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

I am pleased to present below a guest post from Angelo G. Savino of the Cozen O’Connor law firm discussing the Southern District of New York’s application of the Morrison decision in an SEC enforcement action pending against Goldman Sachs employee Fabrice Tourre. This guest post will also be published and distributed in the future as a Client Alert from the Cozen law firm.

My thanks to Angelo for his willingness to publish his guest post here. I welcome guest posts from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly.

Here is Angelo’s guest post::

On June 10, 2011, Judge Barbara Jones of the United States District Court for the Southern District of New York issued a decision in a case entitled SEC v. Goldman Sachs & Co., No. 10-3229 (“Goldman Sachs”), that applied the Supreme Court’s Morrison decision to claims by the SEC under both the Securities Exchange Act of 1934 and the Securities Act of 1933. Goldman had previously settled the claims against it for $550 million, but left Fabrice Tourre, a Goldman Vice President who had worked at its New York headquarters, to face the SEC’s claims. 

The decision is noteworthy because it is the first to apply Morrison, which held that section 10(b) of the Exchange Act does not apply extraterritorially, to claims by the SEC. It is also the first decision to provide a detailed analysis of the second prong of Morrison’s transactional test involving domestic transactions in securities that are not listed on an exchange. Lastly, the decision is the first to apply Morrison to section 17(a) of the Securities Act. 

The SEC alleged that in 2007, Goldman structured and marketed a synthetic collateralized debt obligation (“CDO”) called Abacus 2007-ACI (“Abacus”) that was based on the performance of subprime residential mortgage-backed securities (“RMBS”). CDOs are debt securities collateralized by other debt obligations such as, in this case, RMBSs. The complaint also alleged that Goldman was assisted by a hedge fund, Paulson & Co. Inc. (“Paulson”) in selecting the RMBSs that would collateralize the CDO. At the same time, Paulson allegedly entered into a credit default swap (“CDS”) that essentially bet that the RMBSs would perform poorly. According to the SEC, Goldman and Tourre marketed the CDOs without disclosing to investors that the underlying portfolio of mortgage-backed securities had been selected by Paulson while Paulson was betting against their performance. Tourre was allegedly the Goldman employee principally responsible for structuring and marketing the Abacus securities. 

The SEC also alleged that Goldman and Tourre marketed and sold $150 million worth of Abacus notes to IKB, a German commercial bank, and $42 million worth of notes to ACA Capital Holdings, Inc. (“ACA Capital”), a U.S.-based entity. ACA Capital also entered into a credit default swap involving a $909 million super senior tranche of Abacus. Essentially, ACA Capital assumed the credit risk associated with that portion of Abacus’s capital structure in exchange for premium payments. Thereafter, through a series of credit default swaps among ABN, Goldman, and ACA Capital, ABN assumed the credit risk regarding that $909 million tranche. ABN is a Dutch bank.

The closing for Abacus occurred in New York City and Goldman delivered the notes through the book entry facilities of Depository Trust Company in New York City. Tourre, however, provided the court with trade confirmation indicating that Goldman Sachs International, located in London, was listed as the seller of the notes to an IKB affiliate based on the Island of Jersey, a British dependency. Similarly, the CDS confirmations regarding the ABN transaction listed the seller as Goldman Sachs International and the purchaser as the London branch of ABN. 

The SEC claimed that Tourre had violated section 17(a) of the Securities Act and section 10(b) of the Exchange Act, Rule 10b-5 thereunder, and aided and abetted violations of section 10(b). Tourre moved to dismiss and for judgment on the pleadings based on Morrison on the ground that the complaint failed to state a claim because it did not allege securities transactions that took place in the United States. 

Judge Jones first analyzed the SEC’s Exchange Act claims against Tourre. She noted that the Supreme Court, in Morrison, had adopted a clear transactional test: “whether the purchase or sale is made in the United States, or involves a security listed on a domestic exchange.” Nevertheless, Judge Jones also noted that, because the securities at issue in Morrison were traded only on foreign exchanges, the Supreme Court was largely silent regarding how lower courts should determine whether a purchase or sale is made in the United States. That, however, was the issue she faced because the Abacus securities were not traded on an exchange. 

The court began its analysis of the issue by looking to the statutory definitions of “purchase” and “sale” in the Exchange Act, which were relatively “unhelpful.” The court then turned to case law and determined that the concept of “irrevocable liability” was at the core of both a “sale” and a “purchase.” The court noted that at some time a purchaser incurs irrevocable liability to take and pay for a security while a seller incurs irrevocable liability to deliver a security. 

In applying this concept to the IKB transaction, the court rejected the SEC’s arguments based on Tourre’s presence in New York while he engaged in structuring and marketing of Abacus on the grounds that it was merely conduct, which had been rejected as the determinative factor in Morrison. Judge Jones also rejected the SEC’s argument that courts must look to the “entire selling process” to determine whether a securities transaction is foreign or domestic. The court observed “in reality, the SEC’s ‘entire selling process’ argument is an invitation for this court to disregard Morrison and return to the ‘conduct’ and ‘effects’ tests.” 

The SEC had also conceded at oral argument that the closing in New York, by itself, was not sufficient to make IKB note purchases domestic transactions for purposes of Morrison. For good measure, however, the court noted Quail Cruises Ship Mgmt. v. Agencia De Viagens CVC Tur Limitada, which also rejected the place of closing as determinative under Morrison. Accordingly, the court concluded as follows: 

In view of the fact that none of the conduct or activities alleged by the SEC, including the closing, constitute facts that demonstrate where any party to the IKB note purchases incurred “‘irrevocable liability[,]’” . . . the SEC fails to provide sufficient facts that allow the court to draw the reasonable inference that the IKB note “purchase[s] or sale[s were] made in the United States.” 

Turning to the ABN transaction, the court stated that the SEC provided no facts from which the court could draw the reasonable inference that any party to the ABN CDS transaction incurred “irrevocable liability” in the United States. Thus, Judge Jones ruled that the SEC failed to allege that the ABN CDS transaction constituted a domestic transaction under Morrison for the same reasons as the IKB purchases. 

Because AKA Capital was based in the United States, there appears to have been no opportunity for the court to apply Morrison to those transactions. Instead, the court analyzed whether the SEC had sufficiently pled the elements of a violation of section 10(b), and found that it had. 

The court also analyzed the sufficiency of the SEC’s claim under section 17(a) of the Securities Act, and whether Morrison applied to that statutory section. The court observed that Morrison did not involve or consider section 17(a), none of the parties had cited any cases applying Morrison to section 17(a), and the court was not aware of any such case. Judge Jones observed that In re Royal Bank of Scotland Grp. PLC. Litig. applied Morrison to sections 11, 12 and 15 of the Securities Act, but did not address section 17(a). Nevertheless, the court agreed with Tourre that Morrison applies to section 17(a), stating that “Morrison itself expressly states that the Exchange Act and the Securities Act share ‘[t]he same focus on domestic transactions.’” Because Morrison focused on whether sales of securities were domestic or foreign, Judge Jones concluded that, to the extent section 17(a) applied to sales, it does not apply to sales that occur outside the United States. The court therefore dismissed the section 17(a) claim, but only to the extent that it was based on sales to IKB and ABN. 

The court continued its analysis, however, observing that section 17(a), unlike section 10(b), applies not only to sales of securities, but also to offers to sell securities. The court examined the definition of the term “offer” in the Securities Act, which states that an offer includes “every attempt to offer or dispose of, or solicitation of an offer to buy, a security or interest in a security, for value.” The court stated that this definition left no doubt that the focus of “offer,” under the Securities Act, was on the person or entity attempting, or offering, to dispose of, or soliciting an offer to buy, securities. Applying this definition to the allegations of the complaint, the court noted that the SEC alleged Tourre, acting from New York City, offered Abacus notes to IKB and solicited ABN’s participation in Abacus CDSs. The court observed that Tourre allegedly engaged in numerous communications from New York City that constituted domestic offers of securities or swaps. Thus, Judge Jones permitted the section 17(a) claim to survive to the extent that it was based on such “offers.” 

Conclusion

This case adds significantly to the jurisprudence applying the Supreme Court’s Morrison decision. As an initial matter, the case represents the first time that any court has applied Morrison to claims by the SEC. Because this action was brought prior to the enactment of Dodd-Frank, which purports to grant subject matter jurisdiction over extraterritorial claims by the SEC, it remains to be seen whether subsequent post-enactment SEC cases will follow this decision. It is arguable that Dodd-Frank should not change the Morrison analysis as applied to the SEC. Although Dodd-Frank purports to grant subject matter jurisdiction over extraterritorial securities claims by the SEC, the Supreme Court, in Morrison, held that district courts already had subject matter jurisdiction, but that section 10(b) itself had no extraterritorial reach. Nothing in Dodd-Frank modified section 10(b) in that regard. Thus, courts in post-enactment cases may conclude that they are able to follow Judge Jones’s decision in Goldman Sachs. 

In addition, the Goldman Sachs decision is significant for its analysis of how Morrison applies to transactions in securities that are not listed on an exchange. As Judge Jones noted, because Morrison involved securities traded on foreign exchanges, the decision is essentially silent on the second prong of its transactional test involving the purchase or sale of any other security in the United States. The Goldman Sachs decision furnishes a well reasoned analytical roadmap for other courts to follow in this respect. 

Lastly, the decision is noteworthy for its articulation of the applicability of Morrison to claims under section 17(a) of the Securities Act involving sales of securities, and to the Securities Act generally. 

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In a striking series of developments late yesterday afternoon, the Senate passed the financial reform bill and the SEC announced its record-setting settlement of the enforcement action it filed against Goldman Sachs last April. The Goldman settlement drew extensive coverage in the mainstream media, primarily focused on the sheer size of the $550 million settlement and on Goldman’s concessions that, according to the SEC’s press release, "its marketing materials for the subprime product contained incomplete information."

Goldman Sachs’ July 15, 2010 statement about the settlement can be found here.

There are many other interesting details about the settlement, some of which have not received widespread attention in the media.

First, the settlement resolves only the charges against Goldman Sachs itself. According to the SEC’s July 15, 2010 press release, "the SEC’s litigation continues against Fabrice Tourre," who seems to have left to fend for himself. Things don’t appear quite so "fabulous" for Mr. Tourre just now.

Second, as reflected in Goldman’s July 14, 2010 "Consent" (a copy of which can be found here), the $550 million settlement amount consists of a disgorgement of $15 million and a civil penalty of $535 million.

Goldman acknowledged in the Consent that the settlement funds may be distributed under the Fair Funds provisions of Section 308 of the Sarbanes Oxley Act. In its press release, the SEC states that of the $550 million settlement, $250 million would be paid to "harmed investors" through a Fair Funds distribution and $300 million will be paid to the Treasury.

Third, the Consent also reflects the specifics of Goldman’s admissions regarding the Abacus transaction. In paragraph 3 of the Consent, Goldman "acknowledges" that the Abacus marketing materials "contained incomplete information" and that it was "a mistake" for the materials to state that the Abacus reference portfolio was selected by ACA Management without disclosing the role of Paulson & Co or that Paulson’s economic interests were adverse to those of the CDO investors. The consent states that Goldman "regrets" the omission of this information.

Fourth, Goldman agrees in the Consent that, other than with respect to the amount of the disgorgement, it will not argue that it is entitled to any offset or reduction of a compensatory damages award in any Related Investor Action by any amount of any part of the company’s payment of a civil penalty in the SEC enforcement action. If a court nevertheless grants an offset, the Goldman has to pay the amount of the offset either to the Treasure or the Fair Fund, within 30 days.

Fifth, Goldman agrees both that "it shall not seek or accept, directly or indirectly, reimbursement or indemnification form any source, including but not limited ot payment may to any insurance policy, with regard to any civil penalty" and also agrees that it "shall note claim, assert or apply for a tax deduction or tax credit with regard to any federal state or local tax for any penalty amounts."

Sixth, Goldman acknowledges in the Consent that the Commission has not made any promises or representations "with regard to any criminal liability that may have arisen or may arise from the facts underlying this action or immunity from any such criminal liability."

Finally, in the Consent, Goldman agrees that it will not make any public statements "denying, directly or indirectly, any allegation in the complaint or creating the impression that the complaint is without factual basis." However, this agreement does not affect Goldman’s "right to take legal or factual positions in litigation or other legal proceedings in which the Commission is not a party."

All told, the Consent is a really striking document that -- together with the massive size of the settlement itself -- bespeaks a compelling need on Goldman’s part to resolve this matter as quickly as possible.

An interesting question is the effect that Goldman’s "acknowledgement" in the Consent will have on the various shareholder lawsuits that sprang up in the wake of the SEC enforcement action.

On the one hand, the omissions that Goldman acknowledged in the Consent were made in the marketing materials for the Abacus document, not in the public statements to Goldman’s shareholders.

On the other hand, Goldman’s acknowledgement that it made a "mistake" when it omitted information from the Abacus marketing materials clearly will be useful for the plaintiffs’ lawyers in the shareholder lawsuits. But, as Duke Law Professor James Cox commented on the WSJ.com Law Blog, even though Goldman admitted to a "mistake," it did not admit to fraud.

In any event, the plaintiffs’ lawyers can at least be reassured that Goldman cannot attempt to offset its liability in the shareholder lawsuits by the amount of its massive penalty in this settlement.

Andrew Longstreth's July 15, 2010 Am Law Litigation Daily article with his thoughts about the effect of the Goldman SEC settlement on other litigation pending against Goldman can be found here.

Goldman’s undertaking that it would not seek reimbursement or insurance for the amounts of the penalty seems largely symbolic, since it is highly unlikely that any insurance policy would provide coverage for the disgorgement amounts and penalties that the company has agreed to pay. However, the significance of the undertaking may be what it portends for other settlements in other matters. This kind of requirement that enforcement action defendants will not seek indemnification or insurance for amounts paid in SEC enforcement action settlements represents a substantial (and chilling) threat to other persons the SEC may target.

The exclusion of Tourre from the settlement is interesting. It is possible that Mr. Tourre himself may have declined to participate, either because he believes he did nothing wrong or because he was unwilling to make the type of acknowledgment the SEC might require as a condition of settlement. It is also possible that the SEC expected Tourre to agree to some type of ban that would undermine his ability to continue to work as an investor banker in the United States. Whatever the reason, it does seem noteworthy that Tourre is not a part of this settlement.

Another question about the settlement relates to the proposed Fair Funds distribution. Why does the Treasury get $300 million but "harmed investors" only get $250 million? (I guess that is one way to reduce the deficit.)

The other question about the propose Fair Funds distribution is, who are the "harmed investors" who will get these funds? It seems that it would be the two investors in the Abacus transaction, IKB and ACA-- except that ACA’s interests have been passed along to Royal Bank of Scotland, as a result of other transactions that ACA entered attendant to the Abacus deal.

I suppose the Fair Funds administrator will have to sort all of that out, but it does seem like SEC went to an awful lot of trouble for the benefit of non-U.S. institutional investors that have plenty of problems of their own – and that is setting aside the question whether the institutional investors who entered this transaction are either entirely blameless or merit this type active regulatory protection.

As Professor Cox commented (quite appropriately I might add) on the WSJ.com Law Blog, the investors "made out like bandits." (He added that the investors are "not necessarily saints here.") The Los Angeles Times takes a look here at where the settlement money is going and also summarizes the various sordid background details on the Abacus transaction investors.

It is interesting to reflect that, according to media reports, the SEC was divided 3-2 on whether to bring the Goldman Sachs enforcement action. The settlement seems to make the decision to bring the case look pretty good. But what is even more curious is that, at least according to yet other media reports, the SEC also split 3-2 on whether to settle with Goldman.

I can understand the split vote on whether to bring the action, because the SEC did not, shall we say, have the strongest case in the world against Goldman. But once you have a chance to snag a half a billion dollars, don’t you declare victory and go home for a nice dinner and a glass of wine with your spouse? Geez, seems like a good day’s work to me.

Finally, can I just say that while the SEC has touted this settlement as some kind of record, the fact is that there have been larger SEC enforcement action settlements. As reflected in data from NERA Economic Consulting (here), there have been at least two larger SEC enforcement action settlements, including AIG’s February 2006 $800 million settlement and WorldCom’s July 2003 $750 million settlement. The Goldman Sachs settlement is, as the SEC pointed out, the largest settlement against a Wall Street firm. I guess we can all agree that more than half a billion dollars is a lot of money, even for Goldman Sachs.

UPDATE: The morning press coverage provided some added perspective on some of the points raised above. First, with respect to the size of the settlement, the Wall Street Journal notes that the $550 million settlement "is equivalent to just 14 days of profits at Goldman in the first quarter."  (Maybe half a billion isn't a lot of money for Goldman Sachs.) As for whether the amount represents some kind of record, the Journal notes that in 1988 Drexel Burnham Lambert agreed to pay $650 million in fines and restitution. The Drexel settlement included amounts paid to satisfy investors' civil claims. in 2003, ten Wall Street firms collectively paid $1.4 billion to settle analyst conflict cases. Finally, as for Mr. Tourre, the Journal reports the he plans to "continue trying to clear his name accoding to a person familiar with the matter."

Let the Games Begin: The Senate may now have approved the financial reform bill and all 2,319 pages of the bill will now be headed to the White House for President Obama’s signature. But this is not the end, it is the beginning.

As Broc Romanek points out on the CorporateCounsel.net blog (here), under the Dodd-Frank Act, "a total of 11 regulators are committed to make 243 rulemakings, 67 studies and 22 new periodic reports under the Act. The SEC itself will be required to conduct 95 of those rulemakings, 17 studies and 5 new periodic reports."

Over at the SEC Actions blog, Tom Gorman has a detailed list, here, of several categories of the more significant rule making processes that lie ahead.

To those who want to know the meaning and significance of the financial reform bill’s passage, the only honest answer is – stay tuned.

As The Joker Said, "Why So Serious?": All of this seems way too serious to me, so it is about time to roll out The Egg Trick. If you have never seen this footage of Dom DeLuise’s unforgettable turn on the Johnny Carson Show, drop everything and watch this right now. With all of this other stressful stuff going on, you need a "break." Enjoy.

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The SEC’s high-profile enforcement action against Goldman Sachs and one of its investment bankers may or may not revitalize the waning subprime and credit crisis-related litigation wave, but it has at least sparked an outbreak of follow on civil litigation against Goldman Sachs.

According to their April 26, 2010 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the Southern District of New York against Goldman and certain of its directors and officers. According to the press release, the complaint (which can be found here) alleges that the defendants failed to disclose that:

(i) the Company had, in violation of applicable law, not fully disclosed the facts and circumstances concerning the formation and sale of the ABACUS 2007-AC1 deal to investors such that it had engaged in misleading conduct; (ii) the Company had, in fact, bet against its clients and constructed collateralized debt obligations that were likely, if not designed, to fail; and (ii) the Company had received a Wells Notice from the SEC about the ABACUS transaction but failed to inform shareholders of this fact.

The complaint further alleges that April 16, 2010, Goldman was sued by the SEC "for making materially misleading statements and omissions in connection" with ABACUS 2007-AC1. Following this announcement, Goldman’s stock price fell $24.05, declining from $184.27 per share on April 15, 2010 to close at $160.70 per share on April 16, 2010.

A key issue in this new lawsuit will be Goldman's alleged failure to disclosure the existence of the Wells Notice. Which of course begs the question of whether or not Goldman had any obligation to disclosure the existence of the Wells Notice. There is no bright line rule on this issue, it is a question of materiality. But as Michelle Leder points out on the Footnoted blog (here), lost of other companies do routinely disclose Wells Notices. A post on the Westlaw Business Currents blog (here) is very much to the same effect, that is, that whether or not Wells Notice disclosure is requrired, many companies do disclose Wells Notices.

The securities class action lawsuit filing follows close on the heels of the filing late last week of two separate New York state court shareholders’ derivative lawsuits against Goldman, as nominal defendant, and certain of its directors and officers. According to April 23, 2010 press reports (refer here), the complaints allege that:

The individual defendants engaged in a systematic failure to exercise oversight of the company's 23 Abacus transactions, which were completed over a three and half year period. As a direct and legal result of the individual defendants' wrongful conduct, Goldman Sachs has been significantly and materially damaged, faces billions of dollars of liability, has incurred and will continue to incur millions of dollars of expense in defending claims against the SEC and investors, and has suffered serious damage to its reputation and image.

The same press reports also quote a leading plaintiffs’ securities class action attorney as saying that "I suspect every major pension fund in America" is considering suing Goldman Sachs "over the conduct that occurred."

I have added the new Goldman lawsuit to my running list of subprime and credit crisis-related securities class action lawsuits, which can be accessed here. SInce I first began compiling the list almost exactly four years ago, there have been a total of 210 subprime and credit crisis-related securities suits filed, of which eight have been filed so far this year.

A WSJ.com Law Blog post about the Goldman securities class action lawsuit can be found here. Bloomberg’s article about the lawsuit can be found here.

More About Goldman Sachs and D&O Claims: An April 26, 2010 National Underwriter article by Susanne Sclafane entitled "Long-Awaited SEC Action Emphasizes Need for More D&O Cover, Lawyer Says" (here) presents a lengthy discussion of the possible D&O claims implications from the recent SEC action against Goldman Sachs, as well as any follow on private litigation. The article also contains an extensive summary of the recent Advisen conference call regarding first quarter securities litigation trends.

As for the question of potential insurance coverage for the SEC’s claims and for other claims that filed against Goldman Sachs, an April 26, 2010 Business Insurance article by Roberto Ceniceros entitled "Goldman Legal Woes Could Hit Insurers" (here) explores the issues that could affect the availability of coverage under Goldman’s D&O insurance program. An April 24, 2010 Bloomberg article on the same topic can be found here.

The April 26, 2010 issue of Business Insurance also has an article by Zack Phillips entitled "Subprime Rulings Favor Defendants" (here), discussing recent trends in subprime and credit crisis lawsuit dismissal motion rulings.

Developments on the D&O Claims Front: In Chubb’s April 22, 2010 quarterly earnings conference call (a transcript of which can be found here), Chubb Vice-Chairman John Degnan had the following to say about D&O claims trends:

I am particularly pleased about developments in two areas I want to mention specifically, the frequency of non-credit crisis security class action claims and the recent rulings in credit crisis derivative actions.

For the second straight quarter, even as the number of new credit crisis security class actions virtually disappeared we did not see a corresponding increase in the number of non-credit crisis class actions. So for those observers who have speculated that there was a substantial number of backlog claims waiting to be filed, the evidence so far doesn’t support that. And, the two year statute of limitations is already a bar to actions in which the triggering event, typically a corrective disclosure took place in 2007 and early 2008, the years in which that presumed backlog would have been building.

In addition, we’re encouraged by the continuing relatively high dismissal rate in the first quarter of derivative actions which might otherwise trigger our side A coverages. Unlike the stock option back dating claims which were heavily weighted towards derivative actions, credit crisis claims have been predominately securities class actions. However, in connection with the credit crisis derivative claims which have been brought, we are seeing the allocation of well established legal protections governing mismanagement allocations and the defendants are having great, in some cases even unexpected success in defending those claims.

For example, in the recent decision involving AIG’s credit crisis woes, the court has made it clear that they will not engage in second guessing managements’ legitimate business decisions regardless of how badly those decisions played out. So, although some observers have asserted that credit crisis derivative claims have the potential to impact side A coverages, we are not currently seeing an increased level of exposure as a result of them.

Ordinarily I would not include on this blog anything as insurer-specific as a single company’s earnings conference call transcript, and I do not intend to comment on Chubb’s quarterly results here. I included this selection from the conference call transcript because I have a couple of thoughts about Mr. Degnan’s claims trend observations.

I should emphasize at the outset that in adding my comments that I mean no disrespect to Mr. Degnan, for whom I have nothing but the highest admiration and respect. Moreover, I fully recognize that Mr. Degnan’s comments were made in reference to his own company’s experience, rather than as a general matter. But with respect to more general trends, I do have a few observations.

There is no doubt that securities class action lawsuit filings were down during the first quarter as has been noted elsewhere. However, by my count there have been eight securities class action lawsuits filed so far in 2010 (out of about 40 lawsuit total YTD) in which the filing date was more than a year after the proposed class period cutoff. That 20% of all filings YTD were belated suggests to me that the belatedness of securities lawsuit filing, which first became pronounced in the second half of 2009, has continued into 2010. My earlier post about belated 2010 securities lawsuit filings can be found here.

I agree with Mr. Degnan that so far the credit crisis-related derivative suits have not gone particularly well for the plaintiffs. But as for the potential risks for the Side A product line in general as a result of derivative litigation activity, it is important to note that when derivative cases survive the initial pleading hurdles, they are increasingly costly to settle, and when they do settle, increasingly they are producing Side A losses.

The best illustration of this latter point is the $118 million settlement in the Broadcom options backdating derivative lawsuit, to which Excess Side A insurers contributed $40 million. Admittedly, the Broadcom settlement was not credit crisis related but it still represents a very significant development. (Perhaps Mr. Degnan can be forgiven for neglecting to mention the case, however, since his company is one of the few D&O insurers that did not participate in the Broadcom’s Side A tower.)

In any event, the most significant risk to the Side A product line is from insolvency related claims, not derivative claims. In the current economic environment, bankruptcy related claims remain a significant threat.

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Madoff Investor Lawsuit Against the SEC Dismissed: In an April 20, 2010 order (here), Central District of California Judge Stephen V. Wilson granted the motion of the SEC to dismiss the suit brought against the agency by Madoff investors under the Federal Tort Claims Act.

The investors had alleged that the SEC "owed a duty of reasonable care to all members of the general public" and that the agency’s negligent acts and omissions "caused Madoff’s scheme to continue, perpetuate and expand," alleging specifically that the SEC "failed to terminate Madoff’s Ponzi scheme despite multiple opportunities to do so."

The SEC moved to dismiss arguing that the court lacked jurisdiction over the FTCA claims, due to the statute’s "discretionary function exception," which bars federal courts from adjudicating tort actions arising out of federal officers’ discretionary acts.

Judge Wilson said that the plaintiffs’ allegations "identify decisions that, in hindsight, could have and should have been made differently," while others "reveal the SEC’s sheer incompetence." However, Judge Wilson also found that the complaint lacks "any plausible allegation revealing that the SEC violated its clear, non-discretionary duties." Judge Wilson granted the motion to dismiss, but did grant the plaintiffs 30 days leave to amend their complaint to attempt to allege that "the SEC failed to conform to its mandatory duties."

It won’t help them overcome the jurisdictional hurdle, but the plaintiffs undoubtedly will be tempted to allege in their amended complaint that at the same time the agency failed to investigate Madoff, senior SEC enforcement department attorneys were spending up to eight hours a day viewing pornography on their work computers.

An April 22, 2010 Law.com article about the ruling in the Madoff investors’ lawsuit against the SEC can be found here.

D&O Dispute Over Stanford Defense Fees to be Heard in September: In an April 21, 2010 order (here), Southern District of Texas Judge Nancy Atlas set a September 1, 2010 date for the commencement of the hearing on the motion for preliminary injunction of jailed financier R. Allen Stanford and three others to compel the Stanford Group’s D&O insurers to fund the individuals’ defense against criminal allegations. The insurers contend that coverage under the policy is precluded by the policy’s money laundering exclusion.

As readers will recall, on March 15, 2010, the Fifth Circuit had remanded the coverage dispute back to the district court for a factual determination whether or not the money laundering exclusion has been triggered (that is, whether or not there has "in fact" been money laundering as that term is defined in the policy). The Fifth Circuit also ruled that the insurers must continue to advance defense expense until the factual determination has been made.

Judge Atlas’s scheduling order not only establishes the schedule for the evidentiary ruling but also sets a schedule for factual discovery as well. It seems probable that at some point fairly early in the discovery process, one of the individual defendants will feel compelled to take the fifth in response to a deposition question. Similarly the individuals are likely at the September hearing to assert their Fifth Amendment rights from the witness stand.

While an individual’s assertion of their Fifth Amendment rights cannot be held against them in a criminal trial, there is substantial precedent that in a civil trial a finder of fact can draw "adverse inferences" from an individual’s assertion of their Fifth Amendment rights. The individuals and their attorneys will face the formidable challenge of attempting to establish that there was no money laundering within the meaning of the policy without themselves being able to testify on their own behalf.

In any event, as reflected in the April 22, 2010 Law.com article about Judge Atlas’s scheduling order (here), the September hearing "could give a preview of the criminal trial in January."

Abacus: Sung to the Tune of "Springtime for Hitler"?: A loyal reader alerted me to the following letter to the editor that appeared in the April 24, 2010 New York Times:

The investment deal that Goldman Sachs created sounds like something out of the Mel Brooks show "The Producers": plotting to make more money with a flop than with a hit!

Daniel Pitt Stoller
Bayside, Queens, April 19, 2010

Mr. Stoller’s letter is pretty funny. While I appreciate the humor of his comment, I do think it unintentionally points out something about the infamous Abacus deal that, in light of intervening events, might be easy to overlook.

The fact is that, in the Mel Brooks movie, "Springtime for Hitler" turned into an unexpected hit, even though, like the Abacus CDO, it was "built to fail."

John Paulson may well have felt confident that a mortgage meltdown was coming, but as Max Bialystock found out in the movie, fate and fortune can be fickle. It all turned out great for Paulson and he became a wealthy man, but there were no guarantees. Sometimes unexpected things can happen. Neither Abacus nor Springtime for Hitler, as truly awful as they both were, were guaranteed to fail.

In any event, all of this calls for a "built to fail" video tribute. Keep a close watch for Mel Brooks (who won an academy award for the movie screenplay), appearing briefly to sing "Don’t be stupid, be a smarty/Come and join the Nazi Party."

And if you consider this video from just the right perspective, I am sure you will find a whole lot of Fabrice ("Fabulous Fab") Tourre in it, too.

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The SEC’s blockbuster announcement last Friday of its civil enforcement action against Goldman Sachs and one of its investment bankers rocked the securities markets and made headlines in the financial press around the world. Undoubtedly because of Goldman’s prominence and perhaps also because of the nature of the allegations, the SEC’s action is widely seen as a watershed event.

Beyond the implications for Goldman itself, however, the development may be even more significant for what it may portend about possible future actions and claims, both by the SEC and by aggrieved investors. Here are some questions about what may be coming next.

Can we Expect Further SEC Enforcement Actions involved Subprime-Related Financial Instruments?:

According a March 29, 2010 CNBC interview with SEC Chairman Mary Shapiro (here), the agency has been working since the subprime meltdown emerged to build up staff with the right skill and experience to pursue financial-crisis related cases. Now that the SEC has staffed up, she advised, we can expect to see more crisis-related enforcement actions. She said, with reference to these actions, "there are more in the pipeline."

Indeed, in its April 16, 2010 Litigation Release related to the Goldman Sachs action (here), the SEC specifically said that its "investigation is continuing into the practices of investment banks and others that purchased and securitized pools of subprime mortgages and the resecuritized CDO market with a focus on products structured and marketed in late 2006 and early 2007 as the U.S. housing market was beginning to show signs of distress."

There has already been extensive press coverage raising questions some other transactions that may be under scrutiny. Gretchen Morgenson’s December 23, 2009 New York Times article raising questions about many of these transactions, including in particular the so-called Abacus transaction that is at the heart of the SEC’s action against Goldman, refers to numerous other transactions at Goldman and elsewhere where, as in the Abacus transaction, the investment banks created investment securities that were structured so that the banks and others could profit on financial bets that the investments would lose money.

There have also been a number of press articles (refer here for example) about Illinois-based hedge fund Magnetar, which sponsored over 30 CDO transactions in late 2006 and early 2007, which the hedge fund itself shorted, allowing it to make significant profits when the underlying mortgages began to default.

As the New York Times stated in an article on Sunday, the Goldman Sachs action is the SEC’s "the first big case — but probably not the last." Whether or not there may be more SEC actions relating to the toxic subprime-related transactions remains to be seen, but in the meantime concerned parties seem to be taking defensive measures. By way of illustration, when J.P. Morgan Chase released its first quarter financial results on April 14, 2010 (refer here), the firm disclosed that it "$2.3 billion in additional litigation reserves, including those for mortgage-related matters"

It should be noted that further regulatory action may come not just from officials in the U.S. According to press reports (here), German and U.K. government officials are conferring about possible regulatory actions against Goldman, in light of the revelations in the SEC’s complaint against the firm.

Finally, it should probably also be noted quite a number of observers have commented that the SEC’s case is far from a slam dunk, and the SEC could face formidable hurdles in attempting to sustain its allegation. The most balanced of these types of commentaries, by Professors Henning and Davidoff, appears in the Dealbook blog (here). An April 18, 2010 Wall Street Journal article (here) raises many of the same questions.

Will More Senior Officials Get Dragged In?:

The SEC named 31-year old Fabrice Tourre as a defendant because, the SEC alleged, Tourre was "principally responsible" for the Abacus transaction," having "devised the transaction, prepared the marketing materials and communicated directly investors." He also drew a big bull’s-eye on himself in an email suggesting that he ("the fabulous Fab") is the "only potential survivor" of the coming collapse, standing in the middle of "monstrosities" he had "created without necessarily understanding." (Note to file: It is never a good thing to have a personal email reproduced on the front page of the Wall Street Journal, above the fold.)

Tourre, who was 28- years old at the time of the Abacus deal, was not, however, simply off on a personal frolic in putting together this $2 billion transaction. Indeed, "senior level management" of Goldman Sachs is alleged, in paragraph 40 of the SEC’s complaint, to have approved the transaction. The referenced individuals, apparently members of Goldman’s Mortgage Capital Committee, were neither identified by name in the complaint, nor were they named as defendants.

Gretchen Morgenson’s April 18, 2010 New York Times article (here) suggests that the SEC may try to use Tourre to "get" more senior officials. Morgenson also suggests that as the subprime market began to unravel in 2007, senior Goldman officials became more directly involved in the firm’s mortgage department. A separate April 19, 2010 New York Times article talking about senior Goldman executives' supervision of and involvement in the mortgage unit can be found here.

Susan Beck, in her April 16, 2010 Am Law Litigation Daily article about the SEC’s action against Goldman (here), suggests that perhaps New York Attorney General Andrew Cuomo may "start rooting around and come up with other individuals," noting that Cuomo has had not been afraid to name top executives as defendants in his action against BofA.

The pressure the SEC faced from Judge Jed Rakoff in attempting to settle its enforcement action against BofA, among other reasons for its failure to name the specific individuals responsible for the alleged violations, suggests the likelihood that any future SEC enforcement actions will include individuals among those targeted. But the question remains, both with respect to any further regulatory against, whether against Goldman or other financial players, more senior company officials will become involved.

Will the SEC’s Action Against Goldman Spawn Further Investor Litigation?:

In an April 17, 2010 post on WSJ.com Law Blog (here), Amir Efrati quotes a leading plaintiffs’ securities class action attorney as saying that "private lawyers are foaming at the mouth" over the prospects of pursuing claims against Goldman. (Presumably, this expression was merely a figure of speech.). An April 17, 2010 Reuters story (here) quote one plaintiffs’ attorney as saying that Goldman investors have already contacted him about pursing actions to recover their losses.

These developments also suggest that investors who lost money in other subprime-related investments may be asking whether their transaction involved the same kind of undisclosed conflict of interest as the SEC alleges in the Abacus deal. Indeed, one claimant that has a case pending against Merrill Lynch based on a subprime-backed security has alleged (refer here) that Merrill failed to disclose that it had a relationship with another client that was betting against the investment, similar to what happened at Goldman Sachs.

These developments arise just as the long-running subprime and credit crisis-related litigation wave appeared that it might be losing momentum. Many commentators recently have noted the dwindling numbers of new subprime related securities class action lawsuits. Moreover, in an April 8, 2010 Wall Street Journal article entitled "Banks Winning When Investors Sue" (here), Ashby Jones suggested that plaintiffs were faring poorly on dismissal motions in subprime-related securities lawsuits against previously filed against financial firms.

In light of popular and press reaction to the SEC’s allegations against Goldman, it is possible that these revelations in the Goldman complaint could revitalize the subprime litigation wave. Indeed, the SEC’s action may be only one of several recent developments that could reinforce a renewed interest in pursuing claims against Wall Street firms. The examiner’s report in the Lehman bankruptcy and the revelations of the Senate subcommittee investigation into the financial crisis could drive a renewed interest in holding financial firms accountable. These accumulating developments could also counterbalance the apparent judicial skepticism of fraud claims raised in the wake of the financial crisis.

The bottom line is that the SEC’s enforcement action is a significant event with important implications. How all of this will unfold remains to be seen, but it seems possible in the wake of the SEC’s complaint there could be a cascade of consequences.

National Public Radio’s April 16, 2010 "All Thing Considered" report about the SEC's complaint against Goldman Sachs can be found below. The report includes my recorded comments about these developments.

Another Surge of Failed Banks: Amidst all of the hoopla surrounding the Goldman Sachs enforcement action you may not have noticed that on Friday, April 16, 2010, after the close of business, the FDIC took control of eight more banks, bringing the year to date total of bank closures to 50. During 2009, when there were a total of 140 failed banks, the FDIC did not close its 50^th bank until July 2, 2009, suggesting that the pace of bank failures is well ahead of last year’s pace.

Three of the banks closed on April 16 were based in Florida, bringing the number of 2010 bank closures in that state to nine, the highest for any state this year. Since the beginning of 2008, there have 25 bank failures in Florida. The state with the highest number of bank failures during the period 2008-10 is Georgia with 37, including seven in 2010, the second highest number for any state this year. Other states with the highest numbers of bank failures this year include Washington (5), California (4), and Minnesota (3).

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