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

In an interesting twist on a long –running credit-crisis related securities suit, Wells Fargo has agreed to pay $75 million to settle the Wachovia equity investor securities class action lawsuit, even though their suit had been dismissed at the district court level and was on appeal at the time of the settlement. The parties’ November 21, 2011 notification of the settlement to Southern District of New York Judge Richard Sullivan can be found here. Victor Li’s December 3, 2011 Am Law Litigation Daily article about the settlement can be found here.

The settlement relates to litigation brought by former equity shareholders and bondholders of Wachovia Corporation.  The equity securities holders’ and bondholders’ actions arise from  financial disintegration Wachovia experienced between its 2006 purchase of Golden West Financial Corporation and its 2008 merger with Wells Fargo & Company. The allegations are based on the difficulties Wachovia experienced as a result of the Golden West “Pick-A-Pay” mortgage portfolio. Further background regarding the equity securities litigation can be found here and background regarding the bondholders’ litigation can be found here.

As discussed here, on March 31, 2011, Southern District of New York Judge Richard Sullivan granted the defendants’ motions to dismiss the equity securities litigation, but he denied the motion to dismiss the bondholders’ action, other than with respect to certain bond offerings in which the plaintiffs had not actually purchased any securities. A copy of Judge Sullivan’s opinion can be found (here),

Judge Sullivan granted the defendants’ motions to dismiss the equity securities plaintiffs’ ’34 Act claims, finding that the plaintiffs had not sufficiently alleged scienter. Judge Sullivan concluded that the “more compelling inference” is that “Defendants simply did not anticipate the full extent of the mortgage crisis and the resulting implications for the Pick-A-Pay loan portfolio. Although a colossal blunder with grave consequences for many, such a failure is simply not enough to support a claim for securities fraud.” He added that “bad judgment and poor management are not fraud, even when they lead to the demise of a once venerable financial institution.”

Judge Sullivan also granted the defendants’ motion to dismiss the equity securities plaintiffs’ ’33 Act claims, finding that their “scattershot pleadings” failed to “afford proper notice, much less provide facially plausible factual allegations.” He added that he could not conclude “that the relevant offering documents contained material omissions in violation of affirmative disclosure obligations.”

Thereafter, the bondholders, whose case survived Judge Sullivan’s dismissal motion rulings, went on to settle their lawsuit for a total of $627 million, which, as discussed here, is the largest settlement to date as part of the subprime and credit crisis-related litigation wave. The settlement amount of $627 million represented two different settlement funds: $590 million on behalf of the Wachovia defendants, including 25 former directors and officers of Wachovia, as well as 72 different financial firms that underwrote bond offerings for Wachovia between 2006 and 2008; and $37 million on behalf of Wachovia’s auditor, KPMG.

Meanwhile, the Wachovia equity investors, whose action Judge Sullivan had dismissed, had appealed the dismissal to the Second Circuit. In an apparent move to avoid having the case revived on appeal, Wells Fargo has now agreed to pay $75 million to settle the equity investors’ suit. The case must be remanded from the Second Circuit in order for the settlement to be presented to the district court for approval.

As I noted at the time of the $627 million settlement with the Wachovia bondholders, Wachovia’s purchase of Golden West has to be one of the leading candidates for the title of worst deal leading into or as part of the credit crisis-related financial transactions. There is a lot of competition in the worst transaction category, including Bank of America’s purchase of Countrywide. But there is no doubt that the Golden West deal is one of the real stinkers.

From the perspective of Wells Fargo, the litigation consequences for the bank from the mortgage meltdown are becoming rather impressive. When you consider this $75 million settlement and he Wachovia defendants’ $590 contribution to the bondholders’ settlement, which came on the heels of the $125 million Wells Fargo mortgage backed securities settlement (about which refer here), it looks like the financial crisis litigation consequences for Wells Fargo have been massive . The bank’s current aggregate settlement costs of $790 million may provide some explanation why it preferred to settle this case than to run the risk that the securityholders might succeed in having the dismissal of their case overturned on appeal.

The $75 million Wachovia equity investors’ settlement comes on the heels of the public disclosure of the $315 million Merrill Lynch mortgage-backed securities settlement, which Alison Frankel first reported in a November 18, 2011 article on Thomson Reuters News & Insight (here). Though the fact and amount of the settlement have been public for a couple of weeks, the parties have only just now filed their actual stipulation of settlement, dated December 5, 2011 (here). The $315 Merrill settlement dwarfs Wells Fargo’s earlier $125 million MBS settlement, which has stood as the largest MBS-related settlement so far.

In the Merrill Lynch MBS lawsuit, the plaintiffs alleged that the defendants (Merrill Lynch and related Merrill entities; certain other underwriter defendants and certain Merrill officers) had mislead investors who purchased the MBS securities, through statements in the securities’ offering documents that misrepresented the quality of the loans and the adequacy of the collateral within the loan pools.

Like Wells Fargo, Merrill and its acquirer Bank of America have also now paid out or at least agreed to pay out an impressive aggregate amount in subprime and credit crisis-related securities lawsuit settlements. As discussed here, Merrill had previously settled the subprime-related securities lawsuit brought by its shareholders for $475 mm, and had also settled the related ERISA lawsuit for $75 million.   Merrill separately settled the subprime-related lawsuit brought by its bondholders for $150 million (refer here). With the addition of the recent $315 MBS settlement, Merrill’s aggregate settlements are now up to $1.015 bb.

And to line up everything in its proper category, the $624 million Countrywide settlement, in addition to the $1.015 bb of Merrill settlements, all arguably belong on BofA’s ledger. The Merrill and Countrywide settlements altogether total about $1.639 billion, or fully 40 percent of all of the subprime and credit crisis related lawsuit settlement amounts so far (which total about $3.913 billion). These Merrill and Countrywide settlements plus the Wells Fargo settlements total $2.48 billion, which reresents almost 64% of the aggregate amount of the subprime and credit crisis related lawsuits settlements to date

What the Merrill, Countrywide and Wachovia/Wells Fargo settlements have in common, in addition to representing the largest of the subprime and credit crisis related lawsuit settlements, is that in each case the corporate defendant is now part of a financially strong successor in interest. This circumstance contrasts significantly with other subprime and credit crisis cases – like those involving Lehman Brothers and Washington Mutual, for instance – where the corporate defendants are defunct and there is no solvent successor in interest. Securities suits involving these defunct companies have settled for much smaller amounts that those involving solvent companies.

I have in any event added the Wachovia equity investors’ settlement and the Merrill MBS settlement to my running tally of subprime and credit crisis-related securities class action lawsuit case resolutions, which can be accessed here.

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The $277.5 million jury verdict in the Apollo Group securities lawsuit caused a great sensation at the time it was returned in January 2008 (as discussed here). The verdict heartened plaintiffs’ attorneys and it served as a counterweight to the defense verdict in the virtually contemporaneous JDSU Uniphase securities lawsuit trial (which is discussed here).

But on August 4, 2008, Judge James Teilborg of the United States District Court for the District of Arizona entered an order (here) granting the defendants’ motion for judgment as a matter of law, based on his finding that the trial testimony did not support the jury’s finding of loss causation. Judge Teilborg’s order vacated the judgment and entered judgment in defendants’ favor.

The Apollo Group securities lawsuit involved alleged misrepresentations and omissions relating to a February 6, 2004 “Program Review” in which a Department of Education representative discussed the company’ potential violation of DoE rules. News of the allegations in the Program Review first became public on September 14, 2004, but the company’s share price did not react. Apollo’s share price fell significantly on September 21, 2004, when a securities analyst issued a report (the “Flynn reports”) expressing concern about the company’s possible exposure to future regulatory issues.

Judge Teilborg had held in connection with the parties’ pre-trial cross-motions for summary judgment that the issue whether the Flynn reports constituted “corrective disclosure” sufficient to support a finding of loss causation was a question for the jury

In its post-trial motion, Apollo argued that the evidence at trial was insufficient to support a finding that the Flynn reports represented “corrective disclosure,” because they did not contain any new fraud-revealing information. Judge Teilborg found that “the evidence at trial undercut all bases on which [the plaintiff] claimed the Flynn reports were corrective.”

Accordingly, the court concluded that although the plaintiff “demonstrated that Apollo misled the markets in various ways concerning the DoE program review,” the plaintiff “failed to prove that Apollo’s actions caused investors to suffer harm.” The court therefore concluded that “Apollo is entitled to judgment as a matter of law.”

Judge Teilborg then went on to consider conditionally Apollo’s motion for a new trial, as a precaution against the possibility that the appellate court could reverse the grant of judgment as a matter of law. He found that “none of the reasons cited by Apollo warrant a new trial in the case” and so the court conditionally denied Apollo’s motion for a new trial.

The possibility of significant post-trial developments in the Apollo case is something I expressly suggested at the time of the jury verdict, and, indeed the case still has a great deal farther to run procedurally, with additional opportunities for even further developments in the case.

In the interim, the post-trial disposition in the Apollo Group case alters the mix of securities lawsuit trial outcomes. According to data from the Securities Litigation Watch (here), six post-PSLRA cases (including Apollo Group) have gone to verdict, with three of the verdicts in favor of the plaintiffs and three in favor of defendants, although on November 26, 2007, the Ninth Circuit reversed and remanded the defense verdicts in the Thane International case (about which refer here). With the vacatur of the plaintiff’s verdict in the Apollo Group case, the securities lawsuit jury verdict scoreboard now stands evenly distributed, three each for plaintiffs and defendants – subject to further procedural developments.

As for the significance of this development, it may be hard to say definitively until all proceedings are complete, but the verdict’s vacatur can’t be encouraging for plaintiffs’ lawyers. This development together with the defense verdict in the JDS Uniphase trial would seem to argue pretty compellingly in favor of avoiding jury trials and seeking pretrial resolution

One practical significance of the vacatur of the Apollo jury verdict is that it removes any suggestion that the jury’s verdict represents a finding of fraud sufficient to trigger the fraud exclusion in the company’s D&O insurance policy. This undoubtedly represents significant relief to the company and the other defendants, in addition to the sense of vindication the company likely feels following the court's ruling.

The company’s August 5, 2008 press release about the Judge Teilborg’s ruling can be found here. A detailed summary of the Apollo Group securities case, including links to pleadings, can be found here.

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Add E*Trade and SunTrust Bank to the growing list of companies that have been sued in purported class action lawsuits on behalf of auction rate securities investors against companies that sold them the instruments. The plaintiffs’ attorney’s April 2, 2008 press release regarding the E*Trade auction rate securities lawsuit can be found here, and the complaint can be found here. The plaintiffs’ attorneys’ April 2, 2008 press release regarding the SunTrust lawsuit can be found here and the SunTrust complaint can be found here. With the addition of these two new suits, there have now been a total of ten companies sued in these auction rate securities class action lawsuits.

The auction rate lawsuits are interesting. Clearly the plaintiffs’ lawyers think they are worth pursing. And if the intensity of the auction rate securities investors’ anger is an accurate gauge, then the plaintiffs’ lawyers filing of these lawsuits ultimately could be justified. As a result of prior posts on this blog (here and here) about auction rate securities, I have received numerous emails and inquiries from upset auction rate securities investors. Notwithstanding the investor anger, it is probably worth noting that so far as I can tell the leading plaintiffs’ securities firms are not (at least not yet) active in this space. Most of the auction rate securities class action lawsuits thus far have been filed by two plaintiffs’ firms (refer here and here).

The allegations in these auction rate securities class action lawsuits are largely identical. Essentially the plaintiffs contend that the defendants failed to disclose material facts about the instruments. In particular, the defendants are alleged to have failed to disclose that the auction rate securities were not cash alternatives, but rather that there were only liquid at the time of auction. More to the point, the complaints allege that the defendants failed to disclose that the auction rate securities would become illiquid as soon as the broker-dealers stopped maintaining the auction market.

In each of these class action lawsuits, the complaint names as defendants a specific financial institution and its broker-dealer affiliate. No individual defendants are named. While each complaint contains substantially identical generalized allegations of misrepresentations or omissions, the complaints contain virtually no allegations about specific statements the particular defendants companies are alleged to have made.

And even though the complaints purport to allege breaches of Section 10(b) of the ’34 Act, the complaints’ only basis for alleging scienter are generalized allegations of knowing falsity; there are no allegations of insider trading, and no particularized factual allegations supporting the general allegations of knowing falsity. The complaints similarly depend on the failure of the auction rate market itself as satisfying the loss causation requirement, rather than referring to any alleged curative disclosures or anything else in particular about the specific securities in which the class members invested.

The defendants undoubtedly will argue that these generalized allegations are insufficient to meet the threshold pleading requirements, in reliance in particular on Tellabs and Dura Pharmaceuticals. But while the defendants may seek to have the actions dismissed, the plaintiffs’ lawyers clearly intend to keep filing these actions.

The lawsuits potentially may also raise some interesting D & O liability insurance coverage issues. Because the complaints do not name any individuals as defendants, the sole potential coverage under the typical D & O policy that these claims might trigger is the so-called “entity coverage” found in most policies. In most public company D & O policies, the entity coverage is strictly limited to “securities claims.” While the auction rate securities lawsuits purport to raise claims under the securities laws, these allegations may or may not trigger the potentially applicable entity coverage, depending on how the term “securities claim” is defined in the applicable policy.

There are two general variants of the “securities claim” definition. One variant defines the term “securities claim” by reference to the securities laws themselves, including within the definition claims that assert breaches of federal or state securities laws or their equivalent. The other definitional variation defines “securities claim” by reference to the claimants and securities allegation with respect to which would be recognized as a securities claim. For example, this latter category might limit a “securities claim” to claims brought by holders of the company’s securities, or alternatively, might limit a securities claim to alleged breaches in connection with trading of the company’s own securities.

Clearly this definitional distinction could make a difference in connection with these recently filed auction rate securities lawsuits, as these claims might assert a “securities claim” and trigger the entity coverage in policies that use the former variants, but may or may not trigger the entity coverage in the policies that have the latter variant.

It is probably also worth noting that a number of the companies (for example, E*Trade) that have been sued in these auction rate securities class actions have also separately been sued in securities class action lawsuits by the companies’ own shareholders. These companies’ available insurance coverage may be under significant pressure already.

With the accumulation of these lawsuits, whose numbers are likely to continue to grow, it may well be time for these lawsuits to be broken out into their own separate statistical category, much as the IPO laddering cases were when the were filed in 2001. The auction rate securities lawsuits clearly represent a litigation category distinct from the more typical securities class action brought by public company shareholders.

But with the addition of the two latest lawsuits, the total number of subprime related lawsuits, as reflected on my running subprime lawsuit tally (which may be accessed here), now stands at 64, of which 26 have been filed in 2008. As noted above ten of these 64 lawsuits represent lawsuits brought by auction rate securities investors. Two of the 64 were brought by asset-backed securities investors against the investment banks who created the instruments. Two of the 64 were brought by mutual fund investors against the fund companies and fund managers. The remaining lawsuits were brought by public company shareholders.

Subprime Derivative Lawsuits: In addition to securities lawsuits, some shareholders have also filed subprime-related shareholders’ derivative lawsuits against company management alleging breach of fiduciary duty and other legal breaches. The latest of these subprime-related derivative lawsuits was filed on April 1, 2008 in the United States District Court for the District of Maryland against Municipal Mortgage & Equity (“Muni Mae”) , as nominal defendant, and certain of its directors and officers (complaint here). Muni Mae has previously been sued in a subprime-related securities lawsuit (refer here).

The derivative suit against Muni Mae joins other subprime-related derivative lawsuits that previously have been filed against, among others, Countrywide, American International Group, Regions Financial, and Bear Stearns. I have not been separately tracking the subprime-related derivative lawsuits, basically because I failed to anticipate that shareholders would file as many subprime-related derivative actions as they have. In response to readers’ inquiries, I will now endeavor to track the subprime-related derivative suits.

Unfortunately, because I am coming at this task belatedly, I may fail to account for derivative lawsuits that were filed previously and of which I am unaware. I would be grateful if readers would let me know of any pending subprime-related derivative lawsuits of which they are aware, so that I can add them to my tally and the list will be as complete as possible.

Subprime Litigation Overview: The field of subprime-related litigation has continued to grow and expand, to the point where it is difficult to get an organized sense of the range of issues and litigants involved. An April 1, 2008 memorandum from the Gibson Dunn law firm entitled “Subprime-Related Securities Litigation: Where Do We Go From Here?” (here) provides a top-level overview of current exposures facing companies involved in subprime-related businesses. The paper identifies early trends and key defenses, takes a brief look at likely D & O insurance issues, and describes the factors that are likely to affect the likely future direction of this litigation.

A Canadian Backdating Lawsuit: Though the backdating scandal now seems like ancient history, it seems that the lawsuits are still continuing to come in, although the most recent instance involves a Canadian company sued in a Canadian court.

According to news reports (here), a shareholder of Savanna Energy Services Corp. has filed an action in Alberta’s Court of Queen’s Bench against eleven current or former directors and officers of the company, alleging that the defendants manipulated the company’s stock options in order to profit personally. The lawsuit seeks damages equal to the defendants’ ill-gotten gains and a ban on issuing options to the company’s executives. The plaintiffs’ complaint relies on an affidavit from Eric Lie, the University of Iowa professor whose research initially triggered the options backdating scandal. Lie’s affidavit reports “a high statistical probability” that individuals at Savanna backdated options between 2004 and 2007.

Because Savanna is a Canadian company whose shares trade only on the Toronto Stock Exchange and because it has been sued in Canadian court under Canadian law, I have not tried to shoehorn the case into my running tally of options backdating lawsuits (which may be accessed here). The Savanna lawsuit may represent its own unique category of one.

Delaware Corporate Law Update: Francis Pileggi has posted on his Delaware Corporate and Commerical Litigation Blog (here) an interesting series of posts (here, here and here) reporting on the proceedings at Tulane University's Corporate Law Institute, which took place this past week. The posts include a number of interesting commentaries from members of the Delaware judiciary. Francis's post (here) about Delaware law regarding the sale of companies is particularly noteworthy and interesting, particularly Vice Chancellor Strine's remarks about the duties of boards of companies in the process of the sale of a company.

Death by Blogging?: Readers who may not appreciate how stressful it can be to maintain a blog may want to review the April 6, 2008 New York Times article entitled “In Web World of 24/7 Stress, Writers Blog Till They Drop” (here), which surveys the toll that blogging is taking on some authors.

While no one here at The D & O Diary seems to be in any immediate danger, maintaining the blog is unquestionably stressful. The authors described in the Times article are (or rather, were) at least getting paid for their troubles, whereas The D & O Diary lacks even that consolation. Our blogging efforts defy Samuel Johnson’s sage words that “No man but a blockhead ever wrote except for money” -- words that we frequently contemplate to our distress. Yet on we blog, as if by compulsion. A blog is indeed a harsh mistress.

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