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

The credit crisis recently entered a dark new phase, and this new darker phase has also already produced its own distinctive round of lawsuits. Like the ominous economic circumstances, the new litigation phase also seems darker and more threatening.

 

In the latest issue of InSights (here) -- entitled "Has the Credit Crisis Litigation Wave Reached an Inflection Point?" – I briefly review the subprime litigation wave as it developed over the past two years and then examine the dramatic events that occurred in the financial marketplace beginning in September 2008. The article then examines the recent wave of litigation surrounding these events and concludes with an assessment of what these developments may signify going forward.

 

No Avalanche After All?: Following the U.S. Supreme Court’s February 2008 decision in the LaRue case (about which I wrote here), in which the court recognized an individual’s right to pursue a breach of fiduciary duty claims for mismanagement of their 401(k) plan, there was significant speculation that the decision could unleash an avalanche of lawsuits. The avalanche may yet materialize. But in the meantime it is worth noting that despite his victory in the Supreme Court, LaRue himself has voluntarily dismissed his case in the district court, where the case was on remand after the Supreme Court’s decision.

 

As reflected in the October 21, 2008 Consent Order of Dismissal in the case (here),LaRue withdrew his complaint after he "decided that it is not financially feasible to continue to pursue his claim."

 

As Professor Paul Secunda noted on the Workplace Law Prof Blog (here), LaRue’s withdrawal of his case shows that "these types of claims are still extremely difficult for plaintiffs to prevail upon" and "all the doomsday prognostications to the contrary seem just a tad off."

 

Just In Case Those Bank Lawsuits Do Materialize: In a recent post (here), I speculated that we may be entering a new phase of litigation involving failed banks. Apparently I am not the only one who anticipates that we may be seeing more failed bank litigation. In an October 23, 2008 memorandum entitled "Failed Financial Institution Litigation: Remember When" (here), the Willkie Farr & Gallagher law firm observes that the recent dramatic financial institution failures "are likely to fan the flames for myriad government agencies to pursue litigation against all parties associated with the financial institutions."

 

The Willkie Farr memorandum takes a comprehensive look at the potential failed financial institution litigation that may emerge, referring to the litigation that unfolded during the S&L crisis as a guide. The memo examines likely litigants, including in particular the probable defendants. The memo also reviews the factual and legal issues that are likely to arise, including some issues that may be different in the current era than previously– for example, with respect to circumstances involving credit default swaps.

 

The memorandum also briefly reviews the D&O insurance issues that are likely to arise in connection with claims against the directors and officers of the failed financial institutions. Among other issues, the memorandum review issues in connection with the regulatory exclusion (about which I previously wrote here), and in connection with the insured vs. insured exclusion (which I wrote about here).

 

The Willkie Farr memorandum is thorough and comprehensive, and is a good resource to keep at hand in the event the "dead bank" litigation does in fact materialize.

 

An Insurance Professional Takes A Look Back: It may surprise those outside the industry, but the insurance business really is full of a wide assortment of interesting, amusing and entertaining people. Many of their stories are humorously retold by industry veteran Larry Goanos in his new book Claims Made and Reported: A Journey Through D&O, E&O and Other Lines of Insurance (here). Larry’s book examines the careers of some of the luminaries of professional lines insurance industry and provides valuable insights for business success.

 

While writing the book, Larry apparently interviewed over 400 people, some of whom started in the industry back in the 1940s and 1950s. Many of the stories Larry recounts have become legendary in the industry, such as the tale of the broker whose suit was seemingly in flames during a meeting while he continued to talk or the mid-level executive who bought a Rolls Royce as his company car --on his lunch hour. The book is written with in the same spirit of friendship and good humor that characterizes the best side of our industry, and will be enjoyable for anyone who is a part of or is interested in the industry.

 

Congrats to Larry on his book. He obviously had a lot of fun writing it, and a lot of people are going to have fun reading it. It is worth noting that Larry intends to split the proceeds from the book’s sales among four charities, including the PLUS Foundation and Grateful Nation Montana.

 

What the Hell is the Point of 36 Watches -- Or, For That Matter, Three Mirrored Disco Balls?: In an October 29, 2008 Wall Street Journal article (here) describing unexpected challenges facing lenders that foreclosed on properties, the article details issues arising in connection with Indianapolis developer Christopher T. White and his business, Premier Properties USA:

 

Indianapolis prosecutors charged Mr. White in June with theft and fraud for writing a $500,000 check to Premier for payroll purposes on a nearly empty account. Mr. White's defense attorney counters that the developer believed money was arriving to cover the check. A lender seized Mr. White's personal property and in August auctioned items including five Vespa scooters, 15 flat-panel televisions, 36 watches and three mirrored disco balls.

 

"Where the Hell is Matt?": If you have not yet seen this latest viral Internet video, you have to take four minutes and watch it right now. Absolutely guaranteed to make you smile. Matt really does seem to have visited (and danced in) all the places depicted, which kind of makes you wonder how long it took to make this video. While he was dancing, the rest of us were sitting at our desks doing much more productive things...

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A November 18, 2007 New York Times article entitled "If Buyout Firms Are So Smart, Why Are They So Wrong?" (here) takes a critical look at many buyout firms' sudden haste to walk away from deals that were much ballyhooed only a short time ago. Clearly the bloom has gone off the buyout vine. As I discussed in an earlier post (here), litigation is an inevitable byproduct of the bursting of the buyout bubble. The battle lines in many of these lawsuits will the "material adverse effects" provision in the various buy-out agreements, which permit termination of the transaction where the target company's business conditions have deteriorated.

The right of a would-be buyer to invoke this provision is getting a close examination in the lawsuits arising our of the failed J.C. Flowers takeover of Sallie Mae. As discussed in a November 14, 2007 Law.com article entitled "Sallie Mae Litigation Raises Issue of Deal 'Adverse Effect'" (here), J.C. Flowers is arguing that the collapse of the securitization market and the disruption of asset-backed commercial paper have disproportionately affected Sallie Mae, and therefore have had a materially adverse effect on the company. Sallie Mae for its part contends that the credit crunch was excluded from the adverse effect clause. The court has set a July trial for the dispute.

The invocation of the materially adverse effect clause is one way for a would-be buyer to attempt to bail from a pending acquisition that no longer looks as attractive. An alternative approach, albeit one rarely followed, may be seen in the action of Cerberus Capital Management, which on November 14, 2007 advised United Rentals that it was not prepared to complete its planned acquisition of the company. (Refer here for the company's announcement.) Rather than arguing that there has been a materially adverse development, Cerberus has simply terminated the contract and tendered the specified termination fee of $100 million. As United Rentals put it,

Cerberus has specifically confirmed that there has not been a material adverse change at United Rentals. United Rentals views this repudiation by Cerberus as unwarranted and incompatible with the covenants of the merger agreement. Having fulfilled all the closing conditions under the merger agreement, United Rentals is prepared to complete the transaction promptly. The Company also pointed out that Cerberus has received binding commitment letters from its banks to provide financing for the transaction through required bridge facilities. The Company currently believes that Cerberus' banks stand ready to fulfill their contractual obligations.

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In prior posts (here and here) I have questioned whether SOX whistleblower protection is "more theoretical than real." A forthcoming study by Richard Moberly of University of Nebraska Law School entitled "Unfulfilled Expectations: An Empirical Analysis of Why Sarbanes-Oxley Whistleblowers Rarely Win" (here) takes a look at just how poorly employee whistleblowers have fared under the Sarbanes-Oxley whistleblower protections and why.

The study looked at the 470 SOX Whistleblower cases filed at the initial regulatory level between August 19, 2002 (when the first case was filed) and July 13, 2005, as well as all 236 administrative appeals filed through June 1, 2006. Of the 361 cases that actually reached decision at the initial regulatory level, employees won only 13 times, or a rate of 3.6%, and of the 93 decisions at the administrative appeal level, employees won only 6 times or 6.5%.
Based on these statistics, the authors observes that

Despite Sarbanes-Oxley's pro-whistleblower provisions and a few early employee victories...administrative decisions over the first three years of the Act's life failed to fulfill Congress' expectation that a strong anti-retalitatory provision would both encourage and protect whistleblowers.

Based on his study of the whistleblower cases, the author suggests several statutory revisions that "would better reflect Congress' goal of protecting whistleblowers and remedying retaliation."

First, the author found that many claimants ran afout of the short 90-day statute of limitations, which he recommends extending at least to 180 days.

Second, he found that there is uncertainty surrounding "boundary issues" such as whether the company was a "covered employer" or the employee engaged in "protected activity." He calls for Congressional clarification of these issues, and clarification that "employees of privately-held companies are protected when they report fraud at publicly-traded corporations." He also recommends that the Act be modified to requires whistleblower exposure on general fraud only, without the added requirement that the disclosure pertain to securities fraud.

The author concludes by observing that:

Ultimately, Sarbanes-Oxley failed to fulfill the great expectations generated by the Act's purportedly-strong anti-retaliation provisions...The under enforcement of [the whistleblower provisions] undermines Congress' policy goal of deterring corporate fraud and leaves literally millions of private-sector employees vulnerable to retaliation.

It may be important to note that in the author's statistical analysis, he does not include as within his tally of employee "wins" the whistleblower cases that were settled. A significant percentage of cases (11.6%) have settled at the initial regulatory stage and a larger percentage (18.3%) have settled at the regulatory stage. While settlement suggests compromise, the fact that the affected employee was willing to compromise further suggests that the employee found the settlement acceptable under the circumstances. Employers for their part felt compelled to compromise, whether or not they agreed the case had merit, and so at least incurred the cost of settlement. So the "win" rate as expressed by the author's analysis may not be a sufficient statement of employers' exposure to SOX whistleblower claims. The risk to the employer extends beyond the concern that employees might prevail outright.

But in any event, it is hard to contradict the author's conclusion that the SOX whistleblower provision apparently has failed to encourage fraud detection and disclosure or to provide employees from fear of retaliation for blowing the whistle.

Hat tip to the SOX First blog (here) for the link to the article.

Original Whistleblower Loses Case: As if to prove the point, a June 5, 2007 article on CFO.com reports (here) that David Welch, the first person to win a case under the Sarbanes Oxley Whistleblower provisions, has had the lower-level ruling in his favor overturned by the Department of Labor's Administrative Review Board. In part the Board overturned the decision because the Welch's complaints were not "protected activtity" (because they were not with SOX itself and because they did not relate to the federal securities laws). The Board also found that Welch could not have reasonably believed that the alleged fraud would have presented investors with a misleading picture of the company's financial picture.

The Administrative Review Board's May 31, 2007 opinion can be found here.

Let Them Eat Self-Reliance: In his readable one-volume biography of Gandhi, Yogesh Chadha reports following incident that occured while Gandhi was still a young lawyer with a growing family:

Shortly after Gandhi took up chambers in Bombay, an American insurance agent visited him in his office. The smooth-talking agent discussed Gandhi's future "as though we were old friends." He stressed the need for insurance coverage for the family. Gandhi was impressed and took out an insurance policy for ten thousand rupees. Later, however, he became annoyed with himself for having fallen into the agent's trap, for he had earlier maintained that "life insurance implied fear and want of faith in God." He let the policy lapse. "In getting my life insured I had robbed my wife and children of their self-reliance," he reasoned. "Why should they not be expected to take care of themselves? What happened to the families of numberless poor in the world? Why should I not count myself as one of them?"

I don't think I have ever heard anyone contend that life insurance is a moral hazard for the beneficiaries. How many among us would consciously allow a life policy to lapse to avoid "robbing" the putative widow and orphans-- by providing for their future? I guess only a truly moral person could see that an uneducated widow with life-long, chronic health problems and a squadron of children who were prevented by their father from receiving formal schooling would be much better off without the moral burden of financial protection.

Even though the life insurance agent is twice-disparaged (not only smooth-talking but American) in my mind the unnamed agent has to be the all-time, indoor-outdoor, world champion closer - to seal the deal, he managed to overcome Gandhi's moral qualms, for crying out loud. Otherwise, how could Gandhi possibly have fallen into such a "trap" as providing for his dependants?

All in all, yet another example proving that a working professional's continuing education necessarily requires a broad curriculum.

If it has been a while since you have seen Ben Kingsley's amazing portrayal of Gandhi in Richard Attenborough's 1983 academy award winning film biography of Gandhi, you may want to view this brief excerpt from the movie; the first scene shows how Gandhi's moral rigor complicated his relations with everyone, even his wife, and in the the second scene, he articulates his philosophy of nonviolence:

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In a prior post (here), I raised the question whether the whistleblower protection under Section 806 of the Sarbanes-Oxley Act is "more theoretical than real." A February 2007 study by Alexander Dyck of the University of Toronto, Adair Morse of the University of Michigan Business School, and Luigi Zingales of the University of Chicago entitled "Who Blows the Whistle on Corporate Fraud?" (here, $ required) confirms statistically that SOX whistleblower protection is not encouraging employee whistleblowers and may be discouraging them.

The authors looked at a sample of 230 cases of corporate frauds that were alleged between 1996 and 2004 regarding companies with more than $700 million in assets, in order to determine who was involved in the revelation of fraud. The authors found that between 1996 and SOX's enactment, employee whistleblowers represented 21 percent of the fraud detectors, but that after that, they represented only 16 percent.

The authors found that employee whistleblowers face significant discinventives. They found that in 82% of cases where the employee whistleblower's identity was revealed, the employee "quit under duress, or had significantly altered responsibilities." In addition, may whistleblowers report having to move to another industry or to another town.

SOX attempted to create protections for employee whistleblowers. Section 301 requires public company audit committees to create procedures for "confidential anonymous submission" of questionable accounting or auditing matters. Section 806 provides protections for employees against being fired for coming forward with this kind of information. The authors found that the drop in the employee whistleblowers as a percentage of fraud detectors after the enactment of Sarbanes-Oxley suggests that "SOX's modest incentives for whistleblowers has not been very effective." They suggest that "protecting the whistleblower's current job is a small reward given the extensive ostracism whistleblowers face."

The D & O Diary would add to the authors' analysis that, as discussed in prior posts (most recently here), the protection that the SOX whistleblower provisions theoretically provide have proven cumbersome and procedurally challenging. The statutory protections, as implemented, arguably create affirmative disincentives for would-be employee whistleblowers.

The study's authors have an interesting observation about employee whistleblowers in industries (such as healthcare) that conduct significant business with the government, and where employees can receive substantial financial rewards for bringing a so-called qui tam action. The authors found that in the healthcare industry, where employees have these kinds of financial incentives to blow the whistle on fraud, employee whistleblowers account for 46.7% of fraud detectors, as opposed to only 16.3% in industries where employees cannot bring qui tam lawsuits. The authors also found that in the healthcare industry, fewer fraud lawsuits were dismissed or settled for less than $3 million than compared to all companies in all industries, leading the authors to conclude that there was no evidence that the availability of the qui tam lawsuits increased the level of frivolous litigation.

The authors conclude that the SOX whistleblower protection, offering only after-the-fact job protection, provides little incentive for employees to assist in fraud detection. The authors recommend "extending the qui tam statute to corporate frauds."

Whether or not employee whistleblowers should have added fraud detection financial incentives, the authors' point about the financial incentives for employee whistleblowers in the healthcare industry (and other industries that do substantial business with the government) is an important point for D & O insurance professionals. Clearly, with respect to companies in the healthcare industry and other industries that do substantial business with the government, it will be particularly important for the standard insured-versus-insured exclusion to be modified to carve back coverage for whistleblower suits, including in particular qui tam or False Claims Act lawsuits.

A February 13, 2007 CFO.com article entitled "Sarbox Curbs Fraud Whistleblowing" discussing the report referred to above can be found here.

Go Ask Alice: According to news reports (here), "a male lawyer who appeared in court in women's clothes as a protest against what he said was New Zealand's overly masculine judiciary was suspended Wednesday after being found in contempt of court." The lawyer, who officially has changed his name to "Miss Alice," was held in contempt for posting on the Internet certain documents pertaining to a bridge collapse, despite a court order that the documents not be distributed. The lawyer announced after the ruling that he would quit the law altogether, so that he would no longer appear "in a 19th century Alice in Wonderland environment that allows pomp, self-importance and deference to the court to eclipse the truth." However, a subsequent news report (here) suggested that he had changed his mind about leaving the practice of law -- perhaps he felt his attire entitled him to that prerogative.

"Miss Alice," this video is for you.

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At the heart of recent calls for regulatory reform in the Interim Report of the Committee on Capital Markets Regulation and in the Bloomberg/Schumer Report is the assertion that the U.S. securities markets are losing global IPO marketshare because of supposed regulatory overkill and the litigious environment in the U.S. Accompanying this assertion is the concern that foreign securities markets (particularly in London) are supposedly attracting IPO activity by their comparatively light regulatory touch. Reform of the U.S regulatory approach and litigation system is needed, these Reports assert, so that the U.S. can recapture a larger share of the global IPO activity.

The D & O Diary has previously presented (most recently here) its belief that the reformers' case for regulatory reform is "weak." More recently, events both overseas and in the U.S. further belie both ends of the reformer's premise - that is, these recent events suggest that companies (even foreign companies) may yet seek to list on U.S. exchanges, in preference to other exchanges, even without regulatory reform; and that companies might not be able to count on a lighter regulatory touch on competing exchanges.

1. London's Attraction To (or Appetite For) Russian and Chinese Companies May be Waning:

A very large part of the London markets' success in growing their share of the global IPO market in recent years has been based on their success in attracting listings from Russia (and other former Soviet republics) and from China. Indeed, in 2006 alone, 12 offerings by companies from Russia or other former Soviet republics raised proceeds of nearly 6.6 billion pounds. But now in early 2007, the bloom very much seems to have gone off the rose for Russian offerings in London. As reported in a February 8, 2007 Financial Times article (here), the listing of the shares last week of two Russian companies (Polymetal and Sitronics) came in at the low end of the offering range and in response a third company, GV Gold, withdrew its offering amidst "lackluster demand." According to the Financial Times article, these developments "underline the increasingly tough environment companies from Russia and other former Soviet states are likely to face this year as investors become increasingly selective."

At the same time the pipeline of Russian companies to London has started to slow, two Chinese companies, 3SBio and JA Solar Holdings, completed successful offerings on NASDAQ.

Without the flood of Russian listings, and with Chinese companies successfully listing in the U.S., the apparent market share advantage enjoyed by the London exchanges could be diminishing

2. The Successful Fortress Investment Group IPO Will Attract Additional Hedge Fund and Private Equity Fund Listings on U.S. Exchanges

Fortress Investment Group's successful February 9, 2007 IPO was not the first public offering by a private equity fund or hedge fund, nor was it the largest. But it was the first public hedge fund offering on a U.S securities exchange, and it was the most successful. According to the February 10, 2007 Wall Street Journal (here, subscription required) 19 private equity and hedge fund firms sold shares in 2006 on foreign markets, raising $12.4 billion. U.S. groups have been among the firms to list their shares in these offering. KKR, for example, sold shares in a private equity fund on the Euronext Amsterdam exchange. But the KKR fund shares trade in a narrow range close to their offering price.

Fortress chose to list its shares on the NYSE, notwithstanding those supposedly prohibitive regulatory constraints that are driving companies away from the U.S. securities markets. Its reward was that its offering priced at the top end of the range and its shares jumped 68% in the first day of trading. Commentators can argue all they want about whether regulatory burdens are deterring companies from listing on U.S. exchanges, but high valuations and a successful debut like Fortress Investment Group's will unquestionably attract companies to list on U.S. exchanges.

The title of the Wall Street Journal's February 10, 2006 article about the offering, "Hedge Fund Crowd Sees More Green As Fortress Hits Jackpot with IPO" (here, subscription required) says it all. Along those lines, a February 9, 2007 Business Week article (here) reporting on the Fortress Investment Group IPO contained a prediction that more than 30 hedge funds and private equity funds could seek to list their shares on U.S. exchanges by the end of 2008.

It should also be noted that the Fortress group was one of 17 offerings this week on U.S. securities exchanges, raising over $3.4 billion, the most active week in terms of deal value in over three years. It certainly seems like the market for IPOs on the U.S. exchanges is healthy -- perhaps healthy enough to question whether the reformers' dire warnings about the competitiveness of the U.S. markets are seriously overblown.

3. London's Regulators, Perhaps Spurred by Criticism, Have Begun to Show Some Teeth

It probably has nothing to do with the remarks (here) of John Thain, the head of the NYSE, at the recent World Economic Forum in Davos, Switzerland, that the London markets need to "tighten up" to avoid "damage" to "their reputation." But within days of these remarks, the U.K.'s Serious Fraud Office launched an investigation (here) into Torex Retail, following the London Stock Exchange's suspension of trading of Torex Retail's shares on the Alternative Investment Market (AIM).

The Torex Retail matter may involve only one company, but it does serve as a reminder that markets will strive to maintain their integrity in order to preserve investor confidence. There are no advantages for being perceived as having won the race to the bottom. Companies attracted to the London markets out of a perception of a lighter regulatory touch will find that they still face regulatory scrutiny. It will not take too many cases like Torex Retail before the London regulators will have shown their vigilence is not less than regualtors elsewhere.

UPDATE: On February 12, 2007, another AIM listed company, Adamind LTD, disclosed (here) that the Financial Services Authority had initated an investigation regarding the company. The Adamind investigation is noteworthy because it involves one of those companies -- Adamind is a U.S.-based company with R & D facilities -- that chose to list in London and about which the would-be reformers have been fretting so much. Special thanks to alert reader Uri Ronnen of the AccountingClues blog for the link to the Adamind disclosure.

Each of these developments serve as a warning against seizing upon possibly temporary or transient phenomena as pretexts for reducing regulatory rigor in the U.S. In the global economy, transactions will go where they can realize their greatest financial advantage. The factors that in the recent past led to a greater number of listings in London may have had little to do with the regulatory regime in the U.S. The changing IPO market place so far in 2007 suggests that the competitive landscape among the various securities markets is already evolving, and will continue to evolve - and that that is happening without the adoption of any of the various proposed regulatory reforms. We should be very wary of compromising this country's regulatory rigor based on transient shifts in the global financial marketplace that have no relation to the level of regulation in this country.

Now This: When we heard about the untimely death of Anna Nicole Smith, we found that we could not think of her marriage to J. Howard Marshall without associating this scene from the film, Best in Show:

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In the latest of the securities class action opt out settlements, California's teacher pension fund reached a $46.5 million settlement in its separate case against Qwest Communications, its accountants and investment banks, and certain former directors and officers. According to news reports (here), the parties resolved the pension fund's case, which was pending in the San Francisco Country (Cal.) Superior Court, in December 2006, but the settlement only recently came to light as a result of a California Public Records Act request of the Associate Press. The pension fund had opted out of the $400 million settlement of the class action lawsuit against the Qwest defendants. A description of the class settlement as well as a number of the opt out lawsuits may be found here.

The settlement reportedly included a $1.5 million payment on behalf of Qwest's former CEO Joseph Nacchio. According to Nacchio's counsel (here), Nacchio's settlement contribution was "made with insurance funds." Nacchio is scheduled to go to trial in federal court in Denver on March 19, 2007, on a 42-count insider trading indictment, in which it is alleged that Nacchio sold $101 million of Qwest stock based on inside knowledge that the company would not meet revenue targets. A February 4, 2007 Denver Post article discussing the criminal case against Nacchio can be found here.

The $46.5 million settlement with the California State Teachers' Retirement Systems' (CalSTRS) is apparently only one of several settlements that the Qwest defendants have recently reached with opt-out plaintiffs. According to a February 3, 2007 Rocky Mountain News article entitled "Qwest Quietly Settles Lingering Lawsuits" (here), the Qwest defendants have also reached settlements in undisclosed amounts with the New York City Employees' Retirements System, Stichting Pensioenfunds of Netherlands, and the Teachers' Retirement System of Louisiana.

According to the statement of its Chief Executive in a January 31, 2007 CalSTRS press release (here), the pension fund will receive "about 30 times more than it would have recovered if it had taken part in the class action." CalSTRS is one of the largest public pension funds in the country, second only to the California Public Employment Retirement System (CalPERS).

A copy of CalSTRS complaint against the Qwest Defendants may be found here, and the December 29, 2006 Amended Settlement Agreement can be found here.

The CalSTRS opt-out settlement in Qwest follows the December 2006 opt out settlement by the State of Alaska in connection with claims against AOL Time Warner (refer here). The State of Alaska reportedly received a settlement of $50 million on its claimed investor loss of $60 million, or about 83 cents on the dollar. The attorney for the State of Alaska claimed that the state received "50 times more than we would have gotten if we had remained in the class." The lawyer also said that the state was able to take advantage of Alaska's favorable blue sky laws. (A description of the AOL Time Warner class settlement can be found here.)

These opt-out settlements follow the settlement by five New York City public pension funds that did not join the $6.1 billion World Com settlement. According to news reports (here), the pension funds received $78.9 million on their $130 million claimed fraud losses to their equity and bond portfolio. The city's counsel claimed that the funds wound up with "three times more than they would have received if they joined the class action."

The emergence of large separate opt-out settlements represents a potentially very significant development in securities fraud litigation. Certainly if institutional investor defendants perceive that they can substantially increase their recoveries by pursuing their claims individually rather than collectively in the form of a class action, the utility of the class litigation, at least for institutional investors, could be significantly reduced.

While class lawsuits have been demonized for years, they do offer unarguable advantages in certain respects, most obviously when they afford the opportunity to resolve numerous disputes in a single proceeding. Following the adoption of the Private Securities Litigation Reform Act of 1995, there are certain procedural advantages to the federal securities class action litigation, most significantly the stay of discovery while motions to dismiss are pending. If a company is forced to defend itself in multiple proceedings in multiple courts, particularly if it is also forced to defend a class lawsuit also, the costs and complexity of defense escalate enormously. And if individual investor recoveries really do exceed class recoveries as a percentage of investor losses, then the aggregate cost of final resolution could escalate significantly as well.

But some caution may be required before it can be conclusively determined that opt-outs will fare better than class members. Typically, the percentage of a plaintiffs' attorney's fee recovery in an individual case is higher, because it is applied against a smaller fund. (A class attorney can accept a lower percentage because the fund is so much larger, and the resulting fee is larger as well.) So the individual plaintiffs' recovery net of fees would have to take this larger plaintiffs' fee percentage into account.

From the plaintiffs' attorney's point of view, the prospective class fee will almost always be larger than the prospective fee representing an opt out investor, and indeed a plaintiffs' lawyer's incentive to take on an opt out case is going to be limited to cases where the individual investor's prospective recovery is very large. To put this into context, the median 2006 securities class action settlement, according to NERA (here), was $7.7 million. If half of all settlements are below $7.7 million, there are going to be relatively few instances where the potential incremental benefit from an opt out case will sufficiently outweigh the associated friction costs. There are not going to be very many occasions where there will be plaintiffs' lawyers eager to pursue these cases, either. So, on its face, the opt out lawsuit would appear to be a phenomenon restricted to only the largest cases and settlements.

Nevertheless, in these largest cases, the emergence of opt out cases could require a reassessment of the assumed range of claims severity. In assessing potential severity, it may not be sufficient to look at class action settlement data alone. It may also be necessary to crank into the calculus the possibility of opt-outs, with the potential for heightened defense expense and settlement exposure. This dimension of added exposure could also have important implications about D & O insurance limits adequacy. The limits required to defend the company and its directors and officers in a multi-front war with opt-out institutional investors and the class, and required to settle all of the lawsuits (particularly if opt-outs expect recover percentages approaching 100% of investor losses), could be significantly higher than may have been assumed in the past.

The Lies, Damned Lies Blog takes a closer look at the plaintiffs' firms involved in the CalSTRS opt out settlement with the Qwest defendants, here.

UPDATE: On February 7, 2007, CalSTRS announced (here) a separate $105 million settlement in its separate opt out action involving its claims investor loss at AOL Time Warner. Refer here for a more detailed discussion of CalSTRS AOL Time Warner settlement.

Star Trek Meets Monty Python: The ultimate nerd movie mashup.

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The growing bribery scandal at Siemens has made the front pages of the world's financial papers in recent days. For example, on January 31, 2007, the Wall Street Journal (here, subscription required) ran an article entitled "At Siemens, Witnesses Cite Pattern of Bribery." In its February 1, 2007 SEC filing on Form 6-K (here), Siemens, whose ADRs have traded on the NYSE since 2001, reported that the U.S. Department of Justice is "conducting an investigation of possible criminal violations of U.S. law" and also announced that it "understands that the U.S. Securities and Exchange Commission's enforcement division is conducting and informal inquiry into matters at this time."

Siemens apparently is already under investigation in German, Lichtenstein, Italy, Switzerland and Greece. The investigation gained momentum in November 2006, when, according to the Journal, more than 200 German police raided about 30 offices and homes of current and former Siemens employees." The German police searched office of Siemens management board members, including that of Siemens' CEO, Klaus Kleinfeld. In December, the company announced that it had uncovered $544 milllion in "suspicious transactions." covering over seven years. The investigation involves the possibility that Siemens officials diverted funds through sham consulting contract to slush funds used to bribe potential customers. Investigators are looking into possible bribes in a number of countries, including Saudi Arabia, Russia, Slovakia, Argentina, Nigeria, Egypt, Cameroon, and Kazakhstan. A number of high-ranking Siemens officials have been arrested, including a member of the management board. The Company's former CFO reportedly is a suspect.

It obviously remains to be seen whether the DoJ investigation or the informal SEC investigation will lead to further proceedings. But according to the February 3, 2007 Wall Street Journal article discussing the U.S.-based investigations (here, subscription required), these U.S investigations "heighten the legal risk for Siemens, which could face lawsuits and be banned from bidding on infrastructure contracts in the U.S. and other countries if there is evidence of wrongdoing."

The company also faces significant (but uncertain) financial risk as well. In its 6-K announcing the U.S. investigations, while acknowledging that the company "cannot exclude the possibility that criminal or civil sanctions may be brought against the Company itself or against certain of its employees," the company also reported that so far "no charges or provisions for any ...penalties or damages have been accrued as management does not yet have enough information to reasonably estimate such amounts." As a company with 2006 sales of over $113 billion, Siemens would have to sustain a very significant fine, penalty or damages for it to have a material impact on its financial condition, although certain enforcement outcomes could definitely impact the company's future prospects. The absence of any accrual at this time does raise at least the possibility of a negative financial effect from an adverse investigative development.

The involvement of the SEC in the Siemens investigation underscores a point that The D & O Diary has made in several prior posts relating to investigations involving the Foreign Corrupt Practices Act (most recent posts here and here). That is, these investigations can give rise to follow on securities claims. This is the reason that I have often cited the FCPA as a threatening potential new source of D & O exposure. The threat is not so much from the corrupt practices investigation itself, but from the follow on claims that could arise in which it is claimed that the corrupt practices caused a misrepresentation of the company's financial condition - which presumably is the question the SEC is examining in connection with the Siemens probe.

The Siemens investigation is also important in connection with the current calls inside the U.S. for regulatory reform to improve the competitive position of U.S. securities markets in the global financial marketplace. The Siemens investigation originated outside the U.S. and only came to this country after the provision by foreign authorities of investigative information to U.S. authorities. It is evident that regulators throughout the world increasingly understand the importance of vigilance and scrutiny. The magnitude and scope of the Siemens investigation suggest cross-border commitment to regulatory rigor and the extent of the alleged misconduct is likely to spur further efforts for oversight and reform As international regulatory standards respond to these circumstances, differences between the standards in the U.S. and those elsewhere are likely to continue to diminish.

The Here After: It turns out that in the cycle of death and rebirth, what we are really here after is beer:

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As The D & O Diary has previously noted (here and here), earlier this month the National Economic Research Associates (NERA) and Cornerstone Research (in conjunction with the Stanford Law School Securities Class Action Clearinghouse) released their respective studies of the 2006 securities class action lawsuit filings. The NERA study can be found here and the Cornerstone study can be found here. Although the two studies differ in some of their numerical details, the two studies agree in most of their important conclusions, including the fact that the number of 2006 filings represents the lowest annual total since the passage of the Private Securities Litigation Reform Act of 1995. Each of the studies has some interesting additional observations about the 2006 filings.

In the latest issue of InSights (here), I review the two studies' observations and also take a closer look at the 2006 lawsuits to try to better understand the data. In particular I analyze the data (by SIC Code, Industry and Sector) to determine who got sued, where and when. In addition, I review NERA's study's conclusions about the 2006 securities class action settlements, assesses the possible reasons for the 2006 filings decline, and close with some thoughts about the possible impact of the decline on the pricing of D&O insurance.

Famous Last Words: "I'm confident it will work, the only thing is, we're just not sure how much dynamite to use."

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Regular D & O Diary readers know that I have been maintaining a running tally of options backdating related litigation (here). According to the most recent count, so far there have been 23 securities class action lawsuits raising allegations of options grant manipulations. (The Stanford Law School Securities Class Action Clearinghouse maintains its own tally on its home page, here, that agrees with my count.)

My running tally includes cases that did not originally involve (or feature prominently) allegations related to stock grant manipulations, but that were later amended to include or emphasize options backdating allegations. Because I have already made the decision to incorporate in my tally cases that included options backdating allegations by amendment, I feel compelled to revise my tally to include the Amkor Technology case.

The initial complaints in the Amkor Technology case, filed in January 2006, may be found here. The initial complaints did not contain options backdating allegations. In an Amended and Consolidated Complaint filed in the Amkor Technology case on August 14, 2006, the allegations in that lawsuit were significantly augmented to include detailed allegations of supposed options backdating, complete with the now standard stock price graphs showing arrows superimposed on stock price troughs when options allegedly were granted. (Links to the Amended and Consolidated Complaint are unavailable, but the Amended Consolidated Complaint in Amkor is available on PACER; anyone who wants a copy of the pleading but lacks a PACER subscription should drop me a note and I will email a copy).

I only became aware of the Amkor Amended and Consolidated Complaint by accident while I was looking for something else. I am concerned that there may be other pending securities fraud cases that did not contain options backdating allegations when initially filed that have been amended to include them. It would be extraordinarily helpful if D & O Diary readers who are aware of securities fraud lawsuits that have been amended to add options backdating allegations could let me know, so that I could adjust the options litigation tally accordingly.

With the addition of the Amkor Technology case, the tally of securities fraud lawsuits raising options grant manipulation allegations stands at 24.

As also noted in my running tally, the number of companies that have been named as nominal defendants in shareholders derivative lawsuits stands at 141. This count has been substantially revised this week thanks to information supplied by alert D & O Diary readers Bill Ballowe and Ben Eng. Hat tip to these gentlemen for their helpful information.

UPDATE: My request for help from readers has already yielded results. The list of securities fraud lawsuits involving options grant manipulations has been amended to include the lawsuit pending against Quest Software. The lead plaintiff's counsel's press release regarding the Quest Software case may be found here. With the addition of this case, the tally of securities fraud lawsuits now stands at 25. Hat tip to Adam Savett of the Lies, Damned Lies blog for the link to the press release.

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On January 16, 2007, the Lerach Coughlin firm filed a purported securities class action lawsuit in federal court in the District of Columbia against Sunrise Senior Living and several of its directors and officers. A copy of the law firm's press release can be found here and a copy of the complaint can be found here. The complaint raises a variety of different allegations but also contains allegations that the defendants manipulated the company's stock option program by backdating or springloading option grants.

The Complaint alleges that the "top insiders of Sunrise took advantage of the artificial inflation in Sunrise's shares to bail out of the stock, unloading almost a million shares of the stock." What is interesting about the plaintiffs' insider trading allegation is their assertion that the defendants stock sales were triggered "in early 2006, as widespread revelations of a stock option backdating scandal began to sweep corporate America." The allegedly backdated or springloaded options were awarded during the period 1997 to 2001.

The plaintiffs do not specify why the unfolding scandal supposedly motivated the defendants to sell their shares; the suggested inference, I suppose, is that defendants sold their shares because they knew when the marketplace found out about the backdating in the company's options, the company's share price would drop. But in fact, the company's share price declined in value as a result of its announcement (here) that it would be restating its financial statements for the years 2003 through 2005, not because of disclosures relating to options backdating.

Apparently in anticipation of the defendants' likely arguments that their share sales were made pursuant to Rule 10b5-1 trading plans, the plaintiffs raise a number of interesting allegations. The plaintiffs not only contend that the plan terms "did not comply with regulatory requirements" but also that when the defendants put the plans in place, they knew "that they were already pursuing a scheme to defraud and falsify Sunrise's reported financial results" hoping that the plans "would give them protection from the legal liability they knew they would otherwise face." In other words, the plaintiffs are trying to argue that the Rule 10b5-1 plans themselves were part of the scheme to defraud.

Updated Options Backdating Litigation Tally: The initiation of the lawsuit against Sunrise brings the total number of options backdating related securities class action lawsuits to 23. The number of companies named as nominal defendants in shareholders' derivative lawsuits based on options backdating allegations now stands at 131. The D & O Diary's running tally of the options backdating related lawsuits can be found here.

Courts Reject SOX Whistleblower's Claim: Employees of public companies who believe they have been retaliated against because they engaged in "protected" whistleblowing activity may assert a claim against their employer under Section 806 of the Sarbanes-Oxley Act. The burden is on the employee to show that the protected activity was a contributing factor in the adverse employment action. The D & O Diary's prior post about the difficulty employees are having obtaining relief under the SOX Whistleblower provisions can be found here.

There is still relatively little case authority establishing what constitutes "protected activity." A recent federal court decision from Michigan examined how direct the causal connection has to be between the allegedly protected activity and the job action.

In the case (Sussman v. K-Mart Holding Corp.) the plaintiff (Sussman) alleged that he had sent the company's President a letter alleging that his supervisor was accepting kickbacks from vendors. K-Mart investigated the supervisor, but before the investigation was complete, the supervisor was terminated for unrelated reasons. Five months later, Sussman's performance came under criticism, and he received a warning. Sussman asked his (new) supervisor whether the warning was related to his complaints about his prior supervisor. After additional performance shortcomings, Sussman was terminated.

In SOX whistleblower case that Sussman filed against K-Mart, the court held that Sussman had failed to establish a causal link between the job action and the activity he claimed was protected. The court did observe that Sussman was not engaging in protected activity when he raised with his new supervisor that he had blown the whistle on his prior supervisor's kickbacks. The court found that his comments about his previous supervisor's actions could not be related to protecting shareholders from fraud because his prior supervisor was fired for unrelated reasons five months before he made the remarks to his new supervisor.

A detailed summary of the decision, as well as a brief overview of the "protected activity" case law, can be found a memorandum by the Sutherland, Asbill & Brennan law firm, here.

The Ultimate Team Building Video: This YouTube video is for anyone who has ever felt like a team of one. The video takes about a minute to watch, but rewards a complete viewing.

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