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

When H-P announced on November 20, 2012 that it was taking an $8.8 billion charge after it discovered “accounting improprieties, misrepresentations and disclosure failures” at its Autonomy unit (which H-P acquired in October 2011 for $11.1 billion), there was a great deal of speculation that litigation would quickly follow. The intervening Thanksgiving weekend may have slowed down the filing of the first of the lawsuits, but only a little bit. The first of what will likely be many related lawsuits has now arrived.

On Monday November 26, 2012, plaintiffs’ lawyers filed a securities class action lawsuit in the Northern District of California against H-P and certain of its directors and officers. A copy of the plaintiff’s complaint can be found here. The plaintiffs’ lawyers’ November 26, 2012 press release can be found here.

The complaint names as defendants the company itself; Leo Apotheker, who was H-P’s CEO until September 2011 and who was CEO at the time the Autonomy deal was agreed upon; Meg Whitman, who became CEO in September 2011, but who had also served on H-P’s board at the time the Autonomy deal was agreed to; H-P’s CFO, Catherine Lesjak; and the company’s Chief Accounting Officer, James T. Murrin. The complaint was filed by an individual H-P shareholder on behalf of a class of investors who purchased H-P stock between August 19, 2011 (the date the Autonomy deal was announced) and November 20, 2012 (the date H-P announced the alleged improprieties at Autonomy).

The complaint alleges that the defendants violated the liability provisions of the Securities Exchange Act of 1934. Significantly, and as noted below, the complaint relates not just to the accounting improprieties at Autonomy, but also to the earlier $8 billion goodwill charge associated with H-P’s Enterprise Services business, as noted below.

According to the plaintiff’s lawyers’ press release, the complaint alleges that the defendants “concealed that the Company had gained control of Autonomy in 2011 based on financial statements that could not be relied upon because of serious accounting manipulation and improprieties.” The “true facts,” according to the complaint, “which were known by the defendants but concealed from the investing public,” were that

(a) at the time Hewlett-Packard acquired Autonomy, the business’s operating results and historic growth were the product of accounting improprieties, including the mischaracterization of sales of low-margin hardware as software and the improper recognition of revenue on transactions with Autonomy business partners, even where customers did not purchase the products; (b) at the time Hewlett-Packard had agreed in principle to acquire Autonomy, defendants were looking to unwind the deal in light of the accounting irregularities that plagued Autonomy’s financial statements; and (c)  Enterprise Services’ operating margin had collapsed from 10% in 2010 to approximately 6% as of April 30, 2011, 4% as of October 31, 2011, and 3% as of April 30, 2012, due to various reasons, including unfavorable revenue mix and underperforming contracts.

The reference to the Enterprise Services division relates to the H-P unit that incorporated the business formerly known as Electronic Data Systems Corporation (“EDS”), which Hewlett-Packard had acquired in August 2008 for $13.0 billion. On August 22, 2012, H-P took an $8 billion impairment charge on the goodwill associated with the EDS acquisition. The sequence of disclosures that the complaint cites is arranged to portray a pattern of misrepresentations regarding H-P’s Enterprise Services division, of which Autonomy was a part following H-P’s acquisition of the company.

It is interesting to note that the complaint names as defendants only the four current and former H-P officers. It does not name any of the other members of the H-P board, nor does it name any of the outside firms that advised H-P in connection with the Autonomy transaction and that presumably assisted with the due diligence review of the target company. It also seems noteworthy that the complaint does not name any of the former Autonomy directors or officers, even though at least some were also officials at H-P following the acquisition. (The absence of any Autonomy defendants may be due to the fact that Autonomy’s shares were not traded on U.S. exchanges immediately prior to the acquisition, and so, under the Supreme Court’s Morrison decision, the alleged pre-acquisition misrepresentations are beyond the ambit of the U.S. securities laws.)

This is of course the first complaint to be filed; there likely will be others, as this event seems likely to keep many lawyers busy for many years. Subsequent complaints may name others as defendants.

There is of course some irony that H-P and its senior management are targets of this litigation, as --at least from their perspective and according to the account -- the company is itself the victim of the fraud. Indeed, in its press release regarding the Autonomy revelations, the company disclosed that it has contacted the U.K. Serious Fraud Office and the SEC. The company will clearly argue that it could not have knowingly or recklessly misled its investors in violation of the securities laws, as it was itself misled.

The complaint does not allege any specific grounds for the assertions that the defendants knew but concealed from the investing public during the class period that Autonomy had misrepresented its operating performance and financial condition.The complaint does not provide any explanation of what the defendants’ motivation would have been to make these misrepresentations. Perhaps in recognition of these potential issues, the complaint refers not only to H-P’s revelations about the accounting improprieties at Autonomy, but also references H-P’s earlier goodwill impairment charge in connection with the EDS transaction. It seems as if the plaintiffs hope to contend that both the EDS and Autonomy deals were part of failed strategy for the company’s Enterprise Services business, which the company sought to try to conceal until the problems could no longer be hidden from shareholders – although if this is the plaintiff’s theory, it is at this point only implied in the complaint, not explicitly stated.

As I said, there will likely be other lawsuits to come. The other suits and the likely amended complaints may further elaborate the plaintiffs’ theory of this case.

The ABA Blawg 100: I am delighted to report that The D&O Diary has once again been named to the American Bar Association’s Blawg 100, the bar organization’s list of the top blogs about lawyers and the law. The ABA’s Sixth Annual Blawg 100 list can be found here. We are delighted to be included again in this year’s list, if for no other reason than the blogs we follow and respect the most are all on the list as well.

As it has done in past years, the ABA is once again inviting readers to choose the top blogs in each of 14 different categories. Voting begins today and ends at close of business Friday, December 21, 2012 Winners will be announced by January 3, 2013. You can vote for your favorite blog here (registration, which is free, is required to vote). You can also vote by clicking on the “Vote for this Blog” box in the right hand column. Everyone here at The D&O Diary would be very grateful to any readers who might consider casting a vote for this site.

The Deadline for the Towers Watson D&O Survey is Approaching: As I have previously noted on this site, Towers Watson is once again conducting its annual D&O insurance survey. Everyone in our industry benefits from the survey results, so we all have a stake in making sure that the survey responses are as representative as possible of the industry as a whole. The deadline for this year’s survey is this Friday, November 30, 2012. Please take a moment and think about whether you have a client that could help with this year’s survey. The survey form itself is relatively short and only takes a few minutes to complete. The survey form can be found here. Please take a moment and forward this link to any prospective survey respondents you can think of.

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This mix of items from around the web may be just the thing after a long weekend of leftover turkey --even though we are well aware that nothing can come close to a heaping helping of Turkey Tetrazzini three days after Thanksgiving. 

Adding up the Likely Legal Costs from H-P’s Autonomy Accounting Scandal: Last week’s news that H-P is taking an accounting charge of $8.8 billion dollars following the company’s discovery of “serious accounting improprieties” at Autonomy, which H-P acquired last year, is likely to generate more than just headlines in the business pages. As the various parties try to sort out responsibility for this debacle, litigation that could take years to resolve seems likely, according to Ohio State Law School Professor Steven Davidoff and Wayne State Law Professor Wayne Henning in their November 21, 2012 post on the New York Times Deal Professor Blog (here).

H-P’s announcement of the accounting issues and related charges included the company’s statement that it had notified the Serious Fraud Office and the SEC of the supposed accounting improprieties H-P had uncovered at Autonomy. But the likely litigation fall out from the company’s disclosures are likely to include not only regulatory investigations and enforcement actions, but also civil litigation, perhaps involving Autonomy’s former executives and even perhaps officials at H-P itself, as well as H-P’s advisors in connection with the Autonomy transaction.

However, all of these likely investigative and litigation initiatives could be complicated by the fact that Autonomy was a U.K company whose shares did not trade in the U.S and by the fact that H-P’s acquisition of Autonomy took place outside of the U.S. It may difficult for prospective claimants to pursue their claims in the U.S. particularly under the U.S. securities laws, as a result of the U.S. Supreme Court’s decision in Morrison v. National Australia Bank.

Despite these potential complications, litigation nonetheless seems likely. The professors conclude that “while the matter will probably involve tens of thousands of hours and millions of dollars spent on investigation and litigation, none of this is likely to restore the $8.8 billion the company lost.” 

Insurance Coverage for Data Breach Claims: One of the growing liability risks that many companies face is the exposure arising from the possibility of a serious breach of the company’s computer systems. The costs associated with a data breach can be enormous, as the companies involved respond to state law notification requirements and possible third-party claims. As the potential costs associated with data breaches mount, a recurring question has been the availability of insurance to protect against these costs.

A November 2012 memorandum from the Kelley, Drye & Warren law firm entitled “Insurance Coverage for Data Breach Claims” (here) takes a look at these recurring insurance coverage questions. The memorandum reviews the considerations affecting the availability for data breach claims under CGL and Property Insurance policies, as well as under specialty insurance policies. The authors conclude that “any time a potential data breach occurs, it is essential for an insured to consider all forms of insurance that it carries and to provide prompt notice to its insurer(s) of any policy that even potentially could apply.”

More About the Plaintiffs’ Lawyers’ Latest Say-on-Pay Litigation Gambit: A recent guest post on this site (here) discussed the plaintiffs’ lawyers latest say-on-paylitigation tactic, which involves a pre-emptive lawsuit filed in advance of the annual say on pay vote that challenges the adequacy of the compensation-related disclosures in the company’s proxy statement.

A November 19, 2012 memorandum from the Pillsbury Winthrop Shaw Pittman law firm entitled “Plaintiff’s Firms Gaining Steam from New Wave of Say-on-Pay Suits?” (here) describes the plaintiffs’ lawyers “new strategy” of trying to “hold companies liable: suits to enjoin the shareholder vote because the proxy statement fails to provide adequate disclosure concerning executive compensation proposals.” According to the memo, plaintiffs’ lawyers have filed at least 18 of these lawsuits in recent months. The memo notes that these new cases “have met with some success – with two court orders enjoining shareholder meetings and five settlements prior to companies’ annual meetings.”

Accompanying the memorandum are two helpful and interesting tables, detailing the outcomes of the various say on pay related lawsuits during the period 2010 through 2012, as well as the disposition of the latest injunctive relief actions that have been filed more recently.

Leftovers Again: Did you know that Turkey Tetrazzini is named in honor of the famous early 20^th century Italian opera star, Luisa Tetrazzini? Neither did we. In honor of the patron saint of leftover Thanksgiving turkey, here is an audio tribute to Signora Tetrazzini, La regina del staccato:

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