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

During 2011, elevated levels of M&A related litigation and the surge of litigation involving U.S.-listed Chinese companies offset declining numbers of credit crisis-related lawsuits, leading to overall levels of securities class action lawsuit filings consistent with recent years, according to a annual securities litigation study of NERA Economic Consulting. NERA’s December 14, 2011 report, entitled “Recent Trends in Securities Class Action Litigation: 2011 Year-End Review,” can be found here.

Based on the 213 filings between January and November 2011, NERA projects 2011 year-end filings of 232, which would be slightly below the 241 securities class action lawsuits filed in 2010 but above the 218 filed in 2009, and consistent with the 1997-2004 average of annual filings of 231.

Though the 2011 filing levels are consistent with recent years, the mix of cases has “changed substantially.” Credit crisis-related case, which predominated among filings in recent years, declined, while at the same time, M&A-related cases accounted for nearly 29% of all filings and filings against U.S.-listed Chinese companies have accounted for 18%.

Filings in the Second and Ninth Circuits accounted for more than half of all 2011 filings. However, the M&A objection suits are much more evenly distributed, with eight to ten merger objection cases filed in each of the Third, Fourth, Fifth and Ninth Circuits.

By contrast to recent years in which filings against companies in the financial sector predominated, 2011 filings have not been concentrated against companies in any one sector. (Filings against companies in the financial sector accounted for about 16% of all filings, which is in line with pre-credit crisis averages). More filings were against companies in the electronic technology and technology services sector that any other sector, representing about 21% of filings. Health technology accounted for 15% of filings.

More than a third of 2001 filings were against foreign-domiciled companies, more than double the levels of such filings in recent years. This increase of filings against foreign-domiciled companies was largely driven by filings against companies either domiciled or having their principal executive offices in China, which accounted for 39 of the 2011 filings. The pace of filings against Chinese companies slowed as the year progressed, with 27 filings in the year’s first half and 12 during the period July through November. However, the 12 filings during the period July to November are still above the 2010 total of ten cases involving Chinese companies.

Securities class action lawsuit settlements during 2011 averaged $31 million, compared to $108 million in 2010. However, if settlements in excess of $1 billion and the IPO laddering settlements are excluded, the 2010 average falls to $40 million, while the 2011 average stays at $31 million.

The 2011 median settlement was $8.7 million compared to 2010’s all time-median settlement of $11 million. Though the median settlement fell in 2011 compared to 2010, the median still represents the third highest annual median.

The NERA study is quite detailed and contains a wealth of other information and it merits being read at length and in full.

Discussion

In “counting” securities class action lawsuit filings, NERA counts multiple lawsuits against the same defendant in the same circuit as a single filing. However, if there are filings against the same defendant in different circuits, NERA counts those filings in separate circuits as separate filings, which may result in NERA’s annual filing count being higher than filing accounts that are published elsewhere.

In addition, NERA’s 2011 filings count is the result of a year end-projection based on actual filings from January through November. The fact that NERA’s 2011 filing number is the result of a projection may also result in differences between NERA’s year end number and those shown in other year end reports.

NERA “counts” only securities class action lawsuits filed in federal court. That means it does not include securities class action lawsuits filed in state court (as is permitted under The Securities Act of 1933). Similarly, while the NERA report contains extensive analysis of M&A related lawsuit filings, that analysis is limited to M&A cases filed in federal court. Many M&A related cases are in fact filed in state court. NERA’s analysis of M&A related litigation does not relate to those state court lawsuits.

Finally, in reporting on annual filing levels, NERA’s analysis reflects a consideration only of absolute numbers of filings. NERA’s does not include an analysis of those filings compared to the total number of publicly traded companies. As I have commented elsewhere, the total number of companies whose shares are publicly traded in the U.S. has declines substantially in recent years. The fact that absolute numbers of filings have stayed more or les consistent while the numbers of public companies has declined could be argued to suggest that overall levels of securities class action lawsuit filing have been increasing.

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On January 21, 2010, the insurance information firm Advisen released the latest in a series of various observers’ year end analyses of 2009 securities litigation. Advisen’s year report can be accessed here. The Advisen report takes a somewhat different approach than the other reports, and reaches some strikingly different conclusions. Among other things, the Advisen report, perhaps by contrast to prior studies, concludes that "securities litigation" (as that term is used in the report) is actually increasing.

Warning! Terminology Matters!

In order to appreciate the Advisen report, it is absolutely indispensible to understand that the Advisen report uses its own unique terminology.

The most important thing to understand is that the Advisen report uses the term "securities litigation" to include a very broad range of kinds of lawsuits, including not just securities class action lawsuits, but also derivative actions, regulatory and enforcement actions, individual lawsuits, and collective actions in courts outside the United States.

The Advisen report also apparently includes within the category "securities lawsuits" claims alleging "common law torts, contract violations and breaches of fiduciary duties."

So the report uses the term "securities lawsuits" basically to mean any type of corporate or securities litigation (other than ERISA litigation), regardless even of whether or not the legal action was commenced in the U.S. or even apparently whether it alleges a violation of the securities laws. Because of the enormous variety of litigation encompassed within this category, throughout this post I have put the phrase "securities lawsuits" or "securities litigation" in quotation marks.

The Advisen report also uses the phrase "securities fraud" lawsuits as a subset of the larger group of "securities lawsuits." Contrary to what you might expect, however, the category of "securities fraud" lawsuits does not include class action lawsuits alleging securities fraud – securities fraud class action lawsuits are their own separate category ("SCAS"). Instead, the phrase is used to refer to regulatory and enforcement actions -- yet somehow also includes private securities lawsuits that are not filed as class actions.

So the "securities fraud" lawsuit category includes lawsuits alleging fraud under the federal securities laws if the fraud is alleged by an individual but not if it is alleged on behalf of a class.　

The Report’s Conclusions

Perhaps the most important contribution that the Advisen report makes to understanding what happened from a litigation standpoint is its observation that "securities litigation" -- as broadly defined in the report – actually increased in 2009 by comparison to prior years. Thus the report states that in 2009 the number of "securities lawsuits" actually grew to 910 suits, up 13% from 2008, which in turn was up 33% from 2007.

This observation is interesting and seemingly contrasts with conclusions reported in other studies suggesting that securities litigation declined in 2009. The difference in the analysis is due to the fact that the other studies concentrated exclusively on securities class action lawsuit filings in the United States, whereas the Advisen report is focused more broadly on corporate and securities litigation generally, and on litigation both inside and outside the United States.

It appears that for several years, securities class action lawsuits as a percentage of all "securities lawsuits" have been declining. As recently as 2004, securities class action lawsuit filings represented as much as half of all " securities lawsuits" filed, whereas in 2009 securities class action lawsuits represent only about one quarter of all "securities lawsuits."

The point here is an important one – that is, even if absolute numbers of securities class action lawsuit filings are declining, that does not mean that overall claims activity is decreasing. To the contrary, claims activity is actually increasing, while at the same time the mix of cases filed is changing. So if you were to focus only on securities class action lawsuit filing levels, you might mistakenly conclude that overall claims susceptibility is decreasing. It is not. It is increasing.

But even with respect to the narrower issue of securities class action lawsuit filings ("SCAS"), the Advisen report reflects a different perspective than other studies.

The Advisen report reports a relatively higher number for the number of securities class action lawsuit filings in 2009 (234) compared, for example, to the Cornerstone tally of 169 securities class action lawsuit filings in 2009, but the Advisen study also reports a much slighter decline in securities class action lawsuit filings from 2008 to 2009 (234 in 2009, 239 in 2009), than does the Cornerstone study (223 in 2008 to 169 in 2009).

Part of the explanation for this seemingly enormous difference is categorization. Thus, the Advisen study counts securities class action lawsuits that were filed in state courts (there apparently were 15 state court securities class action lawsuit filings in the fourth quarter of 2009 alone), but the Cornerstone study does not.

Part of the explanation for the difference is methodological. As stated in its report, Advisen "counts each company for which securities violations are alleged in a singled complaint as a separate suit." As far as I can tell, the Cornerstone study would count that single complaint only once regardless of the numbers of corporate defendants named in the complaint – that is certainly the approach I use in my own tallies. The Advisen approach will inevitably lead to higher numbers than are reported in some other studies.

Part of the explanation for the difference is simply timing. The Advisen report includes filings through December 31, 2009, whereas the Cornerstone report only counts filings through December 21, 2009.

Among other things, the Advisen report states that the aggregate losses claimed in the "securities lawsuits" filed in 2009 was $1.3 trillion, compared to $1.2 trillion in 2008. The average losses per "securities lawsuit" were $9.8 billion in 2009, compared to $6.4 billion in 2008, which may be interpreted to suggest the possibility of "record payouts" for the securities lawsuits filed in 2009.

The report also contains an extensive discussion of the growing significance of "securities lawsuits" against non-U.S. companies. According to the study, there were 117 "securities lawsuits," or 13 percent of the total, filed against non-U.S. companies in 2009, including 46 "large cases" filed in non-U.S. courts. (The report does not specify what constitutes a "large case.") However, the report also notes that one subset of these "securities lawsuits" against non-U.S. companies, that is, the filings in the subcategory of "collective actions" were almost entirely concentrated in the first quarter and largely driven by Ponzi scheme cases.

The Advisen report is quite extensive and contains a wealth of information, and is worth reading at length and in full (albeit very carefully). But of all the observations contained in the report, by far the most important one is that even if securities class action lawsuit filings may have declined, overall "securities litigation" has not decreased – in fact, in 2009, "securities litigation," as that term is used in the Advisen report, increased materially and for the second consecutive year.

Securities Litigation Webinar: On Friday January 22, 2010 at 11:00 a.m. EST, I will be participating in a free one-hour "Review of Securities Litigation 2009 and Expert Views for the Year Ahead." The other panelists include Travelers's Mark Lamendola, Beecher Carlson's Jeff Lattmann, and Advisen's Dave Bradford. Advisen's Jim Blinn will moderate the panel. You can register for the webinar here.

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What a difference a year makes. Just 12 months ago, the subprime and credit crisis litigation wave was in full spate, and the onslaught of Madoff and other Ponzi scheme cases had just begun to surge. And while both of these lawsuit filing trends continued well into 2009, by year’s end both of these phenomena had largely played out. At the same time, however, other litigation trends emerged as the year progressed, and in the end, the number of new securities class action lawsuits filed during 2009, though significantly below the number filed in 2008, was well within historical norms.

First, let’s run the numbers. By my count -- please see the note below about how I "counted" -- there were 189 new securities class action lawsuits in 2009, which is just below but within range of the 1966-2007 annual average of 192, although 15.6% below the 2008 total of 224 new securities lawsuits.

As was the case for the two preceding years, the 2009 lawsuit filings were largely driven by lawsuits against financially-related firms. Of the 189 new securities suits in 2009, 69 were against companies in the 6000 Standard Industrial Classification (SIC) code series (Finance, Insurance, and Real Estate). In addition, another 39 of the defendant firms targeted in 2009 securities class action lawsuits lacked SIC Codes. These lawsuit targets without SIC code designations included mutual funds, ETFs, and closed end funds. In general, the defendant entities that lacked SIC codes were all financially related.

If these two groups, the companies in the 6000 SIC code series and the entities that lacked SIC code designations, are added together, the total is 108. So these two groups together represented roughly 57.1% of the new lawsuits filed in 2009.

A significant factor driving this concentration of filings in the financial sector was the number of credit crisis-related lawsuits. By my count, there were 62 new credit crisis-related securities lawsuits filed in 2009, bringing to 205 the total number of credit crisis related securities lawsuits that were filed since the litigation wave commenced in February 2007. (My complete list of the subprime and credit crisis-related securities suits can be found here.)

But though the credit crisis litigation wave carried over into 2009, as the year progressed the number of credit crisis-related filings dropped off. So too did the concentration of filings against financial companies. Thus, while 72.6% of the lawsuits in the first half of 2009 were against financially-related companies, only 41.3% of the filings in the year’s second half involved financial companies.

And even though the lawsuits filed against financially related companies declined in the second half of the year, by and large, the rate of lawsuit filings overall did not decline. Thus, while there were 95 new securities class action lawsuits in the first half of 2009, there were 94 in the second half – virtually the same filing rate in both halves of the year.

Part of the reason that the overall lawsuit filing rate did not decline in the second half of the year even though the credit crisis-related lawsuits trailed off is that a couple of filing trends emerged in the second half of the year that fueled lawsuit filings and took up the slack.

The first of these two trends was the outbreak of a rash of lawsuits against leveraged exchange-traded funds (ETFs), which I discussed in a prior post here. By my count, there were twelve separate securities lawsuits filed against ETFs, all during the second half of 2009. These suits largely have been filed against leveraged ETFs drawn from within a single fund family, and all present more or less the same allegations (essentially that investors were not told that the funds would track their target measures or ratios only for very short periods). Because these lawsuits represent more than 6% of all new 2009 securities lawsuits, they represent a significant part of the year’s securities litigation activity.

The second trend that emerged during the second half of 2009 was the emergence of a significant number of belated lawsuit filings, where the lawsuit filing date came long after the proposed class period cut-off date, a phenomenon I discussed several times in the latter half of the year (most recently here). These belated filings appear to be the result of a lawsuit backlog that developed while the plaintiffs’ lawyers were preoccupied with the credit crisis related lawsuit filings.

By my count, 22 of the 94 securities lawsuits filed during the second half of 2009 were filed more than a year after their proposed class period cut-off date. In some instances, the lawsuit filings came at the very end of the two-year limitations period. For example, the Pitney Bowes securities class action lawsuit was filed one year and 364 days after the proposed class period cutoff date. Indeed, in at least two cases (the Avanir Pharmaceuticals case and the Regions Financial case), the filing came nearly three years after the proposed class period cutoff, raising a rather obvious question about how these cases will withstand statute of limitations objections.

The belated filings continued to arrive right through the end of the year, with several of December’s filings including cases with filing dates more than a year after the proposed class period cutoff date, including the new lawsuits filed against Siemens (about which refer here), NightHawk Radiology Holdings (here), and Terex (refer here).

Almost all of these backlog cases have been filed against companies outside the financial sector, which accounts in part for the shift in filings away from financial companies in the second half of 2009. That is, it appears that while the plaintiffs’ lawyers were rushing to file credit crisis-related lawsuits during the period mid-2007 through mid-2009, they were also building up a backlog of cases against nonfinancial companies, and now they are working off the backlog.

And so, while over half of the new securities lawsuits filed in 2009 involved financial companies, by year’s end, the 2009 securities lawsuits overall involved a broad spectrum of kinds of companies. The 2009 securities lawsuits were filed against firms in 90 different SIC Code categories. Many of these categories had lawsuits against only a single company. Outside the financial sector, the SIC code categories with the highest number of lawsuits were SIC Code category 2834 (Pharmaceutical Preparations), which had five lawsuits, and SIC Code category 2836 (Biological Products), which had four lawsuits.

The 2009 securities lawsuits were filed in 38 different federal district courts, but, due to the number of lawsuits against financial companies, the largest number of lawsuits (78, or about 41% of all 2009 lawsuits) were filed in the S.D.N.Y. The courts with the next highest number of 2009 securities lawsuit filings were N.D. Cal (12) and C.D. Cal. (9). There were five different courts -- D.N.J., E.D.N.Y., N.D. Ill., S.D. Fla., and S.D. Tex. – that had six securities lawsuit filings each. The eight courts with the highest number of 2009 filings together had 128 new lawsuits, or 67.7% of all 2009 securities lawsuit filings.

24 (or 12.7%) of the 2009 securities lawsuit filings involved companies that are domiciled outside the United States. These lawsuits involved companies from 12 different countries. The countries with the highest number of companies suit were the U.K. (with 6), Germany (with 5), and Canada (3).

Some Thoughts about Counting Securities Lawsuits: I know that many readers wonder why the various annual securities litigation studies report such materially different lawsuit filing numbers. The reason the studies’ lawsuit counts vary so widely is not just that the various studies’ authors have different information; another significant factor is that the different studies use different protocols to count lawsuits.

For example, some of the studies count duplicate complaint filings in separate circuits as a single lawsuit (that is, the case counts only once), while other studies count duplicate complaints filed in different circuits as separate lawsuits until they are formally consolidated (that is, the case can be counted multiple times). For my purposes, I count duplicate complaints only once regardless of whether there are duplicates filed in different circuits, which is one reason why my 2009 securities lawsuit count appears lower than, for example, NERA’s 2009 securities litigation study.

There is of course absolutely no reason why separate studies should not use their own preferred counting protocol. But I do believe that the studies’ readers would be enormously benefitted if each study would explicitly state what their study "counted" – that is, what does the study include in its tally of securities lawsuits, and what does it omit?

In the best of all worlds, the studies would also explain how their methodology differs from those used by other published reports. These reports do not after all exist in a vacuum, and by and large the audience for each of the various reports basically consists of the same group of readers. It would be helpful, I think, if the reports were to recognize both the fact that their audience reads the other reports and that these readers want to understand any and all identifiable reasons why the various reported numbers differ.

In my own analysis of the 2009 securities lawsuit filings, I have tried to tally up the separate class action lawsuits seeking to recover damages under the federal securities laws. I don’t count lawsuits that were not filed as class actions; that do not seek to recover damages; or that don’t allege violations of the federal securities laws. Thus, for example, I would not count a lawsuit that alleges common law fraud but that does not allege a securities fraud under the federal statutes. I would not count an indiviudal lawsuit that does not purport to proceed as a class action.

Two particular recurring lawsuit categories that I do not count are merger objection lawsuits, where the lawsuit’s goal is simply to increase a proposed acquisition price; and lawsuits against private entities in which the plaintiffs’ allegation is that the defendants failed to register securities.

Even within my overall counting criteria, it can sometimes be very difficult to determine whether or not a new complaint represents a new lawsuit or is merely a duplicate of a previously filed complaint. For example, in December, when plaintiffs’ lawyers filed a complaint on behalf of Bank of America bondholders relating to the Merrill Lynch acquisition and bonus payments, the question arose whether the complaint counted as a separate lawsuit, or was just a duplicate of the suit filed earlier in the year on behalf a purported class of Bank of America equity securityholders?

In the end, I concluded that because the two complaints involved separate classes of claimants, the bondholder suit represented a separate lawsuit that should be counted separately. This is undeniably a very close question, and reasonable minds might well reach a different conclusion.

Because there are many of these kinds of close questions in the course of trying to keep a count of securities lawsuit filings, it is almost inevitable that different lawsuit counts will vary. But though the variance of lawsuit counts may be inevitable, readers at least want to be able to understand the reasons why the lawsuit counts vary. The publishers of the various annual securities litigation studies would significantly benefit their readers if they were to explicitly and expressly state (and not just in footnotes or endnotes, but in a conspicuous way) what their study purports to be counting, and what protocols were used to determine what was and what wasn’t included in the count.

It would be even more helpful to readers if the reports were to recognize that their readers also read the other reports and to state explicitly and expressly how their methodology may differ from the other annual litigation studies.

I know the various annual litigation study publishers view themselves as in competition with each other, and so it may be difficult for them to acknowledge each other’s existence. They may believe that it as not their job to explain competing analyses. However, each publisher’s silence on these issues means the readers are left on their own trying to figure out why the numbers vary so widely.

The fact is that most of us read all of the reports. I feel quite confident in saying that readers would find it extremely helpful to have better information to understand why the studies’ numbers differ. The reports that recognize and their readers’ needs into account would win their readers’ loyalty, gratitude and appreciation.

Speakers’ Corner: On January 4, 2010, I will be presenting with Jason Cronic of the Wiley Rein law firm on a panel entitled "Directors and Officers Liability Insurance" at the Practicing Law Institute's Current Developments in Insurance Law 2010 conference. Background regarding the conference can be found here.

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The credit-crisis securities litigation wave, which began with the filing of the first subprime mortgage-related lawsuits in early February 2007, is about to enter its third year. Though the wave has evolved during the intervening period, it shows no sign of slowing down. The more interesting question going forward will be whether the litigation, which up until now has largely been concentrated in the financial sector, will spread to encompass companies in the wider economy.

The Wave’s History – So Far

The current subprime and credit crisis-related securities litigation wave began on February 8, 2007, with the filing of a securities lawsuit against New Century Financial Corporation and certain of its directors and officers. (Refer here for my most recent post on the New Century case.) Two years later, there have been 152 separate subprime or credit crisis-related lawsuits filed against companies and other entities, as reflected in my running tally of the suit, which can be accessed here.

The initial cases during 2007 were largely filed against subprime loan originators, banks, mortgages companies, home builders and residential real estate investment trusts. However, by year end 2007, a number of lawsuits had also been filed against investment banks, investment advisors, and rating agencies.

During 2007, there were a total of 40 subprime-related securities lawsuits filed.

In 2008, the lawsuits against banks and other mortgage originators continued to mount, but the litigation activity spread beyond just residential mortgage and real estate issues. The litigation also involved student lenders, commercial construction companies, commercial real estate investment trusts, bond insurers, and mortgage guaranty insurers. As I noted at the time (refer here), by early 2008, the litigation activity was no longer just about the subprime meltdown but had by that time become a credit crisis litigation wave.

The litigation wave also picked up considerable momentum during 2008, driven in part by the onslaught of cases involving auction rate securities. A total of 21 separate auction rate securities lawsuits were filed in 2008, against broker dealers, security issuers and mutual funds, among others. There were also a significant number of separate securities lawsuits filed on behalf of preferred shareholders and subordinated debtholders, which represents a relatively unusual securities litigation development, as discussed here.

The crisis in the global financial markets during fall 2008 also significantly affected the litigation wave. As I noted here, as a result of the financial market turmoil, the litigation wave reached an "inflection point" during the third quarter of 2008, where companies began to find themselves exposed to litigation not because of their own direct vulnerability to the credit crisis, but because of the companies’ exposure to other companies that were experiencing credit crisis-related issues.

During 2008, a total of 101 subprime and credit crisis-related securities lawsuits were filed.

As 2009 has begun, the litigation wave has shown no sign of slowing down. Indeed, during January 2009 alone, there were eleven new credit crisis-related securities lawsuits. A spreadsheet of the 2009 cases can be found here.

One important consequence of the litigation wave’s evolution over time is that it has become increasingly difficult to maintain absolute definitional clarity about what should be included in the category. This challenge has become even more difficult now that the financial crisis basically encompasses the entire global economy. It has become progressively tricky to determine whether or not newly filed lawsuits logically ought to be group together with the earlier suits, or whether they represent something entirely different. This categorization challenge has made simply "counting" the subprime and credit crisis-related lawsuits increasingly more difficult over time.

Financial Sector Concentration

Though the litigation has evolved and become more diverse, the litigation activity has largely been concentrated in the financial sector. Of the 152 subprime and credit crisis-related securities lawsuits that have been filed as of February 4, 2009 and that involved companies or other entities that have assigned standard industrial classification codes (SIC Codes), fully 117 of them have involved companies or other entities with SIC Codes in the 6000 series (Finance, Insurance and Real Estate).

Moreover, the 18 entities that have been sued but that have no SIC Code designated are also almost exclusive concentrated in the financial sector. These entities include mutual funds, private equity firms, hedge funds, and foreign firms whose shares do not trade on U.S. exchanges (e.g., Fortis and Société Générale).

Of the financial companies, the SIC Code categories with the largest number of lawsuits were SIC Code 6021 (National Commercial Banks) and SIC Code 6798 (Real Estate Investment Trusts), both of which had 16 lawsuits. Other categories with a significant number of securities lawsuits include SIC Code 6211 (Security Broker Dealers), which had 13 lawsuits; SIC Code 6189 (Asset Backed Securities), which had 12 lawsuits; and SIC Code 6035 (Savings Institutions, Federally Chartered), which had 11 lawsuits.

Has the Wave Entered a New Phase?

But while the litigation activity has largely been concentrated in the financial sector, there has more recently been a "new wave" of credit crisis lawsuits, as discussed at greater length here. These new wave lawsuits involved companies exposed to some of the credit crisis casualties (Lehman Brothers, Fannie Mae, Freddie Mac, Washington Mutual, American International Group, etc); that made wrong-way bets on commodities or currencies; and companies outside the financial sector whose balance sheets are laden with auction rate securities or other troubled assets.

The interesting question these new wave cases present is how far outside the financial sector these kinds of cases will spread as we go forward.

How are the Cases Faring?

Even though the subprime and credit crisis-securities litigation wave is about to enter its third year, most of the cases are still only in their earliest stages. There has really been only one significant settlement, the recent massive $550 million settlement involving Merrill Lynch (about which refer here). The few other settlements have been considerably more modest (refer here).

Only a handful of these cases have even reached the motion to dismiss stage. Among the cases where dismissal motions actually have been addressed, there have been several notable cases in which the dismissal motions were denied – for example, the New Century case (refer here) and the Countrywide case (refer here).

On the other hand, there have also been a handful of cases in which the motions to dismiss have been granted, and at least some courts have seemed skeptical that the target companies financial woes were the result of fraud (about which refer here).

My complete list of subprime and credit crisis-related securities lawsuit settlements, dismissals and dismissal denials can be found here.

Looking Ahead

Even though the litigation wave is about to enter its third year, it is clear that we have still only just begun. With the cases already filed only in their earliest stages and with new lawsuits continuing to pour in, the subprime and credit crisis-related litigation wave is likely to continue to remain an important feature of the litigation landscape for years and years to come.

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When, as has been the case recently, there is a single predominant story, there also is a danger that other important developments may be overlooked. The subprime and credit crisis meltdown and related litigation has been so preoccupying that almost nothing else has broken through the noise.

However, a recent casual observation made me go back and take a closer look at latest securities class action lawsuit filings. I was surprised to observe that, at least by one measure, a majority of recent filings are unrelated to the credit crisis.

What initially caught my eye was the recent flurry of litigation filing activity involving life sciences companies. Just since September 23, 2008, four life sciences companies have been sued in securities class action lawsuits:

1. Spectranetics: On September 23, 2008, plaintiffs’ lawyers initiated a securities class action lawsuit in the District of Colorado against Spectranetics, a medical device manufacturer, and certain of its directors and officers. As reflected more fully here, shareholders filed the suit after the company’s stock price declined following publicity relating to the company’s alleged involvement in customs’ law violations.

2. Medicis Pharmaceuticals: On October 3, 2008, plaintiffs’ lawyers filed a securities class action lawsuit in the District of Arizona against Medicis Pharmaceuticals, a specialty pharmaceutical company, and certain of its directors and officers. As described here, the lawsuit followed the company’s announcement that it would be restating its annual and quarterly financial statements for the period 2003 through 2007, due to the company’s sales return reserve calculation.

3. Biovail: On October 8, 2008, plaintiffs’ lawyers announced that they had filed a securities class action lawsuit against Biovail, a specialty pharmaceutical company, and certain of its directors and officers, following disclosures of issues involving one of the company’s developmental stage drugs. The plaintiffs’ lawyers’ October 8 press release can be found here.

4. Elan Corp.:  On October 14, 2008, plaintiffs' lawyers initiated a securities class action lawsuit in the Southern District of New York against Irish biopharmaceutical company Elan Corp. and certain of its directors and officers alleging that the company failed to disclose unfavorable results in Phase II clinical trials of a compount the company is developing to be used to treat patients suffering from Alzheimer's disease. A copy of the plaintiffs' lawyers' October 14 press release can be found here.

Obviously, none of these lawsuits has anything directly to do with the turmoil in the financial markets that has been dominating the headlines. Nor are these cases the only securities lawsuits filed in recent weeks that are unrelated to the financial meltdown.

A review of the securities lawsuit filings during September 2008 reveals that a majority – 14 out of 24 – of the September filings were not directly related to the credit crisis. Moreover, the case filings spread across a wide variety of kinds of companies, including children’s apparel (Carter’s, about which refer here), gas exploration and development companies (Quest, refer here) and computer graphics, (NVDIA, refer here).

There was a flurry of activity in September involving companies in the wireless industry. The September filings included lawsuits against wireless broadband companies NextWave Wireless (refer here) and Novatel Wireless (refer here), and a wireless network management software company, Harris Stratex (refer here).

But whether or not there is any significance to this flurry of lawsuits involving companies in the wireless industry, or to the flurry of lawsuits noted above involving life sciences companies, the most noteworthy point is that these lawsuits are not related to the credit crisis, and that many of the other recent filings similarly are unrelated to the credit crisis.

There is no doubt that the most significant factor in the overall increase in securities litigation activity in recent months has been the subprime and credit crisis related litigation. But merely because this litigation has been the most important factor does not mean that it is the only factor. There has been a significant amount of securities litigation activity unrelated to the subprime meltdown and the credit crisis. Focusing exclusively on the credit crisis-related litigation could result in overlooking the other important securities lawsuit filing developments.

Although the plaintiffs’ lawyers have been quick to pursue claims from the credit crisis, they have not done so to the exclusion of all other activities. Indeed, the plaintiffs’ bar continues to pursue other kinds of claims, and so merely because a company has not been directly affected by the credit crisis does not by itself mean that the company is free from securities litigation exposure in the current environment.

A Note About Lawsuit Counts: There are two cases that complicate how the September 2008 filings are categorized. As I have previously noted (here and here), the lawsuit filings involving The Reserve Group and Constellation Energy do not directly arise out of the subprime meltdown or credit crisis. However, as explained more fully in my prior posts, these cases arguably represent a "second derivative" of the credit crisis.

At the same time, it should be noted that the Stanford Law School Securities Class Action Clearinghouse, employing a strict definition, did not categorize these two cases as subprime related. I have noted on this blog in the past the difficulties involved with "counting" these lawsuits as the subprime litigation wave has evolved. But, in any event, the statement above that the majority of September securities lawsuit filings were not related to the credit crisis, uses the Stanford website’s categorization, which I suspect also reflects a more common understanding.

A Final Note: The essential thrust of this blog post depends on the assumption that the distinction between cases that are and are not credit crisis-related is readily apparent. However, as the credit crisis becomes more generalized and if there is a significant downturn in the larger economy, there may be an eventual convergence of the two categories, as all companies become subject to the general downturn.

If the entire economy is suffering the effects of the unavailability of credit, the litigation that follows may no longer be susceptible to the categorization I have been trying to maintain. The possibility of this development is one more reason to maintain a broader perspective across all of the ongoing litigation activity.

Déjà vu All Over Again: Biovail, a Canadian corporation, is no stranger to U.S.-style securities class action litigation. As reflected here, the company was the target of a 2003 securities class action lawsuit that ultimately settled for $138 million. The settlement was just finalized on August 8, 2008, exactly three months before the filing of the most recent securities lawsuit against the company. (UPDATE: As a result of the reader comment, I relaize the prior sentence should say that the new lawsuit was exactly TWO months to the day from the finalization of the prior dismissal. I stand corrected!)

Similarly, Elan, a company domiciled in Ireland, has been the target of two previous securities class action lawsuits, refer here and here.

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On July 29, 2008, Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse released their mid-year 2008 report on securities litigation, entitled “Securities Class Action Filings: 2008 Mid-Year Assessment” (here). A July 29, 2008 press release describing the Report can be found here.

Although the Cornerstone Report differs in some details, it is otherwise entirely consistent with my own mid-year 2008 securities lawsuit filing report (which can be found here). Consistent with the observatoins in my prior report, the Cornerstone Report observes that securities filings in the first half of 2008 “continued the rebound that started in the second half of 2007.”

The Cornerstone Report states that there were 110 securities class action filings in the first half of 2008, which projects to an annualized total of 220. A year end total of 220 lawsuits would represent a 27.2 percent increase over 2007 and a 14.6 percent increase over the annual average for the 11 years ending in 2007.

The Report also notes that over half of the 2008 first-half filings (58) were driven by subprime and credit crisis-related allegations. Of these, 17 were related to auction rate securities.

The Report also notes that “market capitalization losses for defendant firms associated with filings in the first half of 2008 were higher than the average semiannual loss in the eleven preceding years,” and rival “the historical highs seen in 2000-02.” These market capitalization losses may well drive the value of future settlements in these recently filed securities lawsuits.

The Report also contains analysis suggesting that the so-called filing lull that prevailed from mid-2005 to mid-2007 “was partly due to a strong stock market with low volatility,” and that the more recently increased filing level was associated with increased volatility.

While the Cornerstone Report reflects analysis regarding the apparent connection between stock market volatility and securities lawsuit filings, the most recent Report omits analysis that appeared in Cornerstone’s mid-year 2007 report suggesting that the reduced filings during the period mid-2005 to mid-2007 was due to a “permanent shift” to a lower securities class action lawsuit filing level. As I noted at the time (refer here), I regarded the low stock market volatility as a much likelier explanation than any permanent behavioral shift as an explanation for the reduced filing levels.  

The Ultimate Solution to Stock Trader Misconduct: According to a July 27, 2008 Reuters report (here) , “A Chinese court upheld the death sentence of a former securities trader charged with embezzling 97.56 million yuan ($14.31 million).”

Hat tip to Kelly Rehyer for the link to the Reuters report.

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The latest issue of InSights, entitled “The Foreign Corrupt Practices Act: A 70’s Revival?” (here), presents an overview of a frequent topic on this blog – the growing significance of FPCA enforcement activity. Not only is the heightened activity a regulatory and operational concern for all companies with overseas operations, but it also presents a growing source of potential liability in the form of follow-on civil litigation.

Many of the themes discussed in the InSights article are underscored in a July 7, 2008 Gibson, Dunn & Crutcher memorandum entitled “2008 Mid-Year FCPA Update” (here). The memo reports that the “frenetic pace” of FCPA enforcement activity “has carried through the first half of 2008.” Year to date prosecutions are up “substantially” from “last year’s record-setting totals.” Indeed, the memo notes that in the first half of 2008, there were more FCPA prosecutions than in any prior full year except 2007.

Among the many topics addressed in the Gibson Dunn memo is a theme I have frequently sounded on this blog and that I reviewed at length in the InSights article, which is the threat of civil litigation following along in the wake of an FCPA enforcement action. The Gibson Dunn memo characterizes the level of this litigation activity as an “outburst,” adding that “our recurring advice to clients and friends has been to expect and prepare for ‘tag along’ civil litigation when a new governmental FCPA investigation becomes public.”

In addition to the specific FCPA-related securities class action lawsuits I note in the InSights article, the Gibson Dunn memo also cites the recent settlement in the FARO Technologies securities litigation. According to the company’s press release (here), the company’s D&O insurers paid $6.875 million to settle securities law claims alleging, among other things, that the company or its representatives had made payments in connection with the company’s Asian sales in possible violation of the FCPA. The company apparently was also named as nominal defendant in a related shareholders’ derivative lawsuit.

As an aside, and in addition to the FCPA-related litigation described in the Gibson Dunn memorandum, a loyal reader advised me of yet another FCPA securities class action lawsuit settlement of which I was previously unaware, involving Titan Corporation. (Background regarding the lawsuit can be found here.) The plaintiffs in that case alleged that Titan Corporation, in order for its planned merger to go forward, had failed to disclose that foreign consultants had made improper payments to foreign officials in violation of the FCPA, and that the company had improperly accounted for funds used in those payments. The case settled in 2005 for $61.5 million.

In addition to the FCPA-related shareholder lawsuits, the Gibson Dunn memo also notes a “new diversity of FCPA-inspired civil litigation theories.” The memo specifically notes the arrival of civil litigation brought by foreign governments alleging that U.S. companies had corrupted the government’s own officials. The memo specifically references the Alcoa action, which I discussed in a prior post, here.

The memo also refer to an action brought in June 2008 by the Republic of Iraq against Chevron and ninety other companies, alleging that the defendants conspired with Saddam Hussein’s regime to corrupt the Oil-for-Food program by diverting as much as $10 billion to Hussein’s government. Iraq claims that the defendants violated RICO, as well as other fraud and money laundering statutes.

These FCPA-related cases and others are proceeding even though there is no private right of action under the FCPA itself. However, the Gibson Dunn memo notes that on June 4, 2008, Rep. Ed. Perlmutter (D. Colo.) introduced the “Foreign Business Bribery Prohibition Act of 2008” (H.R. 6188), which would provide for a limited private right of action under the FCPA. However, potential litigation targets are limited to “foreign concerns,” so the class of potential defendants is restricted to foreign persons unaffiliated with U.S. stock exchanges. While the Bill itself is still before the relevant Congressional committees, it represents yet another part of the increasing focus on corrupt activity as well as the increasing risk of civil litigation arising out of  that process.

The Gibson Dunn memo concludes that the trend of “continually increasing enforcement is here to stay for the near future.” 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 the D&O policy, the policy could be called upon to respond to the costs of defending against an FCPA enforcement action. In any event, any follow-on civil litigation would also trigger the company’s D&O coverage, subject to all of the policy’s terms and conditions.

The growing importance of this litigation activity makes this an increasingly important issue to be considered in connection with the policy placement process. The specific issues involved are discussed at greater length in the InSights article.

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Securities lawsuit filings remained elevated during the first half of 2008. The 105 new securities lawsuit filings during the first six months of 2008 were more than 50% higher than the number of new securities lawsuit filings (69) in the first six months of 2007. (Please refer to the note below regarding my lawsuit filing “count”, which may differ from some other published tallies).

The 204 new securities lawsuit filings during the 12-month period from July 1, 2007 to June 30, 2008 is 15% higher than the 176 filings for the full year 2007 and also represents a 65% increase compared to the 123 filings during the 12-month period from July 1, 2006 through June 30, 2007. The 204 new securities lawsuit filings during the 12-month period ending on June 30, 2008 is the highest 12-month total since the period July 2004 through June 2005, during which 228 lawsuits were filed.

The 105 lawsuits filed during the first half of 2008 projects to a year-end total of 210 securities lawsuit filings, meaning that the filing rate is above the post-PSLRA filing average. According to Cornerstone Research, here, the annual average number of securities class action lawsuits during the period from 1996 to 2006 was 194.

A year end total of 210 filings would also represent the highest annual total since 2004, when 237 securities lawsuits were filed. (Because my YTD lawsuit count omits a number of lawsuits, for reasons discussed below, my YTD tally and my year-end projection may be lower the numbers that may appear in other published sources.)

The most significant factor in the elevated securities filing activity is the number of new lawsuits associated with the subprime and credit crisis. 58 of the first half filings (about 55%) of the first half securities lawsuit filings are subprime or credit crisis related. As reflected on my running tally of the securities class action lawsuits, which may be accessed here, the total number of subprime and credit crisis related lawsuits, including those filed in 2007 as well as those filed in 2008, now stands at 98. (Please refer to the note below regarding the recent revisions to my subprime and credit crisis-related lawsuit tally.)

Only 46 of the 105 first-half securities lawsuit filings were not subprime or credit crisis-related, meaning that the subprime related litigation unquestionably was a driving factor in the elevated securities lawsuit filing levels (although one might also speculate that other filings are down because the plaintiffs’ securities’ bar is preoccupied with the still emerging subprime litigation).

The subprime and credit crisis filings show no sign of abating. Of the 58 subprime lawsuits filed in the first half of 2008, 29 – exactly half-- were filed in the second quarter, including eleven in June alone. This continued steady filing level suggests that the subprime and credit crisis-related litigation wave will continue during the second half of 2008.

An analysis of the first half filings by Standard Industrial Classification (SIC) code confirms the foregoing conclusions. Although the companies sued in the first half of 2008 represented 56 different SIC Code categories, fully 62 of the lawsuits (or about 59% of the first half filings) were filed against companies in the 6000 SIC Code series (Finance, Insurance and Real Estate). The two most prominent SIC Code categories were SIC Code 6021 (National Commercial Banks), which had 17 lawsuits, and SIC Code 6211 (Security Broker Dealers), which had 14 lawsuits. No other single SIC Code category outside the 6000 SIC Code series had more than three lawsuits. (Please refer to the note below regarding SIC Code categorization.)

These statistics underscore an important point about the subprime and credit crisis related litigation. That is, with a couple of arguable exceptions, the subprime and credit crisis related litigation wave really has not spread beyond the financial sector. Although I have long speculated (most recently here) that the credit crisis litigation might hit nonfinancial companies, by and large that has not yet happened, at least not to any significant degree.

One consequence of the predominance of the subprime and credit crisis related litigation is that many of the first half lawsuits involved nontraditional plaintiffs and defendants. The traditional or conventional securities lawsuit to which I refer here involves a securities class action lawsuit brought by public company shareholders against the company and its directors and officers. This traditional type of securities lawsuit may sometimes include other third party defendants such as the company’s auditors or the company’s offering underwriters.

But many of the first half lawsuits involve plaintiffs other than public company shareholders. For example, among the first half filings were 17 auction rate securities lawsuits, in which the plaintiffs were not public company shareholders, but rather auction rate securities investors who were suing the broker dealers or financial institutions that sold them the instruments. (The securities issuers were not usually targeted in these lawsuits.) Refer here for my prior discussion of the auction rate securities lawsuits.

Similarly, the multiple securities lawsuits brought by mortgage-backed securities investors against the financial institutions that created the instruments also do not involve traditional shareholder plaintiffs. In addition, as I discussed here, the plaintiffs lawyers have chosen to bring many of these lawsuits against the securitizers in state court, to be be removed subsequently by the defendants to federal court. So the first half 2008 filing total is also noteworthy for its inclusion of a number of state-court initiated lawsuits.

The credit crisis litigation wave has also hit a number of nontraditional defendants. Rather than targeting just public company defendants, the plaintiffs in many of these lawsuits targeted, for example, hedge funds (refer here) and mutual funds (refer here). The presence of these nontraditional defendants sometimes pose some tough questions at the margins about whether or not a specific lawsuit should be included in the lawsuit count, as discussed further below.

It is probably worth noting that in addition to the lawsuits from the current credit crisis-related litigation wave, the first half filings also included two options backdating-related securities lawsuits filings.

Companies domiciled outside the United States were sued in 19 of the first half new securities lawsuit filings, representing 12 different countries, including four each from Canada and from Switzerland.

The lawsuits filed against domestic companies included corporate defendants from 27 different states, with the largest number from New York (22 lawsuits) and California (11 lawsuits).

The lawsuits were filed in 26 different U.S. district courts, but by far the largest number were filed in the Southern District of New York, where 43 (or about 41%) of the 105 lawsuits were filed. Other courts with a significant number of filings included the District of Massachusetts (11 lawsuits), the Northern District of Illinois (8 lawsuits), the Central District of California (5 lawsuits) and the Northern District of California (5 lawsuits).

A Note about “Counting” Lawsuits: As noted above, the presence of nontraditional plaintiffs and defendants, as well as the emergence of state court and other nontraditional filings, raises many hard questions about what to include in the lawsuit count. These factors by themselves create significant potential for different lawsuit counts.

In addition, the pattern of much of this litigation also poses some “counting” challenges. A couple of examples will illustrate the problem

Lehman Brothers (or at least one of its officers) was first sued in February 2008 in the Northern District of Illinois. That lawsuit was voluntarily dismissed. A second Northern District of Illinois lawsuit involving Lehman Brothers was filed in April 2008. Then a separate lawsuit was filed in the Southern District of New York in June 2008. I have only counted this litigation once, as has, for example, the Stanford Law School Securities Class Action Clearinghouse (as shown here).

By contrast, Falcon Strategies, a Citigroup-affiliated hedge fund, was sued in a securities lawsuit in April 2008, in federal court in Florida. That lawsuit was later voluntarily dismissed. (Refer here). Then the fund was sued in May 2008 in federal court in New York in a tender offer-related securities lawsuit (refer here) I could see counting this litigation once, but the Stanford website has counted each lawsuit separately and so have I.

But while I am in accord with the Stanford website to that extent, I could not agree with the Stanford site on some other specifics. For example, one of the lawsuits on their list is the Safeco litigation (refer here). The Safeco lawsuit is a merger objection suit. I have never counted these kinds of lawsuits in my tallies; were this lawsuit to be included, a whole raft of other merger objection litigation would also arguably have to be included. In my opinion, this lawsuit should not be counted in the securities lawsuit tally, but reasonable minds clearly could differ.

Similarly, the 2008 lawsuit involving Heartland Resources (about which refer here) contains allegations that the defendants improperly failed to register certain limited partnership interests. Alleged violations of the obligation to register securities seem to me to be fundamentally different than a lawsuit for securities law damages based on alleged misrepresentations or omissions relating to publicly traded securities. Reasonable minds could differ on this issue as well, but to my mind this kind of lawsuit should not “count.” This analysis applies not just to the Heartland Resources lawsuit, but also to the lawsuits involving Maximum Financial Group (refer here) and WCI Communities (refer here).

I have illustrated this analysis in detail here first to show how tricky this whole "counting" exercise is, and second to explain why there may be differences between my tallies and some others that may be published, including for example any lawsuit count based on the Stanford website. That does not mean that I think mine is right and the others are wrong – as I have stressed throughout, reasonable minds could differ on many of the specifics. The most important thing is that the various analyses are directionally consistent, which undoubtedly is and will be the case. The marginal differences are relatively unimportant.

A Note about SIC Code Categorization: As discussed above, the first half 2008 lawsuits include some filed against nonconventional defendants, including some, like hedge funds and mutual funds, that have not been assigned to an SIC Code category. In addition, many of the lawsuits included a host of related entity defendants.

Where the list of defendants includes a public company, I have used the public company’s SIC Code, even if it is not the primary defendant. Similarly, where a fund defendant is affiliated with a public company, I have used the public company’s SIC Code.

Nevertheless, there were a total of three of the lawsuits filed in the first half where I was unable to assign any SIC Code. These cases primarily involve mutual fund defendants.

A Note about the Subprime Lawsuit Tally: Regular readers know that I have been maintaining a running tally of the subprime and credit crisis-related securities lawsuits (which may accessed here). Readers that have been monitoring the list closely over time may have been somewhat surprised by the credit crisis lawsuit numbers I have used in this mid-year analysis. These numbers may appear suddenly larger than more recent tallies.

The reason for this adjustment is that as part of this mid-year review, I undertook a comprehensive audit of my lawsuit lists, and, in particular I conducted a cross-comparison with the Stanford website and a number of other sources.

As a result of this process, I added several items to my list of subprime securities lawsuits. Some of these additions were required because I had simply omitted certain items (where, for example, I was aware of the lawsuit but had simply neglected to add it to the list). Some of the additions were the result of recategorization, some simply new additions. All of these additions are highlighted in red in my updated list, which can be accessed here.

Break in the Action: The D&O Diary will slowing down in the next few days and will resume its normal publication schedule during the week of July 7.

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