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

Among 2010 securities class action lawsuit filing trends are two phenomena that emerged in the second-half of the year – the flurry of lawsuits filed against for-profit education companies and the proliferation of suits involving companies domiciled in China. These two filing trends converged in a single case filed last week against a Chinese for-profit education company.

According to their December 2, 2010 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit against China Education Alliance, Inc. and certain of its directors and officers. The complaint, which was filed in the Central District of California, can be found here.

According to the complaint, the company provides educational resources and training through its Internet websites and training facilities in China. The complaint seeks to hold the defendants liable for misrepresenting the company’s financial performance. According to the press release, the complaint alleges that

contrary to the Company’s annual reports filed with the SEC for fiscal 2008, which reported $24.9 million of revenue, an annual report for the Company’s main operating subsidiary filed with the Chinese authorities reported less than a million of revenue for 2008. This discrepancy, along with other accounting inconsistencies, and contradictions about the Company’s online education and training center operating segments, has raised red flags of fraud. When this adverse information was released to the market on November 29, 2010 the price of China Education Alliance stock fell substantially damaging investors.

In my prior post discussing the recent outbreak of securities suits targeting Chinese companies, I noted that a recurring theme in the suits is the allegation that the companies had reported different financial information to Chinese authorities than they reported in their SEC filings. The new complaint against China Education Authority echoes this recurring allegation.

The complaint also cites sources reporting that the company’s Internet sites are not functional and its training centers appear to be inactive, suggesting that the company may not even be an operating business as claimed in its U.S. public filings. (These allegations, which make for rather interesting reading, are detailed in paragraph 37 of the complaint.)

In any event, the plaintiffs’ firm that filed the suit against China Education Alliance apparently has concluded that suing Chinese companies is a growth business. In addition to the new suit against China Education Alliance, the same firm also filed a separate lawsuit in the Southern District of New York last week against Mecox Lane Limited, a Chinese company that just completed its U.S. debut in an IPO on Nasdaq in October 2010.

According to the plaintiffs’ firm’s December 4, 2010 press release (here), the online apparel company’s share price declined significantly on November 29, 2010 when the company disclosed that "contrary to the company’s registration statement filed with the SEC, the company’s gross margins had been adversely impacted by increased costs and expenses, which made it impossible for Mecox to achieve the results defendants projected at the time of the IPO."

The extent to which the plaintiffs’ firm that filed these suits perceived an opportunity in suing Chinese companies is underscored in firm’s press release about the new Mecox Lane lawsuit. Among other things the press release cites about the firm, it also states that the firm "has substantial experience litigating matters involving companies based in the People’s Republic of China."

In any event, of the roughly 162 new securities class action lawsuits filed so far this year, nine of them (or about 5.5%) have involved Chinese companies. Seven of these nine have been filed just since September 17, 2010.

Ten of the 162 YTD 2010 securities suits (or about 6%) have involved for-profit education companies. All of those suits have been filed since mid-August.

The plaintiffs’ firm that filed these suits may well be on to something, as all signs suggest that problems involving Chinese companies may continue to emerge. According to a December 3, 2010 Audit Integrity memo (here, registration required), "many U.S.-listed Chinese companies have little to no intrinsic value."

The Audit Integrity memo adds that "many of these companies have relied on the ‘China’ brand in order to go public," but "the vast majority of these companies are thinly capitalized and are in lines of business that are neither unique nor innovative." Many of the Chinese company stocks "may prove to be valueless" and in many cases the companies "appear to be manipulating their financial results."

Even though the U.S. Supreme Court’s June 2010 decision in the Morrison case may restrict the scope of suits that may be filed against foreign domiciled companies in certain respects, foreign companies may still be sued under U.S. securities laws in connection with securities transactions taking place in the U.S.

Since many Chinese companies have pursued U.S. listings in recent years, these companies are susceptible to securities suits in the U.S., at least as to investors who purchased their shares on U.S. exchanges. The Audit Integrity analysis suggests that many more Chinese companies could well find themselves as U.S. securities suit targets, in addition to the nine companies that have been sued so far this year.

Message From the Fringe: Our San Francisco correspondent filed this report via text message Friday evening: "There’s a wookie in the BART station."

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While there were a number of significant, high-profile securities class action lawsuits filed during the first-half of 2010, overall filing levels for the year’s first six months, annualized for a full year, were well below last year’s filings and historical averages.

In the first half of 2010, there were 76 new securities class action lawsuits. This figure, if annualized, would mean 152 new securities class action lawsuits for the year, which is below the 169 that were filed in 2009, and about 29% below the 1997-2008 average of 197 filing per year.

The lawsuits were filed against companies in 41 different SIC Code categories, although as has been the case for the past several years, the first six months’ filings were again weighted toward the financial sector. 13 of the 72 first half filings were in the 6000 SIC Code category (Finance, Insurance and Real Estate), and another ten filings were against entities that lacked SIC Codes that were all financially related. This total of 23 first half filings against financially related filings represents 32% of the filings in the first six months.

Among these lawsuits filed against financially related targets were six new lawsuits filed against Exchange Traded Funds and six lawsuits filed against commercial banks. The filings against the ETFs is a trend that began in the second half of 2009. The suits filed against the commercial banks reflect in part the wave of bank failures that has been sweeping across the sector.

As in the past, life sciences companies also continue to be targeted. There were 7 lawsuits filed in the first half against companies in the 283 SIC Code group (Drugs) and 5 against companies in the 384 SIC Code group (Surgical, Medical and Dental Instruments and Supplies). These 12 lawsuits represent 16.6% of the first half filings.

In recent years, filings against foreign-domiciled companies have been an important part of total filings. For example, in 2008, lawsuits against companies from outside the U.S. represented 15% of all filings, and in 2009 they were 12.7% of all filings. However, so far in 2010, there have been relatively fewer securities suits filed against foreign companies. Four of the first half lawsuits were filed against foreign companies, representing only about 5.18% of the suits filed.

Even if, as I have speculated might be the case, the Supreme Court’s ruling in the Morrison v. National Australia Bank case might have the effect of discouraging suits against foreign domiciled companies (particularly those whose shares do not trade on U.S. exchanges), it already seems that filings against foreign domiciled companies are now a relatively less significant part of all filings than they have been in recent years.

The first half lawsuits were filed in 31 different federal district courts, although a significant number of the lawsuits were filed in the S.D.N.Y. There were 21 new securities class action lawsuits filed in the Southern District of New York in the first half of 2010, largely as a result of the concentration of cases filed against companies in the financial sector. The district court with the second most number of first half filings was the District of Massachusetts, which had four.

As I noted last year, there has been an increase in what I have described as "belated filings" – that is, new lawsuits where there is a gap between the proposed class period cutoff date of a year or more. By my count there were 14 of these belated cases filed in the first half, and they continued to be filed as the period progressed. It will be interesting to see what impact, if any, the Supreme Court’s statute of limitations ruling the Merck case (about which here) will have on the continued filing of these belated cases.

The subprime litigation wave began in early 2007. Though it is now in its fourth year, the subprime related and credit crisis related cases continue to come in. By my count, there were 13 subprime and credit crisis related lawsuits filed in the first half of 2010, many of them (such as the securities lawsuit filed against Goldman Sachs) related to mortgage securitizations that went bad. For a listing of the subprime and credit crisis related securities suits, including those filed in 2010, refer here.

As I have noted elsewhere, the plaintiffs have seemed particularly interested in pursuing claims in the wake of headline crises that various companies have suffered. Indeed, the Deepwater Horizon oil spill alone has generated securities class action lawsuits against BP, Transocean, and Anadarako. Other headline related securities suits in the first half include those filed against Goldman Sachs, Massey Energy and Toyota.

Though the number of new securities class action lawsuits are relatively down compared to historical levels, that does not necessarily mean that overall claims activity has declined. Indeed, analysis by Advisen (refer here) suggests that securities class action lawsuits represent an increasingly smaller percentage of all claims, a trend that began in 2006 and that increased in the first half of 2010.

In addition to the securities class action lawsuits, claimants are filing individual lawsuits (rather than class actions), a phenomenon that has been particularly evident with respect to many of the subprime and credit crisis-related claims. Claimants are also filing shareholders derivative suits or otherwise proceeding on different theories.

But this diversification notwithstanding, it is evident that securities class action filings were down in the first half of 2010, relative to historical levels, as they have been since about the second quarter of 2009.

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The subprime and credit crisis-related litigation wave may now be in its fourth year, but lawsuits continue to come in. The latest of these suits – a securities class action lawsuit involving Las Vegas Sands – has a number of interesting features, and it also raises the question whether we may see even further new filings related the credit crisis in the months ahead.

On May 24, 2010, plaintiffs’ attorneys filed a securities class action lawsuit in the United States District Court for the District of Nevada against Las Vegas Sands Corp., its Chairman and CEO, Sheldon Adelson, and its former President and COO, William Weidner. The complaint can be found here. A May 24, 2010 Las Vegas Sun article describing the lawsuit can be found here.

The complaint alleges that the defendants’ misled investors concerning developments at the company’s Asian casino properties, as well as with respect to the company’s liquidity and the company’s vulnerability to the economic downturn. Specifically, the plaintiffs allege that defendants’ statements during the class period were false and misleading because, according to plaintiffs' lawyers May 25, 2010 press release about the case:

(i) increasing competition in Macau was steadily eroding the Company's foothold in the region, which undermined defendants' representations that everything was proceeding according to plan; (ii) the Company was facing a significant liquidity crisis as a result of its ongoing expenditure of capital in Macau and Singapore, which forced the Company to divert funds from other operations to develop its Asian properties; (iii) that the Company, could not, in fact, weather the economic downturn, because the credit markets were drying up and Las Vegas Sands had failed to timely access those markets; and (iv) increasing visitor restrictions in Macau, which defendants represented would not impact the Company as significantly as its competitors, were expected by defendants to have just as devastating an effect on Las Vegas Sands.

There are several very interesting things about this new lawsuit. The first is that it follows in the wake of an unsuccessful shareholders’ derivative suit based largely on the same circumstances and similar allegations. The first of these lawsuits was filed in January 2009. A copy of the complaint can be found here. 

According to a November 6, 2009 Las Vegas Sun article (here), Clark County (Neb.) District Judge Allan Earl granted the defendants’ motions to dismiss these cases, citing, among other things, Adelson’s investment of over $1 billion of his personal fortune to try to rescue the company. Judge Earl found that the company’s predicament was the result of "reasonable business decisions," that, while risky, and that may have brought the company to the "brink of financial instability," might in the future "provide the economic stability to ensure the future success of the company."

Judge Earl also noted that the events played out against a "backdrop" that involved "a deteriorating global economy that struck with such frightening speed and force that it engulfed nearly every major banking, investment and gaming company in the world."

The other interesting thing about the new lawsuit, and that might be a direct consequence of the fact that it follows after the unsuccessful derivative suit, is that this case falls in the category of "belated lawsuits." This complaint was filed on May 24, 2010 but the class period is August 1, 2007 to November 6, 2008. In other words, the complaint was filed 18 months after the date of the proposed class period cutoff.

As I recently noted (here), belated lawsuit filings, where the filed date is more than a year after the proposed class period cut-off, have been a key component of 2010 securities class action lawsuits. The phenomenon first emerged in mid-2009, but the earliest cases related to nonfinancial companies. The speculation about the emergence of this filing trend has been that up until mid 2009, plaintiffs’ lawyers were preoccupied filing credit crisis lawsuits against financial firms, and a backlog of cases against nonfinancial firms built up.

The Las Vegas Sands securities lawsuit seems to represent something different – a belated case that is related to the credit crisis. Of course, Las Vegas Sands is not a financial company, and in that respect the new lawsuit is not inconsistent with the whole belated lawsuit filing phenomenon. But the case and its allegations about the company’s real estate developments, liquidity and funding problems are all related to the credit crisis.

For that matter the Las Vegas Sands case is not the first belatedly filed credit crisis-related securities suit in 2010. Cases filed earlier this year against The Hartford Financial Group (refer here) and the Morgan Keegan funds (refer here) each also were first filed more than a year after the proposed class period cutoff date and both reflect subprime meltdown or credit crisis related allegations.

The consensus view has been that the subprime and credit crisis-related litigation wave has largely ended, but the fact is that a number of subprime and credit crisis related securities suits have been filed in 2010—as many as 13, by my count. The possibility of further belated filings, relating back to events that unfolded a significant time ago, raises the prospect that there could be even further subprime and credit crisis-related cases yet to come.

Bottom line: it may be premature to suggest that the subprime and credit crisis-related litigation wave has ended. It may have quite a bit further to run.

I have in any event added the Las Vegas Sands case to my table of subprime and credit crisis-related lawsuit filings, which can be accessed here. I note that the list, which I first began compiling in April 2007, is now 214 cases long. I certainly never foresaw how lengthy or long-lived the list would be when I first began it so long ago.

Special thanks to Adam Savett of the Securities Litigation Watch blog for providing a copy of the Las Vegas Sands securities class action complaint.

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One of the most distinctive attributes of the 2009 securities class action lawsuit filings was the prevalence, particularly in the second half of the year, of new lawsuits in which the filing date came well after the date of the proposed class period cutoff. There has been much discussion over the cause of the belated filings. But whatever the reason may be for these filings, the phenomenon clearly has carried over into 2010, and at least so far seems to be a significant feature of the 2010 securities lawsuit filings.

The two new securities class action lawsuits filed on Friday, February 5, 2010 both represent this distinct class of cases.

First, as reflected in their press release (here), on February 5, plaintiffs’ lawyers filed a securities class action lawsuit in the Southern District of New York against Nokia and certain of its directors and officers, alleging that the defendants had misled the company’s ADR investors about delays and price competition the company was experiencing with respect to its communications handsets. Though the complaint (which can be found here) was not filed until February 5, 2010, the proposed class period cutoff date is September 5, 2008, well nearly a year and a half before the filing date.

Second, as reflected in their press release (here), on February 5, a different set of plaintiffs’ attorneys filed a securities class action lawsuit in the Southern District of New York against the Bermuda-based workers’ compensation insurer CRM Holdings, Ltd., and certain of its directors and officers, relating the company’s pricing and reserving practices. Though the complaint (which can be found here) was not filed until February 5, 2010, the proposed class period cutoff date is November 5, 2008, over a year before the filing date.

These latest lawsuit follow along behind two other seemingly belated lawsuits already filed this year. The proposed class period cutoff date in the securities class action lawsuit filed on January 15, 2010 against medical device company Stryker Corporation is November 13, 2008, over a year before the filing date.

The most extreme example among the belated 2010 filings is the securities class action lawsuit filed on January 21, 2010 against Motorola. The January 22, 2008 class period cutoff date is a full 1 year and 365 days before the filing date, bringing the new lawsuit just inside the two year statute of limitations for actions under the ’34 Act.

In addition to their apparent belatedness, these filings also have a number of other attributes. Most particularly, none of these cases seem related to the subprime meltdown and global credit crisis. Even though CRM holdings is in the financial services industry, the allegations in that case do not appear to related to the economic crisis.

To that extent at least, then, the belated securities lawsuit filings seem consistent with the theory, which some plaintiffs lawyers have advanced (as discussed here), that the reason for these lag filings is that throughout most of the last three years, the plaintiffs’ firms were preoccupied with filing subprime and credit crisis cases. Now that that filing wave has died down the plaintiffs firm, by their account, are turning back to cases that they backburnered.

The other theory about these belated cases, advanced most notably by Professor Joseph Grundfest (refer here), is that the plaintiffs’ lawyers are running out of meritorious cases so they are scraping the bottom of the barrel (my words, not his) to file cases that, based on his analysis of past lawsuit filings, are statistically more likely to be dismissed.

I don’t know for sure why these cases have been filed belatedly. All I can say is that it is a very distinct and observable pattern that clearly has carried over into the New Year. Among other things, these filing patterns create challenges for D&O underwriters, who will face a great deal of uncertainty about when a company that has experienced past issues may be "out of the woods." To borrow an auto racing analogy, it as if a yellow flag has been raised for all the cars on the track – proceed with caution.

One final note about these belated filings so far in 2010 is that at least the Nokia and the CRM holdings cases involve foreign domiciled companies – they are based in Finland and Bermuda respectively. The susceptibility of non-U.S. companies to securities litigation in U.S. courts is a hot topic right now, with the National Australia Bank pending before the U.S. Supreme Court and with the Vivendi jury verdict having just been returned. These latest lawsuits suggest that the incidence of U.S. securities lawsuits against non-U.S. companies will remain a hot button issue for the foreseeable future.

Fifth Circuit Stays Ruling that Stanford Group’s D&O Insurers Must Pay Defense Fees: As I noted in an earlier post (here), on January 26, 2010, Southern District of Texas David Hittner had ordered Stanford Financial Group’s D&O liability insurers to pay the defense expenses that former Stanford officers (including Allen Stanford) are incurring in connection with various legal matters arising out of the Stanford scandal.

However, according to a February 4, 2010 Houston Chronicle article (here), the Fifth Circuit Court of Appeals has entered a stay of Judge Hittner’s ruling. The article also reported that the Fifth Circuit has schedule oral argument on the legal issues in the case for February 25, 2010.

So the story goes on, with out any greater clarity on the question whether or not the individuals are entitled to have their defense fees paid by the company’s D&O insurance carriers. High-profile financial scandals make for some high stakes (and therefore fiercely litigated) coverage issues.

Hat tip to the Securities Docket (here) for the link to the Chronicle article

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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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In a detailed October 27, 2009 opinion (here), Western District of Washington Judge Marsha J. Pechman substantially denied the defendants’ motions to dismiss the plaintiffs’ amended complaint in the Washington Mutual subprime securities class action lawsuit. Judge Pechman’s ruling is noteworthy in and of itself, but perhaps even more because Judge Pechman had previously granted the defendants motions’ to dismiss all of the plaintiffs’ ’34 Act claims and all but one of defendants’ ’33 Act claims.

As discussed here, in granting the prior motions to dismiss, Judge Pechman had been sharply critical of the clarity and organization of the plaintiffs’ initial consolidated amended complaint, which she characterized as "verbose and disorganized." and as embodying "puzzle pleading."

By contrast, in her October 27 ruling, Judge Pechman stated that the second amended complaint (hereafter, the "complaint") presents "cogent and concise allegations against Defendants." She also stated that the Plaintiffs have "largely succeeded in remedying the deficiencies of their initial complaint."

As described in the October 27 opinion, the complaint alleges that the defendants "(1) deliberately and secretly decreased the efficacy of WaMu’s risk management policies; (2) corrupted WaMu’s appraisal process; (3) abandoned appropriate underwriting standards; and (4) misrepresented both WaMus’ financial results and internal controls."

The complaint’s ’34 Act claims assert claims for securities fraud against the seven officer defendants, although the complaint also alleges Section 20 control person liability against the outside director defendants as well as the officer defendants.

With respect to the plaintiffs’ ’33 Act claims, the complaint alleges different specific allegedly misleading statement as to each of the individual officer defendants. The defendants moved to dismiss these allegations on the grounds that the complaint does not sufficiently allege that the statements are false and misleading and failed to allege "particularized facts giving rise to a strong inference of scienter."

In reviewing the adequacy of the plaintiffs’ allegations, Judge Pechman reviewed each of the alleged misstatements with respect to each of the individual officer defendants, grouping the allegedly false statements in four categories "(1) risk management; (2) appraisals; (3) underwriting; and (4) internal controls."

Other than with respect to two statement of WaMu’s former CEO, Kerry Killinger, which Judge Pechman found to "lack sufficient clarity to state a claim," Judge Pechman found that the plaintiffs’ ’34 Act claims were sufficiently pleaded, and therefore (other than with respect to two of the CEO’s statements), the motion to dismiss the ’34 Act claims was denied. Judge Pechman also denied the motion to dismiss the Section 20 control person liability claims against the individual officer defendants and the outside director defendants.

In denying the motion to dismiss, Judge Pechman referred repeatedly to the allegations drawn from internal memoranda and on testimony from confidential witnesses. With respect to the plaintiffs’ scienter allegations, Judge Pechman found with respect to each of the statements (other than the two statements of the CEO that were dismissed) that the "defendants have not raised a competing inference of innocence that outweighs the strong inference of scienter."

In her prior ruling in the case, Judge Pechman had granted the defendants’ motions to dismiss the ’33 Act claims, finding that the plaintiffs at that time did not have standing to assert ’33 Act claims in connection with WaMu’s August 2006, September 2006 and December 2007 securities offerings. The most recent amended complaint purports to add several additional plaintiffs, in an effort to establish standing to assert ’33 Act claims as to the August 2006, September 2006 and December 2007 offerings.

Judge Pechman found none of the new plaintiffs had standing to assert claims as to the August 2006 offering of 5.50% Notes. Judge Pechman also found that the plaintiffs’ lacked standing to assert Section 12(a)(2) claims as to both 2006 offerings. She otherwise found that the plaintiffs had standing to assert ’33 Act claims as to the other offerings. She also found that the complaint’s allegations met the ’33 Act’s substantive pleading requirements.

In short, virtually all of the plaintiffs’ most recent amended complaint survived the renewed dismissal motions. This is a fairly dramatic turnaround from the outcome of the initial motions, in which the initial dismissal motions were substantially granted, other than with respect to the ’33 Act claims in connection with the August 2007 offering. The turnaround is all the more noteworthy given how critical Judge Pechman was of the plaintiffs’ initial complaint. It is a very long way from Judge Pechman’s assessment that the prior complaint was "verbose and disjointed" to her assessment that the most recent complaint is "cogent and concise."

But the difference in outcomes is not attributable solely to the improved organization of the amended complaint. It is also clear that the added allegations, particularly those drawing on confidential witness testimony, were instrumental in bringing about the different outcome.

This turn of events could be significant in connection with the many other pending subprime and credit crisis related securities class action lawsuits, particularly those in which initial motions to dismiss have been granted with leave to amend. If nothing else, Judge Pechman’s October 27 opinion shows that plaintiffs can successfully amend their complaints in order to remedy initial pleading deficiencies. This possibility underscores the fact that initial dismissals without prejudice are indeed provisional, and no one should assume that a case in which initial motions have been granted is done – the plaintiffs in those cases, like the plaintiffs in the WaMu case, may yet succeed in overcoming the initial pleading hurdles.

A couple of aspects of the way in which the WaMu plaintiffs overcame the initial pleading hurdles are instructive for other plaintiffs in subprime and credit crisis-related securities lawsuits. Clearly, Judge Pechman preferred the more organized presentation of the amended complaint to the "puzzle pleading" presented in the prior complaint. Clarity and brevity are indeed virtues, in pleading cases as in all other endeavors, which is a consideration other plaintiffs might well want to heed.

Another clear implication from Judge Pechman’s October 27 order is the value of allegations based on the testimony of well-placed confidential witnesses. This lesson was also apparent from the recent ruling on the renewed motion to dismiss in the Dynex Capital case (about which refer here). While not every plaintiff will be similarly able to present allegations based on the testimony of well-place confidential witnesses, that clearly is one way to overcome the steep pleading hurdles that plaintiffs face at the outset of these cases. And, as I noted in connection with the Dynex Capital ruling, even the rigorous requirements for pleading scienter under the Tellabs case can be overcome with the right kind and quantum of confidential witness testimony.

But perhaps the greatest significance of the ruling on the renewed motions to dismiss is that the motions were denied in a high profile case like the WaMu suit. As I have noted elsewhere on this blog, the defendants generally have seemed to be doing better on the motions to dismiss in the subprime and credit crisis cases. However, the WaMu ruling adds a significant counterweight to the plaintiffs’ side of the ledger, along with the dismissal denials in the Countrywide (refer here) and New Century Financial subprime suit (refer here). The WaMu ruling may be even more significant, given that the dismissal motion had previously been substantially granted.

One final note about the October 27 order in the WaMu case is that the motion was denied as to all defendants, including the offering underwriters and WaMu’s auditors, Deloitte. The fact that the gatekeepers have been kept in the case is significant if for no other reason that its suggestion that gatekeepers generally will continue to be a part of the subprime and credit crisis-related litigation, which could have important implications for how these cases are resolved, as well as what the aggregate costs of these cases might eventually be.

In any event, I have added the October 27 ruling in the WaMu case to my running tally of the dismissal motion rulings in the subprime cases, which can be accessed here.

Special thanks to a loyal reader for providing me with a copy of the October 27 opinion. I get my best material from readers and I am always grateful when readers take the time to send things along to me.

Andrew Longstreth’s October 28, 2009 article on AmLaw Daily about the WaMu decision can be found here.

Another Belated Securities Suit Filing: In several prior posts (most recently here), I have noted the recurring phenomenon during 2009 of new securities class action lawsuit filings in which the proposed class period cutoff is well in the past, in some cases nearly two years before the filing.

The securities class action lawsuit filed on October 28, 2009 against Pitney Bowes and certain of its offices pushes this belated filing phenomenon to its furthest edge of its theoretical possibilities. As reflected in the plaintiffs’ counsel’s October 28 press release (here) , the proposed class period in the case runs from July 30, 2007 to October 29, 2007. In other words, the plaintiffs filed their complaint on what appears to be the last day before the two-year statute of limitations would have expired. A copy of the complaint in the case can be found here.

The Pitney Bowes case is merely the latest (and arguably most extreme) example of this phenomenon. I have long speculated that this rash of seemingly belatedly filed lawsuits may be attributable to a backlog of case filings that built up over prior periods in which plaintiffs lawyers were concentrating on filing subprime and credit crisis related lawsuits as well as lawsuits related to the Madoff scandal. Now that the new filings in those other areas are dying down, the plaintiffs’ lawyers may be getting around to working off the backlog.

The Pitney Bowes case, as is the case with many of these other seemingly belated cases that have been filed during the latter half of 2009, was filed against a company outside the financial sector. This feature of the phenomenon seems to suggest that as the plaintiffs’ counsel work off what seems to be a backlog of cases, the mix of companies sued will shift back toward the more usual spread of kinds of companies, and away from the concentration in the financial sector that characterized filings during the period from mid-2007 through the first part of 2009.

The one thing about these belated filings is that it does create a challenge in trying to determine when a company is "out of the woods" with respect to any adverse developments the company might have had.

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On March 11, 2009, Cornerstone Research released its report of 2008 securities lawsuit settlements entitled "Securities Class Action Settlements: 2008 Review and Analysis" (here). Cornerstone previously released its review of 2008 securities class action filings, which can be found here. Among other things, the newly released Cornerstone Report concludes that "the value of cases settled in 2008 was lower than the historically unprecedented high totals reported from 2005 through 2007." Cornerstone's March 11, 2007 press release regarding the report can be found here.

Although the Cornerstone Report is more or less consistent with prior analyses of the 2008 settlements (for example, the previously released study by NERA Economic Consulting, which can be found here), it also differs in some specific details. The differences are in part explainable due to the methodology used to assign settlements to a particular year. In the Cornerstone Report, the designated settlement year corresponds to the year in which the hearing to approve the settlement was held, rather than the year in which the settlement was first announced.

The Report finds that the median value of 2008 settlements was $8 million, which is lower than 2007’s all-time high median of $9 million but is higher than the median of $7.4 million for all cases settled during the period 1996 through 2007. Median settlements as a percentage of estimated damages were generally higher for cases settled in 2008 compared to settlements during the period 2002-2008. Just over half of the 2008 settlements were for less than $10 million, although the number of "very small settlements" is declining, while the number of settlements in the $20-$25 million range is increasing.

The average settlement in 2008 "fell dramatically" from $62.7 million in 2007 to $31.2 million, which is partly due to the fact that there were no settlements approved in 2008 that exceeded $1 billion (by contrast to 2007, during which the massive Tyco settlement was announced). If the top four all-time settlements are excluded from the analysis, 2008’s average settlement of $31.2 million is "in line with" the average settlement during the period 1996 through 2007 of $34.6 million. (All settlement amounts are adjusted for inflation and are expressed in 2008 dollars.)

The Report found that the average time from filing to settlement has increased steadily. Whereas historically cases settled approximately three years after filing, during 2007 and 2008, the average time from filing to settlement increased to three and a half years.

The Report also identified a number of factors that appeared significant with respect to settlement values:

1. GAAP Violations: The Report found that GAAP violations, which were alleged in 70% of 2008 settled cases, "continued to be resolved with a larger settlement amount and a higher percentage of estimated damages relative to cases not involving accounting allegations."

2. Restatements: Allegations involving restatements were involved in 35% of 2008 settlements. However, cases with restatements "are no longer associated with a statistically significant increase in settlement amounts," consistent with PCAOB research concluding that restatement announcements "are viewed by the market as less significant events." However, cases in which an accountant was named as defendants continued to settle for the "highest percentage of estimated damages among cases with accounting allegations."

3. ’33 Act Claims: Controlling for the presence of underwriter defendants, the presence of Section 11 or Section 12(a)(2) claims is "not associated with a statistically significant increase in settlement amounts." The Report does note that suits with ’33 Act allegations reached "historically high levels" in 2007 and 2008, and that as these cases settle over the next few years, the importance of ’33 Act claims in determining settlement amounts "may increase."

4. Institutional Investor Plaintiffs: When institutional investors are lead plaintiffs, settlements are "significantly higher." However these higher settlements are "associated with public pension plans, as opposed to union funds or other types of institutional investors."

5. Accompanying Derivative Claims: The number of settlements of securities class actions that were accompanied by derivative actions decreased in 2008 compared to prior years. But with respect to the securities suits that were accompanied by derivative actions, the settlement amounts were "significantly higher." In general, cases with accompanying derivative actions tend to be larger (in terms of estimated damages) and also typically involve accounting allegations and public pension plaintiffs, and include accompanying SEC actions. Controlling for these other factors, the Report concludes that cases involving derivative actions "are associated with statistically significant higher settlement amounts."

6. SEC Actions: Cases with associated SEC actions are involve "significantly higher settlements" as well as higher settlements as a percentage of estimated damages.

7. Non-Cash Components: 9% of 2008 settlements involved non-cash components. Settlements involving non-cash components are statistically higher in value, even controlling for estimated damages and the nature of the allegations.

The Report concludes with several remarks about the recent wave of subprime and credit crisis related securities litigation. First the report notes that the three settlements of these cases so far include the $475 million Merrill Lynch class action settlement. The Report notes that the Merrill case reached settlement in 18 months, which is relatively quick compared to other cases. Otherwise, however, the Report notes that, with only three of these cases settled so far, "it is still too early to anticipated what impact, if any" settlements of the credit crisis cases will have on overall settlement trends.

(My running table of subprime and credit crisis related securities lawsuit settlements and dismissals can be accessed here. My commentary on the Merrill Lynch settlement can be found here.)

The Report concludes with an observation regarding the damages represented in the 2008 securities lawsuit filings. That is, the "disclosure dollar losses" (a defined term in the Report representing one measure of investor losses) associated with the 2008 filings "reached historic highs in 2008." Because disclosure dollar loss is a "significant predictor of settlement size," the size of settlements "may increase in the future."

The Report reflects a number of different findings of significant interest to D&O insurers. In particular, the Reports finding regarding the increase in settlements in the $20 to $25 million could have significant implications for excess insurers that are active in this space. Moreover, the Report’s detailed analysis of factors affecting settlement values could be important considerations in setting case reserves.

However, D&O insurers will also want to take a couple of additional considerations into account in assessing the implications of this report. First, the Cornerstone report reflects only settlement amounts. D&O insurers’ losses in connection with any given claim also include defense expense, which is not reflected in the Cornerstone study. Indeed, D&O insurers can incur significant amounts of defense expense even if a case is dismissed and there is no settlement.

In addition, the Cornerstone study reflects only class action settlements. It does not take into account any amounts that defendants or their insurers were obligated to pay as part of settlements to plaintiffs that opted out of the settlement class. As I have noted previously, opt outs are an increasingly important factor in the resolution of securities lawsuits. As a result, class action settlement data along may insufficiently express the overall dollar exposure of securities class action defendants and their insurers.

The Cornerstone contains extensive additional analysis and warrants reading at length and in full. Once again, the Report’s authors, Laura Symons and Ellen Ryan, have done an outstanding job analyzing the latest settlements and explaining their findings.

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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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Has the "due diligence" standard articulated in the WorldCom securities litigation produced an increase in the Section 11 litigation? That is the question addressed in David J. Michaels’s November 29, 2008 paper entitled "An Empirical Study of Securities Litigation After World Com" (here).

In this post, I review the analysis based upon which Michaels contends that, due to the WorldCom due diligence decision, Section 11 filings have increased as a percentage of all securities lawsuits, followed by my own discussion of the data on which Michaels relies.

The Author’s Analysis

Outside directors historically have had little Section 11 liability exposure, owing to their ability to rely on Section 11’s due diligence defense. Michaels notes that courts generally have found outside directors’ due diligence obligations to be minimal. However, Michaels contends, the Southern District of New York’s Section 11 due diligence decision in In re WorldCom Securities Litigation, 2005 WL 638268 (S.D.N.Y. 2005) (refer here) "significantly changed the landscape for outside directors" by holding them to a "stringent standard of liability."

A more detailed review of the impact of the WorldCom litigation on the due diligence defense can be found here.

Michaels hypothesized that because the WorldCom decision represents a change in the due diligence standard, making it easier for plaintiffs to pursue Section 11 claims (particularly against outside directors), securities cases under Section 11 would increase. In order to test this hypothesis, Michaels examined the ratio of securities filings asserting Section 11 claims to Section 10b-5 filings during the period 2002 through 2007, using data from the Stanford Law School Class Action Clearinghouse website. Because the court issued the WorldCom opinion in March 2005, the period selected included both years preceding and following the decision.

Michaels reported the following ratios of Section 11 filings to Section 10b-5 filings for the years 2002 through 2007:

2002 13%

2003 11%

2004 6%

2005 10%

2006 13%

2007 23%

Michaels concludes that these data suggest an "abnormal rise in Section 11 filings." Michaels concedes that "it is difficult [to] prove a causal relationship between WorldCom and the rise in Section 11 filings," he nevertheless asserts that it "is reasonable to attribute causation of the rise in Section 11 filings to WorldCom." In support of this conclusion, Michaels states:

Consider the following series of events. Prior to WorldCom, Section 11 filings were relatively constant; WorldCom comes along and greatly alters 35 years of precedent by making it easier for plaintiffs to survive a motion for summary judgment; Section 11 filings increase.

Michaels ends his paper by arguing that the upward trend in Section 11 cases will continue, but also that WorldCom’s holding applying a stringent standard to outside directors’ "due diligence" defenses is contrary to the ’33 Act’s purposes. He proposes a safe harbor for outside directors that "would exclude from liability outside directors who follow certain procedures designed to inform them of all material information surrounding a given offering."

Discussion

Michaels may be correct that the WorldCom decision will result in an increase in Section 11 filings. Reasonable minds may differ on whether the data support his conclusion that there already has been a demonstrable increase in Section 11 filings. Those same reasonable minds might hesitate before jumping to any conclusions about the causes of any increase that arguably may have taken place. A more conservative view is that it is at best premature to reach any conclusions in that regard.

First, the data on which Michaels relies represents only a brief time period. Since the WorldCom opinion was issued in 2005, that data from calendar year 2005 represent only a partial year. Michaels’s analysis places an enormous weight on data from just two years, 2006 and 2007. Michaels does not explain why he believes a data set that small is sufficient to support his conclusions.

Second, Michaels does not consider whether or not there were external factors that may have affected securities filings during the period after the WorldCom decision. In fact, it has been well documented (refer, for example, here) that there was a filing "lull" during the period from mid-2005 through mid-2007, in which there were an historically low number of securities filings overall. Michaels does not even mention this fact, nor does he consider whether the filing levels during that period may suggest that other factors may have been at work during this period.

Third, although Michaels is convinced that there was an "abnormal rise" in the Section 11 filings after WorldCom, the only thing I can conclude from looking at the data is that something was going on during 2007, as the 2005 and 2006 data are consistent with the prior years’ data. Michaels is essentially arguing the filing activity in a single year supports his hypothesis. Again, Michaels does not consider whether or not there may have been some anomalous factor behind the 2007 data.

My own prior review of the 2007 filing data (refer here) concluded that a significant number of the overall 2007 filings involved companies that conducted IPOs during the 12 months prior to getting sued. Many of these IPO cases involved foreign domiciled companies. Perhaps it may be concluded that the 2007 uptick in Section 11 litigation was due to a wave of IPOs involving foreign companies that were not ready to go public. At a minimum, there are certainly other plausible explanations for the 2007 uptick in Section 11 litigation other than the WorldCom decision alone.

Not only does Michaels fail to consider other possible explanations for the anomalies in the data, but the basis on which he nevertheless argues that WorldCom decision alone explains the supposed increase is also suspect.

In effect, he urges us to conclude that because the supposed increase in Section 11 filings came after the WorldCom decision, the decision must have been the cause of the supposed increase. This analysis arguably represents an example of the logical fallacy post hoc ergo propter hoc (after this, therefore because of this). Essentially, Michaels is trying to substitute chronological sequence for causation. However, the mere order of events does not rule out other factors that might explain the data, as the preceding paragraph shows.

From my perspective, given the anomalousness of the 2007 data, it is premature to reach any conclusions without the opportunity to consider subsequent years’ data, to see, for example, whether the 2007 uptick represented a trend or (as I strongly suspect) is merely a statistical outlier. I can say from my own informal review of the 2008 year to date filing data, a much smaller percentage of 2008 cases involve IPOs (14 out of 195 year to date in 2008, compared to 29 out of 172 in 2007), which suggests that the number of Section 11 filings will prove to have been down substantially in 2008 compared to 2007.

The decline in 2008 IPO-related lawsuits is hardly surprising given the downturn in the number of IPOs in recent months. Given the low level of IPO activity during 2008, and indeed the low level of securities offerings of any kind, it seems probable that Section 11 litigation could well taper off in the months ahead. All of which suggests to me the inadvisability of trying to make a few months of filing data support sweeping conclusions.

It may well be, as Michaels argues, that WorldCom’s articulation of the Section 11 due diligence standard arguably is inconsistent with the ’33 Act’s goals, particularly to the extent it may result in the imposition of greater Section 11 liability on outside directors. I simply disagree with Michaels’s conclusion that WorldCom decision has demonstrably caused an increase in Section 11 filings. Michaels’s hypothesis may or may not eventually prove to be correct, but it will be a significantly longer period of time than he has allowed before we can reach any conclusions.

Special thanks to Werner Kranenburg of the With Vigour and Zeal blog for the link to Michaels’s article.

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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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In flush times, the balm from the boom economy covers a multitude of sins. But when the economy sours, even transactions that once appeared favorable can turn bad. When they do, lawsuits can, and usually do, arise. Two recently filed securities class action lawsuits illustrate this point and also suggest that adverse economic circumstances may fuel even further litigation.

The first of these two recent lawsuits involves FCStone Group. FCStone is “an integrated commodity risk management company providing risk management consulting and transaction execution services to commercial commodity intermediaries, end users and producers.” Basically, it helps those involved in commodities business to manage their exposure to commodities price fluctuations.

Plaintiffs filed a purported securities class action lawsuit against FC Stone and certain of its directors and offices in the Western District of Missouri on July 15, 2008. The plaintiffs’ counsel’s July 16, 2008 press release describing the lawsuit can be found here and the complaint can be found here.

According to the complaint, the lawsuit relates to “a misdescription of an important hedge instrument purchased by the Company.” According to the complaint, the hedge transaction provided net income to the company for the first two fiscal quarters of 2008, ending on February 29, 2008. The press release describing the lawsuit states:

In an conference call on April 10, 2008, the Company concealed the true nature of the Hedge, by failing to reveal that should there develop a significant spread between the U.S. based Fed Funds interest rate (the “Feds Funds Rate”) and the London Inter-Bank Rate (“LIBOR”), the Hedge would decline in notional value. Based on what the market was told, the investing public viewed the hedge as simply one to protect the Company from falling interest rates, and not one which was crucially dependent upon the spread between the Fed Funds Rate and LIBOR not widening.

The complaint alleges that in the company’s 2008 third fiscal quarter, a spread arose between the Fed Funds Rate and LIBOR and the company’s gains for the first two fiscal quarters were eliminated. The press release describing the lawsuit states:

On July 10, 2008, FCStone shocked the market by announcing third quarter earnings per share of 28 cents versus the expected 47 cents. Much of the deviation was due to the decline and sale of the Hedge. In addition, the Company announced previously unmentioned and significant bad debt expenses due to volatility in the cotton markets which had occurred in March. Nothing was said about this volatility and its adverse effects on the April 10, 2008 conference call. Upon revelation of this adverse news FCStone shares dropped over 41% wiping out over $300 million in shareholder value.

The second of the two lawsuits was filed in the Southern District of New York on July 17, 2008 based on the failure of Hexion Specialty Chemicals to follow through on its planned acquisition of Huntsman Corporation.

The Huntsman lawsuit arises out of the agreement announced on July 12, 2007 (here), that Hexion would acquire the company in a transaction valued at $10.6 billion. According to the original press release, Hexion is a portfolio company of Apollo Management. . The sale was approved by Huntsman’s shareholders on October 16, 2007 (here). On January 26, 2008, Hexion exercised its rights to extend the termination date of the merger agreement (here), to obtain regulatory approvals, and further extended the date in April 2008 (here). In its May 14, 2008 earnings release (here), Hexion provided a “transaction update” in which it noted that the parties had agreed, pursuant to the Merger Agreement, to allow additional time in order to obtain necessary regulatory approvals.

However, on June 18, 2008, Hexion issued a press release stating that the “transaction is no longer viable” and announcing that it had initiated a lawsuit in Delaware Chancery Court to declare its rights under the merger agreement. Huntsman later announced that it had counterclaimed to enforce the merger agreement in the Delaware lawsuit (here) and separately announced (here) that it had filed its own lawsuit against Apollo and two of its partners for fraud in inducing Huntsman to terminate its prior merger agreement with a separate merger partner, by presenting the Hexion merger proposal.  

On July 17, 2008, plaintiffs’ lawyers, purporting to represent a class of Huntsman shareholders, filed a lawsuit in the United States District Court for the Southern District of New York against Hexion, its CEO and one of its directors. A copy of the plaintiff’s counsel’s July 17, 2008 press release announcing the filing can be found here and a copy of the complaint can be found here.

According to the press release,

On May 14, 2008, Hexion disclosed that it agreed to allow additional time to obtain the regulatory approvals. Unbeknownst to the public, defendants had determined to abort the merger and took steps to abrogate the Merger Agreement. Defendants retained the services of Duff & Phelps to render an opinion that the combined entity lacked financial viability. On June 18, 2008, Duff sent a letter to the Board of Directors of Hexion opining that the combined company’s assets would not exceed its liabilities, that it would not have the ability to pay its total debts and liabilities as they become due and that it would have an unreasonably small amount of capital. On that same date, defendants filed a complaint in the Delaware Court of Chancery, seeking abrogation of the Merger Agreement. The reaction in the marketplace was devastating to the price of Huntsman’s common stock. On June 19, 2008, the first day of trading after the June 18, 2008 actions by Hexion, the market price of Huntsman common stock fell approximately $8, or 40%, from $20.86 to close at $12.84, on enormous volume of approximately 43 million shares.

The complaint purports to be filed on behalf of the class of persons who purchased Huntsman shares between May 14 and June 18, 2008.

According to the complaint, Hexion started to try to back away from the agreement because the defendants “were disturbed by Huntsman’s financial results for the three quarters after the signing of the Merger Agreement as well as the state of the economic market and the global credit crunch.”

Interestingly, though the plaintiffs’ class consists of Huntsman shareholders, their lawsuit is filed against Hexion and two of its senior officials. The complaint does not allege secondary liability, but rather it alleges that the defendants violated their primary obligations under Section 10(b). Specifically, the plaintiffs allege that

Defendants failed to disclose the material facts that they had decided to abort the merger if possible and had taken affirmative steps to determine whether they could abort the merger and abrogate the Merger Agreement and retained the services of Duff to render an opinion that the combined entity lacked financial viability and Wachtell to draft and filed a complaint. These material misstatements and omissions had the cause and effect of creating in the market an unrealistically positive assessment that the merger would close by July 4, 2008 … causing the Huntsman’s common stock to be overvalued and artificially inflated during the Class Period.

The attempt by Huntsman shareholders to hold Hexion and its officials liable under the federal securities laws raises some unusual issues and will be interesting to watch. The unusual occurrence of a securities lawsuit brought by another company’s shareholders also potentially raises an interesting theoretical issue depending on the definition of “Securities Claim” in Hexion’s D&O insurance policy. There are two usual variants of this definition, one of which defines the term by reference to the kind of claims (that is, claims under specifies securities law), and one that defines the term by reference to the kind of claimant (that is, by reference to claims by holders of securities of the company).

I have no direct knowledge of Hexion’s insurance program, but because so-called entity coverage under D&O policies is typically limited to “Securities Claims,” the definition of that term in the Hexion policy could determine whether or not the company itself has coverage for the claims brought against them by the Huntsman shareholders. The availability of coverage for the claims against the entity could well depend on which variant of the definition of the term “Securities Claim” appears in the Hexion policy. To the extent the term is restrict to claims brought by holders of Hexion’s own securities, coverage potentially might not be available for the company itself for the Huntsman shareholders’ lawsuit.

Perhaps the circumstances involved in these two cases might have arisen even in more stable economic times, but the troubled transactions underlying the lawsuits seem symptomatic of the currently turbulent economy. Indeed, the Huntsman shareholders lawsuit specifically alleges that among the reasons why Hexion sought to back away from the merger were “the state of the economic market and the global credit crunch.”  In both of these instances, transactions that initially appeared favorable appeared unfavorable as circumstances changed.

The challenging circumstances that undermined these transactions are hardly unique to these two companies.  In all likelihood, in the weeks and months ahead, other companies will be finding that transactions entered in more clement circumstances now appear troubled. As more companies stumble on these troubled transactions, further lawsuits undoubtedly will emerge.

One final note. These is nothing about these lawsuits that make them subprime related, and it is only in the broadest sense that they lawsuits might be categorized as credit crisis related. If nothing else, these lawsuits at the outer edge of the current litigation wave demonstrate the complicated definitional problems involved with trying to track subprime and credit crisis related lawsuits. In the end, I have decided not to “count” these lawsuits in my running tally of subprime and credit crisis related litigation (which can be accessed here), because they seem to relate to much larger economic issues (such as interest rates and the adverse business climate). Reasonable minds may differ on this categorization.

Tellabs Not a Filing “Deterrent”: When the U.S. Supreme Court issued its June 2007 opinion in the Tellabs case, it was widely hailed as a significant defense victory. My own view at the time (refer here) is that the outcome was at most a draw, and in the end is unlikely to have a significant impact.

A July 2008 memorandum from the Jones Day law firm entitled “Tellabs Proves to Be No Deterrent to Securities Class Action Filings” (here) suggests that commentators predicting that Tellabs would have “little impact on future securities class action filings” were “the better prognosticators.”

The memorandum notes that in federal circuits (such as the First, Fourth, Sixth and Ninth) that actually had more demanding pleading standards than the one articulated by the Supreme Court in Tellabs, “cases are actually more likely to survive a motion to dismiss after Tellabs than before.” The memorandum goes on to note that “even in formerly less demanding circuits, Tellabs did not set the pleading bar at a level that deters filings.”

The memorandum concludes by stating that “Tellabs plainly has not operated to deter securities class action filings. To the contrary, the data confirms [sic] that filing opportunities remain wide open for plaintiffs.”

Special thanks to a loyal reader for supplying a copy of the Jones Day memorandum.

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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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