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

One of the most interesting aspects of the complicated sequence of events surrounding the Bank of America/Merrill Lynch merger is the suggestion that Treasury Secretary Henry Paulson instructed BofA’s CEO Ken Lewis not to disclose to BofA shareholders that the government, in order to keep BofA from backing out of the deal, was backstopping BofA to the tune of billions of dollars of additional TARP funds and asset guarantees.

 

As I recently pointed out in my discussion of the opinion, Southern District of New York Judge Kevin Castel, in his August 27, 2010 dismissal motion ruling in the BofA/Merrill securities suit, found that the plaintiffs had not sufficiently alleged scienter in connection with BofA’s alleged failure to disclose this federal backstop.

 

In support of this conclusion, Castel said the defendants were "acting at the instruction of the Treasury Secretary during a moment of acute economic and political uncertainty. There are no allegations of personal gain derived from the federal funds, or a violation of a statute or regulation in a ‘highly unreasonable’ manner."

 

Castel doesn’t say that BofA didn’t have a duty to disclose the existence of the federal backstop. But if BofA had a duty to disclose the information, what difference does it make under the federal securities laws that Paulson told Lewis not to disclose it? As CNN Money journalist Colin Barr noted on September 1, 2010 in his Street Sweep blog post entitled "Judge Embraces ‘Paulson Made Me’ Defense" (here), Castel’s ruling has "left some observers scratching their heads."

 

Is Castel suggesting that there is some kind of governmental instruction or national emergency exception to the disclosure requirements under the federal securities laws? On what basis? Whose instruction is sufficient? What level of exigency is sufficient and who decides?

 

I was glad to see Barr’s post focusing on this aspect of Judge Castel’s ruling. I think these issues are both interesting and important, but for whatever reason, this part of Castel’s opinion has largely gone without public comment.

 

I did explore these issues in my prior post about Judge Castel’s opinion. Because I think these issues are worthy of attention and further consideration, and at risk of appearing a little too self-referential, I am reproducing here my prior comments about this aspect of Judge Castel’s ruling, in order to try to highlight these issues and to try to encourage further discussion of these questions. Here are my thoughts on this issue:

　

The BofA/Merrill Lynch merger was one of highest profile events during the peak of the global financial crisis in late 2008 and early 2009. The disclosures in early 2009 about Merrill’s losses and about the bonus payments were highly controversial. As a result, Judge Castle’s opinion in the consolidated shareholder litigation undoubtedly will provoke extensive scrutiny and commentary. There are indeed a number of parts of the opinion that are worthy of discussion, but the part this is the most interesting to me is his conclusion regarding the inadequacy of the scienter allegations in connection with the alleged failure to disclose the federal bailout that Lewis negotiated with Paulson.

　

As alleged in the complaint, this massive federal package was negotiated after the shareholder vote but before the deal closed. Its existence was apparently critical to the BofA board’s vote to go forward with the deal rather than to invoke the MAC clause. Moreover, it was understood that Paulson’s verbal agreement would have to be disclosed if it were reduced to writing – and accordingly, it was not reduced to writing so it wouldn’t have to be disclosed.

　

In concluding that these actions, which seem to have been taken precisely so that something everyone recognized as important would not have to be disclosed prior to the merger closing, do not give rise to a strong inference of scienter, Judge Castel relied on two considerations: (1) Paulson "instructed" Lewis not to disclose the federal package; and (2) Lewis had nothing to gain personally from withholding disclosure.

　

Though these factors undoubtedly are relevant, it strikes me that these points do not necessarily answer the question whether or not Lewis consciously misled BofA shareholders of acted with reckless indifference to the truth.

　

It could be argued that the allegations strongly suggest that Lewis did not want the BofA shareholders to know that the only reason the BofA board was willing to go forward with the deal was the existence of massive federal support. A plausible inference is that he, like Paulson, feared the chaos that would have emerged if these facts were revealed before the deal closed. It is also plausible to infer that Lewis and others didn’t want to anger Paulson and risk losing the proffered federal support.

　

These might all have seemed like good and sufficient reasons to withhold the information, but whether or not the reasons might have seemed good and sufficient does not answer the question whether Lewis and others acted with awareness of or conscious disregard whether BofA shareholders would be misled.

　

The fact that Paulson "instructed" Lewis to withhold disclosure does not answer the question whether or not Lewis was aware BofA shareholders would be mislead; to the contrary, it might actually suggest a concern that BofA’s shareholders couldn’t be trusted with the truth. (Indeed, Paulson’s instruction arguably does nothing more than make him complicit in the alleged deception, which in Paulson’s case, encompassed not just BofA shareholders but also U.S. taxpayers.)

　

Why is Paulson’s "instruction" relevant at all to the question whether or not the securities laws were violated? Is Castel suggesting that there is some sort of immunity from securities liability if the actions were at the request of a government official? It seems to me that the supposed relevance of Paulson’s instruction is surprisingly unexamined in Castel’s opinion, and the entire discussion of the issue is disconnected from the question whether or not Lewis knew that the shareholders would be misled.

　

Judge Castel’s emphasis on Lewis’s lack of personal benefit, while not irrelevant, is also beside the point. Lewis’s lack of personal benefit certainly doesn’t answer the question whether Lewis and others were deliberately taking steps to avoid disclosing material information because they were afraid of what would happen if they did.

　

In the final analysis, I think Judge Castel’s ruling can perhaps only be understood by his observation that these events took place "during a moment of acute economic and political uncertainty." While this fact has nothing to do with whether or not Lewis was consciously withholding information from BofA shareholders, it does suggest Castel is simply unwilling to permit liability for actions taken at the direction of senior public officials at a time of national exigency. It is almost as if he is saying, with shrugging shoulders, "What else was BofA going to do?" I certainly understand this way of looking at these circumstances. The problem is that it doesn’t necessarily address the questions required by the securities laws.

　

Judge Castel does not actually say he is inferring either an official instruction or national emergency exception to the requirements of the securities laws. But by emphasizing those aspects of the situation, he seems to be suggesting that these exceptions exist and apply.

　

To be sure, Judge Castel did observe that the scienter allegations regarding the nondisclosure of the federal package, which he characterized as "thin," might have been sufficient if they were accompanied by adequate allegations of motive or recklessness. It could be argued that his ruling is simply a reflection of insufficient factual pleading, which may be the case. Nevertheless, his analysis raises many questions that in my view are insufficiently examined, whether or not the scienter allegations themselves were or were not sufficient.

　

Given the high profile nature of this case, I suspect there will be much discussion of Judge Castle’s opinion in the weeks and months ahead. Legal proceedings arising out of these circumstances do seem to attract controversy – as, with for example, Judge Rakoff’s high profile rejection of the SEC’s settlement of its enforcement action against BofA arising from these circumstances.

　

Back to School: Add one more company to the list of for-profit education companies that have recently been sued in securities class action lawsuits. As I discussed in a recent post, within the space of just a few days in August, plaintiffs’ lawyers filed a cluster of lawsuits against for-profit education companies. On August 31, 2010, plaintiffs’ lawyers added one more company to the list when they sued Corinthian Colleges and certain of its directors and offices, based on allegations similar to those raise against the other for-profit education companies. A copy of the plaintiffs’ lawyers’ press release can be found here.

　

Old School: I wonder if this for-profit education company’s schools cover their chairs with Soft Corinthian Leather. For those who miss the reference, and in respectful memory of Ricardo Montalban, here is the original Chrysler Cordoba advertisement to which I was referring :

　　

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In a post last week, I discussed a recent article by three academics in which they considered whether companies involved in securities lawsuits  financially underperform after the cases are settled. The prior post provoked an unusual level of reader commentary. Among the comments posted was one from former plaintiffs’ securities class action attorney William Lerach.

 

Because I know readers enjoy a spirited discussion as much as I do, and because I believe this blog can and should encompass a wide variety of viewpoints, I communicated with Mr. Lerach to see if he would allow me to republish his comment in the form of a guest post on this site. Mr. Lerach agreed and so his comment is reproduced below. In order to appreciate the context for Mr. Lerach’s remarks, I strongly recommend reading the prior post on which he is commenting. Here are his comments:

 

After reading Kevin's description of this study concerning the post settlement performance of companies sued for securities fraud and his own evaluation of the paper I don't know whether to characterize them both as silly or stupid. They're probably a combination of both. Almost everything about the study and the associated commentary ignores the basic realities of the circumstances that surround the vast majority of securities fraud litigations. Most companies end up being sued for securities fraud––and then end up (with the help of directors’ and officers’ liability insurance) paying a settlement––because they have lied to the marketplace about the quality of the corporation's business or its products or finances. Frequently the revelation of the truth results and not only a sharp drop in the stock price but adverse financial revelations, a drop in revenues and cash flow, violation of bank or lending covenants and management shakeups. So are we surprised that companies with these characteristics suffer "greater risks of financial distress" after they later settle a lawsuit. Of course they face such risks because they were lying about the nature of their business earlier--to cover up flaws in products, performance or the business model itself. Often such companies face a" liar's discount" in the marketplace as a consequence of their prior bad conduct. It's not the lawsuit or the settlement of the lawsuit that injures the company-or impairs it ongoing performance of financial condition-it is the misconduct, the lying and the financial falsification of the executives that got the company sued in the first place that undermines the future performance and financial health of the company. We should not be surprised that companies that have committed securities fraud––whether it's stuffing the channel, lying about their products, or falsifying their financials, "perform worse than their peers". What is it about such companies and their managements that would cause us to believe that they would perform better than their peers? Kevin's conclusion that this flawed study suggests that suits are better directed at the individuals who perpetrated the misconduct i.e. the officers of the company-- and that this would somehow spare the corporate entity the financial distress of the settlement -ignores the reality of the indemnification obligation of the company which in virtually every case causes the company to fund the bulk of any settlement on behalf of the officers directors and then only to the extent it has not been paid for by directors and officers liability insurance, a contributor which would have no material adverse impact on the corporate entity. Underlying the study and Kevin's commentary on it is the notion somehow that suits brought on by half of shareholders merely transfer money from one group of shareholders to another and therefore really don't benefit anyone-- but harm the company. Not only does this ignore the reality that the bulk of the settlement monies in these cases comes from directors and officers insurance but it completely misses the point that the vast majority of settlement proceeds go to former shareholders of the company––those investors who purchased the shares of the company at an inflated price during the fraud period but who in most instances, out of anger , frustration, or even for tax considerations later sell the shares at a loss and have no further interest in the corporate entity. These are former shareholders not current shareholders with the equivalent of a tort claim against the company. I normally am not moved to comment on the academic work done concerning securities lawsuits but the simplistic nature of this study is so obvious that I could not resist pointing out these shortcomings. It may well be that there are many defects with securities fraud class action lawsuits but any financial underperformance of companies that follows their settling such lawsuits against them and their officers and directors is not one of them.

 

I would like to thank Mr. Lerach for taking the time to communicate his reaction to my prior post and for allowing me to reproduce his thoughts here. As I have already had my say on this topic, and because my business partners prefer that I attend to my day job from time to time, I will not respond here to Mr. Lerach’s comments. However, I expect some readers may have their own reactions to Mr. Lerach’s remarks, and I encourage everyone to consider adding their thoughts to this post using the blog’s comment feature. I have always hoped this site would serve as a platform for the exchange of ideas, and I encourage all readers to use post their thoughts for the benefit of other readers.

 

In a prior post (here), I reviewed the recent biography of Mr. Lerach, Circle of Greed. My interview with the book’s authors can be found here.

 

That's Reassuring:  I am still trying to work out whether I am silly or stupid. Or perhaps both. In the meantime, I take some consolation from the fact that Lexis Nexis has selected The D&O Diary as one of the Top 50 Insurance blogs, as reflected in the icon embedded in the right hand margin.

 

In addition, George Mason Law Professor J.W. Verret, writing in the Truth on the Market blog on Monday, included The D&O Diary as one of twelve blogs he lists as his "favorite corporate law blogs." UCLA Law Professor Stephen Bainbridge, commenting on Verret's list on  the ProfessorBainbridge.com blog, also included The D&O Diary on his (somewhat longer) list of corporate law blogs he reads regularly.  My thanks to both venerable Professors (and fellow bloggers). I should add that my blog list is very much like theirs and that my list also includes both of their blogs.

 

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In an August 27, 2010 opinion so massive that its table of contents alone is five pages long, Southern District of New York Judge Kevin Castel granted in part and denied in part the motions to dismiss in the consolidated securities and derivative litigation arising from Bank of America’s January 2009 acquisition of Merrill Lynch and related events. Though the opinion dismisses parts of the lawsuit, other substantial pieces, particularly those related to the controversial bonuses paid to Merrill employees at the end of 2008, will be going forward.

 

Background

In the whirlwind of events in mid-September 2008 that included the collapse of Lehman Brothers and the dramatic government bailout of AIG, BofA agreed to acquire Merrill Lynch. According to the allegations in the subsequent lawsuits, one of the important features of the merger negotiations related to 2008 bonuses scheduled to be paid to Merrill employees in January 2009. The complaint alleges that BofA agreed to a $5.8 billion bonus pool and agreed that the bonus payments could be accelerated so the payout occurred prior to year end 2008 and before the merger transaction closed on January 1, 2009.

 

The complaint alleges that these bonus arrangements were not disclosed to BofA shareholders in the proxy materials that were sent to shareholders on November 3, 2008. (The arrangements were described in a "Disclosure Schedule" that was not available to shareholders prior to the shareholder vote).

 

On October 7, 2008, after the merger was announced but prior to the proxy vote, BofA conducted a $9.9 billion secondary offering. In October and November 2008, while shareholder approval of the transaction was pending, Merrill suffered losses of over $15 billion and also took a $2 billion goodwill impairment charge. The Complaint alleges that BofA’s senior officials were aware of these losses as they occurred. The Complaint alleges that the losses were so significant that BofA management discussed terminating the transaction, prior to the December 5, 2008 shareholder vote on the merger, in which BofA shareholders approved the merger.

 

In discussions after the merger vote about Merrill’s deteriorating condition, BofA senior management considered whether BofA had the right to terminate the merger under the merger agreement’s "material adverse change" (MAC) clause. On December 17, 2008, BofA Chariman and CEO Kenneth Lewis called Treasury Secretary Henry Paulson to advise him that BofA was "strongly considering" invoking the MAC clause. At Paulson’s invitation, Lewis flew to Washington for a face-to-face meeting, at which Paulson and Federal Reserve Board Chair Ben Bernanke urged Lewis not to invoke the MAC clause.

 

In subsequent conversations, Lewis again advised the government officials that BofA intended to invoke the MAC clause. According to the complaint, BofA’s board voted on December 21, 2008 to invoke the MAC clause, but on the following day, the Board voted to approve the merger, apparently in part based on Lewis’s statement that he had received verbal assurances from Paulson that BofA would received a capital infusion and a guarantee against losses from risky assets if the merger concluded. Lewis allegedly told the Board that the company would not enter into a written agreement concerning the federal funds because he could not risk public disclosure of the government loans prior to the transaction’s scheduled January 1, 2010 closing. Instead, the government bailout package would be disclosed at the time of the company’s earnings release later in January.

 

On January 16, 2010, BofA disclosed the fourth quarter losses of both BofA and Merrill and also revealed the federal funding package, which included $20 billion in capital and protection against further losses on $118 billion in assets. In following days, news about Merrill’s bonus arrangement broke.

 

In response to this news, BofA’s share price declined, and shareholder litigation ensued. The plaintiffs alleged that the defendants misstated and concealed matters related to the Merrill bonuses, the losses that accrued in the Fourth Quarter of 2008 after the merger was announced, and the pressure to consummate the deal from government officials. After the securities and derivative lawsuits were consolidated, the defendants moved to dismiss.

 

The August 27 Order

Judge Castel’s massive August 27 memorandum opinion and order covers a lot of ground, much of which cannot be easily summarized. For simplicity’s sake, I have summarized here only his rulings pertaining to the major categories of factual allegations.

 

Merrill Lynch Bonus Payments: First, Judge Castel held that the plaintiffs had sufficiently alleged actionable misstatement with respect to the parties’ "undisclosed written agreement authorizing the payment of bonuses to Merrill," because the proxy "portrayed bonus payments to Merrill employees as a contingent event, when, in reality, the parties had reached agreement as to the timing and range of bonuses." Accordingly, the proxy materials "omitted information necessary to render the statements truthful" and the omission "was material."

 

Judge Castel also held that the plaintiffs had sufficiently alleged scienter in connection with the Merrill Lynch bonus allegations, at least other than with respect to two specific BofA officials (Price and Crotty) who were not sufficiently alleged to have been involved in the negotiations or disclosures.

 

Judge Castel found that "the Securities Complaint explicitly alleges awareness of the bonus arrangement on the part of Lewis and [Merrill CEO John] Thain, which was memorialized in the secret Disclosure Schedule." Both of these men, Judge Castle said, "were closely involved in the details of the bonus negotiations, the resolution of which was concealed from BofA shareholders." These allegations, Judge Castle said, "raise an inference of recklessness that is ‘at least as compelling as any opposing inference of nonfraudulent intent.’"

 

With respect to the BofA directors, Judge Castel concluded that the allegations of scienter were insufficient, but the allegations were sufficient to allege negligence, and therefore, while not stating a claim under Section 10(b), were sufficient to state a claim under Section 14(a). Judge Castel observed with respect to the BofA directors that if they "were aware that the Joint Proxy was materially deficient (as is alleged) or if they should have been aware of deficiencies but took not steps to remedy or inquire about them (as is also alleged), the negligence standard of Section 14(a) would be satisfied." The allegations against Price and Crotty were insufficient event to establish negligence.

 

Fourth Quarter Losses: Judge Castel also concluded that the plaintiffs had sufficiently alleged actionable misstatements with respect to the alleged failure to disclose the fourth quarter losses. However, while concluding that the complaints adequately allege that the magnitude of the losses was material, the Complaint does not "sufficiently allege how the failure the failure to disclose the losses was ‘highly unreasonable’ and "represented an extreme departure" from the standards of ordinary care."

 

Judge Castel added that the securities complaint fails "to adequately and plausibly explain why a defendant would be motivated to accurately disclose a ‘turbulent’ and ‘tumultuous’ economic forecast for the quarter yet recklessly or intentionally conceal the dire reality as the quarter unfolded." Accordingly he concluded that the securities complaint "fails to allege scienter as to defendants’ failure to disclose the fourth quarter losses."

 

　

However, while Judge Castel concluded that the securities complaint "does not satisfy the threshold for alleging fraud" it does "adequately set forth a theory grounded in negligence." Accordingly he denied the defendants’ motion to dismiss securities plaintiffs’ Section 14(a) claims, as well the derivative plaintiffs’ claims, based on the failure to disclosure the fourth quarter losses.

 

Undisclosed Federal Bailout Arrangements: Judge Castel found that the plaintiffs had sufficiently alleged an actionable misstatement or omission with respect to the bailout understanding that Lewis reached with Paulson. He found that "detailed, non-conclusory allegations plausibly allege that BofA received concrete assurances from officials …that BofA would receive a massive capital infusion in exchange for proceeding with the Merrill acquisition" but that this agreement was "intentionally not memorialized to avoid public disclosure." Judge Castel concluded that these allegations "adequately alleged the particulars of fraud."

 

However, Judge Castel found that the allegations about the nondisclosure of the federal agreement fail to satisfy the requirements for pleading scienter. He noted that "the scienter allegations are thin" and that the complaint only explicitly asserts scienter as to Lewis.

 

Judge Castel noted that the complaint alleges a consciousness on Lewis’s part of avoiding liability because he sought a letter from Bernanke providing immunity from civil claims. Judge Castle observed that the securities complaint does not allege that Lewis or any other defendant "stood to gain from non-disclosure" and to not allege "a quid pro quo type arrangement" or that failing to disclose the federal funding brought a benefit to any defendant.

 

Judge Castel noted further that "the decision not to disclose federal support originated in an instruction by Paulson." There is, Judge Castel noted, "no allegation that Lewis or any other defendant hatched a scheme to avoid public disclosure of the federal capital support." Rather than "self-interested motivations," Lewis "acted as ‘instructed’ by Paulson." Judge Castel added that "while Paulson’s instruction would not necessarily preclude a finding of scienter if other allegations established motive or recklessness, it anchors the defendants’ concealment to Paulson’s directions."

 

The defendants, Judge Castel noted, "were acting at the instruction of the Treasury Secretary during a moment of acute economic and political uncertainty. There are no allegations of personal gain derived from the federal funds, or a violation of a statute or regulation in a ‘highly unreasonable’ manner."

 

The October 2008 Offering: Judge Castel denied the defendants’ motion to dismiss the securities plaintiffs’ ’33 Act claims, except to the extent the allegations related to non-actionable puffery.

 

Other Holdings: Judge Castel dismissed both the securities plaintiffs’ and the derivative plaintiffs’ allegations relating to the defendants’ disclosures regarding the defendants’ failure to invoke the MAC and the alleged failure to disclose the defendants’ consideration of possible invoking the MAC. Judge Castel also dismissed the plaintiffs’ claims relating to statements about the adequacy of BofA’s due diligence. Judge Castel also rejected the plaintiffs’ claims relating to a number of post-merger statements.

 

Demand Excused: Judge Castel concluded that the demand was excused on the derivative plaintiffs’ Section 14(a) claims because the directors "faced a ‘substantial likelihood’ of personal liability on the Section 14(a) claim at the time the suit was commenced," which would have "prevented them from exercising their disinterested and impartial judgment to a demand request." However, Judge Castel concluded that demand was not excused as to the derivative plaintiffs’ breach of fiduciary duty claims against the BofA board for approving the merger.

　

Discussion

The BofA/Merrill Lynch merger was one of highest profile events during the peak of the global financial crisis in late 2008 and early 2009. The disclosures in early 2009 about Merrill’s losses and about the bonus payments were highly controversial. As a result, Judge Castle’s opinion in the consolidated shareholder litigation undoubtedly will provoke extensive scrutiny and commentary. There are indeed a number of parts of the opinion that are worthy of discussion, but the part this is the most interesting to me is his conclusion regarding the inadequacy of the scienter allegations in connection with the alleged failure to disclose the federal bailout that Lewis negotiated with Paulson.

 

As alleged in the complaint, this massive federal package was negotiated after the shareholder vote but before the deal closed. Its existence was apparently critical to the BofA board’s vote to go forward with the deal rather than to invoke the MAC clause. Moreover, it was understood that Paulson’s verbal agreement would have to be disclosed if it were reduced to writing – and accordingly, it was not reduced to writing so it wouldn’t have to be disclosed.

 

In concluding that these actions, which seem to have been taken precisely so that something everyone recognized as important would not have to be disclosed prior to the merger closing, do not give rise to a strong inference of scienter, Judge Castel relied on two considerations: (1) Paulson "instructed" Lewis not to disclose the federal package; and (2) Lewis had nothing to gain personally from withholding disclosure.

 

Though these factors undoubtedly are relevant, it strikes me that these points do not necessarily answer the question whether or not Lewis consciously misled BofA shareholders of acted with reckless indifference to the truth.

 

It could be argued that the allegations strongly suggest that Lewis did not want the BofA shareholders to know that the only way the BofA board was willing to go forward with the deal was the existence of massive federal support. A plausible inference is that he, like Paulson, feared the chaos that would have emerged if these facts were revealed before the deal closed. It is also plausible to infer that Lewis and others didn’t want to anger Paulson and risk losing the proffered federal support.

 

These might all have seemed like good and sufficient reasons to withhold the information, but whether or not the reasons might have seemed good and sufficient does not answer the question whether Lewis and others acted with awareness of or conscious disregard whether BofA shareholders would be misled.

 

The fact that Paulson "instructed" Lewis to withhold disclosure does not answer the question whether or not Lewis was aware BofA shareholders would be mislead; to the contrary, it might actually suggest a concern that BofA’s shareholders couldn’t be trusted with the truth. (Indeed, Paulson’s instruction arguably does nothing more than make him complicit in the alleged deception, which in Paulson’s case, encompassed not just BofA shareholders but also U.S. taxpayers.)

 

Why is Paulson’s "instruction" relevant at all to the question whether or not the securities laws were violated? Is Castel suggesting that there is some sort of immunity from securities liability if the actions were at the request of a government official? It seems to me that the supposed relevance of Paulson’s instruction is surprisingly unexamined in Castel’s opinion, and the entire discussion of the issue is disconnected from the question whether or not Lewis knew that the shareholders would be misled.

 

Judge Castel’s emphasis on Lewis’s lack of personal benefit, while not irrelevant, is also beside the point. Lewis’s lack of personal benefit certainly doesn’t answer the question whether Lewis and others were deliberately taking steps to avoid disclosing material information because they were afraid of what would happen if they did.

 

In the final analysis, I think Judge Castel’s ruling can perhaps only be understood by his observation that these events took place "during a moment of acute economic and political uncertainty." While this fact has nothing to do with whether or not Lewis was consciously withholding information from BofA shareholders, it does suggest Castel is simply unwilling to permit liability for actions taken at the direction of senior public officials at a time of national exigency. It is almost as if he is saying, with shrugging shoulders, "What else was BofA going to do?" I certainly understand this way of looking at these circumstances. The problem is that it doesn’t necessarily address the questions required by the securities laws.

 

Judge Castel does not actually say he is inferring either an official instruction or national emergency exception to the requirements of the securities laws. But by emphasizing those aspects of the situation, he seems to be suggesting that these exceptions exist and apply.

 

To be sure, Judge Castel did observe that the scienter allegations regarding the nondisclosure of the federal package, which he characterized as "thin," might have been sufficient if they were accompanied by adequate allegations of motive or recklessness. It could be argued that his ruling is simply a reflection of insufficient factual pleading, which may be the case. Nevertheless, his analysis raises many questions that in my view are insufficiently examined, whether or not the scienter allegations themselves were or were not sufficient.

 

Given the high profile nature of this case, I suspect there will be much discussion of Judge Castle’s opinion in the weeks and months ahead. Legal proceedings arising out of these circumstances do seem to attract controversy – as, with for example, Judge Rakoff’s high profile rejection of the SEC’s settlement of its enforcement action against BofA arising from these circumstances.

 

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

 

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Most securities lawsuits settle. The common assumption is that once the cases are settled, the litigation wraps up and everybody moves on. But does the litigation have a lingering effect on the defendant company? Is there a "hidden dark side" for companies that settle securities lawsuits?

 

That is the question asked in a March 18, 2010 paper entitled "Lying and Getting Caught: An Empirical Study of the Effect of Securities Class Action Settlements on Targeted Firms" (here) by Cincinnati Law Professor Lynn Bai, Duke Law Professor James Cox, and Vanderbilt Law Professor Randall S. Thomas. (Hat Tip to the Class Action Countermeasures blog, which has a post about this paper here.):

 

Through their research, the authors sought to discover whether getting hit with a securities a lawsuit and then subsequently entering into a settlement "weakens the defendant firm so that from the point of view of well-received financial metrics the firm is permanently worse off as a consequence of the settlement."

 

In order to examine this question, the authors examined 480 companies that were defendants in settled post-PSLRA securities class action lawsuits. The authors then examined whether there is any change in the defendants’ financial well-being and stock performance relative to their peer group over time.

 

The authors compared the defendants’ performance with that of comparable companies over several time periods. "Comparable" companies consisted of those with the same SIC Code and the same asset size but that had not been involved in a securities class action lawsuit during the relevant time periods.

 

The authors compared the defendant companies to the comparable companies using seven performance criteria, including asset turnover; return-on-assets: the ratio of Earnings Before Income and Tax payments to total assets; the current ratio; the Altman Z-Score (a bankruptcy prediction measure); the market to book ratio; and the one-year stock price return. The authors looked at changes in defendants’ performance according to these measures over time using multivariate regressions.

 

The authors’ research produced a number of results which even they characterized as "puzzling." On the one hand, companies that settled securities class action lawsuits experienced no decline in sales opportunities, but did "experience a reduced level of operating efficiency while the lawsuit was pending (but not after it was settled)."

 

More significantly however, the authors did also observe that "defendant firms experience liquidity problems post-settlement and worsening Altman-Z scores." The authors wrestle with how to interpret these latter findings. On the one hand, the deterioration of the Altman Z-scores could suggest that "settlements drive firms toward financial distress (i..e., settlements are causally related to the worsening situation)," but on the other hand these data could suggest that "the financial deterioration observed in earlier time periods continues downward." Or perhaps it could be some combination.

 

The authors concede that their analysis could support alternative conclusions, but they nevertheless offer their own interpretations as well. Among other things, they note that "while uncertainty persists about the precise connection between the settlements and financial distress, there is no uncertainty that firms that are involved in securities class action litigation experience statistically greater risks of financial distress than their cohort firms."

 

The authors also conclude that their findings "lend strong support for the view that such suits are better directed toward the officers, advisors and other individuals who bear responsibility for the fraudulent representation(s) that spawned the suit."

 

Discussion

The authors’ findings about the post-litigation performance of companies settling securities class action lawsuits are interesting. With full recognition that the question of the causation for that diminished performance is uncertain, the conclusion that companies experiencing securities suits perform worse than there peers is relevant information, both from an investment and a D&O insurance underwriting standpoint.

 

One implication of the authors’ analysis is particularly interesting to me, because one factor implicitly contributing to the negative post-litigation performance is the financial burden the litigation and the settlement imposed on the company. This implication (if indeed my interpretation is valid) seems at odds with other recent research, particularly that of Stanford Law Professor Michael Klausner, who in a recent article published with a colleague concluded that "on the whole D&O insurance pays substantial portions of settlements in a large majority of cases, and that both corporate and individual defendants are highly protected."

 

There seems to be a tension in the analysis between these two academic studies, since if it is the case that D&O insurance substantially protects corporate defendants in securities class action lawsuits, why should there be lingering negative financial effects on the defendants companies?

 

Perhaps the answer may be that the reason for the negative performance relative to the companies’ peers post-litigation may not be financially related, but may be operationally related, and the same below standard operational performance post-litigation in some cases may be related to the factors that led to the litigation in the first place.

 

An alternative explanation may be that while the D&O insurance funds a "substantial portion" of settlements, that still leaves a substantial portion unfunded, and the burden on the companies to fund the difference harms them financially. The authors even note that their analysis insurance in consistent with the conclusion that insurance "provided less than full coverage of the settlement amounts and that the defendants paid the discrepancy out of their current assets. The settlement payment exacerbated liquidity constraints, making the defendants more vulnerable to liquidity crunches and prone to bankruptcy."

 

In other words, it may be that once the case is settled, everyone may move on to other things, but the company is left financially impaired in a way that undermines its future performance – which obviously harms the interests of the company’s shareholders. All of which does leave you wondering about the ultimate value of a process carried out in the name of shareholders but that leaves shareholders’ interests indelibly impaired. .

　

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In a recent post, I discussed several recent decisions in which securities cases involving failed or troubled banking institutions survived dismissal motions. By contrast, however, in an August 16, 2010 ruling (here), Southern District of New York Judge Robert Patterson, Jr. granted the defendants’ motion to dismiss without prejudice in the securities class action lawsuit filed against Raymond James Financial and certain of its directors and officers alleging inadequate disclosures regarding the company’s banking subsidiary’s loan loss reserves.

 

As discussed in greater detail here, plaintiffs first filed their action against Raymond James Financial in June 2009. The plaintiffs’ allegations center on the loan portfolio and loan loss reserves at the company’s banking subsidiary, Raymond James Bank. Judge Patterson stated in his August 16 opinion that, despite the length of the complaint (which "extreme length," Judge Patterson noted, provides "an independent ground for dismissal"), the plaintiff’s allegations "boil down to one proposition: that the Defendants purposefully underfunded their loan loss reserves and then made material misrepresentations about het adequacy of those loan loss reserves during the class period."

 

With one small exception, Judge Patterson concluded that the misrepresentations and omissions on which plaintiff seeks to rely are not actionable. For example, he concluded that the alleged misrepresentations about the bank’s loan loss reserves "are, without exception, general statements of optimism" which "in and of itself renders these statements inactionable."

 

Similarly, Judge Patterson concluded that the statements about the quality of the bank’s loan portfolio "were, similarly, very general and not sufficiently detailed to have misled investors" and "for the most part" represent "classic puffery."

 

The one exception to his conclusion that the statements on which the plaintiff sought to rely are not actionable were two paragraphs in the Amended Complaint relating to the quality of the loan portfolio. These statements included representations that the bank "independently underwrote" all loans, including loans "sourced from agent or syndicate banks." The Amended Complaint reference the testimony of a confidential witness who avers that many loans that were later charged off were not independently underwritten.

 

However, Judge Patterson also concluded that the plaintiff had not sufficiently alleged scienter. He concluded with respect to the plaintiffs’ scienter allegations that:

 

None of the allegations of scienter are sufficiently specific that they allow the Court to determine whether the Defendants knew (or even likely knew) that their statements were false when made. For the most part, the scienter allegations are of the sort that could be made about nearly any company operating in the United States, namely that the executives were motivated to create profit, that the executives received a near-constant stream of information about economic trends, and that the executives made mistakes in some of their forward-looking projections.

 

These allegations, Judge Patterson concluded, were insufficient to give rise to a strong inference that the defendants acted with the requisite state of mind.

 

Accordingly, Judge Patterson granted the defendants’ motions to dismiss, but he did so without prejudice.

 

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

 

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Among the very, very latest trends in securities class action lawsuit filings are suits against for-profit educational companies. Just since the middle of last week, at least five companies in this sector have been tagged with new lawsuits, four of which were securities class actions.

 

These lawsuits have been accumulating in the wake of an August 3, 2010 Government Accountability Office report (here) which alleged that several companies in the for-profit education industry encouraged fraud and engaged in deceptive advertising. The report was prepared in connection with the August 4, 2010 hearing before the Senate Committee on Health, Education, Labor and Pensions.

 

The GAO report said that undercover tests revealed that at least four schools encouraged fraudulent practices and all 15 tested made deceptive or questionable statements to the GAO’s undercover applicants. The fraud involved encouraging falsified financial aid applications. A summary of the report can be found here. A statement of the report’s highlights can be found here.

 

Though no specific companies are named in the report (or perhaps because no specific companies are named in the report), the share prices of many of the publicly traded for-profit education companies fell after the news about the GAO report circulated. And, perhaps inevitably, the lawsuits started coming in.

 

As far as I am aware, at least four for-profit education companies have been named in securities class action lawsuits just since the end of last week. These companies include the following:

 

Education Management Corp., against which the first suit was filed on August 11, 2010. A copy of the complaint filed in the Western District of Pennsylvania can be found here.

 

American Public Education, against which the first suit was filed on August 12, 2010. A copy of the complaint filed in the Northern District of West Virginia can be found here.

 

Lincoln Educational Services, against which the first suit apparently was filed on August 13, 2010. A copy of the complaint can be found here.

 

Apollo Group, Inc., against which the first suit apparently was filed on or about August 16, 2010. A copy of complaint can be found here.

 

In addition to these securities class action lawsuits, a separate class action lawsuit against Alta Colleges, Inc. (parent of Westwood College) and related entities and persons was filed on August 11, 2010 in the District of Colorado alleging violations of the Colorado Consumer Protection Act. A copy of the Alta/Westwood complaint can be found here.

 

With five suits in already, it seems safe to predict that other publicly-traded for-profit education companies could also get hit with one of these suits. This seems to be one of those classic contagion events that produces an epidemic of similar lawsuits that comes up every now and then. Last year it was ETFs (refer here); this year it seems to be for-profit educational companies.

 

The name Apollo Group may be familiar to many readers, as the company was the target of a prior securities class action lawsuit that has achieved a certain amount of notoriety because it is one of the few securities cases that has actually gone to trial. The trial resulted in a plaintiffs’ verdict, although the presiding judge later set the verdict aside in a response to a post-trial motion. More recently, the Ninth Circuit reversed the trial court’s ruling and remanded the case to the district court for further proceedings, a development that has sparked significant interest and discussion.

 

Unfortunately for Apollo Group, all of the long-running drama in the prior case was no shield against another case being filed.

 

It remains to be seen how these cases will fare. But this industry-specific litigation outbreak is a reminder of the many odd and circumstance-specific events that can drive securities class action lawsuit filings. Many things determine filing levels, many of which cannot be captured or predicted in historical filing data. As a result, it can be misleading to try to generalize from short term trends about future filing levels. Simply put, the numbers vary over time, because, for example, contagion events and industry epidemics happen.

 

New Securities Suit Based on FCPA-Related Allegations: Regular readers know that I have frequently commented that one result of increased Foreign Corrupt Practices Act enforcement has been the growth in the number of follow-on private civil lawsuits based on the underlying corruption allegations.

 

The latest example of this phenomenon is the lawsuit filed against SciClone Pharmaceuticals and certain of its directors and officers. According to the plaintiffs’ lawyers’ August 16, 2010 press release (here), the complaint they filed in the Northern District of California alleges that:

 

defendants were engaged in illegal and improper sales and marketing activities in China and abroad regarding its products. This ultimately caused the Company to become the focus of a joint investigation by the Securities and Exchange Commission ("SEC") and the Department of Justice ("DOJ") for possible violations of the Foreign Corrupt Practices Act ("FCPA"). It was only at the end of the Class Period, however, that investors ultimately learned the truth about the Company's operations after it was reported that the SEC and DOJ were investigating the Company for violations of the FCPA. At that time, shares of the Company declined almost 40% in the single trading day.

 

This case presents further support for the proposition that increased anticorruption enforcement activity represents a growing area of liability exposure for company executives.

 

Thought for the Day: "Time flies like an arrow. Fruit flies like a banana." (Often attributed to Groucho Marx, but although it seems as if he would have said it, he apparently did not.)

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Though we are in the midst of the dog days of summer (at least in the northern hemisphere), the federal courts, at least, have been busy. In the last several days alone, several courts have issued dismissal motion rulings in lawsuits arising out of the subprime meltdown and the credit crisis.

 

As noted below, several of these decisions involve failed or troubled banks, and therefore may be of particular interest in relation to the many banks have failed in recent months or that are continuing to struggle now. Though investor plaintiffs in other cases involving failed or troubled banks have sometimes struggled to survive the initial pleading stages, in the cases discussed below, the plaintiffs managed to survive the dismissal motions, at least in part.

 

PFF Bancorp: In an August 9, 2010 opinion (here), Central District of California Judge Andrew Guilford denied the defendants’ motions to dismiss in the securities class action lawsuit against two former directors and officers of PFF Bancorp, the corporate parent for PFF Bank & Trust, which failed on November 21, 2008.

 

As reflected here, in January 2009, shareholders of the holding company filed a securities lawsuit alleging that the company’s President and CEO and its CFO contending that they concealed the Bank’s unsafe lending practices and made misleading statements about the bank’s loan loss reserves and capital levels.

 

In his August 9 order, Judge Guilford found that while the plaintiffs’ allegations that defendants made misleading statements about the banks’ "cautious" and "conservative" lending practices were insufficient to state a claim, the plaintiffs’ allegations that defendants had falsely characterized the bank’s loan loss reserves as "adequate" were sufficient to state a claim.

 

Judge Guilford also found that plaintiffs had adequately alleged scienter, finding that plaintiffs’ allegations "permit the inference that Defendants knew PFF’s loan practices were risky and that PFF had inadequate loan loss reserves, yet told investors that the loan loss reserves were adequate."

 

Interestingly, Judge Guilford found plaintiffs’ scienter allegations to be adequate despite the defendants’ contention that they had actually purchased PFF shares at the supposedly inflated prices. Judge Guilford declined, at the motion to dismiss state, to take judicial notice of the SEC forms on which defendants sought to rely in order to establish their share purchases.

 

Popular, Inc. (Securities Claim): In an August 2, 2010 order (here), District of Puerto Rico Judge Gustavo Gelpí granted in part and denied in part the defendants motion to dismiss the securities class action lawsuit that had been filed against Popular, Inc., certain of its directors and officers, its auditor and its offering underwriters.

 

The plaintiffs’ complaint focused on the company’s accounting for a deferred tax asset. In the three years preceding the beginning of the class period (which went from January 24, 2009 to February 2009), the company had recorded tax loss carry forwards that totaled over $1 billion, largely as a result of the company’s U.S. subprime and other lending operations. The benefit of these deferred tax assets could only be realized if the company experienced sufficient U.S.-based gains within 20 years.

 

To offset the possibility the company might not fully realize the value of the deferred tax assets, accounting rules required reporting companies to take a valuation allowance, but the company recorded no material valuation allowance of this asset until late 2008. The company ultimately recorded an allowance for the full value of the asset. Following the announcement of this action, the company’s share price fell substantially.

 

The plaintiffs allege that the increasing, multiyear U.S.-based operating losses prevented it from anticipating sufficient taxable income to realize the full value of the deferred tax asset prior to the expiration of the 20-year period, yet failed to take a valuation reserve because doing so would have lowered the bank’s risk-based capital ratio below regulatory requirements. The financial picture the company’s treatment of the asset portrayed allowed the company to raise over $300 million in a May 2008 offering.

 

The Court found that the plaintiffs allegations adequately alleged material misrepresentations, given that "Popular’s three-year cumulative loss position, combined with the Company’s significant downsizing of its U.S. mainland operations and the worsening market conditions, constituted strong evidence that at the beginning of the class period it was more likely than not that the Company would not be able to realize the benefit of its [deferred tax asset] in full."

 

The Court also concluded that the complaint adequately alleged scienter, concluding that the defendants’ decision "not to take an earlier valuation allowance was ‘highly unreasonable’ and an ‘extreme departure from the standards of ordinary care’ to the extend that the danger was either know to the defendants or so obvious that they must have been aware of it."

 

The Court also concluded that the ’33 Act allegations against the officer defendants were also sufficient. However, because the Court found that the amended complaint in which the plaintiffs added as defendants the outside directors, the company’s auditor and its offering underwriters had been filed more than a year after there were sufficient "storm warnings" to put the plaintiffs on inquiry notice, the ’33 Act claims against those defendants were untimely and were therefore dismissed.

 

Popular, Inc. (Derivative Suit): In an August 11, 2010 opinion (here), applying Puerto Rico law, in the shareholders’ derivative lawsuit filed against Popular, Inc, as nominal defendant, certain of its directors and officers, and its outside auditor, Judge Jay Garcia-Gregory denied in part and granted in part the defendants’ motions to dismiss. The allegations in the derivative suit largely mirror those alleged in the securities class action lawsuit.

 

The officer and director defendants had moved to dismiss on the ground that the plaintiff had not presented a demand to the company’s board to pursue the lawsuit. The plaintiff argued that demand was futile, and the Court agreed. The Court found that the plaintiffs’ allegations and of the requirements of SFAS 109 "provide ‘reason to doubt’ the legality of declining to record a valuation allowance until 2009" and therefore "demand is excused" because the presumption that the board took a valid business judgment had been rebutted by the alleged lack of "legal fidelity."

 

The Court did, however, dismiss the plaintiff’s gross mismanagement claim as duplicative of the breach of fiduciary duty claim. The Court also found that the plaintiff had not adequately alleged corporate waste. Finally, the Court found that the plaintiff’s claim against the company’s auditor should also be dismissed, on the grounds that the plaintiff had not made a demand on the company’s board to pursue the claim and had not established demand futility.

 

Discussion

Plaintiffs have had some difficult surviving initial dismissal motions in many of the securities class action lawsuits that have been filed against the directors and officers of banks that have failed during the current failed bank wave. For example, the securities class action lawsuit arising out the failure of Downey Financial Corp. (whose operating bank failed the same day as PFF Bank & Trust) was dismissed with prejudice.

 

Similarly, the motion to dismiss in the Fremont General case was also ultimately dismissed with prejudice. Similarly, the motion to dismiss was granted in the BankUnited securities case, albeit without prejudice.

 

More recently, however, the motion to dismiss was denied in the securities class action lawsuit arising out of the failure of Corus Bankshares. With the above decisions, it seems as if the plaintiffs in these cases have managed to overcome the initial pleading hurdle at least in several cases now.

　

To be sure, the reasoning the Popular case is based on circumstances that may be unique to that case. The allegations in the PFF Bancorp case, however, arguably are more typical. But while the PFF Bancorp case survived the dismissal motions, it remains to be seen whether the case will survive additional proceedings in the case, if defendants are able to establish that the purchased company shares at the allegedly inflated prices.

 

Ultimately, the fundamental question about the failed banks is whether the FDIC will lower the litigation boom on directors and officers of the failed banks. So far, the FDIC’s litigation activity has been limited to a single lawsuit it filed against officers of a subsidiary of IndyMac (about which refer here). Whether and to what extent the FDIC will pursue other claims will be revealed in the weeks and months ahead.

 

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

 

Very special thanks to the loyal readers who provided me with copies of these decisions.

　

Another Banking Institution Dismissal Motion Ruling: Though the financial institution involved has neither failed nor is seriously troubled, it should be noted here at least briefly that in an August 10, 2010 order (here), Southern District of Ohio Judge Sandra Beckwith denied in part and granted in part the defendants’ motion to dismiss in the securities class action lawsuit that had been filed against Fifth Third Bancorp and certain of its directors by former shareholders of First Charter, which Fifth Third acquired in a deal announced in August 2007.

 

As discussed here, the former First Charter shareholders alleged that in connection with the merger, Fifth Third and certain of its directors and officers had materially misrepresented Fifth Third’s exposure to poorly performing residential real estate markets, and had not fully represented how seriously its mortgage portfolio was deteriorating.

 

Judge Beckwith’s detailed and painstaking August 10 opinion denied the motion to dismiss as to the claims of certain classes of First Charter shareholders, but granted the motion to dismiss as to all other claims and claimants.

 

Another Credit-Crisis Related Securities Suit Dismissal Motion Ruling: In an August 13, 2010 order (here), District of Maryland Judge Catherine Blake denied in part and granted in part defendants’ motions to dismiss the securities class action lawsuit that had been filed against Constellation Energy.

 

As discussed here, Constellation Energy was one of the many nonfinancial companies that suffered credit crisis related financial reverses in late 2008 and early 2009 and attracted securities litigation arising out the companies’ financial woes.

 

In September 2008, Constellation shareholders and subordinated debenture holders filed a securities class action lawsuit against the company, certain of its directors and officers and offering underwriters. Their complaint asserts claims under Section 11, 12(a)(2) and 15 of the ’33 Act and under Section 10(b) of the ’34 Act.

 

Essentially, the plaintiffs alleged that the defendants had misrepresented the additional collateral the company would have to post in connection with its merchant energy business in the event of a company credit downgrade. (As the company itself later disclosed, the collateral requirements for a one-notch credit downgrade were less than had been disclosed; the collateral requirements for a two or three notch downgrade were significantly greater than disclosed.)

 

The plaintiffs also alleged that the defendants had not sufficiently disclosed the company’s exposure to Lehman Brothers. The plaintiffs also alleged that the defendants’ misrepresented the company’s future earnings, business outlook, risk management and internal controls.

 

In fall 2008, after the company suffered a several notch ratings downgrade and after Lehman collapsed, the company’s share price fell and investors’ sued. The company ultimately sold a substantial portion of its assets.

 

In her August 13 order, Judge Blake found that the plaintiffs’ ’33 Act allegations regarding the company’s downgrade collateral obligations were sufficient to state a claim. Interestingly, Judge Blake reached her conclusion even though the company’s debenture prices dropped only slightly immediately after the disclosure of the company’s revised collateral obligation and in fact rose thereafter for several weeks. These facts "ultimately may counsel against materiality" but are "not dispositive at this stage of the litigation.

 

Judge Blake found that the plaintiffs’ remaining ’33 Act allegations were insufficient to state a claim.

 

As for plaintiffs ’34 Act allegations, Judge Blake found that the plaintiffs had not adequately alleged scienter in connection with the downgrade collateral obligations. She noted that "without additional factual allegations that the defendants were somehow aware that the downgrade collateral requirements were miscalculated …neither Constellation nor its officers can be presumed to have known of a faulty computer calculation."

 

Judge Blake also found that the plaintiffs’ remaining ’34 Act allegations were inadequate.

 

I have also added the Fifth Third and Constellation Energy rulings to my running tally of credit crisis lawsuit dismissal motion rulings, which again can be accessed here.

 

Special thanks to a loyal reader for providing a copy of the Constellation Energy decision.

　

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In the latest development in the long-running lawsuit that is among the very few securities cases to actually have gone to trial, the Ninth Circuit – in its second crack at the case – affirmed the district court’s dismissal. The Ninth Circuit’s August 9, 2010 opinion (here) in the Thane International securities class action lawsuit affirmed the district court’s entry of judgment for the defendants on the issue of loss causation.

 

Background

Reliant Interactive Media Corp. was acquired by Thane International in September 2001. Reliant shareholders received Thane shares in the merger. Thane’s shares had not been publicly traded, but the merger prospectus stated that Thane’s shares had been "approved for quotation and trading on the NASDAQ National Market" upon completion of the merger.

 

However, when the merger was consummated, Thane’s shares commenced trading not on the NASDAQ National Market System by on the NASDAQ Over-the-Counter Bulletin Board. For nineteen days, the shares traded above the merger price. However, when the company then reported disappointing earnings, the share price fell, and it continued to decline until Thane ultimately bought back the shares at a fraction of the merger price.

 

In September 2002, a class of former Reliant shareholders sue Thane and four of its directors and officers under Sections 12(a)(2) and 15 of the ’33 Act, alleging that the pre-merger prospectus had been misleading because it implied that Thane Shares would list on the NASDAQ National Market System.

 

Following a three-day bench trial, the district court concluded that Thane did not violate Section 12(a)(2), finding that the prospectus was not misleading, and that in any event the misrepresentations were not material because Thane’s share price did not depreciate below the merger price after the market became aware of the market on which the company’s shares were trading.

 

As discussed here, in a prior appeal, the Ninth Circuit reversed the district court’s trial ruling, holding that the statements in the prospectus, even if literally true, contained misleading statements regarding where Thane shares would be listed and trade, and that the information was material, because a reasonable investor would have wanted to know where the shares would trade. However, the Ninth Circuit recognized that the defendants could still prevail by establishing the affirmative defense of lack of causation.

 

On remand, the district court held that the defendants had carried their burden of establishing lack of loss causation, holding that there could be no loss as long as Thane’s share price remained above the merger price, and there could be no loss causation since the stock price didn’t fall below the merger price after "impounding" the information about the nonlisting on the National Market System. The plaintiffs’ appealed.

 

The August 9 Opinion

In its latest opinion, the Ninth Circuit quickly rejected the plaintiffs’ argument that the appellate court’s prior ruling that the prospectus misrepresentation "foreclosed" the defendants’ reliance on the loss causation defense. The Ninth Circuit found that materiality and loss causation are separate issues, and the question whether investors would find information important (materiality) is different than the question whether a particular misstatement actually resulted in a loss (loss causation). Even if the "two inquiries are related" that "does not mean they are the same."

 

The Ninth Circuit also rejected the plaintiffs’ argument that, due to the inefficiency of the market in which Thane’s shares traded, the share price could not be used in a loss causation assessment. The Court said the absence of efficiency "does not mean that prices are unreliable." The Court rejected the theory urged by the plaintiffs that it is inappropriate to rely on stock prices in an inefficient market to determine loss causation.

 

Finally, the Ninth Circuit held that the district court did not err when it found that Thane’s share price had "impounded" (absorbed) the failure to list on the National Market System before it fell below the merger price.

 

Discussion

The decision is likely to be of greatest interest to the parties involved, although it also has some value for its analysis of the relation between materiality the loss causation issue. The Court’s analysis of the role in the loss causation analysis of prices for shares that trade on an inefficient market is also interesting.

 

However, the thing that makes this decision most noteworthy is that it involves one of the very rare securities class action lawsuits that actually went to trial. Yes, the trial was a three-day bench trial, and yes the case’s lengthy post-trial procedural history essentially reduces the fact that there was a trial to just one event in the long history of the case.

 

Nevertheless, the process of tracking securities cases that have gone to trial has taken on an importance of its own, so for purposes of maintaining the running scorecard of securities cases that have gone to trial, this Ninth Circuit’s decision upholding the lower court’s dismissal is noteworthy.

 

According to data compiled by Adam Savett, the Director of Securities Class Actions at Claims Compensation Bureau, there have been nine securities class action lawsuits that have gone to trial post-PSLRA involving post-PSLRA conduct, including the Thane International case. Taking the Ninth Circuit’s recent ruling in the Thane case into account (as well as other recent developments, including the Ninth Circuit’s recent action in the Apollo Group case), the scoreboard in those nine post-PSLRA cases currently stands at five for the plaintiffs and four for the defendants.

 

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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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Earlier this week, I hosted a guest post from the counsel for the plaintiffs in the Vivendi securities class action lawsuit, in which plaintiffs’ counsel summarized their position on the impact that the U.S. Supreme Court’s decision in Morrison v. National Australia Bank had on their case.

 

In response to their post, University of Minnesota Law Professor Richard Painter prepared the following commentary and submitted it to me for publication here. By way of background, Professor Painter’s opening reference is to George Conway of the Wachtell Lipton firm, who, as reported in the prior post on this topic, briefed and argued the Morrison case for National Australia Bank, and who has been quoted as characterizing the position of the Vivendi plaintiffs on this issue as “Completely nuts, N-U-T-S.” 

 

 

Here are Professor Painter’s comments:

 

 

Actually, Conway has to be right. The argument that Section 10(b) applies to foreign transactions in securities merely because those securities are listed in the United States is absurd.

 

 

First, a reading of the entire Morrison opinion leads to the conclusion that the Court did not extend the reach of Section 10(b) to foreign transactions in securities listed on an American exchange. The Court’s unequivocal holding is that Section 10(b) does not apply “extraterritorially.” The Court repeatedly emphasizes that the “focus” of American securities laws is on “domestic transactions” and on “purchases and sales of securities in the United States.”

 

 

An extremely large hole would be driven through that holding if the mere listing of a stock or an ADR on an American exchange were enough to justify application of U.S. law to a foreign purchase of the stock on a foreign exchange, as there are hundreds if not thousands of foreign issuers that list their home-country shares or ADRs on a U.S. exchange.

 

 

Second, the Court was well aware that NAB had ADRs listed in New York. In order for a foreign issuer to sponsor and list ADRs on a U.S. exchange, it must register the underlying, deposited shares with the SEC and, at least for the NYSE, actually list the underlying shares (though not for trading). NAB’s registration statement in the United States, for example, pertained to “ordinary shares” (At page 58 of the Supplemental Joint Appendix in Morrison v. NAB, the 20-F cover says NAB’s ordinary shares were “registered on the NYSE.” This cover looks exactly like the 20-F cover for Vivendi that the plaintiffs there are relying on.)

 

 

The Court nonetheless held that Section 10(b) did not apply to NAB’s ordinary shares traded in Australia. This holding is inconsistent with a theory that the Court would apply Section 10(b) to any security listed on a U.S. exchange even if the transaction in that security is outside the United States.

 

 

Many companies have ADRs trading in the United States. It cannot possibly be the case that the Court intended Section 10(b) to apply not only to the ADR itself but also to a foreign purchase of the underlying stock on a foreign exchange simply because the underlying shares are registered in the United States to enable the company to issue the ADR.

 

 

Indeed, if the Vivendi plaintiff’s counsel were correct, Section 10(b) after Morrison would have a broader extraterritorial reach than ever before. Think of the many foreign-cubed claims dismissed under the Second Circuit’s conduct test before the Supreme Court ruled: many – if not most – of the defendant issuers in those cases had sponsored ADRs that traded on American exchanges, just like NAB, and just like Vivendi. On plaintiffs’ reading of Morrison, those cases were wrongly dismissed. Section 10(b) – which the Supreme Court said did not have any extraterritorial application “at all” – according to Vivendi plaintiffs’ counsel would apply more extraterritorially than ever before.

 

 

This is the exact opposite of what the Court clearly intended. And it would mean that the Court got the result wrong in Morrison itself.

 

 

There are other points to make against the plaintiffs’ contention, such as the significance of Section 30 of the Exchange Act, whose territorial limitations would be rendered meaningless if plaintiffs’ reading of Morrison were correct. The bottom line is: it is quite clear that plaintiffs who transacted in securities outside the United States have no cause of action under Section 10(b) merely because these securities or related ADRs are listed on a U.S. securities exchange.

 

 

Nice try plaintiffs, but if you want a different rule, ask the SEC to recommend one in its study of extraterritorial private rights of action that Congress mandated in Dodd-Frank. Don’t waste your time with a meritless interpretation of Morrison.

 

 

I encourage reader to respond to Professor Painter’s commentary or to the Vivendi plaintiffs’ prior column using this blog’s comment function.

 

 

I welcome guest blog posts from responsible commentators on topics of interests to readers of this blog. Please contact me (using the Contact function in the right hand column) if you are interested in submitting a guest column.

 

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The New Century Financial securities class action lawsuit – which was the first of the subprime-related securities class action lawsuits when it was filed in February 2007 – has been settled for $124,827,088, subject to court approval. The plaintiffs’ July 30, 2010 unopposed motion for settlement approval can be found here.

 

The settlement actually consists of three separate settlement stipulations and three corresponding settlement funds. Of the total settlement amount, $65,077, 088 will be paid on behalf of the thirteen former New Century directors and officers; $44,650,000 will be paid on behalf of KPMG, New Century’s auditor; and $15 million will be paid on behalf of the offering underwriter defendants.

 

The $65 million to be paid in the class action settlement on behalf of the individual directors and officers is actually part of a larger settlement on the individuals’ behalf. As reflected in the separate director and officer settlement stipulation filed in connection the motion for settlement approval, a total of $91,102,331.51 will be paid in cash by eleven directors’ and officers’ liability insurers (which are listed on page 11 of the stipulation) in order to settle in whole or in part not only the claims against them in the securities class action lawsuits but also the claims pending against some or all of the individuals in proceedings before the SEC, in separate litigation brought against them by other plaintiffs, as well as bankruptcy trustee claims.

 

As reflected at greater length here, plaintiff investors first filed their action against the defendants in February 2007. New Century filed for bankruptcy in April 2007. In March 2008, the New Century bankruptcy examiner filed a report (refer here) finding, among other things, that the company had "engaged in a number of significant improper and imprudent practices related to its loan originations" that "created a ticking time bomb that detonated in 2007." On December 3, 2008, Central District of California Judge Dean Pregerson denied the defendants’ motions to dismiss (refer here).

 

The New Century Financial case was one of the higher profile subprime-related securities class action lawsuits and one of the most prominent in which the motion to dismiss was denied. However, as reflected in my running tally of subprime related case resolutions and settlements (which can be accessed here), it is only the fourth largest subprime securities suit settlement so far, behind the Countrywide settlement ($624 million), the Merrill Lynch settlement ($475 million) and the Merrill Lynch bondholders settlement ($150 million).

 

Unlike those larger settlements, however, in the New Century Financial case there was no viable entity remaining to fund a larger settlement. The size of the insurers’ contribution and the number of insurers involved in the D&O settlement stipulation suggests that the remaining D&O insurance was exhausted to fund the D&O portion of the settlement. These figures also suggest that there were certain constraints on the possible size of the settlement. KPMG’s very sizeable contribution of $44.75 million toward the settlement represents a significantly greater contribution that it paid in the much larger Countrywide settlement ($24 million).

 

I suspect that this was an enormously difficult settlement to pull off. Given the number of parties, the number of proceedings, the number of insurers, and the amount of money at stake, trying to settle this case undoubtedly was challenging, particularly since continuing defense expenses eroded the amount of insurance remaining as the settlement negotiations went forward. I tip my hat to the lawyers involved in bringing this settlement together.

 

The SEC’s separate July 30, 2010 announcement of its settlement of its enforcement action pending against three former New Century directors and officers can be found here. The stipulation of settlement in the class action lawsuit specifies that the portion of the $91 million in insurance funds is to be paid in part on behalf of the three individuals in the SEC proceeding; however, the stipulation specifies that these amounts "shall not be applied towards penalties owed pursuant to" the SEC settlement.

 

Another Subprime Securities Suit Settlement: In addition to the New Century Financial case, the subprime-related securities class action lawsuit involving The PMI Group also recently settled. The company announced in its August 3, 2010 filing on Form 1-Q (here) that on July 13, 2010 the parties agreed to a proposed settlement of $31.25 million, subject to court approval. The settlement is to be funded entirely by The PMI Group's insurers. Background regarding the case can be found here. Like the New Century Financial case, the PMI Group subprime-related securities class action lawsuit had also survived a motion to dismiss, as discussed here.

 

A Different Sort of Insurance Cover: Being an astronaut is a dangerous occupation, and those that climb into space launch vehicles understandably would want life insurance in case the worst were to happen. However, life insurers have proven reluctant to insure astronauts.

 

As reflected in this fascinating post on the UK Insurance blog (here), the interesting way the crews for the Apollo 11 through 16 dealt with this issue was for each crew member to sign specially issued, stamped and marked envelopes, with the idea that were the worst to happen, the value of the "insurance covers" would "sky-rocket" allowing the astronauts’ families to secure financial benefits without formal insurance.

 

Fortunately, none of the missions that used this makeshift form of insurance suffered any fatalities (though Apollo 1 did meet an unfortunate fate and later Space Shuttle Challenger and Columbia missions did suffer terrible disasters). The Apollo missions "insurance covers" were never used and now trade among collectors.

 

Special thanks to loyal reader Chris Areheart for sending along this interesting item.

　

　

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In a series of recent posts (most recently here), I have been taking a look at the practical impact that the U.S. Supreme Court’s June 24, 2010 decision in Morrison v. National Australia Bank will have on securities litigation in the United States involving non-U.S. companies. Among the cases seemingly most impacted by the decision is the Vivendi securities class action lawsuit pending in the Southern District of New York. Not only is the defendant company domiciled outside the United States, but about three quarters of its shareholders reside in France and most presumably purchased their shares on non-U.S. exchanges.

 

The question of whether these shareholders may assert a claim in a U.S. court under U.S. law is particularly acute due to the verdict that the jury returned on behalf of the plaintiffs in the case in January 2010.

 

As Andrew Longstreth reported on July 27, 2010 in the Am Law Litigation Daily (here), the parties to the Vivendi case recently presented their arguments to the court on the impact of Morrison. Among other things, the article characterized the plaintiffs’ argument that the foreign plaintiffs may proceed in the case as "highly creative" and the article also quoted George T. Conway III of the Wachtell Lipton law firm – who briefed and argued the Morrison case for the defendants – as describing the plaintiffs arguments as "Completely nuts, N-U-T-S."

 

After I linked to the Am Law Litigation Daily article, counsel for the plaintiffs in the Vivendi case reached out to me to express their concerns that their position has been misunderstood and is not receiving a fair hearing in the press and the blogosphere. In response, I offered to host a guest blog post on this site, in which the plaintiffs counsel could present their position as they wished. What follows is the guest post submitted to me by Michael Spencer of the Milberg law firm.

 

　

 

 

The emerging conventional wisdom in legal circles and the media is that the Supreme Court’s decision in Morrison v. National Australia Bank sounded the death knell for use of Section 10(b) of the Securities Exchange Act on behalf of "foreign" purchasers of securities who were allegedly defrauded. Some are even suggesting that defrauded Americans who bought shares traded on a foreign exchange have no remedy.

 

Any fair and careful lawyer should find that conventional wisdom galling. The first part of the test articulated by the Morrison Court is being missed -- or deliberately ignored. In assessing the so-called extraterritorial scope of Section 10(b), the Court applied the plain language of the statute and found coverage for "transactions in securities listed on domestic exchanges and domestic transactions in other securities." That holding is repeated several times in the Court’s decision, including in the final paragraph. But the first part of the test has been passed over in lower court decisions, legal commentary, and media reports in the month since Morrison was issued. It’s as though the words repeatedly used by Justice Scalia -- "securities listed on domestic exchanges" -- disappeared the moment he wrote them.

 

It is indubitable that many "foreign" companies’ ordinary (common) shares are registered under the Exchange Act and listed on the NYSE, even if the shares are not traded on the exchange and quoted in the Wall Street Journal. (Justice Scalia used "registered" and "listed" interchangeably; he said "The Act's registration requirements apply only to securities listed on national securities exchanges.") That is not surprising, since many provisions of the Exchange Act, including Section 10(b), come into play when securities are registered under the Act. Any competent corporate lawyer practicing in this area will confirm that foreign companies sponsoring upper-level ADR programs in the U.S. must, and do, register and list. Some observers are confusing registration and listing with "trading," but the Court repeatedly used "registered" and "listed," the terms from the statute and regulations. And those who think only the particular custodial shares "underlying" an ADR program get registered should please refer to 17 C.F.R. § 240.12d1-1 ("Registration effective as to class or series"). It takes 20 seconds to google a foreign company’s Form 20-F cover page to ascertain the status of its shares.

 

Justice Scalia usually means what he says. Under the plain language of the Supreme Court’s holding, Section 10(b) covers transactions in shares "listed on a domestic exchange." Period. No matter whether the purchaser is foreign or domestic, no matter where the transaction occurred.

 

That result apparently gets defense lawyers in a dither. Wachtell partner George Conway, who represented the winner in Morrison, was quoted as calling the argument "N-U-T-S." As a plaintiffs’ lawyer, I’m happy to read that reaction -- if Conway can respond only with a quip rather than a substantive answer, we are probably on to something. The argument wasn’t made by plaintiffs’ counsel in recent motion practice over whether claims even by domestic purchasers of Credit Suisse ordinary shares traded abroad survive after Morrison; SDNY Judge Marrero dismissed the claims, persumably without knowing that the company is registered and listed on the NYSE. SDNY Judge Holwell has the question squarely before him in post-verdict motions in Vivendi for both foreign and domestic ordinary share purchasers, and will probably rule within the next month or so. Today’s conventional wisdom should by right become tomorrow’s embarrassment.

 

　

 

 

I encourage readers who have comments in response to Michael Spencer’s guest post to add their comments to this post using the site’s Comment feature.

 

I would like to thank Michael Spencer for his willingness to submit this post and have it published on this site. I welcome the opportunity to publish guest posts from responsible observers on this site. Those who may be interested in publishing a guest post on this site should feel free to contact me using the Contact function in the upper right hand column of this site.

　

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On July 28, 2010, Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse issued the most recent entry in the series of mid-year 2010 securities class action litigation studies. Its report, entitled "Securities Class Action Litigation: 2010 Mid-Year Assessment" can be found here. The related July 28 press release can be found here.

 

Consistent with the earlier studies that have been released, the Cornerstone study reports that securities class action litigation continued to decline in the first-half of 2010. According to the study, there were 71 class action securities lawsuits in the first six months of 2010, which represents about a 15% decline from the 84 that were filed in the first half of 2009. The 2010 first half filings represent the lowest semiannual total since the first half of 2007. The 71 first half filings annualize to 142, which would be well below the 1997-2009 annual average of 195 filings.

 

One note about the way that Cornerstone "counts" lawsuits – unlike some of the other securities litigation reports (for example, the NERA Economic Consulting study released yesterday), the Cornerstone report counts all related lawsuits filed against the same defendants as a single lawsuit, even if filed in different judicial districts. This counting protocol helps explain why the Cornerstone tally appears to differ from other published lawsuit counts.

 

The Cornerstone report attributes the relative decline in class action lawsuit filings to the decline in the number of lawsuits relating to the credit crisis. However, though credit crisis-related lawsuits have declined, companies in the financial services industry remain the most frequently targeted. Health Care and Energy companies experienced a pick up in first half filings as well.

 

The Cornerstone study reports that the average "lag" between the end of the proposed class period cutoff date and the initial filing date declined in the first half of 2010 compared to recent periods, suggesting that the plaintiffs may be catching up on their lawsuit filing "backlog."

 

My own prior analysis of the first half securities litigation can be found here. Advisen’s study can be found here. NERA’s study can be found here.

 

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The Supreme Court’s decision last month in the Morrison v. National Australia Bank precludes so-called "f-cubed" claims (claims brought by foreign plaintiffs who bought foreign stock on a foreign exchange). An unanswered question is whether Morrison also precludes "f-squared" claims – that is, claims by Americans who bought their shares of foreign companies on foreign exchanges. In a July 27, 2010 opinion, Southern District of New York Judge Victor Marrero ruled in the Credit Suisse Group case that Morrison also precludes the f-squared claims as well.

 

Background

As discussed at greater length here, In the majoirty opinion in Morrison, the U.S. Supreme Court said that the relevant portions of the U.S. securities laws related solely to "transactions in securities listed on domestic exchanges" and to claims relating to "domestic transactions in other securities." Unfortunately, the opinion does not say what is meant by "domstic transactions," although the opinoin does later provide an alternative formulation of this second prong, clarifying that the relevant scope of the securities laws includes "the purchase or sale of any other security in the United States."

 

As I recently noted (here), on July 16, 2010, Central District of California Judge Dale Fischer held in connection with the lead plaintiff motion in the Toyota securities class action lawsuit that the argument that Morrison precluded f-squared claims was "better supported" by the Supreme Court’s decision. However, Judge Fischer emphasized that she was not making a "final determination" of the issue, and that her analysis for purposes of the lead plaintiff motion would not preclude the plaintiffs in that case from arguing that U.S. residents who purchased Toyota common stock on the Tokyo stock exchange have claims under the U.S. securities laws.

 

Though Judge Fischer drew back from making a "final determination" in the Toyota case that Morrison precluded f-squared claims, at least one U.S. court has now made such a determination on the merits. In his July 27 opinion in the Credit Suisse case, Judge Victor Marrero concluded that, in addition to f-cubed cases, Morrison also precludes claims f-squared claims as well.

 

As detailed here, Credit Suisse shareholders first sued the company and certain of its directors and officers in April 2008. The plaintiffs alleged that defendants failed to record losses on the deterioration in mortgage assets and collateralized debt obligations ("CDOs") on Credit Suisse’s books; that Credit Suisse’s internal controls were inadequate to ensure that losses on residential mortgage-related assets were accounted for properly; and that Credit Suisse’s traders had put incorrect values on CDOs and other debt securities, concealing the exposure the Company had to losses.

 

As discussed here, Judge Marrero had initially dismissed the plaintiffs’ claims, but in a February 11, 2010 decision, he held that the plaintiffs’ proposed Second Amended Complaint was sufficient to overcome the initial defects and he allowed the case to go forward as to plaintiff shareholders who had purchased Credit Suisse ADRs on the NYSE and as to U.S.-based shareholders who had purchased Credit Suisse shares on the Swiss Stock Exchange. However, he also ruled that he also ruled that the court lacked jurisdiction over the claims of plaintiffs that resided outside the U.S. and that had purchased their shares outside the U.S. – that is, he previously precluded the f-cubed claimants’ claims.

 

The July 27 Decision

Judge Marrero’s July 27 ruling related to one of the two groups of claimants whose claims he had previously ruled could go forward – that is, the U.S.-based shareholders who bought their shares outside the U.S. The defendants in the Credit Suisse case moved, in light of the Morrison decision, for a partial judgment on the pleadings to dismiss the plaintiffs who had purchased their Credit Suisse shares on the Swiss Stock Exchange. In his July 27 opinion, Judge Marrero granted the defendants’ motion.

 

In opening his discussion of the issues, Judge Marrero said that Morrison had "buried the venerable ‘conduct or effect’ test." For the remainder of the opinion, Judge Marrero worked this metaphor that the prior test is dead and buried. Thus, he characterized plaintiffs’ arguments by saying that the plaintiffs "seek to exhume and revive the body." However, the jurisprudence on which the plaintiffs seek to rely is now a "dead letter" and the plaintiffs’ "cosmetic touch-ups will not give the corpse a new life."

 

The Morrison court had held that Section 10(b) related only to the purchase or sale of a security listed on an American exchange or the purchase or sale of any other security in the United States. Judge Marrero said that "a corollary of this rule" is that the Act’s provisions "would not apply" to transactions involving the purchase or sale, wherever it occurs, of securities listed only on a foreign exchange or a purchase or sale of securities, foreign or domestic, which occurs outside the United States.

 

Judge Marrero said that the Morrison court had eliminated the prior doctrine and replaced it with "a new bright-line transactional rule embodying the clarity, simplicity, certainty and consistency" that the prior rule lacked. He said further that nothing in Morrison envisions the "exceptions and embellishments with which Plaintiffs seek to embellish the rule" – indeed an exception for U.S.-based investors who purchases shares on foreign exchanges would, Judge Marrero said, merely reinstate the old "effects" test and an exception because portions of the transactions took place in the U.S. would restore the old "conducts" test.

 

The urged exception, Judge Marrero said, would "defeat the various purposes the Supreme Court’s rule seeks to achieve" and would also, contrary to require U.S. courts to "enforce American laws regulating transactions in securities that are also governed by the laws of the foreign country."

 

The plaintiffs had argued that the Morrison court had not decided any of these issues, and that Morrison appropriately should be limited to its facts and limited holding. Judge Marrero said, however, that the Supreme Court’s decision in Morrison cannot be "squeezed, as in spandex, only into the factual straightjacket of its holding." The Supreme Court, Judge Marrero said, "went out of its way to fashion a new rule designed to correct the enumerated flaws" of the prior "conduct and effects" test, and the "geographic exception" "would not satisfy the new rule."

 

Judge Marrero concluded by saying that in the Morrison case, the Second Circuit’s conduct and effect doctrine "took a great fall" and "neither the Plaintiffs’ law horses nor this Court’s pen can put the pieces together again."

 

Discussion

Despite the tone of certainty of Judge Marrero’s opinion, it remains to be seen whether or not other courts will similarly conclude that Morrison precludes f-squared claims. His opinion depends fundamentally on what he describes as the "corollary" of the Supreme Court’s holding in Morrison – the issues he decided were not, strictly speaking, before the Supreme Court in Morrison. Plaintiffs in other cases will undoubtedly argue, as the plaintiffs attempted to argue here, that the Supreme Court’s holding simply did not reach these issues, which were not before the Court.

 

But Judge Marrero in the Credit Suisse case, as well as Judge Fischer in the Toyota case, had no problem concluding that Morrison required them to reach the result they did, and it clearly will be challenging for plaintiffs in other cases to argue that the "transaction" test enunciated in Morrison left enough room for U.S-based shareholders of who purchased their shares on foreign exchanges – particularly with these lower court decisions on the books.

 

Fundamentally, the claimants in other cases will have to argue that the second prong of the Supreme Court’s "transactional" test – that is "(ii) the purchase or sale of any securitiy in the U.S." -- preserved courts’ authority to reach claims of U.S.-based purchasers, even where the transaction may have taken place outside the U.S. If Judge Marrero’s opinion is any indication, these claimants may face an uphill battle.

　

Special thanks to the several loyal readers who sent me copy of Judge Marrero’s opinion.

 

Did the Dodd-Frank Act Change Anything?: Judge Marrero notes in a final footnote to his opinion, for "whatever comfort it may bring to Plaintiffs and counsel," that Section 929(b) of the Dodd-Frank Act granted federal courts extraterritorial jurisdiction under the conduct or effect test for proceedings brought by the SEC. (The Act also calls for further SEC study of the issue of the extraterritoriality of the U.S. securities laws.)

 

However, according to a July 21, 2010 memo by George T. Conway, III of the Wachtell Lipton law firm, as a result of a "drafting error," the new provision purporting to give the SEC extraterritorial authority under certain circumstances is ineffective. (Conway, it should be noted, briefed and argued the Morrison case for the defendants.) Conway points out that the new statutory provision unambiguously refers only to the "jurisdiction" of the U.S. courts, which he says, is not sufficient to extend court’s authority in light of the Morrison case:

 

In National Australia Bank, the Supreme Court reiterated the longstanding principle that the territorial scope of a federal law does not present a question of "jurisdiction," of a "tribunal’s power to hear a case," but rather a question of substance—of "what conduct" does the law "prohibit"? The new law does not address that issue, and accordingly does not expand the territorial scope of the government’s enforcement powers at all.

 

Of course, Conway notes, some courts may be "tempted" to find that Section 929(b) extended the courts’ reach, but courts generally are admonished to refrain from correcting Congressional drafting errors. In other words, Congress may have to go back and tone up the language in Section 929(b) in order for the SEC effectively to be able to exercise the authority Congress intended to extend in that provision.

 

Meanwhile, Vivendi Plaintiffs Get "Creative": The defendants in the Vivendi securities class action case are also trying to narrow the plaintiffs’ claims in their case, which is an exercise of considerable import give the jury verdict entered on behalf of plaintiffs in the case in January 2010. According to Andrew Longstreth’s July 27, 2010 Am Law Litigation Daily article (here), the plaintiffs are getting rather "creative" in their efforts to argue that Morrison does not preclude the claims of the claimants who purchased their Vivendi shares outside the U.S.

 

The plaintiffs arguments are complicated but basically they are arguing that because Vivendi ADRs trade on the NYSE, and the ADRs are backed by common shares, the company’s common shares trade in the U.S. (there may be more to it than that, but I have to admit I really didn’t understand the argument after a couple of tries). The article quotes George Conway (whom I cited in the preceding item) as saying that the plaintiffs’ arguments are "Completely nuts. N-U-T-S."

 

The point is that plaintiffs in many pending are scrambling to try to preserve what they can in the wake of the Morrison decision. For many plaintiffs, it is going to be an uphill battle.

 

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Largely as a result in the decline of the number of new credit crisis related cases, the number of new securities class action lawsuits filings is "on track to decline for a second successive year from their 2008 peak," according to a NERA Economic Consulting report entitled "Trends 2010 Mid-Year Study: Filings Decline as the Wave of Credit Crisis Cases Subsides, Median Settlements at Record High," released on July 27, 2010. The report can be found here and NERA’s July 27, 2010 press release about the report can be found here.

 

According to NERA, there were 101 securities class action lawsuit filings in the first half of the year. That filing level projects to 202 filings for the year, which would represent a decline from the 221 filings in 2009 and the 221 filings in 2008, as well as the 1997-2004 average of 231.

 

A note about how NERA counts filings – as reflected in a footnote in the report, NERA counts multiple filings in separate circuits that may relate to the same fraud as separate filings until they are consolidated. It addition, NERA reports multiple filings if different cases are filed on behalf of securityholders. These counting protocols may result in NERA’s filings figures appearing slightly higher than those in other reports published by other observers who may count each of these types of filings only once.

 

Though NERA’s numbers may differ in the details, its figures are directionally consistent with other published analyses of mid-year filing levels, including the Advisen’s recent report (about which refer here). My own analysis of mid-year filing can be found here.

 

According to the report, the drop off in securities class action lawsuits has been partially offset by an increase in other types of lawsuits, including cases alleging breaches of fiduciary duties. And though the numbers of credit crisis related cases have declined compare to recent years, the credit crisis "continues to generate a substantial volume of litigation" beyond just securities class action litigation, including state court derivative litigation, ERISA litigation and other types of cases.

 

Despite the decline in credit crisis cases, companies in the financial sector remained the most frequent securities class action lawsuit target in the first half of 2010, though the health technology sector saw the largest percentage increase in filings between 2009 and annualized 2010. The report notes in particular the growth in the first half of 2010 in cases alleging product and operational defects. This category encompasses both traditional, tangible goods and financial products like ETFs and CDOs, but the more traditional allegations (such as those relating to the Gulf of Mexico oil spill and the Toyota vehicle recall) were most frequent.

 

According to the NERA report filings against foreign-domiciled companies represented about 16% of all first half filings, a larger share than any year since the PSLRA’s enactment. However, the report also notes that the U.S. Supreme Court’s Morrison v. National Australia Bank case could substantially affect these filing levels going forward.

 

The average time to filing from the end of the proposed class period to the date of the first filing was 231 days, which though below the 272 day average during the second half of 2009, is still well below the average of 141 days during the period 2007 to mid-2009. However, more than half of the first have filings were made within 66 days, which the report notes that the filing lag may have been attributable to plaintiffs’ attorneys catching up on a filing backlog.

 

Though average securities class settlements, when factored for outlier settlements, were slightly down in the year’s first half, the median settlement in the first six months of 2010 was $11.8 million, which continues in the generally upward trend in median settlements. The median in 1996 was $3.7 million, and only exceeded $6 million once between 1996 and 2004. However, since 2005, the median has exceeded $7 million every year, and the first half 2010 median is more than three times the 1996 median.

 

The report contains a number of other interesting analyses, including a detailed study of the amount of time required for securities class action case resolutions and the percentage of plaintiffs’ attorneys’ fees as proportions of settlement amounts. The analysis of plaintiffs’ attorneys’ fees shows that the percentage of fees is markedly smaller for larger cases – though the fees represent as much as a third for settlements below $5 million, they represent only about 8.8% of settlements over $500 million.

 

The report notes that median investor losses for cases filed in the first half of 2010 fell for the first time since the credit crisis began. The lower median losses "indicate that the typical settlement may eventually fall from its current high level," though the higher investor losses involved in the many pending credit crisis cases "suggests that there may be a number of large settlements in the pipeline."

 

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A couple of years ago, a "worrisome trend" developed in securities class action litigation, in which large institutional investors began routinely opting out of plaintiff class to separately pursue their own individual claims under the securities laws. The settlement of these individual opt out actions in many cases rivaled, in the aggregate, the amount of the class action settlement, and often exceeded the class settlement in terms of percentage of shareholder losses recovered.

 

These developments caused some observers to question whether we were headed toward a two-tiered system of securities litigation, where the large institutional investors separately pursued their own claims and the class action proceeded on behalf of other investors.

 

As it turned out, however, the phenomenon of the large individual opt out settlement separate from the class has ceased to be as prominent as it briefly was during the period 2006 to 2008. Since that time, there have been fewer high profile opt out settlements, and the predictions about fundamental alterations of securities class action litigation have died down.

 

However, in a development that seems to raise the possibility that the high profile opt-out action may be back, on July 22, 2010, New York Comptroller Thomas P. DiNapoli announced that he had filed two separate individual actions on behalf of New York state pension funds against Merrill Lynch and Bank of America and their respective individual directors and officers.

 

In the Merrill Lynch complaint (a copy of which can be found here), DiNapoli alleges that between October 17, 2006 and December 31, 2008, the defendants misrepresented the company’s "true exposures to poorly underwritten subprime mortgages, as well as the value of the Company’s subprime-exposed assets and liabilities and the effectiveness of Merrill’s risk management. The complaint alleges beginning in October 2007 the company began a series of stair step writedowns of the value of the company’s toxic assets, and that ultimately the company was forced to merge with Bank of America as a result of its exposure to subprime mortgages.

 

In the Bank of America Complaint (a copy of which can be found here), DiNapoli alleges in the documents for BoA’s merger with Merrill, the company and three of its senior executives failed to disclose Merrill’s massive fourth quarter 2008 losses and also failed to disclose BofA’s and Merrill’s agreement to permit Merrill to pay up to $5.8 billion in bonuses. The Complaint also alleges that the defendants violated the securities laws through a series of misleading statements and omissions during the period September 15, 2008 (when the merger was announced) and January 21, 2009 (when the information about the fourth quarter losses and the bonuses were made public).

 

The New York State Pension funds owned 17.7 million BofA shares at the time of the merger and acquired another 3 million between September 15, 2008 and January 21, 2009.

 

The circumstances described in DiNapoli’s complaints have previously been the subject of extensive litigation. Among other things, the allegations in DiNapoli’s complaint against the Bank of America defendants previously were the subjective of a high profile SEC enforcement action that ultimately resulted in a $150 million settlement. (For a discussion of the events surrounding this SEC settlement, refer here.)

 

In addition, there previously have been securities class action lawsuits filed against both the Merrill defendants and Bank of America defendants. The Bank of America class action lawsuit is in fact being driven by a group of public pension fund defendants, led by Ohio Attorney General Richard Cordray on behalf of Ohio public pension funds.

The circumstances referenced in DiNapoli’s Merrill Lynch complaint were also the subject of a separate securities class action lawsuit, about which refer here. Indeed, the parties to the Merrill Lynch lawsuit have already entered a $475 million settlement on behalf of the class, which the Southern District of New York Judge Jed Rakoff approved on August 4, 2009.

 

In bringing his separate lawsuits on behalf of the New York public pension funds, DiNapoli has made a conscious and deliberate decision to opt out of the preexisting class action litigation against the two sets of defendants. Public statements by representatives of DiNapoli’s office made it clear the reason he took the separate action on behalf of the public pension funds is because "our attorneys believe this gives us a chance to get a better recovery." The possible recovery on behalf of the funds could reach "tens of millions of dollars."

 

DiNapoli’s action to opt out of the class action on the theory that the funds’ recovery will be greater if they proceed individually rather than part of the class is exactly what commentators had been predicting a couple of years ago, before the opt-out phenomenon faded into the background. DiNapoli’s action is all the more noteworthy with respect to the Merrill Lynch suit is all the more noteworthy, given the fact that the class has already entered a massive $475 million settlement. DiNapoli’s action not only raises the question whether other institutional plaintiffs might opt out in these cases, but whether the plaintiffs will opt out in other cases as well.

 

The interesting thing about the public explanations for DiNapoli’s action is that the decision seems to be the result of persuasion from the attorneys who convinced DiNapoli’s office to opt out. The presence of an entrepreneurial group of plaintiffs’ lawyers motivated to try to obtain individual institutional investor representations by convincing the investors to opt out of the class suggests that, even if the prevalence of high profile opt out actions may have faded into the background, we are likely to continue more of these kinds of developments going forward. The political motivations of public pension fund representatives clearly support these developments.

 

Of course, it remains to be seen if the New York funds will actually fare better than the classes in these cases. As Adam Savett pointed out in an interesting January 22, 2010 post on the Securities Litigation Watch, even if some claimant fare better by opting out, there can also be a "downside." The post refers to the claimants that opted out of the Aspen Technology class action (which settled for $5.6 million) but ultimately had their claims dismissed based on lack of proof of fraud, and so received nothing.

 

Nevertheless, if other institutional investors are persuaded that they will do better by proceeding individually, securities class action litigation could become even more complicated than it already is. The existence of separate proceedings could both drive up total litigation costs and increase both the cost and complexity of case settlements. My prior discussion of the potential problems the opt-out phenomenon might represent can be found here.

 

DiNapoli’s decision to separate the New York funds from the Bank of America class action, in which the Ohio Attorney General is taking the lead, presents an interesting contrast to DiNapoli’s actions in connection with the securities litigation pending against BP, in which the Ohio AG and DiNapoli are collaboratively pursing the class action litigation on behalf of their respective states’ pension funds, and, as reflected here, are in fact together seeking lead plaintiff status in the litigation. Whatever else might be said, it seems that DiNapoli has not been persuaded that the New York funds will always do better outside of the class action process.

 

Understanding the Global Economy: If like me you find so much about the current circumstances of the global economy confusing, you will want to watch the following John Clark and Bryan Dawe video in which they summarize the basics in an admirable fashion, particularly the way the unbroken chain of governmental borrowing ultimately presents unanswerable questions. (Special thanks to the CorporateCounsel.net blog for the link to this entertaining video.)

 

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The U.S. Supreme Court’s decision last month in the Morrison v. National Australia Bank case made it clear U.S. securities laws do not allow so-called "f-cubed" cases -- securities claims against foreign domiciled companies and brought by foreign-domiciled claimants who purchased their company shares on foreign exchanges -- in U.S. courts. The securities laws, the Court said in Morrison, relate solely to "transactions in securities listed on domestic exchanges" and to claims relating to "domestic transactions in other securities."

 

But what did the Court mean when it referred to "domestic transactions"? Unfortunately the Court didn’t say. As the recent lead plaintiff decision in the securities class action lawsuit involving Toyota demonstrates, this question could be a problem in many cases involving foreign companies, particularly where the cases involve claims brought by or on behalf of U.S. domiciled investors who bought their shares in the foreign companies on foreign exchanges – the so-called "f-squared" claimants.

 

These issues were addressed recently in the lead plaintiff decisions in the Toyota class action securities litigation. As discussed at greater length here, in February 2010, Toyota and certain related corporate entitles, as well as certain of its directors and officers, were sued in securities class action lawsuit in the Central District of California. The plaintiffs allege that Toyota misled investors by allegedly failing to disclose that there was a design defect in Toyota’s acceleration system that could cause its cars to accelerate suddenly.

 

Toyota’s common stock trades on the Tokyo stock exchange and its American Depository Shares trade on the NYSE.

 

The Supreme Court’s Morrison decision became relevant in connection with the court’s selection of lead plaintiff in the Toyota case. As reflected in her July 16, 2010 memorandum opinion, Judge Dale Fischer had to determine whether or not the Morrison decision allows claims under the securities laws by domestic U.S. shareholders who purchased their shares in a foreign company on a foreign exchange. She had to determine for purposes of the lead plaintiff motion whether the claims of U.S. purchasers of Toyota common stock on the Tokyo exchange were relevant for purposes of the lead plaintiff selection.

 

In her July 16 opinion, Judge Fischer noted the Morrison decision’s statement that the securities laws allows claims relating to "domestic transactions in other securities," which the decision also refers to as "the purchase or sale of any security in the United States." In exploring what these phrases from the Morrison decision might mean, Judge Fischer said:

 

One view of the Supreme Court’s holding is that if the purchaser or seller resides in the United States and completes a transaction on a foreign exchange from the United States, the purchase or sale has taken place in the United States. However, an alternative view is that because the actual transaction takes place on the foreign exchange, the purchaser or seller has figuratively traveled to that foreign exchange – presumably via a foreign broker – to complete the transaction. Under this second view, "domestic transactions" or "purchase[s] or sales[s]…in the United States" means purchases and sales of securities explicitly solicited by the issuer within the United States rather than transactions in foreign-traded securities where the ultimate purchaser or seller has physically remained in the United States.

 

Judge Fischer concluded that the latter of these two positions was "better supported" by Morrison, largely because the Morrison decision emphasized that the U.S. securities laws were not intended to regulate the foreign exchanges.

 

Having worked through this analysis of whose claims were proper under the U.S. securities laws, Judge Fischer then selected as lead plaintiff the proposed lead plaintiff that had the larges alleged American Depository Share loss.

 

However, Judge Fischer did say at the outset of her opinion with respect to her analysis of whose claims the Court could properly entertain that "this is not a final determination of the issue and Plaintiffs are not foreclosed from arguing that domestic purchasers of Toyota common stock [as opposed to domestic purchasers of Toyota’s American Depository Shares] have claims" under the securities laws." She added, however, that "the Court currently believes that a fair reading of Morrison excludes those claims" – that is, the claims of domestic U.S. shareholders who purchases Toyota’s common stock on the Tokyo stock exchange.

 

When the U.S. Supreme Court released its opinion in the Morrison case, it was immediately apparent that the decision would have a significant potential impact on pending and future securities cases involving foreign-domiciled companies. However, as the lead plaintiff decision in the Toyota case shows, it may not be entirely clear how the Morrison decision will affect the cases against foreign companies.

 

It remains to be seen whether or not "f-squared" cases will be precluded on the Morrison decision, but it seems likely that this will be a hotly contested battleground in many of the cases involving foreign companies.

 

Very special thanks to a loyal reader for providing me with a copy of Judge Fischer’s July 16 opinion.

 

My pre-Morrison discussion of an" f-squared claimant" case involving European Aeronautic Defence & Space Co. (EADS) can be found here.

 

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When Ohio Attorney General Richard Cordray announced this past Friday that he had entered a massive $725 million settlement on behalf of three Ohio pension funds in the long standing securities class action lawsuit against AIG, he definitely accomplished his objective –his announcement made the front pages of all the newspapers in Ohio (it was the lead story in Saturday’s Cleveland Plain Dealer).

 

There is only one problem. AIG doesn’t have the money to pay for the settlement. The plan, such as it is, is that AIG is going to fund the first $175 million following the settlement’s preliminary approval. Then, AIG is going to try to conduct a stock offering to raise the remaining $550 million.

 

As Susan Beck put it on the Am Law Litigation Daily, there have been lots of settlement over the years, but "we’ve never seen one quite like this."

 

As reflected in greater detail here, the plaintiffs first sued AIG, certain of its directors and officers, its auditor and certain third parties in October 2004, shortly after then-New York Attorney General Eliot Spitzer first announced his investigation of a "scheme" in connection with commercial insurance transactions involving bid-rigging and the payment of contingent commissions. Further allegations made their way into the complaint following additional revelations.

 

The plaintiffs’ 497-page consolidated third amended complaint filed in March 2006 included  the bid-rigging and contingent commission allegations, as well as allegations that AIG falsified its financial statements, among other things, by entry into a finite reinsurance transaction with General Reinsurance Corporation, as well as of reinsurance transactions with other offshore entities. In May 2005 AIG restated five years of earnings, reducing shareholders’ equity by more than $2.7 billion.

 

Even before the $725 million AIG settlement announced Friday, the Ohio AG’s office had already entered settlements totaling $284.5 million in the case. First, on October 3, 2008, the Ohio AG entered a $97.5 million settlement with PricewaterhouseCoopers, as reflected here.

 

Second, on February 2, 2009, the Ohio AG announced that Gen Re had agreed to a $72 million settlement.

 

Third, on August 13, 2009, the Ohio AG announced that he had entered a $115 million settlement with former AIG CEO Maurice Greenberg, and several other former AIG executives, as well as certain corporate entities affiliated with Greenberg. (Several of these same individuals and entities also separately settled a related derivative lawsuit for $115 million, largely funded by insurance, as discussed here.)

 

The sum of these settlements in the securities class action case, including the recently announced settlement with AIG, is $1.0095 billion, which, according to data from Risk Metrics (here), would rank as the tenth largest securities class action settlement amount. Indeed, the AIG settlement by itself would rank twelfth on the list.

 

There is the small problem of how AIG’s is going to pay for the $725 million settlement. The company, you will recall, has received over $130 billion in U.S government bailout support and is now 80 percent owned by the U.S. taxpayers. The company is struggling to sell assets to repay the bailout money.

 

According to AIG’s July 16, 2010 filing on Form 8-K, the settlement is "conditioned on its having consummated one or more common stock offerings raising net proceeds of at least $550 million prior to final court approval." The decision whether "market conditions or pending or contemplated corporate transactions make it commercially reasonable to proceed with such an offering will be within AIG’s unilateral discretion."

 

The intent is for AIG to register a secondary offering of common stock on behalf of the U.S. Treasury. AIG also has the option to fund the $550 million from other sources. If AIG fails to fund the $550 million, the plaintiffs have several options. They can terminate the agreement; they can "elect to acquire freely transferable shares of AIG common stock with a market value of $550 million provided AIG is able to obtain the necessary approvals"; or they can  extend the period for AIG to complete the offering.

 

A securities offering conducted for the sole purpose of funding past litigation is not exactly the most attractive investment opportunity, even under the best of circumstances. But these are not the best of circumstances for AIG. Indeed, the settlement’s announcement comes at a time when the company’s leadership seems in disarray, after the company’s board chair resigned following a "board battle" with the current CEO. The company faces a daunting array of challenges as it seeks to repay the bailout money, as reflected in a July 17, 2010 Wall Street Journal article here unrelated to the settlement and the projected stock offering,

 

A July 16, 2010 New York Times article about the settlement quotes one commentator as saying, "There’s still a lot of question marks hanging over AIG. How would you write the prospectus for it? The document would be quite appalling when it described the risks."

 

The offering would, according to the article, be "rife with uncertainties" given the fact that the offering would be dilutive of the government’s ownership interest. On the other hand, as the article also points out, "taxpayers and legislators would cry foul" if the lawsuit were funded out of the $22 billion that remains available to the company.

 

Along with the questions of how the company will fund the $550 million settlement chunk is the question of how the company is paying for the first $175 million. Given the U.S. taxpayers’ interest in the company, it seems like there should be some explanation somewhere about the source of that money, but none of the publicly available information provides any explanation. It is possible that insurance will fund that portion, although none of the disclosure documents make any suggestion of that possibility, and in addition, significant insurance funds were previously paid to fund the derivative lawsuit settlement identified above. The settlement agreement itself might answer the question, but it is not yet available on PACER.

 

The lawsuit itself is a vestige of a different time and place. Though the events involved are only a half dozen years in the past, the complaint reflects a lengthy roster of individuals whose roles have long-since changed in ways that no one could possibly have imagined at the time. The alleged wrongdoing , while involving some fairly egregious circumstances, pales by comparison with the cataclysmic events that followed. Given this antediluvian aspect of this case, it does seem high time that it settled. However, only time will tell if the parties have in fact succeeded in driving a stake into the heart of this beast.

 

Somehow it seems fitting that just this past week there were news reports that during a recent lunch at the Four Seasons Hotel in New York, where Greenberg was having lunch with former Citigroup CEO Sandy Weill, Spitzer approached Greenberg, stuck his hand out, and asked Greenberg if he would appear on Spitzer’s CNN show. Unsurprisingly, Greenberg declined. Can you imagine the look on Greenberg’s face? The world is a very strange place sometimes. Or, at least there are some strange inhabitants.

 

It is also entirely fitting that Cordray’s and Spitzer’s names should be linked in connection with this story. Cordray has definitely borrowed several key pages out of Spitzer’s political play book. Playing the role of Wall Street Scourge definitely worked for Spitzer, at least until his extracurricular activities earned him some extended gardening leave followed by his current rehabilitation assignment on CNN. It also seemed like it was working for Connecticut AG Richard Blumenthal until it turned out he had oversold his credentials as a veteran.

 

Cordray is playing the angle for all it is worth. His website has a separate page devoted to securities class action litigation activities, including a June 1, 2010 summary of the current cases. (The document is headed "Holding Wall Street Accountable.") However, it is probably worth noting that many of the cases on Cordray’s list were actually launched by his predecessors, although Cordray did demonstrate his own initiative with the action he recently filed against the rating agencies, about which refer here.

 

The New Homogeneity: If, as seems likely, Elena Kagan’s nomination to the Supreme Court is confirmed, the Court’s make-up will, at least in certain respects, reflect unprecedented levels of diversity. Three women will be served on the Court for the first time. The Court includes a Hispanic and an African-American. There will be six Catholics and three jews, although, curiously, no Protestants.

 

But in another respect, Kagan’s arrival will make the Court even less diverse. As detailed on a July 16, 2010 post on the Economix blog (here), with Kagan’s addition, eight out of the nine justices will have attended one of two elite East Coast, Ivy League law schools. The only exception, Justice Ginsberg, graduated from Columbia Law School, but she started at Harvard and transferred after her first year to be in New York with her husband. According to data cited in the blog post, for the first time in the Court’s history, every sitting justice will have a law degree from the Ivy League.

 

The immediate question is whether this matters. There has always been a healthy representation of Ivy League graduates on the Court. Such luminaries as Oliver Wendell Holmes and Louis Brandeis immediately come to mind.

 

But even if the Ivy League has always been well represented on the Court, it has never been quite so dominant, and a wider diversity of educational backgrounds was always present. William Rehquist and Sandra Day O’Connor were classmates at Stanford Law School. Earl Warren attended Boalt Hall at the University of California. Warren Berger attended the William Mitchell College of Law. Indeed, Robert Jackson, usually cited as one of the Court’s finest writers, did not even graduate from law school, but rather apprenticed for a lawyer in Jamestown, New York.

 

Nor is the Court is the only branch of government that has been captured by these same two schools. The last four occupants of the White House, including the current President, all have at least one educational degree from one of these same two schools. (George W. Bush had one of each.)

 

When and how did this very peculiar form of elitism get instituted?

 

To be sure, no one could claim that the current justices or the recent Presidents are cookie cutter copies of each other. But the concentration of power and authority in the hands of a few persons sharing the same elite background seems highly antithetical to some of the most basic notions of American self-government. Or to put it another way, if ethnic and gender diversity are desirable goals, at the same time shouldn’t we be taking care that we are not undermining the benefits of diversity by concentrating power and authority in the hands of a small elite?

 

The Court’s peculiar narrowness actually takes several forms. Not only do the current justices share a common background of higher education, their careers have all followed similar and similarly narrow paths. Their individual resumes consist largely of service in the judiciary and academia, with the occasional service as a government lawyer or prosecutor thrown in. None of the current justices has ever had to make payroll or struggled to try to make a profit. None has ever had to establish a political coalition or get themselves elected. None has served in the military. Even their legal experience is narrow – none has been a criminal defense attorney, for instance.

 

Some may argue that I am making too much of the necessarily limited demography of a very small population. But I do think the slender reach of the Court’s collective education and experience has practical consequences. For example, the Court has recently shown a predilection to take up securities cases, but none of the justices seem particularly motivated by a concern for the financial markets or to have a vital appreciation of the importance of the financial markets for the country’s well being. Instead, the cases seem to represent challenging intellectual problems, detached from their deeper significance.

 

All I am saying is that before everyone puts their arms out of joint congratulating each other about the increasing diversity on the Court, perhaps the question should be asked whether one kind of uniformity is simply being replaced with a different kind of homogeneity.

 

I Will Assume She Was Not Referring to Me: In her July 17, 2010 column in the Wall Street Journal entitled "Youth Has Outlived Its Usefulness," Peggy Noonan said:

 

Why do so many young bloggers sound like hyenas laughing in the dark? Maybe it’s because there’s no old hand at the next desk to turn to and say, "Son, being an enraged, profane, unmoderated, unmediated, hit-loving, trash-talking rage money is no way to go through life."

 

Poor old Peggy, her memory must be going. Clearly she has forgotten that the surest way to show that your sell by date has passed is to start fulminating about "young people these days" and the things that somebody ought to tell them. On the other hand, she could use somebody to tell her that attempting in a single paragraph to portray her bêtes noires as both laughing hyenas and rage monkeys hardly sets an example of restraint. Perhaps the rage she detects is her own.

 

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In a striking series of developments late yesterday afternoon, the Senate passed the financial reform bill and the SEC announced its record-setting settlement of the enforcement action it filed against Goldman Sachs last April. The Goldman settlement drew extensive coverage in the mainstream media, primarily focused on the sheer size of the $550 million settlement and on Goldman’s concessions that, according to the SEC’s press release, "its marketing materials for the subprime product contained incomplete information."

 

Goldman Sachs’ July 15, 2010 statement about the settlement can be found here.

 

There are many other interesting details about the settlement, some of which have not received widespread attention in the media.

 

First, the settlement resolves only the charges against Goldman Sachs itself. According to the SEC’s July 15, 2010 press release, "the SEC’s litigation continues against Fabrice Tourre," who seems to have left to fend for himself. Things don’t appear quite so "fabulous" for Mr. Tourre just now.

 

Second, as reflected in Goldman’s July 14, 2010 "Consent" (a copy of which can be found here), the $550 million settlement amount consists of a disgorgement of $15 million and a civil penalty of $535 million.

 

Goldman acknowledged in the Consent that the settlement funds may be distributed under the Fair Funds provisions of Section 308 of the Sarbanes Oxley Act. In its press release, the SEC states that of the $550 million settlement, $250 million would be paid to "harmed investors" through a Fair Funds distribution and $300 million will be paid to the Treasury.

 

Third, the Consent also reflects the specifics of Goldman’s admissions regarding the Abacus transaction. In paragraph 3 of the Consent, Goldman "acknowledges" that the Abacus marketing materials "contained incomplete information" and that it was "a mistake" for the materials to state that the Abacus reference portfolio was selected by ACA Management without disclosing the role of Paulson & Co or that Paulson’s economic interests were adverse to those of the CDO investors. The consent states that Goldman "regrets" the omission of this information.

 

Fourth, Goldman agrees in the Consent that, other than with respect to the amount of the disgorgement, it will not argue that it is entitled to any offset or reduction of a compensatory damages award in any Related Investor Action by any amount of any part of the company’s payment of a civil penalty in the SEC enforcement action. If a court nevertheless grants an offset, the Goldman has to pay the amount of the offset either to the Treasure or the Fair Fund, within 30 days.

 

Fifth, Goldman agrees both that "it shall not seek or accept, directly or indirectly, reimbursement or indemnification form any source, including but not limited ot payment may to any insurance policy, with regard to any civil penalty" and also agrees that it "shall note claim, assert or apply for a tax deduction or tax credit with regard to any federal state or local tax for any penalty amounts."

 

Sixth, Goldman acknowledges in the Consent that the Commission has not made any promises or representations "with regard to any criminal liability that may have arisen or may arise from the facts underlying this action or immunity from any such criminal liability."

 

Finally, in the Consent, Goldman agrees that it will not make any public statements "denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis." However, this agreement does not affect Goldman’s "right to take legal or factual positions in litigation or other legal proceedings in which the Commission is not a party."

 

All told, the Consent is a really striking document that -- together with the massive size of the settlement itself -- bespeaks a compelling need on Goldman’s part to resolve this matter as quickly as possible.

 

An interesting question is the effect that Goldman’s "acknowledgement" in the Consent will have on the various shareholder lawsuits that sprang up in the wake of the SEC enforcement action.

 

On the one hand, the omissions that Goldman acknowledged in the Consent were made in the marketing materials for the Abacus document, not in the public statements to Goldman’s shareholders.

 

On the other hand, Goldman’s acknowledgement that it made a "mistake" when it omitted information from the Abacus marketing materials clearly will be useful for the plaintiffs’ lawyers in the shareholder lawsuits. But, as Duke Law Professor James Cox commented on the WSJ.com Law Blog, even though Goldman admitted to a "mistake," it did not admit to fraud.

 

In any event, the plaintiffs’ lawyers can at least be reassured that Goldman cannot attempt to offset its liability in the shareholder lawsuits by the amount of its massive penalty in this settlement.

 

Andrew Longstreth's July 15, 2010 Am Law Litigation Daily article with his thoughts about the effect of the Goldman SEC settlement on other litigation pending against Goldman can be found here.

 

Goldman’s undertaking that it would not seek reimbursement or insurance for the amounts of the penalty seems largely symbolic, since it is highly unlikely that any insurance policy would provide coverage for the disgorgement amounts and penalties that the company has agreed to pay. However, the significance of the undertaking may be what it portends for other settlements in other matters. This kind of requirement that enforcement action defendants will not seek indemnification or insurance for amounts paid in SEC enforcement action settlements represents a substantial (and chilling) threat to other persons the SEC may target.

 

The exclusion of Tourre from the settlement is interesting. It is possible that Mr. Tourre himself may have declined to participate, either because he believes he did nothing wrong or because he was unwilling to make the type of acknowledgment the SEC might require as a condition of settlement. It is also possible that the SEC expected Tourre to agree to some type of ban that would undermine his ability to continue to work as an investor banker in the United States. Whatever the reason, it does seem noteworthy that Tourre is not a part of this settlement.

 

Another question about the settlement relates to the proposed Fair Funds distribution. Why does the Treasury get $300 million but "harmed investors" only get $250 million? (I guess that is one way to reduce the deficit.)

 

The other question about the propose Fair Funds distribution is, who are the "harmed investors" who will get these funds? It seems that it would be the two investors in the Abacus transaction, IKB and ACA-- except that ACA’s interests have been passed along to Royal Bank of Scotland, as a result of other transactions that ACA entered attendant to the Abacus deal.

 

I suppose the Fair Funds administrator will have to sort all of that out, but it does seem like SEC went to an awful lot of trouble for the benefit of non-U.S. institutional investors that have plenty of problems of their own – and that is setting aside the question whether the institutional investors who entered this transaction are either entirely blameless or merit this type active regulatory protection.

 

As Professor Cox commented (quite appropriately I might add) on the WSJ.com Law Blog, the investors "made out like bandits." (He added that the investors are "not necessarily saints here.") The Los Angeles Times takes a look here at where the settlement money is going and also summarizes the various sordid background details on the Abacus transaction investors.

 

It is interesting to reflect that, according to media reports, the SEC was divided 3-2 on whether to bring the Goldman Sachs enforcement action. The settlement seems to make the decision to bring the case look pretty good. But what is even more curious is that, at least according to yet other media reports, the SEC also split 3-2 on whether to settle with Goldman.

 

I can understand the split vote on whether to bring the action, because the SEC did not, shall we say, have the strongest case in the world against Goldman. But once you have a chance to snag a half a billion dollars, don’t you declare victory and go home for a nice dinner and a glass of wine with your spouse? Geez, seems like a good day’s work to me.

 

Finally, can I just say that while the SEC has touted this settlement as some kind of record, the fact is that there have been larger SEC enforcement action settlements. As reflected in data from NERA Economic Consulting (here), there have been at least two larger SEC enforcement action settlements, including AIG’s February 2006 $800 million settlement and WorldCom’s July 2003 $750 million settlement. The Goldman Sachs settlement is, as the SEC pointed out, the largest settlement against a Wall Street firm. I guess we can all agree that more than half a billion dollars is a lot of money, even for Goldman Sachs.

 

UPDATE: The morning press coverage provided some added perspective on some of the points raised above. First, with respect to the size of the settlement, the Wall Street Journal notes that the $550 million settlement "is equivalent to just 14 days of profits at Goldman in the first quarter."  (Maybe half a billion isn't a lot of money for Goldman Sachs.) As for whether the amount represents some kind of record, the Journal notes that in 1988 Drexel Burnham Lambert agreed to pay $650 million in fines and restitution. The Drexel settlement included amounts paid to satisfy investors' civil claims. in 2003, ten Wall Street firms collectively paid $1.4 billion to settle analyst conflict cases. Finally, as for Mr. Tourre, the Journal reports the he plans to "continue trying to clear his name accoding to a person familiar with the matter."

 

Let the Games Begin: The Senate may now have approved the financial reform bill and all 2,319 pages of the bill will now be headed to the White House for President Obama’s signature. But this is not the end, it is the beginning.

 

As Broc Romanek points out on the CorporateCounsel.net blog (here), under the Dodd-Frank Act, "a total of 11 regulators are committed to make 243 rulemakings, 67 studies and 22 new periodic reports under the Act. The SEC itself will be required to conduct 95 of those rulemakings, 17 studies and 5 new periodic reports."

 

Over at the SEC Actions blog, Tom Gorman has a detailed list, here, of several categories of the more significant rule making processes that lie ahead.

 

To those who want to know the meaning and significance of the financial reform bill’s passage, the only honest answer is – stay tuned.

 

As The Joker Said, "Why So Serious?": All of this seems way too serious to me, so it is about time to roll out The Egg Trick. If you have never seen this footage of Dom DeLuise’s unforgettable turn on the Johnny Carson Show, drop everything and watch this right now. With all of this other stressful stuff going on, you need a "break." Enjoy.

 

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Overall levels of corporate and securities litigation increased during the second quarter of 2010, according to a new study released on July 15, 2010 by the insurance information firm Advisen. A copy of the report can be found here.

 

Preliminary Notes

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

 

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

 

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

 

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

 

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

 

The Report’s Analysis

Even though subprime and credit crisis case filings during the second quarter were well below 2009 levels, overall corporate and securities litigation activity was up in the quarter – "nearly 30 percent higher than the first quarter and about 19 percent above the very active second quarter."

 

The report also notes that securities class action litigation activity was up in the quarter as well, largely as a result of litigation relating to the government investigation of Goldman Sachs and the Deepwater Horizon oil spill.

 

However, in what may be the report’s most significant observation, securities class action litigation is becoming an increasingly smaller percentage of all corporate and securities litigation. The report notes that this percentage has been trending downward for several years; securities class action lawsuits, which represented more than half of all corporate and securities lawsuits before 2006, represented only 23 percent of these suits in 2009 and only 19 percent in the first half of 2010.

 

In addition to the relative number of securities class action lawsuits, the absolute number of securities class action suits also declined in the first half of the year. According to the Advisen report, there were 85 securities class action lawsuits in the first half of 2010, which annualizes to 170 cases. The average annual number of securities class action filings during the period 2005-2009, according to the report, is 213. The 2010 decline "is due substantially to a sharp drop in subprime/credit crisis cases."

 

The report also notes that the average time between the end of the class period and the date the lawsuit was filed is lengthening, from 126 days in 2008 to 228 days in the first half of 2010.

 

Though new subprime and credit crisis cases continue to decline, companies in the financial sector remain the most frequent corporate and securities litigation target. According to the report, financial firms were named in about 34 percent of all corporate and securities lawsuits in the second quarter.

 

Though securities class action lawsuit filings as a percentage of all corporate and securities lawsuits have declined, lawsuits alleging breach of fiduciary duty are becoming an increasingly larger percentage of all corporate and securities lawsuits, primarily in connection with merger and acquisition activity. Breach of fiduciary duty cases represented only eight percent of all corporate and securities lawsuits in 2004, but 32 percent of all such litigation in 2009.

 

Discussion

The public dialog about securities litigation tends to concentrate on securities class action lawsuit filings. Though securities class action litigation remains the most costly type of corporate and securities litigation, from a frequency standpoint, securities class action litigation is becoming increasingly less important. According to the Advisen report, more than 80 percent of all corporate and securities litigation in the first half of 2010 involved types of litigation other than class action securities litigation.

 

Moreover this movement of litigation activity away from securities class action litigation is now well-established, having persisted (and indeed accelerated) for well over five years now.

 

The fact is that companies and their senior managers face an increasingly diverse range of potential litigation exposures. The changing landscape of corporate and securities litigation may have important implications for companies’ management liability insurance decisions. At a minimum, the changing mix of litigation suggests that companies should carefully consider potential liability exposures beyond just those involved with possible securities class action litigation.

 

The changing mix of litigation also provides an important context within which to interpret apparent declines in securities class action litigation activity. Even if fewer class action lawsuits are being filed (at least lately, anyway), that does not mean the overall threat of litigation has declined. To the contrary, the Advisen report shows that the threat of corporate and securities litigation generally continues to increase. The litigation threat is not declining, it is simply changing.

 

The more interesting question is what the future may hold for securities class action litigation. In all likelihood the apparent recent decline in new securities class action lawsuits is merely cyclical – there have certainly been prior periods where new securities class action lawsuits fell below historical levels (for example, during the period from mid-2005 to mid-2007). On the other hand, some recent activity – for example, the increase in the number of belated lawsuit filings – suggests that a variety of forces and factors are at work.

 

My own view is that, as has always been the case in the past, the litigation cycle will eventually turn and filing activity levels will revert to the mean. There is an entrenched industry of highly entrepreneurial plaintiffs’ securities class action lawyers who have every incentive to continue to file lawsuits. I suspect strongly that one factor in the current relative downturn in new securities class action filings is that the plaintiffs’ lawyers are simply swamped trying to keep up with the massive wave of complex lawsuits they filed in the wake of the subprime meltdown and the credit crisis. Eventually the decks will clear and they will resume their normal activities, particularly if there are headline-grabbing events that provide litigation fodder.

 

My own prior analysis of first half 2010 securities class action litigation filing activity can be found here. The Advisen report’s analysis of securities class action lawsuit filings in the year’s first half is directionally consistent with my own observations.

 

Advisen Securities Litigation Webinar: At 11:00 am EDT on Friday July 16, 2010, I will be participating in a free, one-hour Advisen webinar to discuss the firm’s Second Quarter Securities Litigation Report. Joining me for the webinar panel discussion will be Carl Metzger from the Goodwin Proctor firm; Carol Zacharias from ACE, and Louise Pennington of Integro. Information about and registration instructions for the webinar can be found here.

　

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Corporate Scienter: One of the recurring issues in securities litigation is the question of what is required to establish that the corporate defendant acted with scienter. The question was squarely presented by the Vivendi trial verdict, where, as discussed here, the jury found that the corporation was liable, even though the two individual defendants were exonerated. Judge Rakoff also posed the issue in his notorious initial critique of the SEC’s settlement of the Bank of America enforcement action (about which refer here), where he questioned why the SEC was proceeding solely against the corporation without also pursuing the company’s senior managers.

 

An interesting July 12, 2010 memo from the Arnold & Porter law firm entitled "Whose Mind is It? Pleading and Proving Corporate Scienter" (here) take a detailed look at the appellate case law addressing the questions of what is required to establish that the corporation acted with the requisite state of mind to establish a corporate securities violation.

 

The memo surveys the various recent corporate appellate decisions, including, among others, the Ninth Circuits’s decision in the Glazer Capital Management case (refer here) and the Seventh Circuit’s decision on remand from the Supreme Court in the Tellabs case (refer here). The memo states that "the courts consistently have … considered whether plaintiff pleaded or proved scienter on the part of one or more members of senior management who bore sufficient responsibility for issuing the challenged statements, which could then be attributed to the corporation."

 

The authors suggest that none of the appellate cases have endorsed a "collective scienter" approach whereby plaintiffs may establish a claim against a corporation without naming any corporate officer or employee who acted with scienter – although the authors do labor to reconcile the dicta in Judge Posner’s opinion in the Seventh Circuit’s consideration of Tellabs with this overall analysis.

 

Finally, the authors conclude by suggesting that one of the recurring issues in this area is the fundamental question of what it means to "make" a statement, because it goes to the heart of the question of who made a statement for issue of potential securities liability. The authors suggest that the Supreme Court may well provide necessary guidance in its upcoming term on this issue in the Janus Capital Case, in which the Court recently granted a writ of certiorari (about which refer here).

 

European Corporate and Securities Developments: In light of the U.S. Supreme Court’s recent decision in the Morrison v. National Australia Bank case (about which refer here), narrowing the availability of U.S. courts to claimants who did not purchase their shares on U.S-based exchanges, there may be increased interest the regulatory and legal regimes outside the U.S. There are certainly relevant developments outside the U.S., particularly in Europe.

 

A July 2010 memorandum from the Sherman & Sterling law firm entitled "Governance & Securities Law Focus: Europe Edition" (here) takes a detailed look at corporate and securities developments at the EU level as well as at the level of certain individual countries (particularly Germany and the U.K.) The memo also includes a brief summary of key U.S. developments as well.

 

U.K. Bribery Bill: Regular readers know that a recurring theme on this blog is consideration of the question of the increasing liability exposure that companies may face under the Foreign Corrupt Practices Act. But the U.S. authorities’ enforcement of this statute is far from the sole regulatory effort to enforce anticorruption measures, as the German authorities’ pursuit of the Siemens case demonstrates.

 

In addition the U.K. recently substantially increased regulators’ statutory antibribery authority, and these changes have important implications, even for U.S.-based companies, according to a July 7, 2010 memo from the Reed Smith law firm entitled "What the U.K. Bribery Act Means for U.S. Companies" (here).

 

According to the memo’s authors, the Bribery Act 2010 , which has not yet come into force, "introduces important new offences which will apply to any business either based in the U.K. or which has some part of its operation in the U.K." and in "some important respects" will be "more far reaching than the FCPA."

 

Among other things, the FCPA requires at least one actor in the alleged bribery to have a role in the public sector, whereas the Bribery Act will "apply to acts of bribery which take place between two entirely private entities." The FCPA also has a statutory safe harbor for small "grease payments," but the Bribery Act has no such carve out. The Bribery Act also provide for significantly greater criminal penalties.

 

Pertinent to the question of corporate state of mind discussed above, the Bribery Act gets around the challenging question of corporate intent by making the new corporate offense described into a strict liability offense. Guilt can be a result of attempted or actual bribery a corporation’s "associated person." which seemingly includes not only employees and agents but anyone who provides services for the company.

 

As a result of this corporate strict liability, the activities of a U.S. company in any part of the world "could make it liable to a prosecution in the U.K. for this corporate offence if that U.S. company carries on some part of its business in the U.K. or for a principal bribery offence if some part of it is committed in the U.K."

 

The memo also addresses the question of the procedures that the Act requires, noting that "to avoid U.K criminal liability under the corporate offence introduced in the Bribery Act, it will be essential for U.S. companies which operate in the U.K. to put in place and to maintain clear and effective anti-bribery procedures over both their own staff and those who provide services to them."

 

Advisen Quarterly Securities Litigation Seminar: At 11:00 EDT on Friday, July 16, 2010, I will be participating in a free, one-hour webinar sponsored by Advisen to discuss 2Q2010 securities litigation trends. The panel will include my good friends Carl Metzger of the Goodwin Proctor law firm, Carol Zacharias of ACE, Louise Pennington of Integro and David Bradford of Advisen. Information about and registration instructions for the webinar can be found here.

 

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Suit Against Auction Rate Securities Investor Dismissed: When plaintiff investors first sued Mind M.T.I. and certain of its directors and officers in the Southern District of New York in August 2009, I noted at the time that the new suit seemed to reflect two securities class action lawsuit filing trends: first, the case presented an example of a "belated" lawsuit filing, where the initial filing came more than a year after the proposed lawsuit date; and second, the case represented another instance where a company’s shareholders had filed suit due to their company’s investment auction rate securities.

 

The case, however, failed to surmount initial pleading thresholds, and July 2, 2010 was dismissed with prejudice.

 

Unlike many auction rate securities cases, which typically were brought against the firm that had sold the plaintiffs the securities, this suit (like others, refer here) was brought against a company that had invested in the auction rate securities.

 

The lawsuit pertained to the company’s 2006 purchase of $22.8 million in auction rate securities. The securities the company purchased were issued by the now-infamous Mantoloking CDO, about which refer here.

 

The plaintiffs alleged that the defendants "knowingly and recklessly concealed that most of Mind’s reported cash position was comprised of illiquid Auction Rate Securities (ARS)" and that the company’s internal controls for monitoring, accounting and reporting of the Company’s investments in cash equivalents and/or short-term investments were materially deficient." The defendants moved to dismiss on the grounds that plaintiffs’ had not sufficiently pled scienter.

 

In a July 2, 2010 order (here), Southern District of New York Judge Richard M. Berman, granted the defendants’ motion to dismiss with prejudice, holding that the plaintiffs had failed to allege sufficient facts showing a motive and opportunity for the fraud, and also had failed to alleged facts sufficient to constitute strong circumstantial evidence of conscious misbehavior or recklessness.

 

In concluding that the plaintiffs had not sufficiently alleged scienter, the court noted that the defendants had argued that the company "rather than acting with scienter, was itself defrauded by its investment bankers into believing its investment was a safe, liquid alternative to bank deposits." Judge Berman found that the plaintiffs allegation do not offer any factual explanation in contradiction of this contention. According, he concluded that the plaintiff had failed to raise an inference of scienter that is cogent and at least as compelling as any opposing inference of nonfraudulent intent.

 

After the marketplace for auction rate securities froze in February 2008, plaintiffs’ lawyers launched a barrage of lawsuits against the investment banks and other firms that had sold investors these securities. By and large, these cases against the auction rate securities have fared poorly, particularly with respect to the financial firms that separately entered regulatory settlements intended to provide small investors relief regarding their illiquid securities investments.

 

For example, the securities suit filed on behalf of auction rate securities investors against UBS, which had entered into a auction rate securities-related regulatory settlement was initially dismissed with prejudice. After the plaintiffs amended their pleading, the court granted the defendants’ renewed dismissal motion but allowed the plaintiffs leave to attempt to further amend their pleadings. However, on July 7, 2010, after the plaintiffs failed to file further amendments within the allotted time, the court entered judgment on behalf of the defendants.

 

The poor track record in the auction rate securities cases has not been limited just to companies that had entered regulatory settlements, as was demonstrated, for example, in the dismissal granted in auction rate securities suit filed against Raymond James (about which refer here).

 

Similarly, the dismissal granted on the Merrill Lynch auction rate securities suit in March 2010 (about which refer here) did not depend on Merrill’s entry into a regulatory settlement, but was on the merits.

 

But the suits filed against the financial firms that had sold the auction rate securities represented only one type of auction rate securities lawsuit. In addition, there were a number of suits filed against the companies that had purchased the securities, in which it was alleged that the companies had misrepresented the companies’ financial condition by failing to disclose its investment. The dismissal of the Mind C.T.I. suggests that these suits against auction rate investors may fare not better than the many suits filed against the auction rate securities investors.

 

2010 Securities Suit Filings at the Year’s Midpoint: In a publication issued this past week, Charles River Associates issued its review of the Second Quarter 2010 securities lawsuit filings, including an analysis of the 2010 filings for the first half of the year. Though different in some details, the Charles River report is directly consistent with the observations noted on my recent post (here) on first half filings.

 

Among other things, the report notes that though second quarter 2010 filings were up 25% compared to the second quarter of 2009, the filings in the first half of 2010 were down 9% compared to the first half of 2009, and down 38% compared to the first half of 2008.

 

The report also notes that though the second quarter filings involved companies in a wide range of industries, the filings were "primarily concentrated in the financial services and oil and gas sectors." The report also notes that a number of the second quarter filings involved class periods that ended more than a year prior.

 

Special thanks to Christopher Noe of Charles River for providing a copy of the report.

 

The Dodd-Frank Bill and Securities Litigation: If the Dodd-Frank Wall Street Reform and Consumer Protection Act is finally enacted into law, we can all look forward to months of commentaries beginning like this: "A little noticed provision of the financial reform legislation may have unexpected implications." The sheer sweep of the Bill’s 2,500-plus pages and countless provisions virtually ensures that for months and years the legislation will be slowly revealing sometimes unexpected implications.

 

Among many other subjects that the Bill touches upon is securities litigation. Though the Bill does not reach as far as it initially appeared it might, the Bill does contain a number of provisions with securities litigation implications. These implications are helpfully catalogued in a couple of recent law firm memos.

 

First, in a July 9, 2010 article entitled "The Impact of Financial Reform on Securities Litigation Enforcement" and posted on the Harvard Law School Forum on Corporate Governance and Financial Regulation blog (here), several attorneys from the Wachtell Lipton firm catalogue the Bill’s various provisions.

 

Second, in a July 9, 2010 memo entitled "Securities Litigation Implications of the Dodd-Frank Bill," the Paul Weiss firm takes a look at the Bill’s securities litigation provisions and also review the various additional proposed provisions that did not make it into the Bill’s final version.

 

Finally, a July 6, 2010 memo by the Katten Muchin law firm entitled "Dodd-Frank Wall Street Reform and Consumer Protection Act Corporate Governance and Disclosure Provisions" reviews the Bill’s various provisions relating to corporate governance and disclosure practices.

 

These memos are detailed and helpful. Just the same, the massive Bill seem likely to have yet other sections that may involved undiscovered implications that will only be revealed in the fullness of time.

 

World Cup Final Notes:

1. I agree with my sixteen year old son's assessment -- I am sorry the World Cup is over. Notwithstanding those damn vuvuzelas.

 

2. The Spaniards should be proud, they scored and they won. Iker Casillas, Spain's goalie, played just well enough to allow his team to win. But truth be told, the tournament's final match was not a very good game. It was marred by unnecessary violance and poor sportsmanship, not to mention astonishing failures by both teams to capitalize on scoring opportunities.

 

3. The consolation round game on Saturday was a much better game, which I am very glad I watched. It was an exciting, fair match well played by both Uraguay and Germany. And it literally came down to the last tick of the clock. A great game all the way around.

 

4  I aboslutely concur in the award of the golden ball to Diego Forlan of Uraguay. He had a great tournament and he is an exciting player to watch. Rumors that he is about to sign with the Miami Heat apparently are totally unfounded.

 

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While there were a number of significant, high-profile securities class action lawsuits filed during the first-half of 2010, overall filing levels for the year’s first six months, annualized for a full year, were well below last year’s filings and historical averages.

 

In the first half of 2010, there were 76 new securities class action lawsuits. This figure, if annualized, would mean 152 new securities class action lawsuits for the year, which is below the 169 that were filed in 2009, and about 29% below the 1997-2008 average of 197 filing per year.

 

The lawsuits were filed against companies in 41 different SIC Code categories, although as has been the case for the past several years, the first six months’ filings were again weighted toward the financial sector. 13 of the 72 first half filings were in the 6000 SIC Code category (Finance, Insurance and Real Estate), and another ten filings were against entities that lacked SIC Codes that were all financially related. This total of 23 first half filings against financially related filings represents 32% of the filings in the first six months.

 

Among these lawsuits filed against financially related targets were six new lawsuits filed against Exchange Traded Funds and six lawsuits filed against commercial banks. The filings against the ETFs is a trend that began in the second half of 2009. The suits filed against the commercial banks reflect in part the wave of bank failures that has been sweeping across the sector.

 

As in the past, life sciences companies also continue to be targeted. There were 7 lawsuits filed in the first half against companies in the 283 SIC Code group (Drugs) and 5 against companies in the 384 SIC Code group (Surgical, Medical and Dental Instruments and Supplies). These 12 lawsuits represent 16.6% of the first half filings.

 

In recent years, filings against foreign-domiciled companies have been an important part of total filings. For example, in 2008, lawsuits against companies from outside the U.S. represented 15% of all filings, and in 2009 they were 12.7% of all filings. However, so far in 2010, there have been relatively fewer securities suits filed against foreign companies. Four of the first half lawsuits were filed against foreign companies, representing only about 5.18% of the suits filed.

 

Even if, as I have speculated might be the case, the Supreme Court’s ruling in the Morrison v. National Australia Bank case might have the effect of discouraging suits against foreign domiciled companies (particularly those whose shares do not trade on U.S. exchanges), it already seems that filings against foreign domiciled companies are now a relatively less significant part of all filings than they have been in recent years.

 

The first half lawsuits were filed in 31 different federal district courts, although a significant number of the lawsuits were filed in the S.D.N.Y. There were 21 new securities class action lawsuits filed in the Southern District of New York in the first half of 2010, largely as a result of the concentration of cases filed against companies in the financial sector. The district court with the second most number of first half filings was the District of Massachusetts, which had four.

 

As I noted last year, there has been an increase in what I have described as "belated filings" – that is, new lawsuits where there is a gap between the proposed class period cutoff date of a year or more. By my count there were 14 of these belated cases filed in the first half, and they continued to be filed as the period progressed. It will be interesting to see what impact, if any, the Supreme Court’s statute of limitations ruling the Merck case (about which here) will have on the continued filing of these belated cases.

 

The subprime litigation wave began in early 2007. Though it is now in its fourth year, the subprime related and credit crisis related cases continue to come in. By my count, there were 13 subprime and credit crisis related lawsuits filed in the first half of 2010, many of them (such as the securities lawsuit filed against Goldman Sachs) related to mortgage securitizations that went bad. For a listing of the subprime and credit crisis related securities suits, including those filed in 2010, refer here.

 

As I have noted elsewhere, the plaintiffs have seemed particularly interested in pursuing claims in the wake of headline crises that various companies have suffered. Indeed, the Deepwater Horizon oil spill alone has generated securities class action lawsuits against BP, Transocean, and Anadarako. Other headline related securities suits in the first half include those filed against Goldman Sachs, Massey Energy and Toyota.

 

Though the number of new securities class action lawsuits are relatively down compared to historical levels, that does not necessarily mean that overall claims activity has declined. Indeed, analysis by Advisen (refer here) suggests that securities class action lawsuits represent an increasingly smaller percentage of all claims, a trend that began in 2006 and that increased in the first half of 2010.

 

In addition to the securities class action lawsuits, claimants are filing individual lawsuits (rather than class actions), a phenomenon that has been particularly evident with respect to many of the subprime and credit crisis-related claims. Claimants are also filing shareholders derivative suits or otherwise proceeding on different theories.

 

But this diversification notwithstanding, it is evident that securities class action filings were down in the first half of 2010, relative to historical levels, as they have been since about the second quarter of 2009.

　

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It was possible to overlook it amongst the flurry of high profile opinions the Supreme Court released on the final day of the 2009 court term, but on June 28, 2010 the Court granted yet another petition for writ of certiorari in a case arising under the securities laws. Although the case arises out of the specific context of a mutual fund market timing case, it raises fundamental issues about who may be a "primary violator" under the securities laws. The Court seems poised to delve yet again into critical issues under the federal securities laws.

　

Background

Janus Capital Group (JCG) is the holding company for a family of mutual funds. Janus Capital Management (JCM) is the funds’ investment advisor. In November 2003, JCG investors filed a complaint in the District of Maryland alleging that the two firms were responsible for misleading statements in the certain funds’ prospectuses. The allegedly misleading statements represented that the funds’ managers did not permit, and took active measure to prevent, "market timing" of the funds. The investors claim they lost money when market timing practices JCG and JCM allegedly authorized were made public.

 

In 2004, JCM reached a settlement with the SEC in connection with the market timing allegations in which the firm paid a disgorgement of $50 million and an additional $50 million in civil penalties. Information regarding the settlement can be found here.

 

The district court dismissed the shareholders suit in May 2007. The shareholders appealed to the United States Court of Appeals for the Fourth Circuit. In a May 7, 2009 opinion (here), the Fourth Circuit reversed the district court, finding that the shareholders had adequately stated a claim under the securities laws. The defendants’ filed a petition for writ of certiorari, which the Supreme Court granted on June 28, 2010.

 

Issues Involved

As the Supreme Court itself recently affirmed in its Stoneridge case (about which refer here), there is no private action for aiding and abetting liability under the federal securities laws. Accordingly, the defendants can be liable if at all if they are "primary violators," that is, if they are directly responsible for the allegedly wrongful conduct. The Janus entities contend that as mere service entities for the actual funds, they cannot be held primarily liable.

 

The plaintiffs argue that JCM was not a "mere service provider" contending that the firm handles all of the funds’ operations, "including preparation, filing, and dissemination of the Fund prospectuses and prospectus statements" and that all of the funds’ officers were executives at the advisor. The investors contend that they had every reason to believe that the Fund prospectus statements were JCM’s work.

 

The Fourth Circuit ruled that "a service provider can be held primarily liable in a private securities fraud action for ‘helping’ or ‘participating’ in another company’s misstatements." The Fourth Circuit’s ruling is at odds with the decisions of other Circuit courts. Some courts hold that only someone that "makes" a statement and has it attributed to him can be held liable as a primary violator. Other courts, similarly to the Fourth Circuit, have held that someone that "substantially participates" in the activities that led to the creation of the allegedly misleading statement can be held liable as a primary violator, even if the statement is not attributed to him or her.

 

Discussion

Though this case nominally is just about whether or not a service provider can be held liable, fundamentally it is about who can be held liable as a primary violator. A bright line test would limit primary violator liability to those who speak or who have statements attributed to them. However, a broader "substantial participation" test would substantially widen the scope of persons who potentially could be held liable. The scope of liability could potentially extend to a wide range of persons who are involved in the preparation of public statements, including, for example, potentially even the issuers’ attorneys and accountants.

 

Indeed, at some level, this "substantial participation" test starts to sound a lot like the "aiding and abetting liability" that the Supreme Court had rejected in connection with private lawsuits in the Stoneridge case. That may, in fact, be why the Supreme Court took up the case – not just to reconcile an apparent split in the Circuits, but to align the principles of primary violator liability with those of the secondary violator jurisprudence. In a June 29, 2009 Am Law Litigation Daily article (here), Susan Beck furhter develops these issues relating to the tension between the Fourth Circuit's standard and the case law relating to secondary liabiltiy.

 

I have absolutely no way of knowing how this case ultimately will turn out, and indeed the case has yet to be fully briefed or argued. But if I were a betting man, I would bet that the principles on which the Fourth Circuit based its decision are unlikely to survive Supreme Court scrutiny. (I could also be wrong, which is why I don’t gamble.)

 

It is worth noting that the Court suddenly seems particularly keen to take up securities cases. As I recently noted here while discussing the Court’s cert grant in the Matrixx Intiaitves case, there was a time when the Court would go many terms without taking up any securities cases. For several years now, the Supreme Court has taken up one or two securities cases. The Court’s increased interest in securities cases make great blog fodder, but it also creates the potential for disruptive alterations of the settled litigation landscape.

 

The Court’s sudden heightened interest in securities cases must be particularly unnerving for plaintiffs’ lawyers as the Court, with its current lineup, has generally proven to be less than entirely plaintiff friendly. There is some considerable risk that the Janus case will provide yet another opportunity for the Court to deliver an opinion the plaintiffs’ bar finds unhelpful.

 

In any event, the Supreme Court will now have two potentially significant securities cases on its docket next term. I really do find it surprising, given this blog’s topical focus, how often I find myself writing about Supreme Court-related issues –especially lately. I never expected that. I do find it all very fascinating though

 

Special thanks to the several readers who sent me links and other materials about this case. Special thanks to the SCOTUS Wiki blog (here) for links to some of the key documents to which I linked above.

 

Surprising Stuff Under the Hood of the Financial Reform Act: In recent posts (most recently here) I noted the possibility that the Supreme Court’s decision in the Morrison v. National Australia Bank case could well trigger Congressional action, particularly with respect to the SEC’s authority over conduct in the U.S. even if the transaction occurred outside the U.S.

 

An alert reader who clearly has a lot of patience managed to sift through the thousands of pages of the Conference Committee version of the financial reform bill (the "Dodd-Frank Wall Street Reform and Consumer Protection Act," which can be found here), and he reports (and my review of the Bill confirms) that the Conference Bill actually addresses the extraterritorial question.

 

First, Section 929P(b) authorizes an action brought by the Commission, inter alia, based on "conduct within the United States in furtherance of the violation," in effect allowing the Commission to take enforcement action based on conduct in the U.S. even if the transaction took place outside the U.S. (if all the provision's conditions are met).

 

Second, Section 929Y, entitled "Study of Extraterritoral Private Rights of Action," directs the Commission to study whether private rights of action should be allowed on the same basis as authorized for the Commission in Section 929P(b). The provision directs the Commission to deliver the report to Congress within 18 months of the statute’s enactment.

 

In other words, if the Bill is enacted in its current form, the Commission will have the ability to bring cases involving foreign companies and even involving transactions outside the U.S., if the conduct meets the standards defined in the provision, and the Commission will study and report to Congress on whether private claimants should have the same right.

 

Very special thanks to the alert reader who found these provisions and pointed them out to me.

 

Bank Shot: Regular readers know I have been reporting frequently on the possibility of litigation arising in the wake of the wave of failed banks. The July 2010 issue of U.S. Banker has an article entitled "First the Failures, Then the Lawsuits" (here) which takes a very interesting look at this possibility.

 

The article reports that the FDIC "has begun laying the groundwork for potentially years of lawsuits against senior executives and directors it claims may have been responsible for their bank’s collapse." The article notes that the FDIC has sent "hundreds of demand letters," which the article describes as "the necessary first steps in assessing accountability."

 

Among other things, the article reflects a dispute over who the FDIC is targeting with the demand letters. On the one hand, the article quotes the executive director of the American Association of Bank Directors as saying that the "where there’s money to go after," the FDIC is pursuing the claim, "whether there is a good case or not." On the other hand, the article quotes an agency attorney as saying "How far we go depends on the facts and circumstances of each case…If … there’s nothing there, then we close out the investigation."

 

The article points out that while the FDIC has not filed any director or officer lawsuits during the current crisis, "but observers say that will likely change soon," particularly in light of the three-year statute of limitation. One attorney is quoted as saying we may start to see the suits in 2011 with more in 2012.

 

The article quotes an agency official as saying that the purpose of the demand letters "is simply to preserve insurance," adding that "we try to make enough of a preliminary investigation to make sure that when we send the letter we’re sending it to the right people and we have a basis for the claim."

 

Special thanks to a loyal reader for sending a link to the article.

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As I discussed in a recent post, on June 23, 2010, the Ninth Circuit issued an opinion reinstating the $277.5 million jury verdict in the Apollo Group securities class action lawsuit. In my post discussing the opinion, I included some observations about the Ninth Circuit’s ruling and the likely future course of the Apollo Group case, as well as about the current state of play on post-PSLRA jury trials in securities class action lawsuits in general.

 

Over the weekend, Tower Snow of the Howard Rice law firm sent me a note commenting on my observations. Because I think Tower makes a number of interesting points, I asked his permission to reproduce his observations on this blog. Tower very graciously gave me permission, and the text of his email is reproduced in indented text below.

　

Although I rarely disagree with what you post on the blog, I do disagree with the conclusions you draw re where the Apollo case is heading.

　

The Ninth Circuit reversed based on the concept that the market may have failed to appreciate the significance of earlier disclosures and that any earlier disclosures may not have been of sufficient intensity and credibility for the market to understand them. Thus, according to the Ninth Circuit, the jury could properly conclude that the disclosure at issue was "corrective."  These are alien concepts to economists and the efficient market theory.

　

There is a vast universe of economic studies and literature which incontrovertibly shows that the financial markets are incredibly efficient (and sophisticated) and absorb and properly evaluate new information entering the markets in a matter of minutes. There is no respected economic literature which supports the idea that markets sometimes "fail to appreciate the significance" of negative information or that markets may be misled by disclosures because they are not of sufficient "intensity or credibility" to be fully understood. To the contrary, all the studies conclude the opposite.

　

The courts can't rely on the efficient market theory for purposes of creating a rebuttable presumption of reliance for purposes of class certification and then ignore its underpinnings for purposes of evaluating loss causation. Either one embraces the theory or one does not. If one embraces it, then once it is established that the prior disclosures revealed the truth about the allegedly misstated or omitted information, there is nothing left for the jury to decide. The later disclosure, by definition, cannot be corrective, as the market already had absorbed the information. Here, the "corrective" disclosure came out seven days after the information had been previously released. Seven days is an eternity in the financial markets.

　

The district court denied the defendants' motion for summary judgment on this issue because it had not heard the evidence. When it did, the court properly concluded that the "corrective" disclosure was old news. It was, and it could not under well established economic doctrine have caused plaintiffs' losses. The district court got it right.　

　

This case has a good chance of eventually making its way to the Supreme Court. If it does so, the defendants will win. Loss causation is too important an issue, and the lower courts are all over the map in applying the efficient market doctrine in different contexts. Either the efficient market theory has to be embraced and applied consistently, as economists apply it, or it should be thrown out.

　

For what it is worth, I also come to a different conclusion re Post-PSLRA trial results. Although your win/loss numbers are correct, when one takes into account post plaintiff-verdict settlements and plaintiff verdicts in the context of the damages sought, plaintiffs have done very poorly. What the trials show is that juries view investing as a high risk game, they hold investors accountable for their actions and losses, and they are not inclined when seeing individual officers and directors-- absent very compelling evidence -- to easily conclude that  they engaged in fraud. Couple these dynamics with plaintiffs' fear of post-trial adverse rulings, the dangers of appeals, the time delays, and a host of other factors, and it becomes apparent that even a plaintiff "win" often turns into a loss. I personally doubt whether either the Apollo or Vivendi verdict will survive.　

 

I would like to express my thanks to Tower for taking the time to send a detailed commentary and for his willingness to allow me to reproduce it here. I welcome submissions from responsible persons who are interested in proposing guest posts for publication on this blog. I am in any event always interested in hearing what readers think.

　

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It was obvious from the first reading that the U.S. Supreme Court’s decision in Morrison v. National Australia Bank represents a sweeping victory for the defendants. As I noted in my initial post after the decision came down, the Court’s holding that plaintiffs can’t pursue fraud claims for securities purchased on foreign exchanges will have a significant impact both on pending cases and on future filings.

 

On further reflection, it seems the case could have even more significant implications.

 

First, with respect to pending cases, it is worth noting that Vivendi itself believes, as I suggested in my prior post, that National Australia Bank ruling has significant implications concerning the jury verdict entered against the company in January 2010. Indeed, Vivendi issued a June 25, 2010 press release (here), in which it said that the company is "very satisfied" with the decision, commenting further that the Court’s ruling is "totally in line with the position defended all along by the Group in the American and French Courts."

 

According to prior press reports (here), as many as two-thirds of Vivendi’s investors live in France, and undoubtedly many of them, as well as many of Vivendi’s other investors that reside outside the United States, likely bought their shares on securities exchanges outside the United States. Under the transactional test the Court enunciated in the National Australia Bank decision, investors who bought their share on non-U.S. exchanges cannot pursue a claim under U.S. securities laws. It seems likely that the class of persons entitled to claim injury in the Vivendi case necessarily will be dramatically narrowed.

 

There are many other pending cases that are likely to be similarly affected. In a June 25, 2010 AmLaw Litigation Daily article (here), Andrew Longstreth examines the likely impact of the National Australia Bank case on the securities class action litigation filed under U.S. securities law against BP and certain of its directors and officers. BP’s common shares trade on the London Stock Exchange, and though many investors likely bought American Depositary Receipts for BP on U.S. exchanges, many of its shareholders more likely bought their shares in the U.K. (The AmLaw article notes that 28% of BP’s equity is in ADRs, so those shares are unlikely to be affected by the Supreme Court’s recent decision.)

 

Other cases that are likely to be affected by the Supreme Court’s decision include the action brought against Porsche, which was sued in January 2010 by short sellers of Volkswagen stock who claimed Porsche secretly cornered the market in Volkswagen shares but denied that it intended to acquire Volkswagen. According to a June 25, 2010 Bloomberg article (here) discussing the impact of the National Australia Bank decision on the Porsche case, the plaintiffs claims in the case are likely reduced only to "causes of action based on low-volume American depositary shares."

 

A number of foreign-domiciled companies that have been the target of securities class action litigation under U.S. securities laws filed amicus briefs in the National Australia Bank case; the cases filed against many of these companies, including EADS and Alstom, seem likely to be substantially affect by the Court’s holding.

 

Other recently filed cases also seem likely to be affected, including the cases recently filed against Toyota,

 

Securities suits against foreign companies have in recent years been a significant part of overall securities lawsuit filings in recent years. For example, 24 (or 12.7%) of the 2009 securities lawsuit filings involved companies that are domiciled outside the United States. In 2008, there were 34 foreign domiciled companies sued in securities class action lawsuit, or about 15% of all filings that year.

　

Not all of these securities suits are necessarily going to be affected by the National Australia Bank case. For example, the lawsuit filed earlier this year against Nokia was at the very outset brought only on behalf of investors who bought their American Depositary Shares in the company on U.S. exchanges. Similarly the lawsuit filed late last year against Siemens was brought solely on behalf of purchasers of the company’s American Depositary Receipt shares.

 

The fact that cases against foreign companies with securities trading on U.S. exchanges may still be susceptible to securities class action litigation in U.S. court because their securities trade on U.S. exchanges could well discourage some overseas companies from having their shares trade here.

While there will still be circumstance even after National Australia Bank in which securities suits in U.S. courts against foreign-domiciled companies will still be filed and will still go forward, it seems probable that many other cases that might have been filed in the past will now simply go unfiled, at least in the U.S -- particularly in those cases where the foreign companies do not have significant numbers of ADRs or other securities trading on U.S. exchanges.

 

Given what a significant percentage of total U.S.-based securities class action filings these actions against foreign companies have become in recent years, the reduction in these filings could mean a material reduction in the overall level of securities class action filings (although please see my comments below about some other possibilities for U.S.-based litigation.)

 

The fact that investors who bought shares on foreign exchanges can no longer access U.S. courts clearly creates a problem these investors. As the filing levels described above demonstrate, these investors increasingly had come to rely on the U.S processes and remedies as a way to seek redress when they felt they had been misled, at least where the alleged fraud involved U.S-based conduct.

 

Indeed, numerous foreign institutional investors had filed amicus briefs in the National Australia Bank case (refer for example here), arguing that "both foreign and domestic investors alike rely on American Law to ensure that corporations doing business in America are not tainted by fraud."

 

Now that these investors can no longer "rely on American Law" in many instances, these investors will have to consider their alternatives. One possibility is that these investors will increasingly rely on remedies in their own country. Without access to U.S. courts, these and similarly situated investors may find action in their domestic courts more attractive.

 

For that matter, without access to U.S remedies and processes, investors in foreign countries may press for the implantation of legal reforms in their home countries to permit them better means of attempting to recoup losses based on alleged fraud.

 

Of course, resourceful plaintiffs’ lawyers in this country are now highly motivated to try to find ways around the National Australia Bank decision. Some possible ways it might be circumvented include filing individual lawsuits in state court under state law, and filing federal court class actions alleging state law violations. Claimants in these kinds of cases arguably may face the same hurdles of trying to show that the relevant law provides remedies regarding securities transactions on foreign exchanges, but the existence of U.S.-based fraudulent conduct potentially could provide a sufficient basis for relief under many legal theories, even if not under the federal securities laws.

 

Another possibility is that the foreign institutional investors and others may seek legislative change in the U.S. in order to establish a new statutory basis for relief in U.S. courts for investors who bought shares overseas, at least where there is U.S.-based conduct involved in the alleged fraud. As I pointed out in my prior post, legislative initiatives in the current Congress proposed to do that very thing.

 

As Luke Green points out in his post on the Risk Metrics Securities Litigation blog (here), the National Australia Bank case does not carve out an exception for the SEC and the DoJ, and there may be considerable interest providing statutory means for these agencies to pursue remedies for U.S.-based fraudulent conduct even if in connection with transactions on foreign exchanges. (Green also has a number of other interesting thoughts and comments about the decision.)

 

UPDATE: An alert reader points out that in the Conference Committee of the financial reform bill (called "The Dodd-Frank Wall Street Reform and Consumer Protection Act", here ) there are provisions addressing these questions of extraterritoriality. First, Section 929P(b) authorizes an action brought by the Commission based on a statutorily defined conduct and effects test. Second, Section 929Y directs the Commission to study whether private rights of action should be allowed on the same basis as authorized for the Commission in 929P(b). The Commission is to report to Congress within 18 months of the statute's enactment.

 

The bottom line is that National Australia Bank is an important decision that will have a number of significant impacts, some immediately and some in the months and years to come. Some of the impacts are obvious and apparent now, and some will only become apparent over time.

 

The National Australia Bank case does underscore how significant it is when the U.S. Supreme Court decides to take up a securities case. Each occasion represents a context within very significant changes in the interpretation or application of the U.S. securities laws potentially could occur, as proved to be the case here. Full consideration of this possibility makes it all the more interesting and potentially significant that the Supreme Court recently agreed to hear the Matrixx Initiative securities suit. This development raises the possibility for even further landscape altering case law from the U.S. Supreme Court in its next term.

 

It’s Not Over Yet, Folks: While it is not too early to start looking ahead to the Supreme Court’s next term, it is also worth noting that this current term is not yet complete, as the Court has yet to issue decisions in four high profile cases. As noted on the WSJ.com Law Blog (here), these four decisions are likely to be issued on Monday, June 28, 2010.

 

Among the four cases yet to be decided is Free Enterprise Fund v. PCAOB, which will address the question whether it was appropriate for Congress to give authority to the SEC to name the members of the Public Company Accounting Oversight Board. The case raises basic questions about the separation of powers between the Executive and Legislative branches and potentially could address the question of the constitutionality of the Sarbanes Oxley Act.

 

Depending on how the Court rules, this case could potentially be very significant, particularly if the Court reaches the constitutionality question. As the WSJ.com Law Blog comments, "If the justices agree that the accounting board isn’t constitutional, it could force Congress to revisit Sarbanes-Oxley, or at least the portion of it that creates the accounting board. It could also call into question other independent agencies and how they appoint members of similar boards."

 

More World Cup Notes:

1. A tip of the hat to the Ghanians, who played with speed, skill and opportunism and did what they had to do to win an exhausting, exciting game.

 

2. A final salute to the Americans, too, who played all four of their games with heart and class and who are going home simply because there is a limit to how many times a team can come from behind. Landon Donovan's winning goal in extra time last Wednesday against Algeria is one of the great moments of this World Cup.

 

3. England's fans have to be beside themselves over Frank Lampard's disallowed goal late in the first half of their game against Germany. On the other hand, as unjust as the disallowance was, England pretty much got beat, by a clearly better team. .

 

4. The Mexicans have a legitimate gripe about Argentina's first goal on Sunday. Carlos Tevez was clearly offsides. However, poor officiating had nothing to do with the total defensive breakdown that allowed Gonzalo Higuain's goal for Argentina's second score, and the Argentiines' third goal was a magnificent strike from Tevez. The Germany/Argentina game next week should be terrific.

 

5. If, as seems likely at this point, FIFA spends the next four years trying to figure out how to improve  the offciating at the next World Cup, I hope they will also take a hard look at ways to better enforce the rules against embellishment. Too many players seem more inclined to flop than to play. It really is revolting.

 

6. The French don't have to worry about anybody disrespecting them, because there's really no need -- the French have done such a masterful job of it themselves. The Irish can be excused for any pleasure they might be taking from the French team's embarrassment.

 

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In a long-awaited ruling, the U.S. Supreme Court on June 24, 2010 issued an opinion affirming dismissal of the Morrison v. National Australia Bank case. Among other things, the Court’s opinion will limit securities claims by investors who bought their shares on foreign exchanges. This ruling could have a dramatic impact on many pending cases as well as on future filings.

 

Background

NAB is Australia’s largest bank. Its shares trade on securities exchanges in Australia, London, Tokyo and New Zealand. Its American Depositary Receipts trade on the New York Stock Exchange. NAB has a mortgage servicing subsidiary, HomeSide, based in Florida. In 2001, NAB disclosed that it was taking a significant write-down due to a recalculation of the amortized valuating of HomeSide’s mortgage servicing rights. Following this announcement, the price of NAB’s shares and ADRs declined, and investors filed a securities class action lawsuit in the Southern District of New York.

 

The claim was initially brought by four plaintiffs. One of the four purported to represent domestic purchasers of NAB’s securities. The three other plaintiffs bought their shares abroad and sought to represent a class of non-U.S. purchasers. Background regarding the case can be found here.　

 

On October 25, 2006, the District Court granted defendants’ motion to dismiss the complaint. The District Court held that it lacked subject matter jurisdiction over the foreign claimants claim. The court dismissed the domestic plaintiff’s action for failure to state a claim because the domestic plaintiff failed to allege that he suffered damages. The three foreign plaintiffs appealed. The domestic plaintiff’s claim was not before the Second Circuit, and so the appellate court was exclusively concerned with the jurisdictional issue.

 

As discussed at greater length here, on October 23, 2008, the Second Circuit ruled (here) that U.S. courts lack subject matter jurisdiction over the claims of foreign claimants in that case who bought their NAB shares on a foreign exchange and affirmed the district court’s dismissal of the case. The Second Circuit found that the U.S. based conduct was not sufficient to support jurisdiction under the Circuit’s long-standing two-part test measuring whether there were sufficient domestic actions or effect to support jurisdiction. The plaintiffs filed a petition for writ of certiorari.

 

The Supreme Court’s Opinion

In an opinion written by Justice Antonin Scalia, the Court affirmed the Second Circuit’s holding, but overturned decades of jurisprudence on the question of the extraterritorial reach of the U.S. securities laws, holding that the U.S. securities laws do not apply extraterritorially.

 

The opinion opens with a recitation of the "longstanding principle of American law" that "when a statute gives no clear indication of an extraterritorial application, it has none." The opinion notes that despite this presumption, the Second Circuit over the course of many years developed an extensive body of case law intended to "discern" when Congress would have wanted the statute to apply. The opinion notes that "the Second Circuit never put forward a textual or even extratextual basis for these tests."

 

The opinion completely rejected this entire body of case law and the two-part test on which the Second Circuit had relied in this case, noting that "the results of this judicial-speculation-made-law – diving what Congress would have wanted if it had thought the situation before the court –demonstrate the wisdom of the presumption against extraterritoriality. Rather than guess anew in each case, we apply the presumption in all cases, preserving a stable background against which Congress can legislate with predictable effects."

 

The majority opinion rejected the arguments of the claimants and of the Solicitor General (that would be Solicitor General Elena Kagan, the current Court nominee) that the securities laws contained statutory support for extraterritorial application, finding that "there is no clear indication in the Exchange Act that Section 10(b) applies extraterritorially, and we therefore conclude that it does not."

 

The opinion also specifically rejected the argument that the domestic conduct was sufficient to support jurisdiction, observing that "it is a rare case of prohibited extraterritorial application that lacks all contact with the territory of the United States."

 

What matters is not where alleged deceptive conduct occurred but where the securities were purchased:

 

The focus of the Exchange Act is not upon the place where the deception originated but upon purchases and sales of securities in the United States. Section 10(b) does not punish deceptive conduct, but only deceptive conduct "in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered."

 

Based on this analysis, the Court concluded that "only transactions in securities listed on domestic exchanges, and domestic transactions in other securities, to which Section 10(b) applies."

 

The Court also noted another reason for rejecting a standard that would allow jurisdiction for securities cases solely on the basis that the deceptive conduct took place in the U.S. That is, "some fear that [the U.S.] has become the Shangri-La of class-action litigation for lawyer representing those allegedly cheated in foreign securities markets."

 

Because this case "involves no securities listed on a domestic exchange, and all aspects of the purchases complained of by those petitioners who still have live claims occurred outside the United States" the Petitioners have "failed to state a claim on which relief can be granted" and the Court therefore affirmed the dismissal.

 

Justice Breyer wrote a separate opinion concurring in part in the opinion and concurring in the judgment, saying in effect it was sufficient for him that the securities involved in this case were not purchased in the U.S.

 

Justice Stevens wrote a separate concurring opinion, joining in the judgment, by rejecting the majority’s "transaction test." He would not have rejected the Second Circuit’s two-prong test, saying that the Second Circuit has "refined its test over several decades and dozens of cases, with the tacit approval of Congress and the Commission and with the general assent of its sister Circuits."

 

Justice Sotomayor did not take part in the case.

 

Discussion

The Supreme Court’s opinion in the NAB case seems to put an end to the so-called "f-cubed" cases – that is, claims brought in U.S. courts under U.S. securities laws by foreign domiciled claimants who bought their share in foreign companies on foreign exchanges. Indeed, the opinion seems to sound the death knell for any would-be claimants under the U.S. securities laws who bought their shares on foreign exchanges.

 

The opinion would seem to have very significant implications for the many pending cases in which the claims of claimants who bought shares on foreign exchanges are involved. Among other very high profile cases, the Vivendi case, which involved primarily foreign domiciled claimants and recently resulted in a plaintiff’s verdict, would seem to be subject to substantial reconsideration in light of this opinion. (UPDATE: At least one reader has raised the question whether the Court's holding will or even can be applied retroactively. to damages suffered before and purchases made before. I am not sure general prohibitions on retroactive application apply here, as this decision is about the basic reach of the securities laws, but I thought it was worth noting this question here.)

 

The Supreme Court’s transactional test would also seem to suggest that we have seen the end of filings in U.S. court against foreign companies, except those whose shares are traded on U.S. securities exchanges. (UPDATE: One reader has noted that the "except" clause in the prior sentence does raise the question about whether there might still be jurisdiction over "f-squared" cases, that is those that involve either foreign domiciled companies and foreign investors who bought their shares on U.S. exchanges, or foreign domiciled companies and U.S. investors who bought their shares on foreign exchanges. The first of these two categories seems to meet the test of the NAB case, the second category is a more interesting question. In any event these kinds of issues will have to be sorted out in lower courts in the wake of the NAB decision.)

 

My concern with that possibility is that it could lead foreign companies to decide not to list their shares on U.S. exchanges, or to delist their shares, as a way to avoid the burden and expense of U.S.-based litigation exposure.

 

It is entirely possible that this entire debate will now shift to Congress. Indeed, during the current Congressional term, there were specific proposals to incorporate a version of the two-prong test directly in the securities laws. While these proposals had been languishing, it is possible that the NAB opinion could give these proposals new life.

 

While Congress might now reconsider these proposals, one portion of the NAB opinion might weigh against these kinds of statutory revisions. The majority opinion specifically refers to the arguments of many foreign countries in amicus briefs that the extraterritorial application of U.S. securities laws would result in "interference with foreign securities regulation." These concerns and the requirements of comity, which are detailed in the majority opinion, could well weigh against the legislative reform.

 

But in any event, the Supreme Court’s opinion in the NAB case must now be applied in the lower courts. There are dozens of cases pending in the lower courts involving claimants who purchased their shares on foreign exchanges. These claimants will now be scrambling to try to establish some basis for their cases to be preserved notwithstanding the Supreme Court’s ruling in the NAB case. However, it seems probable that the foreign purchasers’ claims are likely to be dismissed. This will have significant implications for Vivendi and many other pending cases.

 

Andrew Longstreth's June 24, 2010 Am Law Litigation Daily artice about the decision can be found here.

 

Many thanks to the several loyal readers who send me copies of the Supreme Court's opinion.

 

　

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In a terse June 23, 2010 ruling (here), the Ninth Circuit reversed the district court’s post-trial ruling that set aside the $277.5 million jury verdict in the Apollo Group securities class action lawsuit, and remanded the case for "entry of judgment in accordance with the jury’s verdict."

 

Background

Apollo Group is the parent of the University of Phoenix (UOP), the largest for-profit provider of higher education in the United States. According to the plaintiff's amended complaint (here), in 2003, two former UOP employees filed a False Claims Act action against UOP alleging that UOP received U.S. Department of Education funding in violation of laws specifying the way company educational recruiters may be compensated.

 

The Department of Education initiated an investigation of the issues raised in the False Claims Act action, and on February 5, 2004, a Department of Education employee issued a "Program Review Report" that accused UOP of violating the Department of Education rules with respect to education employees' compensation. The plaintiff in the securities case alleges that the violations in the report could have resulted in the limitation or termination of Department of Education funding to UOP.

On September 7, 2004, Apollo agreed to pay the Department of Education $9.8 million to settle the program review. The settlement agreement (a copy of which can be found here) specified that Apollo's entry into the agreement did not constitute an admission of wrongdoing or liability. News of the allegations in the Department of Education report first became public on September 14, 2004. The price of Apollo's stock fell significantly on September 21, 2004, when a securities analyst issued a report expressing concern about the company's possible exposure to future regulatory issues. Plaintiff shareholders subsequently initiated a securities class action lawsuit in the District of Arizona.

 

On January 16, 2008, a civil jury entered a verdict in favor of the plaintiff class on all counts, awarding damages of $277.5 million. Under the verdict, Apollo is responsible for 60 percent of the plaintiffs' losses, former Apollo CEO Tony Nelson is responsible for 30 percent, and former CFO Kenda Gonzales is responsible for 10 percent. The jury verdict is discussed at greater length here.

 

As discussed in greater length here, on August 4, 2008, Judge James Teilborg of the United States District Court for the District of Arizona entered an order (here) granting the defendants’ motion for judgment as a matter of law, based on his finding that the trial testimony did not support the jury’s finding of loss causation. Judge Teilborg’s order vacated the judgment and entered judgment in defendants’ favor.

　

Judge Teilborg had held in connection with the parties’ pre-trial cross-motions for summary judgment that the issue whether the analyst reports constituted "corrective disclosure" sufficient to support a finding of loss causation was a question for the jury.

 

In its post-trial motion, Apollo argued that the evidence at trial was insufficient to support a finding that the analyst reports represented "corrective disclosure," because they did not contain any new fraud-revealing information. Judge Teilborg found that "the evidence at trial undercut all bases on which [the plaintiff] claimed the (analyst) reports were corrective."

 

Accordingly, the court concluded that although the plaintiff "demonstrated that Apollo misled the markets in various ways concerning the DoE program review," the plaintiff "failed to prove that Apollo’s actions caused investors to suffer harm." The court therefore concluded that "Apollo is entitled to judgment as a matter of law."

 

The Ninth Circuit’s Opinion

In its June 23, 2010 opinion, a three-judge panel of the Ninth Circuit held that the district court "erred in granting Apollo judgment as a matter of law." The opinion states that "the jury could have reasonably found that the (analyst) reports following various newspaper articles were ‘corrective disclosures’ providing additional or more authoritative fraud-related information that deflated the stock price."

 

The Ninth Circuit further held that Apollo is not entitled to a new trial and that there is no basis for remittitur (reduction of the verdict). The Ninth Circuit reversed and remanded the case with "instructions that the district court enter judgment in accordance with the jury’s verdict."

　

Discussion

Given the procedural development of this case so far, there may be no reason to assume that the June 23 ruling by the three-judge panel represents the case’s final stage. The defendants undoubtedly will seek rehearing and/or rehearing en banc, and given the stakes involved, the defendants may well seek Supreme Court review. However, the likelihood of the defendants obtaining rehearing or rehearing en banc, much less convincing the Supreme Court to take up the case, seems like a remote possibility. The defendants may continue to agitate, but they may be running out of options.

 

With the reinstatement of the plaintiffs’ verdict in this case, and the entry of the jury verdict in the plaintiffs’ favor in the Vivendi case, the securities class action jury trial scoreboard is looking more favorable to plaintiffs.

 

According to data included in the 2009 NERA year-end securities litigation study (about which refer here), and adjusted for the Ninth Circuit’s opinion in Apollo Group and for the verdict in Vivendi, the securities lawsuit jury verdict scoreboard shows as follow: since the enactment of the PSLRA, there have been 23 securities class action lawsuit that have gone to trial, of which 16 have gone all the way to verdict. Of those 16 cases, nine have resulted in a verdict for the plaintiffs in whole or in part, and six have gone in favor of the defendants.

 

Data from Adam Savett of the Claims Compensation Bureau (here) show that there have now been nine cases filed post-PSLRA involving conduct occurring after the enactment of the PSLRA that have resulted in jury verdicts or bench decisions at trial. Of these nine, five have gone for the plaintiffs and four have gone for defendants.

 

Plaintiffs have to be heartened by the Ninth Circuit’s decision in the Apollo Group case. But notwithstanding this development, and for many reasons, trials in securities lawsuits still are likely to remain extremely rare.

 

A June 23, 2010 Bloomberg article by Thom Weidlich and Emily Heller about the Ninth Circuit’s opinion can be found here.

 

Special thanks to a loyal reader for providing a copy of the Ninth Circuit’s opinion.

 

Self-Restraint:  I considered captoning this post "Apollo -- "Oh No!" but thought better of it.

　

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As opening speaker on June 21, 2010 at the Stanford Law School Directors’ college, Southern District of New York Judge Jed Rakoff shared his views about Bank of America’s settlement of the SEC enforcement action, including some thoughts about why he approved the revised $150 million settlement of the case after he rejected the prior $33 proposed settlement. He also commented on what he hopes the significance of the sequence of events may be.

 

In August 2009, the SEC filed an enforcement action against Bank of America related to the events surrounding the company’s acquisition of Merrill Lynch. At the outset, the case related solely to omissions pertaining to the payment of bonuses at Merrill Lynch prior to the merger, although as later amended the action extended to omissions in the proxy materials relating to Merrill’s deteriorating financial condition after the merger was announced but prior to the shareholder vote.

 

In a harshly worded September 14, 2009 opinion (here), Judge Rakoff had rejected the parties initial $33 proposed settlement, finding that it did not meet the requisite standard for judicial approval, as it was "neither fair, nor reasonable, nor adequate." He challenged the very premise of the deal, which he said "proposes that shareholders who were the victims of the Bank’s alleged misconduct must now pay the penalty for the misconduct."

 

On February 4, 2010, the SEC announced a revised settlement of its amended enforcement action. Though the revised settlement substantially increased the cash value of the settlement, many observers at the time questioned whether the revised settlement addressed Rakoff’s numerous concerns with the initial pact. Yet Rakoff approved it, although "reluctantly."

 

In his speech at the Stanford Directors College, Judge Rakoff provided some explanation of the reasons he approved the revised deal. Among other things, he noted that the revised settlement included "specific prophylactic measures" regarding disclosures that had not been included in the initial proposal.

 

In addition, though the settlement funds would still ultimately come from Bank of America’s then-current shareholders, the funds under the revised settlement would go to Bank of America’s pre-merger shareholders, rather than to the SEC, as had been the arrangement under the initial settlement. Because about half of the post-merger shareholders had prior to the merger been Merrill Lynch shareholders, but only the pre-merger Bank of America shareholders would receive the settlement funds, the practical effect of the settlement was a "renegotiation" of the price of the merger deal.

 

Rakoff also mentioned that the day before the settlement was proposed, New York Attorney General Andrew Cuomo ("Hereinafter to be referred to as ‘The Candidate,’" Rakoff added) filed a state court action against Bank of America and two of its officers charging them with fraud (about which refer here). He said that "under the circumstances, he had no alternative but to examine" the material the AG had relied upon, as a result of which he concluded that the SEC’s "view of the facts was not unreasonable."

 

Rakoff added that he "really would have preferred that the case go to trial, as that would have provided an opportunity for a jury to determine what the facts were," but his role was not to determine his own preferences but rather to determine whether the proposed settlement was "fair, reasonable and adequate."

 

In commenting on what the significance of these events may be, Judge Rakoff noted that in the past SEC consent judgments have largely been free from "scrutiny" because of the generally "high regard" the judiciary has for the SEC and the "deference" the SEC is given as a result.

 

Judge Rakoff said he "harbors the hope" that the questions he raised about the Bank of America settlement may "encourage some of my colleagues in being more proactive in assessing other SEC consent judgments" as well as consent judgments in other cases. These kinds of efforts may or may not contribute to greater "efficiency" but they "will lead to greater justice."

 

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There was a time when it was relatively rare for the Supreme Court to take up securities cases. Until recently, the Court basically went several years between cases filed under the securities laws. Those days are clearly over, as the Court has granted cert petitions in several securities cases in recent years, including the Merck and National Australia Bank cases this term.

 

The Court has now granted cert in a securities suit for next term as well. On June 14, 2010, the Supreme Court granted the petition for a writ of certiorari in the Matrixx Initiative case.

 

The question presented is whether plaintiffs must allege that adverse event information is "statistically significant" in order to establish that the defendants’ alleged failure to disclose the information was material. Though the issues involved appear narrow, the case potentially could address broader issues of securities claim pleading sufficiency.

 

Background

Matrixx Initiatives manufactured an internasal cold remedy called Zicam. In April 2004, plaintiff shareholders filed a securities class action lawsuit against Matrixx and three of its directors and officers, alleging that the defendants were aware that numerous Zicam users experienced loss of the sense of smell. The complaint alleges that the defendants were aware of these problems because of calls to the company’s customer service line; because of academic research, which was communicated to the company; and because of product liability lawsuits that had been filed against the company.

 

The district court granted the defendants’ motion to dismiss, finding that the complaint failed to adequately allege that the alleged omissions were material, because the complaint did not allege that the number of customer complaints was "statistically significant."

 

As discussed at greater length here, on October 28, 2009, the Ninth Circuit reversed the district court, holding that the district court "erred in relying on the statistical significance standard" in concluding that the complaint did not meet the materiality requirement. The Ninth Circuit said that a court "cannot determine as a matter of law whether such links [between Zicam and loss of smell] was statistically significant, because statistical significance is a matter of fact."

 

The Ninth Circuit said (citing Twombly and its progeny) that the appropriate test is whether the claim is "plausible on its face." The Ninth Circuit found that the complaint’s allegations of materiality were sufficient to "nudge" the plaintiffs’ claims from "conceivable to plausible."

 

On June 14, 2010, the U.S. Supreme Court granted the defendants’ petition for writ of certiorari, on the question whether the plaintiff can state a securities claim "based on a pharmaceutical company’s nondisclosure of adverse event reports even though the reports are not alleged to be statistically significant."

 

Discussion

When the U.S. Supreme Court grants cert, there is always the question "why"? On the theory that the Court wouldn’t take the case if it thought the Ninth Circuit got it right, one view might be that the Court took the case simply to overturn the Ninth Circuit. However, as we say in connection with the Supreme Court’s consideration of the Merck case (about which refer here), this assumption is not always borne out by the Court’s actions.

 

Perhaps the more neutral explanation is that as a result of the Ninth Circuit’s opinion, there is now a split in the circuits on the issue of the need to plead "statistical significance." Several other circuits (on which the district court relied in dismissing the Matrixx case) have held that plaintiff alleged that adverse events were "statistically significant," which the Ninth Circuit rejected that view and instead adapted a view that statistical significance cannot be resolved at the pleading stage and instead the court must consider facial plausibility.

 

Even if resolution of this narrow issue is all the Supreme Court accomplishes by taking up the Matrixx case, its review will still be significant. As the Morrison & Foerster law firm pointed out in its memo discussing the Supreme Court’s cert petition grant, companies regularly receive many customer complaints. These companies need to know when they have sufficient information about a product’s potential adverse effects that it must disclose that information.

 

Companies and defense attorneys would like a bright-line answer to this question, whereas, the MoFo memo suggests, plaintiffs "will push for an amorphous case-by-case determination."

 

There is a possibility that the Supreme Court’s consideration of this case could involve more than just this narrow issue, as important as it might be. Among other things, the 10b-5 Daily suggests that the Court could extend itself to a broader review of the issues of pleading materiality generally. Given what the Ninth Circuit said about what determinations are appropriate at the pleading stage, and what must be left to the trier of fact, this possibility seems substantial.

 

I also think it is critical to the Ninth Circuit’s rejection of the use of the "statistically significant" standard that its analysis was made in reliance on what it saw as required by the Twombly line of cases. Given the Ninth Circuit’s conclusion that its holding was required by Twombly, it seems unlikely that the Supreme Court could address the Ninth Circuit’s analysis without discussing what is required by Twombly and the larger issues of pleading sufficiency at the motion to dismiss stage.

 

There is the further possibility that the Supreme Court could range further and address other aspects of the Ninth Circuit’s decision, including even perhaps the Ninth Circuit’s conclusion that the plaintiff had adequately alleged scienter.

 

The Ninth Circuit’s conclusion that the scienter allegations were sufficient was based on plaintiffs allegations that the "high level executives …would know the company was being sued in a product liability action," and also based on the fact that the various academic research results and customer complaints were communicated to the company’s director of research – though there were no allegations that the other two individual defendants were aware of this information.

 

The Ninth Circuit put a great deal of emphasis on what the defendants’ "would have known" as higher level executives, without necessarily considering whether the plaintiffs had alleged that the defendants did know the supposedly omitted information.

 

This aspect of the case raises the question whether scienter may be sufficiently alleged based on an individual officers’ officer or position, even without supporting allegations about whether the defendants knew or what information they were provided access to.

 

Of course, there is no way of knowing whether the Supreme Court will reach these issues, or whether it will narrowly address the immediate questions presented. That is always one of the great uncertainties (and interesting possibilities) when the Court grants cert, you never know where the case might go. The broader possibilities here, while present, may also be conjectural best.

　

In any event, the next Supreme Court term will involve yet another consideration at the highest judicial level of questions involving securities lawsuit pleading questions. Perhaps this will be one of the first cases to be considered by Justice Kagan (assuming for the sake of argument that she does indeed join Justice Sotomayor and the other seven justices on the Supreme Court bench next term.

 

Readers may be interested to know that on June 16, 2009, the FDA warned consumers (here) to stop using three Zicam intranasal products because the products may cause a loss of smell. As reflected here, a second securities class action lawsuit was filed after the company’s share price plunged following this announcement.

　

Why Do They Call Them Wells Notices?:  If like me you have always wondered why a Wells Notice is called a Wells Notice, you will want to take a look at the recent post from the Compliance Building blog. Turns out there was, as we all suspected, someone named Wells – in fact, John W. Wells, an attorney who, in 1972 was appointed to chair a committee that made a number of recommendations, including the process now referred to as a Wells notice. Now we know.

My personal thanks to Doug Cornelius, the blog’s author, for answering a question I have always kind of wondered about.

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At least one prominent commentator has suggested that the reason for the accumulation during late 2009 of a significant number of belated securities suits, where the filing date came well after the proposed class period cut-off date, is that plaintiffs lawyers are "trying to fill the litigation pipeline by bringing older lawsuits that weren’t attractive enough to file" as subprime- related cases mounted during earlier periods.

 

The further suggestion was that "these lawsuits are more likely to be dismissed and can be characterized as lower quality claims."

 

Whether or not the belated cases in general are or are not likelier to be dismissed, and even whether or not the cases are "lower quality claims," at least one of the first of the belatedly filed cases recently survived a motion to dismiss, suggesting that at least some of the belated cases could represent serious claims exposures

 

Background

As discussed at greater length here, Ambassadors Group was first sued in a securities class action lawsuit in July 2009. The complaint, filed in the Eastern District of Washington, purported to be filed on behalf of persons who bought company stock during the period February 8, 2007 to October 23, 2007. In other words, the initial filing date came some 21 months after the proposed class period cut-off date.

 

Ambassadors is in the business of providing student travel trips, primarily to middle school students. The plaintiffs alleged that the defendants had omitted to disclose that in December 2006, the mailing list company from which Ambassadors purchased its middle school names list ended its relationship for undisclosed reasons. Ambassadors purchased a replacement middle school names list from a different company.

 

On October 22, 2007, when the company released poor financial results, among the reasons given was the unexpected underperformance of the replacement mailing list. The company’s share price declined 44% on the poor financial news.

 

The plaintiffs alleged that the defendants’ statements during the class period were materially misleading because the company knew as early as summer 2007 that response rates were poor and had known in late 2006 that it had lost access to a key mailing list. The defendants moved to dismiss.

 

The June 2, 2010 Ruling

In a June 2, 2010 order (here), Judge Justin Quackenbush denied defendants’ motions to dismiss as to the July 24, 2007 statement of the company’s Executive Vice President that the company’s was launching its 2008 marketing campaigns, which were "similar in timing and delivery as previous years."

 

Plaintiffs had argued that this statement was "simply untrue" because the 2008 marketing campaign was note similarly in delivery to previous years, owing to loss and subsequent replacement of the mailing list, which represented 90% of the company’s marketing leads and 45% of the company’s business.

 

The court concluded that the plaintiffs’ complaint "pleads sufficient facts, that when taking as true, create a genuine issue of material fact regarding whether the 2008 campaign was not, in fact, similar to delivery in previous years."

 

However, Judge Quackenbush found that the defendants’ remaining statements on which the plaintiffs sought to rely were "general and vague" and constituted puffery and therefore could not serve as a basis of liability.

 

In finding that the plaintiffs had sufficiently alleged scienter, Judge Quackenbush found, in reliance on the "core functions" doctrine, that the company’s mailing campaign was "so integral to the operations of [the company that knowledge thereof cannot be denied by senior executives." The company’s CEO and Executive Vice President were also alleged to have sold over $4 million of their personal holdings in company stock between May and August 2007. The court noted that the insider trading was the subject of an SEC investigation.

 

Judge Quackenbush went on to observe that:

 

Ambassadors is a small company. There is no reasonable argument that the Defendants were not aware of the mailing list issue. The core operations inference in this case is a strong one, as the Middle School names list accounted for 45% of the marketing leads for Ambassadors. The inference is strengthened by the allegations of the confidential witnesses, the SEC investigation, and the stock sales.

 

The Company’s CEO and CFO each separately moved to dismiss the claims against them on the grounds that they themselves were not alleged to have made the allegedly misleading statements. After reviewing case law relating to the "group pleading" doctrine, Judge Quackenbush rejected the two individual defendants’ separate dismissal motions, observing that:

 

Corporate officers, however, may not stand idly by as investors and analysts, upon whose recommendations other investors rely, are mislead [sic]. Corporate exeutiveship often carries with it substantial financial remuneration, but with such remuneration comes duties and obligations to the company and its stockholders that must not be ignored, as the economic catastrophes befalling the company in the past two years have harshly illustrated. Affirmative steps are required to prevent fraud or to even merely clarify when a statements veers into a dangerous grey area. [The CFO] may not cloak himself in his silence and avoid liability for the misleading statements of his co-defendants made to public stock analysts during a conference call at which he was present.

 

Discussion

A single ruling arguably represents little from which to try to make any generalizations about the belated cases as a group. Moreover, there may be those who might want to argue that this case is going forward on the basis of a single seemingly neutral statement about the initiation of the marketing campaign.

 

Some observers might also note that Judge Quackenbush’s ruling is heavily dependent both on the "core functions" doctrine and the "group pleading" doctrine, the applicability of both of which under the PSLRA have been the subject of considerable debate.

 

Nevertheless, the case did survive the initial dismissal motion. The time lag between the class period ending date and the initial filing date was irrelevant to the court’s decision. The dismissal motion ruling suggests that at least some of the belated failings will survive dismissal motion rulings and that the mere fact that a case was belatedly filed may not necessarily mean that the case will be unable to overcome initial pleading thresholds.

 

It is interesting to note that in his discussion of the responsibility of corporate officers to prevent fraud, Judge Quackenbush invoked both concerns about executive compensation and about the possible role of corporate officials in the financial crisis, suggesting a judicial context within which the activities of corporate officers may be viewed, even in the absence of allegations that the officers whose conduct is at issue received disproportionate compensation or contributed to the financial crisis.

 

The suggestion is that the popular outrage growing out the financial crisis may inform judicial decision-making, even in cases that seemingly do not directly involve the financial crisis.

 

One final observation is that, whatever the reason for the increase in belated securities class action lawsuit filings, and whether or not they represent "poorer quality claims," the plaintiffs’ lawyers continue to file them, as I noted in my recent discussion of recent securities lawsuit filing trends, here.

 

Special thanks to a loyal reader for sending me a copy of the Ambassadors Group decision.

　

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My weekend reading over the Memorial Day holiday included a hefty selection from the stack of law firm memos that accumulated in my inbox in recent weeks. Many of the most recent memos related to the Senate’s passage of its version of the financial reform legislation, but the memos also reflected a variety of other developments, including recent significant case developments and the passage of the UK bribery bill. I have set out below some of the more noteworthy recent law firm memos that have crossed my desk.

　

The Senate Financial Reform Bill

The Senate’s passage of the Restoring American Financial Stability Act of 2010 has triggered a flood of law firm memos. Though many of the memos have attempted to provide an overall description of the sweeping legislation, some have concentrated on focused on a narrow part of the bill. Several law firms have released memos focused just on the bill’s proposed corporate governance.

 

A May 24, 2010 memo from Sullivan & Cromwell provides an overview of the bill’s corporate governance reforms, including the bill’s provisions relating to majority voting for directors, "say on pay," executive compensation clawbacks, compensation committee independence and disclosures, and limitations on broker non-votes. The Sullivan & Cromwell memo points out that a number of the provisions in the bill – whistleblower protections, amendments relating to whistleblowers, private placement provisions and broker voting—would apply to non-U.S. issuers.

 

A May 28, 2010 memo from the Bingham McCutchen law firm also discusses the bill’s corporate governance reforms. Of particular interest, the Bingham memo contains an extensive discussion of the proposed "say on pay" reforms, with particular emphasis on concerns about "the amount of power the change would place in the hanks of proxy advisory firms," which provide compensation guidelines in connection with the proxy advice.

 

The Morgan Lewis firm also issued a May 27, 2010 memo about the Senate bill, here. The Morgan Lewis firm memo has an interested in discussion about the provision in the Senate bill that would require the securities exchanges to include the adoption of a compensation clawback policy as a listing requirement (by which incentive based compensation would be clawed-back from company officials in the event of a financial restatement of the financial statement of prior periods to which the compensation relations). The memo details the way that this provision the existing clawback requirements promulgated by SOX.

 

A May 27, 2010 memorandum from the Sidley Austin firm also provides an overview of the corporate governance reforms in the bill, and notes that that the bill contains additional compensation limitations for bank holding companies, and a separate provision requiring public companies to file a special SEC report of they using certain specified mineral products that may have originated in the Democratic Republic of Congo.

 

　

The Senate bill contains provisions designed to encourage corporate employees to blow the whistle on securities fraud. A May 21, 2010 Morgan Lewis memo (here) points out that these new provisions "give whistleblowers significant enhanced incentives to make a report" as part of the SEC’s new whistleblower program, and also provides extensive additional retaliation protections. The provisions would allow whistleblowers to receive rewards of between 10% and 30% of the monetary recovery. The provisions would also allow the whistleblower claiming retaliation to bypass existing administrative procedure requirements and proceed directly in federal court. The provisions also proposed a much longer statute of limitations and would create a double-back-pay remedy for retaliation claims, which created an incentive to bring retaliation claims.

 

Finally, a May 25, 2010 memo from the Faegre & Benson firm reports that the Senate’s financial reform bill "may give plaintiffs little to celebrate," noting that Congress "largely has chosen not to empower private parties" to enforce the rules. Indeed, the House bill’s provisions that would create the new consumer protection agency specifies that "nothing" in the provision establishing the new consumer protection "shall be construed to create a private right of action."

 

The Faegre & Benson memo does note that both the House and the Senate versions of the bill have "carved out a role for private litigants" to "help safeguard the integrity of the rating process" by allowing investors to sue credit rating agencies for securities fraud. The two versions disagree on the standard of liability to be required. Though the two versions must now be reconciled, some allowance private civil litigation against the rating agencies seems likely.

 

Securities Law Case Developments

A number of law firms have written memoranda discussing the Second Circuit’s April 27, 2010 opinion in the Pacific Investment Management Co. v. Meyer Brown case. Though the case outcome, in which the Second Circuit affirmed the dismissal of the securities fraud lawsuit against Refco’s lawyer, may have been unsurprising given the Supreme Court’s decision in Stoneridge, the law firm memos make the point that we may not have heard the last of the case.

 

As detailed in Arnold & Porter’s May 2010 memo about the case (here), the Second Circuit rejected the "creator theory" that both the plaintiffs and the SEC (in an amicus brief) had urged the court to adopt and instead held that "a secondary actor can only be held liabile for false statements in a private damages action for securities fraud only if the statements are attributed to the defendant at the time the statements are disseminated."

 

The Arnold & Porter memo points out that the decision, adopting the attribution test and rejecting the creator theory, has "two crucial limitations"; that is that it relates only to private civil actions under Rule 10b-5 and "does not speak" to government enforcement actions; and the Second Circuit refrained from addressing the question whether attribution is required for claims against corporate insiders.

 

The memo also notes that "perhaps most significant" is the fact that the decision was accompanies by Judge Barrington Parker’s concurring opinion, essentially calling for en banc review and even inviting the Supreme Court to weigh in on the matter. In other words, the memo notes, the Second Circuit’s recent opinion may not be the "final word on the subject."

 

Chadbourne & Parke also has a May 6, 2010 memo on the case, here. The Paul Hastings firm’s May 2010 memo on the case can be found here.

 

Finally, a May 26, 2010 memo from the Pillsbury Winthrop law firm discusses the Second Circuit’s May 18, 2010 decision in Slayton v. American Express , in which the Second Circuit held that even though forward-looking statements in the defendant’s SEC filing was not accompanied by meaningful cautionary disclosure, the plaintiffs failed to show that the statements were made with actual knowledge that they were misleading.

 

The Pillsbury firm memo identifies two "key takeaways" from the case: first, that "meaningful cautionary language must be specifically tailored to the statement at issue," as "boilerplate disclosure can be turned against a registrant because of its inherent lack of specificity." The Second Circuit’s holdings confirm the importance of "regularly reviewing the cautionary statements and risk factor disclosures contained in their public filings to ensure that the disclosure continue to be current and meaningful."

 

Second, the Second Circuit considered it to be a close call whether the plaintiffs had carried the burden of proving actual knowledge of falsity, "executive officers should remain vigilant and thoughtful when evaluating whether they have a reasonable basis for a particular forward-looking statement."

　

The U.K.’s Bribery Act 2010

The Morgan Lewis firm has a May 2010 memo entitled "The New UK Regime on Bribery" (here) describing the "far reaching implications" of the U.K.’s Bribery Act 2010. Among other things, the memo notes that the new law expands the scope of behavior that is targeted; no longer limited just to bribes paid to foreign officials, the new law applies to all bribes including purely commercial bribes, and applies to both the person paying and the person accepting the bribe.

 

Even more significant, the Act’s new Section 7 creates a new strict liability offense for organizations if a person associated with the organization bribes another person with the intent of benefiting the organization. However, organizations have a defense if they can show that they have in place "adequate procedures" to prevent bribery. In essence, the new Act is mandating compliance programs, to create controls against improper payments.

 

The Act has what the memo describes as a "wide territorial scope," applying of an act or omission forming part of the violation occurs in the U.K, or if in is carried out by a person with a "close connection" to the U.K.

 

A May 24, 2010 memo from the Weil Gotshal firm says that the new Act "provides the UK with one of the toughest regimes for regulating corruption in the world.

 

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On May 20, 2010, the U.S. Senate passed the Restoring American Financial Stability Act of 2010 (S. 3217) by a vote of 59 to 39. The Senate websites latest version of the Bill can be found here, and the Senate Banking, Housing and Urban Affairs Committee’s link to the most current version can be found here. Though these may be the most current versions available they do not necessariliy represent the final text of the bill, which was substantially amended and is not yet publicly available.

 

The Senate Bill must now be reconciled with the financial reform legislation the House passed last December (about which refer here). The reconciliation committee will be selected this upcoming week, and the plan is to have the reconciled version available for President Obama’s signature before July 4.

 

The massive Senate bill weighs in a 1566 pages. It is in many important ways substantially similar to the House bill, although there are also critical differences. Among the differences is the Senate bill’s controversial provision, sponsored by Sen. Blanche Lincoln, requiring financial firms to separate derivatives trading from banking operations and even spin them off under certain circumstances.

 

Among other measures that were not included in the Senate bill is the amendment proposed by Senator Arlen Specter that would have legislatively overturned Stoneridge and created a private right of action for aiding and abetting securities fraud. Theoretically, the measure could be included during the reconciliation process, but that seems highly unlikely at this point. Susan Beck’s May 21, 2010 Am Law Litigation Daily article reporting on the amendment’s defeat can be found here.

 

Another provision not included in the Senate bill is the measure incorporated in the House version (Section 7216) to provide extraterritorial jurisdiction for securities cases involving conduct within the U.S. constituting significant steps in furtherance of the securities violation, even if the transaction occurs outside the U.S. and involves only foreign investors. This provision, if incorporated in the reconciled version of the legislation, would legislatively address the "f-cubed" securities suit raised in many cases, included the National Australia Bank case now before the U.S. Supreme Court.

 

On the other hand, the Senate bill, like the House version, does incorporate a number of statutory corporate governance reforms. Among other things, the Senate version provides for non-binding shareholder votes on executive compensation (Section 951). The Senate bill also includes a measure requiring clawbacks from "any current or former officer" of incentive compensation awarded in the three year period prior to a financial restatement (Section 954). The Senate bill also adds additional disclosure requirements regarding compensation and regarding employee and director hedging (Sections 952 and 955)

 

In addition the Senate bill also specifies rules governing director elections (Section 971), among other things mandating that in uncontested elections, directors receiving a majority of votes are deemed elected. The measure further provides that directors receiving less than a majority in an uncontested election shall resign, with the board to consider whether or not to accept the resignation.

 

The Senate bill also requires companies to disclose the reasons why they have or have not chosen to have the same person serve both as board chair and CEO (Section 973)

 

The Senate bill also adopts a number of measures under the heading of "Investor Protection and Improvements to the Regulation of Securities." Among other things, the Senate bill, like the House version, includes measures providing protection and rewards for whistleblowers who report securities law violations to the SEC (Sections 922-24). The Senate bill also creates an Investor Advisory Committee that would consult with the SEC on matters pertaining to protecting investor interests (Section 911). The Senate bill also creates an Office of Investor Advocate within the SEC (Section 914).

 

Of particular interest to readers of this blog, the Senate bill, like the House bill, has a number of provisions relating specifically to insurance. The Senate Bill creates an Office of National Insurance (Section 502), which is in form substantially similar to the Federal Insurance Office in the House version. Like the agency created in the House version the agency created in the Senate bill would be housed within the Treasury Department. Neither the House nor the Senate version envisions that that the new federal agency would replace state insurance regulation. Instead, the new agency would monitor the industry in order to identify systemic risks; oversee TRIA; and coordinate international insurance regulatory efforts, among other things.

 

The Senate bill also contains a number of other insurance-related provisions, including a section addressing reporting, payment and allocation of premium taxes (Section 521); and another section relation to the regulation of non-admitted insurance (Section 522). Yet another measure specifies streamlined non-admitted insurance procedures for certain commercial insurance buyers (Section 525)

 

There are many other measures of more general interest in the massive Senate bill, including "improvements" to the regulation of rating agencies (Section 931 et seq.); increased disclosure requirements in connection with municipal securities (Section 975 et seq.); the creation of a Bureau of Consumer Financial Protection (Section 1001 et seq.); provision for the regulation of hedge fund advisors and others (Section 401 et seq.); and the institution of regulation for swap markets (Section 721 et seq.).

 

Though the ultimate shape of the legislation that will be presented to President Obama remains to be seen, the likely scope of many measures is already relatively clear, as both versions of the legislation include numerous substantially similar provisions. Whether or not the provisions ultimately enacted into law will suffice to prevent future financial crisis is a separate question but there can be little doubt that the financial system is about to face some enormous changes.

 

It is probably worth emphasizing here, as it may be overlooked elsewhere given the other high-profile issues the legislation involves, that the reform legislation, when enacted, will entail significant federal government involvement in areas previously viewed as the province of state regulation. Specifically, both insurance and corporate governance have until recently been regarded as matters with respect to which state interests should control.

 

Though significant levels of regulatory responsibility will remain at the state level both for insurance and corporate governance, this reform legislation significantly increases the federal government involvement. It doesn’t seem too suspicious to conjecture that these measures represent significant milestones in what is likely to be continued growth of federal responsibility in these areas.

 

The bill’s provisions relating to insurance could be of practical significance for insurance professionals. I did not review the provisions at length in this post, but if they survive in some form in the final bill, I will undertake a detailed review at that time.

 

Rating Agencies in the Crosshairs: The financial reform bill’s provisions relating to the rating agencies represent only one of a variety of developments that is raising the heat for those firms. David Segal’s May 23, 2010 New York Times article entitled "Suddenly, the Rating Agencies Don’t Look Untouchable" (here) takes a look at the assaults the rating agencies are facing on a variety of directions, including on the litigation front.

 

The article makes the point that though the rating agencies are prevailing in most of the credit crisis related cases in which they have been involved, there have also been a small handful of cases that have survived initial motions to dismiss. The article makes the point that as the litigation evolves, the plaintiffs’ lawyers are learning from every decision, including the dismissals, and are refining their arguments in subsequent cases.

 

The author of The D&O Diary is quoted briefly toward the end of the article.

 

More Deepwater Horizon Securities Litigation: As I have previously noted, the Deepwater Horizon disaster has already produced significant corporate and securities litigation, including the BP shareholders derivative suit (about which refer here) and the Transocean securities class action lawsuit (refer here). Now this litigation also includes a securities class action lawsuit filed against BP and certain of its directors and officers.

 

On May 21, 2010, plaintiffs’ lawyers filed a securities class action lawsuit in the Western District of Louisiana against BP and nine of its directors and officers. A copy of the complaint can be found here. The case is brought on behalf of purchasers of BP’s American Depositary Receipts "based on Defendants' repeatedassurances of BP's safe operations, reflected in the ADR price, have seen the value of their shares plummet 20% overnight - representing about $30 billion in market capitalization - as the truth about BP's operations has emerged."

 

The complaint alleges that "by touting the growth potential of its Gulf of Mexico operations… and highlighting the safety of the operations, BP convinced investors, including Plaintiffs, that BP would be able to generate tremendous growth with minimal risk." However, the plaintiffs allege, "The truth was that BP was cutting comers and reducing its spending on safety measures in an effort to maximize profits in the Gulf of Mexico."

 

Interestingly, the plaintiffs’ Louisiana counsel is the law firm of Domengeuax, Wright, Roy & Edwards, a Lafayette, Louisiana firm that has already been very active in pursuing Deepwater Horizon claims on behalf of commercial fisherman, shrimpers, oystermen, and charter boat operators, as well as on behalf of families of persons suffering injuries or death in the initial platform explosion, as reflected here.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog for providing a copy of the BP complaint.

 

O.K., Who Invited the Actuary?: In his rambling biography of Pablo Picasso, Norman Mailer describes an opium-laced party at Le Bateau-Lavoir, Picasso’s Montmartre rooming house, where the guests included such luminaries as Guillaume Apollinaire and numerous avant- garde sculptors, painters and poets. Mailer also reports that the guests included "Maurice Princet, the actuarial mathematician for insurance companies, who would give them his own popular introduction to Einstein’s work before long."

 

Say what?

 

I mean no disrespect to my many insurance actuary friends, but even were I to have access to Picasso’s opium, I don’t think I could imagine how an actuary wound up in this particular scene. I mean, can you picture Princet trying to bring down the house with the old story about the guy "who couldn’t disprove the null hypothesis"?

 

In fairness, I should acknowledge that Princet was to play in important role in the later development of "cubism," and indeed has been described by one of the principal actors in the drama as the "godfather" of cubism, for having introduced Picasso to certain mathematical concepts. I don’t think I would be alone, however, in finding it startling that the cast of characters in this particular production includes an insurance actuary.　

 

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Though some observers have reported a downturn in 2010 securities class action lawsuits compared to prior years, at least very recently there has been a flurry of filing activity, with six new securities suits in the past week, by my count. With these latest filings coming in, it seemed worthwhile to take a look at the most recent cases, to try to get a handle on where these latest suits are coming from. It does in fact appear that certain discernable factors are driving the recent filings.

 

1. The Headline Hit Parade: It is a truth universally acknowledged that a public company facing a public relations crisis must be in want of a securities class action lawsuit – or at least that seems to be the perspective of the plaintiffs’ bar. This pattern started earlier this year when Toyota’s sudden acceleration debacle led to a host of securities class action lawsuit filings (refer here). The pattern has been perpetuated in connection with the most recent public relations disasters.

 

Massey Energy sustains a coal mining disaster? Wham, in comes the securities class action lawsuit.

 

Goldman Sachs is target in a high profile SEC enforcement action: Pow, in comes the securities class action lawsuit.

 

Transocean is prominently involved in what may be the worst oil spill in U.S. history? Of course, a securities class action lawsuit filing followed closely behind. (The Transocean securities class action lawsuit filing follows closely on the heels of the shareholders’ derivative lawsuit filed against BP in connection with the Deepwater Horizon disaster, which I previously noted here.)

 

To find out which company will be next in line for one of these insult-to-injury lawsuits, just keep a close eye on the headlines – that seems to be what the plaintiffs’ lawyers are doing.

 

2. The Delayed Reaction Phenomenon: Another category of recent lawsuits look completely opposite from the headline driven lawsuits described above. Beginning around the middle of 2009, one phenomenon that developed was the emergence of belated lawsuits, where the filing date was as much as a year or more after the proposed class period cutoff date. Several of the most recent filings reflect this belated filing pattern.

 

For example, on May 11, 2010, plaintiffs’ lawyers initiated a securities class action lawsuit in the Southern District of New York against Pfizer and certain of its directors and officers. The proposed class period cutoff date is January 23, 2009, nearly 16 months prior to the initial filing date.

 

Similarly on May 12, 2010, plaintiffs’ lawyers initiated a securities class action lawsuit in the Western District of North Carolina against CommScope and certain of its directors and officers. The proposed class period cutoff date is October 30, 2008, more than 18 months before the initial filing date.

 

And on May 6, 2010, plaintiffs’ lawyers filed a complaint in the District of Delaware against Heckmann Corporation and certain of its directors and officers, in which the proposed class period cutoff date is May 8, 2009, just short of one year before the filing date.

 

Similarly belated filings have been an important aspect of the 2010 YTD securities class action lawsuit filings. Of the approximately 60 securities class action lawsuit filings this year, eleven (or about 18%) have been first filed at least one year after the proposed class period cutoff date. Perhaps more significantly, many of the most recent filing in May 2010 have been among these belated cases.

 

An interesting question related to these belated filings is whether the U.S. Supreme Court’s recent statute of limitations decision in the Merck case (about which refer here) will lead to the filing of even more superannuated suits. Reliable sources have suggested to me that it will.

 

3. Because That’s Where the Money Is: Since the beginning of the subprime-related litigation wave in 2007, lawsuits against financial services companies have predominated all filings. Though the proportion of filings against financial firms began to diminish around mid-2009, lawsuits against financial companies still represent the largest proportion of securities class action filings so far in 2010.

 

Thus, while the roughly 60 entities against which securities class action lawsuits have been filed so far this year represent 29 different Standard Industrial Classification (SIC) Code categories (and ten of the 60 lack any SIC Code classification), 17 of the 60 (or about 28%) involve companies in the 6000 SIC Code series (Finance, Insurance and Real Estate). Indeed, most of the entities lacking SIC Code designations are also financially related, and lawsuits filed against these two groups (that is, the 6000 SIC Code series entities and the entities without SIC Code designations) represent about 45% of all 2010 lawsuits.

 

The most noteworthy difference among the 2010 lawsuit filings involving financial companies compared to the most recent prior years’ filings is the number of commercial banks among the financial companies that have been sued. Indeed, several of the most recent filings have targeted failed or troubled banks, including, for example, the May 12, 2010 lawsuit filed against BancorpSouth (here), the May 7, 2010 lawsuit against First Regional Bancorp (here), and the April 15, 2010 lawsuit against Frontier Financial (here).

 

As I have recently noted, this lawsuit trend involving failed and troubled banks is likely to continue in the months ahead.

 

4. When All Else Fails: Though lawsuit filings against financial companies have continued to predominate among all securities suit filings, lawsuits against life sciences remain a familiar and important accompanying theme. With six lawsuits so far this year in the 283 SIC Code series (Drugs) and four more in the 384 SIC Code series (Surgical, Medical and Dental Instruments), lawsuits against life sciences companies remain an important part of 2010 lawsuit filings, as they have been in the past.

 

Several of the most recent lawsuit filings have involved life sciences companies, including the May 11, 2010 filing against Pfizer noted above, and the May 11, 2010 filing against NBTY. Indeed, 2010 filings that don’t involve either a financial services company or a life sciences company are in the distinct minority.

 

NERA Updates Options Backdating Securities Settlement Study: Earlier on in the evolution of the Options Backdating litigation, NERA Economic Consulting had reported (refer here), based on the handful of settlements at that time, that the options backdating cases were settling for lesser amounts than NERA’s analysis of all securities class action lawsuit settlements would predict. At the time, NERA proposed two possible alternative explanations – either the weaker backdating cases were settling first or suits alleging backdating were weaker than securities cases as a whole.

 

With many more of the options backdating securities class action lawsuits having settled (including the recent $173 million Maxim Integrated Product options backdating securities suit settlement), NERA has updated its analysis. In a May 12, 2010 report entitled "Do Options Backdating Class Actions Settle for Less – May 2010 Update" (here), NERA has taken a look at the 31 options backdating settlements and compared them to what their database model would predict.

 

Based on their analysis, NERA concluded that actual settlements were about 71% of predicted settlements. As a statistical matter they are unable based on the data to reject the hypothesis that "settlements in backdating class actions are, on average, no different than settlements in other shareholder class actions." This conclusion supports the corollary hypothesis that the "early settlements were relatively low because the weakest backdating class actions tended to settle most quickly."

 

The report includes a detailed list of each of the 31 options backdating related securities class action settlements to date.

 

Special thanks to Branko Jovanovic of NERA for permission to cite and link to the NERA backdating article.

 

SEC Settlements Update: And speaking of NERA updates, on May 14, 2010, NERA released its latest update on SEC settlement trends (here). In it last semiannual report, NERA reported that the SEC settled with 354 defendants in the first half of fiscal 2010, compared to 328 defendants in the second half of fiscal 2009 and 290 in the first half of 2009.

 

The first half of fiscal 2010 included two particularly noteworthy SEC settlements, the $314 million State Street settlement and the $150 million Bank of America settlement. The State Street settlement is the seventh largest SEC settlement since the passage of the Sarbanes Oxley Act.

 

Who’s On First/ In Whose Possession is First Base?: When I first conceived the title for this blog post, I recognized that I must construct the caption carefully or I would earn the scorn of vigilant grammarians. After careful review of the vast literature addressing the who’s/whose conundrum, I believe the caption is correct. It is always hard to tell who’s right and who’s wrong on these issues. But after all, whose blog is this? Who’s to tell? Whose views should prevail?

　

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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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The financial reform bill now working its way through Congress will include an amendment to the securities laws allowing private civil actions for aiding and abetting liability, if an amendment Senator Arlen Specter proposed on May 4, 2010 is part of the final bill. According to the Blog of the Legal Times (here), in conjunction with a Senate Judiciary subcommittee meeting and on behalf of himself and 11 other senators, Specter introduced an amendment to the financial reform bill that would impose liability on "any person that knowingly provides substantial assistance to another person in violation of this title." The proposed amendment can be found here. (Hat Tip: Point of Law blog.)

 

Although the securities laws currently allow for the SEC to pursue aiding and abetting enforcement actions, the Supreme Court held in the Stoneridge case that there is no private right of action for aiding and abetting liability under the federal securities laws.

 

As discussed at greater length here, in July 2009, Senator Specter introduced S. 1551, "The Liability for Aiding and Abetting Securities Violations Act of 2009," which proposed to legislatively overturn Stoneridge. Although Committee hearings were held in connection with that bill, it had not made it out of the Committee. In April 2010, Representative Maxine Waters separately introduced a House version of essentially the same bill, H.R. 5042, which was referred to the House Judiciary Committee.

 

Though there are now alternative versions of the aiding and abetting liability bill in each of the two houses of Congress, neither bill had progressed out of committee. Had the bills made it out of committee on their own, they undoubtedly would have occasioned debate and discussion. Specter’s proposed amendment to the financial reform bill, which is substantially similar to the previously introduced stand-alone bills, potentially could provide a short cut way around that likely debate and discussion.

 

It remains to be seen whether Senator Specter’s initiative to add the aiding and abetting amendment to the financial reform bill will ultimately become a part of the bill that is put before the Senate. But if the amendment is incorporated into the financial reform bill, it would only be one small part of a massive and controversial piece of legislation that will occasion intense partisan debates on a wide variety of issues, most of them much higher profile that than those involved in Specter’s amendment.

 

To be sure, passage of the financial reform bill itself is by no means assured. But debate on the bill will undoubtedly focus on the proposed systemic reforms embodied in the legislation. It is unlikely that Specter’s proposed amendment, if included in the bill, would itself occasion extensive additional debate or even materially affect the ultimate passage of the bill. Indeed, the aiding and abetting liability provision arguably has a greater chance of being enacted as an accessory to a larger reform bill than it might have on its own.

 

Were the provision to be enacted into law, either on its own or as part of a larger piece of legislation, it could represent a significant increase in the potential liability exposure under the securities laws for accountants, lawyers, and other professionals who might be in a position to be alleged to have provided "substantial assistance" to a primary violator.

 

But the increase in potential liability exposure is not limited just to these outside professionals. As I discuss in greater length in my earlier post on S. 1551, the circle of persons whose liability exposure potentially could be increased by the enactment of the proposed aiding and abetting liability provision includes other public companies and their directors and officers.

 

Indeed, in the Stoneridge case itself, the defendants who were alleged to have aided and abetted Charter Communications were vendors who did business with Charter and who allegedly engaged in "round trip" transactions with Charter.

 

In other words, were Senator Specter’s bill to pass, it would not only greatly expand the potential securities liability exposure for companies’ outside professionals. It would also expand the potential securities liability exposure of all companies that transact business with public companies.

 

Were this aiding and abetting provision to be enacted into law, it would have significant implications for insurers that provide professional liability insurance for the outside professional gatekeepers. It could also have potentially significant implications for D&O insurers as well, and as I also discussed in my prior post, the definition of the term "securities claim" used in D&O insurance policies could become particularly important. The critical issue will be whether the term is defined to restrict "securities claims" to claims involving securities of the insured company, or whether the term is defined to include any alleged violation of the securities laws.

 

Finally, it should not be overlooked that the universe of companies that might potentially become the target of an aiding and abetting claim is not limited just to other public companies. Any company, including even private a private company, that does business with a public company might potentially be alleged to have provided "substantial assistance" to the public company’s securities law violations.

 

For all of these reasons, the legislative progress of the aiding and abetting liability provision should be of keen interest to the entire professional liability insurance community, including the D&O insurance community. The possibility of the provision’s inclusion in the financial reform bill will make this a particularly complicated issue to monitor.

 

Radian Group Subprime Securities Lawsuit Dismissed Again, This Time With Prejudice: As discussed at greater length here, on April 9, 2009, Eastern District of Pennsylvania Judge Mary McLaughlin granted the motion to dismiss the subprime related securities complaint that had been filed against Radian Group and certain of its directors and officers, holding that plaintiffs had failed to adequately allege scienter. However, the dismissal was without prejudice. The plaintiffs filed an amended complaint and the defendants renewed their motions to dismiss.

 

In a May 3, 2010 order (here), Judge McLaughlin again granted the defendants’ motions to dismiss, this time with prejudice.

 

The lawsuit related to an affiliate company in which Radian was a minority owner, Credit Based Servicing & Asset Securitization (C-Bass), an investor in the credit risk of subprime residential mortgages. Radian was a joint venturer in the affiliate with MGIC, with which Radian also had an agreement to merge.

 

The plaintiffs alleged that the defendants made false and misleading statements about C-Bass’s profitability and liquidity position and thus, the value of Radian’s investment in C-Bass. The statements allegedly inflated Radian’s share price, which led to losses to shareholders when Radian announced an impairment of its investment on July 30, 2007. The turbulence surrounding the C-Bass affiliate may also have undermined the pending merger with MGIC. Further background about the case can be found here.

 

In order to try to overcome the hurdles that led to the dismissal of their prior complaint, the plaintiffs amended complaint added more information regarding the defendants’ alleged knowledge of C-Bass’s troubles; more details regarding the merger of Radian and MGIC (which transaction, it was alleged, Radian was motivated to make motivations in order to preserve); and more details to bolster insider trading allegations.

 

Judge McLaughlin concluded that "the plaintiffs have failed to sufficiently amend their complaint to allege facts that give rise to a strong inference of scienter."

 

An Impertinent Remark About the Radian Group Decision: In addition to the actual holding itself, another aspect of Judge McLaughlin’s ruling is also of interest. With regard to the plaintiffs’ additional allegations about the defendants’ supposed knowledge of C-Bass’s problems, Judge McLaughlin noted instead of supporting a finding of scienter, "they serve to establish that the market at large knew of the subprime industry’s downward trend."

 

She then added "Indeed, this is not the first action to arise from the subprime mortgage crisis, nor the first to be dismissed." For the latter point she cited a number of other subprime securities suit dismissals (including the dismissal of the separate C-Bass related securities lawsuit filed against MGIC, about which refer here).

 

Judge McLaughlin is indeed correct that there have been many other subprime related lawsuits filed – over 200 by my count. In addition, as has been well-documented on this blog, there have been quite a number of dismissal motions granted in these cases. But a review of the full tally of dismissal motion rulings, which can be accessed here, shows that there also have been quite a number of dismissal motion denials, in addition to the rulings where the motions were granted.

 

Given that many motions have been denied, the fact that the motions have been granted in the cases she cites lacks any particularly persuasive effect (except of course with reference to the MGIC case, which undeniably is relevant). Simply referring to a few of the dismissals without referring to the motion denials represents an incomplete picture. Given the mix of case rulings, the fact that there have been some dismissals, in and of itself, does not seem particularly conclusive of anything.

 

Rating Agencies Lose Another Dismissal Motion: According to a May 4, 2009 Bloomberg article (here), a California state court judge has denied the motions of the rating agency defendants to dismiss the negligent misrepresentation claims that had been brought against them by the California Public Employees Retirement System (Calpers).

 

According to the article, Calpers had sued the rating agencies, alleging that the "faulty risk assessments on structured investment vehicles caused $1 billion in losses." Among the investment vehicles to which the rating agencies had given their highest ratings and that are the subject of the case is Cheyne Financial, which is also the subject of a separate lawsuit pending in federal court in Manhattan, in which Judge Shira Scheindlin had also denied the rating agencies’ motions to dismiss (about which refer here).

 

As detailed in Andrew Longstreth's May 4, 2010 article on AmLaw Litigation Daily about the latest ruling, the California judge rejected the rating agencies' argument that their rating opinions represented protected speech under the First Amendment. As Longstreth points out, the plaintiffs may be believe they now have a road map to overcoming this legal hurdle, in part due to Judge Scheindlin's rulings in the New York case.

 

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Vivendi lost the liability phase of the securities class action jury trial, and now it has lost a rearguard action to try to have French investors excluded from the U.S. investor class. According to press reports (here and here), Judge Jean-Claude Magendie of the Court of Appeals of Paris ruled on April 28, 2010 that Vivendi can’t block French investors from participating in the U.S. class action lawsuit.

 

The U.S. class action lawsuit involved the financial impact on the company from the $46 billion December 2000 merger between Vivendi, Seagram’s entertainment businesses, and Canal Plus. The plaintiffs contended that as a result of this and other debt-financed transactions, Vivendi experienced growing liquidity problems throughout 2001 that culminated in a liquidity crisis in mid-2002, as a result of which, the plaintiffs contend, Vivendi’s CEO Jean-Marie Messier and CFO Guillaume Hannezo　were sacked.

 

The plaintiffs contended that the between October 2000 and July 2002, the defendants misled investors by causing the company to issue a series of public statements "falsely stating that Vivendi did not face an immediate and severe cash shortage that threatened the Company's viability going forward absent an asset fire sale. It was only after Vivendi's Board dislodged Mr. Messier that the Company's new management disclosed the severity of the crisis and that the Company would have to secure immediately both bridge and long-term financing or default on its largest credit obligations."　

 

The long-running case resulted in a January 2010 jury verdict against the company on all 57 counts, as discussed here. Damages are yet to be awarded.

 

In the French court action, Vivendi sought to reduce the number of investors who could claim an award from the class action lawsuit. According to Bloomberg (here), about two-thirds of the members of the U.S. plaintiff class live in France. The same article states that the French court noted the "serious ties existing" between the French company, French investors and the U.S.

 

Significantly, the court restricted its opinion to the question whether the French investors could participate in the action, and did not reach the question whether French courts would enforce any eventual award.

 

This latter question of enforceability is particularly critical in this case, as Judge Richard Holwell in his March 22, 2007 order certifying the class had included investors from certain countries (including France) and excluded investors from other countries (such as German and Austria) based on his assessment of whether or not the judgment of a U.S. court in a securities class action lawsuit would be enforceable in the various countries.

 

In an April 28, 2010 press release (here), Vivendi said that it "regrets that the Court of Appeal has decided not to make a ruling at this stage on the question of whether American class actions were in accordance with French public policy."

 

The press release also states that no judgment has been rendered in the U.S. court action, which the company intends to appeal.

 

In a March 1, 2010 press release (here), the company announced that it had created a reserve of 550 million euros ($723 million) "with respect to the estimated damages, if any, that might be paid to the plaintiffs." The company added that "the amount of damages that Vivendi might have to pay the class plaintiffs could differ significantly, in either direction, from the amount of the reserve."

 

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A unanimous U.S. Supreme Court held on April 27, 2010 that the shareholder lawsuit arising from Merck’s alleged misrepresentations regarding Vioxx is not time-barred by the applicable statute of limitations. A copy of the Court’s opinion can be found here.

 

Background

In an action filed in November 6, 2003, the plaintiffs had contended that the company knowingly misrepresented the risk of using Vioxx, and that when the risks were disclosed the company’s share price fell. Merck claims that more than two years prior to the filing the plaintiffs had or could have discovered the "facts constituting the violation, and therefore was barred by the applicable statute of limitations.

 

The District Court granted Merck’s motion to dismiss, holding that events more than two years prior to the filing should have alerted the plaintiffs to the possibility of a misrepresentation, placing the plaintiffs on "inquiry notice."

 

The Third Circuit reversed the district court, holding that while events more than two years prior to the filing constituted "storm warning," the events did not suggest scienter, and consequently did not put the plaintiffs on "inquiry notice."

 

Merck filed a petition for writ of certiorari to the U.S. Supreme Court, and the Supreme Court agreed to hear the case.

 

The Supreme Court’s Holdings

Justice Breyer's opinion for the Court (with separate concurring opinions by Justices Stevens and Scalia) affirmed the Third Circuit and held that the plaintiffs’ complaint was timely.The Court’s opinion reflected several specific holdings.

 

First, the Court held that the statute’s requirement of filing within two years of "discovery" encompasses "not only facts plaintiff actually knew, but also those facts a reasonably diligent plaintiff would have known." (This is the portion of the opinion in which the concurring Justices did not join. Justice Stevens said this finding was not necessary to the Court’s holding. Justice Scalia, joined by Justice Thomas, disagreed with this part of the opinion while joining the Court’s holding.)

 

Second, the court held that the "discovery" of the facts that "constitute the violation" required the discovery of scienter-related facts. The Court found that "it would frustrate the very purpose of the discovery rule … if the limitations period began to run regardless of whether a plaintiff had discovered any facts suggesting scienter," as otherwise a defendant could conceal that he made a misstatement with an intend to deceive, and the two-year limitations period would expire before the plaintiff had actually discovered the fraud.

 

In reaching this conclusion about what is required to trigger the running of the statute of limitations, rejected Merck’s argument that the statute of limitations could begin to run once plaintiffs were on "inquiry notice." The court observed that the "terms such as ‘inquiry notice’ and ‘storm warnings’ may be useful to the extent that they identify a time when the facts would have prompted a reasonably diligent plaintiff to begin investigating," but in any event the "limitations period does not begin to run until the plaintiff thereafter discovers or a reasonably diligent plaintiff would have discovered the facts ‘constituting the violation,’ including scienter."

 

Finally, the Court rejected Merck’s argument that pre-November 2001 circumstances "reveal ‘facts’ indicating scienter," concluding that prior to November 6, 2001, "the plaintiffs did not discover, and Merck has not shown that a reasonably diligent plaintiff would have discovered, the ‘facts constituting the violation.’" Thus, the Court concluded, the "plaintiffs’ suit is timely."

 

Discussion

In a sense the issues addressed in the Court’s opinion are narrow and technical. In the vast scheme of things, statutes of limitations issues arguably might not affect many securities lawsuits, many of which historically have been filed shortly after the news triggering a sharp stock price drop, when, as is usually alleged, the truth was revealed to the marketplace.

 

However, there are at least a couple of current circumstances that may make the Supreme Court’s opinion in the Merck case particularly relevant just now.

 

First, since the second half of 2009, there have been an increasing number of case filings in which the filing date has come well after the proposed class period cutoff date. The later in time the filing date occurs, the likelier it is that statute of limitations issues could become relevant. Clarity around the issue of what triggers the running of the ’34 Act’s two-year statute of limitations, and particularly the clarification of the requirement for the discovery of facts constituting scienter, may help courts dealing with these belated cases to determine timeliness issues.

 

A second and perhaps more important reason the Court’s holding in Merck could prove relevant just now has to do with the continuing litigation arising out of the subprime meltdown and the credit crisis. As we move forward in time and the crisis-related events recede further into the past, additional filings increasingly may raise questions of timeliness. Statute of limitations questions are already arising in some of these cases, as I discussed in a recent post (here), and they are increasingly likely to arise in future cases.

 

The Merck opinion’s clarification of what is required to trigger the running of the statutue of limitations will help sort out these issues. In particular, the Court’s clarification that facts constituting "inquiry notice" and "storm warnings" alone are not sufficient to trigger the running of the statute could be particularly significant.

 

One final thought about this case is that the Court’s opinion definitely is helpful to the plaintiffs. In recent years, the Court has developed a reputation as hostile to private securities lawsuits. Without a doubt, the Court has issued a series of decisions (Tellabs, Stonridge, Twombley/Iqbal, Dura, etc.) that have proved helpful to defendants. But the Court’s opinion in the Merck case is not only helpful to the plaintiffs in that case but it likely will prove useful to plaintiffs in other cases as well.

 

Honestly, I didn’t see this coming. I thought, given the Court’s recent track record and given what I thought was the common sense notion that the Court would not grant cert just to affirm the Third Circuit, I thought this case would likely lead to a victory for Merck in another defense friendly decision. Instead, the plaintiffs prevailed in a unanimous holding. Maybe my presumptions were completely off base, but I still find the outcome interesting and a little unexpected.

 

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

 

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The SEC’s high-profile enforcement action against Goldman Sachs and one of its investment bankers may or may not revitalize the waning subprime and credit crisis-related litigation wave, but it has at least sparked an outbreak of follow on civil litigation against Goldman Sachs.

 

According to their April 26, 2010 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the Southern District of New York against Goldman and certain of its directors and officers. According to the press release, the complaint (which can be found here) alleges that the defendants failed to disclose that:

 

(i) the Company had, in violation of applicable law, not fully disclosed the facts and circumstances concerning the formation and sale of the ABACUS 2007-AC1 deal to investors such that it had engaged in misleading conduct; (ii) the Company had, in fact, bet against its clients and constructed collateralized debt obligations that were likely, if not designed, to fail; and (ii) the Company had received a Wells Notice from the SEC about the ABACUS transaction but failed to inform shareholders of this fact.

 

The complaint further alleges that April 16, 2010, Goldman was sued by the SEC "for making materially misleading statements and omissions in connection" with ABACUS 2007-AC1. Following this announcement, Goldman’s stock price fell $24.05, declining from $184.27 per share on April 15, 2010 to close at $160.70 per share on April 16, 2010.

 

A key issue in this new lawsuit will be Goldman's alleged failure to disclosure the existence of the Wells Notice. Which of course begs the question of whether or not Goldman had any obligation to disclosure the existence of the Wells Notice. There is no bright line rule on this issue, it is a question of materiality. But as Michelle Leder points out on the Footnoted blog (here), lost of other companies do routinely disclose Wells Notices. A post on the Westlaw Business Currents blog (here) is very much to the same effect, that is, that whether or not Wells Notice disclosure is requrired, many companies do disclose Wells Notices.

 

The securities class action lawsuit filing follows close on the heels of the filing late last week of two separate New York state court shareholders’ derivative lawsuits against Goldman, as nominal defendant, and certain of its directors and officers. According to April 23, 2010 press reports (refer here), the complaints allege that:

 

　

The individual defendants engaged in a systematic failure to exercise oversight of the company's 23 Abacus transactions, which were completed over a three and half year period. As a direct and legal result of the individual defendants' wrongful conduct, Goldman Sachs has been significantly and materially damaged, faces billions of dollars of liability, has incurred and will continue to incur millions of dollars of expense in defending claims against the SEC and investors, and has suffered serious damage to its reputation and image.

 

The same press reports also quote a leading plaintiffs’ securities class action attorney as saying that "I suspect every major pension fund in America" is considering suing Goldman Sachs "over the conduct that occurred."

 

I have added the new Goldman lawsuit to my running list of subprime and credit crisis-related securities class action lawsuits, which can be accessed here. SInce I first began compiling the list almost exactly four years ago, there have been a total of 210 subprime and credit crisis-related securities suits filed, of which eight have been filed so far this year.

 

A WSJ.com Law Blog post about the Goldman securities class action lawsuit can be found here. Bloomberg’s article about the lawsuit can be found here.

 

More About Goldman Sachs and D&O Claims: An April 26, 2010 National Underwriter article by Susanne Sclafane entitled "Long-Awaited SEC Action Emphasizes Need for More D&O Cover, Lawyer Says" (here) presents a lengthy discussion of the possible D&O claims implications from the recent SEC action against Goldman Sachs, as well as any follow on private litigation. The article also contains an extensive summary of the recent Advisen conference call regarding first quarter securities litigation trends.

 

As for the question of potential insurance coverage for the SEC’s claims and for other claims that filed against Goldman Sachs, an April 26, 2010 Business Insurance article by Roberto Ceniceros entitled "Goldman Legal Woes Could Hit Insurers" (here) explores the issues that could affect the availability of coverage under Goldman’s D&O insurance program. An April 24, 2010 Bloomberg article on the same topic can be found here.

 

The April 26, 2010 issue of Business Insurance also has an article by Zack Phillips entitled "Subprime Rulings Favor Defendants" (here), discussing recent trends in subprime and credit crisis lawsuit dismissal motion rulings.

 

Developments on the D&O Claims Front: In Chubb’s April 22, 2010 quarterly earnings conference call (a transcript of which can be found here), Chubb Vice-Chairman John Degnan had the following to say about D&O claims trends:

 

　

I am particularly pleased about developments in two areas I want to mention specifically, the frequency of non-credit crisis security class action claims and the recent rulings in credit crisis derivative actions.

 

For the second straight quarter, even as the number of new credit crisis security class actions virtually disappeared we did not see a corresponding increase in the number of non-credit crisis class actions. So for those observers who have speculated that there was a substantial number of backlog claims waiting to be filed, the evidence so far doesn’t support that. And, the two year statute of limitations is already a bar to actions in which the triggering event, typically a corrective disclosure took place in 2007 and early 2008, the years in which that presumed backlog would have been building.

 

In addition, we’re encouraged by the continuing relatively high dismissal rate in the first quarter of derivative actions which might otherwise trigger our side A coverages. Unlike the stock option back dating claims which were heavily weighted towards derivative actions, credit crisis claims have been predominately securities class actions. However, in connection with the credit crisis derivative claims which have been brought, we are seeing the allocation of well established legal protections governing mismanagement allocations and the defendants are having great, in some cases even unexpected success in defending those claims.

 

For example, in the recent decision involving AIG’s credit crisis woes, the court has made it clear that they will not engage in second guessing managements’ legitimate business decisions regardless of how badly those decisions played out. So, although some observers have asserted that credit crisis derivative claims have the potential to impact side A coverages, we are not currently seeing an increased level of exposure as a result of them.

 

Ordinarily I would not include on this blog anything as insurer-specific as a single company’s earnings conference call transcript, and I do not intend to comment on Chubb’s quarterly results here. I included this selection from the conference call transcript because I have a couple of thoughts about Mr. Degnan’s claims trend observations.

 

I should emphasize at the outset that in adding my comments that I mean no disrespect to Mr. Degnan, for whom I have nothing but the highest admiration and respect. Moreover, I fully recognize that Mr. Degnan’s comments were made in reference to his own company’s experience, rather than as a general matter. But with respect to more general trends, I do have a few observations.

 

There is no doubt that securities class action lawsuit filings were down during the first quarter as has been noted elsewhere. However, by my count there have been eight securities class action lawsuits filed so far in 2010 (out of about 40 lawsuit total YTD) in which the filing date was more than a year after the proposed class period cutoff. That 20% of all filings YTD were belated suggests to me that the belatedness of securities lawsuit filing, which first became pronounced in the second half of 2009, has continued into 2010. My earlier post about belated 2010 securities lawsuit filings can be found here.

 

I agree with Mr. Degnan that so far the credit crisis-related derivative suits have not gone particularly well for the plaintiffs. But as for the potential risks for the Side A product line in general as a result of derivative litigation activity, it is important to note that when derivative cases survive the initial pleading hurdles, they are increasingly costly to settle, and when they do settle, increasingly they are producing Side A losses.

 

The best illustration of this latter point is the $118 million settlement in the Broadcom options backdating derivative lawsuit, to which Excess Side A insurers contributed $40 million. Admittedly, the Broadcom settlement was not credit crisis related but it still represents a very significant development. (Perhaps Mr. Degnan can be forgiven for neglecting to mention the case, however, since his company is one of the few D&O insurers that did not participate in the Broadcom’s Side A tower.)

 

In any event, the most significant risk to the Side A product line is from insolvency related claims, not derivative claims. In the current economic environment, bankruptcy related claims remain a significant threat.

 

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As the number of failed banks has mounted in the last couple of years, the question that has arisen is whether the FDIC will pursue claims against the directors and officers of the failed institutions. While we are still waiting to see what the FDIC will do, private litigants have been moving forward. In particular, in many cases the investors have pursued securities lawsuits against the directors and officers of the failed banks.

 

Unfortunately for some of these plaintiffs, however, a number of these cases have resulted in dismissals. By way of example, dismissal motions were granted in the BankUnited case, and Downey Financial case. However, a recent decision in the securities lawsuit surrounding the collapse of Corus Bankshares went the other way, in an opinion that is largely favorable to plaintiffs.

 

Until the bank was closed on September 11, 2009, Corus Bankshares operated as the holding company for Corus Bank, a depositary institution that concentrated its lending activities in commercial construction loans, particularly condominium construction and conversion loans. Investors sued Corus and two of its former officers alleging that Corus misrepresented its lending practices, capital position and loan loss reserves. As the court later stated "the complaint alleges that Corus misrepresented the nature and extent of its financial troubles and its ability to survive the downturn affecting the economy at the time." The defendants moved to dismiss.

 

In an order dated April 6, 2010 (here), Northern District of Illinois Judge Elaine Bucklo denied the motions to dismiss as to Corus and its former CEO, but granted the motion as to its former CFO.

 

In their dismissal motions, the defendants had argued that the plaintiff’s allegations represented nothing more than "fraud by hindsight," particularly with respect to plaintiff’s allegations about the inadequacy of the loan loss reserves. Judge Bucklo rejected these arguments, finding that "plaintiff here has alleged specific, concrete reasons for his contention that Corus should have known that its reserves were inadequate and needed to be increased, and that Corus’s statements about the adequacy of its reserves were misleading." Judge Bucklo also found that plaintiff’s allegations about other aspects of Corus’s financial condition were also sufficient.

 

Judge Bucklo also concluded that the plaintiff’s scienter allegations were sufficient, at least as to Corus and its former CEO. She said that "an inference of scienter is supported, first of all, by Corus’s awareness of the discrepancy between its public statements about its finances and the corporation’s true financial condition." The inference, she said, was "buttressed by many other allegations," including the company’s undisclosed use of special purpose entities.

 

The defendant had argued that the plaintiff’s scienter theory was undercut by the "frankness" of some of the company’s disclosures. Judge Bucklo said that

 

The argument is not without force, but it does not carry the day. Plaintiff does not contend that Corus sought to pull the wool over the public’s eyes by claiming that it would pass through the recession entirely unscathed. Instead, according to plaintiff, Corus’s fraud consisted largely in concealing the full extent of its financial difficulties. Thus, the fact that Corus disclosed certain of its difficulties during the class period does not necessarily negate any inference of scienter, for Corus’s statements may still have been intended to conceal the fact that its condition was substantially worse than it statements suggested.

 

Judge Bucklo also concluded that the scienter allegations were sufficient as to the company’s former CEO, largely in reliance on plaintiff’s allegations that the CEO was "deeply involved in every major aspect of the lending process." She concluded that plaintiff’s scienter allegations against the CFO were not sufficient, particularly where there were no allegations that the CFO was deeply involved in the lending process.

 

HomeBanc Corporation Securities Suit Dismissed: In a ruling that came out completely opposite from Corus case, on April 13, 2010, Northern District of Georgia Judge Timothy C. Batten, Sr. entered an order (here) granting with prejudice the defendants’ motions to dismiss the securities lawsuit pending against two former officers of HomeBanc Corporation.

 

HomeBanc was an Atlanta-based real estate investment trust in the business of investing in and originating residential mortgage loans. The plaintiffs alleged that prior to the company’s August 9, 2007 bankruptcy the defendants portrayed"overly rosy picture" of the company’s finances, and misrepresented the company’s underwriting practices, loan loss reserve model, and other aspects of the company’s lending and mortgage investment operations. The plaintiffs alleged that the company "loosened its underwriting standards and policies in response to slowing loan originations and shifted from its stated focus on conservative risk management to attempting to profit by selling poor quality loans." The defendants moved to dismiss.

 

In his April 13 order, Judge Batten agreed with the Defendants’ position that "the bulk of the statements upon which Plaintiff relies fail to satisfy the ...standards for materiality." Among other things he found that the complaint "makes conclusory allegations of falsity without establishing contrary true facts." He also said that the complaint is "rife with forward-looking statements made by HomeBanc that were accompanies by meaningful risk disclosures."

 

Judge Batten also concluded that the plaintiff "has failed to allege sufficient facts to demonstrate a cogent and compelling inference of scienter," noting that "the complaint cites differences of opinion, conjecture and innuendo in an attempt to make the Defendants’ behavior look suspicious, but it conspicuously omits any facts that would require one to rule out an innocent explanation for the alleged behavior." Judge Batten also held that the plaintiff had not sufficiently pled loss causation.

 

Discussion

These are two completely different cases involving two completely different sets of parties and two completely different sets of allegations. But it is very hard to read them back to back and not come away with a strong impression of how different the two judges’ approaches were and how the difference of those approaches seemed to lead directly to the outcome. To be sure, the difference of the approach may be nothing more than a reflection of the relative merits of the two cases. On the other hand, it is hard to shake the impression that there were two different outcomes simply because there were two different judges involved.

 

Some might argue that I am being naïve to believe that merits outcomes ought not to turn simply of the luck of the judicial draw. And yet others might say that judicial draw has nothing to do with the difference in outcome of these two rulings, but rather the outcomes reflect the cases. And I suppose it could be said that the system requires only uniform principles not uniform outcomes. But all of that said, it really does seem sometimes that the most significant factor in determining the outcome of a case is the identity (and predisposition) of the judge.

 

At the risk of starting something, I do think it is interesting to note that Judge Bucklo, who denied the motion to dismiss in the Corus case, is a Clinton appointee, and Judge Batten, who granted the motion to dismiss, is a Bush (W) appointee. Not that that has anything to do with the outcomes, of course.

 

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

 

Special thanks to the several readers who sent me copies of the Corus decision and to the loyal reader who sent me the HomeBanc decision.

 

PLUS Webinar: On April 22, 2010, at 2:00 P.M. EDT, I will be participating in a webinar sponsored by the Professional Liability Underwriting Society (PLUS) entitled "D&O Insurance and the Outcome and Timing of Securities Class Action Resolution: What New Data Shows." The purpose of the webinar is to discuss recent research completed by Stanford Law School Professor Michael Klausner on the impact of D&O insurance on securities class action resolutions. Professor Klausner’s research also addresses the timing of case resolution and factors affecting the eventual outcomes.

 

Joining me on the discussion panel, in addition to Professor Klausner, will be Steve Anderson of Beecher Carlson and Todd Greeley of C N A. The session will be moderated by Paul Lavelle of LVL Claims Services.

 

Information and Registration for this free webinar can be found here.

 

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On April 14, 2010, the insurance information firm Advisen released its analysis of first quarter 2010 securities litigation filings and trends. The quarterly report, which is entitled "Securities Suits Ease Back to Normal Following a Frantic Two Years," can be accessed here. As detailed below, the Advisen report concludes that the securities lawsuit filing activity "floated back to earth in 2010, to a pre-credit crisis plateau."

 

 

 

Before any attempt can be made to try to read the Advisen report, it is absolutely indispensible to understand that the Advisen report uses its own terminology.　

 

The most important thing to understand is that the Advisen report uses the term "securities litigation" to include a very broad range of kinds of lawsuits, including not just securities class action lawsuits, but also derivative actions, regulatory and enforcement actions, individual lawsuits, and collective actions in courts outside the United States.　

 

The Advisen report also apparently includes within the category "securities lawsuits" cases that many readers might not think of as "securities claims," including claims alleging "common law torts, contract violations and breaches of fiduciary duties."

 

The Advisen report uses the term "securities lawsuits" basically to mean any type of corporate or securities litigation (other than ERISA litigation), regardless whether or not the legal action was commenced in the U.S. or even apparently whether it alleges a violation of the securities laws. Because of the enormous variety of litigation encompassed within this category, throughout this post I have put the phrase "securities lawsuits" or "securities litigation" in quotation marks.　

 

The Advisen report also uses the phrase "securities fraud" lawsuits as a subset of the larger group of "securities lawsuits." Contrary to what you might expect, however, the category of "securities fraud" lawsuits does not include class action lawsuits alleging securities fraud – securities fraud class action lawsuits are their own separate category ("SCAS"). Instead, the phrase is used to refer to regulatory and enforcement actions -- yet somehow also includes private securities lawsuits that are not filed as class actions.

 

So the "securities fraud" lawsuit category includes, in addition to regulatory and enforcement actions, lawsuits alleging fraud under the federal securities laws if the fraud is alleged by an individual but not if it is alleged on behalf of a class.

 

The Report’s Conclusions

Though the Advisen report’s title suggests that "securities litigation" is "back to normal," overall what the report seems to show is that "securities litigation" declined in the first quarter relative to recent periods.

 

Thus the report shows that there were 178 "securities lawsuits" (again, as that term is very broadly defined in the report). This first quarter filing rate for this broad category of litigation is down 34 percent from the final quarter of 2009 and 39 percent compared the year prior first quarter. This relative reduction in filing activity appears to be due to the decline in the number of credit crisis and Madoff-related lawsuits.

 

The 178 "securities lawsuits" in the first quarter represents an annualized filing rate of 712 "securities lawsuits," which would be 29 percent below the 2009 total number of "securities lawsuits" of 1,003.

 

This filing decline also affected the number of securities class action lawsuit filings as well. (Again, securities class action lawsuits, or "SCAS," represent a subset of "securities lawsuits.") According to the Advisen study, there were 38 securities class action lawsuits filed in the first quarter, which would represent an annualized filing rate of only 152 lawsuits. (Just by way of comparison, Cornerstone reports that the annual average number of securities class action lawsuits during the period 1996 to 2008 was 197.)

 

In continuation of a recent trend, the proportion of securities class action lawsuits as a percentage of all "securities lawsuits" continued to decline in the first quarter of 2010. Securities class action lawsuits represent 21 percent of all "securities lawsuits" in the first quarter of 2010, down from 23 percent in all of 2009, and 28 percent in 2004.

 

Though the decline in quarterly filing activity is attributable to the decline in Madoff and credit crisis-related lawsuit filings, financial firms remained the most frequently targeted. Financial firms were named as defendants in 31 percent of all "securities lawsuits," down from 39 percent in 2009 and 42 percent in 2008.

 

In addition to this still significant but declining level of filings involving financial companies, the report also notes "a wider spread of suits by industry sector," including the following sectors, indentified by their prevalence as targets as a percentage of all "securities suits"; "information technology (14 percent), consumer discretionary (13 percent), healthcare (11 percent), and industrials (11 percent).

 

Seventeen (or ten percent) of first quarter 2010 "securities lawsuits" were filed against non-U.S companies, down from 12 percent in all of 2009. The report states that there was "one large suit [against a non-U.S. company] filed in a non-U.S. court." The report does not define what is meant by "large."

 

Advisen Webinar: On Friday On Friday April 16, 2010, I will be participating in an Advisen webinar, entitled "First Quarter Securities Litigation Review," to discuss first quarter 2010 securities lawsuit filings as well as other first quarter securities litigation developments. Other participants in the webinar, which will take place at 11:00 am EDT, include Ken Ross from Willis, ACE’s Scott Meyer, Wilkie Farr’s Michael Young, and Advisen’s David Bradford. Advisen’s Jim Blinn will moderate. Registration information for the webinar can be found here.　

　

 

Reader Advisory: Terminology Matters!

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Editor's Note: The corrected post is being republished to remedy an error in the prior email notification. The National Australia Bank case now awaiting decision before the United States Supreme Court raises what the Second Circuit in that same case called "the vexing question of the extraterritorial application of the [U.S.] securities laws." But while we all await the outcome of the NAB case, the lower courts are continuing to wrestle with these "vexing" questions. In two recent decisions in separate cases, two federal district court judges found they lacked subject matter jurisdiction over claims under the U.S. securities laws against foreign domiciled companies. Each of these decisions involved different aspects of the jurisdictional question and each represents outcomes that are interesting in distinct ways.

 

These questions of the extraterritorial application of the U.S. securities laws are most apparent in cases involving so-called "f-cubed claimants" – that is, foreign domiciled investors who bought their securities in foreign domiciled companies on foreign exchanges. Many of the most noteworthy recent cases, including the NAB case itself, have arising in the context of f-cubed claimant cases. The Fairfax Financial Holding case discussed below represents another example of an f-cubed claimant case.

 

But the European Aeronautic Defence & Space Co. case discussed below also involved a foreign domiciled company whose shares trade on foreign exchanges, but the plaintiff and the putative class consisted exclusively of U.S.-based investors. Thus, the EADS case represents an example of an "f-squared" case, as described in an April 10, 2010 memo (here) by lawyers from the Wachtell Lipton firm (who represented the EADS defendants in the EADS case) on the Harvard Law School Forum on Corporate Governance and Financial Reform. Nevertheless, though the case represented a lower jurisdictional exponent (i.e., squared rather than cubed) the court nonetheless found that it lacked subject matter jurisdiction, as discussed below.

 

European Aeronautic Defence & Space Co.: EADS is a public company organized under Dutch law and headquartered in the Netherlands. Its shares trade on Paris and Frankfurt stock exchanges, as well as on four Spanish exchanges. Its disclosures are governed by the laws of the European Union and its member states.

 

EADS shares are not traded on any U.S. exchange, although three U.S. banks have unsponsored American Depositary Receipts in EADS shares. EADS does not make filings with the SEC.

 

Bristol County Retirement System (a Massachusetts-based municipal employee retirement system) filed a securities complaint against EADS and three of its officers in the Southern District of New York on behalf of "all persons and entities residing in the United States" who purchased EADS shares during the class period. The complaint alleges that the defendants misled investors about production delays in the Airbus A380 super jumbo aircraft.

 

The defendants moved to dismiss alleging that the court lacked subject matter jurisdiction.

 

In a March 26, 2010 ruling (here), Southern District of New York Judge William H. Pauley III granted defendants’ motion, finding that neither the alleged U.S.-based conduct nor the alleged U.S.-based effects were sufficient to support jurisdiction.

 

With respect to his finding that the plaintiffs’ allegations failed to meet the conduct test, Judge Pauley said:

 

This was a European fraud. EADS is headquartered in Europe. Its shares trade only on European exchanges. It is subject to regulation by the European Union and its member states. Its investor disclosures were prepared and disseminated in Europe. The A380 production difficulties transpired in Europe. Bristol County purchased EADS shares on a European exchange. The gravamen of the Complaint is that EADS’s fraudulent disclosures in Europe inflated its share price on European exchanges, causing Bristol County to lose Euros. The only thing American about this case is Bristol County.

 

Even though Bristol sought to represent a class only of U.S. investors, Judge Pauley concluded that the plaintiffs failed to meet the effects test as well, ruling that "none of the putative class members are alleged to have acquired EADS shares on domestic securities markets." Judge Pauley added that "absent allegations linking the effects of the fraud to the United States, the federal securities laws do not reach this predominantly foreign fraud."

 

Interestingly, Judge Pauley found the plaintiff’s allegations did not meet the effects test despite the plaintiff’s contention that "there are seventy-three U.S. investors who hold 7 percent of EADS’s total outstanding shares," noting that these investors bought their shares overseas, and that even if some class members acquired shares as ADRs, absent a showing of a "substantial" effect on the purchasers, the "Court could not conclude the effects test has been met."

 

Judge Pauley also indicated that the doctrine of foreign non conveniens also separately supported dismissal, finding, among other things that the plaintiffs had an "adequate alternative forum" in European courts, notwithstanding the absence of class action procedures and the absence of recognition of the fraud on the market theory in those jurisdictions.

 

Fairfax Financial Holdings Limited: Fairfax is a Canadian financial holding company with a U.S.-based reinsurance operating unit. A Canadian investment fund, which bought its Fairfax shares in Canada, sued Fairfax in the Southern District of New York in a securities class action lawsuit, alleging that Fairfax had manipulated its reported financial results by improperly accounting for certain reinsurance contracts entered by its U.S.-based unit.

 

Though the named plaintiff bought its shares in Canada, Fairfax’s subordinate voting shares trade on the NYSE, and Fairfax has filed reports with the SEC.

 

In a March 29, 2010 opinion (here), Southern District of New York Judge George B. Daniels granted the defendants’ motion to dismiss for lack of subject matter jurisdiction. Judge Daniels found that "this case involves Canadian plaintiffs who bought shares of a Canadian company on a Canadian exchange" and that "neither the conduct nor the effects test provides a jurisdictional basis."

 

Judge Daniels found that the "allegations concerning United States based conduct are severely limited, both in number and jurisdictional significance." Though Fairfax’s U.S.-based reinsurance unit entered into the questioned transactions, the allegedly misleading financial statements were prepared in Canada. The U.S. unit’s conduct "may have contributed to the alleged scheme," but it was "Fairfax’s alleged conduct in Canada that defrauded investors and caused an inflated stock price."

 

Even thought the plaintiffs alleged an impact on U.S. markets and on U.S. investors, Judge Daniels found "the United States interest affected in this action is minimal, at best," particularly given that "this case involves foreign purchasers who acquired securities in a foreign exchange" and the lead plaintiff "fails to allege that any shares were bought or sold by investors on the New York Stock Exchange."

 

Though there are U.S. investors and though Fairfax has filed reports with the SEC, the lead plaintiff "fails to indicate that any conduct in Canada caused a United States investor to suffer a loss," and "conclusory allegations that Defendants’ fraud had a significant effect on unnamed Fairfax securities holders in the United States are insufficient."

 

Discussion

At least at the surface level, these cases are about nothing more than what the courts found the plaintiffs failed to allege. The inference is that with different allegations, the cases might have been permitted to proceed.

 

As a different level, however, these cases may be more about an unstated but evident judicial reluctance to impose U.S. securities laws on foreign companies in connection with securities transactions that took place outside the U.S. Because there is (at least not yet) no definitive legal authority that U.S. courts lack jurisdiction over extraterritorial transactions involving non-U.S. companies (whether or not the claimant is based in the U.S.), these courts both described their rulings in terms of the insufficiency of the plaintiffs’ allegations. However, in neither case were plaintiffs allowed to amend in order to attempt to cure the pleading defects.

 

Where you come out on the question whether or not these cases were correctly decided may well depend on how you feel about allowing U.S. courts to entertain cases under the U.S. securities laws against foreign domiciled companies, particularly with respect to transactions that took place outside the U.S. The plaintiffs in these cases may well feel aggrieved that a case, on the one hand, on behalf of exclusively U.S.-based investors, and, on the other hand, on against a company whose shares trade on U.S. exchanges and which files reports with the SEC, were not permitted to proceed in U.S. courts.

 

Defense-inclined observers may feel these courts appropriately declined jurisdiction. These observers may well contend that the mere presence of U.S-based investors alone without more arguably should not be enough to support jurisdiction, for the simple reason that there are very few investment vehicles of any kind any where in the world that do not have some U.S. investor involvement. If the mere presence of U.S. investors alone were sufficient to support jurisdiction, there would be few companies or transactions beyond the potential liability reach of the U.S. securities laws.

 

There is, however, a larger question here, which is whether U.S. securities laws appropriate should ever be applied to impose potential liability on non-U.S. companies and corporate officials in connection with transactions that took place outside the U.S. It might fairly be argued that to apply U.S.-based liability principles in this context might be an inappropriate extraterritorial extension of U.S. law to persons and transactions more appropriately regulated by the laws of other jurisdictions. One might argue that principles of comity and judicial restraint weigh against the U.S. courts’ exercise of jurisdiction.

 

The NAB base now awaiting decision at the U.S. Supreme Court may well address these larger principles, although the requirements of the specific case before the court may lead the court to rule narrowly, for example, declining jurisdiction without saying more about the circumstances under which jurisdiction is appropriate and how principles of comity might weigh in the analysis. These cases do raise difficult questions of legal authority and reach in a complex global economy.

 

As the cases above demonstrate, these issues will continue to arise, and absent definitive guidance from the Supreme Court – or Congress – the lower courts will continue to sort their way through these issues.

 

Andrew Longstreth’s March 31, 2010 AmLaw Litigation Daily article about these two cases can be found here. The 10b-5 Daily’s post about the EADS case can be found here. My initial post about the EADS case at the time the case was first filed can be found here.

 

Justice Stevens: The papers this weekend are full of articles about the retirement of Justice John Paul Stevens and his possible replacement. Perhaps in anticipation of these events, a couple weeks ago the New Yorker ran a March 22, 2010 biographical sketch of Stevens (here) written by the journalist and Court observer, Jeffrey Toobin. The article draws an interesting portrait of Stevens as the last of a dying breed, the moderate Republican. I recommend the article. It conveys a strong sense of the role that Stevens has played on the Court, particularly in recent years, as well as the possible consequences his departure may have going forward.

 

Advisen Quarterly Securities Litigation Webinar: On Friday April 16, 2010, I will be participating in an Advisen webinar, entitled "First Quarter Securities Litigation Review," to discuss first quarter 2010 securities lawsuit filings as well as other first quarter securities litigation developments. Other participants in the webinar, which will take place at 11:00 am EDT, include Ken Ross from Willis, ACE’s Scott Meyer, Wilkie Farr’s Michael Young, and Advisen’s David Bradford. Advisen’s Jim Blinn will moderate. Registration information for the webinar can be found here.

　

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As the various year-end securities litigation studies have all shown, cases against financial services companies have dominated securities lawsuit filings for the last several years. But throughout that period, the plaintiffs’ attorneys have also continued to pursue claims against companies in other industries, particularly companies in the life sciences sector. A recent memorandum from David Kotler of the Dechert law firm entitled "Dechert Survey of Securities Fraud Class Actions Brought Against Life Sciences Companies" (here) takes a closer look at the securities lawsuits that were filed against life sciences companies in 2009.

 

According to the memo, there were 19 life sciences companies sued in securities class action lawsuits in 2009, representing roughly 10% of all 2009 securities suits. The 2009 filings against life sciences companies represents a slight decline from the 23 that were filed in 2008, but the proportion of all filings as the same, as the 23 filing in 2008 also represented about 10% of all filing. These proportions are slightly down from but roughly equal with the immediately preceding years – 14% in 2007, 13% in 2006 and 16% in 2005.

 

Consistent with prior years, the majority of 2009 life sciences company filings (12 out of 19) were brought against companies with market capitalizations under $250 million. This is roughly proportionate to the representation of companies of that size among all life sciences companies, as companies with market capitalizations under $250 million represent about 65% of all life sciences companies.

 

By contrast to prior years, but perhaps consistent with the overall economic environment, the 2009 life sciences lawsuits were more focused on allegations of financial improprieties rather than claims of misrepresentations involving industry-specific issues such as product safety or efficacy. Nine of the nineteen cases involved allegations of accounting improprieties, compared to six alleging misrepresentations involving product safety and six involving the prospects for or timing of FDA approval.

 

One particularly interesting section of the memorandum is its analysis of the current status of the securities lawsuits that were filed against life sciences companies in 2007. The memo reports that of the 25 life sciences lawsuits filed that year, 13 (or more than half) have either been dismissed or had summary judgment entered for the defense. As the memo notes this is "an exceptionally high rate of dismissals" (compared, for example, to the historical norms of securities lawsuit dismissals in the 33-40% range).

 

According to the memo, this dismissal rate suggests that "the securities fraud complaints brought against life sciences companies (at least in 2007) were not particularly well founded." The basis for dismissal of a majority of the dismissed cases was the plaintiffs’ failure to adequately plead scienter.

 

The memo includes a reference to the possibility, based on statements of DoJ officials, of life sciences companies’ increased exposure to FCPA enforcement proceedings, which also includes the possibility of civil litigation following on in the wake of disclosures of FCPA actions.

 

The memo’s analysis of the outcomes of the 2007 cases squares with my own perception that life sciences companies are frequently sued, perhaps more frequently than other companies, but that plaintiffs’ lawyers often have a hard time making the allegations stick. The memos analysis suggests that even if life sciences companies are sued more frequently than companies in other industries, the claims against life science companies may be dismissed more frequently as well.

 

Special thanks to David Kotler, the author of the Dechert memo, for sending me a copy of the memo.

　

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On April 6, 2010, PricewaterhouseCoopers issued this year’s version of its annual study of securities class action litigation (here). The PwC report differs in certain particulars from previously released studies of the 2009 securities lawsuit filings, but the overall findings are directionally consistent with the prior reports. PwC’s April 1. 2010 press release about its 2010 study can be found here.　

 

My own analysis of the 2009 securities lawsuit filings can be found here. Cornerstone’s previously released study of 2009 filings can be found here and Cornerstone’s study of the 2009 securities lawsuit settlements can be found here. NERA’s 2009 study can be found here and Advisen’s can be found here.

 

According to the PwC study, there were only 155 securities class action lawsuits in 2009. As discussed below, PwC’s lawsuit count differs materially from all other published account. Consistent with the other studies, however, PwC reports that the number of 2009 filings represented a significant decline from 2008, when, according to PwC, there were 210 filings.

 

With respect to the 2009 filings, PwC notes a "noteworthy trend" involving "the incidence of long delays between the end of the class period and the filing date of the case." The study notes that the 2009 average time lag of 219 days is almost double the average number of 114 days since the PSLRA was enacted.

 

The study also reports that a total of 34 cases were filed one year or more after proposed class period cutoff date, and also notes that most of these delayed cases were not related to the financial crisis. The study suggests that "plaintiffs’ attorneys may now be returning to where they left off before the financial crisis began." (My own most recent post concerning the belated lawsuit filings can be found here.)

 

For the second consecutive year, financial services companies were the most frequent securities lawsuit targets. Financial services companies were named in 41 percent of all filings, compared to 48 percent in 2008.

 

The concentration on financial services companies has meant a "two-year reprieve" for companies in the high-technology sectors. Traditionally these companies have been a favored target, representing, for example, 55 percent of all companies sued in 2001. By contrast, in 2009, high-tech companies were named in only 12 percent of all 2009 filings.

 

Filings against pharmaceutical companies have remained consistent. Since the enactment of the PSLRA, pharmaceutical companies have represented an annual average of eight percent of all filings, and since 2002, the average percentage of filings against pharmaceutical companies has represented double digit percentages. In 2009, new filings against pharmaceutical companies presented 14 percent of total filings.

 

New lawsuit filings against Fortune 500 companies represented 20 percent of all 2009 filings. Almost half of the Fortune 500 companies named in new securities suits in 2009 were financial services companies.

 

The average securities class action settlement in 2009 was $34.6 milllion, which is 20 percent lower than the $43.4 million settlement average in 2008, is above both the ten-year average of $31.5 million and the $30.7 million average since the enactment of the PSLRA. The average settlement value of cases that settled for $1 million or more and up to $50 million is $10.8 million, up slightly from $11.2 million in 2008. The median 2009 settlement was $9.5 million, up from $8.5 million in 2008.

 

(The settlement values, averages and medians exclude "outliers" but the study does not specify how outliers are defined. The PwC study assigns settlements to the year in which they were announced, by contrast to other studies which assign settlements to the year in which they are approved.)

 

The PwC study ends with the observation that though the number of securities class action lawsuits declined, companies should by no means "relax their guard." The study comments that the 2009 decline "may simply be a lull as the plaintiffs’ bar refocuses following two years of intense financial-crisis related filings."

 

Discussion

PwC is one of several organizations providing a substantial public service by making its annual securities litigation surveys publicly available, for free. The firm’s willingness to share its analysis and insights is a boon for which the rest of us should be very grateful.

 

There is a certain audience that is very keenly interested in these reports. Virtually every member of this audience reads all of these reports as they are published. For example, the typical reader of the PwC report has already read all of the other annual reports that I listed and linked to above.

 

Because of this general audience familiarity with all of these published reports, it is probable that most readers are fully aware of the material difference between the lawsuit count published in PwC’s report and those that appeared in the other published versions. By way of example and by contrast to the 2009 lawsuit count of 155 that PwC reported, my own count was 189. Cornerstone’s latest updated 2009 lawsuit count is 178. NERA’s projected number (released before year end) was 235.

 

In the absence of explanation, these differences can vexing and frustrating for the readers of these reports, who, as I mentioned, will typically read all of these reports.

 

There is absolutely no reason why the counts should agree. I know from maintaining my own count that reasonable minds can differ about how to count and whether or not to include certain kinds of cases. But though the counts almost as a matter of course will differ, the authors of the various counts owe it to their audience – which, again is going to be reading all of the various studies – to at least say why their counts differ from other published accounts.

 

One explanation for the difference between the PwC count and some other published counts is that PwC (as explained on the study’s "methodology" page) counts "multiple filings against he same defendant with similar allegations" as one case. Some other studies, for example, the NERA study, will count separate filings against the same defendant as separate lawsuits. But that distinction does not account for the difference between the PwC study and, for example, the Cornerstone study and my own count, both of which count related filings only once.

 

The PwC 2009 lawsuit count comes in at some 20 to 30 cases lower than Cornerstone’s and my count. Obviously, PwC counted something differently or left some things out. Obviously, PwC knows its counts are different and they know why, or could easily determine why, because Cornerstone publishes on the web the identities each of the cases that it counts. Given how easy it is for PwC to identify these differences and how easy it would have been to tell its audience of readers, it would have been far preferable if they could have acknowledged and explained these differences.

 

As I said before, the rest of us should be grateful that PwC and other firms are willing to share their data and analysis. But it doesn’t seem too much to suggest that these various publications could do a little bit more for their audience and acknowledge that their publication does not appear in a vacuum. Its audience is going to read each report in the context of the other reports.

 

The firms publishing these reports would substantially enhance the value of their annual studies to their intended audience if they would simply explain their counting methodology in greater detail and in particular how that methodology may explain differences from other published reports.

 

Again, there is absolutely no reason why the reports should be the same. There is absolutely no reason why the reports should use the same or even similar methodologies. But the reports’ audience would be grateful if they might better understand why they differ.

 

These various publishers would significantly enhance the value of their publications to their intended audience if they would simply acknowledge that each other exists.

 

Note to Subscribers: I recently changed the service I use for delivery of email notifications to subscribers. If you have not been receiving email notifications, the most expeditious thing to do at this point may be to resubscribe by entering your email address in the Subscribe dialog box in the right hand column, clicking Go, and then clicking on the subscription confirmation link. It is my hope the new service will be more reliable and more timely. I apologize for any inconvenience the change may cause.

 

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Oral argument in the Morrison v. National Australia Bank case, now before the U.S. Supreme Court on a petition for writ of certiorari, is scheduled to take place next week, on Monday March 29, 2010. The case presents questions about the extraterritorial application of the U.S. securities laws, questions of growing importance in light of increasing globalization of financial activity. My prior discussion of the Second Circuit’s ruling in the case can be found here.

 

While the NAB case represents the first time the U.S. Supreme Court will directly address these issues in the context of the U.S. securities laws, this is far from the first time the Court has been called on to address the extraterritorial application of U.S. law.

 

For example, the court has previously addressed the extraterritorial application of the U.S. antitrust laws. Most recently in the Court’s 2004 decision in Hoffman-LaRoche Ltd. v. Empagran S.A. (here), the Court held that it was unreasonable to apply U.S. antitrust laws to foreign conduct where the resulting foreign injury was independent of any domestic injury.

 

However, thought the Empagran case does address questions of extraterritorial application of U.S. laws, it may provide relatively little insight into how the Court might address the issues in the NAB case, since the Court in the Empagran case was interpreting an express statutory provision addressing the extraterritorial application of the U.S. antitrust laws, the Foreign Trade Antitrust Improvement Act of 1982. There is no equivalent statutory provision with respect to the securities laws – at least not yet. A brief overview of the extraterritorial application of the U.S. antitrust laws can be found here.

 

The question of extraterritorial application of U.S. laws comes up in a variety of contexts. Stetson Law Professor Ellen Podgor points out on her White Collar Crime Prof Law Blog (here) that a February 2010 petition for a writ of certiorari in the British American Tobacco case raises the question of the extraterritorial application of RICO. A copy of the cert petition can be found here.

 

In addition, according to a March 2010 paper by the Hughes Hubbard law firm (here), the question of extraterritoriality also comes up in the bankruptcy context. Just as there are practical advantages that would lead a foreign investor to pursue securities claim in U.S. courts under U.S. laws, there are reasons why a foreign domiciled debtor might decide to "enjoy the shelter of chapter 11 of the U.S. bankruptcy code," which the foreign debtor apparently can do if it has assets in the U.S. and a U.S. bankruptcy court accepts jurisdiction.

 

The fact is that in a complex global economy where cross-border business transactions are an integral part of financial activity, questions involving the extraterritorial application of law are inevitable.

 

Because of these fundamental considerations, the NAB case is both an important case and a closely watched case. The case has attracted fifteen amicus briefs, including briefs filed, among others, on behalf of the governments of Australia and of France. The United Kingdom and Northern Ireland also filed an amicus brief, here. The foreign governments urge that principles of comity and respect for the sovereign rights of nations to govern their internal affairs militate against the exercise of jurisdiction by U.S. court over the claims non-U.S. claimants against non- U.S. companies. All of the Supreme Court briefs in the NAB case can be found here.

 

Among the briefs is an amicus brief filed by the U.S. Solicitor General. The SG has urged that a transnational securities fraud violates the U.S. securities laws if "significant conduct material to its success" occurs in the United States and if the U.S.-based component of the fraud directly causes the claimant’s injury. (The SG’s brief also argues that the questions before the court are not jurisdictional at all, but rather simply the plaintiffs are entitled to relief under the relevant statutory scheme.)

 

I am going to go out on a limb here and make a prediction that the test that emerges from the Supreme Court is going to look a lot like that urged by the Solicitor General. That is, it will not be enough for claimant to allege merely that the U.S. conduct to be "a substantial component of the fraud," but rather the U.S. conduct must have directly caused the claimant’s injury. That is, the court will look at some sort of nexus to the injury test.

 

By way of illustration, in the NAB case itself, the alleged underlying financial fraud took place in Florida but the allegedly misleading disclosures were issued in Australia. Under the test urged by the SG, the misleading disclosures caused the claimant’s injury, not the underlying financial misconduct, and therefore the case should not go forward in U.S. courts.

 

Hiatus: The D&O Diary will be taking a break from its usual publication schedule for the next few days. Normal publication activities will resume the week of April 5, 2010.

 

Service Announcement: I just wanted to remind readers that I will be changing the service that I use for email notifications. The change will take place during the week of March 29, 2010.

 

The critical message here is that current email subscribers who wish to continue to receive email notifications will have to reconfirm their subscription.

 

If all goes according to plan, on March 29, readers will received an email message from me at The D&O Diary. The email message will require you to resubscribe in order to continue to receive email notifications from The D&O Diary. Please follow the links in the resubscription email in order to continue to receive email notifications.

Because of the break in the publication schedule, the first email notification from the new service will not arrive until the week of April 5.

 

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On March 24, 2010, Cornerstone Research released its annual study of securities class action lawsuit settlements. The most recent study, which is entitled "Securities Class Action Settlements: 2009 Review and Analysis" and is written by Ellen M. Ryan and Laura E. Simmons, can be found here. Cornerstone’s March 24, 2010 press release concerning the study can be found here.

 

The study reflects a number of interesting observations about median and average securities class action lawsuit settlements that were approved during 2009. The study also includes a useful analysis of the factors that affect settlement size, and concludes with some commentary about likely future settlement trends.

 

First, the median 2009 settlement of $8.0 million is unchanged from 2008, although slightly up from the $7.4 median of all settlements during the years 1996 through 2008.

 

Second, the 2009 average settlement amount of $37.2 million is up from the 2009 average of $28.4 million. The 2009 average of $37.2 million is well below the $55.4 million average of all settlements during the period 1996 through 2009. However, if the largest four settlements during the period 1996 through 2008 are removed from the analysis, the average 2009 settlement of $37.2 million is slightly higher than the adjusted $34.4 million average for the 1996 to 2008 period.

 

(This analysis of average settlements excludes the settlements associated with the IPO Laddering cases, which given the number of cases resolved in that settlement has the effect of distorting the average settlement values.)

 

Third, the distribution of 2009 settlements also is comparable to prior years. Almost 60% of all settlements during the period 1996 through 2009 are below $10 million, and more than 80 percent settled for less than $25 million. Settlements in excess of $100 million remain relatively infrequent, occurring in approximately 7 percent of all cases.

 

Fourth, according to the study, the largest single most important factor is the amount of so-called plaintiffs’ style damages (that is, "damages" calculated using the methodology most often urged by securities class action plaintiffs). However, settlements as a percentage of plaintiffs’ style damages generally decrease as damages increase, and this observation is particularly valid for very large cases.

 

Fifth, the Cornerstone also assesses settlement values relative to what it calls Disclosure Dollar Loss, which compares the defendants company’s stock prices on the days before and the days after the corrective disclosure. The study reports that settlements as a percentage of the disclosure dollar loss generally decline as the loss increases.

 

The study also identified a number of other factors that affect overall settlement size:

 

1. GAAP Violations: Approximately 65% of 2009 settlements involved cases included alleged violations of GAAP. These cases "continued to be resolved for larger settlements that for cases not involving accounting allegations.

 

2. Auditor Defendants: Cases in which auditors are defendants settle for a relatively higher percentage of estimated plaintiffs’ style damages even when compared to the broader set of all cases in which improper accounting allegations were made. Since the cases filed in 2009 involve an increased number of auditor defendants even while the overall number of filings declined compared to the prior year, the presence of auditor defendants could become an increasingly significant factor in future settlements.

 

3. Financial Restatements: Approximately 45 percent of 2009 settlements involved financial restatements, which contrasts with reports of declining numbers of financial restatements. However, given the general lag between filing and settlement, the 2009 settlements generally involve cases filed during the 2004 to 2006 period, which was when the most significant numbers of restatements occurred.

 

4. ’33 Act Allegations: After controlling for the presence of underwriter defendants and controlling for other factors, the inclusion of ’33 Act claims does not result in a statistically significant increase in settlement amounts.

 

5. Institutional Investors Plaintiffs: Cases involving institutional investors as lead plaintiffs are associated with significantly higher settlements. The higher settlements are associated with cases involving public pension plans as lead plaintiffs as opposed to union funds or other institutional investors. These larger settlements may be due to the fact that the sophisticated investors get involved in the stronger cases and the larger cases. However, even when controlling for case size and other factors the presence of a public pension plan as lead plaintiff is still associated with a statistically significant increase in settlement size.

 

6. Companion Derivative Suits: Securities class action lawsuits associated with companion derivative cases are associated with statistically significant higher settlement amounts.

 

7. SEC Enforcement Actions: Cases that involve SEC actions are associated with significantly higher settlements, as well as higher settlements as a percentage of estimated "plaintiffs’ style" damages.

 

The study concludes with the observation that the economic environment during 2009 "did not have a distinguishable effect either on the number of settled cases or on the total value of securities case settlements approved during the year.’

 

The study also notes that as a general matter the securities class action lawsuits associated with credit crisis largely have not yet settled. Looking ahead, the study’s authors "anticipate that as these cases are resolved, settlements are likely to increase both in number and in value."

 

Discussion

As has been the case in prior years, Cornerstone’s analysis of the 2009 settlements is interesting and full of useful information. There are a number of important considerations to keep in mind in assessing the information in the study.

 

The first is that the Cornerstone analysis is limited exclusively to aggregate amounts paid in settlement of securities class action lawsuits. It does not reflect, or even provide any indication of, settlement amounts that were or were not paid for out of D&O insurance.

 

Second, the settlement values do not reflect costs incurred in connection with the defending the securities class action lawsuits, or any related proceedings (for example, derivative suits or SEC enforcement proceedings). In considering the Cornerstone data for purposes of assessing D&O limits adequacy, appropriate adjustment would have to made for associated defense expense. Given the incredible escalation of defense expenses in recent years, the adjustment required to accommodate likely defense expense is substantial.

 

Third, the data set upon which the Cornerstone analysis is based is limited exclusively to class action settlements. In recent years, however, there has been the increased incidence of claimants opting out of the class settlement and reaching their own separate settlements. This phenomenon potentially increases the aggregate dollar costs required to resolve all related securities litigation, which is an additional factor that needs to be taken into account in connection with the overall question of D&O limits adequacy.

 

　

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In their terrific new book "Circle of Greed: The Spectacular Rise and Fall of the Lawyer Who Brought Corporate America to Its Knees," Patrick Dillon and Carl M. Cannon detail the fascinating story of Bill Lerach, who rose to the pinnacle of his profession only to be brought down by criminal wrongdoing. My review of the book appears here.

 

While I was reading it, I began to wonder about the Pulitzer-prize winning journalists who had written the book and what they thought about their subject and their project. I approached them and asked them if they would be willing to answer some questions. To my surprise, they said yes.

 

I have set out below my written Q&A exchange with the authors. The text in italics following the Qs represents my questions, and the text following the As represents their answers.

 

 

Q: Why did you write a book about Bill Lerach?

 

A: He’s a great story, and we’re journalists – it was a natural. Bill Lerach’s life and career is a classic parable. We couldn’t resist.

 

Q: Lerach cooperated with your work on this book. What effect do you think this had? What would you say to any reader who thinks his cooperation meant that you soft- pedaled what you wrote?

 

A: We’d tell them to read the book. We hardly soft-pedal Bill Lerach’s crimes or his rough edges. Bill is on record as telling other journalists that he thought we were tough, but fair. We’ll accept that description. And Bill cooperated without ever so much as asking to see a single word of this manuscript before it was published in its final form. To us, that willingness to let the chips fall as they might demonstrated a gutsy pragmatism and a confidence in his own story that we couldn’t help but admire.

 

Q: You obviously drew on many difference sources in gathering your material for the book. Did you run into any particular problems in trying to gather information?

 

A: Much of the material was in the public record. We found other troves in our own files in our attics and basements as we both had written about Learch earlier in our careers. Most of the lawyers and other key actors were generous with their time. Our big regret is that Lerach’s law partner Melvyn Weiss would not consent to an interview.

 

Q: Your book is rich in anecdote and detail. What do you think was the most interesting thing you found in gathering information?

 

A: Well, Kevin, you’ve read it so you know. Fascinating scenes crop up throughout this narrative—because they did in Bill Lerach’s life. He seemed at times to be a real-life (if very smart) version of Forrest Gump. We hope these tales delight readers as much as they did the authors when we came across them: The preposterous art theft that led to the criminal case against Milberg Weiss; the epic trials pitting Lerach against the Methodist Church and, later, against the entire "Chicago school" of business. Bill doing legal battle with the great Sam Witwer; sweet talking iconic leftist Jerry Voorhis, the congressman defeated by Richard Nixon; Bill funneling money to Bill Clinton and then asking him for a veto; wringing a dramatic apology from John McCain; tangling with New York plaintiff’s lawyer Sean Coffey; cross-examining Roy Disney; jousting with Kirk Kerkorian; readying for holy war against Dick Cheney and Halliburton, suing every Silicon Valley entrepreneur you ever heard of; prevailing in Enron. Writing this book sometimes felt like being on a treasure hunt.

 

Q. Your book reports on Lerach’s question whether his criminal prosecution was in retaliation for his pursuit of claims against Halliburton. What do you make of that idea?

 

A: Readers of the book will see that this simply isn’t true. The criminal investigation of Milberg Weiss and its top partners predates the Halliburton mess, and it was managed by a dedicated civil servant in the Los Angeles U.S. attorney’s office named Richard Robinson who is not only a career prosecutor, but a Democrat. We think Bill makes some of these assertions for dramatic effect. Having said that, what’s that old phrase, "You’re not paranoid if they’re really out to get you." That may apply here. How many individuals in this country found their business practices targeted by the Republican Party’s 1994 "Contract with America"? How many had an act of Congress aimed specifically at them? (The Private Securities Reform Litigation Act of 1995 was dubbed the "Get Lerach Act.".) Bill Lerach didn’t imagine that. Bill also believes that the U.S. Supreme Court went through some strange gyrations to make third-party actors virtually immune from class action securities lawsuits—even when their fraud is massive and manifest. In this contention, Lerach appears to the authors to be on solid footing.

 

Q: While writing this book, you obviously had to become immersed in the world of securities class action litigation. Based on what you have seen, what do you think about this kind of litigation and the way it goes forward in our system? 

 

A: Kevin, as someone who is interested in the other side of this issue—the other side from Bill Lerach, that is—you know the havoc that the old "strike suits" wreaked on entrepreneurs, corporate officers, and the companies that insured them. This was especially true before enactment of the PSLRA, when class action securities cases were filed on no more evidence than a simple dip in a company’s stock price. Even in cases with no merit at all, the cost of settling them was less than the cost of defending them. So a consensus emerged that these lawsuits had become a kind of legalized extortion racket and were an anathema to justice and good business practices. Bill Lerach and Mel Weiss and their imitators came to be seen as glorified shakedown artists. We had covered these issues before writing this book (Carl Cannon covered Washington for the San Jose Mercury News, and Pat Dillon edited Forbes ASAP in Silicon Valley) and we knew this back story. It forms the narrative tension in Circle of Greed.

 

However, as we delved deeply into the rationale for such lawsuits, we couldn’t help but notice some other facets of your question. Here’s one: Although Lerach would allege fraud based on little more evidence than a falling stock price and a few upbeat press releases, he would in the course of his litigation routinely uncover instances of insider trading—the dumping of stock by top company officers immediately before bad news was about to be announced. The authors couldn’t help but be disillusioned by the frequency of this practice. A second point we would make: Once Congress decided that class action securities lawsuits were not the best way to enforce shareholders’ interests (not to mention honest business dealings), it became incumbent on the Securities and Exchange Commission to be ever-more vigilant against fraud. Perhaps this was too big a job for the SEC, but this did not happen. The upshot, as Lerach himself had warned many times, was a tsunami of fraud on Wall Street in the past decade that did great harm to investors and working people alike and which we believe made the current recession much worse for almost all Americans.

 

Q: In your book’s Epilogue, you write that "Bill Lerach was no monster, but he had indeed gone after fraud by using fraud." Do you think that this is just an instance of someone getting corrupted by the system, or was it something innate, something particular to Lerach himself, that drove his willingness to cross the line?

 

A: You mentioned that line in your very thoughtful review of our book, but let’s parse that sentence for a moment: He used fraud to go after fraud. That means there was fraud to begin with, and Bill Lerach would say that this reality—not his legal strategy—was the larger underlying problem. This contention may be self-serving, but it’s worth taking seriously. There was indeed something rotten on Wall Street—and in Silicon Valley—and instead of addressing the way corporate capitalism had been turned into an insiders’ game, Congress, the White House, and the Supreme Court spent their energy reining in the law firms that were rooting out corporate corruption and malfeasance.

 

As for Lerach’s personal motivation in being willing to cross the line into illegality, that seems to entail a complicated set of incentives and impulses. Let’s start with his fierce competitive streak. Like most super-successful trial lawyers, Bill Lerach loves to win and hates to lose. In the law, as in life, that attitude can lead to ethical shortcuts. Also, altruism was certainly a factor as well—a fierce brand of altruism animated by Bill’s populist political views: Lerach was convinced, and remains so, that he was doing good with these lawsuits. Finally, of course, greed was a factor in this epic morality play, just as it was for those on the receiving end of Lerach’s wrath—hence our title.

 

Q: Have you been surprised by the responses your book as received?

 

A: We’ve been pleased so far, although it’s instructive to see how critics and commentators tend to concentrate on passages in the book that bolster their pre-existing views.

 

Q: What do you think the lessons learned or conclusions are from the story you have told in this book?

 

A: We’d mention two: First, politics in this country really is broken. It’s an overly partisan hothouse environment where monetary contributions crowd out the art of compromise, and where the merits of any given issue give way to a desire to reward your allies and punish your rivals. Second, in the heat of his three-decade war of attrition with corporate officers and directors Bill Lerach ultimately began to resemble his adversaries—the ones he detested the most. There’s a lesson here for all of us in this, and it’s the line that precedes the one you mentioned about monsters. It’s from Friedrich Nietzsche, who put it this way: "Whoever fights with monsters should see to it that he does not become one himself."

 

The D&O Diary would like to express its deep gratitude to the authors’ willingness to answer our questions. We hasten to add that everyone who has read this far really should definitely read the book.

 

Speakers’ Corner: On Tuesday, March 16, 2010, I will be speaking at the C5 D&O Liability Insurance Forum in London. I will be speaking on a panel with my good friend John McCarrick of the Edwards Angell law firm on the topic "What are the Risks to European D&O Insurers from Class and Derivative Actions in the U.S." Information regarding the event can be found here.

　

 

　

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For those of us who spend a lot of time looking at securities class action lawsuits, the cases often have a familiar pattern. Unfortunately, the familiarity may dull sensitivity to the allegations or even to the process itself. So it was interesting to read a layman’s reaction to a recently filed lawsuit, if for no other reason than it provided a look at the lawsuit and the process with a fresh set of eyes.

 

The lawsuit in question was filed in the Northern District of California on March 9, 2010 against Medivation and certain of its directors and offices. As is so often is the case in these kinds of lawsuits, Medivation is a life sciences company whose developmental stage product failed to meet certain clinical trial goals. Specifically, and as reflected in the plaintiffs’ lawyers March 9 press release (here), its product did not meet primary and secondary goals in a Phase 3 clinical trial for patients with mild to moderate Alzheimer’s disease. When the company announced this news, its stock price declined and the lawsuit followed. A copy of the complaint can be found here.

 

This lawsuit will work its way through the system. The lawyers involved, all of whom undoubtedly are (or when they are retained to defend will be) well versed in these things, and will raise familiar arguments that may or may not succeed. All very familiar to those of us who spend all of our time immersed in these kinds of things.

 

An interesting perspective about this lawsuit appeared on the Blogging Stocks site (here). The author, Gary E. Sattler, has a number of reactions to the plaintiffs’ complaint, summarizing his comments with the observation that "even when given my usually cynical nature, and my usual dislike for big pharmaceutical interests, I still take issue with this potential class action lawsuit."

 

After summarizing the plaintiffs’ allegations, the author notes that

 

The plaintiff class has to cross a significant threshold of proof in order to prevail in this case. Based on my reading of the original complaint, plaintiffs fail to establish intent, fail to reveal purposeful omission of fact, and fail to establish that the actions of the defendants were the true overt cause of any artificial inflation of Medivation's stock value. Furthermore, the plaintiff's complaint seems to disregard that Medivation has had broad yet cautious support from within the Alzheimer's treatment community. Was it all wishful thinking? Perhaps it was, but that support came from many well-educated minds experienced in the field.

 

Sattler goes on to note that "to me, this potential class action smacks of sour grapes." He then reiterates his support for the company and for the company’s Alzheimer’s product.

 

Sattler seems to be reasonably objective (he states that he has no investment interest in the company). Of course, his rough and ready assessments have no direct relationship to how the lawsuit and its allegations might fare in court. But I have often found that the court of public opinion is an accurate sounding board. True, it might be argued that because of Sattler’s preexisting interest in the company and in its product he might be biased in its favor. But just the same it is interesting to look at the allegations through his eyes and see his reaction to the allegations.

 

When the U.S. Supreme Court first issued its opinion in Tellabs, I thought it would make little fundamental difference, because I thought that in the end and regardless of the formal standard, courts would give the green light to cases that raised a stink and would cut short the rest. Regardless of whether I am right about the Tellabs standard, I think trial courts fundamentally assess cases on a smell test, which is basically what Sattler has done in his post, albeit without specific reference to legal standards. Viewed in that light, his rough and ready assessment is interesting. And perhaps significant, at least with respect to the case’s prospects.

 

More About the FCPA: Regular readers know that I have a certain fixation about the Foreign Corrupt Practices Act. (Indeed, one reader has gone so far as to accuse me of being "obsessive" about it.) I continue to believe that the FCPA will be an increasingly important corporate exposure in the years ahead, if for no other reason than the relentless globalization of commerce.

 

For those who remain skeptical on the topic, I suggest a quick review of the March 10, 2010 post by Bruce Carton on his Securities Docket blog (here). In his post, Carton painstakingly compiles all of the recent comments by regulators corroborating that the FCPA is a top priority. He also reviews the significance of the recent Africa Sting enforcement action, as well as the implications of the Bribery Bill which may soon become law in the U.K. As Bruce’s emphasizes, there are a number of very significant implications to the Bribery Bill.

 

As Carton puts it, top FCPA lawyers agree that the anti-bribery activity has reached "a fever pitch." Whether or not I am obsessive, it is indisputably clear that FCPA related enforcement activity will be a significant area of corporate exposure in the months and years ahead.

 

A Picture is Worth a Thousand Words: Want to know what the financial crisis is all about? Check out this graphic depicting the escalating mortgage default rate during the current crisis. No interpretation required. As for myself, I am considering investing in gold. And stocking my basement with water, canned goods, matches, stout rope and a knife. You never know.

 

This Too Shall Pass: You are probably familiar with the OK Go video performed on an array of treadmills. If not, you should get out more. I’ve seen it and I have serious social issues. (See prior item). However, and in any event, everyone should watch the new video from OK Go for its new song, "This Too Shall Pass." Rube Goldberg would be impressed. Smashing pianos, crashing trash cans, smashing TV sets (showing the treadmill video, no less), the whole enchilada.

 

Though I have embedded the Rube Goldberg version below, there is an alternative spoof marching band version here that is also funny in a completely different way. (Don’t you love the Internet?) Please also see the Author's Note below.

　

Authors’ Note: This blog post was written in its entirety on a laptop computer while the author was sitting in Cladgagh Irish Pub in Lyndhurst, Ohio and watching Real Madrid play Lyon in a UEFA Champions League game on the television. (In an excellent game, the teams played to a 1-1 tie.)  I hope you enjoy reading this post as much as I enjoyed writing it. Gradus ad Parnassum.

 

　

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The SEC first acquired the right to impose civil penalties against corporations in the Securities Enforcement Remedies and Penny Stock Reform Act of 1990. Since the Remedies Act was enacted, the SEC has struggled with the question of when it is appropriate to obtain money penalties from corporate issuers.

 

In January 2006, in order to put some clarity around the issue of corporate penalties, the SEC issued its Statement of the Securities and Exchange Commission Concerning Financial Penalties (here). More recently, the sharp questions of a prominent federal judge have put a harsh spotlight on the SEC’s practices regarding corporate money penalties. In light of these questions, it is hardly surprising that the SEC might feel compelled to reexamine its practices for the imposition of penalties on corporations.

 

In a recent speech, current SEC Commissioner Luis Aguilar has proposed revising the guidelines in order to put the "appropriate focus" on the issue of deterrence. However, for reasons discussed below, I question whether Commissioner Aguilar’s position is necessarily the best approach to accomplish the desired goals.

 

Background

In the 2006 Statement, and after reviewing the legislative history of the Remedies Act, the SEC articulated a standard whereby the question of the appropriateness of a corporate penalty turns on two considerations: "the presence or absence of a direct benefit to the corporation as a result of the violation," and "the degree to which the penalty will recompense or further harm the insured shareholders." The Commission also identified seven additional factors that are also "properly considered," including "the need to deter the particular type of offense."

 

In a February 6, 2010 speech (here), SEC Commission Luis Aguilar characterized the 2006 Statement as a "misguided approach." The "serious flaw" in the Statement’s approach, he said, is that "the conduct itself becomes of secondary importance." Aguilar contends that the Commission "fails to appropriately focus on deterrence." He called the Commission to promptly revisit the 2006 guidelines go that penalties are refocused on their "purpose," which is to "deter and punish misconduct."

 

A March 6, 2010 Wall Street Journal article further discussing Aguilar’s views can be found here.

 

Discussion

In the current environment, Aguilar’s desire to focus the Commission’s enforcement efforts on the deterrence of future misconduct is both appropriate and commendable. However, that does not necessarily mean that the imposition of penalties on corporations is the appropriate means to that goal or even that the 2006 Statement needs to be revisited.

 

First, upon review of the 2006 Statement, it is clear that in devising the current guidelines, the Commission took significant pains to consider and to try to implement the considerations expressed in the legislative history of the Remedies Act, particularly the relevant Committee Report. Whatever Aguilar’s views may be, the current guidelines track the sentiments expressed in the Committee Report.

 

The second problem with Aguilar’s view is that, at least as expressed in his recent speech, it appears that his proposed approach simply disregards the fundamental problem with corporate penalties, which is that in many instances the penalties inappropriately harm the company’s current shareholders.

 

In that respect, the timing of Aguilar’s speech advocating the use of corporate penalties for deterrence purposes is more than a little odd, coming as it does so closely on the heels of Southern District of New York Judge Jed Rakoff’s highly publicized questions of the proposed settlement of the SEC’s enforcement action against the Bank of America.

 

Readers will recall that in his blistering September 14, 2009 opinion (here), Judge Rakoff rejected the SEC’s proposed $33 million settlement, on among other grounds that the proposed settlement "does not comport with the most elementary notions of justice and morality" because it "proposes that shareholders who were the victims of the Bank’s alleged misconduct now pay the penalty for the misconduct."

 

In response to the SEC’s argument that the proposed settlement "sends a strong signal" and "allows shareholders to better assess the quality and performance of management," Judge Rakoff said that

 

the notion that Bank of America shareholders, having been lied to blatantly in connection with the multi-billion dollar purchase of a huge, nearly bankrupt company, need to lose another $33 million of their money in order to "better assess the quality and performance of management" is absurd.

 

Judge Rakoff did subsequently approve a $150 settlement of the SEC enforcement action, but essentially as an act of judicial restraint and only while the Court was "shaking its head." Rakoff called the settlement "half-baked justice at best."

 

Judge Rakoff’s strong words seemingly challenge the very idea of corporate penalties, both because of the burden they impose on corporate shareholders and because the disconnect between penalties and the possibility of deterrence. In the immediate aftermath of the questions surrounding the BofA settlement, Aguilar’s advocacy of corporate penalties as a way to achieve deterrence seems both off-key and tone deaf.

 

We can all agree, as Aguilar proposes, that misconduct should be punished and deterred. However, it does not follow that the imposition of corporate cash penalties is the best or even a potentially well-calibrated means to try to achieve those goals. Indeed, as Judge Rakoff’s comments suggest, the problem with corporate penalties is that both the punishment and the putative deterrence are misdirected. Indeed, the notion that penalties paid out of the assets of one corporation will deter future misconduct by another corporation seems both abstract and unpersuasive.

 

Viewed in this light, the principles articulated in the Committee Report accompanying the Remedies Act, as implemented in the 2006 Statement, arguably represent an appropriate balancing of the considerations that should be taken into account in connection with the imposition of corporate penalties – including in particular the question whether the proposed corporate penalty "will recompense or further harm the injured shareholders."

 

My further concern about Aguilar’s initiative to try to ramp up corporate penalties is that his proposal arises at a time when the SEC is desperate to reestablish its regulatory credentials. One danger is that in its eagerness to look tough that SEC might try to extract enormous penalties from corporate treasuries while accomplishing little except the addition of unnecessary and unwarranted costs on beleaguered companies and their long-suffering shareholders (which is in fact the very thing that troubled Judge Rakoff).

 

The bottom line for me is that in the wake of the pointed questions that Judge Rakoff raised in the BofA enforcement action, this is a very odd time for any SEC Commissioner to be advocating increased corporate penalties as a likely or even promising way for the SEC to best accomplish its goals.

 

Just Visiting this Planet: In her latest email epistle, our globetrotting eldest daughter, now working in Quito for a nonprofit organization, passed along the following observation about a recent therapy session for refugee women she attended:

 

I was oddly reminded of the time at the neighborhood barbeque in Hokkaido with the inebriated  Japanese grandpas who wanted to sing Billy Joel. Totally unrelated to Spanish-speaking refugee women discussing how being a refugee increased their stress and messed up their female biorhythms. I think I drew the connection in my mind because of the "where on earth have I ended up" feeling I had both times.

　

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In a ruling that may have potential significance for the many claims that have been filed against the rating agencies in the subprime litigation wave, on February 17, 2010, Southern District of New York Judge Lewis Kaplan dismissed all but one of the claims that had been filed against the individual defendants in the Lehman Brothers Mortgage-Backed Securities Litigation. A copy of Judge Kaplan’s February 17 order can be found here.

 

Background

Plaintiffs had purchased the mortgage back securities that Lehman Brothers issued in August 2005 and August 2006. The plaintiffs allege that the originators of the loans that backed the securities failed to comply with the general loan underwriting guidelines described in the offering documents. The plaintiffs allege that the offering documents had failed to disclose that the rating agencies, which were paid for providing their ratings, had conflicts of interest and had been involved in helping to structure the securities. The plaintiffs also allege that the offering documents failed to disclose that the credit enhancements supporting the loans were insufficient to support the investment ratings the rating agencies gave the securities.

 

The individual defendants in the case are the officers and directors of the Structured Asset Securities Corporation, which issued the registration statements and acted as depositor in the securitization process. The individual defendants moved to dismiss.

 

As noted in prior posts, Judge Kaplan has previously dismissed plaintiffs’ claims against the rating agencies themselves (refer here), rejecting plaintiffs’ arguments that the rating agencies were "underwriters" under the ’33 Act. Judge Kaplan also previously dismissed the separate ERISA class action claims (refer here, scroll down). In his February 17 decision, Judge Kaplan separately ruled on the individual defendants’ motion to dismiss.

 

The February 17 Decision

Judge Kaplan held that the plaintiffs’ allegations that the offering documents failed to disclose the rating agencies’ conflict of interest were insufficient to state a claim, for two reasons.

 

First, Judge Kaplan held that the Securities Act does not require disclosures of "that which is publicly known," and "the risk that the rating agencies operated under a conflict of interest because they were paid by the issuers had been known publicly for years."

 

Judge Kaplan then went on to hold that "the rating agencies’ role in structuring the certificates is not material as a matter of law." His conclusion is based on the following analysis:

 

If the fee arrangement undermined an investor’s confidence in the rating agencies’ independence, a disclosure that a rating agency was involved in structuring the Certificates prior to rating them would have added nothing important to the "total mix" of information. If, on the other hand, an investor trusted the ratings agencies to give an honest opinion notwithstanding the fact that they were paid by the issuer, the fact that they were involved in structuring the Certificates, assuming that they were, likewise would have been unimportant. In consequence, these claims are insufficient.

 

With respect to the plaintiffs’ allegations that the offering documents contained misrepresentations about the amount and form of credit enhancement, Judge Kaplan held that the statement about the credit enhancement was a "statement of opinion," which could be actionable only if the complaint alleged that the rating agencies did not actually hold that opinion.

 

Judge Kaplan found that "at best" the complaint’s allegations "support an inference that some employees believed the rating agencies could have used methods that better would have informed their opinions," which he held to be insufficient to state a claim.

 

But Judge Kaplan did hold that the complaint’s allegations that the loan originators "systematically failed to follow the underwriting guidelines" were "sufficient at this stage to support a reasonable inference that the offering documents’ description of the underwriting guidelines was materially misleading."

 

Accordingly, Judge Kaplan granted the individual defendants’ motion to dismiss all of the claims against them except plaintiffs’ Section 11 claims about the loan originators’ supposed departures from underwriting standards.

 

Discussion

Even though Judge Kaplan’s February 17 opinion was issued in connection with claims asserted against the individual defendants and not in connection with claims asserted against the rating agencies themselves, the opinion nevertheless potentially could be of great significance in other subprime mortgage-related cases in which claims have been raised against the rating agencies.

 

In particular, Judge Kaplan’s holding that the offering documents’ omissions about the rating agencies’ alleged conflicts of interest and role in structuring the securities were not legally actionable may be of particular significance.

 

In many of the other cases in which claims have been asserted against the rating agencies, the claimants have, like the plaintiffs in the Lehman case, alleged that the rating agencies had undisclosed conflicts of interest and were involved in structuring the investments at issue. The rating agencies will undoubtedly find Judge Kaplan’s holding that the alleged omission of this information is not legally actionable to be helpful.

 

Judge Kaplan did not reach the question whether or not the rating agencies’ ratings are protected by the First Amendment, which is another defense on which the rating agencies will attempt to rely. But if the alleged omissions about the rating agencies are not actionable in the first place, there may never be a need to reach the First Amendment issues.

 

Judge Kaplan conclusion that the disclosures concerning the securities’ credit enhancements represented opinion rather than statements of fact is also instructive, even without getting into the First Amendment issues. As his February 17 decision states, statements of opinion are actionable only if the allegations show that the opinions were not actually as disclosed. Again, Judge Kaplan’s rulings are instructive and potentially significant as they suggest ways in which the claims against the rating agencies may be considered without even getting into the First Amendment issues.

 

Finally, Judge Kaplan’s holding that the rating agencies’ alleged conflicts of interest and involvement in the securitization transaction are immaterial does raise interesting questions about claimants’ ability to overcome the rating agencies’ First Amendment defenses. The plaintiffs have argued that the rating agencies were not entitled to rely on the First Amendment defense in the context of these kinds of structured investments because of the conflicts of interest and involvement in the transaction. Perhaps Judge Kaplan’s rulings are unrelated to these issues, but it does seem incongruous that considerations that are immaterial would be sufficient to overcome a constitutional defense.

 

Of course, it is entirely possible that other courts may not be persuaded by Judge Kaplan’s analysis. It is not intuitively obvious that, because it was public knowledge that rating agencies had conflicts, the rating agencies’ involvement in the transactions is legally immaterial. Indeed, the jump between the public knowledge of the conflict of interest and the immateriality of the rating agencies’ involvement in the transactions is frankly unsatisfying. Other courts might well be unwilling to make that analytic jump.

 

I have in any event added Judge Kaplan’s February 17 opinion to my table of subprime-related lawsuit motion to dismiss rulings, which can be accessed here. Because a portion of the claims against the individual defendants survived the dismissal motion, I have listed the ruling in the table of dismissal motion denials.

 

Special thanks to a loyal reader for sending a copy of Judge Kaplan's February 17 opinion.

　　

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In an interesting February 11, 2010 decision (here), Southern District of New York Judge Victor Marrero allowed plaintiffs, whose subprime-related securities class action lawsuit Marrero had previously dismissed, leave to file a second amended complaint against Credit Suisse Global and certain of its directors and officers.

 

Judge Marrero also found the securities fraud allegations in the proposed amended complaint to be legally sufficient, meaning that the claims can now go forward, although he also ruled that the court lacked jurisdiction over the claims of plaintiffs that resided outside the U.S. and that had purchased their shares outside the U.S.

 

Background

Credit Suisse is domiciled in Switzerland. Its shares trade on several securities exchanges outside the U.S. and its ADRs trade on the NYSE. As reported in greater detail here, the plaintiffs filed their initial complaint in this action in April 2008. The plaintiffs alleged that the defendants had made material misrepresentations about the company’s asset valuation system, its internal controls (which allegedly allowed unauthorized placement of high risk mortgage-backed assets in client accounts), and its own exposure to losses related to subprime mortgages.

 

In an October 5, 2009 order (here), Judge Marrero had previously granted the defendants’ motion to dismiss, on the grounds that the court lacked subject matter jurisdiction over the claims of claimants who reside outside the U.S. and who had purchased their shares on foreign exchanges (so-called f-cubed claimants). The complaint had not identified the domicile of some other named plaintiffs, but Judge Marrero dismissed their claims as well.

 

In his prior ruling he required plaintiffs to seek leave to file an amended complaint, which the plaintiffs did. His February 11 opinion addressed the plaintiffs’ motion for leave to file an amended complaint.

 

The February 11 Opinion

In his February 11 decision, Judge Marrero granted the plaintiffs’ motion for leave to file their amended complaint, at least as to certain of the claimants.

 

Judge Marrero first found that the amended complaint failed to establish subject matter jurisdiction as to the foreign domiciled claimants that had purchased their shares on foreign exchanges. In reliance on the Second Circuit’s National Australia Bank standard (about which refer here), he found that because the alleged misrepresentations had originated in Switzerland, there was insufficient U.S.-based conduct to support the court’s exercise of subject matter jurisdiction over the claims of the non-U.S. claimants.

 

However, Judge Marrero found that the amended complaint contained sufficient allegations to permit the exercise of jurisdiction as to the claims of the U.S.-based claimants. The amended complaint alleged that more than 75 million Credit Suisse shares were held by institutional investors, representing over 11% of shares outstanding, and therefore there were sufficient "effect" alleged within the U.S. to support jurisdiction.

 

Judge Marrero then proceeded to determine that the plaintiffs’ securities fraud allegations were legally sufficient. Among other thing, he found that though the proposed amended complaint "contains much extraneous detail and irrelevant information," within the "remaining core of what is pertinent" the plaintiffs’ proposed complaint "sufficiently alleges scienter."

 

The proposed complaint relies heavily on confidential witness statements, from which Judge Marrero determined that the proposed complaint "alleges sufficient facts showing that the Defendants had direct knowledge of information contradicting their public statements or access to similar statements they should have monitored." Judge Marrero concluded that the proposed complaint properly pled scienter to support theories of fraud based on alleged schemes to "overvalue assets, underestimate risk, hide subprime exposure, ignored weaknesses of [the company’] risk management and internal controls, and violate GAAP."

 

Discussion

As a result of Judge Marrero’s February 11 ruling, the Credit Suisse Group subprime-related securities case, which had initially been dismissed, will now go forward. The Credit Suisse case is the latest in a series of subprime-related securities suits in which dismissal motions were initially granted, but in which the amended complaints later survived renewed dismissal motions. This list of cases in this series includes the PMI Group case (here), the Washington Mutual case (here), and the BankAtlantic Bancorp case (here).

 

The ability of the plaintiffs in these cases to cure initial pleading deficiencies and to overcome preliminary pleading hurdles is noteworthy. Among other things, it casts important light on the list of subprime-related securities cases in which motions to dismiss have been granted. Many of these dismissals are without prejudice, meaning that the plaintiffs in a number of these cases, like the plaintiffs in the Credit Suisse case, may yet find a way to survive renewed dismissal motions and live for another day.

 

The outcomes of many of the dismissal motion rulings (at least to this point) the subprime-related securities cases could possible be interpreted to suggest that the cases were not faring particularly well. As reflected in my table of subprime-related lawsuit dismissal motion rulings, which can be accessed here, of the 48 subprime-related securities lawsuits in which dismissal motion rulings had been entered, fully 31, or nearly 65%, had resulted in the dismissal motions being granted, a dismissal rate the far exceeds typical patterns.

 

However, in 16 of the 31 cases, the dismissals were without prejudice. Many of the cases in which dismissal motion motions have been granted may yet survive renewed dismissal motions.

 

In any event, there still have only been dismissal motion rulings in about 27% of the subprime and credit crisis-related securities suits. The dismissal motions have not yet heard in nearly three quarters of the subprime and credit crisis-related securities suits. Though the subprime litigation wave first started in February 2007 and is now entering its fourth year, it still has a very long way to run. And many cases yet to be heard and other cases surviving renewed motions to dismiss, it is far too early to try to say one way or the other that cases are or are not faring well.

 

The fact that the Credit Suisse claims involve a foreign-domiciled corporate defendant is also noteworthy. Many of the subprime-related securities cases involve non-U.S. companies. the Credit Suisse case show that in at least some of these cases against foreign companies, the plaintiffs will succeed in establishing jurisdiction, even if the allegedly misleading statements originated outside the U.S., although in those cases the claims of foreign domiciled investors who purchased their shares on foreign exchanges may or may be allowed to continue.

 

Many thanks to a loyal reader for sending me a copy of the Credit Suisse decision.

 

Speaking of Jurisdiction Over Foreign-Domiciled Companies: One of the ways in which companies domiciled outside the United States can, in at least some kinds of cases, seek to avoid the burden and risk of defending litigation in the United States is by asserting the principle of forum non conveniens. This judicial tenet allows a court to defer jurisdiction where principles of justice and convenience favor the action being brought in another forum.

 

A February 2010 memo by the Sherman & Sterling law firm (here) discusses this principle and analyzes its recent application in the Cadbury Shareholder Litigation, a purported derivative class action that had been filed in connection with Kraft Foods hostile takeover bid. The action was brought in New Jersey federal court though Cadbury is a U.K. company, U.K law governs the Board’s conduct, and none of the parties resided in New Jersey.

 

In the Cadbury case, the court granted the defendants’ motion to dismiss on forum non conveniens grounds, determining among other things that the U.K. was an adequate alternative forum and that the plaintiffs’ choice of forum was entitled to little deference. The court also found that the differences between U.K. and U.S. takeover law did not detract from the availability of an adequate alternative forum in the U.K.

 

The principles of forum non conveniens could provide a substantial defense in other derivative litigation involving foreign domiciled companies. It is less likely to be relevant in class action cases alleging violations of the U.S. securities laws, as the availability of an adequate alternative forum may be far less likely given the absence in many jurisdictions of adequate alternatives to the remedies available under the U.S. securities laws.

 

In any event, the recent decision in the Cadbury case represents yet another case in which U.S. courts have sought to determine the circumstances under which it is and is not appropriate for U.S. courts to exercise jurisdiction over foreign-domiciled companies.

 

Bankruptcy Court Did Not Abuse Discretion in Granted Relief From Automatic Stay Allowing D&O Insurer to Reimburse Individual’s Defense Expenses: In an opinion filed on January 29, 2010 (here), the Ninth Circuit Bankruptcy Appellate Panel held that the bankruptcy court did not abuse its discretion in granting relief from the automatic stay in bankruptcy to allow the company’s D&O insurer to advance an individual insured’s legal expenses.

 

Layne Sapp had been the sole director, chief executive officer and majority shareolder of MILA, Inc., a mortgage brokerage firm. The company had a $1 million D&O insurance policy. The company filed for bankruptcy and the trustee initiated an adversary proceeding against Sapp alleging a number of claims. Sapp incurred legal costs defending himself. The D&O carrier agreed to advance his defense expenses if Sapp obtained a comfort order stating that the Insurer was not violating the automatic stay by making the payments.

 

Sapp filed a request for relief from the automatic stay to allow the D&O insurer to pay his defense expense. The trustee opposed the motion on the ground arguing that the policy proceeds were estate property and that payment of Sapp’s defense expense would deplete the limits. (Oddly and unusually, MILA’s D&O policy did not have so-called entity coverage, so the Trustee’s assertions of the estate’s rights to the policy proceeds were limited to the company’s reimbursement coverage under Side B of the policy).

 

The bankruptcy court granted Sapp’s request and the Trustee appealed.

 

The appellate panel held that the bankruptcy court had not abused its discretion in granting relief from the stay. The appellate panel found that the bankruptcy court had appropriately weighed the parties’ respective harms and determined that Sapp had shown the requisite case for relief.

 

The debate about the right to D&O insurance policy proceeds in the bankruptcy context is a long-standing and sometimes vexatious issue. A good summary of the principles involved can be found in a 2006 memo by Wiley Rein’s Kim Melvin, here.

 

And Finally: A surprising number of people manage to figure this one out on their own without even requiring instruction -- "How to Suck at Facebook" (here).

　

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One of the most distinctive attributes of the 2009 securities class action lawsuit filings was the prevalence, particularly in the second half of the year, of new lawsuits in which the filing date came well after the date of the proposed class period cutoff. There has been much discussion over the cause of the belated filings. But whatever the reason may be for these filings, the phenomenon clearly has carried over into 2010, and at least so far seems to be a significant feature of the 2010 securities lawsuit filings.

 

The two new securities class action lawsuits filed on Friday, February 5, 2010 both represent this distinct class of cases.

 

First, as reflected in their press release (here), on February 5, plaintiffs’ lawyers filed a securities class action lawsuit in the Southern District of New York against Nokia and certain of its directors and officers, alleging that the defendants had misled the company’s ADR investors about delays and price competition the company was experiencing with respect to its communications handsets. Though the complaint (which can be found here) was not filed until February 5, 2010, the proposed class period cutoff date is September 5, 2008, well nearly a year and a half before the filing date.

 

Second, as reflected in their press release (here), on February 5, a different set of plaintiffs’ attorneys filed a securities class action lawsuit in the Southern District of New York against the Bermuda-based workers’ compensation insurer CRM Holdings, Ltd., and certain of its directors and officers, relating the company’s pricing and reserving practices. Though the complaint (which can be found here) was not filed until February 5, 2010, the proposed class period cutoff date is November 5, 2008, over a year before the filing date.

 

These latest lawsuit follow along behind two other seemingly belated lawsuits already filed this year. The proposed class period cutoff date in the securities class action lawsuit filed on January 15, 2010 against medical device company Stryker Corporation is November 13, 2008, over a year before the filing date.

 

The most extreme example among the belated 2010 filings is the securities class action lawsuit filed on January 21, 2010 against Motorola. The January 22, 2008 class period cutoff date is a full 1 year and 365 days before the filing date, bringing the new lawsuit just inside the two year statute of limitations for actions under the ’34 Act.

 

In addition to their apparent belatedness, these filings also have a number of other attributes. Most particularly, none of these cases seem related to the subprime meltdown and global credit crisis. Even though CRM holdings is in the financial services industry, the allegations in that case do not appear to related to the economic crisis.

 

To that extent at least, then, the belated securities lawsuit filings seem consistent with the theory, which some plaintiffs lawyers have advanced (as discussed here), that the reason for these lag filings is that throughout most of the last three years, the plaintiffs’ firms were preoccupied with filing subprime and credit crisis cases. Now that that filing wave has died down the plaintiffs firm, by their account, are turning back to cases that they backburnered.

 

The other theory about these belated cases, advanced most notably by Professor Joseph Grundfest (refer here), is that the plaintiffs’ lawyers are running out of meritorious cases so they are scraping the bottom of the barrel (my words, not his) to file cases that, based on his analysis of past lawsuit filings, are statistically more likely to be dismissed.

 

I don’t know for sure why these cases have been filed belatedly. All I can say is that it is a very distinct and observable pattern that clearly has carried over into the New Year. Among other things, these filing patterns create challenges for D&O underwriters, who will face a great deal of uncertainty about when a company that has experienced past issues may be "out of the woods." To borrow an auto racing analogy, it as if a yellow flag has been raised for all the cars on the track – proceed with caution.

 

One final note about these belated filings so far in 2010 is that at least the Nokia and the CRM holdings cases involve foreign domiciled companies – they are based in Finland and Bermuda respectively. The susceptibility of non-U.S. companies to securities litigation in U.S. courts is a hot topic right now, with the National Australia Bank pending before the U.S. Supreme Court and with the Vivendi jury verdict having just been returned. These latest lawsuits suggest that the incidence of U.S. securities lawsuits against non-U.S. companies will remain a hot button issue for the foreseeable future.

 

Fifth Circuit Stays Ruling that Stanford Group’s D&O Insurers Must Pay Defense Fees: As I noted in an earlier post (here), on January 26, 2010, Southern District of Texas David Hittner had ordered Stanford Financial Group’s D&O liability insurers to pay the defense expenses that former Stanford officers (including Allen Stanford) are incurring in connection with various legal matters arising out of the Stanford scandal.

 

However, according to a February 4, 2010 Houston Chronicle article (here), the Fifth Circuit Court of Appeals has entered a stay of Judge Hittner’s ruling. The article also reported that the Fifth Circuit has schedule oral argument on the legal issues in the case for February 25, 2010.

 

So the story goes on, with out any greater clarity on the question whether or not the individuals are entitled to have their defense fees paid by the company’s D&O insurance carriers. High-profile financial scandals make for some high stakes (and therefore fiercely litigated) coverage issues.

 

Hat tip to the Securities Docket (here) for the link to the Chronicle article

　

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In a flurry of headline-grabbing events involving Bank of America last Thursday, the SEC announced the renewed settlement of its enforcement suit against the company, while at the same time New York Attorney General Andrew Cuomo announced his office’s initiation of a separate fraud action against the company and two former company officials. These high-profile developments pose a series of questions, not the least of which are the questions concerning the claims raised -- or not raised -- against the company officials, which in turn underscore some basic issues concerning the liability of individuals under the federal securities laws.

 

The first and most fundamental question is whether Southern District of New York Jed Rakoff will approve the current $150 million settlement, after previously rejecting the prior $33 million deal.

 

In his harshly worded September 14, 2009 opinion (here), Judge Rakoff rejected the prior settlement, finding that it was "neither fair, nor reasonable, nor adequate." He challenged the very premise of the deal, which he said "proposes that shareholders who were the victims of the Bank’s alleged misconduct must now pay the penalty for the misconduct."

 

Judge Rakoff further criticized the deal because the SEC did not explain why "it did not pursue charges against the Bank management or the lawyers who allegedly were responsible for the false and misleading proxy statements."

 

As Susan Beck of the AmLaw Litigation Daily points out in her February 4, 2010 article about the settlement (here, registration required), the renewed settlement seemingly does not address either of Judge Rakoff’s principal concerns. That is, the company is still proposing to settle the case at the expense of current shareholders. And the settlement does not address Rakoff’s earlier criticism of the SEC for failing to hold any individuals accountable.

 

Along the same lines, the WSJ.com Law Blog quotes (here) Duke Law Professor James Cox as saying "Either I’m hopelessly ignorant or this doesn’t address Rakoff’s concerns at all. Maybe they think Rakoff is getting senile in his old age. But I wouldn’t count on that."

 

The lack of SEC action against individual company officials is all the more evident because of the separate action the NYAG initiated virtually simultaneously with the SEC’s announcement of the renewed settlement. Cuomo’s lawsuit (here) not only names the company, but also names as defendants former BofA CEO Ken Lewis and former CFO Joseph Price. The New York action seemingly begs the question of why the SEC did not pursue claims against individuals, especially in light of Rakoff’s concerns.

 

There are some important considerations that need to be taken into account in contrasting the SEC’s and the NYAG’s respective actions. First of all, the SEC has said all along that the reason it did not pursue enforcement claims against individuals is because of concerns with its ability to satisfy scienter requirements. Indeed, in his September 14 opinion, Judge Rakoff expressly noted that the SEC had contended at that time that it had not pursued claims against individuals as "culpable intent was lacking because the lawyers made all the relevant decisions."

 

Thought the NYAG’s action asserts claims against two former executives, the legal basis of the claim is New York’s Martin Act. Unlike the liability provisions of the federal securities laws, the Martin Act does not require a finding that the individuals acted intentionally. The NYAG’s claims simply do not face the same pleading barriers as the SEC would if it were to pursue claims under the federal securities laws against company executives.

 

The challenge in substantiating claims under the federal securities laws against senior company officials even when their company was engaged in fraudulent misconduct was underscored in the recent Vivendi securities class action trial, where the jury found the company liable on all 57 counts, yet at the same time found the individual defendants not liable. In a post trial interview (here), the individual defendants’ trial counsel explained that this seemingly split verdict can be understood in part by the fact that the jury (defense counsel contend) was persuaded by the individuals’ testimony that they had not intended to mislead anyone.

 

The SEC’s reluctance to pursue the BofA executives and the odd split verdict in the Vivendi trial raise some interesting questions to ponder about the susceptibility of individuals to the imposition of liability under the federal securities law, although the lack of traction against the individual executives in those two cases may simply be a reflection of situation specific circumstances.

 

But in any event, the seeming contradiction between the SEC’s inaction against any individuals and the NYAG’s pursuit of the two executives may not be quite as first appears. Among other things, the SEC settlement and the NYAG’s lawsuit announcement were not in isolation from each other. To the contrary, Cuomo’s press release expressly references the SEC’s settlement and quotes him as saying that he support the SEC’s settlement.

 

The suggestion is that the two developments should not be viewed as in disjunction but rather as complementary. Perhaps the SEC will refer to the NYAG’s suit in response to Rakoff’s likely concerns with the settlement about the SEC’s inaction against individuals.

 

The most important differences between the SEC’s renewed settlement and the earlier version Rakoff rejected are that the latest deal represents significantly larger dollar amounts, and it also includes the company’s agreement to adopt certain corporate governance reforms.

 

The governance reforms arguably provide real value to the current shareholders. But even if the value to shareholders is substantial, the renewed deal still does not avoid Judge Rakoff’s earlier concerns that BofA’s shareholders are being forced to bear the cost for having been misled about the Merrill Lynch transaction. Indeed, the significantly larger dollar value of the renewed settlement seemingly exacerbates this very problem.

 

Given these concerns, it will be very interesting to see what Judge Rakoff does with the renewed settlement. It is very hard to read his September 14 opinion now and to think that this renewed settlement will fare any better than the prior version. It will be particularly interesting to see what Judge Rakoff’s response says about the fundamental notion of holding individuals accountable under the federal securities laws.

 

Broc Romanek’s post about the SEC’s renewed settlement on his CorporateCounsel.net blog (here) has some interesting observations about the role of corporate governance reforms within the resolution of SEC enforcement actions.

 

"Bump-Up" Claims Surge: Much ink has been spilled concerning the supposed decline in the number of securities class action lawsuit filings in 2009. But whether or not the class suits are in fact declining, another form of corporate litigation apparently is on the rise.

 

According to a February 4, 2010 Law.com article (here), there has been an "uptick in shareholder lawsuits over mergers and acquisitions." One source quoted in the article states that filings of those types of claims – referred to as "bump up" actions because they seek to increase the sale price – are up "at least 50 percent" over a few years ago.

 

The article also quotes Boris Feldman of the Wilson Sonsini law firm as saying that "plaintiffs lawyers are trying to replenish their inventory, because traditional securities suits have fallen." He goes on to say that "nature abhors a vacuum, so more and more plaintiff firms have been filing merger suits instead."

 

Many D&O insurance policies have express exclusions precluding coverage for the amount of any additional consideration paid to settle a bump up claim. Moreover, as I discussed at length in a prior post (here), some courts have held that there is no coverage for the additional consideration, even without respect to the exclusion. In many circumstances, however, defense costs at least may be covered.

 

Lehman Subprime-Related ERISA Suit Dismissed: In an earlier post (here), I noted that Judge Lewis Kaplan had dismissed liability claims filed against the rating agencies that had provided ratings opinions in connection certain Lehman Brothers securities offerings. In a separate opinion relating to the Lehman collapse, on February 2, 2010 Judge Lewis Kaplan also dismissed the subprime-related ERISA class action that beneficiaries had filed against former company officials. A copy of Judge Kaplan’s opinion can be found here.

 

In dismissing the case, Judge Kaplan held that the complaint failed to allege that the misconduct alleged against the eleven director defendants violated any fiduciary duties that the individuals had to plan beneficiaries. He further held that the complaint failed to allege that the sole remaining defendant (a member of the plan administrative committee) had any responsibility for or involvement with the company’s supposedly misleading disclosures, or any prior awareness of the company’s imminent collapse.

 

A February 3, 2010 AmLaw article discussing the opinion can be found here (registration required). I have in any event added the opinion to my list of subprime-related lawsuit dismissal motion rulings, which can be accessed here.

 

Lost Generation: If you have not yet seen it, you may want to take a couple of minutes to view the Lost Generation "mirror image" video. It is pretty bare bones, but is still makes an interesting statement. Hat tip to the CorporateCounsel.net blog for the link.

 

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Rating agencies are not susceptible to ’33 Act liability as "underwriters," even if they helped structure the mortgage backed securities at issue, according to February 1, 2010 ruling (here) by Southern District of New York Judge Lewis Kaplan in which he dismissed Moody’s and McGraw-Hill (S&P’s parent) from the Lehman Brothers Mortgage-Backed Securities Litigation.

 

Plaintiffs had purchased the mortgage back securities that Lehman Brothers had issued in two offerings in August 2005 and August 2006. The plaintiffs allege that the originators of the loans that backed the securities failed to comply with the general loan underwriting guidelines described in the offering documents. The plaintiffs allege that the rating agencies determined the composition of the loans in the mortgage pool that the instruments securitized. The plaintiffs also allege that the credit enhancements supporting the loans were insufficient to support the investment ratings the rating agencies gave the securities.

 

The plaintiffs premised their securities liability claims against the rating agencies based on their argument that the rating agencies were "underwriters" within the meaning of Section 11 of the ’33 Act. The plaintiffs based their theory that the rating agencies were "underwriters" within the meaning of Section 11 on the argument that the "underwriter" liability extends to those "who engaged in steps necessary for the distribution."
 

 

Judge Kaplan found this argument "unpersuasive," noting that

 

The Rating Agencies’ alleged activities may well have had a good deal to do with the composition and characteristics of the pools of mortgage loans and the credit enhancements of the Certificates that ultimately were sold. But there is nothing in the complaint to suggest that they participated in the relevant "undertaking" – that of purchasing the securities here at issue, the Certificates – "from the issuer with a view to their resale." The Section 11 claim is insufficient in law.

 

Judge Kaplan also rejected plaintiffs’ arguments that the rating agencies had "seller" liability under Section 12(a)(2) or control person liability under Section 15.

 

The rating agencies dismissal from this subprime-related securities class action lawsuit is not as significant as it would have been if it had based on the rating agencies’ claims that their ratings opinions are proteced by the First Amendment. Though Judge Scheindlin rejected that argument on narrow grounds in the Cheyne Financial case (refer here), the First Amendment defense undoubtedly will play a crucial role in many of the subprime-related securities cases that have been filed against the rating agencies, and the litigants in the many cases that have been filed against the rating agencies will have to await a later date to get a clearer sense of how those arguments will fare in these cases.

 

But though Judge Kaplan did not reach the first amendment issue, his ruling nevertheless is significant. As the subprime litigation wave unfolded, there were a number of complaints filed against the rating agencies asserting ’33 Act claims against them in which the plaintiffs in those cases had argued that the rating agencies were susceptible to "underwriter" liability under Section 11. Judge Kaplan’s rejection of that theory undoubtedly will be influential in those other cases where the plaintiffs have attempted to assert Section 11 "underwriter" liability against the rating agencies.

 

I have in any event added Judge Kaplan’s ruling to my list of subprime and credit crisis-related lawsuit resolutions, which can be accessed here.

 

SEC Issues Climate Change Interpretive Guidance: The SEC decided recently to issue interpretive guidance on climate change disclosure. The SEC has now issued the interpretive guidance, which can be found here. I think this is a significant development, and not just because the SEC has now formally put climate change disclosure on the list of things to do for reporting companies.

 

It is clearly a topic worthy of much longer treatment than I am able to give it while I am in New York attending the PLUS D&O Symposium, but the danger is that the disclosure requirement establishes the predicate for a plaintiff to later claim that a public company failed to meet its climate change-related disclosure obligations. In my view, the SEC’s issuance of the interpretive guidance brings us that much closer to the day when we may start to see D&O claims arising out of misrepresentations or omissions concerning climate change related disclosures.

 

The End of the World: In response to my recent statement that I was tired and could use a nap, one of my much younger colleagues replied "O.K, first we take zee nap, ZEN WE DEESTROY ZEE WORLD!" She undoubtedly saw from the puzzled look on my face that I didn’t have a clue what she was talking about, so she immediately sat down and showed me this YouTube video, which she described as "the original viral Internet video." Readers should be forewarned that  the video uses vulgar language and contains humor that some may find crude or offensive. It is also seriously funny. Viewer discretion is, however, strongly advised.

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In a 90-page January 27, 2010 opinion (here) District of New Mexico Judge James Browning granted substantial parts of the defendants’ motions to dismiss in the Thornburgh Mortgage subprime securities suit, while also denying the motions to dismiss in connection with certain claims against Larry Goldstone, who served as the company’s President and COO, and after December 2007, as its CEO.

 

Judge Browning’s rulings dismiss all of the plaintiffs’ claims under the ’33 Act as well as many of the plaintiffs’ claims under the ’34 Act, except for the claims against Goldstone, which will go forward. Judge Browning reserved any ruling on the claims against the company itself, which is in bankruptcy, as well as to allegations of control person liability against three individual defendants, as those claims depend first upon the possibility of the company’s liability.

 

In a separate 38-page January 27, 2010 opinion (here), Judge Browning also granted the dismissal motions of the offering underwriter defendants, ruling that the plaintiffs’ consolidated complaint failed to allege sufficiently any material misrepresentations or omissions in the relevant offering documents.

 

Background

Thornburg was a publicly traded residential-mortgage lender focused on the market for "jumbo" and "super jumbo" adjustable rate mortgages. Beginning in 2006, real estate values around the country began to falter, but Thornburgh denied that it was affected, claiming its superior underwriting standards insulated the company from the deteriorating conditions. Thornburg’s executives also denied that it originated "subprime" or Alt-A mortgages.

 

Thornburg’s business model depended on a variety of borrowing and capital mechanisms to fund its lending activities. Thornburg maintained an investment portfolio as collateral for its borrowing. Plaintiffs allege that the portfolio consisted in part of securities backed by Alt-A mortgages, and that these securities were both illiquid and, in 2007, declining in value, which in turn triggered certain margin calls.

 

Specifically, in August 2007, Thornburg was forced to sell 35% of the highest-rated assets in its portfolio to meet margin calls, which in turn triggered both a stock price decline and the filing of the first of several securities class action suits against the company.

 

During 2007 and 2008, the company completed several securities offerings. However, Thornburgh also continued to face additional margin calls, and on February 28, 2008, J.P. Morgan notified the company of its failure to meet margin call requirements, triggering cross default provisions in other short term borrowing arrangements.

 

On March 4, 2008, the company’s auditor withdrew its unqualified audit opinion "due to conditions and events that were known or that should have been known to the company." On March 11, 2008, Thornburg filed a restatement of its prior financials. On March 19, 2008, Thornburg announced it had entered a "bailout" agreement with its remaining lenders that resulted in a substantial dilution of shareholders’ interests.

 

On May 1, 2009, Thornburg filed a petition for voluntary Chapter 11 bankruptcy.

 

The plaintiffs filed their consolidated amended class action complaint on May 27, 2008, on behalf of persons who purchased Thornburg shares between April 19, 2007 and March 19, 2008. The plaintiffs allege that the defendants had failed to disclose that the company was facing increasing margin calls and that its financial condition had deteriorated to the point where it was forced to sell assets. The plaintiffs further alleged that the company failed to disclose that it originated Alt-A mortgages and possessed a multi-million dollar portfolio backed by Alt-A loans.

 

The defendants moved to dismiss, arguing that Thornburg’s losses were the result of market forces beyond defendants’ control.

 

The January 27, 2010 Order

In his January 27 order, Judge Browning first focused on the plaintiffs allegations under Section 10(b). He found with respect to many of the statements or omissions that most of them were not false or misleading or related to matters that the company had no duty to disclose. He also found that the plaintiffs had not specifically attributed any wrongful conduct or statements to any of the individual defendants other than Goldstone, and therefore he granted the motion to dismiss the Section 10(b) claims as to all individual defendants other than Goldstone.

 

However, Judge Browning found that Goldstone had in several public statements sought to attribute the downturn to problems with Alt-A lenders, from which he sought to differentiate Thornburg. Judge Browning found that "on at least two occasions" in June and July 2007, Goldstone made statements that "could be construed and reasonably understood as asserting that [Thornburg} did not engage in Alt-A lending or purchase Alt-A assets," statements which Judge Browning found were false and misleading, taking the plaintiffs’ allegations to be true.

 

Judge Browning also found that statements in the company’s 2007 10-K (which Goldstone signed) about the presence of cross-default provisions in the company’s borrowing agreements also to be false and misleading.

 

On the issue of scienter, Judge Browning rejected the defendants’ suggestion that the absence of insider selling and the presence of insider buying negated the inference of scienter, finding rather that the financial crisis itself "provides another motive that adequately fills the gap left by the lack of suspicious insider-trading activity: survival." Judge Browning said that it was a plausible inference that the defendants were motivated by a desire to help the company survive the crisis, although this allegation alone is not sufficient to establish an inference of scienter.

 

Rather, Judge Browning held that Goldstone’s repeated efforts to distance the company from the mortgage crisis by differentiating the company from Alt-A mortgage originators, "gives rise to a strong inference that Goldstone was attempting to hide from the market that [Thornburg] engaged in Alt-A or subprime lending, and knew, or recklessly disregarded that withholding this information would mislead investors." Thornburg’s omission from its 2007 10-K of its failure to meet the J.P. Morgan margin call, and of the consequent triggering of cross-defaults in other agreements, suggests that Thornburg was "concealing information."

 

The most plausible inference, Judge Browning found, was that Thornburg was "a sinking ship," but that the defendants "tried to stay positive" and that Goldstone "made some statements that crossed the line between optimistic and false and/or misleading."

 

Judge Browning granted the motions to dismiss all of the plaintiffs’ claims based on Sections 11 and 12(a)(2) of the ’33 Act, finding that the plaintiffs had failed to allege any false or misleading statements in the relevant offering documents.

 

Due to its pending bankruptcy proceeding, Judge Browning reserved any ruling on the claims against Thornburg itself, as well as on the control person liability allegations under the ’34 Act that are predicated on the sufficiency of claims against the company.

 

Finally, as noted above, in a separate order, Judge Browning granted the dismissal motions of the offering underwriter defendants, based on his finding that the plaintiffs had failed to allege any false or misleading statements in the relevant offering documents.

 

Discussion

Judge Browning’s exhaustive analysis and his rulings are significant on several levels. First, his order present another example where a court has been willing to dismiss ’33 Act claims in a subprime-related securities class action lawsuit. As I noted in my recent post discussing the ACA Capital Holdings case, where ’33 Act claims were also dismissed, it previously had been the case that courts appeared reluctant to dismiss ’33 Act claims in subprime-related securities lawsuits. But with the ACA Capital Holdings rulings, and now with the rulings in the Thornburg case, the suggestion that Section 11 claims are likelier to survive dismissal motions seems to be less certain, if not entirely unsubstantiated.

 

Judge Browning’s analysis of the scienter issue is also significant. His willingness to overlook the defendants’ insider buying is interesting and noteworthy, particularly in light of his willingness to draw an inference that the defendants were motivated – and perhaps motivated enough to make misleading statements – by a desire to help the company survive the downturn.

 

Many defendants in many other subprime and credit crisis-related cases were similarly motivated to try to help their companies ride out the crisis. To be sure, not all companies or their officials made statements that plaintiffs in those cases will be able to allege diverged from actual circumstances at their companies. But the fact that the plaintiffs in the Thornburg Mortgage case were able to survive the dismissal motion, and to overcome the absence of any insider trading and the presence of insider buying, suggests one possible way that other plaintiffs may overcome initial pleading hurdles.

 

Judge Browning granted the dismissal motions in very substantial part, eliminating almost all of the defendants and many of the plaintiffs’ claims. But the plaintiffs were able to survive the dismissal motions at least as to certain substantial allegations against at least one defendant. Large swaths of their case were cut away, but enough made it through to give them a chance to live for another day and to try to salvage something from the case.

 

Because what remains is substantial, even if only a small part of what was initially alleged, I have placed these rulings on my list of dismissal motion denials, in my running tally of dismissal motion rulings in subprime and credit crisis-related securities suits. My table of dismissal motion rulings can be accessed here.

 

More Failed Banks: On January 29, 2010, the FDIC took control of six more banks, bringing the year to date number of bank failures already this year to 15. By contrast, at this same point in 2009, there had only been a total of six bank failures. The bank failure closure rate is on pace for a total of 180 bank failures in 2010, compared to the 140 banks that failed in 2009.

 

The 15 bank failures so far this year have been spread across ten different states, with three bank failures already this year in the state of Washington, and two each in Georgia, Minnesota, and Florida.

 

This Week: I will be attending the PLUS D&O Symposium at the Marriott Marquis in New York this week. I know many readers will also be there. I hope that if you see me at the Symposium that you will say hello, particularly if we have not met before. While I am away for the Symposium, The D&O Diary may run a reduced publication schedule. "Normal" publication will resume next week. See you in New York.

 

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According to January 29, 2010 reports in the New York Times (here) and on Bloomberg (here), the jury in the long-running securities class action lawsuit against Vivendi has resulted in a verdict against the company on all 57 of the plaintiffs' claims. However, the jury also found that the two individual defendants, former Vivendi CEO Jean Marie Messier and former Vivendi CFO, were not liable. According to published reports, damages (with prejudgment interest) could be as much as $9 billion.  

This case involved the financial impact on the company from the $46 billion December 2000 merger between Vivendi, Seagram’s entertainment businesses, and Canal Plus. The plaintiffs contended that as a result of this and other debt-financed transactions, Vivendi experienced growing liquidity problems throughout 2001 that culminated in a liquidity crisis in mid-2002, as a result of which, the plaintiffs contend, Vivendi’s CEO Jean-Marie Messier and CFO Guillaume Hannezo were sacked.

 

The plaintiffs contended that the between October 2000 and July 2002, the defendants misled investors by causing the company to issue a series of public statements "falsely stating that Vivendi did not face an immediate and severe cash shortage that threatened the Company's viability going forward absent an asset fire sale. It was only after Vivendi's Board dislodged Mr. Messier that the Company's new management disclosed the severity of the crisis and that the Company would have to secure immediately both bridge and long-term financing or default on its largest credit obligations." 

 

Additional background regarding the case and the plaintiffs’ allegations can be found here.

 

As reflected in data compiled by Adam Savett on the Securities Litigation Watch (here) since the enactment of the PSLRA in 1995, a total of nine securities class action lawsuits (counting Vivendi) have been tried to verdict. Of those nine, and after all post verdict motions and appeals, defendants have prevailed in five and plaintiffs have prevailed in four. Among the cases in which plaintiffs have prevailed is the Household International securities class action trial, which on May 7, 2009  resulted in a plaintiff’s verdict on the issue of liability (about which refer here.). Damages are also to be determined later in that case.

 

Though plaintiffs have prevailed in the Vivendi trial, at least as to their claims regarding the company, this case undoubtedly has much further to go. Not only will there be post-verdict motions and further proceedings regarding damages, but there almost certainly will be subsequent appeals. Indeed, Vivendi has already indicated that it would appeal if the verdict were unfavorable. Among other things, the case presents significant jurisdictional issues, particularly with respect to the claims of certain foreign domiciled investors. These issues are now pending before the Supreme Court in the National Australia Bank case.

 

But the bottom line is that the two securities class action cases that have gone to the jury in the last 12 months have resulted in verdicts in plaintiffs’ favor, a development the plaintiffs' bar will certainly tout as significant .

 

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On January 27, 2010, NERA Economic Consulting released its updated annual review of Canadian securities class litigation entitled "Trends in Canadian Securities Class Actions: 2009 Update" (here). The report presents an interesting study of the evolution of class action litigation in a jurisdiction outside the U.S.

 

According to the report, there were eight new securities class action lawsuits filed in 2009, which is fewer that the ten filed in 2008 "but still greater than filings in previous years." With the addition of the eight new cases, there are now 23 pending securities class actions, representing more than $14.7 billion in claims. Most of these cases were filed in the last three years although some of the pending cases were filed almost 10 years ago.

 

Though the number of new filings is noteworthy, the more significant developments may be the class certifications in three cases and the ruling allowing the IMAX securities class action plaintiffs leave to proceed under the new Ontario securities laws. (My prior detailed discussion of the rulings in the IMAX case can be found here.). The NERA report comments that these rulings "may ultimately prove to be an inflection point" for securities class action litigation in Canada.

 

Though there were significant new filings in 2009, one noteworthy feature of the cases that were filed is the "absence in Canada of class actions filings relating to the credit crisis." This absence may be due in part to the relatively smaller impact of the credit crisis in Canada compared to the U.S. and the negotiated $32 billion restructuring of the Canadian Asset Backed Commercial Paper market, which may have preempted further litigation.

 

Six cases settled in 2009 for a total of approximately $51 million, for an average of approximately $8.5 million and a median of approximately $9 million (which is roughly comparable to the median settlement of U.S. securities class action lawsuits). 2009 settlements averaged 13.7% of the amount of claimed damages. Cases with cross-border litigation counterparts in the U.S. tended to settle for larger amounts both in terms of absolute dollars and as a percentage of claimed damages.

 

According to a January 27, 2010 article in the Vancouver Sun (here), the number of filings and the procedural developments (including the rulings in the IMAX case) are "a wake up call for publicly traded companies." Law firms are "advising their clients to revisit their compliance and corporate-governance procedures to protect against similar suits."

 

One lawyer quoted in the article says that he is also advising his clients to review their corporate insurance, as well. He goes on to state that "We’ve seen over the years there are a lot of problems in terms of clients don’t really have the type of coverage they need."

 

Yet, as for the question of whether there may be a flood of litigation, one plaintiffs’ attorney quoted in the article sounds a note of caution. The attorney, Dimitri Lascaris, who is one of the lead attorneys in the IMAX case, notes that that the Canadian system still provides for adverse costs, and even the liberalized standard under the new Ontario law are time consuming and expensive. So, he says, "we’re never going to achieve the level of activity in securities class actions that we see in the United States."

 

In light of these developments and their potential significance regarding insurance coverage, the session planned for the upcoming PLUS D&O Symposium (scheduled next Wednesday and Thursday in New York) on the topic of Canadian Securities Class Action Litigation is quite timely. The panel will be moderated by my friend Dave Williams from Chubb (Canada) and planned speakers include a number of prominent players in the area in Canada, including Dimitri Lascaris. Information about the Symposium can be found here.

 

The Securities Litigation Watch blog has a post about the NERA study here.

 

Excess Side A Carrier Contributes to Options Backdating Settlement: On January 25, 2010, a judge in the Western District of Pennsylvania preliminarily approved the settlement of the options backdating lawsuit that had been filed against Black Box, as nominal defendant and certain of its directors and officers. As part of the settlement, the company agreed to pay plaintiffs’ counsel $1.6 million and the company agreed to adopt certain corporate governance measures.

 

As reflected in the parties’ stipulation of settlement (here), as part of the settlement, the company is to receive a payment of $1.5 million from its Excess Side A carrier as well as another $500,000 from its EPL carrier.

 

According to a January 25, 2010 article about the settlement in the Pittsburgh Tribune-Review (here), the company also separately settled a claim against the company by its former CEO, who left the company in connection with the options backdating related matters. At the time he left, the CEO claimed, the company took away over $19.6 million in options related compensation. The company settled these claims for its agreement to pay $4 million.

 

The Black Box settlement marks the second instance of which I am aware in which an Excess Side A carrier contributed toward an options backdating related derivative lawsuit settlement. (The first instance is the Broadcom settlement, about which refer here.) This is yet another instance where Excess Side A insurance is being called on to provide protection outside of the insolvency context. As I have previously noted, the Excess Side A carrier’s contribution to these settlements may be a significant development for the carriers, who have offered the product in a largely low loss environment, at least outside the insolvency context.

 

The settlement with the CEO is an odd component of this settlement. There aren’t many of these cases where the former CEO who left as a result of backdating related issues walked away with a cash payment.

 

I have in any event added the Black Box settlement to my table of options backdating related lawsuit settlements and dismissal motion rulings, which can be accessed here.

 

SEC Will Issue Guidance on Climate Change Disclosure: On January 27, 2010, the SEC voted 3-2 to provide interpretive guidance on existing dislosure requirements to require climate change related disclosure under certain circumstances. The SEC's January 27 release can be found here. The SEC's release states that the interpretive release will be posted on the SEC web site as soon as possible. The news release identifies several examples of situations that might trigger disclosure requirements, including: impact of legislation and regulation; impact of international accords; indirect consequences of regulation or business trends; and physical impacts of climate change.

 

Suit Against Rating Agencies Dismissed, But Without Reaching First Amendment Issues: According to a January 27, 2010 Am Law Litigation Daily article by Andrew Longstreth (here), Judge Lewis Kaplan has granted the motions of Moody's and S&P to be dismissed from a securities lawsuit filed by certain investors who had invested in certain mortgage-backed securities underrwitten by Lehman Brothers. Judge Kaplan has not yet issued a written opinion but according to the article his opinion was based solely on the fact that the rating agencies didn't have anything to do with the offering documents at issue in the case. HIs ruling reportedly did not reach the rating agencies first amendment defenses (about which refer here.)  

　

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Over the years, legislative reforms of the U.S. securities laws have cycled back and forth, between initiatives, on the one hand, to discourage abusive litigation and, on the other hand, to restrain corporate misconduct. In the current Wall Street bailout, post-Madoff environment, sentiment may be running high for legislative reforms that could expand liabilities under the federal securities laws. But though the time for reform may be now, the window of opportunity may be short.

 

According to a January 2010 Wall Street Lawyer article by Boris Feldman of the Wilson Sonsini firm entitled "The Coming Counter-Reformation in Securities Litigation" (here), the best shot for reforms favorable to the plaintiffs’ bar "may be right now—before the mid-term elections in 2010 can create a filibuster firewall in the Senate." In his article, Feldman looks at the most likely areas of reform and the likelihood of the initiatives’ success.

 

The "most important priority for the plaintiffs’ bar" will be the institution of private securities liability for aiding and abetting violations of the securities laws. (There are in fact already current Congressional initiatives to accomplish that very change, about where refer here and here.) This change, were it enacted, would made the biggest difference in the "big frauds," where the "primary wrongdoer is usually bust." If the company’s professionals were "on the hook," then the "entire calculus would change," as the "pot" would then "consist of more than a claim in bankruptcy and some D&O insurance policies."

 

The "real battle" about prospective aiding and abetting liability, according to Feldman, will be how -- not whether-- it is instituted. Questions such as who bears the burdens of proof and persuasion and the state of mind required for liability "will determine whether aiding and abetting liability is a measured response to the current situation or a license to subject outside advisors to in terrorem risk."

 

The next likely target for the plaintiffs’ lawyers, Feldman suggests, is the discovery stay, which has been one of the PSLRA’s "great frustrations" for the plaintiffs’ bar. Feldman suggests that the plaintiffs’ will seek to modify the discovery stay, rather than try to have it overturned. He suggests that one alternative might be a "good cause" exception to the stay. Another alternative is the creation of an exception to the stay for documents already produced to governmental authorities.

 

Feldman also suggest that the plaintiffs’ bar may attack the PSRLA’s pleading requirements, or alternatively seek to rely on initiatives to set aside the "facial plausibility" pleading standard of Twombley and Iqbal (about which refer here).

 

Finally, Feldman suggests that the plaintiffs’ bar may see to limit the impact of Dura Pharmaceuticals, perhaps through reforms specifying that the loss causation issue is to be addressed only at the summary judgment or trial stage.

 

One area Feldman suggests that plaintiffs are unlikely to seek reforms is with respect to the PSLRA’s lead plaintiff requirements. Though these provisions were controversial when first enacted, the plaintiffs’ bar has now "adapted happily" to the requirements, and with institutional investor relationships firmly in place, there is "no incentive for the plaintiffs’ bar to tinker with these provisions."

 

Feldman closes by noting that the "electoral clock is ticking," with the likelihood of legislative action, if any, before fall 2010. He confesses "surprise" that the legislative reforms were not launched a year ago, when the 2008 electoral results were still fresh. Feldman notes that the fact that the plaintiffs’ bar missed this opportunity "may have something to do with absences in their leadership ranks in recent years."

 

Feldman suggests that the "most likely" way these reforms may come about is through the activities of the Financial Crisis Inquiry Commission, which, Feldman notes, has "strong ties to the plaintiffs’ bar" (about which refer here), a fact that may allow the plaintiffs’ bar "to try to get some of their reforms into the recommendations of the Commission."

 

I note that Feldman published his article before last week’s special election in Massachusetts. The election of Republican Scott Brown to the Senate seat vacated by the late Edward Kennedy seems to have scrambled everything. Although I don’t profess to have any particular insight into Congressional dynamics, I wonder whether the possible November effect Feldman anticipates in his memo has now been pushed forward through the calendar. The "filibuster firewall" may already be gone. Without a doubt, every member of Congress facing election this fall is proceeding with significantly greater wariness in the wake of the recent Massachusetts senatorial election. All of which makes me wonder whether or not the window of opportunity on some of these legislative proposals may have been substantially narrowed, if not altogether closed.

 

Opt-Outs Down and Out: Much has been written (refer for example here) about the growing phenomenon of class action securities lawsuit settlement opt-outs – that is, the investor class members who choose not to participate in the class action lawsuit settlement and instead pursue their own individual claims. One of the recurring themes has been how much better the opt-outs do than they would have if they remained in the class.

 

However, as shown in the outcome of a recent case involving Aspen Technology, there is no guarantee that the opt outs will do better by proceeding separately.

 

Aspen and several of its directors and officers had been sued in a securities class action lawsuit in November 2004 (about which refer here). The securities class action lawsuit ultimately settled for $5.6 million, but several class members representing 1.4 million shares of common stock opted out of the class action settlement and filed their own "direct action" lawsuit against the defendants in Massachusetts state court.

 

As reported on the Securities Litigation Watch blog (here), the Aspen Technology investors’ direct action lawsuit didn’t go so well for them. In a January 13, 2010 opinion (here), Massachusetts (Suffolk County) Superior Court Justice Judith Fabricant ruled that "no fraud occurred" and that "defendants are entitled to judgment on all counts of the complaint." In a memo about the decision (here), Skadden, the defense firm in the case, reports that Justice Fabricant also awarded defendants recovery from the plaintiffs of their costs in the case.

 

Options Backdating Securities Suit Dismissal Affirmed: One of the 39 options backdating related securities class action lawsuits involved claims against Jabil Circuit. The case may have been among the more noteworthy options backdating-related securities lawsuit filings, because Jabil Circuit was among the small group of companies specifically mentioned by name in the original March 2006 Wall Street Journal article ("The Perfect Payday") that launched the options backdating scandal. Among other things, the article calculated the likelihood that the Jabil options grants occurred randomly as "one in a million."

 

As noted in an earlier post (here), the Jabil Circuit options backdating-related securities lawsuit was dismissed without prejudice in April 2008. In a January 2009 order (here) on the defendants’ renewed motion to dismiss, the complaint was dismissed with prejudice.

 

In a January 19, 2010 decision (here), the Eleventh Circuit Court of Appeals affirmed the lower court’s dismissal of the case, holding the plaintiffs’ allegations "fail to meet the heightened pleading standards" under the PSLRA.

 

Among other things, the court said that "the allegations of misrepresentations, responsibility for granting misdated options, and personal profiteering fail to raise a strong enough inference of scienter" and that "the allegations contained in the complaint do not create an inference of scienter that is at least as probable as a non-fraudulent explanation—namely that none of the Appellees knew of the accounting errors until the investigation began in 2006"

 

I have updated my table of the outcomes in the Options Backdating-related lawsuits to reflect the Eleventh Circuit’s decision in Jabil Circuit. The table can be accessed here.

 

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On January 21, 2010, the insurance information firm Advisen released the latest in a series of various observers’ year end analyses of 2009 securities litigation. Advisen’s year report can be accessed here. The Advisen report takes a somewhat different approach than the other reports, and reaches some strikingly different conclusions. Among other things, the Advisen report, perhaps by contrast to prior studies, concludes that "securities litigation" (as that term is used in the report) is actually increasing.

 

Warning! Terminology Matters!

In order to appreciate the Advisen report, it is absolutely indispensible to understand that the Advisen report uses its own unique terminology.

 

The most important thing to understand is that the Advisen report uses the term "securities litigation" to include a very broad range of kinds of lawsuits, including not just securities class action lawsuits, but also derivative actions, regulatory and enforcement actions, individual lawsuits, and collective actions in courts outside the United States.

 

The Advisen report also apparently includes within the category "securities lawsuits" claims alleging "common law torts, contract violations and breaches of fiduciary duties."

 

So the report uses the term "securities lawsuits" basically to mean any type of corporate or securities litigation (other than ERISA litigation), regardless even of whether or not the legal action was commenced in the U.S. or even apparently whether it alleges a violation of the securities laws. Because of the enormous variety of litigation encompassed within this category, throughout this post I have put the phrase "securities lawsuits" or "securities litigation" in quotation marks.

 

The Advisen report also uses the phrase "securities fraud" lawsuits as a subset of the larger group of "securities lawsuits." Contrary to what you might expect, however, the category of "securities fraud" lawsuits does not include class action lawsuits alleging securities fraud – securities fraud class action lawsuits are their own separate category ("SCAS"). Instead, the phrase is used to refer to regulatory and enforcement actions -- yet somehow also includes private securities lawsuits that are not filed as class actions.

 

So the "securities fraud" lawsuit category includes lawsuits alleging fraud under the federal securities laws if the fraud is alleged by an individual but not if it is alleged on behalf of a class.　

The Report’s Conclusions

Perhaps the most important contribution that the Advisen report makes to understanding what happened from a litigation standpoint is its observation that "securities litigation" -- as broadly defined in the report – actually increased in 2009 by comparison to prior years. Thus the report states that in 2009 the number of "securities lawsuits" actually grew to 910 suits, up 13% from 2008, which in turn was up 33% from 2007.

 

This observation is interesting and seemingly contrasts with conclusions reported in other studies suggesting that securities litigation declined in 2009. The difference in the analysis is due to the fact that the other studies concentrated exclusively on securities class action lawsuit filings in the United States, whereas the Advisen report is focused more broadly on corporate and securities litigation generally, and on litigation both inside and outside the United States.

 

It appears that for several years, securities class action lawsuits as a percentage of all "securities lawsuits" have been declining. As recently as 2004, securities class action lawsuit filings represented as much as half of all " securities lawsuits" filed, whereas in 2009 securities class action lawsuits represent only about one quarter of all "securities lawsuits."

 

The point here is an important one – that is, even if absolute numbers of securities class action lawsuit filings are declining, that does not mean that overall claims activity is decreasing. To the contrary, claims activity is actually increasing, while at the same time the mix of cases filed is changing. So if you were to focus only on securities class action lawsuit filing levels, you might mistakenly conclude that overall claims susceptibility is decreasing. It is not. It is increasing.

 

But even with respect to the narrower issue of securities class action lawsuit filings ("SCAS"), the Advisen report reflects a different perspective than other studies.

 

The Advisen report reports a relatively higher number for the number of securities class action lawsuit filings in 2009 (234) compared, for example, to the Cornerstone tally of 169 securities class action lawsuit filings in 2009, but the Advisen study also reports a much slighter decline in securities class action lawsuit filings from 2008 to 2009 (234 in 2009, 239 in 2009), than does the Cornerstone study (223 in 2008 to 169 in 2009).

 

Part of the explanation for this seemingly enormous difference is categorization. Thus, the Advisen study counts securities class action lawsuits that were filed in state courts (there apparently were 15 state court securities class action lawsuit filings in the fourth quarter of 2009 alone), but the Cornerstone study does not.

 

Part of the explanation for the difference is methodological. As stated in its report, Advisen "counts each company for which securities violations are alleged in a singled complaint as a separate suit." As far as I can tell, the Cornerstone study would count that single complaint only once regardless of the numbers of corporate defendants named in the complaint – that is certainly the approach I use in my own tallies. The Advisen approach will inevitably lead to higher numbers than are reported in some other studies.

 

Part of the explanation for the difference is simply timing. The Advisen report includes filings through December 31, 2009, whereas the Cornerstone report only counts filings through December 21, 2009.

 

Among other things, the Advisen report states that the aggregate losses claimed in the "securities lawsuits" filed in 2009 was $1.3 trillion, compared to $1.2 trillion in 2008. The average losses per "securities lawsuit" were $9.8 billion in 2009, compared to $6.4 billion in 2008, which may be interpreted to suggest the possibility of "record payouts" for the securities lawsuits filed in 2009.

 

The report also contains an extensive discussion of the growing significance of "securities lawsuits" against non-U.S. companies. According to the study, there were 117 "securities lawsuits," or 13 percent of the total, filed against non-U.S. companies in 2009, including 46 "large cases" filed in non-U.S. courts. (The report does not specify what constitutes a "large case.") However, the report also notes that one subset of these "securities lawsuits" against non-U.S. companies, that is, the filings in the subcategory of "collective actions" were almost entirely concentrated in the first quarter and largely driven by Ponzi scheme cases.

 

The Advisen report is quite extensive and contains a wealth of information, and is worth reading at length and in full (albeit very carefully). But of all the observations contained in the report, by far the most important one is that even if securities class action lawsuit filings may have declined, overall "securities litigation" has not decreased – in fact, in 2009, "securities litigation," as that term is used in the Advisen report, increased materially and for the second consecutive year.

 

Securities Litigation Webinar: On Friday January 22, 2010 at 11:00 a.m. EST, I will be participating in a free one-hour "Review of Securities Litigation 2009 and Expert Views for the Year Ahead." The other panelists include Travelers's Mark Lamendola, Beecher Carlson's Jeff Lattmann, and Advisen's Dave Bradford. Advisen's Jim Blinn will moderate the panel. You can register for the webinar here.

 

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In an earlier post (here), I wrote about a December 30, 2009 ruling in the MBIA coverage litigation that special litigation committee investigation expenses were covered under a D&O liability insurance policy. As I anticipated, the decision has proven to be controversial.

 

Two law firms that traditionally act as coverage counsel for D&O carriers recently released memoranda discussing the opinion. The Wiley Rein issued a brief memo (here) discussing the case and its holding. The Edwards Angell Palmer & Dodge law firm released a longer memorandum (here) also discussing the opinion.

 

The Edwards Angell memo, written by my friend John McCarrick and his colleagues, Maurice Pesso and Peter de Boisblanc, is particularly interesting because opens by reviewing the justification for the insurers’ standard position that special litigation committee expenses are not covered under the typical D&O insurance policy.

 

The Edwards Angell memo also includes a review of implications of and the likely consequences that flow from the decision. Among other things, the memo stresses that the decision did not hold that special litigation committee expenses will always be covered, but only under the facts presented. The memo also recites the difficulties and logical problems involved with characterizing the special litigation committee expenses as "defense costs" (including the likelihood that plaintiffs might use the characterization as a way of challenging the independence of the special litigation committee.).

 

The Edwards Angell memo concludes with this observation:

　

Unless and until the D&O insurers in MBIA press a successful appeal of this ruling to the Second Circuit Court of Appeals, D&O insurers should brace themselves for the likelihood that the MBIA ruling will be cited by policyholder counsel and brokers in an effort to significantly expand the scope of coverage for these kinds of legal expenses and costs, as well as to cover other fees and expenses that an insured can argue were incurred "in connection with" a covered D&O claim.

 

The memo provides an interesting presentation of the carrier perspective on the decision. Reading the memo, I wondered whether any policyholder-side coverage attorneys had written their own analyses of the decision from the perspective of insured companies. I hope that any readers aware of these alternative perspectives will please send them along to me. I will update this post with any additional materials that are sent to me about the case.

 

One final note on a related subject -- the Wilmer Hale law firm has an interesting memo about recent developments in shareholder derivative litigation (here), which, among other things, discusses court's' increased scrutiny of special litigation committees, particularly with respect to the  question whether or not the committees are in fact independent.

　

NAB Update: The closely watched National Bank of Australia case pending before the U.S. Supreme Court on a writ of certiorari from the Second Circuit has now been scheduled for oral argument. According to a post on The 10b5-Daily (here), oral argument in the case, which will address the question of the extraterritorial jurisdiction of U.S. courts over foreign domiciled companies under the U.S. securities laws, is now set for March 29, 2010.

　

The 10b-5 Daily post also has a link to the Petitioners’ Brief., which argues that under the federal securities laws there are no extraterritorial limitations on the U.S. courts’ jurisdiction. Finally, the blog post also links to a National Law Journal article (here) written by Columbia Law School Professor John Coffee suggesting that, in light of various pending legislative proposals, Congress and the Supreme Court are on a "collision course" on the question of extraterritorial jurisdiction of the U.S. securities laws. Coffee concludes by suggesting that "a legal train wreck might result from opposing approaches to global class actions."

　

Detailed background regarding the NAB case can be found here.

　

Another Belated Securities Lawsuit Filing: In prior posts (for example, here), I have noted the phenomenon that developed in the second-half of 2009 where plaintiffs’ lawyers were filing securities class action lawsuit complaints well after the proposed class period cutoff date. In a more recent post (here), I noted that at least one lawsuit first filed in January suggested that this trend has continued in the New Year.

 

Yet another case filed this week suggests that this trend is continuing. In a January 21, 2010 press release (here), plaintiffs’ lawyers announced that they had filed a securities class action lawsuit in the Northern District of Illinois against Motorola and certain of its directors and officers. The lawsuit relates to alleged misrepresentations about the company’s sales of its RAZR2 telephone handset. The complaint in the case can be found here.

 

Though the complaint was only just filed, the proposed class period cutoff date is January 22, 2008, a full one year and 364 days prior to the filing date, and just before the expiration of the two-year statute of limitations applicable to ’34 Act claims.

 

In his comments in connection with the recent release of Cornerstone’s year-end analysis of the securities class action lawsuits, Stanford Law School Professor Joseph Grundfest had a number of choice comments about these belated securities class action lawsuit filings, essentially suggesting that the plaintiffs are scraping the bottom of the barrel (my words, not his) to file these belated lawsuits because they had run out of more meritorious cases to file. Public statements by leading plaintiffs’ attorneys (refer, for example, here) suggest more neutrally that they are just getting around to filing cases that were "backburnered" while the lawyers were concentrating on getting the subprime and credit crisis cases on file.

 

But whatever the explanation may be for the belated case filings, it is a very distinct phenomenon that has appears to be continuing as move well into 2010.

　

New SEC Climate Change Disclosure Guidance Ahead?: In prior posts (here), I discussed the possibility that the SEC could issue guidelines for public companies’ disclosures about climate change related issues and exposures. As discussed on the FEI Financial Reporting Blog (here), the SEC has announced (here) that in a meeting on January 27, 2010, it will be considering "a recommendation to publish an interpretive release to provide guidance to public companies regarding the Commission's current disclosure requirements concerning matters relating to climate change."

　

As the FEI Financial Reporting Blog explains, an interpretive release of this type is designed to provide final guidance on existing disclosure requirements. The blog post speculates that the guidance could be effective immediately upon release.

 

Cheers: I have joined the Facebook group "A Glass of Wine Solves Everything." (here). In vino veritas, dude. I recently have developed an affinity for two very different kinds of red, Oregon Pinot Noir and Argentine Malbec -- in part because one of the problems I have to solve is that I can't afford the Burgundys, Bordeauxs and Super Tuscans I would prefer. In my next life, my blog will be about wine.

 

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RiskMetrics has issued its year-end 2009 scorecard of the Top 100 securities class action lawsuit settlements. The list, which is updated quarterly, can be accessed on the Securities Litigation Watch blog (here). The details in this very interesting tabulation support a number of interesting observations, discussed below.

 

The year-end Top 100 tally reflects the incorporation of 15 new settlements added to the list during 2009. However, because RiskMetrics identifies a specific case’s Settlement Year as "the year in which the hearing to grant final approval of the settlement or most recent partial settlement occurred," there were several high-profile settlements entered late in 2009 that are not, because they are not yet final, reflected in the most recent update, including the $225 million Comverse Technology settlement (about which refer here) and the $160.5 million Broadcom settlement (here).

 

The settlements added to the list during 2009 include the tenth largest all-time settlement, in the form of the $925 million UnitedHealth Group settlement (refer here and here). Among the all-time top 25 settlements are several other settlements added to the list in 2009, including the $586 million IPO Securities Litigation settlement (refer here), the $554 million HealthSouth settlement (refer here), the $475 Merrill Lynch settlement (refer here), the $445 million Qwest Communications settlement (refer here), and the $400 million Marsh & McLennan settlement (here).

 

The price of admission to the Top 100 list is steep. Taking into account the late-year Comverse Technology and Broadcom settlements, which presumably will be added to the list during 2010, future settlements will have to excess $80 million to crack the Top 100. And to break into the top 25, a settlement will have to exceed $400 million. (It should not be overlooked that there have been 25 settlements of $400 million or greater, which is a staggering fact all by itself.)

 

The Securities Litigation Watch blog also notes that the price of admission to the Top 100 list has doubled since the end of 2005; at year-end 2005, the 100^th largest settlement on the list was in the amount of $39 million. By year-end 2009, the 100^th largest settlement was $79.75 million.

 

Settlements related to options backdating securities cases are well-represented among the Top 100 settlements, including number 10 all-time, the UnitedHealth Group options backdating securities lawsuit settlement. Other Top 100 options backdating settlements include Brocade Communications Systems ($160 million) and Mercury Interactive ($117.5 million). The yet to be added Comverse Technology ($225 mm) and Broadcom settlements ($160.5 mm) also rank among the top all-time settlements. The separate $118 million Broadcom options backdating-related derivative lawsuit settlement, though not relevant to this list because it did not arise in a securities class action suit, is nevertheless noteworthy in this connection.

 

The Top 100 settlements also include two subprime-related securities class action settlements, the $475 million Merrill Lynch settlement and the $150 million Merrill Lynch bondholder settlement. Call it a hunch, but I am guessing that before all is said and done with the subprime and credit crisis-related securities lawsuits, there will be a lot more of those cases on the Top 100 settlements list.

 

The Top 100 settlements involve cases in 38 different federal district courts, with the largest number in the Southern District of New York (25). Other districts with significant numbers of settlements include the District of New Jersey (8), the Northern District of California (7), the Central District of California (6), and the Southern District of Texas (5).

 

Among the plaintiffs’ firms, the law firm with the highest number of Top 100 securities class action settlements is the Milberg firm (in its various manifestations), with 29, followed by the Bernstein Litowitz firm, with 26 and the Coughlin Stoia firm, in its various forms, with 14.

 

Of the Top 100 securities class action settlements, over two-thirds (68) were finalized in the most recent five year period between 2005 and 2009. The bar graph on page 5 of the report, which depicts the definite upward trend in the more recent years, strongly communicates the increasing severity of securities class action claims.

 

The inevitable implication of this inexorably increasing claims severity is that the price of poker is going up. This fact, taken together with the dramatic increases in the costs associated with defending securities suits, has important implications for D&O insurance limits selection. Simply put, commonplace notions about limits adequacy that have developed over time may have gone completely out of date in the most recent years.

 

The significant recent increase in the number of mega settlements suggests that the answer to the question "How much insurance is enough" may be categorically greater than even a short time ago. The inevitable ratchet effect from these settlement trends, creating ever greater measures of what "cases like this settle for," also suggests that these numbers will not be going back down either.

 

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In my year-end analysis of the 2009 securities class action lawsuit filings, I noted a number of filing trends that developed in the second half of the year, including the incidence of new filings against leveraged Exchange Traded Funds (ETFs) and the surprising numbers of belated securities suit filings where the filing date came well after the proposed class period cut-off date. If the lawsuit filings in the first two weeks of January are any indication, these trends have continued into the New Year.

 

First, this past week, plaintiffs’ lawyers launched two new lawsuits on behalf of leveraged ETF fund investors, the UltraBasic Materials ProShares Fund (refer here) and the Direxion Energy Bear 3X Shares Fund (refer here). My prior post discussing the phenomenon of securities class action lawsuits and including a link to a running list of the ETF-related suits can be found here. I have updated the list to include these most recently filed suits.

 

Second, in the first 2010 instance of the belated lawsuit filing phenomenon, on January 15, 2010, plaintiffs’ lawyers filed a securities class action lawsuit against Stryker Corporation and certain of its officers and executives. The plaintiffs’ lawyers’ January 15 press release about the case can be found here.

 

The class period cut-off proposed in the Stryker complaint is November 13, 2008, well over a year before the lawsuit was filed.

 

We may have entered a new calendar year, but at least a couple of last year’s securities suit filing trends appear to have carried over from year-end, at least so far.

 

Galleon Out as Lead Plaintiff: Among the stranger circumstances surrounding the Galleon Management insider trading scandal is the fact that just two weeks before the scandal surfaced Galleon had been reaffirmed as lead plaintiff in the Herley Industries securities class action lawsuit. My prior post discussing these circumstances can be found here.

 

However, according to a January 15, 2010 Bloomberg article (here) written by Thom Weidlich, Galleon has now dropped out as lead plaintiff in the case.

 

In a January 15, 2010 order (here), Eastern District of Pennsylvania Judge Juan R. Sanchez permitted Galleon to withdraw as lead plaintiff. According to the Bloomberg article, Galleon’s counsel had advised the court that it had "become clear that the now-defunct Galleon can no longer continue in this role."

 

Delaware Chancery Court Tosses Bribery Follow-On Civil Suit: In numerous prior posts (most recently here), I have noted as along of the increasing number of antibribery enforcement actions has come the increasing incidence of follow-on civil litigation in the wake of the bribery enforcement action.

 

As reflected in a January 15, 2010 post on The FCPA Blog (here), a recent Delaware Chancery Court decision dismissing a case involving Dow Chemical contains language that may be important in future bribery enforcement follow-on civil actions.

 

The Dow suit arose after the Kuwaiti parliament acted to rescind the purchase of certain Dow assets (in a transaction known as K-Dow) based on the suspicion of profiteering and improper commissions paid to the Kuwaiti state owned enterprise that was the actual buyer. The plaintiffs filed suit in Delaware alleging that the Dow board "failed to prevent bribery in connection with the K-Dow transaction."

 

In a January 11, 2010 opinion (here), Chancellor William B. Chandler III dismissed the action on the grounds that the plaintiffs "do not allege that the board knew about or had reason to suspect bribery."

 

The FCPA Blog points out that in a footnote "that may have important consequences beyond this case," the court said that Dow’s compliance program was evidence that the board had met its fiduciary duty to prevent overseas bribery. The Chancery Court specifically referenced the company’s Code of Ethics prohibiting any unethical payments to third parties. The FCPA Blog concludes that this case provides "a powerful reason for directors and officers to insist on robust antibribery compliance programs that include regular reports back to the board."　

　

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The financial relationship between plaintiffs’ securities firms and the clients they represent has long been questioned, and not only because of the kinds of improper kickback payments for which Bill Lerach and Mel Weiss, among others, wound up in jail. Another practice that has raised recurring concerns is what is referred to as "pay-to-play" – which in this context refers to the plaintiffs’ lawyers’ payment of political contributions to elected officials in charge of public pension funds, supposedly in exchange for the lawyers’ selection as the funds’ class action counsel.

 

But while these kinds of concerns are frequently raised, a preliminary question is often overlooked – that is, regardless of questions about the effect the practice might have on the counsel selection process, are the plaintiffs’ lawyers in fact making political donations to elected officials who have authority over public funds?

 

That is the question examined in a recent New York University Law Review article by Drew T. Johnson-Skinner entitled "Paying to Play in Securities Class Actions: A Look at Lawyer’s Campaign Contributions" (here). The article’s author notes that while alleged pay-to-play practices are often discussed, and have even been the subject of various reform proposals, many commentators have simply "skipped" the "first stage of the analysis," which is the question "whether law firms are contributing to investment funds’ leadership at all."

 

In order to analyze the question, the article’s author looked at all 1076 securities class action lawsuits that were filed from 2002 to 2006, and then narrowed the data set to the 74 cases where "the filing lead plaintiff was an institutional investor with at least one state-level elected official or a person appointed by a state-level elected official, on its controlling board."

 

The author then looked at whether the law firms selected as counsel in each of the 74 cases had made campaign contributions to any elected officials affiliated with the funds that selected the firm. Reviewing publicly available information, the author found that "in a majority of cases where pay-to-play was possible, at least one law firm made a political contribution to an elected official with a lead plaintiff pension fund in the case."

 

The author concluded that his analysis "confirms that plaintiffs’ law firms are contributing to the pension funds that select them as counsel," and that "campaign contributions that could be the basis of paying-to-play are present across a broad range of cases." Moreover, the amount of money contributed by firms is also "significant."

 

However, the author cautioned that his research "does not explain why firms contribute to pension funds or the role that campaign contributions actually play in funds’ counsel-selection decisions." Rather, the author suggests that the value of his research is that it rules out any possible contention, in response to pay to play allegations, that law firms are not contributing to pension funds. In fact, they are.

 

While the law review article’s author declined to question whether the plaintiffs’ law firms’ political contributions are a form of pay-to-play, a separate legal study suggests at a minimum that the existence of political contributions may affect the attorneys’ fees that a public pension fund may pay.

 

A December 22, 2009 article (here) by New York University law professor Stephen Choi, Drew T. Johnson-Skinner, and University of Michigan law professor Adam Pritchard suggests that "state pension funds generally pay lower attorneys’ fees when they serve as lead plaintiffs in securities class actions than do individual investors serving in that capacity," but that when the authors controlled "for campaign contributions made to officials with influence over state pension fund" the differential disappears. Thus, the authors conclude, pay to play "appears to increase agency costs borne by shareholders in securities class actions."

 

In any event, questions continue to arise whether plaintiffs’ lawyers campaign contributions to officials that control public pension funds represents a form of improper influence.

 

For example, in connection with the class certification motion in the Countrywide subprime-related securities class action lawsuit, the Defendants had argued that the lead counsel in the case had made a series of campaign contributions to the New York State Comptroller, the sole trustee of the New York State Common Retirement Fund, one of the lead plaintiffs in the case. (The other lead plaintiff group is the New York City Pension Funds.) The various contributions for the lawyers at the firm ranged in amount from $6,200 to $9,600, all made within four days’ time, after the law firm had been selected as lead counsel. The payments totaled "precisely $50,000."

 

In her December 9, 2009 order certifying the class (here), Central District of California Judge Mariana Pfaelzer noted that any suspicion of pay-to-play activity "would be relevant to attorney-class conflicts and the willingness of [the State Fund] to monitor its attorneys and make decisions for the benefit of the class rather than its attorneys," but she found that any such suspicion "may be somewhat speculative" in the Countywide case.

 

Judge Pfaelzer noted as a preliminary matter that "attorneys are free to exercise their right to donate to politicians who support their views" and that the defendants "do not allege that the donations violated any law." She also noted that "though not exactly correlative," lawyers and parties on the defense side have "similar political-donation freedom."

 

Perhaps more importantly, in rejecting the defendants’ objections, Judge Pfaelzer found that the lead plaintiffs’ firm had been retained for the case "after career staff recommended" the firm, following "reasonable ethics protocols" and based on the law firm’s "independent investigation of the case."

 

A December 10, 2009 WSJ.com Law Blog post about Judge Pfaelzer’s ruling can be found here.

 

The suggestion of similar concerns surfaced more recently in connection with the composition of the Financial Crisis Inquiry Commission, which commenced its high profile investigation of the financial crisis on Wednesday. As detailed in a January 13, 2010 Wall Street Journal article (here), one of the individuals on the ten-member commission is a lawyer with the Coughlin Stoia law firm. In addition, a senior commission staffer is on leave as a partner in the Coughlin Stoia law firm.

 

The Journal article reports that the commission chairman, Phil Angelides, received $250,000 in contributions from the law firm during his 2006 campaign for governor. The article quotes a representative of the U.S. Chamber Institute for Legal Reform as saying that the appointment of plaintiffs’ class action attorney to the commission and its staff "raises a very real concern as to whether they will use the important work of the commission ultimately to feather their own nest." A law professor is also quoted as saying that the ties to the law firm could hurt the commission, noting that "the commission must maintain its distance from the perception that this is all a ‘gotcha’ exercise."

 

These kinds of concerns about plaintiffs’ law firms’ political contributions at a minimum draw upon a suggestion of at least the appearance of impropriety. As one way to try to avert this appearance, Florida has instituted a public process, conducted by its State Board of Administration, which oversees the state employee pension funds, to determine which firms will represent the Board in future securities class action lawsuits.

 

According to Allison Frankel’s December 14, 2009 AmLaw Litigation Daily article (here), 31 firms submitted proposals, from which a field of 12 candidates was selected. In a January 12, 2010 update (here), Frankel reported on the outcome of the process and the names of the five law firms finally selected. Her January 12 article also reports on the many "interesting tidbits" revealed in the law firms’ public submissions, including the firms’ hourly rates and the portfolio monitoring services the firms provide for many public pension funds.

 

Though the Florida process has all the virtues of transparency, the process itself did not eliminate the phenomenon of plaintiff’s lawyers’ campaign contributions to influential public officials. According to a December 12, 2009 St. Petersburg Times article (here), in the preceding 14 months, "lawyers and others tied to the firms interested in representing the SBA have spent at least $850,000 on Florida politics." The article quoted critics who suggested that "Florida’s short list mirrors the entrenched, pay-to-play culture between public pension funds and prominent class-action law firms."

 

In other words, as the law review article cited above demonstrates, the plaintiff’s law firms are in fact making political contributions to elected officials who are in a position to influence the counsel selection process. Whether or not the contribution are made for the purpose of influencing the counsel-selection process and whether the process is in fact influenced may be questions about which there may be a diversity of views; the plaintiffs’ lawyers are quick to defend their actions.

 

But I wonder whether this is going to be one of those kinds of issues that is out there and frequently noted, but then suddenly blows up when some very specific development moves it to the front burner. This is the kind of issue that could get people very excited if a certain combination of facts and circumstance should come to light. Even absent some dramatic revelation, the questions will continue, simply because of the way it looks.

 

Indeed, given the shadow it inevitably casts over plaintiffs' attorneys and their motivations, you do wonder why they continue these practices. More cynical minds might suggest that it is obvious why the plaintiffs lawyers don't stop.

 

　

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In an earlier post (here), I discussed legislation that Senator Arlen Specter introduced in July 2009 to legislatively overturn the U.S. Supreme Court’s decision in Stoneridge and allow private actions for aiding and abetting liability. Though this proposed legislation is a matter for serious concern, there was always the possibility that given everything that Congress has on its plate, this particular initiative might not make the cut.

 

There is, however, some significant likelihood that some form of financial reform legislation eventually will be enacted into law. Indeed, as discussed here, the House of Representatives has already passed its version of financial reform legislation.

 

The Senate has yet to act, but among the leading proposed Senate financial reform bills under consideration is Senator Chris Dodd’s proposed "Restoring American Financial Stability Act of 2009" (here).

 

As noted in a January 4, 2009 memo by K. Stewart Evans, Jr. of the Pepper Hamilton law firm (here), the bill contains a provision "hidden on page 795 of 1,136" that amends the ’34 Act to provide liability for any person that "knowingly or recklessly provides substantial assistance" to a person whose conduct violates the securities laws. Evans notes further that the provision would impose liability without the claimant having to even prove that reliance on the secondary actors’ statements.

 

My concerns about the possible imposition of aiding and abetting liability are reflected in my prior post. Evans has his own concerns, arguing that the proposed amendment would be "dangerous and destructive to American business."

 

But regardless of the merits of the proposal, the fact that it proposed amendment creating private aiding and abetting liability is no longer just its own free-floating suggestion, but has now been incorporated into a comprehensive piece of financial reform legislation does seem to suggest that the proposal could be that much closer to being enacted into law.

 

Of course, there is still a long way to go before we know whether or not the Senate will get around to enacting any financial reform legislation, much less what form that legislation might ultimately take. In addition, any bill passed by the Senate would have to be reconciled with the House’s bill, so what might finally emerge is at the point anybody’s guess.

 

But all of that said, the incorporation of the aiding and abetting provision into Dodd’s proposed Senate bill does seem to suggest the possibility that the aiding and abetting initiative will not simply fall by the wayside as the proposed legislation goes forward. Rather, at this point it looks like somebody is going to have to affirmatively knock the proposal out to prevent it from remaining in.

 

Dismissal of BAE Bribery Civil Suit Affirmed: As I have noted in prior posts (most recently here), allegations of bribery in connection with BAE’s fighter aircraft contract with Saudi Arabia – and in particular the UK’s election not to investigate the allegations due to national security concerns -- not only have proven highly controversial, but also has generated follow on civil litigation.

 

As discussed in a recent post on the FCPA Blog (here), on December 29, 2009, the Court of Appeals for the D.C. Circuit affirmed the lower court’s dismissal of the derivative lawsuit that had been filed against BAE, as nominal defendant, and certain of its directors and offices Judge Edwards, writing for the court found that under the 1843 English case of Foss v. Harbottle, 2 Hare 461, 67 E.R. 189, "the company, not a shareholder, is the proper plaintiff in a suit seeking redress for wrongs allegedly committed against the company."  The court further found that the BAE case did not come within any exceptions to the rule.

 

And Speaking of U.S. Lawsuits Against Foreign Companies: According to a January 6, 2010 Law.com article by Andrew Longstreth (here), the three-month long securities class action jury trial against Vivendi and certain of its directors and officers is drawing to a close. According to the article, the parties are now completing their closing statements, and the case will be submitted to the jury later this week.

 

Look for A Lot More Cases Like This in 2010: Though thecomplaint was actually filed in the Northern District of Georgia on December 31, 2009, the plaintiffs’ lawyer press release is dated January 4, 2010, and the investor lawsuit involving a failed bank make prefigure many more lawsuits of the same kind in the months ahead in 2010.

 

The lawsuit arises out of the failure of Haven Trust Bancorp, whose operating banking subsidiary was taken over by the FDIC on December 12, 2008. On February 23, 2009, the holding company filed for bankruptcy. The defendants include certain former officers of the holding company and the bank. The plaintiffs allege that the defendants misrepresented the bank’s financial condition and lending practices in order to induce the plaintiff investors to invest in the holding company. The plaintiffs assert claims under the federal securities laws, Georgia securities laws, as well as certain common law claims.

 

 In light of the 140 banks that failed during 2009, there undoubtedly will be more claims like this to come, both filed on behalf of investors and on behalf of the FDIC as receiver of the failed institutions.

 

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Securities class action lawsuit filings were "down sharply" according to the annual study of securities class action litigation released jointly today by the Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research. The full report can be found here and the January 5, 2010 press release accompanying the report can be found here.

 

According to the study, which found that there were a total of 169 securities class action lawsuit filings through December 21, 2009, the 2009 filings were both 24% below the 223 filings in 2008 and 14% below the annual average of 197 filings during the years 1997 through 2008.

 

The Stanford study reports a lower lawsuit count than previously published studies of the 2009 securities lawsuit filings, including the prior report of NERA Economic Consulting (refer here) as well as my own prior analysis (refer here). I discuss these differences below.

 

The relative decline in the number of lawsuit filings in 2009 compared to prior years, according to the Stanford report, is attributable in part to the decline in subprime and credit crisis related filings. Among other things, the report notes that there were only 17 subprime and credit crisis related lawsuits in the second half of 2009.

 

The press release accompanying the report also quotes Dr. John Gould of Cornerstone Research as saying that the observed decline is consistent with the decline in stock market volatility during 2009, noting that after increasing during the preceding two years, volatility declined both in the first and second halves of 2009.

 

The study also details the large number of filings that were characterized by "a substantial lag between the end of the class period and the filing" date, a phenomenon about which I written extensively in the past (most recently here). The report notes that the percentage of filings with a lag of more than a year has increased steadily from 5% in 2005 to a historical high of 18% in 2009.

 

According to the study, historically, class action lawsuit with longer filing lags "have been dismissed at a higher rate than class actions with shorter filings lags," at a rate of 55% for the one-year lag filings versus 42% for filings with a lag between one year and six months, and 36% with a lag of less than six months.

 

The study also notes that the lag filings are largely the work of the Coughlin Stoia law firm, which was "involved in 63% of the filings with lags longer than six months and 58% of filings with lags longer than a year." This activity levels compares to the firms involvement in 39% of all filings and 29 percent of filings with lags shorter than six months.

 

The press release quotes Stanford Law Professor Joseph Grundfest as saying, with respect to the lag filings, that the belated filings suggest that "plaintiffs are trying to fill the litigation pipeline by bringing older lawsuits that weren’t attractive enough to file while the firms were busy pursuing financial sector claims," adding that "these lawsuits are more likely to be dismissed and can therefore be characterized as lower quality claims" and that the filings may "reflect factors idiosyncratic to one large plaintiff firm’s strategy, and have little to do with larger market forces."

 

In addition to tracking the overall number of filings, the report also notes the number of lawsuits filed against unique issuers, which declined even more sharply than the overall number of filings. Thus, while the report found that overall filings declined by 24% between 2008 and 2009, the total number of unique issuers involved in securities lawsuits decreased by 32 percent. The difference in the attributable to the number of multiple filings against the same target, as well as the relatively large number of filings against private companies and other non-exchange traded entities.

 

The report further notes that of all exchange traded companies, 1.8 percent were defendants in federal securities class action lawsuits filed in 2009 compared to 2.6% in 2008 and compared to a 2.4% annual average for the 12 years ending December 2008.

 

The number of lawsuits against foreign issuers also declined in 2009, according to the study. After peaking at 16.4% of all filings in 2007, the percentage of filings against foreign issuers declined to 12.4% in 2009. The study attributes the relative decline to the falling off of the credit crisis lawsuits, because so many of the suits against foreign companies were related to the subprime and credit crisis.

 

Finally, the decline in 2009 credit crisis filings was also associated with a decline in market capitalization losses in 2009. The disclosure dollar loss attributable to 2009 class actions was $83 billion, a 62 percent decrease from 2008.

 

Some Thoughts about the Numbers: As noted above, the Stanford study’s 2009 lawsuit count varies from previously published figures, including my own. NERA reported 235 filings in 2009, and I reported 189 (I discuss the difference between my count and NERA’s in my prior post, here), compared to the 169 reported by Stanford.

 

I know that part of the explanation lies in the fact that the Stanford report cutoff at December 21, 2009, which meant that the Stanford study missed at least three more lawsuits filed before year end.

 

The Stanford study also counts multiple filings related to the same allegation against the same companies only once. This provides a partial explanation for the differences between the Stanford study and the NERA study, which separately counts separate actions in separate circuits unless and until the lawsuits are later consolidated.

 

Another difference between the studies may be the fact that the NERA study reported a projected year end number, as the result of an extrapolation from filings through mid-December. Though the Stanford study ended prior to year end, it did not incorporate any extrapolation for cases filed after the cutoff date and before year end.

 

All of these factors clearly are relevant but even collectively they don’t seem sufficient to explain the entire difference. Of course, another factor may simply be differences in information, but given that the plaintiffs’ lawyers put out press releases when they file lawsuits, the information differences likely account for only a small part of the differences in lawsuit counts.

 

All of this underscores a point that I made at length in connection with my own study of the 2009 filings, which is that readers would benefit enormously from knowing more about what protocols the various study publishers use when the are deciding what "counts."

 

The Stanford analysis is certainly easier to decode in this respect that other reports since the Stanford Clearinghouse publishes its list of lawsuits on its website — for free, which is a tremendous public service for which all of us should be grateful. But merely knowing which cases were put on the list does not tell us why those cases were included, nor does it tell us what other cases might have been omitted and why. (Indeed, the reason I continue to do my own count and analysis every year, even though Stanford publishes its own list for free on the web, is the uncertainty about what the list does and does not include.)

 

The Stanford report also gets high marks for stating right on its cover what it is included in its "research sample," which is very helpful and very commendable. But even taking this very explicit information into account, it still seems like there must be more going on that would explain the differences between the various reports.

 

Here are some illustrations of questions that would be helpful to know: Are securities lawsuits filed in state courts included? Are merger objection suits included? Are proxy solicitation misrepresentation cases included? How about lawsuits filed separately on behalf of equity shareholders and bondholders – one lawsuit or two? How about lawsuits that only allege state securities law violations? What kinds of cases are omitted from the count? What other sorting criteria are used?

 

The more of this type of information that readers are provided, the more helpful the published reports would be for readers. The approach that would be most helpful to readers would be for the reports to identify the way that their counting protocols differ from those used by other studies, in order to help readers understand the differences.

 

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What a difference a year makes. Just 12 months ago, the subprime and credit crisis litigation wave was in full spate, and the onslaught of Madoff and other Ponzi scheme cases had just begun to surge. And while both of these lawsuit filing trends continued well into 2009, by year’s end both of these phenomena had largely played out. At the same time, however, other litigation trends emerged as the year progressed, and in the end, the number of new securities class action lawsuits filed during 2009, though significantly below the number filed in 2008, was well within historical norms.

 

First, let’s run the numbers. By my count -- please see the note below about how I "counted" -- there were 189 new securities class action lawsuits in 2009, which is just below but within range of the 1966-2007 annual average of 192, although 15.6% below the 2008 total of 224 new securities lawsuits.

 

As was the case for the two preceding years, the 2009 lawsuit filings were largely driven by lawsuits against financially-related firms. Of the 189 new securities suits in 2009, 69 were against companies in the 6000 Standard Industrial Classification (SIC) code series (Finance, Insurance, and Real Estate). In addition, another 39 of the defendant firms targeted in 2009 securities class action lawsuits lacked SIC Codes. These lawsuit targets without SIC code designations included mutual funds, ETFs, and closed end funds. In general, the defendant entities that lacked SIC codes were all financially related.

 

If these two groups, the companies in the 6000 SIC code series and the entities that lacked SIC code designations, are added together, the total is 108. So these two groups together represented roughly 57.1% of the new lawsuits filed in 2009.

 

A significant factor driving this concentration of filings in the financial sector was the number of credit crisis-related lawsuits. By my count, there were 62 new credit crisis-related securities lawsuits filed in 2009, bringing to 205 the total number of credit crisis related securities lawsuits that were filed since the litigation wave commenced in February 2007. (My complete list of the subprime and credit crisis-related securities suits can be found here.)

 

But though the credit crisis litigation wave carried over into 2009, as the year progressed the number of credit crisis-related filings dropped off. So too did the concentration of filings against financial companies. Thus, while 72.6% of the lawsuits in the first half of 2009 were against financially-related companies, only 41.3% of the filings in the year’s second half involved financial companies.

 

And even though the lawsuits filed against financially related companies declined in the second half of the year, by and large, the rate of lawsuit filings overall did not decline. Thus, while there were 95 new securities class action lawsuits in the first half of 2009, there were 94 in the second half – virtually the same filing rate in both halves of the year.

 

Part of the reason that the overall lawsuit filing rate did not decline in the second half of the year even though the credit crisis-related lawsuits trailed off is that a couple of filing trends emerged in the second half of the year that fueled lawsuit filings and took up the slack.

 

The first of these two trends was the outbreak of a rash of lawsuits against leveraged exchange-traded funds (ETFs), which I discussed in a prior post here. By my count, there were twelve separate securities lawsuits filed against ETFs, all during the second half of 2009. These suits largely have been filed against leveraged ETFs drawn from within a single fund family, and all present more or less the same allegations (essentially that investors were not told that the funds would track their target measures or ratios only for very short periods). Because these lawsuits represent more than 6% of all new 2009 securities lawsuits, they represent a significant part of the year’s securities litigation activity.

 

The second trend that emerged during the second half of 2009 was the emergence of a significant number of belated lawsuit filings, where the lawsuit filing date came long after the proposed class period cut-off date, a phenomenon I discussed several times in the latter half of the year (most recently here). These belated filings appear to be the result of a lawsuit backlog that developed while the plaintiffs’ lawyers were preoccupied with the credit crisis related lawsuit filings.

 

By my count, 22 of the 94 securities lawsuits filed during the second half of 2009 were filed more than a year after their proposed class period cut-off date. In some instances, the lawsuit filings came at the very end of the two-year limitations period. For example, the Pitney Bowes securities class action lawsuit was filed one year and 364 days after the proposed class period cutoff date. Indeed, in at least two cases (the Avanir Pharmaceuticals case and the Regions Financial case), the filing came nearly three years after the proposed class period cutoff, raising a rather obvious question about how these cases will withstand statute of limitations objections.

 

The belated filings continued to arrive right through the end of the year, with several of December’s filings including cases with filing dates more than a year after the proposed class period cutoff date, including the new lawsuits filed against Siemens (about which refer here), NightHawk Radiology Holdings (here), and Terex (refer here).

 

Almost all of these backlog cases have been filed against companies outside the financial sector, which accounts in part for the shift in filings away from financial companies in the second half of 2009. That is, it appears that while the plaintiffs’ lawyers were rushing to file credit crisis-related lawsuits during the period mid-2007 through mid-2009, they were also building up a backlog of cases against nonfinancial companies, and now they are working off the backlog.

 

And so, while over half of the new securities lawsuits filed in 2009 involved financial companies, by year’s end, the 2009 securities lawsuits overall involved a broad spectrum of kinds of companies. The 2009 securities lawsuits were filed against firms in 90 different SIC Code categories. Many of these categories had lawsuits against only a single company. Outside the financial sector, the SIC code categories with the highest number of lawsuits were SIC Code category 2834 (Pharmaceutical Preparations), which had five lawsuits, and SIC Code category 2836 (Biological Products), which had four lawsuits.

 

The 2009 securities lawsuits were filed in 38 different federal district courts, but, due to the number of lawsuits against financial companies, the largest number of lawsuits (78, or about 41% of all 2009 lawsuits) were filed in the S.D.N.Y. The courts with the next highest number of 2009 securities lawsuit filings were N.D. Cal (12) and C.D. Cal. (9). There were five different courts -- D.N.J., E.D.N.Y., N.D. Ill., S.D. Fla., and S.D. Tex. – that had six securities lawsuit filings each. The eight courts with the highest number of 2009 filings together had 128 new lawsuits, or 67.7% of all 2009 securities lawsuit filings.

 

24 (or 12.7%) of the 2009 securities lawsuit filings involved companies that are domiciled outside the United States. These lawsuits involved companies from 12 different countries. The countries with the highest number of companies suit were the U.K. (with 6), Germany (with 5), and Canada (3).

 

Some Thoughts about Counting Securities Lawsuits: I know that many readers wonder why the various annual securities litigation studies report such materially different lawsuit filing numbers. The reason the studies’ lawsuit counts vary so widely is not just that the various studies’ authors have different information; another significant factor is that the different studies use different protocols to count lawsuits.

 

For example, some of the studies count duplicate complaint filings in separate circuits as a single lawsuit (that is, the case counts only once), while other studies count duplicate complaints filed in different circuits as separate lawsuits until they are formally consolidated (that is, the case can be counted multiple times). For my purposes, I count duplicate complaints only once regardless of whether there are duplicates filed in different circuits, which is one reason why my 2009 securities lawsuit count appears lower than, for example, NERA’s 2009 securities litigation study.

 

There is of course absolutely no reason why separate studies should not use their own preferred counting protocol. But I do believe that the studies’ readers would be enormously benefitted if each study would explicitly state what their study "counted" – that is, what does the study include in its tally of securities lawsuits, and what does it omit?

 

In the best of all worlds, the studies would also explain how their methodology differs from those used by other published reports. These reports do not after all exist in a vacuum, and by and large the audience for each of the various reports basically consists of the same group of readers. It would be helpful, I think, if the reports were to recognize both the fact that their audience reads the other reports and that these readers want to understand any and all identifiable reasons why the various reported numbers differ.

 

In my own analysis of the 2009 securities lawsuit filings, I have tried to tally up the separate class action lawsuits seeking to recover damages under the federal securities laws. I don’t count lawsuits that were not filed as class actions; that do not seek to recover damages; or that don’t allege violations of the federal securities laws. Thus, for example, I would not count a lawsuit that alleges common law fraud but that does not allege a securities fraud under the federal statutes. I would not count an indiviudal lawsuit that does not purport to proceed as a class action.

 

Two particular recurring lawsuit categories that I do not count are merger objection lawsuits, where the lawsuit’s goal is simply to increase a proposed acquisition price; and lawsuits against private entities in which the plaintiffs’ allegation is that the defendants failed to register securities.

 

Even within my overall counting criteria, it can sometimes be very difficult to determine whether or not a new complaint represents a new lawsuit or is merely a duplicate of a previously filed complaint. For example, in December, when plaintiffs’ lawyers filed a complaint on behalf of Bank of America bondholders relating to the Merrill Lynch acquisition and bonus payments, the question arose whether the complaint counted as a separate lawsuit, or was just a duplicate of the suit filed earlier in the year on behalf a purported class of Bank of America equity securityholders?

 

In the end, I concluded that because the two complaints involved separate classes of claimants, the bondholder suit represented a separate lawsuit that should be counted separately. This is undeniably a very close question, and reasonable minds might well reach a different conclusion.

 

Because there are many of these kinds of close questions in the course of trying to keep a count of securities lawsuit filings, it is almost inevitable that different lawsuit counts will vary. But though the variance of lawsuit counts may be inevitable, readers at least want to be able to understand the reasons why the lawsuit counts vary. The publishers of the various annual securities litigation studies would significantly benefit their readers if they were to explicitly and expressly state (and not just in footnotes or endnotes, but in a conspicuous way) what their study purports to be counting, and what protocols were used to determine what was and what wasn’t included in the count.

 

It would be even more helpful to readers if the reports were to recognize that their readers also read the other reports and to state explicitly and expressly how their methodology may differ from the other annual litigation studies.

 

I know the various annual litigation study publishers view themselves as in competition with each other, and so it may be difficult for them to acknowledge each other’s existence. They may believe that it as not their job to explain competing analyses. However, each publisher’s silence on these issues means the readers are left on their own trying to figure out why the numbers vary so widely.

 

The fact is that most of us read all of the reports. I feel quite confident in saying that readers would find it extremely helpful to have better information to understand why the studies’ numbers differ. The reports that recognize and their readers’ needs into account would win their readers’ loyalty, gratitude and appreciation.

 

Speakers’ Corner: On January 4, 2010, I will be presenting with Jason Cronic of the Wiley Rein law firm on a panel entitled "Directors and Officers Liability Insurance" at the Practicing Law Institute's Current Developments in Insurance Law 2010 conference. Background regarding the conference can be found here.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

　

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

 

Background

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

 

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

 

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

 

The December 4 Order

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

 

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

 

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

 

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

 

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

 

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

 

Judge Watson’s dismissal ruling was with prejudice.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

　

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

 

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

 

 

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

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

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

　

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

 

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

 

Background

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

 

In considering the extraterritorial reach of the U.S. securities laws, the Second Circuit applied the cause test, which the Court articulated as follows: "subject matter jurisdiction exists if activities in this country were more than merely preparatory to a fraud and culpable acts or omissions occurring here directly caused losses to investors abroad." Relying on two 1975 decisions by Judge Henry Friendly – Bersch v. Drexel Firestone Inc. and IIT v. Vencap Ltd., the Court sought to identify which actions constituted the fraud and directly caused harm, or as the Court stated elsewhere in the opinion "what is central or at the heart of a fraudulent scheme."

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

Conclusion

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

 

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

 

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

　　　

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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In an October 28, 2009 opinion (here) in a case in which the Ninth Circuit found the plaintiffs’ allegations met the heightened pleading standards of Twombley and Tellabs, the appellate court reversed the district court’s dismissal of the plaintiffs’ complaint in the Matrixx Initiatives securities class action lawsuit. The decision is significant not only because the appellate court reversed the lower court’s prior dismissal of the case, but also because of what the Ninth Circuit’s opinion implies about the heightened pleading requirements.

 

The plaintiffs sued Matrixx and three of its officers in April 2004, alleging that the defendants were aware that numerous users of Matrixx’s intranasal cold remedy, Zicam, had developed anosmia (loss of the sense of smell), but that they had failed to disclose the risk and instead issued false and misleading statements regarding Zicam. The complaint alleges that the defendants were aware of these problems because of various calls to the company’s customer service line; because of certain academic research, the results of which were communicated to the company; and because of product liability lawsuits that had been filed against the company.

 

The district court granted the defendants’ motions to dismiss, finding that the complaint failed to adequately allege materiality, because the number of anosmia-related complaints of which Matrixx was aware was not "statistically significant." The district court also found that the complaint failed to allege scienter adequately because it "fails to allege any motive of state of mind with relation the alleged omissions."

 

The Ninth Circuit first held that the district court "erred in relying on the statistical significance standard" in concluding that the plaintiffs had not adequately alleged materiality, finding that a court "cannot determine as a matter of law whether such links [between Zicam and anosmia] were statistically insignificant because the statistical significance is a question of fact."

 

Instead the Ninth Circuit said that the appropriate "fact-based inquiry" is (citing Twombley and its progeny) whether the complaint states a claim that is "plausible on its face" – and, with respect to the issue of materiality, whether "the possible link between Zicam and anosmia was information that a reasonable investor would have found significant."

 

After reviewing the plaintiffs’ allegations, the Court found that the complaints allegations were sufficient to meet the PSLRA’s pleading requirements for materiality and, citing Twombley, to "nudge" the plaintiffs’ claims "across the line from conceivable to plausible."

 

The Ninth Circuit further held, with reference to Tellabs standard for pleading scienter, that the inference that the defendants "withheld information intentionally or with deliberate recklessness is at least as compelling as the inference that [the defendants] withheld the information innocently."

 

In reaching this conclusion, the Ninth Circuit noted that the company’s disclosures were "misleading because [they] spoke of the risk of product liability actions without revealing that lawsuits had already been filed." The Ninth Circuit observed that the inference that "high level executives such as [the individual defendants] would know that the company was being sued in a product liability action is sufficiently strong to survive a motion to dismiss."

 

The Ninth Circuit also referenced the various customer complaints and academic studies the results of which were communicated to the company’s director of research and development.

 

Based on its conclusions about materiality and scienter, the Ninth Circuit reversed the lower court’s dismissal and remanded the case for further proceedings.

 

The Ninth Circuit’s decision in the Matrixx case is interesting in a number of respects, not least of which is because the decision reversed the district court’s prior dismissal of the case, although it is certainly interesting in that respect as well.

 

Among other things, the decision is also interesting for its application of the Twombley "facial plausibility" standard to the question of the sufficiency of the plaintiffs’ allegations of materiality. In a prior post (here), I discussed the question whether the "facial plausibility" test of Twombley and its more recent companion case, Iqbal, would have much impact on securities cases, given the PSLRA’s heightened pleading standards. The Matrixx decision suggests that the Twombley standard could indeed impact securities cases, even with respect to elements of a securities claim for which heightened pleading standards are defined in the PSLRA, since the Ninth Circuit cited both the PSRLA’s materiality pleading requirements and Twobley in determining the sufficiency of the plaintiffs’ allegations.

 

The further significance of the Ninth Circuit’s citation to Twombley is the fact that the court also found that the Twombley standard had been satisfied here. Though many objections to Twombley and Iqbal have been raised, the fact is that the "facial plausibility" standard can be satisfied and cases will still be going forward, notwithstanding the pleading standard articulated Twombley and Iqbal.

 

Another interesting thing about the Ninth Circuit’s decision is the way in which the court found that the scienter pleading requirements to have been satisfied, particularly with respect to the individual defendants. The court seems to have put great weight on the individual defendants’ positions, and was less focused on the question whether or not there were allegations of knowledge or awareness as to each of the individual defendants.

 

Thus, for example, with respect to the existence of product liability litigation, the court was willing to draw an inference of scienter as to the individual defendants because "high-level executives… would know" the company had been sued. – without apparent consideration of the question whether the individual defendants did know about the litigation, or even what the company’s practices were for circulating information about new litigation to the company’s senior officials.

 

Similarly, the allegations of scienter based on the alleged awareness of the existence of customer complaints and academic studies was found sufficient as to all three individual defendants, though the allegations refer only to communications of these matters to the company’s director of research. The court’s decision does not refer to what the other two individual defendants are alleged to have known, or even what they would have known in light of the company’s processes for communicating this kind of information internally.

 

If nothing else, the Ninth Circuit’s finding that the scienter allegations were sufficient represents a suggestion that in at least some circumstances (and in at least some courts) allegations that individual defendants held a certain office or position may be sufficient to support a finding of scienter, even where no supporting allegations about what the defendants know or what information they were provided or had access to.

 

Readers may be interested to know that on June 16, 2009, the FDA warned consumers (here) to stop using three Zicam intranasal products because the products may cause a loss of smell. As reflected here, a second securities class action lawsuit was filed after the company’s share price plunged following this announcement.

 

Iqbal on the Hill: Meanwhile, the Iqbal debate arrived on Capitol Hill this week, as the House Committee on the Judiciary Subcommittee on the Constitution, Civil Rights and Civil Liberties held hearings on October 27, 2009. The hearing was entitled "Access to Justice Denied – Ashcroft v. Iqbal." The Committee’s page about the hearing, including links to the witnesses’ testimony can be found here. An October 29, 2009 AmLaw Daily article by Alison Frankel about the hearings can be found here.

 

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Lawsuits seeking to recover large amounts of money are commonplace. But how about a claim that seeks to recover more money than exists in the entire world?

 

According to a September 24, 2009 order (here) by Southern District of New York Judge Denny Chin, the complaint of plaintiff Dalton Chiscolm, Jr. against the Bank of America seeks to recover "1,784 billion trillion dollars," to be deposited in his ATM account "the next day." Oh, and in addition, another $200,164.

 

Judge Chin states that in Chiscolm’s complaint (which Chin describes as "incomprehensible"), the plaintiff "seems to be complaining" that his checks apparently have been rejected because of incomplete routing numbers and when he placed a series of calls to the bank he "received inconsistent information from ‘a Spanish wom[a]n.’"

 

Judge Chin’s September 24 Order directs Chiscolm to show cause in writing by October 23, 2009 the basis on which his claim, which purported to be filed in reliance on federal question jurisdiction, is brought in federal court, or the complaint will be dismissed. As of October 25, 2009, PACER did not show that any statement had been filed.

 

The astonishing quantum of damages sought is more than just a random large number. As it turns out, 1,784 billion trillion – equal to 1.784 multiplied by 10 to the twenty-fourth power, or 1,784 followed by 21 zeroes – corresponds to a value in the International System of Units known as a "Yotta." According to Wikipedia (here), Yotta currently is the largest unit in the system of measurement. In other words, the plaintiff is literally seeking to recover the largest describable number of dollars.

 

An October 23, 2009 BBC News article (here) about Chiscolm’s lawsuit quotes Kevin Houston, a University of Leeds mathematics professor, as saying that "the guy wants more money than there is in the entire world."

 

Well, yeah, but the customer service really was terrible.

 

Judge Chin, who recently was nominated to the Second Circuit, of course is the judge that sentenced Bernard Madoff to 150 years of imprisonment, and so Chin knows a thing or two about large amounts of damages, but the amount of damages that Chiscolm has claimed even managed to get Judge Chin’s attention.

 

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The Supreme Court’s decision in the Iqbal case earlier this year has generated a great deal of controversy and comment and even a proposal to overturn the decision legislatively. Iqbal does seem to be having an impact on a number of cases. An interesting question, however, is whether the Iqbal case will have an impact on federal securities cases, given that the securities laws already have their own separate heightened pleading standards. But a recent Eighth Circuit decision, applying Iqbal to affirm a lower court dismissal, suggests that Iqbal could indeed have an impact in damages actions under the federal securities laws.

 

Background

First, some background. Fed. R .Civ. P. 8(a)(2) requires that a "claim for relief" must contain a "short plain statement of the claim showing that the pleader is entitled to relief." Historically, courts had come to use the shorthand phrase "notice pleading" to describe the requirements under this rule.

 

In the Supreme Court’s 2008 Twombley case (here), the Court said that in order to satisfy these pleading requirements, the complaint must contain sufficient factual matter, accepted as true, to "state a claim to relief that is plausible on its face."

 

In the 2009 Iqbal case, the claimant in a Bivens action had sought to argue that Twombley’s "facial plausibility" test should be limited to the pleadings made in the context of an antitrust dispute, as had been involved in Twombley. The Supreme Court held that the argument  that Twombley was limited to antitrust actions "is not supported by Twombley and is incompatible with the Federal Rules of Civil Procedure." Twombley, the Iqbal court said, "expounded the pleading standard for all civil actions."

 

The Iqbal decision that the "facial plausibility" pleading sufficiency test applies to all federal civil actions has been the subject of a great deal of heated discussion. It has been criticized in many quarters. For example, in a September 3, 2009 article entitled "Plausibility Pleading Revisited and Revised: A Comment on Ashcroft v. Iqbal" (here), Boston University Law School Professor Robert G. Bone argues that Iqbal "takes Twombley’s plausibility standard in a new and ultimately ill-advised direction." Seton Hall Law Professor Edward Hartnett, less critical of the decision, argues in his recent paper (here) that Twobley and Iqbal can and should be "tamed."

 

Twombley and Iqbal have thir supporters. Fellow bloggers Mark Herrmann and James Beck argue on their Drug and Device Law Blog (here) that:

  

There’s nothing radical about requiring a plaintiff to have sufficient facts to plead a prima facie case before the courts will entertain the lawsuit – and that goes for all forms of litigation. It’s simply a construction of the language of Rule 8 "short and plan statement" that emphasizes "statement" a little more and "short" a little less. It’s about time, we think, that courts adopt a construction of the Rules that favors reduced, rather than expanded, litigation.

 

Whether Twombley and Iqbal are generally viewed as good or bad developments largely seems to depend on where your starting point is. But regardless of whether they are good or bad, the cases are having an impact in the lower courts, as Beck and Herrmann underscored in their more recent Drug and Device Law Blog post (here) detailing developments, by way of illustration, in recent medical device cases applying Twombley and Iqbal.

 

These practical impacts have registered with the plaintiffs’ bar, and indeed a September 21, 2009 Law.com article (here) discussed how civil rights and consumer groups and trial lawyers have been meeting to discuss ways to undo Iqbal. According to the article, Iqbal has already had a very significant impact – it has "already produced 1,500 district court and 100 appellate court decisions."

 

These groups have already managed to get proposed legislation introduced in Congress seeking to have Iqbal overturned. On July 22, 2009, Senator Arlen Specter introduced Senate Bill 1504, "Notice Pleading Restoration Act of 2009," which basically provides that courts shall not dismiss a complaint except under the notice pleading standards applicable under Supreme Court precedent prior to Twombley.

 

Whether this legislative effort will go anywhere remains to be seen. Congress has rather a full plate these days, and a bid to adjust a narrow feature of civil pleading standards may not make the cut. On a related note, according to a Point of Law blog post (here), there will be a House hearing on October 27, 2009 on the topic of "Access to Justice Denied – Ashcroft v. Iqbal."

 

Impact on Securities Cases?

Whatever the impact of Iqbal may be in other contexts, it has seemed an uncertain question whether Iqbal will prove to have a substantial impact in damages actions under the federal securities laws, due to the fact that the securities laws already have their own particularized pleading standards. Indeed, under the PSLRA, there are very specific requirements regarding what must be pleaded with respect to misleading statements or omissions and with respect to the required state of mind. The Supreme Court’s 2008 decision in the Tellabs case even further underscored the degree of specificity required to satisfy the state of mind pleading requirements.

 

Given these very specific statutory requirements applicable to the federal securities laws, it could be argued that the more generalized pleading requirements expounded in Twombley and Iqbal might have relatively less impact in the context of a damages action under the federal securities laws. However, a recent decision from the Eighth Circuit suggests that Iqbal could have an impact in securities cases after all.

 

In an October 20, 2009 decision in McAdams v. McCord (here), the Eighth Circuit was reviewing an appeal of a district court’s dismissal of the securities class action lawsuit that have been filed against Moore Stephens Frost (MSF), the outside auditors of UCAP. The district court had held that the complaint "failed to plead with particularity the circumstances of MSF’s alleged fraud, as well as facts giving rise to a strong inference of scienter."

 

The Eighth Circuit held that it "need not decide whether the complaint adequately states with particularity facts giving rise to a strong inference that MSF acted with scienter," because, the court held applying Iqbal to the loss causation pleading requirement under the Dura Pharmaceuticals case, that "the complaint fails to sufficiently plead loss causation."

 

The court referenced what it called the complaint’s "threadbare, conclusory allegation" that as a "direct and proximate cause" of defendants’ fraud the plaintiffs had lost their investments. The court noted that this allegation failed to "specify" how MSF’s alleged statements "as compared to the complaint’s long list of alleged misrepresentations and omissions by the executives, proximately caused the investors’ losses." The court noted further that the complaint "does not state the value of UCAP’s stock when the investors made their investments, or its value right before, or right after, the need for restatement was announced."

 

The Court concluded that without these allegations "the complaint does not show that the investors’ losses were caused by MSF’s misstatements," which "defeats the plausibility of the investors’ claims that MSF’s audit opinions …caused their losses."

 

Discussion

The Eighth Circuit’s decision in the McAdams case, in which the Eighth Circuit held, applying Iqbal, that the claimants’ loss causation allegations lacked "plausibility," shows that Iqbal could indeed have an impact on securities cases.

 

It is particularly interesting that the Eighth Circuit affirmed the lower court’s dismissal on the grounds of insufficient loss causation plausibility, while observing that it did not even need to reach the question whether the plaintiffs had plead scienter with sufficient particularity under the PSLRA. The conclusion suggests that Iqbal’s generalized pleading requirements must be considered analytically prior to the PSLRA’s more particularized requirements. And whether or not the Iqbal standard is to be viewed as prior, its "facial plausibility test" apparently applies to the elements required to state a cause of action under the federal securities laws, even those elements for which the PSLRA does not itself specify particularized pleading requirements.

 

In any event, the basic holding of the McAdams case that the complaint’s loss causation allegations must meet the Iqbal "facial plausibility" standard in order survive an initial motion to dismiss could be a valuable tool for defendants’ to use at the initial pleading stage. (Of course, many plaintiffs will include allegations in the complaint of the kind that the plaintiffs in the McAdams case had omitted, so the extent to which the McAdams decision will affect other cases could be limited – with the inclusion of seemingly minimal additional information about their alleged investment loss, plaintiffs could likely defeat a motion raising similar arguments.)

 

One question that may be of more interest to civil procedure buffs is whether it matters that in McAdams the court was considering a complaint to which (as the McAdams court itself noted) Rule 9(b) applied, rather than (or perhaps, in addition to) Rule 8. Rule 9(b) requires that fraud must be plead with "particularity." To my mind, it does not and should not matter whether the applicable pleading standard is under Rule 9 rather than under Rule 8, either way it would seem (as the McAdams court noted) that the Iqbal "facial plausibility" test should apply, although I would be interested to know if readers disagree.

 

One final thought about Iqbal itself. I tend to agree with the school of thought in favor the decision. I recognize the argument that the "facial plausibility" test does not appear in the Fed. R. Civ. P., but then neither does the phrase "notice pleading." And I find myself puzzled by the critics of Iqbal – are they suggesting that complaints that are not facially plausible should be allowed to go forward? In any event, under Rule 15 (a)(2), courts are admonished to allow pleading amendments "freely when justice so requires," so plaintiffs will typically have at least a second crack at trying to present a "facially plausible" complaint.

 

In any event, based on the McAdams decision at least, Iqbal appears to represent yet another factor raising the hurdle that plaintiffs’ initial pleads must overcome in order to survive a motion to dismiss in a securities class action lawsuit. Clearly, the accumulating number of substantive and procedural developments increasingly favors the defendants in these cases.

 

Very special thanks to Tom Gorman of the SEC Actions Blog for his recent post (here) discussing the McAdams case.

 

More About Loss Causation: An October 21, 2009 memo entitled "Loss Causation Challenges in Securities Cases" (here) by Michael Smith and William Hutchinson of the King & Spaulding law firm surveys recent case law regarding loss causation issues under the federal securities laws.

 

 

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It been a catastrophic week for Galleon Group and its founder, Raj Rajaratnam, with the firm reportedly about to wind itself up in the wake of the epic insider trading allegations raised against Rajaratnam. But the trading indictment is not the only recent stunning legal development involving Rajaratnam and his firm.

 

Among other things, on October 22, 2009, a group of survivors of alleged "terrorist" bombings sued Rajaratnam and his father claiming they knowingly provided financial support to the Tamil Tigers.

 

On a more positive note, Galleon was recently affirmed as lead plaintiff in a securities class action lawsuit pending in the Eastern District of Pennsylvania.

 

The terror victims filed their lawsuit on October 22, 2009 in the District of New Jersey. The seven-count complaint (copy here) was, according the plaintiffs’ lawyers press release (here), the result of "a year-long investigation." The complaint was filed under the Alien Tort Claims Act of 1789, which gives U.S. district court jurisdiction "of any civil action by an alien for tort only, committed in violation of the law of nations or a treaty of the United States."

 

The complaint alleges that Rajaratnam and the family foundation headed by his father provided millions of dollars in funds used for terrorist attacks by the group formerly known as the Liberation Tigers of Tamil Elam (LTTE). The complaint alleges that from 2004 to 2009 LTTE conducted hundreds of attacks and bombings, claiming over 4,000 victims. The complaint alleges that Rajaratnam and his family foundation provided millions in funding to a group that the Treasury Department has described as "a charitable organization that acts as a front to facilitate fundraising and procurement for the LTTE." The complaint alleges that Rajaratnam’s donations were given "with the intent of supporting specific LTTE attacks and operations."

 

The complaint alleges that the defendants aided and abetted terrorist acts "universally condemned as violations of the law of nations: aided and abetted, intentionally facilitated or recklessly disregarded "crimes against humanity in violation of international law," as well as, among other things, wrongful death, negligence and negligent or intentional infliction of emotion distress.

 

Things said about Rajaratnam and his firm in the September 30, 2009 ruling (here) by Eastern District of Pennsylvania Judge Juan R. Sanchez, in which Sanchez affirmed Galleon as lead plaintiff in the Herley Industries securities class action lawsuit, were decidedly more positive. The subsequent events (which the court obviously had no way of anticipating) do cast a very strange light on the opinion.

 

Even prior to events of the last week, Galleon’s selection as lead plaintiff in the case was notable. Investment advisors typically are regarded as lacking standing to pursue the claims of their clients’ funds, because they lack an "injury-in-fact" – that is, they suffered no direct injury. A long line of district court cases have declined to appoint investment advisers as lead plaintiffs for that very reason. In considering these issues, Judge Sanchez observed that Galleon, unlike the investment advisors in the other cases, was "closely connected" to the Galleon funds that held the company’s stock.

 

With respect to the connection between Galleon and the funds, Judge Sanchez noted that "the same people control both Galleon and the funds," adding that "Raj Rajaratnam serves as director of the two funds and as Galleon’s managing partner." There were, however, further standing issues involved because the funds had not assigned their claims to Galleon until after Galleon was initially appointed to serve as lead plaintiff.

 

Finding that Galleon now had standing in light of the assignment, and noting further that "Galleon has served as an adequate plaintiff for more than two years," and that it had a larger financial interest in the case than the competing pension fund, the court exercised its discretion to affirm Galleon as the lead plaintiff in the action.

 

In support of this conclusion, Judge Sanchez observed, among other things that "to appoint a new lead plaintiff at this late date would unduly disrupt the litigation process."

 

Certainly, no one wants the litigation process unduly disrupted, but I suspect that in light of events subsequent to Judge Sanchez’s September 30 order, the litigation process in the Herley Industries case is about to be duly disrupted.

 

Among other ironies is that in the court’s prior order initially appointing Galleon as lead plaintiff (here), the competing pension fund had argued that Galleon was an "unsuitable" lead plaintiff owing to the "unique defenses" to which Galleon was subject. Among other things, the competing pension fund had argued that Galleon was a hedge fund that had shorted Herley’s stock during the class period (and therefore allegedly profited from the fraud on the market), and further argued that the short sale activity violated the federal securities laws. Judge Sanchez found the securities law violation allegations to be speculative and selected Galleon as lead plaintiff in light of the PSLRA’s presumption in favor of the plaintiff that suffered the greatest financial.

 

The competitor pension fund presumably could be substituted in as lead plaintiff, but, as Judge Sanchez noted, the pension fund’s losses "pale by comparison" to Galleon’s.

 

As interesting as all of these things are, I suspect there will be more attention-grabbing legal developments about Galleon and Rajaratnam in the weeks and months ahead.

 

Special thanks to Adam Foulke of the Motley Rice firm for providing me with a copy of the plaintiffs' complaint in the Tamil Tiger case. Special thanks to a loyal reader for providing copies of the opinions in the Herley Industries case.

 

In Case You Missed It: OakBridge Insurance Services announed yesterday that Mickey Estey and Lance Sunder, both previously of NASDAQ Carptenter Moore,  have joined OakBridge and will be opening offices for the company in the metro regions of San Francisco, CA and Minneapolis, MN, respectively.

 

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On October 19, 2009, in a securities case from an earlier era involved allegedly misleading statements regarding asset-backed securities, Southern District of New York Judge Harold Baer substantially denied the defendants’ motions to dismiss the plaintiffs’ complaint as amended, following the long-running case’s trip through the Second Circuit on interlocutory appeal. A copy of the October 19 opinion can be found here.

 

Judge Baer’s decision in the Dynex Capital securities case is noteworthy not only because of the previous high profile appellate decision in the case, but also because Judge Baer found plaintiffs’ amended allegations sufficient to survive the renewed motion to dismiss, after prior pleadings had failed in whole or in part to withstand scrutiny.

 

Though the case is from a slightly earlier era (it was initially filed in 2005), it raises many allegations similar to those involved in the current round of subprime and credit crisis-related securities lawsuits, and therefore could be influential with respect to dismissal motions in the more recent cases.

 

Background

Dynex was in the business of packaging mortgage loans into securities. Between 1996 and 1999, Dynex originated or purchased 13,000 mobile home loans that served as collateral for bonds that a unit of the company issued. The underlying loans performed poorly and in 2003-04 the bonds were downgraded by the rating agencies. The bonds’ value dropped by as much as 85%.

 

The plaintiffs filed a securities class action lawsuit on behalf of investors who had purchased the bonds between February 7, 2000 and May 13, 2004. The plaintiffs allege that the defendants artificially inflated the bonds’ price by misrepresenting that the poor performance of the bond collateral was due to market conditions, concealing that the defendants’ "aggressive and reckless loan underwriting and origination practices generated a pool of collateral loans of poor credit quality and inherent defects."

 

In a February 2006 opinion (here), Judge Baer granted the defendants’ motion to dismiss the complaint as to the individual defendants for failure to adequately allege scienter, but he denied the motion as to the corporate defendants. In June 2006 he certified his opinion for interlocutory appeal on the question "whether scienter could be adequately alleged against a corporation without concomitant allegations that an employee or officer acted with the requisite scienter."

 

In 2008, the Second Circuit held (here) that corporate scienter may be sustained even "in the absence of successfully pleading scienter as to an expressly named officer." However, the Second Circuit held that the plaintiffs had not met the standard for corporate scienter, vacated Judge Baer’s prior ruling and remanded the case to allow the plaintiffs an opportunity to replead.

 

The plaintiff filed a second amended complaint (hereafter, the amended complaint) and the defendants’ renewed their motion to dismiss.

 

The October 19 Opinion

In their newly amended complaint, the plaintiffs added the statements of nine confidential witnesses and also identified and described for the first time four categories of reports that the plaintiffs alleged put the defendants on notice that their public statements were materially misleading.

 

Based on the confidential witnesses’ statements, which bolstered the plaintiffs’ allegations about how the defendants accessed and used the identified categories of reports, Judge Baer found that the plaintiffs had sufficiently alleged that several categories of the statements on which plaintiffs sought to rely were misleading and false. These categories included defendants’ statements regarding the adherence to underwriting standards; the defendants’ statements about the reasons for the deterioration in the collateral performance; and the defendants’ statements about the adequacy of the company’s loan loss reserves and internal controls.

 

More significantly in light of the case’s prior procedural history, Judge Baer found that the plaintiffs had adequately pled scienter. Judge Baer found that the plaintiffs’ allegations about the information available to defendants in the newly referenced documents represented strong circumstantial evidence of scienter. Judge Baer found that the amended complaint, by contrast to the plaintiffs’ prior complaint, "contains factual allegations about several forms of reports that collectively provided to Dynex’s senior management, including the Individual Defendants, information that contradicted their misleading statements."

 

The information in the documents was "available to and reviewed by the senior management responsible for the public statements at issue that either put them on notice of the falsity of these statements or clearly should have done so." Judge Baer found that the inference of scienter from these allegations was as least as compelling as the contrary inference that the defendants sought to draw.

 

Judge Baer found that when the amended complaint is viewed "holistically," a "cogent story of securities fraud is revealed":

 

The Defendants originated or purchased a large number of mobile home loans of generally low credit quality, a substantial number of which were "inherently defective," and packaged them into the Bonds failing to disclose that the stated underwriting guidelines were "systematically disregarded"; then, when adverse market conditions coincided with rising defaults and many loans were uncollectible as a consequence of inherent defects, Defendants publicly stated that market conditions were to blame in an attempt to forestall deeper drops in the value of the Bonds, many of which they held for their own account.

 

Accordingly, Judge Baer held that the amended complaint "alleges facts giving rise to a strong inference" that the statements he "found to be false and misleading were made with scienter."

 

Discussion

The Dynex Capital case arose in February 2005, two years before the current round of subprime and credit crisis litigation began, but the plaintiffs’ allegations are remarkably similar to many of the allegations raised in the more recent lawsuits. The fact that the amended complaint largely survived the most recent motions to dismiss is all the more significant given the plaintiffs’ early difficulties in the district and appellate courts in trying to get over the initial pleading hurdles.

 

The fact that the plaintiffs in the Dynex Capital case were ultimately able to overcome the initial pleading hurdles will obviously be of particular interest to the plaintiffs in the more recent cases. The plaintiffs were able to survive the renewed dismissal motion in this case because of the large number of well-placed confidential witnesses who were able to provide detailed descriptions of the company’s processes and of the key documents and their availability to senior management, as well as how the information in the documents allegedly contrasted with the defendants’ public statements.

 

Obviously not all plaintiffs in other cases will be able to muster the same number or caliber of confidential witnesses or success in being able to utilize confidential witnesses to show with such particularity what information was available to senior management and how the available information contrasted with public statements.

 

But the fact that the plaintiffs in this case were able to put those elements together, and were able to do so in a way sufficient to overcome the court’s original skepticism shows that plaintiffs in general can put together allegations to surmount even the heightened scienter pleading standards of the Tellabs case. The fact that these plaintiffs were able to do so after the initial pleading challenges also suggests that in other cases in which plaintiffs initial complaints failed to survive, the pleading defects still may be overcome with sufficiently particularized amended pleading, even on the critical issue of scienter.

 

In any event, because of the similarity of the allegations on this case to the allegations in many of the current cases, Judge Baer’s recent decision in the Dynex Capital case is likely to be important in the current cases similarly involving asset-backed securities allegedly misleading disclosures about underwriting standards, collateral quality, internal controls and adequacy of loan loss reserves.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog for providing a copy of Judge Baer’s October 19 opinion.

 

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It is always useful to look at aggregate securities lawsuit filing data to try to determine what trends and themes can be discerned, but occasionally it is also useful to look at a single new filing whether it might suggest anything. To choose one example, a closer look at a new securities class action lawsuit filed on October 14, 2009 in the Eastern District of Pennsylvania against Advanta Corporation and certain of its directors and officers seems to reflect a variety of different securities litigation tendencies and motifs.

 

Advanta at one time was the country’s largest issuer of Visa and MasterCard credit cards, through its subsidiary, Advanta Bank Corp. As reflected in the plaintiffs’ lawyers’ October 14, 2009 press release (here), the lawsuit alleges that the defendants failed "to disclose the impact of the economic environment and the deteriorating credit trends on its business and that the Company failed to adequately and timely record losses for its impaired loans and customer delinquencies, causing its financial results to be materially false."

 

Specifially, the complaint (which can be found here) alleges that:

 

(a) Advanta’s assets contained tens of millions of dollars worth of impaired credit card receivables for which the Company had not accrued losses; (b) prior to and during the Class Period, Advanta had been extremely aggressive in granting credit to customers without verifying the customers’ ability to pay, to such a degree that by the summer of 2009, Advanta customers’ default rate would be almost six times worse than industry average; (c) Advanta’s manipulation of its cash rewards program angered customers and caused the Company to lose good, creditworthy customers; (d) Advanta’s credit receivables were unduly risky due to the Company’s practice of issuing credit cards to small business owners without, in many instances, verifying income; (e) defendants failed to properly account for Advanta’s continuing delinquent customers and the credit trends in the Company’s portfolio, resulting ultimately in large charges to reflect impairments; and (f) the Company was not on track to be profitable in 2008.

 

The complaint alleges that the company’s share price plunged after its October 2007 disclosure that it was experiencing a higher rate of delinquencies. The complaint alleges that thereafter the news only got worse, and in May 2009 the company announced in May 2009 the cancellation of "millions of cards held by small businesses." On June 30, 2009, the FDIC entered a cease and desist order (here) against Advanta Bank following allegations of unsafe and unsound banking practices.

 

Though the complaint references these more recent events, the putative class period proposed in the complaint runs from October 31, 2006 through November 27, 2007.

 

This complaint is of course a reflection of the specific circumstance alleged with respect to this one company and its banking subsidiary. Nevertheless, the complaint also reflects a number of different securities litigation themes and trends, some of which are well-established and some of which may only just be emerging.

 

First, this case is yet another example of the kinds of litigation that may emerge in connection with the growing numbers of troubled banks. As I have noted in numerous posts (most recently here), though the level of litigation involving failed and troubled banks is still well below what might be expected given the number of distressed institutions, a number of lawsuits have begun to emerge and there may yet be more in the future.

 

Second, while I have noted elsewhere that as 2009 has progressed the wave of subprime and credit crisis related litigation definitely seems to have slowed (or even just merged into larger litigation developments to the point that it may no longer be its own separately identifiable category of litigation), this case suggests that it is far too early to declare that the litigation wave has ended. Obviously, there may yet be other cases that raise similar credit related lawsuits in the months ahead.

 

This case also demonstrates with respect to the subprime and credit crisis-related litigation wave that the lawsuits encompass a wide variety of kinds and categories of credit, including, as shown here, credit card debt. As noted here with respect to the litigation involving American Express, there have been prior credit crisis securities lawsuits filed with respect to issues concerning credit card debt.

 

Third, the 23-month gap between the end of the proposed class period and the filing of this lawsuit is yet another example of the significant number of filings in the second and third quarter of 2009 that involve class period cutoff dates in the distant past. As noted in prior posts (most recently here), this phenomenon might suggest that while the plaintiffs’ lawyer were previously preoccupied filing numerous credit crisis and Madoff related lawsuits, they developed a backlog of cases that they have now started to work off.

 

Indeed, just in the past several days there have been several other cases with long past class period cutoff dates, including the lawsuit recent filed involving RHI Entertainment (filed on October 8, 2009, class period cutoff of June 19, 2008); Men’s Wearhouse (filed on October 8. 2009, class period cutoff date of January 9, 2008); and EnergySolutions (filed October 9, 2009, class period cutoff date of October 14, 2008).

 

Apparently, as the Advanta case suggests, the backlog may even include other credit crisis cases, which is yet another reason that, as noted above, there may be still other credit crisis cases yet to come.

 

In any event, I have added this case to my list of subprime and credit crisis-related securities lawsuits, which can be found here. If this case is any indication, there could be others credit crisis securities cases yet to come.

 

Courtroom Drama: While we all remain interested in the developments in the ongoing trial in the Vivendi securities class action lawsuit, there is certainly nothing new about courtroom drama, and some of the most compelling courtroom tales have an ancient and venerable pedigree.

 

A particularly engaging tale of courtroom drama is told in The Life and Times of Constantine the Great, a biography of the Roman emperor by D.G. Kousoulas. During Constantine’s reign, Athanasius, the bishop of Alexandria and one of the protagonists in the long-running Arian controversy, was accused by his foes of murder. An inquest of bishops and imperial officials was convened.

 

At the inquest, the accusers presented their case against Athanasius, and even produced a blackened hand, allegedly that of the victim, Arsenius. Kousoulas describes the scene:

 

After the accusers had enjoyed a moment of triumph as they passed the blackened hand around, Athanasius asked in a quiet voice if any of those present knew Arsenius personally. A number of bishops claimed to have known the murdered bishop well. Would they recognize him if they saw him, Athanasius asked. Certainly, they replied, "if he were alive." At that point Athanasius signaled to a man who was standing near the doorway, his face covered with his cloak. The man, his face still covered, moved to the front. "Lift your cloak," Athanasius said. The man removed the cloak and [as a contemporary account noted] "lo and behold it was Arsenius himself." Athanasius moved closer and drew first one and then the other sleeve. Aresenius had both of his hands. "Has God given a man more than two hands?" Athanasius asked with a sarcastic smile.

***

For a moment there was stunned silence. Then one of the accusers declared loudly that all this was sorcery and devil’s work. The man was not Arsenius although he had his face, he was not even human but an illusion produced by Athanasius with his knowledge of black magic. Athanasius asked the bishops to come and touch the man he was accused of having murdered. The meeting turned into a brawl, and Dionysius, the imperial officer attending the meeting on orders from Constantine, had to hurry Athanasius out to save his life.

 

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