class seeks damages of $550 million. (The press release does not state whether or not those are U.S. or Canadian dollars.)

 

UPDATE: Dimitri Lascaris of the Siskinds law firm has written a guest column on the Securities Docket blog (here), in which he explains the basis of jurisdiction in Ontario for the AIG lawsuit, as well as the operation and effects of the Ontario securities laws.

 

Two Final Observations

First, this new lawsuit represents yet another demonstration that the threat of securities litigation outside the United States continues to grow.

 

Second, this new lawsuit presents an interesting and potential dangerous expansion of this growing threat, which is the possibility that U.S. domiciled companies could find themselves the target of securities litigation in other jurisdiction’s courts under other jurisdiction’s laws.

 

To the extent it proves to be successful, the Ontario plaintiff’s new lawsuit against AIG could represent a very unwelcome and potentially complicated expansion of the liability exposures of U.S companies and their directors and officers.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the Ontario court application and statement of claim.

 

Now This: In this time of financial turmoil, it pays to be resourceful. And so, The D&O Diary is giving serious consideration to converting itself into a bank holding company, in order to be able to join other leading American business enterprises and participate in the bailout process.

 

While there might be those who would contend that we are not "too big to fail," we certainly are feeling the effects of the economic downturn, and recent 401(k) statements suggest that radical measures may be required. Capital infusions would be particularly welcome here.

 

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Among the many consequences of an increasingly global economy is that investor interest in pursuing claims for securities wrongdoing has become a more nearly universal phenomenon. While collective-style lawsuits largely had been restricted to claims in U.S. courts under U.S. law, a growing list of countries are adopting at least some elements of U.S.-style securities lawsuits. Several recent articles, discussed below, have examined these developments.

First, in a May 19, 2008 article entitled “Global Realm of Securities Class Actions” (here), John J. Clarke Jr. and Keara M. Gordon of the DLA Piper law firm suggest that as U.S. courts “more carefully define the limits” of subject matter jurisdiction for securities lawsuits brought by foreign investors, “a growing list of nations in Europe and elsewhere are adopting procedures akin to American-style class actions.”

The authors find that the recent case law trend suggests “some reluctance by U.S. federal courts to assert jurisdiction over claims of securities fraud” brought by or on behalf of foreign investors who bought their shares in foreign-domiciled companies on foreign exchanges (so-called “f-cubed” litigants, about whom I have previously written here and here). At the same time, the authors note, “a number of nations have adopted procedural mechanisms similar to U.S. class actions in several respects.” The authors specifically examine developments in Australia, Canada, England and Wales, Germany and The Netherlands.

Second, an April 25, 2008 article by Sandeep Savla of Dewey & LeBoeuf entitled “Securities Class Actions in London” (here) suggests that “companies listed on a London exchange must prepare for a wave of securities lawsuits that will increasingly be instituted in England.” Savla cites three reasons why he predicts increasing numbers of English securities lawsuits:

1. A recent English judicial decision in which the court held that a third-party could buy a litigation claim, continue to pursue and fund the litigation and retain any damages awarded. Savla suggest that this decision will incent hedge funds and others to buy and sell securities claims and then litigate the cases for a profit.

2. Apart from acquiring an entire claim, third-parties can now, as a result of other English case law developments, fund litigation in exchange for an opportunity to share in litigation proceeds. Savla believes that private equity firms, hedge funds and other financial firms will be interested in funding litigation in exchange for a large cut of the damages, and that the availability of this funding will remove some of the litigation disincentives of the English “loser pays” attorneys’ fee principles.

3. New statutory liability of misstatements and enhanced rights to bring derivative claims under the Companies Act of 2006 will, Savla asserts, “spur class actions and derivative suits.”

Third, the recent subprime and credit-related crisis may provide an important impetus to these developments. A May 21, 2008 post (here) on the Pom Talk blog (which is published by the plaintiffs’ firm of Pomerantz Hudek Block Grossman & Gross) notes that “several large European banks have been hit with considerable losses stemming from their exposure to U.S. debt,” and these banks “will likely face intense regulatory scrutiny and a wave of litigation.” Many of these suits may wind up in courts outside the U.S. – “if a U.S. court bars foreign investors from suing here, their only recourse would be to sue the banks on their home turf.”

Notwithstanding the traditional reluctance of many countries’ courts to support this type of litigation, “the severity of the subprime impact and resultant losses could prompt otherwise hesitant investors to take action.”

Clearly, a key component of the developments outside the U.S. is the question whether or not the U.S. courts will or will not exercise subject matter jurisdiction over these claims involving foreign investors. A scholarly overview of the U.S. jurisdictional issues can be found in an article in the Winter 2008 issue of the New York International Law Review entitled “Ebb and Flow: The Changing Jurisdictional Tide of Global Litigation” (here).

The article, written by Perry Granof of Chubb and Richard Hans, Samaa Haridi and Jennifer Kozar of Thacher, Profitt and Wood, examines the extend to which “defendants are increasingly seeking to avoid securities class action litigation in the United States – employing both jurisdictional and forum non conveniens arguments.” At the same time, the authors note, “several courts have expressed concern that too restrictive an approach may render U.S. courts ineffective in addressing fraud in an increasingly global securities market.”

Auction Rate Securities Lawsuit Notes: In a recent post (here), I raised questions about the flood of auction rate securities class action lawsuits that have been coming in since mid-March. (My current tally of companies named as defendants in auction rate securities lawsuits, which may be accessed here, now stands at 17.) A May 27, 2008 Bloomberg article entitled “Auction Failure Damages Face Burden of Proof Eluding Lawyers” (here) raises the possibility that the lawyers filing these lawsuits “may be unable to prove their clients lost money or collect fees themselves.”

Among other things, the Bloomberg article quotes a former SEC attorney as saying, with respect to the penalty interest rates that many of the auction rate securities are now paying, “I don’t see how you can get around the fact that, for the most part, the investors are now doing better.” To be sure, investors’ biggest grievance is not the interest rate but the fact that they can’t sell the instruments right now, about which the article quote Columbia Law School Professor John Coffee as saying “I don’t know that you can easily measure liquidity.”

A separate issue pertaining to auction rate securities is how the instruments are to be valued for balance sheet purposes in the absence of a viable marketplace to trade the securities. As I recently noted (here), this problem afflicts a number of publicly traded companies, included quite a few companies entirely outside the financial sector.

A May 27, 2008 Wall Street Journal article entitled “Auction-Rate Securities Give Firms Grief” (here) reports that “hundreds of U.S. companies still are struggling to clean up the problems caused by the auction-rate securities.” The article reports that over 400 companies hold instruments originally valued at over $30 billion, and that “while some companies have written down the value of their auction-rate holdings, many others haven’t, even though market prices have fallen substantially.”  

Hat tip to the WSJ.com Law Blog (here) for the link to the Bloomberg article.

Updating the Options Backdating Lawsuit Count: As a result of a recent post (here) about options backdating settlements, I have had extensive communications with several individuals at NERA Economic Consulting about the total number of options backdating-related securities class action lawsuits. Based on the information NERA provided, I am revising my count of options backdating-related securities class action lawsuits from 36 to 38, by adding to the list Cyberonics (amended complaint here) and The Children’s Place Retail Stores (complaint here).

The revised list of all options backdating related lawsuits can be found here.

Special thanks to Svetlana Starykh and her colleagues at NERA for their friendly and helpful communication on this topic.

 Speak Not, Memory: A May 21, 2008 article in the Cleveland Plain Dealer entitled “Beachwood Man Reports Rate Ability Not to Forget” (here) describes a Beachwood, Ohio resident with a very rare and perhaps enviable talent. (Coincidentally, Beachwood is also the location of The D&O Diary’s intergalactic headquarters.) The article reports that:

Give Rick Baron a date, any date on the calendar, and neurons start firing. He leans his head back and flips through a mental calendar. Then, in an instant, the recollections spurt out.

It's not just that Baron remembers. He says he can't forget.

Dates and details sear into his mind with amazing clarity, so much so that he's being studied by researchers at the University of California-Irvine. He's one of only three people identified so far with such phenomenal autobiographical memory.

Seemingly trivial details from his life -- such as sitting for his sixth-grade picture (Oct. 10, 1968) or going on a date to Euclid's Lakeshore Cinema to catch the forgettable movie "Problem Child" (Sept. 5, 1990) -- easily flow from memory to mouth.

He delights in recalling historical events with near-encyclopedic precision. He says he remembers anything he reads, hears or sees. "Try me," he says. "Ask me anything."

When was Johnny Carson's last show? ("An easy one -- May 22, 1992.") When did militants seize the U.S. Embassy in Iran? ("You playing with me? Nov. 4, 1979.") When did former Cleveland Indian Duane Kuiper hit his only career home run? ("Aug. 29, 1977, off Steve Stone.")

"I don't dwell on the past," said Baron, 50. "It's just there."

Always.

At first impression, Mr. Baron, with his vast and perfect memory, seems like a truly enviable person. The frustrations of an unreliable memory are a fact of life for many of us, and are a reality that only becomes more insistent with age. The inconvenience of an occasional memory lapse usually sparks regret that we cannot remember more. Imagine how convenient it would be if we could now recall our college calculus as well as we knew it then, or we could recite procedural rules as precisely as we learned them for the bar exam.

The simple truth is that, for most of us at least, our brains are not wired to remember everything, and life would be immeasurably more difficult if we did.

In his short story, “Funes the Memorius,” Jorge Luis Borges explores these fundamental attributes of memory. In Borges’ story, Funes loses consciousness after falling from a horse. After recovering, he couldn’t forget anything he had seen or heard.

He remembered the shape of the clouds in the south at dawn on the 30th of April of 1882, and he could compare them in his recollection with the marbled grain in the design of a leather-bound book which he had seen only once…He could remember all his dreams, all his fancies. Two or three times he has reconstructed an entire day. He told me: I have more memories in myself alone than all men have had since the world was a world.

But this fabulous talent was not in the end an advantage for Funes; it was paralyzing:

I suspect that he was not very capable of thought. To think is to forget a difference, to generalize, to abstract. In the overly replete world of Funes, there were nothing but details, continuous details.

Indeed, the Plain Dealer article about Mr. Baron suggests some of the problems that a perfect memory might involve. The article reports that:

One of the others with the ability - a California woman named Jill Price, who recently released a book titled "The Woman Who Can't Forget" - described it as paralyzing. She likened her memories to home movies playing nonstop in her head.

Baron bristles at Price's portrayal of what he calls a gift. However, he acknowledged feeling like "an oddball" given his unusual talent.

He also described his days as "empty."

Our memories must be selective in order for us to be able to function. Our brains must sort and sift, to clear away until only what remains is that which matters. Imagine a marriage where your spouse remembered with clarity your every frailty and shortcoming. Or how hard it would be if you couldn’t put setbacks and defeats behind you, but had to remember them, eternally and perfectly. We forget our college calculus, and even the name of that girl across the classroom whose eye caught yours for that sweet and blessed instant so long ago, because we have to move on.

The process of forgetting is a kind of refinement, a distillation of the essence, that permits us to see our lives not as a crazy quilt of sights and sounds, but as a progression that has a more general meaning and purpose. If we saw all at once, we could not see the center.

And the most important thing about memory, the thing we must never forget, is …um…

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The growing importance of global anticorruption enforcement efforts was underscored this past week by the revelation of a cross-border investigation involving the French industrial giant Alstom and by developments in the continuing investigation involving Siemens. Moreover, the Siemens developments highlight the increasing significance of liabilities arising from anticorruption exposures for the D&O insurance industry.

First, in a May 6, 2008 article entitled “French Firm Scrutinized in Global Bribe Probe” (here), the Wall Street Journal reported that French and Swiss authorities are investigating whether officials acting on behalf of Alstom paid hundreds of millions of dollars between 1995 and 2003 to win contracts in Brazil, Venezuela, Singapore and Indonesia.

Then on May 9, 2008, German prosecutors announced that they will pursue a civil enforcement action against former Siemens chairman Heinrich von Pierer and several other (unnamed) former Siemens board members. (Refer here for background regarding the Siemens investigation). von Pierer served as Siemens’ chief executive from 1992 to 2005, and as its Chairman until April 2007. Prosecutors apparently have elected for the time at least not to pursue criminal charges against von Pierer.

According to a May 10, 2008 Wall Street Journal article (here), the company itself has also said that “it may seek financial compensation from former managers but didn’t name individuals.”

According to the Journal article about the Alstom investigation, the Alstom and Siemens investigations “suggest that Europe’s prosecutors have begun taking a tougher line on business practices that their U.S. counterparts have long treated as criminal.” It is not merely coincidental that these investigations are now emerging; they are in fact an outgrowth of relatively recent changes in the laws of both Germany and France.

For many years, under the laws of the two countries, corrupt payments were not only legal, but the amount of the payments were tax deductible. But both countries are signatories to the OECD Convention on Combating Bribery of Foreign Officials in International Business Transactions. To implement the Convention, in 1999 Germany passed the German International Bribery Act. According to the Journal, “France outlawed bribery of foreign officials in July 2000.”

Both companies seem to have had difficulties adapting to the new legal prohibitions, as the conduct under investigation both preceded and followed the enactment of the new laws.

One particularly interesting aspect of the Alstom investigation is the way that the circumstances under review came to light. The investigation apparently arose as a result of an audit commissioned by the Swiss Federal Banking Commission of Tempus Privatbank AG, a small private bank. The audit uncovered documents concerning Alstom-related transactions that detailed the flow of about 20 million euros from Alstom to shell companies in Switzerland and Lichtenstein.

These investigations underscore the growing significance of cross-border anticorruption actions and highlight the fact that anticorruption efforts are no longer just a U.S. priority. Moreover, the potential exposures and liabilities are enormous. Siemens itself has already paid a fine of 201 mm euros.

There are also important implications arising from Siemens’ suggestion that it may pursue claims against its former managers. According to a May 5, 2008 Business Insurance article entitled “German Insurers Brace for Siemens Claim” (here), the company has notified its D&O insurers that it intends to file a claim under its D&O policies relating to the company’s antibribery related exposures. The article reports that the company carries D&O limits of 250 million euros. The article does not detail the specifics of the insurance claim or the matters for which the company claims or intends to claim coverage, so there is no way to assess the likelihood of the company’s eventual recovery under the policies.

It is far from certain that the company’s policies would actually cover the claimed amounts. But to the extent the policy’s limit is exhausted by the claims for coverage, it could, at least according to the Business Insurance article, have a substantial impact on the German market for D&O insurance.

The potential insurance implications from the developments in the Siemens investigation demonstrate the growing significance for the D&O insurance industry of the liabilities arising from anticorruption enforcement activity. As investigations like those involving Alstom and Siemens emerge and develop, and as litigation like that involving Alcoa (about which refer here) continues to arise, these issues necessarily will become a significant priority for companies and for D&O insurers. As I have previously suggested (here), anticorruption violations may well represent the “next corporate scandal.”

The May 9, 2008 Financial Times has an interesting editorial about the Alstom investigation and the expansion of anticorruption efforts, here.

Speakers’ Corner: On May 14, 2008, I will be speaking at the American Conference Institute’s D&O Liability Insurance Conference (refer to the agenda, here). I will be participating on a panel with my good friend Dan Bailey in a session entitled “Emerging Exposures Roundup: Fiduciary Litigation, Global Warming and More.”

Then on May 15, 2008, I will be in Toronto to participate in the Professional Liability Underwriting Society (PLUS) Canadian Chapter’s educational event regarding the subprime crisis. Information about the Toronto event can be found here. The other panelists include Dr. Arturo Cifuentes of R.W. Pressprich & Co., Denis Durand of Jarislowski Fraser, and Robert Murray of Chubb.

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The parties in the SCOR Holding (Switzerland) AG class action securities litigation seem to have devised a “global” settlement strategy to resolve the problems arising from the cross-border distribution of would-be class members.

First, some background. The lawsuit relates to alleged misrepresentations and omissions purportedly made by SCOR Holding’s predecessor in interest, Converium. Converium was domiciled outside the U.S .Its shares traded on the Swiss stock exchange, and its American Depositary Shares (ADS) traded on the NYSE.

In a March 6, 2008 order (here) in the SCOR Holding securities lawsuit, Judge Denise Cote had partially granted and partially denied the motion for class certification, as a result of which she certified a class consisting of U.S residents who had purchased Converium shares on the Swiss exchange, and any person who purchased Converium ADS’s on the NYSE. Excluded from the class were Non-U.S. residents who purchased Converium shares on the Swiss exchange.

The persons excluded from the class represent so-called “f-cubed” litigants – that is foreign shareholders of a foreign-domiciled company bought their shares on foreign exchanges. As I have discussed in prior posts (most recently here), courts have struggled with their response to the presence of  “f-cubed” litigants, which can involve complicated issues at the lead plaintiff stage (refer here) and at the motion to dismiss stage (refer here), as well as at the class certification stage, as the SCOR Holding case demonstrates.

But as Adam Savett noted here in a post on his Securities Litigation Watch blog (here) discussing the SCOR Holding class certification decision, the exclusion of the “f-cubed litigants” does raise the problem of how those erstwhile class members can seek compensation for their alleged injuries. As Savett discussed in a prior post on his blog (here), one possibility is that the excluded class members might launch a host of individual lawsuits, as Savett shows to be what happened in the Vivendi case.

The litigants in the SCOR Holdings case seem to have adopted a two-pronged approach to try to head the castoff foreign litigant problem off at the pass, in a settlement that might truly be described as “global.” At least, that certainly appears to the parties’ intent.

As discussed in a May 7, 2008 press release from the SCOR parent company (here), the SCOR Holding securities litigation has been settled through a two-part process. As stated in the press release, “SCOR reached an agreement to settle the claims of the certified class before the US court and the claims of non-US purchasers of Converium securities in a proceeding in the Netherlands for an aggregate amount of EUR 74 million (pre tax and before D&O recoveries).” A May 7, 2008 Business Insurance article describing the settlement can be found here. (74 mm euros is roughly $114.5 mm).

The description of the two-part settlement does not explain what portion of the aggregate total of 74 mm euros was allocable to which portion of the two separate proceedings. Nor does the press release elaborate on the Netherlands proceeding. Presumably the proceeding is similar to that employed in the much-discussed Royal Dutch Shell settlement. For detailed background on the $352.6 mm Royal Dutch Shell settlement, refer to the With Vigour and Zeal blog here and here.

The SCOR Holding litigants certainly deserve points for a creative way of avoiding the problems that arose in the Vivendi litigation with the proliferation of individual actions. They also seem to have come up with an alternative way of addressing the concerns of excluded class members desirous of obtaining relief of the kind available to U.S. resident investors.

The parties’ resort to the Netherlands proceeding does raise a number of interesting questions. One of these questions first arose at the time of the Royal Dutch Shell settlement, which is whether other litigants might try to avail themselves of the Netherlands procedures. The SCOR Holding settlement suggests that the answer is yes, and that the Netherlands procedures potentially could become an avenue for non-U.S. litigants to seek redress. Whether these procedures would be utilized without a prior U.S. based lawsuit still remains to be seen.

Another question is whether other litigants will seek to use the Netherlands procedures as part of a similar two-pronged strategy to try to achieve a settlement that resolves both U.S. and Non-U.S. investors’ claims. The extent to which the SCOR Holding settlement truly is successful in effecting a “global” settlement will clearly have some impact on whether other litigants might try to same approach. The limited information available at this point does not reveal on whose behalf the Netherlands procedure was going forward and how comprehensive the Netherlands settlement will be towards resolving all of the non-U.S. investors’ claims. To the extent the SCOR Holdings litigants’ two-pronged settlement achieves global peace, the settlement could well attract the interest and attention of litigants in other proceedings that also involve non-U.S. investors.

One final attraction of the approach employed in the SCOR Holdings settlement (and I suspect this attraction had something to do with how the approach came about) is that the two-pronged settlement enabled the plaintiffs’ counsel to corral together a larger group of aggrieved investors, which clearly would have some appeal to plaintiffs’ counsel who would not wish to litigants’ interests excluded or straying away into unrelated processes that would diminish the aggregate size of the investor interests on whose behalf the counsel can try to negotiate an aggregate settlement.

Auction Rate Securities Overview: Readers interested in a thorough background regarding auction rate securities and the events that triggered the current round of auction rate securities litigation will want to review the May 6, 2008 publication by NERA Economic Consulting entitled “Auction- Rate Securities: Bidder’s Remorse?”

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As various blue-ribbon committees have struggled with the competitiveness of the U.S. securities exchanges in the global financial marketplace (about which refer here and here), one issue on which they have focused is the aversion overseas companies may have for the U.S. litigation system. But while overseas companies may seek to avoid U.S.-style litigation, overseas investors seem eager to join in the fray. The most recent example involved the securities class action lawsuit against U.K.-based GlaxoSmithKline, in which on October 5, 2007, the court appointed (here) a U.K. pension fund to act as lead plaintiff.

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It is nothing new for corporate America to have to contend with activist investors. But an activist international institutional investor, backed by a sovereign nation and burgeoning oil wealth and committed to a broadly-based social and environmental agenda, represents a different level of activist pressure. The prototype for this international institutional investor is the Norwegian Government Pension Fund, which collects and invests surplus revenue from the country's petroleum production, and which at $300 billion in asset value represents the largest public pension fund in Europe. The Fund is prohibited from investing in Norway, so instead it owns what amounts to a considerable slice of the world.

The Norwegian Fund's impact is not merely financial. The Fund operates according to "ethical" investment principles, pursuant to which the Fund has divested ownership in companies that the Fund's Advisory Council on Ethics believes are involved in certain kinds of weapons production, environmental damage and human rights violations. The most prominent example of its divestitures for ethical reasons was its high profile divestiture of its $400 million investment in Wal-Mart because of alleged child labor law violations by WalMart suppliers (refer here).

A May 4, 2007 New York Times article entitled in the print edition "Norway Backs Its Ethics With Its Cash" (here) discusses the Fund's ethical investing practices and their impact. The article quotes the Norwegian Finance Minister, Kristin Halvorsen, as saying "In a global economy, ownership of companies is the most important way to have influence." As many as 21 companies (so far) have felt this Norwegian "influence," twelve of them American.

Nor is the Fund's activist impact restricted to its investment activities. Norges Bank, the division of the Norwegian Central Bank responsible for managing the Fund's investments, has made its presence felt as a securities fraud lawsuit litigant. For example, Norges Bank was one of the prominent litigants that chose to opt-out of the Time Warner class action settlement (here). Norges Bank was also a major participant in the recent historic Royal Dutch Shell investor settlement (here).

The most prominent institutional investor activist in the U.S. has arguably been the California Public Employee Retirement System (Calpers), which with current investement assets of about $244 billion is actually smaller than the Norwegian Fund. Moreover, because Norway is the world's No. 3 oil exporter (behind Saudi Arabia and Russia), Norway's Fund will grow substantially in the years ahead. The Times article estimates that at the rate at which it is growing, the Fund could be worth $800 billion to $900 billion in a decade. With the Fund's growing size and activist agenda, its impact could be enormous, particularly given the Fund's apparent willingness to resort to litigation.

The Fund's growth will provide it with the powerful tools to drive its agenda. As a result, companies could face growing pressure to provide compliance and disclosure on a broad range of social and environmental issues. Readers of The D & O Diary will recall my recent post (here) on the growing importance of climate change disclosure; the Times article reports that the Norwegian Fund's next area of scrutiny will be companies that contribute to global warming. (There is of course some irony in a country which has grown wealthy from oil production presuming to lecture the rest of the world about global warming.)

The upshot is that public companies could face growing pressure on environmental and social issues, from the Norwegian Fund as well as other investors that follow their lead. Traditional notions of "good corporate governance" will necessarily evolve to adapt to these circumstances. These evolving issues represent risks that may not be apparent on companies' financial statements. Companies will face changing levels of reputational risk and even political risk as part of this evolving global investment dynamic. It will be increasingly important for companies to have tools to measure and control their exposure to these developing concerns, as well as to provide adequate disclosure of these issues to their shareholders.

Cross-Border Prosecutorial Collaboration: Along with the globalization of political and social issues, the increasing global collaboration of national regulatory and investigative personnel also represents a new and growing risk to companies in the global economy. The high-profile collaboration of a multinational investigative force in the Siemens bribery investigation (here) is a recent prominent example. Another example is illustrated in a May 4, 2007 Wall Street Journal article entitled "Cartel Arrests in U.S. Bolster Europe Probe" (here, subscription required).

According to the Journal, executives from companies in Italy, France, the United Kingdom and Japan were arrested in the U.S. this past week for their role in an alleged international cartel to fix prices for industrial hoses used in oil transportation. The arrests reportedly were "the result of a joint U.S. investigation with the European Union and U.K. agencies under a program of trans-Atlantic cooperation against bid rigging." The stumbling block for EU enforcement of its anti-cartel laws has been the lack of any personal liability for cartel participants under EU law. These limitations have restricted EU authorities' ability to pursue cartel activities. The enlistment of American authorities in the anti-cartel efforts circumvents these EU limitations by exposing individuals to personal liability under tougher American anti-cartel laws.

While these developments are perhaps socially desirable for their ability to punish and deter anticompetitive activity, the developments also carry some disturbing implications for officials at companies engaged in the global economy. Executives could face the threat of prosecution not only under the laws of their own country but under the laws of many other countries. The willingness of the U.S. to enforce its antibribery laws against foreign companies whose shares or ADRs trade on U.S. exchanges is another example of this extraterritorial impact of domestic laws. The result of this globalization of criminal enforcement could be a dramatic expansion of corporate executives' risk exposure.

Not only does this evolving globalization of criminal enforcement create a new category of risk management challenges, but it could create new challenges for the structure of the companies' D & O insurance program. Certainly, companies engaged in the global economy will want to understand their policy's potential protection for foreign investigations and proceedings, as well as the policy's protection for criminal processes such as extradition.

Be Here Now: As scientists and commentators have struggled to prefigure a future world beset with the consequences of global climate change, they have projected a litany of grave impacts: coastal erosion and subsidence from rising sea levels; extreme weather events; unprecedented economic impacts; and a deteriorating health environment.

Readers skeptical of these scenarios will want to consider these stories appearing in newspapers just this week alone: the seacoast of East Anglia in the U.K. is sliding into the sea because of rising sea levels (here); Australia's six year drought is now so serious that the country must restrict crop irrigation, while politicians struggle to respond (here); Germany will no longer apply seasonal adjustment to its unemployment statistics because the increasingly mild winters have a diminished employment impact (here); and the global incidence of asthma and hay fever has escalated as a result of the proliferation of allergens due to warming conditions (here).

After I wrote my post a few weeks ago about global climate change and D & O risk (here), I received some very skeptical and even derisive reactions. But the reality is that global climate change is not some distant theoretical construct. Its impacts are already being felt throughout the world. The answer to the question whether or not this will affect the risk profile of publicly traded companies is simply a reflection of the way you frame the issue. You can, as I think is the proper approach, regard global climate change as a separate category of risk to be analyzed as such. Or you can simply look at it as imbedded within numerous other risk categories, such as commodities pricing risk, political risk, and currency risk, as well as what insurers call parameter risk (the risk of events different than those that have occured in the past). Whether viewed separately or as a part of the overall panoply of corporate risk, global climate change will be an increasingly important part of the risk landscape that companies face. The influence of activist investors like the Norwegian Fund suggests that companies disregard these risks at their peril.

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On April 11, 2007, Royal Dutch Shell announced (here) that it had agreed to pay $352.6 million to non-U.S. investors who bought Shell shares outside the U.S., in connection with the company's 2004 oil resources accounting scandal. According to the Times (London), here, the agreement is "thought to represent the largest ever class action settlement in Europe." The agreement is subject to the approval of the Amsterdam Court of Appeals as we as to "agreed opt-out provisions."

Shell also announced that it will be seeking a proportional settlement in the U.S. class action proceeding. According to Bloomberg (here), the European settlement is "contingent on a U.S. judge's ruling not to include claims by non-U.S. investors within the existing class action claim."

Legal counsel for the European shareholder is New York-based Grant & Eisenhofer and the Dutch law firm Pels Rijcken & Drooglever Foruijn .

CFO.com has further information about the settlement, here.

Would-be reformers of U.S. securities regulation, who routinely cite U.S. litigiousness as the justification for proposed reform, should note that this is a European settlement on behalf of European investors (from multiple countries) proceeding in a European court. I have long contended (most recently here) that differences in regulatory and even litigation regimes in advanced economies may well diminish over time, and, in particular, that investors overseas will increasingly seek legal means in local courts to obtain compensation for corporate misconduct. The Shell settlement is the most recent, and perhaps the most vivid, example of these phenomena.

The With Vigour and Zeal blog has interesting and important background on this settlement here as well as links to key resource documents and materials regarding the settlement here. The Best in Class blog also has an interesting post on the settlement here.

A Different Look at Backdating Luck: A central tenet of the backdating scandal has been the supposedly lucky timing of many of the questioned stock option grants (see my earlier post on Lucky Options grants here). A recent paper by NERA Economic Consulting entitled "Options Backdating: The Statistics of Luck" (here) takes a closer look at what role luck or chance might actually have played in many of the questioned option grants, and reaches the somewhat contrarian conclusion that "some of the grant patterns that at first appear extremely unlikely are actually likely and should be expected."

The study finds that just as there are companies that granted options on very favorable days, there are companies that granted on very unfavorable days. The article specifically states that the calculations presented in the Wall Street Journal articles that launched the backdating scandal "can be misleading," and in particular "overstate the number of D & O that have been very lucky."

Hat tip to Kelly Reyher for the link to the NERA article.

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In a recent post (here), I noted that the cross-border Siemens bribery investigation shows that regulators throughout the world increasingly recognize the importance of vigilance and scrutiny, and that the extent of alleged misconduct in that case could spur further efforts for oversight and reform. In that same vein, a February 15, 2007 New York Times article entitled "Germany Battling Rising Tide of Corporate Corruption" (here) notes with respect to the Siemens case and other investigations that "the current spate of scandals will prompt a serious, systemic effort by German companies to impose more stringent internal controls and systems of legal compliance to stop corruption from happening in the first place."

Whether the current wave of German corruption cases reflects lax legal compliance or simply more aggressive prosecution, it is clear that the number of cases is increasing. Germany did not have laws allowing prosecutors to bring bribery cases until 1997, by contrast to the United States, which has had the Foreign Corrupt Practices Act for over 30 years. One source quoted in the article says that in the last five years, "the notion that we need to prosecute economic criminality took on an entirely new dynamic."

This new dynamic clearly will influence both prosecutorial priorities, and by extension, expectations of corporate compliance. As I have previously noted (here), as these regulatory efforts elsewhere gain traction, differences in regulatory standards between the U.S. and other countries will diminish - a consideration that is clearly relevant to the current calls for regulatory reform in the U.S.

Ready, Fire, AIM: In prior posts, I have raised concerns (most recently here) about regulatory standards for London's Alternative Investment Market (AIM), and more recently (here) I have suggested that the AIM may be facing increasing pressure to tighten up. In a February 12, 2007 article in The Times (London) entitled "Most AIM Fundraisers Fail to Enrich Backers Over Three Years" (here) takes a look at the 802 companies that listed on the AIM during the three years ending on December 31, 2006, and finds that 52 percent were "either trading at or below their issue price, or have had their shares suspended."

The Times concludes that the "findings are likely to fuel criticism of AIM that, although it has been the most successful growth market in terms of new listings, it has often sacrificed quality for quantity."

Whatever conclusions may be drawn from the data about the quality of AIM listed companies, the fact that over half of the last three years' listings have failed to make money for investors does have important implications for the likelihood of the past level of listings to continue in the future. This is just one more example of the reasons why current global marketplace circumstances may well change for their own reasons, without any of the regulatory revisions for which the would-be reformers in the U.S. are clamoring.

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When the Committee on Capital Markets Regulation (popularly known as the Paulson Committee) in its Interim Report (here) recommended "setting a cap on auditor liability," the Committee relied for support on the steps in that direction that have been taken by the European Commission. In its latest effort along those lines, the European Commission on January 18, 2007 launched a "public consultation on whether there is a need to reform the rules on auditor liability in the EU." A copy of the Commission's press release can be found here. A copy of the Staff Working Paper can be found here.

In the Working Paper, the Commission's staff offered four alternative proposals to cap the liability accounting firms potentially face when auditing public companies. (The Commission is asking for comment on the four proposals by March 15, 2007.) The four proposals are: a fixed monetary cap on damages that could be sought from auditors; a cap based on the audited company's market capitalization; a cap based on a multiple of the audit fees charged; or the introduction of proportionate liability , which would hold the auditor responsible only for the damages that could be specifically attributed to them.

The initiative to afford accountants some form of liability protection is being led by Charlie McCreevy, the European Commissioner for Internal Market and Services. The initiative would potentially extend protections across the EU's 27 member countries, although the member countries would not be required to enact them. However, the Working Paper notes that "auditor's liability is currently capped in five Member States (Austria, Belgium, Germany, Greece and Slovenia)."

The Commission's motivation for exploring auditor liability caps is essentially the same as that noted by the Paulson Committee in its Interim Report. That is, the Commission is concerned that as the number of audit firms capable of auditing the largest companies has dwindled down to four, the potential consequences from the failure of one of the remaining firms would be harmful to investors. In an October 27, 2006 interview in the Financial Times (here), McCreevy expressed his concern that "further reduction in the number of global firms would make it very hard for companies to get accounts signed off and published - dealing a blow to investors." McCreevy himself advocates a cap on auditor liability.

A January 19, 2007 Wall Street Journal article entitled "EU Offers Plans for Accounting Firms' Audit-Liability Caps" (here, subscription required) suggests that the EU proposals "could help a push by the largest firms for similar protection in the U.S." The article goes on to note that the "adoption of a European auditor-liability shield, even if the member countries weren't required to enact it, would potentially add to a sense that U.S. markets are increasingly at a competitive disadvantage to those in Europe, and, in particular, London."

The competitiveness of the U.S. capital markets will be the theme of a conference that will convened in the spring by Treasury Secretary Henry Paulson. (For a description of the planned conference, announced on January 17, 2007, refer here.) The accounting industry will be one of the three major topics to be discussed at the conference, along with regulation and corporate governance. Robert Steel, the Treasury's undersecretary for domestic finance, in describing the conference's anticipated topics, said that (unnamed) officials are "concerned about the accounting industry," and that the conference will look at whether there are "structural issues" that hurt the industry, such as an "unattractive liability construction." Steel, along with Paulson, recently joined the Treasury Department from Goldman Sachs.

Is the PCAOB Shielding the Big Four?: With the anxiety surrounding the possible investor consequences to investors were another of the Big Four accounting firms to fail, could it be that regulators are treading softly around the "remaining Four?" As The D & O Diary noted in a prior post (here), the Public Company Accounting Oversight Board (PCAOB) does not reveal much about its inspections of the Big Four accounting firms. For example, the PCAOB does not reveal the number of Big Four audits it inspects as part of its annual inspection process, or the percentage of audits inspected that proved to have concerns - even though it releases this information for smaller firms.

A January 18, 2007 post on CFO Blog (here) reports on a recent speech by PCAOB founder and board member Bill Gradison, in which Gradison suggests that the PCAOB considers itself a supervisory body rather than an enforcement agency, and so the agency wants to work with firms to restore "integrity" and even "luster" to the profession. For that reason, the PCAOB prefers to give the audit firms a 12-month grace period to fix problems, rather than to make them public when they happen, since "reputation is so important in a field like auditing."

While I am sure the accounting firm's appreciate this deference to their reputation, investors' interests are definitely forced into the back seat by this ordering of priorities. As my prior post linked above notes, the PCAOB's annual inspection report disclosure leaves a great deal to be desired from the investors' point of view. First and foremost, the PCAOB ought to inform investors what percentage of audits inspected produced inspection concerns. In addition, the PCAOB ought to tell the investing public how many of the audit concerns were material, which audit concerns were material, and what order of magnitude the material concerns represent.

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In my prior comments on the Paulson Committee's calls for regulatory reform (most recently, here), I have suggested that perhaps the U.S. securities markets may be better off without at least some of the companies that are avoiding the U.S. exchanges' tougher listing requirements. A recent report by a U.K. accounting firm contains interesting data that may be pertinent to this question.

BDO Stoy Hayward reports (here) that annual reported instances of fraud in the U.K. rose 33% between 2005 and 2006 and the value of the reported fraud rose almost 40%. (According to the firm's website, the full report will be available in February.) A January 8, 2007 New York Post article reporting on the BDO Stoy Howard study, entitled "Brits Get Bit: Lax British Marts Attract Fraud Along With U.S. Biz" (here), examines whether the increase in London-listed offerings by companies unwilling or unable to meet the U.S. listing requirements explains part of the increase in U.K. fraud. The article notes (as The D & O Diary has previously noted, here) that the London exchanges have "accepted scores of new listings of Chinese and Russian companies that may not have met New York exchanges' stricter rules." The article quotes the head of the BDO Stoy Hayward firm's fraud unit as saying that "I have no doubt that some businesses' plans have been deliberately optimistic, and property, including intellectual property falsely valued."

As Jack Ciesielski notes on the AAO Weblog (here), commenting on the New York Post article linked above, "Investors should be thankful that seedier companies have found the U.S. markets too difficult to easily game because of Section 404." And as I previously have noted (here and here), lowering standards to attract weaker companies is not a sustainable advantage. The valuation premium that companies listing on U.S. exchanges enjoy - because of the stricter regulatory environment - is a real and sustainable advantage.

UPDATE: The With Vigour and Zeal blog (here) adds an important additional perspective on this post. The WVZ blog does concede that the BDO Stoy Hayward study may be relevant to the question whether U.S. exchanges are better off without the companies drawn to London by lighter regulation; however, the WVZ blog also emphasizes that the BDO Stoy Hayward study is concerned with a very wide variety of frauds, not all of which involve listed companies. Among other things, the accountants' report is concerned with a species of tax fraud that is peculiar to the U.K. So, the WVZ blog concludeds, it is "therefore not wholly representative to discuss the report's findings in the context of the securities markets" or in connection with the question of the competitiveness of the U.S. securities markets. I don't disagree with the WVZ blog, but simply note that if the accountants' study is not entirely relevant, it is not entirely irrelevant either. Nevertheless, I agree that the WVZ adds an important additional gloss to this post, and for that reason, readers should refer to the WVZ blog for a more complete picture of the implications of the BDO Stoy Hayward report.

Speaking of the London markets, Legalweek.com has a recent article (here) discussing the potential liability of the London Stock Exchange's Alternative Investment Market's Nominated Advisors (or Nomads) in U.S. courts under U.S. securities laws. Hat tip to the With Vigour and Zeal blog (here) for the link to the Legalweek.com article.

Korea Adopts Securities Class Actions: Another cause the Paulson Committee cited as a reason foreign companies may be shunning U.S. exchanges is the U.S. litigation environment. But as I have previously argued (most recently, here), investors in other countries increasingly are demanding (and getting) the right to hold company management accountable in local courts, and as a result the differences between the U.S litigation environment and those of at least some other countries may be diminishing. The most recent example of another country moving toward a U.S. style class action litigation system is Republic of Korea, better known as South Korea.

According to a January 8, 2007 Korea Herald article entitled "Open Season for Securities-Related Class Actions" (here), South Korea adopted the Securities Related Class Action Act of 2005, subject to a "grace period" during which its enforcement was stayed. The grace period expired on December 31, 2006, meaning that companies listed on the South Korean stock exchanges (including the approximately 730 companies listed on the Korea Exchange), face potential securities class action exposure starting in 2007. At least based on the article, the new Korean class action sounds similar to the U.S.-style securities class action lawsuit, post PSLRA. The article's author, a Korean attorney, speculates that as many as 30 of Korea's 1,600 listed companies could face securities class actions annually.

An interesting discussion of the state of corporate governance reform in Korea, including a discussion of the new Act, can be found here.

The D & O Diary notes that one U.S.-listed Korean-based company, Pixelplus, was sued in a securities class action lawsuit in the U.S. (here) during 2006.

More on Short Selling in PIPE Financing Transactions: In a recent post (here), I reported on two recent SEC enforcement actions involving short selling by investment banks or broker dealers in connection with PIPE financing transaction. On January 4, 2007, the SEC filed yet another settled enforcement action (here) involving short selling in connection with a PIPE transaction, alleging alleged that a trader and a hedge fund entered into contracts to purchase shares in a PIPE offering and then sold those shares short. The SEC Actions blog has a detailed and interesting discussion (here) of the new enforcement action, as well as of the SEC's position regaring short selling in connection with PIPE transactions, including current SEC rule making regarding short selling in PIPE transactions.

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According to January 2, 2007 news reports (here and here), DaimlerChrysler AG has reached a settlement with its D & O insurers in connection with the $300 million settlement of the securities class action lawsuit that had been filed against the company.

The securities class action lawsuit was filed in May 2002, relating to the 1998 merger of Daimler Benz and Chrysler that formed the company. The securities lawsuit had alleged that the defendants issued statements assuring the markets that the transaction would be a "merger of equals," when defendants intended to turn Chrysler into a division of the merged company. The lawsuit cited an interview with former DaimlerChrysler Chairman Jurgen Schrempp in which he said that the transaction had been referred to as a merger of equals rather than as a takeover "for psychological reasons" only. In August 2003, the Company agreed to settle the securities lawsuit for $300 million (or about 240 million euros at the then applicable exchange rate). Further information regarding the securities litigation settlement can be found here.

The company sought to have its 200 milllion euros directors' and officers' liability insurance program cover the bulk of the settlement. According to news reports, only AIG agreed to contribute its limit (25 million euros). The eight remaining insurers on the D & O program declined to pay, apparently arguing that Schrempp's comments showed that the misrepresentations were intentional, which led to litigation between the Company and the remaining insurers. (The remaining insurers were led by ACE and are each named in the news reports linked above.)

The lawsuit between the Company and the remaining D & O carriers was scheduled to go to trial on January 9, 2007 (here, in German), but according to the January 2 news reports linked above, the parties reached a settlement pursuant to which the eight carriers reportedly agreed to pay 168 million euros out of the remaining 175 million euros in limits.

According to Reuters (here), the head of ACE's European Operations said that he "hoped the settlement would spark a discussion in Germany about whether Directors' and Officers' liability insurance coverage was too broad."

The settlement of the securities class action lawsuits was unrelated to the separate but similar individual lawsuit brought by Tracinda Corporation (owned by Kirk Kirkorian) in Delaware federal court. Tracinda claimed that defendants' statements that the transaction was a "merger of equals" had deprived it of a merger premium for its Chrysler shares. The Tracinda lawsuit went to a bench trial between December 2003 and February 2004, and in April 2005, the court entered judgment in the defendants' favor, rejecting Tracinda's arguments. Tracinda's appeal to the Third Circuit remains pending. (Details regarding the Tracinda action can be found here and here.)

In 2004, a separate action was also filed in Delaware federal court on behalf of current of former DaimlerChrysler shareholders who are neither citizens or residents of the United States and who acquired their DaimlerChrysler shares through a foreign stock exchange. The district court dismissed the complaint in January 2006. The plaintiffs' appeal to the Third Circuit remains pending.

In addition, in 1999, former shareholders of Daimler Benz instituted a valuation proceeding against the merged company in Stuttgart district courts. The shareholders claimed that the exchange ratio used in the merger did not properly value their shares. An expert commissioned by the court issued a December 2005 report calculating a range of alternative values for the shares, and in August 2006, the court, in reliance on the expert's report, ruled that the company must pay the shareholders additional compensation which amounted in the aggregate to about 232 million euros. The company continues to contend that the original ratio used was appropriate. Details regarding the Stuttgart valuation action can be found in DaimlerChrysler's annual report, here (refer to pages 182 through 186).

Special thanks to the new With Vigor and Zeal blog (here) for the links to the news reports and other sources regarding the D & O insurance settlement.

An interesting Tuck School of Business at Dartmouth case study about the DaimlerChrysler merger, including an examination of the reasons why the merger failed, may be found here.

An excerpt from Taken for a Ride: How Daimler-Benz Drove Off With Chrysler, the book length examination of the merger, can be found here. The excerpt contains the following memorable description of Schrempp's departure from the first meeting between the managers of the two companies:

Schrempp and the group bellowed song after song until the wee hours. The German co-chairman led one final chorus of ''Bye, Bye, Miss American Pie.'' Then, with a wild gleam in his eye, Schrempp grabbed his ever-present assistant, Lydia Deininger, picked her up, and threw her over his shoulder. The room exploded in laughter as Schrempp snatched a bottle of champagne in his free hand, raised it in the air, and yelled out with a grin: ''See you later, boys!'' Then he carried her off, not to be seen for the rest of the night.

 

More Last Words on Skilling's Sentencing: We here at The D & O Diary would have thought that the last word on Jeffrey Skilling's sentencing had already been written, but a January 1, 2007 post on The New Yorker's website (here) by Malcolm Gladwell (author of Blink and The Tipping Point) sets out a dramatic retelling of the sentencing hearing, including Skilling's lawyer's unsuccessful attempt to have the sentence reduced 10 months so that Skilling could serve his sentence at a lower security facility. An interesting short commentary on the New Yorker column appears on Dealbreaker.com, here. The D & O Diary's prior comments on the Skilling sentencing can be found here.

The Art of Conversation: The current issue of The Economist magazine includes an examination on the dying art of conversation. The article (here, subscription required) warrants reading in full, but here is a selected sample:

The more modern the manual of conversation, the more concrete its advice is likely to be. Ms Shepherd offers seven quick ways to tell if you are boring your listeners, which include: "Never speak uninterrupted for more than four minutes at a time" and "If you are the only person who still has a plate full of food, stop talking." Her checklist of things best not said to the parent of a newborn baby should be memorised for future use. It comprises: "What's wrong with his nose?" "Should he be that colour?" "Isn't he awfully small?" "Shouldn't you be breast-feeding?" "Did you want a boy?" "Is he a good baby?" "He looks like Churchill!/She looks like ET!" "It's really cute!"

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Among the reasons behind the recent calls for regulatory reform, including the Paulson Committee's Interim Report (here), is the belief that foreign companies are declining to list their shares on U.S. exchanges because of the burdens of U.S class action securities litigation. While the U.S. propensity for litigation may be deter some foreign companies from listing in the U.S. now, it should also be noted that international investors increasingly are demanding management accountability, and increasingly are seeking redress in courts - both in the U.S. and in their own countries.

A December 5, 2006 Law.Com article entitled "A Wary Europe Moves a Step Closer to Class Actions" (here), examines the apparent trend for European countries to permit the consolidations of related claims in a single action. According to the article, England, Spain, Germany and the Netherlands have already adopted "some form of class litigation." A draft bill is before the French legislature to permit collective consumer litigation (as previously discussed on the D & O Diary, here), and the Irish, Italian and Finnish governments are considering legislation to permit collective litigation by multiple parties. Norway and Denmark are also considering the adoption of an opt-in class action procedure.

The new German collective-action procedure is examined in a December 2, 2006 New York Times article entitled "Collective Shareholder Lawsuits Reach European Courts" (here). The Times article takes a look at the action now pending under the new procedure against DaimlerChrysler. Interestingly, the plaintiff shareholder group includes investors from the U.S. According to the article, other companies that have also been sued under the new procedure include Deutsche Telecom and the aircraft maker European Aeronautics Defense & Space.

While these new procedures permit collective action in a single lawsuit, the actions lack many of the attributes of U.S. style class action litigation. In most jurisdictions, pre-trial discovery is unavailable or severely limited; the loser pays both sides' legal fees; and punitive damages are barred. As the Times article notes, a few cases "do not mean that the Continent is poised for a flood of litigation."

On the other hand, these new procedures represent a growing legislative recognition that investors are entitled to judicial means to compel accountability from corporate management. As The D & O Diary noted (here), the U.K. recently adopted new legislation that expanded shareholders' rights to pursue derivative lawsuits against corporate officials. And as the Times article noted, "the trend toward a greater number of collective lawsuits will not be reserved soon." The article quotes a Dutch lawyer as saying "the laws are changing and so are the attitudes." It might be more accurate to say that the changed laws reflect a changed attitude.

European investors are also showing an increased interest in becoming more involved in shareholder litigation in the U.S. As detailed in a December 4, 2006 post on the ISS Corporate Governance Blog entitled "Europeans Take a More Active Role in U.S. Cases" (here), European investors (particularly public pension funds) are seeking to serve as lead counsel in U.S. securities fraud class actions. Among other cases, European pension funds are serving as lead plaintiffs in the cases against Parmalat. European and other international investors are also leading U.S. based derivative litigation and are seeking U.S governance changes.

U.S. based plaintiffs' lawyers understand their opportunity and have begun what plaintiffs' lawyer Adam Savett at the Lies, Damned Lies blog has called an "arms race"(here) in their efforts to attract international institutional clients. Several U.S. plaintiffs' firms have announced that they are opening European offices or forming partnerships with U.S. firms. The European institutions for their part are interested in assuring that they are maximizing their opportunity to protect their beneficiaries' interests.

International investors clearly are becoming more accustomed to using the courts to compel accountability both in their own countries and in the U.S. These investors are already successfully compelling changes to their legal systems as they press for means to enforce accountability. As procedures evolve and as these investors become more reliant on their own courts to compel corporate accountability, the differences between the systems may diminish. That process already seems to be underway.

Rubles Without A Cause?: Among the primary concerns to which the Paulson Committee's proposed reforms are addressed is the U.S. exchanges' loss of global IPO market share, particularly to the London exchanges. As the Paulson Committee's Interim Report notes, many of the foreign companies listing on the London exchanges are Russian. The Report acknowledges the possibility that many companies from Russia (and elsewhere) may represent "unacceptable risks," but the Report makes no attempt to exclude "unacceptable risks" from their calculation of what U.S. exchanges have "lost."

A December 5, 2006 Wall Street Journal article entitled "British Spy Probe Turns to Émigrés" (here, subscription required) sheds an interesting light on this issue. The article is accompanied by a chart showing how many Russian companies have listed their shares on the London Stock Exchange in recent years. Just the seven deals completed in 2006 alone total 15.23 billion pounds. The article's details about the Russian émigrés' lifestyle are about equal parts amusing and appalling; the article's details about some of the Russian companies whose shares trade in London are basically just appalling:

Earlier this year, in a huge offering, state-controlled Russian oil company OAO Rosneft listed its global depositary receipts on the London Stock Exchange. Underscoring the disputes from Russia that have spilled over into London, the stock offering came about only after lawyers from Russian oil company OAO Yukos failed to stop the listing after claiming that Rosneft's assets came from the unlawful seizures and sales of Yukos.

Wall Street's bankers may well lament the loss of underwriting fees for these kinds of deals to their counterparts in The City, but readers will decide for themselves how sorry we should be that the stringency of U.S. regulations discourages companies of this type from listing on U.S. exchanges. The D & O Diary wonders on what basis the "failure" of U.S. exchanges to "attract" offerings of this type could possibly justify diminishing regulatory rigor in the U.S. It seems to me that the quickest way to eliminate the valuation premium that foreign companies now enjoy by listing their shares on U.S. exchanges would be for the U.S. to lower its standards so that lower quality companies feel more comfortable listing on U.S. exchanges. (My prior post on the valuation premium may be found here. )

A December 6, 2006 Wall Street Journal article entitled "At Lukoil, an Executive's Death Exposes Network of Inside Deals" (here, subscription required) provides a more detailed look inside another Russian company.



Backdating Up North Too, Eh?: According to a recent press report (here), Canadian companies may also have an options backdating problem. An academic study of options grants between June 2003 and October 2006 at 66 of Canada's largest publicly traded companies found options grant patterns that "may be consistent with backdating" and also that many options grants are not being reported as quickly as required under Canadian law. The final version of the report is due later this month.

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On November 8, 2006, a sweeping bill affecting U.K. companies went into affect when the Companies Bill, which at 696 pages is Britain's longest piece of legislation, received royal approval. (The House of Lords site reflecting all information pertaining to the Bill may be found here.) The Bill contains a statutory statement of directors' general duties and extended authority for shareholders to sue directors for negligence, default, breach of duty or breach of trust - a broader range of conduct than under prior law.

The Bill's statutory statement of directors' general duties sets out seven duties:

• The duty to act within the company's powers;
• The duty to promote the success of the company;
• The duty to exercise independent judgment;
• The duty to exercise reasonable care, skill and diligence;
• The duty to avoid conflicts of interest;
• The duty not to accept benefits from third parties; and
• The duty to declare any interest in any proposed transaction or arrangement with the company.

The new general statutory duty to "promote the success of the company" is the most controversial clause in the Bill, and includes many considerations of which directors must now take into account - not only the long term business consequences of any decision, but also "the impact of the company's operations on the community and the environment." This new statutory duty requires directors to consider wider social responsibility factors when making decisions. The various statutory requirements may create obligations that conflict. But the decision of what constitutes the company's best interests will not be set aside if made in good faith and the directors have exercised reasonable care, diligence and skill.

The Bill extends existing shareholder rights to bring derivative claims. The new statutory procedure enables a shareholder to bring a claim with respect to any actual or alleged negligence, default, breach of duty (including the new statutorily codified duties) or breach of trust. A shareholder seeking to bring a claim must petition the court for the right to proceed, based upon a showing of good faith and taking into account whether the company decided not to pursue the claim. If leave to continue is granted, the company must reimburse the shareholder for brining the action; if not, the shareholder bears his or her own costs.

According to a detailed review (here) of the Bill by the Norton Rose law firm, the absence of the risk of costs if leave to pursue the derivative claim is granted "may make shareholders more likely to bring an action under the new procedure." The new right to bring an action for breach of any duty, including the new statutory duties, "provides another tool for use by activist shareholders to push for change at underperforming companies." But how useful this tool will be depends on "the court's willingness to exercise its discretion to intervene in what, in many cases, will be simply commercial decision making by the company, its directors and majority shareholders." In light of these considerations, the Norton Rose firm's memo suggests that "boards should review the wording of their D & O policies to ensure that defending derivative claims is covered."

A summary of other aspects of the Bill may be found at the CorporateCounsel.net, here.

A Private Conspiracy?: According to a November 15, 2006 Bloomberg.com article entitled "KKR, Carlyle, 11 Other Accused of Rigging Buyouts" (here), the law of Wolf, Haldenstein, Adler, Freeman & Herz has brought a purported class action accusing 13 private equity firms of rigging the market to take companies private. The complaint purportedly alleges that investors did not receive full value for their shares because of a conspiracy that violated antitrust laws. The purported class potentially represents tens of thousands of shareholders in dozens of deals in which public companies were taken private. Among the specific transactions named are deals involving Univision, HCA and Harrah's Entertainment. The list of defendants reads like a who's who in the world of private equity, including KKR, Carlyle, Thomas H. Lee Partners, Blackstone Group, Bain Capital, Apollo Management, Texas Pacific Group, and others.

Prior press reports had disclosed that the antitrust division of the U.S. Deparment of Justice in Manhattan is examing potential antitrust violations by private equity firms engaged in "club deals" to acquire public companies. An October 11, 2006 Wall Street Journal article entitled "Probe Brings 'Club Deals' to the Fore" can be found here (subscription required.)

Best Commercial Ever?: You decide. Roll the tape, here.

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