The D&O Diary

The D&O Diary


The Last of the Mug Shots?

Posted in Blogging

031aThe long-running and ever-popular D&O Diary mug shot show may just about have reached the end. I have only three remaining unpublished mug shots, which I have been holding onto for a while in the hope that perhaps some other readers might send in the pictures. But I don’t want these pictures to get stale, so I have published below this short form mug shot gallery. It is entirely possible that these pictures may be the last in the series.


Readers will recall that early last year , I offered to send out a D&O Diary coffee mug to anyone who requested one – for free – but only if the recipient agreed to send me back a picture of the mug and a description of the circumstances in which the picture was taken. In previous posts (here, here, here, here, here, here, here, here , here, here, here, here, here, here, here, here and here), I published prior rounds of readers’ pictures. I have posted the latest round of readers’ pictures below.


The first pictures in this collection come to us from Peter Hui of ACE USA in New York. The first picture, which was taken in early July, depicts a sunny scene in New York’s Bryant Park. The second picture is taken from an office overlooking Times Square.






















The next picture was taken in Brazil by Guido Cosenza of A.J. Gallagher in Glendale, CA. Here is Guido’s description of his picture: “I had the privilege of attending the World Cup in Brazil and one of the matches I attended was the quarterfinal match between Argentina and Belgium in Brasilia. My colleague, Ryan Davis, had ordered a D&O Diary mug from you so I grabbed it from his desk before I left and took it with me to Brazil. Attached is a picture inside the stadium about 2 hours before kickoff. I know you are a big futbol fan so I’m sure you’ll enjoy it.”










Thanks to Peter and Guido for their great pictures. Guido, you are right, I really did enjoy your picture (and I am deeply envious of you for having been able to attend the World Cup).


My thanks to everyone sent in a mug shot. It has been great fun receiving the pictures and seeing the amazing diversity of locations where people took their mug shots. There is still time for anyone who still wants to send along their own mug shot; nothing would make me happier than to be able to publish another round of pictures.


Cheers to everyone who helped make this series so much fun.



Montana Supreme Court: Not Necessary to Consider Underlying Allegations or Policy Terms to Determine Insurer’s Defense Duty

Posted in D & O Insurance

montanaAs part of our beat here at The D&O Diary, we read a lot of judicial opinions. We like nothing better than to read an appellate opinion where a dissenting justice and the majority really mix thing up. For that reason alone, we read the recent insurance coverage decision out of the Montana Supreme Court with great interest. But regardless of how you feel about spirited dissents, if you find the Court’s majority’s conclusion that a management liability insurer’s duty to defend appropriately may be determined without reference to the allegations in the underling complaint or to the terms of policy as surprising as we do, read on.


The Montana Supreme Court’s August 1, 2014 opinion in the Tidyman’s Management Services, Inc. v. Davis case can be found here.



The dispute underlying this insurance coverage action arises out of a merger between Tidyman’s Management Services, Inc. (TMSI) and SuperValu, which created Tidyman’s LLC. Employee shareholders own TMSI. In January 2007, certain of the employee shareholders filed a federal court lawsuit alleging that in connection with the merger the TMSI directors and officers had breached their duties under ERISA. They also alleged that the individual defendants had breached their corporate fiduciary duties. The plaintiffs eventually settled with all of the individual defendants except Michael A. Davis and John Maxwell. After the settlements, the federal court judge dismissed the federal court action without prejudice after declining to exercise supplemental jurisdiction.


The plaintiffs then filed a separate action in Montana state court against Davis and Maxwell. In their state court complaint, the plaintiffs added TMSI as a party plaintiff and filed their action against the two individuals in their capacities as directors and officers of the LLC – of which TMSI was a member. As the dissenting opinion later summarized with respect to the insurance coverage implications of this state court complaint, “(1) five of the plaintiffs here are directors of the insured (Tidyman’s LLC) and they have sued defendants Davis and Maxwell, who are also directors of the LLC; and (2) plaintiff TMSI, as a 60 percent security holder of the LCC, brought this lawsuit against two directors of the LLC (Davis and Maxwell) with the assistance of other insureds (five plaintiffs who are also directors of the LLC).”


The relevant directors and officers insurance policy had been issued to Tidyman’s LLC in 2006. During the pendency of the federal court litigation, the insurer funded the defense of Davis and Maxwell under the policy. On August 5, 2010, after the state court litigation commenced, a claims representative for the insurer sent counsel for Davis and Maxwell a letter stating that in light of the policy’s Insured v. Insured exclusion, the state court complaint “does not implicate the policy.”  On August 12, 2010, after counsel for Davis and Maxwell received the coverage letter, the plaintiffs amended their complaint in the state court action and added the insurer as a defendant, seeking a declaratory judgment that the state court claims against Davis and Maxwell are covered under the policy. In September 2010, the insurer moved to dismiss the claim that had been filed against it.


During the fall of 2010, counsel for Davis and Maxwell made several attempt to reach the insurer to clarify whether or not the insurer would continue to find the defense for the two individuals. On October 28, 2010, a representative for the insurer advised counsel that “since there is no coverage, [the insurer] is not going to continue to pay the costs of defense in this matter.”


The individual defendants entered a stipulation reciting the insurer’s refusal to defend, specifying the $29 million in damages sought in the state court lawsuit, assigning the individual defendants’ rights under the policy to the plaintiffs, and agreeing that the plaintiffs would not seek to execute any judgment against the assets of the two individual defendants. After the first of the two stipulations had been reached, a representative of the insurer sent the defense counsel a letter referring to “changes” in the insurer’s position, and stating that the insurer would continue to advance defense costs subject to a reservation of rights. The insurer later claimed that at no time did it actually withhold payment of the individuals’ defense expenses.


The plaintiffs then moved for summary judgment against the insurer, alleging that the insurer had breached its duty to defend and therefore was liable for the full amount of the stipulated settlement. The insurer filed a motion for summary judgment on the grounds that the plaintiffs’ claims were not covered under the policy and that the plaintiffs lacked standing. On January 4, 2013, the trial court judge granted the plaintiffs’ motion for summary judgment and entered judgment in the full amount of the stipulated settlement, and awarded prejudgment interest. The insurer appealed.  


The August 1, 2014 Opinion

In an August 1, 2014 majority opinion written by Justice Michael E. Wheat, the Montana Supreme Court affirmed the trial court’s grant of summary judgment on the issue of whether or not the insurer had breached its duty to defend, but reversed and remanded the case on the issue of the reasonableness of the amount of the judgment. Justice Laurie McKinnon concurred with respect to the majority’s rulings on choice of law and prejudgment interest issues, but dissented from the court’s rulings on the duty to defend and part of the court’s rulings on the amount of the judgment.


The insurer had argued on appeal that the trial court erred in concluding that the insurer had breached its duty to defend without analyzing policy coverage. As the majority opinion put it, the insurer “attempts to persuade us to impose a requirement that a district court must analyze policy coverage before finding breach of a duty to defend,” noting that the dissent would accept that argument. The Court said that “our case law, however, makes it clear that the threshold question, instead, is whether the complaint against the insured alleges facts that, if proven, would trigger coverage.”


It doesn’t matter, the court said, that whether the claims against Davis and Maxwell were the same in the state and federal lawsuits, “all that matters is whether [the insurer] was on notice that the Policy was potentially implicated.” The Court concluded that the “facts” show that the insurer was on notice that the policy was potentially implicated. The “facts” that the Court cited were that the insurer had defended the two individuals in the federal court lawsuit; that the insurer had sent a letter after the state court lawsuit was filed that “there is no longer coverage under the Policy” (which the Court read to mean that there had been coverage before); and that the carrier later withdrew its coverage denial and agreed to defend under a reservation of rights. The Court noted that “where the insurer itself recognized the complaint potentially implicated the Policy and required it to provide a defense, we can see no need for further analysis to conclude that the duty to defend was invoked.’


In explaining its ruling, the Supreme Court said “if we were to hold the District Court in error for failing to analyze coverage, as the Dissent urges, we would be providing insurers with an avenue to circumvent the clear requirement imposed by our precedent that where the insurer believes a policy exclusion applies, it should defend under a reservation of rights and seek a determination of coverage through a declaratory judgment action.” The carrier “took its chances” by refusing to defend the individuals and cannot avoid liability for the stipulated settlement “by attempting to convince this Court it was necessary to analyze coverage under the Policy before determining it had breached its duty to defend,” when the proper approach is to defend under a reservation and filed a declaratory judgment action. Since the carrier “unjustifiably refuse to defend, it is now estopped from denying coverage.”


The majority did agree with the insurer that the trial court had improperly refused to hold an evidentiary hearing on the reasonableness of the amount of the $29 million stipulated settlement. The appellate court remanded the case for further consideration of the reasonableness of the settlement amount. However, the majority rejected the insurer’s argument that the evidentiary hearing should also address the issue of whether the settlement was collusive. Finally, the majority also concluded that the trial court had not properly calculated the application of prejudgment interest.


The starting point for the dissent was that the majority had “failed, in a fundamental respect, to appreciate the difference” between the type of reimbursement insurance policy involved here and the “more common form of casualty insurance,’ such as automobile or homeowners insurance. This error caused the Court to disregard Montana precedent and to hold that the carrier had a duty to defend “without examining whether the plaintiffs’ complaint alleged facts representing a risk covered by the terms of the Policy.” In essence, the dissent said, the court denied “the insurer the right to contest a duty to defend in these proceedings by holding that the insurer should have brought a separate action to determine coverage.” We thus, the dissent said, “foreclose the insurer from having a judicial determination of the existence of a duty to defend, which is distinct from a duty to indemnify, based on an actual examination of the allegations of the complaint and the terms of the Policy.”



The majority, the dissent said, found “without any examination of the Policy or the instant complaint” that the insurer had a duty to defend because the complaint “potentially implicated” the Policy. The dissent said, “I disagree that with what appears to be a new standard for determining the existence of a duty to defend when we previously have been clear that a duty to defend may be found only after examining the allegations of the particular complaint to determine whether facts have been alleged representing a risk covered by the terms of the insurance policy.”


The “crux’ of the majority’s confusion is the “false notion” that the pleadings in the subsequent state court lawsuit were the same as in the federal court lawsuit. The dissent showed by its analysis of the allegations in the state court complaint (which I recited above) that the state court complaint appeared to involve allegations of insured persons against insured persons, in apparent contravention of the Policy’s insured vs. insured exclusion. “We cannot” the dissent said, “hold the insurer liable for the stipulated judgment in the absence of some examination of the Policy and of the complaint.”


The dissent then noted that even if there were a duty to defend here, there is a substantial factual question about whether the duty was in fact breached. The dissent cited evidence that the insurer had presented showing that the insurer had continued to pay the defense expenses throughout the proceedings. The dissent argued that there were at least sufficient disputed facts to preclude summary judgment. The dissent said that the majority had instead chosen to credit only the plaintiffs’ allegations. The Court’s approach, the dissent said, was “clearly in error,” adding that “it is inappropriate for a court deciding a motion for summary judgment to weigh evidence, to choose one disputed fact over another, or to assess the credibility of witnesses.”


Finally, the dissent disagreed that the facts as alleged by the insurer did not create a genuine issue of material fact on the issue whether the stipulated settlement was collusive. The dissent added that “I find it truly a sad day for justice in this State and very likely a huge blow for the public’s belief that the courts provide fair resolution of disputes, when this Court dismissively says ‘so what’ to a stipulated judgment that allegedly was obtained by collusion.” The dissent finished by adding that “Courts exist to administer justice fairly, regardless of whom and what a particular party represents. In my opinion, there is never a place for collusion in the administration of justice.”



There is no doubt that the insurer mismanaged its communications during the period after the state court complaint was filed, and that the mismanagement occasioned some of the problems that followed for the insurer.  (And in fairness, for blogging purposes I have compressed the retelling of events, which arguably may have the effect of oversimplifying). But all of that said, it is a surprising proposition that a court might appropriately determine that a carrier has a duty to defend a lawsuit without either reviewing the allegations in the lawsuit or the provisions of the policy. The majority’s idea that somehow the insurer was obligated to defend the state court lawsuit — without any reference to what the state court lawsuit alleged — because the insurer had defended the prior federal court lawsuit is a truly odd proposition.


Based only on the appellate opinions, I have no way of knowing for sure whether or not the carrier was correct in disputing coverage for this claim. But based on the recitation of the facts in the dissenting opinion, there certainly does seem to be a sufficient basis upon which the question of coverage appropriately might be raised. The rather nonsensical effect of the majority opinion’s ruling is that it is entirely possible that the court has concluded that the insurer has breached a duty to defend in connection with a claim for which there is no coverage under the policy. The majority seems to think that this doesn’t matter.


The real problem I have with the majority’s conclusion is that it seemingly flies in the face of the usual “eight corners”  analysis by which the insurer’s duty to defend is to be determined. Under this approach, the duty to defend is determined by looking within the four corners of the complaint and the four corners of the policy. Even in those jurisdictions that do not follow the eight corners rule because they require insurers to consider factors still considered critical to the analysis. The majority here seems to suggest that what is within the eight corners may not even be relevant to the analysis, which is a surprising conclusion, to say the least. The majority opinion’s analysis also seems to fly in the fact of the usual rule that coverage cannot be created by estoppel.


The insurer did at least win the right to try to challenge the reasonableness of the amount of the stipulated settlement. However, I am troubled by the dissent’s comments about the refusal of the majority to allow the insurer to argue that the settlement was collusive. I do not know what the actual facts are here and I have no basis on which to suggest that any of the parties acted collusively. However, I have seen enough of these kinds of deals in my life and I share enough of the same concerns of the dissent that I completely agree that the factual issue of whether or not there was collusion should be subject to an evidentiary review.


While I think the majority here is confused in general, I also agree with the dissent that the majority was specifically confused about the differences between the type of management liability policy here –where the carrier reimburses the policyholder for the costs of defense –and the typical policy liability policy, where the insurer has the duty to provide the actual defense. This distinction mattered in this case. If the insurer continued to fund the defense throughout these proceedings, then there was no breach of the insurer’s defense duties, regardless of what the carrier said in its various communications. The dissent appears to be correct by saying that the insurer has raised a genuine issue of material fact on this issue.


Whatever else might be said about this decision, I know for sure that insurers doing business in Montana are going to struggle with the “potentially implicated” standard for the duty to defend, particularly if the question whether or not the standard has been met can (as apparently seems to be the case) be decided without reference either to the allegations in the complaint or the terms of the Policy. I am sure that hands will be smacking foreheads in insurers’ claims department around the country about this decision.


Time for Nominations to the ABA Journal’s Annual Blawg 100: It is once again time for nominations to the ABA Journal’s annual list of the top 100 law blogs. Everyone should take a moment to nominate their favorite law blogs for inclusion in the list. I would be humbled and grateful if any reader would be willing to nominate my blog. Nominations can be made here. Don’t delay, nominations are due by 5:00 pm EDT on Friday August 8, 2014. 


Class Action Litigation in Latin America: Where We Are Now, Where We Could Be Headed

Posted in International D & O

latinamericaAmong the features of the U.S. legal system that foreign observers often single out for concern is the availability of class action litigation procedures. The fact is, however, that many countries around the world have adopted some form of class action procedure, at least for consumer-oriented litigation. According to a recent report, Latin America is among the regions where many countries have adopted differing local versions of class action procedures. However, in adopting class action procedures, these Latin American countries have not followed the U.S. class action litigation model, but rather have tended to model their approach on the procedures first adopted in Brazil.


According to a second recent report, the fact that the Latin American countries have in the past looked to Brazil may be a cause for concern in light of certain proposed legislative revisions to the Brazilian procedures that are now pending.


The first of these two August 2014 reports, which is entitled Following Each Other’s Lead: Law Reform in Latin America, and which provides an overview of class action procedures in Latin America, can be found here. A Spanish language version of the report can be found here. The second of the two reports, which is entitled Class Action Evolution: Improving the Litigation Environment in Brazil and which takes a look at the development of class action procedures in Brazil and analyzes pending legislative proposals to revise those procedures, can be found here. A Portuguese language version of the report can be found here.


Together these two reports, issued by the U.S. Chamber of Commerce Institute for Legal Reform “highlight the growing danger of litigation abuse in Latin America,” according to the Institute’s August 5, 2014 press release describing the reports.



According to the first of these two reports, several Latin American countries, following the Brazilian model, have adopted some form of class action procedures. Legislation allowing class actions for damages has been enacted in Chile, Colombia, and Mexico. What the report describes as “de facto class actions” exist in other countries, such as Argentina and Costa Rica. There is legislation pending now in several countries to create a new class action system or to modify existing legislation, for example, in Argentina, Brazil, Costa Rica, Ecuador, and Mexico. The report reviews the current state of play in each of these countries.


According to the report, the pending changes in these various countries could impact the litigation risk environment in those countries for years to come. For that reason, the first of these two reports advocates that “businesses should take it upon themselves to monitor these developments as they arise,” and advocates further that as proposed changes are under consideration “private industry should express its concerns, not to hinder development of the law, but to ensure a level playing field for all members of society.”


While these reports are written as advocacy, they provide some balanced consideration of the role of class action litigation in a system of civil justice. The reports acknowledge that in some countries around the world, the need for greater access to justice is a fact. Accordingly, the first of the two reports states that “there is a strong argument in some countries that class actions … would improve access to justice,” adding that “in those places, it is simply not credible to oppose the creation of a class action mechanism.” However, the report also notes, “it is fair and appropriate to oppose class action systems that change the meaning of justice under the guise of creating access to it. If a claim is not viable individually, it should not become viable simply because it is joined with other claims.”


The system currently in place in Brazil, which has served as the starting point for the approach to class action procedures in other Latin American countries, has, according to the reports, its positive features, although the report notes that  the addition some form of class certification procedure would be even more beneficial. The report notes that one of the positive elements of the U.S. class action system is that it provides a tool for settling mass claims. Without a class certification mechanism, the Brazilian model involves a two-step process wherein liability may be established on a class wide basis in the first phased, but damages must be established in the second phase in a series of individual cases, with no means to settle the cases collectively.


For that reason, there are good grounds  for Brazil to look into reforming its procedures, and indeed there are proposals to reform the Brazilian procedures pending in that country’s  legislature. However, as the second of these two report notes, rather than address the areas where legislative reform could introduce some improvements, the reform proposals now under consideration in Brazil are focused on “providing additional tools for plaintiffs to succeed rather than improving the existing law to make it more faire and reasonable.” The current reform proposal, known as Bill 282, “seems to be inspired not only by the assumption that class actions should become more popular, but that they should invariably result in judgments favorable to plaintiffs.”


According to the reports, the Brazilian reform bill and other pending measures if adopted would, among other things, essentially allow for nationwide class actions, grant standing to political parties, allow the judge to shift the burden of proof at any time before the decision, and allow for financial compensation to the class advocates as a stimulus for litigation. The proposals would create financial incentives for outside groups to file class actions by allowing them to receive legal fees no less than 20% of any award.  As summarized in the Institute’s press release, these reforms, while intended to “expand fairness” in Brazil’s civil justice system ‘can lead to undermining it.” According to a statement by Lisa Rickard, the Institute’s President, “if implemented, current proposals could have costly unintended economic consequences.”


The reports unquestionably represent advocacy and must be read and understood on that basis. Nevertheless, the reports provide a thorough and interesting overview of the state of class action litigation in Latin America. Though possibly provocative for some readers, the reports will make interesting reading for anyone interested in developing an understanding of the current evolution of class action procedures in Latin American countries.


Cornerstone Research Releases Securities Litigation Report for the First Half of 2014

Posted in Securities Litigation

cornerAccording to the latest report from Cornerstone Research, the number of securities class action lawsuit filings during the first half of 2014 were down compared to historical filings semiannual filing levels although slightly higher than the number of filings in the first half of 2013. The report, which is entitled Securities Class Action Filings – 2014 Midyear Assessment, and which can be found here, notes that the number of large dollar-loss cases and the number of cases against S&P 500 firms is far off of historical levels. Cornerstone Research’s August 6, 2014 press release about the report can be found here.


Consistent with my own tally and analysis of securities class action lawsuit filings during the first six months of 2014, the Cornerstone Research study reports that there were 78 new securities class action lawsuit filing in 2014’s first half. This number of filings is well below the 91 filings in the second half of 2013 and is 18 percent below the historical semiannual average of 95 filings during the period 1997 to 2013. However, the 78 filings in 2014’s first half is slightly higher than the 75 filings in the first half of 2013. The 78 filings do represent an increase from the low-water mark of 64 filings in the second half of 2012.


What the report characterizes as a “traditional filing” – that is, excluding merger objection suits and Chinese reverse merger cases – decreased 17 percent to 68 in the first half of 2014 from 82 filings in the second half of 2013. Eight of the first half filings involved merger objection allegations and two involved Chinese reverse merger companies.


The annualized rate of securities class action lawsuit filings projects to a year-end 2014 total number of securities suits of 156, which would be below the 2013 total of 166, but above the 2012 total of 152. A year-end total of 156 would be 17 percent below the 1997-2013 historical annual average of 189 filings. Were 2014 to end up at that level, this year would represent the sixth consecutive year with below-average filing activity and would be the third lowest total in the last 18 years.


However, as I noted in detail in my analysis of first half filing, the relative decline in the absolute number of filings is attributable at least in part to the overall decline in the number of publicly traded companies. Indeed, Figure 6 in the Cornerstone Report shows that notwithstanding the decline in the absolute numbers of lawsuits filed, as a percentage of U.S. listed companies, the percentage of companies sued (about 3.2%) remains above the 1997-2013 average of 2.9%


The report also notes that during the course of the last year, the number of publicly traded companies increased for the first time since 1988, due to increased IPO activity. There were 112 IPOs on U.S. exchanges in the first half of 2014, which already represents 71 percent of the IPO activity in 2013 and already exceeds the full years of 2009, 2011 and 2012. However, IPO activity still remains well below the elevated IPO filings levels seen during the 1996-2000 period. The report includes a detailed analysis of the susceptibility of IPO companies to securities litigation and concludes that IPOs following the credit crisis have faced an increased litigation exposure compared to both the pre-credit crisis IPOs and the IPOs during the 1996-2000 period.


Of the 78 first half securities lawsuit filings, 9 cases (or twelve percent) involved non-U.S. domiciled companies, compared to 18 percent of all filings during the full-year of 2013. During 2013, the filings against non-U.S. companies declined for the third consecutive year, and at least based on the first half filings, it looks as if the number of filings against foreign companies will decline again in 2014, to roughly pre-2010 levels.


The filings in the first six months of the year seem to reflect a decline in the number of lawsuits against companies with larger market capitalizations. Of the companies listed in the S&P 500 at the beginning of the year, approximately 2.4 percent were hit with a securities class action lawsuit in the year’s first six months. This annualized rate is the lowest since 2000 when Cornerstone Research first bean tacking the rate. The 2000-2013 annual average for class action lawsuit filings against S&P 500 companies is 5.7%.


The first-half filings involve “some of the lowest aggregate market capitalization losses in recent years” according to a statement in the Cornerstone Research press release by Dr. John Gould.  The maximum dollar loss for filings in the first half is the lowest semiannual total in 16 years. In addition, there were no filings in the year’s first six months involving maximum dollar losses over $10 billion, the first time that has happened in a semiannual period since the second half of 1997. Obviously, the absence of the mega cases could have an impact on settlement levels as these 2014 cases work their way toward settlement in future years. The absence of mega settlements and the lower overall valuation levels are likely to translate into lower overall levels of settlement.


Healthcare, biotechnology and pharmaceutical companies together accounted for 21 percent of total filings in the first half of 2014. The pace of filings against biotechnology companies doubled compared with the two previous semiannual periods.


For another midyear review of securities class action litigation, see the August 4, 2014 report by Jonathan Dickey of the Gibson Dunn law firm posted on the Harvard Law School Forum on Corporate Governance and Financial Regulation, here.

A Closer Look at AIG’s $960 Million Credit Crisis-Related Securities Suit Settlement

Posted in Securities Litigation

aigAIG has agreed to pay $960 million to settle the consolidated securities class action lawsuit that had been filed against the company and certain of its directors and officers in the wake of the company’s near collapse at the peak of the credit crisis. The settlement, which AIG disclosed in its August 4, 2014 filing on Form 10-Q (here, see footnote 10 to the financial statements), is one of the largest to arise out of the wave of litigation that followed the global financial crisis. While other credit crisis related lawsuits remain pending, this settlement may represent just about the last of the major credit crisis-related securities lawsuits to be resolved. The settlement is subject to court approval


In the plaintiffs’ lawyers’ August 4, 2014 press release about the settlement (here) the amount of the “settlements” in the case are described as  “totaling $970.5 million.”  According to a statement by one of the plaintiffs’ lawyers quoted in Law 360’s August 4, 2014 article about the settlement (here, subscription required), the additional amount above the $960 million to be paid by AIG represents a payment from a defendant  (not identified in the article) against whom the plaintiffs’ claims had already been dismissed.



As discussed here, the consolidated AIG litigation has a long history going all the way back to May 2008, when the first of the lawsuits were filed. After the company’s near collapse and massive government bailout in September 2008, the company’s share price plummeted and further securities class action litigation ensued.  In their consolidated amended complaint (here), the plaintiffs alleged that the defendants violated the securities laws through various disclosures and omissions related to the company’s securities lending program and its credit default swap portfolio.


Both the credit default swap portfolio and the securities lending program entailed exposures to subprime mortgages. In many instances, the CDSs were placed in connection with securities backed by subprime mortgages. In the securities lending business, the cash received in exchange for the loaned securities was invested in mortgage-backed securities. Additional collateral requirements for these transactions triggered by the subprime mortgage meltdown led to the government bailout. The plaintiffs contend that these exposures were not adequately disclosed. The defendants moved to dismiss.


As discussed here, on September 27, 2010, Southern District of New York Judge Laura Taylor Swain denied the defendants’ motions to dismiss. Judge Swain held that the plaintiffs’ allegations were “adequate to plead material misrepresentations and omissions on the part of AIG,” particularly with respect to the company’s exposure through its CDS portfolio to subprime mortgages.


Judge Swain rejected the defendants’ contention that the allegedly misleading statements were forward-looking statements protected by the bespeaks caution doctrine, observing that “generic risk disclosures are inadequate to shield defendants from liability for failing to disclose known specific risks” and that “statements of opinion and predictions may be actionable if they are worded as guarantees or supported by specific statements of fact.” Judge Swain cited in particular the defendants’ alleged failure to disclose a litany “of hard facts critical to appreciating the magnitude of the risks described.”  


With respect to scienter, Judge Swain, after reciting a list of adverse undisclosed facts and developments allegedly known to defendants, concluded that the plaintiffs had “satisfied their burden of alleging facts giving rise to a strong inference of fraudulent intent,” adding that “no opposing inference is more compelling.”


Finally, Judge Swain also denied the defendants’ motion to dismiss on loss causation grounds. The defendants had argued that AIG’s stock price decline was “attributable to the decline experienced in the stock market generally, and in the financial services sector specifically.” Judge Swain found that “the sharp drop in AIG’s stock price in response to certain corrective disclosures, and the relationship between the risks allegedly concealed and the risks that subsequently materialized, are sufficient to overcome the argument at the pleading stages” – although she added that the defendants ultimately may be able to prove that “some or all” of plaintiffs’ losses are “attributable to forces other than AIG.”


According to AIG’s recent 10-Q, further proceedings followed after Judge Swain’s ruling on the motion to dismiss. The case had been stayed earlier this year at the parties request during the pendency of the Supreme Court’s reconsideration of the fraud on the market theory and class certification issues in the Halliburton case.


The 10-Q also states that on July 15, 2014, the parties accepted a mediator’s proposal to settle the consolidated litigation for a cash payment by AIG of $960 million. The plaintiffs’ lawyers’ press release states that the mediation process had been spread over a period of two years.


According to the company’s SEC filing, the amount of AIG’s settlement contribution “has been accrued.” Neither the SEC filing nor the plaintiffs’ lawyers’ press release makes any mention of a contribution to the settlement by AIG’s insurers or, for that matter, by any other named defendant. There are as yet no filings related to the settlement available on the electronic court docket.


A settlement of $970.5 million obviously is massive, but it is still not large enough to crack the Top Ten list of all-time largest securities class action settlements. As reflected on the Stanford Law School Securities Class Action Lawsuit Clearinghouse list of the Top Ten securities class action settlements (here), a settlement would have to exceed $1.1 billion to crack the Top Ten list.


The plaintiffs’ lawyers’ press release does assert that ““the proposed securities class action settlement is one of the largest ever achieved in the absence of a criminal indictment or an SEC enforcement action.”


The $970.5 million is, in any event, one of the largest settlements to arise out of the wave of securities litigation that followed in the wake of the global financial crisis. By my reckoning, this settlement is exceeded among credit crisis-related securities suit settlements only by the $2.43 billion BofA/Merrill Lynch securities suit settlement (about which refer here). This latest AIG securities suit settlements far exceeds the other credit crisis-related securities suit settlements, including the $730 million Citigroup bondholders’  action settlement (about which refer here), the $627 million Wachovia Preferred Securities and Bondholder action settlement  (refer here) and the $624 Countrywide securities suit settlement (here).


There is of course further credit crisis-related securities litigation that remains pending. However, with the settlement of the consolidated AIG securities litigation, all or almost all of the highest-profile securities suits to arise out of the credit crisis have now been resolved. Or at least it seems unlikely that there will be many further settlements of securities suits from that era that would rival the size of the largest credit crisis-related settlements.



Professional Liability Insurance: Application Misrepresentation Precludes Coverage for Legal Malpractice Claim

Posted in D & O Insurance

caliIn a July 31, 2014 opinion (here), Central District of California Judge Fernando M. Olguin, applying California law, granted a professional liability insurer’s motion for summary judgment in a coverage lawsuit brought by the Blum Collins LLP law firm and Craig M. Collins dba the Collins Law Firm for breach Judge Olguin agreed that because of a material misrepresentation in law firm’s application for insurance, coverage was precluded under the policy.


The plaintiffs contended that the insurer had wrongfully refused to defend and indemnify them in a legal malpractice lawsuit brought by Cynthia Beck, whom Collins had represented in a property dispute.  In her lawsuit, Beck alleged that Collins’s negligence has resulted in a $7 million judgment against her. Judge Olguin ruled that coverage under the policy for the malpractice claim was precluded due to the Blum Collins law firm’s omission from  its insurance application of the existence of a tolling agreement that had been entered with Beck ten months before the application was completed.



In December 2004, Cynthia Beck retained Craig Collins in his capacity as a partner of the Collins Law From to represent her in a property dispute. In September 2007, Beck and Collins terminated their attorney-client relationship and entered into an Agreement (the “September 2007 Agreement”) whereby “Collins agreed to furnish Beck with time to evaluate her assertions [of malpractice] and her potential damages without filing an action during the time period are in place.” In October 24, 2007 judgment was entered against Beck in the property dispute. The judgment was affirmed on appeal in January 2009. In February 2009, Beck’s representative sent Collins an email alleging that the judgment against Beck had been caused by Collins’s malpractice. In March 2009, the plaintiffs gave notice of Beck’s claims to its professional liability insurer.


Collins had completed an application for the professional liability insurance on July 23, 2008 (that is about ten months after the entry into the September 2007 Agreement). Application Question 10.C. asked the following question: “After enquiry, are any persons listed on Supplement 1 aware of any circumstances, allegations, tolling agreements or contentions as to any incident which may result in a claim being made against the Applicant or any of its past or present Owners [or] Partners ….?”  The response given to Question 10.C. was “No.”


On July 27, 2008, the insurer issued a professional liability insurance policy, designating Blum Collins LLP as the “Named Assured.” The policy defined the term “Named Assured” as the partnership as such, as well as “any lawyers who are partners in the Named Assured.”


The application stated in pertinent part that the insurer “reserve[s} the right to deny or rescind coverage on any Policy that is issued as a result of this Application if, in the statements set forth herein and in any attachments made hereto it is found that material information has been omitted, suppressed or misstated.” Policy Exclusion I precludes coverage for any loss arising from any Claim “arising out of any acts, errors, or omissions which took place prior to the effective date of this insurance, if any Assured on the effective date knew or could have reasonably foreseen that such acts, errors, or omissions might be expected to be the basis of a Claim.”


In January 2011, Beck filed a professional negligence lawsuit against Craig Collins and Blum Collins LLP. The law firm sent the complaint to its insurer seeking a defense to the lawsuit and seeking indemnification. The insurer denied coverage for the claim. In June 2012, the plaintiffs filed their coverage lawsuit against the insurer. The parties filed cross-motions for summary judgment.


The July 31 Order

In his July 31, 2014 order, Judge Olguin granted the insurer’s summary judgment motion and denied the plaintiffs’ motion.


In their motion papers, the plaintiffs had disputed whether or not the plaintiffs’ alleged failure to give the insurer notice of the potential lawsuit was such a material omission as to warrant the insurer’s refusal to defend, arguing that the refusal to defend was a breach of contract.


In support of this position, the plaintiffs made three arguments. The plaintiffs’ first argument was based on the fact that application question 10.C. had asked whether “any persons listed in Supplement 1 are aware of any … tolling agreements … as to any incidents which may result in a claim.” The plaintiffs argued that they were not provided with Supplement 1 and “thus it would be impossible for Plaintiffs to know how to have answer the question.”


Judge Olguin characterized these arguments as “utterly meritless.” He noted that “Plaintiffs provide no authority or evidence to support their argument that the absence of Supplement 1 excuses any misstatement or omission in their response to Question 10.C.” He also noted that “Despite the absence of Supplement 1, plaintiffs answered both questions that referenced it. Had the absence of Supplement 1 truly affected plaintiffs understanding of the question, plaintiffs, a law firm with several experienced attorneys, would not have answered the questions.”


Second, the plaintiffs argued that Blum Collins LLP did not represent Beck and had not entered the September 2007 Agreement with her, and thus was not related to any potential claim for “the Assured” to disclose in the application. Judge Olquin rejected this argument as well, noting that Question 10.C. “clearly contemplates the possibility that claims might be brought against owners or partners of the applicant law firm arising from different associations or employment.”


Third, the plaintiffs argued that Question 10.C. only asked for the disclosure of incidents that “may result in a claim” and since no claim had materialized, they were not aware of any incident that may result in a claim. Judge Olguin said that this argument “ignores the plain language of the September 2007 Agreement,” which, he said, “unequivocally gave plaintiffs notice that there were contentions that ‘may result in a claim’ against one of the ‘Owners [or] Partners’ of Blum Collins LLP…” Judge Olguin added that “any expectation or understanding to the contrary stretches the bounds of credulity.”


Judge Olguin also concluded that not only was the answer to Question 10.C. a misrepresentation or omission, but it was material as well, citing affidavit evidence the insurer provided declaring that a truthful answer to the question would have altered whether the insurer would have issued the policy or the terms that would have been offered. The plaintiffs did not really dispute this, but instead they tried to argue that the insurer had waived the right to rescind the policy. In response to this contention, Judge Olguin cited with approval to case law holding that “established law clearly affords the insurer the right to avoid coverage by way of cross-claims and affirmative defenses when the insured files an action on the contract before the insurer can filed its action for rescission.”


Finally, Judge Olguin also found that coverage for the plaintiffs’ claim was precluded by several policy exclusions, including in particular the exclusion precluding coverage based on the insureds’ knowledge on the policy’s effective date of “acts, errors or omissions” that “might be expected to be the basis of a Claim.” In response to the plaintiffs’ efforts to resist this exclusion based on arguments about which of the plaintiffs’ did or didn’t know about Beck’s assertions and the September 2007 Agreement, Judge Olguin noted that the plaintiffs were taking “contradictory positions,” since on the one hand, they assert that there was not an application misrepresentation “because the September 2007 Agreement as not between Blum Collins LLP and Beck, but rather between the Collins Law Firm and Beck,” while on the other hand, “Blum Collins LP argues that [the insurer] had a duty to defend it in Beck’s lawsuit, because, at the time, Collins was a partner at Blum Collins.”



It is pretty clear that Judge Olguin had very little patience for the plaintiffs’ arguments based on the law firms’ and Collins’s multiple shifting identities. It is also clear that the bottom line for Judge Olguin is that if Blum Collins LLP wanted to argue that it had a sufficient connection to this set of circumstances to expect the insurer to provide a defense to Beck’s claim, then Blum Collins had a sufficient connection to the representation of Beck and to the September 2007 Agreement that the Agreement should have been disclosed in response to the application question.


Readers can reach their own conclusions about the responses the law firm provided to the application questions. For me, this case does provide a reminder of the importance of making sure that all relevant information is provided in response to application inquiries. In most circumstances, that will entail a careful survey of all persons proposed to be insured under the insurance that is being sought. Of course, the failure to fully survey everyone was hardly the problem in this case, as the person completing the application was the very person who was in best position to know about the problems with Beck and about the September 2007 Agreement — which may have been the source of the many problems Judge Olguin obviously had with the plaintiffs’ arguments here.


Securities Suits Hit Firms Allegedly Using Stock Promoters to Boost Share Price

Posted in Securities Litigation

galecOn July 30, 2014, when a plaintiff shareholder filed a securities class action lawsuit against the company and certain of its directors and officers, Galectin Therapeutics became the latest company to be hit with a securities suit following press reports that the company had used a stock promotion firm to try to boost its share price. There have already been several other companies against whom securities lawsuit have been filed this year that are similarly alleged to have used stock promotion firms.


According to their July 30, 2014 press release (here), the plaintiff’s lawyers filed the lawsuit against Galectin in the District of Nevada after press reports that the company was using stock promoters “in a misleading brand awareness campaign aimed at boosting its stock price.” The complaint, which can be here, specifically refers to a July 28, 2014 article by Adam Feuerstein on (here) which said that Emerging Growth Corp., through its parent company TDM Financial, a penny-stock promotions firm, was the investor relations and marketing company Galectin was paying for misleading promotional campaigns to entice investors to buy its stock.


Among other things, the stock promotion firm is alleged to have distributed press  release saying that Galectin was “nipping at [the] heels” of its competitors and “actually may be closer than what first appears with a Phase 1 trial because of the potential to treat fatty liver disease even once it has progressed.”  According to the complaint, Galectin’s share price fell 81% of news of the company’s use of the stock promotion firm.


The lawsuit against Galectin is merely the latest in series of suits that have been filed so far this year against companies alleged to have used stock promotion firms to try to boost their share price. Several of the firms that have been sued are alleged to have used a stock promotion firm known as The DreamTeam Group. 


The first of these DreamTeam related lawsuits was filed on March 5, 2014 against Galena Biopharma, as discussed here. The complaint (here) alleges that on February 12, 2014, an article on  (here) claimed Galena was engaging in a misleading brand awareness campaign aimed at boosting its stock price. Additionally, the article stated that Galena paid investor relations firm The DreamTeam Group to publish articles under aliases promoting the Company’s stock without disclosing who paid for them. On this news, Galena’s stock price dropped 16%. Then, on February 14, 2014, Galena issued a letter to its shareholders acknowledging that the Company had engaged DreamTeam. On this news, Galena’s stock price dropped another 14%.


The Galena lawsuit was followed on March 14, 2014 by a lawsuit filed against CytRx Corporation in the Central District of California, as discussed here. The complaint alleges that the company employed the services of stock promotion firms DTG and MissionIR to create and distribute articles about the company which were published without any disclosure that they had been created by a promotional firm employed by the company. (DTG is The DreamTeam Group). The company’s share price declined after online reports about the company’s use of the promotional firm.


On March 22, 2014, shareholders filed yet another lawsuit against a company that allegedly used The DreamTeam Group’s services. As discussed here, the shareholders filed their lawsuit against InterCloud Systems and certain of its directors and officers in the District of New Jersey alleging that the company misrepresented or failed to disclose that it had hired  The DreamTeam Group to tout InterCloud stock without disclosing that it was paid by the Company to promote the stock. The complaint alleges that the promoter had posted misleading articles on behalf of the Company without disclosing its paid marketing relationship


In addition, on May 22, 2014, plaintiffs filed a lawsuit against Provectus Biopharmaceuticals and certain of its directors and officers in the Middle District of Tennessee, as discussed here. The complaint alleges that the defendants had misled investors about the prospects for its developmental stage skin cancer treatment. The complaint also quotes an article from Seeking Alpha in which the author alleged that the company had used a stock promotion firm called Small-Cap Street LLC, noting that the SEC had recently halted trading in several of the stocks that the firm had promoted.


Altogether That makes at least five securities class action lawsuit that have been filed this year against companies that allegedly used the services of various stock promotion firms, including three lawsuits against companies that allegedly used the services of The DreamTeam Group. Whatever the thought process is for companies using these kinds of firms to promote their companies, it is clear that news about the companies’ use of the firms can have a negative impact on the company’s stock (which obviously is counter to the idea of using the promotional firms in the first place). As the lawsuits above underscore, the alleged use of these firms can also result in securities class action litigation.


It is interesting that four of the five companies involved in these lawsuits are developmental stage biotech firms. The shares of these types of companies often languish as the companies work their way through the stages of the clinical trial process. On the other hand, the share prices can be very sensitive to key developments, either positive or negative. These conditions create a set of circumstances where it is may seem important to the companies to get their stories out, so that investors are aware of their companies’ bright prospects. There is of course nothing wrong with getting the story out, as long as the story is accurate. And as these cases show, as long as the story gets out in a forthright way, rather than allegedly through sponsored articles with undisclosed connections to paid stock promoters.


Back in the day when I was on the underwriting side, I would have duly noted the problems associated with companies’ use of these kinds of stock promotion firms, and I would have made it my business to find out if an applicant was using one of these firms and if so for what kinds of services. Just a thought.


Dark Pool Clients File Lawsuit Against Barclays: Last week when I wrote about the securities class action lawsuit that Barclays ADS holders had filed against the company based on the company’s alleged misrepresentations about its dark pool trading venue, I noted that I hadn’t seen any lawsuits filed by clients that had traded shares in the dark pool venue. However, it now looks as if some clients have now filed a lawsuit against Barclays.


As discussed in an August 1, 2014 Bloomberg article (here), late last week a client of Barclays sued the company alleging that the bank gave high-frequency traders unfair advantages in its operation of the dark pool. The identity of predatory traders and the volume of their trading in the dark pool allegedly was hidden from clients. The plaintiff filed the lawsuit on behalf of Barclays dark pool clients who used the pool starting in 2011. The complaint alleges concealment, unfair competition, and false advertising claims against Barclays for making false statements to and concealing material information from clients about its dark pool. A copy of the complaint can be found here.


The Latest Scandal-Driven Litigation Against Financial Services Companies: Let’s see … after the financial crisis, we had the Libor scandal, the foreign exchange trading scandal, the high frequency trading scandal and the dark pool trading scandal. Each one of these has led to its own set of follow-on civil lawsuits. As of all of there were not enough, we now have the silver futures manipulation scandal. And of course a follow-on lawsuit.


Earlier this year, there were several articles in the press raising questions about the way that gold and silver futures trading are set (refer for example here). The London Silver fix, which has been in place for 95 years and was participated in by a small number of banks, is now due for an overhaul as a result of the questions. In addition, on July 31, 2014, a plaintiff filed a class action lawsuit against the banks in the Eastern District of New York. The complaint, which can be found here, is filed against Deutsche Bank, HSBC, and the Bank of Nova Scotia, the members of the London Silver Market Fixing Limited. The complaint, which purports to be filed on behalf of everyone that transacted in silver futures since January 1, 2007, seeks damages for alleged violations of the Sherman Antitrust Act and the Commodity Exchange Act.


Another day, another scandal, another scandal=driven follow-on lawsuit against a group of financial institutions.



SEC Files Enforcement Action Over Internal Controls Reporting: A Sign of Things to Come?

Posted in Securities Litigation

seclogoOne of the noteworthy features of the Sarbanes-Oxley Act was the legislation’s creation of the requirement for reporting companies to provide a certification from management regarding the company’s internal controls. This requirement has not been the focus of a great deal of attention since the legislation was enacted in 2002. However if the administrative actions filed against two corporate officials last week are any indication, these requirements could be the source of a significant attention in the months ahead.


By way of background, Section 404 of Sarbanes-Oxley Act requires company management to file n internal control report with the company’s annual report. The report must describe management’s responsibilities to establish and maintain a system of internal controls over the company’s financial reporting and management’s conclusion regarding the effectiveness of the internal controls at year-end. The report must also confirm that the company’s has attested to and reported on the company’s internal controls. The company’s CEO and CFO must sign certifications confirming they have disclosed all significant deficiencies to the outside auditors, reviewed the annual report, and attest to its accuracy.


The internal control reporting requirement was one of the more controversial parts of the legislation and it has proven difficult for the management of many companies to implement. But by and large it has not been the focus of regulatory enforcement action. That may be about to change.


As reflected in its press release about the action (here), on July 30, 2014 the SEC instituted administrative proceedings against the CEO and former CFO of QSGI for misrepresenting to external auditors and the investing public the state of its internal controls over financial reporting. The administrative cease desist orders against the two individuals can be found here and here.


The SEC alleges that in the company’s 2008 annual report, the CEO attested that they had assessed the company’s internal controls. However, the SEC alleges that Sherman did not actually participate in assessing the controls. The SEC also alleges that the CEO and CFO certified that they had disclosed all significant deficiencies to outside auditors, but that they failed to tell the auditors about inadequate controls over inventory in the company’s Minnesota operations.


The SEC alleges that the CEO and CFO also withheld from auditors and investors that the CEO was directing and the CFO was participating in a series of maneuvers to accelerate the recognition of inventory and accounts receivables in QSGI’s books and records by up to a week at a time.  The allegedly improper accounting maneuvers, which rendered QSGI’s books and records inaccurate, allegedly were performed in order to maximize the amount of money that QSGI could borrow from its chief creditor. The company ultimately filed for bankruptcy in 2009. It later reorganized and emerged from bankruptcy in 2011.


The CFO has agreed to settle the case without admitting or denying the charges. (In an administrative proceeding, no court approval is required, so the recent judicial aversion to SEC settlements in which the defendant neither admits nor denies the charges is not a factor here.) The CFO agreed to pay a $23,000 penalty and also agreed to a five year ban from practicing as an accountant before the SEC or serving as the officer or director of a public company.  The CEO reportedly intends to fight the charges.


In a July 30, 2014 article about the administrative cases (here), Reuters reports that earlier this year the SEC’s enforcement director had said that the agency’s investigators “were planning to pursue some internal control-related cases,” noting that it is an area that “has been less scrutinized in the past.” The SEC’s enforcement action on this issue is also consistent with SEC Chair Mary Jo White’s vow to focus more effort and attention on bringing accounting-related enforcement actions, an area that has seen less activity in recent years.


The SEC’s press release quotes the deputy head of the enforcement division as saying that ““Corporate executives have an obligation to take the Sarbanes-Oxley disclosure and certification requirements very seriously.” The CEO and CFO, the individual said, “flouted these regulatory requirements and misled investors and external auditors in the process.


At a minimum, this enforcement actions raise the possibility that the Sarbanes=Oxley internal control reporting and certification requirements may be the source of increased scrutiny in the months ahead. If this case is just the first of many enforcement actions focusing on these requirements, senior company officials could be facing increased regulatory scrutiny and possible enforcement liability.


An increased regulatory focus on these issues could prove helpful for the plaintiffs bar as well. The SEC allegations not just that the reporting requirements were violated but that the shortcomings led to or facilitated financial reporting violations could help plaintiffs to craft allegations to serve as the basis of damages claims. The kinds of allegation raised here suggest the possibility that these kinds of enforcement actions could lead to follow-on civil litigation.


These kind of internal control reporting deficiencies have not been a major focus of attention for the plaintiffs’ bar, but to the extent the SEC does become more active on this issue, the follow-on civil lawsuits could trail along behind  as well

Whistleblower Bounties: A Good Idea? UK Regulators Say No

Posted in Securities Litigation

boeWhen Congress passed the Dodd-Frank Act four years ago, one of the legislation’s signature features was the creation of potentially massive bounties for whistleblowers that reported financial fraud to the SEC. The possibility of recovering a bounty, which could range from ten to thirty percent of recoveries over $1 million, seems to have encouraged whistleblowers to come forward.  The SEC reported at the end of its last fiscal year that since the program’s inception in 2011, the agency had received over 6,500 whistleblower reports. Mary Jo White, the S.E.C. chairwoman, said last year that the program “has rapidly become a tremendously effective force-multiplier, generating high quality tips and, in some cases, virtual blueprints laying out an entire enterprise, directing us to the heart of an alleged fraud.”


So the Dodd-Frank whistleblower program is the kind of initiative that securities regulators in other countries would want to copy, right? Apparently not, at least if the recent analysis of UK regulators is any indication.


A July 2014 joint report of the UK Financial Conduct Authority (FCA) and the Bank of England Prudential Regulation Authority entitled “Financial Incentives for Whistleblowers” reports the agencies’ conclusion that “providing financial incentives to whistleblowers will not encourage whistleblowing or significantly increase integrity and transparency in financial markets.”


The UK regulatory agencies had undertaken a review of the possibility of providing financial incentives for whistleblowers at the request of the Parliamentary Committee on Banking Standards. Among other things, the agencies undertook a joint visit with several different U.S. regulatory agencies including the SEC and the Commodities Futures Trading Commission (CFTC), as well as the U.S. Department of Justice. The agencies also seconded staff to the U.S. regulators to observe the U.S. program in action.


Based on this review of the U.S. program, the UK regulators reached a number of interesting conclusions about providing financial incentives for whistleblowers. Among other things, the UK regulators concluded that because of the Dodd-Frank whistleblower bounty’s requirement that the whistleblower report must result in a successful enforcement action in order for the whistleblower to be eligible of the bounty, only a very small number of whistleblowers actually receive payments. The report notes in that regard that only 1% of whistleblower cases lead to financial penalties, suggesting that even the possibility of a bounty payment will arise only for a very small number of whistleblowers. The report concludes that the bounty schemes “reward a few individuals very significantly, but provide little or no protection to whistleblowers whose information does not lead to an enforcement outcome.”


Perhaps even more concerning, the UK agencies also reported their conclusion that none of the U.S. agencies “has seen a significant increase in either the number or the quality of reports from whistleblowers.”


The report also notes the UK agencies concern that the introduction of financial incentives in the U.S. has resulted in the creation of a “complex, and therefore costly, governance structure,” as well as the “imposition of significant legal fees for both whistleblowers and firms” (although the report does also note that many whistleblowers are represented by counsel on a contingent fee). Finally, the report also noted its concern that the introduction of financial incentives could “undermine the introduction and maintenance by firms of effective internal whistleblowing mechanisms,” which both the UK agencies and the Parliamentary committee want to foster.


The report also sets out what it describes as the “moral and other hazards” they perceive to be associated with providing financial incentives for whistleblowers: first,  financial incentives could result in “malicious reporting” from “opportunistic and uninformed parties passing on speculative rumors” which could result in “innocent parties” being “unfairly damaged as a result”; second, some market participants might seek to ‘entrap’ others in order to be able to blow the whistle and benefit financially; third, if the whistleblower’s report resulted in a criminal prosecution, the reliability of the whistleblower’s testimony could be challenged because the witness stands to benefit financially.


Finally, the report noted the agencies’ concerns about the public perception of large whistleblower payments. “Handing over large sums,” the report said, “would be a substantial shift in UK policy norms, which are very different from those of the US.” The report added that “paying significant sums to high-income individuals for fulfilling a public duty could reinforce perceptions that the financial sector is at odds with the rest of society.”


The report does acknowledge the important role whistleblowers can play in helping to bring financial fraud to light and recognizes the need for the agencies to do more to facilitate whistleblowers’ reports. The report lays out a number of mechanisms the agencies propose to institute to facilitate whistleblower reporting and also states that the agencies plan “to press ahead with the regulatory changes necessary to require firms to have effective whistleblowing procedures.”



I think the agencies’ report is correct to note the cultural differences between the UK and the U.S. when it comes to providing large financial incentives. Even before the Dodd-Frank Act created the whistleblower bounty program, there were several longstanding U.S. programs that provided for payment to those who reported fraud: for example, the False Claims Act has for many years provided for the possibility of those reporting the existence of fraud against the government to participate financially in the government’s recovery, and the IRS has for many years maintained a program providing for payment to those reporting tax fraud. These programs’ histories make the Dodd-Frank program seem much more acceptable in the U.S. than a similar program might be perceived to be in the UK.


What is more concerning is the report’s conclusion that among other reasons to reject the adoption of financial incentives for whistleblowers is that the incentives don’t work – that is, the existence of the bounty program has not resulted in “a significant increase in either the number or the quality of reports from whistleblowers.” This conclusion seems at odds with the many statements of representatives from the SEC about its whistleblower program. It is a serious enough assertion that it seems to me that the SEC really ought to respond.


It is even more concerning that the UK agencies concluded that the financial incentives for whistleblowers do not “significantly increase integrity and transparency in financial markets.” If existence of the financial incentives doesn’t materially improve market integrity and transparency, you really do have to question the point of having the whistleblower bounty program.


That said, I do think it is important to note that the UK agencies started their review of the question of providing whistleblowers with financial incentives with a bias against making such payments. If you read the report as a whole, it is pretty clear that from the very beginning the authors thought the idea of providing bounty payments is a bad idea. A cynical interpretation of this report is that it is the result of a process that was designed to confirm the authors’ starting assumptions and preexisting bias against providing financial payments.


On the other hand, it is a fair question to ask whether or not the provision of jackpot level bounty payments for a very small number of whistleblowers really is a good idea. Many other observers have asked before whether the existence of the whistleblower program (with the potential rewards going to those who report first) undermines the existence of companies’ internal reporting mechanisms and frustrates companies’ ability to address problems internally.


All in all, I think the UK report raises some serious questions about the whistleblower bounty program that the SEC and other agencies should not disregard. The US agencies have no choice about implementing and enforcing the Dodd Frank Act’s requirements but just the same it is fair to ask those agencies to respond to the concerns that the UK agencies have raised.


Time for Nominations to the ABA Journal’s Annual Blawg 100: It is once again time for nominations to the ABA Journal’s annual list of the top 100 law blogs. Everyone should take a moment to nominate their favorite law blogs for inclusion in the list. I would be humbled and grateful if any reader would be willing to nominate my blog. Nominations can be made here. Don’t delay, nominations are due by 5:00 pm EDT on Friday August 8, 2014.

Second Circuit Vacates Dismissal of JinkoSolar Securities Suit

Posted in Securities Litigation

jinkoIn an interesting July 31, 2014 opinion (here), the Second Circuit vacated the dismissal of the securities class action lawsuit that had been filed against JinkoSolar Holdings Co. Ltd, and certain of its directors and officers, as well as against its offering underwriters. This ruling will be of interest to many readers because it involves a U.S.-listed Chinese company, but it is also of interest because the allegations involve alleged misrepresentations regarding the company’s environmental compliance.



JinkoSolar is a manufacturer of solar technology products with operations based in China. In May 2010, the company conducted an Initial Public Offering of American Depositary Shares on the New York Stock Exchange. In November 2010, the company completed a secondary offering. The company raised a total of $84.19 million in the two offerings.


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


In October 2011, holders of the company’s ADSs filed a securities class action lawsuit in the Southern District of New York against the company, eight directors and officers of the company; and the company’s offering underwriters. The plaintiffs’ complaint asserted claims under both the ’33 Act and the ’34 Act. In support of their allegations, the plaintiffs relied on statements in the company’s offering prospectuses in which the company explained its environmental compliance efforts and the consequences to the company if it were found to be in violation of the applicable environmental requirements. The defendants moved to dismiss.


As discussed here, in a January 22, 2013 ruling, Southern District of New York Judge J. Paul Oetken granted the defendants’ motion to dismiss. Judge Oetken held that the defendants’ statements regarding the company’s storage of hazardous chemicals, about the Chinese and local environmental regulation and about the costs of environmental compliance were not misleading. However, Judge Oetken found the paragraph in the company’s prospectuses about its pollution abatement equipment and its 24-hour environmental monitoring team “a more complicated matter” and a “close call.” Because he concluded that the investors would not read these statements as guaranteeing compliance, Judge Oetken concluded that the statements were not materially misleading. The plaintiffs appealed.


The July 31, 2014 Opinion

In a July 31, 2014 opinion written by Judge Ralph K. Winter, Jr. for a unanimous three-judge panel, the Second Circuit vacated the dismissal based on its finding that JinkoSolar’s “failure to disclose ongoing serious pollution problems rendered misleading statements describing measures taken to comply with Chinese environmental regulations.”


The appellate court said that though the statements in JinkoSolar’s prospectuses that the company is subject to a wide variety of environmental compliance and about the high cost of compliance are not misstatements, “they are relevant to materiality of the prospectuses’ description of JinkoSolar’s potential to cause serious pollution problems and the steps it was taking to avoid these problems.” 


Regarding the description in the prospectuses of the steps the company said it was taking, the appellate court said, “we believe the complaint sufficiently alleges that the failure to disclose that the prophylactic steps were then failing to prevent serious ongoing pollution problems rendered that description misleading.”


Specifically, the court said that the prospectuses’ description of pollution-preventing equipment and 24-hour monitoring teams “gave comfort to investors that reasonably effective steps were being taken to comply with the applicable environmental regulations.” However, the court said, “investors would be misled” by these statements “if in fact the equipment and 24-hour team were then failing to prevent substantial violations of the Chinese regulations.”


In that regard, the appellate court noted that in June 2010, JinkoSolar had submitted a report to Chinese environmental authorities about “existing problems.” The report describes problems of a nature that is “sufficient, if proven, to allow a trier of fact, absent contrary evidence, to draw the inference that the problems ‘existing’ as of June 8, 2010, were both present and substantial at the time of the May13, 2010 offering.”


The Court said that “at the time the statements regarding pollution presentation and compliance measures were made, a reasonable investor could conclude that a substantial non-compliance would constitute a substantial threat to earnings, if not to the entire venture. Indeed, the prospectus said as much.”  The court concluded by saying that “a trier of fact could find that the existence of ongoing and substantial pollution problems – here the omitted facts – was of substantial importance to investors.”



This case is one of the many securities class action lawsuits that were filed against U.S.-listed Chinese companies in 2011. However, unlike many of the other Chinese companies that were hit with securities suits then, which had obtained their U.S. listings through reverse merger transactions, this company obtained its U.S. listing through a full-blown IPO, meaning that it had been required to file a detailed prospectus as part of its offering process.


The company’s prospectus contained detailed disclosures regarding the company’s environmental compliance challenges. Indeed, in his opinion, Judge Oetkin had referred to what he called the “disquieting frankness of the company’s disclosures regarding its environmental compliance risks.” He also noted “how cautious” the company was in its environmental compliance risk factors in its prospectuses.


Notwithstanding this acknowledged caution and frankness, the appellate court still concluded that the company’s statements about its environmental compliance efforts were materially misleading. It is interesting to me that in reaching this conclusion, the court was willing to make the logical jump that statements about “existing problems” made in a June 8, 2010 report to Chinese regulators could be read by a finder of fact to infer that the problems existed at the time of May 13, 2010 offering.


I can easily imagine a different court concluding that the in order to support a jump like this, the plaintiffs are required to plead facts to show that the problems in the June report were in fact existing at the time of the May offering. Instead, the Second Circuit found the allegations sufficient for a trier of fact to conclude that the problems existed at the time of the offering based only on an “inference.”  


For many readers, the most interesting thing about this case will be that it involves a U.S.-listed Chinese company defendant.  However, for me, the most interesting thing about this case is that it involves alleged misrepresentations with respect to environmental compliance. As I have previously noted on this blog (refer, for example, here), these kinds of cases, involving alleged misrepresentation of environmental issues, do arise periodically.


The possibility of this kind of claim is often a key concern at the time of D&O insurance policy placement, as the question often arises whether the standard policy’s pollution exclusion will preclude coverage for a securities claim based on environmentally-related disclosures. The typical D&O liability insurance policy will contain an exclusion for loss arising from claims for pollution and environmental liabilities. However, many of these exclusions also contain a provision carving back coverage for shareholder claims. This case shows the importance of this kind of coverage carve back. The carve back ensures that directors and officers hit with this kind of shareholder suit filed in wake of an environmental incident are able to rely on their  D&O insurance to defend themselves against the shareholder suit.


In recent years, a number of D&O insurance carriers have introduced policy forms that eliminate the pollution exclusion altogether but that also incorporate into the policy’s definition of “Loss” a provision stating that Loss will not include environmental remediation or cleanup costs. Unless the insured company’s primary D&O insurance policy omits the environmental exclusion in this way, it will be indispensable for the standard environmental liability exclusion be revised in order to preserve coverage for securities claims and derivative claims based on alleged misrepresentations or misconduct relating to environmental issues. These considerations are likely to become increasingly important as environmental disclosure issues become of greater regulatory concern (about which refer here).


With all of that said about the environmental disclosure issues, there is a sense in which it is particularly noteworthy that this case involves a Chinese company, in that this is the relatively unusual securities suit involving a U.S.-listed Chinese company where the plaintiffs have managed to make much headway. Although some of the U.S. securities suits have managed to survive motions to dismiss, many others have not. Even the cases that have survived motions to dismiss have proved challenging for plaintiffs as they have faced numerous procedural hurdles (refer for example here). In addition, in other cases involving U.S.-listed Chinese companies that have reached the settlement stage, the settlement amounts have proved to be modest.


(On the other hand, as noted here, E&Y did recently agree to settle a Canadian securities case relating to Sino-Forest, and a Hong Kong arbitration panel did just make a more than $70 million award based on its determination that China MediaExpress Holdings is a “fraudulent enterprise.” Notably, and arguably ironically, neither of these big recoveries involved one the many U.S.-based securities suits filed against Chinese companies.)


One final note. This case is yet another example of a phenomenon I have frequently noted on this blog, which is how often securities class action litigation follows in the wake of regulatory or investigative activity. Indeed, this lawsuit reflects a particular aspect of this phenomenon, which is the increasing incidence of U.S.-based securities litigation arising in the wake of regulatory action outside the U.S. As I noted in a prior post, and as both U.S. and non-U.S. regulators focus increased regulatory scrutiny on operations outside the U.S., the likelihood is that regulatory investigative and enforcement actions will continue to increase. As these regulatory and investigative actions increase, the likelihood is that the follow-on civil litigation will continue to increase as well.


Very special thanks to Stanley Bernstein of the Bernstein Liebhard law firm for sending me a copy of the Second Circuit’s opinion. The Bernstein LIebhard firm represents the plaintiffs in the JinkoSolar securities class action lawsuit.