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

In a recent post (here), I described the "new wave" of credit crisis lawsuits, in which the companies involved were damaged by their exposures to other companies experiencing credit crisis losses. The latest of these new wave lawsuits to be filed involves the Federal Agricultural Mortgage Corporation, or "Farmer Mac" as it is more familiarly known.

Freddie Mac is a government sponsored entity that was established to support a secondary market for agricultural real estate and rural housing mortgage loans. According to their December 5, 2008 press release (here), plaintiffs’ lawyers have initiated a securities lawsuit against Farmer Mac and certain of its directors and officers in federal court in the District of Columbia. According to the press release,

a) defendants were inflating Farmer Mac's results through manipulations relating to the characterization of impairment costs and/or depreciation expenses which inflated the Company's reported cash flows, gross margins and Core and GAAP-earnings; (b) the Company's financial results were inflated by defendants' use of overly optimistic assumptions of asset valuations and investments, which were also reflected in defendants' misuse of mark-to-market accounting; (c) the Company's exposure to investment losses and credit problems of trading partners such as Lehman Bros. and Fannie Mae was much greater than represented; and (d) the Company was not on track to meet or exceed guidance sponsored or endorsed by defendants.

Investors only first learned the truth about Farmer Mac on September 12, 2008, when its shares closed at $16.56, from an open of $23.78, losing over 30% of their value in one day after the Company filed documents with the SEC saying it would incur significant charges due to its exposure to Fannie Mae securities. Further, shares of the Company continued to trade down thereafter to close to $2.00 per share following announcements concerning the resignation of its Chairman of the Board and losses related to debt issued by Lehman Brothers.

The involvement of the allegations relating to the company’s Fannie Mae and Lehman Brothers investments is the reason I have characterized this case as a new wave credit crisis lawsuit. That is, it was its exposure to these other companies that caused Farmer Mac’s problems, at least in part.

However, because of the allegations relating to Farmer Mac’s own asset valuations, including its alleged misuse of mark-to-market accounting, the lawsuit also has characteristics of the more conventional subprime and credit-crisis related type of litigation that has accumulated over the last two years.

In any event, I have added the Farmer Mac lawsuit to my running tally of subprime and credit crisis-related securities lawsuits, which can be accessed here. With the addition of the Farmer Mac lawsuit, the current tally of subprime and credit crisis-related securities lawsuits now stands at 132, of which 92 have been filed in 2008.

And Speaking of Credit Crisis Litigation: One of the more noteworthy events during the current credit crisis was the collapse of Bear Stearns in March 2008 (which already seems like a long time ago, doesn't it?) and its acquisition by JP Morgan Chase.

Following JP Morgan’s March 16, 2008 agreement to acquire Bear Stearns, shareholders of Bear Stearns filed a New York (New York County) Supreme Court lawsuit against both Bear Stearns and JP Morgan, alleging that the $10 per share consideration JP Morgan paid for Bear Stearns was inadequate. The plaintiffs sought damages from Bear Stearns’ directors for claimed violations of their fiduciary duties and from JP Morgan for its allegedly tortious conduct in effecting the merger.

In a December 4, 2008 opinion (here), Judge Herman Cahn granted the defendants’ motion for summary judgment. The court rejected the plaintiffs’ challenges to the deal, holding that the business judgment rule applied, and that under the rule, the court could not second guess the board:

In response to a sudden and rapidly-escalating liquidity crisis, Bear Stearns’ directors acted expeditiously to consider the company’s limited options. They attempted to salvage some $1.5 billion in shareholder value and averted a bankruptcy that may have returned nothing to the Bear Stearns’ shareholders, while wreaking havoc on the financial markets. The Court should not, and will not, second guess their decision.

In a December 5, 2008 post on the Harvard Law School Corporate Governance Blog (here), the attorneys that represented JP Morgan in the Bear Stearns case discuss the decision in greater detail, noting that "as the credit crisis continues and evolves, boards will continue to face serious challenges. The Bear Stearns opinion confirms, however, that the directors that act diligently and in good faith should not have exposure for their actions."

The suggestion that the Bear Stearns opinion represents a precedent in support of the protection of directors arguably has already been borne out in a North Carolina court.. As Francis Pileggi discusses on his Delaware Corporate and Commercial Litigation Blog (here), the North Carolina court considering shareholders’ challenges to the merger of Wachovia and Wells Fargo has dismissed the action, with reference to  the New York court’s decision in the Bear Stearns case. The Wachovia and Wells Fargo merger was arranged in similarly unusual circumstances in light of the economic turmoil that in very short order saw some of the countries largest financial institutions "go under" or need "bailouts."

A December 6, 2008 Charlotte Observer article describing the ruling in the Wachovia case can be found here.

Fake ID: In a recent post (here), I analyzed the problems associated with credential inflation and reviewed famous examples of identity misrepresentation. However, a recent episode involving prominent attorney Marc S. Dreier, the name partner of Drier LLP, may represent a whole new level of identity misrepresentation.

As reported on December 5, 2008 on the City Room blog (here), earlier last week Toronto police arrested Drier for "fraudulent impersonation." A December 8. 2008 Law.com article (here) reports that at a meeting in the offices of the Ontario Teachers’ Pension Plan with representatives of Fortress Investment Group and involving a multimillion dollar deal between the two organizations, Drier "pretended to be Michael Padfield, senior legal counsel for investments at Ontario Teachers." The Wall Street Journal reports (here) that Dreier passed out Padfield's business card and signed documents as Padfield. When Padfield himself arrived at the meeting, police were called.

As if that were not enough, three attorneys from the Wilson Sonsini firm have been retained "to examine firm operations and finances, including escrow accounts." Whether or not these concerns are related to Drier’s arrest is not specified. However, the Above the Law blog reports here that as much as $38 million is missing from the Dreier firm’s client escrow account.

The Journal also reports that federal prosecutors are looking into concerns raised by Solow Realty, a former client of the firm, "that Mr. Dreier allegedly was selling to hedge funds fraudulent documents falsely purporting to be debt instruments of Solow without Solow's authority."

The firm’s holiday party, planned to take place last Thursday night at the Waldorf Astoria, was cancelled. I guess it is hard to party when your name partner is (or was) in jail and your client escrow account is missing tens of millions of dollars.

I doubt even John Grisham could have made this one up.

UPDATE: The Marc Dreier story just keeps getting weirder and weirder. In a totaly bizarre development, on December 8, 2008, the SEC filed a complaint against Dreier in which it accused him of "fraud in connection with an elaborate scheme that raised at least $113 million from the sale of bogus promissory notes." Read the SEC's press release here. The press release that Dreier has already admitted his involvement with the phony note sale. The WSJ.com Law Blog reports (here), that the DoJ has also filed a criminal complaint against Dreier and that he was arrested upon his return to the U.S. on Sunday. The firm's lender has also sued the law firm because the firm is in default on its line of credit.

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A November 13, 2008 Wall Street Journal article entitled "Inflated Credentials Surface in the Executive Suite" (here) reported on multiple instances where corporate officials lacked claimed academic or work credentials. The article is based on a survey conducted by Barry Minkow, a convicted felon who did jail time for his role in the ZZZZ Best stock scam, who now heads the Fraud Discovery Institute.

The article cites seven examples where corporate officials allegedly falsified credentials. The article notes that this "may be enough to raise investor concerns about executive credibility as well as company procedures for vetting by management and board members." The article also cites industry sources that as many as 20% of job seekers "are found to have inflated their education credentials."

The day after this article appeared, the Journal also reported (here) that J. Terrence Lanni, the departing Chairman and CEO of MGM Mirage, is now "in a dispute with his alma mater over his academic credentials." Contrary to the company’s published statements about Lanni’s education, USC business school has no record of Lanni having received an MBA there. The question about Lanni’s education only came to light after the Journal raised questions based on Minkow’s research.

The November 13 Journal article quotes a Wharton School business ethics professor as saying "I’m very concerned that if people believe you can lie and get away with it, then down the line people will start cheating on their expense report, they’ll start misrepresenting their billable hours, they’ll start misusing their corporate funds."

Credential Inflation and Securities Litigation: Given this sense that résumé falsification (or at least its toleration) could engender a culture of deception, it is hardly surprising that allegations of credential misrepresentation have from time to time made their way into securities class action lawsuits.

For example, in the October 2006 securities class action lawsuits filed against Xethanol and certain of its directors and officers (about which refer here), the plaintiffs allege that the company’s chairman and CEO had "fabricated his résumé" among other things, by allegedly falsely claiming to have worked at Unilever, Northrup Grumman, and Reed Elsevier.

Similarly, in the January 2003 case filed against MCG Capital (about which refer here), the plaintiffs alleged that the company’s November 2001 IPO offering documents misrepresented the "credentials, credibility and integrity" of the company’s Chairman and CEO. Specifically, the complaint alleged that the offering documents misrepresented that the individual had earned a B.A in Economics from Syracuse, when in fact he had not. (It should be noted that the case was later dismissed and the Fourth Circuit affirmed the dismissal.)

Securities lawsuits also frequently allege that companies have misled investors by failing to disclose key details of corporate officials’ backgrounds. For example, in the November 2006 lawsuit filed against Pegasus Wireless and certain of its directors and officers (about which refer here), the complaint alleges that the company’s failed to disclosure the CEO and President’s prior involvement with bankrupt companies, as well as with other companies whose histories the complaint suggests "suspected stock and market manipulation." The company’s CFO is also alleged to have a "history of involvement with failed and suspect ventures," as well as past ties to individuals with "felonious" records.

This last example arguably goes well beyond mere credential inflation, but it does underscore how integrally misrepresentations or omissions about key officials’ histories potentially can affect investor perceptions. That in part explains why disclosure of credential inflation or résumé falsification can produce a significant marketplace reaction. As Minkow is quoted as saying in the Journal article, "you have to ask yourself, as any good investigator would say, what else could there be?"

Identity Misrepresentation: A Short History: The problems of credential inflation and résumé falsification are not limited to the corporate world. There have been numerous recent examples in government, academia and elsewhere. Many readers will recall, among the more notable recent examples, the tale of George O’Leary, who was fired five days after being hired as Notre Dame’s football coach, after it was discovered that he had falsely claimed to have a master’s degree in education and to have played college football for three years. The Wall Street Journal has compiled an extensive list of other recent examples, here.

There is a temptation to classify these deceptive practices as just another byproduct of our iniquitous era of botox and breast implants, where packaging is valued above substance and identity represents not things as they are but as people can be made to believe them to be.

Identity misrepresentation is not, however, unique to our time. These kinds of impostures go back as far as biblical times, where, for example, Jacob’s mother disguised him as his twin brother Esau so that Jacob would received their father’s blessing, intended for Esau.

Similarly, history is full of royal pretenders and alleged monarchs. During the reign of England’s Henry VII, there were actually two pretenders. The first, Lambert Simnel, a commoner who was crowned by Yorkist supporters as the supposed "King Edward VI," and Perkin Warbeck, who pretended to the First Duke of York and the younger son of Edward IV. And of course, there was Anna Anderson, who was claimed to be the Grand Duchess Anastasia, youngest daughter of Tsar Nicholas II.

Literature is full of examples as well. These include the numerous instances of gender disguise in many of Shakespeare’s play, such occurs in Twelfth Night and As You Like It. More recent examples of gender disguise occur in Tootsie and Yentl.

One of the more entertaining examples of identity misrepresentation occurs in one of The D&O Diary’s favorite books, The Count of Monte Cristo, by Alexandre Dumas, in which Edmond Dantès dupes others into believing him to be a Count so that he can revenge himself on his enemies and tormentors.

Identity, Ambition and the Need for Affirmation: The most extensive literary examination of the interplay between the portrayal and the reality of identity may be F. Scott Fitzgerald’s The Great Gatsby. At one level, the book is about nothing more than Nick Carraway’s effort to understand who Gatsby really is.

The sycophants and partygoers that surround Gatsby at the book’s outset aren’t quite certain, but suspect that he may be a bootlegger and may even have killed a man. Gatsby tells Nick an elaborate tale of having been educated at Oxford and then having inherited the family fortune. But that Gatsby’s persona is a façade is so obvious that one of the uninvited partygoers at Gatsby’s house is astonished to learn that the volumes lining the shelves in Gatsby’s library are actually real books.

Gatsby’s self-portrayal is an elaborate invention, a manufactured identity that, as Nick puts it, sprang from Gatsby’s "Platonic conception of himself." Gatsby’s self-contrivance is all part of his involved effort to prove himself worthy of Daisy Buchanan. The origins of Gatsby’s obsession with Daisy are perhaps best understood in his explanation that Daisy’s voice is so fascinating because it is "full of money."

Driven by his obsession for Daisy, Gatsby (born James Gatz) attempts to recreate himself within an intricate structure of credential inflation. The Oxford education proves to have been only a five-month stint following the war. His wealth, supposedly inherited, was actually acquired by means that Gatsby himself is unwilling to discuss.

Gatsby’s determined striving helps explain the credential inflation to which contemporary corporate individuals seem particularly prey. Ambition and desire, combined with a desperate need for affirmation or acceptance, drives these individuals to represent themselves as improved versions of themselves, or perhaps even as somebody different altogether.

In any event, it is clear that when inflated credentials are involved, it may be indispensible to make certain that the books are real.

The Ultimate Inflated Credential: Divinity: Among the most outrageous identity misrepresentations in literature is that of Danny Dravot who, in Rudyard Kipling’s The Man Who Would Be King, is all too willing to be taken by the people of Kafiristan as a god, based on their delusion that he is the son of Alexander the Great. It all ends very badly for Danny and his sidekick, Peachey Carnahan, when the Kafiris discover that Danny is "Not god, not devil, but man!"

The story was made into a memorable 1975 movie (now somewhat disturbing for its colonialist presumptions) starring Michael Caine and Sean Connery. In this video excerpt, Danny and Peachy reckon the benefits of Danny being taken for a god, as well as the secrecy their deception requires:

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