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

In their terrific new book "Circle of Greed: The Spectacular Rise and Fall of the Lawyer Who Brought Corporate America to Its Knees," Patrick Dillon and Carl M. Cannon detail the fascinating story of Bill Lerach, who rose to the pinnacle of his profession only to be brought down by criminal wrongdoing. My review of the book appears here.

 

While I was reading it, I began to wonder about the Pulitzer-prize winning journalists who had written the book and what they thought about their subject and their project. I approached them and asked them if they would be willing to answer some questions. To my surprise, they said yes.

 

I have set out below my written Q&A exchange with the authors. The text in italics following the Qs represents my questions, and the text following the As represents their answers.

 

 

Q: Why did you write a book about Bill Lerach?

 

A: He’s a great story, and we’re journalists – it was a natural. Bill Lerach’s life and career is a classic parable. We couldn’t resist.

 

Q: Lerach cooperated with your work on this book. What effect do you think this had? What would you say to any reader who thinks his cooperation meant that you soft- pedaled what you wrote?

 

A: We’d tell them to read the book. We hardly soft-pedal Bill Lerach’s crimes or his rough edges. Bill is on record as telling other journalists that he thought we were tough, but fair. We’ll accept that description. And Bill cooperated without ever so much as asking to see a single word of this manuscript before it was published in its final form. To us, that willingness to let the chips fall as they might demonstrated a gutsy pragmatism and a confidence in his own story that we couldn’t help but admire.

 

Q: You obviously drew on many difference sources in gathering your material for the book. Did you run into any particular problems in trying to gather information?

 

A: Much of the material was in the public record. We found other troves in our own files in our attics and basements as we both had written about Learch earlier in our careers. Most of the lawyers and other key actors were generous with their time. Our big regret is that Lerach’s law partner Melvyn Weiss would not consent to an interview.

 

Q: Your book is rich in anecdote and detail. What do you think was the most interesting thing you found in gathering information?

 

A: Well, Kevin, you’ve read it so you know. Fascinating scenes crop up throughout this narrative—because they did in Bill Lerach’s life. He seemed at times to be a real-life (if very smart) version of Forrest Gump. We hope these tales delight readers as much as they did the authors when we came across them: The preposterous art theft that led to the criminal case against Milberg Weiss; the epic trials pitting Lerach against the Methodist Church and, later, against the entire "Chicago school" of business. Bill doing legal battle with the great Sam Witwer; sweet talking iconic leftist Jerry Voorhis, the congressman defeated by Richard Nixon; Bill funneling money to Bill Clinton and then asking him for a veto; wringing a dramatic apology from John McCain; tangling with New York plaintiff’s lawyer Sean Coffey; cross-examining Roy Disney; jousting with Kirk Kerkorian; readying for holy war against Dick Cheney and Halliburton, suing every Silicon Valley entrepreneur you ever heard of; prevailing in Enron. Writing this book sometimes felt like being on a treasure hunt.

 

Q. Your book reports on Lerach’s question whether his criminal prosecution was in retaliation for his pursuit of claims against Halliburton. What do you make of that idea?

 

A: Readers of the book will see that this simply isn’t true. The criminal investigation of Milberg Weiss and its top partners predates the Halliburton mess, and it was managed by a dedicated civil servant in the Los Angeles U.S. attorney’s office named Richard Robinson who is not only a career prosecutor, but a Democrat. We think Bill makes some of these assertions for dramatic effect. Having said that, what’s that old phrase, "You’re not paranoid if they’re really out to get you." That may apply here. How many individuals in this country found their business practices targeted by the Republican Party’s 1994 "Contract with America"? How many had an act of Congress aimed specifically at them? (The Private Securities Reform Litigation Act of 1995 was dubbed the "Get Lerach Act.".) Bill Lerach didn’t imagine that. Bill also believes that the U.S. Supreme Court went through some strange gyrations to make third-party actors virtually immune from class action securities lawsuits—even when their fraud is massive and manifest. In this contention, Lerach appears to the authors to be on solid footing.

 

Q: While writing this book, you obviously had to become immersed in the world of securities class action litigation. Based on what you have seen, what do you think about this kind of litigation and the way it goes forward in our system? 

 

A: Kevin, as someone who is interested in the other side of this issue—the other side from Bill Lerach, that is—you know the havoc that the old "strike suits" wreaked on entrepreneurs, corporate officers, and the companies that insured them. This was especially true before enactment of the PSLRA, when class action securities cases were filed on no more evidence than a simple dip in a company’s stock price. Even in cases with no merit at all, the cost of settling them was less than the cost of defending them. So a consensus emerged that these lawsuits had become a kind of legalized extortion racket and were an anathema to justice and good business practices. Bill Lerach and Mel Weiss and their imitators came to be seen as glorified shakedown artists. We had covered these issues before writing this book (Carl Cannon covered Washington for the San Jose Mercury News, and Pat Dillon edited Forbes ASAP in Silicon Valley) and we knew this back story. It forms the narrative tension in Circle of Greed.

 

However, as we delved deeply into the rationale for such lawsuits, we couldn’t help but notice some other facets of your question. Here’s one: Although Lerach would allege fraud based on little more evidence than a falling stock price and a few upbeat press releases, he would in the course of his litigation routinely uncover instances of insider trading—the dumping of stock by top company officers immediately before bad news was about to be announced. The authors couldn’t help but be disillusioned by the frequency of this practice. A second point we would make: Once Congress decided that class action securities lawsuits were not the best way to enforce shareholders’ interests (not to mention honest business dealings), it became incumbent on the Securities and Exchange Commission to be ever-more vigilant against fraud. Perhaps this was too big a job for the SEC, but this did not happen. The upshot, as Lerach himself had warned many times, was a tsunami of fraud on Wall Street in the past decade that did great harm to investors and working people alike and which we believe made the current recession much worse for almost all Americans.

 

Q: In your book’s Epilogue, you write that "Bill Lerach was no monster, but he had indeed gone after fraud by using fraud." Do you think that this is just an instance of someone getting corrupted by the system, or was it something innate, something particular to Lerach himself, that drove his willingness to cross the line?

 

A: You mentioned that line in your very thoughtful review of our book, but let’s parse that sentence for a moment: He used fraud to go after fraud. That means there was fraud to begin with, and Bill Lerach would say that this reality—not his legal strategy—was the larger underlying problem. This contention may be self-serving, but it’s worth taking seriously. There was indeed something rotten on Wall Street—and in Silicon Valley—and instead of addressing the way corporate capitalism had been turned into an insiders’ game, Congress, the White House, and the Supreme Court spent their energy reining in the law firms that were rooting out corporate corruption and malfeasance.

 

As for Lerach’s personal motivation in being willing to cross the line into illegality, that seems to entail a complicated set of incentives and impulses. Let’s start with his fierce competitive streak. Like most super-successful trial lawyers, Bill Lerach loves to win and hates to lose. In the law, as in life, that attitude can lead to ethical shortcuts. Also, altruism was certainly a factor as well—a fierce brand of altruism animated by Bill’s populist political views: Lerach was convinced, and remains so, that he was doing good with these lawsuits. Finally, of course, greed was a factor in this epic morality play, just as it was for those on the receiving end of Lerach’s wrath—hence our title.

 

Q: Have you been surprised by the responses your book as received?

 

A: We’ve been pleased so far, although it’s instructive to see how critics and commentators tend to concentrate on passages in the book that bolster their pre-existing views.

 

Q: What do you think the lessons learned or conclusions are from the story you have told in this book?

 

A: We’d mention two: First, politics in this country really is broken. It’s an overly partisan hothouse environment where monetary contributions crowd out the art of compromise, and where the merits of any given issue give way to a desire to reward your allies and punish your rivals. Second, in the heat of his three-decade war of attrition with corporate officers and directors Bill Lerach ultimately began to resemble his adversaries—the ones he detested the most. There’s a lesson here for all of us in this, and it’s the line that precedes the one you mentioned about monsters. It’s from Friedrich Nietzsche, who put it this way: "Whoever fights with monsters should see to it that he does not become one himself."

 

The D&O Diary would like to express its deep gratitude to the authors’ willingness to answer our questions. We hasten to add that everyone who has read this far really should definitely read the book.

 

Speakers’ Corner: On Tuesday, March 16, 2010, I will be speaking at the C5 D&O Liability Insurance Forum in London. I will be speaking on a panel with my good friend John McCarrick of the Edwards Angell law firm on the topic "What are the Risks to European D&O Insurers from Class and Derivative Actions in the U.S." Information regarding the event can be found here.

　

 

　

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For those of us who spend a lot of time looking at securities class action lawsuits, the cases often have a familiar pattern. Unfortunately, the familiarity may dull sensitivity to the allegations or even to the process itself. So it was interesting to read a layman’s reaction to a recently filed lawsuit, if for no other reason than it provided a look at the lawsuit and the process with a fresh set of eyes.

 

The lawsuit in question was filed in the Northern District of California on March 9, 2010 against Medivation and certain of its directors and offices. As is so often is the case in these kinds of lawsuits, Medivation is a life sciences company whose developmental stage product failed to meet certain clinical trial goals. Specifically, and as reflected in the plaintiffs’ lawyers March 9 press release (here), its product did not meet primary and secondary goals in a Phase 3 clinical trial for patients with mild to moderate Alzheimer’s disease. When the company announced this news, its stock price declined and the lawsuit followed. A copy of the complaint can be found here.

 

This lawsuit will work its way through the system. The lawyers involved, all of whom undoubtedly are (or when they are retained to defend will be) well versed in these things, and will raise familiar arguments that may or may not succeed. All very familiar to those of us who spend all of our time immersed in these kinds of things.

 

An interesting perspective about this lawsuit appeared on the Blogging Stocks site (here). The author, Gary E. Sattler, has a number of reactions to the plaintiffs’ complaint, summarizing his comments with the observation that "even when given my usually cynical nature, and my usual dislike for big pharmaceutical interests, I still take issue with this potential class action lawsuit."

 

After summarizing the plaintiffs’ allegations, the author notes that

 

The plaintiff class has to cross a significant threshold of proof in order to prevail in this case. Based on my reading of the original complaint, plaintiffs fail to establish intent, fail to reveal purposeful omission of fact, and fail to establish that the actions of the defendants were the true overt cause of any artificial inflation of Medivation's stock value. Furthermore, the plaintiff's complaint seems to disregard that Medivation has had broad yet cautious support from within the Alzheimer's treatment community. Was it all wishful thinking? Perhaps it was, but that support came from many well-educated minds experienced in the field.

 

Sattler goes on to note that "to me, this potential class action smacks of sour grapes." He then reiterates his support for the company and for the company’s Alzheimer’s product.

 

Sattler seems to be reasonably objective (he states that he has no investment interest in the company). Of course, his rough and ready assessments have no direct relationship to how the lawsuit and its allegations might fare in court. But I have often found that the court of public opinion is an accurate sounding board. True, it might be argued that because of Sattler’s preexisting interest in the company and in its product he might be biased in its favor. But just the same it is interesting to look at the allegations through his eyes and see his reaction to the allegations.

 

When the U.S. Supreme Court first issued its opinion in Tellabs, I thought it would make little fundamental difference, because I thought that in the end and regardless of the formal standard, courts would give the green light to cases that raised a stink and would cut short the rest. Regardless of whether I am right about the Tellabs standard, I think trial courts fundamentally assess cases on a smell test, which is basically what Sattler has done in his post, albeit without specific reference to legal standards. Viewed in that light, his rough and ready assessment is interesting. And perhaps significant, at least with respect to the case’s prospects.

 

More About the FCPA: Regular readers know that I have a certain fixation about the Foreign Corrupt Practices Act. (Indeed, one reader has gone so far as to accuse me of being "obsessive" about it.) I continue to believe that the FCPA will be an increasingly important corporate exposure in the years ahead, if for no other reason than the relentless globalization of commerce.

 

For those who remain skeptical on the topic, I suggest a quick review of the March 10, 2010 post by Bruce Carton on his Securities Docket blog (here). In his post, Carton painstakingly compiles all of the recent comments by regulators corroborating that the FCPA is a top priority. He also reviews the significance of the recent Africa Sting enforcement action, as well as the implications of the Bribery Bill which may soon become law in the U.K. As Bruce’s emphasizes, there are a number of very significant implications to the Bribery Bill.

 

As Carton puts it, top FCPA lawyers agree that the anti-bribery activity has reached "a fever pitch." Whether or not I am obsessive, it is indisputably clear that FCPA related enforcement activity will be a significant area of corporate exposure in the months and years ahead.

 

A Picture is Worth a Thousand Words: Want to know what the financial crisis is all about? Check out this graphic depicting the escalating mortgage default rate during the current crisis. No interpretation required. As for myself, I am considering investing in gold. And stocking my basement with water, canned goods, matches, stout rope and a knife. You never know.

 

This Too Shall Pass: You are probably familiar with the OK Go video performed on an array of treadmills. If not, you should get out more. I’ve seen it and I have serious social issues. (See prior item). However, and in any event, everyone should watch the new video from OK Go for its new song, "This Too Shall Pass." Rube Goldberg would be impressed. Smashing pianos, crashing trash cans, smashing TV sets (showing the treadmill video, no less), the whole enchilada.

 

Though I have embedded the Rube Goldberg version below, there is an alternative spoof marching band version here that is also funny in a completely different way. (Don’t you love the Internet?) Please also see the Author's Note below.

　

Authors’ Note: This blog post was written in its entirety on a laptop computer while the author was sitting in Cladgagh Irish Pub in Lyndhurst, Ohio and watching Real Madrid play Lyon in a UEFA Champions League game on the television. (In an excellent game, the teams played to a 1-1 tie.)  I hope you enjoy reading this post as much as I enjoyed writing it. Gradus ad Parnassum.

 

　

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The SEC first acquired the right to impose civil penalties against corporations in the Securities Enforcement Remedies and Penny Stock Reform Act of 1990. Since the Remedies Act was enacted, the SEC has struggled with the question of when it is appropriate to obtain money penalties from corporate issuers.

 

In January 2006, in order to put some clarity around the issue of corporate penalties, the SEC issued its Statement of the Securities and Exchange Commission Concerning Financial Penalties (here). More recently, the sharp questions of a prominent federal judge have put a harsh spotlight on the SEC’s practices regarding corporate money penalties. In light of these questions, it is hardly surprising that the SEC might feel compelled to reexamine its practices for the imposition of penalties on corporations.

 

In a recent speech, current SEC Commissioner Luis Aguilar has proposed revising the guidelines in order to put the "appropriate focus" on the issue of deterrence. However, for reasons discussed below, I question whether Commissioner Aguilar’s position is necessarily the best approach to accomplish the desired goals.

 

Background

In the 2006 Statement, and after reviewing the legislative history of the Remedies Act, the SEC articulated a standard whereby the question of the appropriateness of a corporate penalty turns on two considerations: "the presence or absence of a direct benefit to the corporation as a result of the violation," and "the degree to which the penalty will recompense or further harm the insured shareholders." The Commission also identified seven additional factors that are also "properly considered," including "the need to deter the particular type of offense."

 

In a February 6, 2010 speech (here), SEC Commission Luis Aguilar characterized the 2006 Statement as a "misguided approach." The "serious flaw" in the Statement’s approach, he said, is that "the conduct itself becomes of secondary importance." Aguilar contends that the Commission "fails to appropriately focus on deterrence." He called the Commission to promptly revisit the 2006 guidelines go that penalties are refocused on their "purpose," which is to "deter and punish misconduct."

 

A March 6, 2010 Wall Street Journal article further discussing Aguilar’s views can be found here.

 

Discussion

In the current environment, Aguilar’s desire to focus the Commission’s enforcement efforts on the deterrence of future misconduct is both appropriate and commendable. However, that does not necessarily mean that the imposition of penalties on corporations is the appropriate means to that goal or even that the 2006 Statement needs to be revisited.

 

First, upon review of the 2006 Statement, it is clear that in devising the current guidelines, the Commission took significant pains to consider and to try to implement the considerations expressed in the legislative history of the Remedies Act, particularly the relevant Committee Report. Whatever Aguilar’s views may be, the current guidelines track the sentiments expressed in the Committee Report.

 

The second problem with Aguilar’s view is that, at least as expressed in his recent speech, it appears that his proposed approach simply disregards the fundamental problem with corporate penalties, which is that in many instances the penalties inappropriately harm the company’s current shareholders.

 

In that respect, the timing of Aguilar’s speech advocating the use of corporate penalties for deterrence purposes is more than a little odd, coming as it does so closely on the heels of Southern District of New York Judge Jed Rakoff’s highly publicized questions of the proposed settlement of the SEC’s enforcement action against the Bank of America.

 

Readers will recall that in his blistering September 14, 2009 opinion (here), Judge Rakoff rejected the SEC’s proposed $33 million settlement, on among other grounds that the proposed settlement "does not comport with the most elementary notions of justice and morality" because it "proposes that shareholders who were the victims of the Bank’s alleged misconduct now pay the penalty for the misconduct."

 

In response to the SEC’s argument that the proposed settlement "sends a strong signal" and "allows shareholders to better assess the quality and performance of management," Judge Rakoff said that

 

the notion that Bank of America shareholders, having been lied to blatantly in connection with the multi-billion dollar purchase of a huge, nearly bankrupt company, need to lose another $33 million of their money in order to "better assess the quality and performance of management" is absurd.

 

Judge Rakoff did subsequently approve a $150 settlement of the SEC enforcement action, but essentially as an act of judicial restraint and only while the Court was "shaking its head." Rakoff called the settlement "half-baked justice at best."

 

Judge Rakoff’s strong words seemingly challenge the very idea of corporate penalties, both because of the burden they impose on corporate shareholders and because the disconnect between penalties and the possibility of deterrence. In the immediate aftermath of the questions surrounding the BofA settlement, Aguilar’s advocacy of corporate penalties as a way to achieve deterrence seems both off-key and tone deaf.

 

We can all agree, as Aguilar proposes, that misconduct should be punished and deterred. However, it does not follow that the imposition of corporate cash penalties is the best or even a potentially well-calibrated means to try to achieve those goals. Indeed, as Judge Rakoff’s comments suggest, the problem with corporate penalties is that both the punishment and the putative deterrence are misdirected. Indeed, the notion that penalties paid out of the assets of one corporation will deter future misconduct by another corporation seems both abstract and unpersuasive.

 

Viewed in this light, the principles articulated in the Committee Report accompanying the Remedies Act, as implemented in the 2006 Statement, arguably represent an appropriate balancing of the considerations that should be taken into account in connection with the imposition of corporate penalties – including in particular the question whether the proposed corporate penalty "will recompense or further harm the injured shareholders."

 

My further concern about Aguilar’s initiative to try to ramp up corporate penalties is that his proposal arises at a time when the SEC is desperate to reestablish its regulatory credentials. One danger is that in its eagerness to look tough that SEC might try to extract enormous penalties from corporate treasuries while accomplishing little except the addition of unnecessary and unwarranted costs on beleaguered companies and their long-suffering shareholders (which is in fact the very thing that troubled Judge Rakoff).

 

The bottom line for me is that in the wake of the pointed questions that Judge Rakoff raised in the BofA enforcement action, this is a very odd time for any SEC Commissioner to be advocating increased corporate penalties as a likely or even promising way for the SEC to best accomplish its goals.

 

Just Visiting this Planet: In her latest email epistle, our globetrotting eldest daughter, now working in Quito for a nonprofit organization, passed along the following observation about a recent therapy session for refugee women she attended:

 

I was oddly reminded of the time at the neighborhood barbeque in Hokkaido with the inebriated  Japanese grandpas who wanted to sing Billy Joel. Totally unrelated to Spanish-speaking refugee women discussing how being a refugee increased their stress and messed up their female biorhythms. I think I drew the connection in my mind because of the "where on earth have I ended up" feeling I had both times.

　

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In a ruling that may have potential significance for the many claims that have been filed against the rating agencies in the subprime litigation wave, on February 17, 2010, Southern District of New York Judge Lewis Kaplan dismissed all but one of the claims that had been filed against the individual defendants in the Lehman Brothers Mortgage-Backed Securities Litigation. A copy of Judge Kaplan’s February 17 order can be found here.

 

Background

Plaintiffs had purchased the mortgage back securities that Lehman Brothers issued in August 2005 and August 2006. The plaintiffs allege that the originators of the loans that backed the securities failed to comply with the general loan underwriting guidelines described in the offering documents. The plaintiffs allege that the offering documents had failed to disclose that the rating agencies, which were paid for providing their ratings, had conflicts of interest and had been involved in helping to structure the securities. The plaintiffs also allege that the offering documents failed to disclose that the credit enhancements supporting the loans were insufficient to support the investment ratings the rating agencies gave the securities.

 

The individual defendants in the case are the officers and directors of the Structured Asset Securities Corporation, which issued the registration statements and acted as depositor in the securitization process. The individual defendants moved to dismiss.

 

As noted in prior posts, Judge Kaplan has previously dismissed plaintiffs’ claims against the rating agencies themselves (refer here), rejecting plaintiffs’ arguments that the rating agencies were "underwriters" under the ’33 Act. Judge Kaplan also previously dismissed the separate ERISA class action claims (refer here, scroll down). In his February 17 decision, Judge Kaplan separately ruled on the individual defendants’ motion to dismiss.

 

The February 17 Decision

Judge Kaplan held that the plaintiffs’ allegations that the offering documents failed to disclose the rating agencies’ conflict of interest were insufficient to state a claim, for two reasons.

 

First, Judge Kaplan held that the Securities Act does not require disclosures of "that which is publicly known," and "the risk that the rating agencies operated under a conflict of interest because they were paid by the issuers had been known publicly for years."

 

Judge Kaplan then went on to hold that "the rating agencies’ role in structuring the certificates is not material as a matter of law." His conclusion is based on the following analysis:

 

If the fee arrangement undermined an investor’s confidence in the rating agencies’ independence, a disclosure that a rating agency was involved in structuring the Certificates prior to rating them would have added nothing important to the "total mix" of information. If, on the other hand, an investor trusted the ratings agencies to give an honest opinion notwithstanding the fact that they were paid by the issuer, the fact that they were involved in structuring the Certificates, assuming that they were, likewise would have been unimportant. In consequence, these claims are insufficient.

 

With respect to the plaintiffs’ allegations that the offering documents contained misrepresentations about the amount and form of credit enhancement, Judge Kaplan held that the statement about the credit enhancement was a "statement of opinion," which could be actionable only if the complaint alleged that the rating agencies did not actually hold that opinion.

 

Judge Kaplan found that "at best" the complaint’s allegations "support an inference that some employees believed the rating agencies could have used methods that better would have informed their opinions," which he held to be insufficient to state a claim.

 

But Judge Kaplan did hold that the complaint’s allegations that the loan originators "systematically failed to follow the underwriting guidelines" were "sufficient at this stage to support a reasonable inference that the offering documents’ description of the underwriting guidelines was materially misleading."

 

Accordingly, Judge Kaplan granted the individual defendants’ motion to dismiss all of the claims against them except plaintiffs’ Section 11 claims about the loan originators’ supposed departures from underwriting standards.

 

Discussion

Even though Judge Kaplan’s February 17 opinion was issued in connection with claims asserted against the individual defendants and not in connection with claims asserted against the rating agencies themselves, the opinion nevertheless potentially could be of great significance in other subprime mortgage-related cases in which claims have been raised against the rating agencies.

 

In particular, Judge Kaplan’s holding that the offering documents’ omissions about the rating agencies’ alleged conflicts of interest and role in structuring the securities were not legally actionable may be of particular significance.

 

In many of the other cases in which claims have been asserted against the rating agencies, the claimants have, like the plaintiffs in the Lehman case, alleged that the rating agencies had undisclosed conflicts of interest and were involved in structuring the investments at issue. The rating agencies will undoubtedly find Judge Kaplan’s holding that the alleged omission of this information is not legally actionable to be helpful.

 

Judge Kaplan did not reach the question whether or not the rating agencies’ ratings are protected by the First Amendment, which is another defense on which the rating agencies will attempt to rely. But if the alleged omissions about the rating agencies are not actionable in the first place, there may never be a need to reach the First Amendment issues.

 

Judge Kaplan conclusion that the disclosures concerning the securities’ credit enhancements represented opinion rather than statements of fact is also instructive, even without getting into the First Amendment issues. As his February 17 decision states, statements of opinion are actionable only if the allegations show that the opinions were not actually as disclosed. Again, Judge Kaplan’s rulings are instructive and potentially significant as they suggest ways in which the claims against the rating agencies may be considered without even getting into the First Amendment issues.

 

Finally, Judge Kaplan’s holding that the rating agencies’ alleged conflicts of interest and involvement in the securitization transaction are immaterial does raise interesting questions about claimants’ ability to overcome the rating agencies’ First Amendment defenses. The plaintiffs have argued that the rating agencies were not entitled to rely on the First Amendment defense in the context of these kinds of structured investments because of the conflicts of interest and involvement in the transaction. Perhaps Judge Kaplan’s rulings are unrelated to these issues, but it does seem incongruous that considerations that are immaterial would be sufficient to overcome a constitutional defense.

 

Of course, it is entirely possible that other courts may not be persuaded by Judge Kaplan’s analysis. It is not intuitively obvious that, because it was public knowledge that rating agencies had conflicts, the rating agencies’ involvement in the transactions is legally immaterial. Indeed, the jump between the public knowledge of the conflict of interest and the immateriality of the rating agencies’ involvement in the transactions is frankly unsatisfying. Other courts might well be unwilling to make that analytic jump.

 

I have in any event added Judge Kaplan’s February 17 opinion to my table of subprime-related lawsuit motion to dismiss rulings, which can be accessed here. Because a portion of the claims against the individual defendants survived the dismissal motion, I have listed the ruling in the table of dismissal motion denials.

 

Special thanks to a loyal reader for sending a copy of Judge Kaplan's February 17 opinion.

　　

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In an interesting February 11, 2010 decision (here), Southern District of New York Judge Victor Marrero allowed plaintiffs, whose subprime-related securities class action lawsuit Marrero had previously dismissed, leave to file a second amended complaint against Credit Suisse Global and certain of its directors and officers.

 

Judge Marrero also found the securities fraud allegations in the proposed amended complaint to be legally sufficient, meaning that the claims can now go forward, although he also ruled that the court lacked jurisdiction over the claims of plaintiffs that resided outside the U.S. and that had purchased their shares outside the U.S.

 

Background

Credit Suisse is domiciled in Switzerland. Its shares trade on several securities exchanges outside the U.S. and its ADRs trade on the NYSE. As reported in greater detail here, the plaintiffs filed their initial complaint in this action in April 2008. The plaintiffs alleged that the defendants had made material misrepresentations about the company’s asset valuation system, its internal controls (which allegedly allowed unauthorized placement of high risk mortgage-backed assets in client accounts), and its own exposure to losses related to subprime mortgages.

 

In an October 5, 2009 order (here), Judge Marrero had previously granted the defendants’ motion to dismiss, on the grounds that the court lacked subject matter jurisdiction over the claims of claimants who reside outside the U.S. and who had purchased their shares on foreign exchanges (so-called f-cubed claimants). The complaint had not identified the domicile of some other named plaintiffs, but Judge Marrero dismissed their claims as well.

 

In his prior ruling he required plaintiffs to seek leave to file an amended complaint, which the plaintiffs did. His February 11 opinion addressed the plaintiffs’ motion for leave to file an amended complaint.

 

The February 11 Opinion

In his February 11 decision, Judge Marrero granted the plaintiffs’ motion for leave to file their amended complaint, at least as to certain of the claimants.

 

Judge Marrero first found that the amended complaint failed to establish subject matter jurisdiction as to the foreign domiciled claimants that had purchased their shares on foreign exchanges. In reliance on the Second Circuit’s National Australia Bank standard (about which refer here), he found that because the alleged misrepresentations had originated in Switzerland, there was insufficient U.S.-based conduct to support the court’s exercise of subject matter jurisdiction over the claims of the non-U.S. claimants.

 

However, Judge Marrero found that the amended complaint contained sufficient allegations to permit the exercise of jurisdiction as to the claims of the U.S.-based claimants. The amended complaint alleged that more than 75 million Credit Suisse shares were held by institutional investors, representing over 11% of shares outstanding, and therefore there were sufficient "effect" alleged within the U.S. to support jurisdiction.

 

Judge Marrero then proceeded to determine that the plaintiffs’ securities fraud allegations were legally sufficient. Among other thing, he found that though the proposed amended complaint "contains much extraneous detail and irrelevant information," within the "remaining core of what is pertinent" the plaintiffs’ proposed complaint "sufficiently alleges scienter."

 

The proposed complaint relies heavily on confidential witness statements, from which Judge Marrero determined that the proposed complaint "alleges sufficient facts showing that the Defendants had direct knowledge of information contradicting their public statements or access to similar statements they should have monitored." Judge Marrero concluded that the proposed complaint properly pled scienter to support theories of fraud based on alleged schemes to "overvalue assets, underestimate risk, hide subprime exposure, ignored weaknesses of [the company’] risk management and internal controls, and violate GAAP."

 

Discussion

As a result of Judge Marrero’s February 11 ruling, the Credit Suisse Group subprime-related securities case, which had initially been dismissed, will now go forward. The Credit Suisse case is the latest in a series of subprime-related securities suits in which dismissal motions were initially granted, but in which the amended complaints later survived renewed dismissal motions. This list of cases in this series includes the PMI Group case (here), the Washington Mutual case (here), and the BankAtlantic Bancorp case (here).

 

The ability of the plaintiffs in these cases to cure initial pleading deficiencies and to overcome preliminary pleading hurdles is noteworthy. Among other things, it casts important light on the list of subprime-related securities cases in which motions to dismiss have been granted. Many of these dismissals are without prejudice, meaning that the plaintiffs in a number of these cases, like the plaintiffs in the Credit Suisse case, may yet find a way to survive renewed dismissal motions and live for another day.

 

The outcomes of many of the dismissal motion rulings (at least to this point) the subprime-related securities cases could possible be interpreted to suggest that the cases were not faring particularly well. As reflected in my table of subprime-related lawsuit dismissal motion rulings, which can be accessed here, of the 48 subprime-related securities lawsuits in which dismissal motion rulings had been entered, fully 31, or nearly 65%, had resulted in the dismissal motions being granted, a dismissal rate the far exceeds typical patterns.

 

However, in 16 of the 31 cases, the dismissals were without prejudice. Many of the cases in which dismissal motion motions have been granted may yet survive renewed dismissal motions.

 

In any event, there still have only been dismissal motion rulings in about 27% of the subprime and credit crisis-related securities suits. The dismissal motions have not yet heard in nearly three quarters of the subprime and credit crisis-related securities suits. Though the subprime litigation wave first started in February 2007 and is now entering its fourth year, it still has a very long way to run. And many cases yet to be heard and other cases surviving renewed motions to dismiss, it is far too early to try to say one way or the other that cases are or are not faring well.

 

The fact that the Credit Suisse claims involve a foreign-domiciled corporate defendant is also noteworthy. Many of the subprime-related securities cases involve non-U.S. companies. the Credit Suisse case show that in at least some of these cases against foreign companies, the plaintiffs will succeed in establishing jurisdiction, even if the allegedly misleading statements originated outside the U.S., although in those cases the claims of foreign domiciled investors who purchased their shares on foreign exchanges may or may be allowed to continue.

 

Many thanks to a loyal reader for sending me a copy of the Credit Suisse decision.

 

Speaking of Jurisdiction Over Foreign-Domiciled Companies: One of the ways in which companies domiciled outside the United States can, in at least some kinds of cases, seek to avoid the burden and risk of defending litigation in the United States is by asserting the principle of forum non conveniens. This judicial tenet allows a court to defer jurisdiction where principles of justice and convenience favor the action being brought in another forum.

 

A February 2010 memo by the Sherman & Sterling law firm (here) discusses this principle and analyzes its recent application in the Cadbury Shareholder Litigation, a purported derivative class action that had been filed in connection with Kraft Foods hostile takeover bid. The action was brought in New Jersey federal court though Cadbury is a U.K. company, U.K law governs the Board’s conduct, and none of the parties resided in New Jersey.

 

In the Cadbury case, the court granted the defendants’ motion to dismiss on forum non conveniens grounds, determining among other things that the U.K. was an adequate alternative forum and that the plaintiffs’ choice of forum was entitled to little deference. The court also found that the differences between U.K. and U.S. takeover law did not detract from the availability of an adequate alternative forum in the U.K.

 

The principles of forum non conveniens could provide a substantial defense in other derivative litigation involving foreign domiciled companies. It is less likely to be relevant in class action cases alleging violations of the U.S. securities laws, as the availability of an adequate alternative forum may be far less likely given the absence in many jurisdictions of adequate alternatives to the remedies available under the U.S. securities laws.

 

In any event, the recent decision in the Cadbury case represents yet another case in which U.S. courts have sought to determine the circumstances under which it is and is not appropriate for U.S. courts to exercise jurisdiction over foreign-domiciled companies.

 

Bankruptcy Court Did Not Abuse Discretion in Granted Relief From Automatic Stay Allowing D&O Insurer to Reimburse Individual’s Defense Expenses: In an opinion filed on January 29, 2010 (here), the Ninth Circuit Bankruptcy Appellate Panel held that the bankruptcy court did not abuse its discretion in granting relief from the automatic stay in bankruptcy to allow the company’s D&O insurer to advance an individual insured’s legal expenses.

 

Layne Sapp had been the sole director, chief executive officer and majority shareolder of MILA, Inc., a mortgage brokerage firm. The company had a $1 million D&O insurance policy. The company filed for bankruptcy and the trustee initiated an adversary proceeding against Sapp alleging a number of claims. Sapp incurred legal costs defending himself. The D&O carrier agreed to advance his defense expenses if Sapp obtained a comfort order stating that the Insurer was not violating the automatic stay by making the payments.

 

Sapp filed a request for relief from the automatic stay to allow the D&O insurer to pay his defense expense. The trustee opposed the motion on the ground arguing that the policy proceeds were estate property and that payment of Sapp’s defense expense would deplete the limits. (Oddly and unusually, MILA’s D&O policy did not have so-called entity coverage, so the Trustee’s assertions of the estate’s rights to the policy proceeds were limited to the company’s reimbursement coverage under Side B of the policy).

 

The bankruptcy court granted Sapp’s request and the Trustee appealed.

 

The appellate panel held that the bankruptcy court had not abused its discretion in granting relief from the stay. The appellate panel found that the bankruptcy court had appropriately weighed the parties’ respective harms and determined that Sapp had shown the requisite case for relief.

 

The debate about the right to D&O insurance policy proceeds in the bankruptcy context is a long-standing and sometimes vexatious issue. A good summary of the principles involved can be found in a 2006 memo by Wiley Rein’s Kim Melvin, here.

 

And Finally: A surprising number of people manage to figure this one out on their own without even requiring instruction -- "How to Suck at Facebook" (here).

　

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One of the most distinctive attributes of the 2009 securities class action lawsuit filings was the prevalence, particularly in the second half of the year, of new lawsuits in which the filing date came well after the date of the proposed class period cutoff. There has been much discussion over the cause of the belated filings. But whatever the reason may be for these filings, the phenomenon clearly has carried over into 2010, and at least so far seems to be a significant feature of the 2010 securities lawsuit filings.

 

The two new securities class action lawsuits filed on Friday, February 5, 2010 both represent this distinct class of cases.

 

First, as reflected in their press release (here), on February 5, plaintiffs’ lawyers filed a securities class action lawsuit in the Southern District of New York against Nokia and certain of its directors and officers, alleging that the defendants had misled the company’s ADR investors about delays and price competition the company was experiencing with respect to its communications handsets. Though the complaint (which can be found here) was not filed until February 5, 2010, the proposed class period cutoff date is September 5, 2008, well nearly a year and a half before the filing date.

 

Second, as reflected in their press release (here), on February 5, a different set of plaintiffs’ attorneys filed a securities class action lawsuit in the Southern District of New York against the Bermuda-based workers’ compensation insurer CRM Holdings, Ltd., and certain of its directors and officers, relating the company’s pricing and reserving practices. Though the complaint (which can be found here) was not filed until February 5, 2010, the proposed class period cutoff date is November 5, 2008, over a year before the filing date.

 

These latest lawsuit follow along behind two other seemingly belated lawsuits already filed this year. The proposed class period cutoff date in the securities class action lawsuit filed on January 15, 2010 against medical device company Stryker Corporation is November 13, 2008, over a year before the filing date.

 

The most extreme example among the belated 2010 filings is the securities class action lawsuit filed on January 21, 2010 against Motorola. The January 22, 2008 class period cutoff date is a full 1 year and 365 days before the filing date, bringing the new lawsuit just inside the two year statute of limitations for actions under the ’34 Act.

 

In addition to their apparent belatedness, these filings also have a number of other attributes. Most particularly, none of these cases seem related to the subprime meltdown and global credit crisis. Even though CRM holdings is in the financial services industry, the allegations in that case do not appear to related to the economic crisis.

 

To that extent at least, then, the belated securities lawsuit filings seem consistent with the theory, which some plaintiffs lawyers have advanced (as discussed here), that the reason for these lag filings is that throughout most of the last three years, the plaintiffs’ firms were preoccupied with filing subprime and credit crisis cases. Now that that filing wave has died down the plaintiffs firm, by their account, are turning back to cases that they backburnered.

 

The other theory about these belated cases, advanced most notably by Professor Joseph Grundfest (refer here), is that the plaintiffs’ lawyers are running out of meritorious cases so they are scraping the bottom of the barrel (my words, not his) to file cases that, based on his analysis of past lawsuit filings, are statistically more likely to be dismissed.

 

I don’t know for sure why these cases have been filed belatedly. All I can say is that it is a very distinct and observable pattern that clearly has carried over into the New Year. Among other things, these filing patterns create challenges for D&O underwriters, who will face a great deal of uncertainty about when a company that has experienced past issues may be "out of the woods." To borrow an auto racing analogy, it as if a yellow flag has been raised for all the cars on the track – proceed with caution.

 

One final note about these belated filings so far in 2010 is that at least the Nokia and the CRM holdings cases involve foreign domiciled companies – they are based in Finland and Bermuda respectively. The susceptibility of non-U.S. companies to securities litigation in U.S. courts is a hot topic right now, with the National Australia Bank pending before the U.S. Supreme Court and with the Vivendi jury verdict having just been returned. These latest lawsuits suggest that the incidence of U.S. securities lawsuits against non-U.S. companies will remain a hot button issue for the foreseeable future.

 

Fifth Circuit Stays Ruling that Stanford Group’s D&O Insurers Must Pay Defense Fees: As I noted in an earlier post (here), on January 26, 2010, Southern District of Texas David Hittner had ordered Stanford Financial Group’s D&O liability insurers to pay the defense expenses that former Stanford officers (including Allen Stanford) are incurring in connection with various legal matters arising out of the Stanford scandal.

 

However, according to a February 4, 2010 Houston Chronicle article (here), the Fifth Circuit Court of Appeals has entered a stay of Judge Hittner’s ruling. The article also reported that the Fifth Circuit has schedule oral argument on the legal issues in the case for February 25, 2010.

 

So the story goes on, with out any greater clarity on the question whether or not the individuals are entitled to have their defense fees paid by the company’s D&O insurance carriers. High-profile financial scandals make for some high stakes (and therefore fiercely litigated) coverage issues.

 

Hat tip to the Securities Docket (here) for the link to the Chronicle article

　

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In a flurry of headline-grabbing events involving Bank of America last Thursday, the SEC announced the renewed settlement of its enforcement suit against the company, while at the same time New York Attorney General Andrew Cuomo announced his office’s initiation of a separate fraud action against the company and two former company officials. These high-profile developments pose a series of questions, not the least of which are the questions concerning the claims raised -- or not raised -- against the company officials, which in turn underscore some basic issues concerning the liability of individuals under the federal securities laws.

 

The first and most fundamental question is whether Southern District of New York Jed Rakoff will approve the current $150 million settlement, after previously rejecting the prior $33 million deal.

 

In his harshly worded September 14, 2009 opinion (here), Judge Rakoff rejected the prior settlement, finding that it was "neither fair, nor reasonable, nor adequate." He challenged the very premise of the deal, which he said "proposes that shareholders who were the victims of the Bank’s alleged misconduct must now pay the penalty for the misconduct."

 

Judge Rakoff further criticized the deal because the SEC did not explain why "it did not pursue charges against the Bank management or the lawyers who allegedly were responsible for the false and misleading proxy statements."

 

As Susan Beck of the AmLaw Litigation Daily points out in her February 4, 2010 article about the settlement (here, registration required), the renewed settlement seemingly does not address either of Judge Rakoff’s principal concerns. That is, the company is still proposing to settle the case at the expense of current shareholders. And the settlement does not address Rakoff’s earlier criticism of the SEC for failing to hold any individuals accountable.

 

Along the same lines, the WSJ.com Law Blog quotes (here) Duke Law Professor James Cox as saying "Either I’m hopelessly ignorant or this doesn’t address Rakoff’s concerns at all. Maybe they think Rakoff is getting senile in his old age. But I wouldn’t count on that."

 

The lack of SEC action against individual company officials is all the more evident because of the separate action the NYAG initiated virtually simultaneously with the SEC’s announcement of the renewed settlement. Cuomo’s lawsuit (here) not only names the company, but also names as defendants former BofA CEO Ken Lewis and former CFO Joseph Price. The New York action seemingly begs the question of why the SEC did not pursue claims against individuals, especially in light of Rakoff’s concerns.

 

There are some important considerations that need to be taken into account in contrasting the SEC’s and the NYAG’s respective actions. First of all, the SEC has said all along that the reason it did not pursue enforcement claims against individuals is because of concerns with its ability to satisfy scienter requirements. Indeed, in his September 14 opinion, Judge Rakoff expressly noted that the SEC had contended at that time that it had not pursued claims against individuals as "culpable intent was lacking because the lawyers made all the relevant decisions."

 

Thought the NYAG’s action asserts claims against two former executives, the legal basis of the claim is New York’s Martin Act. Unlike the liability provisions of the federal securities laws, the Martin Act does not require a finding that the individuals acted intentionally. The NYAG’s claims simply do not face the same pleading barriers as the SEC would if it were to pursue claims under the federal securities laws against company executives.

 

The challenge in substantiating claims under the federal securities laws against senior company officials even when their company was engaged in fraudulent misconduct was underscored in the recent Vivendi securities class action trial, where the jury found the company liable on all 57 counts, yet at the same time found the individual defendants not liable. In a post trial interview (here), the individual defendants’ trial counsel explained that this seemingly split verdict can be understood in part by the fact that the jury (defense counsel contend) was persuaded by the individuals’ testimony that they had not intended to mislead anyone.

 

The SEC’s reluctance to pursue the BofA executives and the odd split verdict in the Vivendi trial raise some interesting questions to ponder about the susceptibility of individuals to the imposition of liability under the federal securities law, although the lack of traction against the individual executives in those two cases may simply be a reflection of situation specific circumstances.

 

But in any event, the seeming contradiction between the SEC’s inaction against any individuals and the NYAG’s pursuit of the two executives may not be quite as first appears. Among other things, the SEC settlement and the NYAG’s lawsuit announcement were not in isolation from each other. To the contrary, Cuomo’s press release expressly references the SEC’s settlement and quotes him as saying that he support the SEC’s settlement.

 

The suggestion is that the two developments should not be viewed as in disjunction but rather as complementary. Perhaps the SEC will refer to the NYAG’s suit in response to Rakoff’s likely concerns with the settlement about the SEC’s inaction against individuals.

 

The most important differences between the SEC’s renewed settlement and the earlier version Rakoff rejected are that the latest deal represents significantly larger dollar amounts, and it also includes the company’s agreement to adopt certain corporate governance reforms.

 

The governance reforms arguably provide real value to the current shareholders. But even if the value to shareholders is substantial, the renewed deal still does not avoid Judge Rakoff’s earlier concerns that BofA’s shareholders are being forced to bear the cost for having been misled about the Merrill Lynch transaction. Indeed, the significantly larger dollar value of the renewed settlement seemingly exacerbates this very problem.

 

Given these concerns, it will be very interesting to see what Judge Rakoff does with the renewed settlement. It is very hard to read his September 14 opinion now and to think that this renewed settlement will fare any better than the prior version. It will be particularly interesting to see what Judge Rakoff’s response says about the fundamental notion of holding individuals accountable under the federal securities laws.

 

Broc Romanek’s post about the SEC’s renewed settlement on his CorporateCounsel.net blog (here) has some interesting observations about the role of corporate governance reforms within the resolution of SEC enforcement actions.

 

"Bump-Up" Claims Surge: Much ink has been spilled concerning the supposed decline in the number of securities class action lawsuit filings in 2009. But whether or not the class suits are in fact declining, another form of corporate litigation apparently is on the rise.

 

According to a February 4, 2010 Law.com article (here), there has been an "uptick in shareholder lawsuits over mergers and acquisitions." One source quoted in the article states that filings of those types of claims – referred to as "bump up" actions because they seek to increase the sale price – are up "at least 50 percent" over a few years ago.

 

The article also quotes Boris Feldman of the Wilson Sonsini law firm as saying that "plaintiffs lawyers are trying to replenish their inventory, because traditional securities suits have fallen." He goes on to say that "nature abhors a vacuum, so more and more plaintiff firms have been filing merger suits instead."

 

Many D&O insurance policies have express exclusions precluding coverage for the amount of any additional consideration paid to settle a bump up claim. Moreover, as I discussed at length in a prior post (here), some courts have held that there is no coverage for the additional consideration, even without respect to the exclusion. In many circumstances, however, defense costs at least may be covered.

 

Lehman Subprime-Related ERISA Suit Dismissed: In an earlier post (here), I noted that Judge Lewis Kaplan had dismissed liability claims filed against the rating agencies that had provided ratings opinions in connection certain Lehman Brothers securities offerings. In a separate opinion relating to the Lehman collapse, on February 2, 2010 Judge Lewis Kaplan also dismissed the subprime-related ERISA class action that beneficiaries had filed against former company officials. A copy of Judge Kaplan’s opinion can be found here.

 

In dismissing the case, Judge Kaplan held that the complaint failed to allege that the misconduct alleged against the eleven director defendants violated any fiduciary duties that the individuals had to plan beneficiaries. He further held that the complaint failed to allege that the sole remaining defendant (a member of the plan administrative committee) had any responsibility for or involvement with the company’s supposedly misleading disclosures, or any prior awareness of the company’s imminent collapse.

 

A February 3, 2010 AmLaw article discussing the opinion can be found here (registration required). I have in any event added the opinion to my list of subprime-related lawsuit dismissal motion rulings, which can be accessed here.

 

Lost Generation: If you have not yet seen it, you may want to take a couple of minutes to view the Lost Generation "mirror image" video. It is pretty bare bones, but is still makes an interesting statement. Hat tip to the CorporateCounsel.net blog for the link.

 

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Rating agencies are not susceptible to ’33 Act liability as "underwriters," even if they helped structure the mortgage backed securities at issue, according to February 1, 2010 ruling (here) by Southern District of New York Judge Lewis Kaplan in which he dismissed Moody’s and McGraw-Hill (S&P’s parent) from the Lehman Brothers Mortgage-Backed Securities Litigation.

 

Plaintiffs had purchased the mortgage back securities that Lehman Brothers had issued in two offerings in August 2005 and August 2006. The plaintiffs allege that the originators of the loans that backed the securities failed to comply with the general loan underwriting guidelines described in the offering documents. The plaintiffs allege that the rating agencies determined the composition of the loans in the mortgage pool that the instruments securitized. The plaintiffs also allege that the credit enhancements supporting the loans were insufficient to support the investment ratings the rating agencies gave the securities.

 

The plaintiffs premised their securities liability claims against the rating agencies based on their argument that the rating agencies were "underwriters" within the meaning of Section 11 of the ’33 Act. The plaintiffs based their theory that the rating agencies were "underwriters" within the meaning of Section 11 on the argument that the "underwriter" liability extends to those "who engaged in steps necessary for the distribution."
 

 

Judge Kaplan found this argument "unpersuasive," noting that

 

The Rating Agencies’ alleged activities may well have had a good deal to do with the composition and characteristics of the pools of mortgage loans and the credit enhancements of the Certificates that ultimately were sold. But there is nothing in the complaint to suggest that they participated in the relevant "undertaking" – that of purchasing the securities here at issue, the Certificates – "from the issuer with a view to their resale." The Section 11 claim is insufficient in law.

 

Judge Kaplan also rejected plaintiffs’ arguments that the rating agencies had "seller" liability under Section 12(a)(2) or control person liability under Section 15.

 

The rating agencies dismissal from this subprime-related securities class action lawsuit is not as significant as it would have been if it had based on the rating agencies’ claims that their ratings opinions are proteced by the First Amendment. Though Judge Scheindlin rejected that argument on narrow grounds in the Cheyne Financial case (refer here), the First Amendment defense undoubtedly will play a crucial role in many of the subprime-related securities cases that have been filed against the rating agencies, and the litigants in the many cases that have been filed against the rating agencies will have to await a later date to get a clearer sense of how those arguments will fare in these cases.

 

But though Judge Kaplan did not reach the first amendment issue, his ruling nevertheless is significant. As the subprime litigation wave unfolded, there were a number of complaints filed against the rating agencies asserting ’33 Act claims against them in which the plaintiffs in those cases had argued that the rating agencies were susceptible to "underwriter" liability under Section 11. Judge Kaplan’s rejection of that theory undoubtedly will be influential in those other cases where the plaintiffs have attempted to assert Section 11 "underwriter" liability against the rating agencies.

 

I have in any event added Judge Kaplan’s ruling to my list of subprime and credit crisis-related lawsuit resolutions, which can be accessed here.

 

SEC Issues Climate Change Interpretive Guidance: The SEC decided recently to issue interpretive guidance on climate change disclosure. The SEC has now issued the interpretive guidance, which can be found here. I think this is a significant development, and not just because the SEC has now formally put climate change disclosure on the list of things to do for reporting companies.

 

It is clearly a topic worthy of much longer treatment than I am able to give it while I am in New York attending the PLUS D&O Symposium, but the danger is that the disclosure requirement establishes the predicate for a plaintiff to later claim that a public company failed to meet its climate change-related disclosure obligations. In my view, the SEC’s issuance of the interpretive guidance brings us that much closer to the day when we may start to see D&O claims arising out of misrepresentations or omissions concerning climate change related disclosures.

 

The End of the World: In response to my recent statement that I was tired and could use a nap, one of my much younger colleagues replied "O.K, first we take zee nap, ZEN WE DEESTROY ZEE WORLD!" She undoubtedly saw from the puzzled look on my face that I didn’t have a clue what she was talking about, so she immediately sat down and showed me this YouTube video, which she described as "the original viral Internet video." Readers should be forewarned that  the video uses vulgar language and contains humor that some may find crude or offensive. It is also seriously funny. Viewer discretion is, however, strongly advised.

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In a 90-page January 27, 2010 opinion (here) District of New Mexico Judge James Browning granted substantial parts of the defendants’ motions to dismiss in the Thornburgh Mortgage subprime securities suit, while also denying the motions to dismiss in connection with certain claims against Larry Goldstone, who served as the company’s President and COO, and after December 2007, as its CEO.

 

Judge Browning’s rulings dismiss all of the plaintiffs’ claims under the ’33 Act as well as many of the plaintiffs’ claims under the ’34 Act, except for the claims against Goldstone, which will go forward. Judge Browning reserved any ruling on the claims against the company itself, which is in bankruptcy, as well as to allegations of control person liability against three individual defendants, as those claims depend first upon the possibility of the company’s liability.

 

In a separate 38-page January 27, 2010 opinion (here), Judge Browning also granted the dismissal motions of the offering underwriter defendants, ruling that the plaintiffs’ consolidated complaint failed to allege sufficiently any material misrepresentations or omissions in the relevant offering documents.

 

Background

Thornburg was a publicly traded residential-mortgage lender focused on the market for "jumbo" and "super jumbo" adjustable rate mortgages. Beginning in 2006, real estate values around the country began to falter, but Thornburgh denied that it was affected, claiming its superior underwriting standards insulated the company from the deteriorating conditions. Thornburg’s executives also denied that it originated "subprime" or Alt-A mortgages.

 

Thornburg’s business model depended on a variety of borrowing and capital mechanisms to fund its lending activities. Thornburg maintained an investment portfolio as collateral for its borrowing. Plaintiffs allege that the portfolio consisted in part of securities backed by Alt-A mortgages, and that these securities were both illiquid and, in 2007, declining in value, which in turn triggered certain margin calls.

 

Specifically, in August 2007, Thornburg was forced to sell 35% of the highest-rated assets in its portfolio to meet margin calls, which in turn triggered both a stock price decline and the filing of the first of several securities class action suits against the company.

 

During 2007 and 2008, the company completed several securities offerings. However, Thornburgh also continued to face additional margin calls, and on February 28, 2008, J.P. Morgan notified the company of its failure to meet margin call requirements, triggering cross default provisions in other short term borrowing arrangements.

 

On March 4, 2008, the company’s auditor withdrew its unqualified audit opinion "due to conditions and events that were known or that should have been known to the company." On March 11, 2008, Thornburg filed a restatement of its prior financials. On March 19, 2008, Thornburg announced it had entered a "bailout" agreement with its remaining lenders that resulted in a substantial dilution of shareholders’ interests.

 

On May 1, 2009, Thornburg filed a petition for voluntary Chapter 11 bankruptcy.

 

The plaintiffs filed their consolidated amended class action complaint on May 27, 2008, on behalf of persons who purchased Thornburg shares between April 19, 2007 and March 19, 2008. The plaintiffs allege that the defendants had failed to disclose that the company was facing increasing margin calls and that its financial condition had deteriorated to the point where it was forced to sell assets. The plaintiffs further alleged that the company failed to disclose that it originated Alt-A mortgages and possessed a multi-million dollar portfolio backed by Alt-A loans.

 

The defendants moved to dismiss, arguing that Thornburg’s losses were the result of market forces beyond defendants’ control.

 

The January 27, 2010 Order

In his January 27 order, Judge Browning first focused on the plaintiffs allegations under Section 10(b). He found with respect to many of the statements or omissions that most of them were not false or misleading or related to matters that the company had no duty to disclose. He also found that the plaintiffs had not specifically attributed any wrongful conduct or statements to any of the individual defendants other than Goldstone, and therefore he granted the motion to dismiss the Section 10(b) claims as to all individual defendants other than Goldstone.

 

However, Judge Browning found that Goldstone had in several public statements sought to attribute the downturn to problems with Alt-A lenders, from which he sought to differentiate Thornburg. Judge Browning found that "on at least two occasions" in June and July 2007, Goldstone made statements that "could be construed and reasonably understood as asserting that [Thornburg} did not engage in Alt-A lending or purchase Alt-A assets," statements which Judge Browning found were false and misleading, taking the plaintiffs’ allegations to be true.

 

Judge Browning also found that statements in the company’s 2007 10-K (which Goldstone signed) about the presence of cross-default provisions in the company’s borrowing agreements also to be false and misleading.

 

On the issue of scienter, Judge Browning rejected the defendants’ suggestion that the absence of insider selling and the presence of insider buying negated the inference of scienter, finding rather that the financial crisis itself "provides another motive that adequately fills the gap left by the lack of suspicious insider-trading activity: survival." Judge Browning said that it was a plausible inference that the defendants were motivated by a desire to help the company survive the crisis, although this allegation alone is not sufficient to establish an inference of scienter.

 

Rather, Judge Browning held that Goldstone’s repeated efforts to distance the company from the mortgage crisis by differentiating the company from Alt-A mortgage originators, "gives rise to a strong inference that Goldstone was attempting to hide from the market that [Thornburg] engaged in Alt-A or subprime lending, and knew, or recklessly disregarded that withholding this information would mislead investors." Thornburg’s omission from its 2007 10-K of its failure to meet the J.P. Morgan margin call, and of the consequent triggering of cross-defaults in other agreements, suggests that Thornburg was "concealing information."

 

The most plausible inference, Judge Browning found, was that Thornburg was "a sinking ship," but that the defendants "tried to stay positive" and that Goldstone "made some statements that crossed the line between optimistic and false and/or misleading."

 

Judge Browning granted the motions to dismiss all of the plaintiffs’ claims based on Sections 11 and 12(a)(2) of the ’33 Act, finding that the plaintiffs had failed to allege any false or misleading statements in the relevant offering documents.

 

Due to its pending bankruptcy proceeding, Judge Browning reserved any ruling on the claims against Thornburg itself, as well as on the control person liability allegations under the ’34 Act that are predicated on the sufficiency of claims against the company.

 

Finally, as noted above, in a separate order, Judge Browning granted the dismissal motions of the offering underwriter defendants, based on his finding that the plaintiffs had failed to allege any false or misleading statements in the relevant offering documents.

 

Discussion

Judge Browning’s exhaustive analysis and his rulings are significant on several levels. First, his order present another example where a court has been willing to dismiss ’33 Act claims in a subprime-related securities class action lawsuit. As I noted in my recent post discussing the ACA Capital Holdings case, where ’33 Act claims were also dismissed, it previously had been the case that courts appeared reluctant to dismiss ’33 Act claims in subprime-related securities lawsuits. But with the ACA Capital Holdings rulings, and now with the rulings in the Thornburg case, the suggestion that Section 11 claims are likelier to survive dismissal motions seems to be less certain, if not entirely unsubstantiated.

 

Judge Browning’s analysis of the scienter issue is also significant. His willingness to overlook the defendants’ insider buying is interesting and noteworthy, particularly in light of his willingness to draw an inference that the defendants were motivated – and perhaps motivated enough to make misleading statements – by a desire to help the company survive the downturn.

 

Many defendants in many other subprime and credit crisis-related cases were similarly motivated to try to help their companies ride out the crisis. To be sure, not all companies or their officials made statements that plaintiffs in those cases will be able to allege diverged from actual circumstances at their companies. But the fact that the plaintiffs in the Thornburg Mortgage case were able to survive the dismissal motion, and to overcome the absence of any insider trading and the presence of insider buying, suggests one possible way that other plaintiffs may overcome initial pleading hurdles.

 

Judge Browning granted the dismissal motions in very substantial part, eliminating almost all of the defendants and many of the plaintiffs’ claims. But the plaintiffs were able to survive the dismissal motions at least as to certain substantial allegations against at least one defendant. Large swaths of their case were cut away, but enough made it through to give them a chance to live for another day and to try to salvage something from the case.

 

Because what remains is substantial, even if only a small part of what was initially alleged, I have placed these rulings on my list of dismissal motion denials, in my running tally of dismissal motion rulings in subprime and credit crisis-related securities suits. My table of dismissal motion rulings can be accessed here.

 

More Failed Banks: On January 29, 2010, the FDIC took control of six more banks, bringing the year to date number of bank failures already this year to 15. By contrast, at this same point in 2009, there had only been a total of six bank failures. The bank failure closure rate is on pace for a total of 180 bank failures in 2010, compared to the 140 banks that failed in 2009.

 

The 15 bank failures so far this year have been spread across ten different states, with three bank failures already this year in the state of Washington, and two each in Georgia, Minnesota, and Florida.

 

This Week: I will be attending the PLUS D&O Symposium at the Marriott Marquis in New York this week. I know many readers will also be there. I hope that if you see me at the Symposium that you will say hello, particularly if we have not met before. While I am away for the Symposium, The D&O Diary may run a reduced publication schedule. "Normal" publication will resume next week. See you in New York.

 

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According to January 29, 2010 reports in the New York Times (here) and on Bloomberg (here), the jury in the long-running securities class action lawsuit against Vivendi has resulted in a verdict against the company on all 57 of the plaintiffs' claims. However, the jury also found that the two individual defendants, former Vivendi CEO Jean Marie Messier and former Vivendi CFO, were not liable. According to published reports, damages (with prejudgment interest) could be as much as $9 billion.  

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

 

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

 

Additional background regarding the case and the plaintiffs’ allegations can be found here.

 

As reflected in data compiled by Adam Savett on the Securities Litigation Watch (here) since the enactment of the PSLRA in 1995, a total of nine securities class action lawsuits (counting Vivendi) have been tried to verdict. Of those nine, and after all post verdict motions and appeals, defendants have prevailed in five and plaintiffs have prevailed in four. Among the cases in which plaintiffs have prevailed is the Household International securities class action trial, which on May 7, 2009  resulted in a plaintiff’s verdict on the issue of liability (about which refer here.). Damages are also to be determined later in that case.

 

Though plaintiffs have prevailed in the Vivendi trial, at least as to their claims regarding the company, this case undoubtedly has much further to go. Not only will there be post-verdict motions and further proceedings regarding damages, but there almost certainly will be subsequent appeals. Indeed, Vivendi has already indicated that it would appeal if the verdict were unfavorable. Among other things, the case presents significant jurisdictional issues, particularly with respect to the claims of certain foreign domiciled investors. These issues are now pending before the Supreme Court in the National Australia Bank case.

 

But the bottom line is that the two securities class action cases that have gone to the jury in the last 12 months have resulted in verdicts in plaintiffs’ favor, a development the plaintiffs' bar will certainly tout as significant .

 

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On January 27, 2010, NERA Economic Consulting released its updated annual review of Canadian securities class litigation entitled "Trends in Canadian Securities Class Actions: 2009 Update" (here). The report presents an interesting study of the evolution of class action litigation in a jurisdiction outside the U.S.

 

According to the report, there were eight new securities class action lawsuits filed in 2009, which is fewer that the ten filed in 2008 "but still greater than filings in previous years." With the addition of the eight new cases, there are now 23 pending securities class actions, representing more than $14.7 billion in claims. Most of these cases were filed in the last three years although some of the pending cases were filed almost 10 years ago.

 

Though the number of new filings is noteworthy, the more significant developments may be the class certifications in three cases and the ruling allowing the IMAX securities class action plaintiffs leave to proceed under the new Ontario securities laws. (My prior detailed discussion of the rulings in the IMAX case can be found here.). The NERA report comments that these rulings "may ultimately prove to be an inflection point" for securities class action litigation in Canada.

 

Though there were significant new filings in 2009, one noteworthy feature of the cases that were filed is the "absence in Canada of class actions filings relating to the credit crisis." This absence may be due in part to the relatively smaller impact of the credit crisis in Canada compared to the U.S. and the negotiated $32 billion restructuring of the Canadian Asset Backed Commercial Paper market, which may have preempted further litigation.

 

Six cases settled in 2009 for a total of approximately $51 million, for an average of approximately $8.5 million and a median of approximately $9 million (which is roughly comparable to the median settlement of U.S. securities class action lawsuits). 2009 settlements averaged 13.7% of the amount of claimed damages. Cases with cross-border litigation counterparts in the U.S. tended to settle for larger amounts both in terms of absolute dollars and as a percentage of claimed damages.

 

According to a January 27, 2010 article in the Vancouver Sun (here), the number of filings and the procedural developments (including the rulings in the IMAX case) are "a wake up call for publicly traded companies." Law firms are "advising their clients to revisit their compliance and corporate-governance procedures to protect against similar suits."

 

One lawyer quoted in the article says that he is also advising his clients to review their corporate insurance, as well. He goes on to state that "We’ve seen over the years there are a lot of problems in terms of clients don’t really have the type of coverage they need."

 

Yet, as for the question of whether there may be a flood of litigation, one plaintiffs’ attorney quoted in the article sounds a note of caution. The attorney, Dimitri Lascaris, who is one of the lead attorneys in the IMAX case, notes that that the Canadian system still provides for adverse costs, and even the liberalized standard under the new Ontario law are time consuming and expensive. So, he says, "we’re never going to achieve the level of activity in securities class actions that we see in the United States."

 

In light of these developments and their potential significance regarding insurance coverage, the session planned for the upcoming PLUS D&O Symposium (scheduled next Wednesday and Thursday in New York) on the topic of Canadian Securities Class Action Litigation is quite timely. The panel will be moderated by my friend Dave Williams from Chubb (Canada) and planned speakers include a number of prominent players in the area in Canada, including Dimitri Lascaris. Information about the Symposium can be found here.

 

The Securities Litigation Watch blog has a post about the NERA study here.

 

Excess Side A Carrier Contributes to Options Backdating Settlement: On January 25, 2010, a judge in the Western District of Pennsylvania preliminarily approved the settlement of the options backdating lawsuit that had been filed against Black Box, as nominal defendant and certain of its directors and officers. As part of the settlement, the company agreed to pay plaintiffs’ counsel $1.6 million and the company agreed to adopt certain corporate governance measures.

 

As reflected in the parties’ stipulation of settlement (here), as part of the settlement, the company is to receive a payment of $1.5 million from its Excess Side A carrier as well as another $500,000 from its EPL carrier.

 

According to a January 25, 2010 article about the settlement in the Pittsburgh Tribune-Review (here), the company also separately settled a claim against the company by its former CEO, who left the company in connection with the options backdating related matters. At the time he left, the CEO claimed, the company took away over $19.6 million in options related compensation. The company settled these claims for its agreement to pay $4 million.

 

The Black Box settlement marks the second instance of which I am aware in which an Excess Side A carrier contributed toward an options backdating related derivative lawsuit settlement. (The first instance is the Broadcom settlement, about which refer here.) This is yet another instance where Excess Side A insurance is being called on to provide protection outside of the insolvency context. As I have previously noted, the Excess Side A carrier’s contribution to these settlements may be a significant development for the carriers, who have offered the product in a largely low loss environment, at least outside the insolvency context.

 

The settlement with the CEO is an odd component of this settlement. There aren’t many of these cases where the former CEO who left as a result of backdating related issues walked away with a cash payment.

 

I have in any event added the Black Box settlement to my table of options backdating related lawsuit settlements and dismissal motion rulings, which can be accessed here.

 

SEC Will Issue Guidance on Climate Change Disclosure: On January 27, 2010, the SEC voted 3-2 to provide interpretive guidance on existing dislosure requirements to require climate change related disclosure under certain circumstances. The SEC's January 27 release can be found here. The SEC's release states that the interpretive release will be posted on the SEC web site as soon as possible. The news release identifies several examples of situations that might trigger disclosure requirements, including: impact of legislation and regulation; impact of international accords; indirect consequences of regulation or business trends; and physical impacts of climate change.

 

Suit Against Rating Agencies Dismissed, But Without Reaching First Amendment Issues: According to a January 27, 2010 Am Law Litigation Daily article by Andrew Longstreth (here), Judge Lewis Kaplan has granted the motions of Moody's and S&P to be dismissed from a securities lawsuit filed by certain investors who had invested in certain mortgage-backed securities underrwitten by Lehman Brothers. Judge Kaplan has not yet issued a written opinion but according to the article his opinion was based solely on the fact that the rating agencies didn't have anything to do with the offering documents at issue in the case. HIs ruling reportedly did not reach the rating agencies first amendment defenses (about which refer here.)  

　

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Over the years, legislative reforms of the U.S. securities laws have cycled back and forth, between initiatives, on the one hand, to discourage abusive litigation and, on the other hand, to restrain corporate misconduct. In the current Wall Street bailout, post-Madoff environment, sentiment may be running high for legislative reforms that could expand liabilities under the federal securities laws. But though the time for reform may be now, the window of opportunity may be short.

 

According to a January 2010 Wall Street Lawyer article by Boris Feldman of the Wilson Sonsini firm entitled "The Coming Counter-Reformation in Securities Litigation" (here), the best shot for reforms favorable to the plaintiffs’ bar "may be right now—before the mid-term elections in 2010 can create a filibuster firewall in the Senate." In his article, Feldman looks at the most likely areas of reform and the likelihood of the initiatives’ success.

 

The "most important priority for the plaintiffs’ bar" will be the institution of private securities liability for aiding and abetting violations of the securities laws. (There are in fact already current Congressional initiatives to accomplish that very change, about where refer here and here.) This change, were it enacted, would made the biggest difference in the "big frauds," where the "primary wrongdoer is usually bust." If the company’s professionals were "on the hook," then the "entire calculus would change," as the "pot" would then "consist of more than a claim in bankruptcy and some D&O insurance policies."

 

The "real battle" about prospective aiding and abetting liability, according to Feldman, will be how -- not whether-- it is instituted. Questions such as who bears the burdens of proof and persuasion and the state of mind required for liability "will determine whether aiding and abetting liability is a measured response to the current situation or a license to subject outside advisors to in terrorem risk."

 

The next likely target for the plaintiffs’ lawyers, Feldman suggests, is the discovery stay, which has been one of the PSLRA’s "great frustrations" for the plaintiffs’ bar. Feldman suggests that the plaintiffs’ will seek to modify the discovery stay, rather than try to have it overturned. He suggests that one alternative might be a "good cause" exception to the stay. Another alternative is the creation of an exception to the stay for documents already produced to governmental authorities.

 

Feldman also suggest that the plaintiffs’ bar may attack the PSRLA’s pleading requirements, or alternatively seek to rely on initiatives to set aside the "facial plausibility" pleading standard of Twombley and Iqbal (about which refer here).

 

Finally, Feldman suggests that the plaintiffs’ bar may see to limit the impact of Dura Pharmaceuticals, perhaps through reforms specifying that the loss causation issue is to be addressed only at the summary judgment or trial stage.

 

One area Feldman suggests that plaintiffs are unlikely to seek reforms is with respect to the PSLRA’s lead plaintiff requirements. Though these provisions were controversial when first enacted, the plaintiffs’ bar has now "adapted happily" to the requirements, and with institutional investor relationships firmly in place, there is "no incentive for the plaintiffs’ bar to tinker with these provisions."

 

Feldman closes by noting that the "electoral clock is ticking," with the likelihood of legislative action, if any, before fall 2010. He confesses "surprise" that the legislative reforms were not launched a year ago, when the 2008 electoral results were still fresh. Feldman notes that the fact that the plaintiffs’ bar missed this opportunity "may have something to do with absences in their leadership ranks in recent years."

 

Feldman suggests that the "most likely" way these reforms may come about is through the activities of the Financial Crisis Inquiry Commission, which, Feldman notes, has "strong ties to the plaintiffs’ bar" (about which refer here), a fact that may allow the plaintiffs’ bar "to try to get some of their reforms into the recommendations of the Commission."

 

I note that Feldman published his article before last week’s special election in Massachusetts. The election of Republican Scott Brown to the Senate seat vacated by the late Edward Kennedy seems to have scrambled everything. Although I don’t profess to have any particular insight into Congressional dynamics, I wonder whether the possible November effect Feldman anticipates in his memo has now been pushed forward through the calendar. The "filibuster firewall" may already be gone. Without a doubt, every member of Congress facing election this fall is proceeding with significantly greater wariness in the wake of the recent Massachusetts senatorial election. All of which makes me wonder whether or not the window of opportunity on some of these legislative proposals may have been substantially narrowed, if not altogether closed.

 

Opt-Outs Down and Out: Much has been written (refer for example here) about the growing phenomenon of class action securities lawsuit settlement opt-outs – that is, the investor class members who choose not to participate in the class action lawsuit settlement and instead pursue their own individual claims. One of the recurring themes has been how much better the opt-outs do than they would have if they remained in the class.

 

However, as shown in the outcome of a recent case involving Aspen Technology, there is no guarantee that the opt outs will do better by proceeding separately.

 

Aspen and several of its directors and officers had been sued in a securities class action lawsuit in November 2004 (about which refer here). The securities class action lawsuit ultimately settled for $5.6 million, but several class members representing 1.4 million shares of common stock opted out of the class action settlement and filed their own "direct action" lawsuit against the defendants in Massachusetts state court.

 

As reported on the Securities Litigation Watch blog (here), the Aspen Technology investors’ direct action lawsuit didn’t go so well for them. In a January 13, 2010 opinion (here), Massachusetts (Suffolk County) Superior Court Justice Judith Fabricant ruled that "no fraud occurred" and that "defendants are entitled to judgment on all counts of the complaint." In a memo about the decision (here), Skadden, the defense firm in the case, reports that Justice Fabricant also awarded defendants recovery from the plaintiffs of their costs in the case.

 

Options Backdating Securities Suit Dismissal Affirmed: One of the 39 options backdating related securities class action lawsuits involved claims against Jabil Circuit. The case may have been among the more noteworthy options backdating-related securities lawsuit filings, because Jabil Circuit was among the small group of companies specifically mentioned by name in the original March 2006 Wall Street Journal article ("The Perfect Payday") that launched the options backdating scandal. Among other things, the article calculated the likelihood that the Jabil options grants occurred randomly as "one in a million."

 

As noted in an earlier post (here), the Jabil Circuit options backdating-related securities lawsuit was dismissed without prejudice in April 2008. In a January 2009 order (here) on the defendants’ renewed motion to dismiss, the complaint was dismissed with prejudice.

 

In a January 19, 2010 decision (here), the Eleventh Circuit Court of Appeals affirmed the lower court’s dismissal of the case, holding the plaintiffs’ allegations "fail to meet the heightened pleading standards" under the PSLRA.

 

Among other things, the court said that "the allegations of misrepresentations, responsibility for granting misdated options, and personal profiteering fail to raise a strong enough inference of scienter" and that "the allegations contained in the complaint do not create an inference of scienter that is at least as probable as a non-fraudulent explanation—namely that none of the Appellees knew of the accounting errors until the investigation began in 2006"

 

I have updated my table of the outcomes in the Options Backdating-related lawsuits to reflect the Eleventh Circuit’s decision in Jabil Circuit. The table can be accessed here.

 

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On January 21, 2010, the insurance information firm Advisen released the latest in a series of various observers’ year end analyses of 2009 securities litigation. Advisen’s year report can be accessed here. The Advisen report takes a somewhat different approach than the other reports, and reaches some strikingly different conclusions. Among other things, the Advisen report, perhaps by contrast to prior studies, concludes that "securities litigation" (as that term is used in the report) is actually increasing.

 

Warning! Terminology Matters!

In order to appreciate the Advisen report, it is absolutely indispensible to understand that the Advisen report uses its own unique terminology.

 

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

 

The Advisen report also apparently includes within the category "securities lawsuits" claims alleging "common law torts, contract violations and breaches of fiduciary duties."

 

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

 

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

 

So the "securities fraud" lawsuit category includes lawsuits alleging fraud under the federal securities laws if the fraud is alleged by an individual but not if it is alleged on behalf of a class.　

The Report’s Conclusions

Perhaps the most important contribution that the Advisen report makes to understanding what happened from a litigation standpoint is its observation that "securities litigation" -- as broadly defined in the report – actually increased in 2009 by comparison to prior years. Thus the report states that in 2009 the number of "securities lawsuits" actually grew to 910 suits, up 13% from 2008, which in turn was up 33% from 2007.

 

This observation is interesting and seemingly contrasts with conclusions reported in other studies suggesting that securities litigation declined in 2009. The difference in the analysis is due to the fact that the other studies concentrated exclusively on securities class action lawsuit filings in the United States, whereas the Advisen report is focused more broadly on corporate and securities litigation generally, and on litigation both inside and outside the United States.

 

It appears that for several years, securities class action lawsuits as a percentage of all "securities lawsuits" have been declining. As recently as 2004, securities class action lawsuit filings represented as much as half of all " securities lawsuits" filed, whereas in 2009 securities class action lawsuits represent only about one quarter of all "securities lawsuits."

 

The point here is an important one – that is, even if absolute numbers of securities class action lawsuit filings are declining, that does not mean that overall claims activity is decreasing. To the contrary, claims activity is actually increasing, while at the same time the mix of cases filed is changing. So if you were to focus only on securities class action lawsuit filing levels, you might mistakenly conclude that overall claims susceptibility is decreasing. It is not. It is increasing.

 

But even with respect to the narrower issue of securities class action lawsuit filings ("SCAS"), the Advisen report reflects a different perspective than other studies.

 

The Advisen report reports a relatively higher number for the number of securities class action lawsuit filings in 2009 (234) compared, for example, to the Cornerstone tally of 169 securities class action lawsuit filings in 2009, but the Advisen study also reports a much slighter decline in securities class action lawsuit filings from 2008 to 2009 (234 in 2009, 239 in 2009), than does the Cornerstone study (223 in 2008 to 169 in 2009).

 

Part of the explanation for this seemingly enormous difference is categorization. Thus, the Advisen study counts securities class action lawsuits that were filed in state courts (there apparently were 15 state court securities class action lawsuit filings in the fourth quarter of 2009 alone), but the Cornerstone study does not.

 

Part of the explanation for the difference is methodological. As stated in its report, Advisen "counts each company for which securities violations are alleged in a singled complaint as a separate suit." As far as I can tell, the Cornerstone study would count that single complaint only once regardless of the numbers of corporate defendants named in the complaint – that is certainly the approach I use in my own tallies. The Advisen approach will inevitably lead to higher numbers than are reported in some other studies.

 

Part of the explanation for the difference is simply timing. The Advisen report includes filings through December 31, 2009, whereas the Cornerstone report only counts filings through December 21, 2009.

 

Among other things, the Advisen report states that the aggregate losses claimed in the "securities lawsuits" filed in 2009 was $1.3 trillion, compared to $1.2 trillion in 2008. The average losses per "securities lawsuit" were $9.8 billion in 2009, compared to $6.4 billion in 2008, which may be interpreted to suggest the possibility of "record payouts" for the securities lawsuits filed in 2009.

 

The report also contains an extensive discussion of the growing significance of "securities lawsuits" against non-U.S. companies. According to the study, there were 117 "securities lawsuits," or 13 percent of the total, filed against non-U.S. companies in 2009, including 46 "large cases" filed in non-U.S. courts. (The report does not specify what constitutes a "large case.") However, the report also notes that one subset of these "securities lawsuits" against non-U.S. companies, that is, the filings in the subcategory of "collective actions" were almost entirely concentrated in the first quarter and largely driven by Ponzi scheme cases.

 

The Advisen report is quite extensive and contains a wealth of information, and is worth reading at length and in full (albeit very carefully). But of all the observations contained in the report, by far the most important one is that even if securities class action lawsuit filings may have declined, overall "securities litigation" has not decreased – in fact, in 2009, "securities litigation," as that term is used in the Advisen report, increased materially and for the second consecutive year.

 

Securities Litigation Webinar: On Friday January 22, 2010 at 11:00 a.m. EST, I will be participating in a free one-hour "Review of Securities Litigation 2009 and Expert Views for the Year Ahead." The other panelists include Travelers's Mark Lamendola, Beecher Carlson's Jeff Lattmann, and Advisen's Dave Bradford. Advisen's Jim Blinn will moderate the panel. You can register for the webinar here.

 

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In an earlier post (here), I wrote about a December 30, 2009 ruling in the MBIA coverage litigation that special litigation committee investigation expenses were covered under a D&O liability insurance policy. As I anticipated, the decision has proven to be controversial.

 

Two law firms that traditionally act as coverage counsel for D&O carriers recently released memoranda discussing the opinion. The Wiley Rein issued a brief memo (here) discussing the case and its holding. The Edwards Angell Palmer & Dodge law firm released a longer memorandum (here) also discussing the opinion.

 

The Edwards Angell memo, written by my friend John McCarrick and his colleagues, Maurice Pesso and Peter de Boisblanc, is particularly interesting because opens by reviewing the justification for the insurers’ standard position that special litigation committee expenses are not covered under the typical D&O insurance policy.

 

The Edwards Angell memo also includes a review of implications of and the likely consequences that flow from the decision. Among other things, the memo stresses that the decision did not hold that special litigation committee expenses will always be covered, but only under the facts presented. The memo also recites the difficulties and logical problems involved with characterizing the special litigation committee expenses as "defense costs" (including the likelihood that plaintiffs might use the characterization as a way of challenging the independence of the special litigation committee.).

 

The Edwards Angell memo concludes with this observation:

　

Unless and until the D&O insurers in MBIA press a successful appeal of this ruling to the Second Circuit Court of Appeals, D&O insurers should brace themselves for the likelihood that the MBIA ruling will be cited by policyholder counsel and brokers in an effort to significantly expand the scope of coverage for these kinds of legal expenses and costs, as well as to cover other fees and expenses that an insured can argue were incurred "in connection with" a covered D&O claim.

 

The memo provides an interesting presentation of the carrier perspective on the decision. Reading the memo, I wondered whether any policyholder-side coverage attorneys had written their own analyses of the decision from the perspective of insured companies. I hope that any readers aware of these alternative perspectives will please send them along to me. I will update this post with any additional materials that are sent to me about the case.

 

One final note on a related subject -- the Wilmer Hale law firm has an interesting memo about recent developments in shareholder derivative litigation (here), which, among other things, discusses court's' increased scrutiny of special litigation committees, particularly with respect to the  question whether or not the committees are in fact independent.

　

NAB Update: The closely watched National Bank of Australia case pending before the U.S. Supreme Court on a writ of certiorari from the Second Circuit has now been scheduled for oral argument. According to a post on The 10b5-Daily (here), oral argument in the case, which will address the question of the extraterritorial jurisdiction of U.S. courts over foreign domiciled companies under the U.S. securities laws, is now set for March 29, 2010.

　

The 10b-5 Daily post also has a link to the Petitioners’ Brief., which argues that under the federal securities laws there are no extraterritorial limitations on the U.S. courts’ jurisdiction. Finally, the blog post also links to a National Law Journal article (here) written by Columbia Law School Professor John Coffee suggesting that, in light of various pending legislative proposals, Congress and the Supreme Court are on a "collision course" on the question of extraterritorial jurisdiction of the U.S. securities laws. Coffee concludes by suggesting that "a legal train wreck might result from opposing approaches to global class actions."

　

Detailed background regarding the NAB case can be found here.

　

Another Belated Securities Lawsuit Filing: In prior posts (for example, here), I have noted the phenomenon that developed in the second-half of 2009 where plaintiffs’ lawyers were filing securities class action lawsuit complaints well after the proposed class period cutoff date. In a more recent post (here), I noted that at least one lawsuit first filed in January suggested that this trend has continued in the New Year.

 

Yet another case filed this week suggests that this trend is continuing. In a January 21, 2010 press release (here), plaintiffs’ lawyers announced that they had filed a securities class action lawsuit in the Northern District of Illinois against Motorola and certain of its directors and officers. The lawsuit relates to alleged misrepresentations about the company’s sales of its RAZR2 telephone handset. The complaint in the case can be found here.

 

Though the complaint was only just filed, the proposed class period cutoff date is January 22, 2008, a full one year and 364 days prior to the filing date, and just before the expiration of the two-year statute of limitations applicable to ’34 Act claims.

 

In his comments in connection with the recent release of Cornerstone’s year-end analysis of the securities class action lawsuits, Stanford Law School Professor Joseph Grundfest had a number of choice comments about these belated securities class action lawsuit filings, essentially suggesting that the plaintiffs are scraping the bottom of the barrel (my words, not his) to file these belated lawsuits because they had run out of more meritorious cases to file. Public statements by leading plaintiffs’ attorneys (refer, for example, here) suggest more neutrally that they are just getting around to filing cases that were "backburnered" while the lawyers were concentrating on getting the subprime and credit crisis cases on file.

 

But whatever the explanation may be for the belated case filings, it is a very distinct phenomenon that has appears to be continuing as move well into 2010.

　

New SEC Climate Change Disclosure Guidance Ahead?: In prior posts (here), I discussed the possibility that the SEC could issue guidelines for public companies’ disclosures about climate change related issues and exposures. As discussed on the FEI Financial Reporting Blog (here), the SEC has announced (here) that in a meeting on January 27, 2010, it will be considering "a recommendation to publish an interpretive release to provide guidance to public companies regarding the Commission's current disclosure requirements concerning matters relating to climate change."

　

As the FEI Financial Reporting Blog explains, an interpretive release of this type is designed to provide final guidance on existing disclosure requirements. The blog post speculates that the guidance could be effective immediately upon release.

 

Cheers: I have joined the Facebook group "A Glass of Wine Solves Everything." (here). In vino veritas, dude. I recently have developed an affinity for two very different kinds of red, Oregon Pinot Noir and Argentine Malbec -- in part because one of the problems I have to solve is that I can't afford the Burgundys, Bordeauxs and Super Tuscans I would prefer. In my next life, my blog will be about wine.

 

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RiskMetrics has issued its year-end 2009 scorecard of the Top 100 securities class action lawsuit settlements. The list, which is updated quarterly, can be accessed on the Securities Litigation Watch blog (here). The details in this very interesting tabulation support a number of interesting observations, discussed below.

 

The year-end Top 100 tally reflects the incorporation of 15 new settlements added to the list during 2009. However, because RiskMetrics identifies a specific case’s Settlement Year as "the year in which the hearing to grant final approval of the settlement or most recent partial settlement occurred," there were several high-profile settlements entered late in 2009 that are not, because they are not yet final, reflected in the most recent update, including the $225 million Comverse Technology settlement (about which refer here) and the $160.5 million Broadcom settlement (here).

 

The settlements added to the list during 2009 include the tenth largest all-time settlement, in the form of the $925 million UnitedHealth Group settlement (refer here and here). Among the all-time top 25 settlements are several other settlements added to the list in 2009, including the $586 million IPO Securities Litigation settlement (refer here), the $554 million HealthSouth settlement (refer here), the $475 Merrill Lynch settlement (refer here), the $445 million Qwest Communications settlement (refer here), and the $400 million Marsh & McLennan settlement (here).

 

The price of admission to the Top 100 list is steep. Taking into account the late-year Comverse Technology and Broadcom settlements, which presumably will be added to the list during 2010, future settlements will have to excess $80 million to crack the Top 100. And to break into the top 25, a settlement will have to exceed $400 million. (It should not be overlooked that there have been 25 settlements of $400 million or greater, which is a staggering fact all by itself.)

 

The Securities Litigation Watch blog also notes that the price of admission to the Top 100 list has doubled since the end of 2005; at year-end 2005, the 100^th largest settlement on the list was in the amount of $39 million. By year-end 2009, the 100^th largest settlement was $79.75 million.

 

Settlements related to options backdating securities cases are well-represented among the Top 100 settlements, including number 10 all-time, the UnitedHealth Group options backdating securities lawsuit settlement. Other Top 100 options backdating settlements include Brocade Communications Systems ($160 million) and Mercury Interactive ($117.5 million). The yet to be added Comverse Technology ($225 mm) and Broadcom settlements ($160.5 mm) also rank among the top all-time settlements. The separate $118 million Broadcom options backdating-related derivative lawsuit settlement, though not relevant to this list because it did not arise in a securities class action suit, is nevertheless noteworthy in this connection.

 

The Top 100 settlements also include two subprime-related securities class action settlements, the $475 million Merrill Lynch settlement and the $150 million Merrill Lynch bondholder settlement. Call it a hunch, but I am guessing that before all is said and done with the subprime and credit crisis-related securities lawsuits, there will be a lot more of those cases on the Top 100 settlements list.

 

The Top 100 settlements involve cases in 38 different federal district courts, with the largest number in the Southern District of New York (25). Other districts with significant numbers of settlements include the District of New Jersey (8), the Northern District of California (7), the Central District of California (6), and the Southern District of Texas (5).

 

Among the plaintiffs’ firms, the law firm with the highest number of Top 100 securities class action settlements is the Milberg firm (in its various manifestations), with 29, followed by the Bernstein Litowitz firm, with 26 and the Coughlin Stoia firm, in its various forms, with 14.

 

Of the Top 100 securities class action settlements, over two-thirds (68) were finalized in the most recent five year period between 2005 and 2009. The bar graph on page 5 of the report, which depicts the definite upward trend in the more recent years, strongly communicates the increasing severity of securities class action claims.

 

The inevitable implication of this inexorably increasing claims severity is that the price of poker is going up. This fact, taken together with the dramatic increases in the costs associated with defending securities suits, has important implications for D&O insurance limits selection. Simply put, commonplace notions about limits adequacy that have developed over time may have gone completely out of date in the most recent years.

 

The significant recent increase in the number of mega settlements suggests that the answer to the question "How much insurance is enough" may be categorically greater than even a short time ago. The inevitable ratchet effect from these settlement trends, creating ever greater measures of what "cases like this settle for," also suggests that these numbers will not be going back down either.

 

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In my year-end analysis of the 2009 securities class action lawsuit filings, I noted a number of filing trends that developed in the second half of the year, including the incidence of new filings against leveraged Exchange Traded Funds (ETFs) and the surprising numbers of belated securities suit filings where the filing date came well after the proposed class period cut-off date. If the lawsuit filings in the first two weeks of January are any indication, these trends have continued into the New Year.

 

First, this past week, plaintiffs’ lawyers launched two new lawsuits on behalf of leveraged ETF fund investors, the UltraBasic Materials ProShares Fund (refer here) and the Direxion Energy Bear 3X Shares Fund (refer here). My prior post discussing the phenomenon of securities class action lawsuits and including a link to a running list of the ETF-related suits can be found here. I have updated the list to include these most recently filed suits.

 

Second, in the first 2010 instance of the belated lawsuit filing phenomenon, on January 15, 2010, plaintiffs’ lawyers filed a securities class action lawsuit against Stryker Corporation and certain of its officers and executives. The plaintiffs’ lawyers’ January 15 press release about the case can be found here.

 

The class period cut-off proposed in the Stryker complaint is November 13, 2008, well over a year before the lawsuit was filed.

 

We may have entered a new calendar year, but at least a couple of last year’s securities suit filing trends appear to have carried over from year-end, at least so far.

 

Galleon Out as Lead Plaintiff: Among the stranger circumstances surrounding the Galleon Management insider trading scandal is the fact that just two weeks before the scandal surfaced Galleon had been reaffirmed as lead plaintiff in the Herley Industries securities class action lawsuit. My prior post discussing these circumstances can be found here.

 

However, according to a January 15, 2010 Bloomberg article (here) written by Thom Weidlich, Galleon has now dropped out as lead plaintiff in the case.

 

In a January 15, 2010 order (here), Eastern District of Pennsylvania Judge Juan R. Sanchez permitted Galleon to withdraw as lead plaintiff. According to the Bloomberg article, Galleon’s counsel had advised the court that it had "become clear that the now-defunct Galleon can no longer continue in this role."

 

Delaware Chancery Court Tosses Bribery Follow-On Civil Suit: In numerous prior posts (most recently here), I have noted as along of the increasing number of antibribery enforcement actions has come the increasing incidence of follow-on civil litigation in the wake of the bribery enforcement action.

 

As reflected in a January 15, 2010 post on The FCPA Blog (here), a recent Delaware Chancery Court decision dismissing a case involving Dow Chemical contains language that may be important in future bribery enforcement follow-on civil actions.

 

The Dow suit arose after the Kuwaiti parliament acted to rescind the purchase of certain Dow assets (in a transaction known as K-Dow) based on the suspicion of profiteering and improper commissions paid to the Kuwaiti state owned enterprise that was the actual buyer. The plaintiffs filed suit in Delaware alleging that the Dow board "failed to prevent bribery in connection with the K-Dow transaction."

 

In a January 11, 2010 opinion (here), Chancellor William B. Chandler III dismissed the action on the grounds that the plaintiffs "do not allege that the board knew about or had reason to suspect bribery."

 

The FCPA Blog points out that in a footnote "that may have important consequences beyond this case," the court said that Dow’s compliance program was evidence that the board had met its fiduciary duty to prevent overseas bribery. The Chancery Court specifically referenced the company’s Code of Ethics prohibiting any unethical payments to third parties. The FCPA Blog concludes that this case provides "a powerful reason for directors and officers to insist on robust antibribery compliance programs that include regular reports back to the board."　

　

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The financial relationship between plaintiffs’ securities firms and the clients they represent has long been questioned, and not only because of the kinds of improper kickback payments for which Bill Lerach and Mel Weiss, among others, wound up in jail. Another practice that has raised recurring concerns is what is referred to as "pay-to-play" – which in this context refers to the plaintiffs’ lawyers’ payment of political contributions to elected officials in charge of public pension funds, supposedly in exchange for the lawyers’ selection as the funds’ class action counsel.

 

But while these kinds of concerns are frequently raised, a preliminary question is often overlooked – that is, regardless of questions about the effect the practice might have on the counsel selection process, are the plaintiffs’ lawyers in fact making political donations to elected officials who have authority over public funds?

 

That is the question examined in a recent New York University Law Review article by Drew T. Johnson-Skinner entitled "Paying to Play in Securities Class Actions: A Look at Lawyer’s Campaign Contributions" (here). The article’s author notes that while alleged pay-to-play practices are often discussed, and have even been the subject of various reform proposals, many commentators have simply "skipped" the "first stage of the analysis," which is the question "whether law firms are contributing to investment funds’ leadership at all."

 

In order to analyze the question, the article’s author looked at all 1076 securities class action lawsuits that were filed from 2002 to 2006, and then narrowed the data set to the 74 cases where "the filing lead plaintiff was an institutional investor with at least one state-level elected official or a person appointed by a state-level elected official, on its controlling board."

 

The author then looked at whether the law firms selected as counsel in each of the 74 cases had made campaign contributions to any elected officials affiliated with the funds that selected the firm. Reviewing publicly available information, the author found that "in a majority of cases where pay-to-play was possible, at least one law firm made a political contribution to an elected official with a lead plaintiff pension fund in the case."

 

The author concluded that his analysis "confirms that plaintiffs’ law firms are contributing to the pension funds that select them as counsel," and that "campaign contributions that could be the basis of paying-to-play are present across a broad range of cases." Moreover, the amount of money contributed by firms is also "significant."

 

However, the author cautioned that his research "does not explain why firms contribute to pension funds or the role that campaign contributions actually play in funds’ counsel-selection decisions." Rather, the author suggests that the value of his research is that it rules out any possible contention, in response to pay to play allegations, that law firms are not contributing to pension funds. In fact, they are.

 

While the law review article’s author declined to question whether the plaintiffs’ law firms’ political contributions are a form of pay-to-play, a separate legal study suggests at a minimum that the existence of political contributions may affect the attorneys’ fees that a public pension fund may pay.

 

A December 22, 2009 article (here) by New York University law professor Stephen Choi, Drew T. Johnson-Skinner, and University of Michigan law professor Adam Pritchard suggests that "state pension funds generally pay lower attorneys’ fees when they serve as lead plaintiffs in securities class actions than do individual investors serving in that capacity," but that when the authors controlled "for campaign contributions made to officials with influence over state pension fund" the differential disappears. Thus, the authors conclude, pay to play "appears to increase agency costs borne by shareholders in securities class actions."

 

In any event, questions continue to arise whether plaintiffs’ lawyers campaign contributions to officials that control public pension funds represents a form of improper influence.

 

For example, in connection with the class certification motion in the Countrywide subprime-related securities class action lawsuit, the Defendants had argued that the lead counsel in the case had made a series of campaign contributions to the New York State Comptroller, the sole trustee of the New York State Common Retirement Fund, one of the lead plaintiffs in the case. (The other lead plaintiff group is the New York City Pension Funds.) The various contributions for the lawyers at the firm ranged in amount from $6,200 to $9,600, all made within four days’ time, after the law firm had been selected as lead counsel. The payments totaled "precisely $50,000."

 

In her December 9, 2009 order certifying the class (here), Central District of California Judge Mariana Pfaelzer noted that any suspicion of pay-to-play activity "would be relevant to attorney-class conflicts and the willingness of [the State Fund] to monitor its attorneys and make decisions for the benefit of the class rather than its attorneys," but she found that any such suspicion "may be somewhat speculative" in the Countywide case.

 

Judge Pfaelzer noted as a preliminary matter that "attorneys are free to exercise their right to donate to politicians who support their views" and that the defendants "do not allege that the donations violated any law." She also noted that "though not exactly correlative," lawyers and parties on the defense side have "similar political-donation freedom."

 

Perhaps more importantly, in rejecting the defendants’ objections, Judge Pfaelzer found that the lead plaintiffs’ firm had been retained for the case "after career staff recommended" the firm, following "reasonable ethics protocols" and based on the law firm’s "independent investigation of the case."

 

A December 10, 2009 WSJ.com Law Blog post about Judge Pfaelzer’s ruling can be found here.

 

The suggestion of similar concerns surfaced more recently in connection with the composition of the Financial Crisis Inquiry Commission, which commenced its high profile investigation of the financial crisis on Wednesday. As detailed in a January 13, 2010 Wall Street Journal article (here), one of the individuals on the ten-member commission is a lawyer with the Coughlin Stoia law firm. In addition, a senior commission staffer is on leave as a partner in the Coughlin Stoia law firm.

 

The Journal article reports that the commission chairman, Phil Angelides, received $250,000 in contributions from the law firm during his 2006 campaign for governor. The article quotes a representative of the U.S. Chamber Institute for Legal Reform as saying that the appointment of plaintiffs’ class action attorney to the commission and its staff "raises a very real concern as to whether they will use the important work of the commission ultimately to feather their own nest." A law professor is also quoted as saying that the ties to the law firm could hurt the commission, noting that "the commission must maintain its distance from the perception that this is all a ‘gotcha’ exercise."

 

These kinds of concerns about plaintiffs’ law firms’ political contributions at a minimum draw upon a suggestion of at least the appearance of impropriety. As one way to try to avert this appearance, Florida has instituted a public process, conducted by its State Board of Administration, which oversees the state employee pension funds, to determine which firms will represent the Board in future securities class action lawsuits.

 

According to Allison Frankel’s December 14, 2009 AmLaw Litigation Daily article (here), 31 firms submitted proposals, from which a field of 12 candidates was selected. In a January 12, 2010 update (here), Frankel reported on the outcome of the process and the names of the five law firms finally selected. Her January 12 article also reports on the many "interesting tidbits" revealed in the law firms’ public submissions, including the firms’ hourly rates and the portfolio monitoring services the firms provide for many public pension funds.

 

Though the Florida process has all the virtues of transparency, the process itself did not eliminate the phenomenon of plaintiff’s lawyers’ campaign contributions to influential public officials. According to a December 12, 2009 St. Petersburg Times article (here), in the preceding 14 months, "lawyers and others tied to the firms interested in representing the SBA have spent at least $850,000 on Florida politics." The article quoted critics who suggested that "Florida’s short list mirrors the entrenched, pay-to-play culture between public pension funds and prominent class-action law firms."

 

In other words, as the law review article cited above demonstrates, the plaintiff’s law firms are in fact making political contributions to elected officials who are in a position to influence the counsel selection process. Whether or not the contribution are made for the purpose of influencing the counsel-selection process and whether the process is in fact influenced may be questions about which there may be a diversity of views; the plaintiffs’ lawyers are quick to defend their actions.

 

But I wonder whether this is going to be one of those kinds of issues that is out there and frequently noted, but then suddenly blows up when some very specific development moves it to the front burner. This is the kind of issue that could get people very excited if a certain combination of facts and circumstance should come to light. Even absent some dramatic revelation, the questions will continue, simply because of the way it looks.

 

Indeed, given the shadow it inevitably casts over plaintiffs' attorneys and their motivations, you do wonder why they continue these practices. More cynical minds might suggest that it is obvious why the plaintiffs lawyers don't stop.

 

　

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In an earlier post (here), I discussed legislation that Senator Arlen Specter introduced in July 2009 to legislatively overturn the U.S. Supreme Court’s decision in Stoneridge and allow private actions for aiding and abetting liability. Though this proposed legislation is a matter for serious concern, there was always the possibility that given everything that Congress has on its plate, this particular initiative might not make the cut.

 

There is, however, some significant likelihood that some form of financial reform legislation eventually will be enacted into law. Indeed, as discussed here, the House of Representatives has already passed its version of financial reform legislation.

 

The Senate has yet to act, but among the leading proposed Senate financial reform bills under consideration is Senator Chris Dodd’s proposed "Restoring American Financial Stability Act of 2009" (here).

 

As noted in a January 4, 2009 memo by K. Stewart Evans, Jr. of the Pepper Hamilton law firm (here), the bill contains a provision "hidden on page 795 of 1,136" that amends the ’34 Act to provide liability for any person that "knowingly or recklessly provides substantial assistance" to a person whose conduct violates the securities laws. Evans notes further that the provision would impose liability without the claimant having to even prove that reliance on the secondary actors’ statements.

 

My concerns about the possible imposition of aiding and abetting liability are reflected in my prior post. Evans has his own concerns, arguing that the proposed amendment would be "dangerous and destructive to American business."

 

But regardless of the merits of the proposal, the fact that it proposed amendment creating private aiding and abetting liability is no longer just its own free-floating suggestion, but has now been incorporated into a comprehensive piece of financial reform legislation does seem to suggest that the proposal could be that much closer to being enacted into law.

 

Of course, there is still a long way to go before we know whether or not the Senate will get around to enacting any financial reform legislation, much less what form that legislation might ultimately take. In addition, any bill passed by the Senate would have to be reconciled with the House’s bill, so what might finally emerge is at the point anybody’s guess.

 

But all of that said, the incorporation of the aiding and abetting provision into Dodd’s proposed Senate bill does seem to suggest the possibility that the aiding and abetting initiative will not simply fall by the wayside as the proposed legislation goes forward. Rather, at this point it looks like somebody is going to have to affirmatively knock the proposal out to prevent it from remaining in.

 

Dismissal of BAE Bribery Civil Suit Affirmed: As I have noted in prior posts (most recently here), allegations of bribery in connection with BAE’s fighter aircraft contract with Saudi Arabia – and in particular the UK’s election not to investigate the allegations due to national security concerns -- not only have proven highly controversial, but also has generated follow on civil litigation.

 

As discussed in a recent post on the FCPA Blog (here), on December 29, 2009, the Court of Appeals for the D.C. Circuit affirmed the lower court’s dismissal of the derivative lawsuit that had been filed against BAE, as nominal defendant, and certain of its directors and offices Judge Edwards, writing for the court found that under the 1843 English case of Foss v. Harbottle, 2 Hare 461, 67 E.R. 189, "the company, not a shareholder, is the proper plaintiff in a suit seeking redress for wrongs allegedly committed against the company."  The court further found that the BAE case did not come within any exceptions to the rule.

 

And Speaking of U.S. Lawsuits Against Foreign Companies: According to a January 6, 2010 Law.com article by Andrew Longstreth (here), the three-month long securities class action jury trial against Vivendi and certain of its directors and officers is drawing to a close. According to the article, the parties are now completing their closing statements, and the case will be submitted to the jury later this week.

 

Look for A Lot More Cases Like This in 2010: Though thecomplaint was actually filed in the Northern District of Georgia on December 31, 2009, the plaintiffs’ lawyer press release is dated January 4, 2010, and the investor lawsuit involving a failed bank make prefigure many more lawsuits of the same kind in the months ahead in 2010.

 

The lawsuit arises out of the failure of Haven Trust Bancorp, whose operating banking subsidiary was taken over by the FDIC on December 12, 2008. On February 23, 2009, the holding company filed for bankruptcy. The defendants include certain former officers of the holding company and the bank. The plaintiffs allege that the defendants misrepresented the bank’s financial condition and lending practices in order to induce the plaintiff investors to invest in the holding company. The plaintiffs assert claims under the federal securities laws, Georgia securities laws, as well as certain common law claims.

 

 In light of the 140 banks that failed during 2009, there undoubtedly will be more claims like this to come, both filed on behalf of investors and on behalf of the FDIC as receiver of the failed institutions.

 

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Securities class action lawsuit filings were "down sharply" according to the annual study of securities class action litigation released jointly today by the Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research. The full report can be found here and the January 5, 2010 press release accompanying the report can be found here.

 

According to the study, which found that there were a total of 169 securities class action lawsuit filings through December 21, 2009, the 2009 filings were both 24% below the 223 filings in 2008 and 14% below the annual average of 197 filings during the years 1997 through 2008.

 

The Stanford study reports a lower lawsuit count than previously published studies of the 2009 securities lawsuit filings, including the prior report of NERA Economic Consulting (refer here) as well as my own prior analysis (refer here). I discuss these differences below.

 

The relative decline in the number of lawsuit filings in 2009 compared to prior years, according to the Stanford report, is attributable in part to the decline in subprime and credit crisis related filings. Among other things, the report notes that there were only 17 subprime and credit crisis related lawsuits in the second half of 2009.

 

The press release accompanying the report also quotes Dr. John Gould of Cornerstone Research as saying that the observed decline is consistent with the decline in stock market volatility during 2009, noting that after increasing during the preceding two years, volatility declined both in the first and second halves of 2009.

 

The study also details the large number of filings that were characterized by "a substantial lag between the end of the class period and the filing" date, a phenomenon about which I written extensively in the past (most recently here). The report notes that the percentage of filings with a lag of more than a year has increased steadily from 5% in 2005 to a historical high of 18% in 2009.

 

According to the study, historically, class action lawsuit with longer filing lags "have been dismissed at a higher rate than class actions with shorter filings lags," at a rate of 55% for the one-year lag filings versus 42% for filings with a lag between one year and six months, and 36% with a lag of less than six months.

 

The study also notes that the lag filings are largely the work of the Coughlin Stoia law firm, which was "involved in 63% of the filings with lags longer than six months and 58% of filings with lags longer than a year." This activity levels compares to the firms involvement in 39% of all filings and 29 percent of filings with lags shorter than six months.

 

The press release quotes Stanford Law Professor Joseph Grundfest as saying, with respect to the lag filings, that the belated filings suggest that "plaintiffs are trying to fill the litigation pipeline by bringing older lawsuits that weren’t attractive enough to file while the firms were busy pursuing financial sector claims," adding that "these lawsuits are more likely to be dismissed and can therefore be characterized as lower quality claims" and that the filings may "reflect factors idiosyncratic to one large plaintiff firm’s strategy, and have little to do with larger market forces."

 

In addition to tracking the overall number of filings, the report also notes the number of lawsuits filed against unique issuers, which declined even more sharply than the overall number of filings. Thus, while the report found that overall filings declined by 24% between 2008 and 2009, the total number of unique issuers involved in securities lawsuits decreased by 32 percent. The difference in the attributable to the number of multiple filings against the same target, as well as the relatively large number of filings against private companies and other non-exchange traded entities.

 

The report further notes that of all exchange traded companies, 1.8 percent were defendants in federal securities class action lawsuits filed in 2009 compared to 2.6% in 2008 and compared to a 2.4% annual average for the 12 years ending December 2008.

 

The number of lawsuits against foreign issuers also declined in 2009, according to the study. After peaking at 16.4% of all filings in 2007, the percentage of filings against foreign issuers declined to 12.4% in 2009. The study attributes the relative decline to the falling off of the credit crisis lawsuits, because so many of the suits against foreign companies were related to the subprime and credit crisis.

 

Finally, the decline in 2009 credit crisis filings was also associated with a decline in market capitalization losses in 2009. The disclosure dollar loss attributable to 2009 class actions was $83 billion, a 62 percent decrease from 2008.

 

Some Thoughts about the Numbers: As noted above, the Stanford study’s 2009 lawsuit count varies from previously published figures, including my own. NERA reported 235 filings in 2009, and I reported 189 (I discuss the difference between my count and NERA’s in my prior post, here), compared to the 169 reported by Stanford.

 

I know that part of the explanation lies in the fact that the Stanford report cutoff at December 21, 2009, which meant that the Stanford study missed at least three more lawsuits filed before year end.

 

The Stanford study also counts multiple filings related to the same allegation against the same companies only once. This provides a partial explanation for the differences between the Stanford study and the NERA study, which separately counts separate actions in separate circuits unless and until the lawsuits are later consolidated.

 

Another difference between the studies may be the fact that the NERA study reported a projected year end number, as the result of an extrapolation from filings through mid-December. Though the Stanford study ended prior to year end, it did not incorporate any extrapolation for cases filed after the cutoff date and before year end.

 

All of these factors clearly are relevant but even collectively they don’t seem sufficient to explain the entire difference. Of course, another factor may simply be differences in information, but given that the plaintiffs’ lawyers put out press releases when they file lawsuits, the information differences likely account for only a small part of the differences in lawsuit counts.

 

All of this underscores a point that I made at length in connection with my own study of the 2009 filings, which is that readers would benefit enormously from knowing more about what protocols the various study publishers use when the are deciding what "counts."

 

The Stanford analysis is certainly easier to decode in this respect that other reports since the Stanford Clearinghouse publishes its list of lawsuits on its website — for free, which is a tremendous public service for which all of us should be grateful. But merely knowing which cases were put on the list does not tell us why those cases were included, nor does it tell us what other cases might have been omitted and why. (Indeed, the reason I continue to do my own count and analysis every year, even though Stanford publishes its own list for free on the web, is the uncertainty about what the list does and does not include.)

 

The Stanford report also gets high marks for stating right on its cover what it is included in its "research sample," which is very helpful and very commendable. But even taking this very explicit information into account, it still seems like there must be more going on that would explain the differences between the various reports.

 

Here are some illustrations of questions that would be helpful to know: Are securities lawsuits filed in state courts included? Are merger objection suits included? Are proxy solicitation misrepresentation cases included? How about lawsuits filed separately on behalf of equity shareholders and bondholders – one lawsuit or two? How about lawsuits that only allege state securities law violations? What kinds of cases are omitted from the count? What other sorting criteria are used?

 

The more of this type of information that readers are provided, the more helpful the published reports would be for readers. The approach that would be most helpful to readers would be for the reports to identify the way that their counting protocols differ from those used by other studies, in order to help readers understand the differences.

 

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What a difference a year makes. Just 12 months ago, the subprime and credit crisis litigation wave was in full spate, and the onslaught of Madoff and other Ponzi scheme cases had just begun to surge. And while both of these lawsuit filing trends continued well into 2009, by year’s end both of these phenomena had largely played out. At the same time, however, other litigation trends emerged as the year progressed, and in the end, the number of new securities class action lawsuits filed during 2009, though significantly below the number filed in 2008, was well within historical norms.

 

First, let’s run the numbers. By my count -- please see the note below about how I "counted" -- there were 189 new securities class action lawsuits in 2009, which is just below but within range of the 1966-2007 annual average of 192, although 15.6% below the 2008 total of 224 new securities lawsuits.

 

As was the case for the two preceding years, the 2009 lawsuit filings were largely driven by lawsuits against financially-related firms. Of the 189 new securities suits in 2009, 69 were against companies in the 6000 Standard Industrial Classification (SIC) code series (Finance, Insurance, and Real Estate). In addition, another 39 of the defendant firms targeted in 2009 securities class action lawsuits lacked SIC Codes. These lawsuit targets without SIC code designations included mutual funds, ETFs, and closed end funds. In general, the defendant entities that lacked SIC codes were all financially related.

 

If these two groups, the companies in the 6000 SIC code series and the entities that lacked SIC code designations, are added together, the total is 108. So these two groups together represented roughly 57.1% of the new lawsuits filed in 2009.

 

A significant factor driving this concentration of filings in the financial sector was the number of credit crisis-related lawsuits. By my count, there were 62 new credit crisis-related securities lawsuits filed in 2009, bringing to 205 the total number of credit crisis related securities lawsuits that were filed since the litigation wave commenced in February 2007. (My complete list of the subprime and credit crisis-related securities suits can be found here.)

 

But though the credit crisis litigation wave carried over into 2009, as the year progressed the number of credit crisis-related filings dropped off. So too did the concentration of filings against financial companies. Thus, while 72.6% of the lawsuits in the first half of 2009 were against financially-related companies, only 41.3% of the filings in the year’s second half involved financial companies.

 

And even though the lawsuits filed against financially related companies declined in the second half of the year, by and large, the rate of lawsuit filings overall did not decline. Thus, while there were 95 new securities class action lawsuits in the first half of 2009, there were 94 in the second half – virtually the same filing rate in both halves of the year.

 

Part of the reason that the overall lawsuit filing rate did not decline in the second half of the year even though the credit crisis-related lawsuits trailed off is that a couple of filing trends emerged in the second half of the year that fueled lawsuit filings and took up the slack.

 

The first of these two trends was the outbreak of a rash of lawsuits against leveraged exchange-traded funds (ETFs), which I discussed in a prior post here. By my count, there were twelve separate securities lawsuits filed against ETFs, all during the second half of 2009. These suits largely have been filed against leveraged ETFs drawn from within a single fund family, and all present more or less the same allegations (essentially that investors were not told that the funds would track their target measures or ratios only for very short periods). Because these lawsuits represent more than 6% of all new 2009 securities lawsuits, they represent a significant part of the year’s securities litigation activity.

 

The second trend that emerged during the second half of 2009 was the emergence of a significant number of belated lawsuit filings, where the lawsuit filing date came long after the proposed class period cut-off date, a phenomenon I discussed several times in the latter half of the year (most recently here). These belated filings appear to be the result of a lawsuit backlog that developed while the plaintiffs’ lawyers were preoccupied with the credit crisis related lawsuit filings.

 

By my count, 22 of the 94 securities lawsuits filed during the second half of 2009 were filed more than a year after their proposed class period cut-off date. In some instances, the lawsuit filings came at the very end of the two-year limitations period. For example, the Pitney Bowes securities class action lawsuit was filed one year and 364 days after the proposed class period cutoff date. Indeed, in at least two cases (the Avanir Pharmaceuticals case and the Regions Financial case), the filing came nearly three years after the proposed class period cutoff, raising a rather obvious question about how these cases will withstand statute of limitations objections.

 

The belated filings continued to arrive right through the end of the year, with several of December’s filings including cases with filing dates more than a year after the proposed class period cutoff date, including the new lawsuits filed against Siemens (about which refer here), NightHawk Radiology Holdings (here), and Terex (refer here).

 

Almost all of these backlog cases have been filed against companies outside the financial sector, which accounts in part for the shift in filings away from financial companies in the second half of 2009. That is, it appears that while the plaintiffs’ lawyers were rushing to file credit crisis-related lawsuits during the period mid-2007 through mid-2009, they were also building up a backlog of cases against nonfinancial companies, and now they are working off the backlog.

 

And so, while over half of the new securities lawsuits filed in 2009 involved financial companies, by year’s end, the 2009 securities lawsuits overall involved a broad spectrum of kinds of companies. The 2009 securities lawsuits were filed against firms in 90 different SIC Code categories. Many of these categories had lawsuits against only a single company. Outside the financial sector, the SIC code categories with the highest number of lawsuits were SIC Code category 2834 (Pharmaceutical Preparations), which had five lawsuits, and SIC Code category 2836 (Biological Products), which had four lawsuits.

 

The 2009 securities lawsuits were filed in 38 different federal district courts, but, due to the number of lawsuits against financial companies, the largest number of lawsuits (78, or about 41% of all 2009 lawsuits) were filed in the S.D.N.Y. The courts with the next highest number of 2009 securities lawsuit filings were N.D. Cal (12) and C.D. Cal. (9). There were five different courts -- D.N.J., E.D.N.Y., N.D. Ill., S.D. Fla., and S.D. Tex. – that had six securities lawsuit filings each. The eight courts with the highest number of 2009 filings together had 128 new lawsuits, or 67.7% of all 2009 securities lawsuit filings.

 

24 (or 12.7%) of the 2009 securities lawsuit filings involved companies that are domiciled outside the United States. These lawsuits involved companies from 12 different countries. The countries with the highest number of companies suit were the U.K. (with 6), Germany (with 5), and Canada (3).

 

Some Thoughts about Counting Securities Lawsuits: I know that many readers wonder why the various annual securities litigation studies report such materially different lawsuit filing numbers. The reason the studies’ lawsuit counts vary so widely is not just that the various studies’ authors have different information; another significant factor is that the different studies use different protocols to count lawsuits.

 

For example, some of the studies count duplicate complaint filings in separate circuits as a single lawsuit (that is, the case counts only once), while other studies count duplicate complaints filed in different circuits as separate lawsuits until they are formally consolidated (that is, the case can be counted multiple times). For my purposes, I count duplicate complaints only once regardless of whether there are duplicates filed in different circuits, which is one reason why my 2009 securities lawsuit count appears lower than, for example, NERA’s 2009 securities litigation study.

 

There is of course absolutely no reason why separate studies should not use their own preferred counting protocol. But I do believe that the studies’ readers would be enormously benefitted if each study would explicitly state what their study "counted" – that is, what does the study include in its tally of securities lawsuits, and what does it omit?

 

In the best of all worlds, the studies would also explain how their methodology differs from those used by other published reports. These reports do not after all exist in a vacuum, and by and large the audience for each of the various reports basically consists of the same group of readers. It would be helpful, I think, if the reports were to recognize both the fact that their audience reads the other reports and that these readers want to understand any and all identifiable reasons why the various reported numbers differ.

 

In my own analysis of the 2009 securities lawsuit filings, I have tried to tally up the separate class action lawsuits seeking to recover damages under the federal securities laws. I don’t count lawsuits that were not filed as class actions; that do not seek to recover damages; or that don’t allege violations of the federal securities laws. Thus, for example, I would not count a lawsuit that alleges common law fraud but that does not allege a securities fraud under the federal statutes. I would not count an indiviudal lawsuit that does not purport to proceed as a class action.

 

Two particular recurring lawsuit categories that I do not count are merger objection lawsuits, where the lawsuit’s goal is simply to increase a proposed acquisition price; and lawsuits against private entities in which the plaintiffs’ allegation is that the defendants failed to register securities.

 

Even within my overall counting criteria, it can sometimes be very difficult to determine whether or not a new complaint represents a new lawsuit or is merely a duplicate of a previously filed complaint. For example, in December, when plaintiffs’ lawyers filed a complaint on behalf of Bank of America bondholders relating to the Merrill Lynch acquisition and bonus payments, the question arose whether the complaint counted as a separate lawsuit, or was just a duplicate of the suit filed earlier in the year on behalf a purported class of Bank of America equity securityholders?

 

In the end, I concluded that because the two complaints involved separate classes of claimants, the bondholder suit represented a separate lawsuit that should be counted separately. This is undeniably a very close question, and reasonable minds might well reach a different conclusion.

 

Because there are many of these kinds of close questions in the course of trying to keep a count of securities lawsuit filings, it is almost inevitable that different lawsuit counts will vary. But though the variance of lawsuit counts may be inevitable, readers at least want to be able to understand the reasons why the lawsuit counts vary. The publishers of the various annual securities litigation studies would significantly benefit their readers if they were to explicitly and expressly state (and not just in footnotes or endnotes, but in a conspicuous way) what their study purports to be counting, and what protocols were used to determine what was and what wasn’t included in the count.

 

It would be even more helpful to readers if the reports were to recognize that their readers also read the other reports and to state explicitly and expressly how their methodology may differ from the other annual litigation studies.

 

I know the various annual litigation study publishers view themselves as in competition with each other, and so it may be difficult for them to acknowledge each other’s existence. They may believe that it as not their job to explain competing analyses. However, each publisher’s silence on these issues means the readers are left on their own trying to figure out why the numbers vary so widely.

 

The fact is that most of us read all of the reports. I feel quite confident in saying that readers would find it extremely helpful to have better information to understand why the studies’ numbers differ. The reports that recognize and their readers’ needs into account would win their readers’ loyalty, gratitude and appreciation.

 

Speakers’ Corner: On January 4, 2010, I will be presenting with Jason Cronic of the Wiley Rein law firm on a panel entitled "Directors and Officers Liability Insurance" at the Practicing Law Institute's Current Developments in Insurance Law 2010 conference. Background regarding the conference can be found here.

 

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Broadcom Corporation, which previously settled its options backdating related derivative suit for $118 million, announced on December 29, 2009 (here) that it had settled the separate options backdating related securities class action lawsuit pending against the company and certain of its directors and officers in exchange for its agreement to pay $160.5 million. The settlement is subject to court approval.

 

Because the company provided its D&O insurers with complete releases in connection with the prior derivative settlement, Broadcom apparently is funding the class action settlement entirely out of its own resources. Broadcom’s press release states that it will be recording the settlement amount as a one time charge in its fourth quarter 2009 financial statements.

 

Broadcom’s option backdating issues were of course recently in the news in connection with Judge Cormac Carney’s dramatic December 15, 2009 dismissal of the criminal indictments that were pending against several individual former directors and officers of the company. With the dismissal of the criminal charges and the settlements of the derivative and class action cases, Broadcom seems one step closer to finally putting its option backdating issues to rest. Judge Carney also dismissed the options backdating-related SEC enforcement action as well, though the SEC action dismissal was without prejudice. Judge Carney did also "discourage" the SEC from refilng its complaint.

 

In light of the circumstances surrounding Judge Carney's dismissal of the criminal indictments, the size of the class action settlements is interesting. It certainly seems that given the concerns that Judge Carney noted in dismissing the indictments that the class action plaintiffs might face some formidable obstacles on key aspects of their case, including in particular in establishing that the defendants acted with scienter.

 

The dismissal of the criminal indictments doesn't seem to have prevented a very substantial settlement of the class action, however. Indeed, the timing of the class action settlement, coming just two short weeks after the indictments were dismissed, seems to suggest that the elimination of the criminal case somehow opened the way for the class action settlement. Who knows, perhaps with the prosect of finally putting the options backdating woes in the past, the company moved quickly to get the class action case settled so that it might move on.

 

The Broadcom class action settlement is the third largest of the options backdating-related class action settlements, after the UnitedHealth Group settlement ($925.5 million) and the Comverse Technology settlement ($225 million). The Broadcom settlement, at $160.5 million, is just slightly larger than the $160 million Brocade Communications class action settlement.

 

With the addition of the Broadcom settlement, 32 of the 39 options backdating-related securities class action lawsuits that were filed have now been resolved. 23 of the cases have been settled and nine have been dismissed. My complete list of options backdating related lawsuit resolutions can be accessed here.

 

According to data that Adam Savett of the Securities Litigation Watch has been maintaining (here) , and with the addition of the Broadcom class action settlement, the 23 options backdating related settlements total approximately $1.94 billion. The average options backdating class action settlement has been $84.3 million, but if the massive UnitedHealth Group settlement is taken out of the equation, the average drops to about $44.1 million.

　

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In a December 4, 2009 order (here), Southern District of Ohio Judge Michael H. Watson granted the defendants’ motion to dismiss the consolidated subprime-related securities class action lawsuit against Huntington Bancshares. Judge Watson granted the motion based on his findings that plaintiffs had failed to adequately allege both falsity and scienter. The dismissal is with prejudice.

 

Background

In December 2006, Huntington and Sky Financial announced their plans to merge. In July 2007, Huntington’s $3.3 billion acquisition of Sky closed. For many years, one of Sky’s clients had been Franklin Credit Mortgage Corporation. Franklin originated subprime mortgage loans, some of which it sold in the secondary mortgage market. For seventeen years, Sky made loans to Franklin that Franklin used to finance its mortgages. In July 2007, Sky had $1.5 billion exposure to Franklin.

 

On November 16, 2997, Huntington alerted its investors that Franklin recently announced the deterioration of its mortgage portfolio. Huntington announced that because of Franklin’s announcement, it (Huntington) would be taking a fourth quarter after-tax charge of $300 million to build up its allowance for loan losses. Huntington also stated that it expected to report a fourth quarter loss. On this news, Huntington’s share price declined from $16.08 to $14.75.

 

Plaintiffs filed a securities class action lawsuit on behalf of investors who purchased Huntington shares between the date of the merger and November 16, 2007. Plaintiffs allege that Huntington’s acquisition of Sky subjected Huntington to significant subprime exposure because of Sky’s relationship with Franklin. The plaintiffs allege that Huntington misled investors regarding its ability to weather the deteriorating real estate and subprime mortgage market. The defendants moved to dismiss.

 

The December 4 Order

In his December 4, Judge Watson granted the defendants motion to dismiss, on the grounds that the plaintiffs had failed to adequately allege falsity and scienter.

 

In reaching the conclusion that the defendant had not adequately alleged falsity, Judge Watson noted that:

 

The Complaint does not allege any specific facts that Huntington’s disclosures were incompatible with any reports, data, or signs that Franklin would be unable to pay its loans to Huntington, nor does the Complaint do anything more that allege Defendants should have known the continuing erosion of the real estate market would render the loan portfolio precarious. Significantly, Huntington’s public statements all address the faltering real estate market, … increases in delinquencies in the industry, and the prospect of increases of allowances for loan and lease losses. No information suggests Huntington knew of Franklin’s situation prior to Franklin’s own announcement that it was having problems.

 

Even though Judge Watson concluded that the plaintiffs’ failure to allege falsity was a sufficient basis on which to dismiss the complaint, he separate analyzed the scienter issue as "an alternative basis" for his ruling.

 

After reviewing the plaintiffs’ allegations, Judge Watson found that the Plaintiffs "fail to establish a strong inference of scienter." He noted that:

 

Viewed in their aggregate, Plaintiffs’ allegations do not give rise to a "cogent" inference that Defendants possessed the requisite knowing or reckless intent to manipulate, deceived or defraud. The allegations concerning Huntington’s alleged knowledge after the due diligence period during the acquisition, the self-interested motives of Defendants, and the closeness in time of the supposed fraudulent statements and later disclosures, all lack the factual particularity that would support an inference of fraudulent intent that is "at least as compelling as any opposing inference."

 

Judge Watson’s dismissal ruling was with prejudice.

 

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

 

Special thanks to Adam Savett of the Securities Litigation Watch blog for providing me with a copy of the Huntington Bancshares ruling.

 

Amended Complaint Survives Former IndyMac’s CEO’s Dismissal Motion: In a contrary development in a high profile west coast subprime-related lawsuit, on December 11, 2009, Central District of California Judge George Wu’s denied the motion of former IndyMac CEO Michael Perry to dismiss the plaintiffs’ Fifth Amended Complaint. Judge Wu’s minute order entry of his ruling can be found here.

 

The tortured procedural history of the IndyMac case, which among things led up to the filing of five amended complaints, can be found here. As a result of this twisted procedural path and Judge Wu’s December 11 ruling, this IndyMac suit will now go forward solely as to Perry.

 

Judge Wu’s December 11 ruling adds the IndyMac case to the now growing list of subprime lawsuits that were initially dismissed but that following amended pleading survived renewed motions to dismiss, including, for example, the WaMu case (here) and the PMI Group case (here).

 

I have in any event also added the December 11 ruling in the IndyMac case to my tally of dismissal motion rulings, linked above.

 

Apology: I sincerely apologize for the faulty link to the transcript of the hearing in the Broadcom case in yesterday’s blog post. Readers who were frustrated because they could not access the transcript can find a correct link to the transcript here. I have also corrected the link on the blog post.

 

Again, I apologize for the error, which is just one of those things that can happen with late-night blogging.

 

Sometimes I really wish I had a fact-checker or editor following along behind me to protect against blogging boo-boos like that.

　

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On December 15, 2009, NERA Economic Consulting released its annual study of securities class action litigation trends. The study, entitled "Recent Trends in Securities Class Action Litigation: 2009 Year-End Update," and written by my friends Stephanie Plancich and Svetlana Starykh, can be found here. The study concludes that, notwithstanding the decline in credit crisis related filings in the second half of 2009, the projected year-end filing levels will be within historical norms. Average and median securities class action settlements are also consistent with recent trends.

 

According to the study, credit crisis related filings, which predominated class action filings during 2007 and 2008, "gradually declined" as 2009 progressed. Despite this decline, the total number of securities suit filings has not dropped off, "as other types of cases replaced credit crisis filings."

 

Based on NERA’s own counting methodology (which, as is explained in footnote 2 of the report, counts separate filings in separate circuits as separate lawsuits until the cases are consolidated), NERA counted 215 securities class action lawsuit filings through November 30, 2009, which projects to 235 filings by year end. Though the projected total of 235 would be below the 2008 level of 253 filings, it is well within the 1997-2004 average of 231 annual filings.

 

Although the 2009 filing levels look as if they will fall within historical levels, the 2009 filings were swollen by at least a several phenomena that may be short lived. Thus, for example, 36 of the 2009 filings involve Ponzi schemes. Though there may continue to be Ponzi scheme revelations as we head into 2010, it does seem likely that there may be fewer of those stories ahead.

 

Similarly, the 2009 filings were also increased by 13 new cases related to leveraged ETFs. (My prior post about ETF-related lawsuits can be found here). Though there may be further ETF cases yet to come, this group of cases seems likely to decline, as virtually all of these filings relate to a single family of funds and all relate to a single set of disclosures about the funds’ performance over time.

 

A third filing pattern that may not continue going forward is the number of cases in which the filing date falls well after the proposed class action cutoff date. (My most recent post about these apparently belated securities suit filings can be found here.) The NERA study shows that during the second half of 2009, the average time between the end of the class period and the date of the first filing lengthened to 279 days (versus a period of 161 days for suits filed during the preceding three years). The NERA study speculates that this may be a reflection of the fact that plaintiffs firms have been "focused on the large credit crisis cases over the last two years," but that they are "now able to focus on bringing other, non-credit-crisis cases with older class periods."

 

The NERA study reports that cases in 2009 continued to be clustered in the financial sector, with 53% of all filings naming a defendant in the finance sector. Another sector that has continued to see substantial activity is the health technology and services sector.

 

As far as case resolutions, the NERA study reports that for cases that were filed in 2000, 36% have been dismissed and 61% have settled, but that "even almost a decade after filing, there are still approximately 3% of cases that have yet to reach a final resolution," which underscores the fact that in some instances these cases can take as much as a decade or more to resolve.

 

Of course, the majority of cases filed in recent years remain pending. For these most recent cases, a higher proportion of resolutions have been dismissals rather than settlements, which the NERA study notes "is unsurprising, as motions to dismiss are usually fled relatively early in the litigation process, often before settlement discussions commence." Ultimately however, the NERA study comments, "we expect that a higher proportion of these recent filings will result in settlements."

 

With respect to the credit crisis cases, the NERA study notes that over 80% of the cases remain pending, with only 15% of the cases dismissed compared to only 4% (nine cases that have settled.) My running tally of subprime case resolutions can be accessed here. The NERA report comments that this pattern is consistent with observed patterns in which early on more cases are dismissed but that ultimately over time a large proportion of cases settle than are dismissed.

 

As far as settlements, the NERA study reports that the average securities class action settlement in 2009, if the IPO laddering settlement is removed from the equation, was $42 million, which is substantially above the 2003-2009 average of $29 million, but which is consistent with the overall trend, which is that "there has been a general increase in the average settlement values since 1996."

 

But though the average settlements continue to increase, median settlements have held relatively steady. In 2009, the median settlement was $9 million, similar to the medians in 2007 ($9.4 million) and 2008 ($8.0 million).

 

Over the past several years, the ratio of settlement to investor losses has held steady at around 2.5%. The NERA study speculates that because this ratio has held reasonably steady and because investor losses historically have been correlated with settlement values, the fact that investor losses in cases filed during 2007 and 2008 were significantly higher than prior years may be "a signal of potentially higher settlements in the future," as the 2007 and 2008 cases move toward settlement.

 

As always, the 2009 version of the NERA study provides interesting and thorough analyses. It is worth noting that, because the NERA study "counts" separate filings in separate circuits as separate filings as separate cases, the NERA filing will differ from (and almost certainly be higher than) the figures that other commentators may report in their year end reports.

 

One thing about the average and median settlement figures that I think all observers should keep in mind is that these figures do not include defense expense, which can be considerable and in many cases can represent a significant percentage of the settlement amounts. In addition, these class settlement figures do not reflect the value of any separate opt-out settlements, nor do they reflect the amounts of other litigation settlements, such as might be incurred in connection with parallel derivative or ERISA class action lawsuits.

 

My point is that as impressive as the settlement figures reflected in the NERA report are, they represent only a portion of the litigation exposure that the affected companies may have faced, and therefore represent only a partial and incomplete measure, for example, of what insurance limits may be sufficient to protect companies and their directors and officers from their claim exposures.

 

NERA’s December 15, 2009 press release regarding the 2009 study can be found here.

 

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In a landmark development for private securities litigation in Canada, a Justice of the Ontario Superior Court has ruled that a proposed securities suit against IMAX under Ontario’s new statutory provisions allowing private securities litigation may proceed. The court separately certified a global class of IMAX investors on whose behalf the case will now proceed.

 

According to a December 14, 2009 National Post article (here), Ontario Superior Court Justice Katherine van Rensberg, in two separate orders, granted the plaintiffs leave to bring the case and certified the action as a class suit, allowing plaintiffs to proceed with their case against several IMAX directors and officers over disclosures in the company’s 2005 financial statements. Justice van Rensberg's December 14, 2009 opinion granting the plaintiffs' motion for leave can be found here. Her December 14, 2009 opinion granting the plaintiff's motion for class certification can be found here.

 

 

Justice van Rensberg’s decisions are, according to the Post article “groundbreaking” because the case is the first to test recent revisions to the Ontario Securities Act that potentially made it easier for disappointed investors to bring actions for civil liability against directors and officers of public companies for misrepresentations in public disclosure documents. 

 

 

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

 

 

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

 

 

The significance of Justice van Rensberg’s decision in the IMAX case is that, according to Justice van Rensberg, the IMAX case represents "the first .case in Ontario in which the court has been asked to grant leave in such an action." She also observed that the statutory provision "has never been interpreted previously" adding that there is no other statutory similar statutory provision in force in any other Canadian jurisdiction.

 

 

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

 

 

Of particular significance is Justice van Rensberg's conclusion that the standard to be used in determining whether a case should proceed is relatively low. With respect to the first part of the test, she said that "there is no reason to read in a 'high' or 'substantial' onus requirement for good faith in this type of proceeding." She also ruled against a more onerous threshold for the "reasonable possibility of sucess" part of the test, stating that "a threshold that is too difficult may have little deterrent value" and that an onerous threshold "may unduly lengthen and complicate the leave procedure." 

 

 

In a portion of the ruling that is of particular significance for outside directors serving on the boards of Canadian corporations, Justice van Rensberg specifically held that the statutory thresholds had been met with respect to several outside director defendants who served on the audit committee to the board or who otherwise had oversight responsibilties for the company's disclosure documents. 

 

 

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

 

 

In certifying the class, van Rensberg specifically rejected the defendants' arguments that the court could not include within the class the 80 to 85% of IMAX shareholders who resided in the U.S. or were otherwise non-Canadian. The defendants argued that it would be "extraordinary" for the court to recognize a class where most of the class members resided outside the jurisdiction. The defendants also argued that given the pendancy of the separate securities lawsuit pending in the U.S., it would be "premature" for the court to certify a worldwide class.

 

 

In rejecting the defendants' arguments against certification of a worldwide class, Justice van Rensberg took particular note of the arguments that the defendants had raised in opposing class certification in the U.S. securities lawsuit, in which they had also argued against the certification of a global class in that case as well. The defendants in particular had urged the superiority of the Canadian action, leading van Rensberg to conclude that the defendants were trying to have it both ways.

 

 

Justice van Rensberg went on to conclude that the court had authority to certify an international class, noting that the case had a real and substantial connection between the claims asserted on behalf of the foreign class members and the jurisdiction. She also specifically rejected the argument that that the existence of the parallel U.S. proceeding represented a reason not to certify a global class in Canada.

 

 

The Post article quotes two leading Canadian plaintiffs’ class action securities attorneys, who predictably find much to like with the court rulings. Dimitri Lascarias, of the Siskinds law firm, who is co-lead counsel for the plaintiffs in the case, is quoted as saying the decisions represented a “huge undertaking” for the court because there are “no parallels.” He is also quoted as saying that “it’s a very good day for the investing public in Canada. For a long time it’s been difficult for them to advance their claims in a class action setting. Finally, there’s relief on the class-action horizon.” (The other co-lead counsel on the case was Jay Strosberg of the Sutts Strosberg firm.)

 

 

UPDATE: Dimitri Lascaris emailed me the following additional comment on the IMAX case: "We are obviously pleased with the decision, and are particularly gratified that the court certified a global class. Insofar as canadian issuers are concerned, the proper place for the rights of their shareholders, whether foreign or domestic, to be adjudicated is this country. "

 

 

I previously wrote about the IMAX case here in a post in which I raised the question about whether an action in Ontario might be used as a way to obtain discovery that could be used to support a parallel securities action pending in the United States. While that concern may remain, it may be likelier in light of these rulings that litigants may seek to pursue claims in Ontario not to support litigation elsewhere, but for its own sake and purposes, without reference to litigation in the U.S. or elsewhere. That said, the principles reflected in these rulings will be most compelling with respect to Canadian based corporations, suggesting that it is unlikely that the Ontario courts will be flooded with securities litigation involving companies from outside Canada.

 

 

With respect to Canadian companies, these rulings in the IMAX case unquestionably represent significant developments, and they suggest that there potentially could be significant additional litigation to come in the Ontario courts. Both Justice van Rensberg's ruling that a low threshold should apply on a motion to leave and that an Ontario court may certify a worldwide class, if followed by other courts, could make Ontario an attractive jursidiction in which to pursue securities litigation, at least with respect to Canadian companies if not with respect to companies domiciled or based elsewhere.  

 

 

Julie Triedman has a December 15, 2009 article on the Am Law Litigation Daily (here) about the IMAX decisions that among other things quotes Lascaris as saying that the court certified of global class "and the door is now open for foreign investors to benefit from that protection."

 

 

UPDATE: Loyal reader and blog friend, Dave Williams of Chubb, sent me an email reminder that he will be chairing a panel on Securities Litigation developments in Canada at the PLUS D&O Symposium in New York on February 3-4, 2010. Background infromation regarding the Symposium can be found here. Speakers at the panel will include Justice Colin Campbell and Dimitri Lascaris, among others.

 

 

Very special thanks to Dimistri Lascaris for providing me with copies of Justice van Rensberg's opinions in the IMAX case.  

 

 

I welcome comments on this blog from readers on these developments, particularly from my many friends north of the border that I know regularly read this blog.

 

 

Book Note: While I am in a Canadian mode, I want to recommend a recent excellent biography of Samuel de Champlain, the French explorer, navigator and mapmaker. In his splendid book Champlain's Dream, author David Hackett Fischer (who also wrote the excellent book, Washington's Crossing) tells Champlain's extraordinary story.

 

 

Fischer convincingly argues that the success of French attempts to explore and colonize  North America were largely the result of Champlain's persistent and courageous efforts. The portrait that emerges is one of a man of uncommon bravery and intelligence, who mastered not only the arts required for voyages of discovery but also the tact and finesse required to maintain necessary relations at court during the reigns of several French monarchs.  

 

 

Fischer also argues that Champlain was a noble and perhaps even heroic figure, in part because of his insistence that the Native Americans the French settlers encountered should be treated with dignity and respect. As a result, the French were able to establish far more amicable relations with the locals than were the English, Dutch and Spanish colonists.

 

 

A particularly good review of Fischer's book from the October 31, 2008 New York Times can be found here.

 

 

 

What Passes for Humor These Days: My 16-year old son: “What’s brown and sticky?” Me: “I don’t know, what’s brown and sticky?” My son (after a pause): “A stick.” 

 

 

He told me that one right after he asked me, “What do you call cheese that isn’t yours?” Me: “I don’t know, what do you call cheese that isn’t yours?” My son: “Nacho Cheese.” (You might have to repeat that last one out loud a couple of times.)

 

 

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On December 11, 2009, the U.S. House of Representatives approved by a 223-202 vote "The Wall Street Report and Consumer Protection Act of 2009," H.R. 4173 (here). The sprawling 1279-page Bill, which must be reconciled with competing financial reform legislation pending in the Senate, would institute a number of reforms and initiatives that would have a dramatic effect on the financial services industry.

 

In addition to the many higher profile institutional reforms, the Bill also incorporates a number of revisions and amendments that could significantly impact both SEC enforcement actions and private securities litigation.

 

The House Financial Services Committee’s two-page summary of the Bill can be found here. The Committee’s three page list of the Bill’s "highlights" can be found here.

 

The Bill’s high profile reforms include, among other things, the creation of a Consumer Financial Protection Agency; the creation of a Financial Stability Council to identify large, interconnected firms that could put the financial system at risk; the creation of a single federal banking regulator; and the introduction of various regulatory reforms regarding financial derivatives and credit default swaps. The Bill also required hedge funds and private equity funds to register with the SEC.

 

As reflected on the RiskMetrics Corporate Governance Risk & Governance Blog (here), the House Bill also introduces a number of corporate governance reforms, including an annual "say on pay" mandate and authorization for the SEC to issue a proxy access rule. The bill includes a permanent exemption for small issuers (those with less than $75 million in market cap) from the outside auditor attestation requirements of the Sarbanes-Oxley Act.

 

In addition to these higher profile initiatives, the House bill also incorporates variety of legislative revisions to the federal securities laws that could affect securities litigation. Some of these initiatives were the subject of separate legislative proposals that have now been incorporated into the larger financial reform legislation.

 

The House Bill’s provisions that potentially could impact securities litigation include the following:

 

1. Credit Rating Agencies (Section 6003): Clarifies the pleading standard applicable to private securities actions under the ’34 Act against "a nationally recognized statistical rating organization" by specifying that "it shall be sufficient for purposes of pleading any required state of mind for purposes of such action that the complaint shall state with particularity facts giving rise to a strong inference that the nationally recognized statistical rating organization knowingly or recklessly violated the securities laws."

 

The Section also specifies that NRSRO’s credit rating opinions "shall not be deemed forward looking statements."

 

2. Mandatory Arbitration (Section 7201): Gives the SEC authority to "prohibit, or impose conditions or limitations on the use of, agreements that require customers or clients of any broker, dealer, or municipal securities dealer to arbitrate any future dispute between them arising under the Federal securities laws."

 

3. Whistleblower Incentives and Protection (Section 7203): Gives the SEC authority to "pay an award or awards not exceeding an amount equal to 30 percent, in total, of the monetary sanctions imposed in the action or related actions to one or more whistleblowers who voluntarily provided original information to the Commission that led to the successful enforcement of the action."

 

4. Aiding and Abetting Liability (Section 7207): Amends the ’33 Act and the Investment Company Act of 1940 to provide that for purposes of an action brought by the SEC, "any person that knowingly or recklessly provides substantial assistance to another person in violation of a provision of this Act, or of any rule or regulation issued under this Act, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided."

 

Section 7215 also clarifies that recklessness is a sufficient basis on which to impose aiding and abetting liability under the ’34 Act

 

5. Extraterritorial Application of the Federal Securities Laws (Section 7216): Amends the ’33 Act, the ’34 Act and the Investment Advisors Act of 1934 to clarify that federal court jurisdiction for securities cases includes cases that involves "conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors" or "conduct occurring outside the United States that has a foreseeable substantial effect within the United States."

 

6. Deadlines for Enforcement Investigations and Compliance Examinations (Section 7209): Introduces, subject to certain specified exemptions, certain time requirements within which the SEC must complete enforcement investigations and compliance examinations. Among other things, the Section provides that, other than with respect to certain "complex action," within 180 days after serving someone with a Wells Notice, the SEC must either initiate an action against the person or provide notice that it does not intend to file an action.

 

The House Bill also dramatically increases SEC funding, doubling the agency’s budget in five years. The Bill also expands the agency’s subpoena powers and its ability to share and access information gathered by other regulatory and investigative bodies and agencies.

 

Readers of this blog will also be interested to know that Section 8802 of House Bill also creates a Federal Insurance Office within the Treasury Department. The new Federal Insurance Office would not replace state regulation of insurance. Rather, the new agency would monitor the insurance industry; designate insurers for stricter oversight; assist in the administration of TRIA; coordinate on international insurance regulation; and consult with states on insurance matters of national importance.

 

It remains to be seen whether any of these provisions will survive the forthcoming legislative process and actually become law. The Wall Street Journal’s front page article about the House Bill (here) indicates that Democratic leadership in the Senate has committed to having a reconciled agreement in principle about the financial reform legislation by the end of December, to have a bill enacted in the first half of 2010.

 

While the legislation that finally emerges will undoubtedly reflect further changes, it is interesting to observe even at this preliminary stage how some of the proposed initiatives have fared.

 

For example, though it contains provisions addressing the SEC’s authority to enforce aiding and abetting liability under the ’33 Act and under the Investment Advisors Act, the House Bill, at least, does not contain any provisions along the lines of those proposed last summer by Senator Arlen Specter to overturn Stoneridge. Nor does the House Bill contain any provisions reflecting Senator Specter’s initiative to overturn Iqbal. Of course, because those initiatives originated on the Senate side, they may still be incorporated into the Senate version of the financial reform bill and perhaps even in the final version of the reform legislation that ultimately emerges.

 

As noted above, the House Bill does incorporate suggested provisions that would clarify federal court jurisdiction in matters involving companies or persons outside the U.S. These provisions mirror the proposed legislation that Representative Paul Kanjorski introduced earlier this fall (as discussed in a prior post, here.) This jurisdictional provision, if enacted, could make the National Australia Bank case, on which the U.S. Supreme Court recently granted a petition for writ of certiorari, of considerably less potential significance, as jurisdictional issues raised in the case would be controlled in future by the new statutory provisions.

 

Given the current political climate, it seems probable that some form of financial reform legislation will be enacted prior to the 2010 congressional election. The ultimate version may be far different that the Bill approved by the House on Friday. However, if the House Bill is any indication of what might finally emerge, there could be some enormous changes ahead, including among other things significant changes relating to securities litigation and enforcement.

 

Random Thought: Is there anything more unintentionally ironic and completely self-negating than the phrase "This Page Intentionally Left Blank"? (This Internet being what it is, there is actually a website devoted to the phrase, here.)

 

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On December 7, 2009, NERA released its most recent update on trends in the numbers and values of settlements of SEC enforcement actions. The latest study, which is as of September 30, 2009 and complete through the end of the SEC’s 2009 fiscal year, shows that the number of settlements during the year declined for the second straight year, but the average settlement amount increased, and the median settlement amount held steady. NERA’s December 7 press release regarding the study can be found here.

 

As the report notes, because the 2009 settlements largely relate actions initiated in earlier periods, they may or may not be indicative of what reasonably may be expected in the SEC’s current heightened enforcement environment.

 

In addition, the reports observations about the high frequency of individual participation in the settlement of SEC enforcement actions may provide important additional context for Judge Rakoff’s recent high profile rejection of the proposed settlement of the SEC’s enforcement action involving the Merrill Lynch bonuses.

 

First, with respect to the numbers of settlements, the report shows that there were 626 settlements in fiscal 2009, compared to 673 in fiscal and 717 in fiscal 2007. Among other things, the report notes that fiscal 2009 was a year characterized by staff turnover and transition for the agency’s top leadership, which may be relevant to understanding the relative decline in the numbers of settlements.

 

Monetary payments were a component of 58.6% of company settlements and 58.9% of individual settlements for FY 2009. The average monetary SEC settlement during fiscal 2009 was $10.7 million, compared to only $4.7 million in fiscal 2008, but the increased 2009 average is largely a reflection of several very large settlements during fiscal 2009, including, for example, the $350 million Siemens paid in settlement of the FCPA enforcement action the agency filed against the company. Removing the settlements in excess of $100 million reduces the FY 2009 average to $4.4 million.

 

By contrast to the average, the median SEC enforcement settlement was about $1.0 million, about equal to the prior fiscal year’s median.

 

Among largest source of SEC enforcement actions are cases involving alleged misstatements. In an interesting analysis of the relationship between individual and corporate settlements in misstatement cases, the report notes that between the enactment of SOX and the end of FY 2009, the SEC had reached settlements in 353 cases involving alleged misstatements by corporate companies. Of these 353 settlements, 62 involved only the company, 99 cases involve only individual directors or employees, but the remaining 192 cases involved both the company and individuals.

 

In other words, individuals participate to a greater or lesser extent in the vast majority of SEC enforcement actions involving misstatements. As the report points, this pattern presents interesting additional context for Judge Rakoff’s high profile rejection of the SEC’s proposed settlement of the Merrill Lynch bonus enforcement action. Judge Rakoff faulted the proposed settlement because it fined the company (and its shareholders) but not the supposedly blameworthy individuals.

 

The report notes that this outcome is likely to spur the SEC to pursue individuals with "renewed vigor" and indeed SEC officials have made statements to that effect. The SEC’s own settlement patterns show that in general it is the agency’s practice to involve individuals in settlement of restatement cases.

 

The report reflects a number of different interesting findings, and also contains some helpful and interesting tables, including lists of the ten largest corporate and individual post-SOX settlements, as well as interesting data showing relating to the number of insider trading settlements – somewhat unexpectedly, the number of inside trading settlements hit a post-SOX low during fiscal 2009.

 

The report concludes with the observation that the full impact of the reforms that the SEC has only just begun to initiate "is likely yet to be seen." The report suggests that the trends observed in the most recent report are likely to change in the periods ahead.

 

SEC Files Enforcement Action Against Former New Century Officials: Perhaps as a reflection of the newly more active SEC, on December 7, 2009, the SEC filed an enforcement action in the Central District of California against three former New Century Financial Corporation officials.

 

The SEC’s complaint, which can be found here, alleges that the three defendants violated the securities laws failed to disclose important negative information, including dramatic increases in early loan defaults, loan repurchases, and pending loan repurchase requests. Defendants knew this negative information from numerous internal reports they regularly received, including weekly reports ominously referred to internally as "Storm Watch." The SEC’s December 7 litigation release about the action can be found here. 

 

The timing of the SEC's enforcement action against the three New Century officials stands in interesting contrast to the private securities class action lawsuit filed against certain former New Century officials. The private securities, which was the first of the subprime related securities class action lawsuits when it was first filed in February 2007, is nearly three years old. The court denied the defendants' motion to dismiss almost exactly a year ago.

 

 

 The more interesting question is whether the filing of the New Century action represents the first in a series of enforcement actions related to the subprime meltdown and credit crisis. In light of the new environment at the agency and the pressure it is under to reestablish its regulatory credentials, there may well be further actions yet to come.

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More than three years have passed since the first blockbuster revelations about corrupt payments at Siemens, yet litigation arising from the scandal continues to emerge. On December 4, 2009, plaintiffs’ lawyers filed a securities class action lawsuit in the Eastern District of New York against Siemens, based on alleged misrepresentations following initial revelations of the improper payments. The complaint, which can be found here, has a number of interesting features and it potentially raises complicated issues.

 

As reflected in a prior post (here), the bribery scandal at Siemens hit the front pages of the world’s financial papers in late 2006 after more than 200 German police raided the offices and homes of over 30 current and former Siemens employees. The ensuing investigation and enforcement action culminated in the December 15, 2008 announcement (here), that Siemens had agreed to pay a total of $350 million in disgorgement to the SEC, a criminal fine of $450 million to the U.S., and a fine of 395 euros to the office of the Prosecutor General in Germany.

 

The recently filed securities suit refers extensively to the SEC’s enforcement complaint against the company. But though the class action complaint is inextricably linked to the company’s bribery revelations, the complaint is not about the bribery disclosures as such. Rather, the complaint purports to be based on company statements about its business prospects and its ability to compete without making improper payments.

 

That is, the complaint alleges that the company claimed that it "had cleaned up [the] corporate-wide scandal and that it would meet its publicly announced revenue and earning projections" – but, the complaint further alleges, "Siemens ability to generate revenues and achieve earnings expectations was clearly dependent on its corporate-wide bribery activities."

 

Consistent with the theory that the complaint is not about the bribery itself but about the company’s claims about how it would fare as a bribery-free competitor, the proposed class period does not commence at some time prior to the bribery revelations. Instead, the proposed class period begins more than a year after the scandal first emerged, in November 2007, when new management projected significant growth for the company.

 

During the class period, the complaint alleges, management sought to dispel concerns that the lingering bribery investigation would have an adverse impact on the company’s ability to meet its earnings projections. The proposed class period ends at the end of the company’s 2008 second fiscal quarter, when the company announced a sharp drop in second quarter profits.

 

So while the plaintiff’s complaint consists almost exclusively of a detailed recounting of the bribery scandal and its regulatory aftermath, the complaint isn’t about the bribery or even the revelations about the bribery at all; instead, the plaintiffs seek damages based on what the company allegedly said about whether it could meet its goals now that it was no longer getting business by paying bribes.

 

Plaintiffs will obviously face certain challenges demonstrating that their claimed damages are due to these statements about Siemens’ prospects without bribing officials, as opposed to ongoing revelations concerning the bribery investigation – which continued both during and after the proposed class period. Indeed, the class period ends at the same time as the company disclosed certain findings of the law firm the company had hired to investigate the bribery allegations.

 

In one sense it seems as if the plaintiffs arguably are trying to have it both ways with respect to damages. They do not allege what harm was due to the company’s supposedly misleading projections; rather they allege only that "as a result of defendant’s fraud and misconduct, Siemens’ shareholders have suffered, and will continue to suffer, billion of dollars of damages." These broad damages claims are arguably at odds with the complaint’s relatively narrow class period and narrow range of alleged misrepresentations.

 

The complaint may also be susceptible to challenges that it does not sufficiently allege scienter. In that regard, it is interesting to note that the sole defendant named is the company. No individuals are named as defendants. Without any individual defendants, the possibility for the complaint to survive a dismissal motion will depend on some kind of "collective scienter," based on the supposed knowledge or recklessness of responsible corporate officials.

 

Critically, for the plaintiff’s complaint to succeed, they will have to show that during the class period, senior company officials knew (or were reckless in disregarding) that the company could not make its earnings targets without resorting to bribery. To put it as neutrally as I can, it is unclear from the complaint what allegations the plaintiffs intend to rely upon to show that the company’s senior officials knew during the class period that without improper payments Siemens could not meet its earnings projections.

 

The complaint could also face certain hurdles with respect to the claims of so-called "f-cubed" claimants. The proposed class period is not limited solely to the claims of investors who purchased their Siemens securities on the NYSE. To the extent the class purports to include the claims of foreign-domiciled investors who bought their shares in Siemens on a foreign exchange, the complaint could present the same kinds of jurisdictional issues as were raised in the National Australia Bank case, in which the U.S. Supreme Court recently granted a petition for writ of certiorari.

 

Perhaps in anticipation of these kinds of concerns, the new class complaint quotes liberally from the SEC’s allegations concerning the "nexus" between the improper payments and the U.S. However, the misleading statements that are the basis of the new class action complaint clearly appear from the face of the complaint to have been made in Germany. It is therefore possible that the claims of "f-cubed" class members could be susceptible to jurisdictional challenge.

 

In any event, and at a minimum, this case presents yet another concrete example of the way in which regulatory or enforcement investigations into corrupt payments can lead to civil litigation, which many readers will recognize as a recurring theme on this blog.

 

The fact that no individuals are named as defendants in the lawsuit is unusual, and could generate any number of interesting D&O coverage issues. For example, at least in the early days when company coverage first began to be added to insurance policies that previously only protected individuals, the company’s coverage was only available if there were also claims against individuals. These co-defendant requirements largely have fallen by the wayside over time, but the policy’s bias towards protecting individuals in preference to the company still survive in a various respects.

 

A related question about the company’s coverage is whether or not the company’s various admissions in connection with the prior regulatory or other settlements would trigger the conduct exclusions found in most D&O policies. I suppose that if the exclusion is sufficiently narrow, the company could argue that whatever else the company may have admitted, it did not make any admissions about the statements alleged in this complaint to be fraudulent. However, if the exclusion has a broader preamble, a carrier might well argue that the wrongful acts alleged in this complaint arise out of, related to or are based upon improper conduct to which the company as admitted.

 

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In its December 3, 2009 filing on Form-10-Q (here), Dell disclosed that on November 20, 2009, it had entered a written agreement to pay $40 million to settle the consolidated securities class action lawsuit pending against the company and certain of its directors and officers.

 

What makes the $40 million Dell settlement noteworthy is not its amount but its timing – the settlement comes not only after the securities lawsuit had been dismissed with prejudice at the district court level, but following oral argument on the plaintiffs’ subsequent appeal to the Fifth Circuit.

 

On September 13, 2006, the first of four securities class action lawsuits were filed in the Western District of Texas against Dell and four individual defendants, as well as against the company’s outside auditor. The plaintiffs’ 340-page Consolidated Amended Complaint (here) alleges that the company had a "culture of deception" and that it had used "fraudulent accounting" to inflate its revenues by $463 million for fiscal years 2003 through the 2006.

 

The plaintiffs further alleges that the individual defendants took advantage of the company’s inflated share price to unload millions of dollars of their personal holdings in the company stock – indeed, in the case of company founder, Michael Dell, the plaintiffs alleged that he had sold billions of dollars of company stock.

 

In an opinion dated October 6, 2008, Judge Sam Sparks granted the defendants’ motions to dismiss, with prejudice. The plaintiffs appealed to the Fifth Circuit. According to Dell’s most recent 10-Q, oral argument on the appeal took place before the Fifth Circuit on September 1, 2009. Thereafter, and while the appeal was still pending, the parties reached the settlement agreement described above. The parties jointly request that the Fifth Circuit remand the case so that the district court could consider the proposed class settlement.

 

As surprising as it is for a case to have settled following dismissal and while appeal was pending, this peculiar settlement timing is not entirely unprecedented. Most notably, the parties to the Bristol- Myers Squibb securities class action lawsuit agreed to settle that case for $300 million while the case was on appeal to the Third Circuit following the district court’s dismissal.

 

But even though it may have happened before for a securities case to be settled while on appeal following dismissal, the timing of the $40 million Dell settlement – coming as it did shortly after oral argument – does leave you wondering why the case settled when it did.

 

In her blog Footnoted (here), Michelle Leder, who was the first to note and report on the Dell settlement disclosure, speculates that the appeal "had to have gone really poorly" for the company to settle after securing dismissal in the court below. To a certain extent, Leder’s speculation seems plausible. Why else would the company agree to pay $40 million to settle a case that it had already managed to get dismissed?

 

There are some other possibilities. The first is that the company just wanted the case gone. Old cases, even those that are going reasonably well, don’t get better with age. More that one litigant has thrown money at a case just to get rid of it, and for a company with annual revenues of $12.9 billion and third quarter earnings of $337 million, the $40 million settlement (to the extent not funded by insurance) could represent a regrettable but relatively small cost of doing business.

 

Another possibility is that the plaintiffs are the ones for whom oral argument had gone poorly, and that thereafter for the first time they were willing to negotiate in a range that Dell was willing to consider.

 

Whatever the reason for the odd settlement timing, the fact that the parties were able to settle a case while on appeal and after oral argument shows that in a securities lawsuit, the possibility for a deal is always somewhere on the table.

 

Very few securities suits go to trial – in general, the cases either are dismissed or they settle. And, as the Dell case shows, sometimes a case can be both dismissed and settled.

 

Readers who have insight they can share about why the Dell case settled when it did are cordially invited to pass that information along. If I learn anything interesting from readers, I will add it to this post. Anonymity for those who need it will be scrupulously protected.

 

UPDATE: Alison Frankel has a very interesting December 7, 2009 post on the Am Law Litigation Daily (here) about the Dell settlement, including additional procedural history and statements from the plaintiffs' counsel about the settlement.

 

In closing, I should add a note of appreciation for the Footnoted blog. Michelle Leder consistently reports nuggets she has unearthed by digging through companies’ SEC filings. As a result of her diligence, she regularly reports perceptive and interesting things that no one else has noticed. Her site demonstrates the incredible value and power of a really good blog. Footnoted, everyone here at The D&O Diary salutes you.

 

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Courts in the financial center of New York and the tech hotspot of California tend to be where much of the headline grabbing securities law action usually takes place. But this week, the most significant action is in  Washington, D.C., as the Supreme Court and Congress are weighing into several of the hottest topic under the U.S. securities laws.

 

First, on Monday, November 30, 2009, the Supreme Court granted the petition for writ of certiorari in the National Australia Bank case. As a result of taking the case, the Supreme Court is likely to confront generally the question of extraterritorial application of the U.S. federal securities law and will address specifically the question of when U.S. court can properly exercise jurisdiction over securities law claims of so-called "f-cubed" claimants (that is, foreign investors who bought their shares in foreign-domiciled companies on foreign exchanges.) Background on the NAB case can be found here.

 

Second, and also on Monday, November 30, the U.S. Supreme Court heard oral argument in the Merck Vioxx case, in which the Court will address the question of what is required in order to establish "inquiry notice" sufficient to trigger the two-year statute of limitations for private securities lawsuits under the ’34 Act. Background on the Merck case can be found here.

 

Third, on December 2, 2009, the Senate Judiciary Committee is scheduled to hold a hearing on Senator Arlen Specter’s proposed legislation entitled "The Notice Pleading Restoration Act of 2009," which is calculated to set aside the U.S. Supreme Court’s holdings in the Twobley and Iqbal cases. These cases define standards for threshold pleading issues in all federal civil cases, including securities cases. A discussion on the background on the significance of the Iqbal decision for securities cases can be found here.

 

A link for the Senate Judiciary Committee session, which is entitled "Has the Supreme Court Limited Americans’ Access to Justice?," can be found here. The Committee hearing will be webcast and a link of the webcast can be found on the Committee’s hearings webpage.

 

Each of these developments has potential to work sufficient alterations to important aspects of the securities laws or to their application.

 

The NAB case potentially could represent a very significant milestone on the issue of the overseas reach of domestic securities laws in a global economy. The Merck case, though focused on a technical statute of limitations issues, could have important practical consequences (particularly these days when for whatever reason plaintiffs’ lawyers increasingly seem to be filing cases belatedly). Finally, Senator Specter’s bill could produce significant changes on the threshold pleading standards for all civil cases, including securities cases.

 

A November 30, 2009 Law.com article (here) suggests that the Supreme Court showed substantial skepticism that there were sufficient "storm warnings" earlier on that would have put plaintiffs on "inquiry notice" sufficient to trigger the running of the statute of limitations. Ashby Jones also has an interesting post on the WSJ.com Law Blog (here) about the oral argument.

 

Soon Everyone Will Have a Blog: A column in yesterday’s Wall Street Journal reports (here) that Iranian President Mahmoud Ahmadinajad maintains a blog, called "Mahmoud Ahmadinajad’s Personal Memos." (No link supplied here, it just seems ill-advised to visit the site). Not only does Ahmadinajad have a blog, but his blogging experience is one to which many bloggers – including your humble correspondent -- can relate. The column reports that Ahmadinajad "allots himself 15 minutes a week to write his blog, but admits that at times, he exceeds this limit."

 

Yes, it really is hard finding time when you have important things to blog about, particularly when that pesky day job can interfere with important blogging activities. (For the record, I allot myself more than 15 minutes a week for blogging.)

 

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One of the more interesting securities class action lawsuit filing patterns that has developed as 2009 has progressed is the number of securities suits that have been filed long after the end of the purported class period cut-off date, as I have previously noted here. A November 21, 2009 National Law Journal article entitled "Securities Fraud Suits Resurface" (here, registration required) examines these patterns and reports that as plaintiffs’ lawyers turn away from credit crisis-related cases and turn back to "traditional securities suits," the plaintiffs are "slapping public companies with securities class actions months or years after the fraud came to light."

 

According to the article, eight of the 23 securities class actions filed against public companies in October and November 2009 "define the class as investors who bought or acquired the company’s stock during some time between 2006 and the first half of 2009." My prior posts (here and here) demonstrate that this pattern of filings with the class period cut-off date well in the past emerged well before October.

 

The article attributes a statement to Sam Rudman of the Coughlin Stoia law firm to the effect that "he’s working through a backlog of potential targets." The explanation for the backlog is that "lawsuits related to subprime mortgages and financial instruments consumed much of Coughlin Stoia’s energy in recent months," but the new subprime and credit crisis-related filings are "waning." The article quotes Rudman as saying about the subprime and credit crisis cases that "we’re busy litigating cases, but not a lot of new ones are being started," so now the firm is looking at cases "we kind of backburnered for two years."

 

As a result, the firm is "putting many prior stock drops under the microscope before the statute of limitations runs out." Rudman is quoted as saying about the number of cases the firm is looking at, "my list is long."

 

As I noted in my prior posts about the backlog, the plaintiffs’ efforts to work off the backlog poses a challenge for D&O underwriters, because it means that companies with long distant stock price drops could still find themselves involved with securities litigation long after the event. As a result, it is hard for underwriters to be sure when a company is "out of the woods."

 

Another consideration as the backlog cases come in is that the new cases are more broadly distributed across the economy than was true for the filings during at least the last couple of years. Since mid-2007, the new lawsuits have largely been concentrated in the financial sector. But in the second half of 2009, there have been fewer cases against financial companies and the cases that have been filed have hit a much broader variety of industries, as I recently noted in detail here. This filing shift may require a recalibration of risk distribution and, consequently, risk selection.

 

Lawyers tell me that these older cases pose a problem for the companies too. The target companies may have new management that is unfamiliar with the events that gave rise to the prior stock price drop. The company may also be involved in M&A activities, and the overhang of a past stock price drop can, for example, present an uncertainty to an acquirer.

 

One challenge plaintiffs may face with these lawsuits is that in some cases they brush right up against the applicable statute of limitations for securities fraud suits, as was the case with the new lawsuit filed on October 28, 2009 against Pitney Bowes, where the suit was filed one day short of the two-year statute of limitations (as I discuss further here, scroll down).

 

Some of these recent cases have even been filed seemingly after the statute of limitations period has passed, as Adam Savett noted on his Securities Litigation Watch blog (here), with respect to the complaint against Avanir Pharmaceuticals, which was filed three years after the proposed class period cut-off date.

 

There’s delayed, and then there’s stale. In at least a few instances, these cases are being offered up after the sell-by date.

 

Arkansas Securities Plaintiff Attorney Sentenced: Readers may recall the courtroom drama earlier this year when Arkansas-based securities class action attorney Gene Cauley took the Fifth in response to questions from Southern District of New York Judge Jed Rakoff about $9.3 million missing from the funds escrowed in connection with the settlement of the Bisys Group securities class action lawsuit. Shortly thereafter, Cauley agreed to plead guilty to wire fraud and criminal contempt for misappropriating the escrowed funds.

 

Today, Cauley was sentenced to 86 months in prison, and ordered to pay $8.8 million in restitution, in addition to the $500,000 he previously paid, as reported here on the WSJ.com Law Blog.

 

An earlier WSJ.com Law Blog post reported (here) that Cauley was in fact a protégé of Bill Lerach. Today’s article on Bloomberg (here) about Cauley’s criminal sentencing notes that Cauley joins a growing list of plaintiffs’ securities class action attorneys who have "been jailed for felonies," including Bill Lerach himself and his former law partners, Mel Weiss, Steven Schulman and David Bershad, and including even Marc Dreier.

 

These gentlemen of course made their living for many years accusing corporate officials of fraud. Ahem. Yes, well…isn’t ironic, don’t you think?

 

Welcome: The D&O Diary would like to welcome the latest new addition to the blogosphere, the CyberInquirer blog. The blog is maintained by Rick Bortnick and Pam Pengelley of the Cozen O’Conner firm and is devoted to "news and views on recent developments in Cyber Law and Insurance." The blog looks promising and looks like a great new source of new and information about insurance and law issues relating to Cyberspace. I look forward to following future posts and wish the site’s authors great success. They appear to be off to a great start.

 

Speaker’s Corner: Next week, I will be co-Chairing the American Conference Institute’s 15^th Annual Advanced Forum on D&O Liability in New York. The faculty for this event includes an all-star cast of insurance industry professionals and leading attorneys. The conference will be held on November 30 and December 1, 2009 at The Carlton Hotel in New York. The event website can be found here and the agenda, including a complete list of speakers and topics, can be found here.

 

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On November 20, 2009, Ohio Attorney General Richard Cordray announced (here) the filing of a lawsuit in the Southern District of Ohio on behalf of five Ohio pension funds against Standard & Poor’s, Moody’s and Fitch. According to his press release, the complaint, which can be found here, charges the rating agencies with "wreaking havoc on U.S. financial markets by providing unjustified and inflated ratings of mortgage-backed securities in exchanged for lucrative fees from securities issuers."

 

During the period January 1, 2005 through July 8, 2008, the plaintiff pension funds purchased a variety of asset-backed securities all of which had "false and misleading" ratings of AAA or equivalent. The complaint alleges that while the ratings purportedly were objective and independent, "in truth, the Rating Agencies subverted those principles and negligently provided unjustified and inflated ratings in exchange for the lucrative fees the ABS issuers paid the Defendants for not only rating the securities but also for helping to structure them."

 

The complaint makes liberal use of the rating agencies’ internal communications that the SEC disclosed following its own investigation of the firms, and also quote extensively from the SEC’s investigation report (about which refer here).

 

The complaint asserts that "when the housing and credit markets collapsed, the flaws in the Defendants’ AAA ratings gradually became clear." The value of the pension funds’ investments "dropped precipitously" which, the complaint alleges, caused the funds to lose over $457 million, as "these purportedly safe investments became obvious for what they were – high risk securities that both the issuers and the Rating Agencies knew to be little more than a house of cards." The complaint asserts claims for relief under the Ohio Securities Act and for negligent misrepresentation.

 

The Ohio action follow the similar action that Calpers filed in July 2009 against the rating agencies, as discussed here.

 

As I have previously discussed on this blog, the rating agencies have proven to be a popular target for investors angry about losses they sustained on mortgage-backed securities and other investments following the subprime meltdown. But as I have also previously noted, these investor actions could face significant hurdles, particularly with respect to the rating agencies’ constitutional defenses. Significant case law supports the rating agencies’ position that their ratings opinions are protected by the first amendment.

 

In attempting to overcome these arguments, the Ohio funds will undoubtedly seek to rely on Judge Shira Scheindlin’s September 2009 opinion in the Cheyne Financial case, in which she rejected the rating agencies’ argument that their rating opinions were entitled to immunity under the First Amendment.

 

But as I noted in my prior post discussing Judge Scheindlin’s opinion, the extent to which these plaintiffs will be able to rely on her opinion may be limited. First, as a district court opinion, it will be of at most persuasive but not precedential value. Moreover, Judge Scheindlin’s conclusions were made in the context of an action made under New York’s fraud laws, which may or may not be relevant to an action under Ohio’s laws.

 

In addition, Judge Scheindlin’s ruling in the case was limited by its own terms. In disallowing the first amendment defense, she said "where a rating agency has disseminated their ratings to a select group of investors rather than to the public at large, the rating agency is note afforded the same protection." To the extent the ratings the Ohio funds’ allege to be misleading were not made to a select group of investors, as was the case with respect to the investments involved in the Cheyne Financial case, Judge Scheindlin’s ruling arguably may not be relevant.

 

But despite the obstacles, Cordray appears enthusiastic about the case. In fact, he seems to have decided in general that he can extract significant political value by pursing securities litigation. On November 20, 2009, he wrote on his blog, Speak Out Ohio, that "my office is aggressively pursuing Wall Street corporations and executives that harm investors here in Ohio and around the world." (Yes, the Ohio Attorney General has a blog. Doesn’t everybody?) Among other things, he also references in his blog post the recent $400 million settlement in the Marsh contingent commission securities class action lawsuit, in which his office participated.

 

Just to underscore how enthusiastic he is about pursing securities class action litigation, Cordray also separately published on November 20, 2009 a detailed report of the securities class action lawsuits his offices has pursued or is pursuing.

 

The political value that Cordray thinks he can gain by initiating securities litigation may be discerned from the tenor and tone of some of his remarks in his blog. For example, with respect to the rating agency lawsuit, he says that:

 

This case goes to the heart of what’s wrong with Wall Street today. Ohio workers—including our families, friends and neighbors – work hard to create wealth in our economy. Then Wall Street corporations and executives manipulate that wealth, for their benefit, and they do so with total disregard for our life’s work and the importance of our retirement savings. Ordinary people throughout Ohio are hurt by this kind of misconduct. And we won’t stand for it.

 

If you are wondering whether Cordray’s litigation endeavors are producing their intended results (that is, by generating favorable publicity for Cordray, who clearly has higher political aspirations), you will be interested to know that the filing of the rating agency lawsuit made the front page of the business section of Saturday’s Cleveland Plain Dealer. Since the only thing in Cleveland worse than the Cleveland Browns is the Cleveland economy, the paper’s business section is actually widely read, for same morbid reasons that people gawk at traffic accidents.

 

Ben Hallman of the Am Law Litigation Daily has an interesting November 20, 2009 profile of Cordray and of the ratings agency case here. Among other things, Hallman notes that Cordray is a former five-time undefeated Jeopardy! champ. Hallman also (correctly, in my view) notes that Cordray is "making a strong bid to be the Midwest’s answer to Andrew Cuomo."

 

On the Other Hand, Securities Litigation Could Also a Scam Worse Than Bernie Madoff’s: While Cordray is convinced that he is helping to protect the little guy by pursuing securities suits against Wall Street, Lawrence W. Schonbrun, the executive director of Class Action Litigation Watch, asserts that securities class action litigation is "a financial rip-off worse than Bernie Madoff."

 

In a November 21, 2009 editorial in The Buffalo News (here), Schonbrun takes on the plaintiffs’ securities class action bar, asserting that class action securities litigation is "skimming hundreds of millions of dollars from investors in U.S. corporations." Using Judge Rakoff’s rejection of the SEC’s settlement of the BofA/Merrill Lynch bonus action as a starting point, Schonbrun argues that:

 

In a typical year, more than 200 securities class action lawsuits are filed against American companies, with an average settlement of more than $100 million each; that adds up to a staggering $20 billion a year! Over nearly 40 years, that means that the system has drained upward of $800 billion of shareholder wealth, not just from people who directly trade securities but from all Americans who own mutual funds, or have pension funds or other types of investments. Kind of dwarfs Madoff’s $65 billion, doesn’t it?

 

Schonbrun is rather obviously playing fast and lose with the numbers, since there has never yet been even one year when class action lawsuits settlements average $100 million, and there certainly have not be 40 years’ worth of average settlements of $100 million.

 

But his rant does raise an interesting question, which is -- who is actually helped and who is actually hurt by the class action lawsuits? It is true that when class action settlements are funded in whole or in part by defendant corporations, it is shareholders that are hurt. As Schonbrun points out, among the most significant shareholders are the very kinds of pension funds on whose behalf Cordray is busy filing lawsuits. Schonbrun’s intemperate screed didn’t quite get there, but there is a very interesting question about whether the kinds of lawsuits Cordray is busy congratulating himself for filing (at least to the extent they are filed against publicly traded companies, as opposed to the rating agencies) actually benefit the pension funds over the long haul.

 

So here’s my idea: Let’s have a public debate between Cordray and Schonbrun. Call it "Class Action Smackdown" or something like that. To enhance the entertainment value, the rules of engagement could specify (drawing on Cordray’s Jeopardy! experience) all of the contestants’ statements would have to be expressed in the form of a question. That could be quite a spectacle.

 

And Speaking of Class Action Litigation: Meanwhile, back at the Southern District of New York courthouse, the Vivendi securities class action lawsuit trial is now in its sixth week. The trial disappeared from the radar screen for a while, but it was back in the news again this week, as former Vivendi CEO Jean-Marie Messier took the stand.

 

According to news reports, he told the jury that he might have made mistakes but her never misled shareholders. The AP newswire story quotes him as saying "Some of my management decisions turned out wrong, but fraud? No. Never. Never. Never." According to the AmLaw Litigation Daily account of his testimony, Messier also called the allegations in the case "blatant lies, infamous lies." Messier’s testimony reportedly will continue for several days.

 

And Speaking of Liability Exposures: I have been involved with D&O claims, one way or another, for well over 25 years. After such a long period observing the havoc of lawsuits against directors and officers, I never ceased to be amazed by corporate officials who are convinced they don’t need management liability insurance. To me, that attitude as foolhardy and dangerous as that of the soldier who is convinced he doesn’t need a helmet because he is sure that he is never going to get hit.

 

One product I have been particularly surprised that corporate officials often must be convinced they need is Fiduciary Liability Insurance. This insurance, which is quite inexpensive given the extent of the protection it affords, is designed to protect plan fiduciaries against claims by employee plan participants or beneficiaries that the fiduciaries breached their duties.

 

On November 19, 2009, CFO.com had a particularly good article entitled "Fiduciary Liabilities: Are you Covered?" (here) which describes Fiduciary Liability Insurance and explains why it is an indispensible part of every company’s insurance program. I commend the article for anyone involved in advising companies about their management liability insurance.

 

And Finally: So which country do you think has the most English speakers, India or China? You might might be tempted to say India. But you would be wrong. Correct answer? China. I guess if you start with a billion people, having the most of anything is a lot simpler.

 

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One interesting thing about the most recently filed securities class action lawsuits is what they have in common – that is, that while the companies sued are drawn from a surprising diversity of industries, none of them are in the financial services sector. The absence of new securities suits against financially related companies is quite a contrast to the lawsuits that were being filed a year ago, and for that matter that were being filed in the first few months of 2009. There is an increasingly strong suggestion that after more than two and a half years, the subprime and credit crisis-related litigation wave may have finally just about played itself out.

 

The latest securities lawsuit is representative. That is, on November 17, 2009, plaintiffs’ lawyers announced (here) that they had filed a lawsuit in the District of Rhode Island against CVS Caremark and certain of its directors and offices. The complaint, which can be found here, alleges that the defendants failed to disclose operating problems the company was having in its pharmacy benefits management (PBM) business, which the company acquired in 2007. On November 5, 2009, the company disclosed (here) the PBM problems and also disclosed that the company was the subject of an FTC investigation into the company’s drug benefits practices.

 

Whatever else might be said about the new CVS lawsuit, the suit clearly was not filed against a financial services company and the allegations appear unrelated to the financial crisis.

 

The several new securities cases filed over the last two weeks share both these traits. That is, the defendant companies are outside the financial sector and the allegations generally do not appear to specifically relate to the global financial crisis.

 

A case in point is the lawsuit filed last week against The Boeing Corporation and certain of its directors and officers. The plaintiffs’ lawyers’ November 13, 2009 press release (here) describes the securities suit that was filed in the Northern District of Illinois. According to the press release, the complaint (which can be found here) alleges that the company misrepresented the production timeline and anticipated delivery dates of the company’s Dreamliner 787 commercial aircraft.

 

Similarly, on November 6, 2009, plaintiffs’ lawyer initiated a securities class action lawsuit against jewelry retailer Zale Corp. (about which refer here) alleging that the company had improperly recorded certain prepaid advertising expenses and intercompany accounts receivable.

 

Other examples include the November 10, 2009 action against Hemispherix Biopharma, (refer here) alleging misrepresentations in connection with the new drug application of one of the company’s clincal stage products; the action filed on November 6, 2009 against STEC, Inc.(refer here), the memory drive manufacturer, which is alleged to have overstated demand for one of its products; and the November 6, 2009 action filed against specialty women’s clothing retailer Limited Brands (refer here), which is alleged to have made misrepresentations regarding the company’s direct-to-consumer ecommerce initiative.

 

Again, none of these cases involve financial companies and none are directly related to the financial crisis.

 

To be sure, all along as the subprime and credit crisis litigation wave unfolded over the last two and a half (actually nearly three) years, there have been cases that didn’t involve financial companies and that were unrelated to the credit crisis. However, this recent collection of cases, particularly the absence of any financial related suits, seems to represent a categorically different filing pattern.

 

At the same time, there are still some cases being filed that unquestionably reflect back to the credit crisis. Indeed, late last week I noted (here) that a credit crisis-related lawsuit had been filed against VeraSun Energy. Even though the company itself is not financially related, the claims in the complaint relate to the company’s alleged problems arising from the company’s wrong way bets on certain financial derivative hedging contracts.

 

There undoubtedly are other cases yet to come like that filed against VeraSun, where the allegations reflect back on the events of the financial crisis – particularly, as was the case with the VeraSun filing, if the plaintiffs’ lawyers’ continue to file suits where the proposed class period cutoff date is well in the past, and accordingly the lawsuits involved long past events. As I noted in my post about VeraSun, those kinds of cases could continue to arrive for some time to come.

 

But while there could and likely will be further additional cases relating to or arising from the financial crisis, it seems increasingly likely that the mix of cases will be much more diverse that has been the case for almost three years now. This may entail some adjustment for D&O insurance underwriters, who have been very defensive against financial company risks, but much more agreeable to accepting other kinds of risks. The pattern over the last few weeks suggest that securities litigation risk may once again be dispersed across a wide variety of sectors and industries, and a more generalized underwriting approach to risk selection may be required going forward.

 

So What About Bernard Madoff’s Insurance?: If you are like me, you have probably wondered since the very beginning of the Madoff scandal what kind of insurance his firm carried. It turns out that, other than a bond, his firm didn’t carry professional liability insurance.

 

As reflected in Susan Sclafane’s November 17, 2009 National Underwriter article (here), Madoff apparently had for years refused to buy D&O insurance, and instead carried only a $25 million financial institutions bond because he was required to do so by participants in his legitimate clearing trade business. (The bond carrier, which reportedly was on the risk for 15 years, apparently has filed a rescission action.)

 

Not that the D&O insurance would have gone very far, even if there had been D&O insurance in place, in view of the massive scale of the losses. For that matter, given Madoff’s guilty plea, coverage for claims against Madoff or his firm would have been excluded under most D&O policies anyway.

 

Perhaps it was Madoff’s awareness that of the unlikelihood of coverage that convinced him not to squander his ill-gotten gains on insurance designed to protect his victims.

 

Special thanks to a loyal reader for providing the link to the National Undewriter article.

 

Today’s Grammar Question: Observant readers may have noticed that in discussing the recent securities filings I used the plural form of the verb "to be" in connection with my use of the noun, "none" – as in, "none of them are," rather than "none of them is."

 

While I have no particularly strong feelings on the question of the proper verb form to be used with the noun "none," a little bit of Internet research convinced me there are quite a number of people who feel quite strongly on the subject.

 

I also am persuaded that the plural verb form is generally proper (as discussed here), and that even for those who feel that either usage is proper, the plural form is in any event most appropriate when the word "none" is used in the sense in which I used it – that is, to mean "not any, " in reference to plural entities (about which refer here).

 

If there are any readers out there who have a strong reaction to my resolution of this grammatical issue, I suggest that the best response is either a long walk or a short drink. (Or if you prefer, a short walk and a long drink. Better yet, skip the walk.)

 

Further Apologies: I apologize to everyone for continuing service problems with this site, particularly with respect to the delivery of email notifications. LexBlog, my blog hosting service, is continuing to suffer ill effects from a sustained spambot attack a few days ago. Along with everyone else, I sure hope things return to normal soon, if for no other reason than for the sake of my sanity.  

 

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According to its November 13, 2009 press release (here), Marsh & McLennan has agreed to pay $400 million to settle the consolidated securities class action lawsuit pending in the Southern District of New York against the company, its insurance brokerage unit, and certain former officers of the company. The company also agreed to pay $35 million to settle the related ERISA class action suit filed on behalf of the company’s employees. Both settlements are subject to court approval.

 

As reflected in the press release, the company expects that $205 million of the $400 million securities settlement and $25 million of the $35 million ERISA settlement will be covered by the company’s insurance.

 

The securities suit settlement stipulation can be found here. The settlement stipulation in the ERISA suit can be found here.

 

These two consolidated class action lawsuits were both initiated in October 2004, in the wake of then-New York Attorney General Eliot Spitzer’s announcement that he had launched a fraud lawsuit against Marsh and others alleging that Marsh had engaged in bid-rigging, price-fixing and had accepted payoff from insurers in the form of "contingent commissions."

 

As reflected in greater detail here, the investor plaintiffs in the subsequently filed securities suit alleged that the defendants had failed to disclose that "the Company had implemented and executed an unsustainable business practice whereby the Company designed and executed a business plan under which insurance companies agreed to pay so-called ‘contingent commissions’ in return for Marsh to steer them business and shield them from competition." The securities suit further alleged that "the Company's revenues and earnings would have been significantly less had the Company not engaged in such unlawful practices."

 

The ERISA suit alleged that the defendants had breached their fiduciary duties by "imprudently permitting" the company’s benefit plans to invest in and hold MMC stock, despite the fact that defendants knew or should have known that the company or its subsidiaries were engaging in bid-rigging and other illegal activities. As a result, it was alleged, the plan’s investment in MMC stock was no longer prudent and appropriate.

 

Based on the data reflected in the most recent Risk Metrics Group table of the 100 largest securities class action settlements (here), the $400 million securities lawsuit settlement, if approved, would represent the twenty-fourth largest securities largest securities settlement ever. The $35 million ERISA settlement would also be among the larges all-time ERISA class action settlements, as reflected in my table of ERISA case settlements, which can be accessed here.

 

The Marsh lawsuits were among several that were filed in the wake of Spitzer’s "contingent commission" investigation. And though some of these other cases also resulted in settlements, none were any near as large as the recent Marsh settlements.

 

For example, AON paid a comparatively modest $30 million to settle its contingent commission-related securities suit (about which refer here). The contingent commission-related securities suit filed against Hilb, Royal & Hobbs (about which refer here) was actually dismissed, and while the plaintiffs appeal was pending the parties negotiated a stipulation of dismissal.

 

The massive size of the Marsh settlements is impressive, but similarly noteworthy is the extent to which both of these settlements exceeded the amount of insurance available. One of the perennial questions in D&O insurance placement is the issue of "limits adequacy" – that is, the question of how much insurance is enough. The significant extent to which these settlements exceeded the available insurance underscores the dramatic potential for catastrophic claims to exceed the limits of even very large D&O insurance programs.

 

A smart-alecky observer might be tempted to try to extract some irony from the fact that an insurance advisor like Marsh was caught short with insurance limits that proved insufficient. The reality is that very serious claims of the kind filed against Marsh have the terrible potential to exceed any realistically available amount of insurance. As a practical matter, as some level, there is no available and affordable amount of insurance that could be sufficient to ensure limits sufficiency for every possible claim. In any insurance program, even one that is very large, there will always be some risk that the costs associated with serious claims could exceed the available limits.

 

This inherent potential for limits inadequacy underscores the extraordinary importance of limits selection issues. Well-advised insurance buyers will want to purchase limits calculated to reduce the risk of limits insufficiency as much as practicable, consistent with competing concerns regarding affordability and insurance availability.

 

As the same time, the inherent risk of limits inadequacy highlights the need for well-advised insurance buyers to consider program structure issues as well program limits. A well-constructed insurance program should incorporate not only appropriate limits of liability, but should also include appropriate alternative insurance structures, such as Excess/Side A DIC insurance and perhaps even independent director liability insurance, as a way to try to reduce the possibility that individuals might face further potential liability without insurance available to protect them.

 

One final note is that there have now been a couple of dozen securities class action settlements of $400 million or greater. While settlements of this enormous size are still noteworthy, the fact is that it is becoming increasingly common for securities class action settlements to exceed any theoretically available amount of insurance. This troublesome fact has significant risk management implications. Simply put, insurance alone may be insufficient to fully protect against liability exposures under the federal securities laws. There is a longer essay for another day here, but the unmistakable conclusion is that corporate risk management must address far more than just insurance-related issues.

 

The November 13, 2009 press release of Ohio Attorney General Richard Cordray relating to his office’s role in negotiating the Marsh settlement on behalf of various Ohio pension funds can be found here. A post on the 10b-5 Daily blog discussing the settlement and linking to various rulings in the underlying securities suit can be found here. Ben Hallman's November 13, 2009 AmLaw Litigation Daily article discussing the attorneys involved in the settlement can be found here.

 

DoJ Targets Pharma Company FCPA Violations: Earlier this week, I linked to a recent Business Insurance article suggesting the Foreign Corrupt Practices Act-related claims could produce increasing claims costs for D&O insurers. But knowing that there could be growing numbers of FCPA claims does not tell D&O insurance underwriters which of their policyholders or prospective policyholders are likeliest to produce these kinds of claims.

 

Recent comments by a DoJ official suggest at least one industry that could prove to be a significant source of FCPA-related losses. According to a November 12, 2009 Blog of the Legal Times article (here), Assistant Attorney General Lanny Breuer recently told a pharmaceutical industry conference that the application of the FCPA to the pharmaceutical industry will be a priority in the "months and years ahead."

 

The particular concern is that government involvement in foreign health care systems means that health care and medical officials in many countries are government officials, creating a "significant risk that corrupt payments will infect the process." Breuer and others emphasized that their enforcement actions will not be limited to corporate actors, but where facts warrant will also include criminal actions against individuals.

 

Dick Cassin has a post on his FCPA Blog (here) with a link to a complete copy of Breuer’s remarks, as well as Cassin’s own comments on the prospects for increased FCPA enforcement activity in the pharmaceutical industry.

 

And in This Week’s Ponzi Scheme News: I was struck by the news late last week that prosecutors had brought criminal charges against two computer programmers for aiding Bernard Madoff’s fraudulent investment scheme. I think we all suspected that a fraud as massive as Madoff’s could not have been sustained without the complicity of other individuals. Of course there were individuals like these programmers, who apparently were actively complicit – along with those like the regulators and other gatekeepers who may have been passively complicit.

 

The latest Ponzi scheme story involving Florida lawyer Scott Rothstein is all too familiar. The November 14, 2009 Wall Street Journal’s front-page story about Rothstein reflects all of the now-standard features, including large boats, expensive homes and fast cars – all of the accoutrements of accomplishment, where all that had been accomplished was deception. The Miami Herald reports that investigators "do not believe this was a one-man show." That is, the Rothstein scheme may have had other features in common with other Ponzi schemes, including the complicity of others.

 

The Journal’s account of Rothstein’s fraudulent scheme brought home to me that these schemes require yet another kind of complicity --- that is, the complicity of investors seeking outsized returns. It would be unduly harsh (not to mention smug) to presume to blame the investors for their losses. They were, after all, actively misled. By the same token, however, the schemes would have gone nowhere if investors had not been willing to accept the schemes’ unconventional investment proposition in exchange for the promise of returns unavailable from conventional sources. A November 9, 2009 Fort Lauderdale Sun Sentinel article examining this angle of the Rothstein story can be found here.

 

We can bemoan the failure of regulators and other gatekeepers that allowed the schemers to escape detection. But at the same time, a healthy skepticism, including in particular a suspicion of consistently market-beating returns, may be something that no investor can afford to do without. I do not mean to suggest that the victims of these schemes are to blame for their own losses. Rather, I am saying that the rest of us can learn from these events, and with benefit of the lessons from these examples perhaps avoid  these kinds of losses in the future.

 

 

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The D&O Diary is pleased to present the following guest blog post, written by Angelo Savino (pictured),  a partner at the Cozen & O’Connor law firm. Angelo is resident in the firm’s New York office. Angelo’s guest blog post follows:

　

As noted in prior posts (here), the U.S. Supreme Court is considering whether to grant certiorari in the National Australia Bank ("NAB") case, which involves foreign-cubed or f-cubed litigation. At the Court’s invitation, the Solicitor General and the SEC have now weighed in with the government’s position by submitting a joint brief.

 

Oddly, as noted by 10b-5 Daily, the government argues that (1) every Circuit Court that has considered the extraterritorial reach of the federal securities laws since Judge Friendly’s 1975 decision in Bersch has focused on the wrong issue and (2) there is currently a conflict among the Circuits regarding the standard to be applied to foreign-cubed cases under the cause test, but that the Court should nevertheless deny certiorari. Ironically, the government’s position may increase the likelihood that the Court will grant cert.

 

Background

NAB involved claims on behalf of a class of foreign purchasers of stock in NAB, an Australian corporation, on foreign exchanges. The complaint alleged accounting irregularities at NAB’s Florida mortgage servicing subsidiary, Homeside, that were transmitted to NAB headquarters in Australia and incorporated into NAB’s financial statements, which were then disseminated from outside the U.S. The District Court dismissed the claim for lack of subject matter jurisdiction and the Second Circuit affirmed.

 

In considering the extraterritorial reach of the U.S. securities laws, the Second Circuit applied the cause test, which the Court articulated as follows: "subject matter jurisdiction exists if activities in this country were more than merely preparatory to a fraud and culpable acts or omissions occurring here directly caused losses to investors abroad." Relying on two 1975 decisions by Judge Henry Friendly – Bersch v. Drexel Firestone Inc. and IIT v. Vencap Ltd., the Court sought to identify which actions constituted the fraud and directly caused harm, or as the Court stated elsewhere in the opinion "what is central or at the heart of a fraudulent scheme."

 

Applying the above standard, the Court held that subject matter jurisdiction did not exist because NAB, not Homeside, was the publicly traded company and its executives at the Australian headquarters were primarily responsible for the company’s public filings, relations with investors, and public statements. Thus, the conduct that directly caused any loss occurred outside the U.S.

 

Thereafter, the plaintiff petitioned for cert. and the Supreme Court invited the government to submit its view on the petition. Although the SEC had previously submitted an amicus brief to the Second Circuit siding with the plaintiff and asserting that subject matter jurisdiction existed in the case, its current brief urges the Supreme Court to deny cert. because, although the Second Circuit analyzed the wrong issue, it reached the correct result.

 

Discussion

The most striking aspect of the government’s analysis is the assertion, contrary to the jurisprudence of the last 34 years, that "the geography of an alleged fraudulent scheme – i.e., whether it was conceived and executed in whole or in part outside the United States – is irrelevant to the district court’s subject-matter jurisdiction." Instead, the government would engraft a geographical component onto the 10b-5 cause of action. The government notes that in cases of transnational fraud, a private plaintiff should be required to demonstrate a direct causal link between his injury and the U.S. portion of the alleged scheme. The government concluded that, in this case, the link between Homeside’s accounting numbers and the harm to the plaintiffs was too attenuated because, as the Second Circuit explained, the numbers had to pass through numerous checkpoints manned by NAB’s Australian personnel before reaching investors.

 

In an action by the SEC, however, the government asserts that the transnational nature of a fraudulent scheme is relevant only insofar as it has a sufficient connection to the United States to bring it within section 10(b)’s substantive prohibition. This begs the question what is a sufficient connection. The government’s answer this time is to characterize Homeside’s conduct as integral to the overall scheme and, therefore, sufficient to support an SEC enforcement action.

 

So after trashing the analytical method applied by every court to consider the extraterritorial reach of the securities laws over the last 34 years, the government next concludes that the conduct at Homeside is insufficient for foreign private plaintiffs but sufficient for an SEC action. This tends to give the government’s analysis the appearance of intellectual gymnastics designed to preserve or extend its own ability to bring cases. It seems more analytically satisfying to accept the traditional jurisdictional analysis as correct, and require foreign-cubed plaintiffs to satisfy the cause test while requiring the SEC to demonstrate satisfaction of the effects test, which focuses on harm to U.S. investors and U.S. markets. Moreover, to the extent that the SEC seeks, in a given case, to prevent export of fraud from the U.S., it should rightly bear the burden on a motion to dismiss of demonstrating that the resources of U.S. courts are appropriately being used, as it would if the issue is jurisdictional, but not if it is part of the 10b-5 cause of action. The government’s analytical model would shift that burden for private plaintiffs as well, making it more likely that they would bring more actions in U.S. courts.

 

The government’s brief also recognizes the existence of a split among the Circuits, but characterizes it as "much less pronounced than petitioners contend." Different Circuits have in fact articulated different formulations of the cause test, as noted in the brief. Add to that calculus, the Eleventh Circuit’s recent decision in the CP Ships case, affirming a District Court’s finding of subject matter jurisdiction in a case that, like NAB, involved alleged accounting irregularities at the Florida subsidiary of a foreign company whose stock traded predominantly on foreign exchanges. The apparent inconsistencies among the Circuits, of course, may simply be the product of the fact-intensive inquiry inherent in analyzing causation regardless of how courts articulate the cause test. But even then, it would be preferable to have a single nationwide standard. Nevertheless, the government concludes that NAB is not a suitable vehicle for resolving the conflict because the petitioners identify no case indicating that any other Circuit would allow their suit to go forward.

 

Conclusion

The government’s arguments seem motivated by a concern that analyzing foreign-cubed cases as a jurisdictional issue and using the Second Circuit’s short-hand formulation of the cause test (where did the heart of the fraud occur?) could prevent the SEC from bringing enforcement actions in certain cases. The government’s reasoning, however, seems to miss the mark. The cause test will have an impact primarily, if not solely, in the foreign-cubed context where there is a foreign plaintiff. The SEC will be bringing cases generally when it perceives an effect on U.S. investors or markets and may, therefore, be evaluated under the effects test. Alternatively, it will need to justify invoking the power of the U.S. courts to protect primarily foreign interests by demonstrating domestic conduct that directly caused the losses. In any event, the jurisdictional analysis rightly places the burden of demonstrating that the action should proceed on the party bringing the case, which the government’s suggested analytical model would not, at least at the motion to dismiss stage.

 

Despite believing that courts have been misanalyzing the issue for over three decades and despite recognizing a split in the Circuits, the government urges the Court to deny cert. By stressing these issues in its brief, however, the government may very well persuade the Court of the need to resolve these questions in an era of increasing globalization of the capital markets and increasing incidence of foreign-cubed litigation.

 

The D&O Diary is very grateful to Angelo Savino for submitting this article for publication on this site. I welcome draft proposed guest posts from other authors. Anyone interested in submitting a proposed guest post should just drop me a note using this blog’s contact function (see the Contact link in the right hand column, above).

　　　

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Where securities class action lawsuits are concentrated tends to vary over time. At various times over the past several years, companies in the high tech sector, telecommunications category and, more recently, in the financial services industries, have found themselves for a period to be the most popular targets for plaintiffs’ securities class action attorneys. However, beginning in August of this year and accelerating since then, exchange-traded funds (ETFs) appear become among the hottest new targets for securities class action lawsuits. Signs are that there could be more ETF-related securities suits ahead.

 

By my count there have been at least eight or nine and arguably as many as eleven (or more) new securities class action lawsuits filed against ETFs since August. (See my note below about the difficulty in counting these cases.) Though these lawsuits are separate and are separately filed on behalf of separate investors against separate ETFs, the allegations of these suits are quite similar – indeed, in many cases, virtually identical.

 

Two recent cases filed against ProShares Ultra Short Dow 30 Fund (refer here) and Direxion Shares Daily Financial Bear 3X Fund (refer here) illustrate the nature of this category of securities suits. The lawsuits overall, like these two, generally are filed against some variation of the funds themselves, the funds’ investment advisors or managers as well as the funds’ distributors, and the funds’ individual trustees. The ETFs themselves allegedly were designed to provide some multiple of the return (or of the inverse of the return) of some benchmark index or measure.

 

The complaints basically allege that the defendants failed to disclose to investors the risks associated with the investments, and in particular allegedly did not disclose the significant likelihood of losses to the value of the funds’ shares if held over time or even just for more than a single day, nor did the funds disclose the extent to which the funds’ results would likely diverge from their benchmark over time.

 

Though there have been many of these ETF-related securities lawsuits filed recently, there may be many more yet to come. Among other things, as inevitably seems to happen when plaintiffs’ lawyers start racing to stake out their piece of a hot property, at least one plaintiffs’ firm has issued a press release (here) announcing that it is investigating a whole raft of ETFs – indeed, the particular plaintiffs’ firm’s press release lists 75 different ETFs the firm is investigating.

 

Whether these cases will ultimately succeed or fail of course remains to be seen, but the plaintiffs’ firms’ actions clearly suggest that they think they are on to something.

 

These lawsuits already represent a significant part of the total number of securities class action lawsuits this year (depending on how you count, between five and ten percent of the total). If as seems likely at this point new ETF-related cases continue to be filed, the ETF cases will not only represent an even more significant portion of the total number of new securities cases this year, but they could also produce a material increase in the overall number of lawsuits that are filed this year.

 

But whatever the ultimate number of ETF-related cases ultimately proves to be, I believe that we have already reached the point where these cases represent their own separate phenomenon and therefore worthy of tracking on that basis.

 

Accordingly, I have created a separate list of the ETF lawsuit filings, which can be accessed here.

 

It is entirely possible that this list is incomplete, and I would be grateful if readers would let me know about any cases I may have missed. I will be updating this list as new ETF-related cases come in.

 

I should add that trying to keep track of these cases and to tell them apart is a particularly vexing task. Many of the ETFs have bewilderingly similar names, and some of the lawsuits purport to file claims on behalf of investors in multiple ETFs. Figuring out which suits are separate and which are duplicates is a considerable challenge. For each case presented separately on this list there have been multiple other apparently duplicate other filings that I have not listed. Some of these cases do overlap and there may well be consolidation of some (or, who knows, perhaps many or all) of these cases before all is said and done. I have tried as best as I can to identify separate cases separately. I welcome readers’ observations and comments about the list.

 

Though there have been a number of these suits, and though there could be many more, most of these suits are filed against ETFs within one single fund family. As a result, the extent of the contagion effect from this lawsuit outbreak so far has been relatively isolated. This concentration of many suits within a single fund family may diminish the insurance impact of this category event, as the single fund family likely carried only a single insurance program for all of the funds in the family. I stress that I have no direct knowledge one way or the other, but it is relatively unlikely that each new lawsuits represents a significant new insurance related loss or loss exposure.

 

Perhaps the Theory is "Better Late Than Never"?: In recent posts (most recently here),  I have noted another trend, which is the apparently belated filing of securities class action lawsuits, where the date of the proposed class period cut off is well in the past. For example, the new suit filed on October 28, 2009 against Pitney Bowes (refer here) has a proposed class period cut off date of October 29, 2007, suggesting that the case was filed just prior to the expiration of the two-year statute of limitations cut off date.

 

Well, if the cases I previously discussed could fairly be described as "belated," then the securities class action filed in the Southern District of California on October 30, 2009 against Avanir Pharmaceuticals and certain of its directors and officers can only be described as superannuated. Or more succintly, old. Perhaps even stale.

 

The actiion purports to be filed on behalf of persons who acquired shares of the company's stock between July 1995 and October 31, 2006. That is, the complaint (a copy of which can be found here) was not filed until nearly three years after the proposed class action cutoff date.

 

There is no way of telling from the face of the complaint how the plaintiffs intend to try to overcome the rather obvious statute of limitations objection that the defendants will raise, expecially given that the complaint expressly alleges that the company's true condition was revealed in an October 31, 2006 disclosure.  It will be interesting to see how the plaintiffs attempt to respond to the statute of limitations defense.

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In an October 29, 2009 order (here, Hat Tip: Am Law Litigation Daily), Ontario Court of Justice judge Paul Perell ruled that the direct involvement of the U.S.-based law firm Milberg LLP was permissible in the securities class action lawsuit filed against Timminco Limited and pending before the court.

 

Timminco had been sued in two separate proposed class actions under Part XXIII.1 of the Ontario Securities Act. The first filed action (about which refer here) was brought by Toronto-based Kim Orr Barristers P.C. The second was brought later (refer here) by the London (Ont.)-based Siskinds law firm. Each of the respective law firms filed cross-motions to stay the other action. (The motions were presented as "carriage motions," the purpose of which is "to stay all other present and future class proceedings relating to the subject matter.")

 

The Kim Orr law firm argued that because of its association with Milberg, which it described in its motion papers as "a pre-eminent American class action firm," it is "in the best position to prosecute the action." In a response that the Ontario court characterized as "unkindly," the Siskinds law firm drew attention to the "serious stain on the reputation of Milberg LLP," and also raised concerns about the American law firm’s involvement in an Ontario class action.

 

Calling it a "very difficult decision and a very close call," the Ontario court ruled in favor of the Kim Orr firm and stayed the Siskinds action.

 

The court did observe that the Siskinds firm is "one of the pre-eminent class action firms in Canada." The Kim Orr firm, founded in January 2008 was formed by attorneys from other firms that the court described as "pre-eminent."

 

The Ontario court did note the criminal misconduct in which certain Milberg partners had been involved, but also noted that all of the criminally charged attorneys had left the firm. He further noted that the two Milberg attorneys proposed to be involved in the Timminco case were "untainted" by the wrongdoing.

 

The two Milberg attorneys are Michael C. Spencer (currently involved in the trial of the Vivendi securities class action lawsuit in New York) and Arthur Miller (who among other things is an NYU law professor and previously a law professor at Harvard Law School). In support of its motion to lead the Timminco case, a Kim Orr partner submitted an affidavit stating that Milberg’s "experience and resources will greatly enhance our ability to prosecute the case."

 

In reaching its decision to allow the Kim Orr firm action to proceed, the court said it found the involvement of the Milberg firm to be a "neutral factor." The court observed that Milberg "does not bear the mark of Cain," and the two Milberg attorneys "have fine reputations and excellent credentials."

 

The court also noted that while "one can posit examples where the involvement of an American law firm would be grounds for disqualifying an Ontario firm," this is not one of those cases. The court found that Milberg’s proposed role of providing "investigative services, document management services, and strategic advice" not to be disqualifying.

 

After a detailed review of the two law firms’ respective class action claims, the court decided to favor the application of the Kim Orr firm and granted its motion to stay the Siskinds action.

 

An October 30, 2009 Am Law Litigation Daily article about the ruling can be found here.

 

Over the past several years, many of the leading U.S. plaintiffs’ securities class action law firms have launched various initiatives to expand their practice internationally. (Refer, for example, here.) As the Timminco case appears to demonstrate, one consequence seems to be the export to other countries of U.S.-based securities class action experience and expertise.

 

These developments not only seem to be producing an expanded universe of opportunities for the U.S. law firms, but also, given that what the U.S. firms are contributing is their "experience," seem to threaten the possible overseas extension of many attributes of U.S.-style securities class action litigation.

 

The decision in the Timminco case discussed above underscores that there are limitations for U.S. attorneys’ involvement. Indeed, the Am Law Litigation Daily article linked above describes a prior case in which the purely financial involvement of the U.S.-based Motley Rice law firm in a prior Ontario class action lawsuit was disallowed. But the fact that Milberg firm will be participating in the Timminco case does suggest that U.S. plaintiffs’ securities class action attorneys may and sometimes will play a role in the prosecution of securities actions outside the U.S., a development that undoubtedly will be unwelcome for the potential litigation targets in other countries.

 

These developments will also be unwelcome to the potential targets’ D&O insurers as well. Along those lines, it is worth noting that in the October 29 opinion in the Timminco case, Judge Perell expressly noted that "the Timminco directors carry insurance policies that may be available to partially compensate class members if the litigation is resolved in their favor."

 

Timminco’s D&O insurance limits would potentially exposed whether or not the Milberg firm was involved in the case. But the prospect of U.S.-based securities class action plaintiffs’ attorneys aiding securities class action litigation outside the U.S. does seem to present some unwelcome additional possibilities, both in this case as well as other cases yet to come, in Ontario or elsewhere.

 

To be sure, the local attorneys appear highly motivated to develop their own securities class action practices, and it could be, as Judge Perell observed in the Timminco case, that the U.S. plaintiffs’ attorneys presence or involvement really is just a "neutral factor." From my perspective, though, the U.S. securities plaintiffs’ attorneys’ involvement could represent an additional force advancing the development of securities class action litigation outside the U.S.

 

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In an October 28, 2009 opinion (here) in a case in which the Ninth Circuit found the plaintiffs’ allegations met the heightened pleading standards of Twombley and Tellabs, the appellate court reversed the district court’s dismissal of the plaintiffs’ complaint in the Matrixx Initiatives securities class action lawsuit. The decision is significant not only because the appellate court reversed the lower court’s prior dismissal of the case, but also because of what the Ninth Circuit’s opinion implies about the heightened pleading requirements.

 

The plaintiffs sued Matrixx and three of its officers in April 2004, alleging that the defendants were aware that numerous users of Matrixx’s intranasal cold remedy, Zicam, had developed anosmia (loss of the sense of smell), but that they had failed to disclose the risk and instead issued false and misleading statements regarding Zicam. The complaint alleges that the defendants were aware of these problems because of various calls to the company’s customer service line; because of certain academic research, the results of which were communicated to the company; and because of product liability lawsuits that had been filed against the company.

 

The district court granted the defendants’ motions to dismiss, finding that the complaint failed to adequately allege materiality, because the number of anosmia-related complaints of which Matrixx was aware was not "statistically significant." The district court also found that the complaint failed to allege scienter adequately because it "fails to allege any motive of state of mind with relation the alleged omissions."

 

The Ninth Circuit first held that the district court "erred in relying on the statistical significance standard" in concluding that the plaintiffs had not adequately alleged materiality, finding that a court "cannot determine as a matter of law whether such links [between Zicam and anosmia] were statistically insignificant because the statistical significance is a question of fact."

 

Instead the Ninth Circuit said that the appropriate "fact-based inquiry" is (citing Twombley and its progeny) whether the complaint states a claim that is "plausible on its face" – and, with respect to the issue of materiality, whether "the possible link between Zicam and anosmia was information that a reasonable investor would have found significant."

 

After reviewing the plaintiffs’ allegations, the Court found that the complaints allegations were sufficient to meet the PSLRA’s pleading requirements for materiality and, citing Twombley, to "nudge" the plaintiffs’ claims "across the line from conceivable to plausible."

 

The Ninth Circuit further held, with reference to Tellabs standard for pleading scienter, that the inference that the defendants "withheld information intentionally or with deliberate recklessness is at least as compelling as the inference that [the defendants] withheld the information innocently."

 

In reaching this conclusion, the Ninth Circuit noted that the company’s disclosures were "misleading because [they] spoke of the risk of product liability actions without revealing that lawsuits had already been filed." The Ninth Circuit observed that the inference that "high level executives such as [the individual defendants] would know that the company was being sued in a product liability action is sufficiently strong to survive a motion to dismiss."

 

The Ninth Circuit also referenced the various customer complaints and academic studies the results of which were communicated to the company’s director of research and development.

 

Based on its conclusions about materiality and scienter, the Ninth Circuit reversed the lower court’s dismissal and remanded the case for further proceedings.

 

The Ninth Circuit’s decision in the Matrixx case is interesting in a number of respects, not least of which is because the decision reversed the district court’s prior dismissal of the case, although it is certainly interesting in that respect as well.

 

Among other things, the decision is also interesting for its application of the Twombley "facial plausibility" standard to the question of the sufficiency of the plaintiffs’ allegations of materiality. In a prior post (here), I discussed the question whether the "facial plausibility" test of Twombley and its more recent companion case, Iqbal, would have much impact on securities cases, given the PSLRA’s heightened pleading standards. The Matrixx decision suggests that the Twombley standard could indeed impact securities cases, even with respect to elements of a securities claim for which heightened pleading standards are defined in the PSLRA, since the Ninth Circuit cited both the PSRLA’s materiality pleading requirements and Twobley in determining the sufficiency of the plaintiffs’ allegations.

 

The further significance of the Ninth Circuit’s citation to Twombley is the fact that the court also found that the Twombley standard had been satisfied here. Though many objections to Twombley and Iqbal have been raised, the fact is that the "facial plausibility" standard can be satisfied and cases will still be going forward, notwithstanding the pleading standard articulated Twombley and Iqbal.

 

Another interesting thing about the Ninth Circuit’s decision is the way in which the court found that the scienter pleading requirements to have been satisfied, particularly with respect to the individual defendants. The court seems to have put great weight on the individual defendants’ positions, and was less focused on the question whether or not there were allegations of knowledge or awareness as to each of the individual defendants.

 

Thus, for example, with respect to the existence of product liability litigation, the court was willing to draw an inference of scienter as to the individual defendants because "high-level executives… would know" the company had been sued. – without apparent consideration of the question whether the individual defendants did know about the litigation, or even what the company’s practices were for circulating information about new litigation to the company’s senior officials.

 

Similarly, the allegations of scienter based on the alleged awareness of the existence of customer complaints and academic studies was found sufficient as to all three individual defendants, though the allegations refer only to communications of these matters to the company’s director of research. The court’s decision does not refer to what the other two individual defendants are alleged to have known, or even what they would have known in light of the company’s processes for communicating this kind of information internally.

 

If nothing else, the Ninth Circuit’s finding that the scienter allegations were sufficient represents a suggestion that in at least some circumstances (and in at least some courts) allegations that individual defendants held a certain office or position may be sufficient to support a finding of scienter, even where no supporting allegations about what the defendants know or what information they were provided or had access to.

 

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

 

Iqbal on the Hill: Meanwhile, the Iqbal debate arrived on Capitol Hill this week, as the House Committee on the Judiciary Subcommittee on the Constitution, Civil Rights and Civil Liberties held hearings on October 27, 2009. The hearing was entitled "Access to Justice Denied – Ashcroft v. Iqbal." The Committee’s page about the hearing, including links to the witnesses’ testimony can be found here. An October 29, 2009 AmLaw Daily article by Alison Frankel about the hearings can be found here.

 

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Lawsuits seeking to recover large amounts of money are commonplace. But how about a claim that seeks to recover more money than exists in the entire world?

 

According to a September 24, 2009 order (here) by Southern District of New York Judge Denny Chin, the complaint of plaintiff Dalton Chiscolm, Jr. against the Bank of America seeks to recover "1,784 billion trillion dollars," to be deposited in his ATM account "the next day." Oh, and in addition, another $200,164.

 

Judge Chin states that in Chiscolm’s complaint (which Chin describes as "incomprehensible"), the plaintiff "seems to be complaining" that his checks apparently have been rejected because of incomplete routing numbers and when he placed a series of calls to the bank he "received inconsistent information from ‘a Spanish wom[a]n.’"

 

Judge Chin’s September 24 Order directs Chiscolm to show cause in writing by October 23, 2009 the basis on which his claim, which purported to be filed in reliance on federal question jurisdiction, is brought in federal court, or the complaint will be dismissed. As of October 25, 2009, PACER did not show that any statement had been filed.

 

The astonishing quantum of damages sought is more than just a random large number. As it turns out, 1,784 billion trillion – equal to 1.784 multiplied by 10 to the twenty-fourth power, or 1,784 followed by 21 zeroes – corresponds to a value in the International System of Units known as a "Yotta." According to Wikipedia (here), Yotta currently is the largest unit in the system of measurement. In other words, the plaintiff is literally seeking to recover the largest describable number of dollars.

 

An October 23, 2009 BBC News article (here) about Chiscolm’s lawsuit quotes Kevin Houston, a University of Leeds mathematics professor, as saying that "the guy wants more money than there is in the entire world."

 

Well, yeah, but the customer service really was terrible.

 

Judge Chin, who recently was nominated to the Second Circuit, of course is the judge that sentenced Bernard Madoff to 150 years of imprisonment, and so Chin knows a thing or two about large amounts of damages, but the amount of damages that Chiscolm has claimed even managed to get Judge Chin’s attention.

 

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The Supreme Court’s decision in the Iqbal case earlier this year has generated a great deal of controversy and comment and even a proposal to overturn the decision legislatively. Iqbal does seem to be having an impact on a number of cases. An interesting question, however, is whether the Iqbal case will have an impact on federal securities cases, given that the securities laws already have their own separate heightened pleading standards. But a recent Eighth Circuit decision, applying Iqbal to affirm a lower court dismissal, suggests that Iqbal could indeed have an impact in damages actions under the federal securities laws.

 

Background

First, some background. Fed. R .Civ. P. 8(a)(2) requires that a "claim for relief" must contain a "short plain statement of the claim showing that the pleader is entitled to relief." Historically, courts had come to use the shorthand phrase "notice pleading" to describe the requirements under this rule.

 

In the Supreme Court’s 2008 Twombley case (here), the Court said that in order to satisfy these pleading requirements, the complaint must contain sufficient factual matter, accepted as true, to "state a claim to relief that is plausible on its face."

 

In the 2009 Iqbal case, the claimant in a Bivens action had sought to argue that Twombley’s "facial plausibility" test should be limited to the pleadings made in the context of an antitrust dispute, as had been involved in Twombley. The Supreme Court held that the argument  that Twombley was limited to antitrust actions "is not supported by Twombley and is incompatible with the Federal Rules of Civil Procedure." Twombley, the Iqbal court said, "expounded the pleading standard for all civil actions."

 

The Iqbal decision that the "facial plausibility" pleading sufficiency test applies to all federal civil actions has been the subject of a great deal of heated discussion. It has been criticized in many quarters. For example, in a September 3, 2009 article entitled "Plausibility Pleading Revisited and Revised: A Comment on Ashcroft v. Iqbal" (here), Boston University Law School Professor Robert G. Bone argues that Iqbal "takes Twombley’s plausibility standard in a new and ultimately ill-advised direction." Seton Hall Law Professor Edward Hartnett, less critical of the decision, argues in his recent paper (here) that Twobley and Iqbal can and should be "tamed."

 

Twombley and Iqbal have thir supporters. Fellow bloggers Mark Herrmann and James Beck argue on their Drug and Device Law Blog (here) that:

  

There’s nothing radical about requiring a plaintiff to have sufficient facts to plead a prima facie case before the courts will entertain the lawsuit – and that goes for all forms of litigation. It’s simply a construction of the language of Rule 8 "short and plan statement" that emphasizes "statement" a little more and "short" a little less. It’s about time, we think, that courts adopt a construction of the Rules that favors reduced, rather than expanded, litigation.

 

Whether Twombley and Iqbal are generally viewed as good or bad developments largely seems to depend on where your starting point is. But regardless of whether they are good or bad, the cases are having an impact in the lower courts, as Beck and Herrmann underscored in their more recent Drug and Device Law Blog post (here) detailing developments, by way of illustration, in recent medical device cases applying Twombley and Iqbal.

 

These practical impacts have registered with the plaintiffs’ bar, and indeed a September 21, 2009 Law.com article (here) discussed how civil rights and consumer groups and trial lawyers have been meeting to discuss ways to undo Iqbal. According to the article, Iqbal has already had a very significant impact – it has "already produced 1,500 district court and 100 appellate court decisions."

 

These groups have already managed to get proposed legislation introduced in Congress seeking to have Iqbal overturned. On July 22, 2009, Senator Arlen Specter introduced Senate Bill 1504, "Notice Pleading Restoration Act of 2009," which basically provides that courts shall not dismiss a complaint except under the notice pleading standards applicable under Supreme Court precedent prior to Twombley.

 

Whether this legislative effort will go anywhere remains to be seen. Congress has rather a full plate these days, and a bid to adjust a narrow feature of civil pleading standards may not make the cut. On a related note, according to a Point of Law blog post (here), there will be a House hearing on October 27, 2009 on the topic of "Access to Justice Denied – Ashcroft v. Iqbal."

 

Impact on Securities Cases?

Whatever the impact of Iqbal may be in other contexts, it has seemed an uncertain question whether Iqbal will prove to have a substantial impact in damages actions under the federal securities laws, due to the fact that the securities laws already have their own particularized pleading standards. Indeed, under the PSLRA, there are very specific requirements regarding what must be pleaded with respect to misleading statements or omissions and with respect to the required state of mind. The Supreme Court’s 2008 decision in the Tellabs case even further underscored the degree of specificity required to satisfy the state of mind pleading requirements.

 

Given these very specific statutory requirements applicable to the federal securities laws, it could be argued that the more generalized pleading requirements expounded in Twombley and Iqbal might have relatively less impact in the context of a damages action under the federal securities laws. However, a recent decision from the Eighth Circuit suggests that Iqbal could have an impact in securities cases after all.

 

In an October 20, 2009 decision in McAdams v. McCord (here), the Eighth Circuit was reviewing an appeal of a district court’s dismissal of the securities class action lawsuit that have been filed against Moore Stephens Frost (MSF), the outside auditors of UCAP. The district court had held that the complaint "failed to plead with particularity the circumstances of MSF’s alleged fraud, as well as facts giving rise to a strong inference of scienter."

 

The Eighth Circuit held that it "need not decide whether the complaint adequately states with particularity facts giving rise to a strong inference that MSF acted with scienter," because, the court held applying Iqbal to the loss causation pleading requirement under the Dura Pharmaceuticals case, that "the complaint fails to sufficiently plead loss causation."

 

The court referenced what it called the complaint’s "threadbare, conclusory allegation" that as a "direct and proximate cause" of defendants’ fraud the plaintiffs had lost their investments. The court noted that this allegation failed to "specify" how MSF’s alleged statements "as compared to the complaint’s long list of alleged misrepresentations and omissions by the executives, proximately caused the investors’ losses." The court noted further that the complaint "does not state the value of UCAP’s stock when the investors made their investments, or its value right before, or right after, the need for restatement was announced."

 

The Court concluded that without these allegations "the complaint does not show that the investors’ losses were caused by MSF’s misstatements," which "defeats the plausibility of the investors’ claims that MSF’s audit opinions …caused their losses."

 

Discussion

The Eighth Circuit’s decision in the McAdams case, in which the Eighth Circuit held, applying Iqbal, that the claimants’ loss causation allegations lacked "plausibility," shows that Iqbal could indeed have an impact on securities cases.

 

It is particularly interesting that the Eighth Circuit affirmed the lower court’s dismissal on the grounds of insufficient loss causation plausibility, while observing that it did not even need to reach the question whether the plaintiffs had plead scienter with sufficient particularity under the PSLRA. The conclusion suggests that Iqbal’s generalized pleading requirements must be considered analytically prior to the PSLRA’s more particularized requirements. And whether or not the Iqbal standard is to be viewed as prior, its "facial plausibility test" apparently applies to the elements required to state a cause of action under the federal securities laws, even those elements for which the PSLRA does not itself specify particularized pleading requirements.

 

In any event, the basic holding of the McAdams case that the complaint’s loss causation allegations must meet the Iqbal "facial plausibility" standard in order survive an initial motion to dismiss could be a valuable tool for defendants’ to use at the initial pleading stage. (Of course, many plaintiffs will include allegations in the complaint of the kind that the plaintiffs in the McAdams case had omitted, so the extent to which the McAdams decision will affect other cases could be limited – with the inclusion of seemingly minimal additional information about their alleged investment loss, plaintiffs could likely defeat a motion raising similar arguments.)

 

One question that may be of more interest to civil procedure buffs is whether it matters that in McAdams the court was considering a complaint to which (as the McAdams court itself noted) Rule 9(b) applied, rather than (or perhaps, in addition to) Rule 8. Rule 9(b) requires that fraud must be plead with "particularity." To my mind, it does not and should not matter whether the applicable pleading standard is under Rule 9 rather than under Rule 8, either way it would seem (as the McAdams court noted) that the Iqbal "facial plausibility" test should apply, although I would be interested to know if readers disagree.

 

One final thought about Iqbal itself. I tend to agree with the school of thought in favor the decision. I recognize the argument that the "facial plausibility" test does not appear in the Fed. R. Civ. P., but then neither does the phrase "notice pleading." And I find myself puzzled by the critics of Iqbal – are they suggesting that complaints that are not facially plausible should be allowed to go forward? In any event, under Rule 15 (a)(2), courts are admonished to allow pleading amendments "freely when justice so requires," so plaintiffs will typically have at least a second crack at trying to present a "facially plausible" complaint.

 

In any event, based on the McAdams decision at least, Iqbal appears to represent yet another factor raising the hurdle that plaintiffs’ initial pleads must overcome in order to survive a motion to dismiss in a securities class action lawsuit. Clearly, the accumulating number of substantive and procedural developments increasingly favors the defendants in these cases.

 

Very special thanks to Tom Gorman of the SEC Actions Blog for his recent post (here) discussing the McAdams case.

 

More About Loss Causation: An October 21, 2009 memo entitled "Loss Causation Challenges in Securities Cases" (here) by Michael Smith and William Hutchinson of the King & Spaulding law firm surveys recent case law regarding loss causation issues under the federal securities laws.

 

 

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It been a catastrophic week for Galleon Group and its founder, Raj Rajaratnam, with the firm reportedly about to wind itself up in the wake of the epic insider trading allegations raised against Rajaratnam. But the trading indictment is not the only recent stunning legal development involving Rajaratnam and his firm.

 

Among other things, on October 22, 2009, a group of survivors of alleged "terrorist" bombings sued Rajaratnam and his father claiming they knowingly provided financial support to the Tamil Tigers.

 

On a more positive note, Galleon was recently affirmed as lead plaintiff in a securities class action lawsuit pending in the Eastern District of Pennsylvania.

 

The terror victims filed their lawsuit on October 22, 2009 in the District of New Jersey. The seven-count complaint (copy here) was, according the plaintiffs’ lawyers press release (here), the result of "a year-long investigation." The complaint was filed under the Alien Tort Claims Act of 1789, which gives U.S. district court jurisdiction "of any civil action by an alien for tort only, committed in violation of the law of nations or a treaty of the United States."

 

The complaint alleges that Rajaratnam and the family foundation headed by his father provided millions of dollars in funds used for terrorist attacks by the group formerly known as the Liberation Tigers of Tamil Elam (LTTE). The complaint alleges that from 2004 to 2009 LTTE conducted hundreds of attacks and bombings, claiming over 4,000 victims. The complaint alleges that Rajaratnam and his family foundation provided millions in funding to a group that the Treasury Department has described as "a charitable organization that acts as a front to facilitate fundraising and procurement for the LTTE." The complaint alleges that Rajaratnam’s donations were given "with the intent of supporting specific LTTE attacks and operations."

 

The complaint alleges that the defendants aided and abetted terrorist acts "universally condemned as violations of the law of nations: aided and abetted, intentionally facilitated or recklessly disregarded "crimes against humanity in violation of international law," as well as, among other things, wrongful death, negligence and negligent or intentional infliction of emotion distress.

 

Things said about Rajaratnam and his firm in the September 30, 2009 ruling (here) by Eastern District of Pennsylvania Judge Juan R. Sanchez, in which Sanchez affirmed Galleon as lead plaintiff in the Herley Industries securities class action lawsuit, were decidedly more positive. The subsequent events (which the court obviously had no way of anticipating) do cast a very strange light on the opinion.

 

Even prior to events of the last week, Galleon’s selection as lead plaintiff in the case was notable. Investment advisors typically are regarded as lacking standing to pursue the claims of their clients’ funds, because they lack an "injury-in-fact" – that is, they suffered no direct injury. A long line of district court cases have declined to appoint investment advisers as lead plaintiffs for that very reason. In considering these issues, Judge Sanchez observed that Galleon, unlike the investment advisors in the other cases, was "closely connected" to the Galleon funds that held the company’s stock.

 

With respect to the connection between Galleon and the funds, Judge Sanchez noted that "the same people control both Galleon and the funds," adding that "Raj Rajaratnam serves as director of the two funds and as Galleon’s managing partner." There were, however, further standing issues involved because the funds had not assigned their claims to Galleon until after Galleon was initially appointed to serve as lead plaintiff.

 

Finding that Galleon now had standing in light of the assignment, and noting further that "Galleon has served as an adequate plaintiff for more than two years," and that it had a larger financial interest in the case than the competing pension fund, the court exercised its discretion to affirm Galleon as the lead plaintiff in the action.

 

In support of this conclusion, Judge Sanchez observed, among other things that "to appoint a new lead plaintiff at this late date would unduly disrupt the litigation process."

 

Certainly, no one wants the litigation process unduly disrupted, but I suspect that in light of events subsequent to Judge Sanchez’s September 30 order, the litigation process in the Herley Industries case is about to be duly disrupted.

 

Among other ironies is that in the court’s prior order initially appointing Galleon as lead plaintiff (here), the competing pension fund had argued that Galleon was an "unsuitable" lead plaintiff owing to the "unique defenses" to which Galleon was subject. Among other things, the competing pension fund had argued that Galleon was a hedge fund that had shorted Herley’s stock during the class period (and therefore allegedly profited from the fraud on the market), and further argued that the short sale activity violated the federal securities laws. Judge Sanchez found the securities law violation allegations to be speculative and selected Galleon as lead plaintiff in light of the PSLRA’s presumption in favor of the plaintiff that suffered the greatest financial.

 

The competitor pension fund presumably could be substituted in as lead plaintiff, but, as Judge Sanchez noted, the pension fund’s losses "pale by comparison" to Galleon’s.

 

As interesting as all of these things are, I suspect there will be more attention-grabbing legal developments about Galleon and Rajaratnam in the weeks and months ahead.

 

Special thanks to Adam Foulke of the Motley Rice firm for providing me with a copy of the plaintiffs' complaint in the Tamil Tiger case. Special thanks to a loyal reader for providing copies of the opinions in the Herley Industries case.

 

In Case You Missed It: OakBridge Insurance Services announed yesterday that Mickey Estey and Lance Sunder, both previously of NASDAQ Carptenter Moore,  have joined OakBridge and will be opening offices for the company in the metro regions of San Francisco, CA and Minneapolis, MN, respectively.

 

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On October 19, 2009, in a securities case from an earlier era involved allegedly misleading statements regarding asset-backed securities, Southern District of New York Judge Harold Baer substantially denied the defendants’ motions to dismiss the plaintiffs’ complaint as amended, following the long-running case’s trip through the Second Circuit on interlocutory appeal. A copy of the October 19 opinion can be found here.

 

Judge Baer’s decision in the Dynex Capital securities case is noteworthy not only because of the previous high profile appellate decision in the case, but also because Judge Baer found plaintiffs’ amended allegations sufficient to survive the renewed motion to dismiss, after prior pleadings had failed in whole or in part to withstand scrutiny.

 

Though the case is from a slightly earlier era (it was initially filed in 2005), it raises many allegations similar to those involved in the current round of subprime and credit crisis-related securities lawsuits, and therefore could be influential with respect to dismissal motions in the more recent cases.

 

Background

Dynex was in the business of packaging mortgage loans into securities. Between 1996 and 1999, Dynex originated or purchased 13,000 mobile home loans that served as collateral for bonds that a unit of the company issued. The underlying loans performed poorly and in 2003-04 the bonds were downgraded by the rating agencies. The bonds’ value dropped by as much as 85%.

 

The plaintiffs filed a securities class action lawsuit on behalf of investors who had purchased the bonds between February 7, 2000 and May 13, 2004. The plaintiffs allege that the defendants artificially inflated the bonds’ price by misrepresenting that the poor performance of the bond collateral was due to market conditions, concealing that the defendants’ "aggressive and reckless loan underwriting and origination practices generated a pool of collateral loans of poor credit quality and inherent defects."

 

In a February 2006 opinion (here), Judge Baer granted the defendants’ motion to dismiss the complaint as to the individual defendants for failure to adequately allege scienter, but he denied the motion as to the corporate defendants. In June 2006 he certified his opinion for interlocutory appeal on the question "whether scienter could be adequately alleged against a corporation without concomitant allegations that an employee or officer acted with the requisite scienter."

 

In 2008, the Second Circuit held (here) that corporate scienter may be sustained even "in the absence of successfully pleading scienter as to an expressly named officer." However, the Second Circuit held that the plaintiffs had not met the standard for corporate scienter, vacated Judge Baer’s prior ruling and remanded the case to allow the plaintiffs an opportunity to replead.

 

The plaintiff filed a second amended complaint (hereafter, the amended complaint) and the defendants’ renewed their motion to dismiss.

 

The October 19 Opinion

In their newly amended complaint, the plaintiffs added the statements of nine confidential witnesses and also identified and described for the first time four categories of reports that the plaintiffs alleged put the defendants on notice that their public statements were materially misleading.

 

Based on the confidential witnesses’ statements, which bolstered the plaintiffs’ allegations about how the defendants accessed and used the identified categories of reports, Judge Baer found that the plaintiffs had sufficiently alleged that several categories of the statements on which plaintiffs sought to rely were misleading and false. These categories included defendants’ statements regarding the adherence to underwriting standards; the defendants’ statements about the reasons for the deterioration in the collateral performance; and the defendants’ statements about the adequacy of the company’s loan loss reserves and internal controls.

 

More significantly in light of the case’s prior procedural history, Judge Baer found that the plaintiffs had adequately pled scienter. Judge Baer found that the plaintiffs’ allegations about the information available to defendants in the newly referenced documents represented strong circumstantial evidence of scienter. Judge Baer found that the amended complaint, by contrast to the plaintiffs’ prior complaint, "contains factual allegations about several forms of reports that collectively provided to Dynex’s senior management, including the Individual Defendants, information that contradicted their misleading statements."

 

The information in the documents was "available to and reviewed by the senior management responsible for the public statements at issue that either put them on notice of the falsity of these statements or clearly should have done so." Judge Baer found that the inference of scienter from these allegations was as least as compelling as the contrary inference that the defendants sought to draw.

 

Judge Baer found that when the amended complaint is viewed "holistically," a "cogent story of securities fraud is revealed":

 

The Defendants originated or purchased a large number of mobile home loans of generally low credit quality, a substantial number of which were "inherently defective," and packaged them into the Bonds failing to disclose that the stated underwriting guidelines were "systematically disregarded"; then, when adverse market conditions coincided with rising defaults and many loans were uncollectible as a consequence of inherent defects, Defendants publicly stated that market conditions were to blame in an attempt to forestall deeper drops in the value of the Bonds, many of which they held for their own account.

 

Accordingly, Judge Baer held that the amended complaint "alleges facts giving rise to a strong inference" that the statements he "found to be false and misleading were made with scienter."

 

Discussion

The Dynex Capital case arose in February 2005, two years before the current round of subprime and credit crisis litigation began, but the plaintiffs’ allegations are remarkably similar to many of the allegations raised in the more recent lawsuits. The fact that the amended complaint largely survived the most recent motions to dismiss is all the more significant given the plaintiffs’ early difficulties in the district and appellate courts in trying to get over the initial pleading hurdles.

 

The fact that the plaintiffs in the Dynex Capital case were ultimately able to overcome the initial pleading hurdles will obviously be of particular interest to the plaintiffs in the more recent cases. The plaintiffs were able to survive the renewed dismissal motion in this case because of the large number of well-placed confidential witnesses who were able to provide detailed descriptions of the company’s processes and of the key documents and their availability to senior management, as well as how the information in the documents allegedly contrasted with the defendants’ public statements.

 

Obviously not all plaintiffs in other cases will be able to muster the same number or caliber of confidential witnesses or success in being able to utilize confidential witnesses to show with such particularity what information was available to senior management and how the available information contrasted with public statements.

 

But the fact that the plaintiffs in this case were able to put those elements together, and were able to do so in a way sufficient to overcome the court’s original skepticism shows that plaintiffs in general can put together allegations to surmount even the heightened scienter pleading standards of the Tellabs case. The fact that these plaintiffs were able to do so after the initial pleading challenges also suggests that in other cases in which plaintiffs initial complaints failed to survive, the pleading defects still may be overcome with sufficiently particularized amended pleading, even on the critical issue of scienter.

 

In any event, because of the similarity of the allegations on this case to the allegations in many of the current cases, Judge Baer’s recent decision in the Dynex Capital case is likely to be important in the current cases similarly involving asset-backed securities allegedly misleading disclosures about underwriting standards, collateral quality, internal controls and adequacy of loan loss reserves.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog for providing a copy of Judge Baer’s October 19 opinion.

 

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It is always useful to look at aggregate securities lawsuit filing data to try to determine what trends and themes can be discerned, but occasionally it is also useful to look at a single new filing whether it might suggest anything. To choose one example, a closer look at a new securities class action lawsuit filed on October 14, 2009 in the Eastern District of Pennsylvania against Advanta Corporation and certain of its directors and officers seems to reflect a variety of different securities litigation tendencies and motifs.

 

Advanta at one time was the country’s largest issuer of Visa and MasterCard credit cards, through its subsidiary, Advanta Bank Corp. As reflected in the plaintiffs’ lawyers’ October 14, 2009 press release (here), the lawsuit alleges that the defendants failed "to disclose the impact of the economic environment and the deteriorating credit trends on its business and that the Company failed to adequately and timely record losses for its impaired loans and customer delinquencies, causing its financial results to be materially false."

 

Specifially, the complaint (which can be found here) alleges that:

 

(a) Advanta’s assets contained tens of millions of dollars worth of impaired credit card receivables for which the Company had not accrued losses; (b) prior to and during the Class Period, Advanta had been extremely aggressive in granting credit to customers without verifying the customers’ ability to pay, to such a degree that by the summer of 2009, Advanta customers’ default rate would be almost six times worse than industry average; (c) Advanta’s manipulation of its cash rewards program angered customers and caused the Company to lose good, creditworthy customers; (d) Advanta’s credit receivables were unduly risky due to the Company’s practice of issuing credit cards to small business owners without, in many instances, verifying income; (e) defendants failed to properly account for Advanta’s continuing delinquent customers and the credit trends in the Company’s portfolio, resulting ultimately in large charges to reflect impairments; and (f) the Company was not on track to be profitable in 2008.

 

The complaint alleges that the company’s share price plunged after its October 2007 disclosure that it was experiencing a higher rate of delinquencies. The complaint alleges that thereafter the news only got worse, and in May 2009 the company announced in May 2009 the cancellation of "millions of cards held by small businesses." On June 30, 2009, the FDIC entered a cease and desist order (here) against Advanta Bank following allegations of unsafe and unsound banking practices.

 

Though the complaint references these more recent events, the putative class period proposed in the complaint runs from October 31, 2006 through November 27, 2007.

 

This complaint is of course a reflection of the specific circumstance alleged with respect to this one company and its banking subsidiary. Nevertheless, the complaint also reflects a number of different securities litigation themes and trends, some of which are well-established and some of which may only just be emerging.

 

First, this case is yet another example of the kinds of litigation that may emerge in connection with the growing numbers of troubled banks. As I have noted in numerous posts (most recently here), though the level of litigation involving failed and troubled banks is still well below what might be expected given the number of distressed institutions, a number of lawsuits have begun to emerge and there may yet be more in the future.

 

Second, while I have noted elsewhere that as 2009 has progressed the wave of subprime and credit crisis related litigation definitely seems to have slowed (or even just merged into larger litigation developments to the point that it may no longer be its own separately identifiable category of litigation), this case suggests that it is far too early to declare that the litigation wave has ended. Obviously, there may yet be other cases that raise similar credit related lawsuits in the months ahead.

 

This case also demonstrates with respect to the subprime and credit crisis-related litigation wave that the lawsuits encompass a wide variety of kinds and categories of credit, including, as shown here, credit card debt. As noted here with respect to the litigation involving American Express, there have been prior credit crisis securities lawsuits filed with respect to issues concerning credit card debt.

 

Third, the 23-month gap between the end of the proposed class period and the filing of this lawsuit is yet another example of the significant number of filings in the second and third quarter of 2009 that involve class period cutoff dates in the distant past. As noted in prior posts (most recently here), this phenomenon might suggest that while the plaintiffs’ lawyer were previously preoccupied filing numerous credit crisis and Madoff related lawsuits, they developed a backlog of cases that they have now started to work off.

 

Indeed, just in the past several days there have been several other cases with long past class period cutoff dates, including the lawsuit recent filed involving RHI Entertainment (filed on October 8, 2009, class period cutoff of June 19, 2008); Men’s Wearhouse (filed on October 8. 2009, class period cutoff date of January 9, 2008); and EnergySolutions (filed October 9, 2009, class period cutoff date of October 14, 2008).

 

Apparently, as the Advanta case suggests, the backlog may even include other credit crisis cases, which is yet another reason that, as noted above, there may be still other credit crisis cases yet to come.

 

In any event, I have added this case to my list of subprime and credit crisis-related securities lawsuits, which can be found here. If this case is any indication, there could be others credit crisis securities cases yet to come.

 

Courtroom Drama: While we all remain interested in the developments in the ongoing trial in the Vivendi securities class action lawsuit, there is certainly nothing new about courtroom drama, and some of the most compelling courtroom tales have an ancient and venerable pedigree.

 

A particularly engaging tale of courtroom drama is told in The Life and Times of Constantine the Great, a biography of the Roman emperor by D.G. Kousoulas. During Constantine’s reign, Athanasius, the bishop of Alexandria and one of the protagonists in the long-running Arian controversy, was accused by his foes of murder. An inquest of bishops and imperial officials was convened.

 

At the inquest, the accusers presented their case against Athanasius, and even produced a blackened hand, allegedly that of the victim, Arsenius. Kousoulas describes the scene:

 

After the accusers had enjoyed a moment of triumph as they passed the blackened hand around, Athanasius asked in a quiet voice if any of those present knew Arsenius personally. A number of bishops claimed to have known the murdered bishop well. Would they recognize him if they saw him, Athanasius asked. Certainly, they replied, "if he were alive." At that point Athanasius signaled to a man who was standing near the doorway, his face covered with his cloak. The man, his face still covered, moved to the front. "Lift your cloak," Athanasius said. The man removed the cloak and [as a contemporary account noted] "lo and behold it was Arsenius himself." Athanasius moved closer and drew first one and then the other sleeve. Aresenius had both of his hands. "Has God given a man more than two hands?" Athanasius asked with a sarcastic smile.

***

For a moment there was stunned silence. Then one of the accusers declared loudly that all this was sorcery and devil’s work. The man was not Arsenius although he had his face, he was not even human but an illusion produced by Athanasius with his knowledge of black magic. Athanasius asked the bishops to come and touch the man he was accused of having murdered. The meeting turned into a brawl, and Dionysius, the imperial officer attending the meeting on orders from Constantine, had to hurry Athanasius out to save his life.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Background

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

 

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

 

Additional background regarding the case and the plaintiffs’ allegations can be found here.

 

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

 

The Opening Statements

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Observations

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

　

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Could the Bill Pass?

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

What Happens if the Bill Passes?

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Unlike his Stoneridge bill, Specter’s Iqbal bill has not yet made it to committee review. According to Tony Mauro’s September 21, 2009 Law.com article (here), civil rights and consumer groups and trial lawyers have been meeting and conferring on ways to advance the legislation or otherwise to try undo Iqbal. According to the article, Iqbal has already had a very significant impact – it has already "produced 1,500 district court and 100 appellate court decisions."

 

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

 

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Background

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

 

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

 

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

 

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

 

The Eleventh Circuit’s Opinion

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

 

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

 

Recently Filed Securities Class Action Lawsuits

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

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

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

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

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

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

 

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

 

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

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

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

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

 

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

 

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

 

 

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

 

 

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

 

 

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

 

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

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

 

 

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

 

 

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

 

 

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

 

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

 

Background

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

 

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

 

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

 

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

 

The Opinion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Background

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Background

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

 

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

 

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

 

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

 

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

 

The Cert Petition

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

 

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

 

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

 

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

 

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

 

Analysis

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Background

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

 

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

 

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

 

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

 

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

 

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

 

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

 

The Litigation

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Judge Rakoff did find certain distinguish