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

About the UnitedHealth Group Class Action Settlement: UnitedHealth Group announced on July 2, 2008 (here) that it reached an agreement to settle its high profile options backdating-related securities class action lawsuit for $895 million. A July 3, 2008 Law.com article discussing the settlement can be found here.

Not only is this settlement the largest options backdating related securities lawsuit settlement to date, it is one of the largest securities settlements ever. The settlement does at least provide some counterweight to the view that some have expressed (refer here) that the options backdating related lawsuits may be settling low compared to historical standards.

This settlement, together with the $750 million Xerox settlement announced in March 2008 (including $80 million from the company’s auditor) and the flood of high profile, high stakes subprime-related litigation, may also undercut the view that has been expressed that overall settlements may begin to decline as the cases from the era of corporate scandals cycle out of the system.

It is probably worth noting that, as reported in the July 3, 2008 Wall Street Journal (here), the UnitedHealth settlement has not yet been completely resolved, as the settlement does not include United ealth’s former CEO William McGuire, nor does it include its former General Counsel, David Lubben.

Although it has not received nearly as much attention, it is also noteworthy that in its July 2 press release UnitedHealth also announced that it had also settled for $17 million the options backdating related ERISA lawsuit pending against the company and certain of its officials. As far as I am aware, this is the roughly half dozen options backdating related ERISA lawsuit to have settled. (To see a complete list of options backdating related ERISA lawsuits, refer here.)

Derivative litigation related to the options backdating woes at UnitedHealth previously resulted in the largest reported derivative settlement, as I discussed in a prior post, here.

I have added the UnitedHealth options backdating securities class action lawsuit settlement and ERISA lawsuit settlement to my table of the options backdating related settlements and dismissals, which can be accessed here.

Credit Rating Lawsuits: As I discussed in a recent post (here), even though the credit rating agencies’ conflicted role has been a central topic in the discussions surrounding the subprime meltdown, the plaintiffs’ lawyers have largely avoided drawing the credit rating agencies into the subprime litigation. However, lawsuits filed just in the past several days suggest that this may be changing, in addition to the lawsuit discussed in my prior post.

Though the plaintiffs’ lawyers had not generally been targeting the credit rating agencies for their rating activities, they have previously filed lawsuits on behalf of the shareholders of Moody’s (refer here) and  of The McGraw Hill Company, parent of Standard & Poor’s (refer here), alleging misrepresentation in their financial disclosures.

As described in a July 1, 2008 press release (here), plaintiffs’ lawyers have now initiated a shareholder securities class action lawsuit against Fimalac, S.A., the corporate parent of Fitch’s rating agency. According to the press release, the complaint (which can be found here) alleges that the defendants failed to disclose with respect to Fitch’s ratings of Residential Mortgage Backed Securities (RMBS) and Collateralized Debt Obligations (CDO) that:

(i) the information upon which Fitch based its ratings of RMBS and CDOs was misleading and in many cases fraudulent; (ii) to continue to collect fees for its ratings, Fitch was applying lax standards or no standards at all when issuing its RMBS and CDO ratings; and (iii) Fitch was failing to monitor the credit quality of RMBS and CDOs after issuing its initial ratings, as Fitch was obligated to do, and many of these securities had deteriorated badly after Fitch had issued its ratings. Fitch is now under investigation by the New York Attorney General, the Connecticut Attorney General, the Ohio Attorney General and the SEC as a result of its practices of rating billions of dollars of securities without a reasonable basis for doing so and Fimalac’s stock is trading at approximately 50% of its Class Period high.

But the new Fimilac shareholder lawsuit is directed against Fimilac as a reporting company, not directly against the company for Fitch’s rating agency activities. As I noted in my prior post, plaintiffs' lawyers have largely avoided allegations against rating agencies for their rating activities. However, in a lawsuit initiated in New York state court on June 3 , 2008 and removed to federal court on June 23, 2008, plaintiffs have alleged that entities affiliated with Credit Suisse, and the Moody’s, S&P  and the Dominion Bond Rating Service (DRBS) rating agencies misrepresented the values of Mortgage Pass-Through Certificates issued by the Home Equity Mortgage Trusts. (Refer here for background regarding the lawsuit.)

The basis of the claims of liability against the rating agencies in the Home Equity Mortgage Trust lawsuit, as alleged in paragraph 87 of the complaint (here), is that  the rating agencies  “prepared valuations, i.e., assigned ratings to the Certificates, in connection with the Offering, as defined in Section 11 (a)(4) of the Securities Act.” These allegations are similar to the allegations against the credit rating agencies in the HarborView case discussed in my prior post.

Whether or not these cases against the credit rating agencies for their rating activities ultimately go forward remains to be seen. As I have previously discussed (here), the credit rating agencies will contend that their rating activities are protected by the First Amendment.

In addition, it remains to be seen whether the Home Equity Mortgage Trust case will go forward in state or federal court. As discussed at length in my prior post (here), the ’33 Act expressly provides for concurrent state court jurisdiction and also expressly proscribes removal of state court ’33 Act actions to federal court. As discussed here, in at least one case, a federal court has concluded that a ’33 Act claim that has been initiated in state court and removed to federal court must be remanded back to state court.

One More Note About the Fimalac Lawsuit:  Fimilac is a foreign-domiciled company whose shares do not trade on U.S. exchanges. Many of its shareholders obviously are domiciled outside the United States. If these non-U.S. shareholders were to be included in the class, the new class action complaint against Fimilac might present the complicated f-cubed litigant problem (which I discussed most recently here). However, the plaintiffs’ counsel in the Fimilac case purport to represent a class composed solely of U.S. residents, apparently as a way of avoiding the f-cubed litigant problem.

As I discussed in my recent post relating to the new securities class action filed against EADS (refer here), these attempts to plead around the issues involving foreign-domiciled  plaintiffs still test the outer limits of the jurisdictional reach of U.S. securities laws against foreign-domiciled companies whose shares do not trade on U.S. exchanges. The case against Fimilac will be interesting to watch for reasons other than the involvement of a credit rating agency.

And Finally: The news about the dismissal of the lawsuit against Richard Grasso has gained a great deal of press attention. Indeed, the Wall Street Journal, in a July 3, 2008 editorial (here), congratulates Grasso and fellow defendant Kenneth Langone for their success in fighting the lawsuit, which the Journal viewed as an example of the overreaching of former New York AG Eliot Spitzer.  

The Journal’s editorial is perhaps closest to the mark in its observation that “Mr. Grasso is fortunate he had the resources to fight back.” Had Grasso not had the wherewithal to resist, he might never have tasted vindication. Readers of this blog will be particularly interested to know that it was insurance funds – a very large amount of insurance funds – that ultimately allowed Grasso to succeed.

According to Langone, and as reported on Bloomberg (here), in defending themselves against the lawsuit, Grasso, Langone and the NYSE directors “spent more than $70 million fighting the case, all covered by insurance.”

So Grasso is indeed fortunate that he had the resources to fight back, but perhaps contrary to the Journal’s suggestion, and even Grasso’s own prior comments (refer here) it was not his own treasure that financed the fight.

The expenditure of the mind-boggling sum of $70 million in litigating this case is yet another reminder of the extraordinary costs associated with the kind of high stakes litigation in which directors and officers can become involved. As I recently noted (here), the escalating expense associated with this kind of litigation has important implications for limits adequacy assumptions.

While it may be that only extraordinary cases consume these astonishing quantities of money, a company’s D&O program is expected to be able to respond even to catastrophic claims. As seems to be increasingly apparent, the costs associated with just defending a catastrophic claim could exhaust many insurance programs. All of this may suggest the need to reexamine conventional assumptions about limits adequacy.

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Securities lawsuit filings remained elevated during the first half of 2008. The 105 new securities lawsuit filings during the first six months of 2008 were more than 50% higher than the number of new securities lawsuit filings (69) in the first six months of 2007. (Please refer to the note below regarding my lawsuit filing “count”, which may differ from some other published tallies).

The 204 new securities lawsuit filings during the 12-month period from July 1, 2007 to June 30, 2008 is 15% higher than the 176 filings for the full year 2007 and also represents a 65% increase compared to the 123 filings during the 12-month period from July 1, 2006 through June 30, 2007. The 204 new securities lawsuit filings during the 12-month period ending on June 30, 2008 is the highest 12-month total since the period July 2004 through June 2005, during which 228 lawsuits were filed.

The 105 lawsuits filed during the first half of 2008 projects to a year-end total of 210 securities lawsuit filings, meaning that the filing rate is above the post-PSLRA filing average. According to Cornerstone Research, here, the annual average number of securities class action lawsuits during the period from 1996 to 2006 was 194.

A year end total of 210 filings would also represent the highest annual total since 2004, when 237 securities lawsuits were filed. (Because my YTD lawsuit count omits a number of lawsuits, for reasons discussed below, my YTD tally and my year-end projection may be lower the numbers that may appear in other published sources.)

The most significant factor in the elevated securities filing activity is the number of new lawsuits associated with the subprime and credit crisis. 58 of the first half filings (about 55%) of the first half securities lawsuit filings are subprime or credit crisis related. As reflected on my running tally of the securities class action lawsuits, which may be accessed here, the total number of subprime and credit crisis related lawsuits, including those filed in 2007 as well as those filed in 2008, now stands at 98. (Please refer to the note below regarding the recent revisions to my subprime and credit crisis-related lawsuit tally.)

Only 46 of the 105 first-half securities lawsuit filings were not subprime or credit crisis-related, meaning that the subprime related litigation unquestionably was a driving factor in the elevated securities lawsuit filing levels (although one might also speculate that other filings are down because the plaintiffs’ securities’ bar is preoccupied with the still emerging subprime litigation).

The subprime and credit crisis filings show no sign of abating. Of the 58 subprime lawsuits filed in the first half of 2008, 29 – exactly half-- were filed in the second quarter, including eleven in June alone. This continued steady filing level suggests that the subprime and credit crisis-related litigation wave will continue during the second half of 2008.

An analysis of the first half filings by Standard Industrial Classification (SIC) code confirms the foregoing conclusions. Although the companies sued in the first half of 2008 represented 56 different SIC Code categories, fully 62 of the lawsuits (or about 59% of the first half filings) were filed against companies in the 6000 SIC Code series (Finance, Insurance and Real Estate). The two most prominent SIC Code categories were SIC Code 6021 (National Commercial Banks), which had 17 lawsuits, and SIC Code 6211 (Security Broker Dealers), which had 14 lawsuits. No other single SIC Code category outside the 6000 SIC Code series had more than three lawsuits. (Please refer to the note below regarding SIC Code categorization.)

These statistics underscore an important point about the subprime and credit crisis related litigation. That is, with a couple of arguable exceptions, the subprime and credit crisis related litigation wave really has not spread beyond the financial sector. Although I have long speculated (most recently here) that the credit crisis litigation might hit nonfinancial companies, by and large that has not yet happened, at least not to any significant degree.

One consequence of the predominance of the subprime and credit crisis related litigation is that many of the first half lawsuits involved nontraditional plaintiffs and defendants. The traditional or conventional securities lawsuit to which I refer here involves a securities class action lawsuit brought by public company shareholders against the company and its directors and officers. This traditional type of securities lawsuit may sometimes include other third party defendants such as the company’s auditors or the company’s offering underwriters.

But many of the first half lawsuits involve plaintiffs other than public company shareholders. For example, among the first half filings were 17 auction rate securities lawsuits, in which the plaintiffs were not public company shareholders, but rather auction rate securities investors who were suing the broker dealers or financial institutions that sold them the instruments. (The securities issuers were not usually targeted in these lawsuits.) Refer here for my prior discussion of the auction rate securities lawsuits.

Similarly, the multiple securities lawsuits brought by mortgage-backed securities investors against the financial institutions that created the instruments also do not involve traditional shareholder plaintiffs. In addition, as I discussed here, the plaintiffs lawyers have chosen to bring many of these lawsuits against the securitizers in state court, to be be removed subsequently by the defendants to federal court. So the first half 2008 filing total is also noteworthy for its inclusion of a number of state-court initiated lawsuits.

The credit crisis litigation wave has also hit a number of nontraditional defendants. Rather than targeting just public company defendants, the plaintiffs in many of these lawsuits targeted, for example, hedge funds (refer here) and mutual funds (refer here). The presence of these nontraditional defendants sometimes pose some tough questions at the margins about whether or not a specific lawsuit should be included in the lawsuit count, as discussed further below.

It is probably worth noting that in addition to the lawsuits from the current credit crisis-related litigation wave, the first half filings also included two options backdating-related securities lawsuits filings.

Companies domiciled outside the United States were sued in 19 of the first half new securities lawsuit filings, representing 12 different countries, including four each from Canada and from Switzerland.

The lawsuits filed against domestic companies included corporate defendants from 27 different states, with the largest number from New York (22 lawsuits) and California (11 lawsuits).

The lawsuits were filed in 26 different U.S. district courts, but by far the largest number were filed in the Southern District of New York, where 43 (or about 41%) of the 105 lawsuits were filed. Other courts with a significant number of filings included the District of Massachusetts (11 lawsuits), the Northern District of Illinois (8 lawsuits), the Central District of California (5 lawsuits) and the Northern District of California (5 lawsuits).

A Note about “Counting” Lawsuits: As noted above, the presence of nontraditional plaintiffs and defendants, as well as the emergence of state court and other nontraditional filings, raises many hard questions about what to include in the lawsuit count. These factors by themselves create significant potential for different lawsuit counts.

In addition, the pattern of much of this litigation also poses some “counting” challenges. A couple of examples will illustrate the problem

Lehman Brothers (or at least one of its officers) was first sued in February 2008 in the Northern District of Illinois. That lawsuit was voluntarily dismissed. A second Northern District of Illinois lawsuit involving Lehman Brothers was filed in April 2008. Then a separate lawsuit was filed in the Southern District of New York in June 2008. I have only counted this litigation once, as has, for example, the Stanford Law School Securities Class Action Clearinghouse (as shown here).

By contrast, Falcon Strategies, a Citigroup-affiliated hedge fund, was sued in a securities lawsuit in April 2008, in federal court in Florida. That lawsuit was later voluntarily dismissed. (Refer here). Then the fund was sued in May 2008 in federal court in New York in a tender offer-related securities lawsuit (refer here) I could see counting this litigation once, but the Stanford website has counted each lawsuit separately and so have I.

But while I am in accord with the Stanford website to that extent, I could not agree with the Stanford site on some other specifics. For example, one of the lawsuits on their list is the Safeco litigation (refer here). The Safeco lawsuit is a merger objection suit. I have never counted these kinds of lawsuits in my tallies; were this lawsuit to be included, a whole raft of other merger objection litigation would also arguably have to be included. In my opinion, this lawsuit should not be counted in the securities lawsuit tally, but reasonable minds clearly could differ.

Similarly, the 2008 lawsuit involving Heartland Resources (about which refer here) contains allegations that the defendants improperly failed to register certain limited partnership interests. Alleged violations of the obligation to register securities seem to me to be fundamentally different than a lawsuit for securities law damages based on alleged misrepresentations or omissions relating to publicly traded securities. Reasonable minds could differ on this issue as well, but to my mind this kind of lawsuit should not “count.” This analysis applies not just to the Heartland Resources lawsuit, but also to the lawsuits involving Maximum Financial Group (refer here) and WCI Communities (refer here).

I have illustrated this analysis in detail here first to show how “tricky” this whole counting exercise is, and second to explain why there may be differences between my tallies and some others that may be published, including for example any lawsuit count based on the Stanford website. That does not mean that I think mine is right and the others are wrong – as I have stressed throughout, reasonable minds could differ on many of the specifics. The most important thing is that the various analyses are directionally consistent, which undoubtedly is and will be the case. The marginal differences are relatively unimportant.

A Note about SIC Code Categorization: As discussed above, the first half 2008 lawsuits include some filed against nonconventional defendants, including some, like hedge funds and mutual funds, that have not been assigned to an SIC Code category. In addition, many of the lawsuits included a host of related entity defendants.

Where the list of defendants includes a public company, I have used the public company’s SIC Code, even if it is not the primary defendant. Similarly, where a fund defendant is affiliated with a public company, I have used the public company’s SIC Code.

Nevertheless, there were a total of three of the lawsuits filed in the first half where I was unable to assign any SIC Code. These cases primarily involve mutual fund defendants.

A Note about the Subprime Lawsuit Tally: Regular readers know that I have been maintaining a running tally of the subprime and credit crisis-related securities lawsuits (which may accessed here). Readers that have been monitoring the list closely over time may have been somewhat surprised by the credit crisis lawsuit numbers I have used in this mid-year analysis. These numbers may appear suddenly larger than more recent tallies.

The reason for this adjustment is that as part of this mid-year review, I undertook a comprehensive audit of my lawsuit lists, and, in particular I conducted a cross-comparison with the Stanford website and a number of other sources.

As a result of this process, I added several items to my list of subprime securities lawsuits. Some of these additions were required because I had simply omitted certain items (where, for example, I was aware of the lawsuit but had simply neglected to add it to the list). Some of the additions were the result of recategorization, some simply new additions. All of these additions are highlighted in red in my updated list, which can be accessed here.

Break in the Action: The D&O Diary will slowing down in the next few days and will resume its normal publication schedule during the week of July 7.

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Eastern cultures ascribe events to destiny, fate, or “karma.” But in our culture we demand to know who is to blame. The Zeitgeist of America’s blame culture apparently has decreed that Ralph Cioffi and Matthew Tannin, the former Bear Stearns fund managers, are to be the first level scapegoats for the subprime crisis. The “perp walk” to which they were subjected last week – why? Whatever happened to the presumption of innocence?—is now a standard component of the American blame ritual.

 

But a review of the charges against them does raise some concerns. Indeed, many observers have already questioned the proceedings.

 

A number of commentators have observed that Cioffi and Tannin’s alleged misrepresentations were no different than those of many others on Wall Street. Indeed, both Bloomberg’s Caroline Baum (here) and Professor Peter Henning of the White Collar Crime Prof blog (here) see little difference between Cioffi and Tannin’s statements about the Bear funds and the remarks of Bear Stearn’s CEO Alan Scwartz two days before the company’s collapse that “our liquidity position has not changed.” Professor Ribstein, on his Ideoblog (here), suggests that the difference between Cioffi and Tannin on the one hand, and Schwarz on the other, is that Cioffi and Tannin made the mistake of being hedge fund managers rather than corporate executives (“the bad luck of their chosen line of work”)

 

Some commentators even question the culpability of the two individuals’ alleged misrepresentations. As Professor Henning notes:

A false hope that the hedge funds would pull through, no matter how misguided, can be a defense to a fraud charge. Showing that Cioffi and Tannin were of two minds, or conflicted about where the market was headed, does not mean that the statements to investors were part of a fraudulent scheme.

Professor Henning goes on to observe:

As a Wall Street case, the charges seem a bit thin to me. Hedge fund managers are essentially salesmen, touting their wares in much the same way that the man in the used car lot has a great deal for you….The fact that Wall Street salesmen talked out of both sides of their mouths is nothing new.

Professor Henning also questions the significance of Cioffi’s withdrawl of $2 million from one of the funds, noting that “withdrawing your own money is not the type of theft one expects to see in a fraud case.”

 

In a Wall Street Journal op-ed piece today (here), former prosecutor Robert Mintz suggests that the duo’s biggest mistake was failing first – “these two were among the first to see their funds implode and that, perhaps more than any other reason, is why they now find themselves facing the prospect of significant jail time.”

 

These observations are all interesting and might (perhaps under different circumstances) suggest that the government could face an uphill battle. However, the circumstances demand a burnt offering and that is why Cioffi and Tannin were dragged into the public square. A burnt offering we shall have.

 

There is one additional element of the indictment that has not received as much attention that may be worth noting here. That is, as discussed in the U.S. Attorney’s June 19, 2008 press release (here), one element of the indictment relates to a possible cover up. The press release states that, after the SEC had requested the production of documents and materials in Summer 2007, Tannin’s “tablet computer” and Cioff’s “notebook” apparently “went missing."

 

One of the ineradicable lessons from the Watergate era is that the evasion will get you even if the underlying conduct does not. (Just ask Martha Stewart.) If the government can show that the defendants did inappropriately dispose of their technological devices as part of an evasion, the cover-up charges could loom a great deal larger.

 

And while the commentators may question the criminal indictment, they recognize that the alleged misconduct might support civil liability. Indeed, Professor Ribstein acknowledges that while “not a criminal case,” this “sort of case is suited for a civil fraud claim.” It has been somewhat overshadowed by the criminal indictment, but the SEC did in fact file a civil enforcement proceeding against Cioffi and Tannin at the same time as the indictment.

 

The SEC enforcement action (as described in the SEC’s June 19, 2008 Litigation Release, here), contains additional allegations against the two, including for example, that they “misrepresented the funds’ deteriorating condition and the level of investor redemption requests in order to bring in new money and keep existing investors and institutional counterparties from withdrawing money.” Among other things, the SEC alleges that Cioffi and Tannin “misrepresented their funds’ investment in subprime mortgage-backed securities.” It is alleged that the funds’ monthly performance summaries described the exposure as from 6 to 8 percent, when it supposedly later emerged that the “total subprime exposure – direct and indirect—was approximately 60 percent.”

 

The SEC seeks “permanent injunctive relief, disgorgement of all illegal profits plus prejudgment interest, and the imposition of civil monetary penalties.” But as serious as are these proposed sanctions, they still pale by comparison to the threat of incarceration the individuals face as a result of the criminal indictment.

 

As the U.S. Attorney’s press release states, “if convicted of securities fraud, Cioffi and Tannin face maximum sentences of 20 years imprisonment. If convicted of conspiracy, they each face a maximum sentence of five years.”

 

All of which leads to the final question. As Robert Mintz asked in his Journal op-ed piece today, “are we attempting to criminalize conduct primarily based upon the fact that we now know that the investing decisions led to a bad end?”

 

UPDATE: Professor Jay Brown has a paritcularly good post today on these same themes on his Race to the Bottom blog (here). Among other things, Professor Brown says that "this matter should be left to the Securities and Exchange Commission and the private investors...It should not be left to the criminal authorities."

 

Just the Thing: Even more American than the instinct to blame is the propensity for someone to try and profit off of another’s misfortune. And in that spirit, readers may be interested to know that a Ralph Cioffi signed Bear Stearns Hedge Fund Christmas Card is available (here) on eBay. As of the time of this blog post, the current bid was $81.

 

Sometimes I feel like the entire world is nothing more than abstraction of the old comic strip, The Strange World of Mr. Mum.

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Lots has been written, even on The D&O Diary (most recently here), about the way the world is adjusting to investors’ growing desire to hold management accountable. At the same time, U.S. courts have proven increasingly reluctant to project the remedies available under its securities laws into situations where there is an insufficient connection to the U.S. (as discussed here).

 

But the lawsuit filed on June 12, 2008 against the European Aeronautic Defence & Space Co. (EADS) in the United States District Court for the Southern District of New York takes all of that and puts in into a truly interesting and potentially combustible mix   – the plaintiffs are U.S. citizens, but they exclusively bought their shares in this foreign-domiciled company outside the U.S. The company’s shares do not trade on any U.S. exchange.

 

The company and the individual defendants, all current and former directors and officers of EADS, are domiciled outside the U.S. EADS is a Netherlands company with its principle place of business in The Netherlands. This is a company that is foreign to the U.S. in every sense of the word and only the investor plaintiffs themselves have any connection to the U.S.

 

If there were ever a case to test the outer limits for the availability of U.S. courts for remedies under the U.S. securities laws, this case would appear to be the one.

 

The plaintiffs’ attorneys’ June 12, 2008 press release can be found here. A copy of the complaint can be found here.

 

As described in the press release, the complaint alleges that

EADS falsely assured the investing public that it would overcome the technical problems in the production of the Company’s Airbus A380 commercial jets (“A380”) and it would be able to meet its year-end delivery deadlines. Moreover, the Company issued numerous positive statements which described the Company’s increasing financial performance. According to the complaint, these statements were materially false and misleading because they failed to disclose and misrepresented the following adverse facts, among others: (i) that the Company was experiencing insurmountable delays in the manufacture of the A380 commercial jet; (ii) that the Company would be required to compensate its customers for these delays through discounts and certain customers would likely be canceling their entire orders; and (iii) that, as a result of the foregoing, the Company’s ability to receive new contract awards from commercial airliners and its ability to reap future revenues at the levels that it was projecting would be in serious doubt.

On June 13, 2006, the Company announced that its Airbus subsidiary was having production problems with the A380 commercial jet, which would cause a significant delay in delivery to its customers. The Company also issued a profit warning beyond 2006 which was attributable to these delays and announced that it anticipated annual shortfalls of €500 million, without taking into account possible contract terminations from existing customers.

What makes this case interesting is not the specific factual allegations, which, at least by U.S. standards, are not all that remarkable. What makes this case interesting is the putative class on whose behalf the claim is brought. According to the press release, the lawsuit is brought on behalf of “U.S. citizens who purchased the publicly traded stock of European Aeronautic Defence & Space Co. (“EADS” or the “Company”) on the Frankfurt (Frankfurt: EAD.F), Madrid (Mercado Continuo: EAD.MC) and/or Paris (Paris: EAD.PA) stock exchanges between January 17, 2005 and June 13, 2006, inclusive.”

 

There are several noteworthy points about this class description. First and foremost, the plaintiffs’ lawyers do not purport to represent foreign investors who brought their shares abroad, so they are consciously avoiding the so-called f-cubed litigant problem (foreign domiciled investors who bought their shares in a foreign domiciled company on a foreign exchange). But the class description underscores the fact that this company’s shares were not traded on a U.S. exchange. They were only traded on foreign exchanges.

 

This class description raises, in a fairly dramatic way, the ultimate question of how broadly the remedies available under the U.S. securities laws should reach. Do they reach even to a foreign company whose shares do not trade at all in the U.S?

 

The traditional standards, looking to whether there was (or were) fraudulent conduct or the effects of fraudulent conduct in the U.S., might post significant hurdles for the court to exercise jurisdiction in this case, except that those standards were developed to aid court to determine whether or not to exercise jurisdiction on behalf of investors domiciled outside the U.S. Courts have generally not hesitated to exercise jurisdiction, even against foreign domiciled companies, on behalf of U.S. citizens. But will the court be willing to exercise jurisdiction against a foreign-domiciled company whose shares do not trade in the U.S.?

 

There may well be prior cases that raise this particular set of issues, and if so I hope readers will let me know. To my knowledge this is a new angle on the perennial set of jurisdictional questions surrounding securities claims against foreign domiciled companies. If the U.S. court were to exercise subject matter jurisdiction here, it would in effect represent a projection of U.S court jurisdiction and U.S. style securities litigation to any company anywhere, as long as there is a U.S.-based investor. Maybe a court here will go for that, but it seems like a stretch to me.

 

Is there any company anywhere in the world that does not have U.S.-based investors? Should the mere presence of those investors in the U.S. courts allow U.S courts to exercise jurisdiction over all those companies, no matter where they are located and where their shares trade?

 

Finally, there is also the issue of personal jurisdiction over the individual defendants, and perhaps even over the corporate defendant. Have the defendants purposely availed themselves of the jurisdiction or otherwise established minimum contact with the forum such that the exercise of jurisdiction over them comports with traditional notions of substantial justice and due process?

 

There probably are also some very interesting questions here about the basic merits of the claim. But those questions may or may not ever matter. The first innings of this game are going to be the ones to watch. Make sure you have your beer and your hot dog and that you are in your seat for the national anthem, because this game is going to rock and roll from the very first pitch.

UPDATE: On June 13, 2008, a different plaintiffs' firm apparently initiated a separate lawsuit against EADS on behalf of a different plaintiffs' class. According to the firm's press release (refer here), this newest lawsuit "seeks to recover damages on behalf of all U.S. and non-U.S. purchasers of the publicly traded securities of EADS during the Class Period." The new lawsuit also names as defendants Lagardere and Daimler AG, EADS's largest shareholders. This second lawsuit presents faces even more significant jurisdictional barriers, since it purports to represent the so-called f-cubed claimants. Clearly these complaints are testing outer jurisdictional boundaries on the availability of remedies under the U.S. seecurities laws.

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Earlier this week when I posted my list of subprime lawsuits dismissal motion grants and denials (here), I was hoping the publication would encourage readers to let me know about case dispositions of which I was previously unaware. My strategy worked, because a loyal reader who prefers anonymity responded to my post by alerting me to the May 19, 2008 opinion (here) in the subprime-related securities class action lawsuit involving Standard Pacific. Because the court’s opinion is particularly thorough, it merits a detailed review.

 

Standard Pacific is a California-based residential construction company that concentrated in recent years on the formerly go-go growth areas of California, Florida, Texas and Nevada. As s result of the residential real estate slump, the company’s sales activity declined in 2006 and 2007. Plaintiff shareholders initiated a securities class action lawsuit against two Standard Pacific executives in August 2007.

 

The plaintiffs alleged that the defendants misrepresented Standard Pacific’s ability to open new, successful communities; misled the public about the demand for Standard Pacific homes; and lied about the company’s ability to continue its historically strong earning growth. Further background regarding the lawsuit can be found here.

 

In a May 19, 2008 opinion, Judge Margaret M. Morrow of the United States District Court for the Central District of California granted the defendants’ motion to dismiss, but allowed the plaintiffs’ 45 days’ leave to amend.

 

The defendants first argued that the plaintiffs’ complaint failed to satisfy the PSLRA’s pleading requirements because it is a “classic example of prohibited puzzle-pleading,” in that it contains extensive block quotations from the company’s class period statements “without specifying the particular statements that are false and misleading.”

 

The plaintiffs sought to address this issue in their reply papers, but the court found that “the organization the plaintiffs offer in their opposition brief does not cure the deficiencies in the complaint. To the contrary, it highlights plaintiffs’ failures to plead defendants’ purportedly false and misleading statements with specificity as required by the PSLRA,” and accordingly the court granted the motion to dismiss, with leave to amend.

 

The defendants also moved to dismiss on the grounds that the plaintiffs had not adequately pled scienter. The plaintiffs alleged, based on the confidential witness information, that defendants misled investors because they continued to cite sales information in reliance on internal reports they supposedly knew to be inaccurate. Defendants contended that, to the contrary, they informed investors that the company was experiencing sales declines, and that “the crux of plaintiffs’ fraud claim is not that the defendants flatly misrepresented the company’s performance but that they were deliberately reckless because the failed to lower their projections enough.”

 

The court found that

the fact that defendants reduced earnings and home delivery guidance cuts against plaintiffs’ claim that defendants acted with fraudulent intent. As no facts are pled supporting an inference that defendants selected the level of reductions they announced fraudulently or with deliberate recklessness, the complaint suggests a plausible nonculpable explanation for defendants’ conduct…. Taken as a whole…plaintiffs’ allegations do not give rise to a “strong inference” that at the time they made the statements, defendants knew or should have known that the state of affairs was much worse than they had acknowledged publicly….In effect, by arguing that defendants’ predictions and forecasts were not low enough, plaintiffs improperly attempt to allege “fraud by hindsight.”

The court similarly rejected the plaintiffs’ attempt to rely on the defendants’ certifications of the company’s SEC filings.

 

The dismissal, even though it is without prejudice, is still significant. First, the opinion is very detailed and thorough, which could carry some weight in other subprime securities cases, particularly the numerous other cases pending in the Central District of California.

 

Second, many of the other subprime complaints arguable share the “puzzle pleading” defect of the complaint in this case – all too often, the complaints in these subprime cases consist of block quotations from the defendants company’s disclosure documents, without direct connections specifying what about the disclosure the plaintiffs allege is false and misleading, and in what way the statements are false and misleading.

 

Third, many of the companies named in subprime securities lawsuits, like Standard Pacific, are accused not of failing to acknowledge problems but of failing to recognize the problems enough. To the extent other courts view these pleadings with the same level of skepticism as Judge Morrow, the complaints could face some formidable challenges at the motion to dismiss stage.

 

In any event, I have added the Standard Pacific opinion to the list of subprime lawsuit dismissal motion grants and denials. I hope other readers will let me know of any other subprime lawsuit dismissal motion rulings of which they are aware, so that the list can be as complete as possible.

 

Special thanks to the anonymous loyal reader for alerting me to the Standard Pacific opinion.

 

Another Option ARM Lawsuit: In a different post earlier this week (here), I noted the lawsuits that had been filed up to that point relating to Option ARM mortgages, and I suggested the likelihood that there would be further lawsuits relating to Option ARMs. In a quick confirmation of my prediction, on June 11, 2008, plaintiffs’ counsel initiated a securities class action lawsuit in the Central District of California against IndyMac Bancorp and certain of its directors and officers. A copy of the plaintiffs’ lawyers’ June 11 press release can be found here. A copy of the complaint can be found here.

 

According to the press release, the complaint alleges that

defendants issued materially false and misleading statements regarding the Company’s business and financial results. Specifically, defendants downplayed and concealed IndyMac’s growing exposure to non-performing assets, particularly loans in its pay-option adjustable-rate mortgage (“Option ARM”) and homebuilder construction portfolios, and made numerous positive representations regarding the Company’s capital position to alleviate investors’ fears concerning the Company’s capital erosion. As a result of defendants’ false statements, IndyMac stock traded at artificially inflated prices during the Class Period.

It is important to note that IndyMac had previously been sued in a subprime-related securities class action lawsuit, the background regarding which can be found here. In concluding that this latest lawsuit is sufficiently distinct from this prior lawsuit to represent a new lawsuit, I note the following: first, the class period of the prior lawsuit was May 4, 2006 to March 1, 2007, whereas the purported class period for the new lawsuit is from August 16, 2007 to May 12, 2008. In addition, the substantive allegations in the two lawsuits relate to different alleged misrepresentations. In particular, the prior lawsuit does not appear to relate to the companies representations regarding Options ARM mortgages or the company’s capital position.

 

Accordingly, I am recognizing this latest complaint as a new and separate filing. However, I encourage readers who may disagree to let me know of any circumstances that might militate in favor of a different conclusion.

 

I have added the new IndyMac lawsuit to my running tally of subprime and credit-crisis related securities lawsuits, which can be found here. With the addition of the new IndyMac lawsuit, the tally of subprime and credit crisis-related lawsuits now stands at 90, of which 50 have been filed in 2008.

 

Finally, it is worth noting that, as reflected in my list of subprime dismissal motions grants and denials referenced above that motion to dismiss have twice been granted with leave to amend in the prior IndyMac lawsuit.

 

More Subprime ERISA Lawsuits:  I have also added two subprime-related ERISA lawsuits to my running tally of subprime-related lawsuits.

 

First, in a June 11, 2008 press release (here), plaintiffs’ lawyers announced that they had initiated a lawsuit in the Southern District of New York under ERISA against Wachovia Corporation and various of its officers and administrators. According to the press release, the defendants allegedly violated their duties to participants in the Wachovia Savings Plan by “continuing to invest in and hold Wachovia stock despite the fact that they knew or should have known that Wachovia was not properly reporting its financial condition and was not disclosing significant problems which had the effect of inflating the value of Company stock.”

 

Second, on May 9. 2008, plaintiffs’’ counsel initiated a lawsuit in the Western District of Tennessee on behalf of past and present employees of First Horizon National Corporation who participated in the First Horizon Savings Plan. A copy of the complaint can be found here. The complaint alleges that the defendants breached their fiduciary duty by requiring plan participants to invest in First Horizon shares, which the plaintiffs contend was “imprudent… because First Horizon was not fairly and accurately disclosing the risks and likely consequences of a number of its banking practices such that the Plan was purchasing shares of First Horizon Stock at an inflated price.” Among the undisclosed risks alleged is the company’s exposure to subprime and Alt-A mortgages.

 

I have added the Wachovia and First Horizon ERISA lawsuits to my running tally of subprime-related ERISA lawsuits, which can be found here. With the addition of the new ERISA lawsuit, the tally of subprime-related ERISA lawsuits now stands at 17

 

Special thanks to a loyal reader for identifying the new ERISA lawsuits.

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In prior posts (most recently here), I have discussed the fact that life sciences companies remain a favored target of the plaintiffs’ securities bar. A June 2008 memorandum by Michael Kichline and David Kotler of the Dechert law firm entitled “Dechert Survey of Securities Fraud Class Actions Brought Against Life Sciences Companies”  (here) takes a closer look at the 2007 life sciences securities lawsuits and concludes that “life sciences companies remain firmly in the crosshairs of the plaintiffs’ securities bar.”

 

The authors note that the 25 securities class action lawsuits filed in 2007 against life sciences companies represents a 64% increase over the 16 filed the preceding year, and also represents 14% of the 175 total securities lawsuits filed in 2007. (My own numerical analysis of the 2007 life sciences lawsuits, which can be found here, differs slightly, but only in the details, not the direction, and the difference undoubtedly is due to the narrow definition of “life sciences” I used in my analysis.)

 

The authors also have a number of interesting observations about the 2007 life sciences lawsuits, including the fact that “life sciences companies with the greatest market capital -- more than $10 billion – were sued at the same rate as companies with less than $250 million.”

 

The authors also note that the securities lawsuit allegations against life sciences companies “continue to span the product life cycle” and that many of the companies sued 2007 were sued “based on information they communicated, or failed to communicate, to the public about a drug’s efficacy, safety, and/or the results of the FDA approval process.”

 

One particularly interesting observation in the study is that “research personnel were frequently named as defendants,” and specifically that in five cases, the plaintiffs alleged that because “key research personnel had a high level position with the company and access to internal information, they both knew and failed to disclose the alleged adverse non-public information.”

 

The authors predict that life sciences companies will continue to be the targets of securities fraud lawsuits, noting that “the structural factors that lead plaintiffs’ lawyers to target life sciences companies – volatile stock prices and a drug or device product life cycle fraught with potential for adverse and unpredictable events, such as a negative clinical trial result of FDA decisions – remain challenging, especially in the current stock market and regulatory environment.” The authors predict that plaintiffs’ counsel will continue to strive to find new theories. The authors cite as an example the likelihood that “more securities lawsuits will be premised on off-label communication or sales.”

 

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

 

While I concur in all of the authors’ views, I think that in order to fully appreciate life sciences companies’ securities litigation exposure, it is important to consider not only the lawsuit filings, but also the case dispositions. Life sciences companies may be frequent lawsuit targets, but that does not mean that all or even most of the lawsuits are meritorious.

 

As I have noted in prior posts (most recently here), many of the securities lawsuits filed against life sciences companies are dismissed. Indeed, many of the large life sciences companies that have been targeted in securities suits in recent months – including, for example, Guidant, Pfizer and Astra Zeneca – have successfully managed to get the cases dismissed. And it is not just the larger companies that have prevailed; smaller companies, such as, for example, Micrus Endovascular (which recently prevailed on its motion to dismiss, about which refer here), have also prevailed on their dismissal motions.

 

To be sure, there have also been many settlements of life sciences securities lawsuits, some of which have been quite significant. But overall life sciences securities lawsuits have not always been as productive for the plaintiffs’ lawyers as might be suggested by the sheer numbers of filings.

 

I do agree that the volatility of life sciences companies’ share price and the companies’ susceptibility to product-driven dislocations will continue to attract the unwanted attention of the plaintiffs’ lawyers. The good news for these companies is that they have potentially effective defenses available and they may be able to use these defenses to stave off the litigation assault. The risk protection steps suggested in the authors’ memorandum are particularly good starting points for preparing these defenses.

 

Special thanks to David Kotler of the Dechert firm for providing me with a copy of the life sciences securities litigation survey.

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In prior posts (refer here), I have discussed the increasing reluctance of U.S. courts to exercise subject matter jurisdiction over securities claims against foreign-domiciled companies brought by foreign claimants who bought their shares on foreign exchanges (so-called “f-cubed” claimants).

 

In the most recent example of this, Judge Thomas Griesa of the United States District Court for the Southern District of New York, in a June 3, 2008 opinion (here), granted the defendants’ motion to dismiss the claims of “f-cubed” claimants against AstraZeneca and certain of its directors and offices.

 

The complaint essentially alleges that Exanta, a pharmaceutical being develop by the AstraZeneca (a U.K.-based company) “was not as safe or effective as defendants’ public statements made it out to be.” The plaintiffs’ claimed that these statements inflated the company’s share price. Refer here for background regarding the lawsuit.

 

The outcome of the subject matter jurisdiction question was probably tipped in the court’s opening observation that “over 90% of the members of the putative class are foreigners who purchased their shares on foreign exchanges.”

 

The court reviewed the propriety of its exercise of jurisdiction over claims brought on behalf of these foreign shareholders, by considering whether or not there were sufficient allegations of U.S.-based conduct causing sufficient U.S.-based effects. The court found that while there were sufficient allegations of U.S.-based conduct, plaintiffs “do not allege facts in support of the second prong of the test – that the United States conduct ‘directly caused’ plaintiffs’ losses.”

 

The court said that in order to establish this requisite causal link, the plaintiffs must have “sufficiently alleged that the foreign purchasers relied on United States based conduct when deciding to acquire the stock”. In order to establish this kind of reliance, the plaintiffs urged the court in effect to adopt a global “fraud-on-the-market” theory, arguing that “it is illogical to suggest that the fraud-on-the-market theory applies within the United States but not outside of it.”

 

The court noted that other courts had rejected the global fraud-on-the-market theory, out of concerns that it would “extend the jurisdictional reach of the United States securities laws too far.” The court further noted that the Second Circuit had not yet provided guidance on whether the fraud-on-the-market theory should apply to foreign countries, and “in the absence of clear authority in favor of a global fraud-on-the-market theory, the court declines to adopt such a theory.” The court dismissed the claims of the foreign claimants based on lack of subject matter jurisdiction.

 

The court further concluded that the plaintiffs had not sufficiently alleged that two foreign-domiciled individual defendants had the requisite “minimum contacts” with the U.S. for the court to exercise personal jurisdiction over them.

 

Finally, the court concluded that the plaintiffs had not sufficiently pled scienter, and dismissed the remaining claims on that basis. The court held that neither the allegations of insider trading nor the allegations relating to a secondary offering were sufficient to establish scienter.

 

The court further rejected the plaintiffs allegations that the defendants had consciously disregarded the truth, based on the court’s own review of the various disclosure documents on which the plaintiffs sought to rely. The court concluded that the plaintiffs “have not alleged anything to negate the idea that that defendants were attempting to develop a drug they thought beneficial and were do describing it to the public.” The court found that the plaintiffs had “not alleged an inference of scienter as compelling as the opposing inference.”

 

The fact that the case will not be going forward even as to the domestic shareholders reduces the impact of the court’s ruling to exclude the f-cubed claimants from the class. The dispersion of the class, with such an overwhelming percentage of f-cubed claimants in the purported class members may well have inclined the outcome on the jurisdictional issue in any event.

 

Plaintiffs’ attorneys in the most recently filed cases seem to be anticipating that courts are inclined to exclude these claimants from the putative class and increasingly are taking that into account in their initial pleadings. For example, as discussed here, when plaintiffs’ lawyers recently launched a U.S. securities lawsuit against Société Générale, they included in the purported class only U.S residents and investors who bought ADRs on U.S. exchanges. Their purported class by its own construction excludes foreign residents who bought shares on foreign exchanges.

 

The increasing exclusion of f-cubed litigants from U.S. securities class actions (whether voluntary or as a result of court action) is one of the reasons that interest in U.S.-style securities relief is increasing in other countries, as I discussed in a recent post (here).

 

In any event, the court’s dismissal of the AstraZeneca case also continues another trend, which is that while life sciences companies are frequently sued (compared to companies in most other categories), the cases filed against them are often dismissed, as I also discussed in a prior post (here)

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In October 2000, the SEC promulgated Rule 10b5-1 to provide company insiders with a way to trade their shares in company stock without incurring securities law liability, through the pre-trading adoption of a written trading plan. Despite the Rule’s protective purpose, concerns have arisen more recently about Rule 10b5-1 plan abuses, as I noted in prior posts (here and here).

 

Indeed, concerns about Angelo Mozilo’s possible Rule 10b5-1 plan misuse were an important part of the court’s recent refusal to dismiss the Countrywide subprime-related derivative lawsuit. (My prior post about the Countrywide dismissal denial can be found here. A more detailed analysis of the Countrywide court’s discussion of Rule 10b5-1 plan issues can be found on The Corporate Counsel.net blog, here.)

 

A May 27, 2008 paper by University of Chicago Law Professor Todd Henderson, Stanford Business School Professor Alan Jagolinzer, and Penn State Business Professor Karl Muller entitled “Scienter Disclosure” (here) looks at Rule 10b5-1 plans from a different perspective, asking what can be inferred from a company’s disclosure of its officials’ plans. The authors’ surprising conclusion is that the more detailed a company’s plan disclosure, the more likely are the subsequent trades to capture abnormal trading returns.

 

The starting point of the authors’ analysis is that, although Rule 10b5-1 itself does not require the plans to be disclosed, “disclosure can enhance the legal protection by increasing the likelihood of early dismissal of class action lawsuits.” This “litigation benefit” arises due to the fact a Rule 10b5-1 plan trading defense will only be available at to dismissal stage if the plan is identified and described in the company’s SEC filings (which a court may consider at the initial pleading stage). If the company fully discloses the plan details, “a court may better ascertain that the allegedly fraudulent trades fall within the Rule’s affirmative defense, thereby increasing the possibility of a low-cost dismissal.”

 

From this, the authors infer that companies perceiving a greater litigation risk are “more apt to disclose the existence and details of Rule 10b5-1 plans.” But there are costs associated with disclosing the plans, particularly “if investors infer a price relevant signal from disclosure or if disclosure enhances investors’ monitoring of insiders’ trade plan commitment.” The “signal” might encourage investor “front running” which could deprive the insider of anticipated trading profits. The monitoring “reduces the value of early termination options” the insider might have if a planned trade no longer appears desirable.

 

The authors hypothesized that insiders will nonetheless prefer Rule 10b5-1 plan disclosure if the “scienter disclosure” provides incremental litigation benefit – which is likely to be greatest precisely where the ability to trade provides the greatest opportunity to profit. That is, “pre-disclosure of trade may be strategic in the face of high legal risk if it mitigates legal risk and does not fully reveal privately held information.”

 

The authors examined company disclosures for hundreds of companies during the period between October 2000 and December 2006, and grouped the companies according to whether the companies had low, moderate or detailed Rule 10b5-1 plan disclosure. The authors then correlated the companies’ disclosure and “subsequent firm returns and earning performance.” The authors found that “more specific 10b5-1 plan disclosures are associated with more negative post-trade abnormal returns” and that “the association between sales transactions and subsequent negative performance is increasing in disclosure specificity, after controlling for other factors that are associated with firm returns.”

 

As a group, executives at those companies with the most detailed disclosure avoided an average of 12% loss in the companies’ trades relative to the broader market in the six months following their sales. The authors conclude that “voluntary Rule 10b5-1 plan disclosure is associated with the higher level firm legal risk and a proxy for insider’s potential strategic trade.”

 

In other words, the more detailed disclosure manifests insiders’ perception that subsequent trades are more likely to be advantageous – and therefore legal protection is more likely to be important, justifying the detailed disclosure.

 

These data suggest, and the authors hypothesize, that “investors should respond negatively to specific disclosures regarding 10b5-1 participation, if they infer that insiders have high strategic trade potential for which they seek high litigation protection.” However, the authors found that there is no observable negative investor response to Rule 10b5-1 disclosure.

 

The authors’ conclusions have a number of important implications. Obviously, investors may be missing an important signal related to 10b5-1 disclosure. Another important implication relates to the protection that the Rule affords; the authors’ conclusion that the companies with the most detailed disclosure are also the ones with the most fortunate timing suggests that, at least in some companies, transparency may be facilitating aggressive stock sales. The Rule was designed to provide company officials with a way to trade safely, but the authors’ study suggests that at least some company officials may be using the Rule as a shield to unload stock at an opportune time.

 

While I confess that initially I found the authors’ conclusions troubling, after further reflection I am less concerned. The problem here is not that insiders are using Rule 10b5-1 plans and plan disclosure strategically – after all, the whole idea of the Rule was to facilitate trading, and there is certainly no suggestion that trades made pursuant to the Rule cannot be advantageous. The problem is that at least so far, investors have missed the negative signal that Rule 10b5-1 plan disclosure implies.

 

The authors themselves speculate that the absence of negative investor reaction “may indicate that there are frictions to implementing strategies based on 10b5-1 disclosure signals or that investors do not understand 10b5-1 disclosure implications, which is possible if our same period reflects the transition period regarding 10b5-1 use.” To the extent, however, that the signal is better understood, the more the marketplace itself will discipline the process.

 

The greater likelihood that the mere announcement of a 10b5-1 plan could undermine a company’s share price could provide a missing disciplinary constraint on strategic trading and reduce company officials’ ability to capture abnormal returns. In other words, the whole mechanism will function better if investors appreciate the significance of 10b5-1 disclosure – an appreciation that the authors’ research clearly should facilitate.

 

A May 27, 2008 USA Today article discussing the authors’ study can be found here. An entry on the University of Chicago Law School Faculty Blog discussing the article can be found here.

 

Very special thanks to Professor Henderson for alerting me to the article and for providing me with a link.

 

Another Options Backdating-Related Class Action Settlement: In its May 8, 2008 filing (here), Kratos Defense & Security Solutions (formerly known as Wireless Facilities) announced that in March 2008, it had reached a tentative agreement to settle the options backdating-related securities class action lawsuit pending against the company and certain of its directors and officers. The amount of the settlement is $4.5 million, of which $1.7 million will come from the company and the balance of which will come from the company’s D&O insurer.

 

I have added this settlement to my table of options backdating-related lawsuit settlements and dismissals, which can be accessed here.

 

Hat tip to Adam Savett of the Securities Litigation Watch blog (here) for providing the heads’ up about the Wireless Facilities settlement

 

Not Just Immune, But Infallible: If you were immensely rich and powerful, you too might well, as did the Sultan of Brunei in 2004, amend the constitution to “declare himself infallible and immune from any obligation to appear in court …and to subject anyone who criticizes him to criminal punishment.”

 

Those curious to know how a court might actually apply a provision like this and related legal issues will want to refer to Francis Pileggi’s Delaware Corporate and Commercial Litigation Blog (here), in which Pileggi reviews a May 23, 2008 Delaware Chancery Court decisions involving the Sultan and his brother. Among other things, Pileggi notes that in the course of reaching its decision, the Court “recites the background facts of royal family battles that could be part of a movie script.”

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In a development that is in my experience absolutely unprecedented, Phillip Bennett, the former CEO of defunct futures trader Refco, after having pled guilty to criminal charges, is actively cooperating with the lead plaintiffs’ counsel in the civil securities lawsuit pending against the company and its former directors and officers. As discussed below, Bennett’s conduct, in addition to being highly unusual, could also raise some potentially significant insurance coverage questions.

 

A detailed description of the circumstances surrounding Bennett’s cooperation in the class action can be found in a May 28, 2008 article (here) by Bloomberg News reporter Thom Weidlich. The circumstances are also discussed in a WSJ.com Law Blog post (here).

 

Within weeks after it went public in August 2005, Refco announced that Bennett had hidden $430 million in bad debts from the company’s auditors and investors. The details of the scandal can be found here. IPO investors initiated securities class action lawsuits almost immediately. (Refer here for background regarding the class action lawsuit; a website devoted to the lawsuit can be found here.).

 

On February 15, 2008, Bennett pled guilty to bank fraud, conspiracy, money laundering and 17 other charges.

 

In connection with Bennett’s upcoming June 19, 2008 sentencing, counsel for the lead plaintiffs in the class action lawsuit – Sean Coffey of the Bernstein Litowitz firm and Stuart Grant of the Grant & Eisenhofer firm – submitted a letter to the court to provide information they hope “proves helpful as the Court considers the appropriate sentence.” A copy of their letter can be found here.

 

According to the attorneys’ letter, after Bennett pled guilty, his lawyer approached the class counsel to offer cooperation in connection with the civil case. According to their letter, “Bennett has helped to advance our understanding about matters within Refco, providing insights not readily discernable from our ongoing review of documents or cross-examination of deposition witnesses who are almost universally aligned with the defendants.” The letter goes on to report that Bennett has identified “‘red flags’ and other circumstances that would have alerted a diligent gatekeeper that things at Refco were not what they appeared to be.”

 

The letter states that Bennett’s cooperation has “materially strengthened the class claims against a number of defendants.” The defendants specifically mentioned in the letter are Thomas H. Lee, the IPO Underwriters, Grant Thorton, and Mayer Brown. The letter states that:

 

In the opinion of Lead Counsel, his assistance has substantially enhanced the ability of Lead Plaintiffs to hold those defendants more fully accountable for their role in the events resulting in the devastating losses suffered by Refco investors.

 

The Bloomberg article and the WSJ.com Law Blog post linked to above contain remarks from several commentators as to whether the letter will benefit Bennett as his sentencing.

 

There are a number of interesting things about the plaintiffs’ attorneys’ letter. Among other things, Bennett’s cooperation holds the prospect of shifting to Refco’s outside professionals some of the financial consequences for Bennett’s own criminal misconduct, based on their supposed failure to stop or catch him.

 

Another interesting thing, interesting to me at least, is the potential effect from Bennett’s behavior on the D&O insurance coverage that might otherwise be available for other former Refco directors and officers in connection with the Refco securities lawsuit. I emphasize at the outset that I have no direct knowledge of Refco’s D&O insurance program, and I am expressing no views about the availability of coverage under its D&O insurance. My comments here are strictly to note a potential coverage issue that might arise as a result of Bennett’s cooperation with the plaintiffs’ attorneys.

 

The specific insurance issue relates to the possibility that Bennett’s cooperation might trigger the so-called “Insured vs. Insured” exclusion (or IvI as it is more commonly known) that is found in most D&O insurance policies. A typical IvI exclusion provides, among other things, that the insurers is not liable for any loss in connection with a claim “which is brought by any security holder or member of an Organization, whether directly or derivatively, unless such security holder or member’s claim is instigated and continued totally independent of, and totally without the solicitation of, or assistance of, or active participation of, or intervention of, any Executive.”

 

Bennett’s extensive cooperation with the plaintiffs – the significance and materiality of which the plaintiffs’ lawyers expressly acknowledged – would appear at least potentially to implicate this D&O policy exclusion. Now, as a result of his criminal plea, Bennett himself would likely no longer have coverage under the policy, as would appear to be the case for other Refco officers who were criminally convicted in April of this year. But the other former Refco directors and officers, if any, who remain as defendants in the civil lawsuit and who have not pled guilty or been criminally convicted, may still hope to have remaining D&O insurance limits available to fund their defense and indemnity. (A number of the individual defendants have already entered settlements with the class, as described here.) Bennett’s cooperation with the plaintiffs could at least potentially raise coverage concerns, to the extent coverage is otherwise available to these persons.

 

In other words, Bennett’s cooperation not only represents a threat to Refco’s former outside advisors, but could also have serious adverse consequences for the company’s former directors and officers.

 

These events, as noted, are highly unusual and unlikely to recur. Nevertheless, the potential insurance issues that Bennett’s conduct could trigger are a reminder that there claims resolution is a complicated process, with a host of potentially significant consequences at every point. Although sometimes overlooked, the insurance issues can sometimes be particularly significant.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Always.

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

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

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

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

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

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

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

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

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

He also described his days as "empty."

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

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

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

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In the past week, plaintiffs’ lawyers filed a raft of new subprime and credit crisis related securities lawsuits. The cases involve a wide variety of claimants and defendants, and a diverse array of legal theories. But while the lawsuits themselves are diverse, they do all evidence a common theme, which is that the subprime and credit-crisis related litigation wave continues to surge on.

American International Group: The most prominent lawsuit filed in the past week is the securities class action lawsuit filed in the United States District Court for the Southern District of New York against American International Group, its CEO