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

As reflected in their agreement filed on August 26, 2010, the parties to the New York and Delaware derivative actions involving former AIG CEO Maurice Greenberg, as well as certain other former AIG directors and officers, have agreed to settle the case for a payment to AIG by its D&O insurers of $90 million. The agreement also provides that the insurers will pay $60 million to Greenberg and Howard Smith, AIG’s former Chief Financial Officer, for their legal fees.

The settlement is subject to the approval of Delaware Chancery Court Vice Chancellor Leo Strine. Jef Feeley and Hugh Son’s August 27, 2010 Bloomberg article about the settlement can be found here.

This derivative lawsuit settlement follows AIG’s $725 settlement of a related securities class action lawsuit, and also follows the $115 million settlement in 2008 of a separate shareholders derivative lawsuit involving directors and officers of AIG.

Background

In 2004, the first of many separate shareholders derivative lawsuits (later consolidated) were filed in New York and in Delaware, against AIG as nominal defendant, and against numerous former AIG directors and officers, including Greenberg and Smith. The investors alleged that AIG insiders to misstated AIG’s financial performance in order to deceive investors about AIG’s financial condition.

The centerpiece of the lawsuit was an allegedly fraudulent $500 million reinsurance transaction in which various AIG insiders staged an elaborate artificial transaction with Gen Re Corporation. The complaint also alleged AIG insiders allegedly used secret offshore subsidiaries to mask AIG losses, misstated accounts with no basis for their adjustments, failed to correct well-documented accounting problems in an AIG subsidiary, and hid AIG’s involvement in controversial insurance policies that involved betting on when elderly people would die. The complaint also related to alleged bid-rigging allegations and alleged sale of illegal financial products.

In a lengthy February 2009 opinion, Delaware Vice Chancellor Leo Strine denied the motions to dismiss of Greenberg, Smith and certain other senior former AIG officials, although he granted the motion as to certain other individuals. Strine observed, among other things, "The Complaint fairly supports the assertion that AIG’s Inner Circle led a — and I use this term with knowledge of its strength — criminal organization. The diversity, pervasiveness, and materiality of the alleged financial wrongdoing at AIG is extraordinary."

Following further procedural wrangling and developments, the parties participated in a series of mediations involving retired Judge Layn Phillips, which resulted among other things in this settlement agreement.

The Settlement

The August 26 agreement seems to resolve all of the litigation involving all of the parties. However, the agreement is also not self-sufficient, as it is "conditioned upon execution of and compliance with a written settlement agreement under which the D&O carriers" pay the agreed upon amounts. I have not been able to obtain a copy of the separate insurance agreement and indeed the wording of the August 26 agreement suggests that at least at the time the August 26 agreement was drafted, the implied insurance agreement had not yet been drafted or fully executed.

The August 26 agreement does recite that the applicable insurance consists of AIG’s 2004-2005 D&O insurance tower, which has aggregate limits of liability of $200 million. The agreement does not identify the insurers in the tower or their respective limits of liability. The agreement also recites that the parties to the August 26 agreement have claims pending against the insurance tower in excess of its $200 million limit.

The agreement also states that the insurers "dispute that the D&O Insurance Tower is available to pay the claims made under the policies," but that the parties "desire to resolve their disputes regarding the appropriate allocation of their respective rights to the D&O Insurance Tower."

The agreement also incorporates certain understandings as the plaintiffs’ attorneys’ fees. Among other things, the agreement provides that the Delaware plaintiffs’ attorneys shall seek and the other parties shall not oppose attorneys’ fees of no more than 22.5% of the Settlement Amount (i.e. no more than $20.25 million) and no more than $1 million in expenses. The New York plaintiffs’ attorneys will seek a fee of no more than $2.5 million. If the two sets of attorneys were to realize the full amount of these fee awards and expenses, the net recovery to AIG from the settlement would be $66.25 million.

Discussion

There are a number of interesting things about this settlement. First, the cash payments specified in the agreement are to be funded exclusively with the proceeds of the D&O Insurance Tower.

Indeed, the Bloomberg article linked above quotes Greenberg’s attorney as saying that all of litigation by or on behalf of AIG again Greenberg "was settled with Mr. Greenberg paying nothing and other parties paying money to Mr. Greenberg." (This statement is probably worthy of an entire blog post some day all on its own.). Victor Li’s August 27, 2010 Am Law Litigation Daily article (here) about the settlement quotes the Delaware litigation lead plaintiffs’ attorney as saying that as a result of the settlement, $90 million is going to AIG that otherwise would have gone to Greenberg and other defendants based on a 2009 settlement between AIG, Greenberg and Smith, under which AIG agreed to reimburse up to $150 million of their legal fees.

While others can debate who gave or got what in this settlement, the bottom line is that the money for this settlement is coming entirely from insurance.

Without details about the separate insurance settlement referenced in the August 26 agreement, it is hard to know for sure, but it seems as if the $150 million of insurance funds exhausts the remaining funds under the D&O Insurance Tower, either by actual payment of loss or by compromise. (There obviously is some linkage between the $150 million total of payments in the August 26 agreement and the November 2009 agreement between AIG and Greenberg, but the precise connection isn’t apparent from the face of the documents I have seen so far.)

In addition to the fact that the August 26 agreement recites that the parties claims on the D&O Insurance Tower exceed the Tower’s $200 million aggregate limits of liability, another reason I assume that the Tower is actually or effectively exhausted is the interpleader action the primary insurer in this Tower filed against Greenberg and AIG, in order to avoid or resolve an arbitration dispute about priority rights to the proceeds of the $15 million primary policy. By interpleading the $15 million limits of liability, the primary insurer was effectively disclaiming any rights to those funds, indicating that those amounts at least consumed by claims costs. The next layers up above the primary insurance undoubtedly were also substantially eroded if not consumed by claims costs as well.

My final observation about the $90 settlement on behalf of Greenberg with AIG is that this represents yet another jumbo settlement of a shareholders’ derivative suit. There was a time when a derivative lawsuit settlement involving substantial cash payments was very unusual, but in recent years substantial payment of cash in connection with the settlement of derivative lawsuits has become increasingly common.

In addition to the $115 million settlement of the prior AIG derivative suit, other large recent derivative lawsuit settlements include the $118 million Broadcom options backdating related derivative settlement, the $122 million Oracle settlement and the $225 million Comverse Technology options backdating related derivative lawsuit settlement. It is particularly noteworthy that all of these payments are outside the insolvency context.

One consequence of this outbreak of jumbo settlements in derivative lawsuits is that the possibility that Excess Side A insurance might be called upon to pay loss – even outside of the insolvency context -- seems to be increasing. Certainly these massive settlements provide increasing evidence for the value to insureds of these kinds of insurance structures, whether or not the recent AIG settlement did or did not actually involve contributions from Excess Side A insurers. The increasing numbers of derivative settlements involving large cash payments certainly underscores that the Excess Side A insurers are exposed to potential losses -- even outside of the insolvency context -- an exposure that actually seems to be increasing over time.

Special thanks to Jef Feeley for providing a copy of the August 26 agreement.

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When Ohio Attorney General Richard Cordray announced this past Friday that he had entered a massive $725 million settlement on behalf of three Ohio pension funds in the long standing securities class action lawsuit against AIG, he definitely accomplished his objective –his announcement made the front pages of all the newspapers in Ohio (it was the lead story in Saturday’s Cleveland Plain Dealer).

There is only one problem. AIG doesn’t have the money to pay for the settlement. The plan, such as it is, is that AIG is going to fund the first $175 million following the settlement’s preliminary approval. Then, AIG is going to try to conduct a stock offering to raise the remaining $550 million.

As Susan Beck put it on the Am Law Litigation Daily, there have been lots of settlement over the years, but "we’ve never seen one quite like this."

As reflected in greater detail here, the plaintiffs first sued AIG, certain of its directors and officers, its auditor and certain third parties in October 2004, shortly after then-New York Attorney General Eliot Spitzer first announced his investigation of a "scheme" in connection with commercial insurance transactions involving bid-rigging and the payment of contingent commissions. Further allegations made their way into the complaint following additional revelations.

The plaintiffs’ 497-page consolidated third amended complaint filed in March 2006 included  the bid-rigging and contingent commission allegations, as well as allegations that AIG falsified its financial statements, among other things, by entry into a finite reinsurance transaction with General Reinsurance Corporation, as well as of reinsurance transactions with other offshore entities. In May 2005 AIG restated five years of earnings, reducing shareholders’ equity by more than $2.7 billion.

Even before the $725 million AIG settlement announced Friday, the Ohio AG’s office had already entered settlements totaling $284.5 million in the case. First, on October 3, 2008, the Ohio AG entered a $97.5 million settlement with PricewaterhouseCoopers, as reflected here.

Second, on February 2, 2009, the Ohio AG announced that Gen Re had agreed to a $72 million settlement.

Third, on August 13, 2009, the Ohio AG announced that he had entered a $115 million settlement with former AIG CEO Maurice Greenberg, and several other former AIG executives, as well as certain corporate entities affiliated with Greenberg. (Several of these same individuals and entities also separately settled a related derivative lawsuit for $115 million, largely funded by insurance, as discussed here.)

The sum of these settlements in the securities class action case, including the recently announced settlement with AIG, is $1.0095 billion, which, according to data from Risk Metrics (here), would rank as the tenth largest securities class action settlement amount. Indeed, the AIG settlement by itself would rank twelfth on the list.

There is the small problem of how AIG’s is going to pay for the $725 million settlement. The company, you will recall, has received over $130 billion in U.S government bailout support and is now 80 percent owned by the U.S. taxpayers. The company is struggling to sell assets to repay the bailout money.

According to AIG’s July 16, 2010 filing on Form 8-K, the settlement is "conditioned on its having consummated one or more common stock offerings raising net proceeds of at least $550 million prior to final court approval." The decision whether "market conditions or pending or contemplated corporate transactions make it commercially reasonable to proceed with such an offering will be within AIG’s unilateral discretion."

The intent is for AIG to register a secondary offering of common stock on behalf of the U.S. Treasury. AIG also has the option to fund the $550 million from other sources. If AIG fails to fund the $550 million, the plaintiffs have several options. They can terminate the agreement; they can "elect to acquire freely transferable shares of AIG common stock with a market value of $550 million provided AIG is able to obtain the necessary approvals"; or they can  extend the period for AIG to complete the offering.

A securities offering conducted for the sole purpose of funding past litigation is not exactly the most attractive investment opportunity, even under the best of circumstances. But these are not the best of circumstances for AIG. Indeed, the settlement’s announcement comes at a time when the company’s leadership seems in disarray, after the company’s board chair resigned following a "board battle" with the current CEO. The company faces a daunting array of challenges as it seeks to repay the bailout money, as reflected in a July 17, 2010 Wall Street Journal article here unrelated to the settlement and the projected stock offering,

A July 16, 2010 New York Times article about the settlement quotes one commentator as saying, "There’s still a lot of question marks hanging over AIG. How would you write the prospectus for it? The document would be quite appalling when it described the risks."

The offering would, according to the article, be "rife with uncertainties" given the fact that the offering would be dilutive of the government’s ownership interest. On the other hand, as the article also points out, "taxpayers and legislators would cry foul" if the lawsuit were funded out of the $22 billion that remains available to the company.

Along with the questions of how the company will fund the $550 million settlement chunk is the question of how the company is paying for the first $175 million. Given the U.S. taxpayers’ interest in the company, it seems like there should be some explanation somewhere about the source of that money, but none of the publicly available information provides any explanation. It is possible that insurance will fund that portion, although none of the disclosure documents make any suggestion of that possibility, and in addition, significant insurance funds were previously paid to fund the derivative lawsuit settlement identified above. The settlement agreement itself might answer the question, but it is not yet available on PACER.

The lawsuit itself is a vestige of a different time and place. Though the events involved are only a half dozen years in the past, the complaint reflects a lengthy roster of individuals whose roles have long-since changed in ways that no one could possibly have imagined at the time. The alleged wrongdoing , while involving some fairly egregious circumstances, pales by comparison with the cataclysmic events that followed. Given this antediluvian aspect of this case, it does seem high time that it settled. However, only time will tell if the parties have in fact succeeded in driving a stake into the heart of this beast.

Somehow it seems fitting that just this past week there were news reports that during a recent lunch at the Four Seasons Hotel in New York, where Greenberg was having lunch with former Citigroup CEO Sandy Weill, Spitzer approached Greenberg, stuck his hand out, and asked Greenberg if he would appear on Spitzer’s CNN show. Unsurprisingly, Greenberg declined. Can you imagine the look on Greenberg’s face? The world is a very strange place sometimes. Or, at least there are some strange inhabitants.

It is also entirely fitting that Cordray’s and Spitzer’s names should be linked in connection with this story. Cordray has definitely borrowed several key pages out of Spitzer’s political play book. Playing the role of Wall Street Scourge definitely worked for Spitzer, at least until his extracurricular activities earned him some extended gardening leave followed by his current rehabilitation assignment on CNN. It also seemed like it was working for Connecticut AG Richard Blumenthal until it turned out he had oversold his credentials as a veteran.

Cordray is playing the angle for all it is worth. His website has a separate page devoted to securities class action litigation activities, including a June 1, 2010 summary of the current cases. (The document is headed "Holding Wall Street Accountable.") However, it is probably worth noting that many of the cases on Cordray’s list were actually launched by his predecessors, although Cordray did demonstrate his own initiative with the action he recently filed against the rating agencies, about which refer here.

The New Homogeneity: If, as seems likely, Elena Kagan’s nomination to the Supreme Court is confirmed, the Court’s make-up will, at least in certain respects, reflect unprecedented levels of diversity. Three women will be served on the Court for the first time. The Court includes a Hispanic and an African-American. There will be six Catholics and three jews, although, curiously, no Protestants.

But in another respect, Kagan’s arrival will make the Court even less diverse. As detailed on a July 16, 2010 post on the Economix blog (here), with Kagan’s addition, eight out of the nine justices will have attended one of two elite East Coast, Ivy League law schools. The only exception, Justice Ginsberg, graduated from Columbia Law School, but she started at Harvard and transferred after her first year to be in New York with her husband. According to data cited in the blog post, for the first time in the Court’s history, every sitting justice will have a law degree from the Ivy League.

The immediate question is whether this matters. There has always been a healthy representation of Ivy League graduates on the Court. Such luminaries as Oliver Wendell Holmes and Louis Brandeis immediately come to mind.

But even if the Ivy League has always been well represented on the Court, it has never been quite so dominant, and a wider diversity of educational backgrounds was always present. William Rehquist and Sandra Day O’Connor were classmates at Stanford Law School. Earl Warren attended Boalt Hall at the University of California. Warren Berger attended the William Mitchell College of Law. Indeed, Robert Jackson, usually cited as one of the Court’s finest writers, did not even graduate from law school, but rather apprenticed for a lawyer in Jamestown, New York.

Nor is the Court is the only branch of government that has been captured by these same two schools. The last four occupants of the White House, including the current President, all have at least one educational degree from one of these same two schools. (George W. Bush had one of each.)

When and how did this very peculiar form of elitism get instituted?

To be sure, no one could claim that the current justices or the recent Presidents are cookie cutter copies of each other. But the concentration of power and authority in the hands of a few persons sharing the same elite background seems highly antithetical to some of the most basic notions of American self-government. Or to put it another way, if ethnic and gender diversity are desirable goals, at the same time shouldn’t we be taking care that we are not undermining the benefits of diversity by concentrating power and authority in the hands of a small elite?

The Court’s peculiar narrowness actually takes several forms. Not only do the current justices share a common background of higher education, their careers have all followed similar and similarly narrow paths. Their individual resumes consist largely of service in the judiciary and academia, with the occasional service as a government lawyer or prosecutor thrown in. None of the current justices has ever had to make payroll or struggled to try to make a profit. None has ever had to establish a political coalition or get themselves elected. None has served in the military. Even their legal experience is narrow – none has been a criminal defense attorney, for instance.

Some may argue that I am making too much of the necessarily limited demography of a very small population. But I do think the slender reach of the Court’s collective education and experience has practical consequences. For example, the Court has recently shown a predilection to take up securities cases, but none of the justices seem particularly motivated by a concern for the financial markets or to have a vital appreciation of the importance of the financial markets for the country’s well being. Instead, the cases seem to represent challenging intellectual problems, detached from their deeper significance.

All I am saying is that before everyone puts their arms out of joint congratulating each other about the increasing diversity on the Court, perhaps the question should be asked whether one kind of uniformity is simply being replaced with a different kind of homogeneity.

I Will Assume She Was Not Referring to Me: In her July 17, 2010 column in the Wall Street Journal entitled "Youth Has Outlived Its Usefulness," Peggy Noonan said:

Why do so many young bloggers sound like hyenas laughing in the dark? Maybe it’s because there’s no old hand at the next desk to turn to and say, "Son, being an enraged, profane, unmoderated, unmediated, hit-loving, trash-talking rage money is no way to go through life."

Poor old Peggy, her memory must be going. Clearly she has forgotten that the surest way to show that your sell by date has passed is to start fulminating about "young people these days" and the things that somebody ought to tell them. On the other hand, she could use somebody to tell her that attempting in a single paragraph to portray her bêtes noires as both laughing hyenas and rage monkeys hardly sets an example of restraint. Perhaps the rage she detects is her own.

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On February 23, 2009, Advisen released its Report of 2008 securities litigation entitled "Securities Litigation in 2008: Implications for the D&O Market in 2009 and Beyond" (here, $ required). The Advisen Report’s numerical securities litigation analysis is directionally consistent with prior reports of the 2008 lawsuits, although the Report also contributes its own unique observations to the dialog. The Report also provides a number of specific comments about the lawsuits themselves as well as about likely future trends, including in particular reflections on the implications for D&O insurers.

Advisen’s February 26, 2009 press release describing the Report can be found here.

Largely as a result of the way it counted the lawsuits, the Advisen report concludes that securities class action lawsuits as such did not substantially increase in 2008 compared to 2007, although both years’ activity did increase compared to 2006. Pertinent to these conclusions, the Advisen Report provides a lengthy explanation of its "counting" methodology, which is helpful in understanding how Advisen’s numbers differ from those reflected in prior reports. The Advisen Report correctly notes that the phrase "securities class actions" is "increasingly inadequate for categorizing and explaining securities suits."

The Advisen Report is consistent with previous released studies in its conclusion that during 2008 securities litigation was concentrated in the financial sector. The Report notes that "fully half of securities lawsuits filed in 2008 named financial firms and their directors and officers as defendants." Specifically, the Report finds that banking, finance and insurance companies accounted for half of the securities lawsuits in 2008.

The Report stresses that the nature of many of the suits filed in 2008 differs from what may have been standard form in prior years. Many of the suits were not filed against public companies for their financial disclosures, but rather were filed against companies that structured or sold securities, and were being sued for representations about the securities themselves. The auction rate securities lawsuits are one illustration of this new category.

In addition, Advisen reports that during 2008, many of the suits were filed not as securities class action lawsuits as such, but rather in the form of lawsuits for breach of fiduciary duty, breach of contract, or common law torts. Many of these lawsuits were filed in state court.

The Report notes that as the economy continues to deteriorate, "at some point in 2009, the idea of ‘subprime and credit crisis’ as a category of suits will fade away as the credit crisis simply becomes ‘the economy’." Among other things, the Report speculates that the spreading economic woe could cause the growing litigation wave to spread outside the financial sector.

The deteriorating economic conditions could also lead to increased bankruptcies, a development the Advisen Report notes "almost certainly will be accompanied by an increase in securities lawsuits." The Report notes that since 1995, roughly 35 percent of large public companies (defined as having more than $250 million in assets, measured in 2008 dollars) that filed for bankruptcy were also named in securities class action lawsuits. However, in 2007 and 2008, the percentage increased to 77 percent.

The Report also notes a number of factors contributing toward escalating costs of defense, including the complexity of the cases being filed, the novelty of many of the legal theories, and the coincidence of multiple, simultaneous proceedings.

The Report reviews the implications of these developments and trends for D&O carriers. The Report also contains interesting comments from several D&O mavens, including John McCarrick, Rick Bortnick and Joe Monteleone. The Report is interesting, well-written and well-documented, and well worth reading in its entirety.

My own overview of the 2008 securities lawsuit filings can be found here.

Remember Options Backdating?: The cases from the last wave of corporate scandals still remain, although fewer and fewer or them all the time. On February 27, 2009, the parties to the Sunrise Senior Living securities lawsuit, one of the remaining options backdating related securities class actions, agreed to settle the case for $13.5 million. A copy of the stipulation of settlement can be found here.

I have added the Sunrise settlement to my running table of the options backdating related lawsuit settlements, dismissal and dismissal motion denials. The table can be accessed here.

Special thanks to Adam Savett of the Securities Litigation Watch for providing me with a copy of the Sunrise settlement stipulation.

Now I Have Seen Everything: According to a March 2, 2009 story on Bloomberg (here), former AIG Chairman and CEO Maurice "Hank" Greenberg has sued AIG alleging that "material misrepresentations and omissions" caused him to acquire AIG shares in his deferred compensation profit participation plan at an inflated value, and later to lose nearly his entire investment after AIG's losses became known.

A March 2, 2009 Reuters story about the lawsuit (here) says that Greenberg acquired the shares on January 30, 2008, when AIG shares traded at $54.37. The company’s shares closed today at 42 cents. Greenberg seeks the difference between what he paid for the shares and what he said the shares were worth, as well as reimbursement of more than $70 million of taxes.

The defendants in the lawsuit include, in addition to the company, Greenberg’s successor as CEO, Martin Sullivan, as well Joseph Cassano, who headed AIG’s Financial Product (AIGFP) division. Both men worked for Greenberg prior to Greenberg’s departure.

I wonder if his lawsuit would be barred from coverage under AIG’s D&O insurance program (assuming for the sake of argument that it is not otherwise exhausted by prior claims)? As a former officer and director of the company, he still qualifies as an "insured" and so his lawsuit potentially at least could trigger the "insured vs. insured" exclusion typically found in most D&O policies. On the other hand, he left the company in March 2005, and so his claim might come within a coverage carve back in the exclusion, depending on how the applicable provision is worded.

If one were to assume that insurance would not be available, then defense expenses (both for the company and for the individuals, who would be indemnified by the company) would come from AIG itself, which owes the U.S. government approximately a gazillion dollars. The same would go for any uninsured settlements or judgments. I leave to others to comment on whether or not taxpayers ought to have to incur the costs associated with this lawsuit.

Perhaps pertinent to the question whether or not taxpayers should have to bear the cost of Greenberg's lawsuit, in comments published today (here), the current AIG CEO, Edward Liddy, said that Greenberg is partially responsible for AIG’s current woes. Among other things, Liddy said "The formation of the AIGFP unit, which has literally brought us to our knees, that happened on his watch. The compensation systems that have gone astray, happened on his watch. I don’t think it’s as clean and simple as sometimes Hank would like to portray."

And Finally: This week’s Time Magazine has several interesting article about the current economic crisis, including an article highly critical of former SEC Chairman Christopher Cox, entitled "The Inside Story on the Breakdown at the SEC" (here).

In addition, this week’s issue also has a fascinating story entitled "One Bad Bond" (here), which explains how losses have compounded exponentially in connection with a CDO-cubed created in March 2007 and called Jupiter High-Grade CDO V. This poster-child of financial engineering excess was originally rated AAA, but now nearly 59% of the instrument’s investments are worthless. Among Jupiter’s investments is an interest in the Mantoloking CDO, a toxic investment vehicle about which I blogged a year ago, here.

The article is worth tracking down in its original print version, because the print version is more detailed and is accompanied by graphics that are not available online but that do a particular good job in showing how the complexity of these instruments compounded the losses as the underlying mortgages have faltered.

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Questions surrounding the susceptibility of foreign domiciled companies to U.S. securities laws and to the jurisdiction of U.S. court are frequently recurring issues, as I noted most recently here. However, a new case filed in Ontario under Ontario’s securities laws presents an interesting variation on these questions.

The Ontario Action Against AIG

According to its November 13, 2008 press release (here), the Siskinds law firm has filed a class action application and accompanying statement of claim in the Ontario Superior Court of Justice under the Ontario Securities Act against American International Group, American International Group Financial Products, and ten current or former AIG directors and officers. According to the press release, the claim is brought on behalf of Canadian investors who bought AIG securities between November 10, 2006 and September 16, 2008.

A copy of the application and statement of claim can be found here. According to the press release, the statement of claim alleges as follows:

The AIG class action arises out of AIGFP's credit default swaps and the crippling decline in AIG's stock price when the true effect of those credit default swaps became known to the investing public. The AIG disclosures out of which the class action arises are currently the subject of investigation by law enforcement authorities, and are alleged in the class action to have caused massive losses to Canadian investors.

The Ontario Securities Act

The action is brought under the investor protection provisions in Part XXIII.1 of the Ontario Securities Act. (Refer here for the provision of the Act.) The statutory provision specifies the liability standards in connection with "secondary market disclosure."

Section 138.3 of the statute provides a cause of action for damages on behalf of persons who trade in a company’s security -- "without regard to whether the person or company relied on the misrepresentation" -- where "a responsible issuer or a person or company with actual, implied or apparent authority to act on behalf of a responsible issuer releases a document that contains a misrepresentation."

The persons against whom the action may be brought are specified to include, among others, the issuer, "responsible" directors and officers, as well as persons who "knowingly influenced" the issuer or responsible persons.

Jurisdictional Issues

The plaintiff’s statement of claim takes great pains to emphasize that the action has "a real and substantial connection with Ontario." Indeed, in paragraph 155, the statement of claim alleges that the financial disclosures that are the basis of the action were "disseminated in Ontario"; that "a substantial proportion of the Class Members reside in Ontario"; that AIG "carries on business in Ontario"; that AIG considers its Canadian revenue as "domestic" for accounting purposes"; that "key AIG personnel charged with oversight of the above conduct were domiciled in Ontario and undertook part of that effort from Ontario."

The pains taken in the statement of claim to specify the claim’s connection to Ontario suggests an anticipation of a question whether the case properly belongs in Ontario courts. AIG is, after all, domiciled outside of Canada, and its shares do not trade on Canadian securities exchanges (or at least the plaintiff does not so allege). The alleged misstatements were prepared and issued outside of Canada.

On the other hand, the statement of claim does allege misconduct, harm and damages within Ontario. Without presuming the outcome, allegations of this type are of the kind that at least some U.S. courts have found a sufficient basis for the exercise of jurisdiction and the application of U.S. securities laws on companies domiciled outside the U.S.

Discussion

Setting aside these subject matter jurisdiction issues, and disregarding potential personal jurisdiction issues, there are some larger questions about this case. AIG faces extensive litigation in the U.S. on similar or related issues. Should any particular jurisdiction’s court have priority? Should courts defer to another jurisdiction’s courts?

These kinds of questions have come up before, for example, in connection with the Royal Dutch Shell cases, where there were also parallel proceedings in different countries (refer here). The way that these proceedings should coordinate is very much an evolving issue. But the noteworthy difference between that prior example and this instance is that here the target company is a U.S.-based company. It will be interesting to see whether that distinction makes a difference and how the respective cases unfold.

I also have these vague, unformed questions whether or not it makes a difference that AIG is now effectively owned by U.S. taxpayers. The taxpayers’ highest priority right now is getting repaid for the astonishing obligations to the U.S. treasury that AIG has recently undertaken. I haven’t worked it all out yet, but there does seem to be something inconsistent with the U.S. taxpayers’ interest in having the company’s limited resources siphoned off to defend and possibly to pay damages in a foreign jurisdiction. Canadian investors probably don’t care much about that, I suppose.

Of course, it might be argued that U.S. courts have been doing similar things to other countries’ companies (including Canadian companies) for some time now. Indeed, the plaintiff’s lawyers’ press release quotes one of the plaintiff’s attorneys as saying:

for many years, Canadian corporations have had to confront the long arm of America's justice system. But with the enactment of Part XXIII.1 of the Ontario Securities Act, Canadian investors can finally pursue remedies in our own Courts against American corporations that fail to respect Canada's securities laws. Canadian investors are entitled to have Canadian Courts hear their claims.

The one thing that is clear is that a class action under the Ontario securities laws is a serious matter. As I noted in a prior post (here), a prior class under the Ontario securities laws against FMF Capital recently settled for over CAN$28 million. This settlement apparently represents the largest securities class action settlement in Canada, and while the amount may seem small compared to some of the massive U.S. settlements, the amount did represent a very significant percentage of the investors’ claimed investment loss.

At a minimum, the FMF Capital settlement suggests that a claim under the Ontario securities laws represents a serious potential liability exposure. Along those lines, it should be noted that the press release states that the plaintiff class seeks damages of $550 million. (The press release does not state whether or not those are U.S. or Canadian dollars.)

UPDATE: Dimitri Lascaris of the Siskinds law firm has written a guest column on the Securities Docket blog (here), in which he explains the basis of jurisdiction in Ontario for the AIG lawsuit, as well as the operation and effects of the Ontario securities laws.

Two Final Observations

First, this new lawsuit represents yet another demonstration that the threat of securities litigation outside the United States continues to grow.

Second, this new lawsuit presents an interesting and potential dangerous expansion of this growing threat, which is the possibility that U.S. domiciled companies could find themselves the target of securities litigation in other jurisdiction’s courts under other jurisdiction’s laws.

To the extent it proves to be successful, the Ontario plaintiff’s new lawsuit against AIG could represent a very unwelcome and potentially complicated expansion of the liability exposures of U.S companies and their directors and officers.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the Ontario court application and statement of claim.

Now This: In this time of financial turmoil, it pays to be resourceful. And so, The D&O Diary is giving serious consideration to converting itself into a bank holding company, in order to be able to join other leading American business enterprises and participate in the bailout process.

While there might be those who would contend that we are not "too big to fail," we certainly are feeling the effects of the economic downturn, and recent 401(k) statements suggest that radical measures may be required. Capital infusions would be particularly welcome here.

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In a statement issued on Tuesday evening (here), the Federal Reserve announced that it had authorized a loan of up to $85 billion to American International Group. This move is described in detail in a September 17, 2008 Wall Street Journal article entitled "U.S. to Take Over AIG in a $85 Billion Bailout" (here). Bloomberg’s article describing the development can be found here.

The Outlines of the Loan Facility

The loan facility, which the statement says has been extended pursuant to Section 13(3) of the Federal Reserve Act, has been "designed to protect the interests of the U.S. government and taxpayers." According to the Real Time Economics blog (here), the only other time this specific Fed power has been exercised since the Depression era was in connection with the Bear Stearns bailout.

The Fed statement says that it exercised its authority because of adverse economic effects that would follow from a "disorderly failure" of AIG. The loan facility is designed to permit AIG to "meet obligations" in order to "facilitate a process under which AIG will sell certain of its businesses in an orderly manner."

The facility has a 24-month term. The interest rate is set at three month LIBOR plus 850 basis points. Three month LIBOR is a variable rate that resets weekly. The current weekly rate (here) is 2.81%, so the current interest rate on this loan facility is 11.31% -- pretty hefty. Just keep in mind that annual (simple) interest of 11.31% on $1 billion is $113.1 million. On $10 billion it is $1.131 billion. And on $85 billion it is $9.61 billion.

The loan is collateralized by all of the assets of AIG and of its non-regulated subsidiaries. (The good news here is that the assets of the regulated subsidiaries – the insurance companies – are off limits.) The loan is to be repaid from asset sale proceeds.

According to the Fed statement, the government "will receive a 79.9% equity interest" in AIG, with the right to veto dividends to common and preferred shareholders.

The size of the facility presumably was set to accommodate all likely requirements, so AIG may or may not draw down all of it. But AIG will most likely draw down a very large part of it. AIG will have to repay its borrowings (plus interest). In referring to the means of repayment, the press release refers to the orderly sale of "businesses," so one can assume that the non-core subsidiaries are on the blocks for an "orderly" sale.

Questions about the Loan Facility

The problem for AIG is that sale of its non-core subsidiaries alone may not be sufficient to pay back even half of $85 billion. The Deal Journal blog estimates (here) that sales of AIG’s non-core subsidiaries and minority interests might raise "as much as $42 billion" – and that, I might add, is before taxes. (I think Uncle Sam will insist on the payment of all applicable taxes.) Which raises the question whether the sale of "businesses" specifically contemplates the sale of some or all of AIG’s core insurance operations?

Left unanswered in the Fed press release is the question of what this development means for AIG’s continuing business operations. The primary goal of the Fed facility is the orderly sale (as opposed to the "disorderly failure," as the Fed statement put it) of AIG’s businesses. What does this imply about the future of AIG’s operating companies? And what will be left of AIG after the "orderly sale"?

Presumably, the answers to many of these questions will become apparent in the days ahead. In the meantime, there are some things that everyone will want to know. I have posed some of these questions below. Please note that many of these questions may simply be a reflection of the limited amount of information currently available. Many of these questions may appear simple-minded once the information is known. But based on what we know so far, here are the other things we still need to know:

1. Who will run the company? Is current senior management to remain in place, or will AIG get its third CEO this year? (For the record, the government did embed new management at Fannie Mae and Freddie Mac as part of the recent takeover.). How about the Board of Directors, will they also be replaced?

UPDATE: The New York Times reports (here) that AIG CEO Robert Willumstad will be replaced by Edward M. Liddy, the former chairman of Allstate Corporation.

2. What exactly does government ownership of 79.9% of the company equity mean? Is this just a shorthand way of saying that the government is entitled roughly 80% of any later liquidation? Or is there more to it than that?

For example, does the government want the value of its ownership interest to grow? What will the government ultimately do with its ownership interest? Will the government sell its interest, and if so, when, to whom, for what price, and under what circumstance? Why is the government now the majority owner of a major insurance company? Does the government want its insurance company to compete and succeed in a competitive marketplace against investor owned insurance companies?

3. The government wants to get repaid, so it wants the "orderly sale" of the businesses to produce sales values sufficient to effect repayment. That implies that the operating companies should continue operating. But among the insurance companies, for example, there are many practical questions that only active and engaged management can decide – risk appetite, level of pricing aggressiveness, extent of reinsurance, limit exposures, prohibited classes, and so on. All of these decisions must now take place under potentially unusual conditions, in effect under the supervision of a government appointed caretaker/liquidator?

4. What impact will these developments have on credit ratings, both at the parent company level and at the insurance subsidiary level? The fact the company’s primary mission now seems to be a slow-motion liquidation is clearly a relevant factor, as are the unusual operating conditions. In addition, I would expect that all of AIG’s other debt is subordinate to the Fed loan, which also seems relevant to financial strength ratings.

5. What happens if $85 billion is not enough? This is not as absurd of a question as it might seem at first glance. Keep in mind that AIG just raised $20 billion in the second quarter and that clearly was not enough. What does the current lending facility imply about the future – for AIG, for taxpayers, for the economy?

6. What about the credit rating for the U.S. government? How far can this go? The U.S. government just assumed responsibility for $5 trillion in Fannie Mae and Freddie Mac debt. When do we start to get concerned about the government’s balance sheet? When do we start to get concerned about the ability of the U.S. to meet of all of its obligations?

Policyholders’ Interests

Finally, I must address the interests of policyholders. On Tuesday, AIG released a statement (here) that its insurance subsidiaries "remain adequately capitalized and fully capable of meeting their obligations to policyholders." Along those lines, it is important to keep in mind that AIG’s current predicament is not the result of insurance losses, so the separately capitalized insurance companies’ ability to meet its obligations essentially remains unchanged.

Moreover, the collateral securing the Fed’s lending facility does not include the insurance companies’ assets, so even if the parent company heads south in a big way despite the $85 billion loan, the insurance companies’ existing surplus should remain to address policyholder claims, subject of course to the effects of claims payment.

In the days ahead it will be very important to understand how the current operating circumstances will affect the insurance companies and their operations, and in particular whether there are any other implications for policyholder surplus and the insurance companies’ claims paying ability.

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