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

As it has been doing on a monthly basis during the current banking crisis, the FDIC has once again updated the page on its website describing the failed bank litigation that the agency has initiated. According to the latest update, as of April 12, 2013, the agency has now filed a total of 54 failed bank lawsuits during the current bank failure wave. But though the new suits continue to come in, the agency’s filing pace appears to have slowed, at least for now. In the month since its last web update, the agency has only filed one additional lawsuit, and only four overall since February 1, 2013, even though the significant numbers of institutions reached the third anniversary of their closure during that period (Due to statute of limitations concerns, the agency typically files its failed banks suits shortly before the a failed bank’s third anniversary.)

 

Since its last update last month, the FDIC did initiate one lawsuit in its capacity as receiver for New Century Bank of Chicago, Illinois, which failed April 23, 2010. On March 26, 2013 (that is, just a few weeks before the third anniversary of the bank’s failure), the agency filed a complaint in the Northern District of Illinois alleging that the six former directors and officers named as defendants “acted negligently and grossly negligently and breached their fiduciary duties by disregarding the Bank’s loan policy, prudent lending practices, and regulatory warnings in connection with numerous commercial real estate and other loans during the period April 2005 through July 2008.” The FDIC seeks to recover “more than $33 million in losses.”

 

With the addition of just this one lawsuit, the FDIC has filed only two new complaints against former directors and officers of failed banks since March 1, 2013 and only four new complaints since February 1, 2013. By contrast, during January 2013, the FDIC filed five new complaints, just in that one month alone. In the two month period including December 2012 and January 2013, the FDIC filed a total of nine new lawsuits.

 

This relative slowdown since February 1, 2013 is all the more noteworthy given the number of banks that failed during the corresponding period three years ago. During the period February-April 2010, there were a total of 49 bank closures. By way of comparison, there were only 51 bank closures during all of calendar year 2012, and there have only been five so far during 2013. Early 2010 was a very active period for bank closures, and so given that the FDIC tends to file its suits, if at all, as the third anniversary approaches, it seemed that 2013 was going to be an active period of new lawsuit filing.

 

In addition, each month the agency updates its website to show the increased numbers of lawsuits that have been authorized. At its most recent update, the agency indicated that the number of lawsuits authorized has once again increased during the past month. As of April 12, 2013, the FDIC has now authorized suits in connection with 109 failed institutions against 888 individuals for D&O liability. This figure of 109 authorized lawsuits is inclusive of the 54 filed D&O lawsuits naming 407 former directors and officers that have already been filed. These figures suggest that there is a backlog of 55 cases that have been approved and not yet filed. The backlog seems to be growing. Given the monthly increase in the number of authorized lawsuits, you would really expect to see the agency’s new lawsuit pace moving along an active clip, not as seems to be the case, entering some sort of a lull.

 

There are a number of possible reasons for the apparent slowdown in the number of failed bank lawsuit filings. The first is just timing. I mentioned above that during the period February to April 2010, 49 banks closed, but of those 49 bank failures, 23 occurred in April 2010 alone (a very busy month for bank failures). Of the 23 bank closures in April 2010, 22 took place on or after April 16, 2010. In other words a very large percentage of the banks that failed during this period failed in late April 2010, and thus still have not yet reached the third anniversary of their closure. The third anniversary is coming up, but we are not quite there yet. There could be a flurry of new failed bank lawsuit filings in the next few days.

 

Another possible explanation for the apparent lull of new failed bank lawsuit filings over the last few weeks is that the agency may have entered tolling agreements with the failed banks directors and officers to see if they agency can reach a negotiated settlement with the directors and officers and with their bank’s D&O insurer. If the parties have entered tolling agreements, lawsuits involving some of the banks still could be filed later.

 

Finally, there are a number of cases in which the agency has reached a negotiated settlement with the directors and officers and with the D&O insurer without the agency actually filing the lawsuit. If the agency was able to reach a settlement agreement of this type in a number of cases, that too might account for the apparent filing slowdown over the past several weeks. (The agency has posted the settlement agreements in a number of these kinds of settlements on its website.)

 

Nevertheless, given the number of banks that failed in the first half of 2010 and given the growing number of lawsuits the agency has filed, it seems as if the failed bank lawsuit filing pace should be picking up again soon. As I have previously noted, there have previously been lulls in the FDIC's failed bank lawsuit filing activity (refer here, for example, wiht respect to the two month lull during mid-year 2012). But the prior lulls have in most instances been quicly followed by a period of quickened filing actiivity (as discussed, for example, here).. Circumstances may be poised for the same filing pattern again now.

 

Another FCPA Civil Lawsuit: There is no private right of action in the FCPA. Nevertheless, civil litigation has followed in the wake of the proliferation in the number of governmental enforcement actions alleging violations of the FCPA, as investors allege that company management have violated their corporate duties in allowing the bribery to take place or that, by failing to disclose the briber, management has misrepresented the company’s internal controls or financial condition.

 

The latest example of these kinds of civil suits is interesting because at least so far there is no formal enforcement action against the company involved or its senior officials, although the bribery allegations have been the subject of very high-profile publicity.

 

According to their April 12, 2013 press release, plaintiffs’ lawyers have filed a securities class action lawsuit in the Southern District of New York against Wal-Mart de Mexico SAB (“Walmex”) and Ernesto Vega, the Chairman of Walmex’s board of directors and Chairman of the Board’s audit and corporate practices committee. The complaint, a copy of which can be found here, purports to be filed on behalf of investors who purchased ADRs of Walmex between February 21, 2012 and April 22, 2012. The complaint alleges seeks damages under the ’34 Act.

 

The investors’ complaint alleges that during the class period the defendants made false and misleading statements about Walmex’s business practices with respect to unlawful or unethical bribery conduct. Specifically, according to the plaintiffs’ lawyers press release, the complaint alleges that Walmex “failed to disclose that it had been involved in a bribery scheme,” and that as a result of the defendants’ misleading statements the company’s ADRs traded at inflated prices during the class period.

 

Unlike many of these kinds of civil actions, the plaintiffs do not base their assertions on allegations derived from a prior regulatory enforcement action; so far, there has been no formal regulatory enforcement action taken against the company. Rather, the plaintiffs’ allegations rely heavily on information in an April 22, 2012 New York Times article entitled “Wal-Mart Hushed Up a Vast Mexican Bribery Case” (here). The lengthy article detailed the extensive payment program that executives at Walmex allegedly had pursued in order to obtain Mexican zoning approvals, reductions in environmental impact fees and the allegiance of neighborhood leaders. According to the article, an internal Wal-Mart investigation not only found evidence of the payments, but also that Walmex executives knew about the payments and took steps to conceal the payments from Wal-Mart’s headquarters. The lead investigator recommended that Wal-Mart expand the investigation, but instead, according to the article, Wal-Mart’s leaders shut it down.

 

The new compliant quotes extensively from the New York Times article; parts of the complaint are nothing more than lengthy block quotes from the article. Among other things, the Times article notes that in December 2011, after learning of the Times’s reporting in Mexico, Wal-Mart informed the Justice department that it had begun an internal investigation into possible FCPA violations. In subsequent regulatory filings, the company has stated that it is investigating possible improper payments in other countries. To date, there have been (so far as I am aware) no formal regulatory actions taken against Wal-Mart or its officials.

 

Nevertheless, though there had to date been no enforcement action, the Walmex investors have initiated a securities class action lawsuit based on the information provided in the Times article. The case is not the first civil action seeking damages in connection with alleged FCPA violations in the absence of a formal regulatory action. However, it does provide a high-profile example of the way in which FCPA allegations can lead to private civil litigation.

 

One other interesting feature of the Walmex situation is that the alleged bribery allegations first came to light in September 2005 when a whistleblower contacted a senior Wal-Mart lawyer. It is an interesting question of what might happen in similar circumstances today, given the potentially rich whistleblower bounty payments potentially available under the Dodd-Frank whistleblower provisions. The bounty provisions provide a significant incentive for a whistleblower of the kind involved here to go straight to the SEC. These circumstances provide a powerful illustration of the kinds of circumstances that could make the Dodd-Frank whistleblower provisions so significant and could lead to increased regulatory and enforcement activity.

 

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Among the more controversial questions about the U.S.’s Foreign Corrupt Practices Act has been the extent of its reach in enforcement actions against foreign-domiciled individuals. Two recent decisions from the Southern District of New York reached differing conclusions about the statute’s reach. One case rejected the individual’s motion to dismiss the FCPA enforcement action, while the second granted the individual defendant’s motion to dismiss. Both decisions were based on the court’s personal jurisdiction over the individuals. The difference between the two decisions sheds some light on the question of extent of the FCPA’s reach over foreign individuals.

 

The first of these two rulings involved three executives of Magyar Telecom. The company was accused of involvement in schemes to bribe government officials in Macedonia and Montenegro. The company and its corporate parent, which were subject to U.S. jurisdiction because their securities (in the form of ADRs) traded on U.S. exchanges, entered into a non-prosecution agreement and also agreed to pay over $95 million in criminal fines and civil penalties.

 

The SEC also filed an enforcement proceeding against three Magyar executives. The SEC alleged that the three authorized payments to an intermediary, knowing the payments would be forwarded to government officials. The SEC also alleged that the individuals made false statements to the company’s auditors by signing representations that the company’s books and records were accurate. All three executives are Hungarian citizens and residents. The three moved to dismiss the SEC’s complaint, arguing that the U.S lacked personal jurisdiction over them.

 

In a February 8, 2013 order (here), Southern District of New York Judge Richard J. Sullivan denied the defendants’ motion to dismiss. Judge Sullivan held that the SEC had met its burden of showing that the exercise of personal jurisdiction over the three was consistent with constitutional due process. Judge Sullivan based his ruling not on the individuals’ physical location but their actions on Magyar’s behalf. The complaint, Sullivan observed, alleges that the defendants “engaged in a cover up through their statements to Magyar’s auditors knowing that [the company’s securities} traded on an American exchange and that prospective purchasers” would “likely be influences by any false financial filings.”

 

With respect to the question of whether or not the defendants had sufficient “minimum contacts” to support the constitutional exercise of jurisdiction, Judge Sullivan noted that “the Defendants here allegedly engaged in conduct that was designed to violate United States securities regulations and was thus necessarily directed toward the United States, even if not principally directed there.” He added that “because these companies made regular quarterly and annual consolidated filings during that time, Defendants knew or had reason to know that any false or misleading financial reports would be given to prospective American purchasers of those securities.”

 

Judge Sullivan specifically noted that his ruling did not envision any sort of rule that would subject any overseas employee of a company alleged to have violated the FCPA to personal jurisdiction in the U.S. He noted that “although Defendants’ alleged bribes may have taken place outside the Unites States…their concealment of those bribes, in conjunction with Magyar’s SEC filings, was allegedly directed toward the United States.”

 

The FCPA Blog’s post about the ruling can be found here. The FCPA Professor’s blog post about the Judge Sullivan’s ruling can be found here.

 

In the second of the two decisions, on February 19, 2013, Southern District of New York Judge Shira Scheindlin granted the motion to dismiss of one of the seven individual Siemens executives named in a FCPA enforcement action. Judge Scheindlin’s opinion can be found here. Siemens of course has been embroiled in one of the largest bribery investigations of all time. The SEC filed a separate enforcement action against several Siemens executives in connection with alleged bribery activities in Argentina. One of the defendants, Herbert Steffen, moved to dismiss contending that the court lacked personal jurisdiction over him. Steffen, a German citizen, had been CEO of Siemens Argentina twice before his retirement in 2003. He never worked in the U.S. The SEC alleged that Steffen helped facilitate a bribe to the Argentinian president to help secure a large government contract by allegedly encouraging another Siemens official to authorize bribes of Argentinian officials

 

In granting Steffen’s motion, Judge Scheindlin found that Steffen lacked sufficient contacts with the U.S. and dismissed the case against him. Judge Scheindlin found that “Steffen’s actions are far too attenuated from the resulting harm to establish minimum contacts.” She noted that “the SEC does not allege that he directed, ordered or even had awareness of the cover ups … much less that he had any involvement in the falsification of SEC filings in furtherance of the cover ups.”

 

Judge Scheindlin went on to observe that the exercise of jurisdiction over foreign defendants based on their effects upon SEC filings is “in need of a limiting principle,” adding that “if this Court were to hold that Steffen’s support for the bribery contact satisfied the minimum contacts analysis, even though he neither authorized the bribe, nor directed the cover up, much less played any role in the falsified filings, minimum contacts would be boundless.”

 

In further considering whether it would be reasonable for the Court to exercise jurisdiction over Steffen, Judge Scheindlin noted that “Steffen’s lack of geographic ties to the United States, his age, his poor proficiency in English and the forum’s diminished interest in adjudicating the matter all weigh against personal jurisdiction.” She added that the SEC and the Department of Justice “have already received comprehensive remedies against Siemens” and “Germany has resolved an action against Steffen individually.”

 

The FCPA Blog’s discussion of Judge Scheindlin’s ruling (as well as a detailed discussion of the larger background regarding the anti-bribery enforcement proceedings involving Siemens) can be found here. Victor Li’s February 20, 2013 Am Law Litigation Daily article about the ruling can be found here.

 

These two cases reached differing results, although the differing outcomes obviously depended on some very case-specific factual differences. Outcomes of personal jurisdiction motions often are very fact specific. For that reason it could be argued that there is little significance to the fact that in one case the Court found that it had personal jurisdiction over the individual defendants and in another it did not.

 

Though personal jurisdiction rulings are notoriously fact-specific, there nevertheless are certain conclusions that can be drawn from these two decisions, particularly in consideration of the question when a foreign domiciled individual charged with an FCPA violation can be subject to personal jurisdiction in the U.S. As James Dowden and Nick Berg of the Ropes & Gray law firm noted in their February 27, 2013 Law 360 article entitled “Rare Guidance On FCPA’s Reach Over Foreign Nationals” (here, registration required), the two cases “reaffirm U.S. regulators’ long-standing position that the FCPA has broad applicability to foreign nationals, while also setting the outer limits of the civil scope of the FCPA.”

 

In that regard, Judge Scheindlin herself not only referred to Judge Sullivan’s ruling in the Magyar executives’ case, but she identified the critical distinctions between the two cases. She noted first that “there is ample (and growing support in the case law for the exercise of jurisdiction over individuals who played a role in falsifying or manipulating financial statements relied upon by U.S. investors in order to cover up illegal actions directed entirely at a foreign jurisdiction.” She cited Judge Sullivan’s ruling the Magyar executives’ case as an example where the court “exercised jurisdiction over individuals who orchestrated a bribery scheme … and as part of the bribery scheme signed off on misleading management representations to the company’s auditors and signed false SEC statements.”  However, as noted above, Scheindlin found that the Siemens executive in the case before her was not alleged to have been involved in the cover ups or the falsification of the SEC filings.

 

At a minimum, the two rulings signify that though U.S. courts may properly exercise personal jurisdiction over foreign individuals in FCPA enforcement action when the facts support jurisdiction, there is a also a point when a foreign-domiciled individual’s involvement in the alleged corrupt activity is too attenuated to support personal jurisdiction. The specific considerations that matter include the extent of the individual’s connection to the actual bribery, the extent of the individual’s role in any cover-up of the bribery, and the extent of the individual’s involvement in or contribution to the falsification of the company’s financial statements.

 

A February 2013 memorandum from the Arnold & Porter law firm discussing the two cases and entitled “Two Recent Decisions Address Jurisdiction Over Foreign Defendants in FCPA Cases” can be found here.

 

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An overabundance of airplane time and a shortage of Internet access (not the mention my day job’s unrelenting requirements) have kept The D&O Diary on the blogging sidelines despite a host of noteworthy events in recent days. The march of events moves ever onward, but before the sands of time envelop recent notable events altogether, we note them briefly here.

 

Alcoa Settles Bribery Suit With Alba: On October 9, 2012, Alcoa announced (here) that it had agreed to pay Aluminum Bahrain B.S.C. (better known as “Alba”) $85 million to settle the long-running RICO action that the state-owned Bahraini aluminum smelter had filed against the company in the Western District of Pennsylvania. The settlement is noteworthy in a number of respects, not the least of which the settlement’s size. The settlement is also noteworthy given the identity of the claimant, as discussed below.

 

As discussed here, in February 2008, Alba had sued Alcoa, one of its affiliates, and two individuals (one of whom was an officer of an Alcoa affiliate), alleging that the defendants had engaged in a 15-year conspiracy involving overcharging, fraud and bribery of Bahraini officials. The complaint alleges that one of the individual defendants, Victor Daladeh, funneled payments to one or more (unnamed) Bahraini officials as part of an alleged conspiracy to cause Alba to cede a portion of its equity to Alcoa, to pay Alcoa inflated prices for alumina, and to corrupt the integrity of senior Bahraini officials. Alba’s complaint sought to recover damages from the defendants based on the alleged violations of the Racketeer Influenced and Corrupt Organizations Act (RICO), conspiracy to violate RICO, and for fraud.

 

The case was stayed for several years while related U.S. government investigations continued. (The government investigations are continuing.) However, in November last year, Alcoa’s lawyers persuaded the Western District of Pennsylvania Judge Donetta Ambrose to lift the stay so that the defendants could file a motion to dismiss. Among other things, the defendants argued, in reliance on the U.S. Supreme Court’s decision in Morrison v. National Australia Bank, that the court should dismiss the case because the alleged wronging on which Alba relied in support of its claim took place entirely outside the U.S. and therefore not appropriately the subject of a lawsuit in the U.S. under U.S. laws. As discussed in Victor Li’s August 1, 2012 Corporate Counsel article (here), Judge Ambrose rejected defendants’ motion, finding that Alcoa’s Pittsburgh headquarters was the “nerve center” of the alleged scheme, because the control and decision-making of the alleged conspiratorial enterprise came from Pittsburgh.  

 

According to its October 9 press release, Alcoa will pay the $85 million settlement amount in two installments, with half to be made at the time of the settlement and the other half to be paid one year later. The press release also states that Alcoa and Alba have “resumed a commercial relationship” and entered into a long-term supply agreement, “demonstrating a mutual desire to work together going forward.” The settlement does not resolve Alba’s claims against Daladeh, who according to news reports, has been arrested in October 2011 by British officials and charged with bribing officials at Alba.

 

As I have previously noted on this blog, one of phenomena associated with the recent upsurge in FCPA enforcement activity has been related growth in follow-on shareholder litigation. However, by contrast to these more common types of follow-on civil suits, this action was not brought by Alcoa’s shareholders; rather, this lawsuit was brought by the alleged victims of the corrupt activity (and indeed, the suit was initiated before there had been any separate governmental enforcement action; the government action followed after the civil suit).

 

As anti-bribery enforcement activity has increased, the prospect for follow-on civil litigation has also grown. In that regard, the size of the settlement in this case and the claimant’s relative success in bringing its claim will not go unnoticed. The likelihood is that companies that become enmeshed in bribery allegations could also face related civil litigation, and in light of this sizeable settlement, the threat of civil litigation will include not only the possibility of claims from shareholders, but also possible claims from the purported victims of the alleged corrupt activity.

 

Pfizer Settles Celebrex-Related Securities Suit for $164 Million: According to papers filed with the Court, Pfizer has settled the long-running securities suit alleging that Pharmacia (which Pfizer acquired in 2003) had misrepresented the safety of its anti-inflammatory drug, Celebrex, for $164 million. A copy of the parties’ October 5, 2012 stipulation of settlement can be found here. 

 

As discussed here, shareholders first sued Pharmacia and certain of its directors and officers in 2003, alleging that the company had released only part of a long-term clinical study the company had commissioned on the side effects of the drug. The complaint also alleged that scientists affiliated with the company had used the partial data to write an article in the Journal of t he American Medical Association, while failing to reveal that only part of the data was used. When Pharmacia later sought to the FDA’s approval to market the drug without certain warning labels, the agency declined based on questions concerning the completeness of the study results, following which the company’s share price declined.

 

This case had a long and complex procedural history. District of New Jersey Anne Thompson had initially dismissed the case on statute of limitations ground. But as discussed here, in 2009, the Third Circuit reversed the district court, and the case returned to the District Court. The settlement comes as an October 22, 2012 trial date loomed. 

 

Nate Raymond and Ransdell Pierson’s October 9, 2012 Reuters article about the settlement can be found here.

 

This settlement is noteworthy in many respects, not least of which because of its size. However, in a world of class action securities lawsuit settlements measured in the billions, even a settlement of this size does not attract as much attention as it might have at one time. Indeed, according to my research, this $164 million settlement does not even break the top 50 of all time securities lawsuit settlements. It is not even the largest securities suit settlement, having been exceeded, among others, by Bristol Myers Squibb’s $300 million securities lawsuit settlement (about which refer here).  The settlement amount alone does not take into account the defense fees incurred, which, given the case’s long and complicated procedural history, also likely were substantial (particularly given the approaching trial date). 

 

It is not an original observation, but the total economic cost of this kind of litigation is truly astonishing. 

 

Breaking Lull, FDIC Files Latest Failed Bank Lawsuit: On October 2, 2012, in the first lawsuit the FDIC has filed since July in its capacity as receiver of a failed bank against the bank’s former directors and officers, the FDIC filed a lawsuit in the Northern District of Illinois against six former directors and officers of the failed Benchmark Bank of Aurora, Illinois. The FDIC’s complaint can be found here.

 

Benchmark Bank failed on December 4, 2009 (about which refer here). In its complaint, the FDIC alleges that the defendants breached their duties of care by approving certain high-risk acquisition, development and construction loans. The FDIC seeks to recover losses “of at least $13.3 million” allegedly caused by the defendants gross negligence, negligence and breaches of fiduciary duties.

 

The Benchmark Bank lawsuit is the fifteenth failed bank lawsuit the FDIC has filed during 2012 and the 33^rd overall that the FDIC has filed as part of the current bank failure wave. However, it is the first the FDIC has filed since mid-July and only the third the FDIC has filed since late May. The slow filing pace is all the more surprising as comes three years after what had been the period when bank closures were ramping up in earnest. All is equal, it seems as if there would have been more lawsuits filed like this one as the three year closure anniversary approached.

 

The slowdown is all the more surprising because the lull has come even though the FDIC has continued to indicate on its website (here) on a monthly basis that the number of lawsuits the agency has authorized has increased. Indeed, in its latest update (dated October 9. 2012), the FDIC indicated that it has authorized suits in connection with 80 failed institutions against 665 individuals for D&O liability. These figures are inclusive of the 33 filed D&O lawsuits involving 32 institutions, naming 272 former directors and officers. filed so far. 

 

As the number of authorized lawsuits has continued to accumulate and as the three year closure anniversary of an increasingly large number of banks has approached, it has seemed as if we would be seeing increasing numbers of lawsuits filed. Yet in the last five months there have only been three new suits filed, and this latest complaint is the first in three months. Knowledgeable participants in this process have advised me that part of the reason for the slowdown is that in a number of instances the FDIC is engaged in negotiations to see if the matters can be resolved without litigation. But as the number of lawsuits authorized continues to increase it does seem likely that sooner or later we will be seeing an upsurge in new complaints. It just hasn’t happened yet.

 

In the meantime, it is reassuring to note that the number of new bank closures has dwindled. There have been no new bank closures so far during October 2012, after only three in September 2012 and only one in August 2012. It certainly can be hoped that now, more than four years after the depths of the financial crisis, perhaps the wave of bank closures is finally about to come to an end.

 

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Among the many litigation threats companies face, a couple of specific kinds of cases have recently emerged: the civil action following on in the wake of an FCPA investigation or enforcement action, and the shareholder suit following after a negative “say on pay” vote. Many companies involved in an FCPA investigation or experiencing a negative say on pay vote have been hit with these kinds of suits However, as discussed below, more recently these cases appear to be failing to get past the preliminary motions stage.

 

FCPA Follow-On Civil Suit Dismissals

There is no private right of action under the Foreign Corrupt Practices Act. However, as I have noted previously on this blog, companies announcing an FCPA investigation or enforcement action often are hit with follow-on civil actions, in which the claimants typically allege that the company’s directors breached their fiduciary duties by failing to ensure that the company had adequate internal controls or compliance programs to have prevented the improper payments.

 

In at least a couple of recent instances, lawsuits involving these types of allegations have failed to get past the preliminary dismissal motions. The most example of this involved the shareholders’ derivative suit filed in the District of Massachusetts against Smith & Wesson, as nominal defendant, and members of its board of directors. The complaint followed after the indictment on FCPA allegations of the company’s former director of international sales.  (The indictment was later dismissed.) The claimants essentially alleged that the company’s directors breached their duty of care by failing to have effective FCPA controls and oversight. The claimants did not make a pre-suit demand on the company’s board, alleging instead that the demand would have been futile. The defendants moved to dismiss the complaint on the grounds that the claimants had failed to establish demand futility.

 

In a July 25, 2012 order (here), District of Massachusetts Judge Michael A. Ponsor granted the defendants’ motion to dismiss. Judge Ponsor found two reasons for concluding that the plaintiffs had failed to establish demand futility. The first is that a previous decision in a prior, unrelated state court derivative suit (involving allegations that the company had misrepresented its financial condition), the court had concluded that demand was not excused in that prior suit because there was a disinterested and independent board majority that could have considered the pre-suit demand. Applying principles of issue preclusion, Judge Ponsor concluded that the prior court’s conclusion about the independence of the board majority was determinative of the issue in this case.

 

Judge Ponsor did go on to note that even if there had been no prior determination of the issue, the plaintiffs in this case had failed to present the requisite particularized allegations to establish demand futility. He noted that “nothing offered in the complaint comes close to pushing the case” over the “difficult threshold” to establish that demand would be futile, adding that “the complaint is flatly devoid of any adequate justification for failing to make the required pre-suit demand.”

 

The decision in the Smith & Wesson case follows shortly after a similar decision in a case in the Eastern District of Louisiana involving Tidewater, Inc. In November 2011, and in settlement of FCPA allegations involving alleged improper payments in Azerbaijan and Nigeria, the company agreed to pay the SEC $8.1 million in disgorgement and pre-judgment interesting, and also agreed to pay the U.S. Department of Justice a $7.35 million penalty as part of a Deferred Prosecution Agreement.

 

A Tidewater shareholder filed a shareholder derivative action against Tidewater, as nominal defendant, and against its board, alleging that the directors had breached their fiduciary duty by disregarding the payment of bribes and by failing to ensure that the company had adequate internal controls to ascertain FCPA compliance. The defendants moved to dismiss on the grounds that the plaintiff had failed to make pre-suit demand on the board and that the plaintiff had not pled sufficient facts to establish demand futility.

 

In a July 2, 2012 order (here), Eastern District of Louisiana Judge Jane Triche-Milazzo granted the defendants’ motion to dismiss, finding that the “even taking all of plaintiff’s allegations as truth, he has failed to plead with particularity that demand on the board would have been futile.” However, Judge Triche-Milazzo did grant the plaintiffs’ leave to file a motion to amend their complaint.

 

In addition to these cases involving the pre-suit demand requirements, at a recent hearing in the Delaware Chancery Court involving civil litigation arising out of the recent Wal-Mart bribery scandal, Chancellor Leo Strine chastised the prospective lead plaintiffs for rushing to file their suits without first making a books are records request as allowed under the Delaware statutes.

 

As discussed in Lance Duroni’s July 16, 2012 article on Law 360 (here, registration required) about the Wal-Mart hearing, the purpose of the hearing was to determine which of the competing claimants would be named as lead plaintiff in the Delaware derivative litigation seeking to hold certain Wal-Mart directors and officers liable in connection with the company’s alleged improper payments in Mexico. Chancellor Strine rejected motions from both erstwhile lead plaintiffs, stating, according to the article, that “more energy has been spent by the dueling plaintiffs on who gets to be lead plaintiff and counsel than was spent investigating and writing these complaints.” At least one other claimant had in fact made a books and records request, and Strine said he would defer choosing a lead plaintiff until the company had responded to the request and the parties had beefed up their complaints. Alison Frankel also has a July 17, 2012 article on her On the Case blog (here) discussing Chancellor Strine’s ruling in the Wal-Mart case.

 

If nothing else, these cases show that claimants eager to pursue shareholder derivative suits following on FCPA investigations cannot dispense with the procedural prerequisites. The requirement to conduct pre-suit due diligence and then to make the requisite pre-suit demand are substantial requirements with which a failure to comply can be prohibitive. At a minimum, the requirement for pre-suit due diligence raises the cost for prospective litigants, and the enforcement of the requirement for a pre-suit demand could represent an insurmountable barrier in many cases.

 

These procedural requirements are of course not new. If however prospective litigants recognize that they are not going to be able to bypass these requirements, at least some prospective litigants may be deterred from filing their suits. If that were to happen, there might be fewer of these FCPA enforcement follow-on civil suits filed I n the first place.

 

Say on Pay Suits Fare Poorly

 During 2011, the first year in which companies held advisory shareholder votes on executive compensation as required by the Dodd-Frank Act, many of the companies experiencing negative shareholder votes subsequently were hit with shareholder suits, often filed in reliance of the negative “say on pay” vote (as I discussed in posts at the time, here and here).

 

Early on, these cases looked like they may have legs, particularly after a judge in the Southern District of Ohio denied the motion to dismiss in the shareholder suit filed against Cincinnati Bell and certain of its directors and officers after the company experienced a negative say on pay vote. As discussed here, Southern District of Ohio  Judge Timothy Black held in a September 2011 opinion that, where plaintiffs alleged that the company’s directors breached their fiduciary duty when they approved an executive pay package after a negative say on pay vote, “the plaintiff’s allegations create a reasonable doubt that the challenged transaction is the result of valid business judgment, and accordingly, the directors possess a disqualifying interest sufficient to render pre-suit demand futile and hence unnecessary.”

 

However, as discussed in a July 10, 2012 memo from the Vinson & Elkins law firm entitled “Say-on-Pay Lawsuits Losing Steam” (here), many courts considering these same issues after the Cincinnati Bell decision have reached a contrary conclusion, and have rejected the argument that a negative say on pay vote rebuts the business judgment rule or constitutes a disqualifying interest. The subsequent cases “indicate that Cincinnati Bell’s approach is quickly falling in to disfavor,” noting that “courts have repeatedly disavowed this approach.”

 

The article notes that these more recent decisions do not necessarily mean that “companies will cease to be sued for negative say-on-pay results.” However, the decisions “do suggest that derivative suits in the wake of an adverse say-on-pay vote may soon be less common than before.”

 

Both of these types of lawsuits – the follow-on FCPA-related civil action and the shareholder suit following a negative say-on-pay vote – seemed to attract a great deal of interest from certain parts of the plaintiffs’ bar. However, recent dismissal motion outcomes in these cases are beginning to suggest that these cases are not faring all that well in the courts. Even if these recent dismissal motion rulings do not discourage the filing of these cases altogether, it may deter some suits from being filed. In many instances these kinds of suits may not represent the opportunity that plaintiffs’ lawyers may have thought earlier on.

 

To be sure, many of the say-on-pay lawsuits may not have been about money. In some instances, the lawsuits may simply represent one more way that activist shareholders are trying to pressure corporate boards about executive compensation issues. To the extent that the lawsuits are simply one more tactical approach in a larger strategic battle about executive compensation, the adverse dismissal motion rulings may represent less of a deterrent. 

 

Community Banks and D&O Insurance: If you have not yet seen it, you may want to take a look at the June 2012 paper that Advisen has posted on its website entitled “Community Bank Lending: Practices and Failures, and the Role of Directors and Officers (D&O) Insurance” (here). The paper provides an interesting top level overview of the risks and exposures facing community banks and their directors and officers – particularly the former directors and officers of failed banks. A more current update of the statistical information in the paper can be found in my recent post on FDIC failed bank lawsuits here.

 

This is Going to Really Bug You: In his article “The Mosquito Solution” in the July 16, 2012 issue of The New Yorker (here), Michael Spector writes, with respect to mosquitos, that “there has never been a more effective killing machine” adding that “researchers estimate that mosquitos have been responsible for half of the deaths in human history.”

 

Malaria accounts for much of the mortality, but mosquitos “also transmit scores of other potentially fatal infections, including yellow fever, dengue fever, chikungunya, lymphatic filariasis, Rift Valley fever, West Nile fever and several types of encephalitis.” Mosquitos “pose a greater risk to a larger number of people than ever before.”

 

Spector’s article describes an experimental approach to try to combat mosquitos, by releasing genetically altered male mosquitos into the wild. The modified males mate but their progeny are genetically programed to die quickly after hatching. This approach has shown early promise by reducing the mosquito populations in controlled release areas. However, the proposal to release genetically altered bugs into the wild has proved to be controversial, as described in the article.

 

This is an interesting and important article.

 

Three Thoughts About the London Olympics:

 

1. Her Royal Majesty Queen Elizabeth II as a Bond  girl. Sheer brilliance. The rest of the opening ceremony looked a lot like chaos dressed up in period costumes.

 

2. After waiting four years to see Olympic sports competition, and after an entire day of Olympic competition in which numerous medals were awarded, we turn on our TV in prime time, and what does NBC choose to show us? A preliminary round of Beach Volleyball. And Ryan Seacrest. Oh. My. God.   

 

3. Ryan Lochte wins Olympic gold in the 400 meter individual medley. Switch to a commercial break with three ads featuring Ryan Lochte. And to think that Jim Thorpe once had to forfeit his Olympic medals for violating the principles of amateurism because he had played semi-pro baseball to earn a living.

 

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The rating agencies must defend against  claims for negligent misrepresentation in connection with the ratings the firms assigned to a pair of structured investments vehicles, Southern District of New York Judge Shira Scheindlin has ruled in a pair of May 4, 2012 decisions. Judge Scheindlin did grant the defendants’ motions to dismiss claims for negligence, breach of fiduciary duty and aiding and abetting, which substantially narrowed the plaintiffs’ claims.  But she denied the rating agencies’ motions to dismiss with respect to the negligent misrepresentation claims, finding that, based on the plaintiffs’ allegations, the ratings qualified as actionable misstatements under New York law.

 

Judge Scheindlin issued the opinions in two cases involving structured investment vehicles, one called Rhinebridge and one called Cheyne Financial. Judge Scheindlin’s opinion in the Rhinebridge case can be found here and the opinion in the Cheyne Financial case can be found here.

 

The background on the Cheyne financial case can be found here. The Rhinebridge case arose out of the Rhinebridge structured investment vehicle’s (SIV) June 27, 2007 offering of certain investment securities to certain Qualified Institutional Buyer and Qualified Purchasers. In connection with the offering, the rating agencies gave the Rhinebridge securities the highest ratings. The plaintiffs also allege that the rating agencies helped structure the investment vehicle. The offering proceeds were invested in a variety of residential mortgage related investments. The SIV was forced into receivership on October 22, 2007, becoming, the plaintiffs alleged, “perhaps the shortest-lived ‘Triple A’ investment fund in the history of corporate finance.”  In addition to the rating agencies, the plaintiff investors had also sued IKB Deutsche Industriebank AG , the bank that sponsored the SIV, and Morgan Stanley, which had acted as offering underwriter.

 

Judge Scheindlin had originally dismissed the plaintiffs’ common law claims, holding under New York law that the common law claims were preempted by the Martin Act. However, in December 2011, as discussed here, the New York Court of Appeals rejected Martin Act preemption for common law claims, and Judge Scheindlin allowed the plaintiffs leave to amend their pleadings to assert common law claims. After the plaintiffs amended their pleadings the defendants renewed their motions to dismiss.   

 

In her May 4 ruling in the Rhinebridge case, Judge Scheindlin granted the defendants’ motions to dismiss the plaintiffs’ claims for negligence, breach of fiduciary duty and aiding and abetting. However, she denied the motion to dismiss the plaintiffs’ claims against the rating agencies for negligent misrepresentation.

 

In denying the motions to dismiss the negligent misrepresentation claims, Judge Scheindlin said that:

 

the Rating Agencies (1 intended that their ratings would be used to evaluate the SIV; (2) intended that the plaintiffs –members of a select group of qualified investors – would rely in the ratings to evaluate the SIV; and (3) prepared their ratings with the end and aim of inducing investors such as the plaintiffs to invest in the SIV.

 

Judge Scheindlin’s ruling was specifically dependent on her determination, based on the plaintiff’s allegations, that “there was a privity-like ‘special relationship’ between the plaintiffs and the Rating Agencies.”  Judge Scheindlin also allowed the negligent misrepresentation claims to go forward as to IKB Deutsche Industriebank and Morgan Stanley.

 

Judge Scheindlin’s ruling in the Cheyne Financial case paralleled her rulings in the Rhinebridge case, and her order in the Cheyne Financial case expressly referenced her rulings in the Rhinebridge case.

 

Discussion

Among the causes many cite for the subprime meltdown is the willingness of the rating agencies to assign investment grade rating to securities backed by subprime mortgages. For that reason, in many of the lawsuits filed as part of the subprime litigation wave, plaintiffs have named rating agencies as defendants, seeking to hold them responsible for their investment losses. However, as discussed here, whether the rating agencies could actually be held liable is unclear, because in the past courts have found the rating agencies’ rating opinions to be protected by the First Amendment. The rating agencies have also raised a number of other defenses regarding their rating opinions.

 

A series of rulings in several cases have questioned the rating agencies’ defenses. As discussed here, in a September 2009 ruling in the Cheyne Financial case, Judge Scheindlin held that, at least where the rating agencies’ ratings were released only to a select group of investors, the rating agencies could not rely on their First Amendment defense. In May 2010, a California state court judge followed Judge Scheindlin in rejecting the rating agencies first amendment defense, as discussed here. In November 2011, in a case involving Thornburgh Mortgage mortgage pass through certificates, District of New Mexico Judge James Browning also rejected the rating agencies first amendment defenses, also relying on Judge Scheindlin’s opinion in the Cheyne Financial case, as discussed here.

 

Judge Scheindlin’s May 4 rulings arguably represent the latest decisions holding that the rating agencies could at least potentially be held liable for their ratings opinions. However, Judge Scheindlin’s latest rulings, like the prior rulings holding that the rating agencies could not rely on First Amendment defenses, were largely reliant on the fact at that the securities in question had only been distributed to a select group of investors. Indeed, in the Rhinebridge case, Judge Scheindlin found that the plaintiffs had adequately alleged that there was a privity-like relationship between the plaintiff investors and the rating agencies.

 

The various rulings In these cases, including also Judge Scheindlin’s most recent rulings in the Rhinebridge and Cheyne Financial cases, represent significant developments in connection with investors’ efforts to try to hold the rating agencies liable. However because these rulings are all dependent on the fact that the securities at issue were distributed only to a select group of investors, these rulings may not be helpful in cases involving securities that were more broadly distributed. But though these rulings have limitations, they also represent a growing body of case law on which investors can try to rely in asserting their claims against the rating agencies.

 

David Bario’s May 7, 2012 Am Law Litigation Daily article discussing Judge Scheindlin’s rulings can be found here.  Special thanks to Dan Newman of SCN Strategies for sending along copies of the opinions.

 

FCPA-Related Securities Class Action Suit Filed Against Wal-Mart: In yesterday’s post, I noted that CalSTRS had filed a shareholder derivative action against Wal-Mart, as nominal defendant, and certain of its directors and officers, in connection with the revelations concerning the company’s Mexican bribery allegations. Now, in addition to the shareholder derivative lawsuits, investors have also launched a securities class action lawsuit in connection with the bribery allegations.

 

According to their May 7, 2012 press release (here), the plaintiffs’ lawyers have filed a securities class action lawsuit against the company and certain of its directors and officers in the Middle District of Tennessee. The complaint, which can be found here, features a quote from and even a picture of company founder Sam Walton (allegedly taken from the company’s annual report). According to the press release, the complaint alleges that the defendants “ concealed from the investing public during the Class Period” that “the Company had violated the Foreign Corrupt Practices Act in connection with the bribery payments” and  that  "Walmart management did not address ethical concerns in a ‘timely and effective manner’ as represented by defendants.”

 

As I said previously about the CalSTRS derivative suit, these lawsuit filings reinforce the view that follow-on civil litigation is an almost invariable accompaniment of FCPA-related investigations, and show that FCPA-related exposures are a matter of serious shareholder concern. Taken collectively, the risk of an FCPA investigation as well of the related follow-on civil litigation risk are increasingly important liability exposures for companies and their directors and officers.

 

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SciClone Settles FCPA Follow-on Derivative Suit : In a settlement that involves a company with significant Chinese operations -- and that also may represent something of a template for the settlement of FCPA enforcement follow-on civil lawsuits -- SciClone Pharmaceuticals and the individual defendant directors and officers have agreed to settle the consolidated derivative lawsuits that were filed following the company’s announcement that it was the target of SEC and DoJ investigations for possible FCPA violations.

 

According to the company’s October 12, 2011 press release (here), the parties have agreed, subject to court approval, to settle the consolidated cases based on the company’s agreement to adopt certain specified corporate governance reforms and the company’s agreement to pay $2.5 million in plaintiffs’ attorneys’ fees. The press release states that the payment of the plaintiffs’ attorneys’ fees is “to be paid by SciClone’s insurers under its director and officer insurance policy.” A copy of the parties’ stipulation of settlement can be found here.

 

The FCPA does not provide for a private right of action. However, as I have previously noted on this site, the advent of an FCPA investigation often triggers a follow-on civil lawsuit. In this case, multiple lawsuits were filed against the company, as nominal defendant, and certain of the company’s directors and officers, shortly after the company announced the existence of the investigation. The lawsuits, which were filed in San Mateo County (Calif.) Superior Court in September 2010, and which were later consolidated, alleged that “the Individual Defendants, by reason of their failure to implement and maintain internal controls and systems at the Company to assure compliance with the FCPA, breached their fiduciary duties and may be held liable for damages.”

 

As a result of mediation, the parties reached the settlement that the company announced in its press release. Among other thing, the settlement requires the company to adopt certain measures for three years, including the implementation of sanctions for employees violating the FCPA; the establishment of a compliance coordinator; the adoption of a compliance program and code; and the adoption of certain internal controls and compliance functions. The governance measures are described in detail in the parties’ settlement stipulation.

 

There are a number of interesting things to me about this settlement. The first is that it involves a company that, according to its own website, is a “China-centric” pharmaceutical company. Though the company has its headquarters in the U.S. its “strategy,” as described on the company’s website is to grow its sales in China.  The existence of the FCPA investigation underscores the challenges facing companies attempting to do business in China. Given the company’s business model, the compliance measures adopted in the settlement arguably are a good idea in any event, without regard to the fact that the company willingness to adopt the measures managed to resolve this consolidated litigation.

 

The D&O insurer’s payment of the plaintiffs’ attorneys’ fees shows how these kinds of lawsuits can contribute to insurers’ loss costs. Obviously, the D&O insurers also incurred the defense expenses as well, meaning that the total loss costs for this suit potentially represents a substantial figure. Moreover, depending on the nature and status of the government FCPA investigation, there could be additional covered loss costs as well. The company and certain of its directors and officers were also named as defendants in a related securities class action lawsuit (about which refer here), but that action was voluntarily dismissed without prejudice.

 

As antibribery enforcement activity is stepped up in this country and elsewhere, it seems likely that these types of lawsuits may become even more common. The likelihood is that this type of litigation could make a significant contribution toward insurers’ aggregate loss costs in the coming years. On the other hand, from an underwriting standpoint, it seems that companies that have already voluntarily adopted the kinds of compliance procedures that were the subject of this settlement should be view in a more favorable light, particularly with regard to those companies that might otherwise be viewed with caution owing to the countries in which they are doing business.

 

Dismissal Motion Denied in U.S.-Listed Chinese Company’s Securities Suit: In the second dismissal motion denial entered as part of the current wave of securities suits filed against U.S.-listed Chinese companies, on October 11, 2011, Central District of California Judge Christina Snyder denied the defendants’ motion to dismiss in the securities suit filed against China Education Alliance, Inc. (CEU) and  certain of its directors and officers. A copy of Judge Snyder’s opinion can be found here.

 

As discussed here, the plaintiffs first filed their action in December 2010. Among other things, the plaintiffs allege that the company overstated its revenue and profits by “exponential proportions.” The plaintiffs, in reliance on the report of an online securities analyst, alleged that the company maintained two sets of books, and that the revenue reported in the company’s Chinese regulatory filings was only a fraction of the revenue the company reported in its SEC filings. The complaint also alleges that the company’s educational website was not functional, and its education building allegedly is an empty building without classrooms.

 

The defendants moved to dismiss, arguing in part that the plaintiffs allegations, made in reliance on the online analyst report, merely repeated the unsubstantiated assertions of a professed short seller that was financially motivated to drive down the company’s share price. In rejecting the defendants’ argument in this regard, Judge Snyder relied on the earlier dismissal motion denial in the case involving another U.S.-listed Chinese company, Orient Paper (about which refer here). Judge Snyder found it was not appropriate to reject the allegations on that basis at this early stage.

 

Judge Snyder also found tat the plaintiffs had adequately alleged scienter, despite the absence of insider trading or other financially motivated conduct. Judge Snyder found that “additional facts” the plaintiff alleged “give rise to a strong inference of scienter.” Those alleged additional facts include the following:

 

That CEU has filed significantly disparate revenue figures in China and the United States: that plaintiffs’ own investigators toured CEU’s on-site “state of the art” facility in China only to find it an empty building; that witnesses told plaintiffs’ investigators that CEU was not the owner of the building; that CEU has had rapid turnover of its CFOs during the class period; and that many of the links on CEU’s website did not work properly despite its online segment purportedly deriving millions of dollars each year.

 

Judge Snyder said that “although each fact taken along might not give rise to an inference of fraudulent intent,” the allegations “taken together” establish that plaintiffs’ theory is at least as compelling as any opposing inference one could draw.

 

Judge Snyder’s dismissal motion denial suggests that in some cases at least the U.S.-listed Chinese companies draw into the wave of recent securities lawsuits may face difficulties evading these lawsuits, at least at the initial stages. Many of the cases, like this one, are based on the reports of financially motivated online analysts. Judge Snyder’s unwillingness to disregard the allegations based on the analyst’s report, notwithstanding the analysts admitted financial interest in driving down the value of the company’s stock, may represent a problem for the other companies tangled up in these cases as a result of negative reports by online analysts.

 

Moreover, Judge Snyder’s conclusion that the plaintiffs’ scienter allegations were sufficient, inter alia, on the discrepancies between the Chinese regulatory filings and SEC filings, may also suggest that a number of these cases could survive the initial pleading stages, as many of them are based on similar discrepancies between Chinese regulatory filings and SEC filings.

 

To be sure, some cases will nevertheless be dismissed, as was the case with the China North East Petroleum case, in which the dismissal motion was recently granted on loss causation grounds (about which refer here). But if Judge Snyder’s holding in the China Education Alliance case is any indication, other cases also will likely survive the initial dismissal motions.

 

Of course, it remains to be seen how valuable these cases ultimately prove to be for plaintiffs, even if they make it past the initial pleading hurdle. But the name of the game is making it past the dismissal motions, and at least in the China Education Alliance case, the plaintiffs have made it at least that far.

 

Special thanks to a loyal reader for providing me with a copy of Judge Snyder’s opinion.

 

Fed Officials Pursue Actions Against Failed Bank Officials: In a significant development in the current wave of bank failures, that involves a failed bank that had significant ties to and operations in China, on October 11, 2011, federal officials concurrently filed a regulatory enforcement action and a criminal prosecution against certain former officers of the failed United Commercial Bank.

 

San Francisco based United Commercial Bank failed on November 9, 2009 (about which refer here). The bank had offices throughout the United States, as well as China and Taiwan. The bank grew rapidly. According to the SEC, it was the first U.S. bank to acquire a bank in the People’s Republic of China. However, during the economic crisis in late 2008 and early 2009, the bank experience significant difficulties in its loan portfolio, which regulators allege led to the bank’s failure, which in turn triggered the recently filed actions involving the bank’s former officers.

 

First, in an October 11, 2011 complaint (here), the SEC filed a civil enforcement action against four former officers of the bank. According to the SEC’s October 11, 2011 litigation release, the complaint alleges that the defendants “concealed losses on loans and other assets from the bank’s auditors, causing the bank’s holding company UCBH Holdings, Inc. (UCBH) to understate its 2008 operating losses by at least $65 million.” The complaint alleges that the further loan losses ultimately caused the bank to fail. The SEC action seeks permanent injunctive relief, an officer bar, and civil money penalties.

 

In addition, as reflected in the FBI’s October 11, 2011 press release (here), a grand jury has indicted two of these same former bank officials, for conspiracy to commit securities fraud, securities fraud, falsifying corporate books and records and lying to auditors.

 

Both the SEC’s litigation release and the FBI’s press release specifically reference the assistance they received in preparing their actions from the FDIC. The FDIC’s role in these actions is a reminder that as part of its failed bank post mortem, the FDIC is not only attempting to determine whether or not it has a valuable civil suit on its own as receiver, but is also looking to see whether or not wrongdoing has occurred that warrants referral to other authorities.

 

Both the SEC action and the indictment refer to securities fraud, which serves as a reminder that, by contrast to the institutions caught up in the S&L crisis a few years ago, many of these failed financial institutions in the current bank failure wave are publicly traded, a circumstance that has many ramifications.

 

It remains to be seen whether or not the FDIC will also file its own separate civil action against the former directors and officers of this bank. The bank’s former investors have in any event already filed their own class action lawsuit. As discussed here, the defendants’ initial motion to dismiss the class action lawsuit was granted, albeit with leave to amend.

 

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The year-end vacation days are over, the holiday decorations have been taken down, and last year’s wall calendars have been replaced. We are now into the Narnia season (at least here in Cleveland), where it is always winter but never Christmas. The New Year has entered with a bang, and that means more than just inexplicable piles of dead birds. It also means there are lots of newsworthy developments to report. Here’s the latest:

 

FDIC Increases Number of Authorized Lawsuits: Earlier this week, the FDIC updated the Professional Liability Lawsuits page on its website to reflect that the number of lawsuits that it has authorized has been increased. The FDIC has now authorized lawsuits against 109 directors and officers of failed financial institutions, up from 82 as of the end of November 2010. The website also reports that the claims against these individuals represent claimed damages of $2.5 billion.

 

The web page includes a monthly table at the end, showing how the number of individuals against whom lawsuits are authorized has increased since the end of the third quarter. The page also reports that the FDIC has authorized four fidelity bond and attorney malpractice lawsuits.

 

The page reflects a number of interesting details regarding the FDIC’s approach to litigation and litigation history. Among other things, the page reports that the investigation preceding the decision whether or not to bring a lawsuit is usually completed "within 18 months," which explains in part why there have been relatively few FDIC lawsuits against directors and officers of failed banks so far (only two lawsuits against 15 individuals).

 

The page also includes some general information about the legal theories on which the FDIC can seek to recover, the applicable statute of limitations, and the FDIC’s prior history of D&O litigation during the S&L crisis.

 

Many thanks to the several loyal readers who sent me links to the New York Times Dealbook blog’s January 5, 2010 post about the updated FDIC web page.

 

2011’s First Filed Securities Suit Continues 2010 Trend: As far as I can tell, 2011’s first filed securities class action lawsuit is the lawsuit filed on January 3, 2011 in the Eastern District of New York against Tongxin International, Inc. and certain of its directors and officers. The plaintiffs’ lawyers corrected press release describing the suit can be found here and a copy of the complaint can be found here.

 

The lawsuit alleges that the defendants misled investors with respect to its financial reports. The plaintiffs allege that the company initially withheld its financial statements, and then was forced to withdraw previously reported results as unreliable. The company later sued its former CEO and CFO for wrongfully transferring the Company’s funds.

 

As I noted in my analysis of 2010 securities class action lawsuits, one of last year’s noteworthy securities suit filing trends was the significant number of lawsuits involving Chinese companies. From a practical perspective (if not strictly as a formal matter), the new Tongxin lawsuit appears to represent a continuation of that filing trend.

 

Tongxin itself is incorporated in the British Virgin Islands. However, it was formed as subsidiary of a special purpose acquisition company (SPAC) that was formed to acquire an automotive manufacturing company in China. In April 2008, the SPAC acquired Hunan Enterprise Co., Ltd, a Chinese automotive supplier, and the SPAC merged into Tongxin. Tonxin’s operating company, and the events referenced in the complaint, all are or took place in China.

 

The litigation trend of new securities lawsuits involving Chinese companies seems to have carried over into the New Year.

 

Record Number of FCPA Enforcement Actions in 2010: According to the Gibson Dunn law firm’s January 3, 2010 memorandum entitled "2010 Year-End Update" (here), 2010 was a record setting year for FCPA enforcement activity. The memo reports that both the SEC’s and DoJ’s 2010 enforcement actions – which were essentially double the prior year’s record levels – "dwarfed the tally from any prior year in the statute’s 33-year history."

 

According to data reflected in the memo, during 2010 there were 48 DoJ FCPA enforcement actions (compared to 26 in 2009) and 26 SEC FCPA enforcement actions (compared to 14 in 2009). The memo also reports that "nearly every FCPA enforcement action from the past 12 months can be traced to multi-defendant, if not industry-wide investigation that involved numerous companies or persons engaged in coordinate or parallel schemes."

 

FCPA-related settlements in 2010 also were at record setting levels. According to a January 5, 2010 post on The FCPA Blog (here), eight of the top ten FCPA settlements of all time were reached in 2010. As it happens, eight of the top ten FCPA settlements involve non-U.S. companies as well.

 

As I have observed numerous times on this blog, FCPA enforcement activity increasingly is accompanied by follow-on civil litigation, a phenomenon that the Gibson Dunn memo notes "saw a marked increase in activity amongst the plaintiffs’ bar." The memo goes on to observe that "hardly an FCPA investigation or resolution was announced during the past year that was not followed in swift succession by a press release from any number of plaintiffs’ firms from any number of plaintiffs’ law firms that have creased a cottage industry for private FCPA enforcement."

 

Despite the absence of a private right of action under the FCPA, plaintiffs continue to "shoehorn" FCPA-related claims under a wide variety of theories, including securities fraud, breach of fiduciary duties, torts and breach of contract. The law firm memo sets out a long list of various cases that plaintiffs have pursued or are pursuing on FCPA-related allegations.

 

As I previously detailed (refer here), FCPA-related claims represent a growing area of D&O exposure, with important D&O insurance coverage implications.

　

Are Bylaw Forum Selection Clauses Unenforceable?: Many corporate litigants prefer the friendly confines of the Delaware Court system. It is not just that many companies are organized in Delaware and its courts are viewed as business friendly, but also the judges who serve on the Court of Chancery are viewed as both highly skilled and as experienced on complex business litigation issues.

 

Earlier this year, in the Revlon Shareholders’ Litigation, the Delaware Court of Chancery suggested that corporations organized under Delaware law are "free" to adopt "charter provisions selecting an exclusive forum or inter-entity disputes." In the wake of this suggestion, many lawyers began to recommend that their client companies adopt charter provisions designating the Delaware Court of Chancery as the preferred forum.

 

However, on January 3, 2011, Northern District of California Judge Richard Seeborg held, in a case of first impression, that a forum selection clause in Oracle’s bylaws was not enforceable, at least in the absence of shareholder approval. Significantly, Judge Seeborg did not reach issues of Delaware law; his ruling of unenforceability was reached as a matter of federal common law. A copy of Judge Seeborg’s opinion can be found here.

 

As might be expected, plaintiffs’ lawyers have welcomed Judge Seeborg’s ruling – refer for example to David Bario’s January 5, 2011 Am Law Litigation Daily article, here, quoting the plaintiffs’ lawyers in the case as saying that

 

The insertion of these forum selection clauses in bylaws, rather than by amending a company's charter with shareholder approval, has been increasing….I think this decision will help to pull the cover off the practice. It shows that passing a bylaw on normal company business is one thing, but when you're going to pass a bylaw that limits shareholders' rights, that's something much different, and I think that's at the core of the decision.

 

Others have been more critical of the decision. Rebecca Beyer’s January 5, 2010 Daily Journal article (here, registration required) about the decision quotes Stanford Law School Professor Joseph Grundfest as saying that "the distinction as to shareholders who hold shares prior to the bylaw amendment and after the bylaw amendment makes no sense….Every bylaw amendment has to bind all shareholders or it can't work."

 

Grundfest said when people buy shares in a company they agree to allow directors to amend bylaws. "If shareholders don't like the unilateral amendment, the shareholders can - by shareholder vote - overrule the board," he said. Grundfest also said that there likely will be further litigation on this issue, and that the issue could eventually make its way to the U.S. Supreme Court.

 

Time Out for A Couple of Technology Questions: What do you do when your Blackberry isn’t working? And why does the march of technological "progress" involve so many different kinds of fruit? (Special thanks to a loyal reader for a link to the video.)　

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Although the world of electoral politics may seem distant from the directors’ and officers’ liability arena, there was one development in Tuesday’s elections that potentially could affect the D&O claims environment, and it happened right here in The D&O Diary’s home state of Ohio. It has not drawn much national attention, but Ohio’s activist Attorney General Richard Cordray (pictured) lost his reelection bid to his Republican challenger, former U.S. Senator Michael DeWine.

 

Regular readers of this blog know that during his time in office, Cordray has been both highly active and highly visible in leading securities class action lawsuits on behalf of the Ohio public pension funds. Cordray was prominently involved in the recently announced $725 million AIG securities class action lawsuit settlement (about which refer here). Cordray put himself forward in connection with the $400 million Marsh contingent commission securities class action lawsuit (about which refer here).

 

In addition, in November 2009, Cordray led the way on behalf of the Ohio pension funds in filing a securities class action lawsuit against the rating agencies, in which he accused the rating agencies of "wreaking havoc on U.S. financial markets by providing unjustified and inflated ratings of mortgage-backed securities in exchanged for lucrative fees from securities issuers." The rating agency lawsuit is discussed here.

 

Cordray’s office has also sought lead plaintiff status in the securities class action lawsuit filed against BP, as discussed in his July 21, 2010 press release.

 

While Cordray was Ohio Attorney General, his office regularly issued reports on the status of the various securities class action lawsuits his offices was leading. The reports were titled "Holding Wall Street Accountable." The most recent report, dated August 31, 2010, can be found here. His office’s webpage detailing the various securities class action lawsuits in which Cordray was involved can be found here

 

In Tuesday’s election, the Republicans made a clean sweep of the Ohio statewide offices, but the Attorney General contest was by far the closest of any of state level race and. Cordray lost to challenger Mike DeWine by a narrow margin.

 

It remains to be seen whether or not DeWine will try to take up his predecessor’s mantle of "Holding Wall Street Accountable." DeWine’s campaign advertisements emphasized his background as a former prosecutor, and (in light of various scandals in Cuyahoga County), his promises to pursue corruption, an approach that potentally could lend itself to a scourge of Wall Street kind of approach.

 

However, one of the key planks of DeWine’s campaign platform was his commitment to "creating jobs through a business-friendly environment." Given DeWine’s overall conservative background and his commitment to maintaining a "business-friendly environment," I suspect the securities class action litigation agenda will be deemphasized once DeWine takes office.

 

To be sure, even if (as seems likely) DeWine steps back from his predecessor’s securities class action leadership role, others elsewhere might step forward. But the absence of an aggressive attorney general whose agenda includes using securities class action litigation as a policy and political tool could impact the frequency and magnitude of future securities litigation, at least to a certain extent.

 

Reuters reporter Dan Levine’s November 4, 2010 article (here) also speculates that Cordray’s defeat, along with the losses of numerous other activist attorneys general nationally, could help speed resolution of the current foreclosure mess, as well, as the defeated candidates seek to advance measures before they leave office. Among other things, Levine describes Cordray as one of the "spiritual leaders" among the activist AG’s who were agitating on the foreclosure issues.

 

Some Data About Follow-On FCPA Lawsuits: I have written frequently on this blog about the possibility of follow-on civil litigation brought by investors against companies that have been the target of an FCPA enforcement action. A November 1, 2010 Reuters article by Brian Grow entitled "Bribery Investigations Spark Shareholder Suits" (here) provides some quantification for this observation.

 

The article reports that according to Westlaw data, since the beginning of 2010 alone, plaintiffs’ lawyers have filed 24 shareholder suits against companies that have disclosed FCPA investigations. (The cases are a mix of class actions and derivative suits). The past average has been about eight such suits a year. The article also reports that though some cases have been dismissed, plaintiffs generally have been successful in these cases. Of the 37 cases in the preceding four years, 26 resulted in settlements.

 

The November 2010 issue of Metropolitan Corporate Counsel published (here) a roundtable discussion entitled "Compliance and Litigation Issues As Foreign Corrupt Practices Act Enforcement is on the Rise." The article includes a discussion of some of the challenges involved with FCPA compliance issues.

 

I will be participating in a panel at the upcoming PLUS International Conference in San Antonio. The panel, which is entitled "Foreign Corrupt Practices Act: Unexpected Liabilities for D&O Insurers, will be moderated by my friend Joe Monteleone, and is scheduled as the first session on Thursday, November 11, 2010. More information about the Conference and the FCPA panel can be found here.

 

The Nuts and Bolts of D&O: I hope readers have noticed that I have added a reference in the right hand column of this blog to my multipart series on the nuts and bolts of D&O. The reference, which can be found right below the "Subscribe" dialog box,  includes a link to the series index.

　

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If you are one of those people who still need persuading that the increasing crack-down on corrupt behavior is a big deal, you will want to take a look at The FCPA Blog’s recent breakdown of the top ten Foreign Corrupt Practice Act settlements, which can be found here. As Dick Cassin, the blog’s author elaborated in a subsequent post, the top ten settlements collectively total $2.8 billion, but the top six, all of which took place just in the last 20 months, represent 95% of the total. Four of the top six settlements were reached just in 2010.

 

As if this past activity were not enough, the newly effective Dodd-Frank Wall Street Reform and Consumer Protection Act seems likely to lead to even further enforcement activity. As noted in a July 20, 2010 memorandum from the Proskauer law firm, Section 922 of the Dodd-Frank Act contains new provisions designed to encourage whistleblowers to report securities law violations. Among other things, the Section provides that if the whistleblower’s information leads to the imposition of sanctions in excess of $1 million, the whistleblower will receive between ten and thirty percent of the total.

 

The law firm memo comments that "if the whistleblower provisions Congress previously provided in other areas are an accurate indication, the Dodd-Frank Act will increase dramatically the likelihood that suspected violators of the securities laws will face costly enforcement actions."

 

This threat, the memo notes further, is "particularly great" with respect to FCPA violations, precisely because of the massive scale of the settlements that the SEC has been achieving in this area. Given the size of these settlements, the potential rewards for whistleblowers are enormous. The potential rewards are so massive that some commentators have referring to these provisions as the "whistleblower bounty provision."

 

A detailed overview of the Dodd-Frank Act’s whistleblower provisions can be found on the FCPA Professor blog, here. Among other things, Professor Mike Koehler, the blog’s author, points out the danger that these whistleblower provisions represent, because the standards for violation of the FCPA are so ill-defined and because so many companies find it expedient to settle FCPA allegations rather than to try to test them in Court. Against this backdrop, he questions the wisdom of offering whistleblowers rewards of up to 30%.

 

However, Professor Koehler, unlike many commentators, conjectures that the whistleblower provisions may have a "negligible impact." in part because the whistleblower provisions are only triggered when public company issuers are involved, whereas many companies targeted in FCPA enforcement actions are private companies. He also points out that the whistleblower provisions create huge incentives for companies to self-report violations. If a company has self-reported, then the whistleblower’s information is not "original" and the whistleblower is not entitled to the bounty.

 

By contrast, and as Ross Todd reports in a July 21, 2010 article on the AmLaw Litigation Daily (here), many commentators, including the former head of FCPA enforcement at the Department of Justice, are advising that we should expect the size and scope of FCPA enforcement cases to increase.

 

Meanwhile, there are important developments across the ocean with respect the UK Bribery Act, which received Royal Assent on April 8, 2010. On July 20, 2010, the U.K. Ministry of Justice released its timetable for the implementation of the Bribery Act, setting April 2011 as the effective date. The Act is widely viewed as in several important respects more "far-reaching" than the FCPA, and is likely to have significant impacts on business that either are based in the U.K. or have significant parts of their operations in the U.K.

 

The April 2011 effective date represents something of a delay, as noted in a July 20, 2010 memo from the Morgan Lewis law firm. The FCPA Professor blog has a detailed discussion here of the possible reasons behind the delayed implementation. Essentially, the extension is intended to allow business to become familiar with the law and to permit the U.K. government to launch a "shore consultation exercise" to provide "guidance" firms can adopt to prevent bribery.

 

Though the U.K. provisions may be somewhat delayed and though the impact of the new Dodd-Frank Act whistleblower provisions may be uncertain, there is no question that this is an area where many things are happening. Anti-corruption enforcement represents a significant and growing area of liability exposure for corporate officials, especially in light of the government’s apparent willingness to resort to sting tactics and other prosecutorial techniques as part of the heightened enforcement.

 

These developments also have significance for purposes of the structure and implementation of insurance calculated to enforce corporate officials. The fines and penalties associated with these kinds of enforcement actions typically would not be covered under a D&O policy, but the defense fees, at least for the individuals might well be. However, the Dodd-Frank Act whistleblower provisions, for example, may raise concerns under the typical D&O policy’s insured vs. insured exclusion.

 

The potential implications of these developments within the D&O insurance context represent a significant area of concern for D&O insurance professionals. It is worth noting that I will be participating in a panel entitled "Foreign Corrupt Practices Act: Unexpected Liabilities for D&O Insurers" at the November 2010 PLUS International Conference. I will be participating on the panel, which will be chaired by my friend, Joe Monteleone of the Tressler law firm.

 

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Every day seems to bring news of a new or expanded bribery or corruption allegations and enforcement actions. In recent days alone, Avon announced that it was suspending four executives in connection with an internal investigation into alleged bribery in the company’s Chinese operations, and U.S. authorities announced they were joining German and Russian authorities in connection with an investigation involving alleged bribery by Hewlett-Packard executives in Russia.

 

If it seems as if the pace of antibribery and anticorruption activity has been picking up, that is only because it has.

 

According to an April 15, 2010 memorandum from the Wilkie Farr & Gallagher law firm (here), the level of Foreign Corrupt Practices Act (FCPA) enforcement in the first quarter of 2010 was "unprecedented." In the first three months of 2010 alone, the U.S. government brought or resolved FCPA charges against 36 companies and individuals, which is 30 more than in the first quarter of 2009 and 32 more than in the first quarter of 2008.

 

Moreover, according to the memo, the signs are that this heightened level of activity will continue for "the foreseeable future." Among other things, there are a variety of "new enforcement initiatives and prosecutorial tools" that have been initiated, including the creation within the SEC’s Enforcement Division of a new unit to focus on FCPA enforcement, and the enactment of the U.K’s Bribery Bill, which received royal assent on April 8, 2010. The Bribery Bill is similar to but broader than the FCPA. In addition, the draft financial reform bill introduced by Senator Chris Dodd contains a provision that, if enacted, would provide significant financial rewards to whistleblowers for providing information leading to a successful enforcement action.

 

These and other developments, including the recent DOJ-FBI sting operation involving individuals in the arms manufacturing industries, suggests, according to the memo, that antibribery enforcement activity is "likely to increase in both the short and the long run."

 

As I have noted in the past (refer for example here), among the risks associated with this types of investigative or regulatory actions is the possibility of follow-on civil litigations following in the wake of the governmental action. There have been many examples in the past of these kinds of follow-on actions, and a recently filed case shows that this threat of litigation following in the wake of an FCPA investigation is continuing. 

 

This most recent example involves a shareholders’ derivative complaint (here) filed on April 15, 2010 in Harris County (Texas) District Court against Pride International, as nominal defendant, and against the eight individual members of Pride’s board of directors. Pride is one of the world’s largest offshore drilling companies. The derivative action arises from "the Board lack of internal control that permitted the Company to engage in years of systematic violations of the FCPA."

 

The complaint alleges that the company’s internal investigation "revealed that Pride paid over $4 million and kickbacks to government officials in every country in which the Company does business." The complaint further alleges that on February 16, 2010, Pride announced that the company was creating a $56.2 million reserve to resolve the FCPA violations. However, the reserve "will only cover the fines, penalties, and disgorgements" and does not include the costs the company has incurred in "investigating and remedying the damages done as a result of the Board’s failure to require that the Company install and maintain a system of internal controls for compliance with the FCPA."

 

The complaint, which seeks recovery for "breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment," alleges that "none of the defendants took any steps to prevent this colossal mistake."

 

UPDATE: This new lawsuit filed against Pride apparently is the second derivative action to be filed against the company relating to these issues. The FCPA Professor Blog had an earlier post (here) describing a prior derivative action that was filed last fall in connection with these same circumstances.

 

This case provides an example of what I have described in the past as the D&O link to FCPA activity. There would not be coverage under the typical D&O policy for the fines and penalties imposed in connection with an FCPA enforcement action, although defense fees incurred in connection with the action potentially could be covered under many policies, depending on the policy wording. But the filing of a civil lawsuit against members of the board of directors, as a follow on to the FCPA action, is an event much more directly linked to the D&O policy and much more likely to give rise to covered loss under the policy.

 

As the escalating levels of FCPA enforcement actions continues to increase, this type of potential Board liability exposure will continue to be a growing concern for Boards, their advisers, and their D&O insurers.

 

Those wondering exactly why we are seeing so many antibribery actions now will want to review the April 20, 2010 post, here, on The FCPA Blog.

 

Special thanks to a loyal reader for providing me with a copy of the Pride International complaint.

 

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For those of us who spend a lot of time looking at securities class action lawsuits, the cases often have a familiar pattern. Unfortunately, the familiarity may dull sensitivity to the allegations or even to the process itself. So it was interesting to read a layman’s reaction to a recently filed lawsuit, if for no other reason than it provided a look at the lawsuit and the process with a fresh set of eyes.

 

The lawsuit in question was filed in the Northern District of California on March 9, 2010 against Medivation and certain of its directors and offices. As is so often is the case in these kinds of lawsuits, Medivation is a life sciences company whose developmental stage product failed to meet certain clinical trial goals. Specifically, and as reflected in the plaintiffs’ lawyers March 9 press release (here), its product did not meet primary and secondary goals in a Phase 3 clinical trial for patients with mild to moderate Alzheimer’s disease. When the company announced this news, its stock price declined and the lawsuit followed. A copy of the complaint can be found here.

 

This lawsuit will work its way through the system. The lawyers involved, all of whom undoubtedly are (or when they are retained to defend will be) well versed in these things, and will raise familiar arguments that may or may not succeed. All very familiar to those of us who spend all of our time immersed in these kinds of things.

 

An interesting perspective about this lawsuit appeared on the Blogging Stocks site (here). The author, Gary E. Sattler, has a number of reactions to the plaintiffs’ complaint, summarizing his comments with the observation that "even when given my usually cynical nature, and my usual dislike for big pharmaceutical interests, I still take issue with this potential class action lawsuit."

 

After summarizing the plaintiffs’ allegations, the author notes that

 

The plaintiff class has to cross a significant threshold of proof in order to prevail in this case. Based on my reading of the original complaint, plaintiffs fail to establish intent, fail to reveal purposeful omission of fact, and fail to establish that the actions of the defendants were the true overt cause of any artificial inflation of Medivation's stock value. Furthermore, the plaintiff's complaint seems to disregard that Medivation has had broad yet cautious support from within the Alzheimer's treatment community. Was it all wishful thinking? Perhaps it was, but that support came from many well-educated minds experienced in the field.

 

Sattler goes on to note that "to me, this potential class action smacks of sour grapes." He then reiterates his support for the company and for the company’s Alzheimer’s product.

 

Sattler seems to be reasonably objective (he states that he has no investment interest in the company). Of course, his rough and ready assessments have no direct relationship to how the lawsuit and its allegations might fare in court. But I have often found that the court of public opinion is an accurate sounding board. True, it might be argued that because of Sattler’s preexisting interest in the company and in its product he might be biased in its favor. But just the same it is interesting to look at the allegations through his eyes and see his reaction to the allegations.

 

When the U.S. Supreme Court first issued its opinion in Tellabs, I thought it would make little fundamental difference, because I thought that in the end and regardless of the formal standard, courts would give the green light to cases that raised a stink and would cut short the rest. Regardless of whether I am right about the Tellabs standard, I think trial courts fundamentally assess cases on a smell test, which is basically what Sattler has done in his post, albeit without specific reference to legal standards. Viewed in that light, his rough and ready assessment is interesting. And perhaps significant, at least with respect to the case’s prospects.

 

More About the FCPA: Regular readers know that I have a certain fixation about the Foreign Corrupt Practices Act. (Indeed, one reader has gone so far as to accuse me of being "obsessive" about it.) I continue to believe that the FCPA will be an increasingly important corporate exposure in the years ahead, if for no other reason than the relentless globalization of commerce.

 

For those who remain skeptical on the topic, I suggest a quick review of the March 10, 2010 post by Bruce Carton on his Securities Docket blog (here). In his post, Carton painstakingly compiles all of the recent comments by regulators corroborating that the FCPA is a top priority. He also reviews the significance of the recent Africa Sting enforcement action, as well as the implications of the Bribery Bill which may soon become law in the U.K. As Bruce’s emphasizes, there are a number of very significant implications to the Bribery Bill.

 

As Carton puts it, top FCPA lawyers agree that the anti-bribery activity has reached "a fever pitch." Whether or not I am obsessive, it is indisputably clear that FCPA related enforcement activity will be a significant area of corporate exposure in the months and years ahead.

 

A Picture is Worth a Thousand Words: Want to know what the financial crisis is all about? Check out this graphic depicting the escalating mortgage default rate during the current crisis. No interpretation required. As for myself, I am considering investing in gold. And stocking my basement with water, canned goods, matches, stout rope and a knife. You never know.

 

This Too Shall Pass: You are probably familiar with the OK Go video performed on an array of treadmills. If not, you should get out more. I’ve seen it and I have serious social issues. (See prior item). However, and in any event, everyone should watch the new video from OK Go for its new song, "This Too Shall Pass." Rube Goldberg would be impressed. Smashing pianos, crashing trash cans, smashing TV sets (showing the treadmill video, no less), the whole enchilada.

 

Though I have embedded the Rube Goldberg version below, there is an alternative spoof marching band version here that is also funny in a completely different way. (Don’t you love the Internet?) Please also see the Author's Note below.

　

Authors’ Note: This blog post was written in its entirety on a laptop computer while the author was sitting in Cladgagh Irish Pub in Lyndhurst, Ohio and watching Real Madrid play Lyon in a UEFA Champions League game on the television. (In an excellent game, the teams played to a 1-1 tie.)  I hope you enjoy reading this post as much as I enjoyed writing it. Gradus ad Parnassum.

 

　

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On February 5, 2010, BAE Systems announced (here) that it has entered separate settlements with the U.S. Department of Justice and the U.S. Serious Frauds Office, pursuant to which the company will pay a total of nearly $450 million to settle long-standing investigations of improper payments.

　

Under the U.S. plea deal, the company will pay $400 million to settle one charge of conspiring to make false statements and under the U.K. deal the company will pay a penalty of £30 and plead guilty to one charge of breach of duty to keep accounting stemming from a payment to a former consultant in Tanzania. A February 6, 2010 Wall Street Journal article discussing BAE’s entry into these deals can be found here.

 

The investigations surrounding BAE’s improper payments have been both very high-profile and very controversial. As discussed at length in a prior post (here), the most sensational aspects of the investigation have involved allegations involving the Al-Yamamah Saudi Arms deal, which allegedly involved improper payments to Prince Bandar bin Sultan, a member of the Saudi royal family. The propriety of the Serious Fraud Office’s decision to terminate that aspect of the BAE investigation was particularly controversial and eventually made its way to the House of Lords, which, as noted here, concluded that the SFO had properly exercised its authority to terminate the investigation, after a lower court had previously ruled that the SFO must reconsider its decision to terminate the investigation. The DoJ continued its investigation of the controverisal arms deal, however.

 

Given the controversy surrounding the BAE investigation, it is hardly surprising that, notwithstanding the sheer size of BAE’s deals resolving the investigation, questions about the resolution of the investigation have arisen.

 

Among others concerns that have been noted, it is very difficult to discern from BAE’s press release and from the SFO’s release (which can be found here) which exactly the company is admitting to having done. Neither document contains words or phrases you might, under the circumstances, expect to see, including, for example, "bribery" "corruption" or even "improper payments" or "improper influence." As the FCPA Professor blog notes here, "can the enforcement agencies on both sides of the Atlantic say with a straight face that this case was merely about improper record keeping, making false statements to the government, and export licenses?"

 

The criminal information that the Department of Justice filed in the District Court for the District of Columbia is a little more specific, as it as least refers to improper payments that the company made in connection with military aircraft transactions involving the governments of the Czech Republic and Hungary. The criminal information also specifically references "undisclosed payments associate with the sale of Tornado Aircraft and other defense materials to the Kingdom of Saudi Arabia." The criminal information also specifically references "substantial benefits" provided to one unnamed Saudi official "who was in a position of influence" regarding the aircraft deals.

 

According to the FCPA Blog (here), the Al-Yamamah arms deal, about which the blog has additional information (including a link to video footage) is "at the heart" of the criminal information, though the details are slight.

 

The paucity of detail almost ensures that controversy will continue to surround the investigation. The tenor of the controversy is succinctly captured by the FCPA Professor blog’s comment in connection with the BAE deals that "transparency, corporate accountability, and indeed a criminal justice system all suffered setbacks today."

 

But though questions will continue to be raised, the sheer size of the payments BAE has agreed to make in order to resolve these investigations should not be overlooked. Along with the staggering amounts to which Siemens agreed to pay in connection with its own separate corrupt practices investigation, these payments demonstrate that corrupt practices investigations represent a very significant risk exposure. It should also not be overlooked that in the case of Siemens and BAE, as well as a number of other companies that U.S. authorities have targeted, these corrupt practices investigations often involved companies domiciled outside of the United States.

 

As I have previously noted (here), one parallel threat accompanying threat of regulatory investigations concerning corrupt payments is the possibility of follow-on civil litigation in U.S. courts. BAE systems was itself the target of a shareholders’ derivative suit regarding the corrupt payments investigation, although as noted here (scroll down after linking), the BAE Systems derivative suit was later dismissed due to the claimants lack of appropriate standing to bring the action.

 

Other foreign targets of FCPA investigations have also been subject to civil litigation in U.S. courts, as demonstrated by the recent securities lawsuit filed against Panalpina and certain of its directors and officers concerning its disclosures and accounting for certain alleged improper payments.

 

The point is that not only does the threat of an improper payments investigation represent a significant risk exposure for companies active in the global economy but that threat includes the risk of civil litigation in U.S. courts. This litigation threat all of these issues important considerations for purposes of D&O insurance, as I discussed in a prior post, here.

 

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Longtime readers know  I have frequently argued that claims related to the enforcement of the Foreign Corrupt Practices Act are a growing source of liability exposure for companies and their senior officials, a stand that has made me the subject of occasional derisive comments. One reader recently suggested to me that I am "obsessive" about the topic. But after yesterday’s massive indictment of 22 individuals as a result of an FBI sting -- the DoJ’s largest FCPA-related investigative action ever -- I think my occasional critics will have to agree that enforcement activities really do represent a significant corporate exposure that must be taken very seriously.

 

As reflected in the Department of Justice’s January 19, 2010 press release (here), the 22 individuals were indicted for engaging in schemes to bribe foreign government officials. The indictments are the result of an FBI undercover operation that focused on allegations of foreign bribery in the military and law enforcement products industries.

 

The 16 separate indictments can be found here. Only individuals are named in the indictments; no companies have been named. The individuals worked for companies in the U.S, the U.K and Israel. All but one of the individuals was arrested while attending an industry convention in Las Vegas.

 

According to the DoJ’s press release, the indictments represent "the largest single investigation and prosecution against individuals in the DoJ’s enforcement of the Foreign Corrupt Practices Act." The press release also quotes the Assistant Attorney General as saying that the "ongoing investigation" is "the first large-scale use of undercover law enforcement techniques to uncover FCPA violations."

 

If you have any doubts about the government’s willingness to commit resources to enforce the FCPA, you should know that, as part of this investigation, 150 FBI agents executed 14 search warrants in at least twelve locations around the country.

 

The investigation also reflects a frequently common aspect of these kinds of enforcement actions – that is, crossborder cooperation between investigative agencies. Specifically, in this case, the City of London’s police executed seven search warrants in connection with their own investigation of the foreign bribery conduct that formed the basis of the indictments.

 

The DoJ’s press release describers how the FBI’s sting operation worked:

 

the defendants allegedly agreed to pay a 20 percent "commission" to a sales agent who the defendants believed represented the minister of defense for a country in Africa in order to win a portion of a $15 million deal to outfit the country’s presidential guard.  In reality, the "sales agent" was an undercover FBI agent. The defendants were told that half of that "commission" would be paid directly to the minister of defense. The defendants allegedly agreed to create two price quotations in connection with the deals, with one quote representing the true cost of the goods and the second quote representing the true cost, plus the 20 percent "commission." The defendants also allegedly agreed to engage in a small "test" deal to show the minister of defense that he would personally receive the 10 percent bribe.　

 

The indictments were returned on December 11, 2009 by a grand jury sitting the District of Columbia and were unsealed yesterday.

 

The indictments allege that the individuals conspired to violate the FCPA, conspired to engage in money laundering, and engaged in substantive violations of the FCPA.

 

The maximum prison sentence for the conspiracy count and for each FCPA count is five years. The maximum sentence for the money laundering conspiracy charge is 20 years in prison. The indictments also seek criminal forfeiture of the defendants’ ill gotten gains.

 

The FCPA Blog has a summary regarding the indictments here. The FCPA Professor Blog also has a post about the indictments here.

 

According to statements quoted in a January 19, 2010 Bloomberg article (here), the investigation has been underway for 2 ½ years, and "is continuing." The official quoted in the article declined to say whether there would be further indictments as a result of this investigation. However, the official noted that there are over 140 open investigations into violations of the bribery laws and he added that ""I can assure you there will be more charges as a result of some of those investigations."

 

The involvement of criminal charges against so many individual defendants raises many questions, including whether or to what extent D&O insurance might respond in these circumstances. The issue will of course depend to a large extent on the precise wording of the policies involved. The criminal forfeitures would not in any event be covered under any policy. However many policies include within their definition of claim the filing of criminal charges in an indictment, which at least for policies with that language might hold open the possibility that the policies might provide at least defense cost coverage.

 

Whether any specific policy would provide coverage for criminal defense expenses will depend in large part on the wordings of other policy provisions, including in particular any potentially relevant policy exclusions. Though they do not appear in many contemporary policies, some older policy forms contain certain exclusions that (if not removed by endorsement) could potentially operate to preclude coverage for FCPA-related criminal defense expenses.

 

But as I have frequently pointed out, the greatest relevance of the D&O policy in connection with bribery related legal proceedings may be in connection with any follow-on civil action that may arise. The FCPA itself does not contain a private right of action, but investors and others sometimes raise claims that company’s senior officials did not take appropriate steps to protect against the improper conduct, or that the company misrepresented its financial condition.

 

The sheer magnitude of this most recent FCPA criminal enforcement action, taken together with the existence of 140 open FCPA-related investigations and the likelihood of further enforcement actions ahead, underscores the seriousness of FCPA exposures for senior company officials. And as highlighted by my brief discussion above of the way the D&O policy may respond in connection with FCPA claims, it is critically (and increasingly) important that these issues are taken into account at the time the D&O policy is formed.

 

Year-End Securities Litigation Review Webinar: On January 22, 2010 at 11 am EST, I will be participating in a webinar sponsored by Advisen entitled "Review of Securities Litigation 2009 and Expert Views for the Year Ahead." Joining me for the hour-long webinar will be Jeffrey Lattman of Beecher Carlson and Mark Lamendola of Travelers, as well as David Bradford and Jim Blinn of Advisen. You can register for the webinar here.

 

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The onslaught of bank closures continues. The FDIC’s closure of five more banks this past Friday night brings the 2009 YTD total number of bank failures to 120 – including twenty-one in just the last three weeks alone. There are a variety of reasons for the growing number of bank failures, but clearly one important reason is the continuing deterioration of commercial real estate loans.

 

As I noted in a prior post (here), there may be further bank failures ahead as commercial real estate mortgages come due or default. A November 5, 2009 BusinessWeek article entitled "The Commercial Loan Nightmare Facing U.S. Banks" (here) suggests that banks’ commercial real estate loan problems may be worse even than may be currently apparent.

 

According to the article, "many banks have been forestalling the day of reckoning" by using an approach the article described as "extend and pretend," which consists of allowing "temporary extensions to trouble borrowers on maturing commercial loans to give them, and the bank, some breathing room."

 

The problem for the banks is that "surging delinquencies and defaults will eventually catch up with them." Many banks are currently showing no charge-offs, but as much as $500 billion in commercial real estate loans will mature within in coming months, while commercial real estate values have declined as much as 40 percent since the beginning of 2007. As these issues catch up with the banks, according to the article, more banks could fail.

 

The article includes a list of the 30 publicly traded banks that may have the most exposure to commercial real estate. The 30 banks have more than 50 percent of their loan portfolios in commercial real estate loans. To be sure, the banks’ heavy concentration in real estate loans is not the same as being burdened with bad loans, but it does mean that the listed banks "have more exposure to the commercial real estate sector."

 

Among the bank closed this past Friday night was the California-based United Commercial Bank, as reflected in this November 6, 2009 FDIC Press Release (here). The bank's parent holding company, UCBH, and certain of its directors and officers, were already the subject of a securities class action lawsuit, as I discussed in a prior post, here. The UCBH lawsuit and the failure of the bank operating company may represent examples of the ways in which the growing numbers of troubled banks could lead to an increased amount of litigation arising from the banks' woes.

 

Another Subprime Securities Suit Dismissal: In an October 6, 2009 order (here), District of Massachusetts Judge Nathaniel Gorton granted the defendants’ motion to dismiss the complaint that had been filed against the commercial construction firm, Perini Corporation and certain of its directors and officers. Judge Gorton’s dismissal ruling granted the plaintiffs leave to amend, but he warned that if the amended complaint is deficient, "dismissal will be with prejudice."

 

As reflected here, the plaintiffs had alleged that Perini had failed to disclose that the developer on a major Las Vegas construction project was experiencing financial difficulties, including difficulties in obtaining project financing for the Las Vegas project. The complaint further alleged that as a result of these difficulties the Las Vegas project faced possible delays and that the developer faced a risk of default. The complaint further alleged that the Las Vegas project represented as much as 20% of the Perini company’s construction backlog and that as a result of the difficulties the company’s ability to maintain its profit margins was in doubt.

 

As Judge Gorton later summarized, the "crux" of the plaintiffs’ complaint is that the company knew about the developer’s financial troubles, "which rendered statement that, in essence, all was well at Perini, false and misleading."

 

In his October 6 ruling, Judge Gorton found that the plaintiffs had failed to adequately allege scienter. He said that even assuming the defendants were aware of the developer’s financial difficulties "the complaint fails to attribute the requisite high level of culpability to them. To the contrary, the complaint sets forth facts showing that the defendants were actively and ultimately successfully, working to ensure that any difficulties of [the developer] did not impact Perini."

 

The court found that the non-fraudulent inferences from the defendants’ conduct and statements to be "more compelling that any inferences of culpable scienter." Moreover, Judge Gorton found further that the plaintiffs had failed to "plead adequately that the defendants were even ‘aware of’ [the developer’s] financing difficulties in the first instance."

 

Finally, Judge Gorton found that even if the plaintiffs had adequately alleged scienter, the allegedly fraudulent statements do not provide a basis of liability. He found that most of the statements came within the safe harbor for forward looking statements and that the few remaining statements that were not forward looking were not otherwise actionable

 

I have added the Perini decision to my running tally of subprime and credit crisis-related dismissal motion resolutions. The tally can be accessed here.

 

Special thanks to Adam Savett of the Securities Litigation Watch (here) for providing copies of the Perini ruling.

 

Another FCPA-Related Civil Lawsuit Settlement: Regular readers know I have written frequently about civil litigation that can follow in the wake of Foreign Corrupt Practices Act (FCPA) investigations and enforcement actions. (Refer for example here.) In the latest resolution of this kind of follow on civil action, on November 6, 2009, Nature’s Sunshine Products announced (here) that the court had preliminarily approved the settlement of the lawsuit in which the company had agreed to pay $6 million.

 

As reflected here, the plaintiffs in the securities lawsuit had alleged in connection with the improper payments that the company lacked appropriate internal controls and that the company’s books and records did not reflect the foreign transactions. As noted here, the court had denied the defendants’ motions to dismiss.

 

The company’s FCPA-related problems received additional attention earlier this year when (as noted here), the SEC brought control person liability charges against the company’s CEO and CFO, even though the individuals were not alleged to have had any involvement in or even awareness of the company’s allegedly improper payments.

 

The company’s $6 million securities class action settlement is just the latest in a line of settlements in securities cases following in the wake of FCPA-related investigations and enforcement actions. My prior overview of FCPA-related follow-on civil litigation can be found here.

 

The Financial Crisis and D&O Insurance: A wide variety of litigation has arisen out of the global financial crisis, much of which has implicated the D&O insurance of the defendant companies. The involvement of the companies’ D&O coverage in turn has underscored the importance of the applicable policies’ coverage and in particular the sufficiency of the policies’ terms and conditions.

 

A recent memo entitled "Directors’ and Officers’ Coverage Priorities in the Financial Crisis: A Seven-Point Inspection for Your D&O Policy" (here) by Ernest Martin Jr. and Micah Skidmore of the Haynes and Boone law firm presents a comprehensive overview of the critical D&O insurance issues arising from the current financial crisis. The article is thorough and timely.

 

Apologies: Due to a massive spambot attack directed at the "Comment" function of blog sites hosted by the LexBlog network (on which The D&O Diary is hosted), there have been a variety of service and performance disruptions on this site over the last several days. Among other things, the comment function has been disabled and the email notification system was interrupted. I have also had intermittent difficulties just adding new content.

 

I apologize to readers for any difficulties you may have had accessing this site, posting comments, or receiving email notifications. I am hopeful that the problems are now or will soon be completely resolved.

 

My special thanks to everyone at LexBlog for the courteous and attentive service while managing this crisis.

 

This Week: The D&O Diary’s publication schedule during the week of November 9 will be disrupted because I will be in Chicago for the annual PLUS International Conference. I know many readers will also be there and I hope readers who see me there will be sure to say hello and, if we have not met before, to introduce themselves. I look forward to seeing everyone in Chicago.

 

Upcoming Conference: On November 30-December 1, 2009, I will be co-Chairing the American Conference Institute’s Fifteenth Annual Advanced Forum on D&O Liability in New York. This event will include presentations from the leading figures in the D&O insurance field, and the program will address the most critical issues facing the D&O insurance industry today. The program agenda, including registration information, can be found here.

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A recent SEC enforcement action alleging Foreign Corrupt Practices Act violations against Nature’s Sunshine Products and two of its officers may represent a new and disturbing liability threat to corporate officials. The SEC asserted claims directly against the two individuals even though they were not alleged to have either involvement in or knowledge of the alleged misconduct, based solely on their "control person" responsibilities. These allegations, which experts say may represent the first of its kind to be alleged, could represent a troublesome new liability exposure for officers and directors.

 

The SEC’s Enforcement Action

As reflected in the SEC’s July 31, 2009 litigation release (here), the SEC filed a complaint (copy here) in the Central District of Utah against the company, alleging that in 2000 and 2001, the company had made $1 million in payments to Brazilian customs officials in order to facilitate the company’s importation of certain of its products. The complaint alleged that the company had violated the FCPA’s antibribery, books and records, and internal control provisions.

 

The complaint also alleges claims against Douglas Faggioli, the company’s CEO who at the time had been the company’s COO and a member of its board of directors, and against Craig D. Huff, who is no longer with the company but who served as the company’s CFO at the time.

 

With regard to Faggioli, the SEC alleged that his position gave him supervisory responsibility for the senior management of and policies regarding the worldwide distribution of the company’s products. The SEC alleged that Huff had supervisory responsibility for the senior management of and policies regarding the company’s books and records. Both were alleged to have failed to adequately supervise the company’s personnel in 2000 and 2001 to keep the company’s book and records accurately and to devise and maintain a system of books and records sufficient to adequately monitor company activities.

 

Neither the company nor the individuals admitted wrongdoing, but the company agreed to pay a civil penalty of $60,000 and the individuals each agreed to pay a civil penalty of $25,000

 

Discussion

According to an August 11, 2009 memorandum from the Shearman and Sterling law firm (here), the significance of the case is that control person liability allegations have "rarely (if ever) been used by the SEC in FCPA cases."

 

The memo also notes that the SEC did not allege that Fagiolli or Huff were involved the payments or even aware of the improper accounting for the payments. As the memo states, "the SEC’s decision to charge Faggioli and Huff with control person liability without alleging that either of them participated in or had personal knowledge of the FCPA violations raises the disturbing spectre [sic] of strict liability for executives."

 

In a separate interview published in the National Law Journal on August 20, 2009 (here), Philip Urofsky of Shearman and Sterling noted that at least in the civil context, control person liability "has been used against a much wider variety of corporate officers and even directors," so there is even a potential for control person allegations for FCPA violations to be raised against directors, "at least where the directors are very active and involved in the operations of the company."

 

The possibility that directors and officers could be held liable for FCPA violations without any culpable involvement or even knowledge of the misconduct represents a disturbing new potential liability threat to corporate officials. This threat is all the more troublesome because the SEC, under pressure to reestablish its regulatory credentials, has made it clear that FCPA enforcement will be a high priority.

 

Indeed, in an August 5, 2007 speech (here), Robert Khuzami, the SEC’s new Division of Enforcement head, among other things announced the formation of a new FCPA unit, saying that "more needs to be done" to enforce the FCPA. He described the unit’s goals as "being more proactive in investigations, working more closely with our foreign counterparts, and taking a more global approach to these violations."

 

There is no private right of action under the FCPA itself. However, civil litigants have long relied control person liability allegations in claims against corporate officials. Whether these civil litigants can use these theories of control person liability for FCPA violations remains to be seen, although that seems unlikely give the absence of private right of action for FCPA violations.

 

However, as I have frequently noted (most recently here), one of the exposures facing corporate officials related to FCPA enforcement activity is the possibility of follow-on civil litigation – indeed, Nature’s Sunshine Products is itself the subject of a securities class action lawsuit in which investors have alleged that the company and certain of its directors and officers made misrepresentations about the company’s internal controls and financial statements as a result of the overseas FCPA violations. As discussed here, the case previously survived the defendants’ motion to dismiss.

 

To the extent corporate officials are held liable by the SEC for FCPA violations on control person liability theories, they could also potentially be susceptible to claims by private litigants based on alleged fiduciary duty breaches. In addition, other civil claims, including claims based on alleged violations of disclosure duties under the securities laws, could be bolstered by an SEC enforcement action alleging control person liability claims.

 

In short, these developments may represent a significant new area of D&O liability exposure, or at least a significant extension of previously existing exposures. The typical D&O liability insurance policy would not likely cover any fines or penalties imposed on corporate officials for their control person liability, but their expenses incurred in defending against the claims likely would be covered under the typical policy, as would their defense expenses and any settlements or judgments against them in any follow-on civil litigation. Because of these possibilities, these developments potentially could represent a significant new loss exposure for the D&O insurers, too – or at least an expansion of a previously existing exposure.

 

One final note is that there seems to be a disturbing new trend where the SEC is seeking to use its authority to impose liability on or to effect recoveries upon corporate officials even where the individuals themselves are not alleged to have engaged in culpable misconduct. As I noted here, the SEC recently took steps to try to clawback executive compensation form the CEO of CSK Auto even though he was not alleged to have any knowledge or involvement in the events that required the company to restate its previously issued financial statements. In the Nature’s Sunshine Products case, the SEC sought to impose control person liability on the two individual defendants despite their lack of culpable participation in or awareness of the FCPA violations.

 

I recognize that the SEC is under pressure to show that it is tough and that it is a trustworthy regulatory guardian, but I find this new willingness to try to impose liability on individuals who are not themselves alleged to have engaged in culpable misconduct troubling. I recognize the theoretical appeal of a "captain of the ship" type approach to corporate misconduct, but I still think individuals without culpable participation in or even awareness of misconduct ought not to be subject to the burden, humiliation and expense of governmental enforcement activity. The pursuit of persons lacking culpability seems to me like the essence of overzealous regulatory action.

 

That said, I note that the law firm memo linked about does recite certain background features of the Nature’s Sunshine Product case that may go a long way toward explaining why the SEC sought to impose control person liability in this particular case. It is entirely possible that the claims asserted are simply a reflection of the facts involved, and nothing more.

 

Special thanks to the several readers who sent me links regarding the Nature's Sunshine Products case.

 

Has Global Financial Turmoil Increased FCPA Risks?: The FCPA prohibits corruptly offering or providing anything of value to "foreign officials." As a result of the global financial crisis, government ownership in a wide variety of enterprises has proliferated. According to an August 10, 2009 New York Law Journal article by Stephanie Melzer and Christopher Tierney of the Cadwalader law firm entitled "Has Economic Uncertainty Expanded the Reach of the Foreign Corrupt Practices Act?" (here), the number of "foreign officials" may have dramatically increased, in ways that could have transformed long-established business practices into conduct violative of the FCPA.

 

The authors show that the published guidance and case law resources do not really establish conclusively what level of governmental involvement or ownership in an enterprise is required in order for an entity’s representative to be a "foreign official." Various settlements do show that U.S. authorities have been willing to extend the FCPA to "conduct involving payments to employees of entities that are less than majority-owned or controlled by foreign governments."

 

Accordingly, the authors conclude that given the massive amounts that governments have injected in a wide variety of enterprises, "a legitimate question arises whether employees of previously private enterprises will be viewed as ‘foreign officials’ under the FCPA." In short, "the current financial crisis may have turned some previously private employees into ‘foreign officials.’" – creating the unsettling possibility that previously acceptable and appropriate business entertainment or other ordinary business activities could now be alleged to constitute conduct violative of the FCPA.

 

Does FCPA Enforcement Encourage Corruption?: It may sound counterintuitive, but a recent paper (here) by attorney and scholar Andy Spaulding suggests that among the "unintended consequences" of aggressive FCPA enforcement may be that it could cause corruption to proliferate unimpeded in emerging markets.

 

As reflected in an August 5, 2009 Wall Street Journal article discussing Spaulding’s paper (here), Spaulding contends that FCPA enforcement might be deterring corporations from investing in developing countries where corruption is rampant. But if U.S. corporations stop investing in emerging markets, entities from other nations that are not as committed to fighting corruption will step in. As Spaulding puts it, "’black knights’ will move in to fill the void," as a result of which "the world economy could slowly begin to bifurcate into two economies: one in which bribery is tolerated and one in which it is not."

 

Spaulding concludes that "the FCPA is thus revealed to be a large-scale study in the law of unintended consequences."

 

Portrait of a Corrupt Society: An August 22, 2003 Wall Street Journal article entitled "Pride and Power" (here), about the current political and economic conditions in Russia, reported the following about the culture of corruption in that country:

 

One of the major obstacles to conducting business in Russia is the all-pervasive corruption. Because the government plays such an immense role in the country's economy, controlling some of its most important sectors, little can be done without bribing officials. A recent survey by Russia's Ministry of the Interior revealed, without any apparent embarrassment, that the average amount of a bribe this year has nearly tripled compared to the previous year, amounting to more than 27,000 rubles or nearly $1,000.

 

And Finally: For those readers who like me are fascinated with these emerging FCPA-related issues, The FCPA Blog is an absolutely essential daily read. The blog’s author, Richard Cassin, regularly updates the key developments in anticorruption activities around the globe. For example, Cassin’s take on Spaulding’s provocative paper about the FCPA’s unintended consequences can be found here.

 

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For some time, I have been asserting (refer here, for example) that increasing levels of Foreign Corrupt Practices Act enforcement activity represents an important development in the world of D&O insurance. During a conversation at the American Bar Association Annual Meeting in Chicago this past week, a senior claims executive from one of the leading D&O insurers expressed skepticism to me on this topic, essentially suggesting that D&O insurance doesn’t have anything to do with FCPA enforcement.

 

It is certainly true that fines and penalties imposed as a result of an FCPA violation would not be covered under the typical D&O insurance policy. But in many instances, defense costs incurred in defending against the enforcement action, which could be quite substantial, are likely to be covered under many D&O policies, so even just to that extent, increased FCPA enforcement activity could represent a significant D&O insurance development.

 

But perhaps even more significant for D&O insurance purposes than expenses incurred in defense of the enforcement activity itself is the exposure presented by the possibility of a follow-on civil lawsuit. As I have previously noted (most recently here), a separate civil action by shareholders or others is an increasingly frequent accompaniment of the FCPA enforcement activity. A recently filed case provides the latest example of this phenomenon.

 

On July 23, 2009, investors in Panalpina World Transport (Holding) Ltd. filed a securities lawsuit in the Southern District of Texas against the company, certain of its current and former directors and officers, and the foundation that owned the company prior to its September 2005 IPO. The investors’ complaint can be found here.

 

Panalpina is a Swiss company which the complaint alleges has "substantial operations in the Southern District of Texas." The complaint describes the company as "the market leader in freight forwarding services for the oil and gas industry." The complaint alleges that the company "concealed" that its Nigerian operations "depended on bribes to customs agents in Nigeria," in violation of the FCPA. The complaint further alleges that in its public reports the company "has essentially conceded its violations of the FCPA."

 

The complaint further alleges that when the illegal practices were revealed, the company "was forced to cease them," and its financial results and share price were "materially and negatively impacted." The complaint alleges that since disclosing its illegal activities in Nigeria on July 24, 2007, and subsequent disclosures regarding the material impact of the Nigerian business, the company’s common stock has lost over 78% of its value.

 

The complaint alleges violations of the Sections 10(b) and 20 of the Securities Act; Common Law Fraud; Aiding and Abetting Common Law Fraud; and Negligent Misrepresentation.

 

There are several interesting things about this new complaint. First, the case is an example of the ways in which FCPA-related activity can result in, for example, securities litigation against a company and its directors and officers. Subject to the terms and conditions of the applicable coverage, the expense of defending this kind of claim, as well as any subsequent settlement or judgment, would likely by covered by the typical D&O insurance policy. This case is just the latest example of how the growing FCPA enforcement activity represents a significant development from a D&O claims perspective.

 

But there are other interesting aspects of this suit, separate and apart form this primary consideration. Among other things, the complaint does not appear to be brought as a class action lawsuit. Rather, the action appears to have been brought solely on behalf of four apparently related investment partnerships, based in Connecticut and in the Cayman Islands.

 

The absence of class action allegations could be due to the fact that though Panalpina is a publicly traded company, its shares do not trade on any U.S. exchanges. (Its publicly traded shares trade only on the Swiss Exchange.) As a foreign domiciled company whose shares trade only on a foreign exchange, many of its shareholders likely are also domiciled outside the U.S., and so an action on behalf of a class of Panalpina shareholders could present a classic example of the f-cubed claimant problem (that is, foreign investors who bought their shares in a foreign company on a foreign exchange). Though the named plaintiffs include at least on foreign domiciled fund, several of the named plaintiffs are based in Connecticut and thus to that extent the f-cubed problem may be averted.

 

There may yet be some interesting jurisdictional questions in this case. Not only is the company foreign domiciled, and not only are its shares traded elsewhere, but the supposed bribery took place outside the U.S. And, without plumbing the depths of the factual allegations, it would seem that many of the alleged misrepresentations took place outside the U.S., notwithstanding the fact that the company may have substantial U.S. operations. The case seems to present circumstances quite analogous to the facts involved in the securities suit against National Australia Bank case (refer here), in which the Second Circuit ultimately concluded that the U.S. courts lacked subject jurisdiction over the matter.

 

Jurisdictional issues notwithstanding, this case in and of itself represents yet another example of a recurring phenomenon, one that I think will continue to gain importance in the months ahead, as a result of increasing FCPA enforcement activity.

 

The latest information regarding the increasing levels of FCPA enforcement can be found here.

 

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In prior posts, I have frequently noted the rising tide of Foreign Corrupt Practices Act (FCPA) enforcement activity as well as the increasing level of FCPA follow-on civil litigation. If the trends noted in a recent law firm memo are any indication, we are likely to continue to see both heightened enforcement activity and ensuing civil litigation for some time to come.

 

In a July 7, 2009 memo entitled "2009 Mid-Year FCPA Update" (here), the Gibson Dunn law firm takes a comprehensive look at FCPA enforcement trends. The memo notes that during the first six months of 2009, the regulatory authorities have "continued the recent explosion of FCPA enforcement activity, and the number of ongoing investigations suggest that this trend will not soon subside."

 

In substantiating the observation that there is a "continuing explosion of FCPA prosecutions," the memo notes that "in just the first six months of 2009, more FCPA prosecutions were brought than in any other full year prior to 2007" and that "the nineteen enforcement actions initiated to date in 2009 exceeds the enforcement activity undertaken during the first half of any prior year."

 

The memo also observes that the heightened enforcement activity trend is likely to continue for the foreseeable future. The memo cites key regulators as having "confirmed" that "at least 120 companies are the subject of ongoing investigations."

 

The memo also addresses a theme frequently raised on this blog, which is the threat of civil litigation following in the wake of FCPA enforcement action. As the memo notes, even though the FCPA does not provide a private right of action, "enterprising plaintiffs’ lawyers have not been deterred from shoehorning alleged FCPA violations into a variety of civil actions," including securities fraud actions, shareholder derivative suits, contract claims and tort claims. At the same time, the memo notes, some corporate enforcement action defendants "have brought suit against the individuals responsible for these violations."

 

Among other things, the memo discusses the continuous threat of FCPA-related securities litigation, mentioning specifically the UTStarcom securities litigation (background here) in which the plaintiff shareholders allege that the company knowingly violated the FCPA by bribing officials in China, Mongolia, and India in order to secure contracts.

 

The growing significance of FCPA-related securities litigation was underscored in the January 2009 NERA Economic Consulting report discussing, among other things, the growing size and number of FCPA securities class action lawsuit settlements. As discussed here, the NERA report notes that a total of $84.4 million was paid in securities class action settlements between 2002 and 2008.

 

In addition to FCPA-related securities lawsuits, plaintiffs have also filed FCPA-related shareholders derivative lawsuits. The Gibson Dunn memo specifically mentions the April 2009 settlement in which FARO Technologies agreed to implement certain corporate governance changes and to pay $400,000 in plaintiffs’ attorneys’ fees to settle a derivative suit alleging that the directors and officers breached their fiduciary duties by failed to properly oversee the company’s internal activities. The FARO Technologies derivative settlement follows FARO’s earlier settlement of an FCPA-related securities lawsuit in which its D&O insurers paid $6.785 million to settle the suit.

 

During the first half of this year, plaintiffs also filed a shareholders derivative lawsuit against Halliburton and KBR as nominal defendants and against the companies’ current and former directors and officers to recover as civil damages amounts the companies paid in connection with their recent high profile FCPA settlements, as discussed here.

 

The Gibson Dunn memo emphasizes that the follow-on lawsuits are not always successful, and the memo specifically cites as examples of unsuccessful cases the shareholders’ derivative suits involving Baker Hughes and Chevron Corporation, where motions to dismiss were granted earlier this year.

 

The memo also describes civil litigation that companies themselves are pursuing to try to recoup amounts the companies paid to settle FCPA enforcement actions. Among other cases the memo specifically mentions is an action brought by Willbros International against several former officials and consultants. Willbros pled guilty to violating the FCPA in 2008 and now alleges that the defendants were responsible for the unlawful conduct.

 

The Gibson Dunn memo concludes that "the number of recent enforcement actions and ongoing investigations suggests that the FCPA enforcement environment that we have observed over the past several years is here to stay." As the FCPA enforcement activity continues to grow, an increasing number of companies will find themselves involved in FCPA-related civil litigation.

 

Even though the FCPA enforcement fines and penalties generally would not be covered under a D&O insurance policy, the policy could be called upon to respond to the costs of defending against an FCPA enforcement action, and any follow-on civil litigation could also trigger the company’s D&O coverage, subject to all of the policy’s terms and conditions.

 

On a final note, the SEC Actions blog had an interesting recent post (here) emphasizing the high priority that FCPA enforcement actions are being given, both here and abroad. I would be remiss if I did not also note that The FCPA Blog (here) is a continuing source of excellent information on FCPA related developments that I follow regularly.

 

Pay to Play?: According to a July 7, 2009 article in the Deseret (Salt Lake City) News (here), U.S. Senator Bob Bennett (R. Utah) has asked the SEC to investigate whether plaintiffs’ law firms are making campaign contributions to public officials that oversee government pension funds in the hope of later being able to represent the funds in securities class action litigation.

According to the article, Bennett wrote that "state officials with control over pension fund decisions…receive very substantial campaign contributions from out-of-state law firms with no apparent interest in the election – other than the possibility of being chosen as the pension fund’s lawyer in a class action."

Bennett noted that these practices are of particular concern at a time when pension funds "are reeling from the decline the financial markets."

You Can’t Make This Stuff Up: As part of the eternal vigilance required in order to maintain this blog, I am constantly scouring the media for important developments. Sometimes I run across items that are noteworthy, even if they are not particularly important. Just to make sure that my readers are not deprived of these vital items, I share the following:

"Drunk Badger Disrupts Traffic in Germany" (here)

"France Faces EU Lawsuit for Failing to Protect Endangered Hamster" (here)

"Iowa State Fair Rethinks Jackson Butter Sculpture" (here)

 

Non, Je Ne Regrette Rien: With apologies to Edith Piaf and with a hat tip to Francine McKenna on whose blog, Re: The Auditors (here) I first saw this video, here is a musical tribute to a funny and odd assortment of Internet regrets.

 

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Regular readers know that a recurring theme on this blog is the increasing prevalence of civil litigation following on in the wake of FCPA enforcement actions (refer for example here.) In the latest example of the phenomenon, on May 14, 2009, the Policemen and Firemen Retirement System of the City of Detroit has filed a derivative lawsuit in Texas (Harris County) District Court against Halliburton Company and KBR as nominal defendants, and against the companies’ present and former directors and officers, to recover civil damages, inter alia, in connection with the companies’ recent high-profile FCPA enforcement settlements.

 

By way of background, and as reflected here, on February 11, 2009, KBR and Halliburton agreed to pay $177 million in disgorgement in connection with SEC charges that KBR subsidiary Kelly Brown & Root LLC bribed Nigerian officials over a 10-year period in violation of the FCPA. In addition, Kelly Brown & Root agreed to pay $402 million to settle parallel criminal charges. Halliburton’s press release regarding the settlement can be found here.

 

The recently filed Texas civil action seeks "to hold Defendants responsible for the reign of terror their reckless failure to monitor the Companies’ internal controls permitted to take place at the Companies."

 

The plaintiffs’ Petition alleges that "the Companies were permitted to engage in conduct so notorious that the name ‘Halliburton’ has become virtually synonymous with corruption, just as Enron became the poster-child for fraud."

 

The complaint further alleges that KBR and its employees and agents "engaged in a course of conduct that includes bribery, gang rape, human trafficking, illegal operations in Iran, mishandling of toxic materials, and systemic overbilling."

 

The plaintiffs allege that the defendants were either complicit with or lacked oversight over these actions.

 

The increasing likelihood of civil litigation following on after an FCPA enforcement action, of which the new Texas lawsuit is but one example, represents a growing liability exposure for directors and officers of public companies and for their insurers. The fines and penalties in the underlying enforcement action would not be covered under the typical D&O insurance policy, although many of the costs of defending against allegations could well be covered. However, the costs of defense and in all likelihood any settlement of the follow-on civil litigation would be covered under most D&O policies. As a result, as I have discussed in prior posts, these kinds of lawsuits could represent a growing area of exposure for D&O insurers.

 

An AmLaw.com article regarding the lawsuit can be found here. A May 15, 2009 Bloomberg article regarding the lawsuit can be found here.

 

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A recurring theme on this blog has been the growing threat of civil litigation following in the wake of increased Foreign Corrupt Practices Act enforcement activity. (Refer for example, here.) A recent study both establishes both the overall scale of FCPA enforcement activity and quantifies the magnitude of the FCPA follow-on securities litigation.

 

The January 28, 2009 NERA Economic Consulting study, entitled "FCPA Settlements: It’s a Small World After All" (here) reports that since 2002, SEC and DOJ litigation and class actions involving the FCPA have "increased steadily," with over "$1.2 billion in settlements and penalties involving more than 30 countries during that period."

 

While this impressive number is inflated by the $800 million penalty and disgorgement recently imposed on Siemens, it also apparently does not include the pending $559 million settlement to which Halliburton recently agreed.

 

The Report, which draws on a database of all FCPA settlements between 2002 and 2008, includes a list of the ten largest regulatory settlements (again, not including the pending Halliburton settlement), which range between $16 million and $800 million. These figures include settlements with both the SEC and the DOJ.

 

What makes this Report really interesting is its analysis of settlements of securities class action lawsuits based on FCPA-related allegations.

 

The Report states that in securities fraud class action lawsuits arising from alleged FCPA violations a total of $84.4 million has been paid in settlements between 2002 and 2008. The Report further notes that if the outsized Siemens settlement is removed from the analysis, the settlements related to securities class action lawsuits represent 21% of all of the total FCPA-related civil and regulatory settlement by public companies during the period 2002 through 2008.

 

Based on the author’s review of several recently settled FCPA-related class action settlements, the Report concludes that "the behavior connected to the alleged FCPA violation can sometimes have a lasting impact on the company’s business." The class action settlements demonstrate "the link between alleged FCPA violations, ongoing revenue and the potentially large impact on firm value."

 

The Report also contains a table reflecting the market-adjusted price reactions to FCPA-related news and announcements. Analysis of the data shows that "the majority of companies that exhibited statistically significant price reactions at the 5% level to FCPA-related news had resulting 10b-5 actions filed against them."

 

The Report concludes by stating that as a result of globalization trends, coordinated regulatory activity and record-keeping requirements, FCPA enforcement is a growing priority around the world, and states that "as FCPA-enforcement against domestic and foreign issuers increases, it is likely that related securities litigation will be an issue in many of these cases."

 

The NERA Report’s detailed analysis is very interesting and is also quite consistent with my own analysis of the growing liability threat that FCPA enforcement activity represents. The Report also provides statistical support for my view, expressed here, that "the proliferation of this type of litigation activity and the significant involvement of the leading plaintiffs’ firms suggests that this category of emerging litigation may represent an increasingly important area of potential liability to directors and officers."

 

This growing liability exposure also raises a number of potentially significant D&O insurance coverage issues, which I discussed at length in the June/July 2008 issue of InSights, which can be found here.

 

My  recent post analyzing the opinion in the InVision case, in which the Ninth Circuit affirmed the dismissal of a securities class action lawsuit that had been based on FCPA-related allegations, can be found here.

 

A recent post with a year-end 2008 FCPA update can be found here.

 

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Among the many lawsuits that have flooded in as part of the subprime and credit crisis litigation wave has been a profusion of lawsuits against the mortgage-backed securities issuers and their securities offering underwriters. These lawsuits, typically filed under the ’33 Act and alleging misrepresentations in the offering documents, claim that investors who purchased securities in the offering have been harmed due to the deterioration in the performance of the underlying mortgages.

 

As discussed below, questions about the damages claimed in these lawsuits could present serious hurdles as the cases go forward.

 

Background

A recent example of the class action securities litigation filed on behalf on investors in these mortgage-backed securities investments may be found in the January 26, 2009 press release (here) in which the plaintiffs’ lawyers described the lawsuit they filed in the Eastern District of New York against Deutsche Alt-A, Inc., and certain other defendants in connection with the offering of mortgage-backed pass-through securities by 32 mortgage loan trusts.

 

As described in the press release, the complaint (here) alleges that the offering documents failed to disclose that:

 

sellers of the underlying mortgages to Deutsche Alt-A were issuing many of the mortgage loans to borrowers who: (i) did not meet the prudent or maximum debt-to-income ratio purportedly required by the lender; (ii) did not provide adequate documentation to support the income and assets required to issue the loans pursuant to the lenders’ own guidelines; (iii) were steered to stated income/asset and low documentation mortgage loans by lenders, lenders’ correspondents or lenders’ agents, such as mortgage brokers, because the borrowers could not qualify for mortgage loans that required full documentation; and (iv) did not have the income or assets required by the lenders’ own guidelines necessary to afford the required mortgage loan payments, which resulted in loans that borrowers could not afford to pay.

 

The complaint alleges as the underlying mortgages have deteriorated, "the Certificates are no longer marketable at prices anywhere near the price paid by plaintiff and the Class and the holders of the Certificates are exposed to much more risk with respect to both the timing and absolute cash flow to be received than the Registration Statement/Prospectus Supplements represented."

 

 

This case is only one of several recent lawsuits in which the same or similar allegations have been raised. Plaintiffs’ lawyers have raised similar allegations against, for example, mortgage-backed pass through certificates sponsored by JP Morgan Acceptance Corporation (refer here); mortgage backed securities sponsored by GS Mortgage Securities Corp. (refer here); mortgage pass-through certificates sponsored by Washington Mutual (refer here); and mortgage-pass through certificates sponsored by Residential Asset Securitzation Trust (refer here). By my count, there have been more than a dozen of these types of lawsuits filed in connection with the current subprime and credit crisis-related litigation wave.

 

Like many of these cases, the Deutsche Alt-A case was originally filed in state court, and removed by defendants to federal court. (The removal petition, which accompanies the complaint, can be found here.) The federal court subsequently denied the plaintiffs' motion to have the case remanded to state court, in this case on the relatively narrow and specific ground that that one of the entities that originated the underlying mortgages, American Home Mortgage Corporation, is in bankruptcy in the federal court in Delaware, and the securities case is related to the bankruptcy proceeding. A copy of the January 8, 2009 opinion denying the remand motion can be found here.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the removal petition and complaint in the Deutsche Alt-A case.

 

Damages Analysis

In each of these cases, the harm claimed is similar to that alleged in the Deutsche Alt-A case; that is, that as a result of problems associated with the underlying mortgages, the securities are "no longer marketable at prices near the price paid" and the holders are exposed to much more risk with respect to the timing and absolute cash flow."

 

These allegations raise some interesting and perhaps novel questions, as discussed in a January 2009 article from the Milbank Tweed law firm entitled "Subprime Litigation Against Issuers and Underwriters of Mortgage-Backed Securities—Where are the Actual Losses?" (here).

 

As the memo notes, these lawsuits embody "the relatively untested assumption" that the current paper value of these securities is "the appropriate reference point" for determining whether the investors have "suffered a loss that is ripe for litigation (and the extent of any such loss)."

 

The authors note that these securities are not listed on any public exchanges, but rather all trades are privately negotiated. The securities themselves are essentially contracts that entitle the owner to certain portions of principal and interest from the pools of mortgages that serve as collateral for the securities. The securities also have various forms of credit enhancement, such as overcollateralization, subordination and excess spreads, so that defaults on the underlying mortgages will not necessarily trigger a default on the payment obligations on the securities themselves.

 

As a result, an investor could continue to receive payments under the securities as scheduled, even if GAAP accounting might require the carrying value of the securities to be reduced.

 

These circumstances lead the authors to ask

 

Is the fear that certain tranches of the [mortgage backed securites] might not be paid in full a sufficient basis for brining a claim under the ’33 Act? Is such a claim a ripe case or controversy for the courts? And is the fact that some "paper measure of price" for the [mortgage backed securities] tranche has declined since the time of purchase enough to overcome these hurdles?

 

In considering these questions, the authors note that the typical offering documents for these kinds of securities expressly warn that a secondary market for the securities may not exist and that investors may not be able to sell the securities at the price they hope to obtain. For most investors in these types of securities, this consideration is generally of less concern, because the investors "expect to make money by holding the bond through maturity and receiving the income stream they bargained for, not by trading on a secondary market."

 

Nevertheless, the lawsuits relating to these securities claim damages based on the decline in their valuation and the fears that payments may be at "risk" in the future. The memo reviews the well-publicized difficulties associated with valuing these securities, and notes the probable lack of valuation uniformity among holders of these securities, given the flexibility of the relevant accounting standards. As a result, the securities holders may face challenges in establishing with sufficient certainty that they have suffered an "economic loss," as the securities laws arguably require. These difficulties are particularly where, as is the case with many of these securities, the investors continue to receive all payments due to them.

 

The authors suggest that generally there is no basis in law for seeking damages where the damages cannot be quantified and may never come to pass. They suggest that defendants in these cases will attempt to argue based on these principles that investors "who continue to be paid the full amount of any principal and interest payments due to them may have little choice but to ‘wait and see’ whether feared, modeled, or projected losses…come to fruition (i.e., become ‘clear and definite’) before being able to state claims under the securities laws."

 

The authors add that this argument may be particularly compelling where "intervening events such as legislative or executive action….could drastically alter the future payment outlook for many mortgage-backed securities."

 

These lawsuits against the issuers of mortgage-backed securities represent a significant number of the subprime securities lawsuits. Plaintiffs’ lawyers seem inclined to file these lawsuits, undoubtedly in part due to the degree of investor concern about their investments. Whether and to what extent these cases ultimately will succeed remains to be seen. As the law firm memo demonstrates there may be a host of questions surrounding these lawsuits. At a minimum it will be interesting to see what the courts make of these cases, and in particular the alleged damages, as the lawsuits proceed.

 

A more academic overview of many of these issues may be found in the paper Harvard Law School professor Allen Ferrell and Babson Business School Professors Jennifer Bethel and Gang Hu entitled "Legal and Economic Issues in Litigation Arising from the 2007-2008 Credit Crisis" (here).

 

Largest FCPA Penalty Ever Against U.S. Company: Fast on the heels of Siemens recent agreement to pay $800 million to settle bribery allegations (about which refer here), Halliburton has now agreed to pay $559 million to settle charges that one of its former units bribed Nigerian officials during the construction of a gas plant.

 

According to Halliburton’s January 26, 2009 press release (here), Halliburton has agreed to pay $382 million to the U.S. Department of Justice in eight installments over the next two years. In addition, Halliburton agreed to pay the SEC $177 million in disgorgement. Both settlements are subject to final approval by the relevant authorities.

 

As reported on the WSJ.com Law Blog (here), the Halliburton penalty is by far the largest ever for a U.S. company, far surpassing the prior record of $44 million by Baker Hughes in 2007. More detail about the Halliburton agreement can be found on The FCPA Blog (here).

 

The Halliburton settlement is further evidence of a point I have made numerous times on this blog, that FCPA enforcement activity represents a growing area of concern. As I discussed most recently here, an important part of this exposure is the threat of civil litigation that frequently follows on after the enforcement proceeding. The sheer magnitude of the Siemens and Halliburton settlements suggest that potential FCPA liability could represent a significant exposure for corporations and their directors and offices.

 

Blast from the Past: Another Options Backdating Settlement: The options backdating cases are a vestige from another time and place, yet they remain, like so much cosmic dust, reminders of a distant catastrophe. In a recent development in one prominent case, the Delaware Chancery Court has approved a settlement that is noteworthy in at least a couple of respects.

 

As reflected in a January 2, 2009 opinion by Chancellor William Chandler in the Ryan v. Gifford case (here), the court has approved the settlement of the options backdating case involving Maxim Integrated Products, over shareholder objections. Under the settlement, which is detailed in the opinion, the defendants agreed to pay a total of $28,505,473 in cash. In addition, the defendants agreed to cancel, reprice or surrender claims with respect to certain options they continued to hold. The company also agreed to certain corporate governance reforms.

 

The settlement is noteworthy in a couple of respects. The first is simply that it involves the Ryan v. Gifford case, in which Chandler had written an influential and important February 2007 opinion denying the defendants’ motion to dismiss (as discussed here). Because of this opinion, the case is among the more prominent of the options backdating cases.

 

The other noteworthy aspect of the settlement is the individual defendants’ significant contribution toward settlement. Of the $28.5 million settlement amount, $21 million was paid by insurance. The balance of the cash was paid by the individual defendants. John Gifford, the company’s former CEO, agreed to make his own cash payment of $6 million to Maxim, even though, as the Court noted, he was "covered by insurance." The court’s statement in this respect seems to suggest that there were additional insurance funds available to fund this amount, but that as part of the settlement Gifford nevertheless agreed to pay this amount out of his own assets. Other individuals agreed to pay lesser amounts.

 

It is not entirely clear whether the insurance would in fact have covered the amounts of these individual payments. For example, in connection with the payments by the individuals other than Gifford, the court noted that the amounts paid "represent the entire amount that they were alleged to have benefitted from the exercise of backdated stock options." To the extent these amounts represent disgorgement or return of ill-gotten gains, the policy’s coverage would not apply. The court’s opinion is not as specific with respect to Gifford’s payment, but to the extent his contribution also represents his return of benefits from the exercise of backdated options, the insurance coverage similarly would not likely apply.

 

In any event, the size of the settlement, the prominence of the case and the significance of the individuals’ contributions make this a noteworthy settlement. I have added the settlement to my list of options backdating lawsuit settlements, dismissals and dismissal motion denials, which can be accessed here.

 

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I encourage those that questioned my inclusion of FCPA issues in my list of top ten 2008 development to refer to the January 5, 2009 memo from the Gibson Dunn law firm entitled "2008 Year-End FCPA Update" (here).

 

As the memo puts it, 2008 was ‘by any measure …a monster year in Foreign Corrupt Practices Act (‘FCPA’) enforcement." The memo goes on to note that "2008 saw the FCPA’s enforcement regime mature like never before," adding that "there were no unimportant FCPA enforcement actions this year."

 

The memo highlights several enforcement trends. First, with particular emphasis on the recent massive Siemens FCPA fine, the report notes the trend toward escalating corporate financial penalties.

 

The memo reports that the Siemens fine eclipsed the prior record FCPA fine by nearly twenty times; in fact, the memo notes, the Siemens fine substantially exceeds "the aggregate of every dollar collected by the U.S. government in connection with FCPA settlements over the statute’s thirty-one year history." The memo also emphasizes the staggering costs that Siemens incurred in connection with the investigation. The memo notes that the company’s investigation and corporate remediation costs exceeded $1 billion.

 

To show that "enormous foreign prior settlements are certain not to be a fluke of 2008," the memo cites ABB’s recent announcement that it has reserved $850 million for potential costs associated with the continuing investigation of alleged improper practices.

 

The memo also addresses a theme I have frequently sounded (most recently here), that FCPA enforcement actions increasingly are accompanied by follow-on civil litigation. The memo notes that FCPA investigations increasingly have "spurred a variety of collateral civil suits, including securities fraud actions, shareholder derivative suits, and lawsuits initiated by foreign governments or business partners." Companies "can no longer assume that making peace with DOJ and the SEC will end the pain associated with their alleged FCPA violations."

 

With respect to securities litigation following on after FCPA investigations, the memo notes that "in recent years, courts have been trending towards finding that plaintiffs adequately alleged false or misleading statements, thereby meeting the heightened pleading standard under the PSLRA." However, as I noted in a recent post (here), the Ninth Circuit in the InVision Technologies case made it clear that "there are limits on the types of allegations that will meet this threshold."

 

The memo also reproduces an interesting bar graph showing the foreign jurisdictions having the "dubious distinction of being the most-referenced setting for FCPA allegations." Among the top countries are Nigeria, Iraq, China, Vietnam and Ecuador.

 

The memo, which is detailed and interesting, identifies a number of other important trends, including the increased internationalization of foreign anti-corruption endorsement.

 

Answer: Less Than One Day: In my January 7, 2009 post (here) regarding the accounting scandal dramatically disclosed at the Indian technology company Satyam Computer Services, I raised the question of how long it would take for plaintiffs’ lawyer to initiate a securities class action lawsuit against the company in a U.S. court.

 

The answer is – less than a single day.

 

Even before the close of business on January 7, plaintiffs’ lawyers announced (here) that they had filed a securities class action lawsuit in the Southern District of New York on behalf of purchasers of the company’s ADRs (which are traded, or at least were traded, on the NYSE) against the company and certain of its directors and officers. A copy of one of the Satyam complaints that has been filed can be found here.

 

The well of scandal is an ever-flowing stream, providing the plaintiffs’ bar with a constantly replenished source of new litigation targets. So much for the notion that the pool of potential securities litigation defendants is "fished out."

 

New Year’s Resolution: Some people resolve lose more weight, other people resolve to get more exercise. Even though I need to spend more time fooling around with technology like I need a hole in my head, my New Year’s resolution is to try to get more plugged into the new social media.

 

Along those lines, you will note that I have added a button in the right hand sidebar that links to my LinkedIn profile. I encourage everyone to check out my profile by clicking on the button. I would also like to strongly encourage other readers that are active on LinkedIn to "connect" with me. I am still trying to figure out what the site will lead to, but at least if readers of this blog start connecting we can try to work through it together.

 

In addition, I have recently signed up for Twitter. Again, I am still feeling my way along with the new technology, but I will say that I have used Twitter several times over the past couple of days to alert "followers" (in effect, subscribers) to developments before I had a chance to get a post up on my blog. For example, as soon as I saw the link to Cornerstone’s year end report, I posted a "tweet" on Twitter. I also added a "tweet" about the new Satyam lawsuit as soon as I learned about it. I encourage readers who may also be active on Twitter to sign up for future updates.

 

Finally, I welcome readers’ thoughts and comments on these new media. As I said, I am still trying to figure all of this out, and I am particularly interested in thoughts and comments about how best to take advantage of these new technologies.

 

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In a November 26, 2008 opinion (here), the Ninth Circuit affirmed the lower court’s dismissal of a lawsuit asserting securities law violations against InVision and certain of its directors and officers based on FCPA-related disclosures. The case is noteworthy not only for its involvement of FCPA-related allegations, but also for the appellate court’s consideration of "collective scienter" issues, as well as of the significance of Sarbanes-Oxley certification issues.

 

Background

On March 15, 2004, InVision announced it would be acquired by GE in a cash-for-stock transaction. That same day, the company filed its annual filing on Form 10-K to which the merger agreement was attached. On July 30, 2004, InVision announced that an internal investigation had revealed possible violations of the Foreign Corrupt Practices Act (FCPA). The company voluntarily reported the activities to the SEC and the DOJ. The company later entered negotiated arrangements with the DOJ and the SEC (refer here). GE later consummated the pending merger.

 

Shortly after InVision announced the FCPA concerns, shareholders initiated a securities class action lawsuit against the company and certain of its directors and officers. (Refer here for further background regarding the case). The plaintiffs based their claims on three alleged misstatements in the merger agreements, which InVision had attached to its 10-K.

 

The plaintiffs alleged that the merger agreement misleadingly stated that the company was "in compliance … with all applicable law"; in compliance with the "books and records" provision of the FCPA; and that that neither the company nor any of its officers, directors or employees had knowledge that the company had violated the FCPA’s antibribery provisions.

 

The district court dismissed the complaint and the plaintiffs appealed.

 

The Ninth Circuit’s Decision

The appellate court essentially assumed that the plaintiff had satisfied the requirement to plead falsity with respect to the three alleged misrepresentations stating that "even if [the plaintiff, Glazer] properly pled falsity, the district court’s dismissal would still be appropriate if Glazer failed to plead scienter adequately with respect to the three statements."

 

In order to satisfy the scienter requirement, the plaintiff urged the Ninth Circuit to adopt the "collective scienter" theory, following the Second Circuit’s recent decision in the Dynex Capital case (refer here) and the Seventh Circuit’s recent decision in the Tellabs case (refer here). Under this theory, as articulated by the Seventh Circuit, "it is possible to draw a strong inference of corporate scienter without being able to name the individuals who concocted and disseminated the fraud."

 

After reviewing the case law concerning corporate securities liability, including its own prior decision in the Nordstrom v. Chubb case (a decision that will be familiar to many of this blog’s readers), the Ninth Circuit ultimately concluded that this case did not require the court to decide whether or not to adopt the theory of collective scienter.

 

The court concluded that because of "the limited nature and unique context of the alleged misstatements" involved in the case, the "collective scienter" issue was not before the court. In reaching this conclusion, the court noted that

 

Glazer rests its securities fraud claim on three statements, all of which appear in a sixty-page legal document. If the doctrine of collective scienter excuses Glazer from pleading individual scienter with respect to these legal warranties, then it is difficult to imagine what statements would not qualify for an exception to individualized scienter pleadings. In fact, because the merger agreement warranted that the company was in compliance "with all laws," then under the collective scienter theory urged by Glazer, so long as any employee at InVision had knowledge of the violation of any law, scienter could be imputed to the company as a whole. This result would be plainly inconsistent with the pleading requirements of the PSLRA.

 

Accordingly, the Ninth Circuit held that in order to succeed on his claim, the plaintiff had to establish that individual defendants acted with scienter in making the statements in the merger agreement. The court said that "we see no way that [the defendant] could show that the corporation, but not any individual [director or officer] had the requisite intent to defraud." Only the company’s CEO and CFO had signed the merger agreement, and the plaintiff alleged scienter only with respect to the CEO, Magistri.

 

The court found with respect to Magistri, however, that Glazer had not pled any facts to demonstrate that "Magistri was personally aware of the illegal payments or that he was actively involved in the details of the details of InVision’s Asian sales."

 

The Ninth Circuit also refused to infer scienter from the CEO’s and the CFO’s signature of the Sarbanes-Oxley certifications, holding that the mere signature, without more, is insufficient to raise a strong inference of scienter.The Ninth Circuit followed prior decisions of the Eleventh and Fifth Circuits, concluding that there was no evidence that the SOX certification requirements were intended to alter the PSLRA’s pleading requirements. The Court said that "the Sarbanes-Oxley certification is only probative of scienter if the person signing the certification was severely reckless in certifying the accuracy of the financial statements.

 

Discussion

The Ninth Circuit’s decision is noteworthy for its discussion of the "collective scienter" issue, although in the end it is of limited significance on this point given the court’s conclusion that it did not need to reach that issue. The decision is also noteworthy for its discussion of the Sarbanes-Oxley certification issue, but in that respect it also merely followed existing precedent.

 

But perhaps the greatest significance about the Ninth Circuit’s opinion may be what it suggests about securities cases based on FCPA-related disclosures. The Ninth Circuit’s refusal to allow the claim to proceed in the absence of allegations that senior officials were aware of the improper conduct could present a significant hurdle for FCPA-related securities claims, at least in the circuits that have not adopted the "collective scienter" theory.

 

As the Ninth Circuit noted in the InVision case, "the surreptitious nature of the transactions creates an equally strong inference that the payments would have deliberately kept secret – even within the company." Obviously, payments of this kind invariably are of a surreptitious nature and of a kind that would be kept secret, even within the company. The implication is that in order for a securities claim alleging FCPA-related disclosures to survive the initial pleadings stage, the claimants may have to plead that the company officials who prepared the company’s public disclosures were aware of the improper activities.

 

In prior posts (most recently here), I have noted the increasing prevalence of follow-on civil litigation accompanying FCPA investigations, including the increasing frequency of follow-on securities litigation alleging misrepresentations in the FCPA-related disclosures. The Ninth Circuit’s decision in the InVision case suggests that, at least in jurisdictions that have not recognized the collective scienter theory, the ability of these follow-on securities lawsuits to get past the pleading stage may depend on the existence of allegations that senior company officials were aware of the improper payments. Given the invariably "surreptitious nature" of these payments, claimants may find this a challenging requirement to satisfy.

 

The SEC Actions blog has a thorough analysis of the Ninth Circuit’s discussion of the pleading issues in the InVision case, here. The FCPA Blog also has a good discussion of the case, here.

 

Special thanks to Neil McCarthy of Lawyerlinks.com for providing me with a copy of the Ninth Circuit’s opinion.

 

Another New Wave Securities Lawsuit: In a recent post (here), I noted that there have been several recent securities class action lawsuits in which the companies involved have been hit with significant losses due to wrong way bets on commodities or currencies.

 

The latest example of this type of securities litigation involves a case filed on November 26, 2008 in the Southern District of Florida against Brazilian forest products manufacturer Aracruz Cellulose S.A. and certain of its directors and officers on behalf of investors who purchased the company’s American Depositary Receipts on the NYSE., as well as purchasers of the company’s common stock, which trades on the Sao Paulo Bovespa.

 

According to the plaintiffs’ lawyer November 26 press release (here), the complaint alleges that

 

During the Class Period, Aracruz entered into undisclosed currency derivative contracts to purportedly hedge against the Company's U.S. dollar exposure. The Company characterized the use of these contracts as protection against foreign interest rate volatility and assured investors that this type of trading did not represent "a risk from an economic and financial standpoint." However, these contracts violated Company policy in that they were far larger than necessary to hedge normal business operations. As a result of Aracruz's clandestine and speculative currency wagers, credit rating agencies downgraded Aracruz, the Company's CFO resigned, and Aracruz's stock suffered a severe decline, plummeting to the lowest levels in 14 years.

 

As I noted in my prior post, many companies were also exposed to sudden and unexpected losses by dramatic changes in the commodities and currencies markets earlier this year. For example, the November 29, 2008 Wall Street Journal reported (here) on several airlines that have recently reported the negative impact from fuel cost hedges that generated huge losses. These kinds of developments and other unexpected fallout from the crisis roiling global financial markets are likely to affect a wide variety of companies, some of which may be subject to securities litigation.

 

It is interesting to note that the plaintiffs’ lawyers in the Aracruz case appear to have made a conscious decision to include within the class the Brazilian company’s common shareholders. Within this group are likely to be a number of shareholders domiciled outside the U.S. that bought their shares against the foreign company on a foreign exchange. The presence of these so-called "foreign-cubed" litigants could pose subject matter jurisdiction issues, at least as to those claimants.

 

My recent post discussing the Second Circuit’s recent "foreign-cubed" litigant ruling in the National Australia Bank case can be found here. The November 24, 2008 Southern District of New York decision granting the motion to dismiss the securities class action lawsuit that had been filed against Vodafone for lack of subject matter jurisdiction, in reliance upon the National Australia Bank decision, can be found here. (Note: Special thanks to the reader who pointed out that I had incorrectly referred to the Vodafone case as the Vivendi case. My apologies for any confusion.)

 

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The growing importance of global anticorruption enforcement efforts was underscored this past week by the revelation of a cross-border investigation involving the French industrial giant Alstom and by developments in the continuing investigation involving Siemens. Moreover, the Siemens developments highlight the increasing significance of liabilities arising from anticorruption exposures for the D&O insurance industry.

First, in a May 6, 2008 article entitled “French Firm Scrutinized in Global Bribe Probe” (here), the Wall Street Journal reported that French and Swiss authorities are investigating whether officials acting on behalf of Alstom paid hundreds of millions of dollars between 1995 and 2003 to win contracts in Brazil, Venezuela, Singapore and Indonesia.

Then on May 9, 2008, German prosecutors announced that they will pursue a civil enforcement action against former Siemens chairman Heinrich von Pierer and several other (unnamed) former Siemens board members. (Refer here for background regarding the Siemens investigation). von Pierer served as Siemens’ chief executive from 1992 to 2005, and as its Chairman until April 2007. Prosecutors apparently have elected for the time at least not to pursue criminal charges against von Pierer.

According to a May 10, 2008 Wall Street Journal article (here), the company itself has also said that “it may seek financial compensation from former managers but didn’t name individuals.”

According to the Journal article about the Alstom investigation, the Alstom and Siemens investigations “suggest that Europe’s prosecutors have begun taking a tougher line on business practices that their U.S. counterparts have long treated as criminal.” It is not merely coincidental that these investigations are now emerging; they are in fact an outgrowth of relatively recent changes in the laws of both Germany and France.

For many years, under the laws of the two countries, corrupt payments were not only legal, but the amount of the payments were tax deductible. But both countries are signatories to the OECD Convention on Combating Bribery of Foreign Officials in International Business Transactions. To implement the Convention, in 1999 Germany passed the German International Bribery Act. According to the Journal, “France outlawed bribery of foreign officials in July 2000.”

Both companies seem to have had difficulties adapting to the new legal prohibitions, as the conduct under investigation both preceded and followed the enactment of the new laws.

One particularly interesting aspect of the Alstom investigation is the way that the circumstances under review came to light. The investigation apparently arose as a result of an audit commissioned by the Swiss Federal Banking Commission of Tempus Privatbank AG, a small private bank. The audit uncovered documents concerning Alstom-related transactions that detailed the flow of about 20 million euros from Alstom to shell companies in Switzerland and Lichtenstein.

These investigations underscore the growing significance of cross-border anticorruption actions and highlight the fact that anticorruption efforts are no longer just a U.S. priority. Moreover, the potential exposures and liabilities are enormous. Siemens itself has already paid a fine of 201 mm euros.

There are also important implications arising from Siemens’ suggestion that it may pursue claims against its former managers. According to a May 5, 2008 Business Insurance article entitled “German Insurers Brace for Siemens Claim” (here), the company has notified its D&O insurers that it intends to file a claim under its D&O policies relating to the company’s antibribery related exposures. The article reports that the company carries D&O limits of 250 million euros. The article does not detail the specifics of the insurance claim or the matters for which the company claims or intends to claim coverage, so there is no way to assess the likelihood of the company’s eventual recovery under the policies.

It is far from certain that the company’s policies would actually cover the claimed amounts. But to the extent the policy’s limit is exhausted by the claims for coverage, it could, at least according to the Business Insurance article, have a substantial impact on the German market for D&O insurance.

The potential insurance implications from the developments in the Siemens investigation demonstrate the growing significance for the D&O insurance industry of the liabilities arising from anticorruption enforcement activity. As investigations like those involving Alstom and Siemens emerge and develop, and as litigation like that involving Alcoa (about which refer here) continues to arise, these issues necessarily will become a significant priority for companies and for D&O insurers. As I have previously suggested (here), anticorruption violations may well represent the “next corporate scandal.”

The May 9, 2008 Financial Times has an interesting editorial about the Alstom investigation and the expansion of anticorruption efforts, here.

Speakers’ Corner: On May 14, 2008, I will be speaking at the American Conference Institute’s D&O Liability Insurance Conference (refer to the agenda, here). I will be participating on a panel with my good friend Dan Bailey in a session entitled “Emerging Exposures Roundup: Fiduciary Litigation, Global Warming and More.”

Then on May 15, 2008, I will be in Toronto to participate in the Professional Liability Underwriting Society (PLUS) Canadian Chapter’s educational event regarding the subprime crisis. Information about the Toronto event can be found here. The other panelists include Dr. Arturo Cifuentes of R.W. Pressprich & Co., Denis Durand of Jarislowski Fraser, and Robert Murray of Chubb.

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In a powerful affirmation of the rule of law, two justices of the U.K.’s High Court of Justice ruled in an April 10, 2008 opinion (here) that the British Serious Fraud Office (SFO) must reconsider its decision to discontinue its bribery investigation into the award of a weapons contract between Saudi Arabia and BAE Systems plc. My prior post regarding the BAE investigation can be found here.

The SFO announced its decision to discontinue the investigation in December 14, 2006. The investigation had been ongoing for some time and had even withstood a prior attempt in October 2005 to have the investigation stopped. However, in July 2006, apparently when the SFO was about to obtain access to certain Swiss bank accounts, the British government received “an explicit threat made with the intent of halting the investigation.”

In the proceedings before the court, the government refused to characterize the threat, but the opinion quotes news reports that what happened was that Prince Bandar bin Sultan bin Abdul Aziz of al-Saud “went to Number 10” and told the Prime Minister’s Chief of Staff to “get it stopped” or the military weapons contract ‘was going to be stopped and intelligence and diplomatic relations would be pulled.” (Prince Bandar, the Saudi ambassador to the United States from 1983 to 2005, is now and in 2006 was the Secretary-General of the Saudi National Security Council.)

Following the July 2006 threat, an internal governmental review process unfolded, including high level consultations with the British ambassador to Saudi Arabia and others, culminating in a previously confidential December 8, 2006 memorandum by then-Prime Minister Tony Blair to his Attorney General Peter Goldsmith that “developments” had “given rise to the real and immediate risk of the collapse of UK/Saudi security, intelligence and diplomatic cooperation.” This, the Prime Minister said, would “have seriously negative consequences for the UK public interest in terms of both national security and our highest priority foreign policy objectives in the Middle East.” The government was particularly concerned with the Saudis continued counter-terrorism support, without which, it was feared, British lives could be in danger.

According to news reports (here), in August 2006 (that is, one month after Prince Bandar’s visit to “Number 10”), BAE won a $8.7 billion order from the Saudi government for 72 Eurofighter Typhoon warplanes, purportedly the latest component of the Al Yamamah arms deal, which dates back to 1985 and is the largest British export contract ever.  

The legal challenge to the decision to terminate the investigation was presented by two public interest groups, Corner House Research and the Campaign Against Arms Trade. They challenged the SFO’s decision to accede to the threat as “contrary to the constitutional principle of the rule of law,” as well as on other grounds. By contrast, the government argued, as the court summarized, that “the law is powerless to resist the specific, and as it turns out, successful attempt by a foreign government to pervert the course of justice in the United Kingdom.” (The court said of this argument that “so bleak a picture of the impotence of the law invites at least dismay, if not outrage.”)

The April 10 opinion was written by Lord Justice Alan Moses. After a detailed review of the background to the SFO’s decision to terminate the investigation, the Court considered the claimants’ challenge, which Lord Justice Moses said did not question the government’s assessment of the national security risk. The threat that was the basis of the decision to terminate the investigation “was not simply directed at the company’s commercial, diplomatic and security interests, it was aimed at its legal system.”

The threat was made “with the specific intention of interfering with the course of the investigation.” The court noted that “had such a threat been made by one who was the subject of the criminal law of this country, he would risk being charged with an attempt to pervert the course of justice.” Surrender to such threats “merely encourages those with power, in a position of strategic and political importance, to repeat such threats.” The court concluded that “in yielding to the threat, the [SFO director] ceased to exercise the power to make the independent judgment conferred on him by Parliament.” As a result, the court concluded that the submission to the threat was “unlawful.”

The court’s opinion reviews a host of other considerations, including in particular the U.K’s obligations as a signatory Organization for Economic Cooperation and Development’s Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (which specifies that investigations “shall not be influenced by considerations of national economic interest, the potential effect upon relations with another State or the identity of the natural or legal persons involved.”). But the court’s essential conclusion is that the decision to terminate the investigation was contrary to the principles of the rule of law. “It is difficult,” the court said,” to identify any integrity on the role of the courts to uphold the rule of law if the courts are to abdicate in response to a threat from a foreign power.”

The full opinion is lengthy but it is well worth the read. The details surrounding the government’s consideration of how to respond to the threat are fascinating, and the court’s analysis of the legal considerations involved is thought-provoking, particularly its consideration of how imminent a threat of loss of life must be before a court might consider yielding. The inherent tension in the court’s decision arises from the fact that this case tests the limits of what any government might be willing to risk in resisting corruption; the lesson the court rejected is that if the corrupt forces are rich and powerful enough, they have nothing to fear from the force of law.

It remains to be seen, however, whether the investigation will go forward in the end; the court did not rule that the investigation must proceed, only that the December 2006 decision to terminate the investigation was unlawful. According to an April 11, 2008 article in The Guardian (here), “the high court will reconvene in a fortnight to decide what remedy to award the two groups of anti-corruption campaigners who brought the judicial review of the Serious Fraud Office decision to end the inquiry.”

As I have noted in a number of prior posts, most recently here, many governments around the world (including the U.S. government) are increasingly committed to enforcing anti-corruption laws. BAE is also being investigated in the U.S. and in Switzerland, and is only one of several current high-profile corruption investigations. The April 10 opinion underscores the seriousness of the issues involved, as well as the stakes. Courts will continue to grapple with the challenges these cases present, but it is important for companies to understand that the risks involved with corrupt practices include the threat of civil litigation, as I discussed here. BEA is in fact already the target of a shareholders’ derivative lawsuit in the United States. The growing threat of this type of litigation suggests why corrupt activity may represent the “next corporate scandal.”

Press coverage of the April 10 decision can be found here and here. The FCPA Blog’s post on the decision can be found here.

Subprime Litigation Webcast: On Friday April 11, 2008, at 11:00 a.m., I will be a panelist on a webcast sponsored by Risk Metrics on the topic “Subprime Litigation and Liability.” The panel will be moderated by Adam Savett, author of the Securities Litigation Watch blog, and will include defense attorney Darryl Rains, of the Morrison and Foerester firm, and plaintiffs’ attorney Mark Lebovitch, of the firm Bernstein, Litowits, Berger & Grossman. Registration for the webcast (which is free) can be accessed here. Further information, including links to background papers by Risk Metrics, can be accessed on the Securities Litigation Watch, here.  

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Add Merrill Lynch and Morgan Stanley to the growing list of companies that have been sued in securities class action lawsuits by investors for allegedly deceptive representation in connection with the sale of auction rate securities. According to the plaintiffs’ attorneys’ March 25, 2008 press release (here), the plaintiffs’ have filed a securities class action lawsuit in the United States District Court for the Southern District of New York against Merrill Lynch and its asset management company on behalf of investors who purchased auction rate securities from Merrill Lynch between March 25, 2003 and February 13, 2008.  A copy of the complaint can be found here.

According to the press release, Merrill Lynch “offered and sold auction rate securities to the public as highly liquid cash-management vehicles and as suitable alternatives to money market mutual funds.” The complaint alleges that Merrill Lynch failed to disclose that  

(1) the auction rate securities were not cash alternatives, like money market funds, but were instead, complex, long-term financial instruments with 30 year maturity dates, or longer; (2) the auction rate securities were only liquid at the time of sale because Merrill Lynch and other broker-dealers were artificially supporting and manipulating the auction rate market to maintain the appearance of liquidity and stability; (3) Merrill Lynch and other broker-dealers routinely intervened in auctions for their own benefit, to set rates and prevent all-hold auctions and failed auctions; and (4) Merrill Lynch continued to market auction rate securities as liquid investments after it had determined that it and other broker dealers were likely to withdraw their support for the periodic auctions and that a “freeze” of the market for auction rate securities would result.

According to news reports (here), plaintiffs also filed a separate but substantially similar lawsuit against Morgan Stanley, raising more or less the same allegations on behalf of a class of investors who purchased auction rate securities from Morgan Stanley during the same class period as proposed in the Merrill Lynch lawsuit. I have not located the Morgan Stanley complaint itself, but will add a link when I get a copy.

UPDATE: A copy of the plaintiffs' lawyers' March 25, 2008 press release announcing the Morgan Stanley auction rate securities lawsuit can be found here and a copy of the complaint can be found here.

These two new lawsuits join a group of similar lawsuits, all filed by the same law firm on behalf of auction rate securities investors, against Deutsche Bank, Wachovia, TD Ameritrade and UBS. The law firm’s webpage describing these various lawsuits can be found here.

With the addition of these two new subprime-related securities class action lawsuits, my running tally of subprime related securities lawsuits, which can be accessed here, now stands at 59, of which 21 have been filed in 2008. Two of these 59 represent lawsuits brought on behalf of investors against mortgage-backed asset securitizers, six are class action lawsuits on behalf of auction rate securities investors, two are brought on behalf of mutual fund investors, and the remaining 49 of which are brought on behalf of public company shareholders.

Subprime Litigation Wave Hits Regions: Birmingham, Alabama-based Regions Financial Corporation has been hit with a couple of different subprime-related lawsuits as the subprime wave continues to spread beyond New York, California, and Florida, the states where the subprime litigation originally was concentrated.

First, according to a March 25, 2008 Birmingham News article (here), the Catholic Medical Mission Board, a Regions shareholder, has filed a shareholders’ derivative lawsuit against Regions, as nominal defendant, and certain Regions directors and officers, alleging that the defendants failed to disclose the extent of Regions’ lending exposure to residential homebuilders, which permitted company insiders to sell their shares in company stock at inflated prices. According to the news report, the complaint alleges that "Regions Financial's stock was artificially inflated because the defendants directed the company to hide the true extent of its subprime exposure.’

The derivative complaint (which can be found here) asserts claims for breach of fiduciary duty, waste of corporate assets, unjust enrichment, and breach of Section 10(b) of the ’34 Act.

Second, Regions has also been hit with a lawsuit filed under ERISA on behalf of its participants in the Regions defined contribution plan. A copy of the complaint can be found here. The complaint alleges that the offered plan participants Regions stock and investment options in Regions Morgan Keegan funds “when it was imprudent to do so.” The complaint also alleges that the investment in Regions stock and the Regions Morgan Keegan funds was maintained “when it was no longer prudent to do so.”  The complaint alleges that the defendants knew or should have known that these investments were imprudent because of Regions and the funds heavy investment in or vulnerability to subprime mortgage investments, loans and securities. The complaint also alleges that the defendants failed to communicate the risks of investing in the plan and also failed to communicate conflicts of interest.

As noted on my running tally of subprime related litigation (which can be accessed here), with the addition of the Regions ERISA litigation, my running tally of subprime-related ERISA lawsuits now stands at 11.

I have not been keeping a running tally of subprime-related derivative litigation (basically because the primarily state court oriented litigation is hard to track), but there has been substantial subprime related derivative litigation, involving, among others, Bear Stearns, American International Group, and Countrywide.

Special thanks to alert reader Rob Lichenstein for the links to the two Regions lawsuits and the Birmingham News article.

About the Bear Stearns Deal: If as I do you find many of the articles discussing the updated Bear Stearns deal confusing, you will want to read a couple of interesting posts on the Conglomerate blog, that provide insight into a couple of points about the revised deal that have received significant press attention.

First, there has been a great deal of discussion in the press about the possibility that the improved buyout offer may have resulted in part from drafting errors in the initial deal documents. BYU law professor Gordon Smith deconstructs this issue in a detailed Conglomerate blog post here (here), with helpful citations and cross-references to other blogs. Smith’s analysis of the differences between the original and the revised deal documents raise some interesting questions about what J.P. Morgan seems to have sought by offering revised terms. Bottom line, in exchange for the improved merger price, J.P. Morgan has eliminated the provisions that would have kept the deal open for a full year, and also obtained a 39.5% ownership interest as a means to try to ensure that the deal is concluded.

Second, and with respect to that 39.5% ownership interest transfer, Smith has a separate post on Conglomerate (here), that explores the Delaware case law behind the 39.5% interest and the limitations on share transfers to lock in shareholder merger approvals. As Professor Smith’s post notes, there is no automatic cutoff under Delaware law whereby a company can sell up to 40% of itself without shareholder approval, and suggestions to that effect in the mainstream media are “what is known in the law biz as ‘wrong.’” Practitioners have evolved the 40% rule of thumb, but “none of this has been tested in court.”

More About the FCPA: Regular readers know that I have frequently commented (most recently here) on the growing importance of Foreign Corrupt Practices Act enforcement proceedings and follow on civil litigation. Two recent publications provide significant additional information on this topic.

First, a March 25, 2008 Law.com article entitled “Today, No Bribe is Too Small” (here), takes a look at the expanding reach of enforcement activities. As the title suggests, the article looks at some seemingly small corrupt transactions that have attracted regulatory attention. The article states that “it seems that no bribe is too small to earn the attention of the department.” The article also focuses on regulatory actions that have been taken by middlemen and third party contractors, and how those seemingly remote actors’ actions have come back to haunt the sponsoring company.

Second, in a much more detailed look at recent FCPA enforcement activity, Porter Wright attorney Tom Gorman has recently posted a running series on the issues involved in recent FCPA regulatory actions on his SEC Actions blog. The most recent post can be found here. Taken collectively, these posts present an excellent overview of the current state of FCPA regulatory actions.

Finally, readers who recall my recent post (here) about the civil litigation arising from potentially problematic activities involving Alcoa’s operations in Bahrain will be interested to note that the U.S. Department of Justice has initiated a criminal investigation of the activities, and in that connection has asked for the entry of stay in the civil proceedings,  as discussed in a March 21, 2008 Wall Street Journal article entitled “U.S. Opens Alcoa Bribery Probe” (here).

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In prior posts (most recently here), I have commented on the growing threat of follow-on shareholder litigation ensuing in the wake of Foreign Corrupt Practices Act (FCPA) enforcement actions. A lawsuit recently filed in the United States District Court for the Western District of Pennsylvania represents an entirely different kind of threat arising from allegations of foreign corrupt activities, in the form of a civil action brought directly against the alleged wrongdoer(s) by the alleged victims of the corrupt activity, without any preceding FCPA enforcement action.

On February 27, 2008, Aluminum Bahrain B.S.C. ("Alba") filed a lawsuit against Alcoa, an Alcoa affiliate, and two individuals, one of whom was an officer of an Alcoa affiliate. Alba (owned by an entity in which the Bahrain government has a 70% ownership interest), alleges that the defendants engaged in a 15-year conspiracy involving overcharging, fraud, and bribery of Bahraini officials. A copy of the complaint can be found here. Alba is in the aluminum smelting business, and it has depended since 1990 on Alcoa affiliates for its supply of alumina, a key ingredient in the production of aluminum.

The complaint alleges that beginning in 1993, over $2 billion in payments were funneled through companies (located in Singapore, Guernsey, Switzerland and elsewhere) owned or controlled by a Canadian businessman of Jordanian descent named Victor Dahdaleh, who is named as a defendant in the complaint. A portion of these payments were secretly directed to one or more (unnamed) Bahraini government officials as part of an alleged conspiracy to cause Alba to cede a substantial portion of its equity to Alcoa, to pay inflated prices for alumina, and to corrupt the integrity of senior Bahraini government officials.

A front-page February 28, 2008 Wall Street Journal article describing the complaint (here) states that the lawsuit emerged from Bahrain’s own effort "to root out misbehavior." The Journal also reports that last year Bahrain retained Kroll Associates, which "had uncovered cases of corruption in its state-owned enterprises, and numerous individuals had been arrested."

The FCPA prohibits corrupt payments to foreign officials, but, as pointed out in a post on The FCPA Blog (here) commenting on the Alba case, "there is no private right of action under the FCPA." So enforcement of the FCPA is exclusively the province of the Department of Justice and the SEC. But as the Department of Justice notes in its Lay Person’s Guide to the FCPA, "conduct that violates the antibribery provisions of the FCPA may also give rise to a private cause of action for treble damages under the Racketeer Influenced and Corrupt Organizations Act (RICO) or to actions under other federal or state laws." Alba’s complaint, in fact, seeks to recover damages from the defendants based on their alleged violations of RICO, conspiracy to violate RICO, and for fraud.

The Alba complaint underscores the civil liability exposure that may potentially arise from foreign corrupt practices. While I have previously emphasized the potential threat of lawsuit filed by shareholders against company management as a follow-on to government FCPA enforcement actions, the Alba lawsuit illustrates the threat of direct civil litigation based on foreign corrupt activity without any prior enforcement activity.

This kind of litigation may represent a significant corporate threat for companies engaged in business in countries whose cultures encourage or even seemingly compel this type of corrupt activity. This threat may also extend beyond the corporation and its corporate affiliates to individuals, as well. Only one of the individual defendants named in the Alba lawsuit appears to be an officer of an Alcoa affiliate, but the complaint does also specifically allege that Alcoa’s Chairman and CEO traveled to Bahrain in connection with Alcoa’s efforts to obtain an equity ownership position in Alba. The complaint alleges that this effort was corrupted by the bribery-induced intervention of a Bahraini government official.

Individual directors and offices who find themselves the target of corruption-based civil litigation may face challenges in securing insurance protection in connection with these allegations. Certainly, a determination of liability for the kinds of corrupt conduct alleged in the Alba complaint could run afoul of the typical D & O liability policy’s conduct exclusions. In addition, some D & O policies still retain a commissions and payments exclusions specifically calculated to preclude liability for improper payments. However, individual director or officer defendants could have a strong basis on which to argue that their defense expenses incurred in connection with this kind of litigation should be covered. They could even have a basis on which to try to argue that settlement amounts, in the absence of an actual finding of liability, ought to be covered.

With respect to the corporate entity defendants in these kinds of lawsuits, the picture is slightly different. The typical public company D & O policy provides entity coverage only for claims based on alleged violations of the securities laws. None of the allegations in the Alba complaint arise under the securities laws, so there would not appear to be coverage under the typical public company D & O policy, even for defense expense. Even were entity coverage to extend beyond securities claims (as is the case for many private company D & O policies), the conduct exclusions and any applicable commissions and payments exclusion would preclude coverage for damages imposed on the basis of an adjudication of liability

But in any event, given the increasing globalization of trade and the increasing significance being given to anticorruption efforts in many jurisdictions, the possibility exists for further civil litigation based on alleged corrupt activity, even in the absence of prior enforcement actions. This litigation threat represents another way in which corrupt activity exposure may possibly represent, as I recently wrote, the "next corporate scandal."

Now This:

According to Wikipedia (here), Bahrain is "slightly larger than the Isle of Man, though it is smaller than … King Fahd International Airport" in Saudi Arabia.

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In prior posts (most recently here), I have discussed the growing threat that Foreign Corrupt Practices Act (FCPA) enforcement may present for companies doing business overseas. This trend became even more pronounced in 2007, and at least one legal commentator has suggested (here) that the increasing FCPA enforcement trends raise the possibility that FCPA violations "may be this year's corporate crime of the century."

The one thing that is clear is that FCPA enforcement activity is escalating. As discussed in the January 28, 2008 Fenwick & West memorandum entitled "The Foreign Corrupt Practices Act: The Next Corporate Scandal?" (here), 2007 was "a watershed year for FCPA enforcement." Among other things, the memo notes that that "the number of enforcement actions brought by the DoJ and the SEC doubled compared with the number brought in 2006."

The memo also notes that "public companies disclosed over 50 pending government investigations." In addition, the DoJ and the SEC imposed the largest combined civil and criminal fines in history in 2007, the total fines of $44 million imposed against Baker Hughes and its subsidiaries (as discussed in my prior post, here).

There are a number of important trends driving this increased FCPA enforcement. Obviously the globalization of business activity provides an important context, but globalization alone does not explain the increased enforcement. The enforcement activity is being driven by a number of trends and patterns.

First, the DoJ and the SEC have developed a practice of targeting specific industries, through an industry-wide investigation. For example, a January 25, 2008 Sidley Austin memo entitled "FCPA Enforcement Trends During 2007" (here) notes that the authorities have targeted "sales and marketing practices of companies in the medical device industry in Europe." A January 24, 2008 Jenner & Block memorandum entitled "Recent Enforcement Activity Under the Foreign Corrupt Practices Act" (here) also cites the recent enforcement actions involving the "companies participating in the U.N. Iraq Oil for Food program." The Fenwick & West memo cited above also notes that the FCPA is now "being actively enforced against technology companies."

Second, the authorities have targeted companies doing business in countries where bribery is part of the local business culture. The Jenner & Block memo notes that the authorities have "continued to press enforcement as to companies doing business in Nigeria." Business activities in China have also drawn scrutiny, which is certainly a challenge given that many companies are finding it indispensible to have a China strategy.

Third, the U.S. authorities have shown an increased willingness to cooperate with foreign governments in joint investigations, even, the Jenner & Block memo notes, where the target companies "are already the subject of law enforcement investigation or sanction in their home country." The most prominent example of this latter phenomenon is the current investigation involving Siemens (which I discussed in prior posts, here and here). Another example is the investigation of BAE Systems (which has been surrounded by some significant controversy, as discussed here).

Fourth, increased M & A activity has led to the discovery and disclosure to the authorities of a number of FCPA violations. The Sidley & Austin memo referenced above cites the entry of Delta & Pine into a $300,000 FCPA settlement following its merger with Monsanto (refer here) and York International's FCPA settlement following its merger with Johnson Controls, whereby York agreed (here) to a $10 million criminal penalty, a $2 million civil penalty, and the disgorgement of $10 million profit.

The Sidley & Austin memo notes that "acquisition due diligence is an essential program, and the failure to adequately assess potential liabilities can result in serious consequences." The Fenwick & West memo notes that "FCPA issues can be a major sticking point in negotiations with the acquiring party, often causing delay of the deal or a change in the price terms."

Fifth, as a result of changing priorities and increased resources, the authorities are no longer dependant on self-reporting alone as the means by which FCPA violations are identified. In recent year, the combination of the increased self-scrutiny SOX requires and corporations' desire to obtain cooperation credits have led companies to self-report, providing the authorities with the bases for many of the FCPA enforcement investigations. But, as the Jenner & Block memo notes, "the Government is increasingly interested in developing cases affirmatively, without relying on disclosures." Both the DoJ and the SEC have increased their staffing in this area, and the agencies have said repeatedly said publicly that they will be more "proactive."

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