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 January 22, 2013 opinion (here), Southern District of New York Judge J. Paul Oetken has dismissed one of the many securities class action lawsuits that were filed against U.S.-listed Chinese companies in 2011. Though the primary interest in the case may be that it involves U.S. securities suit against a Chinese company, Jinkosolar Holdings, the case is also interesting with respect to the alleged misrepresentations on which the suit is based, which relate to the environmental problems in one of the company’s manufacturing facilities.

Jinkosolar is a manufacturer of solar technology products with operations based in China. In May 2010, the company conducted an Initial Public Offering of American Depositary Shares on the New York Stock Exchange. In November 2010, the company completed a secondary offering.

In April and May 2011, the company had a series of communications with the Chinese environmental authorities regarding hazardous waste disposal issues at its Zhenjian plant. The company did not disclose these communications to its shareholders. However, as the Court later put it, a “kerfuffle” at the company’s plant “forced Jinkosolar’s hand.” In August and September 2011, Residents living near the plant became concerned about a large scale fish-kill near the plant. In mid-September, the media began reporting on locals’ demonstrations outside the company’s plants. In two press releases in late September, the company announced that it had suspended operations at the plant and also revealed the earlier communications with the environmental authorities. As the news came out, the price of the company’s ADSs declined 41%

In October 2011, holders of the company’s ADSs filed a securities class action lawsuit in the Southern District of New York against the company, eight directors and officers of the company; and the company’s offering underwriters. The plaintiffs’ complain asserted claims under both the ’33 Act and the ’33 Act. In support of their allegations, the plaintiffs relied on three statements in the company’s offering prospectus in which the company explained its environmental compliance efforts and the consequences to the company if it were found to be in violation of the applicable environmental requirements. The defendants moved to dismiss.

In his January 21, 2013 order, Judge Oetken granted the defendants’ motions to dismiss. Judge Oetken found with respect to two of the three statements from the prospectus on which the plaintiffs sought to rely that he could “easily dispense” with the allegations. He noted with respect to these two statements that:

These paragraphs do, of course, explain to shareholders that Jinkosolar is obliged to follow certain regulations. But if anything, they weigh the pluses and minuses of following such regulations with a disquieting frankness. The first paragraph, for instance, explicitly balances the costs of “compliance” with safety regulations with the “adverse publicity and potentially significant monetary damages” stemming from “non-compliance.” Similarly, the second paragraph notes that Jinkosolar is “subject” to Chinese regulations, but – particularly when read alongside the first paragraph – does nothing to indicate any sort of commitment on the part of Jinkosolar to follow those regulations.

The third Prospectus statement on which the plaintiffs sought to rely presented, Judge Oetken found, “a more complicated matter.” The statement indicates, among other things, that the “we generate and discharge chemical waste, waste water, gaseous waste, and other industrial waste,” reiterates the company’s monitoring efforts and adds that “we are required to comply with all PRC national and local environmental protection laws and regulation.”

With respect to these statements, the plaintiffs argued that these statements “falsely imply that Jinkosolar had an effective pollution treatment system and a good pollution record, suggesting that the company had put the environmental issues “in play” and creating an obligation to keep shareholders updated.

Judge Oetken said that was “a close call” whether the statements on which the plaintiff’s sought to rely are materially misleading. In particular one sentence “does give the court pause”: the sentence stated that “We also maintain environmental teams at each of our manufacturing facilities to monitor waste treatment and ensure that our waste emissions comply with PRC environmental standards.” Judge Oetkin said that one way the sentence could be read is to signify that the company is able to “ensure that our waste emissions comply with PR environmental standards. “ But read another way, the statement is merely saying that the environmental teams are “maintained” with the purpose or function to “monitor and to ensure” compliance.

The Court found that the second of these two alternative readings is “the more sensible one.” The Court went on to say that it “cannot say that a reasonable investor would, or even could, read this one ambiguous sentence as a pronouncement that Jinkosolar is ‘ensuring’ environmental standards were met.” This, the court said, is “all the more true given how cautious Jinkosolar was in it Prospectus.” The company “carefully laid out the plusses and minuses” of abiding by the Chinese regulations and “underscored to investors that fines due to pollution are a real possibility.” These warnings, “taken together with the overall weakness of the instances f material misstatements and omissions proffered by Plaintiffs, indicate that no reasonable investor coul d have believed that the Prospectuses ensured a positive environmental record.”

In granting the defendants’ motions to dismiss, Judge Oetken did not expressly indicated whether or not the dismissal was with prejudice. However, in his final line of his opinion, he did direct to Clerk to “close this case.”

Discussion

For many readers, the primary interest of this case will be that it involves a U.S.-listed Chinese company. However, unlike many of the U.S.-listed Chinese companies that have been hit with securities class action lawsuits in recent years, this company did not obtain its listing by way of a reverse merger transaction. This company completed a full-blown IPO, which may have made a difference in the outcome of this case.

It was only as a result of the company’s IPO that the company completed a full and detailed Prospectus. (The company also completed a full Prospectus in connection with its secondary offering.) The Prospectus contained extensive and detailed precautionary statements. It was the detail and extent of these statements that seemed to have made a difference to Judge Oetken. Thus, in his opinion, Judge Oetkin refers to what he calls the “disquieting frankness” of the company’s disclosures regarding its environmental compliance risks.” He also noted “how cautious” the company was in its environmental compliance risk factors in its Prospectuses.

Because of the depth of the disclosures in its offering documents, Jinkosolar was able to make arguments and raise defenses in reliance on the detailed Prospectus disclosures. Because so many of the U.S.-listed Chinese companies did not complete a full-blown IPO, but rather obtained their U.S. listings through reverse merger transactions, they likely did not create offering documents with similarly precautionary disclosure. For that reason, the outcome of this dismissal motion ruling may not be all that helpful to many of the other U.S.-listed Chinese companies involved in U.S. securities suits. Indeed, most of those other companies are unlikely to be able to raise the kinds of arguments that Jinkosolar raised here, and certainly seem unlikely to be able to cite disclosure statements that a court might describe as reflecting “disquieting frankness.”

For me, the most interesting thing about this case is not that it involves a Chinese company defendant, but rather that it involves alleged misrepresentations with respect to environmental liabilities and exposures. As I have previously noted on this blog (refer, for example, here), these kinds of cases, involving alleged misrepresentation of environmental issues do arise periodically. The possibility of this kind of claim is often a key concern at the time of D&O insurance policy placement, as the question often arises whether the standard policy’s pollution exclusion will preclude coverage for a securities claim based on environmentally-related disclosures.

As this case demonstrates, it is critically important for the standard pollution exclusion to be revised to carve back coverage for securities claims and derivative claims based on environmental disclosures. (It is worth noting that many of the modern Excess Side A DIC insurance policies often have no environmental or pollution exclusion. In addition, some carrier’s primary D&O insurance forms omit the standard pollution exclusion and simply provide that the policy’s definition of “Loss” does not include costs of environmental remediation. Unless the insured company’s primary D&O insurance policy omits the environmental exclusion in this way, it will be indispensable for the standard environmental liability exclusion be revised in order to preserve coverage for securities claims and derivative claims based on alleged misrepresentations or misconduct relating to environmental issues. These considerations are likely to become increasingly important as environmental disclosure issues become of greater regulatory concern (about which refer here).

The one final thing I will say about this case and the fact that it does involve a U.S.-listed Chinese company is that it is yet another case involving a Chinese company in which the plaintiffs have struggled. Although some of the U.S. securities suits have managed to survive motions to dismiss, others (like this one) have not. Even the cases that have survived motions to dismiss have proved challenging for plaintiffs as they have faced numerous procedural hurdles (refer for example here). In addition, in other cases involving U.S.-listed Chinese companies that have reached the settlement stage, the settlement amounts have proved to be modest. (On the other hand, as noted here, E&Y did recently agree to settle a Canadian securities case relating to Sino-Forest, and a Hong Kong arbitration panel did just make a more than $70 million award based on its determination that China MediaExpress Holdings is a “fraudulent enterprise.” Notably, and arguably ironically, neither of these big recoveries involved one the many U.S. court securities suits filed against Chinese companies.)

Special thanks to a loyal reader for sending me a copy of Judge Oetken’s opinion in this case.  

Upcoming Event: Readers of this blog may be interested to know about a seminar that will be held at the St. John's School of Risk Management in New York on February 5, 2013 entitled "A Day at Lloyd's: An Introduction to the Lloyd's Market Structure and the Use of ADR to Manage Disputes Involving Lloyd's."  The event will be moderated by my good friend Perry Granof and includes a number of distinguished speakers, among them another good friend, Nilam Sharma of the Ince & Co. law firm. The event, which will take place on the day prior to the beginning of the PLUS D&O Symposium, runs from 12:30 to 5:00 pm. Further information about the event can be found here. You can register for the event here.

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According to papers filed in the Southern District of New York on August 3, 2012, the parties to the Tronox securities litigation have agreed to settle the case for a total of $37 million. As I noted at the time that this suit was first filed back in July 2009 (here), the case, which alleged that the defendants had misrepresented Tronox’s environmental liabilities when the company was spun out of Kerr-McGee and thereafter, involved a host of recurring and interesting issues.

A copy of the parties’ stipulation of settlement can be found here. The settlement agreement is subject to court approval.

As discussed in greater detail here, the action was filed on behalf of those who purchased certain securities  of Tronox, Inc. between November 25, 2005 and January 12, 2009. The plaintiffs named as defendants certain former directors and officers of Tronox, as well as Kerr-McGee Corporation, Andarko Petroleum Corporation and certain Kerr-McGee executives.

As reflected in the their amended consolidated complaint (here), the plaintiffs alleged that Tronox’s IPO was a “scheme orchestrated by Defendant Kerr-McGee to foist the vast majority of its enormous environmental remediation and related tort liabilities, accumulated over decades, onto Tronox, so that Kerr-McGee could thereafter present itself for sale.” The plan, which allegedly involved spinning Tronox out as a separate company in an initial public offering, “reaped massive and almost immediate benefits when, on August 10, 2006, Defendant Anadarko acquired Kerr-McGee for $18 billion in cash and assumption of debt purportedly free and clear of any obligation for what had become, as of that date, Tronox’s environmental remediation and tort liabilities.”

The plaintiffs’ case survived, in whole or in part, multiple motions to dismiss, and following mediation, the parties agree to settle the lawsuit. As reflected in the parties’ stipulation of settlement, the $37 settlement consists of the following: Anadarko, Kerr-McGee and the Kerr-McGee director and officer defendants “shall pay, or shall cause their insurance carriers to pay $21,000,000”; the former Tronox individual director and officer defendants “shall cause their insurance carriers to pay $14,000,000”; and Tronox’s auditor, Ernst & Young, “shall pay $2,000,000.”

As I noted at the time the case was first filed, one of the interesting things about this case is that it presents the clear example of a securities claim based upon disclosures relating to environmental liabilities. The possibility of this kind of claim is often a key concern at the time of D&O insurance policy placement, as the question often arises whether the standard policy’s pollution exclusion will preclude coverage for a securities claim based on environmentally-related disclosures. As this case demonstrates, it is critically important for the standard pollution exclusion to be revised to carve back coverage for securities claims and derivative claims based on environmental disclosures. (It is probably worth noting that many of the modern Excess Side A DIC insurance policies often have no environmental or pollution exclusion, which could well have been relevant here, given that by the time these suits were filed, Tronox was in bankruptcy.).

Another interesting thing about this case is that it involved three corporate entity defendants (Tronox, Kerr-McGee, and Anadarko), but the securities of only one of the three, Tronox. The issue here has to do with the definition of the term Securities Claim in the standard D&O policy. In many policies, the term is defined to refer to any claim based upon the purchase or sale of the securities of the Insured Entity itself. The question here would be whether or not a claim involving the purchase or sale of Tronox’s securities would constitute a “securities claim” under the Kerr-McGee’s and Anadarko’s policies. Of course, the individual Kerr-McGee directors and officers would be entitled to coverage whether or not the lawsuit represented a “securities claim” within the meaning of the term; this question has to do with whether or not there would be coverage under the policies for the entities themselves.

In the end, it appears that the portion of the settlement pertaining to the liabilities of the former Tronox director and officer defendants is to be covered by insurance, and the portion relating to the liabilities of the Kerr-McGee director and officer defendants, as well as Kerr-McGee and Anadarko themselves, would be funded in whole or in part by insurance. This outcome suggests that in the course of negotiations these issues, if actually involved in this case, were worked out or compromised in the course of the settlement negotiations.

As I previously observed, the allegations in the underlying complaints are noteworthy because they represent specific examples of what I have previously identified (most recently here) as the growing disclosure risks public companies face regarding their environmental liabilities. Although more recently I have emphasized the growing risks surrounding climate change related issues, as this case demonstrates, the disclosure risks also include the risks associated with more conventional environmental liability exposures. The case also underscores the importance of addressing at the time of policy placement the possibility of securities claims arising based on environmental disclosures.

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On February 2, 2010, the SEC published its interpretive release providing guidance to public companies on the SEC’s existing disclosure requirements as they apply to climate change. The release can be found here. A February 4, 2010 memo from the Gibson Dunn law firm analyzing the SEC’s release can be found here.

While the interpretive release take pains to emphasize that it only clarifies existing obligations, the release nevertheless represents the Commission’s clearest statement about expectations for public company’s climate change disclosures. The release’s specificity and its reliance on requirements that have themselves previously been cited in suits pertaining to more traditional environmental disclosures raise the question whether suits pertaining to climate change-related disclosure may be next.

The release cites several existing disclosure rules that it says required public companies to provide disclosures regarding climate change, including Items 101, 103 and 303 (among others) in Regulation S-K.

The release also identifies four topics that could require climate change-related disclosures, including: the impact of climate change legislation and regulation; the impact of international climate change accords; indirect consequences of climate change regulation or business trends; and the physical impacts of climate change.

Public companies will now have to accommodate their disclosure practices to the SEC’s guidance. While the SEC claimed only to be clarifying existing requirements, the practical reality is that many companies will now have to reconsider their disclosure process and practices, and, in many cases, alter the content of their disclosures.

With the SEC’s clarification of the disclosure requirements comes the opportunity for claimants or even for the SEC itself to later allege that a company’s climate change disclosures fell short of requirements. By way of illustration of how these claims might arise, it is worth considering that the very disclosure provisions with respect to which the SEC provided its climate change guidance have previously served as reference points in claims alleging misrepresentations or omissions of more traditional environmental liabilities and exposures.

For example, as I noted in a prior post (here), the SEC has in the recent past brought disclosure-related enforcement actions against reporting companies for alleged failures to observe existing environmental reporting requirements.

Nor are these types of claims limited solely to regulatory enforcement actions; investors have also brought damages actions relating to alleged misrepresentations or omissions regarding environmental issues. For example, as I noted in a recent post here, shareholders of Tronox Corporations recently filed a securities class action lawsuit against the company and certain of its directors and offices, as well as the company’s corporate predecessors in interest, based upon the company’s alleged failure to disclose the true nature of its environmental and tort liabilities.

There may be a temptation to view climate change related considerations as remote and distant future concerns, but as I noted in a recent post here, climate change related issues are already a practical component of current business conduct, for example, in the M&A context.

Just as disclosure obligations regarding traditional environmental concerns have given rise to disclosure-related enforcement actions and even shareholder litigation, the newly clarified expectations regarding climate change disclosures seem likely to create a context out of which similar actions may arise in the future.

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With the United Nations Climate Change Conference set to begin December 7, 2009 in Copenhagen, activists and observers are dialing up the volume both with calls for reform and with updated reports of the projected risks that global warming threatens. Among the long-standing initiatives advocates are now seeking to advance is the petition before the SEC calling for the adoption of climate change disclosure requirements.

These renewed calls for disclosure reform, as well as the release of additional data regarding insurance industry exposure to climate change, are clearly intended to coincide with the upcoming UN conference. One question, however, is how much recent email revelations of climate change researchers’ practices will affect the current dialog.

First, with respect to climate change disclosures, on November 23, 2009, a coalition of twenty public pension funds, public officials and environmental groups filed a "Supplemental Petition on Interpretive Guidance" (here) renewing their call for the SEC to "act promptly to clarify that existing disclosure requirements apply to climate change." Background regarding the group’s initial September 2007 petition can be found here.

As described in their November 23, 2009 press release (here), the group has renewed its call for climate change disclosure reform because of the "spate of recent regulatory, legislative and scientific developments – including the Environmental Protection Agency’s new mandatory greenhouse gas reporting rule – and the new economic opportunities that dramatically change the landscape of corporate climate change disclosure."

In a separate development, a November 23, 2009 report issued jointly by Allianz and the World Wildlife Fund entitled "Major Tipping Point in the Earth’s Climate System and Consequences for the Insurance Sector" (here) asserts that rising sea levels due to global warming could put trillion of dollars of U.S. assets at risk. Among other things, the report states that the planet’s atmosphere is close to dangerous atmospheric thresholds or "tipping points" that could cause dire environmental and economic consequences. The World Wildlife Fund’s November 23, 2009 press release regarding the report can be found here.

In addition to rising sea levels, the report also cites three additional "tipping points" that likely to have an impact: an increasingly arid climate in California; disturbances in the summer monsoon in India and Nepal; and reduction to the Amazon rainforest due to drought.

At the same time, the upcoming Copenhagen conference is clearly creating pressure for governmental action, as suggested by the announcements last week that both Chinese and U.S. officials will arrive at the conference with various country-level carbon emissions goals (as discussed here).

This same pressure could increase the likelihood of implementation of reforms such as the proposed climate change disclosure requirements, as these types of initiatives afford governmental officials the opportunity to show they are taking actions without at the same time requiring theme to address proposals that could directly affect economic activity or that could prove politically more controversial.

However, one wild card that has been played in the midst of all of these developments is the recent revelation of email communications amongst climate change researchers. These emails have been portrayed as suggesting that the researchers manipulated data to support their findings of climate change and that they suppressed contrary points of view. The question arises of how much these disclosures will undermine the perception of trustworthiness of the scientific conclusions on which so much of the current dialog is premised.

One example of the way in which the email revelations can affect perceptions is the joint Allianz/WWF report described above. Two of the three individual authors of the report are affiliated with the Tyndall Centre for Climate Change at the University of East Anglia, which is the institution form which the hacked emails were obtained. While the report’s authors’ affiliations would hardly have occasioned comment previously, now these institutional associations will inevitably raise the question whether the report and its conclusions reflect trustworthy and objective scientific analysis, or something else.

Climate change skeptics and reform opponents are already attempting to seize on the email disclosures to try to suggest that, due to the damage to the perception of trustworthiness of the climate change science, reform initiatives are doomed.

There is no doubt that the email disclosures have affected the dialog. At the same time, events such as the upcoming Copenhagen conference carry their own inertial dynamic. President Obama’s commitment to address the conference certainly will reinforce this dynamic. In this context, reform initiatives, such as the proposed climate change disclosure application, could acquire a certain inevitability. That is certainly the hope of the initiative’s proponents.

The prospect for increased climate change-related disclosure requirements, and the continuing agitation of climate change activists, will put increased pressure on public companies to address climate change issues in their public filings. As I recently noted (here), investor interest in climate change-related disclosures, along with the effects of voluntary initiatives (such as the NAIC’s climate change disclosure project, about which refer here), may separately create their own independent pressures for corporate climate change disclosures.

As these disclosure expectations become more generalized, the possibility of investor litigation relating to climate change disclosure also increases. As I recently noted (here), litigation developments in other areas of the law have moved the possibility of climate change-related disclosure litigation one step closer.

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While I have long predicted (refer here) the possibility of litigation against directors and officers of public companies concerning global climate change-related disclosures, to date the lawsuits have not materialized. Which is not to say that there have not been relevant developments – to the contrary, there have been many, as discussed below. There just haven’t been any disclosure lawsuits.

However, recent case law developments in the Second and Fifth Circuits, though relating to an entirely different area of the law, suggest that there may be a new environment for climate change-related lawsuits, as a result of which climate change disclosure lawsuits have moved one step closer.

The Recent Decisions

As summarized in an October 29, 2009 memorandum entitled “Judicial Climate for ‘Global Warming’ Claims Getting Worse?” (here) by Theodore Howard and Jeremiah Galus of the Wiley Rein law firm, the two recent case law developments are the Second Circuit’s September 21, 2009 decision in Connecticut v. American Electric Power Co. (here) and the Fifth Circuit’s October 16, 2009 decision in Comer v. Murphy Oil USA (here).

In each of these cases, a variety of claimants asserted claims based on nuisance and other tort theories against a variety of utilities and energy related companies, claiming that the defendants’ carbon emissions had caused (or increased) the plaintiffs’ claimed harm. The claimants in the Comer case are victims of Hurricane Katrina, who basically claim the defendants’ activities exacerbated the hurricane damage. In each case, the district court held the plaintiffs’ claims could not surmount initial justiciability and standing hurdles.

However, in both cases, the appellate courts determined that the plaintiffs did have standing to assert their claims and held that their claims do not present non-justiciable political questions.

As the law firm memo notes, these rulings “may have removed significant hurdles from the paths of plaintiffs seeking to hold corporate emitters of greenhouse gases liable for harms allegedly caused by global warming.” But though the decisions “may signal a shift in the way courts view tort-based global warming claims,” it is “still too early to project the decisions’ significance.”

Among other considerations the memo notes as suggesting that the decisions’ significance ultimately may be reduced is the fact that at least one district court case already has expressly declined to follow the Second Circuit’s analysis in the American Electric Power case. The memo also notes that the “plaintiffs undoubtedly still face the potentially insurmountable task of proving how and to what extent a particular corporation’s contribution to global warming proximately caused a particular plaintiffs’ injuries.”

For these reasons, the memo notes, it “remains to be seen” whether the cases “pose a serious risk of liability exposure for corporate defendants,” but the corporations – and their insurers – “should be paying close attention to further developments in these cases.”

Discussion

On at least one level – and arguably on all levels – these developments have little to do with the possibility of claims against corporate directors and officers for climate change-related disclosures. These lawsuits raise claims only on tort and nuisance theories. Moreover, it does, as the law firm memo notes “remain to be seen” whether these cases will result in any liability even on those claims.

Nevertheless, I believe these cases represent potentially significant developments with respect to the possibility of climate change disclosure litigation. First, as the memo notes, these cases “may signal a shift in the way in which the federal courts view tort-related global warming claims.” The extent to which judicial perspectives have been changed and to which hurdles have been removed may not be limited just to the context of tort-related cases.

The context within which all climate change related cases are considered may have changed, particularly to the extent these courts “newfound willingness” to consider these cases is, as the memo suggests, “derived from a perceived failure on the part of the legislative and executive branches to address the issue.” If prospective plaintiffs believe that climate change-related claims may be more likely to receive a receptive hearing, they may be encouraged to bring further claims, whether based on tort or based on other theories.

Some readers may regard my generalization of these tort case developments to the world of D&O claims as analytically unwarranted, and they may be right. However, I think this recent case decisions are most properly viewed as the just the latest in a series of developments that have brought the climate change debate ever closer to the courts.

The first development in this chain was the U.S. Supreme Court’s 2007 decision in Massachusetts v. EPA (about which refer here). The chain continued with New York AG Andrew Cuomo’s climate change disclosure subpoenas to several utilities, which resulted in several of the utilities agreeing to certain disclosure principles (refer here). There have been several other extensions of the chain, including the National Association of Insurance Commissioners’ promulgation of climate change disclosure principles for insurance companies, as well as the EPA’s April 2009 endangerment finding (about which refer here). Similarly, there have been a variety of Congressional and other initiatives toward mandating climate change related disclosures (refer here).

These appellate decisions are just the latest event in this continuing chain of developments. In addition,  there are other reasons why I think we can expect to see disclosure related litigation. Among other things, the pattern for the kind of disclosure related case that may yet arise is already established. As I noted in a recent post (here), there is already a pattern for disclosure-related cases based on alleged misrepresentations or omissions related to environmental liabilities and contingent litigation exposures.

Moreover, there is an extensive network of activists who are politically motivated to bring these kinds of claims. Andrew Cuomo was attempting to appeal directly to this network when he filed the disclosure-related subpoenas against the utilities, and there are countless others whose political agenda would be served by similar initiative, including litigation. As the chain of developments outlined above continues to lengthen, these motivated actors, who already have demonstrated their willingness to pursue litigation to advance their goals, may well target concerned players concerning their climate change-related disclosure.

I know from prior communications with readers that there is some significant skepticism about the prospect for climate change-related disclosure litigation any time soon. These skeptics could well be right, since there that kind of litigation is unlikely to arise in the absence of a significant share price decline from a company’s disclosure of some climate change or greenhouse gas emission related issue. But I still think the possibility of these kinds of claims arising is merely a question of when, not if. (Some people I am sure assume I am afflicted with some unbreakable curse that compels me to make these predictions at least once every quarter.)

A Couple of Securities Class Action Settlement Notes: The long-running securities class action lawsuit involving Adams Golf and certain of its directors and officers has finally settled. The case, which was went all the way through discovery and which suffered from delays owing to judicial vacancies,  was first filed in June 1999 and related to the company's July 1998 IPO. More details about the case can be found here.

According to the company's November 3, 2009 press release (here), the settlement provides for a payment to the plaintiff class of $16.5 million, of which Adams Golf itself has agreed to contribute $5 million.

Readers of this blog may be interested in the statement in the press release that Adams was "forced" to contribute the $5 million "because one of its former insurers refused to contribute to teh settlement based on the alleged late notice of the claim." The press release states that Adams has commenced coverage litigation against the former insurer and against its former insurance broker. The settlement requires Adams to pay the class action plaintiffs the first $1.25 million of any recovery, net of fees and expenses, that Adams recovers in the ongoing litigation with the former insurer and former broker. Further details about the settlement and the coverage litigation can be found on Adams Golf's November 3, 2009 filing on Form 8-K (here).

In a separate development, in a November 3, 2009 press release (here), Quest Software announced that it has settled the options backdating related  securities class action lawsuit that had been filed against the company and certain of its directors and officers. The case settled for $29.4 million. Background regarding the case can be found here. I have added the Quest Software settlement to my running tally of options backdating related settlements, which can be found here.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing the information about the Quest settlement.

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From time to time on this blog I try to draw generalizations from a variety of disparate claims as a way to identify emerging themes. However, a single recently filed securities class action manages to embody in a single complaint several themes I have previously tried to describe.

The case in question is the action filed on July 10, 2009 in the Southern District of New York on behalf of those who purchased common shares of Tronox, Inc. between November 28, 2005 and January 12, 2009. The complaint names as defendants certain former directors and officers of Tronox, as well as Kerr-McGee Corporation, Andarko Petroleum Corporation and certain Kerr-McGee executives.

According to the plaintiffs’ lawyers’ July 10, 2009 press release (here), the complaint alleges that:

Tronox was spun-off from Kerr-McGee in a two-step transaction. In November 2005, Kerr-McGee sold 17.5 million shares of Tronox Class A shares in an initial public offering for $14.00 per share (the "IPO") generating proceeds for Kerr-McGee of $225 million. After the IPO, Kerr-McGee continued to hold 56.7% of Tronox’s outstanding common stock. In March 2006, Kerr-McGee distributed the balance of the shares that it owned as Class B shares to its shareholders as a dividend (the "Spin-Off").

The Complaint alleges that, throughout the Class Period, Defendants failed to disclose material adverse facts about the Company’s true financial condition, business and prospects. Specifically, the Complaint alleges that Defendants failed to disclose the true scope and extent of Tronox’s environmental and tort liabilities. When the market learned of the true facts about the Company, the price of Tronox stock declined precipitously.

The complaint itself (which can be found here) alleges that the alleged misrepresentations and omissions

(i) deceived the investing public regarding the true nature and extent of the Company’s environmental and tort liabilities, Tronox’s business, operations, management, and the intrinsic value of Tronox’s stock; (ii) enabled Kerr-McGee to sell $225 million of Tronox stock to the unsuspecting public at artificially inflated prices; (iii) enabled Kerr-McGee to successfully rid itself of hundreds of millions of dollars of liabilities, thereby clearing the way for Kerr-McGee to sell itself to Andarko; and (iv) cause Plaintiff and other members of the Class to purchase Tronox common stock at artificial prices.

There are a number of interesting things to me about this complaint, all of which sound themes that will be familiar to readers of this blog.

First, this case represents yet another example of the way in which the spreading wave of corporate bankruptcies is extending the litigation consequences of the financial crisis beyond just the financial sector. (My prior post on this topic can be found here.) Tronox, the bankrupt company at the cent of this case, is engaged in the business of producing and marketing titanium dioxide, a white pigment used in a variety of products. Tronox, which definitely is not a financial services company, was not named as a defendant in the case owing to its bankrupt status.

Second, the complaint is based on alleged misrepresentations and omissions regarding Tronox’s environmental and tort liabilities. Among other things, the complaint alleges that the defendants ignored known information in setting Tronox’s reserves for environmental liabilities, and in particular that the reserves did not include any allowance for special sites (supposedly known as "secret sites") Kerr-McGee had identified as part of an investigation. The complaint also alleges that the defendants knew that independent third parties had reviewed the company’ s non-public information regarding its environmental liabilities and concluded that the company’s liabilities could be substantially larger.

These allegations may be noteworthy in and of themselves, but they are also noteworthy because they represent specific examples of what I have previously identified (most recently here) as the growing disclosure risks public companies face regarding their environmental liabilities. Although more recently I have emphasized the growing risks surrounding climate change related issues, as this case demonstrates, the disclosure risks also include the risks associated with more conventional environmental liability exposures.

Third, the roster of defendants involved in this case demonstrates a potential problem that can arise under D&O insurance policies in certain situations. Under the typical D&O insurance policy, coverage for the corporate entity is provided solely for "securities claim," which is a policy term that is typically defined in one of two ways. The first way is with respect to the securities involved, and the second way is with respect to the specific legal violations alleged.

In the first of these formulations, the policy includes within its definition of the term "securities claim" for which entity coverage is provided any claim based upon the purchase or sale of the securities of the Insured Entity itself. The alternative formulation pertains to claims alleging violation of any federal, state, local, or foreign securities law. (It should be noted that some current policies incorporate both formulations within the definition of the term "securities claim.")

The interesting thing about the Tronox lawsuit in connection with these alternative definitions of the term "securities claim" is that the Tronox complaint alleges violations of the securities laws against Kerr-McGee and Andarko, but not in connection with the purchase or sale of those companies’ own securities, but rather in connection with the securities of Tronox. Thus, to the extent these companies’ D&O insurance policies contain only the first of the two alternative formulations for the term "securities claim," their respective insurers might take the position that the Tronox complaint is not a "securities claim" with the meaning of their policies.

I should emphasize here that I have no familiarity with the specific terms or conditions of the D&O insurance policies of any party involved in this case and I am expressing no opinions one way or the other about the availability of coverage under any policies that may be applicable.

As I noted above, many policies available in the D&O insurance marketplace today actually incorporate both alternative formulations with the definition of the term "securities claim." But the Tronox complaint provides an example of how problems might arise in connection with D&O insurance policies containing more restrictive definitions of the term.

As for my first two observations noted above, I suspect that there will be many other securities lawsuits yet to come arising out of bankruptcies outside the financial sector. And I suspect strongly that in the months and years ahead we will see an increasing number of securities lawsuits raising allegations based on supposed misrepresentations or omissions relating to environmental liabilities and exposures, including but not limited to climate change issues.

And Speaking of Climate Change-Related Disclosure Issues: Just the other day I added a post (here) in which I raised the possibility that companies may soon find themselves facing the need to incorporate climate change-related disclosures in their periodic filings. A recent news article suggests that these changes may be even closer than I anticipated.

According to a July 13, 2009 New York Times article entitled "SEC Turnaround Sparks Sudden Look at Climate Disclosure" (here) federal regulators are preparing to launch a "very serious look" at requiring corporations "to assess and reveal the effects of climate change on their financial health."

According to the article, the SEC is following up on the landmark disclosure requirements enacted by the National Association of Insurance Commissioners this spring (and about which refer here). SEC representatives have also met with CERES, which submitted a petition in 2007 asking the SEC to clarify and strengthen requirements for climate change disclosure (and about which refer here).

Although the article hints strongly that formal disclosure requirements might be ahead, the article also acknowledges that nothing specific is actually underway now, and that a variety of practical and policy concerns would complicate any initiative that is launched.

Nevertheless, the message is that the SEC’s new leadership is more receptive to these possibilities and interested in pursing them further.

Hat tip to the Securities Docket for the link to the New York Times article.

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The recent Environmental Protection Agency (EPA) proposal to find that greenhouse gases "contribute to air pollution that may endanger public health or welfare" is just the latest in a series of actions and events suggesting that climate change related issues could affect a large number of companies, in a variety of ways, including most specifically with respect to at least some companies’ disclosure obligations. These trends could have important implications for potential liability exposures of directors and officers of public companies.

On April 17, 2009, the EPA released a proposed "endangerment finding" with respect to six greenhouse gases (including carbon dioxide). The EPA’s April 17 press release can be found here and a summary of the proposal can be found here. Under the EPA’s proposed finding (which can be found here), the EPA is proposing that the six gases "threaten the public health and welfare of current and future generations." The EPA also proposes to find that motor vehicle emission of these gases "contribute to concentrations of these key greenhouse gases and hence to the threat of climate change."

The proposed endangerment finding was promulgated in response to the 2007 U.S. Supreme Court decision in Massachusetts v. EPA (discussed at length here). The EPA’s proposed finding, which is now in its public comment period, does not itself include any specific regulatory action or requirements. However, if the proposed finding is adopted, regulatory and even legislative action seems probable, especially given the politics and inclinations of the current President and Congress. Indeed, the adoption of the proposed finding could motivate legislators to act preemptively, to try to avert regulatory provisions they might find unacceptable.

The potential scope of any future regulatory or legislative action can be gauged by the specific observations in the EPA’s proposed endangerment finding. That is, the proposed finding not only concludes that climate change "impacts human health in several ways" (such as increased threat of catastrophic weather activity or harm to water and other natural resources), but also that the effects of climate change will have a "disproportionate impact" on certain vulnerable segments of the populations, such as the very poor, the elderly and those already in poor health.

The EPA’s report also includes the suggestion that climate change has "serious natural security concerns" based on the instability that could follow in the wake of "increasing scarcity of resources."

With these kinds of concerns as a starting point, the potential for any ensuing regulatory or legislative activity to have a disruptive impact on many industries and companies seems high. Indeed, if the risk assessments in the EPA’s findings are anywhere near accurate, the climate change itself, independent of any governmental action, could have a disruptive impact on many industries and companies.

Many of the industries and companies likeliest to be affected already are under pressure to anticipate these changes and assess their possible future impact.

The most recent effort to mandate these kinds of assessments is the disclosure requirement adopted on March 17, 2009 by the National Association of Insurance Examiners (NAIC). The NAIC’s March 17 press release can be found here and further background regarding the NAIC’s disclosure initiative can be found here.

The NAIC’s new disclosure requirements specify that no later than May 1, 2010, all insurance companies with annual premiums over $500 million must complete a Insurer Climate Risk Disclosure Survey. The Survey is designed to require the insurers to disclose "the financial risks they face from climate change, as well as the actions the companies are taking to respond to those risks."

Under the NAIC’s mandate, insurers will be required to report on "how they are altering their risk-management and catastrophe-risk modeling in light of the challenges posed by climate change." Insurers must also report on "steps they are taking to engage and educate policymakers and policyholders on the risk of climate change," as well as "whether and how they are changing their investment strategies." As discussed below, the requirement for insurers to disclose how they are "engaging and educating" policymakers and policyholders could be the bridge that extends the NAIC’s initiative to many other industries.

Another industry under pressure to analyze and assess climate change impacts is the utilities industry. As discussed (here), in August 2008, New York Attorney General Andrew Cuomo reached the first of several regulatory settlements with utilities companies, in which the settling companies agreed "to disclose financial risks that climate change poses to investors."

Among other things, the settling utilities have undertaken to disclose risks associated with probable future climate change regulation; climate change related litigation; and the physical impacts of climate change. In his press release relating to the first of these settlements, Cuomo expressly stated that he expected these companies’ disclosure undertakings to "establish a standard."

The insurance and utilities industries may be the most likely industries but they are far from the only industries that potentially will be affected by climate change regulation and the physical impacts of climate change. Other obvious possibilities include auto manufacturing; oil and gas extraction, production and distribution; transportation and shipping; mining; agriculture; tourism; and forestry.

But the comprehensive nature of climate change suggests that the potential impacts will not be restricted just to these more obvious industries; the regulatory and the physical impacts of climate change are likely to extend to any business that is engaged in manufacturing; owns or operates vehicles; owns or operates buildings or other physical facilities; or has any other process or activity that has carbon outputs.

In other works, the impacts could well reach every company and enterprise. This assessment may seem overly dramatic, but at a minimum it seems likely that the kinds of disclosure requirements now facing insurance companies and the utilities industry could come to be expected of many other companies. As Cuomo said in connection with the settlement described above, he expects that the disclosure requirements will "establish a standard."

Whether these changes will actually take place remains to be seen. But whether or not they ultimately happen, the prudent course would seem to be to anticipate that they will. Which leads to the point referenced above, about the prospect that insurers could wind up driving change for many other companies.

That is, with insurers themselves obliged to start reporting next May among other things on what steps they are taking to engage and educate policymakers and policyholders on climate change, one possibility is that insurers could take the lead in communicating the message that prudent companies should assume that these changes are coming. Insures could wind up spurring their policyholders to undertake the same kind of risk assessment and disclosure that Cuomo is requiring in the regulatory settlements with the utilities.

Specifically, it seems possible that D&O insurers, in order to fulfill their own disclosure obligations under the NAIC’s mandate (and to look proactive while doing so) could undertake to "educate" their policyholders about the need to assess both the possible regulatory and physical impacts of climate change on their operations and financial condition, and to disclose those assessments to investors, as a way to manage a variety of climate change related risks.

In any event, whether or not insurers actually take that step, well-advised companies may independently conclude on their own that given the possible regulatory and physical impacts of climate change, risk assessment and disclosure is simply prudent.

One of the lurking dangers when a single issue predominates, as the global financial crisis recently has, is that all other concerns may seem trivial and unimportant by comparison. For many companies, especially those outside the insurance and utilities industries, climate change issues may now seem subordinate and remote to the point of irrelevance. But when we finally emerge from the current crisis, we may find that the climate change risks loom larger than ever and are more important than anyone now imagines.

This is not the first time I have raised these climate change related issues (refer for example here). I know there are those who think I am alarmist about this issue, and I suppose the skeptics could be right. However, even the most hardened cynic will have to acknowledge that, given the EPA’s recent pronouncement and given the current political environment in Washington, regulatory and even legislative activity seems likely, which is clearly a risk, trend or uncertainly that prudent companies will be assessing and disclosing.

And allow yourself for a moment to consider the possibility that the risk assessments in the EPA report could actually come to pass. At a minimum, if these things are possible, shouldn’t companies also be assessing the possible impact of climate change on their operations and financial condition?

Many companies today might conclude that there will be time enough tomorrow to deal with tomorrow’s problems. That was exactly the logic that led Detroit to keep grinding out SUVs and Hummers for the last twenty years, when more forward-looking competitors were already capturing market share by making hybrid vehicles. Just as Detroit’s past leaders are now criticized for their lack of vision, so too may other corporate leaders who now defer on these issues find themselves later under siege for failing to look ahead and anticipate the changes and problems just ahead.

Somehow, on Earth Day, these issues seemed particularly important for me. And for my kids.

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