The Top Ten D&O Stories of 2011
The year just ended was eventful in many ways. Earthquakes, hurricanes, tornadoes, floods, blizzards and droughts were scattered across the globe, and political unrest shook many countries. In a year filled with such significant developments, events in the world of D&O liability pale by comparison. But even if there were no earth-shaking events, 2011 was nevertheless an eventful year in the directors and officers’ liability arena. Here is my selection of the top ten stories from the world of D&O.
1. M&A Litigation Becomes the Lawsuit of Choice for Plaintiffs’ Securities Attorneys: The traditional focus for any discussion of D&O litigation exposure has been federal securities class action litigation. But in recent years, there has been a shift in the mix of corporate and securities litigation filings. Taking into account both federal and state lawsuit filings, M&A-related lawsuits now outnumber federal securities lawsuit filings and M&A-related litigation is now the lawsuit of choice for many plaintiffs’ securities attorneys.
As a result of legislative changes and U.S. Supreme Court case law developments, “dispossessed plaintiffs’ lawyers” (as one academic recently put it) have been forced to seek an alterative business model. And M&A litigation appears to be an attractive business model for many plaintiffs’ lawyers. Corporate defendants, eager to complete the underlying business transaction, often are keen to settle these cases quickly. Settlements often include a not insignificant provision for plaintiffs’ fees.
The attractions of this business model is drawing competition, as increasingly each merger transaction is attracting multiple separate lawsuits, often filed in differing jurisdictions. The jockeying between the plaintiffs’ lawyers in the competing cases in multiple jurisdictions has led to procedural complications and rapidly increasing costs of defense. Delaware, the traditional forum for this type of litigation, arguably now faced with “market share” competition, is according to some under pressure to show that it is not inhospitable to these kinds of lawsuits, and even to support plaintiffs’ fee awards (about which see more below).
Not only are both defense expenses and plaintiffs’ fee awards in merger objection suits mounting, but it is increasingly common for M&A-related cases to result in cash settlements on an order of magnitude often seen only in traditional securities class action lawsuits. Thus, the Kinder Morgan case, settled in August 2010 for $200 million (refer here); the Del Monte case settled in September 2011 for $89 million (refer here); the May 2010 ACS settlement was $69 million (refer here); and the 2011 Intermix Media settlement was $45 million (refer here).
The new M&A litigation model represents both a high frequency and a high severity risk. The severity risk is particularly acute given the exacerbating effects of escalating defense expenses and rising plaintiffs’ attorneys’ fees. The bottom line is that it is no longer sufficient to focus just on federal securities class action litigation. M&A related litigation is an increasingly important part of the overall mix of corporate and securities litigation. For anyone whose tasks include understanding the risks and exposures associated with corporate and securities litigation, this is an important development with significant implications.
2. Chinese Take-Out: U.S.-Listed Chinese Companies Hit With Class Action Securities Litigation: Every year there seems to be one group or sector of companies that draws the unwanted attention of plaintiffs’ securities attorneys. During 2011, the hot sector was U.S.-listed Chinese companies. There were 39 different U.S.-listed Chinese companies hit with securities class action lawsuits during 2011, representing nearly one-fifth of all securities class action lawsuit filings during the year. Since January 1, 2010, there have been securities class action lawsuits filed against 49 different Chinese companies.
This surge of litigation involving Chinese companies has arisen out of accounting scandals, many of which were first revealed by online analysis, many of whom have short positions in the companies they are attacking. The Chinese companies have attempted to deflect the assertions by charging that the attacks are merely rumors started by interested parties with a financial incentive to drive down the companies’ shares prices. Fair or not, the online reports seem to be leading directly to shareholder litigation, as in many cases the shareholder plaintiffs’ are simply quoting the online analysts’ reports in their complaints.
Obviously not all of these cases are meritorious and indeed some of them have been dismissed (refer for example here). On the other hand, other cases have survived the initial dismissal motions (refer for example here). Even in those cases in which the plaintiffs’ claims survive the initial pleading threshold, their claims stiff face substantial challenges, not the least of which are problems involved with effecting service of process and in conducting discovery in China, as well as deriving from the geographic distances and language issues involved. (Refer here).
Eventually the plaintiffs’ lawyers will simply run out of Chinese companies to sue, but for now the phenomenon shows no sign of letting up. During the second half of 2011, there were a total of 13 Chinese companies sued in securities class action lawsuits in the U.S., including two in December alone.
The recent litigation against the U.S.-listed Chinese companies is a reminder of circumstance-specific events that can drive securities class action lawsuit filings. Countless things determine litigation activity levels, many of which cannot be captured or predicted in historical filing data. Simply put, the numbers vary over time, because, for example, contagion events and industry epidemics happen.
3. Massive Settlements Emerge as the Subprime and Credit-Crisis Litigation Wave Slowly Plays Out: The subprime and credit crisis-related litigation wave is about to enter its sixth year. Though there were additional credit crisis-related lawsuit filings during 2011, the arrival of new cases seems to have largely come to an end. However, there is still a massive backlog of cases filed over the last five years that is yet to be resolved. During 2011, a number of these cases were settled, and in some cases the settlements were massive.
The 2011 settlements include the largest so far in subprime and credit crisis-related cases, the $627 million Wachovia bondholders settlement, about which refer here. Other settlements include the following: Merrill Lynch Mortgage Backed Securities, $315 million (refer here); Lehman Brothers offering underwriters settlement, $417 million (refer here); Washington Mutual, $208.5 million (refer here); Wells Fargo Mortgage Backed Securities, $125 million (refer here); National City, $168 Million (refer here); Colonial Bank, $10.5 million (refer here); and Lehman Brothers executives, $90 million (refer here) and E*Trade, $79 million (refer here).
If you include the Lehman Brothers’ offering underwriters’ settlement, the various subprime and credit crisis lawsuit settlements total about $4.432 billion. The average settlement so far is about $110 million, although that figure is clearly driven upward by the largest settlements. If the Countrywide, Wachovia bondholders and Lehman offering underwriters’ settlements are removed from the equation, the average settlement drops to about $74.7 million.
As impressive as these settlement numbers are, there are still many more cases pending. Of course, a certain number of the pending cases will ultimately be dismissed. But many will not, and eventually those remaining cases will be settled. Although it is impossible to conjecture how large the total tab for all these cases ultimately will be, the implication from the cases that have settled is that the total amount will be massive.
The possibilities here may have significant implications for D&O insurers. Of course, not all of these amounts will be covered by D&O insurance. But a significant chunk will be. Indeed, a number of the recent settlements will be funded entirely or almost entirely by D&O insurance, including the D&O portion of the WaMu settlement, the Colonial Bank settlement, the E*Trade settlement and the Lehman Brothers executives’ settlement. Interestingly, the Lehman executives’ settlement will come close to exhausting what is left of Lehman’s $250 million insurance tower.
In other words, the D&O insurers have had some very large bills to pay. Signs are that there will be further amounts due in the months ahead.
4. Costs Incurred in Connection with Informal SEC Investigation Held Not Covered: One of the perennial D&O insurance coverage questions is whether or not a D&O insurance policy provide coverage for defense expenses and other costs incurred in connection with an informal SEC investigation. In October 2011, in a case that was closely watched in the D&O insurance industry, the Eleventh Circuit issued a per curiam opinion affirming a lower court holding that costs Office Depot had incurred in connection with an informal SEC investigation and investigating an internal whistleblower complaint were not covered under its D&O insurance policies.
The sheer dollar value of the costs for which Office Depot had sought coverage underscores the extent of the problems involved. Office Depot had incurred tens of millions of dollars in expense before the SEC investigation became formal. Under the circumstances presented and based on the policy language at issue, the district court held and the Eleventh Circuit affirmed that Office Depot did not have insurance coverage for these costs. The holding was a reflection of the specific policy language at issue, but D&O insurers undoubtedly will try to rely on the holding in other circumstances in which coverage is sought for costs incurred in connection with informal SEC investigations.
Meanwhile, the insurance marketplace has evolved in recognition of policyholders’ interest in having insurance coverage for the costs of informal SEC investigations. Recently, some carriers have been willing to provide coverage for costs individuals incur in connection with informal SEC investigations. In addition, at least one carrier now offers a separate insurance product that provides coverage for costs that the entity itself incurs in connection with an informal SEC investigation. Although this entity protection for informal SEC investigative costs is subject to a large self-insured retention and to coinsurance, the fact remains that if such a policy had been available to Office Depot and if Office Depot had had such a policy in place, at least a significant part of Office Depot’s costs of responding to the informal SEC investigation might have been covered.
Policyholder advocates undoubtedly will take the position that the Eleventh Circuit’s opinion in the Office Depot case does not represent the final word on the question of D&O insurance coverage for costs incurred in connection with informal SEC investigation. In making these arguments, the policyholder advocates undoubtedly will seek to rely on the Second Circuit's July 2011 opinion in the MBIA case, in which the court held that costs incurred in voluntarily responding to a governmental investigation are covered. (The MBIA case is itself also a reflection of the policy language involved and circumstances presented, including in particular the fact that most of the costs at issue were incurred after the SEC had issued a formal investigative order, by contrast to the Office Depot case, where most of the costs were incurred before the investigation was formalized.)
These questions undoubtedly will continue to be disputed and even litigated. But it will be interesting to see how the marketplace continues to evolve as the industry continues to try to craft solutions to this recurring problem.
5. FDIC Litigation Against Failed Bank Directors and Officers Slowly Emerges: Since January 1, 2008, there have been 414 bank failures, including 92 in 2011 alone. Though the number of bank closures this past year represents a decline from the prior year’s total of 157, the likelihood is that there are further bank failures ahead in 2012, albeit at a reduced pace from recent years. (The January 3, 2012 Wall Street Journal comments that “failures will be a part of the landscape for many months, maybe years, as weak banks take a long time to recover or fail.”) But even if the number of new bank failures may finally be starting to decline, the FDIC’s pursuit of litigation against the directors and officers of failed banks may just be getting started.
During 2011, the FDIC stepped up its failed bank litigation activity. The FDIC filed 15 lawsuits against directors and officers of failed banks in 2011, bringing the total number of FDIC failed bank lawsuits to 17. Signs are that the number of FDIC lawsuits will continue to grow in the months ahead. According to the FDIC’s website, as of December 8, 2011, the FDIC has authorized suits in connection with 41 failed institutions against 373 individuals for D&O liability for damage claims of at least $7.6 billion. These figures representing the authorized lawsuits contrast starkly with number of lawsuits that the agency has actually filed: So far, the agency has filed only 17 lawsuits against 135 former directors and officers of 16 failed financial institutions. Given the discrepancy between the number of suits authorized and the number of suits filed, there clearly are many more suits in the pipeline, with even more lawsuits likely to be authorized in the months ahead.
As the FDIC’s failed bank lawsuits have begun to emerge, settlements of these cases are also slowly developing. The most noteworthy of the settlements so far is the well-publicized resolution of the FDIC’s lawsuit against three former WaMu officers. Although widely reported as having a value of $64.7 million, the cash value of the settlement was actually about $40 million, as discussed here. All but a very small portion of the cash component was paid for out of WaMu’s directors and officers’ insurance coverage. Although it is interesting that the individual defendants were called upon to contribute out of their own assets toward the settlement, the fact is that D&O insurance represented almost all of the cash component of the settlement.
The point here is that as the FDIC failed bank lawsuits accumulate in the coming months and as the filed cases move toward resolution, D&O insurers could be called upon to contribute amounts toward defense and resolution of these cases that in the aggregate could be massive.
6. Eurozone Crisis Includes Corporate Liability Exposures: The financial crisis gripping the European economic community has many dimensions. As governments wrestle with concerns about sovereign debt of Eurozone countries, as well as unemployment and unrest, companies exposed to European sovereign debt face perils of their own. As the fallout from the collapse of MF Global demonstrates, the hazards these companies face include, among many other concerns, liability exposures stemming from the companies’ investments in European sovereign debt.
Among the many disturbing features of MF Global’s demise is the speed of its collapse. And inevitably its collapse was immediately followed by an onslaught of securities class action lawsuit filings against the firm’s directors and officers. MF Global collapsed because of its exposure to European sovereign debt. The company is of course far from the only enterprise exposed to European debt. A host of other financial institutions and banks are also exposed and many more enterprises are exposed to the companies with European debt exposure. The possibility of sovereign debt rating downgrades or even debt write-offs looms over the firms carrying these assets on their balance sheets.
Though the larger problems for the global financial marketplace clearly are of a much higher order, these issues also pose a challenge for D&O insurance underwriters. As noted above, there is not just the question of whether or not a company is exposed to European sovereign debt. There is also the far more difficult to discern question of whether or not a company is exposed to a company that is exposed to European sovereign debt. If the European difficulties were to evolve from a crisis to a disaster – for example, though the withdrawal of one or more countries from the Euro – the aftereffects could be even more widespread. As MF Global’s rapid demise illustrates, these kinds of concerns are sufficient to quickly send a company into bankruptcy.
There is no way to know for sure, but I suspect strongly that as the New Year progresses, there will be a lot more to be said about European sovereign debt risk, at both the global and individual company levels.
7. Whistleblower Rules Go Into Effect, Whistleblower Lawsuits Emerge: The SEC issued its implementing regulations with respect to the Dodd-Frank whistleblower provisions in August 2011. In November 2011, the agency released its first report to Congress, as required by the Dodd-Frank Act, on whistleblower activities, as of the end of the 2011 fiscal year end on September 30, 2011.
Though the SEC’s report reflected only a seven week time period, it revealed a heightened level of whistleblower reporting. In just the first seven weeks, the program recorded 334 whistleblower reports, which implies an annualized level of nearly 2,500 reports. Interestingly, about 10 percent of all whistleblower reports during the period reflected in the study originated outside the United States. The SEC made no whistleblower bounty payments during the period reflected in the study, as permitted under the Dodd-Frank Act. It seems likely that as the agency makes bounty payments additional whistleblowers will be motivated to come forward.
With the implementation of provisions for potentially rich whistleblower bounties under the Dodd-Frank Act, there have been concerns that the incentives will not only lead to increased numbers of reports and increased enforcement activity, but that the regulatory action will in turn generate follow-on civil litigation. As discussed here, a December 2011 securities class action lawsuit filed against Bank of New York Mellon give a glimpse of how heightened whistleblower activity could lead to increased follow-on civil litigation.
The lawsuit followed whistleblower reports that the company engaged in a scheme to fraudulently overcharge its customers for foreign currency exchange transactions. Although the whistleblower allegations first emerged in separate whistleblower lawsuits, the foreign currency exchange allegations are also the subject of whistleblower reports to the SEC. In addition to the securities class action lawsuit, the whistleblower allegations have also triggered multiple regulatory actions. The train of events that the BNY Mellon whistleblower allegations set in motion shows how the revelation of whistleblower allegations can lead not only to significant regulatory action but also to significant follow on civil litigation.
Given the substantial bounties for which the Dodd-Frank Act provides, it seems likely there will be increased numbers of reports to the SEC, which in turn could mean increased levels of enforcement activity. Along with all other concerns these possibilities present, there is also the concern that the increased number of reports and increased enforcement activity could, following the same sequence illustrated in connection with the BNY Mellon whistleblowers, lead to a surge in follow-on civil litigation. As we head into 2012, we will have to watch whether increased whistleblowing will lead to increased follow-on civil litigation, similar to the suit against BNY Mellon.
8. Aggrieved Overseas Investors Seek Litigation Alternatives Outside the United States: For many years, the United States was the forum of choice for aggrieved investors to seek redress, regardless of whether or not the investors purchased their shares in the United States. However, the U.S. Supreme Court’s June 2010 decision in Morrison v. National Australia Bank abruptly and unexpectedly eliminated access to U.S. courts for investors who purchased their shares outside the U.S. As a result, these investors increasingly are seeking alternative means to pursue their claims. Though we are still in the earliest days following the Morrison decision, there seem to be significant indications that aggrieved investors are developing a new playbook that includes resort to non-U.S. courts.
Investors’ pursuit of claims outside the United States was not long in coming after the Morrison decision and as its implications began to emerge in the lower U.S. courts. For example, in January 2011, after investors’ claims in U.S. court against Fortis were dismissed based on the Morrison decision, investors filed an action in Dutch court seeking remedies under Dutch law, but raising the same allegations that previously had been asserted in U.S. courts. Similarly, in December 2011, hedge funds and other investors whose action against Porsche had been dismissed from U.S. courts based on Morrison filed an action raising the same allegations against the company and its management in a German court.
Developments in other jurisdictions also reflect investors’ efforts to develop alternative remedies in the absence of access to U.S. courts. Among other things, at least two class actions pending in Canadian courts have not only survived dismissal motions but have had global classes certified. As discussed here, investors have also shown a willingness to pursue claims in a variety of other countries, including, for example, Germany and Australia. Recent statutory amendments in other countries (including, in particular, Mexico) may lead to investors in those countries to seek to pursue claims there.
Increased litigation and regulatory exposure outside the United States has a variety of implications, not the least of which concerns D&O insurance. As companies and their directors and officers face increased exposures on a global basis, D&O insurance policies will be called upon to respond in new and unusual situations. These developments in turn will require policies that are well adapted to the changing circumstances.
9. Judge Rakoff Rejects Settlement of SEC Enforcement Action Against Citigroup: Southern District of New York Judge Jed Rakoff’s November 2011 rejection of the $285 million settlement of the SEC’s enforcement action against Citigroup was not the first occasion on which Rakoff rejected a proposed SEC settlement. But this latest rejection has caused quite a stir, and not only because of the sharp rhetoric he used in rejecting the settlement (among other things, he derided the settlement because it “shortchanged” investors.) The most significant aspect of Rakoff’s rebuff is his refusal to accept a settlement in which Citigroup neither admitted nor denied the SEC’s allegations.
The SEC, perhaps stung by the Rakoff’s sharp words, and even more concerned about the possibility that it might be constrained from the entry into future no admit/no deny settlements, has appealed Rakoff’s ruling to the Second Circuit. The SEC is right to be concerned about the implications of Judge Rakoff’s ruling. Following Judge Rakoff’s ruling, at least one other court has questioned a proposed SEC settlement that contained the “neither admit nor deny formulation.”
The problem for the SEC is that if proposed settlements cannot be approved unless the target defendants admit to wrongdoing, it may become significantly more difficult to settle cases and the SEC will be forced to take more enforcement actions to trial. This would not only put an enormous strain on the agency’s resources, but it could result in an overall reduction in the agency’s enforcement reach as it is forced to concentrate both more time and means on fewer enforcement actions.
The inability to enter into a no admit/no deny settlement presents a highly unattractive picture for target defendants as well. If fewer enforcement actions settle and more enforcement actions are forced to trial, the costs of defending an SEC enforcement action could escalate substantially. Target defendants unable to avoid the risks and uncertainty of trial without admitting wrongdoing will have to consider the possible effects of any admission on separate private civil actions. Any admissions in the enforcement actions could undermine their defenses in the separate civil actions. Moreover, depending on what is admitted, the admissions could have the further also undermine the target defendant’s insurance coverage by triggering a conduct exclusion on the defendant’s insurance policy.
For these and a host of other reasons, the SEC’s appeal of Judge Rakoff’s ruling to the Second Circuit will be very closely watched. Crucially, however, the Second Circuit has not yet agreed whether or not it will actually hear the appeal of Judge Rakoff’s ruling. In additiona, there is always the possibility that Citigroup and the SEC will reach an agreement that Judge Rakoff finds acceptable (a footnote in his opinion rejecting the initial settlement does lay out a schematic for a settlement that would be acceptable to him, as I discuss here). Depending on how it all finally goes down, this case has the potential to be one of the top stories of 2012, as well.
10. A Big Fee Award in Delaware Gets Everybody’s Attention: Sometimes in litigation, a case that results in a big number is interesting in and of itself. And on that score, Delaware Chancellor Leo Strine’s October 2011 post-trial damages award of $1.263 billion in a lawsuit arising out of Grupo Mexico’s 2005 sale of Minerva Mexico to Southern Peru Copper Corporation certainly qualifies as interesting. (The later addition of pre-judgment and post-judgment interest increased the amount of the award to $2 billion). But what really has drawn attention to the case is Strine’s award to the plaintiffs’ of fees amounting to 15% of the damages and interest – that is, $300 million. A December 28, 2011 Wall Street Journal article entitled “Christmas Comes Early for These Lawyers” (here) describes the award.
As noted in a December 28, 2011 WSJ.com Law Blog post (here), the $300 million fee award may be the largest fee award ever in a shareholders’ derivative suit. Indeed it appears to be one of the largest fee awards in any corporate or securities case, approaching in order of magnitude the awards in the massive Enron and World Com cases (where the fees awarded were $688 million and $336 million, respectively).
Grupo Mexico undoubtedly will appeal both the damages award and the fee award. Whether or not the $300 million award ultimately withstands scrutiny, there are reasons to be concerned about the award. As noted above with respect to M&A litigation, Delaware’s courts are facing competition and appear to have been losing “market share” for corporate litigation. At least some interpreters have concluded, as reported in the Journal article linked above, that the plaintiffs’ fee award is a not-so-subtle signal to plaintiffs’ lawyers that Delaware’s courts are “open for business.” Other interpreters suggested that the fee award represents a “message to the plaintiffs’ bar.”
It is an obvious concern if Delaware’s judges feel obliged -- in order remain competitive in the jurisdictional competition and to try to preserve declining corporate litigation market share -- to prove that plaintiffs’ lawyers will be rewarded for resorting to the state’s courts.
Bloggers of the World, Unite!: Everyone here is pretty much reconciled to the fact that writing a blog is not exactly accorded equal dignity with, say, writing for The New Yorker. So we were all very gratified by the article in December 31, 2011 issue of The Economist entitled "Marginal Revolutionaries" (here), in whch the magazine reports that "the financial crisis and the blogosphere have opened up mainstream economics to new attack." Among other things, the article cites "the power of blogging as a way of getting fringe ideas noticed." The article recounts the experiences of the "invisible college of bloggers" whose revolutionary economic analyses have moved from the fringe to become part of the central economic dialog of our times.
In the immortal words of the theme song of revolutionaries everywhere , "Allons enfants de la patrie, Le Jour de gloire est arrivé!"
Perspective: Those worried about the troublesome events of the day may want to spend a few minutes contemplating "The Hisory of the Earth as a Clock" (here). In the grand scheme of things, the current crises are a mere passing cloud. (Source: UW-Geoscience).
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Time-honored legal principles typically shield corporate officers and shareholders from direct personal liability for legal violations of the corporation itself, consistent with the notion that the corporation itself has a distinct and separate legal identity. However, as I noted in a prior post (
