What Difference Does it Make that Paulson "Instructed" Lewis Not to Disclose the Fed Backstop of the BofA/Merrill Deal?

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 :

  

Guest Post: Bill Lerach on Whether Companies Underperform After Settling Securities Suits

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.

 

Motions to Dismiss Denied, Granted in Part in BofA/Merrill Merger Securities Suit

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. 

 

Do Defendant Companies Financially Underperform Following Securities Lawsuit Settlements?

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. .

 

Inadequate Loan Loss Reserve Disclosure Case Dismissed

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.

 

The Latest Securities Litigation Target

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.)

Dismissal Motions Denied in Failed and Troubled Bank Securities Cases

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.

 

Ninth Circuit Affirms Dismissal in Securities Case that Involved Rare Trial

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.

 

NERA Releases Updated Study of Japanese Securities Litigation

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.

 

Guest Post: A Response to the Vivendi Plaintiffs About Morrison v. National Australia Bank.

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.

 

First-Filed Subprime Securities Suit Settles for $125 Million

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.

 

 

Guest Post: Vivendi Plaintiffs' Argument on the Impact of Morrison v. National Australia Bank

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.

 

Cornerstone Releases Mid-Year 2010 Securities Class Action Litigation Study

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.

 

Morrison Precludes F-Squared Cases, Too, Court Concludes

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.

 

NERA Releases Mid-Year 2010 Securities Litigation Study

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."

 

Are Securities Class Action Opt-Outs Back?

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.)

 

O.K., F-Cubed Claims Are Out, But What About F-Squared Claims?

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.

 

There's Just One Little Problem About That $725 Million AIG Securities Suit Settlement

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.

 

A Closer Look at the Goldman Sachs SEC Enforcement Action Settlement

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.

 

Advisen Releases Second Quarter Securities Litigation Analysis

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.

 

Law Firm Memo Round-Up

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.

 

Securities Litigation Web Notes and Updates

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.

 

Securities Lawsuit Filings Down in Year's First Half

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.

 

Supreme Court Grants Cert in Another Securities Case

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.

Guest Post: Tower Snow Comments on the Ninth Circuit's Apollo Group Opinion

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.

 

More Thoughts About Morrison v. National Australia Bank

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.

 

Supreme Court Limits Foreign Investors' Access to U.S. Courts

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.

 

 

Ninth Circuit Reverses Apollo Group Securities Lawsuit Post-Trial Ruling, Reinstates $277.5 Jury Verdict

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.

 

Judge Rakoff Addresses Stanford Directors' College

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."

 

Supreme Court Grants Cert Petition in Matrixx Initiative Securities Suit

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.

Belated Securities Suit Survives Dismissal Motion

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.

 

Law Firm Memo Roundup

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.

 

Perspective on the Senate Financial Reform Bill

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. 

 

Who's Getting Hit With Securities Suits These Days?

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?

 

NERA Releases Comprehensive Study of Australian Class Actions

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.

 

Will the Financial Reform Bill Include An Aiding and Abetting Liability Provision?

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.

 

French Vivendi Investors O.K. to Participate in U.S. Class, French Court Holds

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."

 

U.S. Supreme Court Allows Merck Vioxx Securities Suit to Proceed

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.

 

Shareholders Launch Follow-on Securities Lawsuit Against Goldman Sachs

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.

 

A Failed Bank Securities Lawsuit Dismissal Motion Ruling for Plaintiffs

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.

 

Advisen Releases Analysis of First Quarter Securities Litigation

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!

The "Vexing" Question of Extraterritorial Jurisdiction (Corrected Version)

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.

 

The Latest on Life Science Companies and Securities Litigation

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.

 

PwC Issues 2009 Securities Litigation Study

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.

 

Extraterritoriality: Not Just a Securities Law Issue

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.

 

Cornerstone Releases Study of 2009 Securities Lawsuit Settlements

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.

 

 

Interview with the Authors of "Circle of Greed"

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.

 

 

 

A Fresh Look at a New Securities Lawsuit

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.

 

 

Corporate Penalties and the SEC

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.

 

Rating Agencies' Alleged Conflicts of Interest Held Immaterial

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.

  

Previously Dismissed Credit Suisse Subprime Securities Suit Allowed to Proceed

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).

 

Those Belated Securities Lawsuit Filing Blues, 2010 Edition

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

 

BofA: Securities Fraud Enforcement and Individual Liability

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.

 

Rating Agencies Are Not '33 Act "Underwriters"

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.

Dismissal Motions in Thornburgh Mortgage Subprime Securities Suit Denied in Part, Granted in Part

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.

 

Vivendi Found Liable in Securities Class Action Trial

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 .

 

NERA Releases Annual Canadian Securities Class Action Study

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.)  

 

Legislative Reform for the Securities Laws Before the 2010 Elections?

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.

 

Advisen Releases Year-End Study of "Securities Lawsuits"

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.

 

Insurance Coverage for Special Litigation Committee Expenses and Other Web Notes and Updates

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.

 

Risk Metrics Releases Updated Top 100 Securities Settlements List

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 100th largest settlement on the list was in the amount of $39 million. By year-end 2009, the 100th 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.

 

Securities Suit Filing Trends Continue in 2010 and Other Web Updates

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." 

 

Plaintiff's Securities Counsel: "Pay-to-Play" Practices?

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.

 

 

More Aiding and Abetting Liability Legislation and Other Web Notes and Updates

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.

 

Securities Lawsuits "Down Sharply" According to 2009 Cornerstone Report

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.

 

A Closer Look at the 2009 Securities Lawsuits

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.

 

Broadcom Settles Options Backdating Securities Class Action Suit

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.

 

Huntington Bancshares Subprime Securities Suit Dismissed With Prejudice

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.

 

NERA Releases 2009 Securities Litigation Study

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.

 

In Landmark Rulings, Ontario Court Allows IMAX Securities Suit to Proceed, Certifies Class

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.)

 

 

House Financial Reform Bill Includes Securities Law Reforms

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.)

 

NERA Releases SEC Settlement Trends Update

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.

New Siemens Securities Suit: Did the Company Misprepresent Its Ability to Hit Targets Without Bribery?

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.

 

The Unusual Timing of Dell's $40 Million Securities Suit Settlement

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.

 

Big Securities Law Doings in D.C.: Supreme Court, Congress Gear Up

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.)

 

The Securities Lawsuit "Backlog"

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 15th 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.

 

So What About the Ohio AG's Lawsuit Against the Rating Agencies?

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.

 

Look Who's Getting Sued Now

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.  

 

Marsh Settles "Contingent Commission" Securities Suit for $400 Million

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.

 

 

Guest Post: Foreign-Cubed Litigation - Developments at the Supreme Court

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).

   

ETFs: The Hot New Securities Lawsuit Targets?

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.

Latest U.S. Export: Securities Class Action Legal Services?

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.

 

Ninth Circuit Reverses Matrixx Securities Suit Dismissal, Concludes Twombley and Tellabs Satisfied.

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.

 

Lawsuit Against BofA Seeks a Yotta Money

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.

 

The Iqbal Case and Damages Actions under the Federal Securities Laws

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.

 

 

Other Provocative Legal Developments Involving Rajaratnam and Galleon

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.

 

Asset-Backed Securities Case from Earlier Era Survives Renewed Dismissal Motion

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.

 

A Single New Securities Lawsuit, Many Current Trends

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.

 

Advisen Releases Third Quarter Securities Litigation Report

Lawsuits alleging violations of the securities laws showed a strong comeback in the third quarter of 2009, according to an Advisen report released on October 14, 2009 (here). The report, the latest in a quarterly series from Advisen, reports that securities lawsuit filings were up "solidly" in the third quarter after a relative decline in the second quarter. Advisen’s report is directionally consistent with my own prior analysis of third quarter securities class action lawsuit filings, which can be found here.

 

One absolutely critical thing to understand about the Advisen report is that it uses its own unique terminology. As reflected on page 2 of the report, the report uses the term "securities suit" to describe a broad range of lawsuits beyond just securities class action lawsuits. As used in the report, the term "securities suits" includes, beyond the class actions, regulatory and enforcement actions; collective actions outside the United States; lawsuits alleging common law torts, contract law violations and breaches of fiduciary duty; derivative actions; and any other "securities-related suit" that impacts management liability insurance policies other than ERISA liability suits.

 

In addition, the report uses the phrase "securities fraud suits" to describe regulatory and enforcement actions brought by the SEC and other regulatory and enforcement agencies. Importantly this category of "securities fraud suits" also includes "cases brought by private parties alleging violations of securities laws that are not styled as class actions."

 

The report notes with respect to the broader category of "securities suits," as that term is used in the report, that there were 169 "securities suits" in the third quarter, which represents an 11 percent increase over the second quarter of 2009.

 

The report also notes that there were 55 new securities class action lawsuits in the third quarter of 2009, up from 38 cases in the second quarter, but down from 59 in the third quarter of 2008. The securities class action filing rate through the first three quarters of 2009 annualizes to 220 new lawsuits, which is "below the 230 filed in 2008 but well within its historical range."

 

The class action securities cases were, however, only the second largest subcategory among the larger group of "securities cases" (as that term is used in the report) filed in the third quarter. The largest subcategory among "securities cases" in the third quarter was "securities fraud cases" (which, again, is the term that the report uses to describe securities-related regulatory and enforcement actions, as well as private securities suits that are not filed as class actions), of which there were 70, up from 50 in 2Q09.

 

Overall, the securities class action lawsuits continue to represent an increasingly smaller proportion of all "securities suit" filings. The report notes that the proportion of securities class action lawsuit filings as a percentage of all "securities suits" has "been on a long downward trend." Whereas in the past, securities class action lawsuits have represented a majority of all "securities suits," in the third quarter, securities class action lawsuits represented just 33 percent of all "securities suits."

 

The report also notes that though filings against financial firms "remained strong" in the third quarter, new filings were more "widely dispersed" among other sectors than in the first half of the year. The report also notes that new Madoff and credit crisis-related suits "dropped substantially" in the third quarter compared to the first half of the year.

 

The report also notes the "long-term trend of growing numbers of suits against non-U.S. companies." Specifically, the report notes "the number of large securities suit filings against non-U.S. companies" are on a "long-term growth path."

 

With respect to potential insurance, the report notes that there is a growing number of "securities suits" that potentially trigger insurance coverage other than D&O insurance. The report notes that this trend "started in 2008 and continued in 2009," largely due to the filing of credit crisis and Madoff-related lawsuits. These cases may even be excluded by D&O policies but covered by E&O or fiduciary liability policies.

 

The Advisen report introduces a couple of nifty new features this quarter. First, the report includes a "Sector Impact Metric," which is designed to show the degree to which "securities suits" hit various industrial sectors over the past decade. The other new feature is the "Market Cap Impact Metric," which measures the market capitalization loss experienced by companies with securities class action lawsuits.

 

Speaker’s Corner: On Friday, October 16, 2009 at 11 am EDT, Advisen will be hosting a webinar to discuss the third quarter, in which I will be participating along with Arthur J. Gallagher’s Phil Norton, Zurich’s Paul Schiavone, and Advisen’s David Bradford. The session will be moderated by Advisen’s Jim Blinn. In addition to reviewing trends of securities litigation during the third quarter, the panel will discuss appropriate D&O limits.Registration for the webinar can be found here.

 

Vivendi Securities Trial: A Closer Look at the Opening Statements

As noted in a prior post (here), trial in the Vivendi securities class action lawsuit began last week in the Southern District of New York. Thanks to the AmLaw Litigation Daily (here), the transcript of the opening arguments in the case are available here. The opening statements make for some interesting reading in and of themselves, and there are already a number of critical observations that may be made about this case.

 

Background

This case involves the financial impact on the company from the $46 billion December 2000 merger between Vivendi, Seagram’s entertainment businesses, and Canal Plus. The plaintiffs contend 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 defendants in the case include the company, Messier and Hannezo. The plaintiffs contend that the between October 2000 and July 2002, the individual 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.

 

A prior SEC enforcement proceeding against the company and the two former officers resulted, according to the SEC’s December 23, 2002 press release (here), in "Vivendi's consent to pay a $50 million civil money penalty. The settlements also include Messier's agreement to relinquish his claims to a €21 million severance package that he negotiated just before he resigned his positions at Vivendi, and payment of disgorgement and civil penalties by Messier and Hannezo that total over $1 million."

 

The Opening Statements

The lawyers making the opening statements on October 6, 2009 were: for the plaintiff class, Arthur Abbey of the Abbey, Spanier Rodd & Abrams firm; for Vivendi, Paul Saunders of Cravath, Swaine & Moore; for Messier, Micheal Malone of King & Spaulding; and for Hannezo, Martin Perschetz of Schulte, Roth & Zabel. The available transcript covers only the statements on the first day of trial, and does not include Perschutz’s opening argument, which took place the morning of the trial’s second day, so I have not discussed his opening argument below.

 

In his opening statement, Abbey tried to reduce the case to three points:

 

Number one, we are going to show you that Vivendi had growing problems during 2001 and the first half of 2002...and the problems that they had were with a thing called liquidity. Number two, they didn't tell the truth about those problems....And the third thing that we will prove is that in the middle of 2002, the truth about Vivendi's liquidity condition finally came out, and when that happened, unfortunately for my clients, the stock price fell and the investors that we represent suffered great losses. In a nutshell, that is why we are here today--a growing problem, failing to tell the truth, and then, like every lie, it finally comes out.

 

The overall theme of the plaintiffs’ case is that the defendants portrayed the company one way publicly, but another way internally:

 

Publicly, and I can’t stress this enough, defendants portrayed Vivendi as strong, healthy, and growing. They continuously downplayed the risks, the warnings, and they told the investing public how successful Vivendi was and would be in the future. But inside the company, behind the closed doors at Vivendi, the defendants were acknowledging a far different truth.

 

Among other things, Abbey referred to a "book of warnings" Hannezo supposedly compiled for the new CEO after Messier’s departure from Vivendi, which Abbey characterized as a collection of documents showing various forewarnings and admonitions Hannezo had send Messier and others about the company’s growing liquidity risks. Abbey read to the jury one note that Hannezo wrote to Messier at the end of 2001 following a meeting Hannezo had had with the rating agencies, in which Hannezo said "he felt like he was sitting in the death seat of a car that was accelerating in a sharp turn, and he didn't want it to all end in shame." Abbey emphasized that while Hannezo had been communicating these warnings internally, they were not communicated to investors.

 

Abbey also argued in his opening that the company was under pressure to meet EBIDTA goals, and he further argued that the company was only able to report that it had met these goals by using, accounting adjustments (Abbey cited internal Vivendi documents referring to "accounting magic"), particularly "purchase accounting." Abbey told the jury that Vivendi never told investors the significant impact purchase accounting had on Vivendi’s reported results. He argued further that while use of accounting adjustments allowed the company to continue to report that it had met EBIDTA goals, the noncash adjustments did not help the company with its liquidity problems.

 

In support of the plaintiffs’ contentions, Abbey also referred to documents the company had filed in its severance dispute with Messier, in which the company supposedly said that Messier had driven the company "to the brink" yet had failed to disclose the problems to the company’s board.

 

Saunders, on behalf of Vivendi, argued that, contrary to the plaintiffs’ allegations about the company’s supposed liquidity problems, the company always had enough cash and credit to pay its bills, and in fact did pay all of its bills. He also argued that, contrary to the plaintiffs’ arguments that the defendants had misled investors, the company never had to restate its financials, even after new management came in. Saunders also emphasized that within days of his arrival, the new CEO completed a financing of over $1 billion, which, Saunders argued, demonstrated that even at the peak of the supposed crisis the company had sufficient resources (including credit) to pay its bills.

 

Saunders also argued that far from representing anything sinister, the company’s use of "purchase accounting" was only entirely appropriate, it was in fact required as a result of the three-way merger.

 

Saunders conceded that the company did have difficulties during the class period, but largely as a result of the September 11 tragedy and the following decline in economic activity (particularly at the company’s theme park properties). In that regard, he compared Vivendi’s stock price decline to the stock graphs of companies that the plaintiffs’ own expert had said were comparable, and that the stock graphs were virtually indistinguishable.

 

Finally, Saunders explained the two individuals’ departures from the company as a result of disagreements over the strategic steps the company should take in response to the business challenges it was facing, including a dispute between the board and Messier over whether Vivendi should sell its heirloom French water utility business.

 

Malone, arguing on behalf of Messier, contended that the plaintiffs’ case depended entirely on discrete "snippets" take out of context from a wide variety of documents, but that when the statements were put back in context, they show only the ordinary activities of business people struggling to deal with day to day business challenges. Malone emphasized the case is not about whether or not the company had problems or even about whether or not there were errors of judgment, but only about whether or not there had been an intentional effort to mislead investors.

 

Malone also emphasized that when Messier exercised stock options at the end of 2001, he invested all of the proceeds in Vivendi shares, and even took out a bank loan to buy additional shares. Messier also invested his entire April 2002 bonus in Vivendi shares, and indeed, within days of leaving Vivendi, Messier invested even more in Vivendi shares. Malone argued that Messier never sold a share, and that when Vivendi’s share price collapsed, no individual lost more than Messier.

 

Observations

Though the transcript only represents the arguments of counsel and not the actual presentation of evidence, a number of themes clearly emerge.

 

First, this case will be complex and will require the jury to grapple with a host of daunting technical terms and concepts. Just in his opening, Abbey referred to EBIDTA; purchase accounting; debt service; noncash earnings; nonoperational accounting entries; free cash flow; liquidity; and dividends. Saunders referred to negative cash flow; generally accepted accounting principles; and market capitalization. Malone referred to options exercises; hedging and hedging transactions; and tax advantages.

 

It is not that juries are incapable of figuring out these kinds of things. The problem is that these kinds of things put an enormous burden on the lawyers, the witnesses and the court to keep things clear; to avoid letting the trial get bogged down in technical minutiae; and making sure the jury it neither confused nor bored to death.

 

Second, much has been made (for example, here) of the fact that this Vivendi case is so unusual because it is the first "f-cubed" case to go to trial – that is, it involves claims against a foreign-domiciled company by foreign claimants who bought their shares on foreign exchanges. Whatever else might be said about whether or not f-cubed cases ought to be heard in U.S courts, it is clear just from the attorneys’ opening statements that there are serious challenges involved in attempting to put on one of these cases in a U.S. court. All of the lawyers wrestled with problems, for example, involving currency conversions and language translations. Abbey in particular seemed to experience embarrassment and discomfort using French names and phrases. The lawyers also warned that much of the testimony and many of the documents are in French for which the jury would be given English translations.

 

In addition, the opening statements also showed the complications that will arise from differing accounting systems, different account practices and standards, and different accounting conventions.

 

Third, all of the lawyers’ opening statements underscore the problems any plaintiff would face when large unrelated but material events – such as the 9/11 tragedy and the dot-com crash – happened at the same time as the supposed events of which the plaintiffs were complaining. Abbey tried to anticipate these issues and explain the plaintiffs’ theory of how these events should be understood in the context of the plaintiffs’ case. The defense counsel, for their part, showed that the defendants will argue that the challenges the company faced can only be understood within the context of these external events, which are, the defense counsel contend, among the root causes of the company problems involved in the case.

 

The parallel to the challenges facing the plaintiffs in the current round of subprime and credit crisis-related cases is unmistakable. The plaintiffs in these more recent cases will face the same challenge of attempting to explain how company-specific rather than marketplace-wide developments led to the defendant companies’ problems.

 

The final observation from a reading of the transcript is that the trial of a complex matter like a class action securities case is an elaborate, time-consuming, pain-staking exercise that could quickly become mind-numbingly tedious. Just judging from the opening statements, the jury could be in for a very long slog. One can only imagine how the jurors’ hearts sank when they heard Messier’s counsel tell them in his opening statement that "this trial will go on for months."

 

Nor will the verdict of this jury bring an end to this matter. Not only will there likely be further proceedings in this case, but as a result of the court’s class certification ruling in this case excluding Austrian and German investors from the plaintiff class, this case may only be the first of the trials in this matter. As reported in an October 7, 2009 article in the Telegraph (here), the defendants could face a "second trial" brought on behalf of European investors excluded from the plaintiff class in the Southern District of New York. (Hat tip to the 10b-5 Daily, here, for the Telegraph article link).

 

In my earlier post about the Vivendi trial, I noted how rare trials are in securities class action lawsuits. In an October 8, 2009 post (here) on his Enforcement Action blog, Bruce Carton (also the author of the Securities Docket blog), interviewed Adam Savett of the Securities Litigation Watch blog. In the brief interview, hosted on the Enforcement Docket site, Savett reviews statistical data regarding the prior securities cases that have gone to trial, and discusses why trials in these cases are so rare. He also discusses the significance of the presence of the f-cubed claimants.

 

They’re a Page Right Out of Hist-oh-Ree: Even allowing for the fact that The Flintstones show was set in the Stone Age, the program advertisement linked below still seems deeply primitive. Clearly, prehistoric peoples had a longer attention span, as the commercial seems almost movie-length compared to its more modern counterparts.

 

And even allowing for the time lapse since those long ago days, the advertisement’s politically incorrect premise and tobacco-related message seem vestiges of a culture completely unrelated to our own.

 

Finally, the way that Fred and Barney are sneaking around together and hiding from their wives, you do start to wonder whether the final line in the show’s theme song lyrics implied more than might originally have been suggested.

 

Vivendi Securities Suit Goes to Trial

In a rare case in which a securities suit is actually going to trial, on Monday a jury was empanelled in the Vivendi securities class action lawsuit pending in the Southern District of New York. An October 5, 2009 New York Times article summarizing the background of the case can be found here. A more detailed description of the case can be found here.

 

The Vivendi trial is unusual in another respect – it involves the claims of so-called "f-cubed" claimants, as detailed in an October 5, 2009 AmLaw Litigation Daily article by Andrew Longstreth (here). That is, the case involves claims by foreign shareholders of a foreign domiciled company who bought their shares on foreign exchanges.

 

However, because of March 22, 2007 class certification rulings by Southern District of New York Judge Richard Holwell, the class on whose behalf the claims are asserted does not include all potential f-cubed claimants. That is, though the class includes claimants from France, England and the Netherlands, it does not include investors from Austria and Germany.

 

As the AmLaw Litigation Daily article notes, plaintiffs’ lawyers, who are keenly interested in bringing claims in U.S. courts on behalf of foreign investors, will be watching this case closely.

 

As noted in a prior post (here), the question of the extraterritorial application of the U.S. securities laws is a current hot topic that could well wind up before the U.S. Supreme Court this term. In addition, as noted here, subject matter jurisdiction over the claims of f-cubed claimants is one of the issues addressed in financial reform legislation recently introduced in Congress.

 

The Vivendi case is actually the second securities class action lawsuit to go to trial this year. As detailed here, on May 7, 2009, a jury in the Northern District of Illinois entered a mixed verdict in the plaintiffs’ favor in the Household International securities suit.

 

As reported on the Securities Litigation Watch blog (here), only 21 cases (prior to Vivendi) have gone trial since the 1995 enactment of the PSLRA. Only seven of the 21 cases (including the Household International case) that have gone to a verdict involved conduct that occurred after the PSLRA was enacted. Accounting for post trial motions and appeals (and post-appeal trials), with respect to the seven cases, the current scoreboard standings show three wins for the plaintiffs and four for the defendants.

 

Credit Suisse Subprime Suit DIsmissed on Jurisdictional Grounds: In a topically related development that also took place in the Southern District of New York yesterday, on October 5, 2009, Judge Victor Marrero released his opinion (here) explaining his prior September 28, 2009 dismissal, on the grounds of lack of subject matter jurisdiction,  of the subpime securities class action lawsuit that had been filed against Credit Suisse and certain of its directors and officers.

 

As described in greater detail here, the plaintiffs had alleged that the defendants misrepresented the company's financial condition by failing to disclose schemes to overstate assets, underestimate risk, hide subprime exposure, and ignore weaknesses in risk management and internal controls. The risk management and internal control allegations referred to the criminal prosecution of two former U.S.-based Credit Suisse employees, Julian Tzolov and Eric Butler, in connection with their sale of securities to customers of the bank, about which refer here.

 

In considering the sufficiency of the court's subject matter jurisdiction over the case, Judge Marrero divided the question between the claims of foreign-domiciled claimants who bought their shares in the foreign-domiciled claimants on a foreign exchange (the "f-cubed" claimants) and the claims of claimants who had bought ADRs on the NYSE. Approximately 4.1% of investors had bought their investment through ADRs on the NYSE.

 

Judge Marrero concluded that the court did not have jurisdiction over the f-cubed claimants,  observing that the plaintiffs "have not adequately alleged or otherwise demonstrated that hte fraudulent schemes...were concocted or masterminded in the United States." He found further that the allegedly misleading statements had originated abroad, and the wrongful acts alleged in the United States (even the alleged criminal misconduct of the two former Credit Suisse employees) fail to satisfy the conduct test for the exercise of jurisdiction over the claims of foreign claimants.

 

Judge Marrero also held that the court lacked subject matter jurisdiction over the claims of investors who bought ADRs on the NYSE, holding that he could not conclude that the plaintiffs "have demonstrated the required effects on United States investors." This latter result appears largely to be due to "lack of information" and "lack of briefing" on the plaintiffs' part. (Among other things, the amended complaint neglects to specify the domicile of the proposed lead plaintiffs who had bought ADRs on the NYSE.)

 

Judge Marrero allowed the plaintiffs 20 days to file a motion in which to attempt to show why allowing the plaintiffs to amend their complaint would not be futile.

 

The contrast between the events yesterday in the Southern District of New York courthouse involving these two cases could not be more stark. On the one hand, a jury is being empanelled with respect to the claims of the f-cubed claimants in the Vivendi case, which appears likely to head to a verdict. Yet in the same courthouse, Judge Marrero issued an opinion in whch he concluded that the court lacked subject matter over the claims of the f-cubed claimants. To be sure, this stark difference between the way the two cases have fared in the courthouse may simply be a reflection of underlying differences between the cases. Nevertheless, the contrast is stark.

 

Special thanks to a loyal reader for providing a copy of the October 5 opinion.

 

 

 

Congressional Overhaul of Financial Regulation Launched, Securities Law Reforms Proposed

One consequence of the current economic crisis that has long seemed inevitable is some form of legislative overhaul of the financial regulatory system. This possibility may have taken one step toward realization with the October 1 release of a package of legislative proposals by Pennsylvania Democratic Congressman Paul E. Kanjorski, the Chairman of the House Financial Services Subcommittee on Capital Markets, Insurnace and Government Sponsored Enterprises.

 

In his October 1, 2009 press release (here), Kanjorski released "discussion drafts" of three pieces of proposed legislation that, in the words of the press release, are "aimed at tracking key parts of reforming the regulatory structure of the U.S. financial services industry. The three bills include the Investor Protection Act (here), the Private Fund Investment Advisors Registration Act (here), and the Federal Insurance Office Act (here).

 

Most of the media coverage of these initiatives has focused on the second of these three proposals, the Private Fund Investment Advisors Act, as reflected for example in an October 2, 2009 New York Times article (here) about Kanjorski’s proposals. This proposed Act would for the first time require many financial providers, such as hedge funds and private equity funds, to register with the SEC. The proposed provisions specify recordkeeping and disclosure requirements and provide regulators with the authority to, as the press release states, "examine the records of these previously secretive investment advisors."

 

The Federal Insurance Office Act, as its name suggests, would create a national office of insurance. It does not appear that the proposed legislation would supplant state regulator of insurance or even provide for the so-called dual option that has been discussed for some time and which would allow insurers to choose whether to be regulated at the state or federal level, as banks do now.

 

The creation of a Federal Insurance Office would be intended to remedy a perceived "lack of expertise within the federal government" regarding the insurance industry. The new Insurance Office would "provide national policymakers with access to information" in order to allow them to respond to crises and to ensure a "well functioning financial system."

 

Though it has received less attention, the third piece of proposed legislation, the Investor Protection Act, also contains some potentially significant provisions, including some proposed revisions to the federal securities laws.

 

The Investor Protection Act contains a number of proposed legislative changed designed to strengthen the SEC and boost investor protection. Among other things, the Act would, according to the press release, double the SEC’s funding over five years and provide "dozens of new enforcement powers and regulatory authorities."

 

The Investor Protection Act also introduces a number of proposed innovations, including a proposed whistleblower "bounty" that is intended to "create incentives to identify wrongdoing in our securities market." These provisions allow for bounties of up to 30 percent of monetary sanctions imposed on wrongdoers to be paid to whistleblowers, and also provide protection for whistleblowers from retaliation. The proposed Act also includes a number of provisions designed to facilitate collaboration between the SEC and foreign securities regulators. Broc Romanek outlines a number of the other provisions of the proposed Act on his CorporateCounsel.net blog (here).

 

Among the changes proposed in the Investor Protection Act are the jurisdiction provisions proposed in Section 215 of the Act, relating to "Extraterritorial Jurisdiction."

 

It has long been noted that federal securities laws are silent about their extraterritorial reach. The courts have long struggled with jurisdictional issues in securities cases involving foreign-domiciled companies – as, for example, was extensively reviewed by the second circuit in its 2008 decision to Morrison v. National Australia Bank (about which refer here) and by the 11th Circuit in its recent decision in the CP Ships case (refer here).

 

Section 215 of the proposed Act would in effect legislatively mandate a jurisdictional standard for extraterritoriality. The jurisdictional reach proposed in the statute is very broad. By way of contrast, the defendants and amici in the Morrison case had urged the court to adopt a "bright line" test that would have held that mere conduct in the U.S. alone should not be enough for U.S. courts to exercise subject matter jurisdiction when the conduct had no effects in the U.S.

 

In its opinion in the Morrison case, the Second Circuit had rejected this proposed bright line test, holding that subject matter jurisdiction exists "if activities in this country were more than merely preparatory to a fraud and culpable acts or omissions occurring here directly caused the losses abroad."

 

Section 215 would amend the ’33 Act, the ’34 Act and the Investment Advisors Act of 1940 to specify that U.S. courts could properly exercise jurisdiction in any action involving "conduct with the United States that constitutes significant steps in furtherance of violation, even if the securities transaction occurs outside the United States and involves only foreign investors," as well "conduct outside the United States that has a foreseeable substantial effect in the United States." Under the first of these two prongs, U.S. based conduct alone would be sufficient jurisdictional basis, even with respect to foreign purchasers of who purchased their shares of foreign-domiciled companies on foreign exchanges (so-called "f-cubed claimants").

 

This proposal may represent a legislative effort to head off the Supreme Court, which is currently considering whether to grant certiorari in the Morrison case. Of course, it remains to be seen whether or not this jurisdictional provision will survive the legislative process, or even whether regulator reform legislation in any form remotely resembling the proposal Congressman Kanjorski has put forward.

 

According to the Times, the House Financial Services Committee has scheduled an October 6, 2009 hearing to discuss this issue of hedge fund regulation, among other issues. Though there is a glut of items on the current Congressional agenda, reform of financial regulation in some form seems likely in the current political and economic environment. What will emerge of course will only be revealed in the fullness of time, but Congressman Kanjorski’s opening salvo suggest that the process could be interesting and that the final outcome could included significant innovations and alterations on a wide variety of topics.

 

Special thanks to a loyal reader for sending along links to Congressman Kanjorski’s press release.

 

PLUS Chapter Event: On Wednesday, October 7, 2009, I will be moderating a panel at a Professional Liability Underwriting Society Midwest Chapter event at the Hyatt Hotel in Cincinnati, Ohio. The title of the panel is "Bankruptcy and Barriers to Coverage." The panel, which will go from 3 pm to 5 pm, followed by a reception, will include several of the leading D&O coverage experts. Registration information is available here.

 

Securities Suit Filings Rebound in Third Quarter

After a brief lull during the second quarter, securities class action lawsuit filings during the third quarter were closer to historical norms, although the filings levels did drop again during September.

 

By my count, there were 49 new securities class action lawsuits during the third quarter. For reasons discussed below, my count could vary significantly from third quarter tallies that others may publish. But the 49 third quarter filings brings the year to date total through September 30, 2009 to which brings the year to date total of new securities class action lawsuit filings to 143.

 

The annualized equivalent of the filings for the first nine months of 2009 projects to a twelve-month filing rate of 191, which is slightly below but still well within range of the average of 197.7 annual filings during the 13-year period between 1996 and 2008.

 

After a decline in filings during April and May at the end of the second quarter, when there were monthly filing totals of 11 and six respectively, there were 20 new securities lawsuit filings in June. But the number dropped to 17 in July and only 12 in September. Clearly, the filing activity levels have fluctuated month to month so far during 2009.

 

There may be any number of reasons for this fluctuation, but I continue to believe that the fluctuations are largely due to the fact that the plaintiffs’ lawyers are jammed up with the mass of lawsuits they filed over the last three years. As I have detailed at length elsewhere (here), many of the third quarter filings have proposed class period cutoffs well in the past, in some cases more than a year in the past. These filings may suggest that the plaintiffs’ lawyers have been so preoccupied with the other cases and with the Madoff lawsuits that they developed a backlog, which they are now getting around to working off.

 

The filings during the third quarter were not nearly so concentrated in the financial sector as during the first half of the year. In the first six months of 2009, about two thirds of the target defendant companies were in the financial sector. However, in the third quarter, only 12 of the 49 new securities lawsuit involved companies with Standard Industrial Classification Codes in the 6000 series (Finance, Insurance and Real Estate). There were also nine new securities class actions involving firms without SIC codes, most of which were financially related companies.

 

Even if all nine of those companies lacking SIC Codes are counted as financial, that still makes only 21 out of the 48 third court suits in the financial sector. Thus less than half of the third quarter filings were against companies in the financial sector, as compared to over two-thirds in the first half of the year.

 

One contributing factor in the relative decline in the number of new securities suits against financial companies may be the declining number of new lawsuits relating to the subprime meltdown and credit crisis. Thus, while there have been nearly 200 securities lawsuits filed since February 2007 related to the subprime and credit crisis litigation wave, including as many as 58 total in 2009, only about seven of subprime and credit crisis related cases were filed in the third quarter (depending on how you count).

 

As I noted in my recent interim update of the subprime and credit crisis related litigation (here), this apparent decline in the cases related to these phenomena may be due to the changing financial circumstances. What started several years ago with the subprime meltdown has evolved into a global financial crisis, affecting all companies across the entire economy. As a result of these developments, it has become increasingly difficult to define precisely what constitutes a subprime and credit crisis-related lawsuit. It may not be so much that the subprime and credit crisis litigation wave has crested as it is that the wave has merged into a larger tidal movement and is no longer its own separately identifiable phenomenon.

 

The high incidence of lawsuits involving companies without SIC Codes is a reflection of the number of new cases involving unusual lawsuit targets. There were, for example, several filings during the third quarter involving ETF Funds (refer here, here and here, for example). There were also new lawsuits filed involving closed end investment funds (refer here) and mortgage trusts (refer here and here). These actions are a continuation of the filing activity we have seen for several quarters, as a wide variety of complex financial firms and investment vehicles have been and continue to be drawn into securities litigation.

 

But though the third quarter filings, as was the case with the filings in the first half of the year, involved a number of these unusual targets, many of the companies named in third quarter lawsuits are more representative both of the larger economy and of more traditional securities litigation targets. Overall the companies named as defendants represented over 30 different SIC Code categories. For example, six of the third quarter filings involved life sciences companies in the 2830 SIC Code category and three involved filings against medical device companies in the 3840 SIC Code category.

 

By contrast to the first six months of the year, relatively few of the third quarter filings involved foreign domiciled companies. Thus, while 18 of the first half lawsuits involved foreign companies, only two of the third quarter lawsuits involved foreign companies. Many of the foreign targets in the first half of the year were financial companies, so the relative decline in filings against foreign companies may simply be a reflection of overall reduction in lawsuits against financial firms.

 

The new securities lawsuit filings in the third quarter were not nearly so heavily concentrated in the Southern District of New York as in the first half of the year. Thus, while in the six months of 2009, 45 out of 94 (or nearly half) of the new securities lawsuits were filed in the Southern District, only 12 of the 48 third quarter filings (or only 25%) were initiated in the S.D.N.Y. Again, this relative decline may be a reflection of the reduced number of lawsuits involving financial companies.

 

About Counting: As has been the case in recent quarters, the process of "counting" new securities lawsuits continued to be quite challenging during the third quarter. As has been the case in the past, I have not counted breach of fiduciary duty/merger objection lawsuits. In addition, I have also excluded from my count the "failure to register securities" lawsuits when these suits have been filed in state court (refer for example here), or even if filed in federal court assert only state law claims (refer for example here). In addition, the recurring phenomenon of lawsuit involving nontraditional financial vehicles makes it extremely challenging, given the outward similarity of many of these vehicles and their names, to tell whether or new complaint represents a new or a duplicate lawsuit.

 

These kinds of sorting issues inevitably result in some line drawing and some marginal categorization issues. Reasonable minds clearly could differ on many of these sorting concerns.

 

The bottom line is that my lawsuit count for the third quarter and for the first nine months almost certainly will differ from similar tallies that other may publish – indeed, for the same reason, the various other tallies will also likely disagree with each other as well. Certainly, anyone trying to come up with their own count that were to include, for example, merger objection suits or failure to register claims, would reach a substantially different number than the one I came up with.

 

I emphasize these counting issues, as I have in the past, as a way to try to explain the differences that may appear in the various published accounts. No one should be surprised by the differences, although consumers of the counting data have every right to know what has been included and excluded from any given count in order to understand how and why the count differs from other published versions.

 

Up Next: Securities Suits Against Municipalities?

Among the many firms and entitles struggling with the effect of the global economic downturn are a host of municipalities, many of whom face diminished tax revenues, unfunded pension and health care liabilities and aging infrastructure. A number of these municipalities also labor under a burden of debt undertaken when times were flush. Financial woes have already forced credit rating downgrades on some issuers’ bonds and others are flirting with default. Among other things, these kinds of problems can lead to securities litigation, and recent developments in one securities suit involving a municipality raise the question whether there could be more suits to come.

 

Municipalities traditionally have various levels of exemptions from securities registration and reporting requirements, although these exemptions have evolved over time (about which refer here). But municipalities have always been subject to the antifraud provisions of the securities laws. Over the years the SEC has pursued a number of high profile enforcement actions in connection with municipal bond offerings. A lengthy list of the SEC’s enforcement actions against municipalities between 2003 and 2008 can be found here, including actions against issuers, public officials, and offering underwriters. Earlier cases can be found here and here.

 

Perhaps the most high-profile SEC enforcement action in recent months involving a municipality is the securities fraud complaint filed against five former San Diego city officials. As described in the SEC’s April 7, 2008 press release (here), the SEC alleged that the five officials, who allegedly played key roles in connection with inadequate municipal securities disclosures in 2002 and 2003, had "failed to disclose to the investing public buying the city’s municipal bonds that there were funding problems with its pension and health care obligations and these liabilities had placed the city in serious financial jeopardy."

 

As reflected in the SEC’s San Diego complaint (here), the five officials were the former City Manager, the former City Treasurer, the former City Auditor and Controller, the former Deputy City Manager, and the former Assistant Auditor and Controller. The complaint sought to enjoin the officials from further violations and to require the officials to pay a civil penalty.

 

The SEC’s actions clearly are designed to enforce the securities laws and to vindicate the principles they represent. However, the SEC’s actions in and of themselves will do little directly for the investors who were harmed by the alleged misrepresentations.

 

To be sure, investors are not precluded from initiating their own action to seek damages to redress their injuries. In at least one recent action involving the city of Alameda, California and related municipal entities, investors have filed a civil action seeking to recover damages for alleged violations of the securities laws.

 

As reflected in its Amended Complaint in the Alameda case (here), the plaintiff alleges that earlier in this decade with the City of Alameda issued certain municipal revenue anticipation notes, it knew the funding mechanism was never going to achieve the results needed, because the funding mechanism "was not economically feasible" for multiple reasons, "all of which were known to the City." The project was "not risky, but rather a surefire loser." The complaint is not filed as a class action, but a separate counterclaim brought by the Nuveen fund family raising substantially the same allegations against the City has also been filed in the same district.

 

The plaintiff in the Alameda case alleges violations of both the federal and California securities laws. The municipal defendants filed a motion to dismiss the California state securities law claims, based on statutory sovereign immunity.

 

In an August 11, 2009 order (here), Judge Susan Illston held that the statutory immunity provisions were not intended to provide local governments with immunity from securities fraud, and that the state securities law claims against the municipal entities may proceed.

 

As noted in a September 24, 2009 Daily Journal article entitled "The Newest Securities Litigators?" (here, subscription required), by Richard Gallagher of the Orrick, Harrington & Sutcliffe law firm, Judge Illston’s ruling is "a matter of first impression" under California law. As Gallagher further observes, Judge Illston’s ruling in the Alameda case is only one of several recent developments, including current SEC initiatives to provide greater regulatory oversight, that could further subject municipalities to litigation alleging securities law violations.

 

These developments, Gallagher comments, could not come at a worse time for municipalities, since many cities and counties around the country are dealing with record budget deficits and other financial difficulties. These public entities are in many instances struggling to meet debt obligations and are contending with problems arising from credit downgrades and even defaults.

 

These financial woes are producing significant bondholder losses, which could in turn lead to investor lawsuits like those filed against Alameda. Indeed, rulings such as that entered by Judge Illston, in which she held that municipal entities lacked statutory immunity from state securities laws claims, might embolden disappointed investors to pursue these kinds of claims.

 

The problem is that the financially troubled public entities can ill afford expensive, high-stakes securities litigation. Even if, as Gallagher notes, the municipalities would have substantial defenses for these kinds of claims, the defense costs alone could be staggering for financially strapped municipalities.

 

Readers of this blog may well wonder whether there are insurance products that could protect municipalities from these kinds of risks. Certainly, Public Official Liability Insurance includes liability protection not only for individual public officials but also for the public entities themselves. But many of these policies include an express exclusion precluding coverage for claims arising out of any debt financing. There may well be public entities that have procured insurance designed to provide protection for these kinds of claims, but the typical municipality has not, even if it otherwise purchases public official liability insurance.

 

The poor financial condition of defaulting public entities and the absence of insurance among other concerns do raise the question of what the investor plaintiffs’ litigation objectives may be – the beleaguered taxpayers of the troubled municipality hardly qualify as an attractive target, whatever wrongs the investors may allege.

 

Perhaps the motivation of investor plaintiffs in these kinds of cases may be understood from the lineup of the defendants in the Alameda case. The defendants named in that case include not only the various municipal entities, but also the offering underwriters that sponsored the city’s note offering, authored the offering documents, and sold the notes to the public.

 

The plaintiff’s complaint in the Alameda case alleges that the offering underwriter knew, "as the City did, that the project was not economically feasible," or in the alternative, that the underwriter "failed utterly in its duty to undertake due diligence to unearth the City’s misrepresentations and omissions of material fact." The plaintiff purchased $8.5 million of the city’s notes from the offering underwriter, which the plaintiff further alleged has been "an Advisor in which the Plaintiff reposed trust and confidence."

 

Thus, while Judge Illston’s ruling that municipalities lack statutory immunity from state securities law claims may be significant, the municipal defendants in the Alameda case may or may not even be the central targets.

 

Other aggrieved municipal bond investors may also seek to pursue similar claims against the outside professionals that advised the issuer municipalities. These gatekeeper kinds of claims could face substantial hurdles of their own, including with respect to the federal securities claims the U.S. Supreme Court’s 2008 ruling in the Stoneridge case that there is no private right of action for scheme liability or aiding and abetting under the federal securities laws.

 

These hurdles and the disincentives to pursuing financial trouble municipalities could discourage some prospective litigants from pursuing these kinds of claims. Nevertheless, the prospect of further municipal bond defaults and developments such as Judge Illston’s ruling in the Alameda case could encourage some claimants to proceed.

 

There may, in fact, be specific reasons why municipalities may be particularly vulnerable to securities suits, notwithstanding all of the contrary considerations noted above. That is, as Gallagher notes in his article, "municipal issuers may lack procedures for achieving consistent disclosure goals, leaving them vulnerable to securities suits." The provision of "incomplete financial information regarding the issuer’s financial affairs" could "present some serious litigation risks."

 

As Gallagher concludes, municipalities could find themselves for the first time in coming years defending themselves from securities fraud claims, particularly with respect to state law-based allegations.

 

Very special thanks to Richard Gallagher for providing a copy of his article and a copy of Judge Illston’s opinion.

 

Specter's "Aiding and Abetting" Bill: Why it Could Pass and Why it Matters

In January 2008, the U.S. Supreme Court in the Stoneridge case followed its prior decision in Central Bank of Denver and held that there is no private right of action for "scheme liability" or aiding and abetting under the federal securities laws, ruling that Congress had reserved to the SEC the right to enforce aiding and abetting liability.

 

But what Congress has decreed, Congress can also change, and change is what Senator Arlen Specter proposed on July 30, 2009 when he introduced Senate Bill 1551, "The Liability for Aiding and Abetting Securities Violations Act of 2009." If enacted, the bill would, in effect, legislatively overturn Stoneridge by amending the securities laws to allow private litigation against a person that provides "substantial assistance" in a violation of the securities laws.

 

On September 17, 2009, the bill had its first committee hearing at a session of the Subcommittee on Crime and Drugs of the United States Senate Committee on the Judiciary. A link to the Subcommittee proceedings site for the session, including links to the written witness testimony, can be found here. A September 18, 2009 memorandum (here) by Leslie Platt and Kimberly Melvin of the Wiley Rein law firm provides an excellent and detailed summary of the Subcommittee’s proceedings. (Thanks to Kim Melvin for providing a copy of the memorandum.)

 

Of particular interest among the witnesses’ written statements is the testimony of University of Michigan Law Professor Adam Pritchard opposing the bill (here), and the testimony of Columbia Law Professor John Coffee supporting the bill (here), subject to certain suggested amendments.

 

Professor Coffee suggests that "it is anomalous that one could be criminally liable of aiding and abetting by not civilly liable for the same conduct in a private suit." He also argues that allowing private suits for aiding and abetting would be "the most realistic means to prevent misconduct," because it would "deter those who have less to gain" from fraudulent misconduct, who also have "the ability to block the transaction."

 

Professor Pritchard by contrast argues that the bill would "tear down the safeguards" instituted in Central Bank and Stoneridge, "creating the potential for the securities laws to be injected in a wide range of ordinary commercial transactions." Enacting the bill would also, Professor Pritchard contends "undermine the United States’s international competitiveness and raise the cost of capital." The goal of the bill, he contends, is simply "to rope in more ‘deep pocket’ defendants to feed the plaintiff’s bar’s lucrative class action machine." The written testimony of Robert J. Giuffra, Jr., a partner at the Sullivan Cromwell law firm, is very much in the same vein as Pritchard’s.

 

In the Wiley Rein memo linked above, the authors advise that the bill will next likely be marked up for presentation to the full Senate. The current legislative calendar is remarkably full, and therefore the bill may not be considered before the end of 2009 – but, the authors note, "the 111th Congress does not end until 2010." The bill could also be "incorporated into a larger finance, banking or securities-related bill."

 

Could the Bill Pass?

Two years ago, a bill of this type would have stood little chance. The dynamic at the time was against further regulatory constraints and in favor of markets and the kind of "light touch" prevailing in the U.K. But the events of the past two years, both political and economic, have changed all that and the changed circumstances may substantially increase the likelihood of the bill’s passage. The sweeping Democratic victory in the 2008 elections and current popular need to assign blame for the global economic crisis will likely increase the collective willingness of Congress to remove barriers to the imposition of liability.

 

But separate and apart from these considerations that might suggest a Congressional inclination in favor of the bill, there are a variety of other factors that might further increase the possibility that the bill could pass.

 

First, the courts have presented Congress with an engraved invitation to implement these changes. The most prominent example of this is the March 17, 2009 opinion (here) by then-Southern District of New York Judge Gerald Lynch in the Refco case. (On September 17, 2009, the Senate confirmed Judge Lynch’s nomination to the Second Circuit.) In the opinion, Judge Lynch dismissed the securities claims filed against a lawyer that had advised the client later criminally convicted of securities fraud.

 

Judge Lynch commented that "it is perhaps dismaying that participants in a fraudulent scheme who may even have committed criminal acts are not answerable to the victims of the fraud." Judge Lynch stated that the Congressional decision to leave the enforcement of aiding and abetting liability solely to the SEC "may be ripe for re-examination." He noted that "while the impulse to protect professionals and other marginal actors who may too easily be drawn into securities litigation may well be sound, a bright line between principles and accomplices may not be approximate."

 

The sentiment expressed in the opinion of a judge as respected as Judge Lynch could provide intellectual cover, and perhaps even policy justification, for Congress to take steps to which it is likely already inclined.

 

Second, as a result of its fumbled opportunities to investigate Bernard Madoff and other developments, the SEC’s regulatory credentials are held in particularly low regard right now, which underscores the concern with leaving aiding and abetting enforcement exclusively with the SEC.

 

As Professor Coffee noted in his written testimony, "does anyone really believe today, in this post-Madoff world, that the SEC, by itself, can adequately deter most secondary participants in securities frauds?" He added that the SEC is "cost constrained, has limited personnel and a large backload of cases," noting that the SEC "sometimes missed for years frauds (such as Madoff and Stanford Ponzi schemes) that others had begun to suspect."

 

Third, in the wake of the global financial crisis, there is particularly strong public sentiment in favor of holding gatekeepers accountable. The gatekeepers most frequently cited are the rating agencies, but other gatekeeper scapegoats include auditors, lawyers and offering underwriters. Riding alongside this general public outrage is a parallel public perception that the SEC has so far at least has done relatively little in the wake of the subprime meltdown and global financial crisis to target and pursue wrongdoers, a perception that puts further stress on the SEC’s exclusive right to pursue aiding and abetting liability claims.

 

A final consideration that could increase the likelihood of the bill’s passage is a bill amendment Professor Coffee has proposed. He suggests placing a ceiling on liability for secondary defendants of $2 million for individuals and $50 million for corporations, subject to the further provision that the award should not in any event exceed the greater of ten percent of the defendant’s average income; net worth; or market capitalization. Professor Coffee’s proposed ceiling, if adopted, could further advance the likelihood of the bill’s passage.

 

What Happens if the Bill Passes?

Of course, it remains to be seen if the bill will in fact pass. Congress is extraordinarily preoccupied right now, and the bill’s opponents, who are legion, will be well-organized and active. The bill could yet wind up on the dust heap of failed legislative initiatives.

 

But what happens if it does pass? Well, at a minimum, the roster of defendants in securities class action lawsuits will be greatly expanded, and public companies’ outside professional advisors increasingly will find themselves named as co-defendants in securities suits along with their client companies. The likely costs of defense alone for these gatekeeper defendants will be enormous, which in turn will create significant pressure for these gatekeeper defendants to settle, at least for cases surviving initial dismissal motions. In short, if the bill passes, look for the cost of professional liability insurance to escalate. (Indeed, Coffee cited concerns about the availability of professional liability insurance as one reason to justify the adoption of a secondary liability ceiling.)

 

That said, plaintiffs seeking to pursue claims against the gatekeepers would still have to satisfy the PSLRA’s requirement that the complaint plead "with particularity facts giving rise to a strong inference that the defendant acted with the requisite state of mind." This hurdle is hard enough for plaintiffs to satisfy with respect to primary actors; it will be that much more challenging in connection with allegations against secondary actors. Moreover, the PSLRA’s proportionate liability provisions at least theoretically should reduce the liability that would be imposed on less culpable defendants.

 

But while the potential exposure the bill might pose for gatekeepers is an interesting question, it is not the only question the bill’s passage would present. The potential liability of other companies and their directors and officers for aiding and abetting claims is a related and equally serious question that the bill’s passage would present.

 

In that regard, it is important to keep in mind that aiding and abetting defendants in the Stoneridge case were not Charter Communications’ outside professionals. Rather, the defendants against whom the plaintiffs sought to impose secondary liability were Scientific Atlanta and Motorola, who were acting as customers and suppliers that allegedly facilitated a "round trip" revenue scheme so that Charter could hit its revenue targets.

 

My point here is that the potential defendants who could find themselves drawn into securities class action lawsuits on aiding and abetting claims if the bill passes will include not just gatekeepers but also other companies whose business transactions with the alleged primary violator are alleged to have aided and abetted the securities fraud.

 

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.

 

At a minimum, this possibility has significant implications for D&O insurance coverage. In particular, the way in which the term "securities claim" is defined in the D&O insurance policy could become even more important than it is now. Currently, there are two variations in the way the term is defined. Under one formulation, the term is defined solely with reference to violations alleged in connection with the purchase or sale of the insured company’s own securities. In the other formulation, the term is defined with respect to any alleged violation of the securities laws. (To be sure, there are some definitions that incorporate both formulations.)

 

The first formulation potentially might be too narrow to encompass a claim that the insured company aided and abetted a securities law violation by another company. Clearly in anticipation of the possibility that the Specter bill might pass, it is critically important to carefully review the D&O policy’s definition of the term "securities claim" to ensure that it is sufficiently broad to encompass aiding and abetting claims.

 

A more challenging issue may arise with respect to private companies. There is nothing about the kind of vendor wrongdoing alleged in the Stoneridge case that would restrict the possibility of a claim on that basis solely to public companies. These kinds of allegations clearly could also be alleged against private companies as well. But private company D&O insurance policies usually contain some form of securities claim exclusion. These exclusions typically are tied to the public offering of the insured company’s own securities. But in light of the possibility of aiding and abetting claims even against private companies, these private company D&O insurance policy exclusions should be carefully scrutinized to determine how they might affect coverage under the policy in the event of an aiding and abetting claim against the insured private company.

 

A final note about the possibility of private litigant aiding and abetting claims is that, were the bill to be enacted, it could enormously complicate the jobs of professional liability insurance underwriters. The potential liability exposures of both outside professionals and of companies that do business with public companies will be expanded, in ways that traditional underwriting tools may be ill-suited to test and measure. It seems probable that underwriters may attempt to raise rates as the only instrument available to protect insurers from the possibility of expanded aiding and abetting liability exposure.

 

Special thanks to the several loyal readers who have sent me links regarding the Specter bill.

 

And While You're At It, Congress: Stoneridge is not the only Supreme Court decision that Senator Specter has targeted. In addition, on July 22, 2009, Senator Specter introduced Senate Bill 1504 , "Notice Pleading Restoration Act of 2009," the purpose of which is to legislatively overturn the Supreme Court’s decision in the Iqbal case. Iqbal, building on the Court’s previous holding in the Twombley case, held that in order to survive initial motions to dismiss, plaintiffs’ complaints must provide "facial plausibility" for the claims asserted.

 

Unlike his Stoneridge bill, Specter’s Iqbal bill has not yet made it to committee review. According to Tony Mauro’s September 21, 2009 Law.com article (here), civil rights and consumer groups and trial lawyers have been meeting and conferring on ways to advance the legislation or otherwise to try 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."

 

Whether or not these legislative efforts ultimately succeed, it is clear that the plaintiffs’ bar and their allies intend to try to circumvent the effects of a string of defense-friendly Supreme Court rulings. The current Congressional logjam will clearly be a factor in whether or not these bills even make it through the process. The more interesting question is whether the pendulum has swung enough as a result of the current economic crisis that these legislative initiatives will carry the day.

 

More About the Securities Lawsuit Filing Decline the First Half of 2009.

After a year of heightened securities litigation activity during 2008, the number of securities lawsuit filings declined in the first-half of 2009, largely due to a drop in filings during the second quarter. In this latest issue of InSights (here), I take a detailed look at the 2009 securities lawsuit filings and explain the possible reasons for the decline in the number of second quarter filings. The article concludes with a discussion of early third quarter developments and what we expect in the months ahead.

More Subprime Lawsuit Dismissals and Other Web Notes

Finacial Downturn, Not Fraud, Caused Plaintiffs’ Losses: In a ruling that is interesting for what it says about the relevance of the overall economic downturn to the wave of subprime lawsuits, on August 20, 2009, Eastern District of Pennsylvania Judge R. Barclay Surrick, Jr. granted the motion to dismiss the securities fraud lawsuit that Luminent Mortgage Corporate had filed against Merrill Lynch and related entities. A copy of the August 20 opinion in the case, which was filed solely on behalf of the named plaintiffs and not as a class action, can be found here.

 

In August 2005, Luminent had acquired $26 million worth of the most junior tiers of Mortgage Loan Asset-Backed Certificates that were backed by nearly $1 billion of underlying mortgage loans. Merrill and the related defendant entities underwrote, issued and sold the securities. Luminent acquired the securities as part of a complex transaction whereby Merrill had financed Luminent’s purchase and then held the securities as collateral, while Luminent retained the rights to the income stream from the certificates. As the court later noted, Luminent’ purchase of securities from the most junior layers represented a riskier investment, a consideration that clearly affected the court’s analysis.

 

In April 2007, Luminent reviewed a sampling of some of the underlying mortgages and found that several of the mortgages deviated from information about the mortgages Luminent had been given prior to the purchase transaction. Luminent contended that a result of these deviations, which allegedly showed the mortgages to be less secure than had been represented prior to the purchase transaction, the underlying mortgages were experiencing an unexpectedly harsh rate of default and delinquencies.

 

The investment performance on the certificates was so poor that in September 2007, Luminent demanded rescission of its purchase. After the defendants refused to rescind, Luminent filed suit under a variety of legal theories, among other things alleging that the defendants, in violation of the federal securities laws, had misrepresented the composition of the pool of mortgages and had misrepresented their due diligence in scrutinizing and selecting the mortgages. The defendants moved to dismiss.

 

Judge Surrick granted the defendants’ motion on several grounds. First, he held that the complaint did not adequately plead scienter, finding that the plaintiffs had not alleged facts sufficient to show that the discrepancies in the loan sample Luminent reviewed were the result of anything more than negligence. He also found that the plaintiffs’ theory of fraud was inconsistent with the fact that Merrill retained Luminent’s securities as collateral for the purchase loan, as a result of which any purported fraud would have harmed Merrill as well as Luminent.

 

Judge Surrick also granted the defendants’ motion to dismiss on the grounds that the plaintiffs had not adequately pled economic loss or loss causation. With respect to the economic loss issue, Judge Surrick found that Luminent did not hold the securities themselves and did not and could not have sold them at a loss, and he found further that the plaintiffs had failed to allege how their diminished income stream "can be distinguished from the market-wide losses in mortgage-backed securities generally."

 

This latter point, about the indistinguishability of the plaintiffs’ losses from market-wide losses is the most interesting aspect of Judge Surrick’s opinion. In similarly holding that the plaintiffs had not adequately alleged loss causation, Judge Surrick cited Second Circuit case law to the effect that "when the plaintiff’s loss coincides with a marketwide phenomenon causing comparable losses to other investors, the prospect that plaintiffs’ loss was caused by fraud decreases."

 

Though the Second Circuit case from this cited language is drawn is a RICO case, Judge Surrick’s opinion is the second recent decision in which a district court granted a motion to dismiss in a subprime-related securities class action lawsuit on loss causation ground in reliance on this language. As noted here, on August 5, 2009, District of Massachusetts Judge Joseph L. Tauro also granted a motion to dismiss in the subprime-related securities class action lawsuit pending against First Marblehead, citing the identical language from the Second Circuit.

 

In convincing courts to grant their securities lawsuit dismissal motions on loss causation ground in reliance on the language drawn from a RICO case, defendants seem to have hit on a formula that appears to be drawing a sympathetic judicial response – that is, the argument is that if the plaintiffs were harmed at all, it was due only to the global financial crisis, not to the defendants’ alleged misconduct. Given the magnitude of the economic downturn, which was nearly universally unanticipated, this argument could well be extended to many if not most of the subprime and credit crisis-related lawsuits. The extent to which the defendants are able to exploit this argument in other cases remains to be seen, but for now defendants seem to have established a significant formula for dismissal motion success in these cases.

 

Luminent’s directors and officers were themselves a target of a subprime-related securities class action lawsuit. (Luminent itself filed for bankruptcy in September 2008.) As noted in detail here, the Luminent securities lawsuit settled in December 2008 based on defendants’ agreement to pay $8 million.

 

An August 28, 2009 article in the Legal Intelligencer about Judge Surrick’s opinion can be found here.

 

Citigroup Shareholders’ Derivate Lawsuit Dismissed: In an August 25, 2009 order (here) that largely tracks the earlier dismissal of the related Citigroup derivate lawsuit that had been pending on Delaware, Southern District of New York Judge Sidney Stein, applying Delaware law, granted the defendants’ motion to dismiss the consolidated Citigroup derivative lawsuit, holding that "the complaint fails to allege with specificity facts showing that plaintiffs are excused from pre-suit demand."

 

The plaintiffs had filed their complaints, later consolidated, against certain directors and officers of Citigroup, in connection with the billions of dollars Citigroup had lost from its investments in mortgages and mortgage-related securities. The consolidated complaint alleged that the defendants should be liable for allowing Citigroup to invest in subprime mortgages; failing to disclose the extent of Citigroup’s exposure to subprime mortgages; approving a stock repurchase plan despite Citigroup’s subprime exposure; committing securities fraud for failed to adequately disclose the company’s subprime exposure; and engaging in or allowing others to engage in insider trading.

 

The allegations were similar to but not identical to the allegations in the separate Delaware derivate lawsuit. The Delaware action, for example and by contrast to the New York action, also contained a claim for waste based on the severance package awarded former CEO Charles Prince. The New York action, by contrast, contained claims not alleged in the Delaware suit based on securities fraud and insider trading allegations.

 

In concluding that the plaintiffs in the New York action had failed to establish that the pre-suit demand was excused, Judge Stein, applying Delaware law, largely followed (and expressly quoted from) Chancellor Chandler’s prior dismissal ruling in the Delaware case

 

The interesting part about Judge Stein’s opinion is with respect to the claims that were raised in the New York action but not in the Delaware lawsuit, and therefore with respect to which Chancellor Chandler did not rule in his earlier opinion.

 

Specifically, in concluding that the plaintiffs had failed to establish that demand was excused with respect to their derivative claim for securities fraud, among other things, Judge Stein concluded that the plaintiffs had not established that the defendants "face a substantial likelihood of liability of securities fraud." (If the faced such liability, then the plaintiffs’ pre-suit demand would be excused as futile.)

 

Judge Stein found that the plaintiffs’ complaint "fails to allege with specificity which statements plaintiffs contend are fraudulent," and that it does not "allege with specificity why any alleged misstatement is fraudulent." In addition, Judge Stein held, citing Tellabs, that the complaint "does not state with particularity facts giving rise to a strong inference that the defendants acted with the required state of mind."

 

While Judge Stein found that the plaintiffs had failed to show a substantial likelihood of liability for securities fraud, he was careful to note that his ruling related only to the allegations in the consolidated derivative complaint in this case, and not to the securities fraud allegations that may have been raised in other lawsuits involving Citigroup and the same or related circumstances.

 

Judge Stein expressed skepticism that the plaintiffs could cure their pleading defects, and therefore rather than simply allowing the plaintiffs leave to file an amended complaint, he required them to file a motion seeking leave. The plaintiffs’ motions are due September 14, 2009.

 

I have in any event added Judge Stein’s ruling to my register of subprime-related lawsuit dismissal motion grants and denials, which can be accessed here.

 

My prior post discussed the corporate waste allegations in connection with Charles Prince’s severance package in the Citigroup derivative lawsuit in Delaware, which allegations survived the initial motion to dismiss in that case, can be found here.

Plaintiffs Target Stanford Financial’s Outside Counsel: On August 27, 2008, former Stanford Financial investors claiming damages of over $7 billion filed a purported class action lawsuit in the Northern District of Texas against former Stanford Financial outside counsel Thomas Sjoblum and his law firm, Proskauer Rose. A copy of the plaintiffs’ complaint can be found here.

 

In an apparent attempt to circumvent the limitations of the Stoneridge case, the plaintiffs filed their aiding and abetting claims against Sjoblum and his firm under the Texas securities laws rather than under the federal securities laws. The plaintiffs also assert alternative legal theories under Texas law, including civil conspiracy, aiding and abetting civil conspiracy and respondeat superior.

 

Given the revelations of former Stanford CFO James Davis at his August 27, 2009 guilty plea, it may not be surprising that Sjoblum has now gotten drawn into the case. (In an August 27, 2009 post, here, the WSJ.com Law Blog details Davis’s revelations.) Among other things, Davis, in the factual recitations in his plea agreement, suggested that Sjoblum, in concert with Stanford officials, made representations to the SEC that were contrary to information he had been given about the company and its operations, including problematic characterizations of the company’s portfolio.

 

The extent to which the plaintiffs will succeed in imposing gatekeeper responsibility on Sjoblum remains to be seen. The interesting thing to me about the lawsuit is how unusual it is for the lawyers to have gotten dragged into the litigation. There have been very few instances (if any) where lawyers have become targets in the litigation arising out of the various other Ponzi scheme scandals or any of the collapses associated with the subprime meltdown and credit crisis. To my knowledge neither the Madoff scandal nor the subprime litigation wave drawn in gatekeeper claims against the lawyers involved in the underlying transactions, even though gatekeeper claims have been an important part of both related categories of litigation (primarily with respect to auditors, offering underwriters and rating agencies).

 

I have in any event added the lawsuit against Sjoblum to my running register of the Stanford-related lawsuits, which can be accessed here.

 

An August 31, 2009 National Law Journal article about the Sjoblum lawsuit can be found here.

 

Upcoming Directors and Officers Liability Conference: On November 30, 2009 and December 1, 2009, I will be co-Chairing the American Conference Institute’s Fifteenth Annual Advanced Forum on D&O Liability, in New York City. The program features an all-star cast of experts in the field on a wide variety of critical topics in the area. A copy of the agenda and registration information can be found here.

 

More About Extraterritoriality and the U.S. Securities Laws

While we wait to see whether the U.S. Supreme Court will grant the pending petition for a writ of certiorari in connection with the Second Circuit’s recent landmark opinion in the Morrison v, National Australia Bank case, the lower courts must continue to wrestle with questions regarding the extraterritorial application of the U.S. securities laws, particularly with respect to the claims of so-called "f-cubed" or "foreign-cubed claimants" – that is, foreign domiciled investors who bought their shares in foreign companies on foreign exchanges.

 

In an interesting August 13, 2009 decision in the C.P. Ships Ltd. class action securities lawsuit (here), the Eleventh Circuit distinguished the Second Circuit’s holding in Morrison and concluded that in that case the district court had properly exercised jurisdiction over the claims of the f-cubed claimants under the circumstances presented. The decision illustrates how these jurisdictional issues can arise in a surprisingly broad variety of procedural contexts and also shows how the cases continue to raise complex jurisdictional and policy concerns as well.

 

Background

C.P. Ships Ltd. is a Canadian company with its headquarters in the United Kingdom that also conducts "crucial headquarters activities" (that were central to the alleged fraud) in Tampa, Florida. The company’s shares trade on the New York and Toronto Stock Exchanges.

 

In 2004, the company transitioned to a single accounting platform. Later, the company disclosed that the transition had caused it to understate its operational costs. The company’s share price declined and investors initiated lawsuits in the both U.S. and Canadian courts. Background regarding the U.S. action can be found here.

 

On April 5, 2007, the district court dismissed the U.S. securities lawsuit (refer here), and the plaintiffs appealed. While the appeal was pending, the parties agreed to settle for $1.3 million. The settlement class included claims of some foreigners but, the Eleventh Circuit stated, it "specifically excludes the claims of Canadian citizens who purchased CP stock" on the Toronto exchange.

 

A Canadian investor who bought his shares on the NYSE, Allen Germain, objected to the settlement on behalf of Canadian investors who, like himself, bought their shares on the NYSE, as well as on behalf of other foreign investors who purchased their shares on the Toronto exchange. Among other things, Germain asserted that the district court lacked subject matter jurisdiction over these investors’ claims. The district court overruled Germain’s objections and approved the settlement. Germain appealed.

 

The Eleventh Circuit’s Opinion

Even though Germain bought his shares on the NYSE and therefore lacked standing to represent the interests of foreign investors who bought their shares on the Toronto exchange, the Eleventh Circuit addressed the jurisdictional issues of both groups of foreign claimants, "because of our obligation to examine our jurisdiction sua sponte,"noting that there do not in any event appear to be many of the latter group of investors.

 

After observing that the ’34 Act is "silent as to its extraterritorial application," the court reviewed the two jurisdictional tests for transnational securities frauds, the "conduct" test and the "effects" test, the court concluded that the Complaint "alleges ample facts sufficient to establish subject matter jurisdiction under the ‘conduct text’ over unnamed foreign class members who purchased" their shares on the Toronto exchange, and therefore it did not need to address the "effects" test.

 

In arguing that the district court lacked subject matter jurisdiction over the foreign investors’ claims, Germain sought to rely on the Second Circuit’s holding in Morrison, in which the court there had found that because the principal activities supporting the alleged fraud had taken place in Australia, rather than at the company’s Florida-based subsidiary, the district court in that case lacked jurisdiction. Germain argued that the U.S.-based activities alleged in the C.P. Ships case were merely preparatory, and that the alleged misrepresentations appeared in connection with the company’s overseas release of its financial statements that were prepared overseas.

 

The Eleventh Circuit concluded that the Morrison case was "distinguishable," because in Morrison case, "all of the executives bearing responsibility to present accurate information to the investing public, and all the actions in supervising and verifying the information, occurred in Australia."

 

By contrast, in the CP Ships case, where the company’s CEO was based in Tampa, the Eleventh Circuit said "not only did the manipulation and falsification of numbers occur in Florida, the executives with responsibility for ensuring the accuracy of the accounting data operated from Florida." The court also found that the chain of causation in the CP Ships case between the conduct in the U.S. and the alleged fraud "was direct and immediate," by contrast to the Morrison case.

 

Based on its conclusion that the Morrison case was distinguishable due to the difference in factual allegations, the Eleventh Circuit found that the district court properly exercised subject matter jurisdiction. The court further concluded that the district court had properly overruled Germain’s objections to the settlement, and accordingly the Eleventh Circuit affirmed the district court’s approval of the settlement.

 

Discussion

Even though the Second Circuit held there was no subject matter jurisdiction in the Morrison case itself, its holding (and in particular its rejection of the "bright line" test urged by some parties and amici) expressly recognized the possibility that under certain circumstances it would be appropriate for U.S. courts to exercise subject matter jurisdiction over the claims of "f-cubed" claimants. The CP Ships case provides an example where a court concluded that such a jurisdictional exercise is held to be appropriate.

 

The implication of these cases is that these jurisdictional issues are very fact dependent and must be decided on a case by case basis. By the same token, the Eleventh Circuit’s careful analysis of the difference in the allegations between the CP Ships case and the Morrison case in effect provides a road map for plaintiffs seeking to establish U.S. court jurisdiction for the claims of f-cubed claimants.

 

This analysis is all very pragmatic and measured, but still it arguably disregards the larger policy question of whether or to what extent U.S. courts should be implementing what is in effect the extraterritorial application of U.S. securities laws. It is worth reflecting that in addition to the U.S. court action involving CP Ships, a separate action involving the same issues was pending in Canadian courts. The Eleventh Circuit’s decision says remarkably little about the significance of this parallel proceeding and how its existence ought to affect the U.S. court’s exercise of jurisdiction over the claims of foreign claimants.

 

These questions about the extraterritorial application of U.S. securities laws matter, because, as analyses of the 2008 securities class action lawsuit filings all show (refer for example, here), foreign-domiciled companies increasingly are the targets of U.S. securities class action lawsuits.

 

Moreover, while most of these cases involve companies whose shares trade on U.S. securities exchanges, some do not. For example, EADS, whose shares do not trade on the U.S. exchanges, is the target of a U.S. securities lawsuit (about which refer here)

 

Indeed concerns about these extraterritoriality issues clearly have influenced at least some courts to decline to exercise jurisdiction over the claims of foreign domiciled investors (refer for example here, with regard to the case involving AstraZeneca).

 

Perhaps if the U.S. Supreme Court grants the writ of certiorari in the Morrison case, these larger policy concerns will be addressed.

 

But in the meantime the Eleventh Circuit’s opinion in the CP Ships case demonstrates that even after the Second Circuit’s ruling in Morrison, there are circumstances where courts will conclude that their exercise of subject matter jurisdiction – even with respect to the claims of f-cubed claimants – is appropriate.

 

This possibility creates an obvious liability concern for potentially affected companies outside the U.S. It also presents a challenge for D&O underwriters, who must factor into their risk analysis of companies outside the U.S. the possibility of those companies facing securities liability exposure under the U.S. securities laws. And as the EADS case shows, this exposure may not even be limited to companies whose shares trade on the U.S. securities exchanges – the exposure potentially could extend even to companies whose shares trade only on exchanges outside the U.S.

 

One thing that is clear is that in an increasingly global economy, the question of the cross-border application of domestic securities laws is a serious and growing concern.

 

The "Ultimate Solution" to Securities Fraud?: According to an August 6, 2009 Associated Press article entitled "China Executes Two for Defrauding Investors" (here), China executed two business people for defrauding hundreds of investors out of about $127 million, calling the scam "a serious blow to social stability."

 

The article reports that Du Yimin, a beauty parlor owner, collected more than $102.5 million from hundreds of investors promising them monthly returns up to ten percent, from investments in beauty parlors, real estate and mining businesses. She spent most of the money on houses, cars and luxury items. The second defendant collected $24 million from 300 investors in a separate scam by saying they could received interest up to 108 percent.

 

Bernard Madoff’s 150-year prison sentence looks positively restrained by comparison.

 

Special thanks to a loyal reader for the link to the AP story.

 

Recent Filings Confirm Securities Lawsuit Trends

I hate to sound like a broken record a broken record, but as the third quarter securities lawsuit filings continue to come in, certain definite trends are clearly emerging. As I previously noted (here), the most recent filings are characterized by a high number of new lawsuits against companies outside the financial sector and by proposed class period cutoff dates in the distant past. Last week’s new filings reflect these previously noted trends, which I think both explain the second quarter filing "lull" and suggest what we might expect for the balance of the year.

 

The following table shows the filing date for four of the new class action securities lawsuits filed last week (each of the company names in the table below is hyperlinked to a web page providing further information about the respective lawsuit):

 

 

 

Recently Filed Securities Class Action Lawsuits

Company Filing Date Class Period End Date
Flotek Industries 8/10/09 1/23/08
Align Technlogy 8/11/09 10/24/07
MIND C.T.I., Ltd. 8/13/09 2/27/08
Sturm, Roger & Company 8/13/09 10/29/07

 

 

As shown in the table, each of these new lawsuits has been filed against companies outside the financial sector and each of them has a proposed class period cutoff date well over a year and a half ago.

 

These latest filings, taken together with the filings noted in my prior post on this topic (here), represent growing data supporting my theory that during the run-up in securities lawsuits against financial companies in connection with the subprime and credit crisis litigation wave, the plaintiffs’ lawyer accumulated a backlog of cases against companies outside the financial sector, and they are now starting to work off that backlog.

 

Indeed, even with respect to recent filings that have a more recent proposed class period cutoff date, the filings are largely with respect to companies outside the financial sector, as reflected in the new lawsuit recently filed, for example, against Huron Consulting (refer here); Repros Technology (here); Textron (here); and Allscripts-Misys Healthcare Solutions (here).

 

All of which leads me to a number of conclusions: the filing "lull" noted in the second quarter is over; part of the reason for the lull was that plaintiffs’ lawyers hit a logjam because of credit crisis and Madoff-related litigation activity, as a result of which they accumulated a backlog of cases against companies outside the financial sector, that they are now starting to work off; and as a result we are seeing a rush of new lawsuits against companies outside the financial sector.

 

Furthermore, I strongly suspect that this observed third quarter trend of new lawsuit filings against companies outside the financial sector will continue for the balance of the year, and many of these new lawsuits will be characterized by proposed cut-off dates approaching the two-year period of the statute of limitations. Notwithstanding the second quarter filing lull, by year end the annual rate of new filings for 2009 will be consistent with, if not slightly above historical norms.

 

In support of this final point about likely year end filing levels, I note not only the conjectured lawsuit backlog discussed above, but also the recent heightened level of SEC enforcement activity and the marketwide run-up in share prices since March, which could position some individual companies for the kind of sudden and conspicuous share price decline that attracts the unwanted attention of the securities class action plaintiffs’ attorneys.

 

Another Trend Noted: The lawsuit noted above that was filed last week against MIND C.T.I. Ltd. also represents another securities lawsuit filing trend I have described previously (refer for example here) – that is, the investor lawsuit regarding a company’s balance sheet exposure to auction rate securities.

 

The typical ARS-related lawsuit is brought by an ARS purchaser against the firm that created or sold the security. However, in contrast to this more typical ARS lawsuit, the suit filed against MIND alleges that the company misrepresented or failed to fully disclose the company’s balance sheet exposure to ARS investments. That is, rather than suing the ARS seller, the type of suit filed against MIND is brought against the ARS buyer.

 

As I noted in my most recent post (here) about auction rate securities litigation, numerous public companies continue to face surprisingly large balance sheet exposures to ARS, and some of them may be potentially vulnerable to this type of investor over the companies’ ARS-related disclosures.

 

It is interesting to note that MIND’s auction rate securities investments included investments in the infamous Mantoloking CDO, about which I previously wrote here. As I noted in my prior post, this single CDO has spawned an enormous amount of litigation, including even (as I noted in the prior post) a FINRA arbitration initiated by MIND against the creators and sellers of the Mantoloking CDO.

 

Insolent Sprat: When I told my then 15-year old son that he sounded like a broken record, he said "What does a broken record sound like?"

 

Recent Securities Suit Filings Reinforce "Backlog" Theory

My suggestion (here) that the apparent second quarter securities lawsuit filing lull was due in part to the fact that plaintiffs’ lawyers have a backlog of cases outside the financial sector has proven controversial. All I can say that there is an increasing amount of evidence consistent with the backlog hypothesis. Specifically, a significant number of recently filed securities lawsuits propose class period ending dates that are well in the past, in many cases well over a year in the past. Three cases filed this past week reinforce this observation.

 

To cite the most recent example, on August 7, 2009, plaintiffs’ lawyers initiated a securities class action lawsuit in the Southern District of Texas against Flotek Industries and certain of its directors and officers. As reflected in the plaintiffs’ lawyers’ August 7 press release (here), the ending date of the proposed class period in their complaint (which can be found here) is January 23, 2008, well over a year and a half before the complaint was filed.

 

Similarly in the class action securities lawsuit filed in the Southern District of New York on August 6, 2009 against Conseco, Inc. and certain of its directors and officers, the proposed class period ending date is March 17, 2008, as reflected in the plaintiffs’ lawyers August 6 press release (here).

 

And, to cite another example just from among the complaints filed during this past week, the ending date for the class period proposed in the lawsuit filed on August 4, 2009 against Allscripts-Misys Healthcare Systems (refer here) is February 13, 2008.

 

These cases join a large number of other recently filed cases in which the proposed class period cutoff date is well in the past. Thus, the purported class period in the July 30, 2009 securities class action lawsuit filed against International Game Technology (refer here) ends on October 30, 2008. The proposed class period ending date in the lawsuit filed on July 22, 2009 against Accuray (refer here) is August 19, 2008.

 

An even more noteworthy example is the class period proposed in the securities class action filed on July 17, 2009 against Bare Escentuals (about which refer here), in which the proposed class period end date is November 26, 2007. Similarly, in the securities class action lawsuit filed on July 14, 2009 against Ambassadors Group and certain of its directors and officers, the proposed class period end date is October 23, 2007 (refer here).

 

Other recent cases in which the class period cutoff date is at least six months prior to the filing date include the lawsuit filed on July 10, 2009 against Tronox (refer here).

 

These cases were all filed during July and August, though every single one of them might have and could have been filed earlier. The seeming delayed timing of the filing of these cases might be due to any number of factors. But at a minimum, the seeming delay alone could account for the supposed class action lawsuit filing "lull" observed during 2Q09. The rapid accumulation of these cases during the third quarter suggests that the supposed lull is over. It also suggests that when all is said and done by year’s end, the 2009 securities lawsuit filings levels will likely be consistent with historical norms.

 

Another thing these lawsuits have in common is that, with the exception of the Conseco case, they all involve companies outside the financial sector. It is generally recognized that for some time going well into last year, securities lawsuit filings have been largely concentrated in the financial sector. This noteworthy recent accumulation of seemingly dated cases against companies outside the financial sector strongly suggests that while lawyers were racing to the courthouse over the past couple of years to file lawsuits against financial companies, they were also building up a backlog of cases against companies outside the financial sector, and that they are now actively working off that backlog. Indeed, this process may have started earlier this year (refer here), but it now appears to be picking up considerable momentum.

 

For D&O underwriters, the possibility of lawsuits over long past events may pose a particularly difficult underwriting challenge, as it makes it particularly tricky to determine when a company that has experienced problems is "out of the woods." Compounding the difficulty is the fact that while the D&O insurance market for financial sector companies has "hardened" as a result of economic and related litigation developments, the market for companies outside the financial sector remains competitive, and underwriters may face pressures to compete even for a company with past problems, not withstanding these underwriting uncertainties.

 

It would be all to easy, based on a review of the various recently released mid-year securities litigation reports, to conclude that securities class action lawsuit filing activity is both concentrated in the financial sector and declining. As I have suggested before (here), it is premature to conclude that overall securities litigation activity is in some sort of secular decline. By the same token, it would be incautious to conclude that the securities litigation threat is largely confined to the financial sector. The recent lawsuit filings in fact confirm that companies outside the financial sector continue to face considerable securities litigation exposure.

 

D&O Insurance in Troubled Times: An August 7, 2009 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation blog (here) incorporates a memorandum from the Wachtell, Lipton law firm summarizing the critical D&O insurance issues in the current era of "historically significant dislocation." The memo provides a good but brief summary of critical issues, emphasizing the importance of Side A excess insurance, as well as considerations relating to the financial condition of insurers.

 

Among other things, the memo notes that "it may make sense to spend more for coverage from insurers that appear well-capitalized and financially strong."

 

Apologies for Service Issues: In recent days, some readers may have experienced problems attempting to access some documents to which I have linked on this site. In a sequence of events characterized both by lack of foresight and poor communications, the web address for a server I was using to host some documents for this site was changed without my knowledge, breaking the link to the URLs I used to link to the documents. I have fixed the most important links, but it will take a while to fix all of them. Readers may experience broken links on some older pages on this site for the next week or ten days while I fix the problem.

 

I encourage anyone who needs a particular document that they are unable to access as a result of this problem to contact me directly and I will provide you with a .pdf of the document. I apologize for this service glitch. I also note that anyone who thinks it would be easy to maintain a blog isn't reckoning, among other things,  with the infinite potential for other people to radically screw things up.

 

Web Notes and Updates

Another Subprime-Related Securities Lawsuit Dismissal: In yet another subprime-related securities class action lawsuit decision in defendants’ favor, on July 29, 2009, District of Connecticut Judge Stefan Underhill granted the defendants’ motion to dismiss in the securities lawsuit pending against CBRE Realty Finance and certain of its directors and officers. A copy of the opinion can be found here. Background regarding the case can be found here.

 

As reflected in Alison Frankel’s July 30, 2009 article about the decision in The American Lawyer Daily (here), the court’s order in the CBRE Realty case may be particularly noteworthy because the plaintiffs’ complaint asserts claims under the ’33 Act, in connection with which the plaintiffs would not have to plead scienter or even loss causation in order to survive a motion to dismiss -- they only need to plead a material misrepresentation or omission.

 

In his July 29 order, Judge Underhill found that the plaintiffs had not adequately pled that the alleged misrepresentations or omissions were material. The plaintiffs had alleged that in connection with company’s IPO, the company’s offering documents had not adequately disclosed the risk of default in connection with two Maryland condominium conversion projects known as Triton. Judge Underhilll concluded that plaintiffs had failed to allege that there was not sufficient collateral to back the $51 million loan to Triton.

 

Judge Underhill’s ruling does not indicate whether or not it is with or without prejudice; however, he did order the court clerk to close the file.

 

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

 

Still More Bank Failures: In case you missed it, this past Friday night, the FDIC closed five more banks, bringing the year to date total number of bank failures to 69. The FDIC has taken control of 32 banks just since June 19, 2009. An August 1, 2009 Bloomberg article detailing the latest bank closures can be found here.

 

The most recent round of bank closures continues the trend concentration of recent bank closures within the community banks. Four of the five latest bank closures involved institutions that had assets of under $1 billion. Of the 69 banks that have closed this year, 59 have had assets under $1 billion.

 

The signs are that the bank closures will continue for some time to come. The July 31, 2009 Wall Street Journal reported (here) that banking regulators have already entered at least 285 memoranda of understanding with banking institutions this year, on pace for nearly 600 by year end, compared with 399 for the full year last year. While the MOUs are designed to try to direct the institutions away from closure, the sheer number of agreements is a reflection of the difficult circumstances that many banking institutions are facing.

 

The FDIC’s complete list of banking institutions that have failed since October 2000 can be found here.

 

Another Madoff-Related Insurance Coverage Action: In an earlier post (here), I noted the arrival of the Madoff-related insurance coverage litigation and suggested there would be much more similar coverage litigation ahead. Another Madoff-related coverage lawsuit has now arrived.

 

On July 20, 2009, Blezak Black filed an action (here) in New Jersey (Camden County) Superior Court against its crime insurers. The plaintiff alleges to have invested over $13 million with Madoff, which it lost. The plaintiffs’ crime insurers have denied coverage for the claim. The plaintiff’s complaint alleges breach of contract and seeks a judicial declaration of coverage.

 

I have added this lawsuit to my register of Madoff-related insurance coverage litigation, which can be found in Table V of my register of Madoff lawsuits. The register can be accessed here.

 

Special thanks to a loyal reader for providing a copy of the latest Madoff-related insurance coverage lawsuit complaint.

 

Advisen Releases Second Quarter 2009 Securities Litigation Study

In a July 31, 2009 report , Advisen became the latest group to confirm that securities litigation declined in the second quarter of 2009, noting in its report entitled "Securities Litigation Drops in Q2 2009" (here) that securities lawsuit filings "fell off in the second quarter from the frantic first quarter." Advisen’s July 31, 2009 press release describing its study can be found here.

 

But while the Advisen report is consistent with the report released earlier by Cornerstone Research (refer here), NERA Economic Consulting (refer here), as well as my own prior report (here), the Advisen report takes a slightly different approach to the topic and as a result contributes an important additional perspective.

 

It is absolutely critical to note at the outset that in using the term "securities lawsuit," the Advisen report is describing a category broader than just securities class action litigation. In addition to the securities class action litigation, the Advisen report uses the term "securities lawsuit" to include shareholder derivative litigation; breach of fiduciary duty litigation; "securities fraud" litigation, which includes regulatory actions brought by the SEC; as well as other kinds of litigation.

 

Using this broad definition, the Advisen reports that there were 121 "securities lawsuit" filings in the second quarter, down from 212 in the record-setting first quarter. Overall the first half "securities lawsuit" filings were within although slightly below historical norms.

 

The Advisen report notes that there were 37 new securities class action lawsuit filings in the second quarter, down from 70 in the first quarter. The 107 first half securities class action lawsuit filings would translate into 214 filings on an annualized basis, "in line with most recent years."

 

In speculating on the reasons for the first half decline, the Advisen report comments that the first half filings seem to have been "frontloaded" into the first quarter of the year. The report also states that "the second quarter could represent a lull in litigation activity while law firms worked on the flood of suits from the first quarter." The report does note (as I also observed, here) that "the first few weeks of the third quarter have seen a surge in securities suits once again."

 

The Advisen report also states that there were 41 settlements/awards in securities lawsuits in the second quarter of 2009, including the $2.9 billion jury award against Richard Scrushy in the HealthSouth shareholders’ derivative lawsuit. Taking the Scrushy award into account, the average settlement/award in the second quarter was $101.5 million, but if the Scrushy award is disregarded the average settlement/award drops to $60.0 million. The average securities class action settlement in the second quarter was $74.5 million, a quarterly average amount the report describes as "quite high."

 

The report has a number of other interesting observations, many of which have been noted in the previously released reports, including the concentration of the litigation activity in the financial sector; the increasing level of litigation involving foreign domiciled companies; and the elevated levels of activity involving the Ponzi scheme allegations.

 

Advisen Webinar: Advisen will be hosting a free webinar to discuss the findings in its second quarter report on August 3, 2009 at 11 am EDT. I will be participating in the call along with David Bradford and John Molka of Advisen, Randy Hein of Chubb and Tripp Sheehan of Marsh. For further information about the call and to register, refer here.

 

About Those July Securities Filings: The Advisen report mentions that in the first month of the third quarter, securities class action lawsuit filings seem to have ramped up again. Just to detail that point, by my count, there were at least 16 new securities class action lawsuits filed in July, which is a filing rate that is back at historical levels.

 

With respect to the new July filings, it is also interesting to note how few of these new lawsuits were in the financial sector. While five of the new lawsuits involve financial companies, the other eleven did not, which is sort of the exact opposite of the equivalent proportions for the first half of the year. Of the eleven new suits involving nonfinancial companies, as many as seven involved companies involved in the life sciences sector.

 

The other interesting thing about these July filings is how many of them involve purported class periods ending dates that are well in the past, as I previously noted here. To cite the most recent example, the purported class period in the July 30, 2009 securities class action lawsuit filing against International Game Technology (refer here) ends on October 30, 2008.

 

The July filings seem to me to be consistent with the hypothesis that the downturn in securities class action filings during the second quarter was just a temporary lull. In addition, the July filings are inconsistent with the hypothesis that the plaintiffs’ lawyers are running out of targets to sue. Rather, the July filings suggest to me, as I have speculated elsewhere, that the plaintiffs’ lawyers ran into a logjam during the second quarter and as they ran up a backlog of cases to be filed against nonfinancial companies. All of the evidence so far in the third quarter is entirely consistent with this final hypothesis.

 

One Thing the Plaintiffs’ Lawyers Were Up to During the First Half: As I also noted elsewhere, though the plaintiffs’ lawyers’ may not have been filing new securities class action lawsuits during the second quarter, they were by no means idle. A July 31, 2009 press release (here) by the Tramont Guerra & Nunez firm, issued in response to the various published reports regarding the decline in second quarter filings, provides some insight into at least one particular way the plaintiffs’ lawyers were otherwise occupied during the second quarter.

 

According to the press release, Finra’s dispute resolution statistics show an 82% increase in the arbitration claims for the first half of the year, with the majority of claims filed for breach of fiduciary duty and misrepresentation. Finra’s statistics can be found here. As I said, the plaintiffs’ lawyers were not idle.

 

NERA Releases Mid-Year 2009 Securities Litigation Study

On July 27, 2009, NERA Economic Consulting became the latest to publish a mid-year analysis of the year to date securities litigation developments. The NERA report, written by Stephanie Plancich and Svetlana Starykh, is entitled "Recent Trends in Securities Class Actions Litigation: 2009 Mid-Year Update," and can be found here. The NERA Report joins the earlier mid-year report of Cornerstone Research (refer here). My own mid-year review can be found here.

 

The NERA report seemingly reports a higher number of securities class action filings than the earlier reports, although the seeming difference requires some explanation; on closer review, the apparent difference arguably becomes more apparent than real. In addition to an analysis of the first half lawsuit filings, the NERA report also includes a review of the first half securities lawsuit settlements as well.

 

For the first six months of 2009, NERA reports that there were 127 new securities class action filings. This tally is quite a bit higher than the 87 first half filings that Cornerstone reported in its recent study of first half filings. However the difference may be attributable to a difference in counting methodology. As explained in footnote 2 of the NERA report, "unless cases are consolidated, we report all filings potentially related to the same alleged fraud, if the complaints are filed in different Circuits or if different securities are alleged to be affected by the fraud." Since many of the complaints filed in the first half involve duplicated allegations with multiple complaints filed in different circuits, NERA’s reported number of filings is quite a bit higher than other published reports. NERA notes that "if cases are ultimately consolidated, the data are adjusted." Hence, my statement that the seeming difference in the number of filings may be more apparent than real.

 

The NERA report notes that the first half filings are on an annualized pace of more than 250 filings, which would be more than in 2008. Consistent with earlier reports, the NERA report does note that the number of filings declined in the second quarter. The NERA report also notes that the first half filings were largely driven by the credit crisis cases and new lawsuits relating to the Ponzi schemes. Over 40% of first half filings were credit crisis related and over 20% were related to the Ponzi scheme allegations. About 67% of first half filings named at least one financial company as a primary co-defendant.

 

In addition, the NERA report notes that accounting firms have been named as co-defendants in 17.3% of filings, which represents a significant increase from prior years. Cases against foreign domiciled defendants have also increased, with 19 cases or 15% of all cases naming a foreign company as a primary defendant, the highest percentage since the passage of the PSLRA.

 

In terms of drivers affecting the pace of securities class action lawsuit filings, the report confirms that the filing rate is correlated to overall market volatility, but the relationship is "not tight" and in fact volatility accounts for only about 28% of the variability in quarterly filing levels.

 

In looking at case resolutions, the report attempts to determine how long on average it takes for these cases to be resolved. Looking back at the cases filed in 2000, the report finds that on average, the time to resolution is 2.9 year, with an average time for dismissals of 1.7 years and settlements it was 3.5 years. Most of the more recent cases, particularly those related to the subprime meltdown and the credit crisis still remain only in their earliest stages, and so it is too early to tell how these cases ultimately will be resolved.

 

In analyzing case outcomes overtime, the report finds that a higher fraction of cases have been dismissed since the U.S. Supreme Court’s 2005 ruling in Dura Pharmaceuticals, consistent with the hypothesis that defendants are more likely to prevail in a motion to dismiss as a result of that decision.

 

With respect to settlements so far this year, the NERA report finds that the median securities class action settlement is $8 million, which is about the same as in 2008. Median values have remained very consistent for the past five years.

 

The average securities class action settlement during the first half of the year has been $43 million, about even with last year’s average and slightly below the average of $49.6 million for the period 2003 to 2009. The high average relative to the median is driven by large outlier settlements. If the settlements above $1 billion are removed, the average for the period 2003 to 2009 drops to $27.6 million, although the year to date average for 2009 settlements remains at $43 million. A substantial number of settlements this year have been over $100 though less than $1 billion.

 

Median investor losses for cases filed in 2009 ($600 million) are much higher than for cases settled in 2009 ($289 million). Since settlement amounts traditionally have been "strongly correlated" to investor losses, this would seem to suggest that the 2009 cases would be much higher than more recently settled cases. However, given that the companies affected by the credit crisis "may no longer have …substantial resources to make …large settlement payouts" the traditional relationship of settlement amount to investor losses may or may not hold.

 

Another Subprime Securities Lawsuit Settlement

In a July 15, 2009 motion (here), the plaintiff in the subprime-related securities class action lawsuit involving RAIT Financial Trust moved for preliminary approval of a proposed settlement of the case. According to the company’s May 27, 2009 filing on Form 8-K (here), the parties entered a preliminary agreement on May 26 2009 to settle the case for a cash payment of $32 million, to be funded entirely by the company’s D&O insurers.

As reflected in greater detail here, the company was first sued in August 2007 in a securities class action lawsuit alleging that in the offering materials accompanying the company’s January 2007 IPO as well as subsequent statements, the defendants made misrepresentations and omissions about the company’s credit underwriting, exposure to investments in debt securities, loan loss reserves and other financial items.

In a December 22, 2008 ruling, Eastern District of Pennsylvania Judge Legrome Davis substantially denied the defendants’ motions to dismiss. Among other things, Judge Davis’s ruling was noteworthy for its acceptance of the "core business operations" theory in concluding that the plaintiffs had adequately pled scienter, as discussed at greater length here.

The RAIT settlement joins the recent Accredited Home Lenders settlement (refer here) as subprime-related securities lawsuits in which the cases settled after the motions to dismiss were denied. The $22 million settlement in the Accredited case together with the $32 million settlement in this case suggest that companies (or at least their D&O insurers) may face significant financial consequences for losing the dismissal motion in these cases. These settlements and the recent $30.5 million settlement in the Beazer Homes case also start to create an impression that overall, the subprime and credit crisis cases might prove to be very expensive to resolve.

I have in any event added the RAIT settlement to my register of the subprime and credit crisis-related lawsuit resolutions, which can be accessed here.

Very special thanks to a loyal reader for calling my attention to the RAIT settlement.

Lawsuits May Be Down, But the Plaintiffs' Lawyers Haven't Gone Away

As I have shown (here) and has been detailed by others (here), the number of securities class action lawsuits declined during the first half of 2009 compared both to last year and to historical norms. There is a lot that might be said about the decline and its causes. However, the mainstream media (refer, for example, here) has latched onto the message that the number of securities suits is declining because the plaintiffs are "running out of people to sue."

 

Let’s be honest -- fish gotta swim, birds gotta fly, and plaintiffs’ lawyers make their living filing lawsuits. The fish and the birds can be counted upon to continue their traditional activities, and so can the plaintiffs’ lawyers. The very idea that the plaintiffs have run out of targets is a flawed conclusion built on a faulty premise.

 

Before I get started on this topic, I think it would be useful to review why this question matters. Once before, the idea circulated that the securities class action plaintiffs’ lawyers were going out of business. This hypothesis turned out to be very wrong and it proved to be a very expensive mistake.

 

After the PSLRA was enacted at the end of 1995, some D&O insurers assumed the statute’s passage would mean that many fewer securities lawsuits would be filed, and so they slashed their insurance pricing. The marketplace followed. When securities litigation ramped back up, the D&O insurance industry suffered hundreds of millions of dollars in losses. The industry paid a lot of tuition to learn that what plaintiffs’ lawyers do is file lawsuits. Given how expensive the lesson was, it would seem unwise to start assuming now that anything has changed.

 

But with respect to the recent decline in securities lawsuits, let’s at least get the facts straight. The number of lawsuits did not decline during the entire first six months of the year. During the period January through April, the number of new securities lawsuit filings was more or less at normal levels. The drop took place in May and June. Now, looking at the ebb and flow of securities lawsuit filings during the last 14 years, there arguably is nothing noteworthy about a two-month decline. It could just be a blip. It may or may not continue; only time will tell. It does seem important (to me at least) that so far in July, there have already been at least twelve new securities lawsuits, more than were filed in either May or June.

 

The other thing about the first half of 2009 is that it was not as if the plaintiffs’ lawyers were idle -- they were just otherwise occupied. Among other things, they were busy filing lawsuits related to Madoff, the Stanford Financial Group and other Ponzi schemes. Indeed, my list of Madoff-related lawsuits (which can be accessed here) now runs to some 23 pages, with more than 40 new cases filed during May and June.

 

This other extensive litigation activity is highly relevant, because of the similarity to what happened back in the period mid-2005 to mid-2007. That was the period when there was a sustained "lull" in new securities class action lawsuit filings. During that period as well, the plaintiffs’ lawyers were also otherwise engaged. Then, they were busy filing options backdating-related shareholders’ derivative lawsuits, eventually filing 168 of them (as shown here).

 

That prior "lull" in new securities lawsuit filings motivated some observers to speculate that the move to lower securities litigation levels might represent a "permanent" change. Subsequent history has shown that in fact there was no permanent change, and indeed the securities lawsuit activity returned with a vengeance.

 

Of course, it is possible that plaintiffs’ lawyers have indeed run out of targets and that lower level of new securities class action filings will persist going forward. Only time will tell. Just based on what history has shown, though, both after the passage of the PSLRA and after the so-called "lull," I think it would be unwise to bet that hereafter the plaintiffs lawyers will file fewer securities lawsuits.

 

My own theory about why the number of lawsuits has dipped is that the plaintiffs’ lawyers have been busy, not just with the Madoff lawsuits, but also dealing with the extraordinary number of lawsuits they previously filed in connection with the subprime meltdown and credit crisis. Many of these lawsuits are uncommonly complicated and they have in many cases entered procedurally demanding stages.

 

The main reason I believe that the plaintiffs’ lawyers have just been jammed up is that I think there is evidence that they are dealing with a backlog of cases, a point that I have made before (here). Recent filings even further reinforce the conclusion that the plaintiffs’ lawyers are now starting to work off a backlog.

 

Many of the recent filings have proposed class periods that are well in the past, sometimes years in the past. For example, the securities lawsuit filed on July 14, 2009 against Ambassador Group (refer here) has a proposed class period cutoff date of October 23, 2007. The securities lawsuit filed on July 17, 2009 against Bare Escentuals (refer here) has proposed class period cutoff date of November 26, 2007. The securities lawsuit filed on July 22, 2009 against Accuray (refer here) proposes a class period cutoff of August 19, 2008. Other recent filings though not quite as superannuated involve class period cutoff dates that well over six months past (refer, for example, here).

 

If you notice from the cases I have listed above and in my prior post, these cases not only involve a time gap, but they also are all outside the financial sector. It seems as if the plaintiffs lawyers have been so preoccupied with the race to the courthouse in lawsuits against the financial sector, they are just now getting around to filing the cases against the other kinds of companies.

 

The way I look at it, the plaintiffs’ lawyers have not had a shortage of targets, they have just had a shortage of time. But evidence suggests that they are getting caught up and they are now getting around to working off the backlog that has been accumulating. The one thing I know for certain is that they will continue to file lawsuits. Consider how reliable the birds and fishes are, and I think you will see what I mean.

 

One line of analysis that does give me pause is the suggestion that the lawsuit filings declined because of diminished stock market volatility. According to this theory, there is a correlation between overall market volatility and the level of securities lawsuit activity. This theory may have something to it; it is certainly the case that an individual lawsuit is directly related to the target company’s experience of volatility in its own share price. If this market volatility theory is true and if the lower volatility persists, then we could be in for a period of lower numbers of security lawsuits. We had a lull before, we could certainly have one again.

 

Because of the possibility that persistent lower market volatility might mean reduced lawsuit filings for awhile, I am not making any absolute predictions. I am just saying that I wouldn’t make any bets based on the assumption that the plaintiffs lawyers have run out of people to sue.

 

Cornerstone Releases Mid-Year 2009 Securities Litigation Report

 The 2009 securities lawsuit filings have been characterized by an overall decline in filing activity, particularly in the second quarter, as well as the continued prevalence of lawsuits against financial sector issuer-defendants, according to a July 20, 2009 study by the Stanford Law School Securities Class Action Clearinghouse in cooperation with Cornerstone Research. The study, which is entitled "Securities Class Action Filings: 2009 Mid-Year Assessment" can be found here. A July 20 press release describing the study can be found here. My own prior study of the first half securities lawsuit filings can be found here.

 

According to the Cornerstone study, there were 87 securities class action lawsuits filed in the first half of 2009, which represents a 22.3 percent decline from the 112 securities suits that were filed in both the first half and the second half of 2008. The first half filings project to an annual filing rate of 174 securities class action, which would represent a 22.3 percent decrease from 2008 and an 11.7 percent decrease from the annual average for the 12 years ending in December 2008.

 

The drop in new filings was particularly pronounced in the second quarter of 2009, as only 35 of the 87 new filings occurred during the second quarter. The Cornerstone Report notes that over the same period, there was "a similarly dramatic decline" in the stock market volatility measured by the Chicago Board Options Exchange Volatility Index. The report also suggests that the "decline in market volatility raises the possibility of a return to the subdued levels of filing activity observed from the third quarter of 2005 to the second quarter of 2007."

 

Filings against companies in the financial sector predominated in the first half of 2009, as financial companies were named as defendants in 66.7 % of the first half filings. Slightly less than 50% of the first half filings were related to the credit crisis, as 42 of the 87 first half filings contained allegations related to the credit crisis.

 

The 2009 mid-year report contains a couple of new metrics. The first measures the number of unique issuers whose exchange-traded securities were involved in class action lawsuits. The metric shows that the number of lawsuits against unique exchange traded issuers has declined even more rapidly than the overall number of new lawsuits. The decrease is "driven by a large number of filings related to non-exchange trade securities and private companies" in the first half of 2009. These suits relate to Ponzi scheme allegations as well as other filings "related to mortgage-backed securities, preferred stock and open-ended mutual funds."

 

The other new metric in the mid-year report measures the number of filings against defendant corporations headquartered outside the United States. The metric shows that the number of suits against non-U.S. companies has been gradually increasing over the years, from only 6.8 percent of all filings during the period 1997 through 2003 to 13.8 percent in 2008. This upward trend continued in the first half of 2009, with 20.7 of all filings against non-U.S. companies, largely due to cases against foreign domiciled companies in the financial sector. Interestingly, this increase in litigation activity has coincided with a decrease in the share of foreign companies listed on the major U.S. exchanges.

 

In terms of the potential damages involved in the first half filings, the report’s detailed analysis shows that the 2009 filings are characterized by a decrease in losses associated with announcements at the ends of class periods and an increase in overall market capitalization losses for the entire class periods.

 

The report notes that since the end of 2008, there has been an "unprecedented" concentration of new Ponzi-scheme related filings. The Madoff scandal has resulted in five filings in the second half of 2008 and 15 in the first half of 2009, and there were four additional Ponzi scheme-related filings unrelated to Madoff in the first half of 2009.

 

The report concludes with an observation of the heightened number of bank failures during 2009, adding the observation that only 21 of the 45 banks that had failed through June 30, 2009 were publicly traded, and only one of the bank failures has resulted in a securities class action lawsuit.

 

The report’s new metric related to number of lawsuits against unique exchange-traded issuers is particularly useful for observers of public company litigation trends. Though the numerous lawsuits against private firms and mutual fund companies are interesting and important, those developments are less likely to affect the overall market for public company directors and officers liability insurance. In that respect, the Cornerstone report’s observation that the decline in lawsuits against unique publicly traded companies is even more pronounced than the overall decline in lawsuit filings is a particularly significant observation. The addition of this new metric is a particularly useful and welcome addition to Cornerstone’s reporting on litigation activity.

 

The report’s suggestion that the decline in lawsuits is linked to a decline in market volatility is also particularly interesting, as is the observation that lower volatility may mean a return to the low filing activity of the period mid-2005 through mid-2007. My own view, expressed in my prior post (here), is that the decline in lawsuit filing activity during the second quarter arose because plaintiffs’ lawyers found themselves in a logjam, due to the onslaught of Madoff-related litigation and the fact that many of the previously filed credit crisis cases had reached critical procedural stages.

 

The filings so far in July have in fact been characterized by the number of lawsuits outside the financial sector, many with class period ending dates considerably before the filing dates, which does suggest that plaintiffs’ lawyers are to a certain extent working off a backlog. Of course, the pace and nature of the second half filing activity overall remains to be seen.

 

ABA TIPS Panel: The Financial Collapse -- What Caused It and How Will It Continue To Impact Corporations and Their Boards?: The American Bar Association Tort Trial & Insurance Practice Section (TIPS) Task Force on Corporate Governance will hold this meeting at the ABA Building in Chicago on July 30, 2009 as part of the ABA Annual Meeting, to discuss the 2008 financial collapse and how corporations can manage risk throughout the remainder of the ongoing crisis.

 

I will be participating in this free session, which will be chaired by my good friend Kim Hogrefe from Chubb. The panel will also include Fiona Phillip of Howrey LLP and Dr. Faten Sabry of NERA Economic Consulting. The event will be followed by a reception. More information about the event, including event registration can be found here.

 

NERA Releases Japanese Securities Litigation Trends Study

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

A Single New Securities Suit, Many Recurring Issues

From time to time on this blog I try to draw generalizations from a variety of disparate claims as a way to identify emerging themes. However, a single recently filed securities class action manages to embody in a single complaint several themes I have previously tried to describe.

 

The case in question is the action filed on July 10, 2009 in the Southern District of New York on behalf of those who purchased common shares of Tronox, Inc. between November 28, 2005 and January 12, 2009. The complaint names as defendants certain former directors and officers of Tronox, as well as Kerr-McGee Corporation, Andarko Petroleum Corporation and certain Kerr-McGee executives.

 

According to the plaintiffs’ lawyers’ July 10, 2009 press release (here), the complaint alleges that:

 

Tronox was spun-off from Kerr-McGee in a two-step transaction. In November 2005, Kerr-McGee sold 17.5 million shares of Tronox Class A shares in an initial public offering for $14.00 per share (the "IPO") generating proceeds for Kerr-McGee of $225 million. After the IPO, Kerr-McGee continued to hold 56.7% of Tronox’s outstanding common stock. In March 2006, Kerr-McGee distributed the balance of the shares that it owned as Class B shares to its shareholders as a dividend (the "Spin-Off").

The Complaint alleges that, throughout the Class Period, Defendants failed to disclose material adverse facts about the Company’s true financial condition, business and prospects. Specifically, the Complaint alleges that Defendants failed to disclose the true scope and extent of Tronox’s environmental and tort liabilities. When the market learned of the true facts about the Company, the price of Tronox stock declined precipitously.

 

The complaint itself (which can be found here) alleges that the alleged misrepresentations and omissions

 

(i) deceived the investing public regarding the true nature and extent of the Company’s environmental and tort liabilities, Tronox’s business, operations, management, and the intrinsic value of Tronox’s stock; (ii) enabled Kerr-McGee to sell $225 million of Tronox stock to the unsuspecting public at artificially inflated prices; (iii) enabled Kerr-McGee to successfully rid itself of hundreds of millions of dollars of liabilities, thereby clearing the way for Kerr-McGee to sell itself to Andarko; and (iv) cause Plaintiff and other members of the Class to purchase Tronox common stock at artificial prices.

 

There are a number of interesting things to me about this complaint, all of which sound themes that will be familiar to readers of this blog.

 

First, this case represents yet another example of the way in which the spreading wave of corporate bankruptcies is extending the litigation consequences of the financial crisis beyond just the financial sector. (My prior post on this topic can be found here.) Tronox, the bankrupt company at the cent of this case, is engaged in the business of producing and marketing titanium dioxide, a white pigment used in a variety of products. Tronox, which definitely is not a financial services company, was not named as a defendant in the case owing to its bankrupt status.

 

Second, the complaint is based on alleged misrepresentations and omissions regarding Tronox’s environmental and tort liabilities. Among other things, the complaint alleges that the defendants ignored known information in setting Tronox’s reserves for environmental liabilities, and in particular that the reserves did not include any allowance for special sites (supposedly known as "secret sites") Kerr-McGee had identified as part of an investigation. The complaint also alleges that the defendants knew that independent third parties had reviewed the company’ s non-public information regarding its environmental liabilities and concluded that the company’s liabilities could be substantially larger.

 

These allegations may be noteworthy in and of themselves, but they are also noteworthy because they represent specific examples of what I have previously identified (most recently here) as the growing disclosure risks public companies face regarding their environmental liabilities. Although more recently I have emphasized the growing risks surrounding climate change related issues, as this case demonstrates, the disclosure risks also include the risks associated with more conventional environmental liability exposures.

 

Third, the roster of defendants involved in this case demonstrates a potential problem that can arise under D&O insurance policies in certain situations. Under the typical D&O insurance policy, coverage for the corporate entity is provided solely for "securities claim," which is a policy term that is typically defined in one of two ways. The first way is with respect to the securities involved, and the second way is with respect to the specific legal violations alleged.

 

In the first of these formulations, the policy includes within its definition of the term "securities claim" for which entity coverage is provided any claim based upon the purchase or sale of the securities of the Insured Entity itself. The alternative formulation pertains to claims alleging violation of any federal, state, local, or foreign securities law. (It should be noted that some current policies incorporate both formulations within the definition of the term "securities claim.")

 

The interesting thing about the Tronox lawsuit in connection with these alternative definitions of the term "securities claim" is that the Tronox complaint alleges violations of the securities laws against Kerr-McGee and Andarko, but not in connection with the purchase or sale of those companies’ own securities, but rather in connection with the securities of Tronox. Thus, to the extent these companies’ D&O insurance policies contain only the first of the two alternative formulations for the term "securities claim," their respective insurers might take the position that the Tronox complaint is not a "securities claim" with the meaning of their policies.

 

I should emphasize here that I have no familiarity with the specific terms or conditions of the D&O insurance policies of any party involved in this case and I am expressing no opinions one way or the other about the availability of coverage under any policies that may be applicable.

 

As I noted above, many policies available in the D&O insurance marketplace today actually incorporate both alternative formulations with the definition of the term "securities claim." But the Tronox complaint provides an example of how problems might arise in connection with D&O insurance policies containing more restrictive definitions of the term.

 

As for my first two observations noted above, I suspect that there will be many other securities lawsuits yet to come arising out of bankruptcies outside the financial sector. And I suspect strongly that in the months and years ahead we will see an increasing number of securities lawsuits raising allegations based on supposed misrepresentations or omissions relating to environmental liabilities and exposures, including but not limited to climate change issues.

 

And Speaking of Climate Change-Related Disclosure Issues: Just the other day I added a post (here) in which I raised the possibility that companies may soon find themselves facing the need to incorporate climate change-related disclosures in their periodic filings. A recent news article suggests that these changes may be even closer than I anticipated.

 

According to a July 13, 2009 New York Times article entitled "SEC Turnaround Sparks Sudden Look at Climate Disclosure" (here) federal regulators are preparing to launch a "very serious look" at requiring corporations "to assess and reveal the effects of climate change on their financial health."

 

According to the article, the SEC is following up on the landmark disclosure requirements enacted by the National Association of Insurance Commissioners this spring (and about which refer here). SEC representatives have also met with CERES, which submitted a petition in 2007 asking the SEC to clarify and strengthen requirements for climate change disclosure (and about which refer here).

 

Although the article hints strongly that formal disclosure requirements might be ahead, the article also acknowledges that nothing specific is actually underway now, and that a variety of practical and policy concerns would complicate any initiative that is launched.

 

Nevertheless, the message is that the SEC’s new leadership is more receptive to these possibilities and interested in pursing them further.

 

Hat tip to the Securities Docket for the link to the New York Times article.

 

Rule 10b5-1 Trading Plan Supports Securities Suit Dismissal

Though Rule 10b5-1 trading plan abuses have figured in recent high profile cases (refer here), predetermined trading plans remain a good idea. A July 1, 2009 dismissal of a securities class action lawsuit pending in the Southern District of New York underscores the potential protective benefit that a trading plan can provide.

 

Gildan Activewear is a Canadian sportswear company based in Montreal. Its shares trade on both the NYSE and the Toronto Stock Exchange. Following the company’s April 2008 press release in which it announced a reduction in its earning guidance, its share price declined and litigation ensured. Background regarding the case can be found here.

 

 

 

On November 17, 2008, the lead plaintiff filed a Consolidated Amended Class Action Complaint (here), and on December 19, 2008, the defendants moved to dismiss.

 

 

 

In a July 1, 2009 opinion (here), Southern District of New York Judge Harold Baer, Jr., granted the defendants’ motion to dismiss, apparently with prejudice. Judge Baer granted the motion among other reasons on the grounds that plaintiff’s scienter allegations were insufficient to meet the PSLRA’s pleading requirements.

 

 

In attempting to establish scienter, the lead plaintiff had sought to rely on alleged insider trading by Gildan’s CEO, Glenn J. Chamandy, and by its CFO, Laurence G. Sellyn. Judge Baer noted that Chamandy’s sales, which comprised “over 99% of the total insider trading” alleged, were made pursuant to a non-discretionary Rule 10b5-1 trading plan, which, Judge Baer said, “undermines any allegation that the timing or amounts of the trades was [sic] unusual or suspicious.”

 

 

Judge Baer noted several other shortcomings regarding the plaintiff’s insider trading allegations. Among other things, he noted that though the plaintiff alleges that the defendants’ sales produced gross proceeds of $96 million, it fails to “allege any facts relating to the amount of profit” the defendants garnered by their sales. Judge Baer also found that the relatively low percentage of the sales compared to the defendants’ overall holdings, as well as the timing of the sales, in addition to the fact that the other officers and directors did not sell their shares, also militated against a finding of scienter.

 

 

Although Judge Baer’s discussion of Chamandy’s Rule 10b5-1 plan is relatively brief, it appears that the critical components of the plan were that Charmandy entered the plan in advance of his trades, the plan was non-discretionary, and the sales were pursuant to the plan. Judge Baer’s holding is yet another reminder that a well-constructed Rule 10b5-1 trading plan can provide substantial protection.

 

 

Judge Baer’s opinion cites the Eighth Circuit’s 2008 opinion in Elam v. Niedorff, which also found sales pursuant to a Rule 10b5-1 plan sufficient to rebut scienter allegations, and which is discussed in an earlier post, here.

 

 

Special thanks to Adam Savett of the Securities Litigation Watch for providing a copy of Judge Baer’s opinion.

 

 

Best Boards in America?: When Eric Jackson at TheStreet.com set out to identify the best boards in America as part of his July 7, 2009 article (here), he found that it was easier to list companies with poor governance practice than the best. Part of the problem is that there is no universally accepted definition of good governance. In addition, past attempts to identify exemplary boards look dubious in retrospect, as the performance of many companies cited later slumped.

 

 

Jackson quotes University of Delaware Professor Charles Elson to the effect that board governance alone is no guarantee of success, but “good governance give you protection when things to wrong. It the long run, that will play out.”

 

 

In creating his best boards list, Jackson ultimately relied on two factors Elson identified: equity ownership of directors and independence of directors. Jackson added his at third criterion, which is that directors must actually have enough time to serve.

 

 

Based on these criteria, Jackson identified three companies as having the best boards: Berkshire Hathaway, Johnson & Johnson, and Amazon.com. Of the three, Jackson judged Amazon.com as the best, saying it has “done things right on the important governance factors of equity ownership, independence and time,” as a result of which Jackson says Amazon is “far less likely to suffer a Lehman-like shock that could destabilize or kill the company.”

 

 

Securities Docket Mid-Year Litigation Update Webcast: On July 9, 2009, at 2:00 P.M. EDT, I will be participating in a Securities Docket webcast entitled “2009 Mid-Year Review: Securities Litigation and Enforcement.” The webcast will be moderated by Bruce Carton of Securities Docket and the panelists will also include Francine McKenna of the Re: The Auditors blog; Lyle Roberts of The 10b-5 Daily blog; and Tom Gorman of the SEC Actions blog. Further information and registration instructions can be found here.

 

Second Quarter Securities Lawsuit Filings Dip

While the number of securities class action filings through the year’s first half still project to an annualized filing rate consistent with historical averages, there was a noticeable slackening in the number of new securities lawsuits filed as the second quarter of 2009 progressed. New filings in the second quarter were well below the number of filings in the first quarter as well as in last year’s second quarter. There were few new filings in May and even fewer in June.

 

Overall, the filings continue to be largely concentrated in the financial sector. In addition, as discussed below, a significant number of the securities lawsuit filings in the first half of 2009 did not involve publicly traded companies, but instead involved other types of entities, such as private investment partnerships and mutual funds.

 

 

Based on my review of the securities filings through June 30, 2009, there were 94 securities class action lawsuits filed in the first half of 2009. (Please see my comments below on the topic of “counting” the lawsuits during the year’s first half.) The 94 first half filings represent an annualized filing rate of 188, which is slightly below but within range of the average number of filings of 197.7 during the 13-year period between 1996 and 2008. The annualized rate of 2009 filings is also below the average filing level of 204.7 for the most recent seven year period of 2002 through 2008.

 

 

The filing level during the second quarter of 2009 was below both the first quarter of this year and last year’s second quarter. There were only 35 new securities lawsuit filed during the second quarter of 2009, compared to 59 during the first quarter of this year and 56 in the second quarter of 2008.

 

 

The lower filing level during the second quarter of 2009 reflects the low number of new securities class action lawsuit filings during the months of May and June. There were just eleven new securities lawsuit filings in May and only six in June. The June filings represent the lowest monthly number of new filings since December 1996, when there were just five new securities class action filings.

 

 

But though there were fewer new securities class action filings during the second quarter of 2009, the total number of filings for the twelve-month period ending June 30 remains within historical annual averages. There were 205 new filings during the twelve month period ending on June 30, 2009, which, though below the 219 new filings during the twelve month period ending on June 30, 2008, is consistent with the average annual number of filings noted above.  

 

 

In addition to the filing activity levels, the first half filings were characterized by the relatively unusual types of claimants involved. For example, as many as ten of the first half lawsuits were filed on behalf of holders of preferred or subordinated securities. As I noted at greater length here, these are relatively unusual claimants.

 

 

The securities class action litigation targets during the first half were also unusual. An uncharacteristically high number of the first half lawsuit defendants were entities other than public companies, including private investment partnerships, mutual funds, and other nonpublic entities. As many as sixteen of the new first half lawsuit filings involved primary defendant entities that lacked Standard Industrial Classification code (SIC) designations. As many as eight of the new filings in the first half involved mutual funds (many of them in the Oppenheimer mutual fund family).

 

 

One characteristic that the first half filings did have in common with the filings in immediately preceding periods is that the new filings continue to be concentrated in the financial sector. Though the first half filings represented 38 different SIC Code classes, fully 51 of the first half filings against entities with SIC Codes involved companies in the 6000 SIC Code series (Finance, Insurance and Real Estate). In addition, virtually all of the 16 actions involving entities that lacked SIC codes also involved enterprises in the financial sector, so that more than two-thirds of the new first half filings involved financial services entities of one kind or another.

 

 

The concentration of the filings in the financial sector is largely a result of the continuing subprime and credit crisis litigation wave. By my count, 51 of the first half filings involved subprime and credit crisis related allegations. My complete list of all subprime and credit crisis securities lawsuit filings can be accessed here.

 

 

Another factor contributing to the concentration of securities lawsuit filings in the financial sector is the number of new securities class action lawsuits that were filed in the first half related to the Madoff scandal. By my count there were 11 new Madoff-related securities lawsuit in the first half, although there were many more duplicate Madoff-related lawsuits filed during that same period as well. My complete list of the Madoff related lawsuit filings can be accessed here.

 

 

The first half securities lawsuit filings were filed in 26 different courts, but fully 45 of them, or nearly half, were filed in the Southern District of New York.

 

 

Eighteen of the first half lawsuit filings involved foreign domiciled companies, representing ten different countries. The country with the largest number of first half filings was the United Kingdom. However, a number of these lawsuits against foreign-domiciled companies involve multiple separate lawsuits against a single target. For example, the six lawsuits filed against U.K. companies actually involve just two different companies, Royal Bank of Scotland and Barclays.

 

 

Of the actions against U.S.-domiciled companies, the first half lawsuits involved companies from 22 different states, with the largest number in New York (28) and California (12).

 

 

Why the Apparent Slowdown?: There may be any number of possible reasons for the relative slowdown in the number of filings during the second quarter. My own theory is that the plaintiffs’ lawyers may have found themselves in a logjam, due to two factors. One factor is the onslaught of Madoff-related litigation (which is not fully reflected in the above numbers but has nevertheless been massive) Another factor is the sheer quantity of previously filed subprime and credit crisis-related litigation, which in many instances has reached critical procedural stages.

 

 

If I am correct about the reasons for the second quarter slowdown, then the downturn could proved to be temporary and filing levels could ramp back up as plaintiffs’ lawyers circle back and attempt to work off the backlog. (Indeed, I have previously noticed signs that plaintiffs lawyers could already have been working off backlogs from earlier periods, as noted here). My view is that we will soon see filing activity return to historical norms. Of course, only time will tell.

 

 

Some Comments on “Counting”: The various litigation statistical services will also be issuing their counts for the first half of 2009 and their counts almost certainly will vary from mine. Because the Stanford Law School Securities Class Action Clearinghouse publishes all of the actions that it includes in its running tally, it is easiest for me to compare my count with theirs, and so I already know that my count differs from theirs, as I have both omitted lawsuits Stanford Clearinghouse has counted and I have counted lawsuits that the Stanford Clearinghouse omitted.

 

 

I have set forth these differences below not because I think I am right and alternative version wrong, but simply so readers might be able to understand the differences. Reasonable minds might well reach different conclusion as to whether the items mentioned below should or should not be recognized in any count.

 

 

Thus, I have omitted at least a couple of cases from the Stanford Clearinghouse list that to me appear to represent double counting of lawsuits that were counted elsewhere in the Clearinghouse’s list. (Refer for example here and here for examples of cases previously counted in the Stanford Clearinghouse tally.) Also, because I only count class actions seeking damages for disclosure violations under the federal securities laws, I have omitted merger objection lawsuits (refer for example here).

 

 

By the same token, I have included federal securities class action lawsuits that were filed in state court (refer for example here), which the Stanford Clearinghouse did not. I have also included a number of other actions that do not appear on the Stanford Clearinghouse list, including lawsuits involving Metaldyne (here); Royal Bank of Scotland Series Q preferred shares (here), Deutsche Bank Alt-A Securities (here); Merrill Lynch Mortgage Pass-Through Certificates (here); FM Multi-Strategy Investment Fund (here); Citigroup 8.125% Non-Cumulative Preferred Stock, Series AA (here); Agape World (here); Wells Fargo Mortgage Pass-Through Certificates Series 2006 et seq. (here); Citigroup 8.50% Non-Cumulative Preferred Stock (here); and Thornburgh Mortgage Pass-Through Certificates (here).

 

 

During the first half of 2009 the seemingly simple process of counting new lawsuit filings was extraordinarily complicated. As the filings have continued to emerge involving different classes of securities, it is increasingly challenging to determine whether or not each additional complaint represents a duplicate lawsuit or a separate action. In addition, the flood of Madoff-related litigation has involved an enormous number of similar or overlapping lawsuits.

 

 

If you would like a particularly challenging example of the difficulties involved in “counting,” refer to this June 30, 2009 press release in which plaintiffs’ counsel describe the class complaint they filed in the Eastern District of California on behalf of holders of derivative interests in bonds issued by the California Infrastructure and Economic Development Bank. To greatly oversimplify the action, the lawsuit alleges that the bond documents misrepresented certain bond attributes, for which the plaintiffs seek to recover damages under the federal securities laws. It is an investor class action lawsuit seeking to recover damages under the federal securities laws, and for that reason I included it in my count. On the other hand, it involves public financing authority rather than a public company; others might not count it. Read the press release and I think you will see what I mean. This is not simple.

 

 

Whether or not to count any of these complaints as a new action or as a duplicate lawsuit, or at all, is enormously challenging and reasonable minds almost certainly would reach differing results. The various published versions of the number of lawsuits filed during the first half of 2009 almost certainly will vary, perhaps substantially.

 

 

Securities Docket Mid-Year Litigation Update Webcast: On July 9, 2009, at 2:00 P.M. EDT, I will be participating in a Securities Docket webcast entitled “2009 Mid-Year Review: Securities Litigation and Enforcement.” The webcast will be moderated by Bruce Carton of Securities Docket and the panelists will also include Francine McKenna of the Re: The Auditors blog; Lyle Roberts of The 10b-5 Daily blog; and Tom Gorman of the SEC Actions blog. Further information and registration instructions can be found here.

 

Rare Fifth Circuit Securities Case Reversal

On June 19, 2009, the Fifth Circuit, in a per curiam opinion (here) written by a panel that included retired Supreme Court Justice Sandra Day O’Connor sitting by designation, reversed and remanded the district court’s denial of class certification and entry of summary judgment in defendants’ favor in the Flowserve securities class action lawsuit.

 

CORRECTION: The original version of this post suggested that Justice O'Connor herself had written the June 18 opinion. In light of  reader comments (please see below) I have revised this post to reflect the fact that the Fifth Circui's decision was in the form of a per curiam opinion that does not indicate which member of the panel authored the opinion. The entire staff here at The D&O Diary apologizes for any confusion our original post may have caused.

 

With respect to the class certification issue, the Fifth Circuit vacated the district court’s refusal to certify the class based on what the Fifth Circuit found was the district court’s application of an erroneous standard on the loss causation issue, and remanded the case for further proceedings. In addition, the Fifth Circuit reversed the district court’s entry of summary judgment, essentially on the ground that the district court’s analysis on the loss causation issue for class certification purposes was not in any event dispositive of the loss causation issue on the merits, and therefore was not the appropriate basis for entry of summary judgment.

 

 

The Fifth Circuit’s opinion is noteworthy for a number of reasons. First, it represents a rare occasion where securities class action plaintiffs have succeeded, even if only provisionally and for the time being, in a circuit that is generally perceived as heavily defense oriented. It should be noted that there is nothing in the Fifth Circuit’s opinion that precludes the district court from ruling against the plaintiffs on either issue on remand; even with application of what the Fifth Circuit described as the correct legal standard, the district court could nonetheless again rule in the defendants’ favor.

 

 

Second, the Flowserve case represents the latest example of the Fifth Circuit’s struggles with the question of the proper consideration of loss causation issues at the class certification stage. These same or similar issues are presented in both the Belo securities case (about which refer here) and the Halliburton securities case (here), both of which are now also pending before the Fifth Circuit. Given the continuing controversy on these issues, it seems increasingly likely that these issues could wind up before the U.S. Supreme Court.

 

 

Finally, the opinion is perhaps most interesting for the final commentary provided in the opinion's concluding paragraph:  

 

To be successful, a securities class-action plaintiff must thread the eye of a needle made

smaller and smaller over the years by judicial decree and congressional action. Those ever higher hurdles are not, however, intended to prevent viable securities actions from being brought.

 

 

Whether or not these remarks perhaps represent an expression of concern with how far the pendulum had swung in the Fifth Circuit in these kinds of cases, these words undoubtedly will be repeated by plaintiffs’ counsel in future filings, both inside and outside the Fifth Circuit, in support of the claims.

 

 

Very special thanks to a loyal reader for providing a copy of the Fifth Circuit’s Flowserve opinion.

 

 

Speakers’ Corner: During the period June 21-23, 2009, I will be in Palo Alto, California, where I will be participating as a faculty member at the Stanford Law School Directors’ College. A summary agenda for the event can be found here.

 

Eleventh Circuit: HealthSouth Settlement Appropriately Eliminated Scrushy's Indemnification Rights

In a June 17, 2009 opinion (here), the Eleventh Circuit upheld the district court’s entry, in connection with the $445 million partial settlement of the HealthSouth securities action, of a bar order that extinguished Richard Scrushy’s contractual claims both for indemnification of any settlement he may enter in the case as well as for advancement of his legal defense costs. The opinion raises interesting and important issues and arguably includes some troublesome analysis, particularly with respect to the advancement issues.

 

Background

In 1994, Scrushy and HealthSouth had entered an agreement requiring HealthSouth to indemnify Scrushy to the fullest extent permitted by law. The agreement also entitles Scrushy to receive advancement of attorneys’ fees as they become due, provided he agrees to repay the amount advanced if it is later determined that he is not entitled to be indemnified.

 

In 2003, HealthSouth, Scrushy and several other HealthSouth officials were sued in a series of securities class action lawsuits that were later consolidated. Refer here for background regarding the case. In 2006, HealthSouth and several of the officials reached a partial settlement agreement in which HealthSouth and its insurers agreed to pay the plaintiffs $445 million. (The insurance carriers paid $230 million of this settlement amount.) Scrushy was not a party to this settlement, and he has still not settled.

 

The parties’ stipulation of settlement proposed several bar orders for the court’s approval. Among other things, the proposed bar order extinguished any non-settling party’s claim for contribution against settling parties. The contribution bar order is reciprocal (that is, HealthSouth’s contribution claim against Scrushy is also barred), and is also balanced by a judgment credit, under which a future judgment against non-settling party is to be credited by the amount of the settlement.

 

The district court entered the bar order over Scrushy’s objections that the order extinguished his contractual indemnification and advancement rights. Scrushy appealed to the Eleventh Circuit.

 

The Opinion

Scrushy raised several arguments against the bar order, contending first that the mandatory contribution bar in the PSLRA was exclusive, and therefore the bar could extend only to his rights to contribution, but not to his separate contractual rights of indemnification and advancement. The Eleventh Circuit held that the PSLRA’s contribution bar was not exclusive, and in fact was enacted against a background of established case law which had approved bar orders precluding indemnification claims.

 

Scrushy also argued that under case law and the PSLRA if he were to be deprived of valuable rights in a contribution bar order, he is entitled to compensation. The Eleventh Circuit held that the judgment credit represented very valuable compensation, since if Scrushy were to take the case to trial, the plaintiffs "will recover nothing at all from Scrushy and other non-settling defendants unless the verdict exceeds $445 million." The court also noted that Scrushy should be able to use that fact as "a very significant bargaining chip" in settlement negotiations with plaintiffs.

 

Scrushy argued further that depriving him of his indemnification rights would be contrary to public policy under Delaware law designed "to encourage qualified individuals to serve as corporate officers." The court said that these considerations must be "balanced against countervailing policies in favor of settlement." The court also referenced extensive case law that indemnification of securities violations is inconsistent with policies underlying the securities laws. The court concluded that the bar order’s elimination of Scrushy’s indemnification right was not against public policy.

 

The court then turned to Scrushy’s argument that the bar order’s elimination of his advancement rights was inappropriate. Scrushy argued that his rights of advancement were independent of any liability he might have to plaintiffs, and therefore it inappropriate in a settlement involving plaintiffs’ liability claims to strip him of his independent contractual rights.

 

The court conceded that "no circuit court… has addressed this issue" and acknowledged that the injury to Scrushy with respect to his advancement rights is not measured with respect to amounts Scrushy might have to pay to the plaintiffs. However, the court said that "the attorneys’ fees are nonetheless paid on account of liability to the underlying plaintiffs or risk thereof." The court found that the claim for attorneys’ fees "clearly cannot be considered to be independent of his liability to the underlying plaintiffs" because it is "so close in nature of the claims which established case law holds are appropriately barred" that so holding is "a minimal and reasonable extension thereof."

 

Scrushy raised a separate public policy argument with respect to his advancement rights, arguing that Delaware law "supports advancement of litigation fees for officers and directors to ensure that they will resist unjustified claims, and to encourage qualified individuals to serve."

 

The court recognized that in the absence of fee advancement "an innocent officer might have difficulty proving his innocence, and thus might have difficulty realizing a prevailing status." But the court said these considerations have to be balanced by policies in favor of settlement. It noted that HealthSouth might well have been reluctant to settle if "it would continue to be liable for endless legal fees to fund Scrushy’s individual defense" as that would constitute "limited peace." The Eleventh Circuit also said (and I want to take care to quote this carefully here) "advancement of legal fees might be inconsistent with the policies underlying the securities laws."

 

The court rejected Scrushy’s argument that he was not compensated in the bar order for the elimination of his advancement rights; the court said the "overall compensation was adequate" given the judgment credit.

 

Accordingly the Eleventh Circuit held that the district court to not abuse its discretion in entering the bar order.

 

Discussion

At one level, the outcome of this dispute is hardly surprising, as it is particularly difficult to meet the "abuse of discretion" standard applicable to the Eleventh Circuit’s review of the district court’s entry of the bar order.

 

On the other hand, the Eleventh Circuit’s apparent commitment to upholding the settlement and to rejecting Scrushy’s claims seems to have driven their consideration of these issues, and whether or not the outcome ultimately is appropriate, there are parts of the court’s analysis that I find less than comfortable.

 

Although I also have issues with respect to the court’s analysis of indemnification issues, my real concerns relate to the court’s holding regarding Scrushy’s advancement rights.

 

In particular, the court gave very short shrift to Scrushy’s public policy arguments regarding advancement. True, the court did concede that an innocent officer "might" have difficulty proving his innocence if his advancement rights are eliminated, and (the court delicately added) "might have difficulty realizing a prevailing status."

 

A fair assessment of these points would not be written in the conditional sense -- there is no "might" about it. The reality is that company official whose advancement rights are cut off is pretty much screwed unless he or she has individual resources to defend him or herself. (I am setting insurance issues to the side here, in order to concentrate on the advancement issues).

 

I also think the court strained very hard but not very convincingly to substantiate its conclusion that Scrushy’s advancement rights are not independent of the plaintiffs’ liability claims against him.

 

My overwhelming impression of this opinion is that the outcome was dictated by the identity of the appellant. The fact that it was the notorious and reviled Richard Scrushy before the court clearly seems to have had an impact, and in particular a presumption of Scrushy’s liability for the violation of which he is accused pervades the Eleventh Circuit’s opinion. For example, the Eleventh Circuit said that "Scrushy made no showing in the district court that he was merely an innocent bystander with respect to the violations at issue here."

 

The court also noted, approvingly, that "a party in HealthSouth’s shoes might well have been more willing to leave extant the contractual claims for advancement of fees on the part of an outside director who could adduce evidence of excusable ignorance of the violations."

 

The unmistakable message seems to be that it is OK for the bar order to extinguish Scrushy’s advancement rights because we all know that he is a bad guy. Indeed, the popular consensus is that Scrushy is a bad guy and even that he did all the stuff that plaintiffs allege. But in our system, we generally require these kinds of things to be proven before they can serve as the basis for depriving someone of their contractual rights. Scrushy was in fact acquitted in the criminal trial relating to these allegations, though later convicted on unrelated bribery and racketeering charges. The entry of the bar order did not follow a trial, it followed only a fairness hearing. (Readers who feel I am disregarding some important findings of fact in connection with these proceedings are invited to let me know if I am overlooking something.)

 

Several days ago I defended Bank of America’s advancement of Angelo Mozilo’s defense fees (see my prior post here), and many of the things I said there seem applicable here. In reflecting on these issues, I find myself wondering about the Eleventh Circuit’s consideration of public policy under Delaware law. I can’t help but find the contrast overwhelming between the outcome of the Eleventh Circuit’s analysis on the advancement issue here, and the ruling of the Delaware Chancery Court in the Sun-Times case (linked in my earlier post about Mozilo) that the company had to continue to advance defense costs even though the former officers had been convicted of crimes, had been sentenced and were in jail.

 

It seems to me that the right way to think about the advancement issue is to forget that the appellant here was Richard Scrushy and imagine instead that we are talking about some poor anonymous sucker that got cut out of a settlement and now faces a panoply of securities law allegations by himself. Imagine further that unlike Scrushy the poor sucker has no independent resources with which to defend himself. Perhaps the outcome on the question of the appropriateness of a bar order extinguishing advancement rights might be the same for the poor sucker as it was here. But I find the impression overwhelming that the outcome of this case had to do with the fact that it was about Scrushy and not some anonymous poor sucker.

 

My final concern about this opinion is that in its zeal to uphold the settlement against Scrushy’s challenge the court managed to say some things that simply don’t stand up. The worst example is the court’s statement (which I quoted carefully above) that "the advancement of legal fees might be inconsistent with the policies underlying the securities laws." I really cannot explain or understand this statement, but it seems to be a very radical suggestion to even pose the possibility that it is against public policy for companies to advance defense fees on behalf of corporate officials who have merely been accused of securities laws violations.

 

I feel confident that this is a proposition that would elicit no assent in any quarter, but if it were an accurate statement of the law, I think we would see a wave of mass resignations as no one would voluntarily undertake the kind of risks that this proposition implies.

 

I have said some strong things here. I hope readers who disagree with my view of this case will take the time to add their comments to this post.

 

Many thanks to a loyal reader for providing me with a copy of the Eleventh Circuit opinion.

 

UPDATE: On June 18, 2008, a Jefferson County (Alabama) Circuit Court judge entered a $2.8 billion judgment against Richard Scrushy following a bench trial in a derivative lawsuit filed against him. Although there are no findings of fact in the Final Judgment (copy here), the order clearly represent a finding that Scrushy engaged in the alleged misconduct. This ruling obviously puts the Eleventh Circuit's decision in a different light. However, this ruling had not yet been issued at the time the Eleventh Circuit issued its decision, so I think many if not all of my questions raised above remain valid given the record before the Eleventh Circuit at the time it ruled.

 

What Does The SEC's Enforcement Action Against Countrywide's Mozilo Signify?

In its most significant enforcement action yet related to the subprime meltdown, on June 4, 2009, the SEC filed a civil securities fraud complaint (here) in the Central District of California against Angelo Mozilo, the former CEO of Countrywide Financial Corp., as well as the company’s former COO and CFO. The complaint alleges that the defendants mislead investors by misrepresenting the company’s loan origination standards and practices and by hiding the company’s deteriorating financial condition. The complaint also contains allegations of improper inside trading against Mozilo for initiating Rule 10b5-1 trading plans to sell shares while he was aware of material nonpublic information about the company’s deteriorating loan practices.

 

As discussed in its June 4, 2009 press release (here), the SEC’s complaint charges that from 2004 through 2007, Countrywide engaged in "an unprecedented expansion of its underwriting guidelines and was writing riskier and riskier loans, which these senior executives were warned might curtail the company’s ability to sell them" to investment bankers and other mortgage buyers.

 

The complaint alleges that while the company was issuing reassuring statements to investors, Mozilo "internally issued a series of increasingly dire assessments of the various Countrywide loan products and the risks to Countrywide in continuing to offer or hold these loans."

 

One of the more interesting aspects of the SEC’s press release about the suit is the accompanying document (here) in which the SEC summarizes email messages from Mozilo in which he delivered some of his "increasingly dire assessments." Among other things, an email attributed to Mozilo is quoted as saying that "we are flying blind on how these loans will perform in a stressed environment." Another email is also quoted as saying, with respect to the company’s subprime 80/20 loans, that "in all my years in the business I have never seen a more toxic prduct [sic]."

 

In other emails, Mozilo refers to the company’s 100% subprime second mortgages as "poison" and says that the 100% loan-to-value subprime mortgage is "the most dangerous product in existence and there can be nothing more toxic."

 

All of these statements attributed to Mozilo allegedly were made before Mozilo established several Rule 10b5-1 trading plans during the period October through December 2006. In December 2006 and February 2007, as the company’s share price was rising to record highs, he adjusted several previously established plans to allow him to sell even more shares. Pursuant to these plans and during the period November 2006 through August 2007, Mozilo exercised over 51 million stock options and sold the underlying shares for total proceeds of over $139 million.

 

Among other things, the complaint alleges that Mozilo approved his October 2006 trading plan one day after sending the email quoted above about "flying blind" on how the loans would perform. The complaint also alleges that five days before executing his December 2006 trading plan he circulated a memorandum to all managing directors and to the company’s board of directors noting a number of substantial concerns about the company’s subprime loan origination processes and noting that Countrywide expected its 2006 subprime loans to be the worst performing on record.

 

While many of these same kinds of allegations also appear in the pending Countrywide securities class action litigation (about which refer here), the SEC’s allegations nonetheless represent a significant development. SEC officials have been saying for over two years (as noted here, for example) that the agency would be cracking down on alleged Rule 10b5-1 trading plan abuses. Indeed, as discussed here, in an October 8, 2007 letter (here) to then-SEC Chairman Christopher Cox, North Carolina Treasurer Richard Moore had specifically asked the SEC to examine Mozilo’s stock trading pursuant to his Rule 10b5-1 plans.

 

With the SEC’s public commitment to cracking down on Rule 10b5-1 abuses and with the bull’s-eye drawn so specifically on Mozilo’s trading, it may have simply been a matter of time before some version of this complaint was filed. (Indeed, Alison Frankel’s June 4, 2009 American Lawyer article about the SEC’s complaint, which can be found here, is entitled "SEC (Finally) Charges Former Countrywide CEO Angelo Mozilo.") The SEC’s action nevertheless is a significant development, if for no other reason than the prominence of the company and of Angelo Mozilo and because of the nature and specifics of the allegations.

 

The more interesting question is the extent to which the SEC will be targeting other officials, whether for Rule 10b5-1 plan abuses or for disclosures relating to subprime loans and other lending practices. Given the continuing current public need to assign blame for the current crisis, the prospect for further enforcement activity in these areas seems likely.

 

Indeed, according to a June 4, 2009 Washington Post article (here), new SEC Chairman Mary Schapiro has specifically said that as part of her plan to try to rebuild the SEC’s tarnished reputation, she intends to step up enforcement efforts and to push cases related to the financial crisis. As a result, the Countrywide complaint may be only the first in a series of SEC enforcement actions designed to assign blame for the meltdown while also demonstrating that the SEC is "tough" again.

 

The World Was So Much Nicer Before Aggrieved Homeowners Had Access to Counseling Services:  Mozilo’s email practices got him in hot water even while he was still CEO of the company. In May 2008, Mozilo drew media attention (refer for example here) when he accidentally hit the "Reply" button rather than "Forward" after calling a homeowner’s plea for help "disgusting."

 

The borrower’s email had come from Daniel Bailey, a homeowner who was trying to stay in his home of 16 years. Bailey signed an adjustable rate mortgage and was told at the time that he could refinance after one year, before the payments became unaffordable. In drafting his note, Bailey had relied on suggested language from an Internet website that provided coaching services for troubled borrowers.

 

The email response Mozilo inadvertently sent Bailey said "Most of these letters now have the same wording. Obviously they are being counseled by some other person or by the Internet. Disgusting."

 

Mozilo seems to have had a deep commitment to ensuring that he would later look like a cartoon villain. I mean, here’s a guy who had just made a cool $140 million, yet when one of the suckers stuck with one of the loans that Mozilo himself described as "toxic" has the audacity to ask for relief, all Mozilo can think about is how "disgusting" it is that all of the losers stuck with these loans have the same grievances.

 

Does the Royal Dutch Shell Settlement Approval Portend a Rush of European Collective Actions?

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

 

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

 

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

 

Background

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

More Bankruptcy-Related Securities Suits Outside the Financial Sector

The high-profile bankruptcies of two of the country’s leading auto companies have dominated recent headlines, but for all their size, complexity and notoriety, the GM and Chrysler bankruptcies are only part of the recent wave of bankruptcies that have swept through economy. Numerous other companies have also found themselves in bankruptcy court. As these bankruptcies have spread, bankruptcy-related securities lawsuits against the bankrupt companies’ directors and officers have followed. Unlike much of the credit crisis-related litigation thus far, these latest bankruptcy-related securities lawsuits are not concentrated in the financial sector.

 

The most recent example of bankruptcy-related securities litigation is the securities class action lawsuit that was filed on June 1, 2009 in the Eastern District of Arkansas against the CEO, CFO and Chairman of Charter Communications. Charter, which filed for bankruptcy on Marsh 27, 2009, was not named as a defendant. The complaint, which can be found here, purports to be filed on behalf of all persons who acquired Charter shares between October 23, 2006 and February 12, 2009.

 

The complaint alleges that during the class period the defendants made a series of statements that misled the investing public about the company’s ability to service its debt, about its need to refinance or recapitalize, and about its cash resources. As reflected in plaintiff’s counsel’s June 1 press release (here), the plaintiff contends that "defendants failed to disclose, among other things, that Charter would not be able service its debt to September 2010, but rather Charter would file bankruptcy in March of 2009. Also, the Defendants issued misleading statements about Charter’s potential for mergers. As a result of defendants’ false and misleading statements, Charter’s securities traded at artificially inflated prices during the Class Period."

 

A second recently filed bankruptcy-related securities lawsuit is the action filed on May 18, 2009 in the Southern District of New York against the former CEO and former CFO of Nortel Networks. Nortel, which filed for bankruptcy on January 14, 2009, is not named as a defendant. The complaint, which can be found here, purports to be brought on behalf of persons who acquired Nortel shares between May 2, 2008 and September 17, 2008.

 

According the plaintiffs’ counsel’s May 19, 2008 press release (here), the complaint alleges that the defendants "failed to disclose material adverse facts about the Company’s true financial condition, business and prospects." Specifically, the complaint alleges that the defendants failed to disclose that

 

(i) that demand for the Company’s products was declining as carriers cut back their capital expenditures and other customers deferred purchase decisions; (ii) that the Company’s financial results were materially overstated as the Company was failing to properly write-down its goodwill; (iii) that the Company’s restructuring was not meeting with success as the Company was struggling to cut costs and improve profitability; (iv) and as a result of the foregoing, defendants lacked a reasonable basis for their positive statements about the Company, its business, operations, earnings and prospects.

 

These two actions join the bankruptcy-related securities lawsuits recently also recently filed against the directors and officers of Idearc (about which I previously wrote here) and MRU Holdings (about which I wrote here).

 

In addition to the common element of bankruptcy, and the fact that as a result of the bankruptcy in each of the cases the company was not names as a defendant in the lawsuits, the recent actions against Charter, Nortel and Idearc also share something else in common, which is that each of these companies is outside the financial sector.

 

As has been well-documented elsewhere (refer, for example, here), the securities litigation arising out of the credit crisis has to this point largely been concentrated in the financial sector. However, these recent actions suggest that the spread of adverse financial consequences from the current economic crisis will not only result in an increasing number of bankruptcies but also in an increasing number of bankruptcy-related securities lawsuits.

 

These bankruptcy-related securities lawsuits, like the ones described above, are likely to arise in a wide variety of business sectors, not just in the financial sector. Indeed, because the bankruptcies are and are likely to continue to be spread throughout the larger economy, it seems increasingly likely that going forward the litigation arising from the current economic crisis will not be concentrated just in the financial sector.

 

Whether or not these most recent lawsuits will be successful of course remains to be seen. The scienter allegations in the Charter and Nortel complaints are not overwhelmingly detailed. Neither complaint contains insider trading allegations; rather, the scienter allegations depend on assertions about what the defendants knew or must have known, without further elaboration showing that the defendants had contrary knowledge at the time of the allegedly misleading statements.

 

The other interesting detail about the Charter complaint is that a number of the allegedly misleading statements on which the plaintiff relies were actually made by a UBS media analyst. Neither UBS nor the analyst is named as a defendant; rather, the plaintiff alleges that the analyst was "directed" to make "statements related to Charter by the Defendants." The complaint further alleges that after making these statements and recommending Charter’s stock, the analyst "became Charter’s primary banker."

 

Allegations that securities litigation defendants misled the investing public through statements by third party analysts are certainly not unprecedented, but as a result of Regulation FD and other developments, these kinds of allegations have become relatively rare, particularly in private securities lawsuits. Whether and to what extend these allegations in the Charter case serves as the basis of liability will be interesting to monitor.

 

In a recent issue of Insights (here), I discuss at greater length the likelihood that more bankruptcies could result in increased securities litigation, and the D&O insurance issues that bankruptcy-related securities lawsuits could present.

 

Institutional Investors, Securities Litigation, and Corporate Monitoring

One of Congress’ goals when it instituted the "lead plaintiff" provisions of the PSLRA was to encourage institutional investors to become more involved in controlling and monitoring securities class action lawsuits. But now that institutional investors are indeed more involved in securities lawsuits, the question has become – what difference has it made? A recent academic study suggests that institutional investor involvement in securities litigation not only enhances investors’ success in seeking financial recovery, but also improves the quality of the defendant companies’ corporate governance. The authors conclude that securities litigation is an effective corporate monitoring tool for institutional investors.

 

A January 2009 paper entitled "Institutional Monitoring through Shareholder Litigation" (here), by Agnes Cheng of LSU, Henry He Huang of Prairie View A&M University, Yinghua Li of Purdue, and Gerald Lobo of University of Houston, examined all securities lawsuits that were filed from January 1, 1996 to July 20, 2005 and that had been resolved by June 1, 2006. 1,811 lawsuits met these selection criteria, of which 1,525 lawsuits were led by individual lead plaintiffs, 178 lawsuits were led by at least one public/union pension fund or mutual fund, and 108 lawsuits were led by other categories of institutions.

 

Among other things, the authors found a "trend of increasing institutional involvement in securities litigation." The percentage of lawsuits with institutional investor lead plaintiffs has more than doubled from less than 15% in 1996 to more than 30% in 2004.

 

The authors were most concerned in determining the effect of institutional investor involvement in case outcomes. Prior research had already shown (as reflected in my prior post, here) that cases with institutional investor lead plaintiffs result in larger settlements, primarily because institutional investors tend to become more involved in the larger, more serious cases.

 

In order to be able to control for the differences due to the kind of case in which institutional investors become involved, the authors identified the "determinants" that affect institutional investor involvement and used these factors as control variables. The authors identified a range of variable associated with the increased likelihood of institutional investor involvement, including merit and potential damages, size of the defendant company, and prior performance of the defendant company.

 

Among other things, the authors found that institutional investors are more likely to be involved when the case does not involve an IPO, when accounting issues are present, and when accounting firms are involved. The cases also tend to involve longer class periods, more significant investor losses and companies with higher levels of institutional shareholdings.

 

The authors used a multivariable regression analysis to control for these case differences, in order to be able to determine the impact attributable to having an institutional investor as the lead plaintiff. The authors found that after controlling for the determinants of having an institutional investor lead plaintiff, "lawsuits with an institutional lead plaintiff are less likely to be dismissed and have significantly larger settlements."
 

 

Specifically, the authors found that "institutional plaintiffs play a significant role in defeating the defendant firm’s motion to dismiss," finding that "an institutional lead plaintiff can reduce the dismissal probability by 38.2%" The authors found this relationship held even when tested against control variables relating to the possibility that the institutional lead plaintiffs simply selected the most meritorious cases.

 

The authors also found that the presence of an institutional lead plaintiff "can increase the total settlement amount by approximately 59.8%," when controlling for all the various factors that might be due to the type of case in which institutional investors tend to become involved. The authors concluded that "having an institutional investor lead plaintiff is associated with both a statistically and an economically larger impact on the settlement amount than having an individual lead plaintiff."

 

Finally, the authors also found that within three years of the lawsuit filing, defendant companies that faced institutional investor lead plaintiffs experienced greater improvement in board independence than those facing individual lead plaintiffs.

 

To measure this impact, the authors looked at changes in three variables within three years of the lawsuit filing: percentage of independent boar members in the full board, percentage of independent audit committee members, and whether there is a lead director. The authors found that the presence of an institutional lead plaintiff was associate with more significant reform in these three areas, from which the authors concluded that "the impact of securities class action on governance change depends on the type of lead plaintiff."

 

From these various observations, the authors conclude that "institutional investors’ involvement in securities litigation enhances not only investors’ success in seeking financial recovery, but also the quality of the defendant firms’ corporate governance." From this, the authors further conclude that "institutional investors could use litigation as a mechanism to discipline management and to secure the long-term health of the firm"

 

The authors noted the increasing incidence of institutional investors choosing to opt out of certain class settlements, which the authors note suggests that some investors may find opting out and filing individual lawsuits to be a stronger monitoring tool that leading the class action. The authors, citing recent research by Columbia Law Professor John Coffee (about which refer here), observed that "while the reasons for institutions opting out are interesting, our empirical sample limits our ability to study that issue." The questions surrounding institutional investors’ willingness to opt out raises a host of interesting issues, not the least of which is the relative importance on a continuing basis of class action litigation of a monitoring tool along the lines the authors suggest. The authors note that this is an interesting question for another day.

 

One final observation about the authors’ interesting study is that their article, like an increasing amount of legal literature, depends on the application of sophisticated mathematical tools to problems arising in the legal context. While this approach unquestionably has its value, it does make for some daunting presentations and some impenetrable analyses.

 

I certainly am in no position to question (much less fully appreciate) the validity of the authors’ quantitative approach. I confess that I must simply take it on faith that the authors’ regression analyses are both suitable and properly applied. The more critical approach I generally prefer to take is simply not an option for me when it comes to considering this type of quantitative analysis. I am uncomfortable taking so much on appearances – the authors’ work certainly appears to be rigorous – but without undertaking a massive self-reeducation project, I am hardly in a position to do anything differently.

 

At least I understand and appreciate the authors’ conclusions. Like a docile and uncritical church congregation, I know when to say "Amen."

 

A post on the Harvard Law School Forum on Corporate Governance and Financial Regulation blog about the authors’ paper can be found here.

 

Inspiring Words: While reading Ronald C. White, Jr.’s literary biography of Abraham Lincoln entitled The Eloquent President (here), I had occasion to re-read Lincoln’s First Inaugural Address, including the speech’s stirring final paragraph:

 

I am loath to close. We are not enemies, but friends. We must not be enemies. Though passion may have strained it must not break our bonds of affection. The mystic chords of memory, stretching from every battlefield and patriot grave to every living heart and hearthstone all over this broad land, will yet swell the chorus of the Union, when again touched, as surely they will be, by the better angels of our nature.

 

It is easy for us now to admire the eloquence of these words at the remove of nearly a century and a half and with the luxury of time for quiet reflection, but the words are even more impressive when considered in the context of the circumstances in which they were first delivered. At the time of the inauguration, seven states had already seceded; the very next day, Lincoln would receive word from the commander of Fort Sumter that his supplies were nearly exhausted. Lincoln’s optimistic words reflect an earnest but nearly impossible hope for reconciliation at one of our nation’s darkest hours.

 

Reading Lincoln’s words filled me with the same feelings I had when listening to Winston Churchill’s "Battle of Britain" speeches while I was touring the War Cabinet Rooms in London earlier this year. Both examples underscore the powerful potential of words to illuminate and inspire, even in desperate and hopeless times.

 

One of the more interesting details about this paragraph of Lincoln’s speech is that it was the result of an unlikely collaboration between Lincoln and his Secretary of State, William Seward. As well-told in Doris Kearns Goodwin’s excellent book, Team of Rivals, Lincoln and Seward would go on to become political allies and close friends, but at the outset of Lincoln’s presidency, they were political rivals who hardly knew each other and who had never worked together. Lincoln set aside his ego and not only asked Seward to review his draft speech, but he adopted most of Seward’s suggestions.

 

The most fascinating part of this collaboration is how Lincoln adopted Seward’s suggestions. White’s book puts Seward’s suggestions and Lincoln’s final text in side by side columns, which highlights how Lincoln transformed Seward’s proposed language, sometimes in subtle, sometimes in powerful ways. For example, Seward did indeed suggest the phrase "mystic chords" but Lincoln rendered the phrase as "mystic chords of memory." Seward suggested "the guardian angel of the nation," which Lincoln changed into "the better angels of our nature." Lincoln turned Seward’s well-intentioned prose into meaningful, musical poetry, with words that still resonate and inspire.

 

The transformative power of Lincoln’s use of language was not lost on Seward; he came to appreciate the power of Lincoln’s words perhaps as much as anyone. Though Seward presumed to make six pages of suggestions to Lincoln’s First Inaugural Address, his presumptions changed as he came to know Lincoln better. Three years later, when asked if he had helped Lincoln write the Gettysburg Address, Seward said, "No one but Abraham Lincoln could have made that address."

 

One of the more remarkable things about Lincoln’s powerful use of language is that he had less than one year of formal education. For some reason, in our own time, we have restricted higher office eligibility to individuals who acquired at least a part of their higher education at one of two elite Eastern universities. Indeed, the current President and his three immediate predecessors all share this common educational connection. I am not sure why this peculiarly narrow form of educational elitism now predominates our politics, but the danger is that something vital and fundamentally American could be lost as a result.

 

One interesting note about Lincoln’s first inauguration is that Lincoln was the ninth President for whom Chief Justice Roger Taney administered the oath of office, a feat of longevity and endurance that so unlikely that is seems incomprehensible. Given our current Chief Justice’s relative youth, one can wonder whether he might eventually swear in as many Presidents as Taney. Perhaps in future inaugurations, Chief Justice Roberts will actually administer the Oath’s required words correctly, on the first try.

 

In our time, the Gettysburg Address, the Emancipation Proclamation and even Lincoln’s Second Inaugural Address may all be better remembered than the speech Lincoln delivered at his first inauguration. Lincoln’s words in his other speeches are indeed memorable. But it seems to me that in our time as throughout our history, the mystic chords of memory unite us to our past and our aspirations now more than ever and the prayerful hope for the influence of the better angels of our nature remain as strong as ever.

 

Lincoln’s words remind us that our nation’s history includes days that were darker than even those today, but even in those desperate times, we never lost hope and we did persevere — as Lincoln might have said, with God’s help.

 

Supreme Court Grants Cert in Merck: Is This a Big Deal?

Relatively few securities lawsuits make it to the U.S. Supreme Court, so for that reason alone it is a noteworthy development that on May 26, 2009, the U.S. Supreme Court granted Merck’s petition for a writ of certiorari in the securities class action lawsuit relating to the company’s disclosures about Vioxx, the pain medication Merck withdrew from commercial distribution in 2004.

 

The Supreme Court will address the question of what is required to establish "inquiry notice" sufficient to trigger the running of the two-year statute of limitations for private securities lawsuits. As discussed below, the question before the court is likely to produce an opinion that, while likely to be narrow and technical, could nevertheless have a great deal of practical significance for many cases.

 

Background

The first Vioxx-related securities class action lawsuit was filed on November 6, 2003. (Refer here for a detailed background on the case.) Though Vioxx was not finally withdrawn from commercial distribution until September 2004, the district court granted Merck’s motion to dismiss the consolidated class action based on the statute of limitations, finding that there was sufficient public information available prior to November 6, 2001 to trigger the plaintiffs’ duty to investigate the alleged fraud. A copy of the district court April 12, 2007 opinion can be found here.

 

On September 9, 2008, the Third Circuit, in an opinion (here) written by Judge Dolores Sloviter, and accompanied by a vigorous dissent from Judge Jane Roth, reversed the district court and concluded that no "storm warnings" of the alleged fraud existed for more than two years prior to the filing of the original complaint.

 

In order to determine whether or not there was sufficient publicly available information to trigger the statute, the Third Circuit reviewed several categories of information that the district considered to have constituted "storm warnings," including: various studies that raised concerns about Vioxx’s side-effects; an FDA warning letter that publicly criticized Merck for its misleading marketing of Vioxx; several consumer fraud lawsuits that were filed against Merck throughout 2001; and an October 2001 New York Times article that discussed Vioxx testing results and side effects.

 

Based on its detailed factual review of each of these various categories of information, the Third Circuit concluded that "the District Court acted prematurely in finding that [plaintiffs] were on inquiry notice of the alleged fraud." Among other things, the Third Circuit found it relevant that throughout the period Merck continued to issue reassuring statements that minimized the various public disclosures. The Third Circuit also considered it relevant that Merck’s share price did not react to the various disclosures and that the analysts following Merck did not alter their ratings in response to these developments.

 

In dissent, Judge Roth stated her view that there various categories of information provided sufficient "storm warnings" to put investors on inquiry notice, regardless whether or not there was any significant change in Merck’s share price or in analysts’ ratings.

 

The Cert Petition

In its petition for certiorari, Merck argued that the various Circuit courts have issued conflicting opinions on what is required to put a plaintiff on "inquiry notice" sufficient to trigger the running of the statute of limitations. Merck argued that the Third Circuit, together with the Ninth Circuit but in contrast to the other Circuits, had held that "no duty to investigate arises, and the statute of limitations does not begin to run, until the plaintiff receives specific evidence of the elements of its claim without the benefit of any investigation."

 

Merck argued that as a result of its "more lenient" standard, "the Third Circuit has excused an investor from asking a single question until it has evidence not just of scienter, but of materiality and loss causation as well." Merck contended that the Third Circuit’s standard "runs contrary to the fundamental purpose of inquiry notice – to encourage the timely filing of fraud claims by placing an affirmative burden on plaintiffs to investigate potential claims."

 

Merck argued that the existence of a split in the circuits on this question not only undermines the goal of the uniform application of the statute of limitations, but it encourages plaintiffs to forum shop, burdens the parties with uncertainty and leaves investors unsure of their obligations.

 

In their brief in opposition to the writ, the plaintiffs had argued that the Third Circuit had made a very fact intensive determination, and had simply held that on the record there were not sufficient facts to trigger the obligation to investigate potential claims. The plaintiffs argued that the purported split in the circuits pertained only to what a plaintiff must do once the duty to investigate has been triggered, which, plaintiffs contend and the Third Circuit found, had not happened in this case.

 

On May 26, the U.S. Supreme Court granted the writ, and the case will be argued in the court term that begins in October, possibly with a new Justice on the bench.

 

Analysis

The possible significance of this case will be even more apparent after the case has been fully briefed and argued, but based on the record so far, I note the following:

 

First, the court seems to have taken this case based on Merck’s argument that there is a split of authority among the Circuit courts on what it is that puts a securities plaintiff on inquiry notice. Under these circumstances, the likeliest outcome at the Supreme Court level is that the Court will articulate the standard to be applied and then remand the case back to the lower courts for further proceedings. (I am assuming here that it is unlikely that the Third Circuit will not simply be affirmed, because the Supreme Court didn’t have to grant cert in order for the Third Circuit’s ruling to stand.)

 

This prospect in turn suggests a couple of things to me. The first is that the statute of limitations question in this case likely will be, as it has been up to this point, ultimately be decided on a very fact intensive basis. In addition, it also seems likeliest that the Court will simply choose among one of the existing standards for what triggers inquiry notice, which in turn suggests that it is unlikely that the Supreme Court’s decision in this case will plow any new ground.

 

Both of these factors suggest strongly that the Supreme Court’s decision will be narrow, precise and technical – as might be expected in a dispute over standards for triggering the statute of limitations.

 

That said, even if the Supreme Court’s opinion plows no new ground, it could nevertheless have enormous practical significance in at least some individual cases. Depending on how the Court’s decision unfolds, it could answer a number of critical issues that could be outcome determinative in some cases, including the following:

 

1. In order for plaintiff to be put on "inquiry notice," must the plaintiff be aware of the probability that fraud may have occurred, or merely the possibility that fraud may have occurred?

 

2. Is the awareness of the probability or possibility alone enough to trigger the statute, or must it also be shown that plaintiffs would have discovered facts sufficient to actually bring suit?

 

3. What is the relevance to the analysis, if any, of the presence or absence of movement in a company’s stock price or in analysts’ opinions?

 

4. What is the relevance to the analysis, if any, of reassurances from the Company, and how does that affect the triggering of inquiry notice?

 

All of that said, though the outcome of this case is likely to be narrow and technical and will likely produce a narrow definition of a technical standard, the decision potentially could have practical significance on questions of the timeliness of many securities lawsuits.

 

The Gibson Dunn law firm has an interesting May 27, 2009 memo here explaining in detail the contours of the split in authority among the various Circuit courts on the question of what triggers the running of the statute of limitations.

 

Special thanks to the several readers who send me links to briefs and articles relating to the Supreme Court’s cert grant in this case.

 

About the Nominee: Speaking of the recent nominee to the U.S. Supreme Court, a May 27, 2009 memo from the While & Williams firm (here) suggests that in insurance coverage cases, Second Circuit Judge Sonia Sotomayor has a track record of ruling in favor of insurers. On the other hand, as the memo also notes, not that many insurance cases actually make it all the way to the Supreme Court. Hat tip to the Point of Law blog (here) for the link to the memo.

 

Judge Explains Lead Plaintiff Selection, Addresses Conflict Question

As discussed in a prior post (here), at an April 1, 2009 hearing, Southern District of New York Judge Jed Rakoff had raised concerns that a proposed lead plaintiff’s law firm may have a "blatant, shocking conflict of interest," as a result of free portfolio monitoring services the firm performed for its client, the Iron Workers Local No. 25 Pension Fund. On April 25, 2009, Judge Rakoff entered an order (here) naming the Public Employees’ Retirement System of Mississippi (MissPERS) as lead plaintiff, stating that he would explain his reasons in a forthcoming opinion.

 

On May 26, 2009, Judge Rakoff entered his opinion (here) explaining his lead plaintiff selection in the case, which involves consolidated lawsuits relating to Merrill Lynch mortgage pass-through certificates. The opinion contains some interesting comments and observations about the two competing plaintiffs and their relations to their counsel

 

In his opinion, Judge Rakoff explained that because of "problematic relationships" between plaintiffs and their counsel, he was faced with a choice between "two less-than-perfect plaintiffs." He was particularly concerned with the relationship between the Iron Workers Fund and its counsel, because of testimony at the April 1 hearing showing that the Fund had a contractual arrangement with counsel whereby the law firm provided "free monitoring" of the Fund’s portfolio, in exchange for which if the firm recommended that the Fund pursue securities litigation, the firm would be retained on a contingency fee basis.

 

Judge Rakoff said that this arrangement goes "far beyond any traditional contingency arrangement" and creates a "clear incentive" for the firm to "discover fraud" and to recommend litigation, a practice that "fosters the very tendencies toward lawyer-driven litigation that the PSLRA was designed to curtail."

 

As the April 1 hearing, Judge Rakoff had questioned whether this arrangement was ethical. Following the hearing, the concerned law firm filed an affidavit from distinguished scholar Geoffrey Hazard, who opined that the arrangement did not create an improper conflict of interest. Among other things, Professor Hazard based his opinion on the conviction (speaking with respect to securities litigation) that plaintiffs’ lawyers had every incentive to proceed only if the claim is reasonably viable. He also noted that in contemporary practice, most plaintiffs are sophisticated and have access to sophisticated advisors.

 

Judge Rakoff noted that while he has "the very greatest respect" for Professor Hazard, he was not persuaded. First, the Professor’s statements about plaintiffs’ counsel’s incentives to pursue only viable claims are contrary to the concerns of Congress in enacting the PSLRA "regarding abusive lawyer-driven litigation."

 

And with respect to the supposed sophistication of plaintiffs and their access to sophisticated advisors, Judge Rakoff noted that the Iron Worker’s Fund’s administrator "was not particularly sophisticated in evaluating securities actions" and "only had a rough idea what this lawsuit was all about," and the "sophisticated advisors" on whom the Fund was relying were "the very lawyers who would be bringing suit."

 

Judge Rakoff concluded that he "need not determine whether there here exists a conflict of interest that violates ethical rules," since it is clear that the Iron Workers Fund is "in no position to adequately monitor the conduct of this complex litigation."

 

Which is not to say that MissPERS, the lead plaintiff he selected, is "without blemish," since it too relies on portfolio monitors and has very regularly served as a lead plaintiff. However, Judge Rakoff found that MissPERS relies on twelve different monitors, rather than a single monitor, and it employs a group of lawyers to evaluate litigation recommendations and "plainly had a sophisticated knowledge of such matters."

 

As for the objection that MissPERS was a "professional plaintiff" of the kind the PSLRA disfavors, Judge Rakoff noted that when the alternative plaintiff had little expertise, "the accumulated experience of MissPERS in pursuing multiple securities fraud actions seems a benefit more than a detriment."

 

In a final footnote, Judge Rakoff raised, but did not address, concerns about Pay-to-Play arrangements that could affect relations between plaintiffs’ firms and elected officials, but he declined to address the issue, which he said was not "presently before the Court in this case."

 

It is probably worth noting that the strong language Judge Rakoff used at the April 1 hearing has drawn considerable attention in other forums. For example, in a May 5, 2009 hearing before Central District of California Judge Andrew Guilford to determine the lead plaintiff in a case pending there, Judge Guilford noted (here) that because the same law firm was involved in the case before him as in the case before Judge Rakoff, he was "concerned" by Judge Rakoff’s observations at the April 1 hearing, and he noted further that his lead plaintiff "determination will benefit" from the analysis Judge Rakoff was to provide in his then-forthcoming opinion. Clearly, Judge Rakoff’s various statements and rulings could have significance outside the confines of the specific case in which they were delivered. Special thanks to a loyal reader for a copy of the May 5 opinon

 

On the other hand, it is relevant to note that in another recent lead plaintiff decision by a judge in same courthouse as Judge Rakoff did not consider the monitoring services this particular law firm provided to the lead plaintiff to even be a relevant consideration. In a  May 22, 2009 opinion (here), Southern District of New York Judge Barbara S. Jones rejected arguments that the law firm had a conflict of interest due to the portfolio monitoring servicves it provided to the proposed lead plaintiff. Judge Jones said that "the Court has been shown no reason why this monitoring system causes any issues or impediments to teh firm's representation," noting that the firm "has substantial experience in representing shareholders in securiteis class actions" and that she "believes the firm will serve the class adequately." Special thanks to a loyal reader for a copy of the May 22 opinion.

 

Andrew Longstreath’s May 27, 2009 Law.com article about Judge Rakoff’s opinion can be found here.

 

More Problem Banks: In prior posts (most recently here), I noted concerns regarding the increasing number of failed banks, and conjectured that banking closures were likely to continue to accumulate for the foreseeable future, citing the FDIC’s estimates of the number of "problem banks."

 

In its latest Quarterly Banking Profile, released on May 26, 2009 for the first quarter of 2009 (here), the FDIC increased the number of banks on its "Problem List" from 252 at year end 2008 to 305 as of March 31, 2009, and increased the total assets at problem institutions from $159 billion to $220 billion. (The FDIC does not identify the banks it has designated as "problems" by name.)

 

To put this increase in context, the number of banks on the Problem List as of the end of the third quarter of 2008 was only 171, and at the end of the second quarter of 2008, the count was only 117. In other words, the number of banks on the Problem List not only increased 21% from year end 2008 to the end of the first quarter 2009, but it has increased 160% in just nine months between the middle of 2008 and the end of the first quarter.

 

As I have said before, all signs are that the current banking woes are likely to continue for the foreseeable future.

 

Latest Securities Suit Target: Trust Preferred Securities

Amidst the current wave of credit crisis-related securities lawsuits have been a noteworthy number of cases involving various classes of subordinated or preferred securities investors, as I previously noted here. In particular, and just in the past several weeks, plaintiffs’ lawyers have filed several securities class action lawsuits involving banks’ "trust preferred securities." As discussed below, these hybrid securities have particular characteristics that make them particularly sensitive to the current financial turmoil, which, in turn, suggest that there could be further litigation ahead involving these securities.

 

Background

Trust preferred securities are hybrid securities that have characteristics of both equity and debt. Although any corporation could issue these securities, they have most popular with bank holding companies, due to a 1996 Federal Reserve Board opinion allowing the proceeds of a trust preferred offering to be treated as "Tier I" capital by the bank holding company. Under these Fed guidelines, up to 25% of a bank’s Tier I capital may be from funds raised through trust preferred securities offerings.

 

In anticipation of a trust preferred securities offering, the bank holding company creates a wholly-owned subsidiary organized as a trust. The holding company issues debt to the trust and the trust in turn issues securities to investors through an initial public offering. The holding company’s debt is the trust’s sole asset. In many instances, the trust preferred securities are traded on the public securities exchanges, with their own ticker symbol. The proceeds of the offering are transferred from the trust to the holding company, where the proceeds are treated as capital on the holding company’s balance sheet.

 

The advantage to the holding company from this transaction structure, in addition to the ability to reflect the transaction proceeds as regulatory capital, is that the holding company’s interest payments on the debt issued to the trust are tax deductible (unlike dividends on conventional preferred shares, which would come out of after-tax income).

 

Further background regarding trust preferred securities can be found here and here.

 

In recent years, these kinds of offerings were a popular way for bank holding companies to raise regulatory capital. According to a recent publication from the Federal Reserve Bank of Philadelphia (here), at the end of 2008, over 1,400 bank holding companies had approximately $148.8 billion in trust preferred securities outstanding. However, during 2008, there were relatively fewer of these offerings, as the market for these kinds of offerings "essentially dried up" due to "disruptions in the credit market."

 

Trust preferred securities offerings were an effective way for bank holding companies to bolster their regulatory capital when their financial performance was strong. However, when the holding company’s financial condition deteriorates and its regulatory capital declines, then, according to the Philadelphia Fed article, limitations the percentage of trust preferred securities that may be counted in regulatory capital and the restrictive covenants on the debt obligation "further exacerbate the institution’s financial problems and raise supervisory concerns."

 

In addition, concerns that the holding companies are more likely to defer interest payments on the securities as the economic crisis continues have resulted in ratings downgrades for the securities and significant declines in the valuation of the securities as well.

 

The Litigation

Given the combination of circumstances, it is hardly surprising that litigation involving these trust preferred securities has begun to appear. Just in the past few weeks, there have been several securities class action lawsuits brought on behalf of trust preferred securities investors who purchased their shares in the initial public offering of the securities.

 

For example, on May 4, 2009, a purported class action lawsuit was brought in the Northern District of Georgia on behalf of persons who purchased SunTrust Capital IX 7.875% Trust Preferred Securities of SunTrust Banks, in connection with the February 2008 initial public offering of the securities. The complaint (here) names as defendants SunTrust Banks; the trust itself; certain directors and officers of SunTrust; the offering underwriters; and PricewaterhouseCoopers.

 

The complaint alleges that there were material misrepresentations and omission in the offering documents in violation of the liability provisions of the ’33 Act. Among other things, the complaint alleges that:

 

(a) The Company's assets, including loans and mortgage-related securities were impaired to a greater extent than the Company had disclosed; (b) Defendants failed to properly record losses for impaired assets; (c) The Company's internal controls were inadequate to prevent the Company from improperly reporting its impaired assets; and (d) The Company's capital base was not as well capitalized as it had represented.

 

Other recent actions involving trust preferred securities include the action brought on April 1, 2009 involving Regions Financial Corporation’s 8.875% Trust Preferred Securities of Regions Financing Capital Trust III, which issued securities in an April 2008 offering. Background regarding the case can be found here.

 

Three different recent securities lawsuits target separate trust preferred offerings involving Deutsche Bank. These filings involve actions commenced on February 24, 2009 (refer here); March 19, 2009 (refer here) and March 30, 2009 (refer here). Each of these actions relate to separate trust preferred securities offerings sponsored by Deutsche Bank.

 

Each of these cases are brought under the ’33 Act, and each names as defendants the bank holding company, the trust, the holding company’s directors and officers, the offering underwriters, and in many cases the auditor. Each of cases raises factual allegations similar to those raised in the SunTrust case.

 

Subject to the possible constraint noted below, it seems likely that there will be more of these kinds of lawsuits ahead. The trust preferred securities, which were offered to investors under different economic circumstances, are now beaten down as a result of the current financial turmoil. Each of the hundreds of separate offerings involved a distinct and discrete class of investors, which in turn gives plaintiffs’ lawyers a series of separate points of access from which to target specific troubled financial institutions, as the multiple separate lawsuits against Deutsche Bank demonstrate.

 

Each of the offering also affords a separate potential opportunity to assert claims under the ’33 Act. Bringing an action under the ’33 Act, rather than under the ’34 Act, avoids the need to satisfy the heightened standards for pleading scienter. In addition, the issuing entity is "strictly liable" under the ’33 Act for material misrepresentations and omissions.

 

The ’33 Act’s relatively short one year/three year statute of limitations (refer here) may provide some constraint on the offerings that plaintiffs’ lawyers might now attempt to target. On the other hand, the looming time limitations may simply spur a host of filings before time expires.

 

One final note is that the litigation possibilities arising from problems surrounding these securities are not limited just to the bank holding companies that initiated the trust preferred securities transactions. Investors who suffered losses because of interest payment defaults on trust preferred securities have also been hit with lawsuits. For example, the securities class action filed against RAIT Financial Trust (about which refer here) arose after American Home Mortgage defaulted on its trust preferred securities interest payments obligations, which meant the loss to RAIT of $95 million in revenue.

 

Investors alleged that RAIT had failed to disclose its exposure to American Home and to adequately reserve against the possibility of American Home’s nonpayment. As noted here, on December 22, 2008, the court granted in part and denied in part defendants’ motion to dismiss the RAIT plaintiffs’ complaint.

 

Shareholders Win Japanese Class Action: According to news reports (here), on May 21, 2009, shareholder plaintiffs won a 7.6 billion yen ($81 million) securities class action verdict against Takafume Horie, the founder of failed Internet company Livedoor, and other Livedoor executives. 3,340 individual and corporate shareholders had brought the action, which alleged that the defendants "used stock swaps and other dubious maneuvers to pad Livedoor's books and inflate its share price."

 

Horie (who is popularly known as "Horiemon") is out on bail while he appeals his criminal conviction for securities fraud. Background regarding the fraud allegations can be found here.

 

Subprime Securities Suit, Previously Dismissed, Survives Renewed Dismissal Motion

As the early returns have slowly accumulated for the subprime and credit crisis-related securities lawsuits, the question has arisen (refer here for example) whether or not these cases are faring poorly, in light of the numerous dismissal motions that have been granted thus far. Many of these dismissals have been granted, however, with leave to amend. And now at least one case in which a dismissal was granted with leave amend has survived a renewed motion to dismiss, suggesting that at least in the cases where dismissals were granted with leave to amend, it may be premature to write off the plaintiffs’ prospects.

 

As noted in a prior post (here), on December 11, 2008, Southern District of Florida Judge Ursula Ungaro granted defendants’ motion to dismiss, with leave to amend, in the BankAtlantic Bancorp subprime-related securities class action lawsuit. Judge Ungaro granted the motion on the ground that the plaintiff’s complaint failed to plead facts giving rise to a strong inference that the defendants acted with scienter in making the alleged misrepresentations and omissions.

 

On January 12, 2009, the plaintiff filed a first amended consolidated complaint (here), and the defendants’ renewed their motion to dismiss.

 

In a May 11, 2009 ruling (here), Judge Ungaro found that the amended complaint "cures the most pertinent deficiencies" that she had found in the earlier complaint. Thus, whereas the earlier complaint relied on confidential witnesses "about whom the Court knew nothing," and on allegations that were "vague and [that] failed to show what each of the individual defendants’ knew," Judge Ungaro found that the amended complaint "contains sufficient information regarding these confidential witnesses, including their employment duties, whether they were employed during the Class Period, and how they obtained direct knowledge of the facts they were reporting."

 

Judge Ungaro further found that the amended complaint "clearly states" how the individual defendants were reckless in not knowing the alleged misrepresentations regarding the bank’s lending practices.

 

Judge Ungar considered the defendants’ arguments for the court to consider competing inferences that might be drawn from the plaintiff’s allegations. Noting that the inferences of scienter "need not be irrefutable," she found that the facts alleged gave rise to a strong inference of scienter because the amended complaint "includes specific facts demonstrating that [the defendants] knew or were severely reckless in not knowing of the Company’s risk exposure, which was greater than they disclosed to investors."
 

 

With respect to defendants’ argument that the bank’s woes were due to the "deterioration in the real estate market," Judge Ungar said "whether or not Defendants’ alternative causation theory bars Plaintiff’s claim for damages is a question for another day."

 

Noting that the "pleading requirements under the PSLRA are stringent but are not insurmountable," Judge Ungaro concluded that plaintiffs had sufficiently alleged that the Defendants were "extremely reckless" in the company’s disclosure about the bank’s commercial loans, and so defendants’ renewed motion to dismiss was denied.

 

The amended complaint’s survival is most significant because it comes after the initial motion to dismiss had been granted, raising the possibility that even if the plaintiffs whose original complaints fails to survive dismissal motions may yet be able to file an amended complaint that can overcome the court’s concerns. It may be premature to count out the plaintiffs in the various other cases where initial motions to dismiss have been granted with leave to amend.

 

Judge Ungaro’s denial of the renewed motion to dismiss is also interesting because this case, perhaps by contrast to some other cases (such as the Countrywide and New Century cases) where dismissal motions have been denied, does not involve some of the more dramatic allegations involved in those other cases. For example, by contrast to the Countrywide case, allegations of insider trading were not a significant consideration in Judge Ungaro’s denial of the motion to dismiss in this case.

 

Plaintiffs’ lawyers may well find Judge Ungaro’s opinion as a positive development. Perhaps if the allegations in this case are sufficient, other cases may yet survive motions to dismiss as well. This impression is underscored by the fact that Judge Ungaro was not deterred by the general downturn in the real estate market or the economy.

 

In any event, I have added Judge Ungaro’s latest opinion to my running tally of settlements, dismissal and dismissal motion denials in the subprime and credit crisis-related lawsuits, which can be accessed here.

 

Special thanks to Chris Keller at the Labaton Sucharow law firm for providing me with a copy of Judge Ungaro’s latest opinion. The Labaton Sucharow represents the plaintiff in the BankAtlantic case.

 

Should He Stay or Should He Go?: In the recent Household Financial securities lawsuit jury trial (about which refer here), among the individual defendants who were found to have acted recklessly in making public disclosures was Household director William Aldinger. As a result, Aldinger not only faces the prospect of having to pay monetary damages; he also faces further questions about his continued service on other corporate boards.

 

As reflected in a May 12, 2009 Chicago Tribune article (here), Aldinger serves on the board of four other publicly traded companies: Illinois Tool Works; AT&T; Charles Schwab Corp.; and KKR Financial Holdings LLC. As the article notes, "the verdict raises the question of whether Aldinger should have to resign from the boards."

 

This is uncharted territory in many ways, because so few securities lawsuits actually go to trial. While the verdict does not "automatically disqualify" Aldinger from continued service on the other boards, according to one expert cited in the Tribune article, it certainly puts the boards of those other organizations in a difficult position. The article quotes governance commentator Nell Minow as suggesting that Aldinger should resign and save those other companies from embarrassment and shareholder scrutiny.

 

Aldinger had been CEO of Household prior to its 2003 acquisition by HSBC.

 

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

 

Speaker's Corner: On Thursday May 14, 2009, I will be in Los Angeles for the Professional Liabiltiy Underwriting Society Southern California Chapter eductional event. I will be participating as a panelist on a sesion discussion the State of the Insurance Market. Further information about the session can be found here. If you are attending the event, I hope you will make a point of greeting me and introducing yourself. 

 

A Backlog of Securities Suits Against Companies Outside the Financial Sector?

By now, it is well-established that the recent heightened securities lawsuit filing activity has been largely concentrated in the financial sector. However, litigation involving companies in other sectors has by no means gone away. In addition, recent filings suggest that while the plaintiffs’ lawyers have been concentrating on the financial sector, a backlog of actions against other companies may have been piling up, and that the plaintiffs’ lawyers are now getting around to working off the backlog by initiating long-deferred cases against companies outside the financial sector.

 

The most recent example of this apparently postponed activity against nonfinancial companies involved the online auction company, Bidz.com. As reflected in their May 7, 2009 press release (here), plaintiffs’ counsel has initiated a securities class action in the Central District of California against the company and one if its officers. Though the case was just launched this past week, the purported class period runs from August 13, 2007 to November 26, 2007. That is, the proposed class period ends more than a year and half before the case was filed.

 

The Bidz.com action joins several other recently filed securities class action lawsuits filed against nonfinancial companies where the end of the proposed class period is well before the date on which the cases were first filed.

 

For example, the securities class action first filed in the Southern District of New York on April 28, 2009 against fashion apparel company Liz Claiborne and certain of its directors and officers (about which refer here) has a proposed class period of February 28, 2007 through April 30, 2007. The proposed class period end is nearly two full years prior to the date on which the action was finally commenced.

 

In addition, in the securities action first filed on April 14, 2009 in the Southern District of New York against Coach, Inc., the fashion accessory and leather goods company, the class period proposed runs from January 23, 2007 to October 22, 2007 (refer here for background about the case).

 

These cases join other securities suits filed earlier this year against nonfinancial companies in which the filing date came considerably after the proposed class period end. The Sprint Nextel action (here), first filed on March 10, 2009, has a proposed class period of October 26, 2006 through February 27, 2008. The Rackable Systems case (here), first filed on January 16, 2009, has a proposed class period of October 30, 2006 through April 4, 2007.

 

At one level, there may be nothing remarkable about the timing of these actions’ filings, given the applicable statute of limitation (refer here), which allows actions to be brought up to two years after the discovery of the alleged fraud. These lawsuits are in that sense by no means "stale."

 

But as a practical matter, it is noteworthy that these lawsuits are only now arising, in some cases as much as nearly two years after the supposed revelation of the underlying events. Particularly when these cases are viewed collectively, there is a definite suggestion that these cases may have been deferred while plaintiffs’ lawyers were preoccupied with other things.

 

All of which raises the possibility that while the plaintiffs’ lawyers were caught up in the litigation frenzy concentrated in the financial sectors following the subprime meltdown and the credit crisis, they were also building up a backlog of deferred cases against other companies, to which they are now finally getting around.

 

Of course, this flurry of apparently belated activity against nonfinancial companies could be purely coincidental. Time will tell. The challenge in the interim for D&O underwriters is that the perennial problem of assessing the continuing litigation risk for a company that had some adverse news some time ago may be even trickier now. It is always difficult to know for sure when a company that has had a problem is "out of the woods," and with the possibility that plaintiffs’ lawyers may now be working off a backlog, this assessment may be dicier than ever.

 

The suggestion that plaintiffs’ lawyers may be working off a backlog of cases against nonfinancial companies raises the possibility that the focus of securities litigation activity in coming months may shift to companies outside the financial sector. And as I recently noted (here), the mounting number of corporate bankruptcies may also drive litigation activity outside the financial sectors. Of course, it remains to be seen whether or not these apparent trends will continue to emerge. But the prospect for increased securities litigation involving nonfinancial companies is certainly one of the critical issues to watch as the year progresses.

 

Climate Change and D&O Issues: Regular readers know that I have in the past written extensively (more recently here) about the possibility of a growing D&O exposure arising from climate change-related disclosure issues. My good friend Carol Zacharias, General Counsel of ACE Professional Risks, has written an article published in the Spring 2009 issue of The John Liner Review entitled "Climate Change is Heating Up D&O Liability" (here) that provides a comprehensive overview of the topic, including a review of related litigation that has already arisen.

 

Along with her many interesting observations, Zacharias concludes that "the question is no longer whether there will be actions arising out of how a company and its leadership assess, quantify, and disclose climate change risks, but rather how extensive the litigation will be and when it will be lodged against directors and officers."

 

Hat tip to Mason Power at MAPO Online (here) for the link to the article.

 

$9 Million Missing, Plaintiffs' Lawyer Takes the Fifth - O.K., That's Not Good

Several of the lawyers for the plaintiffs in the Bisys Group securities lawsuit are concerned with the whereabouts of more than $9 million from the $65.8 fund established in connection with the settlement of the case. 

 

As reflected in the transcript of the April 20, 2009 hearing before Southern District of New York Judge Ned Rakoff (here), in response to a question from the court about the missing $9.3 million, counsel for plaintiffs’ attorney Gene Cauley (sole signatory on the settlement fund escrow account) reported that "the funds are presently unavailable to be delivered," and when asked why, counsel responded by saying that "if I go into anymore detail, I think I might violate a privilege against self-incrimination."

 

In response, Judge Rakoff said that "it appears not unlikely... that Mr. Cauley may have committed a crime or several crimes" and that "he may have committed disbarrable conduct in one or many ways." Judge Rakoff also said that he was drawing the inference from Cauley’s taking the Fifth that "Mr. Cauley has either misappropriated or otherwise misallocated these funds" and that because of that possibility, Rakoff "asked the U.S. Attorney to have someone here today." There was in fact an AUSA in the courtroom at the hearing, and Rakoff observed that "I trust there will be a prompt investigation of this matter by the U.S. Attorney’s office."

 

When the Bisys Group litigation settled in October 2006, Cauley’s former law firm, Cauley Bowman Carney & Williams, was a co-lead counsel in the case and appointed as custodian for the settlement fund. Cauley was designated as sole signatory on the escrow account in which the funds were deposited.

 

Rakoff had ordered distribution of the settlement funds to the class plaintiffs through a class action settlement administrator, AB Data. The class funds were to be provided to administrator in a series of payments, the last of which, in the amount of $9.3 million, was to have taken place on April 2, 2009. Apparently Cauley advised A.B. Data that the funds for the April 2 installment were invested in a 90-day Treasury bill and that the funds would be available by April 8. However, the $9.3  million is yet to be provided to A.B. Data.

 

On April 15, several of the lawyers from Cauley’s former firm, now part of a firm called Carney Williams, faxed Rakoff a letter advising him of the situation. Though Rakoff was out of the country at the time, he directed his law clerk to convene a joint conference call, in which Cauley apparently declined to participate. Rakoff then issued an order requiring Cauley’s appearance at the April 20 hearing.

 

At the April 20 hearing, Rakoff ordered the funds that have been deposited so far with the settlement administrator to be distributed to the plaintiff class.

 

In a WSJ.com Law Blog post about these remarkable circumstances here, Cauley’s counsel is quoted as stating with respect to the missing $9.3 million that Cauley is "working to be able to find the money and to pay it in 90 days." The lawyer also said that Cauley "expects to make everyone 100% whole."

 

Judge Rakoff closed the April 20 hearing with a brief peroration reflecting on the unusual circumstances in the Bisys Group case: "When I hear people cracking lawyer jokes, I always take umbrage and point out that the profession of Lincoln, the profession of Madison and Jefferson often represents the highest ideals in our society. But recent events give me pause about how true that is."

 

Cauley was the subject of a past, somewhat colorful WSJ.com Law Blog post (here), which makes for even more interesting reading in light of these more recent circumstances.

 

Special thanks to a loyal reader who also forwarded me a copy of the hearing transcript.

 

Plaintiffs Prevail in Mixed Jury Verdict in Household International Securities Fraud Trial

On May 7, 2009, a jury in the Northern District of Illinois entered a mixed verdict finding in plaintiffs’ favor on several counts in the Household International securities fraud securities class action lawsuit, a long-running case with overtones of the current subprime meltdown. Background regarding the case can be found here.

 

The verdict form the jury entered (which can be found here) is quite complex and very detailed. The jurors were asked to make specific findings with respect to 40 allegedly false and misleading statements. The jury found in favor of the defendants with respect to 23 of the statements. However, the jury found in favor of the plaintiffs with respect to 17 of the statements. Table A to the verdict form identifies and assigns a number to each of the 40 statements.

 

As detailed in by Adam Savett of the Securities Litigation Watch blog (here), the jury found that all four defendants acted recklessly with respect to the 16 statements on which the jury found in favor of plaintiffs. In addition, with respect to an additional statement (Statement No. 14), two defendants (Household and former Chairman and CEO William Aldinger) were found to have acted knowingly, one defendant (Gary Gilmore, the former Vice-Chair of Consumer Lending was found to have acted recklessly, and one defendant (David Schoenholz, the former CFO and COO) was found not liable.

 

 

With respect to the recklessly misleading statements, the jury assigned 55% of the responsibility to Household; 20% to Aldinger; 20% to Schoenholz; and 10% to Gilmer.

 

 

The jury found that from March 23, 2001 (the date of Statement No. 14, with respect to which two of the defendants were found to have acted knowingly), the allegedly misleading statements inflated Household’s share price by as much as $23.94.As the class period progressed, however, the amount of inflation the jury found changed; it ranged between $23.94 a share and negative $4.66 a share. (Negative share inflation is a puzzling concept that I am sure will have to be sorted out at a later date.)

 

 

The available record does not explain how these findings will translate into damages. However, as discussed in press coverage at the time the trial commenced (here), the case was bifurcated with liability issues to be tried first and damages to be tried later if necessary. Apparently there will be further proceedings, based on the jury’s findings in the initial phase, the fix the amount of damages.

 

 

Significance for Current Subprime Cases?: The verdict in the Household case arguably has significance with respect to many of the cases filed in connection with the current subprime litigation wave. Even though the Household case was initially filed in 2002, it involved allegations in connection with representations about residential real estate lending practices.

 

In their complaint, the plaintiffs had alleged that during the class period, the defendants concealed that Household "was engaged in a massive predatory lending scheme." The plaintiffs had alleged that Household "engaged in widespread abuse of its customers through a variety of illegal sales practices and improper lending techniques." Household also reported "false statistics" that were intended to "give the appearance that the credit quality of Household’s borrowers was more favorable that it actually was." The plaintiffs allege that the "defendants’ scheme" allowed them "to artificially inflate the Company’s financial and operational results."

 

In the third quarter of 2002, the company took a $600 million charge and restated its financial statements for the preceding eight years, and in October 2002, the company announced that it had entered into a $484 regulatory settlement regarding its lending practices. On November 14, 2002, the company announced that it was to be acquired by HSBC Holdings. (In recent months, HSBC’s results have been significantly affected by losses in the subprime mortgage portfolio it acquired in the Household deal and its chairman has publicly admitted that "with the benefit of hindsight, this is an acquisition that we wish we had not undertaken.")

 

Securities Lawsuit Trials Are Very Rare: Trials in subprime related securities class action lawsuits are extremely rare. According to data compiled by the Securities Litigation Watch (here), only 21 cases have gone to trial since the PSLRA was enacted in 1995. Only seven of those 21 cases involved conduct that occurred after the PSLRA’s enactment.

 

Two recent high profile securities class action trials involved JDS Uniphase and Apollo Group. As noted here, on November 27, 2007, the jury in the JDS Uniphase trial returned a defense verdict. The Apollo Group trial initially resulted in a January 2008 plaintiffs’ verdict and an award of $277.5 million in damages, but as detailed here, on August 4, 2008, the judge granted the defendants’ motion for judgment as a matter of law, which set aside the jury verdict. A detailed discussion of the two cases can be found here.

 

Not only are verdicts susceptible to post-trial motions, but they are also susceptible to reversal on appeal, as happened in connection with the defense verdict in the Thane International case, where the Ninth Circuit overturned the jury verdict on appeal and ordered a new trial (about which refer here). The retrial in the Thane case resulted in a defense verdict.

 

With the inclusion of the Household International verdict and adjusting for the post-trial motion in the Apollo Group case and the post-appeal verdict in Thane, the scoreboard for the seven post-PSLRA trials – as adjusted for post-trial proceedings--  now stands at three wins for the plaintiffs and four for the defendants.

 

Analysis: While there are further procedures yet to go, the verdict in the Household case nevertheless represents a significant development. The subprime overtones in the case and the defendants’ connection to financial giant HSBC guarantee that the verdict will be very high profile, and it could well cast a shadow over the many other more recently filed cases where questionable lending practices are involved. It is unlikely that many other litigants will be encouraged to push their cases to trial, but the settlement potentially could influence settlement discussions in the other cases.

 

The way that plaintiffs might try to use the Household verdict in the current litigation can be clearly discerned in the statement from Patrick Coughlin, whose firm Coughlin Stoia Geller Rudman & Robbins represented the plaintiffs in the Household case. Coughlin states that “The jury’s verdict is a victory for the million of Americans suffering as a result of deceptive predatory lending practices and a victory for all investors fighting for greater corporate transparency, honesty and integrity. “

 

Andrew Longstreth of AmLaw Daily has a May 7, 2009 article about the Household verdict, here.

 

Securities Litigation Update: On Friday May 8, 2009, I will be participating in a webinar sponsored by Advisen in which Advisen’s finding regarding 1Q09 securities lawsuit filings will be discussed. The hour-long webinar, which is free, will begin at Noon EDT. Registration for the webinar is available here. Advisen’s report on first quarter filings can be accessed here.

 

Mounting Bankruptcies Spread Securities Litigation Risk

As the subprime meltdown has become a more generalized economic crisis, the adverse consequences have moved far beyond the residential real estate sector where the trouble first began. Until recently, however, the worst effects were concentrated in the financial sector. But as Chrysler’s recent bankruptcy filing shows, the turmoil is no longer limited to the finance sector alone. The infiltration of the credit crisis into the larger economy not only threatens a rise in bankruptcies, but could also include increased bankruptcy-related securities litigation, much of which may be outside the financial sector.

 

An indication of how these developments might arise can be seen in the securities class action lawsuit filed in the Northern District of Texas on April 30, 2009, against certain former officers of Idearc, Inc. A copy of the complaint can be found here. Idearc "manages and delivers print, online and wireless publishing and advertising services on multiple platforms," including yellow and white pages, online directories and search services. Idearc itself filed for protection under the U.S. bankruptcy laws on March 3, 2009, and so is not named as a defendant in the securities lawsuit.

 

The complaint alleges that in 2006 and 2007, the company had "touted" its credit and collection policies and procedures, which it claimed had resulted in a steady decline in its bad debts. However, the complaint alleges, during 2007, the company "relaxed" its credit policies "in order to increase the dollar amount" of reported revenue.

 

The complaint further alleges that the company, "by selling to non-creditworthy customers, effectively reported tens of millions of dollars of sales that it otherwise would not have reported while accumulated tens of million of dollars of uncollectible receivables." However, the complaint alleges, in mid-2008, the company admitted that it had relaxed its credit policies in 2007, and "began to write off these uncollectible receivables in a piecemeal fashion over several quarters."

 

The complaint alleges that by year end 2008, the company had written off $47 million of receivables, which among other things "materially contributed to the company’s need to file for bankruptcy protection." The complaint alleges that investors were misled by the company’s disclosures regarding its credit and collection policies and procedures as well as by the piecemeal revelation of its company’s growing problems with receivables collections and reserve for bad debts.

 

As the economy sours, many companies – including companies outside the financial sector, like Idearc – are likely to experience increasing difficulties realizing the anticipated benefits from customer, vendor or counterparty obligations. By the same token, reduced economic activity may render many companies unable to meet their own obligations to their creditors, suppliers and others.

 

As these problems accumulate, other companies will find it necessary to seek protection under the bankruptcy laws. The officers and directors of many of these bankrupt companies, like those at Idearc, may find themselves the target of a post-filing securities class action lawsuit. Another recent example of a post-filing bankruptcy lawsuit involves former directors and officers of MRU Holdings, about which I previously wrote here.

 

The increase of these kinds of bankruptcy related lawsuits may be the means by which the current wave of subprime and credit crisis-related litigation spreads outside the financial sector. In its recent quarterly report on securities litigation (here), Advisen suggested that "it is likely that the wave of subprime-related suits, and in particular suits filed against financial services companies, will crest in 2009." The report goes on to suggest that "as bankruptcies rise through the economy, hitting all sectors, and securities suits are filed as a consequence, suits filed will become more dispersed …broadly affecting all sectors."

 

More Failed Banks: In what is now a standard weekend ritual, this past Friday evening the FDIC closed three more banks, bringing the year to date total number of failed banks to 32. The three banks closed this Friday night were: Silverton Bank of Atlanta, Georgia, which prior to its closure had assets of $4.1 billion, making it the fifth largest bank to fail since the beginning of 2008 (further details about the bank can be found here); Citizens Community Bank of Ridgewood, N.J. , which had assets of $45.1 million (refer here); and America West Bank of Layton, Utah, which had assets of $299.4 million (refer here).

 

Silverton is the sixth Georgia bank to be closed this year and the eleventh since January 1, 2008, the highest total for any state during either of those two periods.

 

In light of their relatively small size, both Citizens Community Bank and America West Bank qualify as community banks. As I recently noted (here), the 2009 bank failures have largely involved these kinds of smaller community banks. Indeed, 27 of the 32 banks that have failed so far this year have involved financial institutions below $1 billion in assets, which is one standard measure of community banks.

 

Silverton was quite a bit larger than these community banks, and it is also somewhat unusual in that Silverton did not take deposits from the general public or make loans to consumers. Silverton was a wholesale bank, providing services, according to the Wall Street Journal (here), to one in every five banks in the country. Silverton was known as the Bankers Bank until last year. Its customers, depositors and investors are all banks. Banks that had invested in Silverton will incur losses as a result of its failure, which could pose problems other banks.

 

The FDIC’s complete list of failed banks since October 2008 can be found here. The Wall Street Journal has a nifty interactive table of all the failed banks here, which can be sorted by name, closure date, asset and deposit size, and other factors. (The Journal’s list does not yet include Citizens Community Bank and America West Bank.)

 

Speakers’ Corner: On Monday, May 4, 2009, I will be in New Orleans at the spring meeting of the Casualty Actuarial Society, participating on a panel entitled "An Update on the Credit Crisis and Related Issues for D&O Insurers." The panel will be chaired by Joe Lebens of the Towers Perrin firm, and will include Stephanie Plancich from NERA Economic Consulting and David Bradford from Advisen. More information about the session and the conference can be found here.

 

First Quarter 2009 Securities Lawsuit Filings Up

Securities class action lawsuits filings are on pace to make 2009 the most active for securities class action filings in years, according to Advisen’s May 1, 2009 Securities Litigation Quarterly (here). According to the report, there were 67 securities class action lawsuits in the first quarter of 2009, up from 56 a year earlier. The first quarter filings represent an annualized filing rate of 268 securities class action lawsuits, which would not only represent a significant increase over 2008 but would even be greater that the "relatively litigious year of 2004."

 

My own analysis of the first quarter 2009 securities class action filings can be found here.

 

The overall purpose of the Advisen report is to analyze "securities lawsuits" in the first quarter of 2009. As used in the Advisen report, the term "securities lawsuits" refers not just "securities class action lawsuits," but also includes SEC enforcement actions, state court fiduciary duty cases, and even lawsuits filed in non-U.S. courts.

 

In addition, the report uses yet a different term – "securities fraud lawsuits" – as a subset of "securities lawsuits," to describe SEC enforcement proceedings and other regulatory actions.

 

So in the report "securities class action lawsuits" and "securities fraud lawsuits" are each separate and distinct subcategories of the larger category of "securities lawsuits."

 

According to the Advisen report, filings in the broadest category -- "securities lawsuits" -- were up significantly in the first quarter of 2009, with 169 of these actions, compared with only 125 in the fourth quarter of 2008, and 134 in the first quarter of 2008. These filings (which, again, represent a broader category than just "securities class action lawsuits") were significantly increased by Madoff-related lawsuit filings, which represented 30% of all the "securities lawsuits" in the first quarter. The report notes that "2009 might end up as a year with a heavy front-end load of lawsuits" due to the "flurry of Madoff-related cases" in the first quarter.

 

Using its own categorization, the report notes that fewer of the "securities cases" plaintiffs are filing are "securities class action lawsuits," and that plaintiffs increasingly have been filing securities lawsuits alleging common law torts, contract law violations, and breach of fiduciary duties." The report speculates that plaintiffs’ counsel may be pursing these alternatives in order to be able to proceed in state court and to avoid having their case consolidated with the larger class action suit.

 

With respect to "securities lawsuits" other than "securities class action lawsuits," the enforcement and regulatory actions that the report categorizes as "securities fraud lawsuits" accounted for 34 suits filed in the first quarter, up from 19 in fourth quarter of 2008, but down from 54 in third quarter of 2008. The "securities fraud lawsuits" filed in first quarter of 2009 represent an annualized filing rate136 cases, flat with 2008 but down from 175 in 2007.

 

Other types of "securities lawsuits" other than "securities class action lawsuits" filed in the first quarter of 2009 were: breach of fiduciary duties (26), collective actions in non-US courts (20), derivative shareholder actions and other derivative cases (14), and others (8).

 

The Advisen report notes that suits against financial firms dominated the "securities lawsuit" filings in the first quarter. The report notes that 117 out of the 169 "securities lawsuits" filed (or 69%) in the first quarter involved financial services firms (including insurance companies). These financial services claims fall in four basic groups: the Madoff-related claims; subprime and credit crisis-related claims; specialist improper trading claims; and Stanford Group-related claims.

 

With respect to the subprime and credit crisis-related claims, the report suggests that these claims "will crest in 2009," adding that "as bankruptcies rise through the economy, hitting all sectors, and securities suits are filed as a consequence, suits filed will become more dispersed…broadly affecting all sectors."

 

The report notes that many of the cases will not only potentially trigger D&O insurance policies, but "may also trigger coverage under errors and omissions (E&O) and fiduciary liability policies" which is true with respect to may of the Ponzi scheme cases as well as with to some of the subprime and credit crisis-related cases.

 

First Quarter Report Webinar: On Friday May 8, 2009, at Noon EDT, I will be joining David Bradford and Jim Blinn of Advisen for a free one-hour webinar to discuss the findings in the Advisen quarterly report and to discuss the implications for the liability insurance market. Registration for this free webinar is available here.

 

Will TARP Money Fund Securities Lawsuit Settlements?:

Several of the recipients of TARP funding have also been the targets of securities class action lawsuits and other litigation. In an April 29, 2009 post on the DealBook blog (here), Dan Slater, formerly of the WSJ.com Law Blog, raises the concern that TARP money could be used “to line the pockets of allegedly aggrieved shareholders and the lawyers who, wrapped in the flags of corporate governance, are in the process of making a billion-dollar cottage industry out of filing strike suits.”

 

As an example, Slater cites the case of Merrill Lynch, which, on the same day as its new corporate parent Bank of America announced that it was receiving an additional $20 billion in TARP money, announced that it would pay $550 million to settle a securities class action lawsuit and an ERISA lawsuit. (For further detail regarding the Merrill settlement, refer here.) Slater contends that as a result of the settlement either BofA will be less able to repay its TARP obligation or must cut its TARP allotment to settle up

 

 

Slater also notes that 19 of the 32 recipients of $1 billion or more of TARP money have since January 2008 been sued in securities class action lawsuits. “Put another way,” Slater states, “of the more than $300 billion that’s been paid out in TARP money, nearly $240 billion of it, or 78 percent, is subject to shareholder suits.”

 

 

Slater argues that while there has always been a circularity involved in the funding of securities lawsuit settlements, now, “in the world according to TARP,” the securities settlement money could be coming from taxpayers.

 

 

Slater raises an interesting point, and the example of Merrill Lynch is particularly telling. I think his analysis is incomplete, however, to the extent that it disregards the existence of D&O insurance, E&O insurance, and fiduciary liability insurance, which will be funding a very substantial amount for the defense and settlement of these lawsuits.

 

 

However, the Merrill Lynch settlement unquestionably raises the concern, given its sheer size, that the resolution of these cases could require funding that far exceeds that amount of insurance available. To that extent, at least, there arguably is a concern that TARP money could fund, or at least offset the cost of, securities class action settlements.

 

 

Slater’s points are, to that extent at least, well taken. I think it should be noted that plaintiffs’ lawyers are well aware of these concerns – many of the lawsuits to which Slater refers were filed before TARP was instituted, and since the TARP payments were first made, plaintiffs’ attorneys have had to take these kinds of concerns into account on deciding whether or not to file new cases.

 

 

These kinds of issues may also be part of the constellation of considerations that has been affecting courts’ reactions to the early motions to dismiss. As I have previously noted (most recently here), while it is still early, many of the subprime and credit crisis-related cases have not been faring particularly well in the courts at the motions to dismiss stage, and concerns like those that Slater has raised may be part of the reason.

 

 

An April 29, 2009 Am Law Litigation Daily post discussing Slater’s article can be found here.

 

 

Madoff Redemption Clawbacks?: One of the more interesting and complicated questions that has arisen lately is the extent to which Irving Picard, the trustee for the Bernard Madoff Investment Securities liquidation, wil be able to "clawback" amounts from BMIS investors who redeemed their investors who redeemed their investments prior to the firm's collapse. An April 28, 2009 paper by NERA Economic Consulting entitled "Clawbacks from Madoff Investors: Questions of Economics, Equity and Law" (here) takes a detailed look at the issues surrounding the extent of the trustee's ability to recover the amounts previously redeemed. As the paper reviews at length, there are a variety of competing considerations that will have to be balanced in determing the extent to which the trustee appropirately may clawback these amounts.  

Ken Lewis, BofA and the Fed Strong-Arm: Ten Questions

Bank of America’s acquisition of Merrill Lynch went through, so we will (fortunately) never know what would have happened if the deal had collapsed. But as detailed in the April 23, 2009 letter (here) from New York AG Andrew Cuomo to Sen. Chris Dodd, Rep. Barney Frank and others, if it had been up to BofA, the deal would not have closed, and it was only as a result of a combination of threats and inducements from Henry Paulson and Ben Benanke that BofA and its Chariman, Kenneth Lewis, were convinced to complete the deal.

 

In his letter, Cuomo urged Congressional and regulatory officials to examine the pressure that Paulson and Bernanke applied to Lewis and to BofA. Cuomo wrote that the federal officials' actions "raise fundamental questions about the interactions of regulators and those they regulate, as well as important issues of corporate responsibility and shareholders' rights." 

 

The information in the April 23 letter and accompanying documents is fascinating, but the still-incomplete picture of the December meetings in which BofA was convinced to complete the deal raise a number of serious questions. The letter and the accompanying exhibits can be found here.

 

1. Why did Lewis contact Paulson and Bernanke to tell them that BofA wanted to invoke the "material adverse event" clause and kill the deal? Presumably, the merger agreement was a private transaction between two private parties. Right? Well, maybe not. Apparently, as a result of its role in having brokered the Merrill deal, the government retained something more than a gaming interest in the transaction.

 

But why did Lewis have to report to the feds? Doesn’t it seem like he was asking their permission? Why? Was there a prior strong-arm session, perhaps back in September, where the government previously offered threats and inducements to BofA to get them to accept the deal in the first place? Did BofA make a commitment to the feds, and vice versa, as part of the events that led to the original deal?

 

2. Did Lewis and the BofA board accede to the fed officials’ demands in order to preserve their positions? Cuomo’s letter certainly intends to communicate that Lewis was convinced to go through with the deal in order to be able to keep his job. Lewis undeniably testified when examined by NYAG’s office personnel that Paulson threatened BofA’s board and Lewis with a loss of their positions. (A transcript of Lewis’s testimony can be found here.)

 

BofA’s December 22, 2008 Board of Directors Meeting minutes (here) reflect that Lewis reported to the board that Paulson had threatened them (Lewis and the board) with the loss of their positions if the deal failed to go through. Cuomo’s letter also reports that Paulson told the NYAG’s officials that the job threat to Lewis "changed his mind about invoking the MAC clause and terminating the deal."

 

To be sure, the December 22 board minutes also very carefully recite that "the Board clarif[ied] that is [sic] was not persuaded or influenced by the statement by federal regulators that the Board and management would be removed if federal regulators if the Corporation were to exercise the MAC clause and failed to complete the acquisition by Merrill Lynch." And both the December 22 and December 30, 2008 board minutes (here) reflect concerns about the possible damage to the global economy if the deal failed to go through.

 

But there doesn’t seem to be any doubt that the threats were made, that Lewis reported the threats to the BofA board, that the board and Lewis discussed the threats, and Paulson at least seems to think the threats had the effect he intended.

 

3. Realistically, could BofA have turned down the fed officials’ demands? It is not as if just that the Secretary of the Treasury and the head of the Federal Reserve Board alone were strong-arming BofA. BofA’s December 30 board minutes reflect that Bernanke was communicating about the deal to the Office of the Comptroller of the Currency, the FDIC, and the "incoming economic team of the new administration." The existence of these communications were revealed to reassure BofA that it could count on promised additional TARP money, but the existence of the communications also carried an unsubtle implied threat for a high profile company in a highly regulated industry.

 

At a minimum, BofA had to wonder how regulators might respond, at a very precarious time for the company, if it walked away.

 

4. Who said what to whom about disclosure? The April 23, 2009 Wall Street Journal led with the story, supported by the transcript from Lewis’s testimony before NYAG officials, that Paulson directed Lewis to withhold disclosure of BofA’s concerns with the deal in order to ensure that it went through. Whether or not these directions took place will be the central issue in the investigative frenzy that is no doubt about to unfold.

 

The one thing that is clear is that the BofA board was concerned about disclosure. Among other things, the minutes of the BofA’s December 30 board meeting show that the reason the federal officials could not give BofA written assurance that additional TARP funds would be forthcoming if the deal closed is that "written assurances would require formal action by the Fed and the Treasury, which formal action would require public disclosure." The wording of this sentence makes it unclear whether it is BofA or the feds that were worried about disclosure, but it seems clear that the feds were aware of and involved in the disclosure question.

 

A December 22 email from Paulson to the BofA board (here) seems to suggest that Lewis and the board was concerned about preventing disclosure, but the email arguably is ambiguous. In the email Lewis told the board that Paulson "could not send a letter of any substance without public disclosure, which of course, we do not want." The problem with this sentence is the question of who the word "we" refers to? Is Lewis reporting that Paulson used the word "we" (referring, perhaps, Paulson and his fellow regulators, or perhaps, to Paulson and Lewis), or is does the statement attributed to Paulson stop at the comma, and is the clause after the comma a statement of Lewis’s own, with the word "we" referring to BofA’s board?

 

 

Cuomo's letter and Lewis's transcript both seem to suggest that disclosure was not just a concern on the part of the BofA board, but that it was also a concern of Paulson's, and that he actibvly sought to avoid disclosure related to the unreported Merrill losses. Disclosure was a concern, a topic of discussion and focus in discussions between Lewis and Paulson. Which leads to my next two questions.

 

5. Did Paulson or Bernanke provide Lewis with immunity assurances? We are talking about some very smart guys, and they were fully aware of the legal requirements of disclosure, even if they didn’t pause to analyze the legal particulars. Lewis had to have known that by going through with the deal even though the Company felt entitled to invoke the MAC clause, and that by withholding disclosure of Merrill’s huge and unexpected fourth quarter losses, he and even perhaps the BofA board were potentially undertaking a massive legal exposure – at a minimum, a civil lawsuit exposure, and possibly even much worse exposures.

 

Did Lewis raise these issues with Paulson and Bernanke? (I find it almost impossible to believe that he did not.) Did they provide any assurances to him? Was he given assurances of immunity or indemnity? Did they promise him a "get out of jail free" card? Without these assurances, how could he possibly have been persuaded to "take one for the team"? Doesn’t it seem wildly improbable that these issues were not discussed?

 

6. Are Paulson and Bernanke or others potentially exposed to aiding and abetting liability? This question is not facetious and in fact it is particularly important to me, because I have former colleagues from GenRe, people whom I knew and whom I respect, who are going to jail for their complicity in a deal that seems miniscule and trivial compared to this minuet. Certainly, if the federal regulators directed Lewis and BofA not to disclose material nonpublic information, their involvement in nondisclosure that is later found to constitute securities fraud could implicate them as well.

 

But could they be implicated even if they did not direct the nondisclosure but simply accommodated and facilitated it (for example, by not following through on required federal processes that would have compelled public disclosure)? That is certainly all the Gen Re officials did, and as a result they are going to be spending some serious time in the federal penitentiary.

 

Let me hasten to add that I am not suggesting that criminal prosecution is something that I think will happen here, or even that I think should happen here. But if these kinds of questions are later raised, the questions clearly should be followed all the way to their logical conclusion.

 

7. The strong-armed deal may have hurt BofA shareholders, but could it have been worse for them if the deal crumbled? There is no doubt that Paulson’s demand that BofA go through with the deal despite the BofA’s view that it was entitled to invoke the MAC clause had the effect of requiring the BofA shareholders to take a big hit for the sake of the global economy. But that does not necessarily mean it was contrary to the BofA’s shareholders’ interests for BofA to go through with the deal.

 

Given how massively disruptive Lehman Brothers’ collapse was to the global financial marketplace, it is almost inconceivable how disruptive it could have been if the Merrill deal had fallen through. Merrill would have been cast off, and the revelation of its staggering and unexpected fourth quarter losses would have triggered its immediate collapse – or maybe federal officials could have tried a huge AIG-style rescue of Merrill while somehow trying to reassure that global financial marketplace that there was no reason to panic.

 

My point is that if the Merrill deal had fallen through, the collateral damage from the ensuing firestorm could have substantially damaged BofA's near and longer term interests.. It is impossible to know now, but the fact is that it may well have been in the BofA shareholders overall best interests for the firestorm to have been averted. Of course, it does seem like the BofA shareholder ought to have had the right to decide for themselves, doesn’t it?

 

8. Is there a national interest exception to the disclosure requirements in the federal securities laws? Imagine for a second if BofA had come right out and disclosed that it felt entitled to invoke the MAC clause but that in order to support the global economy and in exchange for some additional TARP money, it was going through with the deal anyway. Now basic principles dictate that they should have disclosed all of this. But if they had, the chaos that would have followed might have been as bad or even worse than what happened if the deal failed to close – which might well have happened anyway in the wake of these kinds of disclosures.

 

It is easy for commentators to try to argue now what should have been done, as if this were just an amusing question in a parlor game. At the time, however, the principals had no way of knowing how close they were running to potentially catastrophic financial disruption. In view of the weakness in the financial markets and the economy, it was no time for any experiments.

 

But do their fears, even if well founded, earn them a pass for their silence? If they get a pass, on what basis? What is the legal justification and where is it found? On what standard is it based? And who gets to decide when interests are sufficiently important to override the securities laws – can any government official decide that national interests override disclosure requirements? And what precedent would be set for the future? And isn’t it a duty of public officials to ensure compliance with the law, rather than encouraging noncompliance?

 

9. Given the facts on the table at the time and the surrounding revelations about Merrill’s fourth quarter losses, how is it possible that the controversial Merrill bonuses were permitted? Obviously, there is a lot more to be told on this score, but if the federal regulators had the authority to tell BofA it had to complete the deal, and if they felt empowered simply to override federal disclosure requirements, surely these same people had the clout to shut down the bonuses? If they felt they had the ability to trample, or simply disregard, BofA shareholders’ rights, why would they hesitate to bar the payment millions in bonuses for billions of losses?

 

Given all that was going on, that the bonus payments happened seems even more incomprehensible to me – and I am sure I am not the only one.

 

10. How long will it be before this all gets sorted out? I suspect this will go on for years and years to come. Expect the most immediate steps to include a cycle of sessions in Congressional hearing rooms, replete with the revolting spectacle of speechifying politicians grandstanding at the expense of public dignity. The various judicial processes, some of which are already well underway, some of which will be launched in the months ahead, will grind on for years, with at least two or three round trips to the Supreme Court. My prior post about lawsuits already filed about these circumstances can be found here.

 

At some point, possibly in the near future, a coalition of crusaders, a lynch mob, or a gang of zealots will try to organize Lewis’s ouster, and who knows, maybe they may well succeed this time. Indeed, for those wondering why all of this is coming to light all of the sudden now, the timing was obviously due to the fact that the BofA shareholders' meeting is next week -- leaving just enough time for the voices of outrage to get fully tuned up for the meeting.

 

Whatever else you want to say about these circumstances, the spectacle to which we are all about to be subjected will not be pretty and is unlikely to be edifying.

 

Judge Calls Plaintiffs' Firm's "Monitoring" Services "Shocking Conflict of Interest"

One of the recurring issues in securities litigation is the way the erstwhile class counsel and their clients, the prospective class representatives, come together. In what one federal judge described as a "blatant, shocking conflict of interest," it appears, from testimony at a recent lead plaintiff selection hearing, that the leading plaintiffs’ firms are providing investment portfolio "monitoring services" for which the firms are paid only if their public pension fund clients pursue litigation recommended by the law firm. In a post-hearing brief in the case, the  firm involved defended its practices as appropriate.

 

These issues arose at an April 1, 2009 hearing before Southern District of New York Judge Jed Rakoff, involving two cases, the Credit Based Asset Servicing case (about which refer here) and the Merril Lynch Mortgage Pass Through Certificate case (refer here). Both cases involve alleged misrepresentations in connection with the initial public sale of certain mortgage-backed securities.

 

At the April 1 hearing, Judge Rakoff consolidated the two cases. The primary purpose of the April 1 hearing was to determine which of the two proposed plaintiffs was the "most adequate" to represent the class in the consolidated case.

 

As reflected in the hearing transcript (here), Judge Rakoff first heard testimony from an administrator for Iron Workers Local No. 25 Pension. In response to questions from the Judge, the administrator testified that they way he learned about the allegations in the case was that "they were brought to me by counsel."

 

The administrator explained that the lead plaintiffs’ firm representing the pension fund in the case has a long-standing investment portfolio monitoring contract with the fund. Under this contract, the law firm monitors the fund’s investments and advises the firm when circumstances arise that would warrant a lawsuit. The plaintiffs’ firm is only paid if they bring a lawsuit and recover.

 

Among other things, Judge Rakoff called this arrangement "about as obvious an instance of conflict of interest as I’ve ever encountered in my life," noting that the plaintiffs’ counsel,

 

under the guise of monitoring the [pension fund’s] investment to determine whether or not there are any violations of the law …have made an arrangement whereby they will only get paid if there are lawsuits brought that they can recover on, and that they will be plaintiffs’ counsel in that lawsuit.

 

Judge Rakoff observed that "if that isn’t a gross conflict of interest in violation of the most elementary fiduciary duties, I don’t see what is." He added that the arrangement inherently compromises the objectivity of the monitoring they’ve been asked to undertake. Indeed, to be frank, I’m shocked that any law firm would enter into such an arrangement."

 

Counsel for the Iron Workers gamely defended the arrangement, among other things asserting that "this portfolio monitoring is not something unique to this firm," an argument that did not impress Judge Rakoff. In response to plaintiffs’ counsel’s suggestion that his law firm analyzes and evaluates the merits of the case before recommending that the fund become involved in litigation, Judge Rakoff said that arrangement "makes crystal clear that the Iron Workers are being led by counsel rather than the other way around," a circumstance the PSLRA had tried to eliminate.

 

Judge Rakoff then heard testimony from the Special Assistant to the Mississippi Attorney General, on behalf of the other proposed lead plaintiff, the Mississippi Public Employees Retirement System. The representative’s testimony established that Mississippi also had monitoring arrangements with plaintiffs’ law firms, but with twelve separate firms rather than just one. The representative also testified that the possibility of bringing this particular action had been brought to the state’s attention by a separate firm that performs bankruptcy related services for the state.

 

The representative explained by using plaintiffs’ firms for monitoring , rather that paying for independent monitoring services, the state was able to save costs. The state representative described the use of plaintiffs’ firms for monitoring services as a "commonplace practice," in response to which Judge Rakoff observed

 

Yes, well, I’m learning that, and to be frank, that doesn’t make me less shocked, that makes me more shocked, because what you’re telling me is that persons, entities with a fiduciary duty, which includes a fiduciary duty to monitor the investments they’re making with their members’ money, have concluded that to save a few bucks they will employ as monitoring entities firms that can only profit of their advice goes one way and not the other.

 

Judge Rakoff did find certain distinguishing characteristics in Mississippi’s case, in that one of its twelve monitoring firms had not brought the case to the state (although it turns out that the bankruptcy firm that did bring the case to the state does have a contingency fee interest in the case); and that even if one of the twelve firms were to bring a case forward, the case would be independently evaluated by other firms and the state’s own representatives. Finally, the state representative testified that in this case the state had reached out to the lead plaintiffs’ firm, rather than the other way around.

 

Ultimately Judge Rakoff did not rule at the April 1 hearing on the question of which of the two proposed plaintiffs would be the lead plaintiff in the case. Rather, he asked for further briefing, noting a concern that at the hearing he might have been "overreacting because of hearing about this arrangement for the first time."

 

Even though Judge Rakoff ultimately did not rule at the April 1 hearing, his shocked response to the practices that were described multiple times at the hearing as "commonplace" does seem to suggest that there may be concerns with the monitoring arrangements. Certainly, the language the Judge used to characterize the arrangements is impressive, to say the least.

 

Pursuant to Judge Rakoff’s briefing schedule, and in response to his comments, on April 8, 2009, the Iron Workers filed a legal brief (here), that among other things defends the monitoring arrangements on the grounds that the monitoring agreement does not itself authorize the firm to initiate litigation on the fund’s behalf without the fund’s authorization, and that the fund is under no obligation if it decides to pursue litigation to use that particular law firm.

 

In addition, the Iron Workers’ brief cites multiple cases in which various courts found that the existence of similar monitoring arrangements were not a barrier to the proposed plaintiffs’ service as a class representative.

 

Finally, the brief also includes an opinion from the distinguished legal scholar Geoffrey Hazard that the portfolio monitoring services were not "professionally improper" and that there is no conflict of interest in these circumstances because the pension fund is not obligated to bring suit even if the firm recommends it. Hazard also stated that the mere fact that the plaintiffs’ firm was "working for a contingent fee" does not present an "inappropriate bias."

 

The Mississippi Public Empoyees' Retirement System's brief regarding the alleged conflict and the lead plaintiff issue can be found here. Merrill's brief can be found here.

 

UPDATE: In an  April 23, 2009 order (here), Judge Rakoff appointed the Mississippi Public Retirement System as the lead plaintiff in the cases. In the April 23 order, Judge Rakoff also stated that  the lead plaintiff determination "involved the Court's resolution of several difficult issues, which will be elaborated in a written opinion." Judge Rakoff said that he would issue the detailed opinion after he completed an ongoing criminal trial that he has been conducting.

 

Special thanks to a loyal reader for providing a copy of the hearing transcript.

 

 

More About Life Sciences Companies and Securities Litigation

In prior posts (most recently here), I discussed the fact that while litigation against the financial sector has predominated recent securities lawsuit filings, plaintiffs’ attorneys also have targeted other sectors, including in particularly the life sciences sector. An April 2009 memorandum by 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 2008 life sciences securities lawsuits and analyzes the allegations on which the claims are based.

 

The memo notes that the 23 securities lawsuits filed against life sciences companies in 2008 is about the same number as the 25 life sciences securities lawsuits filed in 2007. However, the report also notes that the 2008 life sciences securities lawsuit filings represented only 10% of all securities lawsuit filings during the year, compared to 14% in 2007. The report attributes this slight drop to the fact that securities lawsuits in the financial sector "skyrocketed" in 2008.

 

The memo reports that, similarly to prior years, half of the life sciences companies sued in 2008 were very small, with market capitalizations below $250 million. However, by contrast to 2007, when nearly half of the life sciences companies sued had market capitalizations greater than $10 billion, on 2008 "only 13% of total actions were brought against the largest companies."

 

With respect to the allegations raised in the new lawsuits, the memo notes that in 2008, the majority of claims "pertained to accounting improprieties and/or misstated or misleading financial results and forecasts, by comparison to the 2007 filings, where industry-specific issues such as product safety, efficacy or marketing predominated.

 

The memo does note that about 25% of the 2008 filings contained allegations of alleged misrepresentations or nondisclosure regarding the commercialization or marketing of the product, and about 25% alleged that the defendants had made false and misleading statements about the safety of their product.

 

The memo also notes that one trend observed in 2007 had continued in 2008; that is, the plaintiffs’ lawyers are continuing to include key research personnel as defendants, on the apparent theory that these individuals "had a high level position within the company and access to internal information," and therefore "they knew and failed to disclose the allged adverse non-public information." The memo reports that key research personnel were named as defendants in five of the 23 life sciences securities lawsuits filed in 2008.

 

With respect to the likelihood of future litigation in the sector, the memo notes that life sciences companies "are particularly vulnerable to securities lawsuits because of their inherently volatile stock prices, often driven by a drug or device product life cycle that is fraught with potential for adverse and unpredictable events." That vulnerability "may increase in coming months and years when the boom of securities class actions in the financial sector busts." The memo speculates that "once plaintiffs’ targets in the financial sector dry up, other sectors, including life sciences, may see an increase in lawsuits aimed their way."

 

In discussing the 2007 version of Dechert’s life sciences securities litigation report, I had raised (here) the question whether or not the numerous lawsuits against life sciences companies actually were successful, and in particular, I asked whether or not the cases were dismissed more frequently than other securities lawsuits. The 2008 Dechert memo addresses these questions by taking a look at how the 2007 life sciences securities lawsuits have fared so far.

 

The 2008 memo reports that of the 25 life sciences securities lawsuits filed in 2007, eleven have been dismissed and two have settled. The memo states that the two settlements are "within the standard range" for securities lawsuit settlements generally, and that the dismissal rate "mirrors that of securities class actions in general."

 

The dismissals largely have been based on the plaintiffs’ failure to fulfill the requirements for pleading scienter. The memo comments that "though plaintiffs may be given multiple opportunities to amend their complaints, they will not be able to survive a motion to dismiss with general, conclusory or generic allegations of knowing misconduct."

 

The Dechert memo’s tally of 23 life sciences securities lawsuits in 2008 squares with my own count. I note that in preparing my count of the life sciences lawsuits, I had used a rather narrow definition of the category, limiting the "life sciences" companies to those either in SIC Code series 283 (Drugs) or SIC Code series 384 (Surgical, Medical and Dental Instruments and Supplies).

 

The memo, which concludes with practical risk minimization suggestions, is quite good and merits reading at length and in full.

 

Special thanks to the author of the Dechert memo, David Kotler, for providing me with a copy of the memo.

 

The Rise and Fall of Bill Lerach: The Professional Liability Underwriting Society (PLUS) has posted its acclaimed video, "The Rise and Fall of Bill Lerach," on the members’ section of its website. PLUS members can access the video here. The video alone might justify cost of membership. A trailer of the video can be found on the Securities Docket site, here.

 

Alleged Anticompetitive Behavior and Follow-on Securities Litigation

Antitrust regulation and securities enforcement each involve entirely separate areas of the law. However, an increasingly frequent follow-on effect of a regulatory investigation for allegedly anticompetitive conduct is an ensuing class action lawsuit under the securities laws. A lawsuit recently filed in the Southern District of New York, which also has some unique characteristics all of its own, is the latest example of this kind of follow-on securities litigation. These cases may present important D&O insurance considerations, as well.

 

According to their April 9, 2009 press release (here), plaintiffs’ counsel have filed a securities class action lawsuit against Mechel OAO and certain of its directors and officers. Mechel is a Russian mining and metals company whose American Depositary Receipts trade on the NYSE. The securities complaint (which can be found here) follows in the wake of declines in the company’s share price after allegations of "anticompetitive and monopolistic practices."

 

The sequence of events surrounding the allegations involves a remarkably compressed time frame. According to the complaint, on July 24, 2008, then-Russian Prime Minister Vladimir Putin "called for antitrust authorities to investigate Mechel’s raw material pricing policies," amid allegations that Mechel charged Russian customers twice what it charged non-Russian customers. On July 28, 2008, Putin also stated that Mechel had used offshore traders to minimize tax payments, which he characterized as "tax evasion."

 

According to the complaint, on August 14, 2008, barely three weeks after Putin’s initial statement, Mechel was found guilty of breaking competition laws; discriminating against Russian consumers; and maintaining a monopoly in the coal market. Mechel was ordered to take several remedial steps, including cutting prices and signing long term deals with local clients. The company was also ordered to pay a $32 million fine.

 

The securities complaint filed on April 8 alleged that the defendants failed to disclose:

 

(i) that the Company had engaged in anticompetitive conduct by employing a discriminatory pricing policy for raw material sales between domestic and foreign steel firms; (ii) that the Company had engaged in monopolistic conduct by fixing and maintaining coking coal prices at artificially high levels and unreasonably refusing contracts; (iii) that as the Company’s anticompetitive and monopolistic practices were discovered, the Company would incur a significant level of fines, and would be forced to enter into long term coking coal supply contracts below market prices; (iv) that a portion of the Company’s revenue was derived from anticompetitive and monopolistic conduct, and when such behavior was discovered, the Company’s revenue would significantly decline in future periods; (v) that the Company had used a sophisticated sales and distribution scheme involving wholly owned offshore trading companies to evade paying taxes on a portion of its revenue; (vi) that the Company lacked adequate internal and financial controls; (vii) that the Company’s financial statements were not prepared in accordance with United States Generally Accepted Accounting Principles ("U.S. GAAP"); and (viii) that, as a result of the foregoing, the Company’s financial statements were materially false and misleading at all relevant times.

 

The Mechel complaint has a number of distinctive and noteworthy features, but in addition it shares one characteristic in common with several other recently filed securities lawsuits – that is, the alleged securities law violations are based on an alleged disclosure failures relating to supposed anticompetitive behavior.

 

For example, in August 2008, investors filed a securities class action lawsuit in the Eastern District of Michigan against Reddy Ice Holdings and certain of its director and officers. Background regarding the case can be found here. The complaint alleges that the company engaged in a price-fixing conspiracy that permitted the company to report revenues that were "derived from illegal activities in violation of the U.S. antitrust laws."

 

Similarly, in December 2008, investors filed a securities class action lawsuit in the District of Delaware against container shipping company Horizon Lines and certain of its directors and officers. Background regarding the case can be found here. The securities lawsuit followed in the wake of guilty pleas entered by three Horizon employees to fixing shipping fees in the Puerto Rico shipping Lane. The securities complaint alleges, among other things, that as a result of the price fixing, Horizon’s revenues had been inflated and its earnings reports and revenue guidance had been misleading.

 

These lawsuits alleging violations of the securities laws based on allegations of anticompetitive conduct should be distinguished from cases in which plaintiffs seek to allege antitrust violations as a way to circumvent the procedural requirements of the PSLRA. The U.S. Supreme Court rejected this kind of "end run" in the IPO Laddering Antitrust Case (Credit Suisse v. Billing), which is discussed at greater length here. The Supreme Court said in that case that it could not allow the antitrust case to proceed, as "to permit an antitrust lawsuit risks circumventing [the statutory requirements of the PSLRA] by permitting plaintiffs to dress what is essentially a securities complaint in antitrust clothing."

 

By contrast, the Mechel case and the other cases above are seeking to accomplish the reverse; that is, they are seeking to dress allegations of anticompetitive behavior (and the economic consequences of the regulatory enforcement action) in the clothing of a securities class action lawsuit. The plaintiffs will of course have to satisfy the PSLRA’s pleading requirements in order to be allowed to proceed. But the point that should not be overlooked is that there has been a string of cases in recent months where plaintiffs have filed follow-on securities lawsuits in the wake of allegations of anticompetitive behavior.

 

Given the predominance of the subprime and credit-crisis securities litigation since early 2007, it is easy for less conspicuous trends like this to be overlooked. The likelihood is that there could be more of this kind of litigation ahead as a result of the current economic turmoil, because of the danger that desperate companies might do desperate things, like calling a competitor to try to work things out.

 

The possibility of securities litigation based on allegations of anticompetitive behavior does raise an important D&O insurance consideration. Although it is relatively uncommon in public company D&O insurance policies, some private company D&O insurance policies contain an antitrust exclusion. For example, one private company D&O insurance carrier’s form excludes coverage for loss "based upon, arising from, or in any way related to any actual or alleged violation of any law, rule or regulation relating to anti-trust, restraint of trade, unfair business practice or interference with another’s business, contractual or economic relationships or interests."

 

These kinds of exclusions are objectionable on a number of different grounds, but the cases described above demonstrate one very specific reason to avoid policies containing this language. Were this language to make its way into a public company D&O policy, the insurer might, especially given the breadth of the preamble language ("based upon, arising from, or in any way relating to"), attempt to rely on this provision to try to preclude coverage for the kind of claim described above. The typical public company D&O policy does not contain this exclusion, but its mere existence even just in some private company forms is reason enough to be on guard.

 

While the Mechel case shares some attributes with the two other cases discussed above, it is in most ways a strikingly unique case. Among other things, the complaint’s references to Vladimir Putin’s statements represent an element of a kind not found in many complaints – with one other significant exception, as described below.

 

Mechel itself is not the first Russian company to become involved in a U.S. securities lawsuit. For example, investors in Yukos Oil tried to bring a U.S. securities lawsuit against the company (refer here), but with little success. The Yukos investors also separately attempted to sue the Russian Federation, several Russian oil companies, and a number of Russian officials (including the current Russian Prime Minister Dmitry Medvedev). Putin himself was not named as a defendant in the case but the complaint did quote certain statements attributed to him. As described here, this separate case ultimately was dismissed on jurisdictional grounds.

 

Mechel is merely the latest of many foreign domiciled companies to become involved in securities litigation in the U.S. Just in 2009 alone, as many as 14 of the roughly 65 securities class action lawsuits filed so far this year (about 21%) have been filed against companies domiciled outside the U.S. Similarly in 2008, 34 of the 226 securities class action lawsuits (about 15%) were filed against foreign companies. Clearly the non-U.S. companies are sued at a greater rate than are domestic companies. Some of the foreign companies may simply make attractive targets, but the number of suits may also suggest that the foreign companies are not always ready for the scrutiny that comes with a U.S. listing.

 

An April 9, 2009 Bloomberg article by Thom Wiedlich about the Mechel case can be found here.

 

Optional Federal Insurance Regulation?: A recurring topic in recent years has been the possibility of the introduction of federal insurance regulation. Although this idea has a long history, it could received greater attention in the current environment.

 

The idea was recently revived in proposed legislation introduced on April 2, 2009. The National Insurance Protection Act (H.R. 1880) would allow insurers and insurance producers to elect federal regulation. An April 8, 2009 memorandum from the Locke, Lord, Bissell & Brooke firm entitled "Once More into the Fray: National Insurance Consumer Protection Act Revives Optional Federal Charter Discussion" (here) describes and analyses the bill in detail.

 

Among other things, the memo notes that the recent financial turmoil has "increased momentum for change to regulation of the financial services industry and the insurance industry is no exception." However, the memo also notes that it is unclear how the proposed legislation would fit within the Treasury Department’s overall plan for regulatory reform, and until the Treasury details its plan, the proposed legislation "may not gain much legislative traction."

 

Special thanks to Peter Schwarz of the Securities Mosaic for providing a copy of the memo.

 

Radian Group Subprime Securities Suit Dismissed

On April 9, 2009, the subprime securities lawsuit pending against Radian Group joined the growing list of subprime-related cases in which the dismissal motions have been granted. Eastern District of Pennsylvania Judge Mary McLaughlin entered the order dismissing the case, without leave to amend. A copy of the opinion can be found here.

 

As reflected in an earlier post about the lawsuit (here), Radian provides credit protection products (such as mortgage guarantee insurance). 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 (the company and several of its directors and officers) 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.

 

Judge McLaughlin granted the motion to dismiss based on the plaintiffs failure to adequately plead scienter. She found that the plaintiffs’ allegations "do not establish either motive and opportunity or conscious misbehavior or recklessness on the part of the defendants" and that the plaintiffs therefore have not "raised a strong inference of scienter." She also found that the inference of scienter the plaintiffs sought to draw "is neither cogent not at least as compelling as the plausible opposing inferences suggested by the defendants."

 

The plaintiffs had alleged that the defendants had delayed announcing the material impairment to the C-Bass investment in order to allow the completion of the MGIC merger, and also to allow the defendants to sell shares in their personal holdings of Radian.

 

Judge McLaughlin found the motivation to complete the merger is not "distinctively unique" as it is like "the motives that have been found to be generally possessed by most corporate directors." She also found that the plaintiffs failed to allege any concrete and personal benefit the completion of the merger might provide the individual defendants.

 

Judge McLaughlin found further that the allegations of insider trading inadequate to establish motive and opportunity. One of the three individual defendants more than tripled his investment during the class period, which a second sold only 2.7% of his holdings, and the related Form 4s showed they were sales of restricted stock, and in part motivated to pay taxes. The third individual defendant sold a much larger percentage of his holdings but the public record showed that he was not planned to be a part of the merged company and was divesting his ownership.

 

In support of their allegation that the defendants had been reckless, the plaintiffs had argued that as a result of their positions with Radian, the defendants were aware of the risky nature of C-Bass’s business and the deteriorating conditions of the subprime industry. Judge McLaughlin found first that the plaintiffs’ allegations did not establish that C-Bass was in fact impaired before the company took the impairment charge. Judge McLaughlin also found that the plaintiffs’ allegations "did not establish with sufficient particularity that the defendants knew or should have known that their statements presented an obvious danger of misleading the investing public."

 

The plaintiffs had also argued that the defendants had to be aware of the problems at C-Bass because of their positions of responsibility within the company and the relation of the C-Bass investment to the "core operations" of the company. Judge McLaughlin said that while some courts have found that knowledge of core activities can be imputed to company officials under some circumstances, they had done so only when there were particularized allegations showing that the defendants had ample reason to know of the falsity of the allegedly misleading statements.

 

Judge McLaughlin said that the plaintiffs had failed to explain why C-Bass’s activities were part of Radian’s core activities. She also found that the plaintiffs had failed to show why defendants must have known that their statements presented a danger of misleading investors. In this connection, Judge McLaughlin reviewed the plaintiffs’ extensive allegations about the deteriorating conditions in the subprime marketplace, which the plaintiffs alleged the defendants must have known.

 

With respect to these allegations, Judge McLaughlin observed that "these facts were known to the plaintiffs and by the market at large, and the [amended complaint] itself establishes that Radian publicly disclosed its knowledge of these facts and their potential to effect on Radian’s investment in C-Bass."

 

Judge McLaughlin also found that the plaintiffs’ attempt to establish scienter in reliance on confidential witnesses, the defendants’ sox certifications and the company’s alleged violation of GAAP were equally unavailing,

 

Judge McLaughlin’s opinion joins the growing list of subprime and credit crisis-related securities class action lawsuits in which courts have granted preliminary motions to dismiss. It is also is yet another case that seems to reflect a general judicial unwillingness to conclude that merely because companies were caught in the downdraft accompanying the subprime meltdown that the company had engaged in fraud. (Refer here for similar observation regarding the recent dismissal motion grant in the subprime case involving Downey Financial.)

 

I have in any event added the Radian opinion to the table in which I have been tallying the subprime case resolutions. The list can be accessed here.

 

Special thanks to a loyal reader for forwarding me a copy of the Radian decision.

 

Dismissal Denied Again in Countrywide Case: Perhaps by contrast, and in one of the prominent cases in which a dismissal motion has been denied, on April 6, 2009, Judge Mariana Pfaelzer largely denied the defendants’ renewed motions to dismiss. A copy of Judge Pfaelzer’s opinion can be found here.

 

In a prior opinion (available here), Judge Pfaelzer had substantially denied the defendants motions to dismiss, although she did granted the motion in certain respect with leave for the plaintiffs to amend. The plaintiffs filed an amended complaint and the defendants renewed their motions to dismiss.

 

In her April 6 opinion Judge Pfaelzer largely incorporated her reasoning from her prior opinion. However there were a couple of respects in which the April 6 ruling is noteworthy. First, she found that the plaintiffs’ revised allegations against defendant KPMG, whose dismissal motion previously had been granted, would now "suffice" and therefore KPMG’s renewed dismissal motion was denied.

 

However she also found that insider allegations as to certain insider defendants, whose sales were made pursuant to written Rule 10b5-1 trading plans, were insufficient and accordingly the insider trading were dismissed. However she refused to dismiss most of the insider trading allegations against former Countrywide CEO Angelo Mozillo, even though he too purported to have traded pursuant to a Rule 10b5-1 plan, because of "unusual" modifications he had made to his plan.

 

Allison Frankel’s April 8, 2009 American Lawyer article about Judge Pfaelzer’s latest opinion can be found here. I urge everyone to read it, if for no other reason that along the way Frankel refers to The D&O Diary’s author (that would be me) as "our favorite subprime litigation savant." I am humbled by the accolade.

 

Special thanks to several loyal readers who supplied me with a copy of the April 6 opinion.

 

A Case of Divided Loyalties

The possibility that a conflict of interest could arise when an attorney or law firm simultaneously representes a corporation and one or more of its officers or directors is a a frequently recurring issue. The issue  was raised recently, for example, in the civil complaint that former Stanford Financial Group CFO Laura Pendergest-Holt filed against the firm’s former outside counsel, in connection with his conduct of the defense in connection with the SEC’s investigation of the firm. (A copy of Pendergest-Holt’s complaint can be found here.)

 

An April 1, 2009 opinion (here) by Central District of California Judge Cormac Carney in the Broadcom Corporation options backdating criminal case presents a far more dramatic example of the pitfalls that can arise from dual representations.

 

The opinion involves the Irell & Manella law firm’s "separate, but inextricably interrelated representations" of Broadcom and its CFO, William Ruehle. The law firm represented the company in its internal investigation of the backdating allegations. It also represented the company and Ruehle in the defense of the backdating related civil litigation.

 

In June 2006, two lawyers from the firm interviewed Ruehle, without disclosing possible conflicts or disclosing they might later reveal his statements to third parties (such as the government). Subsequently, the law firm, at the company’s direction, disclosed Ruehle’s statements to the company’s auditors, the SEC and the DoJ.

 

Ruehle sought to suppress the government’s reliance on his statements in connection with the criminal prosecution, because the statements represented privileged communications. Judge Carney agreed, but his April 1 opinion went far beyond this conclusion.

 

Judge Carney found that Irell "committed at least three clear violations of its duty of loyalty" – it failed to advise Ruehle of and obtain his written consent to the conflict; it interrogated him for the benefit of another client (Broadcom); and it disclosed privileged communications to a third party without consent.

 

Judge Carney said that he found Irell’s "ethical breaches" to be "very troubling," not only because they resulted in the suppression of relevant evidence, but also because they "compromised the rights of Mr. Ruehle, the integrity of the legal profession, and the fair administration of justice." Because of these concerns, Judge Cormac concluded that he "must refer Irell to the State Bar for discipline."

 

Judge Carney’s blistering opinion is noteworthy in and of itself, both because of the prominence of the firm involved and because of the heat of the rhetoric he employed. His opinion is also a cautionary example both to lawyers involved in corporate representations and to corporate officers whose interests may be being represented by the company’s own counsel in connection with serious investigations that may potentially involve criminal implications.

 

The opinion may also be relevant for insurance professionals who often are called upon to address questions surrounding the possible need for separate counsel for individual defendants. Judge Carney’s opinion in the Broadcom case underscores how serious these issues may be, and the consequences that can sometimes arise if separate counsel issues are not appropriately addressed.

 

Insurance professionals of course cannot become involved in the kinds of ethical questions presented in Judge Carney’s opinion, but an awareness of the kinds of issues that can arise is an important perspective to bring to the table when questions involving separate representation do arise.

 

It is sometimes the case that it is the firm’s outside law firm that is resisting the suggestion that the firm may not be able to maintain the multiple representations it has purported to assume. These kinds of discussions can be particularly vexing, as law firm can often dominate the dialog and the insured company or insured individuals may not see where their interests may diverge from the position the law firm is advocating. While these conversations can sometimes be extremely delicate, they can involve critical issues. Insurance professionals aware of the kinds of issues involved in the Broadcom case can at least raise appropriate questions to try to ensure that issues are discussed.

 

Special thanks to a loyal reader for proving a copy of Judge Carney’s opinion.

 

IPO Laddering Cases Settled for $586 Million

The consolidated  IPO Laddering Cases, that superannuated vestige of a long-gone era that has continued to grind on despite numerous procedural setbacks, apparently has been settled (again), at least according to the parties’ April 1, 2009 settlement stipulation (here). Hat tip to the WSJ.com Law Blog for the link to the stipulation.

 

According to the settlement stipulation, the aggregate gross amount of the settlement is $586 million, out of which will come both plaintiffs’ attorneys’ fees and extensive notice and administrative expenses. The amount of the plaintiffs’ attorneys’ fees are not specified in the agreement. News reports (here) suggest that the plaintiffs intend to seek fees of as much as $195.3 million, plus $56 million in expenses, from the settlement.

 

The stipulation provides for two different $10 million advances from the gross settlement fund for the payment of notice and administration expenses, and provides a mechanism should further expenses become necessary. Clearly, the parties anticipate that notice of and administration for the settlement will be massive, expensive undertakings.

 

The publicly available version of the stipulation does not answer the question I was most interested to know, which is who, between the underwriter defendants and the issuer defendants and their insurers, will be paying how much of the proposed settlement? Unfortunately, Exhibits E and F to the stipulation, which reflect the defendants’ respective settlement contributions, were filed under seal. The prying curiosity of nosy bystanders like me sadly will go unfulfilled.

 

My curiosity about the relative settlement contributions is driven largely by the convoluted history of the prior attempts to settle this case (or should I say these cases?). Readers will recall (as discussed at length here), that prior settlement attempts were derailed on December 6, 2006 when the Second Circuit held that the district court had erred in certifying a class against the offering underwriter defendants. Among other things, that decision vitiated the pending settlement in which the issuer defendants had agreed to pay the investor plaintiffs $1 billion, with the issuers’ contribution to be reduced to the extent of investor recoveries from the underwriter defendants. The decision also set aside J.P. Morgan’s proposed agreement to pay $425 million to settle its liability.

 

Following that setback, the case ground on. On March 26, 2008, Southern District of New York Judge Schira Schindlin denied the defendants’ renewed motions to dismiss, as discussed here. Though this case probably could have kept squadrons of attorneys employed from now until doomsday, there comes a time for all things to end.

 

So much as has changed since these cases first flooded in during 2001, particularly in recent months. Not only has Lehman Brothers gone bankrupt, but other high profile underwriter defendants have been merged out of existence. 41 of the issuer defendants have gone bankrupt. Indeed, Mel Weiss, who was at the outset at the vanguard on behalf of the investor plaintiffs, has pled guilty to criminal charges. And so this massive case, initially involving 55 underwriter defendants and 310 issuer defendants, may have finally come to an end.

 

Press reports (here) quote one of the plaintiffs’ attorneys as saying "When these cases were filed in 2001, no one would have believed that in 2009 Bear Stearns would be out of business, Lehman in bankruptcy, and names like Salomon and Merrill Lynch erased from the financial landscape…Under the circumstances, this settlement is the best available real-world alternative."

 


 

It should be noted that the agreement is subject to court approval as well as a host of contingencies, and could still be terminated by any one of a number of parties or contingencies.

 

The mammoth size of the proposed settlement is impressive. A quick look at historical settlement data suggests that this settlement would represent the 12th largest securities class action settlment of all time. Inevitably this latest settlement attempt will draw comparisons to the prior $1 billion minimum attempt to settle the case.

 

In addition, curious readers will want to take a look at the schedules to Exhibit C to the stipulation, which show a number of interesting things. First, the schedules show, as required by the PSLRA, the gross recovery per damaged subject security – in most cases, only a penny or two per share.

 

Second, the schedule also shows the plaintiffs’ preliminary estimate of the potential damages for class members, indexed by issuer defendant. These estimates reflect some truly staggering numbers. Even if they are purely theoretical, they are nonetheless impressive. Some of them, with respect to just a single issuer, exceed the entire amount of the settlement itself. For example, the estimate for Priceline.com is $1.166 billion. The estimate for Global Crossing is $780 million. Foundry Networks, $720 million; Commerce One, $641 million.

 

The schedule omits to provide an aggregate number for all of the issuer defendants, but I suspect that the figure would rival the kind of numbers that only someone like the late Carl Sagan and Timothy Geithner would be comfortable saying in public (and even then, in Geithner’s case, only recently). In any event, those are some big numbers.

 

One likely byproduct of this settlement will be the forthcoming mailings to the settlement class members. I can only imagine how many individual pieces of mail we are talking about, and how much the postage alone will cost. No wonder the notice and administrative expenses are expected to be so high. The class mailings by themselves could remedy the U.S. Postal Service’s chronic operating deficits.

 

In all seriousness, this settlement stipulation obviously was a maddeningly difficult thing to nail down. The attorneys who finally got this monster worked out in a global settlement (or at least an attempted global settlement) are to be congratulated on tackling what had to have been an extraordinarily difficult challenge. Even if history should ultimately little note nor long remember what happened here today, their efforts are worthy of respect.

 

PwC Releases 2008 Securities Litigation Study

On April 1, 2009, 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 2008 securities lawsuit filings, but the overall findings are directionally consistent with the prior reports. The PwC report also adds some interesting observations of its own.

 

My own analysis of the 2008 securities lawsuit filings can be found here. Cornerstone’s previously released study of 2008 filings can be found here and Cornerstone’s study of the 2008 securities lawsuit settlements can be found here. NERA’s 2008 study can be found here and Advisen’s can be found here.

 

The PwC study found, consistently with the prior reports, that as a result of the financial crisis, the number of securities class action lawsuits rose for the second year in a row in 2008. The PwC report tallied 210 securities lawsuits in 2008, a number that is notably below the numbers reported by other studies. The 2008 total represents a 29 percent increase over 2007. The report found that the filings were steady throughout the year, with a slight uptick in the fourth quarter.

 

The report found that the majority of the 2008 filings were related to the financial crisis. Indeed, the report noted that "for the first time since the PSLRA, in 2008 the plaintiffs’ bar filed more federal securities lawsuits against the financial services industry group (banking, brokerage, financial services and insurance) than any other industry." By the same token, for the first time since the PSLRA’s passage, high tech companies were not the most frequently targeted.

 

The number of filings against companies in the pharmaceutical industry remained consistent with 2007, with 21 lawsuits in the sector in both years. My own analysis of the 2008 securities filings in the life sciences sector can be found here.

 

Filings against companies in the Fortune 500 were up in 2008, with 37 filings during the year, or 18% of all cases filed. The average annual percentage of filings against Fortune 500 companies since the PSLRA’s enactment is 13%. The majority (65%) of the Fortune 500 companies sued in 2008 were in the financial sector.

 

The report notes that the profile of financial companies sued in 2008 changed from those named as defendants in 2008. The focus changed from loan originators in 2007 to entities involved in loan securitization in 2008. (I might add parenthetically that the loan securitizers remain a target in 2009.) In 2008, the auction rate securities lawsuits were a significant part (38%) of the suits filed against entities involved in loan securitization.

 

According to the PwC report, securities lawsuits in the United States against foreign issuers "reached an all-time high in 2008, with 36 cases representing 17 percent of the total federal securities class actions filed." These filings against foreign issuers represent the highest percentage of the total cases in any year since the enactment of the PSLRA. 15 (or 42%) of the 36 cases filed against foreign issuers involved companies in the financial services industry, and 32 out of the 36 of the suits against foreign issuers were filed in the Second Circuit. The countries whose companies were sued most frequently were Canada, China and Switzerland.

 

The report notes that the number and aggregate dollar value of securities lawsuit settlements declined in 2008. However, if the $3.2 billion Tyco settlement is excluded from the 2007 numbers, the remaining total value of the 2007 settlements ($3.3 billion) is 9 percent less than the total value of the 2008 settlements ($3.6 billion).

 

The average 2008 settlement of $41 million represented a substantial increase from 2007’s average of $28.3 million, but the 2008 average was still well below the 2005 average of $67.6 million. The median 2008 settlement of $8 million was unchanged from 2007.

 

The report has an interesting statistic showing that the 2008 average for settlements greater than $1 million but less than $50 million was $11.2 million, which not only represents an increase over the equivalent 2007 average of $9.6 million, but also represents the highest such average since the PSLRA’s enactment.

 

The report also has extensive additional interesting analysis regarding the prevalence and type of accounting allegations, and their impact on settlement; the nature of SEC enforcement activity; and the increase in foreign regulatory activity.

 

The report concludes by noting that there are three areas in which "companies will want to remain especially vigilant," which are "institutional plaintiff activity (particularly activity relating to public and union pension funds), internal controls accounting-related allegations, and FCPA enforcement." The report ends with the observation that "securities litigation activity in 2009 is likely to reflect [the] new era of accountability and oversight, particularly if the regulatory environment is overhauled, as most think inevitable."

 

An interesting interview discussing the PwC report can be found here.

 

Special thanks to a loyal reader for providing me with a link to the PwC report.

 

Heightened Securities Lawsuit Filing Pace Continues in 1Q09

Largely driven by litigation in the financial sector arising from the ongoing credit crisis, the heightened pace of securities filings continued during the first quarter of 2009.

 

There were a total of 57 separate, new securities class action lawsuits filed during the first quarter. The 57 new securities lawsuits represents an annualized pace of 228 filings, which would be basically unchanged from the 226 lawsuits filed in 2008. (My analysis of the 2008 filings can be found here.)

 

However, the 57 first quarter filings do represent a decline from the 67 new lawsuits that were filed in the fourth quarter of 2008, when the Madoff-related filings that came in at year end and increased the quarterly numbers.

 

The filings during the first quarter 2009 were driven by the filing of new subprime and credit crisis-related securities lawsuits. Of the 57 first quarter suits, 35 (61% of the total) were subprime and credit crisis-related. A spreadsheet of the 2009 subprime and credit-crisis related securities lawsuit filings can be found here. A table of all of the subprime and credit crisis securities cases filed during the period 2007 to 2009 can be found here.

 

The first quarter lawsuit filings targeted entities in 26 different Standard Industrial Classification (SIC) code categories. But consistent with the predominance of the subprime and credit crisis cases, most of cases were filed with SIC codes in the financial sector. A total of 30 of the 57 cases (52%) involved companies in the 6000 SIC Code (Finance, Insurance and Real Estate) series. Indeed, 21 of the 57 cases (37%) were filed against companies in just three SIC Codes: SIC Code 6021 (National Commercial Banks), 9 filings; SIC Code 6029 (Commercial Banks not elsewhere classified), 6 filings; and SIC Code 6189 (Asset Backed Securities), 6 filings.

 

Not only were the first quarter cases largely concentrated in the financial sector, but many of the cases involved very specific kinds of financial transactions. At least 12 of the 57 cases were based upon the offerings of subordinated, preferred or other specialized classes of the issuer-defendants’ securities. (Some entities, for example, Deutsche Bank, were hit with multiple distinct suits relating to different securities offerings, as discussed further below.)

 

In addition at least five of the new filings involved actions against the issuers of mortgage pass-through certificates.

 

The various Ponzi scheme frauds were also a material factor in the first quarter filings. For example, the Madoff and Stanford Financial frauds accounted for a least six distinct cases among the first quarter filings. (There obviously were multiple additional duplicate filings involving these frauds, a source of one of the many counting problems associated with the first quarter filings.)

 

A significant number of the first quarter filings did not involve publicly traded companies. For example, the first quarter securities lawsuit filings targeted mutual funds, private investment firms or investment partnerships, and other private entities. At least eight of the 57 first quarter filings involved entities that lacked an SIC code designation.

 

Thirteen of the 57 new filings (or about 23%) involved foreign-domiciled companies, representing six different countries. However, many of these cases involved separate suits filed against the same companies. For example, while there were five separate lawsuits filed against U.K.-based companies, only two different companies, RBS and Barclays, were actually involved in those five separate cases.

 

The 57 cases were filed in 25 different courts, but 29 of them (about 51%) were filed in the Southern District of New York. Only one other court, the Northern District of California (5 filings) had more than two.

 

Even though the 57 first quarter filings represent a heightened level of litigation activity, the impact of those cases on D&O insurers will be more muted than might otherwise be expected, due to the nature and distribution of the filings.

 

First, the litigation activity was predominantly concentrated in the financial sector, which means that carriers that have not been active in this sector have largely avoided significant claims activity so far in 2009. The carriers that were active in the sector are not as fortunate, but that represents only a subset of the overall D&O insurance marketplace.

 

Second, the incidence of multiple distinct lawsuits against the same company, which was a significant part of the first quarter lawsuit activity, means that the maximum potential aggregate insurance exposure from the new lawsuits is likely substantially less than if 57 separate lawsuits had been filed against 57 complete separate companies.

 

Third, a certain percentage of the cases, particularly the Ponzi scheme cases, are likelier to produce E&O losses rather than D&O losses, so the impact on the D&O insurers from these cases could be more limited than might otherwise be the case for the more typical securities class action lawsuits.

 

All of that said, the pace of litigation activity certainly shows no signs of abating. There are still reasons to believe that the current litigation wave will spread more generally beyond the financial sector. The likelihood of litigation from corporate insolvencies also threatens continued heightened litigation activity as the year progresses.

 

Counting: A final word about counting the filings. I suspect that other observers have or will likely reach differing counts than I have for the first quarter filings. Part of the difference is a result of the perennial counting problems – for example, whether or not to count merger objection lawsuits or lawsuits where the main allegation is that the defendant failed to register securities (neither of which categories I count).

 

But beyond these recurring issues, the kinds of cases that were filed in the first quarter made counting particularly uncertain. The cases themselves made it very challenging to determine whether or not a new complaint represent a duplicate lawsuit or a new lawsuit.

 

For example, how many different lawsuits can there be regarding Deutsche Bank preferred securities? Is a lawsuit involving a different class of preferred securities a duplicate or distinct?

 

The multiple Madoff-related lawsuits post a particularly difficult categorization challenge, as the protean mix of defendant feeder funds targeted in the lawsuits present a dizzying array of combinations.

 

Just to cite one specific counting challenge, I refer to the complaints that have been filed in connection with Wells Fargo’s Mortgage Pass-Through Certificate offerings. One lawsuit represent certificate investors was filed in January 2009 (refer here). A second complaint was filed in March 2009 also brought on behalf of Mortgage Pass-Through Certificate investors (refer here). The March complaint related largely (but not exclusively, as far as I can tell) to different specific offerings of Mortgage Pass-Through Certificates. Reasonable minds (particularly reasonable minds with an abundance of time to undertake an intense textual comparison between the two complaints) might reach a different conclusion, but upon consideration of the different offerings involved, I counted these as two distinct filings rather than as duplicate filings.

 

These are not easy issues and different people could and probably will reach far different conclusions. I have at least tried to be internally consistent with my own counting. In any event, don’t be surprised if other securities lawsuit counts published elsewhere vary from my own. Even if the precise numbers differ at the margins but the general findings should be generally consistent.

 

Rare Securities Lawsuit Jury Trial Commences in Case with Predatory Lending Issues

A rare jury trial has commenced in a long-running securities lawsuit that resonates with overtones of the current subprime mortgage meltdown. On March 30, 2009, Northern District of Illinois Ronald Guzman began empanelling a jury in the securities class action lawsuit styled as Lawrence E. Jaffee Pension Plan v. Household International, Inc., a case that has been pending since August 2002. Background regarding the case can be found here.

 

According to the plaintiffs’ consolidated amended complaint (here), the case was brought on behalf of all persons who acquired Household International securities between October 23, 1997 and October 11, 2002. The plaintiffs contend that during the class period, the defendants concealed that Household "was engaged in a massive predatory lending scheme."

 

According to the complaint, Household "engaged in widespread abuse of its customers through a variety of illegal sales practices and improper lending techniques." Household also reported "false statistics" that were intended to "give the appearance that the credit quality of Household’s borrowers was more favorable that it actually was." The plaintiffs allege that the "defendants’ scheme" allowed them "to artificially inflate the Company’s financial and operational results."

 

In the third quarter of 2002, the company took a $600 million charge and restated its financial statements for the preceding eight years, and in October 2002, the company announced that it had entered into a $484 regulatory settlement regarding its lending practices. On November 14, 2002, the company announced that it was to be acquired by HSBC Holdings. (In recent months, HSBC’s results have been significantly affected by losses in the subprime mortgage portfolio it acquired in the Household deal and its chairman has publicly admitted that "with the benefit of hindsight, this is an acquisition that we wish we had not undertaken.")

 

The defendants in the lawsuit include Household International and its mortgage finance subsidiary, Household FInancial Corporation, and Household’s former CEO and CFO, as well as one other former individual officer of the company, as well as the former company’s former directors. The company’s offering underwriters were also initially named as defendants, but they were later dismissed from the case (refer here). The plaintiffs also reached a prior settlement with the company’s former auditor, Arthur Anderson.

 

According to news reports (here), Judge Guzman has bifurcated the case into two parts, with a damages phase to follow the initial liability phase, which is expected to last four weeks, if the initial phase results in a finding of liability.

 

As most readers undoubtedly are aware, jury trials in securities class action lawsuits are extremely rare. According to data compiled by Adam Savett at the Securities Litigation Watch (here), only 20 cases have gone to trial since the PSLRA was enacted in 1995. Six of those 20 cases involved conduct that occurred after the PSLRA’s enactment.

 

Two recent high profile trials involved JDS Uniphase and Apollo Group. As noted here, on November 27, 2007, the jury in the JDS Uniphase trial returned a defense verdict. The Apollo Group trial initially resulted in a January 2008 plaintiffs’ verdict and an award of $277.5 million in damages, but as detailed here, on August 4, 2008, the judge granted the defendants’ motion for judgment as a matter of law, which set aside the jury verdict. A detailed discussion of the two cases can be found here.

 

With the adjustment for the post-trial motion in the Apollo Group case, the jury verdict scoreboard for the six post-PSLRA cases now stands at three each for the plaintiffs and defendants, as explained in my post regarding the Apollo Group post trial motion.

 

As for the question why this case is going to trial when so many others settle, there undoubtedly are many factors but one may be the "billion-dollar price tag" that news reports suggest that plaintiffs have put on the case.

 

A March 30, 2009 AmLaw Daily article discussing the case can be found here.

 

Cornerstone Releases 2008 Securities Lawsuit Settlement Analysis

On March 11, 2009, Cornerstone Research released its report of 2008 securities lawsuit settlements entitled "Securities Class Action Settlements: 2008 Review and Analysis" (here). Cornerstone previously released its review of 2008 securities class action filings, which can be found here. Among other things, the newly released Cornerstone Report concludes that "the value of cases settled in 2008 was lower than the historically unprecedented high totals reported from 2005 through 2007." Cornerstone's March 11, 2007 press release regarding the report can be found here.

 

Although the Cornerstone Report is more or less consistent with prior analyses of the 2008 settlements (for example, the previously released study by NERA Economic Consulting, which can be found here), it also differs in some specific details. The differences are in part explainable due to the methodology used to assign settlements to a particular year. In the Cornerstone Report, the designated settlement year corresponds to the year in which the hearing to approve the settlement was held, rather than the year in which the settlement was first announced.

 

The Report finds that the median value of 2008 settlements was $8 million, which is lower than 2007’s all-time high median of $9 million but is higher than the median of $7.4 million for all cases settled during the period 1996 through 2007. Median settlements as a percentage of estimated damages were generally higher for cases settled in 2008 compared to settlements during the period 2002-2008. Just over half of the 2008 settlements were for less than $10 million, although the number of "very small settlements" is declining, while the number of settlements in the $20-$25 million range is increasing.

 

The average settlement in 2008 "fell dramatically" from $62.7 million in 2007 to $31.2 million, which is partly due to the fact that there were no settlements approved in 2008 that exceeded $1 billion (by contrast to 2007, during which the massive Tyco settlement was announced). If the top four all-time settlements are excluded from the analysis, 2008’s average settlement of $31.2 million is "in line with" the average settlement during the period 1996 through 2007 of $34.6 million. (All settlement amounts are adjusted for inflation and are expressed in 2008 dollars.)

 

The Report found that the average time from filing to settlement has increased steadily. Whereas historically cases settled approximately three years after filing, during 2007 and 2008, the average time from filing to settlement increased to three and a half years.

 

The Report also identified a number of factors that appeared significant with respect to settlement values:

 

1. GAAP Violations: The Report found that GAAP violations, which were alleged in 70% of 2008 settled cases, "continued to be resolved with a larger settlement amount and a higher percentage of estimated damages relative to cases not involving accounting allegations."

 

2. Restatements: Allegations involving restatements were involved in 35% of 2008 settlements. However, cases with restatements "are no longer associated with a statistically significant increase in settlement amounts," consistent with PCAOB research concluding that restatement announcements "are viewed by the market as less significant events." However, cases in which an accountant was named as defendants continued to settle for the "highest percentage of estimated damages among cases with accounting allegations."

 

3. ’33 Act Claims: Controlling for the presence of underwriter defendants, the presence of Section 11 or Section 12(a)(2) claims is "not associated with a statistically significant increase in settlement amounts." The Report does note that suits with ’33 Act allegations reached "historically high levels" in 2007 and 2008, and that as these cases settle over the next few years, the importance of ’33 Act claims in determining settlement amounts "may increase."

 

4. Institutional Investor Plaintiffs: When institutional investors are lead plaintiffs, settlements are "significantly higher." However these higher settlements are "associated with public pension plans, as opposed to union funds or other types of institutional investors."

 

5. Accompanying Derivative Claims: The number of settlements of securities class actions that were accompanied by derivative actions decreased in 2008 compared to prior years. But with respect to the securities suits that were accompanied by derivative actions, the settlement amounts were "significantly higher." In general, cases with accompanying derivative actions tend to be larger (in terms of estimated damages) and also typically involve accounting allegations and public pension plaintiffs, and include accompanying SEC actions. Controlling for these other factors, the Report concludes that cases involving derivative actions "are associated with statistically significant higher settlement amounts."

 

6. SEC Actions: Cases with associated SEC actions are involve "significantly higher settlements" as well as higher settlements as a percentage of estimated damages.

 

7. Non-Cash Components: 9% of 2008 settlements involved non-cash components. Settlements involving non-cash components are statistically higher in value, even controlling for estimated damages and the nature of the allegations.

 

The Report concludes with several remarks about the recent wave of subprime and credit crisis related securities litigation. First the report notes that the three settlements of these cases so far include the $475 million Merrill Lynch class action settlement. The Report notes that the Merrill case reached settlement in 18 months, which is relatively quick compared to other cases. Otherwise, however, the Report notes that, with only three of these cases settled so far, "it is still too early to anticipated what impact, if any" settlements of the credit crisis cases will have on overall settlement trends.

 

(My running table of subprime and credit crisis related securities lawsuit settlements and dismissals can be accessed here. My commentary on the Merrill Lynch settlement can be found here.)

 

The Report concludes with an observation regarding the damages represented in the 2008 securities lawsuit filings. That is, the "disclosure dollar losses" (a defined term in the Report representing one measure of investor losses) associated with the 2008 filings "reached historic highs in 2008." Because disclosure dollar loss is a "significant predictor of settlement size," the size of settlements "may increase in the future."

 

The Report reflects a number of different findings of significant interest to D&O insurers. In particular, the Reports finding regarding the increase in settlements in the $20 to $25 million could have significant implications for excess insurers that are active in this space. Moreover, the Report’s detailed analysis of factors affecting settlement values could be important considerations in setting case reserves.

 

However, D&O insurers will also want to take a couple of additional considerations into account in assessing the implications of this report. First, the Cornerstone report reflects only settlement amounts. D&O insurers’ losses in connection with any given claim also include defense expense, which is not reflected in the Cornerstone study. Indeed, D&O insurers can incur significant amounts of defense expense even if a case is dismissed and there is no settlement.

 

In addition, the Cornerstone study reflects only class action settlements. It does not take into account any amounts that defendants or their insurers were obligated to pay as part of settlements to plaintiffs that opted out of the settlement class. As I have noted previously, opt outs are an increasingly important factor in the resolution of securities lawsuits. As a result, class action settlement data along may insufficiently express the overall dollar exposure of securities class action defendants and their insurers.

 

The Cornerstone contains extensive additional analysis and warrants reading at length and in full. Once again, the Report’s authors, Laura Symons and Ellen Ryan, have done an outstanding job analyzing the latest settlements and explaining their findings.

 

Stanford Group Investors Sue SEC, Receiver

On March 4, 2008, twenty-one Stanford Financial Group investors filed an action in the Southern District of Texas against the SEC, the U.S. Marshal’s Service and the Stanford Group receiver claiming that the defendants violated the investors’ rights under the U.S. Constitution by freezing their Stanford Group accounts though the investors have been accused of no wrongdoing.

 

The investors’ complaint (which can be found here) opens with a quotation from Thomas Jefferson ("The true foundation of republican government is the equal right of every citizen in his person and property and in their management") and alleges that "acting in secret on President’s Day," the defendants "seized private property and suppressed free speech and assembly." The complaint alleges that the defendants "have not come forward with any evidence that the owners of the seized accounts did anything wrong, yet the Defendants continue to exercise control over Plaintiffs’ property in a reckless and negligent manner."

 

The complaint alleges that the SEC obtained a judicial order authorizing the freezing of the Stanford entities’ assets and appointing Ralph Janvey as receiver, and that the next day the U.S. Marshals surrounded and seized Stanford’s offices. As a result of these actions, the complaint alleges, the defendants took control of 35,000 bank accounts, including those of the plaintiffs. As a result of these actions, the plaintiffs cannot access their accounts. 


 

The group of twenty-one plaintiffs includes a gallery of victims whose woes surely tug the heartstrings. Plaintiff Tory DeArmond "lost her husband to cancer five days after the Presidents’ Day order froze the couple’s account." Plaintiff Alva Kerr suffers "the constraints of multiple sclerosis." Plaintiff Catherine Coulter "runs the Greyhound Pets of America Houston organization that places retired greyhounds for adoption."

 

Interspersed with these paragons are a number of financial advisor plaintiffs, some of whom were employed by the Stanford Group, and one of whom contends that he "wants to contact his clients immediately to tell them about the freeze and to advise them to take actions" but was told "that if he communicated with his clients, he could be put in jail."

 

The complaint seeks relief for "Violations of the First Amendment" (an apparent reference to the prohibitions barring the financial advisors from contacting their clients); "Violations of the Fourth Amendment" (for unreasonable seizures); Conversion; Negligence; and Gross Negligence. The complaint seeks actual damages; prejudgment interest; attorney’s fees; punitive damages; and post-trial damages. Oddly, the complaint does not specifically seek to have the freeze order lifted.

 

Meanwhile, and coincidentally also on March 4, the Stanford Group receiver, Ralph Janvey, apparently has petitioned the court to release the frozen Stanford investor accounts containing less than $250,000, so long as they aren’t linked to an $8 billion fraud investigation, according to a March 4, 2009 Bloomberg article, here. The accounts could be released as soon as March 9.

 

However, since the twenty-one plaintiffs seek compensatory not injunctive relief, the receiver’s actions to lift the freeze order would at least on a theoretical level neither supersede the plaintiffs’ claims nor provide the relief the plaintiffs seek.

 

The perennial law student within me feels compelled to point out that lurking somewhere within the investors’ complaint is what is referred to as a Bivens action. The name refers to the 1971 Supreme Court case of Bivens v. Six Unknown Named Agents of the Federal Bureau of Narcotics. The Bivens case held that a plaintiff can recover money damages from officers of the U.S. government for their actions violating the plaintiff’s fourth amendment rights. However, one difficulty these plaintiffs will face is that Bivens actions can only be asserted against federal officials, not federal agencies. Against federal agencies, the equivalent relief is limited to that available under the Federal Tort Claims Act, which among other things, prohibits relief for many intentional torts.

 

These legal observations are supplemented by the helpful comments of an esteemed legal professor (to whom I happened to married), who points out that the Administrative Procedure Act allows actions for injunctive relief against the U.S. and that the U.S. Supreme Court has long allowed plaintiffs to sue federal officials personally for injunctive relief. Which highlights the question as to why the investors’ complaint fails to seek injunctive relief.

 

I have in any event added this complaint to my list of Stanford Group lawsuits, which can be accessed here.

 

A March 4, 2009 Bloomberg article about the investors’ lawsuit can be found here.

 

You, You’re Nothing But a Hedge Fund: Apparently the insult du jour is to say that an enterprise is "just a hedge fund." First, on March 3, 2009, Ben Bernanke, in congressional testimony in which he declared how "angry" the AIG bailout made him, said that the AIG Financial Products division "was a hedge fund basically that was attached to a large and stable insurance company."

 

If a company can be disparaged by calling it a hedge fund, then how about a whole country? Michael Lewis (author of Liar’s Poker and other books) in an article in the April 2009 issue of Vanity Fair entitled "Wall Street on the Tundra" (here) quotes an unnamed IMF official as having said in October 2008, "Iceland is no longer a country. It is a hedge fund."

 

Lewis’s article tells the fascinating tale of how Iceland turned itself into a global financial powerhouse, and describes the astonishing wreckage left behind when the powerhouse turned out to be a house of cards. There are so many gems in this article it is hard to choose just one, but here is a sample. In explaining how the country adopted an entirely new way of economic life, one commentator noted that it was "just a bunch of young kids" who "came in, dressed in black, and started doing business."

 

His Name Was Maurice, He Called Himself Hank, But Everyone Knew Him for Chutzpah: Over the years, The D&O Diary has studiously avoided saying anything critical about Hank Greenberg. Frankly, The D&O Diary is scared of Hank Greenberg. However, all of a sudden, others seem to have decided that it is open season on Hank Greenberg.

 

First, a March 4, 2009 column in the Financial Times entitled "Too Much Time in the Spaceship, Hank" (here) chides Greenberg for his "chutzpah," compares him to "Ozymandias" and derides him because AIG’s failings "stem from its having been designed to be run by Mr. Greenberg. As soon as its domineering chief executive was shown the door, it was difficult for anyone to get a grip on what was going on."

 

The column hastens to add that "this implies, however, that things would be all right if Mr. Greenberg were still at the helm of AIG, and there is no proof of it." To the contrary, the column notes, the activities that brought AIG down started on Greenberg’s watch. The column concludes that "from this distance, amid this noise, it is hard to know what occurred, but no version of events fully exonerates Mr. Greenberg."

 

There is much more of this in the same vein in Ann Wolner’s March 4, 2009 Bloomberg column (here), in which she too emphasizes that the AIG Financial Products Division started while Greenberg still ran the company, and that it was on his watch that "that AIG began marketing credit default swaps linked to subprime mortgages."

 

She also notes that "it is rarely convenient for him to mention his status as an unindicted co-conspirator in a $500 million deal involving General Reinsurance Corp. that got the indicted co-conspirators convicted and imprisoned," and that "the company has so far paid $1.8 billion in fines and penalties to resolve civil claims by government regulators looking into the Greenberg era at AIG." She concludes that "it would be refreshing if Greenberg would stop for a moment pointing his finger at others and admit that he, too, was part of the problem."

 

I wish to stress that the views expressed in the two columns quoted above are solely those of their authors and should not necessarily be interpreted as expressing the views or opinions of The D&O Diary.

 

March Madness is Just Around the Corner: Many readers will be interested to learn about the Washington Post’s new site entitled "Beer Madness" (here). Be sure to roll your cursor across the beer bottles on the bottom of the page.

 

If You Knew Sushi Like I Knew Sushi: Here is a truly odd but interesting video, taken in a  restaurant in Tomakomai, on the Japanese island of Hokkaido. Watch, and leave your world behind for a few moments. (The fun is basically over once the camera goes into the kitchen.) Special thanks to a loyal reader for the video link.

 

Advisen Releases 2008 Securities Litigation Study

On February 23, 2009, Advisen released its Report of 2008 securities litigation entitled "Securities Litigation in 2008: Implications for the D&O Market in 2009 and Beyond" (here, $ required). The Advisen Report’s numerical securities litigation analysis is directionally consistent with prior reports of the 2008 lawsuits, although the Report also contributes its own unique observations to the dialog. The Report also provides a number of specific comments about the lawsuits themselves as well as about likely future trends, including in particular reflections on the implications for D&O insurers.

 

Advisen’s February 26, 2009 press release describing the Report can be found here.

 

Largely as a result of the way it counted the lawsuits, the Advisen report concludes that securities class action lawsuits as such did not substantially increase in 2008 compared to 2007, although both years’ activity did increase compared to 2006. Pertinent to these conclusions, the Advisen Report provides a lengthy explanation of its "counting" methodology, which is helpful in understanding how Advisen’s numbers differ from those reflected in prior reports. The Advisen Report correctly notes that the phrase "securities class actions" is "increasingly inadequate for categorizing and explaining securities suits."

 

The Advisen Report is consistent with previous released studies in its conclusion that during 2008 securities litigation was concentrated in the financial sector. The Report notes that "fully half of securities lawsuits filed in 2008 named financial firms and their directors and officers as defendants." Specifically, the Report finds that banking, finance and insurance companies accounted for half of the securities lawsuits in 2008.

 

The Report stresses that the nature of many of the suits filed in 2008 differs from what may have been standard form in prior years. Many of the suits were not filed against public companies for their financial disclosures, but rather were filed against companies that structured or sold securities, and were being sued for representations about the securities themselves. The auction rate securities lawsuits are one illustration of this new category.

 

In addition, Advisen reports that during 2008, many of the suits were filed not as securities class action lawsuits as such, but rather in the form of lawsuits for breach of fiduciary duty, breach of contract, or common law torts. Many of these lawsuits were filed in state court.

 

The Report notes that as the economy continues to deteriorate, "at some point in 2009, the idea of ‘subprime and credit crisis’ as a category of suits will fade away as the credit crisis simply becomes ‘the economy’." Among other things, the Report speculates that the spreading economic woe could cause the growing litigation wave to spread outside the financial sector.

 

The deteriorating economic conditions could also lead to increased bankruptcies, a development the Advisen Report notes "almost certainly will be accompanied by an increase in securities lawsuits." The Report notes that since 1995, roughly 35 percent of large public companies (defined as having more than $250 million in assets, measured in 2008 dollars) that filed for bankruptcy were also named in securities class action lawsuits. However, in 2007 and 2008, the percentage increased to 77 percent.

 

The Report also notes a number of factors contributing toward escalating costs of defense, including the complexity of the cases being filed, the novelty of many of the legal theories, and the coincidence of multiple, simultaneous proceedings.

 

The Report reviews the implications of these developments and trends for D&O carriers. The Report also contains interesting comments from several D&O mavens, including John McCarrick, Rick Bortnick and Joe Monteleone. The Report is interesting, well-written and well-documented, and well worth reading in its entirety.

 

My own overview of the 2008 securities lawsuit filings can be found here.

 

Remember Options Backdating?: The cases from the last wave of corporate scandals still remain, although fewer and fewer or them all the time. On February 27, 2009, the parties to the Sunrise Senior Living securities lawsuit, one of the remaining options backdating related securities class actions, agreed to settle the case for $13.5 million. A copy of the stipulation of settlement can be found here.

 

I have added the Sunrise settlement to my running table of the options backdating related lawsuit settlements, dismissal and dismissal motion denials. The table can be accessed here.

 

Special thanks to Adam Savett of the Securities Litigation Watch for providing me with a copy of the Sunrise settlement stipulation.

 

Now I Have Seen Everything: According to a March 2, 2009 story on Bloomberg (here), former AIG Chairman and CEO Maurice "Hank" Greenberg has sued AIG alleging that "material misrepresentations and omissions" caused him to acquire AIG shares in his deferred compensation profit participation plan at an inflated value, and later to lose nearly his entire investment after AIG's losses became known.

 

A March 2, 2009 Reuters story about the lawsuit (here) says that Greenberg acquired the shares on January 30, 2008, when AIG shares traded at $54.37. The company’s shares closed today at 42 cents. Greenberg seeks the difference between what he paid for the shares and what he said the shares were worth, as well as reimbursement of more than $70 million of taxes.

 

The defendants in the lawsuit include, in addition to the company, Greenberg’s successor as CEO, Martin Sullivan, as well Joseph Cassano, who headed AIG’s Financial Product (AIGFP) division. Both men worked for Greenberg prior to Greenberg’s departure.

 

I wonder if his lawsuit would be barred from coverage under AIG’s D&O insurance program (assuming for the sake of argument that it is not otherwise exhausted by prior claims)? As a former officer and director of the company, he still qualifies as an "insured" and so his lawsuit potentially at least could trigger the "insured vs. insured" exclusion typically found in most D&O policies. On the other hand, he left the company in March 2005, and so his claim might come within a coverage carve back in the exclusion, depending on how the applicable provision is worded.

 

If one were to assume that insurance would not be available, then defense expenses (both for the company and for the individuals, who would be indemnified by the company) would come from AIG itself, which owes the U.S. government approximately a gazillion dollars. The same would go for any uninsured settlements or judgments. I leave to others to comment on whether or not taxpayers ought to have to incur the costs associated with this lawsuit.

 

Perhaps pertinent to the question whether or not taxpayers should have to bear the cost of Greenberg's lawsuit, in comments published today (here), the current AIG CEO, Edward Liddy, said that Greenberg is partially responsible for AIG’s current woes. Among other things, Liddy said "The formation of the AIGFP unit, which has literally brought us to our knees, that happened on his watch. The compensation systems that have gone astray, happened on his watch. I don’t think it’s as clean and simple as sometimes Hank would like to portray."

 

And Finally: This week’s Time Magazine has several interesting article about the current economic crisis, including an article highly critical of former SEC Chairman Christopher Cox, entitled "The Inside Story on the Breakdown at the SEC" (here).

 

In addition, this week’s issue also has a fascinating story entitled "One Bad Bond" (here), which explains how losses have compounded exponentially in connection with a CDO-cubed created in March 2007 and called Jupiter High-Grade CDO V. This poster-child of financial engineering excess was originally rated AAA, but now nearly 59% of the instrument’s investments are worthless. Among Jupiter’s investments is an interest in the Mantoloking CDO, a toxic investment vehicle about which I blogged a year ago, here.

 

The article is worth tracking down in its original print version, because the print version is more detailed and is accompanied by graphics that are not available online but that do a particular good job in showing how the complexity of these instruments compounded the losses as the underlying mortgages have faltered.

 

The List: Tracking the Stanford Group Litigation

LAST UPDATED ON February 24, 2010. With the arrival today of two more lawsuits against R. Allen Stanford and the Stanford Financial Group of companies, it may now be time to start keeping a table of the Stanford Group-related litigation. Given the magnitude of the losses and the publicity surrounding the Stanford scheme, there could well be a great deal more of litigation ahead.

 

My running tally of Stanford Group lawsuits can be found here. The document categorizes the suits into several tables, including a final table in which I have listed related proceedings. I will update the table as new cases arrive, and I will indicate the date of the most recent update at the top of this post.

 

The first of the two lawsuits to be added (that is, latest as of the time this post was originally created) today is the securities class action lawsuit filed on February 20, 2009 in the Middle District of Louisiana, in Baton Rouge. A copy of the complaint can be found here. This latest securities lawsuit joins two separate securities class action complaints previously filed in the Southern District of Texas, as well as the SEC enforcement proceeding filed in the Northern District of Texas. UPDATE: In addition to these cases, the plaintiffs in the first filed Southern District of Texas case have also filed a substantially identical complaint in the Nothern District of Texas as well, refer here.

 

The second of the two Stanford-related lawsuits to be added today is a lawsuit filed in Texas (Harris County) District Court by a trustee for the Rocky Mountain Trust. A copy of the trustee’s Original Petition can be found here. According to the Petition, the trust used its income to fund a foundation for "medical, dental and nutritional programs in Mexico and Central America." The Petition states that thousands of poor, including hundreds of Mexican orphans, have received assistance through the foundation. The defendants in the case include Stanford Group Company and related Stanford entities, as well as R. Allen Stanford and other individual Stanford directors and officers.

 

According to the Petition, the trustee was introduced to the Stanford group by acquaintances in Mexico. The trustee was persuaded to invest all of the trust’s assets in Stanford certificates of deposit. The trust is currently invested in three CDs, two of which total approximately $475,000 in face value and a third of which has a face value of about €202,000. Upon hearing of issues involving the Stanford CDs, the trustee unsuccessfully demanded return of the trust’s investment. The complaint asserts claims for common law fraud, violation of the Texas Securities Act, negligent misrepresentation, breach of fiduciary duty, aiding and abetting, conspiracy, and breach of contract. The complaint also seeks a temporary restraining order, and exemplary damages.

 

One common problem all of these cases will face is trying to get service of process on the elusive Mr. Stanford.

 

Hat tip to the Courthouse News Service (here) for the Louisiana and Texas state court complaints. Thanks to Adam Savett of the Securities Litigation Watch for the new Northern District of Texas complaint.

 

Other Stanford-Related Notes: The FCPA Blog has an interesting post today (here) questioning whether Stanford’s interactions with the Antiguan authorities could subject him to enforcement action under the Foreign Corrupt Practices Act.

 

Meanwhile, the February 24, 2009 Wall Street Journal is reporting (here) that a hedge fund run by Vice President Biden’s son and brother was exclusively marketed by companies controlled by R. Allen Stanford.

 

Finally, if you need a steady stream of news about the Stanford scandal, you will want to check out the Houston Chronicle’s Stanford Watch blog (here). Hat tip to the Daily Caveat for the link to the blog site.

 


For those readers who may not previously have seen it, I am also separately maintaining a list of litigation related to the Madoff scandal, which can be accessed here.

 

First Stanford Financial Group Securities Lawsuit Already Filed

In case you were wondering how long it would take, you should know that investors have already filed the first securities class action lawsuit in connection with the fraud allegations surrounding R. Allen Stanford and his Stanford Financial Group.

 

On February 17, 2009 -- the same day as the SEC announced its charges that Stanford had engaged in a "multi-billion dollar investment scheme" -- plainiff investors filed a securities class action lawsuit against Stanford and his related entites, as well as several other individual directors and  offficers, in the Southern District of Texas. The complaint, which can be found here, is filed on behalf of all persons who purchased securities and CDs from Stanford and affiliated selling agents from January 1, 2000 through February 17, 2009.

 

Though many of the Stanford investors reportedly are domiciled abroad (particularly in Latin America), the named plaintiffs in this initial lawsuit are all residents of the Houston area. The defendants include not only Stanford and his Houston-based firm but the affilated bank, based in Antigua.

 

The complaint describes the allegedly aggressive sales efforts undertaken to sell the affilated bank's CDs. The complaint alleges that the sales efforts misrepresented the safety and security of the CDs. The complaint also alleges that the Stanford affilated entitles misrepresented their performance and investment returns. The returns are alleged to have been "misleading and inflated."

 

Call it a hunch, but I suspect this complaint is only the first of many that will be filed in the days, weeks and months ahead.

Let's Get the Facts Right

The numbers are unambiguous – there were more securities lawsuits filed in the second half of 2008 than there were in the first half. Nevertheless commentators and observers continue to repeat the mistaken conclusion that there were fewer lawsuits filed in the second half, and even to try to discern some significance from a decline that never, in fact, occurred.

 

Here are the facts. As reflected on the Stanford Law School Clearinghouse Securities Class Action Clearinghouse website, which helpfully indexes the securities class action filings by quarter (here), there were 112 securities lawsuits filed in the first half of 2008 and 114 in the second half.

Not only were there more lawsuits filed in the second half of the year, but there were more lawsuits filed in the fourth quarter (65) than any other quarter during the year. Indeed, there were more lawsuits filed in December (30) than any other month during the year.

 

 

Clearly, the fact that securities lawsuit filings in fact accelerated at the end of 2008 potentially has far different implications for the future than the mistaken impression that lawsuit filings were declining.

 

 

The source of the impression that there were fewer lawsuits in the second half of 2008 is the year-end securities lawsuit filing Report jointly published by the Stanford Law School Clearinghouse and Cornerstone Research. The Report, which can be found here, considered only lawsuit filings through December 15, 2008. As I noted at the time the Report was first published (here), by omitting the last two weeks’ lawsuit filings, the Report not only excluded at least 12 lawsuit filings from its analysis, but it also reached a conclusion, inconsistent with the actual aggregate year-end data, that lawsuit filings had declined in the year’s second half. When lawsuit filing data through December 31 are considered, it is clear that the number of filings did not decline in the year’s second half.

 

 

What difference does it make whether or not lawsuit filings declined in the second half? Well, a discussion of the reasons for a lawsuit filing decline is a far different conversation that a debate over the reasons why lawsuit filings accelerated in the year’s final quarter and month. The repetition of the impression that lawsuit filings were declining when in fact they were accelerating not only perpetuates a misunderstanding of what actually happened, but it also allows the possibility that decisions could be made or conclusions reached based on a faulty premise.

 

 

Unfortunately the conclusion that securities lawsuit filings declined in the second half of 2008 continues to be repeated. As reflected in a February 9, 2009 Business Insurance article (here), industry observers continue to distract themselves and perhaps others as well debating the reasons for a lawsuit filing decline that never happened, when in fact the actual discussion ought to be the reason why lawsuit filings actually accelerated at the end of the year.

 

 

The danger from this mistaken conclusion is apparent in the remarks of one leading industry observer at a recent conference. As quoted in the Business Insurance article, the observer noted, in apparent reliance on the Cornerstone report, that “in this last quarter, there were actually fewer cases filed. It got better, not worse at the end of the year.” The world certainly looks a lot different if you think things recently “got better”; unfortunately, they didn’t get better, they got worse.

 

 

The D&O insurance industry has a hard enough time behaving rationally and making sense of what has actually happened. It would be extremely unfortunate if the industry were to become even further confused by a conclusion that unsupported by full-year data.

 

 

I entreat readers to do everything they can to make sure that the misimpression about securities lawsuit filing activity levels is not perpetuated. The industry faces too many other challenges to have to deal with the added burden of laboring under misimpressions.

 

A Closer Look at the 2008 Life Sciences Securities Lawsuits

The 2008 securities lawsuit filings were dominated by new lawsuits filed against companies in the financial sector, as has been well-documented elsewhere (refer here). But while lawsuits against financial companies were the most prominent feature of the 2008 securities filings, there were also a significant number of lawsuits filed against companies outside the financial sector. In particular, life sciences companies, which historically have experienced a heightened level of securities litigation exposure, suffered a significant level of litigation activity once again in 2008.

 

For purposes of this post, I am including under the heading "life sciences" companies any company either in SIC Code series 283 (Drugs) or in SIC Code series 384 (Surgical, Medical and Dental Instruments and Supplies). Reasonable minds could differ about whether additional categories should also be included within life sciences companies, but the interests of simplicity and consistency with my own prior analyses support this categorical definition.

 

A review of the 2008 securities lawsuit filings shows that, notwithstanding the primacy of litigation involving financial companies during the year, heightened securities litigation activity involving life sciences companies continued in 2008.

 

According to my analyses, during 2008, there were 15 new securities lawsuits filed against companies in the 283 SIC Code series, including nine in the 2834 SIC Code category (Pharmaceutical Preparations). There were also eight securities lawsuits filed against companies in the 384 SIC Code category, including five in the 3845 SIC Code category (Electromedical Apparatus).

 

The fact that there were 23 new securities lawsuits filed against life sciences companies in 2008 is quite remarkable given the predominance of the credit crisis litigation wave.

 

The total number of life sciences lawsuits is significant in relative terms as well. By way of comparison to the 23 new securities lawsuits filed against life sciences companies in 2008, there were 21 securities lawsuits filed against life sciences companies in 2007. (My detailed analysis of the 2007 life sciences securities lawsuits can be found here.)

 

The fact that the number of lawsuits filed against life sciences companies actually increased in 2008 is extraordinary in light of the extent of the surging credit crisis litigation wave.

 

The 23 securities lawsuits filed against life sciences companies in 2008 represents approximately 10% of the total of 226 new securities lawsuits overall that were filed in 2008, which is comparable to the 12% that life sciences lawsuits represented of 2007 securities lawsuit filings.

 

That this significant of a percentage of securities litigation activity is unrelated to the credit crisis litigation wave underscores a point I have previously emphasized (for example, here), that while the subprime and credit crisis-related litigation wave is a significant factor driving securities lawsuits filing activity, it is by no means the sole factor.

 

The lawsuits filed against life sciences companies in 2008 involved a wide variety of allegations. The most common allegation, asserted in five of the lawsuits, is that the defendant company misrepresented the results or progress of one or more of its clinical trials. Lawsuits filed against four companies alleged financial misstatements or improper revenue recognition.

 

Other lawsuits involved allegations relating to disclosures about product efficacy; manufacturing deficiencies or controls; merger integration issues; misrepresentations about an officer’s credentials; intellectual property concerns; and product commercial viability.

 

The attributes of these companies that most frequently attract litigation is the combination of their susceptibility to disruptive events and the vulnerability of their share prices. These kinds of setbacks are an almost inevitable attribute of the regulatory and scientific environment in which these companies operate. However, these kinds of risks are also often comprehensively disclosed.

 

As a result, though life sciences companies are frequently sued, they have not proven to be easy targets. As I noted here and here, lawsuits filed against life sciences companies are frequently dismissed. Nevertheless, life sciences companies continue to attract the unwanted attention of the plaintiffs’ lawyers.

 

Securities Litigation Survey: Readers interested in securities litigation topics under the year-in- review heading will want to take a look at  the January 2009 memorandum by the Skadden law firm entitled "Securities Litigation 2008 – Noteworthy Decisions" (here). The memorandum does a particularly good job briefly summarizing the eleven decisions discussed as well as identifying the significance of the decisions.

 

Early Registration Deadline Approaching: The early registration deadline for the C5 D&O Liability Insurance Conference is approaching. The Conference is scheduled to take place March 24 and 25, 2009 in London. As reflected in the program brochure, which can be accessed here, the program has a number of interesting speakers and will be addressing many of the current hot topics in D&O insurance. I will be participating in a panel entitled "Current Litigation Trends in Europe and the US: Are Class Actions on the Horizon?"

 

The early registration deadline for this conference is February 9, 2009, after which the registration fee becomes considerably more expense.

 

A Comprehensive Look at FCPA Settlements

A recurring theme on this blog has been the growing threat of civil litigation following in the wake of increased Foreign Corrupt Practices Act enforcement activity. (Refer for example, here.) A recent study both establishes both the overall scale of FCPA enforcement activity and quantifies the magnitude of the FCPA follow-on securities litigation.

 

The January 28, 2009 NERA Economic Consulting study, entitled "FCPA Settlements: It’s a Small World After All" (here) reports that since 2002, SEC and DOJ litigation and class actions involving the FCPA have "increased steadily," with over "$1.2 billion in settlements and penalties involving more than 30 countries during that period."

 

While this impressive number is inflated by the $800 million penalty and disgorgement recently imposed on Siemens, it also apparently does not include the pending $559 million settlement to which Halliburton recently agreed.

 

The Report, which draws on a database of all FCPA settlements between 2002 and 2008, includes a list of the ten largest regulatory settlements (again, not including the pending Halliburton settlement), which range between $16 million and $800 million. These figures include settlements with both the SEC and the DOJ.

 

What makes this Report really interesting is its analysis of settlements of securities class action lawsuits based on FCPA-related allegations.

 

The Report states that in securities fraud class action lawsuits arising from alleged FCPA violations a total of $84.4 million has been paid in settlements between 2002 and 2008. The Report further notes that if the outsized Siemens settlement is removed from the analysis, the settlements related to securities class action lawsuits represent 21% of all of the total FCPA-related civil and regulatory settlement by public companies during the period 2002 through 2008.

 

Based on the author’s review of several recently settled FCPA-related class action settlements, the Report concludes that "the behavior connected to the alleged FCPA violation can sometimes have a lasting impact on the company’s business." The class action settlements demonstrate "the link between alleged FCPA violations, ongoing revenue and the potentially large impact on firm value."

 

The Report also contains a table reflecting the market-adjusted price reactions to FCPA-related news and announcements. Analysis of the data shows that "the majority of companies that exhibited statistically significant price reactions at the 5% level to FCPA-related news had resulting 10b-5 actions filed against them."

 

The Report concludes by stating that as a result of globalization trends, coordinated regulatory activity and record-keeping requirements, FCPA enforcement is a growing priority around the world, and states that "as FCPA-enforcement against domestic and foreign issuers increases, it is likely that related securities litigation will be an issue in many of these cases."

 

The NERA Report’s detailed analysis is very interesting and is also quite consistent with my own analysis of the growing liability threat that FCPA enforcement activity represents. The Report also provides statistical support for my view, expressed here, that "the proliferation of this type of litigation activity and the significant involvement of the leading plaintiffs’ firms suggests that this category of emerging litigation may represent an increasingly important area of potential liability to directors and officers."

 

This growing liability exposure also raises a number of potentially significant D&O insurance coverage issues, which I discussed at length in the June/July 2008 issue of InSights, which can be found here.

 

My  recent post analyzing the opinion in the InVision case, in which the Ninth Circuit affirmed the dismissal of a securities class action lawsuit that had been based on FCPA-related allegations, can be found here.

 

A recent post with a year-end 2008 FCPA update can be found here.

 

NERA Releases 2008 Canadian Securities Class Action Trends Study

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

First SDNY Subprime Securities Lawsuit Dismissal

On January 12, 2009, in the first dismissal motion ruling among the many subprime and credit crisis-related securities lawsuits pending in the Southern District of New York, Judge Shira Scheindlin granted the defendants’ motion to dismiss in the Centerline Holding Company securities case, with leave to amend. A copy of the opinion can be found here.

 

Background

As detailed more fully here, the plaintiff’s complaint basically alleges that the company and four individual defendants concealed from the investing public that they were structuring a sale of the company’s $2.8 billion portfolio of tax-exempt mortgage revenue bonds to a third party. When the company announced the sale, it also announced that it would be cutting its dividend from $1.68 per share to only 60 cents a share.

 

The company also disclosed at the same time that it had entered into a related party transaction with a company controlled by its Chairman, Stephen Ross, and its Managing Trustee, Jeff Blau, whereby this separate company agreed to provide Centerline with $131 million in financing in exchange for 12.2 million shares of newly-issued convertible stock that will pay an 11% dividend.

 

Upon the announcement of this news, the company’s share price declined 25% and the lawsuits followed.

 

The Motion to Dismiss Ruling

The defendants moved to dismiss the complaint on the ground that the plaintiff had not adequately pled scienter. Judge Scheindlin agreed. Specifically, she concluded that the plaintiff had neither alleged sufficient facts showing that defendants had the motive and opportunity to commit fraud nor adequately pled that defendants acted with recklessness.

 

The plaintiff had alleged that defendants Ross and Blau were motivated to "engineer" the related party transaction to increase their voting control of the company from 17% to almost 30%; to be paid an 11% coupon rate, "thereby diverting a material portion of the Company’s income to insiders…to the great detriment of shareholders"; and to have the opportunity to nominate an individual trustee.

 

Judge Scheindlin said that these allegations "do not explain why Ross and Blau would have wanted to fraudulently conceal the news" of their investment or of the bond portfolio sale. She also said that "if they had any motive, it would have been to disclose information about the bond sale and dividend cut sooner," since their preferred shares are only convertible at $10.75 a share, yet after the announcement of the bond sale, the company’s share price declined to $7.70 a share.

 

The court noted that if Ross and Blau had wanted a "sweetheart" deal, "the would have been motivated to cause information related to the sale of the bond portfolio and dividend cut to be disclosed sooner so that they could have negotiated a lower conversion price."

 

Judge Scheindlin also found insufficient the allegations that the other two individual defendants were motivated by reason of their high salaries, bonus compensation, equity awards or continued employment.

 

Judge Scheindlin also held that the plaintiff had not alleged facts sufficient to establish conscious misbehavior or recklessness. Specifically, she noted that "the Complaint does not allege any facts to show that defendants knew they should have disclosed information of the transactions prior to the date of the announcement, but recklessly failed to do so."

 

The defendants cited an SEC rule (promulgated in implement Section 409 of the Sarbanes Oxley Act) specifying that companies are required to disclose material definitive agreements within four business days of entry into the agreement, and argued that the plaintiff had not alleged that the company had failed to comply with the rule. The plaintiff argued that whether the defendants complied with the SEC’s rule, the company had failed to disclose information about the pending sale information about the pending sale and dividend cut while the company was making other disclosures on those topics, which made those other disclosures "false, inaccurate, incomplete or misleading."

 

Judge Scheindlin said that even if it were assumed that the statements were misleading, the defendants’ compliance with the SEC’s rule "suggests that Lead Plaintiff has failed to show defendants acted recklessly in omitting such information." She added that defendants conduct cannot be described as "highly unreasonable" when "it is arguable that they did not have a duty to disclose such information before they actually did."

 

Because she found that the plaintiff had not presented facts to make the Section 10 claims "plausible," Judge Scheindlin dismissed the claims, but she allowed plaintiff 30 days in which to file an Amended Complaint.

 

Discussion

The significance of Judge Scheindlin’s opinion is that it is the first dismissal motion ruling in a subprime and credit crisis-related case in the Southern District of New York. A very large number of the subprime and credit crisis-related securities lawsuits overall have been filed in the S.D.N.Y because the financial services industry is concentrated there. By my count, as many as 54 of the 101 subprime and credit crisis-related securities lawsuits that were filed in 2008 were filed in the Southern District of New York.

 

However, any inferences about the other cases that might be drawn from Judge Scheindlin’s grant of the dismissal motion in the Centerline case probably need to be heavily discounted because the opinion depends so heavily on case-specific allegations and the specifics of the transaction involved. For that reason the case may offer relatively little insight into the prospects for other cases pending in the S.D.N.Y., except to the extent that it illumines the legal standards that will be applied to scienter issues in other cases.

 

In any event, the ruling was without prejudice, and it remains to be seen whether or not the plaintiffs will be able to amend their pleadings sufficiently to survive a renewed motion to dismiss.

 

Those readers who may have had the thought, as I did, while reading about this case that the allegations really lend themselves more to a derivative lawsuit alleging breaches of the duty of loyalty and care will want to know that there was a separate derivative lawsuit filed in the S.D.N.Y. against Centerline, as nominal defendants, as well as certain of its directors and officers. A copy of the derivative complaint can be found here.

 

I have added the recent Centerline opinion to my table of subprime and credit crisis-related securities lawsuit dismissals, dismissal motion denials and settlements, which can be accessed here.

 

Another 2009 Credit Crisis Lawsuit: In their January 14, 2009 press release (here), plaintiffs’ lawyers announced their initiation of a securities class action lawsuit in the Western District of Washington on behalf of investors who purchased certain WaMu Mortgage Pass-Through Certificates. The Complaint (which can be found here) was filed against the various series of certificates, as well as Washington Mutual bank, WaMu Acceptance Corporation, and certain individuals.

 

According to the press release, the complaint alleges that the "defendants made material misstatements and omissions in connection with the offerings regarding the collateral underlying the certificates."

 

The new WaMu case is already the third subprime and credit crisis-related lawsuit filed so far in 2009. Because I thought that some readers might like to separately track the 2009 credit crisis securities lawsuits, I have created a separate spreadsheet (that can be accessed here) on which I will separately track the 2009 credit crisis cases. I will update the spreadsheet as new credit crisis cases are filed.

 

The addition of the WaMu case brings the total number of subprime and credit-crisis related securities lawsuits that have been filed since 2007 to 144. My list of all of the subprime and credit crisis securities cases can be accessed here.

 

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

 

More about Social Networking: In a recent post, I revealed my New Year’s resolution to become more familiar with and involved in the various professional social networking sites, including LinkedIn and Twitter. The prior post elicited a promising initial response, but because I suspect that many readers may not have seen my prior note, I am reprising the message here.

 

Many readers may be interested to know that between the times when I enter new blog posts, I often add quick notes and links on Twitter. My Twitter site can be accessed here. It is relatively simple to register.

 

I also remain interested in trying to better develop my LinkedIn network. The LinkedIn button in the right hand margin above will take you to my LinkedIn profile. I am interested in trying to bring readers of this blog into my LinkedIn network, so please let me know if you would like to "connect." I am still learning what I might be able to accomplish with the network, but I proceeding on the theory that the only way to figure it out is to plunge in and try to make it work.

 

Updates: Section 11 Jurisdiction and More

Seventh Circuit Weighs In on State Court ’33 Act Jurisdiction and Removal: A January 5, 2009 Seventh Circuit decision in the Katz v. Gerardi case (here) may make it more difficult for plaintiffs to pursue ’33 Act litigation in state court, at least in the Seventh Circuit -- and possibly elsewhere, too.

 

As I detailed in a recent post (here), plaintiffs’ lawyers have proven keenly interested in pursing subprime and credit crisis-related litigation in state court, apparently for forum shopping type reasons. Defendants generally have sought to remove these cases to federal court, relying, among other things on the Class Action Fairness Act of 2005 (CAFA) and the Securities Litigation Uniform Standards Act of 1998 (SLUSA).

 

However, this past summer, the Ninth Circuit held in the Luther v. Countrywide case that the nonremoval provision in Section 22 of the ’33 Act (which provides concurrent state and federal court jurisdiction for ’33 Act cases) effectively trumps the more recently enacted SLUSA and CAFA because it more specifically relates to securities lawsuits. My discussion of the Luther v. Countrywide case can be found here.

 

An October decision in the Second Circuit in the New Jersey Carpenters’ Fund v. Harborview Mortgage case had refused to remand to state court a ’33 Act case, as is more fully discussed on the 10b-5 Daily blog (here). The Harborview decision was primarily based on the fact that the underlying securities lawsuit did not involve "covered securities" for which SLUSA created an explicit removal exception; because the exception did not apply, the case could appropriately be removed to federal court notwithstanding the nonremoval provision in Section 22.

 

In the recent Seventh Circuit opinion, Judge Frank Easterbrook wrote that the provisions of the more recently enacted statutes, particularly CAFA, trump Section 22. Judge Easterbrook expressly rejected Luther v. Countrywide’s conclusion that the more specific securities statute prevailed. However, Judge Easterbrook’s opinion, like the Second Circuit opinion in Harborview, also depended in part on the fact that the investment instruments involved are not "covered securities" (i.e., do not trade on a national exchange), and therefore did not come within one of CAFA’s removal exceptions.

 

In addition, Judge Easterbrook’s opinion does seem to have been influenced significantly by the fact that the plaintiff in the case was really a seller of the investments involved, rather than a buyer, and therefore lacked a legal basis to assert a ’33 Act claim. Although the opinion nevertheless examined the removal/jurisdictional issues as if the plaintiff had a legal right to assert the claim, the opinion’s starting point arguably influenced the outcome of its analysis.

 

In any event, the Seventh Circuit’s recent opinion, together with the Second Circuit’s Harborview opinion, clearly could create substantial jurisdictional hurdles (at least outside the Ninth Circuit) for the numerous plaintiffs now seeking to pursue ’33 Act claims in state court. Many (if not all) of the various subprime and credit crisis-related cases filed in state court related to investment instruments that are not traded on national exchanges and therefore are not "covered securities." Accordingly, contrary to the title of one of my prior posts, Section 11 cases may not be "coming soon to a state court near you" after all.

 

A January 12, 2009 Law.com article discussing the Seventh Circuit opinion can be found here.

 

Collins & Aikman Defendants Criminal Charges Dropped: On January 9, 2009, prosecutors dropped securities fraud and other criminal charges against former Collins & Aikman CEO David Stockman and three others. As reported in the January 10, 2009 Wall Street Journal (here), the U.S. Attorney’s office said further prosecution "wouldn’t be in the ‘interests of justice’ following a renewed assessment of the case."

 

While the individuals involved undoubtedly are relieved to have the prosecutorial threat removed, the government’s action comes only after the now-defunct company’s directors and officers insurance was entirely exhausted by defense fees, as I discussed at length in a prior post (here). Unfortunately for these individuals, they continue to face SEC enforcement proceedings as well as civil litigation (about which refer here), now without any further insurance available to fund their defense in these proceedings, not to mention any settlements or judgments that may follow.

 

A criminal prosecution has such an enormous potential to cause harm. On the one hand, it is commendable that the government was willing to reassess the case and to drop it before any further harm was done. On the other hand, even though the prosecution is over, it has done material damage to the individuals who were unfortunate to be subject to a prosecution that lacked an adequate basis. It is extremely regrettable when the government uses its enormous power when it is unwarranted. In this instance the government can drop the case and walk away without so much as an apology, but the unfortunate consequences of an unjustified prosecution continue for the individuals involved.

 

University of Denver law professor Jay Brown has extensively covered the Collins & Aikman criminal prosecution on the Race to the Bottom blog (here), including in particular his discussion (here) of how the criminal prosecution exhausted the company’s D&O insurance. The SEC Actions blog has a good summary description (here) of the criminal case and raises the question whether the SEC will proceed with the civil enforcement proceeding in light of the discontinuance of the criminal case. All of the key pleadings in the criminal case can be found on the University of Denver Law School’s corporate governance website, here.

 

2008 Delaware Case Law in Review: Francis Pileggi of the Delaware Corporate and Commercial Litigation Blog has released the2008 installment of his annual review of key Delaware opinions. Pileggi’s report, which is must reading for anyone who wants an overview of important legal developments in Delaware’s court’s during 2008, is entitled "Selected Key Corporate and Commercial Delaware Decisions in 2008" and can be accessed here.

 

Fresh Scandal for a New Year: The "Indian Enron"

2009 has barely just begun but the year’s first corporate scandal, which has quickly been dubbed the "Indian Enron," has already arrived. Your radar might not have picked this one up yet, but you may want to take a quick look at today’s news involving Indian information technology company Satyam Computer Services, Ltd.

 

As reported in articles on Bloomberg (here) and the New York Times website (here), Satyam’s Chairman, Ramalinga Raju, has sent a January 7, 2009 letter of resignation to the company’s Board of Directors, with copies the Bombay stock exchanges, in which he reveals, as the Times puts it, that "the company’s financial position had been massively inflated during the company’s expansion from a handful of employees into an outsourcing giant with 53,000 employees and operations in 66 countries."

 

It appears that as much as 53.6 billion rupees (or about $1.04 billion) in cash that the company reported as of the end of the second quarter that ended in September, was nonexistent. The company’s reported second quarter revenue was actually 21 billion rupees, rather than the reported 27 billion rupees.

 

The Chairman’s letter, which can be found here, is an absolutely extraordinary document.

 

With "deep regret and a tremendous burden," the Chairman details the specific balance sheet accounts that were inflated due to "non-existent cash." The letter further explains how the balance sheet "gap" came to exist – it is, the Chairman reports, "purely on account of inflated profits over a period of the last several years."

 

The letter states matter-of-factly that "what started as a marginal gap between the actual operating profit and one reflected in the books of accounts continued to grow over the years. It has attained unmanageable proportions as the size of the company operations grew." The letter goes on to describe how the company strained to maintain the gap over time." The letter further describes the company’s attempts to work out of its dilemma by merging with other companies, which the letter describes as the "last attempt to fill the fictitious assets with real ones." (The mergers fell through.)

 

It was, the letter says "like riding a tiger without knowing how to get off without being eaten."

 

In an apparent bid to exculpate himself, the Chairman notes that neither he nor the company’s Managing Director (or their spouses) sold any shares, nor have the taken "one rupee/dollar from the company" and they have not "benefitted in financial terms on account of the inflated results."

 

The Chairman graciously emphasizes that none of the past or present board members "had any knowledge of the situation in which the company is placed." After identifying each of these individuals by name, he states that none of them "were aware of the real situation as against the books of accounts."

 

The letter concludes with a description of the corrective actions the company will now take, an apology, and the Chairman’s resignation.

 

The company, whose name means "truth" in Sanskrit, trades its shares on the Bombay stock exchange and also has American Depository Receipts that trade on the New York Stock Exchange. Its shares also trade on the Euronext exchange.As of the close of trading on January 6, 2009, the company had a market capitalization of over $3 billion. However, the shares plunged 77% in trading on the Bombay exchange today.

 

The Times reports that the company is audited by PricewaterhouseCoopers.

 

According to a January 7, 2009 commentary on the Wall Street Journal’s website (here), Satyam’s scandal is already being called "India’s Enron." Perhaps that comparison was inevitable, but I think the scandal, particularly the Chairman’s extraordinary letter of confession, has overtones of the Madoff affair.

 

How long do you suppose it will be before a securities class action lawsuit is initiated in the U.S.?

 

UPDATE: The answer to this question is: less than one day. Plaintiffs' lawyers January 7, 2009 press release about their newly filed securities lawsuits agasint Satyam and certain of its directors and officers on behalf of purchasers of the American ADRs can be found here. The case was filed in the Southern District of New York.

FURTHER UPDATE: A copy of one of the Satyam complaints can be found here.

 

Special thanks to a loyal reader for supplying a copy of the Chairman’s letter.

 

Cornerstone Releases 2008 Securities Litigation Report

On January 6, 2008, Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse released their report on the 2008 securities class action lawsuit filings entitled "2008: A Year in Review." The Report can be found here and the accompanying press release can be found here.

 

According to the Cornerstone Report, through December 15, 2008, there were 210 securities class action lawsuits filed in 2008, which represents an 18% increase over 2007 and an 80% increase over 2006. The Report also found that the 2008 filing levels represented a 9% increase over the average annual filing level of 192 for the 11 years ending in December 2007.

 

As discussed below, the Report’s analysis of the 2008 filing levels is consistent with my own previously released analysis, which can be found here.

 

Cornerstone’s release of its annual securities litigation report is a much-anticipated event, and this year’s Report does not disappoint. It contains a veritable treasure trove of detailed observations, including a multitude of complex comments about the magnitude of financial losses involved in securities cases over time. The Report also has a host of other detailed comments about the specifics of the 2008 filings.

 

The Report merits a thorough and comprehensive reading. I briefly summarize the Report’s findings below and follow with my own comments.

 

The Cornerstone Report’s Findings

The Report observes that the period of heightened filing activity began in the second half of 2007. The 317 filings during the last 18 months represent a 71 percent increase over the 185 filings during the preceding 18-month period.

 

The Report finds that the 2008 filing activity was "dominated by a wave of litigation against firms in the financial sector" and that "litigation against firms closest to the on-going subprime/liquidity."

 

The 2008 Report introduces a truly nifty innovation called the Securities Litigation Heat Map, which graphically shows how concentrated the 2008 securities filing activity was in the financial sector. Among other things, the Map shows that nearly a third of all large financial firms were named defendants in a securities class action in 2008.

 

The Heat Map also shows how over the years different sectors have been variously targeted in securities lawsuits.

 

The Heat Maps confirm what practitioners in this area have long known, which is the litigation activity is strongly driven by sectors slides and contagion effects, as a result of which over time industry alone has proven to be a very poor predictor of likely future securities litigation activity. Simply put, the plaintiffs lawyers simply move on to then next hot trend.

 

The Report also includes the annual analysis of what it calls Disclosure Dollar Losses (that is, market capitalization losses at the end of each class period). The Report finds that these losses for 2008 class actions totaled $227 billion, which is 48 percent more than 2007 and 75 percent more than the annual average for the 11 years ending in 2007, and also represents the highest level since 2000.

 

In its review of the status of database cases, the Report finds that of resolved cases, 41 percent were dismissed and 59 were settled. The majority of cases were resolved after the first ruling on the motion to dismiss but before the rulings on summary judgments. For class actions filed between 1996 and 2002 and resolved by the end of 2008, the median time to resolution was 33 months, the median time to settlement was 37 months, and the median time to dismissal was 25 months. The Report also concludes that class action with higher shareholder losses take longer to resolve.

 

The Report also notes that the percentage of cases involving Section 11 claims increased to its highest level in 2008. The Report also noted that with respect to alleged violations of GAAP, there has been a shift from allegations related to income line statements to allegations related to balance sheet components. The Report also notes that seven of the 192 companies named in class actions in 2008 subsequently filed for bankruptcy, compared to two out of 172 in 2007 (although five of the 2007 companies filed for bankruptcy in 2008).

 

The Number of 2008 Filings

The Report’s tally of 210 new securities filings through December 15, 2008 is essentially consistent with my own report’s conclusion (refer here) that there were 224 new securities lawsuits through December 31, 2008, as there were 13 new securities lawsuits filed after December 15 and before December 31. The 13 additional lawsuits I included in my tally but that were omitted from the Cornerstone Report account for virtually all of the difference between the two analyses.

 

The arrival of 13 new securities lawsuits in the last two weeks of the year is unusual, as December is usually a slower month for new filings. The late December influx was largely but not exclusively due to the flood of Madoff- related litigation.

 

Cornerstone’s Report’s cutoff at December 15 is significant in other respects as well. For example, the Report states that lawsuit filings dipped in the second half of the year, and even relies on the supposed second half decline as one of the grounds on which it suggests that financial sector securities lawsuit filings may diminish in 2009. The Report also devotes a great deal of effort to trying to reconcile this supposed second half decline with observations regarding stock market volatility.

 

However, when all of the lawsuits filed through year end are included, it turns out that filings actually increased in the second half of the year. Not only that, but as I pointed out in my report on the 2008 filings, the securities lawsuit filing levels in the fourth quarter 2008 and in December 2008 represent, respectively, the highest quarterly and monthly totals in over five years.

 

Projected 2009 Filing Trends

The Report contains no predictions regarding likely overall 2009 filing levels, but the accompanying press release quotes Stanford Law Professor Joseph Grundfest to the effect that securities litigation against the financial sector may decline in 2009 because "virtually all the major financial services firms have already been sued," as a result of which "the pool of major financial services defendants might be getting fished out." In support of this conclusion, the Report among other things cites the fact that of the 15 largest financial services companies by market capitalization at the beginning of 2007, 12 of them have already been sued.

 

Professor Grundfest does not actually predict that overall securities lawsuit filings will decline in 2009; however, in the press release, he is quoted as saying that, because all of the major financial institutions have already been sued, "the supply of new defendants might be drying up." He also suggests that "litigation activity against the financial sector may decline next year," and in the Report adds that "it is unclear as to whether the wave of litigation will extend significantly beyond the larges financial firms in the near future."

 

My own view is that 2009 could well be a very active year for securities litigation. This view is based in part on the surge of litigation in the latter part of 2008, which shows every sign of continuing. The fact that there were thirty new securities class action lawsuits in December 2008, including ten new credit crisis-related lawsuits, strongly suggests that plaintiffs’ lawyers are finding no shortage of targets.

 

In addition, the credit crisis litigation wave long ago ceased to be just about the large financial institutions, if indeed it ever was just about that. As time has gone by, the wave has continued to spread and evolve. One attribute of this evolution is that as 2008 progressed, the credit crisis litigation has extended far beyond the financial services sector, as I noted most recently here.

 

In other words, the plaintiffs’ lawyers may or may not find new targets in the financial sector. (Although I strongly suspect that as a result of the Madoff scandal the plaintiffs’ lawyers will find innumerable new financial sector targets, but that is a separate issue.) The likeliest scenario, borne out by filing patterns that are already emerging, is that the plaintiffs will simply move on to other sectors, as they have numerous times in the past.

 

I note parenthetically that the probable movement of the litigation to a new sector is graphically foreshadowed by the Cornerstone Report’s Securities Litigation Heat Maps, which vividly show how quickly plaintiffs’ lawyers have moved from sector to sector in the past.

 

All of which I believe suggests that the heightened filing levels show every likelihood of continuing into 2009. Indeed, given the strong likelihood of additional Madoff victim litigation, as well as the likely continued spread of the credit crisis litigation wave outside the financial sector, the likeliest possibility is that 2009 will be a very active year for securities litigation.

 

The WSJ.com Law Blog has a January 5, 2009 post (here) discussing the 2008 securities lawsuit filings and quoting both from the Cornerstone Report and from my analysis of the 2008 filings.

 

Top Ten D&O Stories of 2008

2008 was a remarkably eventful year, from the dramatic events that rocked the financial markets to the Presidential election that resulted in a change in national leadership. Virtually all of the significant events during 2008 also had an impact on the world of D&O insurance, one way or another. In all likelihood, significant developments will continue to emerge during 2009, with further implications for the D&O marketplace.

 

In a year as eventful as 2008, selecting as the most significant events is a challenging task. But with an eye toward the developments of greatest significance for the D&O industry, I have prepared the following list of the top ten stories of 2008.

 

1. Credit Crisis Becomes Global Financial Calamity: What began in 2007 as a subprime meltdown had by early 2008 become a credit crisis, which in turn evolved during Fall 2008 into a full blown global financial disaster.

 

Within the space of just a few short weeks, the government took control of Fannie Mae and Freddie Mac; the FDIC took over Washington Mutual, in the largest U.S. bank failure ever; Lehman Brothers collapsed, in the largest U.S. bankruptcy ever; Bank of America agreed to acquire Merrill Lynch in a government brokered deal; the government undertook a massive bailout of AIG; Congress enacted a colossal $700 billion bailout package; and Wells Fargo agreed to acquire Wachovia. And those events came after a raft of prior financial shocks, including the collapse of Bear Stearns, the seizure of the auction rate securities market, and the disintegration of U.S. residential real estate market.

 

Any one of these events on its own would be significant. Taken collectively these events represent an enormous upheaval, the full ramifications and consequences of which will only emerge over the months and years to come.

 

And those are just the headlines. In other developments reported "below the fold," companies around the world have grappled with a general business downturn, wrestled with the threat of their own insolvency or that of their customers or suppliers, and basically tried to maintain their ground in an increasingly hostile financial environment.

 

All of these developments have enormous potential significance, much of it yet to unfold. These events have not only fueled litigation, but they have also presented D&O underwriters with a dramatically altered underwriting environment. The perils involve not only the challenge of underwriting financially troubled companies, but also the trial of underwriting in the context of rapidly changing (and deteriorating) conditions in the financial and credit markets.

 

During 2008, the world became significantly more dangerous for D&O underwriters. All signs suggest the current perilous conditions will continue into 2009, and perhaps beyond.

 

2. Financial Market Disruptions Hit Major Insurers: The turmoil in the financial markets also battered three insurers that are major players in the D&O marketplace. AIG’s woes required an enormous government bailout. XL and Hartford both faced differing degrees of turbulence due to write-downs in their respective investment portfolios.

 

Each of one of these insurers is dealing with their own unique set of circumstances. Rating agencies have noted and responded to these developments. Insurance buyers remain anxious and wary. The implications of these developments, both for each of these insurers and for the marketplace as a whole, remain to be seen. At a minimum, these events have disrupted the D&O insurance marketplace and introduced a significant element of uncertainty. The disruptive impact from these developments is likely to continue to affect the D&O industry throughout 2009.

 

3. Subprime and Credit Crisis Litigation Wave Rolls On: The subprime litigation wave that began in 2007 continued to surge in 2008, as there were 101 new subprime and credit-crisis related securities lawsuits filed during 2008, bringing the two-year total to 141. My running tally of the subprime and credit crisis-related securities lawsuits can be accessed here.

 

As time has passed, the litigation wave has continued to evolve; for example, the 2008 subprime and credit crisis-related litigation included as many as 21 auction rate securities lawsuits all of which were filed in the earlier part of 2008. Later in the year, a string of lawsuits initiated by holders of preferred or subordinated securities emerged (as discussed here).

 

In February 2009, the subprime and credit crisis-related litigation wave will enter its third year, but the phenomenon shows no signs of abating. The credit crisis-related securities lawsuits continued to accumulate throughout 2008. Of the 101 subprime and credit crisis-related lawsuits filed in 2008, 45 were filed in the second half of the year, including ten in December alone.

 

The credit crisis lawsuit filings remained high as the year ended, suggesting that significant credit crisis litigation activity will continue well into 2009 and perhaps beyond.

 

4. Credit Crisis Litigation Spreads Beyond the Financial Sector: As massive as the subprime and credit crisis-related litigation wave has been, it had until recently been concentrated in the financial sector. But as 2008 wore on, and largely as a result of the dramatic events in the global financial markets during September and October 2008, the litigation wave spread beyond the financial sector.

 

The companies that have become involved in this extended litigation wave include, for example, those that had significant exposure to Lehman Brothers or other companies that collapsed this fall. (Refer here and here for discussion of these "new wave" credit crisis lawsuits). In addition, companies that have been drawn in include companies that made wrong way bets on commodities or currencies (about which refer here).

 

These developments suggest that the credit crisis-related litigation wave may have entered a dangerous new phase, as I discuss at greater length here. These developments also underscore the challenges for D&O underwriters in the current environment.

 

My complete rundown of all 2008 securities litigation can be found here.

 

5. Bank Failures Surge: Led by the FDIC’s assumption of control of Washington Mutual in the largest bank failure in U.S. history, bank failures surged in 2008. According to the FDIC’s website (here), there were 25 bank failures in 2008, the highest annual total since 1994, at the end of the last era of failed banks. Perhaps even more significantly, the pace of bank closures increased as the year progressed; 21 of the 2008 bank closures took place in the second half of 2008, 12 of them in the fourth quarter.

 

In many ways, other financial events have overshadowed this sudden surge in bank failures. Indeed, as I noted here, the WaMu failure, the largest in U.S. history, has largely been relegated to yesterday’s news pile. But the timing and pace of the bank closures during 2008 suggests that there are likely to be further bank failures ahead, carrying with it the threat of associated "dead bank" litigation, a possibility I previously discussed here.

 

6. Madoff Scandal Triggers Litigation Torrent: The revelation of the massive Ponzi scheme involving Bernard Madoff and his firm has triggered a wave of litigation as aggrieved investors scrambled to try to recoup their losses. The first Madoff-related lawsuits targeted Madoff and his firm. But given the unlikelihood of a significant recovery there, investors have quickly moved on to other targets. A running tally of the Madoff investor litigation can be accessed here.

 

The primary Madoff-related litigation targets are the so-called "feeder funds" that invested with Madoff on their clients behalf. Recent blog posts discussing these "feeder funds" lawsuits can be found here and here. Given the magnitude of the investor losses and the depth of investor outrage, these lawsuits are likely to continue to accrue for some time to come. Press reports (for example, here) suggest that lawyers are gearing up for a litigation onslaught.

 

7. Presidential Election Signals Changes: I don’t know whether you heard, but there was an election in November. The coming changes in the White House as well as the increased Democratic majority in Congress could signal significant future legislative and other developments.

 

The arrival of the new administration will likely mean a change in direction for judicial appointments. A more interesting question is whether the Democratic control of Congress and the White House could lead to legislative changes in the securities laws. As discussed at the PLUS International Conference in November (about which refer here), the current financial turmoil could be used as a justification for legislative reform efforts – for example, an attempt to overturn Central Bank and Stoneridge.

 

At a minimum, the coming changes in the leadership at the SEC, together with a different leadership interpretation of the meaning and value of regulation, could lead to a changed environment for the enforcement of the securities laws.

 

8. Largest-Ever Fine Underscores the Growing Significance of the FCPA: For some time now (most recently here), I have been writing about the growing importance of Foreign Corrupt Practices Act (FCPA) enforcement activity and associated civil litigation. The FCPA mounting significance was dramatically underscored recently when Siemens agreed to pay an $800 million fine.

 

The Siemens fine is the largest ever, dwarfing the previous record fine, paid by Baker Hughes, of $44 million (about which refer here). The outcome of the Siemens investigation is merely the latest development in a long chain of events highlighting the growing importance of the FCPA.

 

As I have previously noted (refer here), one of the usual accompaniments of an FCPA investigation is follow-on civil litigation. As the threat of FCPA-related exposure continues to grow, the threat of follow-on civil litigation will also increase.

 

The FCPA Blog has a detailed overview of 2008 FCPA enforcement activity here.

 

9. Defense Expense Tests Limits Adequacy: Companies ensnared in high stakes litigation may find themselves confronting an unexpected new challenge – the increasing likelihood that defense costs alone could exhaust the entire amount of available D&O insurance coverage. This threat was unfortuntately realized in connection with the Collins & Aikman bankruptcy and related criminal proceeding (about which refer here), where accumulated defense expense exhausted the company’s entire $50 million D&O insurance, before the criminal case even went to trial.

 

The possibility that escalating defense expense could entirely deplete available insurance presents a frightening prospect for individuals involved in a serious D&O claim, and also raises troubling questions about traditional notions of limits adequacy. In addition, the possibility of total limits exhaustion as the result of the requirements of multiple claims and multiple insureds underscores the need for insurance buyers to consider alternative insurance structures (such as, for example, separate insurance for an individual or a group of individuals) to ensure that segregated funds remain available in the event of a catastrophic claim.

 

10. Indemnity Developments Trigger Additional Insurance Structure Concerns: In the Schoon v. Troy case (about which refer here), the Delaware Chancery Court held that a board of directors properly could eliminate former directors' advancement rights retroactively. The possibility that former directors could lose their rights to advancement or indemnification comes as unwelcome news to many directors.

 

This case development, like the development about limits adequacy noted above, highlights the need to address program structure as part of the insurance acquisition process. In general, directors and officers have become more concerned about the availability of insurance protection when they need it most. As a result, interest in a wider variety of auxiliary insurance structures has increased. These structures can include new insurance solutions designed for the needs of retiring directors.

 

In a year as eventful as 2008, reasonable minds could differ about what events deserve to be included in any Top Ten list. I am very interested in readers’ views about the top stories, particularly those who feel that other events deserved to be included on the list.

 

More "Top" Lists: Making year-end lists seems to be a nearly universal phenomenon, and Top Ten lists abound. Time Magazine simplified things by creating "The Top Ten of Everything of 2008," which can be found here.

 

Then  there are always the lists of the "Bottom Ten," like Business Week’s list of the Ten Worst Predictions About 2008 (here). Fortune has a list (here) of the "dumbest" business decisions of 2008, but given the kind of year 2008 was, a list of just ten was not enough – the magazine’s targets 21 business decisions as "dumbest."

 

Perhaps the most entertaining "Top" list is VideoGum’s list of the Top Viral Videos of 2008, which can be viewed below. (Viewer discretion is advised as some persons may find some of the content offensive.)

 

PLUS D&O Symposium: Readers will also want to be sure to register for the annual PLUS D&O Symposium, which will be held on February 25 and 26, 2009, at the Marriott Marquis Hotel in New York. Information about the Symposium, including registration instructions, can be found here.

 

The Symposium will feature an all-star cast, including keynote speakers Madeline Albright and NY Insurance Department Superintendant Eric Dinallo. Wilson Sonsini partner Boris Feldman will once again be moderating the annual panel on securities litigation developments. The schedule also includes a panel on Bankruptcies and Bailouts, with panelists including VJ Dowling of Dowling & Partners Securities and David Bradford of Advisen.

 

The conference will also include a replay of the excellent video, "The Rise and Fall of Bill Lerach" (a movie trailer for which can be found here). Stanford Law Professor Joseph Grundfest will lead a panel discussion of the video. The video was shown at the PLUS International Conference in November 2008 and received rave reviews.

 

Readers with any questions about the Symposium should feel free to drop me a note or give me a call.

 

While You Were Out

Over the holidays, I added two blog posts that readers may find particularly interesting. To make sure that readers returning to their desks after the holidays do not overlook them, I have highlighted the two posts below, with links.

 

The List: Madoff Investor and Feeder Fund Litigation (December 26, 2008): This post is the access point to a table of Madoff Investor and Feeder Fund litigation. I have updated the litigation table numerous times since the initial publication, as several readers have helpfully provided relevant additional links and documents.

 

 

I will continue to update the table as new Madoff litigation arises. Readers are strongly encouraged to let me know of any new or additional information necessary to keep the table accurate and up to date.

 

 

A Closer Look at the 2008 Securities Lawsuits (January 2, 2009): As part of an annual feature on this blog, I reviewed last year’s securities lawsuit filings. As detailed in greater length in the post, the 224 new securities filings in 2008 represents the highest annual filing total since 2004.

 

 

The post also discusses the possible impact of the 2008 securities filing activity on the D&O insurance marketplace.

 

 

2008 Year in Review: On January 6, 2008, at 2:00 p.m. EST, I will be participating in a free webcast sponsored by the Securities Docket (here) entitled “2008 Year in Review: Securities Litigation and SEC Enforcement.”

 

 

The webcast will be moderated by Bruce Carton of the Securities Docket, and will feature several of my fellow bloggers, including Francine McKenna of the re: The Auditors blog (here); Tom Gorman of the SEC Actions blog (here); and Walter Olson of the Point of Law blog (here). Additional information about the webcast can be found here.

 

 

A Closer Look at the 2008 Securities Lawsuits

As other commentators previously have noted (refer here), the pace of securities lawsuit filings increased significantly in 2008 compared to recent years. According to my tally, there were 224 new securities lawsuits filed in 2008. The 2008 total represents a 30% increase over the 172 securities lawsuits filed in 2007, and an 88% increase over the 119 securities lawsuits filed in 2006.

 

The 2008 filing total also represents the highest annual filing total since 2004. All signs seem to indicate that the heightened filing levels will continue into 2009.

 

My 2008 securities lawsuit filing tally reflects a lower number than the figures NERA Economic Consulting recently published (refer here), and in that regard I urge readers to refer to my comments below about the particular complications associated with "counting" securities lawsuits in 2008.

 

Overall Observations

The most significant factor in this year’s heightened securities litigation filing activity was the number of subprime and credit crisis-related securities lawsuit filings. Of the 224 new securities cases filed in 2008, 101 were subprime or credit crisis-related. As reflected on my running tally of subprime and credit crisis-related securities lawsuits, which can be accessed here, there have been 141 total of these cases filed overall during 2007 and 2008 combined.

 

One factor that increased the number of subprime-related lawsuit filings in 2008 was the influx of auction rate securities lawsuit filings (about which refer here). There were 21 of these auction rate securities lawsuits filed in 2008, largely in the first half of the year.

 

Another factor that increased the 2008 filings was the influx of Madoff-related litigation during December 2008. My running tally of the Madoff lawsuits can be found here. Investors have initiated Madoff-related securities class action lawsuits against at least seven distinct investment groups, and every sign is that this litigation will continue to flood in during the early weeks and months of 2009.

 

2008 Filings by SIC Code

The predominance of the subprime and credit crisis-related litigation during 2008 is borne out in the profile of the companies that were sued in securities lawsuits during the year. Though the companies targeted represent over 90 different Standard Industrial Classifications (SIC) Codes, fully 99 of the lawsuits hit companies with SIC Codes in the 6000 series (Finance, Insurance and Real Estate), including 19 in SIC Code 6021 (National Commercial Banks) and 20 in SIC Code 6211 (Security Brokers and Dealers).

 

There were a number of securities lawsuit defendants entities in 2008 that have no SIC Code designated. These defendants include mutual funds, private investment firms and other entities. By my count, there were as many as 23 new lawsuits filed in 2008 against entities that lack an SIC designation. In most cases, these entities are involved in investment or financial services-related businesses, which even further underscores the fact that much of the securities litigation activity in 2008 was concentrated in the financial sector.

 

But while securities suits against companies in the financial sector were a predominant factor in the 2008 securities lawsuits filings, there were other SIC Code categories that also saw significant litigation activity, including SIC Code 3674 (Semiconductors) which also saw ten filings; SIC Code 2834 (Pharmaceutical Preparations) which saw nine lawsuit filings; and SIC Code 3845 (Electromedical and Electrotherapeutic Apparatus) which had five.

 

In addition, while the credit crisis lawsuits hit the financial sector hard, the credit crisis litigation wave spread outside the financial sector as the year progressed and the financial turmoil spread. As I noted here, and as a result of the dramatic events in the financial markets during September and October 2008, a number of companies outside the financial sector were hit with credit crisis-related lawsuits, particularly those with exposure to Lehman Brothers, Fannie Mae and Freddie Mac, or those that made wrong-way bets on currencies or commodities.

 

State and Court Distribution of Filings and Defendants

The concentration of cases in the financial sector also affected the geographic distribution of the 2008 case filings. Though securities lawsuits were filed in 48 different federal district courts (as well as several state courts), 97 of the 224 securities filings in 2008 were filed in the Southern District of New York. The federal district with the second highest number of new lawsuit filings was the Northern District of California, where 12 new securities lawsuits were filed. Other districts with a significant number of filings include the District of Massachusetts (10), and the Central District of California (9).

 

Another factor contributing to the significant number of filings in the Southern District of New York was the number of lawsuits filed there against foreign-domiciled companies. Overall, there were 34 foreign companies sued in securities lawsuits in 2008, all but five of which were initiated in the Southern District of New York. The 34 foreign companies sued represented 17 different countries, with the largest number from Canada (8), China (5) and Switzerland (4).

 

The domestic U.S. companies hit with securities lawsuits were based in 31 different states, and the District of Columbia. The state with the largest number of new securities lawsuits was New York (42), followed by California (23), Massachusetts (13) and Ohio (10).

 

The Pace of Filings and Likely Future Trends

The pace of new lawsuit filings increased during the year, with 105 during the first half and 119 in the second half. The fact that the fourth quarter, with 67 new filings, was the most active quarter during the year, together with the fact that there were a significant number of filings (30) in December (typically a quiet month for securities lawsuit filings), suggests that the heightened level of securities filings will continue into 2009. Indeed, the filings in the fourth quarter of 2008 and during December 2008 represent, respectively, the highest quarterly and monthly totals in more than five years.

 

My conclusion that the increased securities litigation activity levels will continue in 2009 is reinforced by the likelihood that the credit crisis litigation wave will continue to spread outside the financial sector in 2009.

 

Some Comments about "Counting": One reason for the wide disparity in the various published versions of the 2008 securities lawsuit filings is that the seemingly simple task of counting lawsuits was particularly complicated during 2008.

 

One complication is that some companies were sued multiple different times by different sets of claimants, on different legal theories, or with respect to different sets of circumstances. For example, one historically unusual phenomenon that recurred during 2008 was the initiation of new securities lawsuits initiated by preferred shareholders or subordinate securities holders (about which refer here). The multiplication of lawsuits involving different claimants or different legal theories but related defendants raised a continuing series of questions whether or not a new action does or does not represent a separate lawsuit that should be separately counted.

 

This question whether or not a separate complaint represents a new lawsuit was particularly complicated with respect to the Madoff-related litigation that flooded in during the final weeks of December. As reflected in my running tally of these lawsuits, which can be accessed here, there have already been multiple lawsuits against related Madoff-feeder funds. Reasonable minds might well differ as to whether or not a particular complaint represents an entirely new lawsuit or simply a related or duplicate complaint.

 

Another attribute of this multiplicity of lawsuit filings is that the number of new lawsuits filed may be significantly different than the number of companies sued, as some companies were sued multiple times in multiple different lawsuits. As a result, there may be a certain amount of double counting associated with some of the lawsuit tallies or some of the analysis of lawsuit filings.

 

Yet another factor complicating the counting is that during 2008 plaintiffs initiated a number of securities class action lawsuits in state court (about which I previously commented here). In many instances these lawsuits are difficult simply to find. The inclusion of these cases, and the uncertainty around their numbers, could significantly affect the overall lawsuit tally.

 

As has been increasingly the case in recent years, it has become progressively more difficult simply to maintain definitional clarity about what exactly is being counted. To clarify what I have been tracking, I try to count class action lawsuits that allege violations of the federal securities laws. That said, I have excluded certain lawsuits that other reasonable minds might include. For example, I generally exclude merger objection lawsuits. In addition, I generally exclude lawsuits in which the securities allegation is simply that the defendants failed to register securities. On the other hand, I include lawsuits even if the defendant entity is not a publicly traded entity (for example, if the defendant is a private equity fund or a hedge fund.)

 

Because of these definitional issues, it is almost inevitable that various tallies of the 2008 securities lawsuits will differ.

 

UPDATE: The WSJ.com Law Blog has a January 5, 2009 post (here) regarding the 2008 securiteis class action filings. The Law Blog entry links to this post and includes comments from a number of commentators and practitioners in the field.

 

Impact on D&O Pricing?: The uptick in securities lawsuit filings in 2008 might well be expected to have an upward impact on D&O pricing, and indeed it may yet have that effect. But particular features of the 2008 filings might moderate that expected effect.

 

First, the concentration of the filings in the financial sector means that the impact from the heightened filing levels is not widespread throughout the D&O industry. D&O carriers are not yet experiencing the impact of the filing levels across their entire portfolio, and carriers that do not have significant financial industry exposure may not yet be experiencing elevated claims activity, although that likely will change as the credit crisis litigation wave spreads outside the financial sector.

 

Second, even with respect to the heightened activity levels, the impact is muted somewhat by the multiple different lawsuit filings against the same companies. The D&O impact from the third, fourth or fifth new lawsuit against the same company may not increase the aggregate losses to which insurance applies. Because the number of companies sued is less than the number of new lawsuits initiated, the aggregate claims frequency level is less than the overall filing levels might indicate.

 

Third, many of the defendant entities are not publicly traded companies. As I noted above, many of the defendant entities in new 2008 lawsuits were mutual funds, investment partnerships, hedge funds, or other investment vehicles. The incidence of litigation against these types of entities would have only an indirect impact at most on the market for public company D&O insurance.

 

Fourth, a significant amount of the securities litigation activity in 2008 involved claims likelier to create errors and omissions (E&O) insurance losses, rather than D&O losses. For example, the Madoff-related litigation and the auction rate securities litigation may or may not produce D&O insurance losses, but may well produce significant E&O losses. The spread of losses to other insurance lines could dilute the overall impact from the 2008 litigation on the D&O carriers.

 

Fifth, most of these cases are still in their earliest stages, and it will be some time yet before the losses begin to accrue. Until loss payments begin to mount, D&O pricing is unlikely to make dramatic changes (at least as a result of securities filing activity levels).

 

All of that said, the increase in litigation activity in 2008, together with the disruption involving market leader AIG and other leading carriers, as well as the prospect for continued significant litigation activity in 2009, are likely to create uncertain conditions in the D&O marketplace and could lead to increased carrier caution as 2009 progresses. Indeed, Advisen, a leading industry observer, is predicting that a hard market for insurance will develop toward the end of 2009 (about which refer here).

 

2008: The Year in Review: Readers interested in learning more about the 2008 securities litigation trends will want to the January 6, 2009 webcast sponsored by Securities Docket.

 

I will be participating in this free webcast, which will begin at 2 pm EST, along with a number of my esteemed fellow bloggers, including the Securities Docket’s own Bruce Carton; Walter Olson of the Point of Law blog; Tom Gorman of the SEC Actions blog; Francine McKenna of the Re: The Auditors blog; and Lyle Roberts of the 10b-5 Daily blog. Further information about the podcast can be found here.

 

The List: Madoff Investor and Feeder Fund Litigation

THE TABLE OF CASES LINKED BELOW WAS LAST UPDATED ON August 8,  2010.

All signs are that the collapse of Bernard Madoff’s Ponzi scheme will produce a flood of litigation. By my count, there have already been at least seven federal securities class action lawsuits against Madoff, his firm, or the "feeder firms" that invested their clients’ funds with Madoff. There have also been a number of state court lawsuits as well.

 

It is already difficult to keep track of the lawsuits that have been filed. In all likelihood, there will be extensive additional litigation against other feeder funds and other third party defendants, which will make it even more difficult to keep track.

 

In order to monitor the Madoff-related litigation in a more orderly way, I have created a table of the lawsuits that have been filed to date.

 

The table can be found here.

 

I believe the table is complete, but I welcome any additional or clarifying information that readers may wish to bring to my attention.

 

I will update the table as new or different lawsuits emerge. Readers are strongly encouraged to let me know about any additional litigation I may have missed or to provide me with any information necessary to make the table more accurate.

 

Another Round of Madoff Investor Litigation

UPDATE: A regularly updated list of all Madoff investor litigation, including in particular Madoff "feeder fund" litigation, can be accessed here.

As further proof that the losses associated with the Madoff fraud scheme will trigger a wave of litigation, on December 23, 2008, plaintiffs’ lawyers initiated a lawsuit in the Southern District of New York on behalf of investors in the FM Low Volatility Fund, against Family Management Corporation ( the Fund’s general partner and manager) and certain of FMC’s directors and officers; three "fund of funds" in which FMC invested investor funds (Andover, Beacon and Maxam); and the Funds’ auditor.

 

The complaint, which can be found here, alleges violations of the federal securities laws and related stated and common law violations, and also asserts derivative breach of fiduciary duties on behalf of the Funds.

 

According to the plaintiffs’ lawyers’ December 24, 2008 press release (here), FMC

 

concentrated more than half of the Fund’s investment capital with at least three funds of funds ("FOFs") -- Andover, Beacon and Maxam -- that, in turn, all heavily invested in entities managed by Bernard Madoff ("Madoff") or Madoff-related entities. Investors who entrusted their savings to FMC suffered millions in damages as a result of Madoff’s fraudulent scheme.
 

 

The complaint further alleges that the defendants failed to perform requisite "due diligence" and "knew or should have known" about Madoff’s Ponzi scheme.

 

The plaintiffs’ also allege that FMC and its defendant directors and officers issued misleading offering documents that

 

falsely stated that FMC would not invest more than 35% of the Fund’s net asset value with any one investment vehicle, but, in reality, more than 60% of the Fund’s assets were funneled through three FOFs – Defendants Andover, Beacon and Maxam – and invested in Madoff-related entities. The Offering Memorandum also falsely stated that FMC would (i) endeavor to verify the integrity of each manager of a FOF in which the Fund was invested; (ii) attempt to monitor the performance of each manager; and (iii) request detailed information regarding the historical performance and investment strategy of each of the selected investments for the Fund. Plaintiffs allege that Defendants, with no or inadequate due diligence or oversight, abdicated their responsibilities and entrusted the Fund’s assets to Madoff-run investment vehicles.

 

Even More Madoff Investor Litigation: In earlier post (here), I noted the class action lawsuit that had been filed against Tremont Group Holdings, certain of its directors and officers, and its corporate parents, on behalf of investors in the American Masters Prime Fund, whose assets Tremont managed and that had suffered losses due to Tremont’s investment of those funds with Bernard Madoff and his firm.

 

On December 23, 2008, plaintiffs filed a similar but separate lawsuit against Tremont and related entities, but on behalf of the class of investors in the Rye Funds, who also claim that they lost their investment due to Tremont’s investment with Madoff and his firm. The Rye Funds complaint also includes as a defendant Tremont’s auditor, KPMG. A copy of the Rye Funds’ investors’ complaint can be found here. A copy of the plaintiffs’ lawyers December 23 press release can be found here.

 

In addition, according to a December 24, 2008 Bloomberg article (here), New York University has initiated a New York state court lawsuit against J. Ezra Merkin, Gabriel Capital, and Ariel Fund, in which it alleges that $24 million of endowment investments due to the defendants’ investment of the assets with Madoff and his firm. A copy of the NYU lawsuit complaint can be found here.

 

An earlier class action lawsuit that previously had been filed against Gabriel and related defendants can be found here.

 

Special thank to Adam Savett of the Securities Litigation Watch (here) for providing a copy of the Rye Funds Complaint.

 

Keeping Track: By my tally, the Family Management Corporation case is at least the seventh federal class action lawsuit filed in the wake of the revelation of the Madoff fraud. Of these, six of these seven are directed against so-called "feeder funds," the seventh directly against Madoff and his firm. In addition, there are several other state court lawsuits, including the one identified above and the earlier lawsuit filed against the Fairfield Greenwich fund firm (about which refer here).

 

If the early returns are any indication, there could be a flood of litigation yet to come. Of course it remains to be seen whether or to what extent any of these claims succeed. But in the meantime, indications are that these Madoff-related lawsuits will continue to mount.

 

More Madoff "Feeder Fund" Lawsuits

In the latest of what undoubtedly will prove to be a surge of Madoff-related litigation, investors have filed two more lawsuits against investment firms that invested their clients’ money with Bernie Madoff, resulting in massive investor losses.

 

UPDATE: Please note that a regularly updated table of all Madoff investor litigation, including in particular Madoff "feeder fund" litigation, can be accessed here.

 

The Tremont Lawsuit

First, as reflected in their December 22, 2008 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the Southern District of New York on behalf of investors in the American Masters Broad Market Prime Fund, L.P., a Delaware limited partnership which is managed by Tremont Group Holdings, which is also the Fund’s General Partner. The defendants in the lawsuit include Tremont; Oppenheimer Acquisition Corporation, which acquired Tremont in 2001; Massachusetts Mutual Life Insurance Company, Oppenheimer’s parent; and Ernst & Young, the Fund’s auditor.

 

The complaint (which can be found here) alleges violations of the federal securities laws as well as state common law fraud, negligence and breach of fiduciary duty. The complaint also assets derivative breach of fiduciary duty claims on behalf of the Fund.

 

According to the plaintiffs’ lawyers’ press release, the complaint alleges that

 

defendant Tremont, general partner of the Fund, concentrated over half of its investment capital with entities that participated in the massive, fraudulent scheme perpetrated by Bernard Madoff ("Madoff"). Investors who entrusted their savings to Tremont have suffered millions in damages and are faced with financial ruin.
 

 

The complaint also alleges that the defendants "failed to perform the necessary due diligence that they were being compensated to perform as investment managers and fiduciaries" and that the defendants "either knew or should have known that the Fund’s assets were employed as part of a massive Ponzi scheme and took no steps in a good faith effort to prevent or remedy that situation, proximately causing billions of dollars of losses and possible complete collapse of the Fund." Oppenheimer and Mass Mutual are named defendants as controlling persons of the Fund.

 

The complaint alleges with respect to Ernst & Young that the firm was "reckless or grossly negligent" in connection with its performance of its auditing duties, and specifically that the firm failed to detect "a myriad of ‘red flags’ indicating a high risk to Tremont from concentrating its investment exposure in Madoff."

 

The complaint alleges that the defendants allowed Tremont to invest $3.3 billion, over half of its assets, with Madoff.

 

The Fairfield Lawsuit

In addition, investors have also initiated a lawsuit in New York County (New York) Supreme Court against the Fairfield Greenwich Group, the hedge fund firm that has as much as $7.5 billion invested with Madoff. A December 22, 2008 Bloomberg article describing the Fairfield lawsuit can be found here. A copy of the complaint can be found here.

 

The lawsuit, which is filed as a class action on behalf of in the Fairfield Sentry fund, names as defendants Fairfield itself; Fairfield’s founding partners, as well as two principals of a Bermuda affiliate of Fairfield. It alleges breach of fiduciary duty, negligence, and unjust enrichment.

 

According to the news reports, the complaint alleges that the fund’s managers "had an obligation to look into Madoff’s investment methods and that the team ignored the ‘red-flag warning’ that Madoff’s investment produced small, steady gains in a declining market." The article also quotes the plaintiffs’ attorney as saying that the case has been filed in state court rather than federal court so that discovery can go forward quickly.

 

The arrival of these new lawsuits, following closely in the wake of the prior Madoff-related litigation suggests that there could substantial associated litigation yet to come, particularly with respect to the so-called feeder funds that invested clients’ assets with Madoff. The press coverage certainly suggests that there will be extensive additional litigation, as reflected, for example, in the December 22, 2008 National Law Journal article entitled "Lawyers from Florida to New York Besieged by Madoff Investors" (here).

 

The Tremont lawsuit’s inclusion of Ernst & Young corroborates an article published in the December 22, 2008 New York Times entitled "In Madoff’s Wake, Scrutiny of Accounting Firms" (here), which suggests that investors suffering losses from their investments in Madoff feeder funds may attempt to target the firms’ auditors. As noted in the article, the lawsuit filed last week against Madoff feeder fund Ascot Partners (about which I wrote here) also named the fund’s auditor, BDO Seidman, as a defendant in that case.

 

Credit Crisis Litigation Issues: A November 17, 2008 paper entitled "Legal and Economic Issues is Litigation Arising from the 2007-2008 Credit Crisis" (here) written by Harvard Law Professor Allen Ferrell, and Jennifer Bethel and Gang Hu of the Babson Business School surveys the marketplace conditions behind the credit crisis litigation and reviews the legal issues that are likely to arise as the litigation goes forward.

 

The article focuses on three principles that the authors believe will be critical in the credit crisis related securities litigation (1) no fraud by hindsight; (2) truth on the market defenses; and (3) loss causation issues.

 

With respect to the truth on the market defense, for example, the authors contend that "the quality of disclosures in the mortgage backed securities registration statements (and virtually all mortgage backed securities were registered) actually improved between 2001 to 2006 (in part due to the promulgation of Regulation AB in 2004) and that it was quite clear from these registration statements that the quality of the underwriting in a number of instances had declined."

 

With respect to the "loss causation issue," the authors contend with respect to the banks that suffered massive writedowns during 2007 and 2008, that the banks"suffered substantial losses due to their ‘super senior’ positions in CDOs and various liquidity guarantees to asset backed commercial paper conduits, rather than directly on their mortgage-backed security holdings."

 

Hat tip to The Harvard Law School Corporate Governance Blog (here) for the link to the authors’ paper.


 

NERA Releases Year-End Securities Litigation Report

Securities lawsuit filings reached a six-year high in 2008, according to a year-end report released today by NERA Economic Consulting. The report, entitled "2008 Trends in Securities Class Actions" (here), was written by NERA economists Stephanie Plancich and Svetlana Starykh, and reports that through December 14, 2008, there were 255 securities class action filings, up from only 131 filings in 2006 and 195 filings in 2007. NERA's December 18, 2008 press release regarding the report can be found here.

 

If the "atypical" cases (e.g., IPO laddering) are excluded from the comparison, the 2008 filings are "on pace to reach a 10-year high." The filings are also on pace for a 37% increase over 2007 and the highest annual increase since 2002 (the year of the corporate scandals).

 

The report attributes the "surge" in filings to the credit crisis. Of the 255 YTD filings, 110 were credit crisis related, and almost 50% of cases involved defendants in the financial sector, as compared to only 16% of cases in the 2005-06 period. (My table of the credit crisis-related securities lawsuit filings can be accessed  here.)

 

But while the financial sector saw increased litigation activity, "other sectors also saw continued filing activity." For example, though lawsuits against companies in the health technology sector declined as a percentage of all filings, the absolute number of filings against companies in the health technology sector increased, as there were 29 filings against health technology companies in 2008, compared to only 19 in 2006.

 

The 2008 filings have been concentrated in the second and ninth circuits. The second circuit filings were increased by the large number of filings in the Southern District of New York, particularly financial companies domiciled there.

 

Though the pattern of increased filing activity in 2008 is clear, "there have been no clear increasing or decreasing trends in the patter of resolutions." The report notes that median settlements have "remained relatively stable." The 2008 median settlement of $7.5 million is slightly below the 2007 median of $9.4 million, but above the 2006 median of $7.0 milllion.

 

Average settlements, which can be substantially affected by large settlements, were up in 2008 relative to 2007. The average settlement in 2008 was $38 million, up from $31 million in 2007, but well below the post-Sarbanes Oxley average from 2003 to 2008 of $45 million. (The annual average settlement has ranged from $21 million to $82 million during this six-year period.)

 

The report does observe that over time there has been an increase in the dollar value of claimed investor losses, from about $120 million ten years ago, to around $340 million during 2008. However, the ratio of median settlement to median investor losses has "stayed relatively steady in the 2-3% range over the past few years."

 

Looking forward, the report notes that there could be "two opposing factors" that could determine whether or not average or median settlements will increase in the future. On the one hand, investor losses associated with the credit crisis lawsuits in 2008 are very large, which could be "an indicator of big settlements to come." On the other hand, the credit crisis has "dramatically shrunk the size of many defendants’ pockets." Lower financial wherewithal might operate as a downward force on settlement values.

 

The report concludes that "only time will tell if the huge investor losses for credit crisis filings may put upward press on median settlements in the future, or if the financial distress faced by defendant companies may pull median settlement values down."

 

My own observations on the 2008 securities litigation activity will be detailed in my year-end analysis, which will be forthcoming after the first of the new year. UPDATE: My year end analysis can be found here. For now, I note a few things.

 

First, this has been an extraordinarily difficult year in which to just try and count the cases. For example, many litigation targets have been sued multiple times by different claimants, whether they are shareholders who acquired their shares over different time periods, or they are security holders with different classes of equity interests. Whether a new filing should or should not be "counted" has been difficult. Further complicating this has been the large number of state court filings, which are difficult just to find. I emphasize this point simply because there is going to be a significant variation in the various commentators’ year-end reports about how many filings there were this year. My own count is lower than NERA’s.

 

Second, while the 2008 filings were significantly increased by filings against companies in the financial sector, as the year has progressed and the impact of the credit crisis has become more widespread, the credit crisis-related filings have spread outside the financial sector (refer for example here).

 

Third, you may see comments elsewhere that the 2008 filings were inflated by one-time sector events, like the auction rate securities lawsuits. While this is true, the recent surge of litigation activity involving the Madoff victims demonstrates that in many ways the pace of securities litigation activity is simply a reflection of a series of supposed one-time events. The mere fact that there is an identifiable event arguably may be irrelevant to analyses of current or future filing trends.

 

Fourth, the NERA report makes no projections about what is likely to happen to the pace of filing activity in 2009. My own view is that the current active filing pace is likely to continue well into 2009 and perhaps beyond. Among other things, filing activity has been elevated over the last several weeks, which is unusual for December, historically a slow month. The continued spread of credit crisis filings outside the financial sector is likely to continue in 2009. Moreover, the impacts of the financial downturn will begin to emerge as company’s report their 2008 results and as the year progresses, which could contribute to litigation activity.

 

As I said, my own report will be forthcoming. I am very interested in hearing readers’ thoughts and reactions in the interim.

 

Special thanks to Ben Seggerson of NERA for providing me with a copy of the NERA report.

 

Madoff Victims' Lawsuits Target Investment Firms, "Feeder Funds"

If today’s filings are any indication, a huge wave of Madoff victim lawsuits could be coming. Madoff investors were quick to sue Madoff and his firm, with the first complaint filed last Friday (as noted here). But with Madoff’s firm in liquidation and the money likely long gone, investors who lost money as a result of Madoff’s scheme are casting around for other targets from whom to try to recover their losses. Early returns suggest that investment firms and Madoff "feeder funds" could find themselves facing substantial Madoff victim litigation.

 

UPDATE: Please note that a regularly updated table of Madoff investor litigation, including "feeder fund" litigation can be accessed  here.

 

First, as reflected in their December 16, 2008 press release (here), plaintiffs’ lawyers have filed a securities lawsuit in the Southern District of New York against investment partnership Ascot Partners L.P., its founder and general partner (Merkin), and its auditor, BDO Seidman. The class members are persons who purchased limited partnership interests in Ascot.

 

According to the press release, the complaint alleges that Ascot and Merkin

 

caused and permitted $1.8 billion -- virtually the entire investment capital of Ascot -- to be handed over to Madoff to be "invested" for the benefit of plaintiff and the other limited partners of Ascot. Plaintiff's investment in Ascot has been wiped out, as a direct result of: (a) defendant Merkin's abdication of his responsibilities and duties as General Partner and Manager of Ascot and its investment funds and; (b) the failure of Ascot's auditor Seidman, in light of "red flags" indicating a high risk to Ascot from concentrating its investment exposure in Madoff as sole third-party investment manager for all of the Partnership's assets, to perform its audits and provide its annual audit reports in conformance with generally accepted auditing standards.

 

The press release states that the complaint alleges ’34 Act violations as well as related statutory and common law breaches. A copy of the complaint can be found here.

 

UPDATE: On December 16, 2008, investors also filed a separate lawsuit against a different fund affiliated with Merkin, Gabriel Partners. A copy of the December 17, 2008 press release can be found here.  A copy of the complaint can be found here.  A WSJ.com Law Blog post about the Ascot and Gabriel lawsuits can be found here.

 

Second, and also on December 16, another plaintiffs’ firm initiated a separate securities lawsuit in the Central District of California. The lawsuit is filed against Madoff and his firm, but also names as defendants Brighton Company, a California limited partnership and a so-called "feeder fund," and its principal ( Stanley Chais). The firm’s press release (here) states that Brighton was "one of the many feeder funds that directed investor capital" to Madoff and his firm. The press release says that Chais "managed several investment groups [including Brighton], the monies for which were given to Madoff" and his firm.

 

The complaint (here) alleges that the plaintiff invested money through CMG Ltd., a California limited partnership. The complaint alleges that CMG provided all of its investment capital to Chais as general partner for Brighton, which in turn invested all of CMG’s money with Madoff. The complaint alleges that "all defendants contributed to the false, misleading, unlawful, unfair and fraudulent acts and practices associated with the Ponzi scheme."

 

The purported class consists of two groups; all persons who invested capital with Chais and Brighton, and all persons who invested with Madoff and his firm. The complaint alleges violations of the ’34 Act.

 

The press release also states that "the firm is investigating the actions of other feeder firms on behalf of investors." The December 17, 2008 Wall Street Journal has an article (here) discussing Stanley Chais and his investment funds'  (and charitable organizations') relation to Madoff
 

 

Given the magnitude and widespread dispersion of the Madoff losses, and given the fact that there appears to be little money left with Madoff and his fund, it seems highly likely that there will be other (perhaps many other) investment funds, "feeder funds," hedge funds, funds of funds, and other entitles, targeted by Madoff victims. The attention in the press (for example, here) to alleged failures of investment firms to catch supposed red flags or to conduct due diligence will only increase the likelihood of this kind of litigation. The inclusion of the auditor in the Ascot lawsuit suggests that some of these claims could range pretty far afield.

 

A December 16, 2008 Business Week article discussing the likelihood of Madoff investor claims against hedge funds and others, also discussing the Ascot lawsuit, can be found here.

 

The Wall Street Journal is helpfully collecting a list of Madoff’s victims here. It is a long list but it is also clearly incomplete; for example, Fairfield Greenwich Advisors may have been hit with $7.5 billion in losses, but those amounts in reality represent the losses of Fairfield’s own investors. The list would be substantially longer if all of these and other fund investors and customers were listed individually. The fund investors are the ones, like the plaintiffs in the cases described above, that will likely target the investment funds.A December 17, 2008 Wall Street Journal article entitled "Fairfiled Group Forced to Confront its Madoff Ties" (here) conveys some pretty strong suggestions along those lines.

 

In any event, going forward, the number one question D&O insurance underwriters will be asking financial institution applicants will be whether the applicant invested funds with Madoff.

 

Meanwhile, the Credit Crisis Litigation Wave Churns On: It seems as if the plaintiffs’ lawyers have kicked it into high gear as the year end approaches. There has been a flood of new securities lawsuit filings so far in December. By my informal count, there have already been at least 20 new securities lawsuit filings so far this month (if you count the two cases described above), an unusually high number for December, which historically is a quiet month for securities filings.

 

And though the filings have included a diversity of cases (as I discussed here), the filings have also included a number of new subprime and credit crisis related lawsuits, including at least four new cases that have been filed or become public this week.

 

For example, as reflected in their press release (here) on December 16, 2008, plaintiffs’ lawyers initiated a securities class action lawsuit in the Southern District of New York against investors in the C-Bass Trust Certificates backed by residential mortgage loans and issued by Credit-Based Asset Servicing and Securitization LLC. The defendants include C-Bass, the issuing trusts, and the offering underwriters. The complaint, which can be found here, asserts claims under the ’33 Act.

 

In addition, on December 4, 2008, plaintiffs’ initiated a securities class action on behalf of investors who purchased AIG shares in shelf offerings conducted during the period 2003 to 2007. The complaint (here) asserts claims against AIG, certain of its directors and officers, and its offering underwriters under the ’33 Act.

 

And on December 8, 2008, defendants removed to federal court a lawsuit that previously had been filed in New York County (New York) Supreme Court against Residential Asset Securitization Trust (which issued certain residential mortgage pass-through certificate), its offering underwriter, and two rating agencies. A copy of the removal petition, to which the original complaint is attached, can be found here.

 

Finally, plaintiff shareholders have initiated a securities class action lawsuit (here) against private equity firm American Capital Ltd. in the District Court of Maryland, alleging among other things that the firm failed to disclose its exposure to disruptions in the credit market.

 

I have added these new lawsuits to my running tally of subprime and credit-crisis related litigation, which can be accessed here. With the addition of these new lawsuits, the running tally of subprime and credit-crisis securities lawsuits now stands at 138, of which 98 have been filed during 2008.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing information and links about these new lawsuits.

 

And Finally: Before writing this post, I had no prior acquaintance with the phrases "Madoff victims" and "feeder funds." I guess I better get used to them.

 

Headline News: Deception, Corruption and Litigation

From this week’s news, it almost appears as if there had been some kind of an unannounced competition for most outrageously fraudulent or corrupt scheme. First, there was Marc Dreier’s incredibly brazen plot to peddle bogus notes to hedge funds using assumed identities. Then there was Illinois Governor Rod Blagojevich’s apparent attempt to flog Barrack Obama’s vacant Senate seat for personal enrichment. And finally there was New York financier Bernard Madoff’s massive Ponzi scheme, which may have taken investors for as much as $50 billion.  

 

The scale of the corruption and deception involved in these schemes is almost incomprehensible. It could be said of the three perpetrators of each of these scandals, as Time Magazine said (here) of Blagojevich, he is “either delusional, stupid or some combination of both.” But as astonishing as these developments may all be, they really don’t represent anything new.

 

 

Buried underneath the week’s headlines were the latest developments in an older but equally unsavory tale, which may serve as a reminder that there is, regrettably, nothing new about massive schemes of deception and corruption.

 

 

According to a December 12, 2008 Bloomberg article entitled “Siemens Agrees to Pay Fine to Settle Bribery Charges” (here), Siemens AG has agreed to plead guilty to Foreign Corrupt Practices Act violations and pay $800 million to settle U.S. charges that it paid $1.36 billion in bribes to government officials in at least a dozen countries.

 

 

The FCPA Blog (here) has an extensive review of the charges against Siemens, as well as links to the supporting documents, including the criminal information filed against Siemens and the DoJ’s sentencing memorandum. As the FCPA Blog puts it, the criminal charging documents detail “years of systematic and intentional violations of the internal controls and books and records provisions. It's a story of fraud, deceit and concealment -- filled with phony contracts, fake invoices, slush funds, and a boardroom feigning ignorance. “

 

 

A hearing on the deal under which Siemens would pay a $450 million fine and forfeit $350 million in profits will take place on December 15. If accepted, the penalty would be by far the largest FCPA penalty ever, far eclipsing the prior record payment of $44 million in the Baker Hughes case (about which refer here).

 

 

The Siemens case is a reminder that, as startling as this past week’s revelations have been, there is nothing new about fraudulent schemes or deceptive behavior. In the timeless words of the Book of Ecclesiastes (here), “What has been will be again, what has been done will be done again; there is nothing new under the sun.”

 

 

Next Up: The Litigation: One inevitable byproduct of the developments like those of the past week is litigation, and so it comes as no surprise that a lawsuit against Bernard Madoff and his firm has already emerged.

 

On December 12, 2008, an investor initiated a purported securities class action lawsuit in the Eastern District of New York against Madoff and his firm (BMIS), on behalf of “all persons and entities who purchased securities sold by or through” Madoff and his firm, “from the early formation of BMIS in the 1960s until December 12, 2008.” Refer here for news coverage of the lawsuit.

 

The complaint (reproduced below) alleges that its claims arise “from one of the most damaging Ponzi schemes in the history of Wall Street and the United States,” and that the defendants “swindled investors out of monies estimated to exceed $50 billion.” The complaint alleges breaches of the federal securities laws, civil RICO violations, and related state and common law violations.

 

Meanwhile, other plaintiffs’ firms have announced (for example, here) that they are investigating the alleged “massive fraud.” UPDATE: Please refer here to access my regularly updated list of all Madoff investor litigation, including in particular "feeder fund" lawsuits.

 

The filing of this lawsuit may not be surprising, and there may be further litigation yet to come. As detailed in the lead story in the December 13, 2008 Wall Street Journal (here), the victims of Madoff’s scheme include a host of institutional investors, hedge funds, and funds of funds. It may well be that these entities’ investors, eager to recoup losses as well as to assign blame, will also file lawsuits in a daisy-chain of litigation based on the Madoff firm’s collapse.

 

Hat tip to the Dealbook blog (here) for the text of the Madoff class action complaint, which can be viewed here:

 

Class Action Lawsuit Against Madoff

 

 

Another Friday Night Special: December 12, 2008 was a Friday, and that can only mean one thing – after the close of business, the FDIC announced another round of bank closures.

 

First, the FDIC announced (here) that state banking regulators had closed, and the FDIC had been appointed receiver of, Haven Trust Bank of Duluth, Georgia. Next, the FDIC announced (here) that state regulators had closed, and the FDIC had been appointed receiver of, Sanderson State Bank of Sanderson, Texas.

 

These two closures represent, respectively, the twenty-fourth and twenty-fifth bank failures so far this year. The FDIC’s complete list of failed banks during the period October 2000 to the present can be found here. Haven Trust is the fifth Georgia bank to close this year, which represents the highest total for any one state. The Sanderson bank’s closure is the second in Texas this year.

 

As I have noted before (here), the pace of bank closures has accelerated as the year has progressed. Of the 25 bank closures in 2008, 21 have taken place since July 1, eight of them just since November 1. The trend certainly suggests that there will be further bank closures in the weeks and months to come. And, pertinent to the preceding discussion, there likely will also be further bank-related litigation (refer here).


 

Securities Litigation: More than Just Subprime

As the year end approaches, various commentators will be issuing their retrospectives on the year’s securities litigation activity. The lead story undoubtedly will be that the wave of subprime and credit crisis-related lawsuits continued to flood in during the year. With some 94 new subprime and credit crisis related securities lawsuits so far in 2008 (by my count, which can be accessed here), the litigation wave undoubtedly is an important part of the story. But it is not the whole story. The danger is that the wave of credit crisis-related litigation has become so predominant that other important developments may be overlooked.

This past week illustrates my point. There were seven new securities class action lawsuits filed during the week of December 8, which is noteworthy in and of itself, as December historically is a slow month for securities class action lawsuit filings.

 

Among this past week’s seven new securities lawsuits was one new credit-crisis related filing. On December 11, 2008, plaintiffs’ lawyers filed a class action lawsuit against GS Mortgage and certain of its directors and officers, on behalf of purchasers of mortgage pass-through certificates and asset-backed securities the company issued. (GS Mortgage is an affiliate of Goldman Sachs, which is also named as a defendant.)

 

According to the plaintiffs’ press release (here), the GS Mortgage complaint alleges a variety of misrepresentations in the instruments’ offering documents, including with respect to the underwriting standards and appraisals used in the origination of the underlying mortgages.

 

But while the seven lawsuits filed last week did include this one subprime-related lawsuit, the other six lawsuits appear completely unrelated to the subprime or credit crisis-related events.

 

The remaining six companies named include a Canadian mining company, Crystallex International, allegedly facing regulatory issues in Venezuela (about which refer here); two medical device companies, Medtronix and Atricure (refer here and here); a media conglomerate, CBS Corporation, that announced non-cash impairment charges to intangible assets and goodwill (refer here); a laser and technology manufacturer, GSI Corp., that restated its financials due to revenue recognition issues (refer here), and a Chinese agricultural company, China Organic Agriculture, facing allegations regarding its development of organic products (refer here).

 

These six lawsuits represent a diverse mix of companies and allegations. The point here is that none of these six lawsuits is related to the subprime meltdown or credit crisis. Similarly, during the past year, while there have been a host of credit crisis-related lawsuits filed, there have also been many other lawsuits that are totally unrelated to the credit crisis.

 

Given the nature and magnitude of the financial developments this year, it is hardly surprising that there has been significant litigation activity involving the financial sector. What may be even more noteworthy is that notwithstanding the predominance of the financial events, there have been a significant number of lawsuits having nothing to do with the credit crisis or the financial sector.

 

I will detail these observations in my own forthcoming year-end analysis of securities litigation activity. In the interim, particularly as the various year-end reports emerge, it is important to keep in mind that 2008 securities litigation activity was not just about the credit crisis alone, nor was it confined just to the financial sector.

 

Does This Sounds Familiar?: Our age is not the first to have to contend with the consequences from cultural excess fueled by speculation, debt and deficit spending enabled by “financial wizardry.” A similar pattern also appeared in the events leading up to the French Revolution. In his book, Revolutionary France, 1770-1880 (here), historian François Furet details the country’s astonishing accumulation of indebtedness, and the consequences that followed.

 

In particular, Furet explores the way the French monarchy, led by Finance Minister Jacques Necker, financed its participation in the American war of independence by increasing state-guaranteed life annuities, fueling a speculative bubble and enabling borrowing backed by inflated values. Furet writes:

 

In total, between 1776 and 1781, 530 million in loans of all kinds fed the Treasury and financed a war that was all the more popular because it was painless. Money continued to flow in, and the resale of annuities enriched Parisian speculation. Even if the state was seriously compromising its future, Necker retained his popularity. In 1781, to counter-attack court intrigues … he published the Compte rendu, a statement of accounts which concealed the expenditure of the extraordinary budget and revealed an apparent surplus revenue of ten million livres.

 

As Furet observed, “after three years of war and no new taxes, that was truly  financial wizardry!” The problem is that, contrary to Necker’s assurances, “the real deficit lay in the region of eighty million.”

 

Similar deficit financing by Necker’s successors furthered the French government’s financial challenges. A successor minister, Charles Alexandre de Calonne, “found, out of 600 million livres in annual revenue, 176 million committed in advance, 250 million absorbed by debt service, and 390 million in accounts in arrears to be settled.” What was Calonne’s response? “He borrowed money on all sides, even more and at a higher rate than his predecessors.”

 

Among other things, this massive indebtedness enabled the illusion of prosperity; “one would need to reconstruct the entire circuit of money borrowed by Calonne to understand how these years were without doubt the most dazzling in court civilization.” But, as Furst notes, “sinking borrowed money into the parasitic round of court life proved eventually to be the downfall of this aristocratic sleight of hand.” This “artifice” unleashed “one of the most gigantic crashes in history.”

 

As we face the consequence of the collapse of our own era of debt-fueled prosperity, with its accompanying speculation, asset-valuation bubbles and financial wizardry, there is something sobering in realizing that once again the response consists of “borrowing money on all sides.” The ever-cumulating deficits have reached the point where figures of billions and trillions have lost all meaning. I am sure I am not the only one with the uneasy  feeling that we may be sinking borrowed money into parasitic hands and that we could be “seriously compromising our future.”

 

PLUS D&O Symposium: The Professional Liability Underwriting Society (PLUS) will be holding its annual D&O Symposium on February 25 and 26, 2009, at the Marriott Marquis in New York City. I will be co-Chairing the event again this year, along with my good friends, Tony Galban of Chubb and Chris Duca of Navigators Pro. There will be a terrific line up of speakers, including the keynote speakers Madeline Albright and New York Insurance Commissioner Eric Dinallo .

 

The panels will include all of the familiar favorites, such as the securities litigation update panel, to be chaired again by Boris Feldman of the Wilson Sonsini firm, and View from the Top panel, featuring the heads of the leading D&O underwriting facilities. Other panels will also address issues surrounding the governmental bailouts and increased business failures. An added bonus is that the fascinating video The Rise and Fall of Bill Lerach will be shown during the conference. (View a trailer of the video here).

 

Further information about the 2009 PLUS D&O Symposium, including registration information, can be found here. This event sells out every year, so early registration is advised.

 

The Evolving Credit Crisis Litigation Wave

In an earlier post (here), I suggested that the credit crisis litigation wave had reached an inflection point, and in subsequent posts, I identified additional "new wave" credit crisis lawsuits.

 

The exact contours of this "new wave" is admittedly amorphous, but the basic concept is that it involves, first, companies that were not themselves undermined by the credit crunch but rather as result of their exposure to companies that were. The most prominent examples are companies that suffered losses due to their exposure to Lehman Brothers. One specific example is Constellation Energy, which, as noted here, is the target of a securities lawsuit alleging among other things that the company insufficiently disclosed its exposure to Lehman Brothers securities.

 

That there will be other lawsuits in the "exposed to others’ misfortunes" category is demonstrated by the lawsuit initiated on December 3, 2008 in the Southern District of New York against Chinese solar cell manufacturer JA Solar Holdings and certain of its directors and officers. According to the plaintiffs’ counsel’s December 3 press release (here), the Complaint alleges that the defendants failed to disclose that:

 

JA Solar purchased from a subsidiary of Lehman Brothers Inc. ("Lehman Brothers") a three month, $100 million note (the "Lehman note") on or about July 9, 2008. At the time of this purchase, Lehman Brothers, which guaranteed the Lehman note, was under severe financial distress. According to the complaint, defendants failed to disclose: (i) that JA Solar had made a material, highly speculative investment in a subsidiary of Lehman Brothers, an entity that was then undergoing a credit crisis and under significant financial distress; (ii) that the value of JA Solar’s investment in the Lehman note had diminished considerably; and (iii) that, as a result of the foregoing, defendants’ positive statements concerning JA Solar’s financial performance, outlook and earnings guidance were materially false and misleading and without reasonable basis.

Ultimately, at the end of the Class Period, JA Solar wrote off its $100 million investment in the Lehman note. After JA Solar fully disclosed and recorded an impairment in the value of its investment in the Lehman note, on November 12, 2008, JA Solar’s stock closed at $2.38 per share, a price that represented a decline of more than 87% from the high during the three month Class Period.

 

A copy of the JA Solar complaint can be found here.

 

Constellation Energy and JA Solar are far from the only companies experiencing losses as a result of the onslaught of bankruptcies and bailouts. Many companies have experienced huge losses as a result of the collapse of Lehman Brothers, Fannie Mae and Freddie Mac, AIG, Washington Mutual, and the other recent massive failures. There undoubtedly will be further lawsuits like the ones filed Constellation Energy and JA Solar.

 

Another category of "new wave" credit crisis litigation relates to companies that made wrong way bets on commodities and currencies, as I noted in a prior post (here). These companies have experienced significant losses as commodities prices and currency exchange rates suddenly and unexpectedly reversed direction this fall. Some of these companies have also been hit with securities lawsuits, as I noted in my prior post, and as also illustrated in the lawsuit recently filed against Aracruz Cellulose (about which refer here).

 

As discussed in a December 3, 2008 Wall Street Journal article entitled "Rapid Price Decline in Commodities Turns Some Offsets into Big Losses" (here), a number of companies "have taken hedging-related losses in the third quarter as a result of the rapid decline in commodities costs." But, the article emphasizes, "it isn’t over, either." Companies hedge their costs a few quarters in advance, so hedges taken more recently "are going to hurt profits for many in the fourth quarter and beyond." The article specifically mentions Campbell Soup, Kraft Foods, Pilgrim’s Pride, and Southwest Airlines.

 

The reference to Pilgrim’s Pride is particularly noteworthy as part of this discussion, because as I previously noted (here), the company has already been hit with a securities lawsuit based among other things on the company’s wrong way bet on corn prices. As the Journal notes, there will be other companies reporting losses after the end of the fourth quarter and even beyond on wrong way commodities and currency bets. Some of these companies likely will also face securities lawsuits.

 

The final category (or at least final until a new category emerges) involves auction rate securities. I refer here not to the mass of litigation filed earlier this year by auction rate investors against the broker-dealers that sold them the auction rate securities. Rather, I am referring to the cases where investors have sued companies because of losses the companies suffered as a result of the companies’ investment in auction rate securities.

 

An example of this auction rate case is the one involving NextWave Wireless (about which refer here) in which it is alleged, among other things, that the company "failed to timely disclose that it had invested all of its marketable securities in extremely illiquid auction rate securities."

 

There are a host of other companies facing distress due to their exposure to illiquid auction rate securities. For example, a December 3, 2008 Wall Street Journal article entitled "LandAmerica’s Collapse Leaves Investors Looking for Cash" (here) describes the failure of title insurance company LandAmerica Financial Group, which came about because one of the company’s subsidiaries had put funds held for real-estate investors in auction rate securities. Land America filed for bankruptcy last week.

 

There undoubtedly will be other companies facing liquidity crises as a result of their exposure to auction rate securities, and some of these companies, like NextWave Wireless, will face securities litigation as a result.

 

One final point about the evolution of the credit crisis litigation wave is that many of the companies involved in these various "new wave" categories identified above are outside the financial services sector. To the extent these new wave lawsuits continue to accumulate, this evolutionary process could be the means by which the credit crisis litigation wave spreads outside the financial sector to the larger economy.


Premonition of War Foretold: As we wonder how we got into the mess, one of the things that is becoming obvious is that the sober voices were silenced and mocked, and the dialog was dominated by the voices of those who had spent far too much time at the punch bowl.

 

The following video compiles of series of clips from the period 2006 through 2007, showing both how many foolish things were said, and also showing the prescience of Peter Schiff of Euro Pacific Capital. I don't know what is more amazing about this video, that Schiff's predictions were so uncanny or that the others, who mocked and even laughed at him, so badly misperceived what was happening, especially with respect to housing prices. I guarantee you will shake your head in disbelief at some of the things that are said in this video. Schiff in the meantime sounds like a man who had access to a crystal ball.

 

Hat tip to Joe Nocera of the New York Times in his Executive Suite blog (here) for the link to the video.

Have Section 11 Filings Increased?

Has the "due diligence" standard articulated in the WorldCom securities litigation produced an increase in the Section 11 litigation? That is the question addressed in David J. Michaels’s November 29, 2008 paper entitled "An Empirical Study of Securities Litigation After World Com" (here).

 

In this post, I review the analysis based upon which Michaels contends that, due to the WorldCom due diligence decision, Section 11 filings have increased as a percentage of all securities lawsuits, followed by my own discussion of the data on which Michaels relies.

 

The Author’s Analysis

Outside directors historically have had little Section 11 liability exposure, owing to their ability to rely on Section 11’s due diligence defense. Michaels notes that courts generally have found outside directors’ due diligence obligations to be minimal. However, Michaels contends, the Southern District of New York’s Section 11 due diligence decision in In re WorldCom Securities Litigation, 2005 WL 638268 (S.D.N.Y. 2005) (refer here) "significantly changed the landscape for outside directors" by holding them to a "stringent standard of liability."

 

A more detailed review of the impact of the WorldCom litigation on the due diligence defense can be found here.

 

Michaels hypothesized that because the WorldCom decision represents a change in the due diligence standard, making it easier for plaintiffs to pursue Section 11 claims (particularly against outside directors), securities cases under Section 11 would increase. In order to test this hypothesis, Michaels examined the ratio of securities filings asserting Section 11 claims to Section 10b-5 filings during the period 2002 through 2007, using data from the Stanford Law School Class Action Clearinghouse website. Because the court issued the WorldCom opinion in March 2005, the period selected included both years preceding and following the decision.

 

Michaels reported the following ratios of Section 11 filings to Section 10b-5 filings for the years 2002 through 2007:

 

2002 13%

2003 11%

2004 6%

2005 10%

2006 13%

2007 23%

 

Michaels concludes that these data suggest an "abnormal rise in Section 11 filings." Michaels concedes that "it is difficult [to] prove a causal relationship between WorldCom and the rise in Section 11 filings," he nevertheless asserts that it "is reasonable to attribute causation of the rise in Section 11 filings to WorldCom." In support of this conclusion, Michaels states:

Consider the following series of events. Prior to WorldCom, Section 11 filings were relatively constant; WorldCom comes along and greatly alters 35 years of precedent by making it easier for plaintiffs to survive a motion for summary judgment; Section 11 filings increase.

Michaels ends his paper by arguing that the upward trend in Section 11 cases will continue, but also that WorldCom’s holding applying a stringent standard to outside directors’ "due diligence" defenses is contrary to the ’33 Act’s purposes. He proposes a safe harbor for outside directors that "would exclude from liability outside directors who follow certain procedures designed to inform them of all material information surrounding a given offering."

 

Discussion

Michaels may be correct that the WorldCom decision will result in an increase in Section 11 filings. Reasonable minds may differ on whether the data support his conclusion that there already has been a demonstrable increase in Section 11 filings. Those same reasonable minds might hesitate before jumping to any conclusions about the causes of any increase that arguably may have taken place. A more conservative view is that it is at best premature to reach any conclusions in that regard.

 

First, the data on which Michaels relies represents only a brief time period. Since the WorldCom opinion was issued in 2005, that data from calendar year 2005 represent only a partial year. Michaels’s analysis places an enormous weight on data from just two years, 2006 and 2007. Michaels does not explain why he believes a data set that small is sufficient to support his conclusions.

 

Second, Michaels does not consider whether or not there were external factors that may have affected securities filings during the period after the WorldCom decision. In fact, it has been well documented (refer, for example, here) that there was a filing "lull" during the period from mid-2005 through mid-2007, in which there were an historically low number of securities filings overall. Michaels does not even mention this fact, nor does he consider whether the filing levels during that period may suggest that other factors may have been at work during this period.

 

Third, although Michaels is convinced that there was an "abnormal rise" in the Section 11 filings after WorldCom, the only thing I can conclude from looking at the data is that something was going on during 2007, as the 2005 and 2006 data are consistent with the prior years’ data. Michaels is essentially arguing the filing activity in a single year supports his hypothesis. Again, Michaels does not consider whether or not there may have been some anomalous factor behind the 2007 data.

 

My own prior review of the 2007 filing data (refer here) concluded that a significant number of the overall 2007 filings involved companies that conducted IPOs during the 12 months prior to getting sued. Many of these IPO cases involved foreign domiciled companies. Perhaps it may be concluded that the 2007 uptick in Section 11 litigation was due to a wave of IPOs involving foreign companies that were not ready to go public. At a minimum, there are certainly other plausible explanations for the 2007 uptick in Section 11 litigation other than the WorldCom decision alone.

 

Not only does Michaels fail to consider other possible explanations for the anomalies in the data, but the basis on which he nevertheless argues that WorldCom decision alone explains the supposed increase is also suspect.

 

In effect, he urges us to conclude that because the supposed increase in Section 11 filings came after the WorldCom decision, the decision must have been the cause of the supposed increase. This analysis arguably represents an example of the logical fallacy post hoc ergo propter hoc (after this, therefore because of this). Essentially, Michaels is trying to substitute chronological sequence for causation. However, the mere order of events does not rule out other factors that might explain the data, as the preceding paragraph shows.

 

From my perspective, given the anomalousness of the 2007 data, it is premature to reach any conclusions without the opportunity to consider subsequent years’ data, to see, for example, whether the 2007 uptick represented a trend or (as I strongly suspect) is merely a statistical outlier. I can say from my own informal review of the 2008 year to date filing data, a much smaller percentage of 2008 cases involve IPOs (14 out of 195 year to date in 2008, compared to 29 out of 172 in 2007), which suggests that the number of Section 11 filings will prove to have been down substantially in 2008 compared to 2007.

 

The decline in 2008 IPO-related lawsuits is hardly surprising given the downturn in the number of IPOs in recent months. Given the low level of IPO activity during 2008, and indeed the low level of securities offerings of any kind, it seems probable that Section 11 litigation could well taper off in the months ahead. All of which suggests to me the inadvisability of trying to make a few months of filing data support sweeping conclusions.

 

It may well be, as Michaels argues, that WorldCom’s articulation of the Section 11 due diligence standard arguably is inconsistent with the ’33 Act’s goals, particularly to the extent it may result in the imposition of greater Section 11 liability on outside directors. I simply disagree with Michaels’s conclusion that WorldCom decision has demonstrably caused an increase in Section 11 filings. Michaels’s hypothesis may or may not eventually prove to be correct, but it will be a significantly longer period of time than he has allowed before we can reach any conclusions.

 

Special thanks to Werner Kranenburg of the With Vigour and Zeal blog for the link to Michaels’s article.

 

Ninth Circuit Rejects Securities Case Based on FCPA Disclosures

In a November 26, 2008 opinion (here), the Ninth Circuit affirmed the lower court’s dismissal of a lawsuit asserting securities law violations against InVision and certain of its directors and officers based on FCPA-related disclosures. The case is noteworthy not only for its involvement of FCPA-related allegations, but also for the appellate court’s consideration of "collective scienter" issues, as well as of the significance of Sarbanes-Oxley certification issues.

 

Background

On March 15, 2004, InVision announced it would be acquired by GE in a cash-for-stock transaction. That same day, the company filed its annual filing on Form 10-K to which the merger agreement was attached. On July 30, 2004, InVision announced that an internal investigation had revealed possible violations of the Foreign Corrupt Practices Act (FCPA). The company voluntarily reported the activities to the SEC and the DOJ. The company later entered negotiated arrangements with the DOJ and the SEC (refer here). GE later consummated the pending merger.

 

Shortly after InVision announced the FCPA concerns, shareholders initiated a securities class action lawsuit against the company and certain of its directors and officers. (Refer here for further background regarding the case). The plaintiffs based their claims on three alleged misstatements in the merger agreements, which InVision had attached to its 10-K.

 

The plaintiffs alleged that the merger agreement misleadingly stated that the company was "in compliance … with all applicable law"; in compliance with the "books and records" provision of the FCPA; and that that neither the company nor any of its officers, directors or employees had knowledge that the company had violated the FCPA’s antibribery provisions.

 

The district court dismissed the complaint and the plaintiffs appealed.

 

The Ninth Circuit’s Decision

The appellate court essentially assumed that the plaintiff had satisfied the requirement to plead falsity with respect to the three alleged misrepresentations stating that "even if [the plaintiff, Glazer] properly pled falsity, the district court’s dismissal would still be appropriate if Glazer failed to plead scienter adequately with respect to the three statements."

 

In order to satisfy the scienter requirement, the plaintiff urged the Ninth Circuit to adopt the "collective scienter" theory, following the Second Circuit’s recent decision in the Dynex Capital case (refer here) and the Seventh Circuit’s recent decision in the Tellabs case (refer here). Under this theory, as articulated by the Seventh Circuit, "it is possible to draw a strong inference of corporate scienter without being able to name the individuals who concocted and disseminated the fraud."

 

After reviewing the case law concerning corporate securities liability, including its own prior decision in the Nordstrom v. Chubb case (a decision that will be familiar to many of this blog’s readers), the Ninth Circuit ultimately concluded that this case did not require the court to decide whether or not to adopt the theory of collective scienter.

 

The court concluded that because of "the limited nature and unique context of the alleged misstatements" involved in the case, the "collective scienter" issue was not before the court. In reaching this conclusion, the court noted that

 

Glazer rests its securities fraud claim on three statements, all of which appear in a sixty-page legal document. If the doctrine of collective scienter excuses Glazer from pleading individual scienter with respect to these legal warranties, then it is difficult to imagine what statements would not qualify for an exception to individualized scienter pleadings. In fact, because the merger agreement warranted that the company was in compliance "with all laws," then under the collective scienter theory urged by Glazer, so long as any employee at InVision had knowledge of the violation of any law, scienter could be imputed to the company as a whole. This result would be plainly inconsistent with the pleading requirements of the PSLRA.

 

Accordingly, the Ninth Circuit held that in order to succeed on his claim, the plaintiff had to establish that individual defendants acted with scienter in making the statements in the merger agreement. The court said that "we see no way that [the defendant] could show that the corporation, but not any individual [director or officer] had the requisite intent to defraud." Only the company’s CEO and CFO had signed the merger agreement, and the plaintiff alleged scienter only with respect to the CEO, Magistri.

 

The court found with respect to Magistri, however, that Glazer had not pled any facts to demonstrate that "Magistri was personally aware of the illegal payments or that he was actively involved in the details of the details of InVision’s Asian sales."

 

The Ninth Circuit also refused to infer scienter from the CEO’s and the CFO’s signature of the Sarbanes-Oxley certifications, holding that the mere signature, without more, is insufficient to raise a strong inference of scienter.The Ninth Circuit followed prior decisions of the Eleventh and Fifth Circuits, concluding that there was no evidence that the SOX certification requirements were intended to alter the PSLRA’s pleading requirements. The Court said that "the Sarbanes-Oxley certification is only probative of scienter if the person signing the certification was severely reckless in certifying the accuracy of the financial statements.

 

Discussion

The Ninth Circuit’s decision is noteworthy for its discussion of the "collective scienter" issue, although in the end it is of limited significance on this point given the court’s conclusion that it did not need to reach that issue. The decision is also noteworthy for its discussion of the Sarbanes-Oxley certification issue, but in that respect it also merely followed existing precedent.

 

But perhaps the greatest significance about the Ninth Circuit’s opinion may be what it suggests about securities cases based on FCPA-related disclosures. The Ninth Circuit’s refusal to allow the claim to proceed in the absence of allegations that senior officials were aware of the improper conduct could present a significant hurdle for FCPA-related securities claims, at least in the circuits that have not adopted the "collective scienter" theory.

 

As the Ninth Circuit noted in the InVision case, "the surreptitious nature of the transactions creates an equally strong inference that the payments would have deliberately kept secret – even within the company." Obviously, payments of this kind invariably are of a surreptitious nature and of a kind that would be kept secret, even within the company. The implication is that in order for a securities claim alleging FCPA-related disclosures to survive the initial pleadings stage, the claimants may have to plead that the company officials who prepared the company’s public disclosures were aware of the improper activities.

 

In prior posts (most recently here), I have noted the increasing prevalence of follow-on civil litigation accompanying FCPA investigations, including the increasing frequency of follow-on securities litigation alleging misrepresentations in the FCPA-related disclosures. The Ninth Circuit’s decision in the InVision case suggests that, at least in jurisdictions that have not recognized the collective scienter theory, the ability of these follow-on securities lawsuits to get past the pleading stage may depend on the existence of allegations that senior company officials were aware of the improper payments. Given the invariably "surreptitious nature" of these payments, claimants may find this a challenging requirement to satisfy.

 

The SEC Actions blog has a thorough analysis of the Ninth Circuit’s discussion of the pleading issues in the InVision case, here. The FCPA Blog also has a good discussion of the case, here.

 

Special thanks to Neil McCarthy of Lawyerlinks.com for providing me with a copy of the Ninth Circuit’s opinion.

 

Another New Wave Securities Lawsuit: In a recent post (here), I noted that there have been several recent securities class action lawsuits in which the companies involved have been hit with significant losses due to wrong way bets on commodities or currencies.

 

The latest example of this type of securities litigation involves a case filed on November 26, 2008 in the Southern District of Florida against Brazilian forest products manufacturer Aracruz Cellulose S.A. and certain of its directors and officers on behalf of investors who purchased the company’s American Depositary Receipts on the NYSE., as well as purchasers of the company’s common stock, which trades on the Sao Paulo Bovespa.

 

According to the plaintiffs’ lawyer November 26 press release (here), the complaint alleges that

 

During the Class Period, Aracruz entered into undisclosed currency derivative contracts to purportedly hedge against the Company's U.S. dollar exposure. The Company characterized the use of these contracts as protection against foreign interest rate volatility and assured investors that this type of trading did not represent "a risk from an economic and financial standpoint." However, these contracts violated Company policy in that they were far larger than necessary to hedge normal business operations. As a result of Aracruz's clandestine and speculative currency wagers, credit rating agencies downgraded Aracruz, the Company's CFO resigned, and Aracruz's stock suffered a severe decline, plummeting to the lowest levels in 14 years.

 

As I noted in my prior post, many companies were also exposed to sudden and unexpected losses by dramatic changes in the commodities and currencies markets earlier this year. For example, the November 29, 2008 Wall Street Journal reported (here) on several airlines that have recently reported the negative impact from fuel cost hedges that generated huge losses. These kinds of developments and other unexpected fallout from the crisis roiling global financial markets are likely to affect a wide variety of companies, some of which may be subject to securities litigation.

 

It is interesting to note that the plaintiffs’ lawyers in the Aracruz case appear to have made a conscious decision to include within the class the Brazilian company’s common shareholders. Within this group are likely to be a number of shareholders domiciled outside the U.S. that bought their shares against the foreign company on a foreign exchange. The presence of these so-called "foreign-cubed" litigants could pose subject matter jurisdiction issues, at least as to those claimants.

 

My recent post discussing the Second Circuit’s recent "foreign-cubed" litigant ruling in the National Australia Bank case can be found here. The November 24, 2008 Southern District of New York decision granting the motion to dismiss the securities class action lawsuit that had been filed against Vodafone for lack of subject matter jurisdiction, in reliance upon the National Australia Bank decision, can be found here. (Note: Special thanks to the reader who pointed out that I had incorrectly referred to the Vodafone case as the Vivendi case. My apologies for any confusion.)

 

European Collective Action Reform and the U.S Model: Compare and Contrast

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

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

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Another Significant Canadian Securities Law Development

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Credential Inflation: Portrayals, Proceedings and Prose

A November 13, 2008 Wall Street Journal article entitled "Inflated Credentials Surface in the Executive Suite" (here) reported on multiple instances where corporate officials lacked claimed academic or work credentials. The article is based on a survey conducted by Barry Minkow, a convicted felon who did jail time for his role in the ZZZZ Best stock scam, who now heads the Fraud Discovery Institute.

 

The article cites seven examples where corporate officials allegedly falsified credentials. The article notes that this "may be enough to raise investor concerns about executive credibility as well as company procedures for vetting by management and board members." The article also cites industry sources that as many as 20% of job seekers "are found to have inflated their education credentials."

 

The day after this article appeared, the Journal also reported (here) that J. Terrence Lanni, the departing Chairman and CEO of MGM Mirage, is now "in a dispute with his alma mater over his academic credentials." Contrary to the company’s published statements about Lanni’s education, USC business school has no record of Lanni having received an MBA there. The question about Lanni’s education only came to light after the Journal raised questions based on Minkow’s research.

 

The November 13 Journal article quotes a Wharton School business ethics professor as saying "I’m very concerned that if people believe you can lie and get away with it, then down the line people will start cheating on their expense report, they’ll start misrepresenting their billable hours, they’ll start misusing their corporate funds."

 

Credential Inflation and Securities Litigation: Given this sense that résumé falsification (or at least its toleration) could engender a culture of deception, it is hardly surprising that allegations of credential misrepresentation have from time to time made their way into securities class action lawsuits.

 

For example, in the October 2006 securities class action lawsuits filed against Xethanol and certain of its directors and officers (about which refer here), the plaintiffs allege that the company’s chairman and CEO had "fabricated his résumé" among other things, by allegedly falsely claiming to have worked at Unilever, Northrup Grumman, and Reed Elsevier.

 

Similarly, in the January 2003 case filed against MCG Capital (about which refer here), the plaintiffs alleged that the company’s November 2001 IPO offering documents misrepresented the "credentials, credibility and integrity" of the company’s Chairman and CEO. Specifically, the complaint alleged that the offering documents misrepresented that the individual had earned a B.A in Economics from Syracuse, when in fact he had not. (It should be noted that the case was later dismissed and the Fourth Circuit affirmed the dismissal.)

 

Securities lawsuits also frequently allege that companies have misled investors by failing to disclose key details of corporate officials’ backgrounds. For example, in the November 2006 lawsuit filed against Pegasus Wireless and certain of its directors and officers (about which refer here), the complaint alleges that the company’s failed to disclosure the CEO and President’s prior involvement with bankrupt companies, as well as with other companies whose histories the complaint suggests "suspected stock and market manipulation." The company’s CFO is also alleged to have a "history of involvement with failed and suspect ventures," as well as past ties to individuals with "felonious" records.

 

This last example arguably goes well beyond mere credential inflation, but it does underscore how integrally misrepresentations or omissions about key officials’ histories potentially can affect investor perceptions. That in part explains why disclosure of credential inflation or résumé falsification can produce a significant marketplace reaction. As Minkow is quoted as saying in the Journal article, "you have to ask yourself, as any good investigator would say, what else could there be?"

 

Identity Misrepresentation: A Short History: The problems of credential inflation and résumé falsification are not limited to the corporate world. There have been numerous recent examples in government, academia and elsewhere. Many readers will recall, among the more notable recent examples, the tale of George O’Leary, who was fired five days after being hired as Notre Dame’s football coach, after it was discovered that he had falsely claimed to have a master’s degree in education and to have played college football for three years. The Wall Street Journal has compiled an extensive list of other recent examples, here.

 

There is a temptation to classify these deceptive practices as just another byproduct of our iniquitous era of botox and breast implants, where packaging is valued above substance and identity represents not things as they are but as people can be made to believe them to be.

 

Identity misrepresentation is not, however, unique to our time. These kinds of impostures go back as far as biblical times, where, for example, Jacob’s mother disguised him as his twin brother Esau so that Jacob would received their father’s blessing, intended for Esau.

 

Similarly, history is full of royal pretenders and alleged monarchs. During the reign of England’s Henry VII, there were actually two pretenders. The first, Lambert Simnel, a commoner who was crowned by Yorkist supporters as the supposed "King Edward VI," and Perkin Warbeck, who pretended to the First Duke of York and the younger son of Edward IV. And of course, there was Anna Anderson, who was claimed to be the Grand Duchess Anastasia, youngest daughter of Tsar Nicholas II.

 

Literature is full of examples as well. These include the numerous instances of gender disguise in many of Shakespeare’s play, such occurs in Twelfth Night and As You Like It. More recent examples of gender disguise occur in Tootsie and Yentl.

 

One of the more entertaining examples of identity misrepresentation occurs in one of The D&O Diary’s favorite books, The Count of Monte Cristo, by Alexandre Dumas, in which Edmond Dantès dupes others into believing him to be a Count so that he can revenge himself on his enemies and tormentors.

 

Identity, Ambition and the Need for Affirmation: The most extensive literary examination of the interplay between the portrayal and the reality of identity may be F. Scott Fitzgerald’s The Great Gatsby. At one level, the book is about nothing more than Nick Carraway’s effort to understand who Gatsby really is.

 

The sycophants and partygoers that surround Gatsby at the book’s outset aren’t quite certain, but suspect that he may be a bootlegger and may even have killed a man. Gatsby tells Nick an elaborate tale of having been educated at Oxford and then having inherited the family fortune. But that Gatsby’s persona is a façade is so obvious that one of the uninvited partygoers at Gatsby’s house is astonished to learn that the volumes lining the shelves in Gatsby’s library are actually real books.

 

Gatsby’s self-portrayal is an elaborate invention, a manufactured identity that, as Nick puts it, sprang from Gatsby’s "Platonic conception of himself." Gatsby’s self-contrivance is all part of his involved effort to prove himself worthy of Daisy Buchanan. The origins of Gatsby’s obsession with Daisy are perhaps best understood in his explanation that Daisy’s voice is so fascinating because it is "full of money."

 

Driven by his obsession for Daisy, Gatsby (born James Gatz) attempts to recreate himself within an intricate structure of credential inflation. The Oxford education proves to have been only a five-month stint following the war. His wealth, supposedly inherited, was actually acquired by means that Gatsby himself is unwilling to discuss.

 

Gatsby’s determined striving helps explain the credential inflation to which contemporary corporate individuals seem particularly prey. Ambition and desire, combined with a desperate need for affirmation or acceptance, drives these individuals to represent themselves as improved versions of themselves, or perhaps even as somebody different altogether.

 

In any event, it is clear that when inflated credentials are involved, it may be indispensible to make certain that the books are real.

 

The Ultimate Inflated Credential: Divinity: Among the most outrageous identity misrepresentations in literature is that of Danny Dravot who, in Rudyard Kipling’s The Man Who Would Be King, is all too willing to be taken by the people of Kafiristan as a god, based on their delusion that he is the son of Alexander the Great. It all ends very badly for Danny and his sidekick, Peachey Carnahan, when the Kafiris discover that Danny is "Not god, not devil, but man!"

 

The story was made into a memorable 1975 movie (now somewhat disturbing for its colonialist presumptions) starring Michael Caine and Sean Connery. In this video excerpt, Danny and Peachy reckon the benefits of Danny being taken for a god, as well as the secrecy their deception requires:

 

 

AIG Hit with Canadian Securities Class Action

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

 

The Ontario Action Against AIG

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

 

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

 

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

 

The Ontario Securities Act

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

 

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

 

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

 

Jurisdictional Issues

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Two Final Observations

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

 

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

 

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

 

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

 

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

 

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

 

NERA Study Details Post-SOX SEC Settlements

On November 10, 2008, NERA Economic Consulting released a report entitled "SEC Settlements: A New Era Post-Sox" (here) that details trends in the number of SEC settlements and of SEC settlement values in the six years since the enactment of the Sarbanes-Oxley Act.

 

The Report has a number of interesting findings, including the observation that prior to SOX’s enactment, the largest SEC enforcement action penalty was the April 2002 penalty of $10 million imposed against Xerox. However, the Report notes, after SOX, "the SEC has imposed penalties of $10 million against 115 parties, include 14 that were penalized at least $100 million." The Report includes a "top ten" settlements list, which is headed by AIG’s 2006 settlement of $800 million.

 

The Report also contains an analysis of the five most frequent allegations. Topping the list is microcap fraud (such as broker room operations or pump-and-dump schemes), followed by misstatement/omissions (including options backdating), and misappropriation of investor funds. The majority of cases against publicly traded companies involve allegations of misrepresentations or omissions.

 

The Report note that the SEC is on pace to reach 739 settlements in 2008, which would represent an increase in the number of settlements for the second straight year. The increase is driven largely by an increase in the number of individual settlements. The number of company settlements, by contrast, is declining. The number of company settlements is on pace to reach 171, which would represent the lowest number of company settlements since SOX was enacted.

 

The median 2008 company settlement through the end of the third quarter is $1.0 million, which is up from the 2007 median of $700,000, but well below the annual medians during the years 2004-2006, when the medians ranged from $1.1 to $1.5 million. The median individual settlement throughout the post-SOX era has been approximately $100,000.

 

Median settlements for public company misstatement cases have declined from a 2006 high of $50 million to a 2008 median (through the end of the third quarter) of $12.0 million. The report speculates that this decline may be due to the 2007 institution of a requirement for Commission approval prior to beginning negotiations in public company cases. (It is also probably worth noting that three of the top ten settlements took place in 2006, whereas none of the top ten has yet taken place in 2008.) The majority of public company misstatement cases settle for less than 1% of market capitalization.

 

The Report did note that of 197 companies the study identified as having settled SEC enforcement proceedings related to company misrepresentations or omissions, 181 had announced the existence of an investigation. The average time from the investigation announcement to the settlement for these 181 companies was 2.3 years.

 

The report also found that forty-three percent of company payments have been in the form of disgorgement, with 57% representing penalties. With respect to individual settlements, disgorgement represents 88% of payment amounts.

 

Relation Between SEC Settlements and Securities Class Action Lawsuits?:  The Report anticipated a question that formed in my mind as I read its analysis, which is the relation, if any, between SEC settlements and private securities class action litigation. The Report notes "it might be tempting to draw a comparison" between the number of class action filings, which increased in 2007, and the increase in the number of SEC settlements in 2007 compared to 2006. The Report notes that this comparison would be "misleading" in two respects:

 

First, the filing of a securities class action represents the first stage of class action legal proceedings, whereas SEC settlements are part of the last stage of the legal process. Because the SEC does not announce its investigations publicly, it is generally not possible to track the beginning of investigations. Instead this paper tracks settlements, which are often the first public information about an SEC matter. Second, most SEC settlements do not parallel shareholder class actions. In 2007, only 22% of SEC settlements were with public companies or their employees and related to misstatements, and were therefore closely comparable to shareholder class actions.

 

SEC Settlements and D&O Insurance, Briefly Noted: It is probably worth emphasizing that very little if any of the amounts involved in these settlements would have been insured under a typical D&O insurance policy. Most policies exclude from their definition of insured "Loss" such items as "fines and penalties" and disgorgements of amounts are typically excluded or do not otherwise represent insurable loss. However, in many instances, defense fees incurred in connection with the enforcement proceedings would be covered, depending on the applicable policy’s definition of the term "Claim."

 

New NERA Website: In addition to its Report, NERA also announced on November 10 the launch of its new website entitled "Securities Litigation Trends" (here) where NERA will be centralizing its own securities litigation analysis and also collecting other useful links (including related blogs).

 

Special thanks to Ben Seggerson at NERA for providing links to the NERA study and to the new web page.

 

Wrong-Way Bets Beget Losses and Lawsuits

One of the more distressing side effects of the recent dramatic events in the global financial markets has been the sudden and unexpected reversal of fortune on any number of financial transactions and positions, particularly with respect to commodities and currencies. These developments have proven to be particularly troublesome for market participants that sought to protect themselves from commodities or currency exposure through financial hedges, only to find themselves suddenly stuck in wrong way bets as commodities prices or currency exchange rates moved quickly in unexpected directions.

 

At least in connection with several companies, the consequences from these adverse hedge transaction developments have included the arrival of securities class action lawsuits.

 

The most recent of these lawsuits have both involved foreign domiciled companies. Sadia, S.A. is a Brazilian meat products and processing company whose shares trade on the Brazilian exchange and whose ADRs trade on the NYSE. According to their November 5, 2008 press release (here), plaintiffs’ lawyers have initiated a securities class action lawsuit against Sadia and certain of its directors and officers in the Southern District of New York, on behalf of persons who bought both shares and ADRs of Sadia between April 30, 2008 and September 26, 2008. A copy of the complaint can be found here.

 

According to the press release, the complaint alleges that during the class period:

 

Sadia entered into undisclosed currency derivative contracts to purportedly hedge against the Company's U.S. dollar exposure. The Company characterized the amounts of these contracts as "nominal." However, these contracts violated Company policy in that they were far larger than necessary to hedge normal business operations and resulted in a loss of $365 million. As a result of Defendants' admission of violating Company policy regarding currency hedging, the American Depository Receipts of Sadia S.A. closed at $9.50 per share, down from the previous day's close of $15.27, a decline of 38%.

 

The second of these recent lawsuits involved Britannia Bulk Holdings, a U.K.-based drybulk shipping and maritime logistics services company that conducted a $116.2 million IPO on June 17, 2008. According to their November 6, 2008 press release (here), plaintiffs’ lawyers have initiated a securities class action in the Southern District of New York against the company and certain of its directors and officers, as well as against its offering underwriters. A copy of the complaint can be found here.

 

According to the press release,

 

on October 28, 2008, Britannia Bulk issued a press release announcing that the Company expected a significant net loss for the third quarter of 2008 compared to the net income achieved during the second quarter of 2008. The loss was due to problems with hedges the Company had entered into earlier in the year. In addition, the Company announced it would not pay a dividend on its common shares for the quarter ended September 30, 2008, or for the foreseeable future.

Following this disclosure, the Company’s stock collapsed to $0.16 per share. The following day, the Company disclosed that it had been notified by its lenders that they were accelerating all of its subsidiary’s obligations under a $170 million lending facility. This would ultimately result in the subsidiary being placed into administration under U.K. insolvency laws.

According to the complaint, the Registration Statement failed to disclose the problems in the Company’s activities in the forward freight agreements ("FFAs") market. Specifically, the Registration Statement concealed that the Company failed to institute and enforce controls that would prevent Company personnel from buying FFAs not purchased to hedge identifiable ship or cargo positions. FFAs were represented to only be used as a hedge for work Britannia Bulk’s ships engaged in. However, in fact, FFAs were used outside of these guidelines, exposing the Company to significant risks. Moreover, the Company had not entered into appropriate fixed price contracts given the dramatic fluctuation in crude oil and bunker fuels.

Add to these two the securities lawsuit recently filed against Pilgrim’s Pride (about which I previously wrote here), which also included allegations of an ill-timed hedge designed to control price increases for its feed materials, that hurt the company when feed prices unexpectedly plunged.

 

While the companies and specific transactions involved are very diverse, the common thread among these cases is that in each case the company was harmed as a result of a wrong-way bet on commodities or currencies. In each case, the sudden and dramatic events in the financial markets during September and October 2008 produced a magnified impact on financial condition of these companies. To be sure, in the Sadia and Brittania Bulk cases, the circumstances appear to have been exacerbated by allegedly unauthorized trading, but nevertheless in all three cases the financial harm resulted from hedging or hedge related activities that suddenly and unexpectedly went very wrong.

 

These companies are far from the only companies that attempted to protect themselves from rising commodities prices or currency exposures through hedge transactions, and that are also likely far from the only companies that found themselves in wrong-way bets when the commodities and currency markets moved unexpectedly and materially in unexpected directions in recent weeks.

 

Indeed, a November 6, 2008 Wall Street Journal article (here) described the steep losses some investors (including several large companies) have incurred in connection with their investment in a relatively new derivative investment called an "accumulator, which obligates the investor to buy a fixed quantity of a security, commodity or currency at a fixed price and at regular intervals. This approach works when prices are rising, but can be devastating when prices fall. The article specifically mentions VeraSun, which recently filed for bankruptcy, and which experienced huge losses on accumulator contracts for the price of corn. The article also mentions Citic Pacific, which recently experience losses of as much as $2 billion on an accumulator contract linked to the Australian dollar.

 

Another common thread among these companies is that most of them are not involved in the financial services industries. Each of these company’s circumstances represents an example of the ways that the turmoil in the global financial markets during September and October 2008 has altered the prior wave of subprime and credit crisis-related litigation, which before that time had been largely been confined to the financial services and real estate industries, to spread into the larger economic and financial marketplace.

 

The fallout from the disruptive events of the past few weeks has already included significant litigation activity outside the financial sector. While it still remains to be seen how extensive the litigation activity beyond the financial sector ultimately will prove to be, at this point it seems increasingly likely that a diverse range of companies could become involved.

 

In making this observation, I am not limiting my prognostication just to companies that have engaged in hedging transactions, but rather I am contemplating the entire universe of companies that have experienced a significant reversal of fortune due to the this fall’s disruptive events. So, in addition to companies that have experienced unexpected reversals on wrong-way bets on commodities or currencies, there are companies that were adversely affected by Lehman Brothers’ failure (refer here) or by the sudden seizing up of the credit markets that followed (refer here). In the days to come, there will be an increasing number of companies reporting problems due to these and other concerns. While not every company reporting these problems will sustain a securities class action lawsuit, a significant number will, and many of them, like the companies mentioned above, will be outside of the financial sector.

 

The Future of the Plaintiffs' Securities Bar?

With the sentencing of the last two defendants in the criminal investigation of the Milberg law firm and several of its former partners, it may be time to ask what the impact has been on the plaintiffs’ securities bar and what the future may be for securities litigation. There are also interesting questions about what the impact may be on securities litigation as a result of  Barack Obama’s election to the White House and the augmentation of the Democrats’ control of Congress.

 

These questions were the focus of a November 5, 2008 panel at the PLUS International Conference in San Francisco. The panel, which was moderated by Edwards Angell Palmer & Dodge partner John McCarrick, included Boris Feldman of the Wilson Sonsini firm; Professor Joseph Grundfest of Stanford Law School; Keith Fleischman of the Grant & Eisenhofer firm; and Judge Vaughn Walker of the Northern District of California.

 

The session was preceded with a fascinating video created for the event entitled "The Rise and Fall of William Lerach," which detailed the career and criminal prosecution of former plaintiffs’ securities bar titan Bill Lerach. The video also included an interview of Lerach that had been taped before Lerach began his incarceration.

 

The video included a detailed history of the circumstances underlying the criminal investigation of the Milberg firm, including the fascinating story of how a lovers’ quarrel in Cleveland and the discovery of stolen paintings in a public storage warehouse led to Lerach’s indictment and eventually to the entry of guilty pleas by Lerach and others. (I detailed these events behind the criminal indictments, including pictures of the stolen paintings and how they related to the overall story, here).

 

The video contained some extraordinary footage, including a vintage video clip of Lerach in a 2003 speech about supposedly corrupt corporate officials, quoting the Bible (refer to text here) as saying, "What profit a man if he gain the whole world but lose his own soul?" – adding parenthetically on his own, "or his freedom." The video also quoted Lerach as saying several times in an apparent attempt to defend the kickback payments that led to his conviction that "it was an industry practice" and that his firm did it "because we had to" in order to "meet competition. "

 

Following the video, the panelists turned to the question of the current state of the plaintiff securities bar and what may lie ahead.

 

The discussion focused initially on the question whether the leading plaintiffs’ lawyers’ demise has opened the door for other plaintiffs’ firms. Boris Feldman observed that the level of talent in the plaintiffs’ has proven to be both deep and broad. He added, however, that in his view that the more significant development is that the power of the securities class action cases seems to have shifted from an individual lawyer, like a Lerach or a Mel Weiss, to institutional investors. Keith Fleishman agreed that institutional investors are in greater control of these cases.

 

Judge Walker expressed a contrary view, commenting that from his perspective the cases "largely have not changed." He said that the involvement of a sophisticated institutional investor that "rides herd" occurs "in relatively few cases." In the vast majority of cases, he said, "things have not changed." He said that in his view, plaintiffs’ lawyers are "still very much in the drivers’ seat."

 

He went on to note that the problems with the system are not confined to the conduct to which Lerach plead guilty, noting that Lerach had plenty of what Walker called "accessories." Among the "accessories" Walker identified are the judges who have not "ridden herd" to scrutinize settlements, fee awards and claim administration. He also identified the defense bar as among the "accessories," who present settlements without having obtained the facts but instead "locking arms" with the plaintiffs’ counsel at settlement hearings, as a result of which there is no "adversary presentation" of the kind on which courts depend.

 

Judge Walker expressed concern that there is little monitoring or participation in the strategic process, and "frankly not enough discipline" in the system "to weed out the cases" that should not be pursued.

 

Keith Fleischman disagreed with Judge Walker and said that in his experience, courts were very much engaged in the supervision of cases and their settlements, and required a process in which the developments were "highly scrutinized."

 

Professor Grundfest offered the view that perhaps both Judge Walker’s and Fleischman’s viewpoints were correct because the cases are "bifurcated" between the larger cases in which institutional investors are actively involved and the smaller cases where smaller plaintiffs’ firms and investors with smaller interests are involved. Grundfest observed that the vast majority of cases either are dismissed or settle for under $10 million, and the institutional investors are not involved in these smaller cases.

 

Boris Feldman observed that some of these smaller plaintiffs may include small Taft-Hartley funds whose involvement may represent a "version 2.0" of the activities that led to the problems of which Lerach was convicted. He raised the question about the small union locals that are repeatedly involved in securities cases in which they actively seek lead plaintiff status, which, Feldman suggests, raises questions about what is really in it for the local funds and whether there are favors of one kind or another that that motivates these small funds.

 

An interesting related question that came up in the panel discussion is whether or not the institutional investors’ involvement in securities litigation could lead to an increase in the number of securities cases that go to trial. Fleischman first raised this, suggesting that expectations on both sides of these cases have changed, which could lead to more cases going to trial.

 

Feldman came back to this topic later, suggesting that the dynamic has changed in cases in which politicians are involved, such as where the lead plaintiff is a large public pension fund. Feldman observed that the specialized lawyers who have handled these cases generally know what a case is worth, and generally know about where a case will settle. Politicians may have other motivations, and may well believe that a trial victory would be more valuable to them than a settlement.

 

Professor Grundfest also suggested that plaintiffs’ firms, managing a portfolio of cases almost in the same way a hedge fund manages its investments, may find it expedient to take cases to trial as one way to try to maximize returns across their entire portfolio. Grundfest agreed that we are probably going to see more trials.

 

The panel discussed a number of other topics, including the way in which plaintiffs’ plead damages in the class action complaint. Judge Walker observed that insufficient attention is paid to whether the theory of damages alleged makes sense. He noted that not enough attention is paid to demonstrating the way that the defendant company’s stock price moved with respect to the alleged misrepresentations.

 

The panelists also discussed the way in which e-discovery has changed these cases. Feldman observed that e-discovery has been a "goldmine" for the plaintiffs’ lawyers, and because of the expense involved, the "big loser" has been the insurance companies. Grundfest noted that he tells his students that "e-mail" stands for "evidence mail" because it "captures and creates smoking guns." Judge Walker noted that these documents can sometimes assume an importance all out of proportion to the case as well.

 

What the Election Means for the Plaintiffs’ Bar: The panel concluded with the panelists making predictions about what Tuesday’s election may signify for securities litigation. Grundfest opened the discussion by stating that as a result of the Democrats’ sweeping electoral victory, the headline is that "Christmas comes early" for the plaintiffs’ bar, and the only question is "what’s in the boxes and what’s under the tree." Grundfest suggested that the plaintiffs’ bar may succeed in having Congress legislatively reverse Stoneridge and Central Bank.

 

Grundfest also suggested that Congress might move toward revising the pleading standard in securities cases, moving from the currently more restrictive standard to one where the case could survive a motion to dismiss if there were the "mild aroma" of fraud. Grundfest also suggested that as the likely changes could "dramatically increase the exposure" for the insurers, because the potential securities litigation exposure is "likely to go up in the future."

 

Feldman agreed that, after a period in which conditions may have been relatively advantageous for defendants, we could have entered "a bad period from a claims perspective for insurance companies." Feldman suggested that Obama’s judicial appointees are likely to be more receptive to class actions, and to favor the "interests of the little man." He agreed that the plaintiffs’ priorities are likely to get through Congress and also that Central Bank is likely to be legislatively reversed. He also said that the current credit crisis will feed into this processes, as excesses unearthed as part of the credit crisis will become the "poster children" to justify the legislative changes.

 

Judge Walker concluded the discussion with an observation of the irony that we now find ourselves in a period of the greatest upheaval of our generation yet two of the most talented plaintiffs’ lawyers are "out of action."

 

Debt Woes, Tough Times and Securities Litigation

At first glance, poultry producer and processor Pilgrim’s Pride and shopping center REIT General Growth Properties would seem to have little in common. But while they may be in different business sectors they share a remarkable number of common woes.

 

Both are laboring under crushing debt obligations associated with recent acquisitions, and both face potentially insurmountable problems servicing or restructuring their debt. The problems facing both companies are further exacerbated by the economic downturn. In each case, the founding families may lose control of the companies, or perhaps even their entire investment. Both companies have also seen their share prices plummet.

 

And now, both companies have been hit with securities class action lawsuits.

 

While these two new lawsuits at one level are the result of these two companies’ particular challenges, the underlying debt issues and complications arising from the current credit crisis could affect legions of other companies, and possible spark even further securities litigation.

 

Pilgrim’s Pride: As detailed in a front-page October 17, 2008 Wall Street Journal article entitled "Debt Woes, Feed Costs Come Home to Roost at Pilgrim’s" (here), Pilgrim’s Pride is struggling under the burden of debt associated with its 2007 acquisition of rival Gold Kist, making Pilgrim’s Pride the "world’s largest chicken company."

 

As noted in a subsequent Journal article (here), in addition to an "increasingly untenable debt load," the company has been "hammered by rising prices for feed, bad bets in the grain market, [and] falling prices for chicken." The October 17 Journal article details an ill-timed hedge the company had entered, fixing its grain feed costs when prices had peaked, locking the company into a costly contract just before prices began to decline.

 

Pilgrim Pride’s financial challenges have been "exacerbated" by the economic downturn, as a result of which fewer consumers are dining out, reducing demand for chicken.

 

Due to these circumstances, Pilgrim Pride’s share price has declined 97 percent this year. On October 30, 2008, press reports (here) speculated that the company, which faces pending interest payments it may not be able to fulfill, is a "likely" candidate for bankruptcy.

 

In addition, and also on October 30, 2008, plaintiffs’ lawyers issued a press release (here), announcing that they have filed a securities lawsuit in the Eastern District of Texas against Pilgrim’s Pride and certain of its directors and officers. A copy of the complaint can be found here.

 

According to the press release, the complaint alleges that the defendants "misrepresented the Company’s financial condition and concealed the impact of the Company’s capital problems on its business and prospects." The Complaint specifically references the company’s September 24, 2008 press release (here), in which it announced that it had "notified its lenders that it expected to report a significant loss" in its fiscal period ending September 27, "due to high feed-ingredient costs, continued weak pricing and demand for breast meat, and the significant impact of hedged grain positions during the quarter."

 

According to the press release, the complaint alleges that the defendants failed to disclose that:

 

(a) the Company’s hedges to protect it from adverse changes in costs were not working and in fact were harming the Company’s results more than helping; (b) the Company’s inability to continue to use illegal workers would adversely affect its margins; (c) the Company’s financial results were continuing to deteriorate rather than improve, such that the Company’s capital structure was threatened; (d) the Company was in a much worse position than its competitors due to its inability to raise prices for customers sufficient to offset cost