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

During the first quarter of 2013, new corporate and securities lawsuits and regulatory enforcement actions increased slightly compared to the fourth quarter of 2012 but remained well below annual averages over the last two years, according to a new report from Advisen, the insurance information firm. The April 2013 report, which can be found here, is entitled “D&O Claims Trends: 1Q 2013,” notes that “if the first quarter is any indication, it appears that this downward trend may continue throughout 2013.”

 

Reeders reviewing the Advisen report will want to be very careful to note that the report uses its own terminology. In particular, the report uses the term “securities suits” to refer to all categories of corporate and securities litigation. Among the subsets within this larger category of “securities suits” is what the report calls “securities fraud” suits, which as used in the report refers to actions brought by regulatory and enforcement authorities, as well as private securities suits that are not brought as class actions. The category of “securities fraud” suits does not include securities class action lawsuits, which have their own separate category of “securities class action” suits, which part of the larger category of “securities suits.” Readers will want to be very attentive to the report’s usage of these terms.

 

According to the report, the first quarter, which traditionally is a busy period for corporate and securities litigation, saw a 40 percent decrease in the number of new corporate and securities lawsuits compared to the first quarter of 2012. Though the activity in 1Q13 was up slightly from the fourth quarter of 2012, the quarterly total of new corporate and securities lawsuits (313) was the third lowest quarterly total since 2009. The leading type of new corporate and securities lawsuits during the first quarter was what the report calls “securities fraud” suits (that is, the regulatory and enforcement actions plus securities suits that are not brought as class actions), which were up 13 percent from the fourth quarter of 2012 but down 33 percent from the 2012 quarterly average.

 

Many readers of this blog are aware that there has been an upsurge in M&A-related litigation in recent years. Interestingly, the report notes that although M&A activity increased during the first quarter of 2013, the number of M&A-related suits decreased, which is, the report notes, “a development that will require further review.”

 

For several years, Advisen has noted in its reports that securities class action lawsuits as a percentage of all corporate and securities litigation has been declining, from 22 percent in 2007 to 11 percent in both 2011 and 2012. The percentage ticked up slightly in the first quarter of 2013, when securities class action lawsuits represented 12 percent of all corporate and securities lawsuits. However, in absolute terms, the number of securities class action lawsuits continued a downward trend during the fourth quarter of 2013. During the first quarter of 2013, there were only 36 securities class action lawsuit filings, compared to 50 during the first quarter of 2012 (representing a decline of 28 percent).

 

Companies in the financial sector experienced the most new corporate and securities lawsuits in the first quarter of 2013. New lawsuits against companies in the sector represented 26 percent of all new corporate and securities lawsuits in 1Q13. While still the sector with the highest level of new lawsuit activity, the percentage of suits against companies in the sector has actually declined. For the forth quarter of 2012, the equivalent percentage was 31 percent and the 2012 quarterly average was 28 percent. The report attributes this decline to the continuing winding down of the subprime and credit crisis-related litigation wave.

 

The Advisen report concludes with a closer look at the recent wave of “say on pay” and other compensation-related litigation.

 

Speakers’ Corner:On Tuesday, April 30, 2013, I will be participating in Advisen’s Quarterly D&O Claims Trends Webinar, in which, among other things, the Advisen report will be discussed. In this free webinar, which will take place at 11:00 am EDT, I will be participating on a panel with Paul Ferrillo of the Weil Gotshal law firm, David Murray of AIG, and Jim Blinn of Advisen. The panel will discuss claims trends and developments during the first quarter of 2013. Registration information for the webinar can be found here.

 

PwC Releases 2012 Securities Litigation Study: Earlier this month, PwC released its annual study of the securities class action litigation. I had not previously linked to the study because for a time the study was not available on the firm’s website. The April 2013 study, which is entitled “At the Crossroads, Waiting for a Sign: 2012 Securities Litigation Study” now can be found here.

 

As other reports have previously noted, the PwC study notes that securities class action litigation declined in 2012 compared to prior years and compared to historical averages. The report also notes that the decline during the year was largely concentrated in the year’s second half; while securities class action litigation filings were at or near historical levels in the first two quarters of 2012, the number of new filings declined sharply during the year’s second half.

 

The PwC study also notes, consistent with prior studies that the number and value of securities class action settlements declined in 2012.

 

How Would You Look With a D&O Diary Coffee Mug?: Only one way to find out. Refer here for details. (Including the fact that the mugs are free. That’s right. Free).

 

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Whistleblower information may be one of the SEC’s “most effective weapons in its new enforcement arsenal,” but the agency’s whistleblower program “faces challenges on many fronts,” according to an April 23, 2013 New York Times Dealbook article entitled “Hazy Future for Thriving S.E.C. Whistle-Blower Effort” (here). As evidence of the whistleblower program’s promise that article cites several “previously undisclosed” enforcement actions that whistleblower information have triggered or aided. Yet due to several potential obstacles and impediments, the future of the program may, according to one source cited in the article “hang in the balance right now.”

 

For its part, the agency says that it has “ramped up” its staffing and the program has “gained momentum.” As evidence of the value the program has already delivered, the article cites the agency’s investigation of Knight Capital. The SEC was already investigating problems the trading company was having following the company’s bungled installation of new trading software. The investigation had been narrow until a whistleblower came forward and “the agency was able to shift gears and expand the investigation.”

 

According to the article, with the help of a whistleblower, the agency’s investigation of the Oppenheimer’s investment firm’s alleged overstatement of the performance of a private equity fund resulted in a fine of nearly $3 million.

 

The article also details an enforcement action that resulted in the first whistleblower bounty payment under the Dodd Frank Act’s whistleblower provisions. According to the article, Dee Stone, an outside consultant to China Voice Holding Corp, received a whistleblower bounty of $46,000 (so far) for providing documents showing that the company was operating a Ponzi scheme. (Refer here for more about this award, which was the first and is so far the only award under the Dodd-Frank whistleblower bounty program). The identity of the whistleblower and the subject of her whistleblower report had not previously been disclosed.

 

But though the program has had its successes, the SEC has also encountered obstacles from companies. Some companies have “drafted policies compelling their staffs to report fraud internally,” while other companies require employees to “attest annually that they never witnessed any fraud, a certification that could be used to discredit employees who later blew the whistle.”

 

The article also notes that companies have been accused of retaliating against whistleblowers. The article cites the September 2012 complaint that James Nordgaard filed in the Southern District of New York against his employer, Paradigm Capital Management and related entities, as well as against its founder and President, in which Nordgaard alleged that his employer retaliated against him after he notified the employer that he had reported what he believed to be illegal activities to the SEC.

 

In his complaint, a copy of which can be found here, Nordgaard sought to recover damages for retaliation under the Dodd-Frank Act. Nordgaard alleged that after he made his report, he was stripped of trading duties and “constructively terminated.” Initially, the company sought to have the dispute submitted to arbitration. In December 2012, Nordgaard voluntarily withdrew his complaint.

 

Discussion

Even though the article highlights the successes that the whistleblower program has already produced, the article nevertheless also suggests that company efforts may undermine the program or limits its usefulness. It may be true that some companies may succeed in diverting would be whistleblowers to internal programs, but even that could still be useful as long as the whistleblower’s reports are not swept under the rug but are dealt with.

 

And while company retaliation could well deter whistleblowing, the specific example of company retaliation that the article notes suggests that retaliation could be as big of a problem for the retaliating company than for the employee, given the retaliation protection available to whistleblowers under the Dodd-Frank Act.

 

The fact is that during the first full fiscal year of the whistleblower’s operation, the SEC received 3,001 whistleblower reports (as discussed in the agency’s 2012 annual whistleblower report, a copy of which can be found here). And while that number may be, as an unnamed source in the article suggests, “somewhat exaggerated,” it is clear that the SEC is receiving a very substantial number of whistleblower reports – and that is despite the deterrent efforts of some companies noted in the article.

 

The agency has at this point made only a single whistleblower bounty award. As the agency makes further awards and as those awards attract publicity, would-be whistleblowers will likely be even further motivated to come forward. As a plaintiffs’ law firm noted in a press release earlier this week, whistleblower awards provide “a reason for taking a risk.” (And it should not be overlooked that the plaintiffs’ bar clearly sees the development of a whistleblower practice as a growth opportunity. The efforts of the plaintiffs’ bar may not by itself be sufficient to cancel out the efforts of companies to try to deter whistleblowers but it does at a minimum represent a countervailing force.)

 

My take is that though companies may be taking steps to avert whistleblower problems, the whistleblower program ultimately will prove, as the article suggests, to be “one of the most effective weapons in the new enforcement arsenal.”

 

As I have said previously on this blog, if 2012 was the year in which the Dodd-Frank whistleblower program finally got off the ground, 2013 will likely be the year when the program picks up serious momentum. It seems likely  that – notwithstanding the impediments noted in the Times article -- we will not only see increased enforcement activity as a result of whistleblowers’ tips, but that we will see increased numbers of whistleblowers’ bounty awards, as well as the possibility of increased private civil litigation following in the wake of the enforcement actions.

 

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What are the factors that affect the timing of securities class action lawsuit dismissals and that affect the timing and size of securities suit settlements? These are the questions examined in an April 2012 PLUS Journal article entitled “When Are Securities Class Actions Dismissed, When Do They Settle and For How Much? An Update” (here) by Stanford Law School Professor Michael Klausner and his colleagues Jason Hogland and Matthew Goforth. In this article, the authors update their earlier research on these same questions.

 

In order to examine these issues, the authors examined the 652 securities class action lawsuits filed between 2006 and 2010. Of the 652 cases, 119 (18%) are ongoing, 257 (40%) have settled, 206 (32%) have been dismissed with prejudice, and 74 (11%) have been voluntarily dropped. Disregarding amounts paid in settlement by third parties (such as offering underwriters), of the cases from this period that settled, the mean settlement amount is $36 million and the median is $9 million.

 

The authors followed the progression of these cases through the motion to dismiss stage. They found that, among other things, as a result of a combination of dismissal motion rulings, voluntary withdrawls and settlements reached before a dismissal motion ruling, over half of all securities class action lawsuits “end well before discovery and before even a second complaint is filed.”

 

In 25% percent of cases, the motion to dismiss is granted with prejudice, on average within 19 months of the date on which the complaints were first filed. An additional 9% of cases were voluntarily dropped before the dismissal motion was heard, and another four percent were dropped after the motion to dismiss was granted without prejudice. Thus, a total of 38% of cases “ended relatively quickly and painlessly for defendants.”

 

In addition, another 13% of cases settled before the motion to dismiss was heard and another 2% of cases settled after the court granted a motion to dismiss without prejudice but before the plaintiffs filed an amended complaint. These cases “entailed costs to defendants and their insurers, but they did not involve extended litigation.”

 

In 34% of cases, the court granted the motion to dismiss without prejudice, of which 85% of plaintiffs filed a second complaint. The outcome of the second complaint cases roughly parallels the outcomes at the first complaint stage. On average about 30 months passed between the initial filing and the resolution of these second complaint stages. Only five percent of cases reached the third complaint stage, and even fewer involve subsequent complaints. The authors conclude that “relatively few cases entail the filing of a second, third or later consolidated complaint.”

 

Of all cases that are ultimately dismissed with prejudice, 66% are dismissed at the first complaint stage, 28% are dismissed at the second complaint stage, and 6% are dismissed at the third complaint stage. (Only one case was dismissed at the fourth complaint stage and one was dismissed at the fifth complaint stage.)

 

Certain factors clearly affect the likelihood of dismissal. For example, when a securities suit involves a parallel SEC enforcement action, the class action was dismissed in only 12% of cases. Cases that involved restatements “were dismissed less frequently than cases that involve non-restatement accounting issues, which in turn were dismissed less frequently than are non-accounting cases.”

 

In looking at the timing of settlement, the authors categorized the procedural stages of the cases as early pleading (that is, up through the first dismissal motion ruling), later pleading (involving the pleading stages following the first ruling but before the final determination), and discovery (involving the period after the dismissal motion has finally been denied). Forty three percent of settlements occur in the early or late pleading stage, that is while there is still a possibility of dismissal. Just under 60% of settlements occur in the discovery stage, some shortly after the motion to dismiss is denied.

 

For cases that settle after the motion to dismiss is denied, the time it takes the cases to settle ranges from one month to 46 months, but the mean length of time for a case to settle after the dismissal motion is denied is 16 months.

 

The authors found that settlement size is related to settlement timing. Settlement size increases as the cases move through the early pleading stage to the discovery stage. The mean settlement for cases that settle in the discovery stage is over $60 million, while the mean settlement of cases that settle in the early pleading stages is less than $20 million.

 

However, though the settlements tend to grow larger as the cases progress, the settlements as a percentage of shareholder losses decline as the cases advance through the various stages. The authors attribute this seeming contradiction to company size, as larger companies tend to settle later than smaller companies. Though cases involving larger companies settle for larger amounts in terms of absolute numbers of dollars, smaller companies tend to settle for a larger fraction of shareholder losses.

 

The authors concluded by noting that their findings in this latest updated study are consistent with the finding in their prior study, which had focused on cases filed between 2000 and 2004. The authors note that “it appears that the forces shaping the patterns of dismissal and settlement over the past decade have remained stable.”

 

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Securities class action lawsuits involving accounting allegations are less likely to be dismissed, take longer to resolve, and make up a much greater proportion of total securities suit settlement dollars than non-accounting cases, according to a new report from Cornerstone Research. The report, entitled “Accounting Class Action Filings and Settlements: 2012 Review and Analysis,” and which can be found here, shows that the number of securities cases involving accounting allegations declined in 2012, both in absolute numbers and as a percentage of all securities suit filings. However, a number of factors suggest that the number of accounting cases could increase in the months ahead. Cornerstone Research’s April 10, 2013 press release regarding the report can be found here.

 

The report defines a securities suit as an “accounting case” if the lawsuit involves allegations of Generally Accepted Accounting Principles or weaknesses in internal control over financial reporting. The alleged GAAP violations vary widely, but include allegations of accounting irregularities, restatement of financials, and asset write-downs.

 

During 2012, new accounting case filings decreased both in number and in proportion of new securities class action filings, to the lowest levels in six years. The number of accounting cases decreased from 78 in 2011 to 45 in 2012, and the proportion of total filings that accounting cases represented decreased from 42 percent to 30 percent. As a result of declines during 2012 in the number of cases involving Chinese reverse merger companies, as well as a general decline in the number of securities class action lawsuit filings in the second half of the year, the number of securities suit filings overall declined during 2012. The drop in Chinese reverse merger cases alone accounted for approximately two-0thirds of the drop in new accounting cases from 2011 to 2012

 

The total number of accounting restatements actually increased in 2012. However, the total number of accounting cases involving financial restatements decreased during 2012, returning to levels seen in 2009 and 2010, after a significant increase in 2011. Perhaps many of the 2012 restatements did not result in lawsuits because the “many of the restatements during 2012 did not have a significant effect on stock price.” It is also possible that a time lag between the time of the restatement and an eventual filing may result in more restatement related filings in 2013.  

 

For the third consecutive year, the majority of accounting cases included allegations of internal control weaknesses. Over the past three years, nearly two out of three accounting cases included allegations relating to internal controls, a much higher proportion than during the period 2007 through 2009.

 

Accounting cases typically are less likely to be dismissed than non-accounting cases. Of the securities class action lawsuits that were filed in 2007, only 35 percent of accounting cases were dismissed by the end of 2012, compared with 52 percent of non-accounting cases. In addition, 60 percent of accounting cases filed in 2007 settled by the end of 2012, compared to 41 percent of non-accounting cases. Of all cases filed during the period 2007 to 2010, only five percent of accounting cases were voluntarily dismissed, compared with 24 percent of non-accounting cases.

 

Accounting cases continue to represent a substantial portion of the total dollar value of all settlements. While accounting cases represented less than 70 percent of the number of 2012 securities lawsuit settlements, accounting cases represented over 90 percent of the total value of the settlements.

 

Both average and median settlement amounts are higher for accounting cases compared with non-accounting cases. During 2012, the average and median settlement amounts for accounting cases were approximately $73 million and $15 million respectively, compared with $16 million and $6 million for non-accounting cases. This difference is due in part to the fact that accounting cases often involve other factors associated with higher settlement amounts, such as an accompanying SEC action. The report also notes that cases in which the company has announced internal control weaknesses are associated with both higher median settlement amounts and a higher settlement share of “estimated damages.”

 

The report notes that factors such as the Dodd-Frank whistleblower program, a recent increase in the number of restatements by accelerated filers, and the JOBS Act’s extension of the exemption from auditor reports on internal controls for emerging growth companies are all factors that could contribute to an increase in the number of securities class action lawsuit filings involving accounting allegations.

 

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Third-Party litigation funding’s moment may have already be here, as I have previously noted. But just the same, it is a little surprising to find stories about litigation funding at virtually every turn, with stories over the weekend appearing, for example, in The Economist and in the Wall Street Journal, among other publications. Two things seem to be driving this media attention: the results that early entrants to the litigation funding arena are achieving; and the arrival of new entrants into the field, undoubtedly attracted by the early entrants’ results.

 

The April 6, 2013 Economist article, entitled “Investing in Litigation: Second-Hand Suits” (here), reports that litigation funders are posting “fat returns.” The article cites the results of two of the publicly traded litigation funders. Juridica, which is listed on the London AIM exchange, on March 15, 2013 reported that during the prior year the company had made cash profits of $38 million on fund of $256 million under investment. Last year, the company “offered the highest dividend yield on London’s AIM market.” Burford Capital, which is also traded on the London AIM but is newer and bigger than Juridica, “boasts a 61% net return on invested capital in 2012.”

 

With results like these, it is little surprise that the litigation funding arena is attracting new entrants. In an April 8, 2013 Wall Street Journal article entitled “Investors Put Up Millions of Dollars to Fund Lawsuits” (here), investors seem to think that litigation is an “increasingly good bet” and that a new generation of investors is “plunging into” litigation funding. Among the entrants identified in the Journal article is Gerchen Keller Capital, which, as described in an April 8, 2013 Crain’s Chicago Business article (here), has raised more than $100 million and which closed its first deal on April 2, 2013. As detailed in an April 7, 2013 interview on Alison Frankel’s On the Case blog (here), the Gerchen Keller firm is well connected and has the advantage, as Frankel puts it, of “sparkly resumes and impressive Rolodexes.” (Question: Does anyone still use Rolodexes? Do they even exist any more? Does anyone under, say, 35 years old have any idea what a Rolodex is? Isn't the world a better place without Rolodexes? )

 

The Journal article also emphasized that the field of litigation funding is “expanding into new areas,” as Frankel’s interview with the Gerchen Keller firm’s principals shows. The Gerchen Keller firm’s founders believe that their opportunity in litigation funding is on the defense side, where they funding firm funds a defense based on an alternative fee arrangement characterized by reduced hourly rates with a provision for a bonus for good results.

 

Litigation funding proponents contend that the funding arrangements helps to level the playing field by allowing litigants to pursue lawsuits against better financed opponents, or simply allowing litigants to keep litigation costs off their balance sheet. It seems clear that as the litigation funding field grows, the funding companies are offering new approaches – for example, the defense side option that the Gerchen Keller firm will be offering, or the “defense costs cover” that provided protection for prospective RBS claimants sufficient for them to be able to take on litigation in the U.K. notwithstanding the “loser pays” litigation model that prevails there.

 

The obvious concern is that the increasing availability of litigation funding could fuel litigation and even encourage frivolous lawsuits. The Journal article quotes principals at several of the leading litigation funding firms to the effect that the requirement to produce a return on capital acts as a disciplining mechanism, providing a strong disincentive for the firms to become involved in suits lacking merit.

 

The requirements of the capital markets do provide a certain kind of discipline, but history has shown that capital does not invariably make the best choices. Moreover, with the kinds of results that the early entrants are producing, new capital will continue to be attracted to the litigation funding arena. The prospect for rich returns and low barriers to entry increase the likelihood that less meritorious litigation could find funding, or even that funds desperate to produce returns comparable to other funders encourage more speculative suits. Recent history shows what can happen when an asset class gets frothy, and there is nothing about litigation as an asset class that makes it immune from these kinds of risks.

 

Even without the market problems that over-exuberance can produce, the presence of litigation funding could drive up litigation costs. The cost of litigating a dispute in the United States is enormous, but the high litigation costs do enforce a form of self-regulation. The prospect of astronomical litigation costs has a way of driving many commercial litigants to the settlement table. Many litigants find it rational to try to find a business solution rather than prolong a distracting and costly dispute. But if the dispute itself is its own business venture, will litigants (or perhaps their financial backers) choose to prolong a case rather than to try to resolve it?

 

Perhaps these fears about the possible effect of litigation funding are unfounded. Given that litigation funding is here now and appears like it is going to be increasingly important, I hope I am wrong. The problem for all of us is that the litigation funding could have significant effects on our litigation system. The experiment is already underway. The full ramifications of this experiment may only become apparent over time. Like it or not, the test is already in progress.

 

One Final Note. In the past when I have written about litigation funding, I have immediately received a flood of calls and emails from people looking for litigation funding. Friends, I am a blogger. I do not offer litigation funding nor do I make referrals for litigation funders. I have mentioned several funders above and there are many more to be found on the Internet. If you want litigation funding, please contact one of the many litigation funders.  Please don’t call or email me looking for litigation funding.

 

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As I have previously noted on this blog (most recently here), plaintiffs’ lawyers recently have evolved a new approach to litigation relating to the advisory “say on pay” vote required under the Dodd-Frank Act. Under this most recent version of the say on pay litigation, the plaintiffs’ lawyers seek to enjoin upcoming shareholder votes on compensation or employee share plans on the grounds of inadequate or insufficient disclosure.

 

On April 3, 2013, Northern District of Illinois Judge Amy St. Eve entered an order granting the motion to dismiss of the defendants in one of these latest say on pay cases. A copy of Judge St. Eve’s April 3 opinion can be found here. An April 4, 2013 Reuters by Nate Raymond about Judge St. Eve’s decision can be found here.

 

As reflected in Claire Zilman's April 4, 2013 Am Law Litigation Daily article about Judge St. Eve's April 3 ruling (here), the defendants in the case before Judge St. Eve were represented by the Katten Muchin Rosenman LLP law firm. In the following guest post, Bruce G. Vanyo, Michael J. Lohnes and Christina L. Costley of the Katten Muchin  law firm take a detailed look at Judge St. Eve’s ruling and discuss the significance of the decision, including possible implications of the decision for other pending say on pay cases as well as other cases that may be raised in connection with the upcoming proxy season.

 

I will like to thank Bruce, Michael and Christina for their willingness to publish their article on my site. I welcome guest posts from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly. Bruce, Michael and Christina’s guest post follows:

 

The Dodd-Frank say-on-pay strike suits, if not yet dead, are close. Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), 15 U.S.C. § 78n-1, requires that public companies permit shareholders to cast advisory votes on executive compensation at least once every three years. Though the Dodd-Frank Act specifically stated it did not “create or imply any change to the fiduciary duties” or “create or imply any additional fiduciary duties,” the plaintiffs’ bar immediately began bringing suits for breach of fiduciary duty following any negative say-on-pay vote. Plaintiffs initially brought the lawsuits after companies’ annual meetings and framed them as derivative claims for waste. In 2011 and early 2012, courts consistently dismissed these cases at the pleading stage, holding that plaintiffs could not plead demand futility based on a board’s decision to disregard an advisory vote. See Gordon v. Goodyear, No. 12 C 0369, 2012 WL 2885695, at *9-10 (N.D. Ill. July 13, 2012).

 

In mid-2012, the plaintiffs’ bar tried a new approach. Instead of bringing derivative suits after a negative say-on-pay vote, they began bringing direct suits seeking to enjoin the say-on-pay vote before it occurred. The real goal, of course, was settlement: if the corporate defendant would agree to make modest additional disclosures, and agree to an attorneys’ fee settlement in the range of $100-$500K, plaintiffs would immediately dismiss the case. Though the cases had little substance, the expense of fighting them and the risks posed by a forced delay of an annual meeting still drove settlements. Some companies chose to fight, however, and in every “pure” say-on-pay case brought, courts refused to issue injunctions. But, because the complaints alleged material omissions (materiality is ordinarily not a matter that can be resolved on the pleadings) most companies answered the complaint instead of moving to dismiss and found themselves in protracted litigation as a result. One notable exception was the Symantec case, which was dismissed by a California state court on the pleadings.

 

On April 3, 2013, the United States District Court for the Northern District of Illinois issued the first federal court decision on this issue in Noble v. AAR Corp., No. 12-C-7973 (N.D. Ill. April 3, 2013). AAR and its directors had already successfully opposed plaintiffs’ motion for a preliminary injunction. Following the decision on the preliminary injunction defendants immediately moved to dismiss and stay discovery. The court granted the motion to stay discovery and postponed all further hearings. Six months later, the court issued a written decision granting with prejudice defendants’ first motion to dismiss. First, the court held that a corporation cannot face liability under the Dodd-Frank Act for omitting information in its proxy statements not required to be disclosed by the applicable federal regulations, Items 402 and 407. Second, the court held, after a say-on-pay vote has occurred, plaintiffs cannot plead a direct cause of action because no injury personal to the shareholder exists. Instead, the court held, any claim that remains can be brought only as a derivative claim for waste. The court called plaintiff’s efforts to maintain the claim as a direct action “painting a derivative claim with a disclosure coating.”

 

The implications of AAR should be far-reaching. The AAR judge also issued the decision in Goodyear, a widely cited decision largely responsible for dispensing of plaintiffs’ efforts to bring post-vote say-on-pay claims. By holding that plaintiffs cannot bring a pre-vote breach of fiduciary duty claim based on the Dodd-Frank Act when a company has already complied with federal regulations, the court offers corporations comfort that strict compliance with pre-existing disclosure regulations should suffice to fend off lawsuits even at the pleading stage. And, by finding that the claim can only be maintained as a derivative action for waste, the court signaled to the plaintiffs’ bar that any attempt to bring a claim based on executive compensation must be strong enough to survive heightened demand futility analysis. In effect, the court has given corporations a way out of these cases at the pleading stage, before they are forced into prolonged and expensive discovery and summary judgment motions, and thus given effect to the Dodd-Frank Act’s stated intent to avoid creating a new basis for litigation.

 

The AAR decision comes just as proxy season is beginning. The proliferation of say-on-pay cases filed in mid- to late 2012 suggested that 2013 proxy season was going to be a mess, with lawsuits being filed in connection with every say-on-pay vote. The AAR decision will go a long ways towards preventing that. The number of say-on-pay investigation notices has already been declining relative to the number of proxy statements being filed, but with AAR, defense counsel will have a concrete tool and a well-reasoned opinion to give other courts comfort that these lawsuits should be dismissed early. The threat is not gone entirely, however, as a second wave of cases related to share authorization and equity compensation have received a relatively warmer reception by courts and have been picking up steam as proxy season continues.
 

 

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As a result of the U.S. Supreme Court decision in Morrison v. National Australia Bank, investors who purchased their shares in a company’s stock on a non-U.S. exchange are unable to pursue securities claims against the company or its management in U.S. courts. I have long thought these investors’ preclusion from U.S. courts would force them to try to develop remedies in their home jurisdictions – which is what it appears that RBS investors, whose U.S. securities claims were dismissed,  now appear to be doing.

 

The near failure and British government bailout of RBS was one of the highest profile features of the global financial crisis. RBS’s collapse follow a series of massive asset write-downs that occurred at RBS due to the company’s substantial holdings in subprime and other mortgage-backed assets and as a result of the company’s disastrous October 2007 acquisition of 38% of ABN Amro.

 

As discussed here, in January 2009, the first of a series of securities class action lawsuits were filed in the Southern District of New York against RBS and certain of its directors and officers. As detailed here, in a January 11, 2011 ruling, Southern District of New York Judge Deborah Batts granted the defendants’ motion to dismiss the claims of RBS shareholders who had purchased their company shares on a non-U.S. exchange. As I noted at the time in my post about Judge Batts’s ruling, “The interesting question is whether the disappointed RBS claimants … will now seek to pursue their claims against the RBS defendants in a non-U.S. jurisdiction.” Based on recent developments, the answer to this question now appears to be “Yes.”

 

As detailed in an April 3, 2013 Law 360 article (here, registration required) and in an April 3, 2013 post on Alison Frankel’s On the Case blog (here),  in the last week, two separate shareholder groups have taken step to initiate claims in U.K. courts against RBS and certain of its directors and officers. The shareholder groups claim that in its prospectus for its April 2008 rights offering, the company misrepresented its financial condition.

 

According to a March 28, 2013 article in The Lawyer (here), a law firm representing UK and international financial institutions and pension funds filed a claim in London’s High Court laws week. And as detailed on their website, on April 3, 2013, a separate group called the RBOS Shareholders Action group has separately initiated a High Court action against RBS and four of its directors and officers. The group’s website does not link to an actual copy of their complaint, but the site does provide a brief description of their allegations. The website also claims that the group represents “over 12,000 private shareholders, many of whom are pensioners, and over 100 institutional investors who lost money in the RBS 2008 rights issue” and estimates that the value of the group’s claim may be valued at as much as £4 billion.

 

As Frankel notes in her post about the U.K. litigation developments, one of the impediments in the past for prospective claimants considering these types of claims has been the U.K.’s “loser pays” rules, whereby an unsuccessful claimant has to be prepared to pay its adversary’s legal costs. What has changed is that insurers have developed a product called “After the Event” policies that protect against the risk that claimants might have to pay the defendants’ legal fees if there is an unsuccessful outcome. The RBOS Shareholders Action group itself says on its website that it has “adverse cost cover” in place.

 

The initiation of these actions against RBS is just the latest in a series of developments in which non-U.S investors, precluded from pursuing claims in U.S. courts, have sought to pursue claims in their own country. As the sequence of events here shows, the prospective claimants’ ability to pursue claims depends in many ways on claimants taking an innovative approach. Of course, it remains to be seen whether or not the RBS claimants’ U.K. claims will result in any recovery. But as aggrieved claimants continue to innovate, the opportunity to pursue claims may become more apparent to other prospective claimants. These kinds of claims could become more common, not only the U.K. but elsewhere as well. The development and availability of litigation funding mechanisms will help to spur these developments. This process may already be well under way in Canada, Australia, and arguably even Germany (where disappointed Porsche investors, closed out of U.S. courts, have filed claims against the company in Germany).

 

Today’s Candidate for Coolest Website: How far is it to Mars? One hell of a lot farther than you think it is. Check out this seriously cool website here.

 

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A year ago, President Obama signed the Jumpstart Our Business Startups (JOBS) Act, a legislative product of rare bipartisan collaboration that was intended to improve employment and make it easier for smaller firms to raise private equity. (For an overview of the Act’s provisions, refer here.) Twelve months later, many of the rules needed to implement the JOBS Act remain uncompleted and the legislation’s promise remains largely unfulfilled.

 

As detailed in a March 29, 2013 Washington Post article entitled “JOBS Act Falls Short of Grand Promises” (here), “nearly a year after its enactment, major portions of the act are in limbo, and other parts have failed to measure up to the grandiose job-creation promises.”

 

The JOBS Act was specifically intended to aid “Emerging Growth Companies” (ECGs), which the Act defined as companies with annual revenues under $1 billion. Among other things, the Act was intended to make it easier for these companies to go public. It would be hard to make the case that the JOBS Act has delivered a boost to initial public offerings. As detailed in a March 27, 2013 Wall Street Journal article entitled “JOBS Act Sputters on IPOs” (here), in the twelve months since the Act’s passage IPOs of ECGs “are on track to fall 21% to 63 from 80 in the prior year.” The Journal article does note that a number of market and economic factors “helped chill the climate for IPOs over the past year” and “the IPO market is showing signs of improving health.”

 

Another concern about the IPOs that are taking advantage of the Act’s provisions is that some may not be exactly represent the kind of companies Congress had in mind. For example, one of the companies that completed its offering while taking advantage of the JOBS Act’s so-called “IPO on-ramp” provisions, was Manchester United, a 135 year old sports club based in Manchester, England, that, though obviously unlikely to create any U.S. jobs, nevertheless qualified as an “Emerging Growth Company.” As Jason Zweig noted in his August 3, 2012 Wall Street Journal article entitled “When Laws Twist Markets” (here), among the other companies taking advantage of the JOBS Act provisions are “blank check companies,” noting that “In an irony only Congress could foster, many of the blind pools rushing to list under the JOBS Act have no employees and say in their prospectuses that they might never hire anybody at all.”

 

Even for ECGs that completed IPOs after the JOBS Act was enacted, the impact of the IPO on-ramp provisions has been mixed. A January 2013 memo from the Skadden firm entitled “The JOBS Act: What We Learned in the First Nine Months” (here) analyzed the 53 ECGs that completed IPOs between April 5, 2012 ad December 15, 2012. The memo relates that certain of the Act’s provisions, such as the provision allowing draft registration statements to be submitted confidentially and the provision allowing ECGs to provide scaled-down executive compensation disclosure, have met with “strong acceptance.” Other provisions such as the option for ECGs to provide an abbreviated period of financial statement disclosure, have met with only “weak acceptance.” Yet other provisions, such as those allowing “test the waters” communications in advance of the offering, have met with “mixed acceptance.” As pointed out in the March 2013 issue of CUG.COMments (here), while “certain aspects” of the JOBS Act “have been seized upon by ECGs,” the ECGs’ “utilization of the available benefits” has been “inconsistent.”

 

While the IPO on-ramp provisions have had a mixed effect, the “most significant bits” of the Act, according to a March 30, 2013 Economist article entitled “America’s JOBS Act: Still Not Working” (here) are “bottled up at the SEC.” Most importantly, the SEC still has not issued rules to implement the Act’s provisions relating to Crowdfunding. The SEC also has not issued rules to allow companies to raise as much as $50 million in the public markets without undertaking reporting obligations, nor has it issued rules lifting restrictions on advertising private securities offerings.

 

Among the reasons for the delays on the crowdfunding rules has been an internal debate within the SEC about the best approach to take. According to the Economist, Mary Shapiro, the outgoing SEC chairman was concerned that the JOBS Act would “eliminate important protections for investors” and she was particularly critical of the crowdfunding provisions. It remains to be seen what the approach will be of the incoming chair, Mary Jo White; at a minimum, it may be many months before the final rules are put into effect.

 

My earlier post on concerns about problems with crowdfunding can be found here. A more basic question concerns who will actually be able to take advantage of crowdfunding, given the Act’s statutory constraints, an issue I discussed here.

 

According to the Post article linked above, the Act’s mixed record has occasioned some concerns and even regrets on Capitol Hill. There is now a perception in Washington that the Act, described in the article as “a grab bag of ideas cobbled together for greater impact,” was “hastily introduced” and enacted due to election year pressures with “record speed.” The result, according to unnamed critics, is “laws fraught with risks to investors.” At a minimum, the Act “underscores how difficult it can be for Washington to spur job creation even when there’s strong bipartisan consensus on a plan.”

 

The picture is not entirely negative. According to the Journal, biotechnology companies, which have been “a bright spot for IPOs during the past year,” appear to be “using the new rules more than other companies.” Many biotech firms are unprofitable when they go public and they find that “the ability to save time and money by taking advantage of the relaxed standards was beneficial.”

 

Among many others concerned with the Act and its possible implications, D&O insurers continue to weigh the Act’s effects. For now, most insurers continue to await developments, particularly the introduction of the crowdfunding rules. The insurers remain concerned about possible crowdfunding abuses and about the liability measures in the crowdfunding provisions. Some insurers have already started adding crowdfunding exclusions to their private company D&O insurance policies. At a minimum, the delays attending the Act’s implementation have introduced an element of uncertainty, which likely has increased the insurers’ general wariness. The general perception seems to be that the Act could still have a significant impact on the scope of policyholders’ potential liability, but exactly what that might mean remains to be seen. Even after a year, the Act’s impact remains unclear, for insurers as for other observers and commentators.

 

About the Ruling in the Consolidated Libor-Scandal Antitrust Litigation: Readers interested in Judge Buchwald's opinion in the consolidated Libor-scandal antitrust litigation (about which refe here), and who are wondering what remains after the recent rulings and what the implications may be for the other Libor-related lawsuits will want to review Alison Frankel's April 1, 2013 post on her On the Case bliog (here). Frankel has a detailed analysis of what portions of the consolidated cases remain after the ruling, as well as what it all might mean for the other cases before Judge Buchwald as well as the cases that have not yet been consolidated in her court.

 

Yet Another Modest Securities Suit Settlement Involving U.S. Listed Chinese Company: During 2010 and 2011, plaintiffs’ lawyers rushed to file lawsuits against U.S.-listed Chinese companies that caught up in various accounting scandals. However, as I have previously noted, even the cases that have survived the preliminary motions have produced only very modest settlements.

 

In the latest example of one of these cases settling modestly, on April 1, 2013, the plaintiffs’ lawyers in the securities suit involving Deer Consumer Products announced that the case had been settled for $2.125 million. As noted in the parties’ stipulation of settlement (here), the settling defendants include the company and two individuals, although the released defendants appear to include all of the Deer company-related defendants. The settlement does not appear to involve the payment of any insurance funds; the stipulation recites that the settlement amount “shall be paid exclusive by the Settling Defendants.”

 

As I recently noted (here, second item), the exceptions to this pattern of the securities suits against U.S.-listed companies settling modestly are the cases in which there are significant settlement contributions from the companies’ outside professionals. For example, as discussed in the recent post, the recent $20 million settlement in the case involving Sinotech Energy Limited included an $18 million settlement contribution from the company’s offering underwriters. And of course there is the eye-popping $117 million settlement payment by Ernst & Young in the Ontario securities class action lawsuits involving Sino Forest.

 

The plaintiffs’ lawyers in the Deer Consumer Products, perhaps recognizing the impact of the claims against the Chinese companies’ outside advisors, on March 9, 2013 filed a separate action in the Central District of California against the company’s outside auditors, Goldman Kurland Mohindin,  in what appears to be something of a second phase of litigation.

 

Rule 10b5-1 Trading Plans: “Avoiding the Heat”: The SEC promulgated Rule 10b5-1 in order to allow company insiders to safely trade in their company securities without incurring liability under the securities laws. As it has turned out, trading under Rule 10b5-1 plans has been a source of significant scrutiny, as I recently noted here. Nevertheless Rule 10b5-1 trading plans can still provide significant liability protection, if they are set up, implemented and maintained appropriately.

 

A March 11, 2013 memo from the Covington & Burling law firm entitled “Rule 10b5-1 Trading Plans: Avoiding the Heat” (here) lays out the practical steps that companies and their executives can take to try to take advantage of the Rule and to avoid the issues that have caused problems with trading plans in the past. The memo’s authors note that “remains a beneficial and frequently utilized provision to permit corporate insiders to sell the securities of their companies while minimizing the risk of engaging in insider trading.” However, they add that “public companies and insiders seeking to rely on Rule 10b5-1 should renew their focus on ensuring that their trading plans comply with the requirements of the rule.”

 

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As a result of changes in the regulatory environment, the securities litigation landscape is changing around the world. In an earlier post (here), Robert F. Carangelo, Paul Ferrillo and Catherine Y. Nowak of the Weil Gotshal & Manges law firm surveyed the regulatory changes and the implications for securities litigation throughout the world. Since the time of that earlier post, the changes have continued. In a guest post below, Weil Gotshal attorneys Carangelo, Ferrillo and  Hannah Field-Lowes take an updated look at the rapidly changing global regulatory environment and the securities litigation implications.

 

The authors would like to thank Amanda L. Burns for her substantial contributions to this article. Mr. Carangelo and Mr. Ferrillo are also co-authors of The 10b-5 Guide, an authoritative primer on securities fraud case law for both business professionals and legal practitioners.

 

Many thanks to Robert, Paul and Hannah for their willingness to publish their article here. I welcome guest posts from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly. Robert, Paul and Hannah’s guest post follows:

 

            About a year ago, we published “A New Playbook for Global Securities Litigation and Regulation,” in which we detailed dramatic changes in the global securities regulatory and litigation arena driven by various factors, including not only the financial crisis of 2007-2008, but also changes in tolerance in the United States to litigation brought by foreign investors against public companies listed on non-U.S. exchanges.

 

            One year later, the regulatory environment continues to revamp with new rules being issued constantly in the United States to conform to the legislative mandates set forth in the Dodd Frank Act. The United Kingdom and European Union also seek to reinforce previous global initiatives to reform and strengthen the Pan-European financial markets.

 

            What is more ever-present, however, is the marked increase in global enforcement activities by regulators in the United Kingdom, Canada, and the European Union, which are attempts to give teeth to the global financial reforms each jurisdiction felt necessary to potentially prevent a “repeat” of the financial crisis. This article seeks to address the increase in global securities enforcement activity and concludes that continued cooperation and coordination in enforcement activities will be required to seamlessly address the desire to strengthen global regulatory initiatives aimed at harmonizing and centralizing international securities regulation to create safer, more fundamentally sound financial markets for investors.

 

Global Enforcement Efforts outside the United States

            The United Kingdom

            Perhaps the most dramatic change in any country’s regulatory and enforcement scheme over the past twelve months is the United Kingdom’s decision to replace the Financial Services Authority (“FSA”) as the single financial services regulator with two successor bodies: the Prudential Regulation Authority (“PRA”) and the Financial Conduct Authority (“FCA”). This “split” becomes effective on April 1, 2013 and comes from the Financial Services Bill of 2012, which received royal assent on December 19, 2012.

 

            While the PRA will focus on the day-to-day supervision of large banking institutions, insurers and certain investment firms with significant risk on their balances sheets, the FCA will focus exclusively on consumer protection, market integrity and conduct issues: regulating how and what services are provided to consumers, and ensuring such services are delivered to consumers so they can rely on the integrity of the markets. The remit of the two bodies will, however, overlap and many large financial institutions will be dual regulated. In an October 2012 speech, Managing Director of the Conduct Business Unit of the FSA (soon to be FCA) Martin Wheatley noted, “Good wholesale conduct relies on effective policing of market abuse. People carrying out transactions in U.K. markets need to have confidence that they are operating on a level-playing field with everyone else. Our approach to market conduct will reinforce the strong track record the FSA has built, where 20 criminal convictions for insider trading have been secured since 2009.”

 

            The FSA had an extraordinarily active year in 2012, particularly with regard to alleged LIBOR manipulation. That activity continues in early 2013 with the February 6, 2013 announcement of a total of $612 million of fines against RBS, including a £87.5 million fine from the FSA related to the bank’s role in the LIBOR scandal.  According to one recent report, “the 10 largest FSA fines of all time now include five 2012 cases.” After RBS, the second and third largest FSA fines, which were assessed against UBS AG and Barclays Bank plc (at £160 million, and £59.5 million, respectively) in 2012, also related to the LIBOR scandal.[i] Going forward, it remains to be seen whether the new FCA will continue to pursue the more “high profile” cases against large banking institutions, or will aim its focus at the rest of the market firms and individuals, where fines and penalties assessed have dropped.[ii]

 

            Initial indications of the FSA’s approach in 2013 are mixed. The FSA’s commitment to a strong individual deterrence program is reflected by the fact that six individuals are currently facing prosecution for alleged insider dealing and three more were recently arrested on suspicion of such offences.   On the other hand, there remains a robust focus on the activities of major financial institutions, as reflected by the FSA’s confirmation that a wide-scale review of sales of interest rate hedging products to small businesses will be undertaken.

 

            European Union Enforcement Activities and Initiatives

            Enforcement activity in the European Union has taken a different track than in the United Kingdom, primarily because there is no “one” securities enforcement regulatory authority with the power to prosecute financial crimes on a cross-European border basis. As Professor Eric C. Chaffee observed, the International Organization of Securities Commission, formed in 1983, “is unable to achieve the harmonization and centralization necessary to regulate the emerging global capital markets. The organization mainly serves a monitoring function, rather than a centralized force for regulation and enforcement.” That enforcement authority is generally limited to the particular countries that have signed on as members of IOSCO through Multi-lateral Memorandums of Understanding. However, many of these members do not have the wherewithal or ability to create an enforcement mechanism within their geographical boundaries. Nevertheless, IOSCO members (like the United States) regulate 95 percent of the world’s securities markets.

 

            Following the financial crisis, the European Securities and Markets Authority (“ESMA”) was established in 2010 to continue the work carried out by a previous European regulatory body. The ESMA was given some new powers and authorities to strengthen coordination among European supervisors and to enable ESMA to take action to ensure the consistent application of rules and facilitate coordinated decision-making. Those responsibilities are organized by ESMA through European Enforcers Coordination Sessions (“EECS”), a forum containing thirty-seven European enforcers from twenty-nine countries, which coordinates enforcement activities that are, in sum, delegated to enforcement authorities within the member states. The EECS monitors and reviews financial statements published by issuers on regulated European securities markets in accordance with International Financial Reporting Standards (“IFRS”) and considers whether those financial statements comply with IFRS and other reporting requirements, including any relevant national law of the home country of the issuer.[iii] The IFRS are developed by the International Accounting Standards Board (“IASB”), with interpretative guidance provided by the IFRS Interpretations Committee.

 

            Since 2011, ESMA, by and through the EECS, has been actively publicizing areas the EECS will focus on when reviewing the financial statements of European-listed entities. In 2011, not unexpectedly, the EECS was focused on publicly traded companies in the financial institution sector and how those companies portrayed their exposure to sovereign debt. The EECS issued two public statements in July and November 2011 that stressed both the need for transparency in reporting exposures consistent with the relevant IFRS and on a country-by-country basis. In 2011, the EECS commenced eighteen enforcement actions that required the issuance of revised financial statements, around 150 actions that required public corrective notes or other public announcements, and approximately 420 actions that required corrections in future financial statements.{iv] 

 

            In November 2012, ESMA issued further guidance as to areas that will be concentrated on by the EECS. In addition to continued focus on disclosures related to sovereign debt exposures and the impairment of financial instruments tied to or related to the sovereign debt crisis, ESMA will also focus on the impairment of non-financial assets, the measurement of discount rates used to measure post-employment benefit obligations, and on disclosures related to contingent assets and contingent liabilities.

 

            Significantly, however, there is “a general impetus in the EU . . . to move to a much more robust and ambitious market abuse regulatory framework.” The general desire to institute an effective regulatory mechanism is embodied by the proposed Market Abuse Regulation (“MAR”) and updated Market Abuse Directive (“MAD II”), and both regulations are likely to become effective by the end of the year.

 

            Importantly, the proposals seek to address a concern that there are, at present, safe havens within the European Union for those who trade on inside information or engage in market abuse. Most notably, Austria, Bulgaria, Slovakia, the Czech Republic, Estonia, Finland and Slovenia do not criminalize insider trading and/or market abuse. While the impact of the reform is likely to be minimal in jurisdictions such as the United Kingdom, which already have robust regulatory frameworks, jurisdictions with less stringent legislation for deterring financial crime are likely to see significant improvements in the tools available to them to tackle insider trading and market abuse.

 

            The enhanced regulatory framework has also been responsive to recent benchmark manipulation with respect to LIBOR and EURIBOR. The proposed reforms have, accordingly, been updated to impose civil sanctions for actual or attempted manipulation of benchmarks amounting to market manipulation. Benchmark manipulation will also constitute a criminal offense under the proposals’ expanded scope, which will impose sanctions on both those who carry out the manipulation or aid and abet those who do, as well as individuals engaging in its incitement.

 

            Canadian Enforcement Activities

            In our last “Playbook” article, we mentioned that Canada was considering consolidating its thirteen provincial securities regulators into one single regulatory enforcement agency at the federal level. Though that initiative was later rejected by the Supreme Court of Canada, securities enforcement activity remains strong, though it is down in relative terms from past years. According to the 2011 report of the Canadian Securities Administrators (which comprises the ten Canadian provinces and the three territories), 126 proceedings were commenced 2011, down from 178 in 2010. $52 million in fines were assessed during 2011—$41 million of which were in connection with illegal distributions.[v]

 

            The drop in securities enforcement activity appears to coincide with the decrease in securities class actions filed in Canada. According to NERA, in 2012 only nine new securities class actions were filed in Canada, down from fifteen in 2011. NERA notes that the decrease in securities class actions corresponds with a drop in both Chinese reverse merger class actions and credit crisis class actions, which were large drivers of class actions filings since 2008.[vi]

 

Enforcement Efforts – The United States Looking Outwards

            So where does the United States factor into this global enforcement picture? From an “outward” reach perspective, the SEC undoubtedly continues to monitor SEC- regulated firms with headquarters overseas. Foreign firms registered with the SEC must generally comply with U.S. securities laws and rules, including requirements that the registrant maintain certain books and records, and submit to examinations conducted by SEC staff. The SEC also has supervisory memorandums of understanding with various overseas counterparts (like the U.K. FSA and the Ontario Securities Commission) that allow the SEC and its foreign counterparts equal access to information that will permit supervisory oversight over large global financial institutions, broker-dealers and investment advisers.{vii]

 

            Further, Section 929P(b) of the Dodd-Frank Act extends the jurisdictional reach of the anti-fraud provisions of U.S. securities laws to securities transactions occurring outside the United States that involve only foreign investors, as well as conduct occurring outside the United States that has a foreseeable effect within the United States. It is important to note that this section of the Dodd Frank Act is limited to actions brought by the SEC (and not private civil actions).

 

            The United States also has a “seat at the table” on the boards of many of the organizations mentioned above, including IOSCO, the Financial Stability Board and the IFRS Foundation Monitoring Board, the overseer of the IASB. The SEC also participates in the Council of Securities Regulators of the Americas (an organization composed of securities regulators in the Western Hemisphere), and the Organization for Economic Cooperation and Development. As noted above, however, the United States does not current subscribe to the use of IFRS. Instead, it continues to follow generally accepted accounting principles established by FASB. Though this topic has been explored for years, the United States does not seem to be close to adopting the IFRS.[viii]

 

Conclusion – So Where Does This All Lead?

            Precipitated by the global credit crisis, and in large part by the international reach of Dodd-Frank, never before have the global financial markets been subject to such increased regulation as they face today. In large part, the benefits of such regulation have been mixed. Here in the United States, regulation of large financial institutions has dramatically increased, and will continue to do so as more and more of the mandates set forth by Dodd-Frank (like the Volcker Rule) become law (or the subject of continued rule-making by the SEC).

 

            In the United Kingdom, given the strong activity of the FSA in 2012, we think the FCA should be off to a running start, though the question remains where the emphasis of its enforcement activities will lie. Will it be weighted towards “headline” events such as continued enforcement of the U.K. Bribery Act and continued LIBOR investigations and prosecutions? Or will the FCA focus its efforts more on day-to-day “blocking and tackling” regulatory issues in its dealing with large global financial institutions, hedge funds and private equity funds? 

 

            As for the European Union, the challenge remains in translating the necessity to oversee and regulate large global firms with the sheer fact that such regulatory authority needs to be ultimately delegated to each individual member state of the European Union, each of which might have their own views as to how to regulate firms within their borders (or not to regulate due to budgetary constraints that might not allow them to proceed). The forthcoming implementation of the MAR and MAD II may, however, go some way to instituting much needed uniformity in addressing financial misconduct across the European Union.

 

            Despite the enormous progress that many jurisdictions have made to give teeth toward necessary regulatory changes, enormous challenges remain. As noted by Professor Chafee in his article, given its enormous head start in the regulatory process, despite the United States failure to adopt IFLRS, it is probably the SEC that is in the best position to push towards harmonization and centralization of international securities laws in an effort to prevent a potential repeat of the 2008 financial crisis.[ix]

 

 

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As the most dramatic evens from the financial crisis recede into the past, there is an urge to consign the downturn to the pages of history, But the banking crisis in Cyprus earlier this week, along with persistent unemployment in this country and elsewhere, show that, as much as we would all like to turn the page, the credit crisis still is not yet in the past. And just like the economic effects, the litigation that accumulated as a result of the crisis continues to grind through the courts as well.

 

The most recent example of the continuation of the credit crisis litigation involves a case pending in the Southern District of New York against Deutsche Bank and four of its directors and officers. The case was filed on behalf of investors who purchased Deutsche Bank common stock between January 3, 2007 and January 16, 2009. (Based on Morrison, the district court dismissed from the case any shareholders who purchased their shares outside the United States.) 

 

In a March 27, 2013 order (here), Southern District of New York Judge Katherine Forrest largely denied the defendants’ motions to dismiss the plaintiffs’ complaint. There are a number of interesting things about Judge Forrest’s ruling, in particular the significance she attached to the massive (and profitable) short bet a Deutsche Bank trader made against residential mortgage backed securities (RMBS) and collateralized debt obligations (CDOs) at the same time Deutsche Bank was profiting from packaging and selling these very kinds of securities to outside investors.

 

Background

As discussed here, the plaintiffs first filed their lawsuit in 2011, seeking damages under the federal securities laws based both on an alleged scheme to defraud and on alleged misrepresentations or omissions. The plaintiffs alleged that the bank had structured and sold RMBS that it knew to be poor quality; misrepresented its risk management practices; failed to write down impaired securities; and disregarded findings that the residential mortgage loans did not comply with underwriting standards.

 

The defendants moved to dismiss, arguing that the “scheme” theory was after the fact construct rather than a before the fact plan; that the alleged misstatements were merely subjective opinions that are not actionable and that in any event were not made with scienter, and that the specific defendants were not the makers of actionable misstatements.

 

In drafting their complaint, the plaintiffs were able to draw extensively on the April 2011 report about the financial crisis of the U.S. Senate Subcommittee on Investigations as well as complaints that the U.S. Department of Justice and the Federal Housing Finance Agency filed against Deutsche Bank. Among other things to which plaintiffs were able to cite and to which Judge Forrest referred in her opinion were internal emails referring to the RMBS that the bank was marketing as “crap” and referring to the CDOs that the bank was structuring as a “balance sheet dump” (As is now all too familiar with allegations of damaging internal emails, there are many similar statements in this same vein.)

 

In her opinion, Judge Forrest also cites at length allegations based on internal communications relating to a massive bet a Deutsche Bank trader, Greg Lippmann, had made against the very kind of RMBS that the bank was packaging and selling. His short position ultimately grew to be as large as $4 to $5 billion. The position was so large that it drew the attention of the top company management, who reviewed his position and allowed him to continue to pursue his strategy. Judge Forrest’s opinion quotes numerous internal emails in which Lippmann disparaged Deutsche Bank’s own RMBS deals. Lippmann’s short bet ultimately returned profits of $1.5 billion, allegedly “the largest profit Deutsche Bank ever obtained from a single short position.”

 

In denying Deutsche Bank’s motion to dismiss, Judge Forrest found the “defendants had specific knowledge of the poor quality of the mortgages” and that the defendants “demonstrated this knowledge by authorizing Lippmann to take and expand a multi-billion dollar short position. Despite their awareness of these problems, the defendants “nonetheless repeatedly assured investors that their credit and lending practices were conservative and being adhered to.”

 

Judge Forrest specifically rejected the defendants’ argument that the alleged misrepresentations and omissions on which the plaintiffs sought to rely were mere non-actionable statements of opinion. She noted that the plaintiffs allege that “at the very time the market was beginning to experience the early effects of the sub-prime implosion, Deutsche Bank made statements that it had acted conservatively with respect to risk and had adhered to conservative lending standards.” Noting that the plaintiffs also alleged that at the same time defendants made these statements, “the same individuals who had made the statements had been provided information indicating the opposite,” allegations that present facts “supportive of both objective and subjective falsity.”

 

In concluding that the scienter allegations were sufficient as to three of the four individuals defendants (the fourth was dismissed for lack of any allegations tying the individual to any specific statements), Judge Forrest noted that the defendants had made statements about the mortgage-backed securities operations “while at the same time knowing that these assets were far riskier than an investor might reasonably suppose.” She specifically reference allegations that Lippmann had made presentations to the Executive Committee, of which the three defendants were members, supporting his view that a multi-billion dollar bet against RMBSs and CDOs was appropriate. These allegations, she found, “support a strong inference of scienter.”

 

Discussion

A few days ago, when it was announced that Citigroup had settled the subprime-related bondholders’ action for $730 million, there was a sense that the subprime litigation stage might finally be winding up, with only a little bit of moping up left to go. At almost the same time, however, the U.S. Supreme Court denied a writ of certiorari in the Goldman Sachs bondholders’ action, ensuring that the Goldman case would go forward with a broad class definition as a result of the Second Circuit’s opinion in that case (about which refer here, fourth item).

 

And now Judge Forrest has denied the motion to dismiss in this case involving Deutsche Bank. The ongoing cases against Goldman Sachs and now this one against Deutsche Bank are reminders that the subprime-related litigation wave may still have a lot further to run yet.

 

The significance that Judge Forrest attached to Deutsche Bank’s internal emails is nothing new. By now we have now grown accustomed to the damaging use that can be made of incautions or ill-advised internal emails. What is perhaps more interesting is the significance that she attached to Lippmann’s short position and his internal communications about it (that is, his defense to company management of his investment position). It is true that Lippmann’s short position ultimately grew to several billion dollars. At the same time, though, Deutsche Bank’s mortgage group held a $102 long position, and another affiliate held a separate long position of almost $9 billion.

 

The defendants had tried to argue that the much larger long position showed the company’s true beliefs about the market for mortgage-backed securities. Judge Forrest said about the divergent bets that “it simply means that they are gamblers unwilling to place their entire bet on red, versus black.” The plaintiffs’ complaint, she found, “plausibly suggests that they assured investors that their bets were in one direction – and omitted that they had taken bets in both directions.” That is, everything they said was consistent with and supported their long position, without divulging the (admittedly much smaller) short position.  The key seems to be that the plaintiffs alleged both that the defendants were aware of Lippmann’s short position and his reasons for taking it; they were not only aware of the concerns on which the short bet was based but they allowed him to expose billions of dollars on the bet, while providing reassuring words to investors.

 

Seventh Circuit Affirms Boeing Securities Suit Dismissal: The outcome of the dismissal motions in the Deutsche Bank case shows how advantageous it can be for plaintiffs lawyers when they have extensive public resources (like a 646-page Senate report) on which to rely in crafting their allegations. The Seventh Circuit’s March 26, 2013 affirmance of the district court’s dismissal of the securities suit that had been filed against Boeing and based on production delays involving its Dreamliner aircraft shows the challenges plaintiffs’ lawyers can face when they don’t have those kinds of resources to rely upon. The Seventh Circuit’s opinion can be found here.

 

As detailed in the appellate court’s opinion, written by Judge Richard Posner for a three-judge panel, the plaintiffs alleged that the defendants had misled investors by failing to disclose that the company would not make its target date for the “First Flight” of the airliner, despite knowing of production issues that would require the flight to be delayed. The plaintiffs’ initial complaint was dismissed because it lacked sufficient allegations to support the allegation that the defendants knew that the production issues would require the first flight to be delayed.

 

In order to try to address these problems in their amended complaint, the plaintiffs sought to rely on a single confidential witness, an engineer later identified as Bishunjee Singh. The complaint relied on Singh’s statements to support amended allegations that company management knew that the airliner had failed certain tests and that the failure might result in a delay of the first flight.

 

There was only one problem – “No one had bothered to show the complaint to Singh” and “investigations by Boeing soon revealed that the complaint’s allegations concerning him could not be substantiated.” In his deposition, Singh “denied virtually everything that the investigator had reported.” The appellate court noted that the district court thought that the plaintiffs’ lawyers “failure to attempt to verify their allegations in the investigator’s notes amounted to a fraud on the court.”

 

The appellate court not only affirmed the dismissal of the plaintiffs’ complaint but remanded the case to the district court for further proceedings with respect to question of sanctions. As if that were not bad enough, the appellate court made a point of noting that the same plaintiffs’ firm had been criticized for making misleading allegations concerning confidential sources in order to stave off dismissal in other cases. The appellate court noted that “recidivism is relevant in assessing sanctions.’

 

Alison Frankel has a particularly interesting commentary on the Seventh Circuit’s opinion in the Boeing case in a March 26, 2013 post on her On the Case blog (here).

 

Readers will be interested to note that the lead plaintiffs’ firm in both the Deutsche Bank case discussed above and in the Boeing case is the same firm. Any number of conclusions might be drawn from the outcomes in the two cases, starting with the fact that one case was dismissed and may result in the award of sanctions, whereas the other case is going forward. Among the many differences between the cases, however, is that in the one case, the plaintiffs were able to rely on a detailed report for a U.S. Senate Committee in drafting their complaint. In the other case, well, the sources were not so good.

 

Readers mulling this over and reaching conclusions about ultimate considerations of justice may want to pause a moment and consider, from the perspective of Boeing investors, the ultimate history of the Dreamliner aircraft. As detailed in an article entitled “Requiem for a Dreamliner?” in the February 4, 2013 issue of the New Yorker (here), the latest problems with the Dreamliner’s batteries, which have grounded the entire fleet of Dreamliners, “is just the latest in a long series of Dreamliner problems, which delayed the plane’s debut for more than three years and cost Boeing billions of dollars in cost overruns. The Dreamliner was supposed to become famous for its revolutionary design. Instead, it’s become an object lesson in how not to build an aircraft.”

 

Given the airliner’s checkered development history, the plaintiffs’ lawyers may feel that the problem was not that they didn’t have a valid claim, but that they just couldn’t come up with the right sources. And if you were of a certain frame of mind and only focused on the portion of the Seventh Circuit’s opinion about the sanctions issue (which has certainly drawn all of the media attention), you might (or might not) take the plaintiffs’ point.

 

However, Judge Posner also had some very interesting things to say about scienter, that might suggest how difficult it would be for plaintiffs’ to state a securities claims based on developmental stage production delays. Judge Posner’s comments about scienter go on for several pages and are worth reading in full; it would be hard to do them full justice here. Among other things, Judge Posner noted how implausible it is that the company had any motivation to mislead either investors or prospective customers by postponing for a few days (until after the Paris Air Show) the announcement that the first flight would be delayed. Posner noted that:

 

A more plausible inference than that of fraud is that the defendants, unsure whether they could fix the problem by the end of June, were reluctant to tell the world “we have a problem and maybe it will cause us to delay the First Flight and maybe not, but we’re working on the problems and we hope we can fix it in time to prevent significant delay, but we can’t be sure, so stay tuned.”

 

Citing Kant on the difference between “a duty of truthfulness and a duty of candor,” Posner added that “there is no duty of total corporate transparency – no rule that every hitch or glitch, every pratfall, in a company’s operations must be disclosed in “real time,” forming a running commentary, a baring of corporate innards, day and night.” (Call it a hunch, but I suspect that Posner’s words are in for a long run in future dismissal motions).

 

At this point, the Dreamliner has accumulated a lifetime supply of hitches, glitches and pratfalls. However, Posner is saying that without more, even a snootful of glitches doesn’t amount to securities fraud. As for what might constitute “more,” well, it seems like the factual details from a voluminous report of a Senate subcommittee appears to be enough. An unreliable witness definitely is not enough -- except perhaps for sanctions

 

Special thanks to a loyal reader for supplying me with a copy of the Boeing decision.

 

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Mutual fund directors have been attacked before. For example, in his 2002 letter to shareholders of Berkshire Hathaway, Berkshire chairman Warren Buffett took a detour in an essay about corporate governance to express concerns about mutual fund directors. He noted that mutual fund directors effectively have only two “important duties”; to pick the fund manager and to negotiate the manager’s fee. The record of mutual fund managers pursuing either goal has been “absolutely pathetic.” The manager selection process for far too many funds has become a “zombie-like process that makes a mockery of stewardship.”

 

Within months of Buffett’s stinging criticisms, many participants in the mutual fund industry were ensnared in the so-called “market timing” scandal, in which it was alleged, among other things, that mutual funds were permitting trading in their fund shares after market close. In the wake of the market timing scandal, the mutual fund industry faced not only a great deal of scrutiny but also a wave of enforcement actions.

 

At least according to a March 25, 2013 Wall Street Journal article entitled “Fund Directors Are Feeling the Heat” (here), mutual fund directors are attracting attention once again. The Journal article was focused on the administrative proceedings that the SEC has filed against eight former members of the board of directors overseeing several Morgan Keegan mutual funds. The agency filed the administrative action, a copy of which can be found here, in December 2012. In its December 10, 2012 press release accompanying the filing, the agency said that the directors had “abdicated” their asset –pricing responsibilities.

 

The administrative proceeding relates to five Morgan Keegan mutual funds whose portfolios contained below-investment grade debt securities, some of which were backed with subprime mortgages. In its press release about the proceeding, the agency claims that the funds “fraudulently overstated the valuation of their securities as the housing market was on the brink of financial crisis in 2007.” The agency has previously charged the funds’ managers with fraud, and the Morgan Keegan itself agreed to pay $200 million to settle related charges.

 

The agency alleges that the directors delegated their fair valuation responsibility to a valuation committee without providing meaningful substantive guidance and made “no meaningful effort to learn how fair values were being determined.”

 

The Journal article reports that the parties to the administrative proceeding are in settlement negotiations, but in the meantime the proceeding is going forward. The Journal article notes that the directors met 30 times in 2007, including 14 times in three months, and received daily updates on the value of the five mutual funds they oversaw.

 

Regardless of how the administrative proceeding against the former Morgan Keegan mutual fund directors ultimately plays out, the proceeding is, according to the Journal article,  “making waves” across the mutual fund industry. According to a December 14, 2012 memorandum from the Debevoise & Plimpton law firm, the administrative proceeding against the Morgan Keegan directors represents “a stark warning to fund directors and all fund personnel charged with management or oversight duties that they need to take their responsibilities for overseeing fund management seriously, even with respect to the complex and technical area of asset valuation.” The action signals “the SEC’s willingness to charge senior officials for failing to ensure the fair valuation of hard-to-value securities.”

 

The SEC’s decision to pursue an administrative action against the fund directorsseems clearly calculated to send a message. The fact that the agency filed the administrative proceeding against the directors after it had concluded an enforcement action against the fund management company itself does seem, as the Debevoise law firm said in its memo, that the administrative proceeding was intended to serve as a “stark warning.”

 

The SEC’s action against the Morgan Keegan directors unquestionably is noteworthy, but it is far from the first instance where allegations have been raised against mutual fund directors in the wake of the financial crisis. There were in fact a number of private securities class action lawsuits filed against mutual funds after the subprime meltdown, and a number of these suits included the funds’ outside directors as named defendants.

 

For example, March 2008, investors in the Charles Schwab YieldPlus Funds initiated a securities suit alleging violations of the federal securities laws and seeking damages; the defendants in that action included the funds’ trustees. The federal litigation ultimately settled for $200 million (with an additional $35 million to settle separate but related state litigation). The consolidated subprime-related securities class action litigation involving several Oppenheimer mutual funds, and which also included the funds’ trustees as named defendants, ultimately settled for a total of $100 million, as discussed here.

 

Indeed, as discussed here, the Morgan Keegan funds themselves were also involved in separate securities class action litigation that included as named defendants the same individual outside directors as were named in the SEC administrative proceeding. The separate Morgan Keegan fund securities class action litigation ultimately was settled for $62 million (refer here). 

 

The SEC’s administrative action against the Morgan Keegan funds’ outside directors not only has important implications in general about mutual funds outside directors’ accountability. It also has important implications about the scope of their potential liability exposure. Together with the possibility of private securities litigation, the possibility of an aggressive SEC pursuing administrative actions or even enforcement proceedings against the outside directors of mutual funds underscores the fact that serving as a mutual fund director entails significant liability exposures.

 

The extent of the liability exposures in turn highlights the importance for the outside directors to confirm that the mutual funds maintain D&O liability insurance sufficient to ensure that the directors can defend themselves against all claims that might arise against them. As the circumstances surrounding the Morgan Keegan funds demonstrate, when adverse developments lead to claims, numerous claims involving numerous parties can be involved. This fact underscores the need to ensure that the mutual funds maintain insurance limits of liability that are sufficient to respond in the complex claims situations. Finally, the need to ensure that the sufficient funds remain to protect the outside directors when multiple claims arise underscores the need to makes sure that the insurance program is structured to provide that a portion of the D&O insurance is dedicated solely to the outside directors’ protection.

 

Securities Suit Against U.S.-Listed Chinese Company Settles: In 2010 and 2011, plaintiffs’ lawyers rushed to file securities suits in U.S. courts against Chinese companies with shares listed on the U.S. securities exchanges. However, the suits have not proven to be as remunerative as the plaintiffs’ lawyers might have hoped. As I noted in an earlier post, many of the cases that have settled have involved only very modest settlements.

 

A recent settlement in one of these suits might provide modest grounds for encouragement for the plaintiffs’ lawyers. On March 25, 2013, the parties to the securities class action lawsuit pending in the Southern District of New York against Sinotech Energy Limited filed a stipulation of settlement indicating that they had agreed to settle the case for a total of $20 million. (The settlement does not include the company’s auditor, Ernst & Young Hua Ming LLP). The settlement is subject to court approval. The parties’ settlement stipulation can be found here.

 

Though this settlement is more substantial than the prior settlements, it should be noted that Sinotech Energy’s contribution to the settlement is only $2 million. The remaining $18 million is coming from several offering underwriter defendants who were also named as defendants in the litigation. This outcome is in fact consistent with what many plaintiffs’ lawyers have told me about these cases, which is that while they hope to recover from the company defendants, their real hope for recovery is based on the attempt to try to recover from the outside professionals who helped the companies to go public. (I am guessing that the reason that Ernst & Young Hua Ming was not a party to this settlement may have something to do with the $117 million that Ernst & Young agreed to pay in the Ontario securities suit relating to Sino Forest; the plaintiffs may be hoping they can use that prior settlement as a “price of poker” indicator.)

 

Whether or not the plaintiffs can succeed in recovering from the outside advisors, they likely will have to set their expectations of recoveries from the Chinese companies themselves at modest levels. It isn’t just that the Chinese companies have not contributed significantly to the settlements so far; it is that apparently in many instances, the Chinese companies are not even paying their own defense lawyers. As reflected in a March 14, 2013 Reuters article entitled “Defense Attorneys in China Securities Cases Look for an Exit” (here), defense counsel in several of these cases involving U.S.-listed Chinese companies are seeking to withdraw from the cases because their Chinese clients are not paying them. It doesn’t bode well for any eventual recovery for the plaintiffs if the defendant company isn’t bothering to pay its own lawyers.

 

Special thanks to a loyal reader for sending me a copy of the Reuters article.

 

The M&A Litigation Problem: As anyone following recent litigation trends knows, litigation relating to M&A transaction has become a serious problem. If it is any consolation, the courts are working on it, at least in Delaware, according to Vice Chancellor Donald Parsons of the Delaware Chancery Court. In a forthcoming article entitled “Docket Dividends: Growth in Shareholder Litigation Leads to Refinements in Chancery Procedure” (here, Hat Tip to the Delaware Corporate and Commercial Litigation Blog), Parsons contends that the Delaware Chancery Court is developing tools to address the concerns associate with the M&A litigation.

 

According to Parsons, Delaware’s courts are best positioned to respond to this litigation, although, owing to the phenomenon of multi-jurisdictions litigation, it is can’t resolve all of the concerns. Those who are interested in Parsons’ views may want to review Alison Frankel’s tidy summary of the article in a March 26, 2013 post on her On the Case blog (here).

 

You Think Your Job is Tough?: Next time you are feeling that your job is too demanding or stressful, spend a little time considering this guy’s job.

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Much happened in recent days while The D&O Diary was away on extended travel. Some of the developments were significant. What follows is a brief summary of the more significant events over the last few days.

 

Subprime-Related Citigroup Bondholders Action Settles for $730 Million: In what is the second-largest settlement of a subprime and credit crisis-related securities class action lawsuit, the parties to the Citigroup bondholders’ action have agreed to settle the case for $730 million. The settlement is subject to court approval. A copy of the plaintiffs’ lawyers’ March 18, 2013 memorandum regarding the settlement can be found here. The plaintiffs’ lawyers’ March 18, 2013 press release regarding the settlement can be found here.

 

The settlement relates to a series of suits consolidated in the Southern District of New York and alleging that in connection with approximately 48 bond offerings between May 2006 and August 2008, Citigroup had misrepresented its exposure to subprime mortgages and related bonds as well as to subprime-related collateralized debt obligations. The consolidated litigation is described in greater detail here. As discussed here, on July 12, 2010, Southern District of New York Judge Sidney Stein substantially denied the defendants’ motion to dismiss the bondholders’ action.

 

The defendants in the consolidated litigation included not only Citigroup itself but also 28 current or former Citigroup directors and officers and nearly eighty investment banks that served as offering underwriters in the bond offerings. According to the parties’ March 18, 2013 stipulation of settlement (here), the settlement appears to resolve all of the claims against all of the defendants. However, the only payment mentioned in the stipulation of settlement is Citigroup’s agreement to pay the full $730 million settlement amount into escrow within the specified time following court approval. Of course, there may have been other arrangements between and among the other defendants with regard to the settlement amount.

 

As massive as this $730 million settlement is, there is a note of defensiveness about the settlement in the plaintiffs’ lawyers’ memorandum. The memo take great pains to emphasize that while the case was pending, the Second Circuit entered its opinion in Fait v. Regions Financial Corp. (about which refer here), in which the appellate court held that securities suit defendants cannot be held liable for statements of “opinion” unless the claimants can plead and prove that the defendants did not actually hold the stated opinions. The plaintiffs’ lawyers  underscore the fact that the defendants would likely argue in motions before the court that many of the valuation and reserve misstatements on which the Citigroup bondholder claimants rely are mere statements of opinion that are not actionable in the absence of allegations that the defendants did not actually believe the opinions. In their discussion of this issue as well as in other features of their memorandum, the plaintiffs’ lawyers -- by highlighting the vulnerabilities of their case -- appear to be anticipating criticism that the settlement is not even larger than it is. (As an aside, it will be interesting to see if in connection with this settlement, as there have been with several of the large subprime and credit crisis securities suits, a number of significant opt-outs from the settlement class.)

 

Just the same, among settlements of subprime and credit crisis-related securities class action lawsuits, this latest settlement is exceeded only by the massive $2.43 billion BofA/Merrill Lynch merger settlement, which is discussed in greater detail here. According to the plaintiffs’ lawyers’ memorandum regarding the latest settlement, the $730 million bondholders’ settlement, if approved by the court, would also represent the second largest recovery in a securities class action lawsuits brought on behalf of purchasers of debt securities, as well as one of the three largest recoveries in a case that does not involve a financial restatement. The settlement also ranks among the fifteen largest recoveries in any securities class action lawsuit.

 

The $730 million Citigroup bondholders’ action settlement also significantly exceeds the $590 million settlement in the separate subprime-related Citigroup shareholders’ action, about which refer here. I have updated my running tally of the subprime and credit crisis case resolutions to reflect this latest settlement. The tally can be accessed here. Here is an updated list of the ten largest subprime and credit crisis-related securities class action lawsuit settlements.

 

Case	Amount	Links
BofA/Merrill Lynch Merger	$2.43 billion	Here
Citigroup Bondholders’ Action	$730 million	This Post
Wells Fargo/Wachovia Bondholders Action	$627 million	Here
Countrywide	$624 million	Here
Citigroup Shareholders’ Action	$590 million	Here
Lehman Brothers (including offering underwriters’ settlement)	$507 million	Here
Merrill Lynch	$475 million	Here
Merrill Lynch Mortgage-Backed Securities	$315 million	Here
Bear Stearns	$275 million	Here
Charles Schwab	$235 million	Here

 

FDIC Failed Bank Litigation Update: As the FDIC has been doing on a monthly basis as the current banking crisis has evolved, the FDIC has updated the page on its website describing the failed bank litigation that the agency has been filing. In the latest update, as of March 19, 2013, the agency states that is has now authorized litigation against the former directors and officers of 106 failed banks (up from 102 as of February 15, 2013).

 

The agency has also now filed a total of 53 failed bank lawsuits against former directors and officers of 52 failed banks (up from 51 lawsuits involving 50 failed institutions as of February 15, 2013). The number of approved lawsuits (which is inclusive of the lawsuits that have been filed) suggests that there may be as many of 53 additional as yet unfiled lawsuits waiting to be filed – however, at least some of these lawsuits may be resolved though pre-lawsuit negotiation.

 

With respect to the two lawsuits filed since the FDIC last updated its website, one, involving the failed Carson River Community Bank, was previously mentioned in a post earlier this month (here, refer to the fifth item in the post). The other new lawsuit involves the failed InBank of Oak Forest, Illinois, which failed on September 4, 2009. A copy of the FDIC’s complaint can be found here. The fact that the FDIC filed the complaint so far past the third anniversary of the bank’s closure suggests that the FDIC”s claims as receiver of the failed bank may have been the subject of a tolling agreement.

 

In addition to the FDIC’s website page regarding failed bank litigation, the FDIC has also significantly updated the page the agency recently added to its site in which the agency has indicated that it will provide information regarding its settlement of failed bank claims. As discussed in a recent post (here), the FDIC has been the target of media scrutiny for its failure to disclose claim settlements. In response to this media attention, the FDIC has added the settlements page to its website; at the time I reviewed the agency’s new website page a few days ago, the agency had posted only a few settlement agreements and indicated that it hoped that by March 31, 2013 the page would more completely reflect all settlements.

 

The agency has now substantially updated the settlements page and added links to numerous additional settlement agreements, including links to several settlement agreements that had not previously been publicly available. Just to cite a couple of examples of the previously undisclosed settlement agreements, readers may recall that December 2012 analysis of the FDIC’s failed bank litigation, Cornerstone Research included a review of failed bank lawsuit settlements (refer here, see page 11). In its list of failed bank lawsuit settlements, Cornerstone Research identified two cases – involving Heritage Community Bank and Corn Belt Bank and Trust Company – for which the settlement amounts had not been reported.

 

In the latest update to the new settlement agreements page on its website, the FDIC has now provided copies of the settlement agreements in these two cases for which the settlement details previously had not been reported.

 

As now reflected on the FDIC’s website, the August 2012 settlement agreement in the Heritage Community Bank failed bank lawsuit, which can be found here, shows that the case settled for $3.15 million, all of which apparently was to be funded by D&O Insurance.

 

The April 2012 settlement agreement in the Corn Belt Bank and Trust Company case, which can be found here, shows that the case settled for a total payment of $700,000, $266,000 of which is to be paid by the individual defendants and the remainder of which is to be paid by the failed bank’s D&O insurer (the insurer is a party to the settlement agreement).

 

The availability of this previously unavailable settlement information is very interesting. Given the volume of new information that the agency has added to the site – the agency has added information relating to settlements in connection with 29 different failed banks in 13 different states -- I have not yet had a chance to work through it all. It is however clear that the agency’s new proactive willingness to provide settlement information will prove to be a rich source of information as the agency resolves the cases and claims that it has asserted as part of the current bank failure wave.

 

Freddie Mac Files Libor Scandal Suit Against Rate Setting Banks, British Bankers Association: In the wake of the three regulatory settlements that have arisen so far in the wake of the Libor-scandal, the government-sponsored mortgage finance company has now gotten into the act and filed its own lawsuit seeking recovery of billions of dollars of damages it alleges it sustained as a result of the manipulation of the benchmark rates. A copy of Freddie Mac’s complaint, which the agency filed on March 18, 2013 in the Eastern District of Virginia, can be found here.

 

There are a number of interesting things about this lawsuit. First of all, the only plaintiff in the case is Freddie Mac. The complaint is not asserted on behalf of its larger sibling agency, Fannie Mae, even though the body responsible for oversight of the two mortgage-finance entities had recommended that both agencies pursue claims based on an estimated more than $3 billion in Libor related damages. Undoubtedly Fannie Mae will be filing its own action shortly.

 

A second interesting thing about the lawsuit has to do with the defendants. Freddie Mac has not only  named the Libor rate-setting banks themselves, but it has also named as a defendant the British Bankers Association itself, which acted as a clearinghouse for the rate-setting banks’ borrowing information, which served as the bases for the Libor benchmarks. As Wayne State University Law School Professor Peter Henning points out in his March 20, 2013 post on the Dealbook blog (here), Freddie Mac has alleged that the organization was aware of the manipulation and did nothing too stop it. As Henning notes, “the fact that one is aware of misconduct by others, and even that their services are being used, is usually not enough to show participation in a conspiracy.” Henning adds that there may also be an issue whether or not a U.S. court even has jurisdiction over the BBA.

 

Third, in addition to an antitrust claim, Freddie Mac has raised some additional allegations against certain of the bank defendants. Unlike many of the claimants in the various Libor scandal lawsuits, Freddie Mac had direct contractual relations with several of the rate-setting banks. Freddie Mac directly purchased swaps from several of the bank. The complaint alleges that when the banks pushed down Libor, the agency received lower payments from the swaps. Freddie Mac asserts separate breach of contract actions against eight of the banks (including Bof A, Citigroup, Deutsche Bank and UBS), alleging that the manipulation violated the terms of the agency’s agreements with the banks.

 

Fourth, there is the court in which Freddie Mac filed the suit. The Eastern District of Virginia is notorious as the so-called “Rocket Docket.” As noted in the March 18, 2013 memorandum from the Hunton & Williams law firm (here, registration required), the Eastern District of Virginia moves with “lightening speed,” adding that “the average time from filing a civil case to trial is approximately 11 months, with 2012 constituting the fastest trial docket in the country for the fifth straight year.” Continuances are virtually unheard of. In other words, even though Freddie Mac’s case has only just been filed, it could accelerate past the other Libor cases that have been pending elsewhere for some time – that is, if Freddie Mac can keep the case in the E.D.Va.

 

The defendants undoubtedly will try to have the case transferred to the Southern District of New York and added to the consolidated litigation pending before Judge Naomi Buchwald. Freddie Mac will undoubtedly argue that its distinct breach of contract claims, as well as its unique status as a government-sponsored entity, militate against transfer and consolidation.

 

In a field of interesting Libor-related claims, this new case will be particularly interesting to watch. It will also be interesting to see if Fannie Mae jumps into the fray as well (seems likely to me).

 

Supreme Court Declines Cert in Goldman Sachs Subprime Suit: As I have noted in numerous blog posts, the Supreme Court has shown a significant propensity in recent years to take up securities cases, a propensity that has it turn led to a series of significant High Court decisions that have had a profound impact on securities litigation. However, the Court can have also a significant impact when it chooses not to act as well as when it chooses to get involved. A recent decision to deny a petition for a writ of certiorari arguably falls into the category of cases where the Court’s failure to act has great significance.

 

As I noted in a blog post at the time (here), in September 2012, the Second Circuit handed plaintiffs in subprime and credit crisis-related securities suits a significant victory on the issue of standing in a case involving Goldman Sachs.

 

The background on the decision has to do with the fact that many of the toxic mortgage-backed securities that were a key part of the subprime mortgage meltdown were sold in multiple separate offerings based on a single shelf registration statement but separate prospectuses. Each separate offering included multiple securities at varying tranches of seniority and subordination. In the litigation following the subprime meltdown, defendants in suits bought by mortgage-backed securities investors initially had considerable success in arguing that the claimants have standing only to assert claims only with respect to the specific offerings and tranches in which the claimants themselves had invested, and lacked standing to assert class claims on behalf of investors who purchased securities in other offerings and tranches.

 

In a September 6, 2012 opinion (here), the Second Circuit ruled  -- in a case involving mortgage-backed securities issued by a unit of Goldman Sachs -- that the investor plaintiff had standing to assert claims relating not only to the specific offerings in which the plaintiff invested but also the claims of investors in other related offerings, to the extent that the securities in the other offerings were backed by mortgages originated by the same lenders that originated the mortgages backing the plaintiff’s securities. The Second Circuit also rejected the argument that the plaintiff lacked standing to assert claims on behalf of investors in the different tranches.

 

The Second Circuit’s recognition of the plaintiffs’ standing to assert claims even related to securities that the plaintiffs’ themselves had not purchased eliminated a significant tool in the defendants’ arsenal to try to narrow the claims involved in any given case. The elimination of this tool presented the prospect that securities defendants could face significantly broader claims than they might have faced had they been able to narrow the case.

 

In other words, Goldman was not the only securities litigation defendant that was interested in seeing if the Supreme Court might take up its case and review the Second Circuit’s holding; many defendants were interested in seeing if the Supreme Court might overturn the Second Circuit’s ruling. In its papers filed with the Supreme Court, Goldman had argued that letting the Second Circuit decision stand "will effectively increase by tens of billions of dollars the potential liability that financial institutions face in this and similar class actions."

 

However, as reflected in the Supreme Court’s docket sheet for the Goldman case, on March 18, 2013, the Court denied Goldman’s petition for a writ of certiorari. The Court’s refusal to take up the case not only means that the Second Circuit’s opinion stands in that Circuit; it also could be argued to suggest that the Court supported the Second Circuit’s analysis, an implication that plaintiffs might try to use to suggest that the Second Circuit’s analysis should be applied even where these other circuits (for example the First and Ninth Circuits) arguably have case law recognizing the narrower standing requirements that defendants would prefer. At a minimum, the broader standing analysis that the Second Circuit recognized in the Goldman decision now unquestionably applies in the Second Circuit itself, where so many of these cases are pending.

 

The Goldman bondholders claim will now go forward. The parties to the case undoubtedly will find the $730 million settlement in the Citigroup bondholders’ case of great interest.

 

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The number of securities class action lawsuits filed against life sciences companies rose in both absolute and relative terms in 2012, according to a March 20, 2013 memorandum by David Kotler of theDechert law form entitled “Survey of Securities Fraud Class Actions Brought Against U.S. Life Sciences Companies.”   According to the report, a copy of which can be found here, life sciences companies “remain an increasingly popular target of securities fraud class action lawsuits.”

 

According to the report, 27 pharmaceutical, biotechnology and medical companies were hit with securities suits in 2012, representing about 18% of all securities suits filed during the year.  By comparison, in 2011, 17 of those companies had securities suits filed against them, representing just 9% (It should be kept in mind when comparing the two years that securities class action lawsuit filings overall declined significantly between 2011 and 2012, as discussed in greater detail here.) The 18% of all securities suits that life sciences companies’ filings represented in 2012 is “well above the percentage of securities fraud complaints filed in recent years.”

 

During 2012, the fillings against life sciences companies continued to be concentrated on smaller companies. During 2012, 50% of all life sciences securities suit filings involved companies with market caps of less than $250 million, as compared to 58% in 2011 and 31% in 2010.

 

Abut 43% of the 2012 life sciences securities complaints involved alleged misrepresentations or omissions regarding product efficacy. However, “complaints claiming financial improprieties and insider trading were still prevalent in 2012.”

 

Though life sciences companies continue to be the target of securities class action litigation, many of these cases are also dismissed. The report notes that “in 2012, life sciences companies continued to enjoy relative success in obtaining dismissals of the securities fraud lawsuits filed in recent years.” For example, the report shows that of the 23 securities lawsuits filed against life sciences companies in 2008, three remain pending, eleven were settled, and nine have been dismissed, or about 45% of all resolved cases.

 

However, as the report also notes, “it is equally worth noting that securities fraud lawsuits still carry a substantial risk of exposure, and even when settled can result in very large payments.” The report notes that the 2008 securities suit filed against Medtronic settled during 2012 for $85 million.

 

The report also discusses the U.S. Supreme Court’s February 2013 decision in the Amgen case (background about which can be found here). The report states that “the Supreme Court’s decision in Amgen is expected to have a profound impact on the critical class certification stage in securities fraud class action lawsuits filed against life sciences companies, especially in the Second, Fifth and First Circuits, where the previously required higher threshold for plaintiffs to overcome the class certification barrier now will be lessened.”

 

The report concludes with a number of practical suggestions for life sciences companies to take to minimize the risk of, and impact from, securities fraud class actions.

 

Very special thanks to David Kotler for providing me with a copy of the report.

 

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Though the number of securities class action lawsuit settlement approvals reached a 14-year low in 2012, aggregate and average settlement amounts increased compared to 2011, according to the annual securities suit settlement report of Cornerstone Research. The report, which is entitled “Securities Class Action Settlements: 2012 Review and Analysis,” can be found here. Cornerstone Research’s March 20, 2013 press release regarding the report can be found here. A one-page infographic of the report’s findings can be found here.

 

According to the report, courts approved 53 securities class action lawsuit settlements in 2012, compared to 65 in 2011 (itself a very low year) and compared to a 2002-2011 average of 98 settlement approvals per year. The report suggests that the low number of settlement approvals in 2012 may be due to the relatively low number of securities class actions filed in 2009 and 2010.

 

Though the number of settlement approvals was down in 2012, the aggregate amount of settlement approvals was up substantially compared to 2011. The total amount of all settlements exceeded $2.9 billion dollars in 2012, compared to about $1.4 billion in 2011. Mega-settlements (those involving settlement amounts of over $100 million) accounted for more than 75% of the 2012 settlement amounts.

 

The average reported settlement amount dramatically increased from 2011 levels—in excess of 150 percent (from the inflation-adjusted amount of $21.6 million in 2011 to $54.7 million in 2012). The median settlement amount increased more than 70 percent in 2012, from $5.9 million last year to $10.2 million.

 

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In the latest of a series of decisions dealing with the enforceability of arbitration agreements, the U.S. Supreme Court in its 2011 decision in the AT&T Mobility LLC v Concepcion case held that the Federal Arbitration Act preempts state laws that refuse to enforce class action waivers in consumer arbitration agreements as unconscionable or against public policy.

 

The Concepcion decision has had a sweeping impact, as was seen most recently in a February 21, 2013 FINRA Hearing Panel decision in a enforcement action involving Charles Schwab & Company. The FINRA enforcement department had brought an action against Schwab challenging the company’s new customer agreement in which the customer was required to agree to arbitrate any disputes and waive any ability to assert a claim by means of a judicial class action. The Hearing Panel concluded that the agreement violated FINRA’s rules. However, it also concluded, in reliance on Concepcion, that the Rules are unenforceable because they conflict with the Federal Arbitration Act. (The Hearing Panel did find the agreement did violate the Rules by attempting to limit the powers of FINRA arbitrators to consolidate individual claims in arbitration.) FINRA has appealed the Hearing Panel ruling, but the Ruling does show the Concepcion decision’s significant impact.

 

And now, the question of the enforceability of arbitration agreements is back before the U.S. Supreme Court again. On February 27, 2013, the Court heard oral argument in yet another case examining the enforceability of arbitration agreements. The case is styled as American Express v. Italian Colors Restaurant. Background regarding the case can be found here. The case involves a purported class action antitrust action filed by a group of vendors against American Express in which the vendors allege that AmEx’s credit card policy constitutes an illegal tying arrangement because it forces the vendors to accept debit and credit cards at the same fee level.  American Express sought to invoke the arbitration clause in its contractual agreement with the vendors.

 

The case has been procedurally complicated and the specific decision on appeal to the Supreme Court represented the third separate opinion by the Second Circuit in the case. In what as known as the American Express III decision (here), the Second Circuit refused to enforce the class action waiver in the AmEx contractual agreement on the ground that it would effectively preclude the plaintiffs from prosecuting their federal antitrust claims because individual arbitrations would make the expert witness expense cost prohibitive.

 

 As a Ballard Spahr law firm points out in a memo about the case, the Third, Ninth and Eleventh Circuits disagree with the Second Circuit on whether or not the “vindication of statutory rights” theory is still viable in light of Concepcion. Those courts have found that Concepcion requires the enforcement of a class action waiver notwithstanding arguments that the plaintiffs would be unable to vindicate their statutory rights without a class action because their claims were worth less than the cost of litigating them.

 

The vendor plaintiffs’ were represented before the Supreme Court by former Solicitor General Paul Clement, who argued that it would not make economic sense for the vendors to pursue their claims individually because the costs of economic experts would be far in excess of their individual damages, and thus they would be effectively precluded from asserting their claims. As described in Daniel Fischer’s account of the oral argument in a February 27, 2013 Forbes article, the vendors’ contentions “did not seem to make much headway with the Justices.” Even liberal Justice Stephen Breyer expressed skepticism and lack of sympathy for the vendors.

 

The outcome of the pending Italian Colors case remains to be seen. But if as seems likely the Supreme Court continues to follow its now established pattern of supporting the enforceability of arbitration clauses, it seems likely that the vendors’ efforts to avoid AmEx’s arbitration clause, including the class action waiver, will fail. Of course, until the Supreme Court issues its decision in the Italian Colors case there is no way of knowing this for sure.

 

If American Express prevails in the Italian Colors case and the Supreme Court holds that the class action wavier in the AmEx customer agreement is enforceable, it raises the question of what may be next in the Supreme Court’s recognition of arbitration agreement and class action waiver enforceability. In particular it raises the question (that Daniel Fischer noted in his Forbes article) that the next step may be the question of enforceability of arbitration requirements in corporate articles of incorporation or by-laws.

 

The question of whether or not a company can impose an arbitration requirement through its articles of incorporation or its by-laws drew a great deal of attention when The Carlyle Group, which was preparing to go public at the time, specified in its partnership agreement that all limited partners would be required to submit any claims to binding arbitration. (I discussed Carlyle’s initiative in a prior blog post, here.) Ultimately, the SEC used its control of the registration process to prevent Carlyle from including this provision. But as illustrated in an April 22, 2012 article by Carl Schneider of the Ballard Spahr law firm on the Harvard Law School Forum on Corporate Governance and Financial Regulation (here), the idea continues to have its advocates and it seems likely that sooner or later there will be a case or circumstance testing the permissibility of arbitration provision in articles of incorporation or corporate by-laws.

 

For now, the questions of whether or not an arbitration clause in a corporate governance document would be enforceable will have to await another day. If the Supreme Court follows the trend of its own cases and upholds AmEx’s class action waiver in the Italian Colors case, we can certainly expect to see arbitration clauses with class action waivers proliferating in commercial documents. Unless and until Congress intervenes, arbitration provisions including class action waivers would likely become an increasingly common provision of transaction documents. Whether AmEx will prevail and whether that would lead to a test case involving articles of incorporation ad corporate by-laws remain to be seen. Until things change, it seems likely that we will all have to become increasingly more accustomed to dispute resolution through arbitration.

 

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Plaintiff law firms continued to file lawsuits in connection with virtually every mergers and acquisitions transaction in 2012, according to an updated report from Cornerstone Research. The February 2013 report, which is entitled “Shareholder Litigation Involving Mergers and Acquistions” and which was authored by Robert M. Daines of Stanford Law School and Olga Koumrian of Cornerstone Research, shows that plaintiff law firms filed lawsuits on behalf of shareholders in 96 percent of M&A deals valued over $500 million and 93 percent of transactions valued over $100 million. Cornerstone Research’s February 28, 2013 press release regarding the report can be found here. The report itself can be found here.

 

According to the report, the litigation rate involving M&A deals in 2012 was essentially unchanged from 2011. In both 2011 and 2012, about 93% of all deals valued over $100 million attracted litigation, and 96% of all deals valued over $500 million attracted litigation. Deals valued over $100 million attracted an average of 4.8 lawsuits per deal in 2012 (down slightly from 5.3 per deal in 2011) and deals valued over $500 million attracted an average of 5.4 lawsuits in 2012 (down from 6.1 in 2011).

 

The report notes that after a contrary trend in recent years, in 2012 a larger percentage of cases were filed in Delaware. In 2012 39% of all M&A lawsuits were filed in Delaware compared to only 25% as recently as 2012. For Delaware Corporations, 16% of deals were challenged only in Delaware, compared with 9% in 2011 and only 2% in 2009.

 

Of the 58% of cases filed in 2012 that had been resolved, the majority (64%) settled. 33% of the resolved cases were dismissed and 3% were voluntarily withdrawn. (These case outcomes are roughly equal to prior years, although with a certain number of the 2012 cases yet unresolved the settlement rate is slightly higher than prior years.)

 

Of the 2012 cases that were settled, 81% of the settlements involved only additional disclosures (compared to 88% in 2011 and 76% in 2010). According to the report, “the parties in only one settlement acknowledged that litigation contributed to an increase in the merger price.” The deal termination fee was reduced in four cases and the parties reached agreement about appraisal rights in six cases. There were two large settlements in 2012, both relating to transactions announced in 2011: the $110 million settlement in the El Paso/Kinder Morgan case and the $49 million settlement in the Delphi Financial/Tokio Marine case.

 

The report includes a detailed table of the ten largest M&A lawsuit settlements during the period 2003-2012. As the report notes, most of the larger settlements in the table “included allegations of significant conflicts of interest.”

 

The average agreed-upon attorneys’ fee for the 2012 settlements was $725,000, The average fee in a disclosure only settlement was $540,000, down from $570,000 in 2011 and $710,000 in 2010. The report includes an analysis of the factors that influence the size of the fee request. The report notes that “plaintiff attorney fees appear to be influenced by the following factors: size of the settlement fund; other monetary benefit to shareholders; number of suits filed; time to settlement; and overall deal value.”

 

The report concludes with a review of the emerging litigation involving shareholder challenges relating to annual proxy votes and disclosures about executive compensation, which mounted quickly as 2012 progressed. The report notes that “as the 2013 proxy season approaches, this litigation may expand.”

 

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In a much anticipated ruling in the Amgen securities class action litigation, the U.S. Supreme Court, in a 6-3 majority opinion written by Justice Ginsburg, held that a securities plaintiff is not required to prove that the allegedly misleading statements are material as a prerequisite to class certification. Justice Thomas, Scalia and Kennedy dissented. A copy of the court’s February 27, 2013 opinion can be found here.

 

As detailed here, the plaintiffs alleged that Amgen and certain of its directors and officers has issued misrepresentations and omissions regarding the safety, efficacy and marketing of two of its flagship drugs. The plaintiffs moved for class certification. The District Court granted the motion to certify a class, rejecting the defendants arguments that the before certifying the class, the plaintiff should be required first to prove that the alleged misrepresentations were material, or in the alternative that the defendants should be permitted to present information rebutting the contention that the class certification was material. The defendants pursued an interlocutory appeal to the Ninth Circuit, which affirmed the district court. The Supreme Court granted the defendants’ petition for a writ of certiorari.

 

The questions before the Supreme Court had to do with the “predominance” requirement under Rule 23(b)(3) of the Federal Rules of Civil Procedure. This Rule provides that as a prerequisite to certifying a class, the court must determine that “questions of law of fact common to class members predominate.” Because it would be difficult for securities claimants to show that a class of shareholders had all relied on misrepresentations, the Court has recognized the “fraud on the market” presumption, which holds that investors rely on an efficient market to include into a company’s share price the public information about the company.

 

The defendants argued that because “materiality” is a requirement for the applicability of the “fraud on the market” theory, plaintiffs should be required to prove that the allegedly misleading statements were material in order to use the “fraud on the market” presumption (and thereby allow a Court to determine that common issues of reliance predominate for class certification purposes).

 

In raising these arguments, the defendants relied on a split within the Circuits on these questions. The Second Circuit, for example, had held that plaintiffs must prove and defendants may rebut materiality before class certification. The Third Circuit had held that plaintiffs need not prove materiality before class certification, but that the defendant may present rebuttal evidence. The Ninth Circuit had held that the plaintiff need not prove materiality before class certification.

 

Justice Ginsberg, writing for the majority, held that “proof of materiality is not required to establish that a proposed class is sufficiently cohesive to warrant adjudication by representation.” The plaintiff is “not required to prove materiality of Amgen’s alleged misrepresentations and omissions at the class-certification stage.” While the plaintiff “certainly must prove materiality to prevail on the merits,” such proof “is not a perquisite to class certification.”

 

Because materiality is judged “according to an objective standard, the materiality of Amgen’s alleged misrepresentations and omissions is a common questions to al members of the class.” The plaintiffs’ failure to proved materiality “would not result in individual questions predominating. Instead, a failure of proof on the issue of materiality would end the case, given that materiality is an essential element of the class members’ securities fraud claim.”

 

Justice Ginsberg’s added that the dissent view that the plaintiffs must first establish materiality to gain certification “would have us put the cart before the horse.”

 

The majority opinion also specifically rejected Amgen's public policy argument that because of the enormous economic pressure that the mere existence of a securities class action lawsuit creates, plaintiffs should be required to prove materiality at the class certification state. Justice Scalia endorsed this view in his dissenting opinion. The majority rejected this argument, noting that this argument could be made for any element of a securities class action claim, yet the Court has previously held that other common elements – such as loss causation and the falsity or misleading nature of the defendant’s alleged misrepresentations -- “need not be adjudicated before a class is certified.”

 

Justice Ginsburg also noted that Congress had amended the federal securities laws in the PSLRA, based on a recognition that securities suits were subject to abuse, yet Congress had “rejected calls to undo the fraud on the market presumption” and “did not decree that securities-fraud plaintiffs” must “prove each element of their claim before obtaining class certification.” Justice Ginsberg added that “we have no warrant to encumber securities-fraud litigation by adopting an atextual requirement of precertification proof of materiality that Congress, despite extensive involvement in the securities field, has not sanctioned.”   

 

While commentators will be digesting the Court’s opinion in coming days, and while it appears that there might be much fruitful inquiry in analyzing the interplay between the majority, concurring and dissenting opinions, the bottom line is that plaintiffs seeking class certification in a securities suit will not be required to prove materiality. This outcome not only spares plaintiffs the burden of a pre-certification contest on one of the merits issues, but is relieves the plaintiffs of that burden in the judicial circuits that up until now had imposed that requirement. Securities class action defendants, on the other hand, will now be deprived of one of their tools in trying to block class certification – a blow that will be felt particularly in those circuits (like the Second Circuit) that had held that proof of materiality is a prerequisite to class certification in a securities suit.

 

If nothing else, this case proves that even with the Court’s current line-up, the Court’s grant of certiorari in a securities suit is not invariably bad news for securities plaintiffs. Though plaintiffs have taken a number of defeats before the Court in recent years, the outcome have not been uniform. The outcome here may not have been entirely unexpected – summaries of oral argument (refer for example here) suggested that some of the justices were skeptical of the defendants' arguments. Nevertheless, it is noteworthy that a Court that is perceived as favoring the defendants in securities cases has entered a majority opinion favorable to plaintiffs.

 

One final note is that the Court did not (at least on first reading) appear to do anything to alter the existence of the fraud on the market theory. As always, a close reading of Supreme Court cases is  required and a closer reading of this case might reveal subtle signals. There had been some speculation that the Court might use this case as an occasion to reconsider or alter the fraud on the market theory. But at least based on the initial reading it does not appear that the Court did so.

 

Special thanks to a loyal reader for alerting me to the Supreme Court's opinon

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By the time you read this blog post, you undoubtedly will have seen one of the stories in the mainstream media reporting on the February 25, 2013 decision of Southern District Court Jed Rakoff ordering former Goldman Sachs director Rajat Gupta to repay most of the legal fees the company incurred in connection with the government’s investigation and prosecution of Gupta. In case you didn’t see the stories, you can find them, for example, here and here.

 

There are a number of interesting things about Judge Rakoff’s order, many of which garnered little attention in the mainstream media reports.

 

By way of background, readers may want to recall that Gupta was convicted in June 2012 of leaking boardroom secrets to Raj Rajaratnam, who relied on the leaked non-public information in making highly profitable securities trades. Gupta was sentenced in October 2012. Gupta is appealing his conviction.

 

Judge Rakoff did not enter the order ordering Gupta to repay Goldman in a separate proceeding. Rather, Judge Rakoff entered the order in connection with the criminal proceeding against Gupta, and in particular as part of his (Rakoff’s) deferred determination of restitution in connection with Gupta’s sentencing. Goldman had specially appeared in Gupta’s criminal case to seek restitution of the $6.9 million in fees it paid to the Sullivan & Cromwell law firm in connection with the criminal case and related matters. (Goldman later withdrew a request for restitution of Gupta’s salary and for restitution of legal fees incurred in connection with a Section 16(b) short-swing profits proceeding against Gupta, which would explain why the amount Rakoff awarded was below the restitution amount Goldman had originally requested.)

 

Goldman sought restitution under the Mandatory Victims Restitutions Act, which mandates restitution in a criminal case where an identifiable victim has suffered a pecuniary loss. Under the Act, the restitution may include “necessary” expenses incurred during participation in the investigation or prosecution of the offense. Under Second Circuit authority, necessary other expenses may include attorneys’ fees, provided that the court finds by a preponderance of the evidence that the expenses were necessary and were incurred in connection with the investigation or prosecution of the offense, and that they were incurred by victims of the offense.

 

Goldman submitted 542 pages of its counsel’s billing records, relating to a range of related matters, not just Gupta’s criminal proceedings alone. Gupta had argued that the restitution, if any, should be limited to fees incurred in his prosecution. But Judge Rakoff interpreted the relief to which Goldman is entitled under the Act broadly. Judge Rakoff said that “this Court has no difficulty in concluding, by a preponderance of the evidence, that nearly all of the expenses Goldman Sachs here claims were the necessary, direct, and foreseeable result of the investigation and prosecution of Gupta’s offense.” 

 

Among other things, Rakoff included expenses incurred during Goldman Sachs’s internal investigation into Gupta’s conduct; the fees Goldman incurred to attend post-verdict proceedings in Gupta’s case; the fees the company incurred in the parallel SEC case against Gupta; and the fees the company incurred in connection with Rajaratnam’s criminal prosecution.

 

It is important to highlight the fact that in ordering Gupta to repay Goldman for the fees it incurred, Rakoff was interpreting and applying the Mandatory Victims Restitution Act. Rakoff’s order did not involve or relate to any interpretation or application of Gupta’s rights for advancement of indemnification of his attorney’s fees under Goldman’s by-laws or under applicable state law. I emphasize this fact because, following Gupta’s conviction, there has been discussion in the press of Goldman’s rights (if any) to seek recoupment from Gupta under applicable principles governing advancement or indemnification.

 

It remains an interesting question whether or not Goldman might have had the right (or would have had the right if Gupta’s conviction is affirmed) to seek to establish in a separate civil proceeding that it had a right of recoupment. But Goldman was not relying on its recoupment rights and Judge Rakoff did not order Gupta to pay Goldman in reliance upon principles of advancement or indemnification. Rather, he was applying the Mandatory Victims Restitution Act.

 

The fact that Rakoff was applying the Act is also important in connection with the question of what the ruling might mean in other cases. The ruling is only going to be relevant in other cases where a corporate official has been criminally convicted and where there is an identifiable victim that has suffered a pecuniary loss. Absent a conviction, there would be no grounds for restitution. A company seeking restitution of attorneys’ fees and other expenses would have to meet the Act’s other requirements as well. (It should be noted that Goldman is not the only company to have sought restitution of attorneys' fees from a former official convicted of a criminal offense; as discussed here, Morgan Stanley is seeking in a separate proceeding to recover millions it paid to and on behalf of Joseph Skowron, a former hedge fund manager for the company who plead guilty to insider trading.)

 

Although it does not appear to have been relevant in Gupta’s case, it is interesting to consider what subrogation rights a D&O insurer might have under the Act in the event of a criminal conviction. To the extent that the attorneys’ fees had been paid by an insurer, the insurer might take the position that it is subrogated to any victims’ restitution rights to which the company is entitled under the Act. Whether the insurer would be as successful casting itself as the victim in that situation is an issue the carrier would have to address.

 

Today’s Classic Rock Note:  (Hat Tip to The Meta Picture.com)

 

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I am sure many readers were disturbed as I was by the February 19, 2012 New York Times article reporting that a Chinese army unit apparently has been executing a concentrated cyber-hacking program targeting U.S. companies and critical U.S. infrastructure. (The report of consulting firm Mandiant that was the basis of the Times article can be found here.) This story is part of a rising tide of media reports about cybersecurity risks. Indeed, concerns about these kinds of activities led President Obama’s February 12, 2013 Executive Order entitled “Improving Critical Infrastructure Cybersecurity” (here).

 

Although the recent disclosures are quite troubling, it is not news that cybersecurity risks represent a significant concern for just about every company involved in the current economy. Prior posts on this site (for example, here) have detailed the liability exposures that these risks represent for all of these companies and for their directors and officers. But while these issues are not new, it really seems that as we have headed into 2013, the volume on these issues has been turned up.. It now seems clear that cybersecurity is going to be one of the hot button issues for the foreseeable future, both in the media and for the affected companies.

 

The heightened scrutiny of cybersecurity issues has a number of important implications for potentially affected companies, and not just from an operational standpoint. These developments also have important implications for public company’s public disclosure statements, and, as a consequence, for the company’s potential regulatory and litigation exposures.

 

Indeed, according to a February 21, 2013 memo from the King & Spaulding law firm entitled “Cybersecurity: The New Big Wave in Securities Litigation?” (here), “it is likely that this issue will continue to gain momentum among both government regulators and opportunistic plaintiff lawyers seeking to catch the next wave of shareholder litigation.” In particular, the failure to promptly disclose a cyber breach “may put a company at risk of facing formal SEC investigations, shareholder class actions, or derivative lawsuits.”

 

As the memo notes, the SEC “has already taken a firm stand on cybersecurity disclosures, and clearly views this issue as ripe for enforcement actions.” In October 2011, the SEC’s Division of Corporate Finance issued “Disclosure Guidance” on cybersecurity related issues. Among other things, the Guidance clarified that the agency expects companies to disclose the risk of cyber incidents among their “risk factors” in their periodic filings and also expects companies to disclose material cybersecurity breaches in their Management Discussion and Analysis.

 

The law firm memo notes that so far, the SEC’s Guidance “seems to have had little impact on corporate disclosure,” and that in many instances companies experiencing cyber breaches are “choosing to keep those events confidential.” However, “given the increasing awareness of this hot issue,” it seems “likely” that the SEC “will increase pressure on companies to disclose such events.” The memo adds that “companies that have experienced significant cybersecurity breaches should prepare themselves for potential SEC investigations and lawsuits.”

 

In addition to the risk of SEC enforcement action, companies experiencing cyber breaches also face the possibility of a securities class action lawsuit. However, the memo notes, a company experiencing a cyber breach “will likely not be a target of a securities class action unless the disclosure of the breach can be linked to a statistically significant drop in the company’s share price.” In that respect, it is worth noting that several high profile companies announcing cyber breaches have not experienced a significant drop in their stock price following the announcement. (For example, recent announcements by Facebook, Apple and Microsoft that they have been the target of sophisticated cyber attacks did not affect the companies’ share prices.) Nevertheless, it seems likely that at least some companies experiencing cyber breaches or subject to cyber attacks will also suffer a drop in their share price, and “thus result in securities class action litigation.” 

 

Companies that do not experience a share price decline following a cybersecurity incident may not get hit with securities class action litigation, but they are still susceptible to derivative lawsuits alleging, for example, that company directors breached their fiduciary duties by failing to ensure adequate security measures. As the law firm memo notes, shareholder may claim that senior management and directors “were either aware of or should have been aware of the breach and the company’s susceptibility to hacking incidents.” Of course, any lawsuit of this type would face significant hurdles, including the requirement to make a formal demand on the board as well as the business judgment rule.

 

In any event, it is clear that cybersecurity issues are going to be an increasing source of scrutiny for companies and their senior officials. This heightened scrutiny not only means that companies will be under pressure to take steps to ensure that their networks and information are secure, but also means that the companies will face pressure both to “disclose the risks associated with potential cybersecurity breaches and provide timely updates when actual breaches occur.” Companies that fall short on these disclosure expectations “will face a substantial risk of regulatory scrutiny and shareholder litigation.”

 

As Rick Bortnick of the Cozen O’Connor firm discussed in a prior guest post on this site (here), cyber security disclosures have already been the source of securities class action litigation, in the high profile case involving Heartland Payment Systems. Although that case was dismissed, Bortnick points out how different the circumstances and disclosures involved in that case might look if viewed through the prism of the SEC”s 2011 Disclosure Guidance.

 

Among other implications from these developments is that cybersecurity disclosure seems likely to be the subject of greatly increased scrutiny, suggesting that this disclosure – particularly precautionary disclosure forewarning investors of the possible adverse effects the company could expect in the event of a serious cyber attack – should become a priority for reporting companies.

 

Finally, these developments and the possible regulatory and litigation implications underscore the fact that cybersecurity exposures represent an important issue to be addressed as part of every company’s corporate insurance program. Indeed, the SEC itself considered the question of insurance for cybersecurity exposures to represent such a critical issue that, in its Disclosure Guidance, it specifically identified the insurance issue as one of the topics companies should address in their disclosure of cybersecurity issues.

 

The insurance issues related to cybersecurity include not only the question of whether companies should acquire dedicated cyber and network security insurance, but also includes the question of the protection available to the companies’ senior officials under their management liability insurance policies. The rapidly evolving nature of these issues and the related liability exposures underscores the importance for all companies to have a knowledgeable and experienced insurance professional involved in the design and implementation of their corporate insurance program.

 

Readers interested in the President’s recent Executive Order and its potential implications will want to take a look at the February 2012 article written by Lockton’s Bill Boeck entitled “Cybersecurity Executive Order: What We Know and What We Don’t Know” (here).

 

Those who are interested in the implications of these developments for corporate directors will want to review the recent guest post on this site by D&O maven Dan Bailey entitled “Cyber Risks: New Focus for Directors” (here).

 

Classic Rock Notes::In its February 23, 2013 review of new autobiography of record industry executive Clive Davis, the Wall Street Journal describes a critical incident that led Davis to become one of the recording industry’s most successful rock music producers. In June 1967, Davis attended the Monterey Pop Music festival, where he heard Janis Joplin deliver a version of Big Mama Thornton’s “Ball and Chain.” Davis described the event as “not merely one of Janis’s greatest moments onstage, but one of the classic performances in rock history. It was simply overwhelming.” Joplin was, according to Davis, “hypnotic” and “mesmermizing.” Davis says he thought on seeing her performance, “This is a social and musical revolution.”

 

Davis wasn’t exaggerating. Even in the grainy Internet video, Joplin’s performance will give you goosebumps. Crank up the volume on your computer and enjoy (watch for the cutaway shot of Mama Cass Elliot regarding Joplin in slackjawed amazement).

 

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In what may be the largest settlement ever in securities class action litigation involving a pharmaceutical company, Merck has agreed to a combined settlement of $688 million to settle two related securities class action cases. The company's February 14, 2013 press release announcing the settlements can be found here.

 

The lawsuits relate to alleged representations concerning the anti-cholesterol drug Vytorin. The drug was marketed through a joint venture between Merck and Schering-Plough. The shareholder claimants allege that the companies and certain of their directors and officers withheld information relating to poor clinical trial results while continuing to promote the drug's benefits.

 

 

According to the company's press release, the company will pay $215 million to resolve the claims against the Merck defendants and $473 million to resolve the claims against the Schering-Plough defendants. The company also announced that it would take a pre-tax and after-tax charge of $493 million, which the company indicated "reflects anticipated insurance recoveries." (Although it is not entirely clear, the company statement about the charge suggests that the company "anticipate" insurance recoveries of $195 million, possibly under the insurance programs of the two companies).The settlements are subject to court approval.

 

 

According to Victor Li's February 14, 2013 Am Law Litigation Daily article (here), the cases settled three weeks before they were set to go to trial. The article also quotes the lead plaintiffs' lawyers as saying that the settlement is the largest ever involving a securities class action lawsuit against a pharmaceutical company; is among the top ten settlements in a securities class action that didn't involve a restatement; and is among the 25 largest securities settlements of any kind.

 

 

Facebook IPO Derivative Suits Dismissed: In a February 13, 2013 opinion (here), Southern District of New York Robert Sweet granted without prejudice the defendants' motion to dismiss the Facebook IPO shareholders' derivative suits that had been multidistricted before him. The ruling not only represents a win for the defendants in the derivative suits, but it could also prove helpful in the parallel securities class action litigation. In addition, parts of the opinion may also be helpful in other state court IPO cases and may even prove helpful for defendants attempting to address the multi-jurisdiction litigation problem in the M&A litigation context.

 

As Alison Frankel discusses in a February 14, 2012 post on her On the Case blog (here), Judge Sweet's ruling contains strong language dismissing plaintiffs' claims based on Facebook's alleged failure to disclose internal projections, noting that "courts throughout the country" have "uniformly agreed" that the internal calculations are not material. He added that "an opposite ruling would have changed at least two decades of IPO practice."

 

Judge Sweet also (as Frankel puts it) "implicitly endorsed" the use of forum selection clauses in certificates of incorporation, though he denied Facebook's motion to dismiss on forum selection grounds. According to the defense lawyers Frankel quotes in her post, the judge's analysis of the issue, though clearly dicta, represents a "significant" development in a relatively undeveloped area of the law.

 

Judge Sweet also held that shareholders who purchased their shares in the IPO do not have standing to complain about pre-IPO conduct. Derivative plaintiffs must be able to show that they owned their shares at the time of the conduct they are complaining about. Because they did not own their shares at the time of the pre-IPO conduct that is the basis of their claims, they lack standing to assert claims based on that conduct.

 

Finally, Judge Sweet held that federal judges have discretion to consider threshold issues such as standing and forum selection clauses even before they determine whether they have jurisdiction over the derivative suits. It is this latter holding that Frankel suggests may be most helpful to defendants litigating multi-jurisdiction M&A litigation, because the defendants could remove the state court cases to federal court and before the case can be remanded the federal court might be able to rule on the threshold issues.
 

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Securities class action filings in Canada were down in 2012 compared to 2011’s record number of filings and compared to recent annual averages, according to a February 13, 2013 report from NERA Economic Consulting. The report, which is entitled “Trends in Canadian Securities Class Actions: 2012 Update,” can be found here. NERA’s press release summarizing the report’s findings can be found here.

 

According to the report, there were nine securities class actions filed in Canada in 2012, down from the “all time high” of 15 new cases filed in 2011, and below the annual average of 12 new cases filed per year since 2008. Eight of the nine 2012 cases were filed under the secondary market civil liability provisions of the provincial securities actions (so-called “Bill 198” cases).

 

The downturn in the number of new securities class action lawsuit filings in Canadian securities class action may be due in part to the abatement of a couple of filing trends that drove filings prior to 2012. In recent years, filing levels had been increased due to credit crisis related filings and due to the surge in cases against Chinese domiciled companies. There were no new case filings in Canada in 2012 related to either of these trends.

 

Eight of the nine cases involved companies with shares traded on the Toronto stock exchange. The ninth case involves Facebook, which does not have shares listed on a Canadian exchange. (As discussed here, there is recent Canadian authority allowing cases against companies whose shares traded exclusively on foreign exchanges to go forward in Canadian courts.)  Six of the nine new Canadian securities class action cases had parallel U.S. filings

 

In addition to these new filings in Canadian courts, there were six U.S. class action filings in 2012 involving Canadian-domiciled companies. Two of these six also involved parallel Canadian securities class actions, but four of the six involved companies for which there is no parallel Canadian class action.

 

Two-thirds of the 2012 securities class action filings in Canada were brought against companies in the mining or oil and gas sectors.

 

The most significant securities class action settlement in Canada is E&Y’s $117 million settlement in the Sino-Forest case, which, the report notes, if approved would represent “the largest settlement of a Bill 198 case to date.” There have only been two prior audit firm defendant settlements of Bill 198 cases, both of which involved the auditors’ agreement to pay $500,000 to settle the claims.

 

The report notes with respect to the twelve Bill 198 cases that have settled to date (excluding partial settlements, which would remove the E&Y/Sino Forest settlement from the calculation) that the average settlement amount is $10.5 million and the median settlement is $9.3 million. The average settlement as a percentage of compensatory damages claimed is 12.6% and the median is 8.9%. The average settlement of the four Bill 198 cases that had parallel U.S. claims is $16.9 million and the median is $17.2 million. The average of the settlements in the eight domestic-only cases is $7.4 million and the median is $5.4 million.

 

With new filings, settlements and dismissals during 2012, there are now a total of 51 active Canadian securities class actions, four more than at the end of 2011 and nearly double the number of active cases four years ago. All but nine of the cases still active as of the end of 2012 were filed after 2007. The combined impact of the growing number of open claims and case law developments suggest that “we may see more settlements during 2013 than we saw in 2012.”

 

For discussion of a recent law firm memo asking whether class action lawsuits in Canada had “reached maturity,” refer here.

 

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Litigation related to M&A activity continued at an “extremely high rate” in 2012, according to the latest research update from Ohio State law professor Steven Davidoff and Notre Dame business professor Matthew Cain. According to the professors’ analysis, presented in their February 1, 2013 paper entitled “Takeover Litigation in 2012” (here), 91.7% of all merger transactions that met the professors’ criteria attracted at least one lawsuit, compared to 91.4% in 2011.

 

The professors’ paper is the latest update on their research originally presented in their January 2012 article entitled “A Great Game: The Dynamics of State Competition and Litigation” (here), which I reviewed here. Following the original article’s publication, the professors updated their research with additional litigation data regarding M&A transactions that took place in 2011. Their latest paper updates their research with regard to 2012 transactions.

 

The professors have limited their analysis to merger transactions over $100 million involving publicly traded target companies with an offering price of at least $5 per share. The 2012 update includes only transactions there were completed as of January 2013. The professors intend to update their 2012 data in six months to incorporate information relating to the in process transactions.

 

It is probably worth noting that there were fewer deals that met the professors’ sorting criteria in 2012. There were only 84 deals with the defined characteristics in 2012, compared to 128 in 2011 (representing a year over year drop of 34%). But the percentage of deals attracting at least one lawsuit remained virtually unchanged, with 91.7% of deals attracting at least one suit, compared to 91.4%. The professors believe based on anecdotal evidence, that when they update their 2012 “the ultimate litigation rate will match or exceed the 91.7% figure.” Though the litigation rate is virtually unchanged from 2011, the 2012 rate is “almost 2.5% that of 2005,” when the litigation rate was only 39.3%.

 

The number of complaints brought per transaction remained at about 5.0 lawsuits per transaction, the same rate as in 2011 but more than double the mean number of lawsuits in 2005, when the figure was 2.2/ Multi-jurisdiction litigation “remained similar in 2012 with 50.6% of transactions with litigation experiencing litigation in multiple states,” compared to 53% in 2011.

 

87.5% of all 2012 cases that had settled involved “disclosure only” settlements, compared to 79.5% in 2011. The average attorneys’ fees were down substantially in 2012, but that may be driven by a few larger settlements in 2011. The median attorneys’ fee award was about the same both years -- $580,000 in 2011, $595,000 in 2012.

 

Delaware attracted a slightly reduced share of M&A litigation in 2012. The state attracted 46.7% of all litigation that could have been filed in there in 2012, compared with 52.8% in 2011. Delaware “also appears to be dismissing fewer cases, thus allowing more cases to be settled” – 76.9% of Delaware cases settled in 2012, compared with 61.5% in 2008. The authors note, referencing their original paper, that “when Delaware loses cases to other jurisdictions it historically has dismissed fewer cases and allowed more to settle, consistent with conduct designed to reattract litigation.”

 

Discussion

Because of the authors’ sorting criteria, their analysis and conclusion are most relevant to the larger transactions. However, based on my own observations, the authors’ conclusions are consistent even with respect to the smaller deals that do not meet their sorting criteria. The explosion of M&A-related litigation in recent years has not been limited just to the larger companies and transactions.

 

The surge in M&A related litigation in recent years has been one of the principal justifications the D&O insurance carriers have given as an explanation for their efforts to try to increase the insurance rates, particularly with respect to the rates for primary D&O insurance. In addition, the upsurge in M&A-related litigation has also affected the terms and conditions that the carriers are willing to offer. In particular, some carriers have been insisting on adding a separate, larger retention for M&A-related claims. The professors’ updated M&A-related litigation date seems to suggest that the carriers will try to continue to push rate and to try to include separate M&A-related claim retentions.

 

As I detailed in a prior post (here), the defense expenses and settlement amounts associated with M&A-related litigation represent a serious problem, for the companies involved and for their insurers. The prevalence of the multi-jurisdiction litigation is a particularly vexing problem, as the proliferating lawsuits are expensive to defend and difficult to resolve.  Unfortunately, based on the professor’s updated research, all signs are that these phenomena will remain a significant part of the corporate and securities litigation landscape for the foreseeable future.

 

Special thanks to Professor Davidoff for providing me with a copy of his latest paper.

 

Chinese Reverse Merger Cases: Is There a “China Discount”?: During 2010 and 2011, and to a lesser extent during 2012, the plaintiffs’ securities lawyers rushed to file securities class action lawsuits against Chinese companies that had obtained a U.S. listing through a reverse merger. But while these cases flooded the courts, they have not proven to be a huge bonanza for the plaintiffs’ lawyers or their clients. As I noted in a prior post, the settlement so far have been rather modest.

 

Michael Goldhaber’s February 12, 2012 Am Law Litigation Daily article entitle “Whither Chinese Reverse Merger Litigation?” (here) suggests that there may be a “China discount” in the Chinese reverse merger cases. The article quotes a defense attorney with the Sherman & Sterling law firm as saying that there is now a “critical mass of settlements between $2 million and $3 million” and that these lower settlements “may exert a gravitational pull on other settlements down the road.” The article notes that “the remarkable uniformity of the settlements suggests that $5 million D&O insurance policies are standard for this niche,” adding that a policy of that amount allows enough for defense fees and a settlement compromise with in the policy limit.

 

The two arguable exceptions to these generalizations both involve proceedings outside the U.S. The first is the $77.5 million Hong Kong arbitration award that C.V. Starr obtained against the founding shareholders of China MediaExpress Holdings (about which refer here) and E&Y’s $118 million December 2012 settlement of a Canadian class action arising out of its audit of Sino-Forest Corporation (refer here). Though these two exceptions each have their own distinct characteristics, these developments may hearten the claimants in the other cases and give them the incentive to continue to try to press on. The evidence so far, however, suggests the greater likelihood of the more modest settlements that have tended to become the norm.

 

A particularly interesting feature of the Am Law Litigation Daily article is a link to Sherman & Sterling document provided a comprehensive status summary of more than 75 disputes in U.S. forums relating to allegations of securities violations by Chinese parties, including more than 50 reverse merger companies. The summary document can be found here.

 

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It is nothing new for seemingly outrageous emails to trigger attention-grabbing claims of wrongdoing. But revelations this past week arguably represent some type of high-water mark, as a cluster of serious allegations were accompanied by a trove of embarrassing excerpts from emails and instant messages. While the latest disclosures provide yet another reminder of the dangers associated with ill-considered use of modern electronic communications technology, they also raise questions about the use that regulators and claimants are attempting to make of the communications.

 

The regulators’ press releases announcing RBS’s settlement this past week of charges of alleged Libor manipulation drew heavily on excerpts from the bank’s internal electronic communications. The CFTC considered the communications so damning that it included several pages of excerpts in its February 6, 2013 press release announcing RBS’s agreement to the agency $325 million penalty. Among other things, the press release quotes RBS yen traders, aware of other rate-setting banks’ manipulative conduct, as saying that “the jpy libor is a cartel now,” to which another trader commented that “its just amazing how libor fixing can make you that much money.” A later communication quotes a yen trader as saying that there is “pure manipulation going on.” 

 

The CFTC’s press release quotes other internal communications that appear to show RBS Libor rate submitters and derivatives traders agreeing on where to set that days rate submissions, with the traders offering (seemingly modest) inducements such as “sushi rolls from yesterday” and “there might be a steak in it for ya” and “we’ll send lunch around for the whole desk.” The messages also seem to show the traders interacting with interbroker dealers, asking them to “speak to” the rate submitters at other banks, so that “as a team” the rates come in at the desired level.

 

A February 6, 2013 Financial Times article detailing many of the RBS emails and entitled “Record of Trader Talk to Haunt RBS,” can be found here.

 

Similarly, and as I noted in my prior post about the DoJ’s recent civil complaint against S&P, the government’s allegations against the rating agency depend heavily on excerpts drawn from internal emails and other electronic communications. The embarrassingly colorful emails seem to suggest that the rating agency consciously issued unjustifiably high ratings for CDOs to please its customers and to avoid losing market share to rival rating agencies. The email excerpts include the now infamous line on one April 5, 2007 instant message from a securities analyst that “we rate every deal … it could be structured by cows and we would rate it.” The complaint also quotes -- at length and in full -- one S&P analyst’s 2007 March parody of the Talking Head’s song “Burning Down the House,” entitled “Bringing down the House” and suggesting that subprime mortgage delinquencies were threatening to wreak havoc.

 

The complaint quotes more serious (and seemingly more damning) messages, including the July 5, 2007 message from a recently hired S&P analyst to an outside investment-banker:

 

The fact is, there was a lot of internal pressure in S&P to downgrade lost of deals earlier on before this thing started blowing up. But the leadership was concerned about p*ssing off too many clients and jumping the gun ahead of Fitch and Moody’s.

 

The emails quoted in the complaint also reflect an apparent internal debate about S&P’s rating methodology and whether proposed tightening could prove competitively disadvantageous. The DoJ complaint quotes one internal May 2004 e-mail as saying:

 

We just lost a huge Mizhuo RMBS deal to Moody’s due to a huge difference in the required credit support level. What we found from the arranger was that our support level was at least 10% higher than Moody’s … this is so significant it could have an impact on future deals. There’s no way we can get back on this one but we need to address this now in preparation for future deals

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There were also revelations this past week in the civil litigation that Belgian bank Dexia filed in 2012 against JP Morgan and its affiliates. As detailed in a February 6, 2013 New York Times article entitled “E-Mails Imply JP Morgan Knew Some Mortgage Deals Were Bad” (here), Dexia is relying on a “trove of internal emails and employee interviews” to allege that when JP Morgan uncovered flaws in thousands of home loans, rather than disclosing the problems, the bank simply adjusted the critical reviews,  perpetuating the appearance that the securities into which the mortgages had been bundled were more secure than they might otherwise appear.

 

Among other things, the Times article quotes a September 2006 internal JP Morgan mortgage loan analysis that determined that “nearly half of the sample pool” was “defective,” meaning that the loans did not meet underwriting standards. The article says that JP Morgan dismissed or altered these and other critical assessments, for example, to show that a smaller number of loans were “defective.” The article cites one specific example in which a 2006 review of mortgages found that over 1,100 mortgages were more than 30 days delinquent, but that the offering document sent to investors showed only 25 loans as delinquent.

 

In its February 8, 2013 front-page article about Tom Hayes, a derivatives trader known as ‘Rain Man” and who worked, serially, for RBS, UBS and Citigroup, and who is one of the few individuals to be individually prosecuted in connection with the Libor scandal, the Wall Street Journal not only quoted Hayes’s email communications but also reported that Hayes would “change his status on his Facebook page to reflect his daily desires for Libor to move up or down.”

 

One interesting feature of a number of these communications is that in many instances the individuals involved evinced awareness that they needed to be careful with what they said. For example, the author of the “Burning Down the House” parody, in an email that followed quickly after the first note in which he sent the parody lyrics, told the parody recipient “For obvious professional reasons, please do not forward this song. If you are interested, I can sing it in your cube.” The CFTC’s press release quotes a transcript from a telephone conversation (recorded because it took place on a trading desk), in which a trader and a rate submitter agreed on a rate level to be submitted to the British Banker’s Association (BBA); in the transcript that submitter advises the trader (after refusing to agree to the rate on Bloomberg Chat), that “We’re just not, we’re not allowed those conversations on [instant messages]” because, the rate submitter tells the trader “of the BBA thing” (that is, reports of investigation involving Libor rate setting at the BBA).

 

There is no doubt that these excerpts from the emails and other electronic communications make a horrible impression and could even cause the various companies involved serious problems. But as damning as some of these emails seem to be, there is also a danger that the impression these messages create is a false one. In an interesting February 7, 2013 essay on Yahoo Finance (here), Henry Blodget (who certainly knows a thing or two about embarrassing emails):

 

the trouble with email is that sometimes people who aren't, in fact, breaking rules often vent or joke or react to information in emails--and, in so doing, create a "paper" trail that, later, out of context, makes it look like they have broken rules (or at least done something sleazy). And when these emails come out, they are often seized upon as proof of wrongdoing, before they have actually been evaluated in context. And that gets a lot of companies and employees in hot water, even when the employees didn't, in fact, break any rules.

 

Of course, as Blodget notes, the emails do sometimes in fact evidence wrongdoing. The problem is that when seemingly damning email excerpts are blasted into the media, it is very difficult to appreciate the larger context within which the excerpts fit.

 

By way of illustration, the handful of emails that the DoJ quotes in its S&P complaint was taken from over twenty million pages of e-mails the rating agency produced to the government. As John Cassidy notes in his interesting and balanced analysis of the DoJ’s complaint in a February 5, 2013 New Yorker article, should the S&P case go to trial, the rating agency will have the opportunity to “place the offending communications in context, and to counterbalance them with more exculpatory materials.” Though the emails unquestionably do not read well, “bad publicity doesn’t necessarily equate to a defeat in court.”

 

I have personal experience with the way that emails can be pulled at random from a mountain of paper and made to look as if they are much more serious and meaningful than they ever were intended to be. For many years, I was the head of a D&O underwriting facility. From time to time, we were involved in coverage litigation, and invariably the claimants’ lawyers seemed to think it was really clever to depose the head of the operation. So being deposed became a regular feature of my job. In many of these depositions, the claimants’ attorneys would pull out emails written in jest or written in haste, and question me about them under oath. There is nothing like having the lens of video camera pointed at your face to take all of the humor out of a gag email.

 

By now, I think we are all aware of the dangers that email and other forms of electronic communications represent. The messages are written in haste and seem ephemeral. Yet because of the permanence of the electronic storage, they stand as an archival record of thoughts and messages that live on long after the moment has passed.

 

As I said at the outset of this blog post, it is nothing new for regulators and claimants to have a field day with ill-considered electronic communications, and I think all of us have heard many times about the need for caution when using email and other forms of electronic communication. However, human nature being what it is, and given the nature of electronic communications (which encourages haste as well as imprecise and sometimes even ill-considered expression), it is perhaps inevitable that in a vast archive of electronic messages there will be a handful of unfortunate items.

 

But though these kinds of unintended blunders can seem inevitable, it is still worth trying to learn from what the regulators and claimants have done with the electronic communications in these cases. These cases underscore the fact that for all of their convenience and ease of use, electronic communications can be very dangerous. In the press of day-to-day business, this danger can be hard to remember. But a useful exercise to try to adopt is to pause and ask yourself, before hitting “send,” how the message would look if it were to fall into the hands of a hostile and aggressive adversary who was looking for ways to try to make you or your company look bad. Were this simple test to be more widely implemented, we would certainly see a marked reduction in, for example, running email jokes about the French maid’s outfit.  

 

My final thought is this – we all know that many electronic messages are written in haste and sometimes with insufficient care. With full awareness of this attribute of electronic communications, we should hesitate to jump to too many conclusions about the seemingly damaging inferences that could be drawn from email or instant message excerpts. But we should also learn from the inferences that regulators and claimants are trying to draw and try to take that into account in our own communications.

 

UPDATE: As if to reinforce my point in this post, today's WSJ has an article entitled "Two Firms, One Trail in Probes on Ratings" (here), that explains why the government is pursuing claims against S&P but not rival rating agency firm Moody's -- it is because Moody's "took careful steps to avoid creating a trove of potentially embarrasing employee messages like those that came back to haunt S&P."  The article explains that Moody's analyts "in recent years had limited access to instant-message programs and were directed by executives to discuss sensitive matters face to face." These strictures apparently were put in place following the investigations and scandals initated by then-NY AG Eliot Spitzer.

 

More About Rule 10b5-1 Plans: As I noted in a recent post, several articles in the Wall Street Journal have raised concerns about the way that some corporate officials are using their Rule 10b5-1 trading plans. The Journal article implied that some officials were using their plans improperly, to try to shield their trades in shares of the company from scrutiny.

 

In a February 6, 2013 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation entitled “The Best Laid Plans of 10b5-1” (here), Boris Feldman, a partner at the Wilson Sonsini law firm, takes a look at the current controversy surrounding the use of Rule 10b5-1 plans. Among other things, Feldman notes that “Rule 10b5-1 plans are a blessing and a curse: a blessing, because they enable executives to diversify their company holdings in a stable, law-abiding manner; a curse, because they tempt cheaters into hiding their malfeasance in a cloak of invisibility.”

 

After considering the questions now being raised about the plans, Feldman suggests “some ‘good housekeeping’ features of plan design and implementation that enhance the odds of surviving such scrutiny.” Feldman’s article provides a number of practical suggestions to try to ensure that trading plans are used for the purposes for which they were intended and provide the protection for which the Rule was designed.

 

More SEC Enforcement Activity Against Private Equity Firms?: According to recent statements from the head of the SEC Asset Management Unit, the agency may be preparing to bring increased numbers of enforcement actions against private equity firms. According to a February 7, 2013 memo from the Weil Gotshal law firm (here), the SEC official, speaking at a recent conference, described the problems in the private equity industry as due to “too many managers chasing too little capital.” The factors the official identified as contributing to a risk of fraud in the industry include “difficulties in valuing illiquid assets and certain incentive structures that are prevalent in the private equity sector.” While noting the more active enforcement role that the agency intends to take, the official also identified the critical steps that management at private equity firms can take to make sure that the firms interests are and remain aligned with those of investors.

 

Upcoming ABA Seminar on Failed Bank Litigation: On February 21, 2013, the American Bar Association Tort Trial & Insurance Practice Section’s Professionals’ Offices and Directors’ Liability Committee will be sponsoring a teleconference on the topic of “Failed Bank Litigation.” The teleconference, which is scheduled to run from 1:00 pm to 2:30 pm, will be moderated by my good friend Joe Monteleone of the Tressler law firm, and will include a panel of distinguished experts.

 

The panel will discuss the investigations and litigation that may ensue against failed banks and their directors and officers, and will also address “various types of liability insurance policies and bonds that could be implicated, and how competing claimants and insureds must deal with finite insurance limits.” Further information about the teleconference can be found here.

 

Today’s Music Video Interlude: Turn the sound down and sit back and enjoy this amazing video of a young boy laying down some astonishing blues vocals. As the guitar shop owner says, “That is smokin’ good.”

 

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In last week’s Advisen webinar on 2012 D&O claims trends, one of the audience questions related to the growth and relevance of litigation funding in the U.S.  In responding to the question I noted, among other things, the rise of litigation funding outside the U.S., particularly in Australia and Canada – a point I underscored in a blog post late last week noting the growing importance of litigation funding in Canadian class action litigation.

 

Consistent with this litigation funding theme, on February 1, 2013 the Am Law Litigation Daily ran an interesting interview of Christopher Bogart, the CEO of Burford Group LLC, one of several firms in the vanguard of the growth of litigation funding in the U.S. Burford Group is the investment advisor for Burford Capital, which according to its website is “the world’s largest provider of investment capital and risk solutions for litigation.” (The formal relationship of the various Burford entities is described here.) Burford’s shares are listed on the London AIM exchange. Bogart helped co-found Burford in 2009, after serving as an attorney for the Cravath, Swaine & Moore law firm and as general counsel of Time Warner.

 

The Am Law Litigation Daily article asks the rhetorical question whether the “litigation funding moment” may have arrived, based on Burford’s reported results for 2012. Among other things, the article notes that Burford took in $47 million in recoveries from 12 investments (which may consist of either a single case or a portfolio of cases for a single client). The article also notes that overall Burford has provided $373 million in financing for over 46 investments. According to a January 24, 2013 Financial News article (here), Burford reported a return on investment for the completed cases of 61%, with further recoveries pending. The Financial News article suggests that this may be the period where litigation funding “comes of age.”

 

In another sign of the firm’s apparent progress, in a January 21, 2013 press release (here), Burford announced the addition to its U.S. operations of several new hires, including the addition of Georgetown University Law Professor Jonathan Molot as Chief Investment Officer.

 

Burford is only one of several litigation funding firms now operating in the U.S. and elsewhere. Juridica Investments is another investment fund that is publicly traded in the U.K. and that has U.S. operations engaged in U.S. litigation funding.  IMF Australia Ltd, another litigation funder that is listed in Australia, is the corporate parent of Bentham Capital LLC, which is also in the business of funding U.S. litigation.

 

The success of companies like Burford has attracted additional competition. For example, in January 2012, Parabellum Capital spin-out from Credit Suisse for purposes on litigation funding investments in the U.S. And, as discussed in a prior post (here) in April 2012, former Simpson Thacher partner Michael Chepiga and former Bernstein Litowitz Partner Sean Coffey announced the formation of Black Robe Capital Partners, as yet another firm formed for purposed of litigation funding investment.

 

In short, there are now a number of firms active in litigation funding in the U.S. Most of these firms have only just been formed within the last few years, but signs are that these firms could take on an increasingly important role in the U.S. litigation scene. Indeed, in Canada and Australia, where the litigation funding track record is longer, litigation funding has become a significant part of the litigation landscape, particularly with respect to class action litigation. For example, in its 2010 study of securities class action litigation in Australia (refer here), NERA Economic Consulting identified the emergence of litigation funding as the most significant development behind the increase in securities class action litigation that country. Similarly, in its recent study of Canadian class action lawsuit developments (discussed here), the Osler Hoskin & Harcourt firm documented how litigation funding arrangements increasingly are accepted by the courts, a development that the firm worries could spark further class litigation there.

 

These developments outside the U.S raise the question of what the growth (and success) of litigation funding may mean for litigation in the U.S. The more positive spin may be that the availability of litigation funding levels the playing field for smaller litigants taking on much larger adversaries. At the same time, however, litigation funding raises a host of questions. First and foremost are the concerns about the possible conflicts between the litigation investors and the actual litigants. The funders’ investment objectives may diverge from the actual litigant’s litigation objectives – differences that could lead to diverging views about litigation tactics and even case resolution approaches and objectives.

 

 Similarly, there is the question whether litigation funding is appropriate in the class action context. While the litigation funding unquestionably may help facilitate a recovery for the class, the amount to be paid to the litigation funder, in the form of commission or other payment, will reduce the amount of the recovery for the class. The absent class members cannot all be consulted in advance about such arrangements, which may or may not look fair after the fact.

 

A more fundamental question has to do with the possible effect of growing amounts of litigation funding on the litigation system. Will the availability of litigation funding encourage an increase in litigation? Will it encourage adversaries -- who might otherwise be able to reach a business resolution of their dispute – to litigate rather than negotiate? And then there are the concerns about a field in which there apparently are huge sums to be made but no apparent barriers to entry -- will the outsize profits that are now being reported attract less scrupulous competitors who attempt to extract outsized returns at the expense of litigants?

 

There are, in short, a host of unanswered questions about the growing presence of litigation funding on the U.S. litigation scene. There is no doubt in light of the outsized returns that the early entrants to the field are reporting that there will be increasing activity in the litigation funding arena and that litigation funding could become an increasingly important part of commercial litigation in the U.S. I fully expect that we will be hearing a lot more on this topic in the months ahead. But the point is –litigation funding is here, now. We had better recognize that, get used to it, and try to understand what it means.

 

One final note. The last time I ran a blog post about litigation funding, I immediately got a host of phone calls from would-be litigants looking for funding. Friends, I am just a blogger. I am not involved in litigation funding nor am I in the business of referring others to litigation funders. If you are a prospective litigant looking for litigation funding, please do not call or email me. I have linked above to the websites for the firms that are involved in litigation funding. Please contact them, not me. Thank you.

 

In the Current Environment, D&O Insurance Remains Critically Important: As numerous observers have noted (refer, for example, here), litigation related to mergers and acquisitions activity declined in 2012 relative to 2011, at least in part due to the decline in the number of M&A deals. The question remains what this development means for litigation activity in 2013. A January 25, 2011 CFO.com article entitled “If Mergers Pick Up, Can Lawsuits Be Far Behind?” (here), notes a number of factors suggesting that M&A activity could improve in 2013, which could lead to a resurgence of M&A claims – a development that could make the D&O insurance for the companies involved increasingly important.

 

The CFO.com article states the M&A related lawsuits “have been in decline because of waning M&A activity.” However, other observers have been reluctant to ascribe the decline in M&A litigation just to the reduced M&A activity alone. For example, and as discussed here, in its recent study of 2012 D&O claims, Advisen noted the number of new merger objection suits declined 24 percent in 2012 compared to the all-time high levels in 2011. The report attributed the decline in merger objection suit filings in part to the decreased M&A activity. However, the report also noted, the ten percent decline in M&A activity “does not fully explain the large decrease in suits.”

 

Whatever may be the reasons for the relative decline in M&A-related litigation in 2012, circumstances suggest that companies may be poised for a rebound of M&A activity in 2013. The CFO.com article notes that corporate cash levels, currently over $1.1 trillion for the S&P 500, may support strong M&A activity this year. Should M&A activity levels rebound in 2013, the likelihood is that the companies involved in the deals will also become involved in litigation related to the transaction.

 

The likelihood of litigation in turn underscores the importance of the D&O insurance available for the companies involved. The CFO.com article emphasizes that because of the likelihood of claims it is more important than ever for all companies – both publicly traded and privately held – to take steps and make inquiries “to make sure they’re adequately covered.” As one commentator quoted in the article notes, company officials should examine their coverage regularly, because “what’s available in the market changes, the forms change and the exclusions change.”

 

Readers who review the CFO.com article will note that the article cites results from the most recent Towers Watson D&O Liability Insurance Survey report. Readers interesting in reviewing the survey report itself should refer here.

 

The Week Ahead at the PLUS D&O Symposium: This week I will be attending the PLUS D&O Symposium at the Marriott Marquis hotel in New York. On Tuesday, February 6, 2013, I will be moderating a panel at the Symposium entitled “Financial Institutions Underwriting: Is it Safe to Come Out Now? Part 2” which is a follow-up to a panel on the same topic that I moderated at last year’s Symposium. Joining me on the panel will be Laurie Banez, Senior Vice President, Chief Underwriting Officer, Argo Pro; Jack Flug, Managing Director, Marsh; Paul Ferrillo, Litigation Counsel , Weil Gotshal & Manges LLP; and Sandy Crystal, Executive Vice President, Crystal & Company. I hope everyone will plan on attending our panel, which should be great.

 

I will be around the Symposium venue throughout the conference, and I look forward to seeing everyone there. I hope that if you see me at the Symposium that you will take a moment to say hello, particularly if we have never met before. I look forward to seeing everyone there.

 

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As numerous observers (including this blog) have noted, securities class action lawsuit filings were down in 2012 compared to the previous year and historical averages. It turns out that the downturn was not limited just to securities class action litigation. New lawsuit filings for corporate and securities litigation generally declined in 2012, according to a January 29, 2013 report from Advisen entitled “D&O Claims Trends: 2012 Wrap Up” (here). The new report details an annual decline across all of the categories of corporate and securities litigation that it tracks, while at the same time noting that litigation filings in the aggregate in 2012 were still elevated compared to prior years.

 

According to the survey, the total number of corporate and securities lawsuits declined 21 percent from 2,043 suits in 2011 to 1,616 in 2012. But though the numbers declined year over year, the 2012 filings still exceeded all other years except 2011. The elevated levels between 2012 and the years preceding 2011 was largely due to what the Advisen report calls “securities fraud” suits (which it should be emphasized is a category that does not include securities class action lawsuits and largely consists of regulatory and enforcement actions) and shareholders derivative suits.

 

The report emphasizes that the apparent decline in overall corporate and securities litigation levels between 2011 and 2012 may be a reflection of the fact that 2011 was an “unusually active year” for litigation. But, the report adds, to the extent that the 2012 figures do represent a longer term trend, it may be that the plaintiffs’ firms’ resources “are being allocated outside the realm of D&O related litigation.”

 

The decline in the number of securities class action lawsuits, which has been mush noted, “likely reflects a change in the emphasis by plaintiffs’ firms due in part to a string of Supreme Court decisions favoring defendants,” as well as a “shift in focus towards other types of suits that can be resolved quickly in more favorable state jurisdictions at a far lower cost to the law firm.”

 

Along those lines, the report notes that as recently as 2007, securities class action lawsuits represented 22 percent of all corporate and securities lawsuit filings, but only about 11 percent in both 2011 and 2012. The declining significance of securities class action lawsuit as a percentage of all corporate and securities lawsuit filings is a reflection of the changing mix of corporate and securities litigation.

 

The largest drop in corporate and securities litigation activity between 20011 and 2012 occurred with respect to breach of fiduciary duty suits, which fell 31 percent year-over-year. A large factor in this drop was the decline in 2012 of new merger objection lawsuit filings, after those types of suits had increased sharply between 2006 and 2011. According to the report, the number of new merger objection suits declined 24 percent in 2012 compared to the all-time high levels in 2011. This decline in merger objection suit filings may be in part a function of the decreasing M&A activity. However, the ten percent decline in M&A activity “does not fully explain the large decrease in suits.”

 

Though suits against financial firms continued to predominate among all corporate and securities lawsuits, the percentages of suits involving financial firms was also down in 2012. Suits against financial firms involved 28 percent of all new filings in 2012 compared to 31 percent in 2011, largely “an outcome of the continuing wind down of subprime and credit crisis activity.”

 

The report notes that during 2012, though the number of settlements was down, the average securities class action lawsuit settlement (including proposed and tentative settlements) was $51.8 million, compared to $34.9 million in 2011.

 

The report includes an interesting report on Foreign Corrupt Practices Act enforcement activity and related follow-on litigation, as we as related D&O insurance issues. The report notes that though FCPA enforcement activity was down in 2012, most commentators expect that the decline will prove to be temporary. The report also notes that between 20% and 30% of FCPA enforcement actions trigger shareholder derivative suits.

 

Advisen Report Webinar: On Tuesday January 29, 2013 at 11 am EST, I will be participating in a webinar sponsored by Adivsen in which the report’s findings will be discussed.  The webinar will provide a quarterly review of securities and other litigation impacting D&O coverage and will identify and analyze the trends of greatest significance to Risk Managers and Management Liability professionals. The participants in this free webinar will include AIG’s Tom McCormack, John McCarrick of the White and Williams law firm, and Advisen’s David Bradford and Jim Blinn. Further information about the seminar, including registration instructions, can be found here.

 

Time for a Music Video Interlude: All the Single Babies. If you like it, then you'd better put a diaper on it.

 

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In a January 22, 2013 opinion (here), Southern District of New York Judge J. Paul Oetken has dismissed one of the many securities class action lawsuits that were filed against U.S.-listed Chinese companies in 2011. Though the primary interest in the case may be that it involves U.S. securities suit against a Chinese company, Jinkosolar Holdings, the case is also interesting with respect to the alleged misrepresentations on which the suit is based, which relate to the environmental problems in one of the company’s manufacturing facilities.

 

Jinkosolar is a manufacturer of solar technology products with operations based in China. In May 2010, the company conducted an Initial Public Offering of American Depositary Shares on the New York Stock Exchange. In November 2010, the company completed a secondary offering.

 

In April and May 2011, the company had a series of communications with the Chinese environmental authorities regarding hazardous waste disposal issues at its Zhenjian plant. The company did not disclose these communications to its shareholders. However, as the Court later put it, a “kerfuffle” at the company’s plant “forced Jinkosolar’s hand.” In August and September 2011, Residents living near the plant became concerned about a large scale fish-kill near the plant. In mid-September, the media began reporting on locals’ demonstrations outside the company’s plants. In two press releases in late September, the company announced that it had suspended operations at the plant and also revealed the earlier communications with the environmental authorities. As the news came out, the price of the company’s ADSs declined 41%

 

In October 2011, holders of the company’s ADSs filed a securities class action lawsuit in the Southern District of New York against the company, eight directors and officers of the company; and the company’s offering underwriters. The plaintiffs’ complain asserted claims under both the ’33 Act and the ’33 Act. In support of their allegations, the plaintiffs relied on three statements in the company’s offering prospectus in which the company explained its environmental compliance efforts and the consequences to the company if it were found to be in violation of the applicable environmental requirements. The defendants moved to dismiss.

 

In his January 21, 2013 order, Judge Oetken granted the defendants’ motions to dismiss. Judge Oetken found with respect to two of the three statements from the prospectus on which the plaintiffs sought to rely that he could “easily dispense” with the allegations. He noted with respect to these two statements that:

 

These paragraphs do, of course, explain to shareholders that Jinkosolar is obliged to follow certain regulations. But if anything, they weigh the pluses and minuses of following such regulations with a disquieting frankness. The first paragraph, for instance, explicitly balances the costs of “compliance” with safety regulations with the “adverse publicity and potentially significant monetary damages” stemming from “non-compliance.” Similarly, the second paragraph notes that Jinkosolar is “subject” to Chinese regulations, but – particularly when read alongside the first paragraph – does nothing to indicate any sort of commitment on the part of Jinkosolar to follow those regulations.

 

The third Prospectus statement on which the plaintiffs sought to rely presented, Judge Oetken found, “a more complicated matter.” The statement indicates, among other things, that the “we generate and discharge chemical waste, waste water, gaseous waste, and other industrial waste,” reiterates the company’s monitoring efforts and adds that “we are required to comply with all PRC national and local environmental protection laws and regulation.”

 

With respect to these statements, the plaintiffs argued that these statements “falsely imply that Jinkosolar had an effective pollution treatment system and a good pollution record, suggesting that the company had put the environmental issues “in play” and creating an obligation to keep shareholders updated.

 

Judge Oetken said that was “a close call” whether the statements on which the plaintiff’s sought to rely are materially misleading. In particular one sentence “does give the court pause”: the sentence stated that “We also maintain environmental teams at each of our manufacturing facilities to monitor waste treatment and ensure that our waste emissions comply with PRC environmental standards.” Judge Oetkin said that one way the sentence could be read is to signify that the company is able to “ensure that our waste emissions comply with PR environmental standards. “ But read another way, the statement is merely saying that the environmental teams are “maintained” with the purpose or function to “monitor and to ensure” compliance.

 

The Court found that the second of these two alternative readings is “the more sensible one.” The Court went on to say that it “cannot say that a reasonable investor would, or even could, read this one ambiguous sentence as a pronouncement that Jinkosolar is ‘ensuring’ environmental standards were met.” This, the court said, is “all the more true given how cautious Jinkosolar was in it Prospectus.” The company “carefully laid out the plusses and minuses” of abiding by the Chinese regulations and “underscored to investors that fines due to pollution are a real possibility.” These warnings, “taken together with the overall weakness of the instances f material misstatements and omissions proffered by Plaintiffs, indicate that no reasonable investor coul d have believed that the Prospectuses ensured a positive environmental record.”

 

In granting the defendants’ motions to dismiss, Judge Oetken did not expressly indicated whether or not the dismissal was with prejudice. However, in his final line of his opinion, he did direct to Clerk to “close this case.”

 

Discussion

For many readers, the primary interest of this case will be that it involves a U.S.-listed Chinese company. However, unlike many of the U.S.-listed Chinese companies that have been hit with securities class action lawsuits in recent years, this company did not obtain its listing by way of a reverse merger transaction. This company completed a full-blown IPO, which may have made a difference in the outcome of this case.

 

It was only as a result of the company’s IPO that the company completed a full and detailed Prospectus. (The company also completed a full Prospectus in connection with its secondary offering.) The Prospectus contained extensive and detailed precautionary statements. It was the detail and extent of these statements that seemed to have made a difference to Judge Oetken. Thus, in his opinion, Judge Oetkin refers to what he calls the “disquieting frankness” of the company’s disclosures regarding its environmental compliance risks.” He also noted “how cautious” the company was in its environmental compliance risk factors in its Prospectuses.

 

Because of the depth of the disclosures in its offering documents, Jinkosolar was able to make arguments and raise defenses in reliance on the detailed Prospectus disclosures. Because so many of the U.S.-listed Chinese companies did not complete a full-blown IPO, but rather obtained their U.S. listings through reverse merger transactions, they likely did not create offering documents with similarly precautionary disclosure. For that reason, the outcome of this dismissal motion ruling may not be all that helpful to many of the other U.S.-listed Chinese companies involved in U.S. securities suits. Indeed, most of those other companies are unlikely to be able to raise the kinds of arguments that Jinkosolar raised here, and certainly seem unlikely to be able to cite disclosure statements that a court might describe as reflecting “disquieting frankness.”

 

For me, the most interesting thing about this case is not that it involves a Chinese company defendant, but rather that it involves alleged misrepresentations with respect to environmental liabilities and exposures. As I have previously noted on this blog (refer, for example, here), these kinds of cases, involving alleged misrepresentation of environmental issues do arise periodically. The possibility of this kind of claim is often a key concern at the time of D&O insurance policy placement, as the question often arises whether the standard policy’s pollution exclusion will preclude coverage for a securities claim based on environmentally-related disclosures.

 

As this case demonstrates, it is critically important for the standard pollution exclusion to be revised to carve back coverage for securities claims and derivative claims based on environmental disclosures. (It is worth noting that many of the modern Excess Side A DIC insurance policies often have no environmental or pollution exclusion. In addition, some carrier’s primary D&O insurance forms omit the standard pollution exclusion and simply provide that the policy’s definition of “Loss” does not include costs of environmental remediation. Unless the insured company’s primary D&O insurance policy omits the environmental exclusion in this way, it will be indispensable for the standard environmental liability exclusion be revised in order to preserve coverage for securities claims and derivative claims based on alleged misrepresentations or misconduct relating to environmental issues. These considerations are likely to become increasingly important as environmental disclosure issues become of greater regulatory concern (about which refer here).

 

The one final thing I will say about this case and the fact that it does involve a U.S.-listed Chinese company is that it is yet another case involving a Chinese company in which the plaintiffs have struggled. Although some of the U.S. securities suits have managed to survive motions to dismiss, others (like this one) have not. Even the cases that have survived motions to dismiss have proved challenging for plaintiffs as they have faced numerous procedural hurdles (refer for example here). In addition, in other cases involving U.S.-listed Chinese companies that have reached the settlement stage, the settlement amounts have proved to be modest. (On the other hand, as noted here, E&Y did recently agree to settle a Canadian securities case relating to Sino-Forest, and a Hong Kong arbitration panel did just make a more than $70 million award based on its determination that China MediaExpress Holdings is a “fraudulent enterprise.” Notably, and arguably ironically, neither of these big recoveries involved one the many U.S. court securities suits filed against Chinese companies.)

 

Special thanks to a loyal reader for sending me a copy of Judge Oetken’s opinion in this case.  

 

Upcoming Event: Readers of this blog may be interested to know about a seminar that will be held at the St. John's School of Risk Management in New York on February 5, 2013 entitled "A Day at Lloyd's: An Introduction to the Lloyd's Market Structure and the Use of ADR to Manage Disputes Involving Lloyd's."  The event will be moderated by my good friend Perry Granof and includes a number of distinguished speakers, among them another good friend, Nilam Sharma of the Ince & Co. law firm. The event, which will take place on the day prior to the beginning of the PLUS D&O Symposium, runs from 12:30 to 5:00 pm. Further information about the event can be found here. You can register for the event here.

 

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Securities class action lawsuit filings were down “sharply” in 2012 compared to the prior year and to historical average, according to Cornerstone Research’s annual report. The study, published in conjunction with the Stanford Law School Securities Class Action Clearinghouse and entitled “Securities Class Action Filings: 2012 Year in Review,” can be found here.  A short, single-page graphic summary of the report’s conclusions can be found here. The two organization’s January 23, 2013 press release discussing the report can be found here. My own analysis of the 2012 securities suit filings can be found here.

 

According to the report, there were 152 securities class action lawsuits filed in 2012, which is below both the number of filings in 2011 (when there were 188) and the 1997-2011 annual average number of filings (193). The 152 filings in 2012 represents a 19 percent decrease from 2011 and a 21 decrease from the 1997-2011 annual average.

 

A significant factor in the reduced number of filings in 2012 was the decline in filing activity during the year’s second half, particularly during the fourth quarter. There were only 64 filings in the second half, compared with 88 in the first half. The filing level in the second half of 2012 was “lower than all semiannual periods other than the historic low observed in the second half of 2006.” The 25 filings in the year’s fourth quarter was “the lowest number of filings in any quarter in the last 16 years.” The report notes that these observations are consistent with “a declining trend since the first half of 2010.”

 

The report states that the decrease in 2012 filings was “largely due” to declines in federal mergers and acquisitions objection litigation and in the number of lawsuits involving Chinese companies (particularly Chinese companies that obtained a U.S. listing through a reverse merger transaction). According to the report, on a year-over-year basis, M&A filings decreased 70 percent (as plaintiffs appeared to prefer state court forums for this type of litigation) and filings related to Chinese reverse merger companies decreased by 68 percent. The report also noted that for the first time since 2007 there were no new securities class action lawsuit filings related to the credit crisis.

 

The number of filings against foreign issuers dropped from 61 in 2011 to 32 in 2012 (a 48 percent drop). Though filings against foreign issuers represented only 24 percent of all 2012 filings, compared to 32 percent in 2011, the 2012 percentage “reflects a level that is greater than al prior years other than 2011.” The continued elevated level of filings against foreign issuers in 2012 is largely due to filngs related to Chinese firms. There were a total of 18 filings against Chinese companies in 2012 (including Hong Kong companies) compared to 40 in 2011.

 

Larger companies were less likely to be the target of a securities suit in 2012 compared to recent years. 3.4% of S&P 500 companies were named in securities suits in 2012, compared to an annual average of 6.1% for S&P 500 companies during the period 2000 to 2011. The 2012 level is comparable to the 13-year low observed in 2011 (3.2%).

 

The most targeted industrial sector in 2012 was Consumer Non-Cyclical, representing 32% of all filings. Health care and life sciences companies comprised 67 percent of all Consumer Non-Cyclical filings (33 filings), compared to 62 percent (28 filings) in 2011. Filings against companies in the financial sector continued a declining trend with 15 filings in 2012, compared with 43 in 2010 and 25 in 2011.

 

As I noted in my own analysis of the 2012 securities suit filings, it is too early to tell whether the late-year decline in filings represents a trend or just a temporary dip in the general ebb and flow of securities suit filings. The report noted that the previous low semiannual filing level was in the second half of 2006, which was quickly followed by the onslaught of the subprime meltdown and credit crisis-related litigation wave.

 

One obvious factor in the overall 2012 decline was the absence of any episodic even driving filing levels. Indeed, Dr. John Gould, one of the report’s authors, is quoted in the press release as having said that “the absence of a filings trend…influenced the total number of new cases,” by comparison to recent years when filing levels have been dominated by “observable filings types,” such as, more recently, the M&A related litigation and litigation involving U.S.-listed Chinese companies.

 

While it is hard to know whether the trend will continue, the press release identifies at least one development that could result in a possible increase in future securities lawsuit filings. The press release quotes Stanford Law School Professor Joseph Grundfest, who notes that the upsurge in SEC whistleblower reports raises the questions whether the SEC will translate these reports into enforcement actions, and, if so, whether “private-party plaintiffs will be successful in prosecuting ‘piggyback’ claims that copy the Commission’s complaints.”

 

One factor that could also explain the declining number of 2012 filings is the plaintiffs’ securities bar’s continuing shift to diversity their inventory. Going back to the options backdating cases in 2006, the plaintiffs lawyers have been pursuing types of litigation other than securities class action litigation (in part due to unfavorable U.S. Supreme Court decisions). While the Cornerstone Report notes the absence of any new credit crisis-related securities class action lawsuit filings in 2012, there were a host of credit crisis-related lawsuits filing as individual actions in 2012. It is hard to tell, but it seems likely that this diversifying trend will continue.

 

Finally, it is worth noting that, as one reader observed in a comment to my blog post analyzing the 2012 securities suit filings, Superstorm Sandy could have had an impact on fourth quarter filings, since the storm basically closed New York’s downtown business district for several weeks during the fourth quarter.

 

Jan Wolfe's January 22, 2013 Am Law Litigation Daily article about the Cornerstone Research report can be found here.

 

 

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In a January 18, 2013 order (here), the U.S. Supreme Court granted a writ of certiorari to hear the appeals of three separate petitioners in cases arising out of the Ponzi scheme of R. Allen Stanford. The petitioners are two former law firms for the Stanford International Bank and an insurance brokerage that allegedly was involved in the sale of certificates of deposits for the bank. The petitioners are asking the Supreme Court to decide whether or not the plaintiffs are precluded under the Securities Litigation Uniform Standards Act (“SLUSA”) from asserting state-law class action claims against the three firms. By taking up the case, the Supreme Court will decide important issues about SLUSA’s scope that have divided the lower courts.

 

Congress enacted SLUSA in 1998 in order to prevent erstwhile securities law claimants from circumventing the restrictions of the Private Securities Litigation Reform Act (PSLRA) by filing their claims in state court under state law. As the Supreme Court said in 2006 in the Dabit case, “To stem the shift from Federal to State courts and to prevent certain State private securities class action lawsuits alleging fraud from being used to frustrate the objectives of the [PSLRA], Congress enacted SLUSA.”

 

SLUSA precludes most state-law class actions involving a “misrepresentation” made “in connection with the purchase or sale of a covered security.” The lower courts have wrestled with the question of what it required in order to satisfy the “in connection with” requirement and trigger SLUSA preclusion.

 

In these cases, the investor plaintiffs contend they were misled to believe that the CDs in which they invested were backed by quality securities traded on major exchanges (though it later appeared that the CDs in fact had little or nothing behind them). The defendants moved to dismiss the state law class actions that had been filed against them, arguing that, though CDs themselves were not “covered securities” within the meaning of SLUSA, the state court class action claims were nevertheless precluded under SLUSA because the plaintiffs claimed they were induced to purchase the securities by misrepresentation that the CDs were backed by SLUSA-covered securities.

 

The district court before which the cases were consolidated granted the defendants’ motions to dismiss and the plaintiffs appealed. In a March 19, 2012 opinion (here), a three-judge panel of the Fifth Circuit reversed the district court, specifically holding that the alleged purchases of covered securities that back the CDs were “only tangentially related to the fraudulent scheme” and therefore that SLUSA does not preclude the plaintiffs from using state class actions to pursue their claims.

 

In reaching its decision, the Fifth Circuit panel exhaustively reviewed the prior case law in which other Circuit courts had considered the question of what connection between an alleged fraud involving uncovered and a downstream transaction in covered securities is required for SLUSA preclusion to apply. The Fifth Circuit’s review of the case law shows that there are divergent and potentially inconsistent views among the various Circuit courts on this question.

 

The two defendant law firms and the defendant insurance brokerage firm filed petitions for writ of certiorari to the U.S. Supreme Court. The cert petitions of the Proskauer Rose and Chadbourne & Parke law firms can be found here and here, respectively. The cert petition of the insurance brokerage, Willis of Colorado, Inc., and its related entities and firms, can be found here. (Hat tip to the SCOTUS Blog for the links to the cert petitions.)

 

In its petition, the Chadbourn & Parke law firm argued that split in authority among the various circuit courts has resulted in inconsistent interpretations and applications of SLUSA preclusion. The firm argued that the Fifth Circuit had adopted an interpretation of the “in connection with” standard that resulted in a determination that SLUSA preclusion did not apply, allowing the case against the firm to go forward, while at the same time rejected a conflicting standard prevailing in the Second, Sixth and Eleventh Circuits that would have resulted in the application of SLUSA preclusion here. The petitioners argued that the Circuit split not only threatened inconsistent outcomes among the Circuits, but it frustrated the very purposes for which Congress enacted SLUSA – that is to establish “national standards” for class actions “involving nationally traded securities.”

 

The Supreme Court’s consideration of these three consolidated cases promises to be interesting and potentially significant. If nothing else, the consolidated cases involve a high-stakes dispute relating to a high-profile fraud. This consideration alone ensures that the Supreme Court’s consideration of these three consolidated cases will receive significant attention.

 

On a more basic level, the Supreme Court’s consideration of these issues should resolve the split among the Circuits in their interpretation of the “in connection with” requirement in the SLUSA preclusion provision. Resolving this split should reduce the possibility of different outcomes in different cases based on nothing more than the judicial Circuit in which the different cases were filed.

 

More importantly, the Supreme Court’s consideration of these issues will help define the scope of SLUSA preclusion in more complex cases where the alleged fraudulent scheme involves a multi-layered transaction. These kinds of questions have been unfortunately common in recent times: for example, the same kinds of questions arose in connection with the Madoff feeder fund suits. (The Courts in the Madoff feeder fund cases concluded that SLUSA preclusion applied.)

 

In a very important sense, the Supreme Court is just the latest battle in the continuing struggle that first emerged after the enactment of the PSLRA. The struggle involves the efforts of the plaintiffs’ securities bar to try to find ways to circumvent the strict standards that Congress imposed in the PSLRA. The plaintiffs’ lawyers first tried to avoid the PSLRA by pursuing their claims in state law suits to which the PSLRA. To avoid that, Congress enacted SLUSA. In these consolidated cases, the Supreme Court will determine the extent to which plaintiffs pursuing claims against remote actors are or are not subject to the constraints of the PSLRA as well as the subsequent Supreme Court case law interpreting the PSLRA

 

In their cert petition, Chadbourne Park argues that the plaintiffs’ filed their claims as state law class action precisely for the reason of circumventing Supreme Court case decisions that restricted federal securities law claims against third party advisors, which is precisely the outcome SLUSA was intended to prevent. In making these arguments, the law firm emphasizes that the aiding and abetting claims the plaintiffs are attempting to assert under state law are not allowed under federal law. The Supreme Court’s determination of these consolidated cases will significantly determine the extent to which plaintiffs can pursue state law securities-related claims against third party advisors. The determination matters because of the possibility it presents that the plaintiffs could pursue these state law claims in circumstances in which federal statutory and case law would not permit such claims.

 

The Supreme Court’s cert grant in these three consolidated cases is just the latest in a series of securities-related disputes that the Court has been willing to take up. The Court already has the Amgen case on its docket this term; the Amgen case has already been argued and the Court’s decision in expected before the end of the current term in June.

 

It used to be that years would pass between Supreme Court cases considering securities law issues. In the past five or six years, though, the Court has seemed to want to take up several securities cases each term. While the Court’s willingness to take up more securities cases certainly provides great blog fodder, it has made the securities litigation environment more volatile and it has occasionally introduced significant and unanticipated changes (as happened for example with the Supreme Court’s paradigm-shifting opinion in Morrison v. National Australia Bank). In final analysis, that is the real reason it is interesting when the Supreme Court agrees to take up a securities case – you never know for sure what might happen when the Supreme Court makes its determination.

 

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In what is as far as I know the first determination of liability in connection with the recent wave of litigation filed against U.S. listed Chinese companies, a Hong Kong-based arbitration panel has entered an award in favor of an investment unit of C.V. Starr of over $77 million against China MediaExpress Holdings and related persons and entities, based on the panel’s determination that the company was a “fraudulent enterprise.” The panel’s December 19, 2012 award, which can be found here, makes for fascinating reading. (Hat tip to Jan Wolfe, who reported the award and related U.S.-court filings in a January 16, 2013 Am Law Litigation Daily article, here.)

 

In October 2010, China MediaExpress obtained a U.S. listing through a reverse merger with a U.S. listed publicly traded shell corporation. Prior to the reverse merger, the predecessor entity was owned by Zeng Cheng (“Cheng”) and Ou Wen Lin and Lin’s brother. China MediaExpress allegedly was in the business of providing advertising on inter-city busses. The company’s financial statements showed growing profits and large cash reserves. Starr invested a total of $53.4 million in China MediaExpress in two private transactions in January 2010 and October 2010. 

 

In early 2011, online analysts published reports questioning China MediaExpress’s financial statements. Shortly thereafter, China MediaExpress’s auditor and CFO resigned, as well as members of its board of directors. (Refer here for background.) Trading in China MediaExpress’s shares was halted. Pursuant to provisions in its stock purchase agreements with China MediaExpress, Starr initiated two Hong Kong arbitration proceedings against China MediaExpress, as well as Cheng, the Lin brothers and related entities. Separately, Starr initiated a securities fraud class action against China MediaExpress, its principals and related entities, and the company’s auditor in the District Court of Delaware. (In addition, certain other shareholders separately filed a securities class action lawsuit against China Media Express in the Southern District of New York, about which refer here.)

 

The arbitration panel, which was chaired by former Delaware Supreme Court Justice Andrew Moore II, heard evidence in the two consolidated arbitrations in May 2012. On December 19, 2012, the panel delivered its Award.  A copy of the arbitration award was filed in the District of Delaware lawsuit on January 13, 2013 (refer here).

 

The 49-page award makes for some fascinating reading. Among other things, the panel concluded that the company was “a fraudulent enterprise that caused Starr to lose the total value of its investment.” Cheng, the panel concluded, has “no credibility whatsoever”. Ou Wen gave the impression on the witness stand that “he would say whatever he thought would advance his case.” 

 

Among many things that troubled the panel was what had happened to the supposedly thriving business that had been represented to Starr. The company attempted to argue that the business had been destroyed by short sellers, a contention the panel described as “ridiculous,” observing that:

 

To put it bluntly, this claim of Cheng and CME that short sellers destroyed his business is nonsense. It is a fabrication evidently designed to hide the fact that CME never had the business it represented to the world that it had or that, if it did, it has been ravished by dishonest conduct on the part of those who conducted the business. Coupled with the conduct when challenged with the matters raised by [the company’s auditors] and other matters, Cheng’s claim that the short sellers destroyed his business indicates that Starr was correct with it contended that CME was a fraudulent enterprise.

 

The one specific transaction Cheng offered to explain what happened to all of the cash that the company had reported on its balance sheet was “a land transaction at Shoushan Waterfall.” However, the “evidence concerning this transaction was so implausible and contradictory that it is impossible to accept his claim that any money invested in that transaction was for the benefit of CME and its shareholders even if money of CME was used to finance this transaction.” Overall, the evidence Cheng offered regarding this transaction (which had not been approved by the Board or reported to shareholders and involved a company in which Cheng had an ownership interest) established that Cheng was “in breach of his fiduciary duty.” The evidence concerning the transaction “simply reinforces the conclusion that Cheng was both an unreliable witness and a dishonest businessman.”

 

As Jonathan Weil said in his January 11, 2013 Bloomberg column about the latest accounting scandal involving a Chinese company, “Chinese stocks may not make for trustworthy investments, but they sure can be entertaining to watch from a distance.”

 

The arbitration panel’s award represents a devastating judgment against China MediaExpress and its key officials. It remains to be seen how Starr will be able to use this judgment in its separate U.S. securities fraud suit and whether it will be able to collect on the Hong Kong panel’s award. It will also be interesting to see what the claimants in the separate securities class action lawsuit will be able to make of the arbitration award. On the one hand, the panel’s brutally worded conclusions about the company and its principals are damning. On the other hand, the issue preclusive effect of these determinations in separate proceedings involving separate parties and separate evidentiary standards is the kind of thing good lawyers could argue about for a long time.

 

In any event, whatever the ultimate effect of the arbitration’s panel’s determinations may prove to be, the fact is that, according a statement by Starr’s lawyer quoted in the Am Law Litigation Daily article linked above, the panel’s ruling represents the “first time any of these issues concerning Chinese reverse mergers have been adjudicated.” The implication for other companies involved in these cases – many of which involve allegations even more sensational than were raised here – is ominous.

 

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On January 10, 2013, in a detailed and interesting opinion with features that may be helpful to other life sciences securities suit defendants, Middle District of Tennessee Judge Kevin Sharp granted the motion of Biomimetic Therapeutics to dismiss the securities class action lawsuit that had been filed against the company over its disclosures concerning developments in the clinical trials of its flagship product. A copy of Judge Sharp’s opinion can be found here.

 

The clinical trials were conducted in support of the company’s efforts to obtain FDA approval of its bone grafting product called Augment. Biomimetic conducted the clinical trial pursuant to protocols it had proposed and that had been approved by the FDA. As later became apparent, Biomimetic based its analysis of the testing results on a different patient population than had been identified in the FDA-approved protocols. The results associated with the different population were more favorable to the company.

 

The FDA expressed concerns to Biomimetic about the population used and other aspects of the clinical trials in a December 3, 2012 deficiency letter. The FDA also raised a number of concerns about the trials in a May 10, 2011 briefing document released in advance of the public expert panel meeting. Following the meeting, the expert panel narrowly voted in favor of approval of the Augment’s safety and efficacy.

 

Biomimetic’s share price declined 35% following the FDA’s May 10, 2011 disclosure of the testing concerns. Its share price declined a further 12% following the narrow expert panel vote, out of concerns that in view of the narrowness of the expert panel vote, FDA approval without additional processes was unlikely.

 

Following the share price decline, shareholders filed a securities class action lawsuit in the Middle District of Tennessee against Biomimetic and certain of its directors and officers. The shareholders alleged that throughout the class period, the defendants made unjustifiably positive statements about the Augment clinical trials and omitted to disclose the specific concerns that the FDA had raised about the trials.

 

According to the court, the “heart” of the plaintiffs’ allegations was that the defendants had engaged in a regulatory “bait and switch” by changing the patient population used to analyze its trial results in a way that allowed the company to report more favorable results that would have been shown if the original population were used. The plaintiffs also alleged that the defendants had failed to disclose the other problems with the clinical trials, including in particular that Biomimetic had failed to include processes to capture measurements on additional items that were of particular concern to the FDA.

 

The defendants moved to dismiss the plaintiff’s complaint.

 

The January 10 Opinion

In his January 10, 2013 opinion, Judge Sharp granted the motion to dismiss without leave to amend, finding that the plaintiffs’ allegations failed to meet the pleading requirements of the PSLRA.

 

Judge Sharp rejected the argument that the company’s use of a modified patient population to analyze the trial results violated the FDA-approved protocol. He also found that in a press release and in an earnings call, the company had “acknowledged the confusion that had been generated between the classifications of patient populations.” In light of these disclosures, the company’s statements about the patient populations “do not suggest a knowing and deliberate intent to deceive or defraud, let alone highly unreasonable conduct.”

 

In reaching this conclusion, Judge Sharp put particular emphasis on the fact that the company had “never suggested approval by the FDA was assured,” adding that “quite to the contrary,” the company “repeatedly and consistently warned that there were no guarantees that Augment would be approved.”

 

Judge Sharp also found that plaintiffs’ allegations that the defendants had deceptively omitted to disclose other clinical trial deficiencies were also insufficient. He concluded that “the alleged deficiencies and the omission in the clinical trials do not raise a strong inference of fraudulent intent as required by the PSLRA.”

 

In particular, Judge Sharp rejected, as insufficient, the plaintiff’s argument that the company was “cutting corners by failing to conduct certain tests or studies.” He noted that

 

The notion that [Biomimetic] would recklessly forego necessary tests and studies or hide adverse events makes little sense, even disregarding Defendants’ assertion that they poured their own money into the company. Plaintiffs’ own allegation is that Augment is [Biomimetic’s] flagship product and necessary to the companies [sic] success, begging the question why it would sabotage all of the company’s efforts on the point.

 

Along those lines, Judge Sharp noted that neither the company nor the individual defendants had engaged in securities sales after the company received the FDA’s deficiency letter.

 

One particularly interesting aspect of Judge Sharp’s opinion is his consideration of the plaintiffs’ allegations that the defendants had deceptively failed to disclosed the FDA’s concerns in the deficiency letter while at the virtually the same time had made positive statements about the progress of the Augment clinical trials. Judge Sharp noted that “a deficiency letter is not a final FDA decision, but a request for more information, and in fact, very few [applications] are approved without the issuance of a deficiency letter.” Judge Sharp then cited with approval language from a prior opinion to the effect that “it simply cannot be that every critical comment by a regulatory agency has to be seen as material for securities law reporting purposes.” He concluded that based on the overall factual allegations, the company “had a reasonable basis for optimism” notwithstanding the concerns noted in the deficiency letter.

 

Discussion

As I noted in my recent analysis of 2012 securities class action lawsuit filings, life sciences companies continue to be a favored target for securities class action litigation. The reason the companies attract securities suits has a lot to do with the complex and unpredictable regulatory process to which the companies are subject. The regulatory process is. As this case shows, many things can happen during the course of a clinical trial, which in turn can significantly affect investors’ perceptions of the prospects for the company involved.

 

There are several aspects of Judge Sharp’s opinion that should be heartening to life sciences companies that find themselves targeted by securities litigation as a result of setbacks the companies experience in the clinical trial process.

 

First, Judge Sharp showed an uncommon willingness to immerse himself in the complexities of the regulatory process and the science involved with the Augment clinical trials. Because of his willingness to understand the complex details, he was able to understand what had happened concerning the change in patient population used for analytical purposes. He was also able to understand the company’s disclosures about the populations used. Because he had this understanding, he was not persuaded by the plaintiffs’ characterization of the change in patient populations as a “bait and switch.” Of course, other life sciences securities suit defendants may not always have a court as wiling to do the hard work to develop those kinds of detailed understandings of the process and of the science. But this case does show the possibilities arising from trying to make those kinds of arguments to the court.

 

A second and more interesting aspect of Judge Sharp’s opinion has to do with his analysis of the plaintiffs’ allegations concerning the defendants’ alleged failure to disclose the concerns noted in the deficiency letter. Although he does not come right out and say that life sciences companies do not have an obligation to disclose an FDA deficiency letter, Judge Sharp’s opinion certainly will provide support for other life sciences securities suit defendants who want to argue that the mere fact that the FDA has sent a deficiency letter alone is not necessarily material and that the failure to disclose concerns identified in a deficiency letter does not by itself amount to securities fraud. This aspect of Judge Sharp’s opinion could prove to be quite helpful for other life sciences securities defendants.

 

Another important aspect of Judge Sharp’s opinion has to do with his analysis of the company’s precautionary disclosures. He clearly considered it important that the company avoided any suggestion that approval of Augment was assured and emphasized the possibility that Augment might not be approved. The company’s precautionary disclosures, along with the absence of any insider or company stock sales at sensitive times, seems to have gone a long way toward reassuring Judge Sharp that the defendants had not set out to deceive anyone. Judge Sharp’s opinion underscores the importance for life sciences companies to avoid overly optimistic statements about future regulatory outcomes as well as for the companies to use the disclosure documents to “bespeak caution” to investors about the uncertainties of the regulatory process.

 

One final note about Judge Sharp’s opinion has to do with the simple fact that the dismissal was granted. Because of the unpredictability of the FDA regulatory process and because of the resulting volatility of life sciences companies’ share prices, the companies tend to attract significant levels of securities litigation. But though the companies may attract lawsuits,  that does not always mean that the suits are always great cases for the plaintiffs. As one industry observer noted (refer here), “courts continued to grant with relative frequency life sciences companies’ motions to dismiss due to plaintiffs’ inability to sufficiently plead scienter.”

 

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Seven former independent directors of Satyam – the Indian company known as the “Indian Enron” due to the high-profile accounting scandal that swamped the firm in 2009 – have secured their dismissal from the U.S. securities litigation the company’s shareholder filed in the scandal’s wake.  Southern District of New York Judge Barbara Jones’s January 2, 2013 opinion granting the directors’ dismissal motions can be found here. The opinion contains an interesting take on the U.S. Supreme Court’s 2010 Morrison decision and also, in its observation that the director defendants “were themselves victims of fraud,” provides an interesting perspective on the issues surrounding the liabilities of outside directors.

 

Background

Satyam was quickly dubbed the "Indian Enron" when it was revealed in January 2009 – in a stunning letter of confession from the company’s founder and Chairman -- that more than $1 billion of revenue that the company had reported over several years was fictitious. Investors immediately filed multiple securities class action lawsuits in the Southern District of New York.

 

The plaintiffs’ consolidated amended complaint alleges that in addition to fabricating revenues senior company officials siphoned off vast sums from the company to entities owned or controlled by the Chairman and members of his family. The defendants include three inside directors, who were alleged to be primarily responsible for the accounting fraud; and seven independent directors, five of whom were alleged to be on the company’s audit committee; certain entities affiliated with the company’s chairman and individuals associated with those companies; and certain PwC-related entities.

 

As discussed here, in February 2011, Satyam agreed to settle the securities claims against the company itself for a payment of $125 million. The settlement did not resolve the claims against the other defendants, including the individual defendants, all of which remained pending. In May 2011, PwC agreed to settle the claims against the PwC-related entities for a payment of $25.5 million (about which refer here).

 

The director defendants moved to dismiss the securities suits on two grounds. First, they argued in reliance on the Morrison decision that certain claimants who had acquired their Satyam shares outside the U.S. could not assert claims under the U.S. securities laws. Second, they argued that the claimants’ claims did not satisfy the pleading requirements to establish a securities claim.

 

The January 2 Opinion

In her January 2 Opinion, Judge Jones granted the directors’ motions to dismiss on both grounds. First, Judge Jones held that the plaintiffs had not pled sufficient facts to establish a strong inference of scienter at least as compelling as the non-fraudulent inferences. Judge Jones observed that “the majority of the allegations” involve “an intricate and well-concealed fraud perpetrated by a very small group of insiders” that and “only reinforce the inference” that the directors defendants were themselves victims of fraud.”  

 

Judge Jones also granted the director defendants’ motion to dismiss the claims of some of the claimants based on the Morrison decision. The director defendants had moved to dismiss the claims of shareholders who had acquired their Satyam shares on the Indian stock exchanges. The director defendants also moved to dismiss the claims of current and former Satyam employees who had acquired their Satyam shares through their participation in Satyam employee stock option plan. The director defendants argued in reliance on Morrison that because those claimants’ claims did not involve either shares listed on a U.S. exchange or a domestic securities transaction, the claims were not cognizable under the U.S. securities laws. (The director defendants did not seek to dismiss the claims of those who had acquired Satyam American Depositary Shares (ADS) on the NYSE.)

 

In opposing the motion to dismiss the claims of shareholders who purchased their Satyam shares on the Indian securities exchanges, the plaintiffs argued that Morrison did not apply because those shareholders had placed their buy orders in the U.S. and had suffered injuries in the U.S. Judge Jones said that this argument “is predicated on precisely the approach that the Supreme Court rejected in Morrison.” She added that “an investor’s location in the United States does not transform an otherwise foreign transaction into a domestic one.”

 

In opposing dismissal of the claims of Satyam employees who acquired Satyam ADSs through the company’s employee stock option plan, the plaintiffs argued that because the employees acquired ADSs through the stock option plan, and because ADSs traded on the NYSE, Morrison did not preclude the employees’ claims. Judge Jones found that the relevant question was not whether or not ADSs trade on a U.S. exchange; the question was whether or not the employees had acquired the ADSs in the U.S.. In reviewing the materials relating to the stock option plan, Judge Jones found that the “exercise of options to acquire Satyam ADSs occurred in India and therefore fall outside the scope of Section 10(b).” Judge Jones rejected the plaintiffs’ suggestion that the stock option exercise was nevertheless a domestic securities transaction merely because the ADSs acquired were the same as the ADSs that traded on the NYSE. Judge Jones said that fact that Satyam’s ADSs were also listed on the NYSE is “irrelevant” the employees acquired their ADSs in India.

 

Discussion

Many outside directors have significant concerns about their potential securities liability, particularly with the respect to the possibility that they might be held liable for management improprieties.  However, the fact is that outside directors are rarely held liable under the U.S. securities laws. Judge Jones’s scienter determination arguably suggests one reason why that is so. 

 

Notwithstanding the massive scale of the Satyam fraud and the fact that several of the director defendants sat on the audit committee, Judge Jones found that the plaintiffs had failed to satisfy the scienter pleading requirements. In reaching this conclusion, Judge Jones emphasized that the fraud, as massive as it was, had been perpetrated by a small group of insiders, and that the director defendants themselves were “victims of the fraud.” Judge Jones’s determination in this regard may provide some reassurance to outside directors concerned that they could be held liable for management misconduct of which the directors are unaware.

 

Judge Jones’s ruling that the claims of the Satyam shareholders who purchased their shares on the Indian exchanges were not cognizable under the U.S. securities laws is consistent with the developing body of case law under Morrison.

 

However, Judge Jones’s ruling with respect to the claims of the Satyam employees who acquired their shares through the stock option plans is interesting. It is n one respect consistent with prior decisions holding that the mere fact that a class of securities trades on a U.S. exchange does not mean that the U.S. securities laws apply to any transaction involving of that class of securities regardless of where it takes place. Judge Jones’s determination is nevertheless interesting because as far as I am aware it represents the first application of Morrison to securities purchased through a foreign-based employee stock option plan.  Judge Jones’s opinion shows how Morrison should be applied to determine whether or not employees acquiring securities through a foreign-based plan can assert claims under the U.S. securities laws.

 

Jan Wolfe's January 3, 2012 Am Law Litigation Daily  story about Judge Jones’s opinion can be found here. Special thanks to a loyal reader for providing me with a copy of the opinion.

 

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Largely as a result of a slowdown in new filings during the fourth quarter, 2012 securities class action lawsuit filings were below the filing levels of recent years and below historical averages. Filing levels remained elevated in the natural resources, life sciences and computer services industries, and filings against non-U.S. companies, though off from 2011 record levels, remained above historical levels.

 

There were 156 new securities class action lawsuit filings during 2012. (Please see the comment below regarding my counting methodology.) The 2012 filing count is down from the 188 securities suits filed in 2011 and is well below the 1996-2011 annual average of 193.

 

The drop in 2012 filings is largely due to the decline in filings during the fourth quarter. There were 45, 45 and 41 filings during the first, second and third quarters, respectively. However, in the fourth quarter there were only 25 new securities class action lawsuit filings. The 66 new filings during the second half represented the lowest filing level for any half-yearly period since the first half of 2007, when 69 new securities suits were filed. (The lowest half-yearly filing period since 1996 was the second half of 2006, when there were only 55 new securities class action lawsuit filings. )

 

The 156 securities class action lawsuits filed during 2012 were filed in 45 different federal district courts, as well as two state courts. (The ’33 Act provides for concurrent state court jurisdiction for liability actions under the Act.) Though securities suits were filed in many different courts, there was a significant concentration of filings of new securities suits in the Southern District of New York. There were 43 new securities suits filed in the S.D.N.Y., representing 27.56% of all 2012 filings. Other courts with significant concentrations of new securities suits included the Northern District of California and the Southern District of California, each of which had 13 new filings during 2012; the District of Massachusetts (8); the Northern District of Illinois (7); and the District of New Jersey (6).  Filings in the S.D.N.Y., N.D. Cal., and S.D. Cal. together accounted for over 44% of all of the 2012 securities suit filings.

 

The 2012 securities suits were filed against companies in a broad variety of industries. The 2012 securities suits involved companies in 81 different Standard Industrial Classification (SIC) Code categories. There were, however, concentrations in certain industries. There were 27 new securities suits against companies in the life sciences industries (represented by companies in the 283 SIC Code group [Drugs] and the 384 SIC Code group [Surgical, Medical and Dental Instruments and Supplies]).These 27 new suits against life sciences companies represented 17.3% of all filing during the year. Of particular note is that there were 15 new filings in the SIC Code category 2834 (Pharmaceutical Preparations) alone, representing nearly ten percent of all 2012 filings.

 

There were 16 new securities suits against companies in the natural resources extractive industries, including mining (SIC Code categories 1000, 1040, 1220, 1221) and oil and gas production (SIC Code category 1311). And there were ten new securities suits in SIC Code group 737 (computer programming, data processing and other computer services).

 

There were 26 new securities suits in 2012 against non-U.S. companies, representing about 16.6% of all 2012 filings. Both the absolute number and percentage of suits involving non-U.S. companies are down from 2011, when there were 68 lawsuits against non-U.S. companies represented 36.2% of all filings. Though the 2012 filings against non-U.S. companies were down from 2011, the 2012 filings against foreign firms were at levels comparable to 2010, when there were 27 suits against non-U.S. firms representing 13.4% of all filings.

 

The record levels of filings against non-U.S. companies during 2011 were largely due to the flood of suits last year against U.S.-listed Chinese companies. There were 41 suits against Chinese-based companies in 2011. Though the number of suits against Chinese companies declined in 2012, there were still 14 suits filed against companies based in China, plus another three suits against companies based in Hong Kong. (Note: I am including in my count of suits against Chinese companies the lawsuit filed on December 31, 2012 in the Southern District of New York against Silvercorp Metals, which is a company with its headquarters in Canada but all of its operations in China.) Overall, the new suits filed against non-U.S. firms in 2012 involved companies based in six different countries. Following China, the country with the highest number of companies sued in U.S. securities class action lawsuits during 2012 was Canada, which had six companies hit with U.S. securities suits.

 

Discussion

My count of 156 securities suits during 2012 will be different from other published tallies of the securities suit filings. My count is slightly above that of the Cornerstone Research because my tally, unlike the Cornerstone Research tally, includes ’33 Act suits filed in state court pursuant to the Act’s concurrent jurisdiction provisions. At the same time, however, my count is below other tallies, such as, for example, the count of NERA Economic Consulting, because I only count related lawsuit filings once, regardless of the number of separate complaints filed. NERA and others count separate complaints filed in separate jurisdictions separately unless or until they are consolidated in the same judicial district. In addition, my count includes only lawsuits that seek to recover damages for alleged violations of the federal securities laws.  As a result, my tally will be lower than other class action  lawsuit counts that include suits  against corporations and their directors and officers that do no allege securities laws violations (for example, merger objection suits).

 

The decline in the number of new securities lawsuit filings during the fourth quarter of 2012 is interesting, but at this point it is hard to know what it might mean, and it is far too early to jump to any conclusions about possible permanent shifts in the level of securities suit filings. There have been periods before (for example, at the end of 2006 and the beginning of 2007) when there were lulls in the level of securities suit filings, but at least in the past, the lulls in filing levels have proven to be temporary and relatively short-lived. Indeed, the lull at the end of 2006 and the beginning of 2007 was followed by a surge of new securities filings during following periods, as securities suits related to the subprime meltdown and credit crisis came flooding in.

 

There seem to be a few possibilities to explain the drop off in securities suit filings in the fourth quarter. The first is the absence of any cyclical phenomenon driving filings. During the period 2007 to 2010, the total number of filings was driven by lawsuits relating to the subprime meltdown and the credit crisis. During 2011, there was a surge of filings against U.S.-listed Chinese firms. By contrast, during 2012, the really wasn’t any particular cyclical development to drive filings.

 

Another factor in the decline in filings during the fourth quarter may be that there were a significant number of lawsuits filed during that time period as individual actions (particularly many of the lawsuits recently filed alleging misrepresentations in connection with mortgage securities offerings, as well as many of the suits filed in connection with the mortgage put-back litigation). It may be that the individual suit filings distracted from class action lawsuit efforts.

 

A third factor behind the decline in securities suit filings may be that the plaintiffs’ securities bar is seeking to diversify its product line. As I have previously noted, the increase in M&A litigation and the surge in say-on-say litigation, among other things, may be understood in part as the efforts by at least certain members of the plaintiffs bar to find new opportunities in lieu of traditional securities litigation, which has both become more costly (owing to electronic discovery) and more difficult (owing to case law developments) to pursue. Of course, if some cyclical phenomenon presenting securities litigation opportunities were to emerge, these diversifying plaintiffs’ attorneys could return to pursue securities litigation again.

 

A final possible explanation for the fourth quarter decline is that the apparent slowdown is purely coincidental and that filing levels will quickly return to normal levels. Just to reinforce this point, though there were only five new filings in October and nine in November, there were seven new securities lawsuit filings just in the final ten days of December alone. It could be that the apparent lull during the fourth quarter was nothing more than a reflection of the natural ebb and flow of securities law suit filings that has characterized filings patterns since 1996.

 

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In a decision that could foreclose a possible way for claimants to try  to circumvent the U.S. Supreme Court’s decision in the Morrison v. National Australia Bank case, a New York appellate court has reversed a lower court and dismissed the fraud suit short-seller hedge funds had brought in New York state court against Porsche on forum non conveniens grounds. A copy of the December 27, 2012 New York Supreme Court Appellate Court, First Department, decision can be found here (starting at page 138).

 

The appellate court’s decision is the latest step in an effort by short-seller hedge funds to pursue claims in the U.S. against Porsche. As discussed here, the  hedge funds first filed an action in the Southern District of New York  alleging that during 2008, Porsche and certain of its executives made a series of misrepresentations in which Porsche claimed that it did not intend to acquire control of Volkswagen, while at the same time it allegedly was secretly accumulating VW shares with the purpose of obtaining control. In October 2008, after Porsche disclosed its intent to obtain control of VW, VW’s share price rose significantly and the short sellers suffered significant trading losses. The short-sellers federal court complaint asserted claims under the U.S. securities laws and also for common law fraud.

 

As discussed here, on December 30, 2012, Southern District of New York Judge Harold Baer dismissed the securities claims  based on Morrison, on the grounds that the subject transactions -- securities-based swap agreements -- represented a foreign transaction and are therefore not within the purview of the U.S. securities laws. Judge Baer declined to exercise supplemental jurisdiction over the common law claims. Judge Baer’s ruling is now on appeal to the Second Circuit.

 

In March 2011, several of the same short sellers launched a separate action in New York Supreme Court against Porsche alleging claims for fraud and unjust enrichment. Porsche moved to dismiss the state court complaint on the grounds of forum non conveniens and for failure to state a claim. Porsche also moved in the alternative to stay the state court action pending the outcome of the Second Circuit appeal in the federal court action. As discussed here, on August 6, 2012, New York (New York County) Supreme Court Judge Charles E. Ramos rejected Porsche’s motion to dismiss the case on forum non conveniens ground. A copy of Judge Ramos’s decision can be found here. Porsche filed an appeal.

 

In its December 27 opinion, a five-Justice panel of the appellate division unanimously reversed Judge Ramos’s decision and entered a judgment of dismissal in Porsche’s favor. In dismissing on the grounds that New York was not an appropriate forum, the appellate court noted that the only alleged connections between the action and New York “are the phone calls between plaintiffs in New York and a representative of the defendant in Germany” and “emails sent to plaintiffs in New York but generally disseminated to parties elsewhere.”

 

The appellate court state that “these connections failed to create a substantial nexus with New York, given that the events of the underlying transaction otherwise occurred entirely in a foreign jurisdiction.” In light of this “inadequate connection” between the transaction and New York, as well as “the fact that defendant and most plaintiffs are not New York residents, the VW stock is traded only on foreign exchanges, many of the witnesses and documents are located in Germany, which has stated its interest in the underlying events and provides an adequate alternative forum,” Porsche has met its “heavy burden” to establish that New York is “an inconvenient forum.”

 

The hedge fund claimants may well attempt to appeal the dismissal to the New York Court of Appeals. IF they do not appeal or if the intermediate appellate court’s ruling stands, the ruling will mean the hedge funds will not be able to pursue their claims in New York state court. The outcome will also undercut the possibility that the hedge fund plaintiffs might have found a way to circumvent Morrison. Judge Ramos’s prior ruling, which would have allowed the hedge funds to pursue their claims in New York state court, seemed to suggest that the hedge funds had found a way to pursue claims against the non-U.S. defendant in U.S. court, by asserting common law claims not subject to Morrison’s constraints.

 

The appellate court’s conclusion that the hedge funds had not established that New York was a convenient forum for this case suggests that the hedge funds may not have found a way around Morrison after all. Of course, it is possible that they may yet be further appeals in this case and so the final story may yet to be told. In that regard, it is interesting to note that the appellate court did not even discuss in its opinion Judge Ramos’s statement in his ruling that the question is whether New York courts “may hold responsible a foreign entity, who conducts business globally, for fraudulent misrepresentation purportedly aimed at New York plaintiffs.” New York, Judge Ramos said, “clearly has a vested interest in such an action.” The appellate court apparently saw it differently.

 

While the Second Circuit appeal in the federal court case remains pending, on March 1, 2012 the Second Circuit did release its opinion in the Absolute Activist Value Master Fund decision, which provided significant interpretation of Morrison and, as discussed here, could have a substantial impact on the Second Circuit appeal in the Porsche case.

 

Yet another alternative for investors who want to pursue claims against Porsche would be to sue them in the company’s home country courts – which is what at least some investors have done. As discussed here, other investors have also initiated an action against Porsche in Stuttgart based on the same allegations. According to news reports, Porsche recently won a procedural skirmish as part of its ongoing efforts to have investors’ civil claim heard in German courts.

 

As noted here, on December 18, 2012, prosecutors in Germany filed criminal charges against former Porsche CEO Wendelin Wiedeking and ex-Chief Financial Officer Holger Haerter alleging that they had made misrepresentations in order to manipulate VW’s shares in connection with Porsche’s efforts to take over VW.

 

Susan Beck's December 27, 2012 Am Law Litigation Daily article about the New York appelllate court's ruling in the Porsche case can be found here.

 

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New securities class action lawsuit filing levels were comparable to historical norms during 2012, but the number of settlements and of dismissals were both down for the year, according to the analysis and projections of NERA Economic Consulting in their December 11, 2012 publication “Flash Update: 2012 Trends in Securities Class Actions” (here).

 

According to the report, there were 195 new securities class action lawsuits filed this year through November 30, 2012. NERA projects that there will be around 213 total lawsuit filings by year end. The projected number is slightly below the 2007-2011 average of 221. (It should be noted that NERA counts multiple actions in multiple jurisdictions against the same defendants as different filings, unless and until consolidated, so NERA’s initial lawsuit filing counts will be higher than those published by some other sources. NERA also notes in the report’s footnotes that it “counts” a case if it involves securities, even where the complaint alleges violations of the common law or breach of fiduciary duty. This criterion may also result in counts differing from other published sources, some of which “count” cases only if they allege violations of the federal securities laws.)

 

The report notes that the 2012 filing levels are more or less consistent with recent years, even though the credit crisis-related lawsuit filings have faded away. The report notes that in 2005-2006, just prior to the credit crisis, annual filing levels had been as low only about 160. The report notes that the number of filings has not declined to these prior lower levels, as “the plaintiffs’ bar has found new causes of action, with merger objection cases picking up much of the slack.”

 

Though filings levels have remained more or less level, the number of cases resolved during 2012 through dismissal or settlement has plummeted. (It is important to understand that the report measures the time of settlement as the date on which it is approved, so some high profile settlements that were announced in 2012 – such as the massive $2.43 billion settlement of the BofA/Merrill Lynch merger case – are not reflected in NERA’s analysis. The NERA report count of dismissals includes dismissals that are not yet final, such as dismissals without prejudice.)

 

According to the report, the 92 settlements that are projected to be approved in 2012 is the lowest number since 1996 and 25% lower than 2011. The 60 dismissals projected for the year represent the lowest level since 1998 and the 2012 total is 50% lower than 2011. The total of 152 cases that have been resolved (settled or dismissed) is also the lowest level since 1996. The report notes that part of the reason for these declines may simply be that there were fewer cases pending and therefore available to be resolved as 2012 began, the lowest level of pending cases since 2000. The report also speculates that the slowdown in the number of settlements and dismissals may also be due to “other changes in the legal environment.”

 

While the number of settlements may have declined, average and median settlements are up. The average securities class action settlement in 2012 was $36 million, compared to a 2005-2011 average of $42.1 million. But if the calculation excludes settlements over $1 billion, the IPO laddering cases and the merger objection cases, the 2012 average is $36 million, up from a revised average for the 2005-2011 period of $32 million. The median settlement in 2012 was $11.1 million, which is the largest ever annual median since 1996, and only the second year since 1996 that the median has exceeded $10 million.

 

FDIC D&O Lawsuits and D&O Insurance Coverage: Former directors and officers of failed banks who are sued by the FDIC may look to the bank’s D&O insurance to defend and protect themselves. However, the bank’s D&O insurer may assert defenses to coverage that could limit the availability of the insurance, according to a December 10, 2012 memorandum entitled “Not So Fast: Directors and officers Sued by the FDIC over Bank Failures Should Not Assume D&O Insurance Will Cover the Claims” (here) by Britt K. Latham and M. Jason Hale of the Bass Berry and Sims law firm.

 

As reflected in the memorandum, among other issues, the carriers are raising the “Insured vs. Insured” exclusion found in most policies as a defense to coverage for claims brought by the FDIC in its capacity as the failed bank’s receiver. The authors review the existing case law and observe that “this issue is expected to be hotly contested in the wake of continuing D&O lawsuits by the FDIC related to bank failures.”

 

My own overview of the impact of the Insured vs. Insured exclusion on the FDIC’s failed bank litigation can be found here. As I discussed in a recent post (here), in October 2012, a federal court in Puerto Rico held that the Insured vs. Insured exclusion does not preclude coverage for an FDIC’s claims as receiver of a failed bank against the bank’s former directors and officers.

 

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In the following guest post, Kara Altenbaumer-Price (pictured) takes a look at two recent case decisions in which courts have declined attorneys’ fee awards in connection with non-cash class settlements. Kara is the Management & Professional Liability Counsel for insurance broker USI. 

 

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

 

Two recent cases striking down attorney fees awards raise questions about lawyer-driven class actions and the viability of suits aimed at garnering attorney fees rather than cash for the class plaintiffs. If the holding in either case gains traction, it could have a significant positive impact on D&O insurance, particularly in the area of merger-objection suits and efforts by carriers to stem the losses from these types of cases.    

 

In the first case, the Dallas Court of Appeals dealt a blow to plaintiffs’ lawyers pursuing so-called “bump up” cases in Texas state courts in September when it rejected a settlement that included cash to the lawyers, but none to the class of investors. Rocker v. Centex Corp. appears to have been a typical “bump-up” case in which shareholders of a company about to merge or be acquired file suit seeking to raise—or “bump up”—the purchase price of the company they hold shares in. 

 

The legacy of this case was thrown into uncertainty on November 30, 2012 when the Texas Supreme Court granted the review of the case without consideration of the merits and set aside the judgment pursuant to an agreement by the parties. Nonetheless, the case warrants discussion because the reversal did not call into question the merits of the lower appellate court decision.

 

The underlying case in Rocker v. Centex was not unusual, as it is not uncommon for the settlement of merger objection cases to include additional disclosures to the shareholders about the proposed deal, but no increase in share price and thus no cash to the shareholder class. Such settlements, however, usually involve hefty attorneys’ fees awards to the plaintiffs’ counsel. What was remarkable about Rocker v. Centex is that the Texas appellate court, however, refused to approve such a settlement, ruling that tort reform legislation passed several years ago in Texas prohibits such awards.

 

The court looked to a Texas Rules of Civil Procedure called the “coupon rule” that provides that “if any portion of the benefits recovered for the class are in the form of coupons or other noncash common benefits, the attorney fee awarded in the action must be in cash and noncash amounts in the same proportion as the recovery for the class.”   In Rocker v. Centex, the entire settlement to the class was a noncash benefit in the form of additional, material disclosures related to the deal. As a result, the court ruled that the plaintiffs’ attorneys could be awarded no cash—even if it meant that they had worked for free. The Centex case eliminates the incentive for plaintiffs’ counsel to bring cases—at least in Texas state courts—where the end goal is attorneys’ fees. If there really is a belief that the share price is too small, and the case causes a rise in the share price, then attorneys fees would still be justified and payable under the Centex ruling.

 

The second case actually arises in the context of privacy litigation, rather than securities class actions, but it tackled the same issue of class settlements than contain no cash to the class. A California federal district court rejected a settlement in a privacy class action against Facebook because the settlement included changes to Facebook, $10 million to organizations involved in internet privacy, and $10 million in attorneys fees, but no cash to the plaintiffs themselves. The court in Fraley v. Facebook  questioned the large size of the fee award. The court also rejected arguments by plaintiffs’ counsel estimating the value of the privacy changes to Facebook to the plaintiffs and questioned whether injunctive awards to plaintiffs can be assigned a value at all for assessing attorneys’ fees. Like the Rocker v. Centexcase, this case  potentially has huge implications for class actions pursued for the purpose of creating plaintiffs’ fee awards.

 

Both of these cases highlight the primary issue that defendants (and insurers) have with merger litigation (even though the Facebook case arose in another context, the principle is the same)—the notion that the cases exist not to ensure that the best deal is achieved for shareholders, but to make a quick and sizeable buck for plaintiffs attorneys. As Advisen wrote in its second quarter 2012 report that “it has been suggested, including by some judges presiding over these cases, that new filings are driven more by plaintiff’s attorneys seeking new sources of fee revenues than by the economics of mergers and acquisitions.” Companies, eager to close the deal, usually offer up a hasty settlement that includes large fee awards, to make the litigation go away. 

 

With 91 percent of merger deals above $100 million resulting in litigation according to Cornerstone, insurance carriers have taken note of this issue, which has turned D&O insurance from a low frequency, high severity product to a high-frequency product in the carrier’s view. Many have blamed the increase in M&A suits for the recent rise in D&O insurance rates. One solution to combat this issue is the introduction of separate M&A deductibles for public company D&O and exclusionary language for M&A cases that is creeping into 2012 and 2013 D&O insurance renewals.   Considering that coverage changes tend to lag behind the litigation trends, it will be interesting to watch this trend develop as carriers continue to try to manage losses associated with M&A cases.

 

Many have blamed the increase in M&A suits for the recent rise in D&O insurance rates. One solution to combat this issue is the introduction of separate M&A deductibles for public company D&O and exclusionary language for M&A cases that is creeping into 2012 and 2013 D&O insurance renewals.   Considering that coverage changes tend to lag behind the litigation trends, it will be interesting to watch this trend develop as carriers continue to try to manage losses associated with M&A cases.

 

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In what is by far the largest settlement in the current wave of securities litigation involving Chinese companies, Ernst &Young, which served as the outside auditor for Sino-Forest, has agreed to pay C$117 million to settle the securities suit that  Sino-Forest investors filed  in Ontario against the accounting firm. (At current exchange rates, the Canadian dollar and the U.S. dollar are valued roughly equally.) According to the plaintiffs’ lawyers’ December 3, 2012 press release (here), E&Y’s settlement of the Sino-Forest suit “is the largest settlement by an auditor in Canadian history, by a large margin, and is one of the largest-ever auditor settlements worldwide.”

 

As discussed here, the plaintiffs’ lawyers first filed their suit in Ontario Superior Court of Justice on behalf of Sino-Forest shareholders in June 2011, following press reports and online reports that the company had substantially overstated the size and value of its forestry holdings in China's Yunnan province. The allegations first emerged in a June 2, 2011 report by online-research firm Muddy Waters, which accused Sino-Forest of outright fraud. Floyd Norris’s June 9, 2011 New York Times article about E&Y’s involvement in the Sino-Forest scandal can be found here. Earlier this year, Sino-Forest filed for bankruptcy protection.

 

As detailed in the claimants’ amended statement of claim, the lawsuit named as defendants Sino-Forest, its senior officers and directors, its auditors, its underwriters and a consulting company. The plaintiffs previously settled with the consulting company in an agreement that did not involve any monetary payments (refer here). An overview of the Ontario litigation, including links to key documents, can be found here.  The plaintiffs’ lawyers’ December 3 press release emphasizes that the plaintiffs’ claims against the remaining defendants (including in particular the individual directors and officers and the offering underwriters, as well as another auditor) remain pending.

 

Perhaps coincidentally (or perhaps not), on December 3, 2012, the Ontario Securities Commission filed charges against Ernst & Young that the firm had failed to conduct their audits of Sino-Forest “in accordance with relevant industry standards.” The OSC’s Statement of Allegations against E&Y can be found here. A December 3, 2012 Financial Post article discussing both the OSC allegations and the separate civil suit settlement can be found here.

 

And in yet another apparent coincidence, on December 3, 2012, the SEC initiated administrative proceedings against the China affiliates of each of the Big Four accounting firms (including E&Y’s Chinese affiliate) and another large U.S. accounting firm for refusing to produce audit work papers and other documents related to China-based companies under investigation by the SEC for potential accounting fraud against U.S. investors. The SEC’s December 3 press release about the administrative action can be found here.

 

E&Y’s settlement of the Sino-Forest suit is noteworthy in several respects, and not just because it is the largest auditor settlement in Canadian history. It is also noteworthy because it is the largest settlement so far of any kind in connection with the wave of securities suits that were filed in the U.S. and in Canada against Chinese companies in recent years. As I noted in a prior post (here), in general the securities suits involving U.S.-listed Chinese companies that have reached the settlement stage have only resulted in modest settlements, well below the range of median settlements for U.S. securities class action lawsuits generally. However, those modest settlements have involved only the corporate entity defendant  and its directors and officers, and the settlements typically involved only the remaining amounts of D&O insurance.

 

From the earliest stages of the wave of securities suits involving Chinese companies, I had been told that owing to the logistical challenges and other shortcomings in the lawsuits against the Chinese companies, the true targets were really not the companies themselves, but rather their outside advisors. Up to this point, I have been skeptical that the plaintiffs might succeed in getting traction in their claims against the outside advisors. Clearly, the massive E&Y settlement in the Sino-Forest case demonstrates that the claims against these companies outside advisors  canhave significant value, at least in some cases. In any event, these cases have suddenly become much more interesting to watch.

 

Dismissal Granted in U.S.-Listed Chinese Company Securities Suit: The securities suits involving Chinese companies are only valuable to the plaintiffs if they are able to get to the case to the settlement stage. Many of these cases have been dismissed at the preliminary motions stage, and on December 3, 2012, the defendants’ motions to dismiss were grated in the securities suit pending in the Western District of Washington against L&L Energy, a U.S. company owning Chinese mining operations, and certain of its directors and officers. The motion was granted with leave to amend.  A copy of the December 3 opinion can be found here.  

 

As detailed here, the plaintiffs had raised a number of allegations against L&L, asserting among other things that the company had misrepresented its revenues in its filings with the SEC. In making these allegations the plaintiffs relied on discrepancies between the financial figures the company reported in its SEC filings and the figures the company’s subsidiaries reported in China with the State Administration for Industry and Commerce (SAIC).

 

In rejecting the plaintiffs’ allegations based on this discrepancy, Western District of Washington Robert Lasnik noted that the two kinds of financial  reports involved a number of different reporting requirements and protocols. Based on these differences in the reporting requirements, Judge Lasnik concluded that while “one might draw the inference that the amounts reported to the SAIC and the SEC are inconsistent … because the inputs and consolidation methods varied in material respects, the inference is not particularly strong.” He concluded that “the bare allegations supporting the plaintiffs’ assertions that the SEC numbers, rather than the SAIC numbers, are fabrications fail to raise the necessary strong inference of falsity.”

 

This decision is just the latest to consider securities fraud allegation based on allegations that the financial figures a Chinese company reported to the SEC were different than those reported to the SAIC. As I noted here, in August 2012, the court denied the motion to dismiss in the securities suit involving Duoyuan Global Water, a case that also involved the same kinds of alleged reporting discrepancies. However, as noted here, in November 2011, the court in the China Century Dragon Media case, like Judge Lasnik in this case, granted the defendants motion to dismiss in another lawsuit involving alleged reporting discrepancies.

 

Clearly, the track record is mixed; the one thing that is for sure is that the mere fact of the reporting discrepancies alone may not be sufficient for plaintiffs’ to survive the initial pleadings stage.

 

Special thanks to a Doug Greene of the Lane Powell law firm for forwarding a copy of the L&L Energy opinion. Lane Powell represents the defendants in the L&L Energy case.

 

Rescue Stairs for Stranded Bears: Feel like smiling? Good. Watch this video. 

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As discussed in an earlier guest post on this site (here), entrepreneurial plaintiffs’ lawyers seem to have hit upon a new way to extract a fee from the fights over executive compensation. This new wave of executive comp suits, in which the plaintiff’s seek to enjoin upcoming shareholder votes on compensation or employee share plans on the grounds of inadequate or insufficient disclosure, have resulted in some success – at least for the plaintiffs’ lawyers involved. These new kinds of executive compensation–related lawsuits possibly may be “gaining steam,” according to a recent law firm study.

 

A November 19, 2010 memo from the Pillsbury law firm entitled “Plaintiffs’ Firms Gaining Steam in New Wave Say-on-Pay Lawsuits” (here) reviews the history of say-on-pay litigation that has followed in the wake of the Dodd Frank Act’s requirements for an advisory shareholder vote on executive compensation. The memo shows that of the at least 43 companies that experienced negative say-on-pay votes in 2011, at least 15 were hit with shareholder suits alleging, among other things, that the companies’ directors and officers had violated their fiduciary duties in connection with executive compensation. However, as is well documented in the law firm memo, these suits have not fared well in the courts; ten of the eleven of the 2011 suits that have reached the motion to dismiss stage have resulted in dismissals.

 

Faced with this poor track record on last year’s say-on-pay suits, plaintiffs’ lawyers have filed fewer of these kinds of suits this year against companies that experience negative votes. However, as the law firm memo explains, one plaintiffs’ firm has now “orchestrated a new strategy to hold companies liable: suits to enjoin the shareholder vote because the proxy statement failed to provide adequate disclosure concerning executive compensation proposals.” According to the memo, there have been at least 18 of these types of suits, with nine of them having been filed just in the month preceding the memo’s publication.

 

As detailed in Nate Raymond’s November 30, 2012 Reuters story entitled “Lawyers gain from ‘say-on-pay’ suits targeting U.S. firms” (here), these new style lawsuits (of which the article says some 20 have been filed) have met with some success. According to the article, at least six of these suits “have resulted in settlements in which the companies have agreed to give the shareholders more information on the pay of the executives.” These settlements have also “resulted in fees of up to $625,000 to the lawyers who brought the cases.” The article also notes, however, that while the settlements have provided additional disclosures and legal fees for the firm that has filed almost all of these suits, “they have netted no cash for shareholders.”

 

These new suits share certain characteristics with the M&A-related lawsuits that are another current litigation trend. (Refer here for background regarding the M&A-related litigation trends.)  That is, they are filed at a time when the defendant company is under time pressure that motivates the company to settle quickly rather than deal with the lawsuit. Just as in the merger context, where the company wants to move the transaction forward and doesn’t want the lawsuit holding things up, companies facing these new style say-on-pay lawsuits, facing an imminent shareholder vote, are pressured to reach a quick settlement rather than risking a delay in the shareholder vote.

 

It is hard to disagree with the sentiment of one defense counsel, quoted in the Reuters article, that these lawsuits are nothing more than a “shakedown for a quick buck.” At least some companies are trying to resist these suits. For example, in a November 13, 2012 ruling, Alameda County (California)Superior Court Judge Wynne Carvill rejected the plaintiff’s injunction request, holding that there is “no risk of any interim, much less irreparable harm” if the say-on-pay vote went forward. A copy of the November 13 order can be found here.

 

A battleground issue that may be increasingly important, at least for the companies trying to fight these suits, will be venue. The plaintiffs’ firm that is leading the charge on these cases has chosen to file them in state courts outside of Delaware. The defendants usually seek to remove the cases to federal court, but, as discussed in Alison Frankel’s November 30, 2012 post on her On the Case blog (here), the plaintiffs have had some success in having the cases remanded to state court. As the statements of the defense attorneys quoted in Frankel’s blog post show, however, the defense attorneys have not conceded this issue, which they clearly view as a vital battleground in trying to fight these cases.

 

But while some companies and their attorneys may be fighting these cases, the plaintiffs’ firms pushing these suits seem likely to continue to file them as long as they can make money doing so. As the author of the Pillsbury memo notes, in a quote in the Reuters article, “Where the plaintiffs securities bar sees that they will get a return on their investment, they’re going to keep filing them.”

 

In my view, both the kinds of say-on-pay lawsuits filed last year and the new style version of the suits that are hot right now are symptoms of a larger phenomenon, which is the attempt by the plaintiffs’ securities bar to diversify their product line. The root cause is that there are fewer traditional securities class action lawsuits these days and the ones that are filed are tougher to prosecute as a result of a string of U.S. Supreme Court decisions over the last several years, as well as the cumulative effect of Congressional reforms. Faced with fewer profit making opportunities in their traditional product line, the plaintiffs’ securities firms have been trying to diversity.

 

A number of current litigation trends are the result of the plaintiffs’ securities bar’s diversification efforts – not just the various kinds of say-on-pay lawsuits, but also the M&A-related litigation that has ramped up so much recently, as well as the class action opt-out litigation trends I noted in a recent post (here). (Indeed, you could argue that these diversification efforts first started with the options backdating cases, most of which were filed as derivative suits, rather than as securities class action lawsuits). The pressure on the plaintiffs’ firms to diversify will likely continue to lead to more lawyer-driven litigation of these kinds, including not only the varieties of lawsuits I have noted here but also perhaps other kinds of suits that will emerge in the months ahead.

 

To be sure, it could be argued that these evolving litigation trends are simply a reflection of the fact that we have an entrepreneurial and opportunistic plaintiffs’ bar in this country. An alternative point of view is that in a global economy our domestic companies are put at an enormous competitive disadvantage as a result of the unproductive costs our over-active litigation system imposes on them. Anybody making a list of unproductive costs accruing due to lawyer-driven litigation would have to put the expenses associated with these new wave say-on-pay suits right at the top of the list.

 

Second H-P Securities Suit Sweeps in a Broader Roster of Defendants: In a post last week, I noted that plaintiffs’ lawyers had quickly jumped on the Autonomy acquisition accounting scandal at H-P and had filed a securities class action lawsuit. As I noted in my post, the first suit filed, at least, named only H-P and certain of its current and former officers as defendants. In particular, I noted that the first complaint did not name as defendant Autonomy or any of its former officers or directors, nor did it name any of H-P’s outside advisors.  However, I also noted that further lawsuit seemed likely, and noted the possibility that additional suits might include additional defendants.

 

Now further lawsuits have in fact been filed and the latest suits have expanded the roster of defendants. As reflected in plaintiffs’ lawyers November 30, 2012 press release (here), the latest suit to be filed names as defendants not only H-P and certain of its officers, but also H-P directors, Autonomy and Deloitte LLC, H-P’s auditors. The complaint can be found here. The individual defendants named in the complaint include not only H-P's former and current CEOs and its current CFO, as well as two other H-P's chief accounting officers, but also Michael Lynch, the former CEO of Autonomy, and Sushovan Hussain, Autonomy's former CFO. (Speical thanks to a loyal reader for providing a copy of the complaint.)

 

The H-P/Autonomy debacle continues to attract critical press scrutiny, including a November 30, 2012 New York Times article entitled “H-P’s Autonomy Blunder May be One for the Record Books” (here) in which James B. Stewart writes that H-P’s acquisition of Autonomy arguable ranks as one of the worst deals ever, ranking right up there with the disastrous Time Warner acquisition of AOL. Among other things, Stewart writes:

 

It’s true that H.P. directors and management can’t be blamed for a fraud that eluded teams of bankers and accountants, if that’s what it turns out to be. But the huge write-down and the disappointing results at Autonomy, combined with other missteps, have contributed to the widespread perception that H.P., once one of the country’s most admired companies, has lost its way.

 

Second Circuit Affirms Dismissal of Securities Suit Filed Against U.S.-Listed Chinese Company: Over the last several years, plaintiffs have filed dozens of securities suits against U.S.-Listed Chinese companies, alleging accounting misrepresentations as well as undisclosed transactions benefiting insiders. (This litigation phenomenon is detailed and discussed at greater length here.)  Though some of these cases have survived dismissal motions, others have not survived the initial pleading hurdles. On November 29, 2012, the Second Circuit, in a summary order (here), affirmed the dismissal of one of these suits.

 

On October 26, 2010, Mecox Lane Limited issued over 11 million American Depositary Receipts in an IPO. As discussed here, on December 3, 2010, following company disclosures, investors filed an action against Mecox, certain of its directors and officers, and its offering underwriter, alleging that the Company's gross margins had been adversely impacted by increased costs and expenses which made it impossible for Mecox Lane to achieve the results defendants projected at the time of the IPO. On March 5, 2012, Southern District of New York Judge Robert Sweet granted the defendants’ motion to dismiss. The plaintiff appealed.

 

In the November 29 summary order affirming the dismissal, a three judge panel of the Second Circuit noted that:

 

Even taking all of the Complaint’s allegations as true and drawing all reasonable inferences in favor of the Plaintiffs, the statements that they point to as untrue or misleading are neither. The Complaint does not mention undisclosed information, but points to nothing to show that disclosures were required.

More About the U.S.-Listed Chinese Companies: The Mecox Lane case is the second of the recent securities suits involving U.S.-listed Chinese companies to reach the Second Circuit. As discussed here, in August 2012, the Second Circuit revived a securities suit that had been filed against China North Petroleum Holding that had been dismissed by the District Court.

 

In addition to the revived securities suit, China North Petroleum has other problems as well. As described in its November 30, 2012 litigation release (here), the SEC has filed a civil enforcement action in the Southern District of New York against the company, its CEO and former Chairman, and its founder and former director, as well as other officers and the family members of one of the officers.

 

The SEC alleges, in connection with the company’s two 2009 stock offerings, that the CEO and the founder, as well as the other officers, “diverted offering proceeds to the personal accounts of corporate insiders and their immediate family members, and also engaged in fraudulent conduct in connection with at least 176 undisclosed transactions between the company and its insiders or their immediate family members, otherwise known as related-party transactions.” The SEC alleges that the transactions totaled approximately $59 million during 2009.

 

More About Law Firm Management Liability Insurance: As I noted in a prior post (here, second item), unsecured creditors of the bankrupt Dewey LeBoeuf law firm have sought the bankruptcy court’s leave to file an action against three of the law firm’s former managing partners, accusing them of law firm management misconduct and seeking to recover under the law firm’s management liability insurance policy.

 

As discussed in a November 29, 2012 Am Law Daily article (here), the bankruptcy court has granted the creditors leave to pursue the claims. However, as the article also discusses, the claimants could face barriers attempting to recover under the insurance policy. As the article notes, “the lead insurer connected to the policy … has said such suits may not be covered because Dewey, as the policyholder, is essentially suing itself.” The article does not explain the basis on which the carrier is contending that the claims of the creditors represent the claims of Dewey itself. However, given the stakes involved, it seems likely that these issues will be sorted out as the creditors press their claims.

 

Special thanks to a loyal reader for sending me a link to the Am Law Daily article.

 

Deconstructing “Skyfall”: (Spoiler Alert, these comments will give away key plot element of the movie, so don’t read this if you haven’t seen the movie).

 

1. Can I just say that Bond’s idea of luring Raoul Silva northward to Bond’s childhood home was a really crappy plan? Not only did it directly result in M’s death, but M16 never did recover the stolen list of undercover agents. The entire sequence conclusively proved that Bond is no longer qualified for service, as the M16 tests earlier in the movie showed. M chose to disregard what the tests clearly established, which ultimately cost her her life.

 

2. Shortly after we were informed that Bond’s childhood home had been sold, the structure was first strafed with automatic gunfire from a helicopter gunship and then blown up. At the real estate closing, it is going to be a disappointing walk-through for the property’s buyers, that’s for sure.

 

3. In case you were wondering, the poem M said she had learned from her late husband and that she recited (in part) to the Parliamentary committee (just before armed gunmen burst into the Committee room) is “Ulysses” by Alfred, Lord Tennyson. Here is the portion she quoted:

 

Though much is taken, much abides; and though

We are not now that strength which in the old days

Moved earth and heaven; that which we are, we are,

One equal-temper of heroic hearts,

Made weak by time and fate, but strong in will

To strive, to seek, to find, and not to yield.

 

4. So we know for sure that Judi Dench will not be in the next Bond movie. But how about Daniel Craig? Most of Skyfall seemed to be a variation on the theme that Bond is getting old and might just be over the hill. And in the scenes where Bond was unshaven, Craig sure was looking pretty scraggly. I am not making any predictions, but don’t be surprised if Craig isn’t there next time Bond is back.   

 

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When the SEC brought civil enforcement charges against former Countrywide Financial CEO Angelo Mozilo in June 2009, a critical part of the agency’s allegations was that Mozilo had manipulated his Rule 10b5-1 trading plans to permit him to reap vast profits in trading his shares in company stock while he was aware of increasingly serious problem in the company’s mortgage portfolio.

 

Among other things, the SEC alleged that pursuant to these plans and during the period November 2006 through August 2007, and shortly after he had circulated internal emails sharply critical of the company’s mortgage loan underwriting and the “toxic” mortgages in the company’s portfolio, Mozilo exercised over 51 million stock options and sold the underlying shares for total proceeds of over $139 million.

 

In October 2010, Mozilo agreed to settle the SEC’s enforcement action for a payment of $67.5 million dollars, including a $22.5 million penalty and a disgorgement of $45 million. The financial penalty was at the time (and I believe still is) the largest ever paid by a public company’s senior executive in an SEC settlement.

 

As if all of this were not enough to cast a cloud over Rule 10b5-1 trading plans, the trading plans are once again back in the news, and once again the news about the plans is negative. A front page November 28, 2012 Wall Street Journal article entitled “Executives’ Good Luck in Trading Own Stock” (here), reports on the newspaper’s analysis of thousands of trades by corporate executives in their company’s stock. Among other things, the newspaper reports on numerous instances where executives, trading in company shares pursuant to Rule 10b5-1 plans, managed to extract trading profits just before bad news sent share prices down or to capture gains with purchases executed just before unexpected good news.

 

The article catalogues a number of deficiencies of at least some plans that undermine the Rule’s goal of allowing insiders to trade in their company shares without creating the impression that the executives were trading because they knew something about the company that other investors did not.

 

Among other plan features that can cause problems, the article shows, is the ability of executives to alter or cancel plans at their own discretion. The article notes that “there is very little in the system to prevent an executive who foresees good news about the company from canceling a scheduled share sale, or an executive who foresees bad news from canceling a scheduled share purchase” 

 

Another weakness is that some plans allow executives to trade immediately after the plan has been set up, creating the impression that the executive set up the plan (and then traded) in anticipation of the undisclosed developments. The article notes that “there is no rule about how long the plans must be in place before trading under the plans can begin.”

 

An additional shortcoming about the plans cited by several commentators in the article is that neither executives nor their companies are required to disclose the existence of their plans, which among other things leave executives free to change or even cancel their plans. The article notes that though there are a number of companies that do disclose that the executives have trading plans, “they rarely disclose the provisions, since they don’t want outside investors to be able to anticipate forthcoming trades.”

 

There is more than a small amount of irony in these concerns about Rule 10b5-1 plans. The Rule was established more than a decade ago in order to provide a way for executives (whose wealth often is entirely locked up in company shares) to be able to trade in the company’s stock without incurring possible liability under the securities laws.

 

There are in fact a number of cases in which courts have held that the inference of scienter that might otherwise arise from insider sales is rebutted when the sales were executive pursuant to Rule 10b5-1 trading plans. Refer here and here for a discussion of recent cases where defendants were able to rely on the Rule 10b5-1 trading plan in order to have the securities claims against them dismissed.

 

In other words, though Rule 10b5-1 plans can cause problems, if done right they can prove to be very valuable. Which of course raises the question -- what does it mean for a trading plan to be done right?

 

First of all, there should only be one plan, not multiple plans. If nothing else, Mozilo’s actions show what a problem it can be if an executive tries to maintain multiple plans.

 

Second, the plan should clearly provide for well-defined trades at well-defined times or under well-defined circumstances. Ideally, the plan would specify that the executive will trade at specified times and at specified amounts.

 

Third, the protective value of the plan is severely undermined if the executive retains any discretion about trade execution, including in particular the ability to alter or cancel the plan. As the SEC noted it its April 2009 guidance about Rule 10b5-1 plans, the cancelation of a transaction under a plan affects the availability of the affirmative defense under the Rule, because the cancellations represent an alteration of or deviation from the plan

 

Fourth, to avoid the types of concerns noted above, the plan should be put in place well before the first trade under the plan. Preferably, the first trade would take place only after an interval of a quarter or longer.

 

Finally, in order to address the kinds of concerns noted in the Journal article, companies whose executives have trading plans should consider disclosing both the plans existence and intended trading schedule in the company’s periodic filings with the SEC.

 

The Deal Journal blog has a number of related suggestions in a November 28, 2012 post (here) about how to structure and implement the kinds of problems cited in the Journal article.

 

Because the point of a Rule 10b5-1 trading plan is to try to allow executives to trade in their company securities without incurring potential liability under the securities laws, it is worth taking a look at a trading plan that a court found to provide that very protection. As discussed here, in October 2008, the Eighth Circuit affirmed the lower court’s dismissal of a class action securities lawsuit that had been brought against executives of the Centene Corporation. The appellate court expressly affirmed the lower court’s ruling that because the executives’ trades had been executed pursuant to a Rule 10b5-1 plan, the trades did not support an inference of scienter.

 

The Eighth Circuit stated that the individual defendants’ trading plans "lay out in advance the dates at which the trade will be made in advance and give control of the trades to a broker." The District Court’s dismissal opinion stated further that the plaints "provided for automatic sales on certain dates if the stock price was above $25." The only sales made under the plans, which were instituted in December 2005, were two in February and April 2006. "There were no later sales, not because defendants halted the program, but because the stock price never reached the $25 mark."

 

The critical aspects of the plan appear to have been, first, that the officials entered the plan in advance; second, that the plan specified the trading dates, but subject further to a specified trading price: three, that the trading on those dates, if the price criterion was met, was automatic; and fourth, that a broker controlled the trades. It does not seem to have mattered that the officials did not trade regularly under their plans because of the minimum share price requirement.

 

It is  important to note that the plan lacked many of the attributes that have attracted criticism. That is, the Centene officials’ plans were not changed, nor were the plans stopped and started; and the individuals were not running multiple plans.

 

Given the negative publicity surrounding Rule 10b5-1 plans, the Eighth Circuit’s opinion is a useful reminder that Rule 10b5-1 plans can and should be a part of a coordinated securities litigation loss prevention program. The negative publicity should not deter companies or the executives from creating and implementing thoughtfully constructed trading plans.

 

The Bill Gates School of Deposition Deportment: The credit crisis-related litigation continues to grind through the court system, and many of the cases have moved into active discovery. Among the many high profile cases remaining is the lawsuit monoline insurer MBIA filed against BofA, as successor in interest to Countrywide. MBIA alleges that mortgages underling many of the financial securities that the insurer was asked to guarantee were not made pursuant to the mortgage company’s stated underwriting guidelines.

 

In May 2012, as discovery of the case has gone forward, MBIA finally had a chance to depose BofA CEO Brian Moynihan. Moynihan’s deposition, according to the Rolling Stone’s Matt Taibbi’s November 27, 2012 article entitled “Bank of American CEO Brian Moynihan Apparently Can’t Remember Anything” (here) “will go down as one of the great Nixonian-stonewalling efforts ever, and one of the more entertaining reads of the year.” As the article (and the deposition transcript to which the article links) shows, Moynihan really doesn’t remember much of anything about Countrywide, even though the business has been one of the bank’s biggest problems since Moynihan took over as BofA’s CEO.

 

As Taibbi puts it, “In an impressive display of balls,” Moynihan essentially testified that Bank of America is a big company, and it is unrealistic to ask the CEO to know about all of its parts, “even the ones that are multi-billion-dollar suckholes about which the firm has been engaged in nearly constant litigation from the moment it acquired the company.” Taibbi concludes that throughout the deposition, Moynihan “presents himself as a Being There-esque cipher who was placed in charge of a Too-Big-To-Fail global banking giant by some kind of historical accident beyond his control, and appears to know little to nothing at all about the business he is running.”

 

Moynihan is not the first CEO to take this deposition approach. Readers will likely recall that then-Microsoft CEO Bill Gates took much the same approach in his deposition in the massive antitrust case against the company, which according to the BusinessWeek article about Gates’s deposition testimony, showed him “slouching behind a table on a videotaped deposition, rocking as he reads documents, and often telling government prosecutors that he can't recall having written E-mails to Microsoft execs on key company issues.”  (The loyal reader who sent me the link to the Rolling Stone article suggested that Moynihan may have also been borrowing a page from another President named Bill, whose deposition performance may have set an unbreakable world record for deposition obfuscation.)

 

Clawback at the SEC?: In a recent post (here), I discussed a recent federal district court decision upholding the right of the SEC under Section 304 of the Sarbanes Oxley act to clawback bonus compensation from corporate executives whose companies later restated the financials on which the bonus compensation was based, even though the executives were not involved in or even aware of the misconduct that led to the restatement . In affirming the policy justifications for the SEC’s clawback authority, the district court judge noted that the executive “should have been monitoring the various internal controls to guard against such misconduct” and that it was there failure to ensure that proper controls were in place that allowed the misconduct to occur. The court added that “where, as here …corporate officers are asleep on their watch,” they are liable for a penalty that is limited to the amounts of their bonus compensation.

 

In a November 28, 2012 post on his eponymous blog, UCLA Law Professor Stephen Bainbridge makes the provocative suggestion that in light of these principles perhaps the compensation of departing SEC chair Mary Schapiro should also be clawed back. Schapiro’s announcement that she is stepping down “raises the question of why she gets a free ride on precisely the same sort of conduct for which corporate executives are subject to having their pay clawed back.”

 

In support of this suggestion, Bainbridge cites the findings of the Government Accountability Office, which “consistently found that the SEC's internal controls are seriously flawed.” Bainbridge also cites recent whistleblower allegations of misconduct at the agency. Bainbridge asserts that “at the very least, Mary Shapiro has been asleep at the switch while the SEC has continually failed to remediate serious internal control deficiencies that the SEC would never tolerate in a private company.” Bainbridge concludes by asserting that:

 

If clawing back executive pay is necessary to give corporate executives "an incentive for (officials) to be diligent in carrying out" their duties over corporate internal controls, maybe clawing back government official pay when they "are asleep on their watch,” would give future SEC chairs the necessary incentive to avoid Schapiro's manifold failures to fix the SEC's internal problems

 

Readers may also be interested in Bainbridge’s take on the Wall Street Journal trading plan article I discussed above; Bainbridge writes about the Journal article “In what may be the dumbest piece of reporting I've seen in a while, the Wall Street Journal offers up a breathless "expose" showing that corporate insiders often beat the market when trading in their own company's stock. This is "news"?”

 

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When H-P announced on November 20, 2012 that it was taking an $8.8 billion charge after it discovered “accounting improprieties, misrepresentations and disclosure failures” at its Autonomy unit (which H-P acquired in October 2011 for $11.1 billion), there was a great deal of speculation that litigation would quickly follow. The intervening Thanksgiving weekend may have slowed down the filing of the first of the lawsuits, but only a little bit. The first of what will likely be many related lawsuits has now arrived.

 

On Monday November 26, 2012, plaintiffs’ lawyers filed a securities class action lawsuit in the Northern District of California against H-P and certain of its directors and officers. A copy of the plaintiff’s complaint can be found here. The plaintiffs’ lawyers’ November 26, 2012 press release can be found here.

 

The complaint names as defendants the company itself; Leo Apotheker, who was H-P’s CEO until September 2011 and who was CEO at the time the Autonomy deal was agreed upon; Meg Whitman, who became CEO in September 2011, but who had also served on H-P’s board at the time the Autonomy deal was agreed to; H-P’s CFO, Catherine Lesjak; and the company’s Chief Accounting Officer, James T. Murrin. The complaint was filed by an individual H-P shareholder on behalf of a class of investors who purchased H-P stock between August 19, 2011 (the date the Autonomy deal was announced) and November 20, 2012 (the date H-P announced the alleged improprieties at Autonomy).

 

The complaint alleges that the defendants violated the liability provisions of the Securities Exchange Act of 1934. Significantly, and as noted below, the complaint relates not just to the accounting improprieties at Autonomy, but also to the earlier $8 billion goodwill charge associated with H-P’s Enterprise Services business, as noted below.

 

According to the plaintiff’s lawyers’ press release, the complaint alleges that the defendants “concealed that the Company had gained control of Autonomy in 2011 based on financial statements that could not be relied upon because of serious accounting manipulation and improprieties.” The “true facts,” according to the complaint, “which were known by the defendants but concealed from the investing public,” were that

 

(a) at the time Hewlett-Packard acquired Autonomy, the business’s operating results and historic growth were the product of accounting improprieties, including the mischaracterization of sales of low-margin hardware as software and the improper recognition of revenue on transactions with Autonomy business partners, even where customers did not purchase the products; (b) at the time Hewlett-Packard had agreed in principle to acquire Autonomy, defendants were looking to unwind the deal in light of the accounting irregularities that plagued Autonomy’s financial statements; and (c)  Enterprise Services’ operating margin had collapsed from 10% in 2010 to approximately 6% as of April 30, 2011, 4% as of October 31, 2011, and 3% as of April 30, 2012, due to various reasons, including unfavorable revenue mix and underperforming contracts.

 

The reference to the Enterprise Services division relates to the H-P unit that incorporated the business formerly known as Electronic Data Systems Corporation (“EDS”), which Hewlett-Packard had acquired in August 2008 for $13.0 billion. On August 22, 2012, H-P took an $8 billion impairment charge on the goodwill associated with the EDS acquisition. The sequence of disclosures that the complaint cites is arranged to portray a pattern of misrepresentations regarding H-P’s Enterprise Services division, of which Autonomy was a part following H-P’s acquisition of the company.

 

It is interesting to note that the complaint names as defendants only the four current and former H-P officers. It does not name any of the other members of the H-P board, nor does it name any of the outside firms that advised H-P in connection with the Autonomy transaction and that presumably assisted with the due diligence review of the target company. It also seems noteworthy that the complaint does not name any of the former Autonomy directors or officers, even though at least some were also officials at H-P following the acquisition. (The absence of any Autonomy defendants may be due to the fact that Autonomy’s shares were not traded on U.S. exchanges immediately prior to the acquisition, and so, under the Supreme Court’s Morrison decision, the alleged pre-acquisition misrepresentations are beyond the ambit of the U.S. securities laws.)

 

This is of course the first complaint to be filed; there likely will be others, as this event seems likely to keep many lawyers busy for many years. Subsequent complaints may name others as defendants.

 

There is of course some irony that H-P and its senior management are targets of this litigation, as --at least from their perspective and according to the account -- the company is itself the victim of the fraud. Indeed, in its press release regarding the Autonomy revelations, the company disclosed that it has contacted the U.K. Serious Fraud Office and the SEC. The company will clearly argue that it could not have knowingly or recklessly misled its investors in violation of the securities laws, as it was itself misled.

 

The complaint does not allege any specific grounds for the assertions that the defendants knew but concealed from the investing public during the class period that Autonomy had misrepresented its operating performance and financial condition.The complaint does not provide any explanation of what the defendants’ motivation would have been to make these misrepresentations. Perhaps in recognition of these potential issues, the complaint refers not only to H-P’s revelations about the accounting improprieties at Autonomy, but also references H-P’s earlier goodwill impairment charge in connection with the EDS transaction. It seems as if the plaintiffs hope to contend that both the EDS and Autonomy deals were part of failed strategy for the company’s Enterprise Services business, which the company sought to try to conceal until the problems could no longer be hidden from shareholders – although if this is the plaintiff’s theory, it is at this point only implied in the complaint, not explicitly stated.

 

As I said, there will likely be other lawsuits to come. The other suits and the likely amended complaints may further elaborate the plaintiffs’ theory of this case.

 

The ABA Blawg 100: I am delighted to report that The D&O Diary has once again been named to the American Bar Association’s Blawg 100, the bar organization’s list of the top blogs about lawyers and the law. The ABA’s Sixth Annual Blawg 100 list can be found here. We are delighted to be included again in this year’s list, if for no other reason than the blogs we follow and respect the most are all on the list as well.

 

As it has done in past years, the ABA is once again inviting readers to choose the top blogs in each of 14 different categories. Voting begins today and ends at close of business Friday, December 21, 2012 Winners will be announced by January 3, 2013. You can vote for your favorite blog here (registration, which is free, is required to vote). You can also vote by clicking on the “Vote for this Blog” box in the right hand column. Everyone here at The D&O Diary would be very grateful to any readers who might consider casting a vote for this site.

 

The Deadline for the Towers Watson D&O Survey is Approaching: As I have previously noted on this site, Towers Watson is once again conducting its annual D&O insurance survey. Everyone in our industry benefits from the survey results, so we all have a stake in making sure that the survey responses are as representative as possible of the industry as a whole. The deadline for this year’s survey is this Friday, November 30, 2012. Please take a moment and think about whether you have a client that could help with this year’s survey. The survey form itself is relatively short and only takes a few minutes to complete. The survey form can be found here. Please take a moment and forward this link to any prospective survey respondents you can think of.

 

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In a November 13, 2012 opinion (here), Western District of Texas Judge Sam Sparks has upheld the right of the SEC under Section 304 of Sarbanes Oxley to seek to clawback bonus compensation paid to the CEO and CFO of Arthrocare, after the company restated its prior financial statements., even though the CEO and CFO had no involvement in or even awareness of the misconduct that caused the company to misreport its financial results. Judge Spark’s opinion provides a detailed theoretical underpinning for the SEC’s authority under Section 304 and represents a broad affirmation of the SEC’s rights to seek to recoup bonus compensation as provided in the statute. .

 

Michael Baker and Michael Glick were, respectively the CEO and CFO of Arthrocare during the period 2006 through the first quarter of 2008. The company later restated the financial statement it had filed with the SEC during this period, owing to the alleged fraud of two of the company’s senior vice presidents, John Raffle and David Applegate. The SEC brought separate enforcement actions against Raffle and Applegate, which resulted in agreed judgments against them. The SEC then filed an action against Baker and Glick, seeking to recover on behalf of Applegate the bonus compensation the company had paid them in connection with the financial reporting periods that the company restated.

 

The defendants moved to dismiss the SEC’s action, arguing in essence that the SEC did not have the right under the statute to pursue claims against them when they had not involvement in or even awareness of the misconduct that led to the restatements.

 

Judge Sparks rejected these arguments, citing with approval from District of Arizona G. Murray Snow’s opinion in the case involving Maynard Jenkins, the CEO Of CSK Auto (about which refer here). Judge Sparks noted that though “it might be surprising at first glance” for the corporate officials to have to reimburse their companies when they have done nothing illegal, there are “good policy reasons” for Section 304’s broad scope. He specifically noted that “by requiring reimbursement, even in the absence of any wrongdoing, Congress was logically extending and expanding the regulatory scheme for publicly traded companies in reaction to the various accounting scandals which triggered Sarbanes Oxley.” The construction of the statute urges by Baker and Glick “would render Section 304 redundant of existing fraud laws.”

 

Judge Sparks also rejected the arguments of Baker and Glick that Section 304 is unconstitutional. Specifically he rejected their arguments that the clawback statute violates the due process clause, is void for vagueness or violates the excessive fines clause.

 

In reaching these conclusions upholding the SEC”s rights to seek to clawback bonus compensation in reliance on Section 304, Judge Sparks got to the heart of Section 304’s sanctions and its purposes:

 

Baker and Applegate, who were senior vice presidents, apparently used their positions of authority to perpetuate serious misconduct, over a significant time period of time. Baker and Glick should have been monitoring the various internal controls to guard against such misconduct; they signed the SEC filings in question and represented they in fact were guarding against noncompliance. As such, they shouldered the risk of Section 304 reimbursement when noncompliance nevertheless occurred.

 

Sparks went on to note that Section 304’s requirements are “crystal clear”; the Act “tells executives precisely what they must do to avoid reimbursement liability.” They must, Sparks noted, “ensure the issuer files accurate financial statements.” They are to do so by establishing and maintaining internal controls. Judge Sparks went further to find that there is a “reasonable relationship” between the conduct and the penalty; “where, as here …corporate officers are asleep on their watch,” they are liable for a penalty that is limited to the amounts of their bonus compensation.

 

As noted above, there have been prior rulings upholding the SEC”s right to pursue clawback actions under Section 304 even in the absence of allegations that the corporate executives from whom compensation clawback is sought were involved in or even aware of the misconduct that led to the restatement. However, Spark’s opinion provides a broad theoretical justification for the SEC’s use of the provision and may represent something of an encouragement to the agency to use  its authority under the statute; indeed, in his conclusion, Sparks said:

 

Apologists for the extraordinarily high compensation given to corporate officers have long-justified such pay as asserting CEOs take “great risks,” and so deserve great rewards. For years, this has been a vacuous saw, because corporate law, and private measures such as wide-spread indemnification of officers by their employers, and the provisions of Directors & Officers insurance, have ensured any “risks” taken by these fearless captains of industry almost never impact their personal finances. In enacting Section 304 of Sarbanes Oxley, Congress determined to put a modes measure of real risk back into the equation. This was a policy decision, and while its fairness or wisdom can be debated, its legal effect cannot. Section 304 creates a powerful incentive for CEOs and CFOs to take their corporate responsibilities very seriously indeed.

 

The question of the SEC’s clawback authority has even broader implications in the wake of the enactment of the Dodd-Frank Act, which makes a much broader range of corporate officials potentially subject to clawback liability.  As discussed here and here, under Section 954 of the Dodd-Frank Act, the national securities exchanges are required to promulgate rules requiring reporting companies to adopt and disclose procedures providing for the recovery of any amount of incentive based compensation paid to any current or former executive that exceeds the amount which would have been paid under an accounting restatement in the three years prior to the date on which the company was required to prepare the restatement. The Dodd-Frank provision is quite a bit broader than Sox Section 304, as it extends to all executives and it reaches back three years and to all incentive based compensation.

 

I have long felt that Section 304 represents part of a dangerous legal trend that tends to want to try to impose liability without culpability (as I discussed at length here).  However, I also agree with Judge Sparks that while we may debate the merits or demerits of the SEC’s authority under Section 304, the provision is the law and it does give the SEC broad authority to recoup bonus compensation. I still think attention needs to be given to the unfortunate trend toward imposing liability without culpability, and by way of example of a looming problem, I question whether the SEC’s clawback authority should have been (as it was in the Dodd-Frank act) extended to reach corporate officials beyond those who have responsibility for certifying financial results. At a minimum, I would argue that the theoretical justification that Sparks gives for the SEC’s authority Section 304 does not work as well when the clawback authority is extended beyond the officers responsible for financial statement certification.

 

I have previously discussed the potential D&O insurance implications of Section 304 clawback actions here.

 

Alison Frankel's November 16, 2012 post on her On the Case blog about Judge Sparks's opinion can be found here. I know that sometimes it may feel that I just follow Frankel around and write about what she has written about. I fee compelled to point out that I had written my post about Judge Spark's opinion before I learned that she had also written about this case. Besides, her blog is so comprehensive, if I coudln't write about things she has written about, I would be left without anything to write about. I will say to all of my readers, if you are not reading Frankel's blog every day, you are making a serious mistake.

 

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Securities class action plaintiffs often allege that the defendants’ statements about their company’s internal controls are misleading. Typically, these internal control-related allegations are made in connection with allegations of accounting misrepresentations, as the plaintiffs contend that the alleged internal control deficienciesp allowed the accounting errors behind alleged accounting misrepresentations.

 

In a November 7, 2012 ruling (here), Judge Lewis Kaplan held in the Weatherford International securities class action litigation that the plaintiff’s internal control misrepresentation allegations were sufficient to survive a motion to dismiss, even where the accounting misrepresentations alleged were not sufficient to survive the dismissal motion. While this ruling may not be unprecedented, it does represent an unusual holding where the internal control allegations were found to be sufficient on a standalone basis. Because Judge Kaplan’s holding depended in part on the relevant corporate officer’s internal control certification, the ruling may also have important implications with respect to the certifications required under Sarbanes Oxley.

 

Background

The plaintiff’s complaint relates to Weatherford’s alleged understatement of tax expenses in its financial statements for the tax years 2007 through 2009 and for the first three quarters of 2010. The plaintiff alleged that beginning in 2007, the company reported industry low effective tax rates, something that was of particular interest to securities analysts and investors. The defendants allegedly touted the company’s low effective tax rate.

 

On March 1, 2011, the company announced that it was restating its financials for the period described in the preceding paragraph due to “material weaknesses” in internal control over financial reporting of income taxes. In particular, the company said that “the Company’s processes procedures and controls related to financial reporting were not effective to ensure that amounts related to current taxes payable, certain deferred tax assets and liabilities, reserves for uncertain tax positions, the current and deferred income tax expense and related footnote disclosures were accurate.” The company ultimately concluded that it had understated its tax liabilities during the period of the restatement by about $500 million.

 

The company share price declined on the news of the restatement and the plaintiff filed a securities class action lawsuit alleging two categories of misrepresentations: (1) those arising directly from the understatement of the company’s tax expenses and (2) those pertaining to Weatherford’s maintenance of its internal controls over its financial reporting. The complaint named as defendants the company itself; four individual directors and officers; and the company’s outside auditor.

 

With respect to the internal controls, the complaint alleged that in its filings with the SEC during the period of the restatement, the company’s CEO and CFO (Becnel) had certified that they were “responsible for establishing and maintaining” financial reporting controls; for designing the controls; and for evaluating and for reporting to the board all significant deficiencies and material weaknesses in the design or operation of the controls.

 

However, in the company’s March 2011 restatement announcement, the company identified a number of “material weaknesses” in internal controls, including that the inadequacy of staffing and technical expertise with regard to taxes; ineffective review and approval with respect to taxes; ineffective processes to reconcile tax accounts; and inadequate controls over the preparation of quarterly tax provisions.

 

The defendants moved to dismiss the plaintiffs’ complaint..

 

The November 7, 2012 Ruling

In his November 7 Memorandum Opinion, Judge Kaplan denied the motions to dismiss of the CEO (Becnel) and of the company itself with respect to the plaintiffs’ allegations concerning the alleged misrepresentations of the company’s internal controls. In denying the motion, Judge Kaplan noted Becnel’s personal participation in the design of the company’s internal controls, as Becnel himself had affirmed in the certifications in the company’s SEC filings. Judge Kaplan found further, in light of

 

the stark realities about the inadequacies of the internal controls that were revealed in the March 2011 restatement, the audit delays and control deficiencies expressly raised to him during the class period, and the fact that the Tax Department uniquely was experiencing problems even while he knew that its functions were of specific importance to the Company, the [amended complaint] sufficiently alleges scienter with regard to his statements.

 

Judge Kaplan found that these allegations were also sufficient to establish scienter with respect to the company itself, but not with respect to the other three individual defendants.

 

While Judge Kaplan found that the plaintiff’s allegations of alleged misrepresentations concerning the internal controls were sufficient as to Becnel and the company, he found that the plaintiff’s allegations regarding the understatement of the company’s tax expense were not sufficient as to any of the defendants.

 

Among other things, Judge Kaplan concluded that the alleged internal control misrepresentations alone were not sufficient to establish that the alleged misstatements of the company’s tax expense were made with scienter. Judge Kaplan said that “while Weatherford’s poor internal controls may give rise to liability with respect to the defendants’ statements about internal controls, the weak internal controls provide little if any circumstantial support that the statements that the understated tax expense were made with scienter.”

 

Judge Kaplan also rejected that the size of the restatement of the company’s tax expense, together with the extent to which the company touted its low effective tax rate in public statements, was sufficient to establish that the understatements of the company’s tax liability were made with scienter. He noted that the size of the fraud alone does not create an inference an inference of scienter, adding that “what is noticeably missing from the [amended complaint] is any allegation that the Weatherford defendants had any contemporaneous basis to believe that the information they related was incorrect.”

 

Though Judge Kaplan had granted the motions of the three individual defendants other than Becnel with respect to the Section 10(b) allegations against them concerning the alleged internal control allegations, he denied those three defendants’ motions to dismiss the plaintiff’s control person liability claims under Section 20(a), meaning that at least some claims against all four of the individual defendants survived the motion to dismiss, as well as the internal control claims against the company itself.

 

Discussion

Judge Kaplan’s decision represents the rare case where allegations of internal control misrepresentations were found to support a finding of scienter, a determination that is particularly unusual where as here the accompanying alleged accounting misrepresentations were found not to be sufficient to state a claim. Judge Kaplan’s holding that the alleged internal control allegations were sufficient on a standalone basis to survive a motion to dismiss, without an accompanying finding that alleged financial misrepresentations were sufficient to state a claim, represents a novel development, even if not entirely unprecedented.

 

Judge Kaplan’s ruling is particularly interesting to the extent it relies on the certifications that the CFO, Becnel, provided in the company’s SEC filings. Since the enactment of the Sarbanes Oxley Act, CEOs and CFOs have been providing certifications with respect to their company’s internal controls. There have been cases in which the internal control certifications have supported securities fraud claims (refer, for example, to Judge Shira Scheindlin’s November 2, 2007 ruling in the Scottish Re Group case), but those are typically n the context of claims in which the claimant has also established the sufficiency of financial misrepresentation allegations.

 

Judge Kaplan’s ruling represents a recognition that the internal control statements can be sufficient to state a claim for liability, even if the claimant is unable to establish sufficient claims of financial misrepresentation. The possibility that corporate executives can be held liable on a standalone basis for misrepresentations concerning internal controls arguably adds some teeth the responsibilities corporate executives undertake when they provide the internal control certifications required by Sarbanes Oxley.

 

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

 

Nobody Could Make This Up: The November 11, 2012 Chapel Hill (N.C.) News-Observer, in an article entitled "Man Says He Saw a U.F.O. Fly Over Carrboro" (here), reports that  "Roy Mars was peeing in his compost last weekend -- it adds nitrogen -- when he looked up and saw something streak across the sky." (Hat Tip: Jim Romenesko)

 

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As I have frequently noted on this blog (most recently here), one of the most distinctive litigation phenomenon has been the rise in litigation involving M&A activity. It has gotten to the point that virtually every merger now also involves a lawsuit (or, more often, multiple suits). These cases have proven attractive to plaintiffs’ lawyers because the pressure to close the deal has allowed the claimants to attract a quick settlement, often involving an agreement to publish additional disclosures or adopt corporate therapeutics and the payment of plaintiffs’ attorneys’ fees.

 

However, as noted in a November 9, 2012 post on the Harvard Law School Forum on Corporate Governance and Financial Reform by Boris Feldman of the Wilson Sonsini law firm, there recently has been a new twist to the M&A litigation phenomenon; increasingly, plaintiffs’ lawyers have “refined their business model” and now they aim to “keep the litigation alive post-close.” Moreover, Feldman notes, the plaintiffs are pursing these post-close M&A cases “even in situations where objective factors suggest a lack of merit to the claims: e.g., high premium; no contesting bidders; overwhelming shareholder approval; customary deal terms.”

 

Feldman posits three reasons that plaintiffs’ attorneys are pursuing these post-close merger claims. First, due to changes in the plaintiffs’ bar, some lawyers are struggling to modify their business model, as a result of which some lawyers have “decided to pursue cases that they would have let run dry in the past.”

 

Second, Feldman acknowledges that the post-close cases have their own in terrorem value, even if it is only a form of “nuisance value.” The continuing case subjects corporate executives to time-consuming and burdensome discovery, sometimes in the context of a deal that may or may not have worked out all that well. The case also threatens a trial on processes and analysis that led to the acquisition, a form of exposure the company may prefer to avoid. Therefore, Feldman notes, “even post-close suits have some ‘go away’ value to the surviving company.”

 

Third, Feldman speculates that at least some of the plaintiffs’ attorneys may be pursuing a longer term strategy, by showing that they are willing to persevere for years, even in a weak case, in the hope that the defendants “may just say ‘pay them and get rid of it’ before the deal closes.” By these lights, “a plaintiffs’ lawyer rationally could pursue a frivolous case, at great expense, post-close, even with low odds of getting a recovery, “simply as a way to improve the profitability of the rest of his inventory.”

 

Feldman notes that the post-close merger cases have their own peculiar dynamic, different than the dynamic of cases pre-close. Among other things, post-close, the plaintiffs’ lawyers have an incentive to try to drag things out. Pre-close, the plaintiffs’ lawyers want to accelerate procedures and discovery, to keep the pressure on the parties to the underlying transaction to settle the case. Post-close, the plaintiffs want to keep the case as long as they can, in part on the hope that as time goes by they might manage to find documents or other materials or information that will support their case, and in part on the hope that as time goes by, the defendants will get weary of the case and pay to make it go away.

 

According to Feldman, defendants in these post-close cases may want to take a more active role, and in particular actively push toward summary judgment. He suggests that though courts have been reluctant to grant summary judgment in the past, judges will “eventually decide that most merger claims are strikesuits and will extirpate them before trial.”

 

As support for this contention that more courts may be willing to grant summary judgment in post-close cases, Feldman cites the recent grant of summary judgment in favor of Intel in the case arising out of Intel’s acquisition of McAfee. (In a November 2, 2012 order (here), California Superior Court Judge James P. Kleinberg granted the defendants’ motion to dismiss in the case, just two weeks prior to the scheduled trial date.)

 

With reference to the grant of summary judgment in the Intel case, Feldman argues that the plaintiffs’ Achilles Heel in the cases may be the exculpatory provisions in the Delaware Corporations Code, which preclude damage claims against directors for breaches of fiduciary duty unless plaintiffs can establish serious conflicts of interest or bad faith. Feldman contends that “it will be the rare case indeed where plaintiffs have such evidence against a director, much less a majority of the Board.” Feldman predicts that many more courts will be willing to jettison cases at the summary judgment stage on this basis.

 

Finally, Feldman notes that even if these cases survive summary judgment, they could prove difficult for the plaintiffs. The cases are challenging to try to settle, as there are no opportunities for non-monetary settlements and as the justification for additional deal consideration will be lacking after shareholder approval. At the same time, the cases will prove difficult for plaintiffs to try, as, Feldman suggests, “very few judges will be willing to second-guess the decisions of independent, well-advised boards of directors as to what their company was worth.” In the final analysis, Feldman suggests, the “ultimate irony” may be that even if plaintiffs’ keep their cases alive post-merger, they will have difficulty figuring out “a way to monetize them that survives judicial scrutiny.”

 

I think Feldman’s analysis is interesting, particularly his estimation of the strong likelihood that defendants will prevail if they push the post-close merger cases to summary judgment or trial. At the same time, however, I think it is important to note that Intel’s summary judgment victory was considered noteworthy precisely because it was so unusual for the defendant company to continue to fight the continuing litigation. (See for example, Nate Raymond’s commentary about the summary judgment ruling on the On the Case blog, here.)

 

Even if Feldman is right about the defendants’ prospects if they continue to fight these cases, the far likelier outcome is that the defendant companies will, as the plaintiffs’ undoubtedly hope, tire of the cases rather than fighting them and seek some type of a compromise. Unfortunately, the plaintiffs’ may continue to pursue post-close merger cases as a way to try to extract something from the merger, even if they are unable to secure a pre-close settlement, simply because the likeliest outcome is that they will eventually get rewarded for doing so. Whether more companies will, like Intel, prove willing to fight the cases remains to be seen.

 

Rating Agencies Take Another Hit: In a post last week, I noted the decision of an Australian Court holding S&P liable for ratings of certain complex financial instruments. The rating agencies took another hit later in the week, in a decision by an Illinois state court judge denying the motion of McGraw-Hill, S&P’s parent, to dismiss an action brought against the rating agency by the Illinois attorney general. The court’s ruling that the alleged misrepresentations are not protected opinion is particularly noteworthy.

 

Illinois Attorney General Lisa Madigan had commenced the action, alleging that during the period 2001 through 2008, S&P had misled the investing public by claiming that its ratings of certain structured financial products were independent, objective and unbiased. The AG alleged that the rating agency’s repeated representations regarding its independence and objectivity were demonstrably false. The Illinois AG asserted claims under the Illinois Consumer Fraud and Deceptive Business Practices Act and under the Uniform Deceptive Trade Practices Act. The defendants moved to dismiss.

 

In her November 7, 2012 opinion (here), Illinois (Cook County) Circuit Court Judge Mary Ann Mason denied the defendants’ motion to dismiss. Her opinion emphasized certain alleged attributes of the ratings themselves. That is, first, that because of the alleged “opaque” nature of the securities (meaning that there was no ready source of information by which investors could otherwise gauge the investments), the rating agency’s assertion that its ratings were independent, objective and unbiased were “of enhanced importance to investors.” Second, because the opinions allegedly were issued pursuant to an “issuer pays” business model, as a part of which the rating agency’s had an incentive to provide the rating the issuer desired in order to secure future business, “allowed the profit motive to override its objectivity and independence.”

 

The defendants moved to dismiss on the ground that its ratings represent protected opinion. However, as Judge Mason noted, the AG’s claims are not based on the rating agency’s opinions but rather its “repeated statements of fact regarding S&P’s independence and objectivity.” Judge Mason expressly rejected the defendants’ arguments that the ratings were protected by the first amendment, because the statements about the agency’s objectivity and independence and not simply opinions; that are, Judge Mason said, “verifiable representations regarding the manner in which S&P assures the integrity and independence central to the credibility of its ratings.”

 

Judge Mason went on to note that “the logical extension “ of the defendants’ arguments “would be to immunize rating agencies from investor claims based on investor claims clearly intended to influence those same investors.” She noted that the entire value of the system from which the rating agencies hope to profit “depends on the investing public’s confidence in the credibility and independence of its ratings.” If the investors lack that confidence, the “ratings lose their value to issuers and issuers lack motivation to seek out the agency’s ratings in the future.”

 

Judge Mason’s ruling is interesting and her reasoning could be persuasive to other courts, at least in other cases in which the misrepresentation that rating agency defendants are alleged to have made relate to the agencies’ supposed independence and objectivity. However, as Alison Frankel notes in an interesting November 9, 2012 post on her On the Case blog (here), Judge Mason’s ruling may not open the floodgates; in particular, as Frankel notes, federal laws may preempt claims against rating agencies involving post-2007 conduct. It could be that Judge Mason’s reasoning is less useful in cases involving alleged misrepresentations after 2007, and the pre-2007 alleged misrepresentations may be untimely.

 

Libor Investigations in Asia: In earlier posts (refer, for example, here), I have examined the regulatory investigations into possible manipulation of the Libor benchmark interest rates. A number of countries are also investigating possible Libor manipulation, including countries in Asia. As detailed in an interesting November 2012 memorandum from the Ince & Co. law firm entitled “LIBOR – The Asia Story” (here), the Asian countries investigating possible Libor or other benchmark interest rate manipulation include Singapore, Korea, and Japan. Interestingly, the related developments in Singapore include a lawsuit brought by an RBS trader who claims he was wrongfully terminated for his involvement in benchmark rate manipulation in order to deflect attention from the bank for its involvement in the Libor scandal.

 

The authors of the Ince law firm memo include my good friends Nilam Sharma and Aruno Rajaratnam, and their colleague Victoria Gregory.

 

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I am pleased to publish below a guest post written by Robert F. Carangelo, Paul A. Ferrillo, David J. Schwartz, and Matthew D. Altemeier of the Weil, Gotshal & Manges law firm and the authors of The 10b-5 Guide, the most recent edition of which can be found here.. The guest post reflects the authors’ report and analysis of the recent oral argument at the U.S. Supreme Court in the Amgen case. Background regarding the Amgen case can be found here.

 

 

I would like to thank the authors for their  willingness to publish their article on this site. I welcome guest posts from responsible commentators on topics of interest to readers of this blog. Any readers who are interested in publishing a guest post on this site are encourage to contact me directly. Here is the authors’ guest post:

 

 

On November 5, 2012, the United States Supreme Court heard oral argument in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds (No. 11-1085) (“Amgen”).  In Amgen, Plaintiff/Respondent Connecticut Retirement Plans and Trust Funds (“Connecticut Retirement”) brought a putative class action under the Exchange Act of 1934, alleging that Defendant/Petitioner Amgen and several of its directors and officers misstated and failed to disclose safety information concerning two of its drugs. Amgen contends that it did not mislead investors and that the information it allegedly concealed was widely known.

 

 

 

Background of Amgen and Path to the Supreme Court

 

The issue in Amgen is the predominance requirement of Federal Rule of Civil Procedure (“Rule”) 23(b)(3), which states that a court may not certify a class for trial without determining that “questions of law or fact common to class members predominate over any questions affecting only individual members.” Because of the near-impossibility of establishing commonality of direct reliance on alleged misstatements in securities fraud litigations, plaintiffs typically rely on a rebuttable presumption of common indirect reliance on the integrity of the market price for the securities at issue. The Supreme Court first recognized this presumption in Basic Inc. v. Levinson, 485 U.S. 224, 241-47 (1988), relying in part on the “fraud-on-the-market” (“FOTM”) theory. The FOTM theory assumes that the market price of securities traded in an efficient market reflects all publicly-available material information, including any material misrepresentations.

 

 

Twenty-five years after Basic, Amgen asks the Court to decide whether class action plaintiffs must prove the materiality of alleged misstatements to use the Basic presumption at the class certification stage (and thus allow a Court to find that common issues of reliance predominate). In Amgen, the district court certified the proposed class for trial even though Connecticut Retirement provided no evidence to establish materiality, ruling that plaintiffs “need only establish that an efficient market exists” to take advantage of the Basic presumption at that phase of the litigation. Conn. Ret. Plans & Trust Funds v. Amgen, Inc., 2009 WL 2633743, at *12 (C.D. Cal. Aug. 12, 2009). The Ninth Circuit affirmed this determination, following the Seventh Circuit’s approach in Schleicher v. Wendt, 618 F.3d 679 (7th Cir. 2010), and holding that plaintiffs must “plausibly allege—but need not prove . . . that the claimed misrepresentations were material” at the class certification stage. Conn. Ret. Plans & Trust Funds v. Amgen Inc., 660 F.3d 1170, 1172 (9th Cir. 2011). This approach, however, differs from that of the Second and Fifth Circuits, which require proof of materiality under such circumstances. See In re Salomon Analyst Metromedia Litig., 544 F.3d 474 (2d Cir. 2008); Oscar Private Equity Invs. v. Allegiance Telecom, Inc., 401 F.3d 316 (5th Cir. 2005).

 

 

The Amgen parties’ prior written submissions to the Court mirror this circuit split. Amgen argues that, because the FOTM theory assumes that efficient markets incorporate only material information, courts have no basis to presume that immaterial statements are reflected in the market price of a security (and thereby affect all plaintiffs in common). Br. for Pet’rs at *17-19, Amgen (No. 11-1085), 2012 WL 3277030 (U.S. Aug. 8, 2012). Connecticut Retirement, on the other hand, contends that the only indispensable FOTM prerequisites are (1) that the security in question was traded in an efficient market, and (2) that the alleged misrepresentations were public. Br. for Resp’t in Opp’n to Cert. at *9, Amgen (No. 11-1085), 2012 WL 1666404 (U.S. May 11, 2012). Once these two predicates are established, says Connecticut Retirement, certification is proper because “falsehood and materiality affect [all] investors alike” and “if the misrepresentations turn out to be immaterial, then every plaintiff’s claim fails on the merits.” Id. at *13.

 

 

Oral Argument Reflects a Divided Court

 

 

During oral argument, questioning by Justices Kagan, Breyer, Ginsburg and Sotomayor suggested an inclination to affirm class certification, reasoning that once plaintiffs establish the existence of market efficiency and a public statement, materiality becomes a common question that courts need not determine at the class certification stage. Counsel for Amgen emphasized that the question before the Court was not materiality, but indirect reliance via the Basic presumption, the commonality of which cannot be established without proof that the alleged misrepresentations were in fact material (and thus actually moved the market).  Counsel for Amgen added that, as with any other FOTM predicate, a finding that materiality is lacking at the class certification stage does not foreclose individual plaintiffs from later moving forward with actions based on direct reliance. Justices Ginsberg and Kagan disagreed on this point, indicating their view that a finding of immateriality at the class certification stage would effectively end the case.

 

 

Justice Breyer also expressed concern that proof of materiality is premature at the class certification stage given materiality’s dual role as both a condition under Basic and an element of the substantive claim. Counsel for Amgen replied that “[t]he point of the class certification . . . is the question whether there is class coherence in the first place. It’s not the merits.” Indeed,

 

 

[t]he real question in this case is what is the purpose of Rule 23? If you think that the purpose of Rule 23 is to postpone to the merits everything that can be postponed without a risk of foreclosing valid individual claims, we lose. But that’s not the purpose. The purpose is for a court to determine whether all of the preconditions for forcing everyone into a class action are present before you certify. (emphasis added)

 

 

According to Petitioner, the alternative of pushing everything to the end “is like letting the fruits justify the search.”

 

 

Counsel for Respondent, on the other hand, contended that a class action is the most efficient method for adjudicating materiality because the presence of an efficient market establishes the relevant security’s “ability to absorb [public] information, both material and non-material,” for all plaintiffs at once. Counsel representing the United States in support of Respondents contributed to this argument:

 

                       

The most efficient course is to actually focus on common issues. . . . In the current [embodiment] of Rule 23(b)(3), you want to certify class actions that are both meritorious and those that are not, so it reaches a binding judgment.

 

 

One major point of dispute during oral argument was Justice Breyer’s suggestion that, unlike other FOTM predicates, materiality “is a common element of the tort . . . it will [always] be litigated, so there is no special reason . . . for litigating [it] at the outset.” However, Justice Scalia strongly disagreed on this point:

 

 

But there . . . is a reason for deciding it earlier, and the reason is the . . . enormous pressure to settle once the class is certified. In most cases, that’s the end of the lawsuit. There’s . . . automatically a settlement.

 

 

In this vein, Justice Scalia noted several times that materiality is a precondition to obtaining the “shortcut” provided by Basic’s presumption of reliance. Justice Scalia underscored this point by openly wondering whether the Court should overrule Basic “because it was certainly based on a theory that -- that simply collapses once you remove the materiality element.”  As Justice Scalia noted, “[i]t’s not an efficient market if it’s, you know . . . random[.] It takes account of material factors.”

 

 

Final Analysis and Conclusions

 

Unfortunately, the oral argument in Amgen offers few additional clues as to how the Court will rule. The Justices’ questions indicate that the Court is divided along its usual ideological lines, with Chief Justice Roberts holding the swing vote. However, the authors continue to believe that Amgen has the better argument in this case. In our view, Justice Scalia, through his questioning, effectively made the point (and will be able to persuade a majority of the Court) that for a plaintiff to avail itself of the significant procedural benefit that the Basic presumption already provides, it has to show materiality at the class certification stage.

 

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The volume of securities litigation against non-U.S. companies has ‘reached record levels” despite the U.S. Supreme Court’s 2010 decision in Morrison v. National Australia Bank, according to a recent report from NERA Economic Consulting. The report, written by Robert Patton of NERA, and entitled “Recent Trends in U.S. Securities Class Actions Against Non-U.S. Companies” can be found here. The report was written as a chapter to the 5th edition of The International Comparative Legal Guide to Class & Group Actions 2013, a collection of articles on class and group actions worldwide published by Global Legal Group in association with Commercial Dispute Resolution (CDR).

 

According to the report, the number of U.S. securities class action lawsuits filed against non-U.S. companies reached a peak in 2011, when there were 60 filings. In the first half of 2012, there were 20 filings against non-U.S. companies. While the 2012 filing pace is off from 2011, it is still higher than prior to 2011 and well above the annual average of 18 filings during the period 2000 to 2007. The filings against non-U.S. companies in 2011 represented 28.1 percent of all securities class action lawsuit filings, and while that percentage for the first half of 2012 has declined to 19.8 of all filings, that filing level is well above levels in 2008, 2009 and 2010.

 

The report notes that both in 2011 and 2012, the proportion of U.S. class actions filed against non-U.S. companies exceeded the proportion of non-U.S. companies listed on the U.S. stock exchanges. The report notes that during 2011 and 2012, non-U.S. companies listed on the U.S. exchanges were likelier to be sued than were U.S. companies, reversing a trend from the preceding three years, when foreign companies listed on the U.S. markets were less likely to be sued than U.S. companies.

 

The report notes the irony that the increase in the number of suits filed against non-U.S. companies has occurred after the U.S. Supreme Court’s 2010 opinion in the Morrison case. It has been widely believed that the transaction-based test enunciated in Morrison would reduce the number of securities suits involving non-U.S. companies

 

According to the report, the reason for the proliferation of suits involving non-U.S. companies has been the wave of litigation involving U.S.-listed Chinese companies. While there were only few of these cases filed in 2008 and 2009, in 2010, there were 15, and in 2011, there were 34, representing 17 percent of all 2011 securities class action lawsuits filings and nearly two-thirds of all securities suits involving non-U.S. companies. In the first half of 2012, the rate of filing against non-U.S. Chinese companies has declined, with ten cases filed. The report notes with respect to the suits against Chinese companies  that “this wave of litigation appears unlikely to re-emerge,” not only because rules regarding reverse mergers (the principal mechanism by which Chinese companies have obtained U.S listing) have become stricter, but also because Chinese companies “have become less likely to seek a U.S. listing, due to an increased perceived cost of litigation.”

 

Even though Morrison has not yet had a perceptible impact on the number of filings involving non-U.S. companies, Morrison has had an impact. As claimant classes are defined to omit claims on behalf of shareholders who purchased shares on non-U.S. exchanges, the shareholder classes on whose behalf the securities claims are asserted have become narrower. As the report states, “Morrison’s effect is more likely to narrow the scope of a claim against a non-U.S. company than to eliminate the claim entirely.”

 

The report also reflects an analysis of securities suit settlements in cases involving non-U.S. companies. The analysis shows that in each year during the period 2008 through the first half of 2012, the average settlement was lower in each year for cases involving non-U.S. companies than for cases against U.S. companies, often by a substantial margin. Although the median settlements for these two groups during the same time period are closer, in each year since 2009, the median settlement in cases involving non-U.S. companies is lower than cases against U.S. companies.

 

A significant factor driving the lower settlement trend for cases involving non-U.S. companies is the relatively low settlement of cases involving U.S.-listed Chinese companies (a phenomenon I previously discussed on this blog, here). The median settlement in cases involving Chinese companies during the period January 2010 through June 2012 was $3.0 million, compared to $9.0 million in cases involving settlements for other non-U.S. companies. In addition, the smaller class sizes in cases involving non-U.S. companies owing to Morrison (as noted above) could also be having an effect.

 

The report concludes by noting that the data in the report “underscore that the Morrison decision has not eliminated the risk of U.S. securities class action litigation to non-U.S. companies with securities traded in the U.S.”

 

Special thanks to the several readers who sent me a link to the NERA Report.

 

The Week Ahead: This week, I will be traveling to Chicago for the annual PLUS International Conference. On Thursday, November 8, 2012, I will be participating in a panel discussing D&O insurance in Asia that will be chaired by industry maven Joe Monteleone and that will also include my good friend Aruno Rajaratnam, as well as Dan Harris, the author of the China Law Blog, and Arthur Dong of Lantai Partners.

 

I also plan to attend many of the other sessions and conference events. I hope that if you see me around the conference you will please stop to say helllo and introduce yourself, particularly if we have not previously met. I look forward to seeing everyone at the conference.

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The growing problem of M&A-related litigation has been well-documented on this site (refer for example here). The prevalence of M&A litigation has grown to the point that virtually every M&A transaction involves litigation, and often involving multiple lawsuits in multiple jurisdictions. These growing problems have been well-documented (refer for example here and here), but coming up with solutions has proven challenging.

 

An October 2012 paper by the U.S. Chamber Institute for Legal Reform entitled “The Trial Lawyers’ New Merger Tax” (here) takes a comprehensive look at M&A litigation and proposes a number of possible legislative solutions to the problems associated with multi-jurisdiction litigation. The paper is being released in conjunction with the U.S. Chamber Institute for Legal Reform’s annual Legal Reform Summit, being held on October 24, 2012 at the U.S. Chamber of Commerce in Washington. D.C.

 

The paper opens with a description of the current state of M&A-related litigation. The paper certainly does not hold back in characterizing the state of M&A litigation. Among other things, the paper describes M&A litigation as “extortion through litigation” that permits trial lawyers to “hold transactions hostage until they collect a ‘litigation tax’ draining a share of the merger’s economic benefit away from shareholders and into the lawyers’ own pockets.”

 

The paper includes a detailed review of recent statistical studies documenting the M&A related litigation trends, noting in particular (and citing the Cornerstone Research’s analysis of M&A litigation, about which refer here) that on average each transaction is subject to five lawsuits, and that many deals attract more than 15 suits. In some cases, merger deals have attracted as many as 25 lawsuits.

 

The paper also notes that increasingly these multiple lawsuits are filed in multiple jurisdictions, which forces defendants “to litigate in numerous jurisdictions that are incapable of coordinating with each other, particularly state courts in different states,” which “dramatically increases the cost of defense and increases the settlement pressure regardless of the merits of the underlying claims.” Because “no   procedure exists to consolidate identical cases filed in the courts of different states and in federal court,” judges today “cannot stop the abuse.”

 

Although there are many aspects of the M&A litigation problem, the paper focuses its proposed solutions on the multiple jurisdiction litigation issue, in part because it is “a principal source of the trial lawyers’ settlement leverage.” The paper suggests several possible legislative reforms to “prevent plaintiffs’ lawyers from exploiting” the burdens imposed by multiple jurisdiction litigation by “eliminating forum shopping and forum multiplication.”

 

In order to address these issues, the paper suggests three possible legislative reforms (not necessarily mutually exclusive) at the federal level. First, the paper suggests that Congress could “enact a statute requiring all merger-related litigation to be brought in the state of incorporation of the defendant company.” (The paper notes that this proposal has also been advanced by committee of the Association of the Bar of the City of New York.) Second, the paper suggests that Congress could amend the “carve outs” in SLUSA and CAPA to required that class actions brought under the carve-outs “may be filed only in the courts of the defendant company’s state of incorporation.”

 

Third, to address the fact that many of these merger related lawsuits are brought in federal court, the paper suggests that Congress could enact legislation providing that any lawsuits relating to mergers or acquisitions that are brought in federal court should be transferred immediately to a federal court for the district containing the state capital.

 

The paper also notes that there is also possibility for legislative reform at the state level, but state legislative reform could be cumbersome and could take time because to be effective it would require enactment by a significant number of states. The paper does note that the M&A litigation problem could be addressed if states enacted legislation specifying the merger objection litigation must be brought in the state of incorporation.

 

The paper contains a number of possible solutions to the multiple jurisdiction litigation problem which are worthy of further discussion and consideration. There is no doubt that the multiple jurisdiction litigation does nothing to benefit shareholders and in fact accomplishes only the multiplication of legal costs and burdens, and therefore there is no doubt that active steps should be taken in order to try to eliminate this problem.

 

As important as it is to address the multiple jurisdiction litigation problem, however, it is worth noting that even if the multiple jurisdiction litigation problem is addressed that will not address all of the concerns with M&A litigation. As the paper itself notes about the legislative reforms proposed, “although these reforms will not entirely eliminate the problem of abuse, they will stop the multiplication of litigation and forum shopping and … and enable companies to fight back against unjustified claims” which, the paper concludes, would make it “more difficult for trial lawyers to collect the litigation tax.”

 

It is probably also worth noting that though the paper’s proposal regarding M&A litigation filed in federal court could reduce the problems when separate M&A-related suits are filed not just in state court but also in federal court, the proposal would not eliminate the problem. Even the transfer scheme that the paper contemplates for the suits filed in federal court would still allow for the possibility of parallel suits proceeding simultaneously in state and federal court. While it would be hoped that the courts would coordinate their actions in order to try to eliminate duplicative litigation burdens and expense, there is nothing about the federal court transfer proposal that would assure that the duplicative litigation would not go forward. 

 

I do think it is interesting that all of the proposals suggested are focused on reforming litigation procedures. The paper does not mention another reform M&A litigation reform proposal that at least for a time had a certain amount of cachet – that was the notion of incorporating a forum selection clause in the company’s charter documents in order to require certain types of shareholder suits to be brought in the courts of the company’s state of incorporation. This idea certainly has its advocates; however, as discussed here, companies that adopted these forum selection by laws found themselves targeted in a wave of shareholder suits challenging the by-laws. It appears that with the litigation and controversy, the forum selection by-law idea may not enjoy the same currency that perhaps it once did.

 

I will say that by addressing the multiple jurisdiction problem rather than trying to come up with a broader proposal attempting to eliminate abusive M&A-related litigation altogether, the paper has chosen a target about which it will easier to reach a consensus on the need for reform and that can be addressed at least in part with some identifiable legislative actions. The reform proposed in the paper is achievable and could help to reduce a serious problem facing corporate America. It is not necessary to agree with all of the paper’s rhetoric in order to agree with the proposed legislative reforms. The proposals suggested in the paper are serious and merit further discussion and consideration and I hope that Congress will take up these issues – at least once they have addressed the looming “fiscal cliff.”

 

Towers Watson Launches 2012 D&O Liability Insurance Survey: Towers Watson is once again taking up its annual D&O Liability Insurance Survey. This survey has a long and venerable tradition in the D&O insurance industry. The Survey went off-line briefly for a few years, but now it is back. The annual survey report, which Towers Watson makes freely available, is a valuable resource for everyone in the D&O insurance industry.

 

Because the survey results are so valuable for everyone in the industry, everyone participant has a stake in seeing that the survey is as representative as possible of the overall D&O industry. The survey is only as good as the data that results from the survey participants, and the more participants there are the better will be the survey results. So everyone has a stake in seeing that as many D&O insurance buyers as possible complete the survey.

 

The 2012 Towers Watson D&O Liability Insurance Survey can be found here. I hope that every D&O Diary reader will forward the survey link to their clients and encourage them to complete the survey. Again, the more companies the complete the survey the better the form will be. So please take the time to forward the survey to your client companies and encourage them to complete the survey form. Please note that the survey must be completed by November 30, 2012.

 

A summary regarding the 2011 Towers Watson D&O Liability Survey can be found here.

 

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In its June 2010 decision in the Morrison v. National Australia Bank, the U.S. Supreme Court enunciated a "transactions" test to determine the applicability of the U.S. securities laws. The Court said that the U.S. securities laws apply only to "transactions in securities listed on domestic exchanges and domestic transactions in other securities." Lower courts have wrestled with Morrison’s “second prong” as they struggled to determine what constitutes a "domestic transaction in other securities." As the Second Circuit has commented, Morrison itself “provides little guidance as to what constitutes a domestic purchase or sale.”

 

Recent developments in the SEC’s pending case against mid-level Goldman Sachs executive Fabrice Tourre and involving the infamous “built to fail” Abacus CDO transaction underscore the difficulties courts face in wrestling with Morrison’s second prong.

 

As discussed here, in April 2010, the SEC filed an enforcement action against Goldman and Tourre. Goldman settled the SEC’s claims against the company for a total of $550 million in penalties and disgorgement (as discussed here). Tourre was not a part of the settlement and the SEC’s action against him has remained pending and is moving toward a July 2013 trial date. Tourre, who allegedly was involved in structuring and marketing the securities at issue in the case, is perhaps best known for his reference to himself in an email as “fabulous Fab.” (An April 2010 New York Magazine article entitled “The Fabulous Life of Fabrice Tourre” can be found here.)

 

As the case against Tourre went forward, one important development was Southern District of New York Judge Barbara Jones’s June 2011 ruling (here) dismissing a part of the SEC’s case based on Morrison.  Tourre moved to dismiss a portion of the complaint relating to the sale of Abacus notes to IKB, a German bank. Tourre argued that because the actual seller in the transaction was a Cayman Islands based issuer, there was an insufficient connection to this country to allow the SEC to pursue claims pertaining to IKB’s purchase of the notes.

 

As discussed in a guest post on this blog (here) by Angelo Savino of the Cozen O’Conner law firm, Judge Jones found that Morrison’s second prong requires a showing that “irrevocable liability” has been incurred in the U.S. She specifically rejected that argument that it was sufficient to satisfy Morrison’s second prong that the transaction closing took place in the United States; she said that

 

In view of the fact that none of the conduct or activities alleged by the SEC, including the closing, constitute facts that demonstrate where any party to the IKB note purchases incurred “‘irrevocable liability [,]’” . . . the SEC fails to provide sufficient facts that allow the court to draw the reasonable inference that the IKB note “purchase[s] or sale[s were] made in the United States.” 

 

Judge Jones dismissed the portion of the complaint relating to the IKB transaction, but other portions of the complaint involving domestic securities purchasers remained pending.

 

The SEC’s enforcement action has now been reassigned from Judge Jones to Southern District of New York Judge Katherine Forrest, a relatively new judge who has been on the bench for just one year. The SEC, perhaps trying to take advantage of this change, has now moved to reconsider Judge Jones’s ruling pertaining to the IKB notes transaction, as discussed in detail in interesting October 19, 2012 article on the New York Times Dealbook blog (here) by Wayne State University law professor Peter J. Henning.

 

The SEC’s motion for reconsideration is based on the Second Circuit’s March 2012 decision in Absolute Activist Value Master Fund Ltd. v. Ficeto, in an opinion that came down about nine months after Judge Jones’s ruling in the Goldman Sachs case. The Second Circuit quoted with approval the “irremovable liability” standard Judge Jones had articulated in the Goldman case. But the appellate court added that “a sale of securities can be understood to take place at the location at which title is transferred” and held that “to sufficiently allege a domestic transaction in securities not listed on a domestic exchange, we hold that a plaintiff must allege facts suggesting that irrevocable liability was incurred or title was transferred within the United States.” (The Second Circuit’s decision in the Absolute Activist Value Master Fund case is discussed in detail here).

 

In moving for reconsideration of Judge Jones’s ruling, the SEC, in reliance on the fact that the closing of the IKB transaction took place in the United States, argued that the U.S. securities laws do apply to the IKB transaction and therefore that  its claims pertaining to the IKB transaction should not have been dismissed. Toure disputes whether these charges can be reinstated at the point in the case, arguing in particular that the parties have already conducted extensive discovery and if the dismissed claims were reinstated, discovery would have to be reopened and the trial date would have to be further postponed.

 

Judge Forrest has yet to rule on the SEC’s motion, which, according to Professor Henning’s article, was argued last week. While the motion has not yet been resolved, the issues that it presents highlight the struggle the lower courts have had to deal with in trying to apply Morrison’s second prong. Judge Jones did the best she could with what was essentially a blank slate at the time, and it is noteworthy that the Second Circuit itself not only did not reject her “irrevocable liability” test but expressly incorporated it into the standard the appellate court applied. But the Second Circuit further held that the place where title transferred can also be sufficient to establish that a deal is a “domestic transaction in other securities.” That is, the appellate court affirmed a basis for the securities laws to apply on a ground Judge Jones expressly rejected.

 

As Judge Forrest takes up the SEC’s motion for reconsideration, it is not going to be enough for her simply to consider the Second Circuit’s decision in Absolute Activist Value Master Fund case. She is also going to have to take into account the fact there are at least two other cases pending before the Second Circuit that could even further impact evolving standards under Morrison’s second prong. As discussed here, appeals before the Second Circuit remain pending both in the Porsche case and in the Société Générale case. Both are high-profile cases and both raise potentially significant issues under Morrison’s second prong. (Background on the Société Générale case can be found here and background on the Porsche case can be found here.)

 

Although the standard the Second Circuit articulated in the Absolute Activist Value Master Fund case seemingly provides a sufficient basis to address both of these two remaining appeals, there is always the possibility that the appellate court’s rulings in the two pending cases might provide further gloss on the standard the court previously articulated. In other words, there is a danger that even if Judge Forrest were now to reconsider Judge Jones’s earlier ruling in the Goldman case, it is possible that when the Second Circuit’s rulings later come down in the two pending cases that there might be yet other considerations presented that might affect the question whether or not the SEC’s allegations concerning the IKB transaction should be reinstated.

 

It is entirely possible that when the Second Circuit finally releases its long awaited rulings in the Porsche and Société Générale cases that these issues will substantially cleared up. That isn’t much help now for Judge Forrest, the SEC or Tourre. As Professor Henning points out in his article linked above, the stakes for Goldman and for the SEC are high in this pending case, which is one of the highest profile cases to come out of the financial crisis. And it seems possible that Judge Forrest’s ruling on the SEC’s motion for reconsideration will provide judicial interpretation of Morrison’s vexing second prong.

 

Silver Anniversary: Long-time readers of this blog will know that The D&O Diary is an attentive follower of American Lawyer writer Susan Beck, whom I interviewed for this site in January 2012 (refer here). In recognition of her 25^th anniversary with The American Lawyer, Beck wrote a retrospective article entitled “The Paper Chase” (here) reflecting on her two and a half decades with the publication. Beck’s article not only provides an interesting overview of her career in legal journalism, it also provides an interesting perspective on the changes in the legal industry and in her profession during her time with the magazine. It was interesting to recall the events on which she has reported and even to see many familiar names, like that of our old friend Tower Snow, whom Beck has interviewed.

 

I had to laugh at her reminiscences about the magazine’s coverage of the collapse of the Shea and Gould law firm, whose 80-year old principals continued to come to work every day. Beck recalled one of the principals, Milton Gould, as saying: “We're kind of like an octogenarian's gonads, still there but not of much use."

 

During her time with the American Lawyer, Beck has been posted to New York and San Francisco, but she is now a neighbor of mine here in Northeast Ohio. As she notes in her American Lawyer article, “In 2007 I moved back to my hometown of Cleveland, which I love. With a phone and an Internet connection, I can work almost anywhere. The one thing that hasn't changed is that every day I'm still searching for a great story.” When I interviewed her for this site, Beck had this to say about living in Cleveland:

 

I love it. There are a lot of great things about New York and San Francisco, but I feel a level of comfort in Cleveland that I missed in those other cities. It’s a lovely place to live. The cost of living is so much better, the people are so nice and friendly, and I even prefer the weather. Those SF summers were way too cold and foggy, and I like snowy winters. On the down side, all our pro sports teams really suck right now. 

 

As befits her journalistic skills, Beck’s assessment of living in Cleveland is succinct and accurate. Everyone here at The D&O Diary congratulates Beck on her 25 years at the American Lawyer. We all also look forward to reading her terrific articles for years to come.

 

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On August 24, 2012, in a decision involving a U.S.-listed Chinese company that is of particular interest because of the significance the court attached to the discrepancies between financial figures the defendant company reported to the Chinese government and the figures it reported to the SEC, Southern District of New York Judge George Daniels denied in part the motions to dismiss of the company and two of its senior officials. He did grant the dismissal motions of the company’s outside auditor and principal outside investor, as well as the control person allegations against the company’s directors. A copy of Judge Daniels opinion can be found here.

 

Background

Duoyuan Global Water (DGW) listed its American Depositary Shares on the NYSE through a June 24, 2009 IPO. In its initial reports following the IPO, DGW reported positive financial results. The first indication of trouble arose when accounting concerns surfaced concerning a separate but affiliated company Duoyuan Printing (which is itself now the subject of a separate securities suit, refer here). Because of the close relationship between the companies (they operate in the same location, and have the same Chairman, among other things), questions arose about DGW. In September 2010, the board’s audit committee retained Skadden Arps to review DGW’s accounting.

 

In April 2011, an online report critical of DGW appeared on the Muddy Waters research analysis website. Among other things, the report accused DGW of replacing the 2009 report to the Chinese State Administration for Industry and Commerce (SAIC) with a forged version to cover up the fact that revenues had been “astronomically inflated.” That same day the company’s CFO resigned. Shortly thereafter, four members of the board resigned to protest the lack of access that Skadden was being given to company documents. Skadden withdrew its representation as well. As detailed here, securities litigation ensured.

 

The plaintiffs based their allegations that the company’s IPO documents and subsequent filings contained financial misrepresentations were based largely on discrepancies between financial figures that two of DGW’s subsidiaries had reported in China to the SAIC and figures the company reported in its SEC filings. The plaintiffs also alleged other misrepresentations, including alleged misstatements concerning the number DGW’s distributors and the number of its employees. The plaintiffs asserted claims under both Section 11 of the ’33 Act and Section 10(b) of the ’34 Act. The defendants moved to dismiss.

 

The August 24 Opinion

In his August 24 opinion, Judge Daniels granted the plaintiffs’ motions to dismiss as to a number of the alleged misrepresentations on which the plaintiffs sought to rely, including the allegations concerning the number of distributors and the number of employees. He denied the motions of the company and its CEO and CFO to dismiss with respect to plaintiffs’ claims of financial misrepresentation based on the discrepancies between the company’s reports to the SAIC and its reports to the SEC.

 

The defendants had argued that the discrepancy in figures did not mean that the SEC reports were false or misleading, particularly given that the SAIC reports were separately filed by each of two of DGW’s Chinese subsidiaries and the SEC reports were consolidated, and given the difference s between accounting conventions involved in the different reporting protocols.

 

Judge Daniels found that:

 

Although Plaintiffs have not proven that the filings were in fact false, the extreme discrepancies alleged in the financial reports, coupled with the logical inference that can be made regarding these figures, at this stage of the proceedings, sufficiently alleges that the statements made in the SEC filings are false. Defendants merely maintaining that the discrepancies are explainable is an insufficient reason to discredit the [amended complaint]. Assuming that that the SAIC filings are true, the CAC states sufficiently that the SEC filings are false. Based on the fact that DGW had more negative disclosures in China and positive disclosures with the SEC, the reasonable conclusion is that there is a fraudulent motive to overstate the numbers yet no fraudulent motive to understate them.

 

In concluding that the plaintiffs’ allegations in this respect were sufficient not only for purposes of their Section 11 claims but also with regard to their Section 10(b) claims, Judge Daniels further concluded that the plaintiffs had satisfactorily alleged scienter.

 

In reaching this conclusion, he noted that the company’s CEO and CFO respectively “knew or should have known that the U.S. reported revenues, operating income and net income were much greater than those in the SAIC filings.” In response to the defense objection that the plaintiffs’ have not alleged that the CEO and CFO even had access to the SAIC reports that DGW’s Chinese subsidiaries had filed, Judge Daniels noted that the two officers “were CEO and CFO of a multinational corporation, and as such, were required to be aware of the Company’s financials.”

 

Judge Daniels noted further that in addition to the two officials’ “executive positions and the large discrepancy between the SEC and SAIC figures,” he also relied on the Muddy Waters report as evidence of the two officials’ scienter, because statements the two provided were “in complete opposition to the alleged facts that were uncovered about DGW by Muddy Waters.” Judge Daniels did note that the Muddy Waters report, while not dispositive, may be relied on as evidence of the two officials’ scienter.

 

Discussion

Because so many of the suits filed against U.S.-listed Chinese companies involved allegations, like those made here against DGW, of discrepancies between figures reported to the SAIC and to the SEC, Judge Daniels’ opinion potentially could boost the plaintiffs in many of those other cases.

 

On the other hand, other courts have been less willing than Judge Daniels to assume that the discrepancies meant the lower figures were false. For example, as noted here, in November 2011, the court in the China Century Dragon Media securities case granted the defendants motions to dismiss in a case alleging similar discrepancies between SAIC and SEC reports. The court in that case did allow the plaintiffs leave to amend, in part to provide further explanation what the discrepancies meant the SEC filings were false. The court said that though the SAIC numbers and the SEC numbers were different, that is “merely consistent with” the possibility that the SEC figures were false, but “does not suffice to make that claim plausible.”

 

Other courts may be more reluctant that Judge Daniels to conclude, based on individual corporate officers’ positions alone, that the officers were aware of the figures reported in China. Judge Daniels seemed particularly willing to make this assumption, even though the figures were filed by separate Chinese subsidiaries. These assumption would be much more convincing if accompanied by allegations concerning the purpose and significance of SAIC reports, in order to show that they were, for example of equal importance as the SEC reports or otherwise so significant that the two officials would have had to have known of their content.

 

It is also worth noting that it is entirely plausible that, contrary to Judge Daniels assumption, that there might be good reasons to falsify the SAIC reports. Although not many defendants would want to make this argument, it is possible that the SAIC reports were falsified for reasons having to do with the purposes of the SAIC reports – for example if they determine taxes due.

 

Perhaps the most interesting aspect of Judge Daniels opinion is his willingness to rely on the Muddy Waters research report as support for his conclusion that the plaintiffs has sufficiently pled scienter. Many of the other securities suits involving U.S. listed Chinese companies also rely on reports of online research analysts like Muddy Waters – indeed, some of the complaints in these cases consist of little more that a recapitulation of the analysts’ reports. The plaintiffs in those other cases will certainly take heart from Judge Daniels’ reliance on the Muddy Waters report in this way.

 

I must confess that I find Judge Daniels reliance on the Muddy Waters report in this regard troublesome. It is well-known that many of the online research analysts also maintained short positions on the shares of the companies they were analyzing and therefore were financially motivated to drive down the company’s share price. There are certainly plausible inferences that might be drawn about motivations of the analysts, but I am uncomfortable with the notion that content from one of these financially motivated third-party online analysts can serve as a basis to establish the state of mind of officials inside the company.

 

In any event, however, and even though a number of the plaintiffs’ claims and a number of the defendants have been dismissed, the plaintiffs’ case against the company and its two senior executives will be going forward. How the plaintiffs will fare remains to be seen, as they, like other plaintiffs in this case will have to overcome procedural hurdles (refer for example here). As I have previously noted, in other cases involving U.S.-listed Chinese companies that have reached the settlement stage, the settlement amounts have proved to be modest. It remains to be seen if these plaintiffs will be an exception to this pattern.

 

Special thanks to a loyal reader for providing me with a copy of the August 24, 2012 opinion.

 

Delaware Supreme Court Affirms Massive Judgment, Attorneys’ Fees in Southern Peru Case: On August 27, 2012, the Delaware Supreme Court affirmed the more that $2 billion judgment and more than $300 million attorneys’ fee awarded in the Southern Peru case. A copy of the Supreme Court’s opinion can be found here (Hat Tip: Delaware Corporate and Commercial Litigation Blog).

 

As discussed here, the lawsuit relates to Southern Peru’s April 2005 acquisition of Minerva México, a Mexican mining company, from Groupo México, Southern Peru’s controlling shareholder. In October 2011, Chancellor Leo Strine concluded that as a result of a “manifestly unfair transaction,” Southern Peru overpaid for Minerva Mexico. A copy of Chancellor Strine’s 106-page opinion can be found here. Chancellor Strine later adjusted the award applying prejudgment interest and awarded attorneys’ fees. Groupo Mexico appealed.

 

There are a number of very good write-ups about the Delaware Supreme Court’s opinion affirming the lower court ruling, particularly Alison Frankel’s August 27, 2012 post on here On the Case blog (here) and David Bario’s August 27, 2012 Am Law Litigation Daily article (here).

 

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Among the more noteworthy aspects of the recently enacted Jumpstart Our Business Startups (JOBS) Act are the legislation’s crowdfunding provisions. These provisions are intended to allow small businesses a new means of raising funds directly from investors using the Internet. But many commentators are concerned about these provisions. Among other things, some have noted that the transaction costs that the Act required fund-raising companies to incur may deter start-ups from using crowdfunding. And a number of other commentators have raised concerns about fraud.

 

The possibility of crowdfunding fraud, and some suggestions about possible means of preventing the fraud, is discussed in an August 22, 2012 Thomson Reuters News & Insight article entitled “Crowdfunding: Small-Business Incubator or Securities Fraud Accelerator?” (here), written by Lyndon Tretter of the Hogan Lovells law firm. The author notes that many commentators are “concerned that the potential for fraud on the crowd may outweigh the promise of new financing for legitimate startups.” Among other reasons for these concerns is that with crowdfunding, “the risk of fraud increases because the pool of investors includes those who have no personal relationship with the business owner and who may be geographically remote from and thus unable to oversee the business itself.”

 

The author notes that, while the JOBS Act expressly provides investors the opportunity to seek a recovery if they believe they have been misled, because each crowdfunding investor will only have a relatively small stake in the enterprise, they may lack the incentive or resources to pursue a recovery. Even in the aggregate, the investors’ collective investments may not be enough to attract the interest of the traditional class action attorney, so the civil liability provisions “may not prove to be very useful in practice.”

 

To address these concerns, the author proposes that the SEC promulgate rules designed to address the likeliest sources of abuse: the promise of unrealistic returns on investment and the ability of insider to use the money they raise for themselves of their own benefit. The author specifically proposes that the SEC use its rulemaking to require the fund raisers to state the personal investments that the insiders have made in the enterprise; require particularized disclosure of the anticipated use of the offering proceeds; require disclosure of any salary, benefits or compensation the issuer is expected to pay in the next year; and require disclosure of any transaction with a related party that the issuer anticipates in the coming year. The author also suggests that the SEC encourage investors to consider the benefits of investing locally, under circumstances when investors might have a better chance to monitor the company directly.

 

The author also proposes augmenting the JOBS Act’s civil liability provisions, among other things by allowing claimants to recover their attorneys fees incurred in pursuing a claim if the claimant can show that an individual insider intended the issuer’s disclosure to be misleading.

 

I think the author has done a commendable job of trying to think of ways to protect investors and to try to make the crowdfunding less susceptible to fraud. Unfortunately, it seems inevitable that there will be those who abuse the crowdfunding mechanism. It is bad enough that the crowdfunding procedure specified in the JOBS Act will be cumbersome and costly, as I noted in a prior post. But if there are highly publicized instances where crowdfunding is abused and investors are defrauded, prospective investors may be deterred altogether, and in the end the process could not only be costly but ineffective.

 

It will be interesting to see the SEC’s rules when they are finally released. But it will be even more interesting to see what becomes of the crowdfunding mechanism – in particular, what kinds of companies use the process, whether they process becomes a standard means of fundraising, and whether or not there are problems with fraud or other abuse. I wonder whether with all of the potential problems crowdfunding will prove to be an important and useful innovation or a just another failed initiative.

 

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One of the trends I noted in my analysis of securities class action lawsuit filings in the first half of 2012 was the apparent rise in securities suits against companies in the natural resources sector. Among other things, I noted that about 14.5% of first half filings were against companies in the natural resources industries, with the largest concentration of cases in the Crude Petroleum and Natural Gas category.

 

An August 21, 2012 memo from the King and Spaulding law firm entitled “Securities Litigation and the Energy Sector” (here) takes a closer look at the rising levels of litigation involving companies in the energy industry. Among other things, the article reports that securities class action lawsuits against energy companies “have increased in the past three years.”

 

Among other reasons for the increase in litigation against companies in the energy industry has been the increase in the number of high profile events involving worker and environmental safety. As a result, safety disclosures have been a prominent part of securities class action lawsuits involving energy companies, including, most significantly, the class action lawsuits involving BP, Massey Energy and Transocean. In each of these cases, investors alleged that companies had misrepresented their safety records or safety procedures. In both the BP and Transocean cases the allegations related to safety were dismissed, based on the determination that general statements about corporate safety goals and commitments were not actionable because they were too vague. However, the Massey Energy case survived the dismissal motion.

 

Although not discussed at length in the law firm memo, another reason for the recent rise in litigation involving companies in the energy sector has been the surge of litigation against U.S.-listed Chinese companies. For example, of the 39 U.S.-listed Chinese companies sued in securities class action lawsuits in 2011, at least eight involved companies in the energy industry.

 

The most traditional source of litigation involving energy companies have been allegations of misrepresentations concerning reserve estimates. The law firm memo reviews questions that have arisen more recently regarding new procedures for estimating oil and gas reserves, and notes that “many industry and federal officials have questioned whether companies are taking advantage of the new rule by over-reporting reserves to increase their company’s value.” The memo notes that several federal agencies including the SEC are looking into the accuracy of reserve estimates. The SEC has in fact subpoenaed several companies, as have two states’ attorney general offices. The law firm memo notes with respect to these investigations that:

 

The results of these investigations have yet to be seen. If any developments come from the subpoenas, then securities class actions and derivative suits will likely follow and we could see more cases like focused on false reserve reporting prior to 2010.

 

The law firm memo notes that hydraulic fracturing, or fracking, is a “hot button issue for many oil and gas companies.” The SEC is among many regulators raising questions about fracking. In particular the SEC has shown interest in having companies provide greater disclosure about fracking. Using the comment-letter process, the SEC has required companies to provide additional information, for example, about specific operational and financial risks associated with fracking, or regarding the expenditures required to comply with regulatory requirements.

 

The law firm memo notes that the New York attorney general has subpoenaed a number of oil and gas companies “requesting information regarding disclosures about the environmental risks of fracking.” The memo notes that how companies respond to these disclosure pressures “could lead to shareholder litigation and increased SEC involvement.”

 

A number of factors have contributed to the recent rise in securities litigation involving companies in the energy industry. At least one factor – the rise in litigation involving U.S.-listed Chinese companies – seems unlikely to continue in the future. But as the law firm memo outlines, there are a number of other factors that suggest that companies in the energy sector could continue to face an elevated risk of securities litigation in the months and years ahead.

 

Libor-Related Claims and D&O Insurance: As I have previously noted, one of the big stories of the summer is the Libor-related scandal and follow on litigation. The scandal and ensuing litigation have a number of implications, not the least of which are the D&O insurance implications of the investigations and claims. An August 22, 2012 article in The Metropolitan Counsel entitled “Libor-Related Insurance Claims Provide A Roadmap To The Issues Faced By Policyholders In Large Exposure D&O Claims” (here) by Alexander Hardiman of the Anderson Kill law firm takes a brief look at the insurance issues involved in the Libor scandal-related claims.

 

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Two of the significant securities litigation trends we have been following are the subprime-related securities litigation and the securities suits that have been filed against U.S.-listed Chinese companies. As discussed below, in the past few days courts granted dismissal motions in each of these kinds of cases.

 

Jiangbo’s CFO’s and Auditors’ Dismissal Motions Granted

First, just when it seemed that the plaintiffs’ in the many securities suits involving U.S. listed Chinese companies might be making some progress (about which refer here, scroll down to second item), a Florida federal judge has granted dismissal motions in a securities suit involving a Chinese company. On August 1, 2012, Southern District of Florida Judge Marcia Cook, in the securities class action lawsuit involving Jiangbo Pharmaceuticals, granted the motions to dismiss of the company’s CFO, Elsa Sung, and of its auditor. The dismissals are without prejudice. A copy of her opinion can be found here.  (Hat tip: Courthouse News Service.)

 

Jiangbo became a listed company in the U.S. as a result of the Chinese company’s reverse merger with a U.S.-listed publicly traded shell company. As detailed here, shareholders first filed their action in July 2011, following the company’s June 7, 2011 filing on Form 8-K, in which the company announced that members of its audit committee had resigned due to the company’s senior executives’ lack of cooperation with an internal investigation of possible accounting concerns. (The audit committee members’ letters of resignation, which details the extremes to which senior company officials went to avoid the investigators, can be found here and makes for interesting reading.) Among other things, the plaintiffs alleged that the company overstated its reported cash balances and failed to report related party transactions.

 

The company itself has failed to appear in the case, but the company’s former CFO and former auditor –who are both located in the U.S. – have appeared, and they both moved to dismiss. In her August 1 opinion, Judge Cook granted their motions, finding that while the plaintiffs sufficiently alleged that the company’s reported cash balances were materially misleading, the plaintiffs had not sufficiently alleged scienter as to the CFO and the auditor.

 

In granting the CFO’s motion to dismiss, Judge Cook said that the inference that the CFO intentionally or recklessly overstated the company’s cash balances “is not as compelling as the competing inference that Sung failed to disclose Jiangboa’s true financial condition because she either was unaware of, or, at most, was grossly negligent in failing to discover the true amount of the Company’s cash balances.”

 

Judge Cook went on to note that the plaintiffs’ arguments that the CFO “must have known” of the company’s over-reporting of its cash balances were based on “conclusory” allegations that the CFO was involved in day-to-day operations and therefore must have known the cash balances were incorrect. “In fact,” Judge Cook noted, “Sung worked mainly in Florida, while the Company conducted its operations in Laiyung.” These facts “support the competing inference that Sung did not know the Company’s true financial condition.” Judge Cook also found that the plaintiffs had not alleged that there was anything in particular about the cash balance amounts that would make them “suspicious”

 

Judge Cook concluded that “even though Plaintiffs sufficiently allege that Jiangbo’s financial statements may have contained materially false or misleading information regarding its cash balances, they have not alleged sufficient facts to yield a strong inference of scienter as to Sung.” Judge Cook reached a similar conclusion with respect the plaintiffs’ allegations against the company’s auditor. Judge Cook did grant the plaintiffs leave to amend, noting that “further facts regarding the magnitude of the fraud and Sung’s knowledge or involvement in the Company’s operations and preparation of the financial statements may well be sufficient to show scienter in this case.”

 

Deutsche Bank’s Dismissal Motion Granted

In an August 10, 2012 order, and based on Deutsche Bank’s motion for reconsideration of her prior ruling in the case, Southern District of New York Deborah Batts granted Deutsche Bank’s motion to dismiss the subprime-related securities suit that had been filed against the company and certain of its directors and officers. A copy of the August 10 opinion can be found here.

 

As discussed here, the plaintiffs had alleged that the company had failed to properly record provisions for credit losses, residential mortgage-backed securities, commercial real estate loans, and exposure to monoline insurers. In an August 19, 2011 order (here), Judge Batts granted the defendants’ motions to dismiss with respect to certain of the plaintiffs’ allegations, but she also ruled that the plaintiffs had adequately stated claims under the Securities Act of 1933 with respect to the company’s 2007, February 2008 and May 2008 securities offerings.

 

However, just four days after she allowed the plaintiffs’ claims to proceed with respect to those three offerings, the Second Circuit released its decision in Fait v. Regions Financial Corporation. As discussed here, the Second Circuit held that estimates of goodwill and loan loss reserves were not “facts,” but rather are “opinions” and that  in order to state a Securities Act claim, a plaintiff must allege not only that the statements were false, but that the defendants’ opinions were not honestly believed when made. In reliance on Fait, Deutsche Bank moved to have Judge Batts reconsider the portion her August 2011 ruling in which she had permitted certain of the plaintiffs’ claims to go forward.

 

In her most recent ruling, Judge Batts granted the defendants’ motion for reconsideration and granted their motion to dismiss as well. Judge Batts said that plaintiffs’ allegations about valuation measures used in the offering documents “suggest that Defendants were wrong, and perhaps egregiously so, in their internal valuation metrics. “ However, after Fait, “it is clear…that such valuations are a matter of opinion rather than fact.” Accordingly, she concluded, the plaintiffs “must allege that Defendants did not honestly believe those valuations when made. The Complaint in this matter contains no such allegations.” Because the plaintiffs state in their complaint that their claims rely exclusively on theories of strict liability and negligence, Judge Batts denied the plaintiffs leave to amend.

 

The plaintiffs’ allegation in their complaint that they were relying exclusively on theories of negligence and strict liability are fairly standard in Securities Act claims, as plaintiffs typically do not want to have to meet the higher pleading standards required under the Federal Rules of Civil Procedure for pleading fraud. Indeed, companies are generally said to be strictly liable under the Securities Act for material misrepresentations or omissions in securities offering documents. But, according to Fait, the things that the plaintiffs are alleging her to be misleading are not facts at all, but opinions. For the plaintiffs to have to allege that the defendants didn’t believe those things when they said them raises a high barrier for the plaintiffs to have to get over.

 

I have in any event added Judge Batts’s ruling in the Deutsche Bank case to my tally of subprime and credit crisis-related dismissal motion ruling, which can be accessed here.

 

Something to Keep You Awake: A spider really can crawl in your ear while you are sleeping. Here’s the story, with (creepy) pictures.

 

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The U.S. Supreme Court’s decision in Morrison v. National Australia Bank presents significant obstacles for claimants who want to pursue securities claims against non-U.S. companies in the U.S courts, as the short sellers who tried to sue Porsche in the Southern District of New York found out—their prior federal court securities suit was dismissed on the basis of Morrison.   However, the short-sellers’ state court common law claims will now be going forward, as a result of a recent New York state court decision that may suggest one way that litigants may be able to avoid Morrison’s constraints.

 

On August 6, 2012, New York (New York County) Supreme Court Judge Charles E. Ramos rejected Porsche’s motion to dismiss the case on forum non conveniens ground. A copy of Judge Ramos’s decision can be found here.

 

As discussed here, the plaintiffs in the federal court suit -- hedge fund investors who lost money short-selling shares of German auto manufacturer VW -- allege that during 2008, Porsche and certain of its executives made a series of misrepresentations in which Porsche claimed that it did not intend to acquire control of VW, while at the same time it allegedly was secretly accumulating shares with the purpose of obtaining control. In October 2008, after Porsche disclosed its intent to obtain control, VW’s share price rose significantly and the short sellers suffered significant trading losses.

 

The short-sellers federal court complaint asserted claims under the U.S. securities laws and also for common law fraud. As discussed here, on December 30, 2012, Southern District of New York Judge Harold Baer dismissed the securities claims on the grounds that the subject transactions, securities-based swap agreements, represented a foreign transaction and are therefore not within the purview of the U.S. securities laws. Judge Baer declined to exercise supplemental jurisdiction over the common law claims. Judge Baer’s ruling is now on appeal to the Second Circuit.

 

In March 2011, several of the same short sellers launched a separate action in New York Supreme Court against Porsche alleging claims for fraud and unjust enrichment. Porsche moved to dismiss the state court complaint on the grounds of forum non conveniens and for failure to state a claim. Porsche also moved in the alternative to stay the state court action pending the outcome of the Second Circuit appeal in the federal court action.

 

In his August 6 order, Judge Ramos denied Porsche’s motion. First, Judge Ramos held that “a balancing of the relevant factors reveals that Porsche has not met the heavy burden of demonstrating that this action should be dismissed on the ground of forum non conveniens.” In reaching this conclusion, he noted that the plaintiffs are located in New York; that Porsche allegedly made multiple misrepresentations directly to the plaintiffs in New York; that Porsche representatives transmitted multiple communications to the plaintiffs and others in New York; and that the five principal plaintiffs’ witnesses are all located in New York.

 

He also noted that though many critical witnesses reside in Germany, “large corporations such as Porsche with ample resources have minimal difficulty bringing foreign witnesses or documents to New York Court,” and that the company regularly transacts business in the U.S.

 

Finally, Judge Ramos rejected Porsche’s “characterization” of the case as alleging “the manipulation of the German stock market and the trade of German securities”; rather, the question is whether New York courts “may hold responsible a foreign entity, who conducts business globally, for fraudulent misrepresentation purportedly aimed at New York plaintiffs.” New York “clearly has a vested interest in such an action.”

 

Judge Ramos also concluded that the plaintiffs had adequately stated claims for fraud and for unjust enrichment, and he declined to stay this action pending the outcome of the federal court appeal.

 

Discussion

The outcome of Judge Ramos’s decision is obviously interesting in and of itself, but it is also particularly interesting in light of the fact that the prior federal securities lawsuit was dismissed on the basis of the Morrison decision. These plaintiffs, stymied by Morrison in their attempt to assert federal securities claims, have nonetheless managed to find a way to pursue claims against the non-U.S. defendant in U.S. court, by asserting common law claims that are not subject to Morrison’s constraints.

 

These plaintiffs ability to pursue their claims against Porsche in a U.S. court may suggest ways that other prospective claimants might be able to circumvent Morrison’s constraints and to pursue misrepresentation claims in U.S. courts against non-U.S. companies.

 

However, there are things that may constrain other prospective claimants from pursuing a similar strategy. For starters, the plaintiffs in this case were only successful in avoiding a forum non conveniens dismissal because of the case-specific factors that tied the case and the underlying circumstances to New York. Other prospective claimants may or may not be able to marshal equally compelling evidence of a connection to a U.S. jurisdiction.

 

The other thing that may make this case somewhat distinct is that many of the alleged misrepresentations on which the plaintiffs relied allegedly were made directly to them by Porsche’s representatives. The existence of these direct misrepresentations significantly boosted the plaintiff’s ability here to assert claims for common law fraud – and more particularly to be able to establish the critical element of reliance. (Alison Frankel has a particularly good explicatioin of Judge Ramos's considertion of the reliance issue in an August 9, 2012 post on her On the Case blog, here.) Other litigants, perhaps relying on market-wide statements, may be less able to show all of the elements necessary to raise claims for common law fraud or other common  law claims.

 

But while there undoubtedly are considerations that may complicate matters for other prospective claimants who want to pursue misrepresentation claims against non-U.S. companies, this case nevertheless does show at least a possible way to pursue those claims in U.S. courts without the constraints of the Morrison decision. It should no noted that, according to David Bario’s August 9, 2012 article in the Am Law Litigation Daily about Judge Ramos’s ruling (here) , the defendants apparently intend to pursue an appeal of the ruling.

 

While the Second Circuit appeal in the federal court case remains pending, on March 1, 2012 the Second Circuit did release its opinion in the Absolute Activist Value Master Fund decision, which provided significant interpretation of Morrison and, as discussed here, could have a substantial impact on the appeal in the Porsche case.

 

Yet another alternative for investors who want to pursue claims against Porsche would be to sue them in the company’s home country courts – which is what at least some investors have done. As discussed here, other investors have also initiated an action against Porsche in Stuttgart based on the same allegations.

 

Perhaps the Chinese Reverse Merger Company Cases Have Legs After All: Maybe the plaintiffs will be able to make something out of the wave of lawsuits against U.S.-listed Chinese companies after all. Last week, the Second Circuit revived the suit against China North Petroleum Holdings, which the district court had dismissed. And on August 8, 2012, Southern District of New York Judge Katherine Forrest denied the motion to dismiss the securities class action lawsuit that had been filed against China Automotive Holdings. A copy of Judge Forrest’s opinion can be found here.

 

China Automotive Holdings obtained its U.S. listing as a result of a reverse merger. As detailed here, the plaintiff shareholders first filed their action in October 2011, alleging that the company had misrepresented its financial condition by accounting improperly for certain convertible notes, which had the effect of overstating the company’s earnings. The company ultimately replaced its auditor and restated its financial statements for prior periods in order to properly account for the convertible notes. During the class period the individual defendants collectively sold over $40 million of their personal holdings in company securities. The defendants include the company, certain of its directors and officers, and the company’s prior auditor. The company and the auditor moved to dismiss. (The individual defendants have not yet been served and have not appeared in the case.)

 

In her August 8, 2012 opinion, Judge Forrest denied the company’s motion to dismiss but granted the auditor’s motion (with leave to amend).

 

In denying the company’s motion, Judge Forrest rejected two substantial arguments that the company had raised; first, the company had argued  that because almost all of the insider sales on which the plaintiff relied were made pursuant to a Rule 105-1 trading plans, the plaintiffs cannot rely on the trades in order to establish scienter; and the company argued that the plaintiffs cannot establish loss causation, because the decline in the company’s share price was attributable to the market’s loss of confidence in the Chinese Reverse merger companies.

 

In rejecting the company’s arguments that the insider sales were made pursuant to Rule 10b5-1 trading plans, Judge Forrest found that because the trading plans were entered during the class period, they “are not a cognizable defense to scienter allegations on a motion to dismiss.”

 

And in rejecting the argument that the plaintiffs have not established loss causation because the decline in the company’s share price was due to marketplace concerns about Chinese reverse merger companies, Judge Forrest noted that “although Chinese Reverse Merger companies have faced ‘public scrutuny’ … to hold that plaintiffs failed to plead loss causation solely because other Chinese Reverse Merger Companies’ stock dropped contemporaneously with [the company’s] stock price decline would place too much weight on one single factor.”

 

Judge Forrest holding with respect to the Rule 10b5-1 trading plans is interesting. These kinds of plans can serve as a basis for the dismissal of a securities fraud lawsuit (refer for example here). However, these kinds of plans can be abused; indeed, Angelo Mozillo’s notorious alleged manipulation of his Rule 10b5-1 trading plan was a significant feature of the Countrywide securities class action lawsuit (about which refer here). In the present case, the timing of the individual defendants’ plans undercut the company’s ability to rely on the plans’ existence to rebut the inference of scienter.

 

Judge Forrest’s loss causation ruling is also interesting and may be useful for other plaintiffs in cases involving Chinese Reverse Merger companies. Many of these companies also experienced a significant share price decline because of the market’s suspicion about these kinds of companies. Judge Forrest’s ruling that the mere fact that there has been a marketplace decline does not alone undercut loss causation could be relevant in many other cases, particularly those cases that were filed after the general marketplace concerns had already emerged.

 

Though the plaintiffs have survived the initial pleading hurdle they may yet have a challenging road ahead. The fact that the individual defendants have not yet been served or entered an appearance gives a glimpse of the logistical, practical and procedural challenges the plaintiffs may face as they try to move this case forward. Among other things, they may face challenges in trying to get a class certified, as has proven to be the case in a least one other lawsuit involving a U.S.-listed Chinese company (about which refer here). And even claimants that have managed to get their suits against U.S.-listed Chinese companies all the way to the settlement stage have found that they often are forced to accept only modest settlements, often because the Chinese companies carry only very modest levels of D&O insurance (about which refer here).

 

But from the plaintiffs’ perspective, the important thing now is they have survived the initial pleading threshold and will now be taking the case forward.  There were many of these cases involving U.S.-listed Chinese companies filed in 2010 and 2011, and they will be interesting to watch. At least recently, it seems that the cases have been faring better than I had anticipated. Stay tuned for further developments, though.

 

Jan Wolfe’s August 8, 2012 Am Law Litigation Daily article about the China Automotive case can be found here.

 

Friends Don't Let Friends Drink and Dial: A Tennesee man called 911 because he was running low on beer. I am not making this up.

 

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According to papers filed in the Southern District of New York on August 3, 2012, the parties to the Tronox securities litigation have agreed to settle the case for a total of $37 million. As I noted at the time that this suit was first filed back in July 2009 (here), the case, which alleged that the defendants had misrepresented Tronox’s environmental liabilities when the company was spun out of Kerr-McGee and thereafter, involved a host of recurring and interesting issues.

 

A copy of the parties’ stipulation of settlement can be found here. The settlement agreement is subject to court approval.

 

As discussed in greater detail here, the action was filed on behalf of those who purchased certain securities  of Tronox, Inc. between November 25, 2005 and January 12, 2009. The plaintiffs named as defendants certain former directors and officers of Tronox, as well as Kerr-McGee Corporation, Andarko Petroleum Corporation and certain Kerr-McGee executives.

 

As reflected in the their amended consolidated complaint (here), the plaintiffs alleged that Tronox’s IPO was a “scheme orchestrated by Defendant Kerr-McGee to foist the vast majority of its enormous environmental remediation and related tort liabilities, accumulated over decades, onto Tronox, so that Kerr-McGee could thereafter present itself for sale.” The plan, which allegedly involved spinning Tronox out as a separate company in an initial public offering, “reaped massive and almost immediate benefits when, on August 10, 2006, Defendant Anadarko acquired Kerr-McGee for $18 billion in cash and assumption of debt purportedly free and clear of any obligation for what had become, as of that date, Tronox’s environmental remediation and tort liabilities.”

 

The plaintiffs’ case survived, in whole or in part, multiple motions to dismiss, and following mediation, the parties agree to settle the lawsuit. As reflected in the parties’ stipulation of settlement, the $37 settlement consists of the following: Anadarko, Kerr-McGee and the Kerr-McGee director and officer defendants “shall pay, or shall cause their insurance carriers to pay $21,000,000”; the former Tronox individual director and officer defendants “shall cause their insurance carriers to pay $14,000,000”; and Tronox’s auditor, Ernst & Young, “shall pay $2,000,000.”

 

As I noted at the time the case was first filed, one of the interesting things about this case is that it presents the clear example of a securities claim based upon disclosures relating to environmental liabilities. The possibility of this kind of claim is often a key concern at the time of D&O insurance policy placement, as the question often arises whether the standard policy’s pollution exclusion will preclude coverage for a securities claim based on environmentally-related disclosures. As this case demonstrates, it is critically important for the standard pollution exclusion to be revised to carve back coverage for securities claims and derivative claims based on environmental disclosures. (It is probably worth noting that many of the modern Excess Side A DIC insurance policies often have no environmental or pollution exclusion, which could well have been relevant here, given that by the time these suits were filed, Tronox was in bankruptcy.).

 

Another interesting thing about this case is that it involved three corporate entity defendants (Tronox, Kerr-McGee, and Anadarko), but the securities of only one of the three, Tronox. The issue here has to do with the definition of the term Securities Claim in the standard D&O policy. In many policies, the term is defined to refer to any claim based upon the purchase or sale of the securities of the Insured Entity itself. The question here would be whether or not a claim involving the purchase or sale of Tronox’s securities would constitute a “securities claim” under the Kerr-McGee’s and Anadarko’s policies. Of course, the individual Kerr-McGee directors and officers would be entitled to coverage whether or not the lawsuit represented a “securities claim” within the meaning of the term; this question has to do with whether or not there would be coverage under the policies for the entities themselves.

 

In the end, it appears that the portion of the settlement pertaining to the liabilities of the former Tronox director and officer defendants is to be covered by insurance, and the portion relating to the liabilities of the Kerr-McGee director and officer defendants, as well as Kerr-McGee and Anadarko themselves, would be funded in whole or in part by insurance. This outcome suggests that in the course of negotiations these issues, if actually involved in this case, were worked out or compromised in the course of the settlement negotiations.

 

As I previously observed, the allegations in the underlying complaints are 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. The case also underscores the importance of addressing at the time of policy placement the possibility of securities claims arising based on environmental disclosures.

 

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In a July 27, 2012 article entitled “In Sliding Internet Stocks, Some Hear Echo of 2000” (here), the New York Times detailed how the shares of some of the hottest publicly traded social networking and Internet companies have been hammered recently. The Times suggested that as the companies’ shares dropped “there were instant echoes of the crash of 2000, when the money stopped flowing, the dot-coms crumbled and Silicon Valley devolved into recriminations and lawsuits.”

 

Whether or not the attempt to draw parallels to the ear of the dot com crash is valid, the comparison certainly seems apt in one particular sense; all four of the companies the article mentions by name as having had their shares pummeled – Facebook, Groupon, Netflix and Zynga – have been hit with securities class action lawsuits this year.

 

The latest company to be sued is Zynga, the Internet gaming company that relies heavily on Facebook as a platform for its gaming services. Zynga went public in December 2011 and its share price recently dropped after the company issued disappointing financial results. On July 31, 2012, a securities class action lawsuit was filed against the company and certain of its directors and officers in the Northern District of California. A copy of the complaint can be found here. According to the plaintiffs’ counsel’s July 31, 2012 press release (here), the Complaint alleges that: the defendants made certain misrepresentations about the company, specifically that:

 

(a) the December 15, 2011 Registration Statement for the Company’s IPO failed to disclose that under Zynga’s agreements with Facebook, Zynga game cards could only be distributed and redeemed on Facebook until April 30, 2012, or the true extent of the current risk of Facebook policy changes on Zynga’s bookings prospects and overall financial condition; (b) Facebook, upon which the Company was heavily reliant for users and bookings, had already begun to change its platform and user policies to a degree that would negatively impact Zynga’s current and future bookings metrics and growth prospects; (c) the March 2012 acquisition of OMGPOP and “Draw Something” could not support the increased bookings and financial forecasts issued during the Class Period; and (d) in light of the facts set forth above, the Company did not have a reasonable basis for its fiscal 2012 financial forecasts issued during the Class Period.

 

The plaintiffs’ complaint also specifically refers to the company’s April 3, 2012 secondary offering in which company insiders (including the individual defendants) sold more than 18.8 million shares of their holdings in the company’s stock, at a price of $12 per share. (The company’s current share price is $2.72 per share). The complaint refers to and quotes a July 26, 2012 online article by analyst and Internet commentator Henry Blodget entitled “Zynga Insiders Who Cashed Out Before the Stock Crashed” (here).

 

The lawsuit against Zynga follows in the wake of lawsuits that were filed against the other three Social Media companies mentioned in the Times article. Netflix was first; as discussed here, Netflix and certain of its directors and officers were sued in a securities class action lawsuit in January 2012 after the company’s shares dropped following the company’s botched attempt to rejigger the way it charged its customers for its services.

 

The next up was Groupon, which, as discussed here, was hit with a securities class action lawsuit in April 2012 after the company announced that it would have to revise its previously released financial results for the fourth quarter 2011 and for the full year 2011 as well.

 

Finally, and as discussed in a prior post (here), Facebook was hit with a raft of securities class action lawsuit almost immediately following its IPO, largely due to the flawed offering process and the immediate decline in the company’s share price.

 

The lawsuits against these four companies are nothing compared to the litigation wave that followed the dot com crash, But the four suits do seem to represent their own distinct phenomenon, as company’s that were briefly darlings of the new media world of the Internet saw their fortunes quickly falter and the lawsuits quickly emerge.

 

For many years beginning in the 2007 time frame, financial services companies saw the greatest concentration of corporate and securities litigation activity, including securities class action lawsuit filings. While the financial services companies were at the center of the storm, it was pretty quiet for technology companies. As the credit crisis has receded into the past, the activity in the financial services sector has diminished (although stay tuned about the emerging Libor scandal litigations). If nothing else, these four lawsuits suggest that the relatively quiet period for technology companies might have ended.

 

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In October 2011, when Southern District of New York Judge Miriam Goldman Cedarbaum dismissed the securities class action lawsuit that had been filed against China North Petroleum Holdings, Ltd, it was the first of the many cases recently filed against U.S.-listed Chinese companies to be dismissed (as discussed at length here). However, in an August 1, 2012 opinion (here), the Second Circuit vacated the dismissal and remanded the case to the district court for further proceedings.

 

The Second Circuit held that the plaintiffs may still pursue their claims even though they had bypassed the opportunity to sell their shares at a profit shortly after the alleged misrepresentations had been disclosed. In reaching this conclusion the Second Circuit rejected a line of lower court decisions that had reached a contrary conclusion on the issue of whether or not price recovery following a stock price drop negates the inference of economic loss and loss causation.

 

As detailed here, the plaintiffs first filed their action in June 2010. According to their amended complaint, during the class period, the defendants inflated the amount of the company’s proven oil reserves, overstated reported earnings inflated profits and misrepresented the company’s internal controls. An allegedly “bizarre series of events” followed the company’s February 23, 2010 announcement that it would be restating prior financials, including “revelation of illicit bank transfers” made to company officials and “a dizzying number of resignations and replacements” of top executives. Over the next few months additional details were revealed regarding the transfers, ultimately resulting in the resignation of the CEO and several members of the board. The NYSE had halted trading on the company’s shares on May 25, 2010, but when trading resumed on September 9, 2010, the company’s share price “plunged.”

 

The defendants moved to dismiss the plaintiff’s complaint on loss causation grounds, arguing that the plaintiff had several opportunities to sell its shares at a profit following the allegedly corrective disclosure at the end of the class period, and contending that had the plaintiff “chosen to sell at those post-disclosure dates, it would have turned a profit.”

 

Judge Cedarbaum agreed. Even though the plaintiff ultimately sold its shares at a loss, she concluded that “that loss cannot be imputed to any of NEP’s alleged misrepresentations,” adding that “a plaintiff who forgoes a chance to sell at a profit following a corrective disclosure cannot logically ascribe a later loss to devaluation caused by the disclosure.” Because she found that the plaintiff “has not suffered any loss attributable to the misrepresentations alleged in the complaint,” and in reliance on a line of district court cases that had reached a similar conclusion, she granted the defendants’ motion to dismiss. The plaintiff appealed.

 

In an August 1, 2012 opinion for a three-judge panel written by Judge Chester Straub, the Second Circuit vacated Judge Cedarbaum’s ruling and remanded the case to the district court. The Second Circuit rejected the reasoning of the line of cases on which Judge Cedarbaum had relied in dismissing the case, and held that the fact that the price of the stock recovered soon after the price dropped does not negate the inference of economic loss and loss causation at the pleading stage. The court said that the reasoning on which Judge Cedarbaum had relied was inconsistent with both the traditional measure of securities fraud damages and the 90 day “look back” provision in the PSLRA. The court said:

 

At this stage in the litigation, we do not know whether the price rebounds represent the market’s reactions to the disclosure of the alleged fraud or whether they represent unrelated gains. We thus do not know whether it is proper to offset the price recovery against [plaintiff’s] losses in determining [plaintiff’s] economic loss. Accordingly the recovery does not negate the inference that [plaintiff] has suffered an economic loss.

 

The Second Circuit’s ruling is obviously significant in that it establishes that a stock price rebound following a corrective disclosure does not in and of itself eliminate the possibility that the plaintiff might be able to prove an economic loss and loss causation. The plaintiff’s law firm’s August 1, 2012 press release about the Second Circuit’s ruling and its significance can be found here.

 

The Second Circuit’s ruling is also significant because it revives one of the securities suits filed against a U.S.-listed Chinese company that had been dismissed. Observers have been watching these cases closely, and counted the dismissal as one of the important early milestones in the development of these cases. It should be noted that on remand to the district court, the defendants will still have the ability to assert the many defenses they have raised in the case and which have not yet been ruled upon because of the district court’s prior dismissal on loss causation grounds. The case has a long way to go yet. Nevertheless, the Second Court’s ruling at least allows this plaintiff to live for another day.

 

As I noted at the time of Judge Cedarbaum’s ruling, because of the unusual movement of this company’s share price, the rulings on loss causation issues here are unlikely to have a significant impact on the other cases involving U.S.-listed Chinese companies. That observation remains true with respect to the Second Circuit’s ruling. However, the Second Circuit’s ruling could prove to be very significant amongst cases in general in which a defendant company’s share price rebounded following an initial price decline..

 

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At the risk of sounding repetitive, I must report here that there has been yet another Libor-scandal related lawsuit filed in the Southern District of New York. The latest lawsuit, filed on July 30, 2012, purports to be filed on behalf of a class of investors who bought U.S. dollar Libor-based derivatives beginning August 1, 2007. A copy of the complaint in this latest action can be found here.

 

The lawsuit was filed by 33-35 Green Pond Road Associates, LLC, which bought an interest rate swap with a floating interest rate tied to the U.S. dollar Libor benchmark rate. The plaintiffs’ complaint names as defendants the 16 banks that were members of the U.S dollar Libor panel during the class period.

 

The purported class on whose behalf the action was filed is a detailed construction; the complaint purports to be filed on behalf of all persons or entities “who purchased U.S. dollar LIBOR-Based Derivatives” in the United States from one of 25 non-Defendant commercial banks and insurance companies “based directly on the rates set by Defendants, from at least as early as August 1, 2007 through such time as the effects of the Defendants’ illegal conduct ceased.” The 25 non-Defendant banks and insurance companies include such banks and insurance companies as Wells Fargo, Met Life, Goldman Sachs, Morgan Stanley, Keycorp and Northern Trust, among others.

 

The complaint asserts a single count for damages based on alleged violations of the Sherman Anti-Trust Act. The complaint alleges an unlawful conspiracy to manipulate and suppress the U.S. dollar Libor benchmark rate. The complaint further alleges that by manipulating Libor, the defendants paid lower returns to customers who bought Libor based derivatives. The complaint alleges that the manipulation of Libor affected purchasers of all Libor-based derivatives, whether or not the purchaser purchased from a defendant bank or a non-defendant bank.

 

This lawsuit is the latest purported class action to allege that the U.S. Dollar Libor benchmark rate setting banks illegally colluded to manipulate Libor, injuring investors in securities cased on the benchmark rate. As detailed at length here, a consolidated antitrust class action is now pending before Southern District of New York Judge Naomi Buchwald. There have now been multiple complaints filed raising similar allegations, and I am sure I will not be the only one to note a very striking similarity between the factual allegations in this latest complaint and the earlier complaint.

 

This latest complaint would appear to be an example of what Alison Frankel, in a July 30, 2012 post on her On the Case blog (here), called the “brawl” developing among plaintiffs’ law firms as they jockey to try to get a piece of the Libor-scandal litigation action.

 

The latest suits, including the one identified above, seem to suggest that the later arriving plaintiffs’ firms are now trying a two-pronged approach to try to claim their a piece of the Libor-scandal action. These firms seem to be trying to identify a specific identifiable group within the larger collection of persons aggrieved by the Libor manipulation on whose behalf to try to assert claims; and the firms also appear to be trying to identify distinct legal theories on which to proceed. This latest case represents an example of the former type of initiative, as it purports to be filed on behalf of investors who bought Libor-rate derivative rom a specified group of non-defendant banks and insurance companies.  The new lawsuit about which I wrote yesterday, in which the plaintiff asserted only common law claims but no antitrust claims, is an example of the latter category.

 

From the perspective an outsider (and one to who antitrust litigation is relatively unfamiliar turf), it seems curious that the plaintiffs in this case would expressly define their class to limit it to those derivative purchasers who bought their securities from non-defendant banks. At least based on initial impressions, this approach would seem to invite a defense motion based on the Illinois Brick doctrine, which holds that indirect purchasers cannot assert claims for damages under the antitrust laws. I will be the first to concede, especially since the plaintiff’s approach seems quite calculated, that there may be a method to the plaintiff’s approach that I am simply not registering. (On the other hand, the carefully crafted class description may simply represent an effort to carve out a class distinct from classes identified in previously filed Libor-scandal related antitrust complaints.)

 

There undoubtedly will be many more lawsuits to come. Indeed, the story surrounding the Libor-scandal is still only just emerging. The July 31, 2012 Wall Street Journal carried a lead article entitled “RBS Braces Itself for a Libor Deal” (here), about how RBS is readying itself to get its moment in the spotlight as it attempts to negotiate resolutions of the pending regulatory and enforcement actions pending against the company in connection with the Libor-scandal. Among other things, the article speculates that public outcry in response to the anticipated regulatory and investigative settlements could cost RBS CEO Stephen Hester his job.

 

The Journal article does not go on to speculate on the extent to which any regulatory settlement might be followed by civil litigation. The bank is already the target of many of the pending lawsuits (including for example, the new lawsuit described above) and the possibility of further litigation following a resolution of the regulatory actions seems likely. RBS is of course only one of many banks in line for this same likely sequence of events. There undoubtedly will be more to come over the months ahead.

 

My prior overview on the Libor scandal and related litigation can be found here.

 

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In the latest lawsuit to arise from the rapidly evolving Libor scandal, a New York bank has filed a purported class action in the Southern District of New York, seeking to recover damages from the U.S. Dollar Libor rate setting banks for fraud. The complaint, which was filed July 25, 2012 and which can be found here, purports to be filed on behalf of all New York based lending institutions.

 

The plaintiff in this latest suit is Berkshire Bank, which, according to the Wall Street Journal’s July 30. 2012 article about the new lawsuit (here), has eleven branches in New York and New Jersey and about $881 in assets. The bank’s complaint purports to be filed on behalf of a class of “all banks, savings & loan institutions, and credit unions headquartered in the State of New York, or with the majority of their operations in the State of New York, that originated loans, purchased whole loans, or purchased interests in loans with interest rated tied to Libor, which rates adjusted at any time between August 1, 2007 and May 31, 2010.”

 

The defendants in the lawsuit include the 16 banks on the panel that set the U.S. dollar London interbank offered rate (Libor) between August 2007 and May 2012. (There are actually 21 named defendants, as multiple related corporate entities have been named as defendants for certain of the Libor setting banks.)

 

The complaint alleges that the plaintiff banks “suffered damages as a result of Defendants’ fraudulent conduct in artificially decreasing the USD LIBOR rate during the Class Period, causing them to receive lower interest than they would have been entitled but for the Defendants’ fraud.” The specific harm the plaintiff alleges is that the reduction of Libor brought about by the defendants’ alleged manipulation of Libor reduced the amount of interest the plaintiff banks could earn on their outstanding loans. The complaint asserts substantive claims for fraud and for unjust enrichment/disgorgement.

 

This latest suit is an interesting variation on the Libor-scandal litigation theme. Unlike many of the other lawsuits filed so far (including a prior antitrust class action purportedly filed on behalf of all community banks), this latest lawsuit does not allege claims under the federal antitrust laws. The absence of this allegation may relieve the plaintiffs of the challenging burden of showing that the defendants acted collectively in setting the rates. The plaintiffs’ assertion only of common law claims may also avoid certain antitrust claim defenses, such as those available under the Illinois Brick doctrine (which prohibits indirect purchasers from asserting antitrust claims).

 

On the other hand, in order to prevail on their fraud claims, the plaintiffs will have to meet the state of mind requirement -- that the defendants acted intentionally. Another concern may be the location of the alleged fraudulent conduct and whether there is a sufficient basis for the assertion of fraud claims in the U.S. And in addition, the plaintiff banks in this case cannot avoid the difficult damages proof problems that will face all claimants in these Libor-scandal cases; that is, the suppressed Libor rates may have helped and hurt the plaintiff banks in different ways and at different times, depending on the specific interest-rate related activities in which the banks were engaged.

 

Evan Weinberger has an July 27, 2012 Law 360 article entitled “Libor’s Complex Web May Limit Rate-Rigging Damages Claims” detail the proof problems associated prospective claimants Libor-scandal related damages claims, here (registration required).

 

 

The purported plaintiff class also seems somewhat heterogeneous. The different depositary institutions may or may not have used Libor-sensitive rates in its lending activities during the class period, or may have used it in different ways. The inclusion of not only banks but S&Ls and credit unions also diversifies the class in potentially complicating ways.

 

Nevertheless, this latest lawsuit represents an unwelcome development for the banks ensnared in the Libor scandal. The case itself represents a new litigation approach based on a new theory of recovery, and it raises the specter that the various rate setting banks could face a multitude of similar lawsuits filed on behalf of depositary institutions in the other states.

 

The other thing about this latest case is that it shows that the potential claimants and their attorneys are now and will continue to be casting about for alternative ways to try to recover damages connected to the Libor scandal. There undoubtedly will be many more lawsuits asserting a variety of purported claims, one of the many possibilities suggesting that the litigation related to this scandal could be a huge burden for the Libor-setting banks.

 

Alison Frankel has an interesting Juy 30, 2012 post on her On the Case blog (here) in which she considers whether this last lawsuit represents a developing "brawl" among the plainiffs' lawyers to represent members of the class of persons harmed by the Libor scandal.

 

Very special thanks to a loyal reader for sending me a copy of the complaint.

 

My recent overview of the Libor scandal and of the scandal-related litigation can be found here.

 

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On July 25, 2012, Cornerstone Research in conjunction with the Stanford Law School Securities Class Action Clearinghouse release it report entitled “Securities Class Action Filings: 2012 Mid-Year Assessment” (here). By contrast to other mid-year securities litigation reports, the Cornerstone Research study reports that securities class action litigation filings decreased by 6 percent in the first half of 2012,  compared to both the first half and second half of 2011. I discuss below possible explanations for the differences in the conclusion between the Cornerstone Report and other published studies of first half filings. Cornerstone Research’s July 25, 2012 press release about the report can be found here. My own analysis of the first half 2012 filings can be found here.

 

According to the Cornerstone Research report, there were 88 filings in the first half of 2012, which annualizes to 176 filings. This annualized figure is below the 1997 to 2011 average number of filings of 193, but in line with the 2009 to 2011 average of 177.

 

The slight decrease in the number of filings is due to the “substantial decline” in Chinese reverse merger filings and also to a decline on mergers and acquisitions related filings. Chinese reverse merger filings were down 79 percent in the year’s first half, compared to the first six months of 2011, and M&A related filings were down 67 percent. The press release quotes Stanford Law Professor Joseph Grundfest as saying with respect to the M&A related filings that in the second quarter of 2012, “the aggregate deal flow count reached the lowest level since the third quarter of 2009,” which obviously was a factor in the decline the federally-filed M&A litigation in the first half of 2012.

 

While litigation related to Chinese reverse merger companies and M&A activity declined in the first half, “traditional filings” increased 23 percent, offsetting the decline in the number of nontraditional filings. Filings against non-U.S. companies decreased in the first half of 2012 after a sharp increase in 2011 (when there were significant numbers of Chinese reverse merger filings) but remained above historical levels. In the first six months of 2012, 26 percent of all filings involved non-U.S. companies, compared to 36 percent in 2011, but also compared to 9 percent for the period 1997 to 2010.

 

Of the 88 securities class action lawsuits filings in the first half of 2012, 10 involved S&P 500 companies, compared to eight in the first half of 2011.

 

In terms of looking ahead, the press release quotes Professor Grundfest as saying that “the Libor-litigation industry is clearly a sector to watch for years to come.” Both the size of the potential exposures and the complexity of the claims mean that the Libor-scandal will “likely generate large amounts of litigation activity in may geographies.” Interestingly, Grundfest suggests that “much of the litigation activity will occur away from the U.S. class action securities sector, but more lawsuits are virtually assured.”

 

Discussion

The Cornerstone Research reports on securities litigation activity are unique, in that it is possible to go to the Stanford Law School Class Action Securities Class Action Clearinghouse website and identify exactly what their reports are “counting.” By comparing the filings listed on their website, it is possible to determine what they are – and more importantly, what they are not – counting in their tally. By comparing the list of cases on the website with my own list of cases, it is a simple matter to determine why the Cornerstone Research tally is lower than other published tallies, and why Cornerstone Research is report that filings are declining, which other observers are reporting that filings are holding steady or increasing.

 

Simply put, the difference has to do with the M&A related filings.  Further review reveals that Cornerstone Research is not including federal court merger objection cases that do not include a claim based on an alleged violation of the federal securities laws. For example, if a federal court merger objection suit contains only a claim for breach of fiduciary duty, but no claim for breach of the federal securities laws, it is not included in the Cornertone list.The exclusion of these cases accounts for a significant part of the differences between the Cornerstone Research tally and other published figures.

 

Another difference between the Cornerstone Research tally and other published figures is that, as the Cornerstone Research report states on the inner page following the title page of the report, in counting filings, the Cornerstone Research report takes the following approach: “Multiple filings related to the same allegations against the same defendant(s) are consolidated in the database through a unique account indexed to the first identified complaint.” Other published reports take a different approach, counting separate complaints in separate judicial districts separately, at least until formally consolidated in a single action or proceeding. These differences in counting methodology also account for apparent differences between the Cornerstone Research report and other published reports.

 

One final observation I have is that the discussion about filing activity and whether filings are up or down often relates exclusively to the absolute number of filings. In my view, the absolute numbers of filings alone, considered without respect to the changing numbers of public companies, can lead to some misleading conclusions. The fact is that the absolute numbers of annual filings over the last 17 or so years has remained within the same very narrow band, while the numbers of publicly trade companies has declined dramatically. The key fact that should not be lost sight of here is that for any given company with shares trading on the U.S. exchanges, the chances of getting hit with a securities class action lawsuit are much higher now than they were, for example, in the late 90s. Focusing solely on the absolute numbers of lawsuit filings is not sufficient to fully understand what is going on.

 

Professor Grundfest’s comments about the likely Libor-scandal litigation are very interesting. Because so many of the events and so many of the prospective defendants are located outside the United States, it does seem more likely that lawsuits would be brought outside the United States -- except for the fact that there are so many procedural advantages to pursuing claims in the U.S. It will be very interesting to see if, as Professor Grundfest has suggested, Libor-related litigation outside the U.S. will be a significant factor.

 

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In June 2012, when Eastern District of New York Judge Frederic Block considered the SEC’s proposed settlement of its enforcement action against former Bear Stearns hedge fund managers Ralph Cioffi and Matthew Tannin, he “reluctantly” approved the deal, bemoaning the fact that he was “constrained” to accept the deal and lamenting the limited power that Congress had given the SEC to recoup investor losses. In that case, the two individuals paid civil penalties totaling about $1 million, after being indicted for defrauding investors of over $1.6 billion. In his June 18, 2012 opinion (here), Judge Block expressly invited Congress to reconsider the penalties that the SEC is authorized to seek.

 

This recent development in the case involving the two Bear Stearns hedge fund managers follows a November 2011 request from SEC Chairman Mary Shapiro that Congress increase the penalties that the SEC is authorized to seek and allow the agency to seek penalties based on the scope of investor losses. In addition, according to a July 23, 2012 Reuters article (here), in a December 2011 speech, President Obama also called for legislation to make “penalties count.”

 

In response to these developments and requests, on July 23, 2012, Democratic Rhode Island Senator Jack Reed and Republican Senator Charles Grassley introduced a bill titled The Stronger Enforcement of Civil Penalties Act of 2012 to increase the SEC’s civil monetary penalties authority and to directly link the size of those penalties to the scope of the harm and investor losses. The Senators’ joint July 23, 2012 press release about the Bill can be found here.

 

The Bill proposes to update the maximum money penalties the SEC can obtain from both individuals and from entities, and further provides that the penalties may be obtained both in enforcement actions filed in federal court and in the agency’s own administrative actions (currently the SEC must file a civil enforcement action in order to seek penalties).

 

Under the laws currently in place, the largest amount that the SEC can seek from individual violators is $150,000 per offense and the largest amount the SEC can seek from entities is $750,000 per offense.

 

The increased penalties proposed by the new Bill are scaled to the seriousness of the offense. For the most serious offenses (specified as the third tier violations involving fraud, deceit or manipulation) the per violation penalty for individuals may not exceed the greater of $1 million; three times the gross pecuniary gain; or the losses incurred by victims that result from the violation. The maximum per violation penalty the SEC can seek from entities is limited to the greater of $10 million; three times the gross pecuniary gain; or the losses incurred by victims.

 

For less serious violations, the maximum amount the SEC may seek is correspondingly lower. For individuals, the per violation penalty may not exceed the greater of $100,000 or the gross pecuniary gain as a result of the violation. The equivalent per violation limit for entities is the greater of $500,00o or the amount of the pecuniary gain. The maximum per violation penalty amount for violations not involving fraud or deceit is the greater of $10,000 for individuals or the amount of the pecuniary gain, and for entities, the greater of $100,000 of the amount of the pecuniary gain.

 

The proposed Bill also provides that for repeat offenders, the maximum penalty amount is three time the applicable cap.

 

Though the Bill was just introduced, given its bipartisan support and the fact that it was introduced at the request of the agency Chairman and in response to concerns noted in the courts, the Bill seems relatively likely to pass. If passed, it will be signed into law, given the President’s support. The practical implication seems to be not just that the SEC will seek higher penalties, but will seek penalties more often, given the proposed new authority to seek penalties in administrative actions. There is nothing specifically about the Bill that directly suggests that this legislation will cause the agency to increase the number of enforcement and administrative actions overall, but with greater firepower at its disposal, the SEC may become more active, and perhaps even more aggressive.

 

The increased penalties would not directly change D&O insurers loss cost exposure, since the increased penalties would not typically be covered by insurance. But if the SEC becomes more aggressive in seeking penalties, and in particular becomes more aggressive in seeking penalties against individuals, it could result in an increase in defense expenses, as companies and individuals, keen to avoid the increased penalties for which no insurance is available, extend the fight to defend themselves.

 

At a minimum, if this legislation passes, we could see a significant increase in penalty amounts. If nothing else the increased penalties could dramatically increase the consequences for both companies and individuals that are targeted by the SEC for securities law violations. Whether or not this actually results in a deterrence of misconduct, it certainly dramatically ramps up the consequences.

 

The Credit Rating Agencies and Their Involvement in the Credit Crisis: Among the many issues arising in the wake of the credit crisis is the question of the extent of the rating agencies’ involvement in the many of the securities at the heart of the financial meltdown and the extent of the rating agencies’ responsibility for many of the credit crisis events.

 

 

In a July 19, 2012 article on Thomson Reuters News and Insight entitled “The Credit Rating Agencies: Power, Responsibility and Accountability” (here) by Robert Piliero of the Butzel Long law firm takes an interesting and detailed look at the involvement and complicity of the rating agencies in many of the events central to the credit crisis. Piliero definitely takes a particular point of view – that is, that the rating agencies ought to be answerable and held liable for many actions taken leading up to the crisis. With appropriate allowances for that point of view, the article provides and interest overview of the issues surrounding the rating agencies potential liability. The author also includes an overview of the case law to date in connection with efforts to hold the rating agencies liable.

 

Today’s Entry for Cease and Desist Request of the Day: Jack Daniels is famous for its alcoholic beverages. It turns out that its lawyers are as smooth as its liquor. In what has to be one of the most polite cease and desist requests ever, its lawyer sent a letter to an author whose book cover was designed to mimic Jack Daniels’ famous bottle label. Take a look at a comparison of the book cover and the liquor bottle label, and also read excerpts the liquor company’s remarkably courteous letter, here. 

 

Midwest PLUS Chapter Event on the JOBS Act: On Friday August 3, 2012, the PLUS Midwest Chapter will be hosting an educational event and cocktail reception at the Market Bar on West Randolph Street in Chicago. The panel discussion is entitled “An Overview of the Jumpstart Our Business Startups (JOBS) Act.” Leading the discussion will be my good friend Perry Granof of the Granof International Group, along with Machua Millet of Marsh. The panel, which is scheduled to run from 5:30 pm to 6:00 pm, will be followed by a cocktail reception. Admission is complementary but you do need to register in advance. You can find further information about the event including how to register here.

 

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According to NERA Economic Consulting’s mid-year 2012 report, securities class action lawsuit filings were at or above historical levels in 2012, and though average securities class action lawsuit settlements during the year’s first half approached all times highs, the pace of securities suit settlements is “slowing down markedly.” NERA’s Report, which is entitled “Recent Trends in Securities Class Action Litigation: 2012 Mid-Year Review,” can be found here. NERA’s July 24, 2012 press release regarding the report can be found here. My own analysis of the first half filings can be found here.

 

According to the NERA report, and largely driven by merger objection cases, there were 116 class action lawsuit filings in the year’s first half, which suggests an annualized rate of 232 filings. (Please see the note below regarding NERA’s counting methodology.) This rate is slightly above the 217 average annual number of filings that NERA calculates for the period 1996 to 2011.

 

However, the report makes a point that I have also made on this site, which is that while the annual number of filings has fluctuated around the same annual figure since the mid-90s, the number of public companies has declined significantly. According to the NERA report, the number of publicly traded companies has decreased by about 45% since 1996, and so “the average company listed in the US is significantly more likely to be the target of a securities class action now than it was in 1996.” This is an important observation that is often overlooked; all too often commentators, referring only to fluctuations in the absolute number of lawsuits, conclude that filings are up and down, without considering the relation of the number of filings to the potential number of lawsuit targets.

 

Merger objection cases remained an important component of securities class action filings in the year’s first half, although at a slightly diminished level from 2010 and 2011. (NERA counts only the merger objection cases filed in federal court; many more merger objection cases are filed in state court.) The NERA report notes that over recent years there have been a number of temporary phenomena that have briefly inflated the number of securities suit filings. However, and nlike these other short term developments, the merger objection cases “may continue indefinitely, in the absence of substantial changes in the legal environment, their number fluctuating with market cycles in M&A activity.” The decline in the number of publicly traded companies may be contributing to the growth in the number of non-traditional securities class action lawsuits, as plaintiffs’ lawyers seek business alternatives in a shrinking market.

 

The NERA report also shows that the number of filings against non-U.S. companies is well off the record pace for such filings in 2011, although the filings against foreign issuers still remains above historical levels and remains disproportionately high relative to the number of foreign issuers listed in the U.S. Thus, foreign issuers represent only 16.4% of all U.S. listed companies, but lawsuits against non-U.S. companies represented 19.8% of all first half 2012 filings (which is down from 2011, when filings against non-U.S. companies represented 28.1% of all filings.).

 

The report also contains a detailed analysis of the status of cases with respect to motions to dismiss, motions for class certification and motions for summary judgment at the time of settlement. Among the  interesting facts that come out of this analysis is that in cases in which a motion to dismiss has been filed, 22% settle before the motion is heard. Another interesting observation is that there are settlements in 10% of the cases in which the dismissal motions have been granted.  

 

For cases filed in 2001, about 35% of all cases were dismissed. However, as more recent filing years have matured, it looks as if the dismissal rate may be increasing. The report notes that “for each annual cohort from 2003 to 2006, the dismissal rate has been 43% or more.”  These figures will ultimately change somewhat, because some cases are not yet resolved and other cases that have been dismissed may see reversals on appeal. The most recent years are still too undeveloped to draw any conclusions. Analysis of the year of dismissal motion resolution (as opposed to year of filing) suggests a similar uptick in dismissal grants. Importantly this analysis of dismissal motion resolution omits merger objection cases, because they are resolved quickly and often are dismissed voluntarily.

 

The majority of cases (58%) settle before a motion for class certification has been filed, and of 46% of the cases in which a motion for class certification has been filed settle before the class certification motion is resolved. For those cases in which the class certification motion is heard, over three-quarter of the class certification motions are heard within there years of the lawsuit filing date. Interestingly, for cases in which the class certification motion has been granted at the time of settlement, the median settlement value is $16.5 million, compared with $9.1 million for all cases.

 

Motions for summary judgment are filed in only a small minority of cases (11%), and of those, nearly half (48.8%) settle before the motion is heard. Less than ten percent (9.8%) of summary judgment motions are granted.

 

Continuing a trend that began to emerge in 2011 (at least of the merger objection cases are removed from the analysis), the pace of settlements so far this year is on pace for the lowest level of settlements since 1998. However, the average value of a settlement in the first half of 2012 was $71 million, a sharp rise from the average value of $46 million over the period 2005-2011. This average is pulled upward by a few very large settlements. If the settlements over $1 billion and the IPO laddering cases are removed from the calculation, this year’s average settlement amount is $41 million. (The 2005-1022 equivalent average is $32 million.) 52% of settlements this year settled for below $10 million. The median settlement amount so far this year is $7.9 million, compared to $7.5 million for all of 2011.

 

So far in 2012, the median settlement amount represents about 1.3% of median investor losses (this figure has declined as claimed investor losses have increased over time, because, as the NERA report shows, the settlement as a percentage of investor losses declines as the amount of investor losses increases). Median attorneys’ fees as a percentage of settlement amounts also declines as the size of the settlement increases. The median plaintiffs’ attorneys’ fees as a percentage of the settlement amount so far in 2012 is 20% (down from 30% in 1996).

 

A final note about counting. There are at least two factors identifiable from the face of the NERA Report to suggest reasons why its published lawsuit filing count may differ (specifically, may be larger than) other published counts. The first is that, as NERA says in the footnotes to its report “If multiple … actions are filed against the same defendant, are related to the same allegations, and are in the same circuit, we treat them as a single filing. However, multiple actions filed in different circuits are treated as separate filings. If cases filed in different circuits are consolidated, we revise our count to reflect that consolidation.” At least as an initial reporting matter, this counting methodology may result in the NERA account appearing higher than other published counts.

 

In addition, it seems that NERA is counting all merger objection suits filed in federal court in its tally. This also may result in the NERA tally appearing higher than lawsuit filing counts published elsewhere, at least where the other tallies include only merger objection suits that affirmatively allege a breach of the federal securities laws (as opposed to alleging only a breach of fiduciary duties or similar allegation). Given how numerous the merger objection filings have been in recent years, this method of counting could significantly affect the reported filing numbers as well as the analysis of the number of filings relative to prior filing periods.

 

This last commentary about filing counts is just another way of saying that when all the reports about the first half filings are in, they are going to reflect seemingly disparate reports. This is a direct reflection of the counting methodology used in preparing the separate reports. It is critically important when you are looking at any analysis of securities class action filing trends that you consider and understanding the counting methodology used, and how the methodology might affect the reported results (particularly by contrast to other reported results).

 

Eleventh Circuit Reverses Trial Court Ruling, Affirms the Ultimate Result in BankAtlantic Securities Case: Many readers will recall the long-running Bank Atlantic subprime-related securities suit saga. Unusually, the case went all the way to trial, resulting in a verdict for the plaintiff (about which refer here), although following the verdict the trial judge entered judgment as a matter of law in the defendants’ favor (about which refer here). A detailed description of the case, the jury verdict, and the post-trial proceedings can be found here. The plaintiff appealed.

 

In a July 23, 2012 opinion (here), the Eleventh Circuit held it was error for the trial court to consider anything the determination the defendants’ motion other than the sufficiency of the evidence. However, because the Eleventh Circuit held that the plaintiffs’ had not established loss causation as a matter of law, the trial court’s ultimate ruling was affirmed.

 

Jan Wolfe has a good summary of the tortured procedural history in the case and of the Eleventh Circuit’s holding in a July 23, 2012 post on the Am Law Litigation Daily (here).

 

Libor Scandal Criminal Charges Coming This Week?: As I reported in my post yesterday about the Libor scandal, authorities in several countries are conducting criminal investigations into the scandal. A July 23, 2012 Reuters article (here) reports that prosecutors are close to arresting individual traders that participating in manipulating the rates. Charges may come as early as this week. Although this will not directly affect the regulatory actions against the banks themselves, it could shed significant light on which banks are involved and how they are involved in the scandal. Stay tuned.

 

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The Libor scandal first began to unfold more than four years ago, but the with  dramatic announcements in late June of the imposition of fines and penalties of over $450 million against Barclays PLC, the scandal has shifted into a higher gear and is now the leading story in financial papers around the world. At this point, it is apparent that the Libor scandal is going to be one of the hot topics for months to come. With that in mind, it seems appropriate to step back and take a detailed look at how this scandal developed, what seems likely to happen next, and what the implications may be.

 

Background about the Benchmarks

The London Interbank Offered Rate (Libor) is one of several benchmarks that banking institutions use to set the interest rates for lending between banks. In a process overseen by the British Bankers’ Association, each morning a panel of large banks reports to Thomson Reuters the interest rates they would pay to borrow from other banks. After removing the highest and lowest figures, the reported interest rates are averaged. The submissions of all of the participants are published, along with each day’s Libor rates.

 

The Libor benchmarks are used as the reference rate for a wide variety of financial instruments, including forward rate agreements; short-term interest futures contracts; interest rate swaps and inflation swaps; floating rate notes; syndicated loans, and variable rate mortgages, among many others. According to the Accounting Degree website (here), the total value of all securities and loans relying on Libor totals $800 trillion. By way of comparison, the total amount of worldwide GDP is $69.65 trillion.

 

Although Libor is often referred to as if it were a single figure, it actually consists of a series of benchmarks, representing interest rates for fifteen different maturities in ten different currencies. (The currencies are the Australian Dollar, the Canadian Dollar, the Swiss Franc, the Danish Kroner, the Euro, the British Pound, the Japanese Yen, the New Zealand Dollar, the Swedish Krona, and the U.S. Dollar).

 

Different banks participate in the reporting panels for the different currencies and the lineup of panel participants has changed over time. There are currently 18 banks on the U.S. dollar panel (refer here for the current list) but at various time during the events that are at the heart of the current scandal there have been differing numbers; there were as few as 16 in December 2008 and as many as 20 in early 2011.

 

Three U.S. banks currently participate on Libor panels. Bank of America is a member of the U.S. dollar panel; Citigroup participates in several panels (including the U.S. dollar, the British pound and the Euro). JP Morgan Chase participates in nine of the ten Libor panels. The other participating banks are from several other countries, including the U.K. France, Germany, Japan, and Switzerland.

 

Libor is only one of several interbank lending benchmarks. Another prominent benchmark is the Euro Interbank Offered Rate (Euribor), a rate for interbank loans within the Eurozone. There are currently 43 banks from over 15 countries participating on the Euribor panels. Another interbank rate is Tibor, the Tokyo Interbank Offered Rate, and Sibor, the Singapore Interbank Offered Rate.

 

As discussed in detail in a July 19, 2012 New York Times article entitled “Libor-Scandal Shows Many Flaws in Rate-Setting” (here), the rate setting process used for Libor has a number of defects. Among other things, the process depends entirely on self-reporting, by participants who know their reports will be subject to public scrutiny. The other problem is that since early in the financial crisis, banks have stopped lending to each other. Accordingly, the reported rates often represent estimates, rather than actual borrowing costs. At best, the rates are the result of an artificial process that may have little relation to reality. And as time has shown, the rates are susceptible to manipulation and distortion.

 

Background regarding the Scandal

As early as August 2007, regulators and academics began to raise questions about Libor. These questions surfaced publicly in two Wall Street Journal articles published in spring 2008. The first of these, dated April 16, 2008 and entitled “Bankers Cast Doubt on Key Rate Amid Crisis” (here), reported concerns that Libor was “sending false signals” and could be “becoming unreliable.” In particular, the article reported “growing suspicions about Libor” that could be interpreted to suggest that “banks’ troubles could be worse than they’re willing to admit.” The article noted that “some banks don’t want to report high rates they’re paying for short term loans because they don’t want to tip off the market that they’re desperate for cash.”

 

On May 29, 2008, the Wall Street Journal ran a second article, entitled “Study Casts Doubt on Key Rate” (here), in which the Journal reported, based on its analysis, that “banks have been reporting significantly lower borrowing costs for the London interbank offered rate, or Libor, than what another market measure suggests they should be.” The Journal compared the panel banks reported borrowing rates to the costs of insuring the banks against default, two measures that historically moved in tandem. The Journal found that the two rates had recently diverged materially, in ways that could be interpreted to suggest that some banks were “low balling their borrowing rates to avoid looking desperate for cash.” The participating banks were reporting similar borrowing rates even when the default insurance market was suggesting widely diverging market perceptions about the various banks’ financial health.

 

It now appears that these concerns about LIbor were registering with regulators. It turns out that among other things, on June 1, 2008, then-New York Fed chair and current Treasury Secretary Timothy Geithner sent Mervyn King and Paul Tucker, the governor and executive director of markets at the Bank of England respectively, an email with a list of suggested “Recommendations for Enhancing the Credibility of Libor.” Among other things, the list included the suggestion to “Eliminate Incentive to Misreport.” According to a July 21, 2012 Wall Street Journal article (here), documents released by the Bank of England in connection with the ongoing Parliamentary investigation of the scandal revewal during 2008 that the Bank of England may have resisted taking a more active role in policing Libor, even as the problems surrounding the benchmark were coming to light.

 

In any event, these developments and similar concerns led to a host of regulatory investigations in a variety of different countries. The roster of investigations and of countries involved continues to expand. A list of the banks that have disclosed that they are under investigation can be found here. In connection with these investigations, several of the banks involved have negotiated varying levels of immunity in exchange for cooperation. Investigations are pending in, among other countries, the U.S., the U.K. Canada, Switzerland, Japan, Singapore, Sweden and South Korea. In addition, several U.S. states are conducting their own investigations, including New York, Massachusetts, and Connecticut. Numerous press reports have stated that several governments are conducting criminal investigations. The publicly available information about the investigations is now sufficiently detailed that there are even press reports of the specific individuals that are under investigation.

 

The Barclays Settlements

The significance of these regulatory investigations took on an entirely new level of seriousness on June 27, 2012, with the announcements that Barclays had entered a series of settlements with regulators and enforcement authorities in the U.S. and the U.K. Barclays’s June 27 press release about the settlements can be found here.

 

On June 27, the U.S. Commodities Futures Trading Commission announced (here) that Barclays had been ordered to pay a $200 million penalty for attempted manipulation of and false reporting concerning the Libor and Euribor benchmarks. The CFTC’s June 27, 2012 Order Instituting Proceedings (here) details the allegations against Barclays. At the same time, the U.S. Department of Justice announced that Barclays had entered an agreement to pay a $160 million penalty to resolved violations arising from Barclays Libor and Euribor submissions. Barclay’s June 26 non-prosecution agreement with the DoJ can be found here. The statement of facts accompanying the agreement can be found here.

 

In addition, the U.K. Financial Services Authority announced (here) that it had fined Barclays £59.5 relating to is Libor and Euribor submissions.  The FSA’s June 27, 2012 “Final Notice” to Barclays can be found here. The total U.S. dollar value of all of these fines and penalties is about $453 million.

 

As impressive as these figures are, they apparently reflect the benefits allowed Barclays for its cooperation. For example, in its announcement, the FSA noted that the fine, in addition to being the “largest fine ever imposed by the FSA,” reflects a thirty percent discount in recognition of Barclays’s cooperation with the investigation. Without the discount, Barclays fine would have been £85 million (about $133.5 million). The Department of Justice ‘s release also cited Barclays’s “extraordinary cooperation,” noting that Barclays had made timely, voluntary and complete disclosure of its misconduct,” and adding that Barclays was “the first bank to cooperate in a meaningful way after disclosing its conduct relating to Libor and Euribor.” The CFTC also noted Barclays’s “significant cooperation.”

 

The various regulatory and investigative filings allege that beginning at least in 2005 and through 2009, and at times on an almost daily basis, Barclays provided Libor and Euribor submissions that were false because they improperly took into account the trading positions of its derivatives traders or reputational concerns about negative media attention relating to its Libor submissions.

 

Specifically, it is alleged that between 2005 and 2007, and then occasionally through 2009, certain Barclays traders requested that Barclays Libor and Euribor submitters contribute rates that would benefit the financial positions held by those traders. The Order also alleges that during at least part of that period, the Barclays traders communicated with traders at other financial institutions to request Libor and Euribor submissions that would be favorable to their trading positions. Documents and emails cited in the FSA’s and the CFTC’s orders detail the traders’ email requests to the persons who submitted the rates for Barclays.

 

In addition, the CFTC Order also alleges that between August 2007 and January 2009, in response to concerns about press suggestions that Barclays’s high U.S. Dollar rate submissions reflected problems at the bank, members of Barclays’s management directed that Barclays U.S. dollar rate submissions be lowered, without respect to the bank’s actual borrowing costs. Among the many questions that have emerged is the debate whether or not the BoE’s Paul Tucker authorized (or even directed) Barclays CEO Robert Diamond to have Barclays underreport its borrowing rates in October 2008, at the height of the credit crisis. (The emails between Tucker and Diamond can be found here.)

 

Barclays obviously sought through its cooperation to curry favor with regulators. As noted above, the bank’s cooperation did at least result in a reduction of the FSA fine. But just the same, the bank’s CEO, Robert Diamond, and its Chairman, Marcus Agius, were forced to resign in the days immediately after the settlements were announced, and the company has also been hit with various civil lawsuits as well. An interesting July 16, 2012 Wall Street Journal article (here) details how missteps and miscalculations may have thwarted Barclays best efforts to manage its fallout from the situation.

 

The irony is that there seems to be an informal consensus that Barclays may not have been the worst offender; a July 19, 2012 Fortune Magazine article suggests that Barclays was not “the worst Libor liar,” but instead that title may belong to Citigroup, based on a recent academic study. The article does note that if Citi only underreported but did not also try to manipulate its reported rates for profit purposes, it may not fare as badly as Barclays.

 

In any event, there has been a recent suggestion that many of the banks under investigation are attempting a group settlement, as a way to try to “avoid a Barclays-style backlash by going it alone.” According to a July 20, 2012 Reuters article, “none of the banks involved now want to be second in line for fear that they will get similarly hostile treatment from politicians and the public.”

 

The Follow-On Civil Litigation

As I have separately noted, a raft of private civil litigation has followed in the wake of the Libor investigation, in which various claimants have alleged that they have been harmed by the Libor and Euribor rate manipulation.

 

Beginning in 2011, a host of municipalities, pension funds and institutional investors initiated a series of private civil antitrust lawsuits. These cases have now been consolidated before Southern District of New York Judge Naomi Buchwald. On April 30, 2012, the various claimants filed their consolidated amended class action complaints. The City of Baltimore’s amended complaint can be found here. The consolidated amended complaint filed on behalf of various commodities futures contract and options traders can be found in three parts here, here and here. (There were other complaints filed in the consolidated action on April 30, 2012, but for whatever reason the other complaints are not available on PACER.)

 

The amended consolidated complaints in these actions make for some interesting (albeit technical) reading. For example, the amended complaint filed on behalf of the futures traders details extensive expert analysis of the ways in which both the Libor benchmarks and the individual panel members’ submitted rates deviated from other economic indicia. This analysis is extensively illustrated with numerous graphs and charts. The futures traders’ complaint also contains extracts from documents filed in courts in Canada, Singapore and Japan in connection with investigations in those countries (see paragraphs 137 and following). Among other things, the information from the Court documents shows that regulators in those countries are probing possible manipulation of other interest benchmarks, such as Tibor and Yen-Libor.

 

In particular, excerpts from court filings in Canada and Singapore (at paragraphs 166 and following) provide extensive details about investigative actions in those countries concerning possible manipulation of the Yen-Libor rates, in order to produce trading gains on interest rate derivatives. The documents from the Singapore court proceedings (at paragraphs 177 and following) details alleged collusion between RBS traders and rate setters, calculated to maximize trading profits.

 

Another of the antitrust suits consolidated before Judge Buchwald in the Southern District of New York is a class action filed by the Community Bank & Trust of Sheboygan (Wisconsin) against the Libor setting banks, on behalf of similarly situated community banks. The suit alleges that the alleged manipulation of the benchmark rate hurt small banks that operate on thin profit margins and that rely more on interest income than large banks with diverse trading operations. In addition to antitrust claims, the community banks’ suit alleges violations of RICO. Tom Hals’s July 16, 2012 Reuters article about the small banks’ suit can be found here.

 

A good short summary of the legal issues involved in the consolidated antitrust litigation can be found in a July 17, 2012 memorandum (here) from the Perkins Coie law firm.

 

In addition, as noted here, on July 6, 2012, plaintiffs initiated a separate antitrust action against a number of large banks, asserting antitrust claims as well as claims under the Commodities Exchange Act. The complaint in the action alleges that Barclays and several other banks conspired to artificially manipulate the reported Euribor rate, which, the complaint alleges is “the baseline interest rate used in the valuation of more than $200 trillion in derivative financial products.” The complaint is filed on behalf of a class of persons or entities in the United States who purchased Euribor-related financial instruments between January 1, 2005 and December 31, 2009,

 

Beyond the antitrust litigation, there are reports that shareholders derivative actions have been filed against Citigroup and Bank of American directors and officers, although at this point I have not seen the complaints in these actions. (If any reader can provide me with copies of the complaints in these actions I will update this post with links to the documents.)  UPDATE: Loyal reader Kari Timm of the Walker Wilcox Matousek firm has provided me with a copy of the Citigroup derivative suit, filed on June 6, 2012 in New York (New York County) Supreme Court against Citigroup, as nominal defendant, and the Citigroup board. The complaint, which can be found here, asserts a single count for breach of fiduciary duty.

 

Finally, as noted here, on July 10, 2012, litigants initiated a securities class action against Barclays and related entities as well as the bank’s former CEO and Chairman. The complaint, which can be found here, is filed on behalf of class of persons who purchased Barclays ADRs between July 10, 2007 and June 27, 2012. The complaint alleges that the defendants participated in an illegal scheme to manipulate the Libor rates, and that the defendants “made material misstatements to the Company's shareholders about the Company's purported compliance with their principles and operational risk management processes and repeatedly told shareholders that Barclays was a model corporate citizen even though at all relevant times it was flouting the law.”

 

Discussion

Outrage over the manipulations and deceptions in the Libor scandal is at a fever pitch. Some commentators have called the revelations about Libor “the biggest scandal yet.” Indeed, at least one observer, Rolling Stone’s Matt Taibbi, is outraged that there isn’t more outrage. The information that has surfaced to date does suggest that there almost certainly is a lot more to come on this issue. It seems likely that we are in for months if not years of periodic revelations and disclosures about misconduct at many of the participating banks.

 

There are good reasons for the outrage. Because of the role Libor has played in the global financial markets, the impact of the rate manipulations involved is enormous. Anytime you have a factor that affects transactions valued in the hundreds of trillions of dollars, even small deviations can have effects measured in the billions. Because of these kinds of figures, much of the press coverage and commentary about the Libor scandal has a sensational, sometimes almost apocalyptic tone.

 

There is no doubt that the dollars involved in the Barclays settlements helps to drive the sensational tone of much of the press coverage. After all, if Barclays, which took the initiative to cooperate with investors, wound up paying those kinds of amounts, what does that imply for the other banks involved in the investigations? It does seem probable that by the time this scandal plays itself out, there will be many more regulatory settlements, some of which might make the Barclays settlements look like pocket change.

 

A related issue that often follows is whether the banks’ civil litigation exposures are also going to be similarly enormous. It is clearly far too early at this point to know for sure. But there are a number of factors that should be kept in mind before anyone jumps to conclusions that the Libor scandal represents a huge litigation event of the kind, for example, that followed the subprime meltdown and the credit crisis.

 

There are a variety of different countries around the world where litigation relating to the Libor scandal might be filed. However, the litigation forum of choice for any prospective litigant is the United States. The availability of contingent fees (and the absences of a loser pays regime), as well as the availability of discovery and jury trials, means that prospective litigants will want to file their claims in the U.S, if they can. But there are a host of impediments that might restrict the availability of a U.S. forum for many of the potential claims.

 

First of all, there are only three U.S. banks involved (Bank of America, Citigroup and JP Morgan Chase). All of the other Libor and Euribor participating banks are domiciled outside the U.S. Among other things, this means that a U.S. court is unlikely to be an available forum for many kinds of cases. For example, because of the “internal affairs doctrine,” which provides that the courts of the country in which a corporation is domiciled should address issues concerning the governance of those companies, U.S. courts are unlikely to be attractive forum for shareholders’ derivative suits against the Non-U.S. banks.

 

And while many of the Libor and Euribor participating banks are publicly traded, only some of them have shares or ADRs that trade on U.S. exchanges; the banks that do not have U.S. listed securities cannot be subject to a suit under the U.S. securities laws. Only a few of the banks caught up in the scandal could even potentially subjected to a securities suit in the U.S. relating to the Libor scandal.

 

There are some even more basic issues affecting the banks’ potential liabilities. The most important of these is the complicated ways that financial market participants were affected by the rate manipulation. Among other things that should be kept in mind is the fact that the banks involved were not the only ones that benefited from the rate manipulation. For example, in the May 2008 Wall Street Journal article that first tried to quantify the extent of the rate manipulation, the paper noted that if Libor were understated as much as it appeared to be, the reduction “would represent a roughly $45 billion break on interest rate payments for homeowners, companies and investors over the first four months of this year.” Of course, investors whose interest income was reduced by the rate reductions experienced losses of a comparable magnitude.

 

Many marketplace participants likely experienced both of these effects from the manipulation of Libor. As noted in a July 17, 2012 Reuters article entitled “Funds May Have Won and Lost in Libor Scandal” (here), most of the institutional investors that potentially might assert Libor-related claims both paid interest and collected interest at rates determined by Libor. And to further complicate things, many of these same investors also participated in comprehensive interest rate hedging strategies. As one commentator quoted in the article says, “If they hedged themselves, there might not be any provable loss.”  Of course, there may be other participants where the calculation of loss is more straightforward (for example, the community banks). For many prospective claimants who claim harm directly as a result of the interest rate manipulation, the damages calculation could be very complicated.

 

Another practical constraint that may affect a prospective claimant is that even if the Libor manipulation damaged them, the claimant may have no direct commercial relationship with the banks that did the manipulating. For example, if I bought an interest rate paying investment from, say, Vanguard, and I believe that I lost interest income because Libor was suppressed, I am going to have a very hard time asserting a claim against the banks that manipulated Libor, since I have no direct commercial relationship them. To put this constraint in the context of the pending antitrust litigation, there is a legal principle that is part of the U.S. antitrust law called the Illinois Brick doctrine. This doctrine basically says that indirect purchasers of goods and services cannot assert antitrust claims. In other words, potential claimants who cannot show that they purchased goods or services directly from the Libor participating banks may find it difficult to assert antitrust claims against them. 

 

Another consideration should be taken into account before anybody jumps to the conclusion that the Libor scandal is going to be a cataclysmic litigation event. That is, the universe of potential defendant companies is finite and relatively small. There are a defined number of identifiable banks that were involved in setting the benchmarks. It is always possible that entrepreneurial plaintiffs’ lawyers will find a way to expand the list of target defendants beyond the roster of benchmark participating banks, but absent some creative development along those lines, the list of potential litigants is limited to a specific pool of large banks. To be sure, these banks could be sued over and over again, but what is not going to happen is that there are not going to be hundreds and hundreds of different companies dragged into litigation, the way so many companies were in connection with the credit crisis litigation wave and even the options backdating scandal.

 

All of that said, there is going to be a lot more private civil litigation to come. Which in turn raises the question of what all of this might mean from an insurance perspective. First of all, and in light of all of the foregoing considerations, it seem unlikely that the Libor scandal is going to become a massive, market changing event for the D&O insurance industry. It undoubtedly will have a significant impact, particularly among those carriers that were most involved in providing insurance to these large banking institutions. But taken in the aggregate, the Libor scandal litigation may not produce as big of an impact as other recent scandals.

 

Among other things, many of the undoubtedly huge costs that are looming likely will not represent insured amounts. The regulatory fines and penalties will not be insured. The company investigative costs also are likely not covered. In addition, most of the antitrust litigation filed to date has named only corporate defendants. Under the typical D&O insurance policy, the companies themselves are only insured for securities claims. So the antitrust litigation, for example, would likely not be covered under the typical D&O insurance policy.

 

Any shareholders derivative litigation potentially would be covered under most D&O insurance policies, but there is a limited universe of potential defendant companies that can be sued in U.S. in derivative suits in the U.S. There is always the possibility of private civil litigation outside the U.S. but based on historical patterns that possibility is somewhat less likely and represents a diminished threat as well.

 

Perhaps the most interesting question is whether or not there will be further securities litigation, which if filed would likely fall within scope of coverage of most D&O insurance policies. The extent of securities litigation may determine how big of an event this is for the D&O insurance industry. As noted above only some of the banks potentially involved in the Libor scandal have shares or ADRs that trade in the U.S., and so it is possible that the securities litigation arising from the scandal may not be that extensive.

 

A further consideration that may diminish the potential impact of this scandal on the D&O insurance industry is the fact that many of these large banks do not carry traditional D&O insurance or may only have restricted insurance. Because of extensive prior losses in the industry, the availability of D&O insurance for these kinds of banks is restricted, and for some of the banks may not even be available at commercially acceptable prices. In some instances, the banks’ insurance may include a substantial coinsurance percentage or a massive self-insured retention. Other banks may only carry so-called Side A only insurance, which covers individual directors and officers only and is only available when the corporate entity is unable to indemnify the individuals due to insolvency or legal prohibition. Given that none of the potentially involved banks have failed, it seems unlikely that this Side A only coverage would be triggered.

 

All of these considerations make me think that in the end, the Libor scandal may not prove to be a significant event for the D&O insurance industry. Of course, events could prove me wrong. The plaintiffs lawyers may come up with creative ways to expand the universe of defendants, or claimants may meet with unexpected success in asserting claims outside the U.S. If these kinds of things were to happen, then the Libor scandal could prove to be a more serious event for the D&O insurance industry. But as things stand, I do not believe this scandal is the kind of thing that is, by itself, going to change the market.

 

The question of what the impact on the D&O insurance industry will be is a different question that what the overall magnitude of this event will turn out to be, outside of the insurance context. Time will tell of course, but on this question of the scandal’s broader impact, I think we will see some very substantial regulatory fines and penalties and we will also see some very sizeable litigation settlements

 

The one thing I know for sure is that this scandal will continue to unfold in the months and even years to come. And on that score, as a blogger, I would like to express my heartfelt thanks to the financial services industry. I have been blogging now for close to seven years, and it seems like every time I feel I am running out of things to write about, the financial services industry will serve up yet another outrageous set of circumstances that sets off a media scrum and yet another wave of litigation. This latest scandal seems likely to provide me with worthy blog fodder for quite a while. So a very special tip of the blogging hat to the financial services industry. I don’t know what I would do without you guys.

 

On Summer and Time: For those of you who have not yet seen my recent post about Pentwater, Michigan, I would like to urge you to take a minutes and read my article – or at least look at the pictures and read the many comments from readers. If you have already seen the post, please send along a link to the article to a friend. The post, which you might have missed because it came out right around the July 4^th holiday, can be found here. Thanks to everyone who posted a comment and to the many readers who have sent me notes about the post.

 

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One of the most distinctive recent securities litigation trends has been the surge of litigation involving U.S.-listed Chinese companies. As a result of the litigation threat, as well as beaten-down market valuations, many Chinese companies are now taking steps to de-list from the U.S. exchanges. However, this step could entail its own set of litigation risks. Indeed, litigation relating to the de-listing could, according to a recent commentary, “become the next big trend in U.S. securities litigation.”

 

According to a July 11, 2012 memorandum from the Reynolds Porter Chamberlain law firm entitled “U.S.-Listed Chinese Companies: Bump-Up Claims” (here) there have been a total of 57 securities class action lawsuits involving U.S.-listed Chinese companies, 39 of which were filed in 2011. By my count, as of June 30, 2012, there only seven new securities class action lawsuits filed against U.S. listed companies during 2012. Nevertheless, these litigation developments and chronically lower market valuations have encouraged many U.S. listed Chinese companies to see to return to private ownership.

 

Though these companies are de-listing as a risk mitigation step, the process, according to the memo, could “expose the companies, their directors and D&O insurers to bump-up claims by shareholders if it is not managed carefully.” In the bump-up claim, the shareholders allege “that the consideration they received for their shares was inadequate.” The possibility of these types of claims is exacerbated by the fact that share prices for U.S.-listed companies have fallen sharply. Although some of the going private transactions have involved well-known private equity firms, others have involved management buyouts, which may encourage claims that the consideration paid was inadequate.

 

According to the memo, at least 16 U.S-listed Chinese companies have de-listed in the last two years and “at least three further large U.S.-listed Chinese companies are known to be in buy-out discussions.” And according to one source cited in the memo, as many as 50 additional companies are “presently considering, or actively seeking, de-listing.”

 

These concerns obviously have implications for the way the buy-out process is managed. There are also implications for D&O insurers. According to the memo, insurers should “brace themselves for an increase in bump-up claims” involving U.S.-listed Chinese companies. The insurers will also want to update their underwriting routines by “seeking disclosure of any de-listing plans from their insureds” and “considering limiting their exposure by endorsing a bump-up exclusion onto their D&O policies.”

 

The possibility of this type of litigation does indeed seem highly plausible. I note that though the memo refers to buy-out transactions involving U.S.-listed Chinese companies that have taken place in the last two years, it does not cite any actual examples of the referenced buy-outs resulting in litigation. Nevertheless, in an environment where virtually every M&A transaction results in litigation, it seems reasonable to assume that U.S.-listed Chinese companies going private transactions might also entail litigation. Whether this litigation is indeed the “next big trend in U.S. securities litigation” will remain to be seen.

 

For general background regarding bump-up claims and coverage for the claims under D&O insurance policies, refer here and here.

 

D&O Year in Review, 2011: Readers of this blog will be particularly interested in the July 17, 2012 publication from the Troutman Sanders law firm entitled “D&O and Professional Liability: Year in Review 2011” (here). The memorandum takes a comprehensive look at the key D&O and professional liability insurance coverage decisions during 2011. The memo is interesting and will be a great resource.  (In fact, several of the entries in the memo are relevant to items currently on my desk.)

 

Dodd-Frank Rulemaking Far Behind Schedule: It may not be news exactly, but it is still worth noting that many rulemakings required by the Dodd-Frank Act, enacted nearly two years ago, are far behind schedule. As detailed in a July 2012 report from the Davis Polk law firm (here), “Of the 398 total rulemaking requirements, 119 (29.9%) have been met with finalized rules and rules have been proposed that would meet 137 (34.4%) more.” Rules have not yet been proposed to meet 142 (35.7%) rulemaking requirements.

 

As of July 2, 2012, a total of 221 Dodd-Frank rulemaking requirement deadlines have passed. Of these 221 passed deadlines, “140 (63%) have been missed and 81 (37%) have been met with finalized rules. Regulators have not yet released proposals for 19 of the 140 missed rules.”

 

Advisen Webinar on Securities Litigation Developments: On Thursday, July 19, 2012 at 11:00 am EDT, I will be participating in free, one-hour webinar sponsored by Advisen and entitled “Second Quarter Securities Litigation Review.” The webinar will be chaired by Advisen’s Jim Blinn and will also include Terence Healy of the Reed Smith law firm. Further information and registration instructions for the webinar can be found here. I hope all blog readers will listen in, this should be a lively webinar. There is a lot to talk about.

 

Advisen’s quarterly report on 2Q12 corporate and securities litigation can be found here.

 

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At the PLUS D&O Symposium in New York this past March, I participated on a panel entitled, “Financial Institutions Underwriting: Is it Safe to Come Out Yet?” The implication of the panel topic was that perhaps with the passage of the credit crisis, financial institutions might not be as big of a D&O underwriting risk as they had been perceived to be during the crisis. At the same time, the presentation of the title in the form of a question suggested that perhaps there might still be further risks ahead.

 

Subsequent events have proven that it was right to continue to ask the question. As I wrote in a post earlier this week, the LIBOR scandal, among other things, shows that the financial institutions arena remains a risky neighborhood. In the earlier post, I questioned whether the follow-on civil litigation arising in the wake of the LIBOR scandal would include securities class action litigation. We now know the answer to that question as well.

 

On July 10, 2012, a Barclays shareholder filed a securities class action lawsuit in the Southern District of New York, against Barclays PLC and two related Barclays entities, as well as the company’s former CEO, Robert Diamond; and its former Chairman Marcus Agius. The complaint, which can be found here, is filed on behalf of class of persons who purchased Barclays ADRs between July 10, 2007 and June 27, 2012.

 

According to the plaintiffs’ lawyers’ press release, the complaint alleges that the defendants participating in an illegal scheme to manipulate the LIBOR rates, and that the defendants “made material misstatements to the Company's shareholders about the Company's purported compliance with their principles and operational risk management processes and repeatedly told shareholders that Barclays was a model corporate citizen even though at all relevant times it was flouting the law..” Alison Frankel has a detailed July 12, 2012 post on the On the Case blog (here) detailing this new securities class action lawsuit.

 

Although (as discussed here) there has already been extensive antitrust litigation filed in connection with the LIBOR scandal, this latest securities suit against Barclays is the first securities class action lawsuit filed in the scandal’s wake. Obviously, Barclays is the only financial institution that has reached a settlement with the regulatory authorities. At the same time, however, Barclays wasn’t the only participant in the scheme. Many other companies have been implicated in the scandal. As the regulatory process unfolds and as other financial institutions reach regulatory settlements, it seems very likely that there will be further securities class action lawsuits to come.

 

While early litigation developments in this latest financial sector scandal are only beginning to unfold, the litigation fallout from earlier scandals is slowly playing itself out. There were key developments in two significant cases filed in connection with prior scandals in the financial arena.

 

First, in July 11, 2012 order (here), Southern District of New York William H. Pauley III denied in part the defendants’ motion to dismiss the securities class action lawsuit that had been filed against the Bank of American, certain of its directors and officers, its offering underwriters and its auditors, in a case filed in the wake of the mortgage foreclosure processing scandal.

 

As detailed here, the plaintiffs alleged that the bank had misrepresented its reliance (and the reliance of Countrywide Mortgage, a company Bank of American purchased at the outset of the financial crisis) on the Mortgage Electronic Registration System (MERS), a computerized system for tracking mortgages that tried to eliminate the need for mortgage originators to physically record mortgages. As the mortgage meltdown unfolded it became clear that it would be difficult if not impossible for the bank to foreclose on mortgages in MERS.

 

The plaintiffs also alleged because of the bank’s reliance on MERS, the bank had breached the warranties it had given in connection with mortgage securitizations that it had good title to the mortgages, and also had breached its mortgage underwriting standards, as a result of which, the plaintiffs allege, the bank is liable for repurchase claims by mortgage securitizers for billions of dollars worth of mortgages. The plaintiffs also allege that in connection with a December 2009 securities offering, the defendants misrepresented the problems associated with the bank’s reliance on MERS as well as the bank’s vulnerability to repurchase claims.

 

Judge Pauley granted the defendants’ motions to dismiss the plaintiffs’ Section 11 claims relating to the December 2009 offering, on statute of limitations grounds. Judge Pauley also granted the motions of the individual director and officer defendants, as well as of BofA’s offering underwriters and auditors, as to all of the remaining allegations. However, the dismissal of the claims (other than the Section 11 claims relating to the December 2009 offering) against the individual defendants was without prejudice. And most importantly from the plaintiffs’ perspective, Judge Pauley denied the motion to dismiss of the bank itself other than with respect to the Section 11 claim.

 

I have added this ruling to my running tally of subprime and credit crisis-related dismissal motions rulings, which can be accessed here. Jan Wolfe’s July 11, 2012 Am Law Litigation Daily article discussing Judge Pauley’s ruling can be found here.

 

Second, in an earlier case arising from the subprime meltdown and credit crisis, on July 9, 2012, the parties to the subprime mortgage securities suit involving BancorpSouth filed a stipulation of settlement indicating that they had agreed to settle the case for $29.25 million. The settlement is subject to court approval. According to the parties’ stipulation (a copy of which can be found here), the settlement is to be entirely funded by D&O insurance; the stipulation provides that as part of the settlement, the defendants will “cause their directors’ and officers’ insurers” to pay the $29.25 million into escrow.

 

As detailed here, the plaintiffs had first filed their suit against BancorpSouth and certain of its directors and offices in the Middle District of Tennessee in May 2010.  The plaintiffs alleged that as the credit crisis had unfolded, the bank had been slow to recognize losses in its lending portfolio, instead claiming that it its portfolio was of a higher quality than those of other lending institutions. Ultimately the bank was forced to recognize extensive losses. The plaintiffs alleged that the bank had failed to properly account for its construction and commercial real estate loans, failing to reflect impairment in the loans and had not adequately reserved for loan losses  On January 24, 2012, the court entered an order accepting the magistrate’s recommendation that the defendants’ motions to dismiss should be denied.

 

I have added the BancorpSouth settlement to my list of subprime case resolutions, which can be accessed here.

 

Dodd-Frank Whistleblower Developments: We are still awaiting the payment of the first whistleblower bound under the Dodd-Frank Act’s whistleblower provisions. But that is not to say that there have not been any developments. To the contrary there have been several recent rulings in various legal proceedings involving the Dodd-Frank Act whistleblower provisions.

 

As Jan Wolfe notes in a July 10, 2012 article in the Am Law Litigation Daily (here), several courts have recently shed significant light on the Dodd Frank whistleblower provisions. Among other things, one court has ruled that the provisions give retroactive protection to the whistleblowers at subsidiaries of public companies, not just to whistleblowers at the  publicly traded parent company. However, an earlier court ruled that, because the Dodd-Frank Act is silent about the extraterritoriality of the whistleblower provisions, the provisions do not apply extraterritorially.

 

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The fallout from the alleged manipulation of LIBOR and other interbank offered rates continues to accumulate. In the wake of Barclays’ record fines, the regulatory investigation continues, and authorities reportedly have also launched criminal investigations. Along with the governmental investigatory and enforcement activity has also come civil litigation activity as well.

 

The latest suit to be filed is an antirust action filed I on July 6, 2012 in the Southern District of New York. The complaint, which can be found here, alleges that Barclays, several Barclays entities, and several other banks, conspired to artificially manipulate the reported European Interbank Offered Rates (“EURIBOR”), which, the complaint alleges is “the baseline interest rate used in the valuation of more than $200 trillion in derivative financial products.”

 

 The complaint, which purports to be filed on behalf of a class of persons or entities in the United States who purchased EURIBOR-related financial instruments between January 1, 2005 and December 31, 2009, relies heavily on documents, emails and other materials and information amassed as part of the governmental investigations. The complaint alleges that the defendants entered an agreement in restraint of trade, in violation of Section 1 of the Sherman Act. The complaint also alleges violation of the Commodity Exchange Act. The plaintiff’s lawyers’ July 6, 2012 press release about the EURIBOR antitrust suit can be found here.

 

Allison Frankel has a thorough overview of the Euribor antitrust lawsuit in a July 9, 2012 post on her On the Case blog (here).

 

The recent EURIBOR antitrust action is far from the only civil action to follow in the wake of the governmental investigation.  According to a May 2012 PLUS Journal article  by Eric Scheiner and Jennifer Quinn Broda of the Sedgwick, Detert, Moran & Arnold law firm entitled “Move Over Subprime? Financial Institutions and Brokers Face Increasing Concerns Over Allegation of Improper Libor Manipulation” (here), in 2011, at least 21 class action lawsuits were filed I n various U.S. federal courts against numerous Libor member banks. These lawsuits were instituted by institutional investors who purchased interest rate swaps tied to Libor and who claim they lost millions through the alleged manipulation of the interbank rate or who lost money on other interest-rate sensitive investments and instruments. Further background about these antitrust suits, which have now been consolidated, can be found here.

 

Nor are these institutional investor lawsuits the only suits to emerge. According to a June 27, 2012 memo from the Kennedys law firm (here),   there have also already been at least two shareholders derivative lawsuits filed, one brought by a Bank of America shareholder and another by a Citigroup shareholder, against former and current directors and officers of those firms, alleging breaches of fiduciary duty “regarding lack of oversight relating to the bank’s purported manipulation and suppression of LIBOR as early as 2006.”

 

The ultimate scope of the Libor scandal remains to be seen, but the stakes involved are clearly enormous. To date, only Barclays has paid regulatory fines, but many other banks, perhaps dozens of banks are likely to become involved. The costs involved – both for defense expenses and for fines and penalties – will be massive. How massive remains to be seen, as we clearly are still just at the outset of this unfolding scandal.

 

What all of this may mean from an insurance perspective also remains to be seen. The regulatory fines and penalties are not likely to be covered. The companies’ costs incurred in the regulatory investigations also are not likely to be covered, as the typical D&O policy provides little coverage for entity related investigative costs, particularly outside of the securities law context.

 

The D&O insurance implications of the civil litigation are  not entirely clear.  The antitrust lawsuits primarily target the company defendants. There have been no individual defendants named in the antitrust suits. The typical public company D&O insurance policy provides entity coverage only for securities claims, which do not appear to be involved in the antitrust suits. In addition, private company D&O insurance policies often have antitrust exclusions. The derivative lawsuits may represent an entirely different matter. The derivative suits name individuals as defendants and alleged breaches of fiduciary duties, not antitrust violations. The derivative claims would be far more likely to be covered under the typical D&O policy.

 

The ultimate consequences for the companies involved and their insurers will only emerge over the coming months and years as this scandal continues to unfold. It does seem likely that the related civil litigation will continue to accumulate. To the extent additional derivative claims are filed, or if shareholders of target banks file securities claims, the follow-on civil litigation could develop into a significant event for the D&O insurance industry. At this point, the one thing that is clear is that it will pay to watch closely as the investigation unfolds and the follow-on civil litigation continues to emerge.

 

A July 2012 memo about the Libor investigation and possible insurance implications from my friend Nilam Sharma of the Ince & Co. law firm and her colleague Simon Cooper can be found here.

 

Special thanks to the several loyal readers who sent me copies of the EURIBOR antitrust complaint. Edvard Pattersson’s July 7, 2012 Bloomberg article about the EURIBOR antitrust suit can be found here.

 

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Former CFO’s Dismissal Motion Denied in Longtop Financial Securities Suit: Longtop Financial Technologies may be unique among U.S.-listed Chinese companies that have been caught up in the wave of accounting scandals and related securities litigation. Unlike many of the others, Longtop did not obtain its U.S.-listing by way of a reverse merger, but instead, in order to obtain its NYSE listing, it went through the full IPO process. Nevertheless, as discussed here, its share price collapsed in April and May 2011 following online research reports critical of the company’s accounting practices.

 

As detailed here, securities litigation against the company and certain of its directors and officers followed. One of the individual defendants, Derek Palaschuk, the company’s former CFO, moved to dismiss.  As detailed in Jan Wolfe’s July 2, 2012 Am Law Litigation Daily article (here), Palaschuk’s motion has now been denied. In a June 29, 2012 opinion (here), Southern District of New York Judge Shira Sheindlin, acknowledging that the online research reports may well have been biased owing to the online analysts’ financial interests as short sellers of Longtop’s stock, nonetheless rejected Palaschuk’s motion.

 

The motion involved only the CFO and not the company itself, owing to the fact that the company, though it has been served, has not yet entered an appearance in the case. As Wolfe put it in the Litigation Daily post, after reading Scheindlin’s opinion, “we can understand why Longtop might be avoiding U.S. courts.”

 

Corporate Directors in the Hot Seat: As research by Stanford Law Professor Michael Klausner and others has found, outside corporate directors are only rarely directly held personally liable for their actions as corporate directors. Nevertheless, directors are increasingly “in the thick of it,” according to an interesting article by Philippa Masters entitled “Corporate Directors on the Firing Line” (here) in the latest issue of Corporate Counsel, dated July 9, 2012.

 

The article opens with an interesting discussion of the recent events that have swamped the beleaguered board at Yahoo (whose members were memorably described by departing Yahoo CEO Carol Bartz as “doofuses”). The article describes how shareholder activists and others are increasingly seeking to hold directors accountable for problems at their companies. As a result of these recent developments, there has been an upsurge in litigation involving corporate directors – for example, in the form of “say-on-pay” litigation and M&A-related litigation, as well as in FDIC failed bank litigation. The article also notes the increased use of such theories as the responsible corporate officer doctrine, to try to hold corporate officials liable.

 

The article is a little longer than the usual online fare, but I recommend taking a few minutes to read the entire piece. It is wide-ranging and interesting.

 

Questioning the Theory of Shareholder Value Maximization: One of the currently accepted tenets of corporate oversight is that companies should be managed to best maximize shareholder value. An interesting June 26, 2012 post on the Dealbook blog (here) takes a look at a recent book by Cornell Law School professor Lynn A. Stout, in which the professor questions the shareholder value “myth.” According to Stout, the misleading shareholder valuation theory is the product of misguided analysis from economists and business professors that has been propagated by the “corporate governance do-gooder movement,” as a result of which short term investors like hedge funds have manipulated companies into delivering short-term stock price driven results at the cost of companies’ long run interests.

 

Stout contends that based on a proper reading of the law, corporate officials are empowered to take a broader range of considerations into account. They might, for example consider the interests of their customers and their employees and may even consider social responsibility. Stout calls for a return to “managerialism,” where executives and directors can run companies without being preoccupied with shareholder value. It is, she contends, in the long run interest of all constituencies that companies move away from short-term strategies and toward consideration of longer range issues.

 

Evergreen Fund Suprime-Related Securities Litigation Settled: The parties to the subprime-related Evergreen Ultra Short Opportunities Fund Securities have settled the case. According to the parties’ June 29, 2012 stipulation of settlement (here), the parties have agreed to settle the case for a payment of $25 million. The settlement is subject to court approval.

 

As described in greater detail here, investors first sued the fund, affiliated entities and certain individuals associated with the fund, in a securities class action lawsuit in June 2008. The plaintiffs alleged that, contrary to its marketing materials, the fund was not managed to preserve capital and avoid principal fluctuations, but rather was composed of illiquid, risky, speculative and volatile securities, particularly mortgage-backed securities. The fund ultimately liquidated at a substantial loss to investors. On March 31, 2010, the court entered an order granting in part and denying in part the defendants’ motion to dismiss.

 

The settlement stipulation does not reveal whether any portion of the $25 million settlement is to be funded with insurance. I have in any event added the Evergreen Fund settlement to my running tally of subprime and credit crisis-related case resolutions, which can be accessed here.

 

Evolutionary Biology and the Dynamics of Law Firm Management: Readers of The New Yorker magazine will recall an article that appeared in the magazine in March 2012 discussing the writings and research of evolutionary biologist Edward O. Wilson and the theory of altruistic behavior among animals. An amusing June 28, 2012 post on the Adam Smith, Esq. blog (here) takes a look at the biological theories of altruistic and individualistic behaviors to suggest that law firms that develop altruistic group behaviors are more likely to survive and thrive than are firms that built upon aggressive individualism.

 

Special thanks to loyal reader Matt Rossman for the link to the Adam Smith, Esq. blog post as well as the article above about Professor Stout’s study of shareholder value.

 

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The number of securities class action lawsuit filings came in slightly above historical averages during the first half of 2012, with filings against natural resources companies, life sciences companies, and foreign issuers leading the way. Filings related to mergers and acquisitions transactions continued to be an important factor in the number of filings, although not as significant of a factor as was the case in 2011.

 

During the first half of 2012, there were 103 new securities class action lawsuit filings. This figure annualizes to 206, which would be above the 1997-2010 annual laverage number of filings of 194. Though securities suit filings were active during the year’s first half, the filings were not evenly distributed during the period. There were 58 filings in the first quarter -- 44 in January and February alone -- but only 45 filings in the second quarter. Given the relative filing slowdown after the first two months of the year, it may be that by year’s end the overall filing level may not remain at the relatively elevated levels that we saw in the first half. .

 

A surprising number of the first half filings involved companies domiciled or with their principle place of business outside the U.S. There were 18 filings in the year’s first six months against these non-U.S. companies, representing about 17.5% of all filings. This level of filings against non-U.S. companies is down from 2011, when 36.2% of all filings involved non-U.S. companies, but the filings against non-U.S. companies are still up from 2008-2010, when the filings against non-U.S. companies averaged about 13.4% of all filings.

 

The largest numbers of these filings involving non-U.S. companies related to companies domiciled in or with their principal place of business in China. There were seven of these suits against Chinese companies during the first half. In addition, there were three more companies that are headquartered or domiciled in Hong Kong but that have their operations in China .Taking all of these into account, there were ten China-related filings. This level of filing against China-related companies is down from 2011, when filings against Chinese reverse merger companies largely drove the filings during the year. The numbers of filings against Chinese-related companies in 2012 still is a little unexpected, as the wave of filings involving Chinese companies in 2011 was largely assumed to be a temporary phenomenon. To be sure, the filings against Chinese-related companies is down significantly from 2011. Nevertheless, the continued level of filings against Chinese-related companies is noteworthy.

 

It should be noted that there were also six filings against Canadian companies, many of them natural resources companies (about which see more below).

 

There were a number of “ripped from the headline” lawsuits in the first six months, including in particular the fillings during the first half against J.P. Morgan, Wal-Mart, Facebook and Netflix. Given the anemic rate of IPO activity during the first six months of 2012, the numbers of IPO related lawsuits are a little bit of a surprise. There were six suits involving IPO companies, including the high profile IPO fizzles Facebook and Groupon.

 

About 15% of the first half filings involved M&A related allegations, which while significant is down from 2011, when M&A related filings accounted for about 22.9% of all filings.

 

The first half securities suits were filed in 38 different district courts. The court with the largest number of filings in the year’s first six months was the Southern District of New York, which had 33 filings (or roughly a third of all filings in the first half). No other court had nearly as many filings. The courts with the highest filing levels after the Southern District of New York were the Central District of California (6); and the Northern District of California, Northern District of Illinois and District of Massachusetts, each of which had five filings. These top five courts together had more than half of all first half filings (52.42%).

 

Many kinds of companies were sued in securities suits in the first half. The companies involved were drawn from 62 different Standard Industrial Classification (SIC) code categories.  However, there were concentrations of filings in certain specific areas

 

The largest concentration of filings was in the 283 SIC code grouping (Drugs), where there were a total of 13 filings, included eight  in the 2834 SIC code category (Pharmaceutical Preparations). Another area of concentration was in the 384 SIC code group (Surgical, Medical and Dental Instruments), which had six filings. The single category within this group that had the highest number of filings was SIC code category 3845 (Electrochemical and Electromagnetic Apparatus). Taking all of these groups and categories together, there were a total of 19 filings against life sciences companies, or about 18.4% of all filings.

 

Outside of life sciences companies, the next highest concentration of filings was in the SIC code series from 1000 to 1400 (which includes mining and natural resources companies), in which there were 15 first half filings (about 14.5% of all filings). The largest single category with this group was SIC code category 1311 (Crude Petroleum and Natural Gas), which had eight filings.

 

Another group with a significant number of first half filings was the SIC code group 737 (Computer Programming and Data Processing), which had a total of eight filings. Finally, there were four filings in SIC code group 8200 (Educational Services),.

 

It is worth noting that there were only a modest number of filings in the 6000-level SIC code series (Finance Insurance and Real Estate). In recent years, subprime and credit crisis-related filings has driven filings among companies in these categories, which as recently as 2010 predominated all filings. However, during the first half of 2012, there were only ten filings against companies in these SIC Code categories, representing about 9.7% of all filings.

 

Discussion

The above comparison to historical filing levels is based on absolute numbers of filings. It could be argued that on a relative basis, the filing rate is actually increasing. According to data on the World Federation of Exchanges website, in the ten year period between January 1, 2002 and December 31, 2011, the number of companies trading on either NYSE or NASDAQ has declined by about 25% (from 6,586 to 4,900), yet in absolute terms the number of filings remains within about the same range (that is, around 200 per year). Relative to the declining numbers of public companies, the rate of securities class action lawsuit filings arguably is increasing.

 

The level of securities litigation activity involving mining and natural resources companies is interesting. Historically, companies in these categories have seen relatively little securities class action filing activity. The single largest factor in the increase of filing activity is litigation arising from M&A transactions. But litigation has also arisen due to the fluctuating pricing of minerals or petroleum; questions about mineral or petroleum reserves; or as a result of extraction mishaps, such as crude oil spills. It does seem as if the increased global competition for natural resources has made companies in these categories more vulnerable to securities class action litigation activity than they have been in the past.

 

There are some important aspects in which my analysis will likely vary from other published versions. There is a significant amount of judgment about what to include in the tally of filings and then about how to categorize the various filings. To use one example of this problem, it is unlikely that other published versions will show the same figures as I have for the number of China-related companies. There are a variety of ways these companies might be tracked, whether limited purely to Chinese domiciled companies, or broadened to also include companies that have their principal place of business in China or companies that have their principal business activities in China. I have used the most inclusive grouping, including within the group companies that have the business activities in China, even if they are not Chinese domiciled and even if they don’t have their principle place of business in China. This categorization may result in a larger tally of China-related companies than you may see published elsewhere. This same precaution about categorization applies equally to the more basic task of tallying up the lawsuit filings; due to differences in counting methodology, my tally is likely to vary from other published counts.

 

Failed Bank Litigation Fizzle?: A number of commentators, including even me, had been projecting that as 2012 progressed then numbers of FDIC failed bank lawsuits would escalate sharply. In the event, quite the opposite has happened, at least so far. In particular, during 2Q12, new FDIC filed bank lawsuit filings have slowed to a crawl.

 

As reflected on the FDIC’s website (here), during the first quarter of 2012, there were nine new FDIC lawsuits against the former directors and officers of failed banks, including four in March along. However, during the second quarter of 2012, the FDIC filed only three new failed bank lawsuits total. The agency filed no lawsuits at all during June.

 

It may well be that new failed bank lawsuit activity will pick back up in the year’s second half. Indeed. on its website, the FDIC indicates that a lawsuits involving a total 65 failed institutions have been authorized (inclusive of the 30 lawsuits involving 29 institutions that have already been filed), which suggests that there may be as many as 36 lawsuits that have been approved but not yet filed.

 

With all of these authorized lawsuits, it seems probable that new lawsuit filings will soon resume and that the period during the second quarter will turn out to have been a short-term lull only. Nevertheless, the relative dearth of new failed bank lawsuit filings during the second quarter is noteworthy and even a little puzzling.

 

The FDIC has in any event continued to take control of failed financial institutions during the first half of the year. There were a total of 31 bank failures during the period, which though well below the  pace of closures during the last few years, is still above even the annual total for 2008, where there were 25 bank failures during the entire year. In other words, even if the pace of failed bank litigation filing seems to have dipped during the second quarter, the problems associated with the current wave of bank failures continue to accumulate and the likelihood is that the fallout from the bank failures will have to be sorted out for years to come.

 

Collegiate Hunter Gatherers: An article in the July 2, 2012 issue of the New Yorker entitled “The Hunter Games” (here)  takes a look at the annual Scavenger Hunt at the University of Chicago known to the undergraduate students there simply as “Scav.” What began a few years ago as a modest diversion has grown into an enormous nerd ritual that exceeds traditional limits of normal human behavior. To cite but one example of the kinds of things the annual event leads to, the article mentions that “in 1999, for five hundred points, a pair of physics students built a working breeder reactor in a Burton-Judson dorm room in one day, converting thorium powder collected from inside of vacuum tubes into weapon-grade uranium, using a device made from scrap aluminum and carbon sheets. A concerned nuclear physicist attested to the machine’s efficacy.”

 

The list of objects to be found or constructed is devised by a group of judges, whose bylaws provide that the planning meeting “could not be adjourned while beer remained on the table.”  Here is a representative sample of a typical challenge: “Build a laptop charger using only materials available in the sixteenth century.” Another requirement is to create “a Scrabble game consisting of nonexistent words, for which the player has to supply definitions (‘mervifeet’ is a medical condition in which only the outer edges of the afflicted person’s feet touch the ground).”

 

The article catalogues the event’s sheer lunacy. However, the article also notes that, despite its “pervasive commotion,” only about ten percent of the undergraduate student body takes place in the event. Others consider it a distraction. The student newspaper parodied the kinds of items on the Scav search list with its own spoof list, including items such as: “Bite your own teeth. Birth a child that is larger than yourself.” One undergraduate is quoted in the article as saying that the Scav is “just really white and socially awkward,” adding that “there’s nothing wrong with being white and socially awkward, but as someone who is not white or socially awkward, it’s not exactly appealing to me.”

 

The Scav may not be universally popular, and it is undeniably a veritable nerd Olympics, but it still stands as an ironic contrast to the University of Chicago’s well-known tag (quoted in the article) that the school is the place “Where Fun Goes to Die.” The contestants come off in the article as brainy and humorous. And seriously odd.

 

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When plaintiffs first filed their securities class action lawsuit against IndyMac Bancorp back in March 2007, the suit was one of the first of what later became a wave of subprime and credit crisis-related securities class action lawsuits. The suit itself, which has come to be known as the Tripp litigation, initially was dismissed and ultimately went through multiple rounds of dismissal motions. In March 2008, during the round of preliminary motions, and in what is the fifth largest bank failure in U.S. history, regulators closed IndyMac Bank. In August 2008, IndyMac Bancorp itself filed for bankruptcy. By the time all of these events had completely unfolded, including in particular the many rounds of dismissal motion rulings, the sole remaining defendant in the Tripp litigation was the company’s former CEO, Michael Perry.

 

According to papers filed in the Central District of California this week, Perry has now reached a settlement of the securities suit against him. As reflected in the parties’ June 26, 2012 stipulation (here), the parties have agreed to settle the case for a payment of $5.5 million. According to the stipulation, the settlement amount will be entirely funded from “insurance policies providing coverage to former officers and directors of IndyMac for the period March 1, 2007 through March 1, 2008.” The settlement is subject to court approval.

 

The litigation involving IndyMac’s former directors and officers includes not only this securities suit, but also a separate securities suit relating to IndyMac’s alleged misrepresentations regarding its exposure to Option ARM mortgages. In addition, there are two different FDIC lawsuits against former IndyMac executives. Indeed, the FDIC’s first lawsuit against former directors and officers of failed banks filed during the current wave of bank failures was filed against two former IndyMac executives (about which refer here). The FDIC also filed a separate lawsuit against Perry. The FDIC’s suit against Perry has been watched closesly as a result of the ruling in the case that Perry, as a former officer, is not entitled to rely on the business judgment rule under California law (the business judgment rule being construed by the district court as protective of directors only, not officers).

 

As noted in an accompanying post, as a result of a June 27, 2012 determination in the IndyMac insurance coverage litigation, there is insurance coverage if at all for these various lawsuits under the 2007-2008 insurance program, meaning that the various claimants in the various cases are in competition with each other for the proceeds of the 2007-2008 insurance program.  It is probably fortunate for the claimants in the Tripp litigation that the parties in the Tripp litigation were able to reach a settlement before the June 27 ruling in the insurance coverage litigation, as the competition for insurance under the 2007-2008 program could have even further complication the settlement of the Tripp litigation.

 

The stipulation provides that insurers from the 2007-2008 insurance program that will be funding this settlement may be required to seek the approval of the bankruptcy court in the IndyMac Bancorp bankruptcy proceedings in order to obtain the bankruptcy court’s approval to use the proceeds for the settlement. The stipulation adds that the parties to the settlement “expressly acknowledge and agree that all obligation of the Defendant with respect to the Settlement Amount are subject to the funding of such Settlement Amount by the Insurers,” adding that the Defendant “shall under no circumstances have an obligation to fund such amount from personnel assets.” The stipulation does provide that if the settlement amount is not paid according to the terms of the stipulation, the settlement is null and void.

 

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

 

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Leading off the second day of the annual Stanford Directors’ College at Stanford Law School in Palo Alto, California was a keynote address from Delaware Chancellor Leo Strine. Strine is surprisingly outspoken and his presentation was lively and interesting.

 

The centerpiece of his presentation was a discussion of the lessons for directors based on the cases he has seen over the years. As a preliminary matter, and actually throughout his discussion of these issues, he emphasized that it is very rare that outside directors are actually held individually liable. He pointed out that, for example, cops, teachers and doctors are held liable much more frequently. But even if an outside director’s chance of being held liable is low, the chance of “looking like a chump” or that you have “failed your mission” is very high if you don’t watch out for certain things.

 

First, from the outset, the director should understand his or her role. In particular, if the director is unable or unwilling to make a decision adverse to management, they should not be in the position. The director also needs to understand the business, how it makes money and its principal risks. The director can’t be voting on things he or she does not understand. Where people tend to get in the most trouble is when they fail to do the work to understand the company and the specifics of the issues on which they are voting.

 

Second, conflicts of interest cause most of the worst trouble. Making sure that there aren’t interested parties involved in the object of board attention is critical. Along those lines it is vital that the board members remain independent, which can be compromised over time if a director’s relationship with the manager. The director needs to be sure that they he or she is still able to be adverse to management when that is what the situation requires.

 

Third, a very specific danger arises when directors are insufficiently skeptical of M&A activity originating within the company itself, particularly through a management buyout brought up when the company is otherwise not for sale or in play. Strine said that this is not the way a company should operate. If a CEO thinks there is a strategic move the company ought to be making, then the directors should be advised and guide the process. The CEO should not be taking advantage of inside information and tampering with employees and enlisting the company’s outside advisors in the interest of a management initiated buyout. (Stine was quite emphatic when he described the problem with this type of situation.)

 

Fourth, one the CEO’s key roles is preparing for management succession. Strine said that if the CEO has been in office three years and there is not a designated successor, the CEO has failed in one of his or her key roles. One of the most important jobs for the CEO is the “build the bench.” Strine cited the example of Johnson & Johnson, which has been a very successful company for decades with a succession of CEOs (all of whom who have been very low profile) that have continued to move the company forward.

 

In response to a question, Strine discussed the massive fee award he granted to the plaintiffs’ attorneys’ in the Southern Peru case. As discussed here, that case had resulted in an award of $1.263 billion, which with interest, approach nearly $2 billion. Strine awarded fees of $285 million, which he defended saying, the only reason the plaintiffs received the massive judgment in the case was the efforts of the plaintiffs’ lawyers. He said that he has much more trouble with cases like the disclosure-only merger objection suit settlement, where the plaintiffs’ lawyers wind up walking away with a $400,000 fee award.

 

The real problem is not a case where plaintiffs’ attorneys produce real value. If the plaintiffs has “delivered something really beneficial, they should be rewarded accordingly.” Rather, the problem is that there are too many incentives for plaintiffs’ attorneys to bring suits where the only beneficiaries are the attorneys. We have, Strine said, an “excess of litigation” that “has no meaningful societal benefit.” Strine commented that the extra costs associated with this litigation have caused the cost of capital for American companies to rise.

 

Strine rejected the suggestion that the Delaware courts might be managing fee awards because of a competition from other states’ courts. Strine stressed that Delaware’s courts are not “trying to attract litigation.” Just the same, he took care to question the effort of other states to try to develop specialized business courts. You can, he said, file suits in “goofy place” and what you will wind up with is corporate law that is “junk.” The movement to form specialized business courts has been “problematic” because all too often those courts have “become places where you can forum shop.” His view is that all courts, by their own account are “overburdened.” That being the case, Strine contends, the each court should “stay in its own lane.” When something is appropriately “in someone else’s lane, then let them do it.”

 

On Monday evening, the keynote speaker at dinner was the CEO of Netflix, Reed Hastings. Hastings also serves on the boards of Microsoft and Facebook. Hastings focused his discussion on the role of the board at very large publicly traded companies, taking pains to emphasize that he was not discussing the boards’ roles at smaller public companies, private companies or at non-profits.

 

Hastings said several times that for the board of a large publicly traded company “the fundamental job is to replace and compensate the CEO.” Where the company has the resources to hire outside consultants as needed, it is not the board’s role to offer counsel or advice. He was dismissive of new directors who come in and try to  “add value” by offering advice. He contends that board members offering advice creates a conflict of interest, because management might feel obliged to follow the advice even if it is poor and if the advice turns out to be mistaken, there is no accountability for the board member.

 

It is fair to say that Hastings remarks drew a very lively response from the audience. He emphasized in responses to questions from the audience that he was only talking the largest public companies, not other types of companies that might need the board’s involvement and guidance. He also said that he was not talking about companies in special circumstances where the situation might require the board to become much more involved. The interaction between Hastings and the audience might have been one of the high points of the conference for me. The audience was engaged in the discussion and Hastings was animated and articulate in discussing his position.

 

Hastings did tell one story from earlier in his career that is worth repeating here. He told the story to emphasize that a CEO must have both leadership qualities and a strategic vision. He said that when he first started working as a young software designer, he kept unusual hours and often had used coffee mugs strewn around his cubicle. He noticed that every few days the coffee mugs would appear on his desk, cleaned. He assumed the janitorial staff was cleaning the mugs. But one morning he arrived at the office at 4 am, and found the company’s CEO in the kitchen, cleaning Hastings’ coffee mugs. The CEO explained that he felt that Hastings did such great work, it was the least the CEO could do for him. Hasting said that this incident made him feel such deep personal loyalty to the CEO that Hastings would have “followed him to the ends of the earth” – which, Hastings said, is where the CEO led the company. It isn’t enough, Hastings said to be able to create a loyal work force, you also have to have a strategic vision.

 

For the record, Hastings did acknowledge that the whole Netflix pricing change was a mistake for which he took responsibility.

 

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The D&O Diary is on assignment this week at The Stanford Directors’ College at the Stanford Law School in Palo Alto, California. As always, the conference is well-attended (it is, in fact, sold out, as usual) and the agenda is full of timely topics and interesting speakers.

 

The conference began on Sunday evening with opening keynote speech from Robert Greifeld, the CEO of the NASDAQ OMX group. NASDAQ is one of the event’s sponsors, and Greifeld joked  with conference co-Chair Joseph Grundfest that next year his firm would increase its sponsorship level so that he would not have to speak at the conference -- a line that drew a knowing laugh from an audience that was all too familiar with the public discussion of the possible involvement of NASDAQ in the problems that surrounded the recent Faacebook IPO.

 

To Greifeld’s credit, he did not run from the topic of the Facebook IPO, and in fact it was the first issue he addressed. He acknowledged that a “design flaw” in NASDAQ’s IPO process allowed problems to come into the early trading, particularly with respect to the timing of order cancellations. He acknowledged that there may have been some “overconfidence” and even “arrogance” in the team that was running the IPO process because they were relying on procedures and routines that had been used in 480 IPOs over the course of several years without a problem.

 

In retrospect, Greifeld said, the pre-offering testing was not rigorous enough. He said that the company has tremendous pride in its technology group, but that perhaps the business unit because too “subservient” to the technology group, as a result of which, there was “not enough business judgment” in the process. He said that the company has reached out for external help from IBM to examine the trading process from an outside perspective. IBM will report at the end of July.

 

As for whether the events surrounding the Facebook IPO will undermine the market for IPOs generally, Greifeld acknowledged their may be some short run effects. However, he added, he expects that over time, IPOs will track the overall market. Over the medium and long term, the markets will mirror GDP growth in the economy, because the markets are tied to the fundamental economic health of the economy.

 

He did observe that the equity markets have had issues since 2008, as since that time there has been a “steady flow” of money from equity investments to fixed income investments – even though in the current interest rate environment, fixed income investments are effectively paying zero return. This, he notes, is not good news for the equity markets.

 

He added that the markets are now “fundamentally different” than they were ten years ago. They are much more fragmented with many more trading platforms, which has produced beneficial competition but has also led to fragmentation. These developments, and other recent developments such as dark pools and high frequency trading, are more beneficial to larger cap companies, because it can help to ensure that the spreads on trading in their securities are tight. For other companies, these developments are bad, and can affect the market liquidity in trading for their shares.

 

Today’s sessions began with a Keynote Presentation from Marc Andreessen and Ben Horowitz, the founders and general partners of venture capital firm Andreessen Horowitz. Andreessen is well known as the founder of early Internet browser company Netscape and Horowitz was the co-founder of Opsware (formerly Loudcloud). Their presentation was in a Q&A format, and one question they received provoked a particularly interesting answer.

 

In response to a question about how a Board should prepare a company for an IPO, Andreessen’s initial response was that the company should first consider every other possibility other than going public. He emphasized that the IPO process and the life for a company post-IPO has changed so much in recent years, that now a company completing an IPO is immediately surrounded by a host of constituencies all of which are prepared to try to extract a “pound of flesh” from the company. If the company has to go public, Andreessen would prefer that the company remains a “controlled” company – that is, subject to control by the founder. He explained that the way for investors to make money on technology investments is for the investors to pick a founder, like a Jeff Bezos, Sergey Brin or Michael Dell, and to make a long-term commitment to them to try to achieve their goals for the enterprise.

 

He went on to say that a faulty premise has emerged around corporate governance, in that there is now a perception that corporate governance ought to operate on basic principles of democracy, particularly as embodied on the “one man, one vote” principle. From Andreessen’s perspective, democracy is not the correct model. According to Andreessen, the correct analogy is the military, and specifically, war. In a wartime environment, politicians cede control to the military commanders so that they can deploy assets and take initiative necessary to “take the hill.” The objectives are more likely to be met if the founders retain control.

 

Horpwitz discussed a number of topics that he has previously addressed on his blog, Ben's Blog. In particular, he discussed the difficulty for a yoind company to try to function with outside managers who are brought in from the outside for their management knowledge but who lack the institutional history and tribal knowedge of the entrepreneur found. In his view, it is easier to teack the entrepreneurial founder the basic principles of management than it is to try to teach the professional manager the firm history and tribal knowledge.

 

The conference continues to run though Tuesday, and I hope to be able to continue to report while I am here. On Tuesday, I will be participating in a session at the conference on the topic of Indemnification and D&O Insurance with my good friends Priya Cherian Huskins of the Woodruff Sawyer insurance brokerage firm, and Chris Warrior of Beazley. The complete program guide for the conference can be found here.

 

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Beginning in 2010 and accelerating in 2011, plaintiffs’ lawyers filed a wave of securities class action lawsuits against U.S.-listed Chinese companies, many of which obtained their U.S. listings via reverse merger. These cases have been making their way through the courts, and some have now reached the settlement stage. The settlements seem to share more in common  than the involvement of U.S.-listed Chinese companies – the settlements are also relatively modest.

 

The latest of these cases to settle is the lawsuit involving Orient Paper and certain of its directors and officers. According to the company’s June 21, 2012 press release, the parties to the suit have agreed to settle the case “in exchange for a $2 million payment from the Company’s insurer.” The settlement is subject to court approval.

 

As I discussed in a post at the time (refer here), the Orient Paper case was the first of the of the Chinese reverse merger company securities suits to survive a motion to dismiss. On July 20, 2012, Central District of California Judge Valerie Baker Fairbanks denied the defendants’ motion to dismiss.

 

The Orient Paper case is not the first of this group of securities suits filed against U.S.-listed Chinese companies to settle. For example, on March 15, 2012, the parties to the securities suit involving Tongxin International filed a settlement stipulation in the Central District of California indicating that they had settled the case for $3 million. The Tonxin settlement will be funded by the company’s insurer.

 

An earlier securities suit involving a U.S. listed Chinese company China Shenghguo Pharmaceutical Holdings, filed back in 2008, settled in 2010 for $800,000. According to the parties’ settlement stipulation (here), $600,000 of the settlement amount is to be funded by the company’s insurer, with the remainder to be funded by the company.

 

You probably noticed that these three settlements have something in common. They not only all three involve U.S.-listed Chinese companies, but all three of the settlements are relatively small. (By way of comparison, Cornerstone Research reports that the median of all securities class action settlements through 2010 was $8.1 million.)

 

The relatively small size of the settlements might be a reflection of the merits or of the companies’ relatively small size. I suspect a different factor. In my experience, U.S.-listed Chinese companies generally carry very low D&O insurance limits. The low limit levels mean that when these companies are sued, defense expenses alone could quickly deplete a significant percentage of the total amount of insurance, leaving little remaining with which to try to settle the case. The relatively low level of these settlements and the fact that all three settlements were settled in whole or in substantial part with insurance funds suggests to me that something like that may have happened here.

 

In 2010 and 2011, when the plaintiffs’ lawyers flooded the courts with these securities suits against U.S.-listed Chinese companies, I wondered at the time why the plaintiffs’ lawyers found these cases so attractive. Even though the factual allegations were in some cases quite sensational, they were always going to be difficult cases to pursue. Service of process on the individual defendants alone would in many cases pose significant challenges. Discovery will also pose substantial challenges, including not just the absence of reliable procedures to effect discovery in China, but also the problems associated with distances, language distances and cultural differences. The plaintiffs in these cases may also face barriers getting a class certified (about which refer here).

 

But even beyond these procedural difficulties, there was always this fundamental problem that in the end there might be very little insurance money out of which to try to collect any settlement or judgment. Given the modest size of these settlements, the attorneys’ fee awards are or will likely be small as well. Small enough to make you wonder how these cases could be worthwhile for the plaintiffs’ lawyers. Of course, going in, they almost certainly had no way of knowing about the lower insurance levels that the Chinese companies often carry.

 

I have made this point before --about the relative unattractiveness of these cases for the plaintiffs’ firms – to others in the insurance industry, which provoked the response that perhaps the real targets in these cases are the investment banks, lawyers and accountants who advised these companies and who helped them obtain their U.S. listings. It may be that these outside professionals may represent attractive targets, but with the limitations on the reach of the securities laws to those who are not primary violators, these cases against the outside professionals pose their own sets of issues.

 

There are many more of these cases against U.S.-listed Chinese companies yet to be resolved. Some of course will be dismissed but the ones that survive the motions to dismiss will likely move toward settlement. As these cases progress, perhaps there will be more sizable settlements and the smaller settlements discussed above will look like early outliers. However, my suspicion is that the relatively low levels of D&O insurance that many of these companies carry will mean that many of the settlements will be similarly diminutive.

 

Special thanks to the several readers who sent me copies of the Orient Paper settlement press release.

 

Every Now and Then I Read a Headline and Say—What?: Like this June 21, 2012 New Scientist article: “Tiny Human Liver Grows Inside Mouse’s Head” (here).

 

Matt is Back! And He’s Still Dancing!: My all-time favorite video is the classic Where the Hell is Matt Video (here). The simplicity of the concept is pure genius. The video consists of short clips of Matt, dancing. In places all over the world, with hundreds and hundreds of people. The background music is awesome too.

 

The great news is that Matt is still dancing. And even better, he has made a new video. It just came out on June 20, 2012. It is every bit as fun as his prior videos. You have to watch it. (Sorry about the commercial at the beginning, it is short). I would like to add a special shout out to my Cleveland friends, you look fine dancing around the “Free” Stamp.” I hope everyone enjoys this video as much as I did.

 

 

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In a recent post on this blog (here), I commented on a May 29, 2012 Dealbook blog post entitled “Why S.E.C. Settlements Should Hold Senior Executives Liable” (here), which had been written by two University of Minnesota law professors, Claire Hill and Richard Painter. After my post appeared, I contacted Professors Hill and Painter to let them know about my post and to invite them to respond to my post if they would like. Professors Hill and Painter (who are pictured to the left) did, in fact, have some comments in response to my post, and I am pleased to be able to publish their comments below as a guest post.

 

I am very grateful to Professors Hill and Painter for their willingness to provide a detailed response to my post and for their willingness to allow me to publish their comments here. The Professors comments follow.

 

Senior executives in investment banks and other financial services firms make a lot of money a lot of the time.   Jamie Dimon, the CEO of JP Morgan, for example will receive total compensation of $23 million this year, even though JP Morgan has suffered a $2 billion (or more) loss incurred by an improvident and unsupervised trader known as the “London Whale.” MF Global’s board had approved an $8 million pay package for CEO Jon Corzine the year before MF Global collapsed, it having “lost” $1.6 billion in customer funds that were apparently comingled with its own. Senior executives at Bear Stearns, Lehman Brothers and Merrill Lynch “earned” similarly large pay packages in the years before those firms collapsed.

 

In a law review article, two op-eds in the New York Times dealbook section, here and here, and in a forthcoming book on the ethics of investment bankers, we express our concern that for too many senior executives in financial services, their work has become a game of “heads I win, tails you lose” played with investors and creditors, and, when there is a government bailout, with taxpayers. This we think is wrong – and it is not the way the banking game was always played.

 

We are not ivory tower academics who don’t like bankers (many of our friends and family members are bankers or have been bankers). We just think that bankers should play the game with some more of their own money. We also think that, if they did, they might play the game differently.

 

In the 1970s the largest investment banks – Morgan Stanley, Lehman Brothers, Salomon Brothers, Goldman Sachs and others -- were general partnerships.   A firm’s capital belonged to the partners, so when they made an investment, or authorized a trader to take a position, they were investing their own money.  If the firm was socked with an SEC fine or civil judgment for violating the securities laws, the fine came out of the firm’s assets, which meant it came out of the partners’ pockets.   If the firm went bankrupt, the partners not only lost the investment they had in the firm, but they were personally liable for debts that the firm could not pay.

 

Investment banks took big risks in those days – but nowhere near the magnitude or risks that in 2008 caused three of the five largest investment banks in the United States – Bear Stearns, Merrill Lynch, and Lehman Brothers – to fail.

 

The fact that these banks, as most all others these days, were operated not as partnerships but as corporations, with limited personal liability for their executives, has, we think, something to do with what happened.   Banking for them is a game of “heads I win, tails you lose.” 

 

To fix this we have proposed that the most senior bankers (those making more than $3 million) be asked in return to make a substantial portion of their personal assets (all except perhaps a few million dollars) available to pay the debts of the firm if it fails, and/or have a portion of their compensation be assessable stock that would be subject to a capital call if the firm becomes insolvent. More recently, we suggested (and one of us suggested two weeks ago in Congressional testimony) that senior executives of a financial institution be asked to pay, perhaps out of the bonus pool, a significant portion of any fine that the SEC or other regulator levies against the bank for illegal conduct.  This, we think, is fairer than imposing the entire cost of the fine on the bank’s shareholders, who had no role in the illegal conduct or responsibility for supervising the individuals who engaged in it.

 

None of what we propose has anything to do with collective guilt or finding of fault without due process, as has been implied in a well-written post by the host of this site. What we propose has to do with collective responsibility for the consequences – both good and bad – of corporate conduct in the financial services industry.   Financial services firms devote a very substantial portion of their revenues to salaries and bonuses (more than many other industries), something we do not in principle object to. We only suggest that when firms break the law, or lose so much money that they become insolvent, the persons responsible for managing those firms should bear a portion of the cost. Banks, shareholders and creditors, and society as a whole, would be better off if bankers went back to playing an honest game of “heads I win, tails I lose.”’ 

 

Why should bankers be treated differently than executives of other firms? Why shouldn’t they get the limited liability that executives at other incorporated firms have?  Financial services firms are different from other businesses in several respects including the fact that leverage ratios are high, financial assets such as derivative products are extremely hard to value, it is difficult for shareholders, creditors and regulators to assess risks that managers are taking, and senior managers are paid extremely well when their bets pay off.   Also, for creditors, other financial services firms and the economy as a whole, the repercussions from risks that bankers take can be enormous. The impact of financial managers’ risk taking turns on, among other things, the types of activities they and their firms engage in, their firms’ size, and the extent to which the firms are interconnected with one another and with other entities. High risk-taking may lead to a firm’s failure, but the firm has a good chance of being bailed out given its size and interconnectedness. The moral hazard – e.g. incentive for managers to take enormous risks – is very strong.

 

Although limited liability has advantages for raising capital and attracting talented employees, it sometimes has downsides. Bankers know this, and before they extend credit to riskier incorporated enterprises they often insist on personal guarantees from the principals. Bankers know that corporate borrowers whose managers have guaranteed corporate indebtedness will be managed more conservatively than corporate borrowers whose managers have not made personal guarantees.   Indeed, up until the 1980s, almost all of the largest investment banks operated as partnerships, with partners personally liable for firm debts.  Now, after 2008, we know that the greatest risk exposure that financial institutions face comes from imprudent decisions by persons in the executive suite who have every incentive to maximize short term profits and bonuses, but not enough incentive to avoid excessive legal and financial risk. 

 

Limited liability for officers of businesses is generally acceptable, but there are exceptions. Investment banks and most other financial services firms should be an exception. Solvency guarantees and partial payment of fines for illegal firm conduct by the most highly paid financial services executives are a reasonable quid pro quo for the enormous pay packages that they receive. 

 

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Worth Reading: Here at The D&O Diary, we never rest from our task of making sure our readers are fulliy informed, and in is in that spirit that we pass along the following links for all of our readers.

 

First, in a excellent June 12, 2012 article on her On The Case blog (here)., Alison Frankel takes a detailed look at Delaware Vice Chancellor Travis Laster's June 11, 2012 opinion in the Allergan derivative litigation, in which the Vice Chancellor, as Frankel puts it, "blasts first-to-file firms" in shareholder derivative and M&A litigation. It is a long-ish article but very much worth reading in full.

 

Second, Victor Li's June 12, 2012 article on Am Law Litigation Daily (here) takes a look at the ruling entered Monday in the Western Distrcit of Pennyslvannia in the long-running RICO action brought in that court against Alcoa and others by Bahrain Aluminum BSC (Alba), in which Alba accuses the defendants of bribing Alba officials and other senior Bahrain government officials. As Li explains, Monday's decision rejected the defendants' attempt made in reliance on the U.S. Supreme Court's decision in Morrison v. National Australia Bank to have the case dismissed.

 

Third, a June 11, 2012 Reuters article entitled "SEC Probes Hit a Wall in Uncooperative China" (here) takes a look at the problems that the SEC is having trying to investigate fraud allegations involving Chinese companies. According to the article, the SEC is finding that "cooperative cross-border investigations are completely foreign to China." 

 

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On Monday, June 11, 2012, the United States Supreme Court granted the petition of Amgen for a writ of certiorari in a securities lawsuit pending against the company. As a result, next term the Court will be addressing the question of whether securities plaintiffs must establish in their class certification petition that the alleged misrepresentation on which they rely was material. The Court’s June 11 order can be found here.

 

As discussed at greater length here, the plaintiff first sued Amgen and certain of its directors and officers in the Central District of California in April 2007. The plaintiff alleged that Amgen made misrepresentations about the safety of two of its products. The plaintiff also alleged that the company made misrepresentations about a May 2004 FDA advisory meeting; about clinical trials involving one of the products; about the safety of on-label uses of the two drugs and about the marketing of the drugs.

 

The plaintiff moved to certify a class of Amgen shareholders. The defendants opposed the motion, arguing that the plaintiff was not entitled to a class-wide presumption of reliance based on the fraud-on-the-market theory, because the plaintiff could not show that the alleged misrepresentations were material. To the contrary, the defendants argued that as a result of analyst reports and public documents, the market was aware of the information that the plaintiff alleged had been concealed.

 

In an August 12, 2009 Minute Order (here), Central District of California Judge Phillip Gutierrez granted the plaintiff’s class certification motion, rejecting the defendants’ argument that the plaintiffs’ had to establish the materiality of the alleged misrepresentation to trigger the presumption.

 

The Ninth Circuit granted the defendants leave to appeal the class certification ruling. In a November 8, 2011 decision written by Judge Barry Silverman for a three-judge panel of the Court, the Ninth Circuit affirmed the class certification.

 

The Ninth Circuit rejected the defendants’ contention that the plaintiff must provide proof of materiality at the class certification stage. The Ninth Circuit said that, as a predicate to class certification, a plaintiff need only show that the market for a company’s shares is efficient and that the supposed misstatements were public. The Ninth Circuit reasoned that because materiality is “an element of the merits” of a securities class action, it need only be addressed at the trial stage or in a summary judgment motion. The Ninth Circuit also approved the district court’s refusal to consider the company’s rebuttal evidence on the issue of materiality.

 

Amgen then filed a petition to the United States Supreme Court for a writ of certiorari. In its petition, a copy of which can be found here, Amgen argued that there is an “irreconcilable conflict” in the federal judicial circuits on the question of whether or not a plaintiff must establish materiality at the class certification stage. According to the cert petition, the Second and Fifth Circuits have held that a plaintiff must prove materiality for class certification and that defendants may present evidence to rebut the applicability of the fraud-on-the-market theory at the class certification.

 

The Third Circuit, according to the petition, has adopted an “intermediate approach” which holds that a plaintiff does not need to demonstrate materiality as part of an initial showing before class certification, but that defendants may rebut the applicability of the fraud-on-the market theory by disproving the materiality of the alleged misrepresentation.

 

The Seventh and Ninth Circuits, by contrast, hold that district courts are barred from considering materiality at the class certification stage.

 

Amgen argues in its petition that

 

The issue at the heart of the circuit split here is whether the defendants should be forced to defend securities fraud litigation against a class of plaintiffs, based on a rebuttable presumption, in instances where the named plaintiff has yet to prove all the predicates of the very theory that allows for class certification in the first place, and where the defendant is given no opportunity for rebuttal prior to certification.

 

Amgen stressed not only the logic concerns, but fairness concerns as well,l because of the “in terrorem power of certification” in the securities litigation context, which often compels defendants to enter into  massive settlements. The presence or absence of this kind of pressure will, Amgen argued, depend on the circuit in which the case was filed. In the Seventh and Ninth Circuits, the company argued, defendants “will frequently be forced by practical realities, to settle cases for enormous sums regardless of whether they have a meritorious materiality defense,” while in the Second and Fifth Circuits, the plaintiffs would have to establish materiality as a precondition to class certification, and in the Third Circuit, the defendants would have the opportunity to rebut any materiality showing.

 

In opposing the cert petition, the plaintiffs first argued that there is in fact no circuit split, but rather, the Ninth Circuit opinion stood alone as the first decision to consider the materiality arguments in light of the U.S. Supreme Court’s recent decisions in Erica P. John Fund v. Halliburton and in WalMart v. Dukes. The plaintiff also argued that the supposed circuit split on which Amgen relies is merely the product of a “strained” reading of the various courts’ opinions. The plaintiff also opposed the petition on procedural grounds, among other things.

 

There were also several amicus briefs filed in connection with Amgen’s cert petition, including one filed by several former SEC commissioners and certain law and finance professors, which was filed in support of Amgen’s petition. In their amicus filing, the commissioners and professors argued that the U.S. Supreme Court’s seminal decision in Basic v. Levinson (which recognized the fraud-on-the-market presumption)

 

recognized that any showing that severs the link between an alleged misrepresentation and the market price of a security – including a showing that a misrepresentation was immaterial – rebuts the presumption of reliance and makes class certification improper.

 

The commissioners and professors also argued that what they described as a “three-way circuit split” has produced a “deep and persistent conflict” that “invites forum shopping.”

 

Amgen was also supported in its petition in amicus briefs filed by the U.S. Chamber of Commerce and the Pharmaceutical Research and Manufacturers of America.

 

Discussion

In granting Amgen’s petition, the Roberts court once again demonstrates its willingness to take up securities cases. Over the past several terms the Court has taken up numerous securities cases that have individually and collectively had a significant impact on securities litigation. In that sense, the plaintiff definitely has a point about the fact that the lower courts are trying to work through all of the issues and implications of the recent raft of securities law and class action procedure questions coming out of the Supreme Court.

 

Though the Supreme Court is still generally weighted toward a more conservative predisposition, and though the Court’s decisions in recent years have included a number of defendant-friendly securities law decisions (for example, the Tellabs and the Morrison decisions), the Court’s decisions have not been uniformly defendant- friendly. For example, the Court’s 2011 decision in the Matrixx Initiatives case rejected the defense argument that in order to establish materiality, a plaintiff had to show that the allegedly omitted information was “statistically significant.”

 

Another element that adds to the unpredictability is the possibility that the Court will go off in an unexpected direction, as it did in the Morrison decision. In Morrison, Justice Scalia’s majority opinion set aside decades of lower court case law on the “cause and effects” test to establish the extraterritorial effect of the securities laws, and promulgated a new “transaction” based test in its stead. There is always the possibility here that the Supreme Court --rather than narrowly interpreting the existing standard under Basic v. Levinson for the applicability of the fraud-on-the-market presumption -- does something more radical instead,  like entirely redefining whether, when and how the fraud-on-the market presumption might apply. Indeed, this case presents the Court with its first clear chance to revisit the doctrine since it was first arrticulated in the Basic case nearly a quarter of a century ago.

 

One final factor that could affect the outcome is the possibility that Justice Breyer may not participate in the consideration of the Amgen case. In its June 11 order granting the cert petition, the Court noted that Breyer “took no part in the consideration or decision of this petition.” If he were to similarly remove himself from the Court’s consideration of the merits of the case, there would be at least the numerical possibility for a dreaded 4-4 split among the justices.

 

This will in any event be an interesting case to watch. Issues relating to class certification potentially have a very significant impact on the seriousness of the case. To the extent Amgen prevails on the merits and establishes that plaintiffs must show materiality at the class certification stage, the defendants will have one more tool in the toolkit to undermine the plaintiff’s case and to try to reduce the threat that the case represents to the defendants.

 

As the Morrison & Foerster firm said in its June 11, 2012 memorandum about the Supreme Court's cert grant in the Amgen case,

 

A clear answer from teh Supreme Court to these questoins coud have a significant impact on securities litigation. A decision that endorses the Ninth Cirtcuit's approach could made securities litigation more costly for defendants, particularly in circuits where plaintiffs are presently required to prove materiality at class certification. Conversely, a decision rejecting the Ninth Circuit's approach could provide defendants an early opportunity to challenge the viability of class action claims.

 

David Bario’s June 11, 2012 Am Law Litigation Daily about the grant of the Amgen cert petition can be found here.

 

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The plaintiffs’ complaint cited twenty-three confidential witnesses and relied on statements the appellate court itself described as “extravagant,” but the First Circuit nevertheless affirmed the lower court’s dismissal of the credit crisis-related securities class action lawsuit investors filed against Textron and certain of its directors and officers. A copy of the First Circuit’s June 7, 2012 opinion can be found here.

 

The plaintiffs’ complaint relates to events at Textron just before and at the beginning of the financial crisis. During 2007 and 2008, Textron made reassuring statements about the strength and depth of order backlog at its Cessna Aircraft subsidiary, which backlog Textron represented would help carry it through the difficult economic times. In early 2009, after several reassuring statements in 2008 about the strength of the backlog, Textron reported substantial cuts to Cessna’s production levels in the fourth quarter of 2008, citing few orders, as well numerous cancellations and delivery deferrals. The company’s share price slumped and securities class action lawsuits ensued.

 

As detailed here, the plaintiffs alleged that the Cessna airplane order backlog was artificially inflated. The plaintiff relied on 23 confidential witnesses in support of its allegations of known weak nesses in the backlog, in part by showing weaknesses in the underwriting for aviation financing offered in support of the airplane purchases. The defendants moved to dismiss.

 

In an August 24, 2011 order (here), District of Rhode Island Judge Paul Barbadoro found that the plaintiffs’ allegations were insufficient to show that material information was omitted. Judge Barbadoro found that the plaintiffs’ allegations of relaxed financing underwriting standards were too vague and failed to show that the alleged misrepresentations about the order backlog were false when made.

 

In its June 7, 2012 opinion written by Judge Michael Boudin for a three-judge panel that included retired Supreme Court Justice David Souter sitting by designation, the First Circuit affirmed the lower court’s dismissal of the case, saying that “we conclude that the complaint was deficient but regard the materiality issue as a close call and rest instead on the failure of the complaint to plead facts justifying a reasonable inference of scienter.” 

 

In addressing the question of materiality, the court did note that the confidential witnesses do “provide at least some indication that underwriting standards were loosened,” while at the same time “Textron comforted investors with assurances of its ‘traditional strong conservative underwriting process.’” After noting that discovery might “have clarified issues” in this regard, the Court observed that “we need not decide the materiality issue because the complaint fails adequately to allege scienter.”  

 

With respect to scienter, the Court said:

 

Nothing in the complaint suggests that any of the named officers believed, or was recklessly unaware, that the backlog’s significance had been undermined by weakened underwriting standards, sales to intermediaries, or any of the other flaws on which the plaintiffs rely…. Textron’s top managers may have been negligent if they were not aware; surely French [Textron’s CFO] was extravagant in saying of the backlog that Textron had “torn it apart.” But negligence or puffing are not enough for scienter…

 

The Court added that “while the relatively detailed factual proffers in the complaint go some distance toward making a case for materiality, they are considerably weaker in offering any direct evidence of guilty knowledge or fraudulent intent.” On the “crucial question” of when the airplane order cancellations began piling up, the various reassuring statements during 2008 and the confidential witnesses description of cancellations increasing “suddenly in ‘late summer 2008’” are, the Court said, “not in conflict.”

 

The Court concluded with the acknowledgement that the PSLRA’s heighted pleading requirements leave “a plaintiff’s counsel with a greater than usual burden of investigation before filings a securities fraud complaint.” District courts can, the Court said, refuse to dismiss cases that “fall into an intermediate gray area,” but “this complaint’s scienter allegations were weaker than its materiality allegations and did not even arguably fall into a gray area encouraging further proceedings.”

 

Discussion

The underlying facts in this case clearly reflect the impact of the global financial crisis as it unfolded in the third and fourth quarters of 2008. The First Circuit does not expressly say it, but its analysis seems to reflect an awareness of how suddenly and dramatically things unraveled during that period. The Court’s analysis does seem to imply that merely because later circumstances turned out significantly different than anticipated, that alone does not mean that earlier statements were untrue or misleading when first made.

 

Nevertheless, the case does demonstrate, as the Court itself acknowledges, how difficult it is for plaintiffs to overcome the PSLRA’s heightened pleading standards. It is difficult to show materiality, and even if a plaintiff can establish materiality, the plaintiff must still establish scienter, and it is hard to establish scienter as well. The sheer difficulty of the task is highlighted by the fact that these hurdles cannot be overcome even with the benefit of the testimony of 23 confidential witnesses and even reliance on statements that the court itself described as “extravagant.”

 

In the end, however, and even though the subsequent events turned out differently than expected, the plaintiff’s case will not be going forward because the plaintiff wA unable to show that the statements were known to be untrue when made. Indeed, given how rapidly the crisis unfolded in late 2008, it seems at least equally plausible that the company truly believed that airplane order backlog would carry it through, and that the company, like so many others, was caught short by the extent of the drop off that followed the dramatic events in September 2008.

 

I have in any event added the First Circuit’s affirmance of the lower court’s dismissal to my running tally of the subprime and credit crisis-related lawsuit case resolutions. The tally can be accessed here.

 

Claire Zillman’s June 8, 2012 Am Law Litigation Daily article about the First Circuit’s opinion and entitled “23 Confidential Witnesses Still Can’t Save Textron Shareholder Suit” (here).

 

And Speaking of the Financial Crisis: With the passage of time, it is easy to forget just how crazy things were in late 2008. (If things continue as they are going in Europe now, we may get to re-experience many of the same emotions and sensations later this summer.) One of the many dramatic events during that period was the collapse of Washington Mutual, which failed on September 25, 2008. As I noted at that time (here), there were so many extraordinary things going on then that even the largest bank failure in U.S. history quickly faded from the front pages.

 

On June 8, 2012, the Wall Street Journal, in an article entitled “A Bank on the Run: How WaMu’s Demise Hit Home” (here) published an excerpt from a new book by Kirsten Grind entitled The Lost Bank, about the collapse of Washington Mutual. The excerpt recounts how the “seeds” of WaMu’s demise “were sown” in a “headlong push into subprime lending that sprouted with the 2004 purchase of Long Beach Mortgage, which was among the most aggressive sellers of home loans to people with sketchy credit histories.”

 

The bank’s subprime mortgage operations quickly produced problems, and the Long Beach Mortgage operations were the subject of critical internal audit reports, which cited the operations “unsafe” lending practices. American International Group, the company insuring WaMu’s mortgages, based on its own sampling of the mortgages, found evidence of mortgage fraud, but WaMu ignored the insurer’s warnings.

 

The excerpt also recounts how WaMu’s own marketing department, attempting to devise ways to make subprime mortgages more attractive to borrowers, compiled video footage of existing borrowers that gave “a sneak peak of the mortgage bust.” Rather than providing support for the attractiveness of the mortgages, the video footage unintentionally constituted a “raw and merciless documentary on high-risk lending.” When shown the footage, the “startled” head of WaMu’s Home Loans Group ordered the marketing team to begin working on “a friendlier approach.”

 

In the end the bank’s collapse has left a legacy of problems for homeowners, for investors and even for J.P. Morgan, which bought WaMu’s assets and which continues to increase its reserves because of deterioration in the WaMu mortgage portfolio.

 

WaMu’s collapse may have taken place nearly four years ago, but the events surrounding its collapse continue to reverberate. Just this past Friday night, the FDIC closed four more banks, after closing only two during the entire month of May. The four latest closures bring the 2012 YTD total number of failed banks to 28. The financial crisis may have peaked a while ago, but the consequences are still continuing to unfold.

 

Man in the Middle: It is never a good sign when  a U.S. Supreme Court justice appears on the cover of Time Magazine. It usually signifies that the Court is at the center of an important controversy, which certainly is the case these days. The justicve on the week's cover is Justice Anthony Kennedy, who could well cast the deciding vote on several key cases either now before the Court or likely soon to be before the Court.

 

The article, entitled "What Will Justice Kennedy Do?" (here) takes a detailed look at Kennedy's backgrodund, his judicial track record, and on his pragmatic, non-ideological approach to the cases before the Court. The article tries to tie his approach to Kennedy's upbringing and professinal career in Sacramento.

 

The article rocounts how Kennedy has in recent years often served as the deciding vote in 5-4 decisions. The article asks rhetorically whether "sonething is wrong with democracy when one person holds so much sway over so many?" and the points out the "Kennedy is not the only person responsible for this state of affairs," adding:

 

He would not havd his majority-making power if his eight colleagues were not so rigid in their views. And the eight woudl not be so adamant if the political parties had not decided over the past generation that only carefully groomed, philosophically pure ideologues should be placed on the high court. Like the rest of the government, the Supreme Court has become polarized, increasingly unable to rise to the American tradition of splitting the difference, finding a compromise, muddling through.

 

Kennedy, the article says,  has "wrestled openly with the complications and nuances of a tough call."

 

The question is whether or not it is a good thing that Justice Kennedy may well prove to be the deciding vote on several of the ksy cases yet to be decided this term and to be decided next term.

 

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In a ruling that has gained a great deal of attention and scrutiny, Southern District of New York Judge Jed Rakoff rejected the “neither admit nor deny” settlement in the SEC’s enforcement action against Citigroup, a ruling that is now on appeal in the Second Circuit (about which refer here). Among other things, Judge Rakoff’s ruling raises the question of whether or not settlements of SEC enforcement actions should be permitted without some type of admission of guilt or wrongdoing.

 

In a May 29, 2012 Dealbook blog post entitled “Why S.E.C. Settlements Should Hold Senior Executives Liable” (here), two University of Minnesota law professors, Claire Hill and Richard Painter, suggest that in order to increase the effectiveness of SEC enforcement actions, rather than requiring an admission of guilt, “a more effective approach would be to make senior, highly compensated officers of the bank pay some portion of the fine.”

 

The authors suggest that officers making more than $1 million a year “should be personally and collectively liable for paying a significant portion (perhaps 50 percent) of S.E.C. fines levied against the bank.” The authors add that independent directors should supervise negotiations with the S.E.C., and if the case is litigated rather than settled, the officers should be personally responsible for a portion of the bank’s legal fees. Banks should be prohibited from reimbursing the officers for the amounts the officers pay. The authors propose that the officers should be personally liable for fines whether or not the bank admits to liability.

 

In support of this proposal, the professors point out that under current practice, fines effectively are paid by shareholders, who “neither caused the behavior that led to the fine nor were they responsible for preventing it.” The authors also point out that many of the investment banks formerly did business in partnership form, which ensured that when there was a loss, the most highly paid partners suffered the most.

 

I have a number of concerns about the authors’ proposal. In commenting on their proposal, I do not in any way mean to minimize their observation about how the costs settlements are now imposed on shareholders. I agree that there are very serious questions that need to be addressed. However, I disagree that forcing corporate officers to bear personal liability for corporate fines is an appropriate solution. I want to stress at the outset that in offering my views here, I mean no disrespect to the Professors or their article. I mean only to present a contrasting point of view.

 

First, it appears that, though not expressly stated in their article, the authors proposal is directed specifically and exclusively toward companies in the financial sector. Indeed, it appears that in proposing their solution the authors were thinking only about investment banks, perhaps because they made their proposal in the context of the Citigroup settlement controversy. However, the authors do not provide any principle whereby their proposed solution would (or could) be limited just to the investment banking sector. If this proposal is fair for officers of investment banks, then it ought to be fair if applied to any publicly traded company. And if it would not be fair for other companies, it would not be fair for investment banks – it not enough simply to say it is fair because investment bankers make a lot of money.

 

Second, it is also not expressly stated in their article, but it appears to me that the authors intended that the officers should be held personally liable for corporate fines regardless of whether the officers had any involvement in or even awareness of the alleged wrongdoing – and indeed whether or not the bank itself has admitted to any wrongdoing.   In other words, the authors seem to be suggesting that the officers should have to pay a portion of the fines not because of any actual or even alleged culpability, but simply as a matter of their status. Indeed, the officers have to be prepared to pay out of their own pockets if they want to fight the charges even if they themselves are not charged with any wrongdoing.

 

As I have stated before on this blog (most recently here), I think there is an increasing and unfortunate tendency to try to impose personal liability in corporate officers without regard to culpability. Among other things, an increasing and indiscriminate use of the “responsible corporate officer” doctrine has been used to impose personal liability on corporate officers for fines involving healthcare and environmental violations. Statutory provisions such as the Sarbanes Oxley compensation clawback provisions similarly have been used to impose liability on corporate officials whose companies restate prior financials, regardless of whether the officers themselves had any actual or even alleged involvement in the circumstances that required the restatement. 

 

I am concerned that a generalized presumption that corporate executives as a group or class are somehow blameworthy and deserving of liability is behind this trend toward imposing liability on corporate executives without actual culpability. There is an unfortunate trend in our society to assume that when something has gone wrong that somebody has to be punished. This general proclivity to look for someone to blame is exacerbated by a general willingness to demonize corporate “fat cats,” which in turn leads some to conclude that corporate executives deserve liability because of their position, without regard of whether they actually did anything culpable.

 

The authors’ proposal to impose personal liability on investment bankers simply because of their pay grade embodies all of these concerns. It overlooks any notion that liability in our legal system ought to be premised on culpability. Moreover, there seems to be a suggestion that because investment bankers are highly compensated, liability can fairly be imposed on them even if it might not be fairly imposed on comparable officials at other types of firms or under other similar circumstances.  

 

It is not an answer or justification for this approach that investment banks formerly did business as partnerships, in which partners bore losses personally. These firms long ago stopped doing business in that form, and chose to do business as corporations precisely because there are advantages to doing business in corporate form. There is absolutely no reason why investment banks doing business in corporate form are any less entitled to the protection of the corporate form than any other type of business doing business as a corporation. There is no reason to overlook the corporate form and impose corporate liability on individual officers simply because officers at the investment bank are highly compensated.

 

Let me come at this from a completely different direction. Many recent law school grads and many commentators have noted that recent law school graduates have had trouble getting legal employment. There are many causes to this problem. One might suggest that the law schools would be quicker to find solutions to this problem if law professors had to give back a portion of their compensation paid to them during the period when the unemployed law students were enrolled at the school. I suspect that law professors would see many problems to this kind of “solution” – it isn’t their fault that the students can’t get employment; their compensation has no relation to the students’ employability; they themselves never promised that the students would get employment, and so on.

 

Many of the same obvious objections to the modest solution about law professor compensation clawbacks are equally applicable to the authors’ proposal about the investment bankers’ personal liability for corporate activity. The point is that the imposition of penalties without culpability is fundamentally unfair, and this fairness is not eliminated simply because the persons on whom the fines would be imposed are highly compensated. When investment bankers are viewed as mere abstractions, as corporate fat cats lighting cigars with hundred dollar bills, it is easy to propose penalties and impositions on them that would not be considered fair in any other context. It is easy to ignore basic constraints such as the notion in our society that there should be no liability without culpability, or that corporations are legally separate from the persons who run them.

 

If there are problems with the way investment bankers are compensated, well, fine, let’s discuss that issue. But even if investment bankers’ compensation needs to be addressed, that is no reason to deprive them of the same protections of fair play that to which everyone else is entitled.

 

I appreciate that many believe corporate executives need to be held more accountable. Nevertheless, I am concerned that as a result of the increased tendency to try to impose liability on corporate executives without culpability, there is a contrary danger that corporate executives could be held liable too frequently, or at least in instances when they have done nothing themselves to deserve it. Scapegoating any individual – even a highly paid investment banker – for circumstances in which they were not involved and of which they were not even aware is inconsistent with some of the most basic assumptions of a well-ordered society governed by law.

 

Lady Justice carries a sword. But she also carries scales that are evenly balanced. And she is blindfolded. It should not matter who stands before the law. .

 

Tiananmen Square Remembered: Yesterday, June 4, 2012 was the 23^rd anniversary of the date in 1989 when the Chinese authorities violently cleared Tiananmen Square after six weeks of protests and demonstrations there. In recognition of the anniversary, the Atlantic Magazine online published a gallery of photos from Tiananmen Square, then and now. The pictures, which are fascinating and moving, can be found here. 

 

Given the violence of the suppression, it is hardly surprising that no one in China wants to talk about those events now. But it is remarkable observing in the photos how many people were involved in the demonstrations. A lot of the people who (understandably) won’t talk about it now were marching in the streets then.

 

I know from my April visit to Beijing that the Square itself is now full of tourists and aspiring capitalists trying to sell genuine Rolex watches to foreigners, and that the street between the Square and the Forbidden City is now full of tour busses, SUVs, and taxi cabs. And also government officials speeding past in Audi A6s with tinted windows.

`

About the Title of This Post: The title of this post is a reference to a line from Voltaire’s Candide. At that time, England had notoriously executed Admiral John Byng for “failing to do his utmost” during England’s naval defeat at the Battle of Minorca, at the outset of the Seven Year’s War. In Voltaire’s book, the main character, Candide, witnesses the execution in Plymouth, and is told that "in this country, it is good to kill an admiral from time to time, in order to encourage the others." (Dans ce pays-ci, il est bon de tuer de temps en temps un amiral pour encourager les autres).

 

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The U.S. Supreme Court’s blockbuster opinion in Morrison v National Australia Bank has had an enormous impact, resulting as it has in the dismissal of numerous securities suits involving non-U.S. companies that previously would have been permitted to go foward in U.S. courts. But over time it has become clear that the Supreme Court's opinion does not answer every question, which in turn has meant challenges for the lower courts in certain circumstances.  

 

In an interesting June 1, 2012 post on the Dealbook blog entitled “Securities Law Ruling Creates Unintended Problems” (here), Ohio State University law professor Steven Davidoff examines problems that have arisen following Morrison in two specific contexts – domestic ADR transactions and derivatives transactions. Davidoff’s column points out that a couple of appeals now pending in the Second Circuit could have an enormous impact on the reach of U.S. securities to these kinds of transactions. There will be much more to be said on these topics once the Second Circuit has ruled in the pending appeals. Though the pending cases could sort out many of these problems, it is still worth considering the problems Davidoff identified in his column now.

 

Just by way of background and to set the table for discussion of these issues, it is worth briefly reviewing Morrison’s holding. Prior to the Supreme Court’s holding in Morrison, the lower courts, it attempting to determine whether or not a specific transaction was within the jurisdiction of the U.S. securities laws, applied a “conduct and effects” test to determine whether or not there had been sufficient conduct in the United States or whether there were sufficient effects in the United States to support the exercise of jurisdiction under the U.S. securities laws.

 

As Davidoff points out in his column, the Morrison court “took a sledgehammer to decades of case law” and rejected the “conduct and effects” test. Rather, the Morrison court said, the U.S. securities laws apply only to “transactions in securities listed on domestic exchanges and domestic transactions in other securities.” Though a single test, this standard has two prongs, the first of which relates to transactions on U.S. securities exchanges, and the second of which applies to all other transactions. 

 

While the lower courts have applied Morrison aggressively, problems have nevertheless arisen, particularly with respect to the meaning of the second prong. What, after all, is a “domestic transaction in other securities”? As I discussed in a prior post (here), in its March 2012 decision in the Absolute Activist Value Master Fund Limited v. Ficeto case, the Second Circuit took an active step to try to define what makes an off-exchange transaction sufficiently “domestic” for the U.S. securities laws to apply. The court said in order to establish the existence of a domestic transaction in other securities, a plaintiff “must allege facts suggesting that either irrevocable liability was incurred or title transferred within the United States.”

 

Davidoff correctly points out that the Absolute Activist Value Master Fund case could have a significant impact on the Porsche case now pending on appeal in the Second Circuit. (Refer here for background on the Porsche case.)  In the Porsche case, the lower court had dismissed a securities lawsuit brought by numerous hedge funds that entered various swap transactions in the U.S. The lower court had held that because the swap referenced a security traded on a German exchange, they were “the functional equivalent of trading the underlying VW shares on a German exchange.” The Absolute Activist Value Master Fund case suggests that rather than looking where the referenced securities trade, the proper inquiry should be on the swap transactions themselves, and whether or not “irrevocable liability” in the swaps transactions was incurred or title was transferred in the U.S.