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

Even as the number of bank failures now appears to be winding down, the FDIC’s failed bank litigation filings seem to just be ramping up. With now 21 lawsuits filed as part of the current wave of bank failures, it may be possible to try to make some generalizations about the lawsuits so far. In a February 1, 2012 post on BankDirector.com entitled “Characteristics of FDIC Lawsuits against Directors & Officers of Failed Financial Institutions” (here), Cornerstone Research takes a look at the FDIC’s failed bank lawsuits to date and finds, among other things,  that the suits so far have involved larger institutions within the same geographic concentrations as the bank failures themselves.  As discussed below, Cornerstone Research’s various findings may have important implications for the lawsuit filings that are yet to come.

The Cornerstone Research study reports that the FDIC has filed lawsuits so far in connection with only about 4.7% of financial institutions failures since January 1, 2007. Two suits were filed in 2010, 16 in 2011, and three so far in 2012. The study also reports that on average the FDIC has waited about 2.2 years after the date of an institution’s failure to file a lawsuit.

The lawsuits so far have “tended to target larger failed institutions,” with the 20 institutions so far involved in the 21 lawsuits to date having had median total assets of $882 million, compared with median total assets of $241 million for all failed financial institutions. The 20 institutions have had a median estimated cost to the FDIC of $179 million, compared with the medial estimated costs of $60 million for all failed banks.

The geographic mix of lawsuits has paralleled the location of failed institutions, with the largest concentrations of both bank failures and lawsuits in Georgia, Illinois and California. The one exception, the report notes, is Florida, which has been the location of 14 percent of all failures since 2007, but where no FDIC failed bank lawsuits have been filed yet.

The 21 lawsuits so far have involved 178 former directors and officers. In six of the cases, only inside directors and officers have been named as defendants, but in the remaining 15 cases, outside directors were also named as defendants. Three of the suits have also named D&O insurers as defendants (about which refer, for example, here); and at least one suit has included the failed bank’s outside law firm as a defendant (refer here). Three cases have involved the spouses of former directors and officers (refer, for example, here).

The aggregate damages sought in the 21 complaints are $1.98 billion. The average and median damages sought is $104 million and $40 million, respectively. Losses on commercial real estate loans and on acquisition, development and construction loans are the most common bases of alleged damages. As the report notes about the sources of alleged damages, “despite the widespread problems in residential lending and residential real estate markets, fewer lawsuits focused on those types of lending.”

The report notes that three of the FDIC’s cases have settled so far: the WaMu case (about which refer here); the First National Bank of Nevada case (about which refer here); and the Corn Belt Bank & Trust Company case (the settlement details of which have not yet been publicly disclosed).

Discussion

Obviously there is a long way to go in the current bank failure litigation wave. The 4.7% percent of bank failures that have involved litigation so far compares to the rate during the S&L crisis, when the FDIC filed lawsuits against directors and officers of the failed institutions in about 24% of all bank failures. Indeed, though the FDIC has filed only 21 lawsuits so far, involving 20 institutions and 178 former directors and officers and aggregate claimed damages of $1.98 billion, , the FDIC’s website states that as of January 18, 2012, the FDIC has authorized lawsuits in connection with 44 failed institutions against 391 institutions, claiming damages of at least $7.7 billion.

Perhaps even more significantly, the FDIC has increased these authorization numbers each month for the past several months – and the number of failed institutions has also continued to increase, as well. In other words, just the suits authorized so far implies quite a number of lawsuits yet to come, and likelihood of increased numbers of future authorization suggests an even greater number of suits ahead. The FDIC may or may not wind up filings suits in connection with 24% of the failed institutions this time around as it did during the S&L crisis, but we still could be in for a substantial amount of future litigation.

The substantial gap between the $7.7 billion of claimed damages in the cases the FDIC has authorized to date, and the aggregate of $1.98 billion of claimed damages in the cases the FDIC has filed so far, suggests that the suits that have been authorized but not yet filed involve larger failed  institutions.

The Cornerstone Research report’s analysis supports this suggestion that there may be a backlog of as yet unfiled cases involving larger institutions, and not just because the report’s findings in general suggest that the FDIC has at least so far largely concentrated its litigation activities on larger institutions. As the report notes, though the FDIC has targeted two of the largest failed institutions (WaMu and IndyMac), “many of the other large or costly failures …have not yet been the target of FDIC lawsuits.” In light of the fact that many of the most costly failures occurred in 2008 and 2009 and given statute of limitations restrictions, “these would seem to be the most likely candidates for FDIC lawsuits in the near future. “

Taking this analysis and looking back at the costliest 2009 bank failures to assess the possible targets, some possible litigation examples might include Colonial Bank (August 2009 failure, $25 billion asset bank, $2.8 billion to the insurance fund); Guaranty Bank (August 2009 failure, $13 billion asset bank, $3 billion loss to the insurance fund); and Bank United (May 2009 failure, $12.8 billion asset bank, $4.9 billion loss to the insurance fund). Of course, whether or not there may be litigation involving these institutions remains to be seen, as would the merits of any litigation that might arise.

The report’s note that there has as yet been no litigation involving a failed bank located in Florida is an interesting insight. Given that over 60 institutions have failed in Florida since 2007, it seems likely that there future lawsuit filings might involve failed Florida banks.

One concluding note in the Cornerstone Research report that is worth emphasizing is that a number of potential lawsuits have been resolved without litigation through mediation or negotiation, often involving the failed bank’s D&O carriers. There are no publicly available statistics on these out of court resolutions and their overall impact is hard to assess. Though the impact is not quantifiable, these types of resolutions may be an important part of the FDIC’s post-failure salvage operations.

In any event, it does seem probable that the current wave of bank failure litigation not only has a long way to run but will also continue to grow in the near term. We can only hope that Cornerstone Research will continue to update and publish their analysis as the process unfolds.

Many thanks to a loyal reader for sending me a link to the Cornerstone Research report.

Carlyle Group Drops Bid to Require Investors to Arbitrate Claims: In a prior post (here), I commented on the unusual effort of the Carlyle Group in connection with its upcoming IPO to require investors to arbitrate rather than to litigate claims. As Victor Li discusses in a February 3, 2012 Am Law Litigation Daily article (here), Carlyle Group has announced that in response to pressure from the SEC and others, the company has dropped its efforts in required arbitration. As Li notes, Carlyle Group’s efforts had been sharply criticized by several U.S. senators and numerous others, and also ran contrary to long-standing SEC prohibitions against approval of arbitration provisions.

Notwithstanding Carlyle Group’s withdrawal of its arbitration proposal, the issue may yet come to a head in the weeks ahead, in light of the efforts of investors at Gannett and Pfizer to have included in their companies’ 2012 proxy ballots shareholder proposals to required investor claims to be litigated. The question of the propriety of a corporate provision requiring the arbitration of shareholder claims may yet be aired at the SEC.

The Week Ahead: This week I will be attending the PLUS D&O Symposium at the Marriott Marquis Hotel in New York City. On Wednesday, February 8, 2012, I will be moderating a panel entitled “Financial Institutions Underwriting: Is it Safe to Come Out Yet?” Joining me on the panel are my good friends Jennifer Fahey of AON; Tim Braun of AXIS; Steven Goldman of ACE: and Dan Gamble of Alterra.

I know many of the readers of this blog will also be attending the Symposium. I hope readers will feel free to greet me, particularly those whom I have not previously met.

I know that many attending this larger conference, particularly first time attendees, can find the crowded sessions and events a little intimidating. Some may even find that despite – or ironically because of – the crowds, it is hard to meet people. I can’t provide any sure fire way to overcome these challenges and to succeed in making many new professional contacts. But one loyal reader did send me a link to an article that may be useful to at least some conference attendees trying to work their way into the mix.

The January 25, 2012 article is from the Harvard Business Review blog, and it is entitled “The Introvert’s Guide to Networking,” which can be found here. There are a number of useful items in this short article, but the best piece is the author’s observation that she “stopped being afraid to be the one to reach out.” This observation is particularly useful in connection with the PLUS D&O Symposium.

My observations after many years in this industry are, first, that there are many people around who have trouble dealing the large crowds at industry events, so you are not alone, and, second, most people are as interested in meeting you as you are in meeting them, and so the best approach is just to go up to someone you don’t know and introduce yourself. Also, don’t be afraid to ask others to introduce you to people you would like to meet. The great thing is that we have a very friendly, sociable industry and most people are happy to be introduced.

I look forward to seeing everyone in New York.

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The changing mix of corporate and securities litigation is a recent phenomenon on which I have frequently commented on this blog. While identifying the fact of the change is relatively straightforward, explaining it is more challenging. According to a January 11, 2012 article in The Review of Securities & Commodities Regulation entitled “Shareholder Litigation After the Fall of an Iron Curtain” (here), written by Boris Feldman of the Wilson Sonsini law firm, the changing pattern in corporate and securities litigation filings is a result of changes in the plaintiffs’ securities litigation bar – particularly, the elimination of a dominant plaintiffs’ firm. These changes, according to Feldman, have resulted in the five recent securities litigation trends he identifies in his article.

For many years, according to the article, the Milberg Weiss law firm was the “dominant securities plaintiffs’ law firm.” Even after it split into two separate law firms on the East and West Coasts, it was, according to Feldman, “the 800-pound gorilla of the shareholder litigation jungle.” In addition to dominating the litigation, the firm “exercised some discipline” on the rest of the plaintiffs’ securities bar, demonstrating “substantial influence over smaller firms and parvenus.”

Now, “for reasons of retirement and incarceration,” the familiar patterns of the past have been disrupted. Feldman analogizes this disruption in the standard order of the securities litigation world to the disruptions that followed in the political world in the wake of the fall of the Iron Curtain.

Without a dominant firm, smaller firms are now “free agents,” and new entrants have appeared. These smaller and newer players are “less predictable (and often less rational).” According to Feldman, these changes in the plaintiffs’ bar explain five trends in shareholder litigation he identifies in his article.

First, Feldman notes the recent rise in multi-jurisdiction litigation, where a single company can face multiple suits in different jurisdictions arising out of the identical factual circumstances. Feldman notes that although this might have happened from time to time in the past, when it did, the plaintiffs firms worked things out among themselves. But this is far less common now. Instead, firms that have “decided they have a better shot at participating in the litigation” have consciously chosen to file outside the company’s home jurisdiction, particularly in connection with shareholder derivative litigation. This multiplication of litigation has forced corporate defendants to have to defend themselves in multiple courts, resulting in added expense and uncertainty.

The second trend Feldman notes is the proliferation of demand letters. In the past, plaintiffs would bypass this statutory prerequisite to the filing of derivative litigation, out of a concern that the demand represented a concession that demand was not futile. More recently, however, demand letters have become “fashionable,” as secondary players, eager “to get in on the action,” will submit a demand even if derivative litigation has already been filed. Feldman notes that this may “actually be advantageous to defendants,” as courts will often stay derivative litigation while the defendant company considers the demand.

Third, Feldman notes the rise of derivative litigation paralleling shareholder class action lawsuits. In the past, the type of stock drop that would trigger a 10b-5 class action would not also spawn a derivative suit, at least in the absence of a major accounting problem and restatement. Now, parallel derivative suits are “de rigeuer.” The plaintiffs bar now “just cannot resist cribbing the class complaints,” even though the company’s setback does not suggest any breach by the company’s board. This change is attributable to a simple explanation: “different suits for different folks.”

The fourth trend Feldman notes is the automatic filing of litigation when a merger is announced. When “giants roamed the earth,” there was merger objection litigation, but not every single time a merger was announced. Now the litigation is pervasive and it follows a standard pattern of an initial suit alleging a breach of fiduciary duty after the deal is announced, followed by an amended complaint alleging disclosure violations after the proxy has been filed. The other change Feldman notes about this litigation is that in the past, the litigation went away once the deal closed, as the defendants defeated the preliminary injunction seeking to block the deal. Now the merger suits are increasingly surviving the closing, based on amended allegations that “range from weak to laughable.” Though few of these suits result in a payout, the plaintiffs’ lawyers “persist,” seeking “a place in the sun.’

Finally, Feldman notes the rise in actions under Section 220 of the Delaware Code seeking to inspect the corporate defendant’s books and records. Feldman says there has been more of this litigation in the past year than in all prior recorded history. In part this rise is due to encouragement from members of the Delaware judiciary. But this rise is also attributable to a cottage industry of plaintiffs’ firms eager to “get in on the action.” Defendant companies find these suits impossible to avoid; whatever they produce, the plaintiffs ask for more until they have “created an impasse and gotten a ticket to sue.” Feldman suggests that this “epidemic” of Section 220 litigation is “unlikely to be solved without intervention by the Delaware legislature.”

Feldman closes by suggesting that in the current, rapidly changing world, the “more fragmented world of plaintiffs’ securities lawyers will continue to amaze and surprise us with their innovation and resilience.”

Very special thanks to Boris Feldman for sending me a link to his article.

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Securities class action filings rise slightly in 2011 compared to the prior year but remained below historical averages according to the annual study of Cornerstone Research, prepared in conjunction with the Stanford Law School Securities Class Action Clearinghouse, which was released today. A copy of the report can be found here, and Cornerstone Research’s January 19, 2012 press release can be found here. My own analysis of the 2011 securities class action lawsuit filings can be found here.

According to the report, there were 188 securities class action lawsuit filings in 2011, compared to 176 in 2010, and compared to the 1997 to 2010 average annual average number of filings of 194. The two largest factors in the number of 2011 filings were the heightened number of M&A-related filings (43) and the elevated number of filings involving U.S.-listed Chinese companies. (33).

The Cornerstone Research report contains a number of insights about the 2011 filings beyond those that have appeared in previously published analysis of the filings. Among other things, the report notes that three percent of companies listed on the three major U.S. exchanges (NYSE, NASDAQ and Amex) were sued in securities suits in 2011. This represents the highest annual percentage since 2004 and is above the 1997 to 2010 annual average percentage of 2.4 percent.

On the other hand, in 2011 only 3.2 percent of S&P 500 companies were sued, “making it the least litigious year for S&P 500 companies since 2000.” Historically, larger companies have been more likely to be sued in a securities class action lawsuit, and that trend continued in 2001. Thus, while only 3.2 percent of the S&P 500 companies were sued in 2011, those companies represented 5.1% of the S&P 500 market capitalization.

This year’s Cornerstone Research report also contains a number of new analyses, including an analysis of the number of private securities class action lawsuits filed between 1996 and 2011 involving Foreign Corrupt Practices Act allegations. The report shows that there were four such filings in 2011, the highest annual number of filings since 2006 (when there were also four filings).

The report also contains a new analysis of the experience of the judges handling securities class action lawsuits during the period 1996 to 2011. The analysis shows that while there are a relatively small number of judges that handled more than ten cases during that period (65), a much larger number of judges (329) handled only one case, and the vast majority of judges (582) handled only three or fewer cases. The inference is that many securities cases are being handled by judges who are relatively inexperienced with securities cases – although there is also a smaller number of judges that are very experienced with these types of cases.

The report also reflects some interesting insight about the plaintiffs’ law firms’ involvement in these cases. The report sets out which law firms are selected most often as lead counsel in securities class action cases that do not involve M&A related allegations and then separately lists the firms most often selected as lead counsel in the M&A cases. The interesting thins is that the lineup of law firms leading the M&A cases looks very different than the lineup for the other cases. These differences shed some light on the changing mix of corporate and securities lawsuits and the growth in the number of M&A cases, suggesting that among other things the rising M&A related litigation activity may reflect dynamics within the securities’ plaintiffs’ bar.

Speaking of M&A related cases, Cornerstone Research has also recently released a separate companion report specifically focused on M&A related litigation, which can be found here.

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There seems to be a general consensus that the amount of M&A-related litigation is increasing. The question of how to quantify the increase has attracted quite a bit of attention lately. In a recent post, I previewed a forthcoming report from Cornerstone Research that will provide detailed statistic analysis of the M&A litigation phenomenon.

My post attracted considerable commentary, and also drew a communication from NERA Economic Consulting, which has released its own statistical analysis of M&A-related litigation, and which they shared with me.

In addition, this week I separately received from Ohio State University Law Professor Steven Davidoff a copy of the January 1, 2012 paper that he and Notre Dame Finance Professor Matthew Cain have written entitled “A Great Game: The Dynamics of State Competition and Litigation” (here), in which they analyze M&A related Litigation from 2005-2010., with particular attention to the question of whether or not there is now competition between the states for this type of corporate litigation. Davidoff should be familiar to many readers as The Deal Professor from the New York Times Dealbook blog.

These two reports add substantial additional quantitative and analytic support for the general observations surrounding the growth in M&A-related litigation. Both of these reports corroborate the explosive growth in M&A-related litigation in recent years. I examine both of these reports below, starting first with Professors Davidoff and Cain’s analysis.

Professors Davidoff and Cain’s Paper

The Professors’ primary interests relate to the question of whether or not the states are competing for corporate litigation. Their interest in this question is driven in part by recent analyses suggesting that Delaware may be losing “market share” for this type of litigation. In order to determine how “both attorneys and courts interact in this game,” the authors examine state court merger litigation. The authors analyzed 955 merger transactions that took place between 2005 and 2010 and having a transaction value great than $100 million.

The authors found that 49.7 percent of transactions during that period attracted at least one shareholder lawsuit, and that the litigation rate increased “sharply” during the period, with only 38.7 percent of the transactions incurring litigation in 2005, compared to 84.2 percent in 2010. In addition, merger transactions increasingly are attracting multiple lawsuits. In 2005, only 8.6 percent of the deals attracted litigation in more than one jurisdiction, compared to 46.5 percent in 2010.

The authors found that during the sample period, 69.8 percent of cases settled, while 30.2 percent were dismissed. Only 4.9 percent of the settlements involved in increased in the amount of the transaction consideration, while 52.1 percent of the settlements involved only the disclosure of additional information. The average plaintiffs’ attorneys’ fee for settled suits is $1.4 million. Cases that settled for additional disclosure only pay the lowest level of attorneys’ fees (average attorneys' fees of $793,000) while settlements involving an increase in the deal consideration  pay the most (average attorneys fees $8.5 million)

The authors used this information to calculate an expected dismissal and attorneys’ fee baseline, as a way to measure “unexplained” dismissal rates and attorneys fees. The authors used these unexplained amounts as an “indicator for state competition.” The authors found significant variation across states, with certain states awarding higher fees than others. Delaware awarded fees $400,000 to $500,000 higher while dismissing a greater portion of cases than other states.

The authors found some statistical support for the claims that Delaware is losing the state court litigation competition, but they also found that “the game” is complex and that the dynamic varies depending on which states are compared. The authors also found evidence that Delaware’s courts are responsive to this competition, concluding that Delaware’s courts award” higher attorneys’ fees to compensate for a higher dismissal rate,” and adjust “dismissal rates down when it loses prior cases to other jurisdictions.” The authors cite the recent $300 million award in the Southern Peru Copper case as an indication that Delaware is” competing more overtly in this game.”

The NERA Economic Consulting Presentation

In a December 6, 2011 presentation done in conjunction with the Wilson Sonsini law firm and entitled “Merger Objection Litigation” (here), NERA provided a detailed statistical review of M&A-related litigation. The NERA study is based on the firm’s examination of the 731 merger transactions it identified as having been announced between 2006 and 2010 and that were completed by February 28, 2011, and that had a value equal to or greater than $100 million. NERA found that 285 of those transactions were challenged in a state or federal lawsuit, through June 20, 2011. NERA also found that litigation settlements had been reached in connection with 162 of the deals.

The NERA study found that while there were fewer deals overall in the last three years of the 2006-2010 study period, the incidence of M&A related litigation escalated significantly in those three later years. Thus, while only 26.1% of the 2006 deals and only 21.9% of the 2007 deals attracted litigation, 45.4% of the 2008 deals, 78.6% of the 2009 deals, and 60.7% of the 2010 deals attracted litigation. Though the 2010 figure represent a slight decline from the prior year, the 2010 level of litigation still represents a significant increase compared to the earlier years in the study period.

The NERA study also found that throughout the 2006-2010 period, the litigation rate increased as the size of the deal increased. Thus, only about 25% of the deals under $500 million attracted litigation, but 38.7% of the deals between $500-$999 million, 40.8% of the deals between $1 billion and $1.9 billion, 53.0% of the deals between $2 billion and $4.9 billion and 70.1% of the deals equal to or greater than $5 billion attracted litigation.

Merger objection litigation can be expected to arise fairly quickly after the deal is announced. The NERA study shows that a third of the litigation arrives in the first two days after the deal is announced and about 60% arrived in the first week. 81% of the merger litigation arrives within the first thirty days after the deal is announced. Although the takeover target is consistently named as a defendant in this litigation, 70% of the time the named defendants also include the acquirer.

The vast majority of the litigation is filed in state court only. 83% of the deals that were litigated attracted only state court litigation. Another 14% attracted both state and federal litigation. Only three percent of the deals attracted only federal court litigation.

The NERA study suggests that many of the deals that attract litigation are attracting litigation outside Delaware. Of the deals that were litigated, 20% were litigated only in Delaware and another 13% were litigated in both Delaware and another state. So about one third of the deals that attracted litigation were litigated at least in part in Delaware. The remaining two thirds of the deals were litigated only outside Delaware. However, the presentation does not show how many of the deals that were litigated only outside Delaware involved target companies that were incorporated in Delaware. The presentation also does not show whether or not the prevalence of litigation outside Delaware changed during the 2006-2010 study period.

With respect to the M&A-related lawsuits in the study period that had settled, the NERA report found that the vast majority of the settlements involved cash payments of less than $1 million. 106 of the 154 settlements in the settlement analysis (nearly 69%) settled for less than $1 million. Another 33 out of the 154 in the settlement analysis settled for less than $10 million. Only 15 of the 154 settlements in the analysis settled for amounts of $10 million or greater, including only 4 with settlements between $100 million and only one with a settlement greater than $1 billion. (The NERA presentation includes a detailed list of the largest settlements at slide 19.)

Thus, while the settlement period included a few very large settlements, the vast majority of the settlements were for less than $10 million, and more than two-thirds were below $1 million.

In fully 87% of the litigated deals that had settled, the only beneficiary from the monetary settlement was the plaintiffs’ attorneys. In only 9% of the settlements did the beneficiaries include both the plaintiffs’ attorneys and class members. Thus the vast majority of monetary settlements pay only for the plaintiffs’ attorneys’ fees and expense, and the “benefits” to the class, although occasionally monetary, more often take another form, such as reduced target company termination fee; fuller disclosure; or improved corporate governance.

Discussion

The information in these two studies provides valuable additional perspective on the increasingly important M&A-related litigation phenomenon. The two studies corroborate that in creasing numbers of M&A transactions are attracting litigation. The NERA data also provides some interesting additional information that has not been a part of other statistical perspectives on this litigation phenomenon, including in particular the data showing how quickly the lawsuits arrive and the information showing the range of settlement outcomes.

The Professors’ report provides additional information about the increasing prevalence of multi-jurisdiction litigation, as well as average attorneys’ fees and dismissal rates. Perhaps most significantly, the Professors’ study provides important insight into the question of state competition for corporate litigation.

The data in these studies are directionally consistent with the previously released studies, including the information I previewed in a recent post about the forthcoming Cornerstone Research report. They are also directionally consistent with each other, while differing somewhat in their details. The two reports also differ somewhat from the Cornerstone Research data I previously reviewed.  (The Cornerstone Research analysis suggests a higher litigation rate both in 2007 and in 2010 than the analysis in either of the two studies discussed above, although all three of the analyses agree that that the litigation rate increased between 2007 and 2010.)

The difference between the analyses may be attributable to the differing data sources used in the studies. There may have been methodological differences as well. For those of use who are studying and trying to understand the growing M&A-related litigation phenomenon, it will be important to understand these differences. We can certainly hope as the various research sources release their analyses that they will help the rest of us understand not only where their data came from and how it was analyzed, but how the approach they used may differ from other analyses that have been published.

In any event, no matter how you slice it, the level of M&A related litigation is growing. The defense expenses and settlement amounts associated with this litigation represent a growing problem as well. All signs are that this phenomenon will remain a significant part of the corporate and securities litigation landscape for the foreseeable future. For that reason it will remain important to understand what this litigation means. The willingness of NERA and of the Professors to share their analysis is extraordinarily helpful in that regard. Along those lines, I would like to express my deep thanks here to NERA and to Professor Davidoff for their willingness to share their presentations with me.

Seven Nation Army: Even though I was not even really focusing on it, I had noticed recently that marching bands and sporting fans everywhere have picked up the same tune, as a rallying cry, as a communal chant, as basic crowd background noise. But if you had asked me to focus on it, I still might not have been able to name the tune. A January 13, 2011 article on Deadspin identified the tune, and also explained how it managed to take over the sportworld.

The song is “Seven Nation Army,” a 2003 tune from the alternative rock band, The White Stripes. Just in case you don’t think you know the tune, I have included a video below of the band performing the song. (I guarantee you if you listen to it, you will say – “Oh yeah, that song. I always wondered what that was.”) I was on the alert for it this past weekend, and I noticed that both the San Francisco crowd at the 49ers/Saints game and the west London crowd at the English Premier League game between Chelsea and Sunderland were chanting the tune during their respective games on Saturday. All very odd for an alternative rock song. But I guess it isn’t any weirder than that fact that a lot of marching banks have also picked up “Carmina Burana” from classical composer Carl Orff.

In any event, for today’s musical interlude, here’s The White Stripes performing “Seven Nation Army.” Now you will know what the heck all of those fans are trying to chant. (My apologies to all of those rock music aficionados – most half my age -- who think I am an idiot for not knowing the song before; please consider my age, location and occupation, and I think you will see how unlikely it is that I would be fully versed in the contemporary alternative rock scene.)

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As a result of developments during 2011, there is a “growing sense of urgency amongst FCPA practitioners as to the direction the statute will take in the coming years,” according to a law firm’s year-end FCPA report. The January 3, 2011 memo from the Gibson Dunn law firm, entitled “2011 Year-End Update,” can be found here. Whatever else might be said, according to the report, “these are interesting times for the FCPA.”

According to the report, FCPA enforcement activity remains near all time highs. In terms of FCPA enforcement actions initiated by the Department of Justice and the SEC, 2011 “was the second most prolific ear in the history of FCPA enforcement.” The 23 DoJ actions and the 25 SEC actions are “outmatched only by the juggernaut that was 2010.” However, the report notes, the 2010 statistics were “elevated substantially” by the 22-defendant SHOT  show arrests.

The report notes a number of interesting FCPA enforcement trends during 2011, including the increasing practice of U.S. regulators to pursue enforcement actions against individual defendants after negotiated settlements with the individuals’ employer. As an example, the report cites the recent enforcement actions brought against seven former Siemens executive and two former Siemens third-party agents. Among other things the report notes, the nine targeted individuals are all foreign nationals. In other words, the parent company, the alleged wrongful activity and the targeted individuals all took place or are domiciled outside the United States, which illustrates the U.S. regulators’’ willingness to “polic conduct beyond [U.S.] borders that it perceives as affecting U.S. markets.

The report also referenced the SEC’s willingness to bring unsettled FCPA enforcement actions as evidence of the agency’s “more aggressive enforcement stance.” In the past the agency “has not been known to file many FCPA cases absent an advance agreement to settle the matter.” But during 2011, the SEC brought 10 unsettled FCPA enforcement actions, more than in the previous 33 years of FCPA enforcement combined.”

FCPA enforcement actions during 2011 also reinforced the “imperative that acquisitive companies conduct thorough pre-acquisition due diligence and equally robust post-acquisition compliance integration.”

The report also notes the DoJ’s recent initiative to pursue foreign government officials who received the bribes paid by FCPA defendants. The FCPA itself does not criminalize the receipt of bribes by foreign officials, but the Department of Justice has tried to use two tools to reach the recipients: money laundering statutes and civil forfeiture actions. These aggressive efforts are still in their early stages.

The report notes that though the FCPA itself does not provide for a private right of action, “enterprising plaintiffs have circumvented the FCPA’s lack of a private redress mechanism by filing derivative lawsuits, securities fraud actions, tort and contract law claims, employment lawsuits, and private actions under the Racketeer Influenced and Corrupt Organizations (RICO) Act.” Among other cases the report cites is the FCPA-related derivative lawsuit involving Avon Products (refer here, footnote 5 to the financial statements), and the FCPA-related derivative lawsuits involving Bio-Rad Laboratories (refer here) and Tidewater, Inc. (refer here). Avon is also the subject of an FCPA-related securities class action lawsuit as well (refer here).

The report also canvasses the various pending legislative and policy developments that could lead to changes to the FCPA itself or its enforcement during 2012. The report also catalogues global anti-corruption enforcement developments. Overall, the report is interesting and well-written, and well worth reading in its entirety.

Readers of this blog will be most interesting in the report’s commentary about FCPA-related civil litigation. The follow-on litigation provides what I have called in the past the link to the D&O insurance policy. There would not be coverage under the typical D&O policy for the fines and penalties imposed in connection with an FCPA enforcement action, although defense fees incurred in connection with the action potentially could be covered under many policies, depending on the policy wording. But the filing of a civil lawsuit against members of the board of directors, as a follow on to the FCPA action, is an event much more directly linked to the D&O policy and much more likely to give rise to covered loss under the policy.

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

Those readers who want a more comprehensive overview of both the historical and current state of FCPA enforcement will want to refer to the Shearman and Sterling law firm’s mammoth 692-page January 3, 2011 “FCPA Digest” (here). The Shearman and Sterling report has a more detailed statistical overview and an exhaustively detailed case summarization. The Shearman & Sterling report also sets out in specific case detail a catalog of follow-on civil actions arising out of FCPA enforcement activities (refer to pages 538 through 620 of the report). The value of the Shearman & Sterling approach is that it is not limited just to actions filed or pending in 2011, but is historically all-encompassing – although some readers may find the report’s sheer size intimidating.

The Morrison  Foerster law firm has a January 5, 2012 client alert (here) detailed the fines and penalties assessed under the FCPA in 2011. A January 6, 2011 Corporate Counsel article reviewing the Gibson Dunn and Shearman & Sterling memos can be found here.

Readers interested in the phenomenon of FCPA follow-on civil litigation will want to read the very interesting post on the FCPA Professor Blog (here) about the $45 million settlement that Innospec in an antitrust lawsuit brought by a competitor following Innospec’s $25.3 million settlement of an FCPA enforcement action. Professor Mike Kohler has some very provocative observations about the case and the settlement.

Finally, for reference purposes, The FCPA Blog has a comprehensive list (dated January 4, 2012) of all severity-eight companies that have disclosed in their respective SEC filings currently pending FCPA investigations.

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The year just ended was eventful in many ways. Earthquakes, hurricanes, tornadoes, floods, blizzards and droughts were scattered across the globe, and political unrest shook many countries. In a year filled with such significant developments, events in the world of D&O liability pale by comparison. But even if there were no earth-shaking events, 2011 was nevertheless an eventful year in the directors and officers’ liability arena. Here is my selection of the top ten stories from the world of D&O.

1. M&A Litigation Becomes the Lawsuit of Choice for Plaintiffs’ Securities Attorneys: The traditional focus for any discussion of D&O litigation exposure has been federal securities class action litigation. But in recent years, there has been a shift in the mix of corporate and securities litigation filings. Taking into account both federal and state lawsuit filings, M&A-related lawsuits now outnumber federal securities lawsuit filings and M&A-related litigation is now the lawsuit of choice for many plaintiffs’ securities attorneys.

As a result of legislative changes and U.S. Supreme Court case law developments, “dispossessed plaintiffs’ lawyers” (as one academic recently put it) have been forced to seek an alterative business model. And M&A litigation appears to be an attractive business model for many plaintiffs’ lawyers. Corporate defendants, eager to complete the underlying business transaction, often are keen to settle these cases quickly. Settlements often include a not insignificant provision for plaintiffs’ fees.

The attractions of this business model is drawing competition, as increasingly each merger transaction is attracting  multiple separate lawsuits, often filed in differing jurisdictions. The jockeying between the plaintiffs’ lawyers in the competing cases in multiple jurisdictions has led to procedural complications and rapidly increasing costs of defense. Delaware, the traditional forum for this type of litigation, arguably now faced with “market share” competition, is according to some under pressure to show that it is not inhospitable to these kinds of lawsuits, and even to support plaintiffs’ fee awards (about which see more below).

Not only are both defense expenses and plaintiffs’ fee awards in merger objection suits mounting, but it is increasingly common for M&A-related cases to result in cash settlements on an order of magnitude often seen only in traditional securities class action lawsuits. Thus, the Kinder Morgan case, settled in August 2010 for $200 million (refer here); the Del Monte case settled in September 2011 for $89 million (refer here); the May 2010 ACS settlement was $69 million (refer here); and the 2011 Intermix Media settlement was $45 million (refer here).

The new M&A litigation model represents both a high frequency and a high severity risk. The severity risk is particularly acute given the exacerbating effects of escalating defense expenses and rising plaintiffs’ attorneys’ fees. The bottom line is that it is no longer sufficient to focus just on federal securities class action litigation. M&A related litigation is an increasingly important part of the overall mix of corporate and securities litigation. For anyone whose tasks include understanding the risks and exposures associated with corporate and securities litigation, this is an important development with significant implications. 

2. Chinese Take-Out: U.S.-Listed Chinese Companies Hit With Class Action Securities Litigation: Every year there seems to be one group or sector of companies that draws the unwanted attention of plaintiffs’ securities attorneys. During 2011, the hot sector was U.S.-listed Chinese companies. There were 39 different U.S.-listed Chinese companies hit with securities class action lawsuits during 2011, representing nearly one-fifth of all securities class action lawsuit filings during the year. Since January 1, 2010, there have been securities class action lawsuits filed against 49 different Chinese companies.

This surge of litigation involving Chinese companies has arisen out of accounting scandals, many of which were first revealed by online analysis, many of whom have short positions in the companies they are attacking. The Chinese companies have attempted to deflect the assertions by charging that the attacks are merely rumors started by interested parties with a financial incentive to drive down the companies’ shares prices. Fair or not, the online reports seem to be leading directly to shareholder litigation, as in many cases the shareholder plaintiffs’ are simply quoting the online analysts’ reports in their complaints.

Obviously not all of these cases are meritorious and indeed some of them have been dismissed (refer for example here). On the other hand, other cases have survived the initial dismissal motions (refer for example here). Even in those cases in which the plaintiffs’ claims survive the initial pleading threshold, their claims stiff face substantial challenges, not the least of which are problems involved with effecting service of process and in conducting discovery in China, as well as deriving from the geographic distances and language issues involved. (Refer here).

Eventually the plaintiffs’ lawyers will simply run out of Chinese companies to sue, but for now the phenomenon shows no sign of letting up. During the second half of 2011, there were a total of 13 Chinese companies sued in securities class action lawsuits in the U.S., including two in December alone.

The recent litigation against the U.S.-listed Chinese companies is a reminder of circumstance-specific events that can drive securities class action lawsuit filings. Countless things determine litigation activity levels, many of which cannot be captured or predicted in historical filing data. Simply put, the numbers vary over time, because, for example, contagion events and industry epidemics happen.

3. Massive Settlements Emerge as the Subprime and Credit-Crisis Litigation Wave Slowly Plays Out: The subprime and credit crisis-related litigation wave is about to enter its sixth year. Though there were additional credit crisis-related lawsuit filings during 2011, the arrival of new cases seems to have largely come to an end. However, there is still a massive backlog of cases filed over the last five years that is yet to be resolved. During 2011, a number of these cases were settled, and in some cases the settlements were massive.

The 2011 settlements include the largest so far in subprime and credit crisis-related cases, the $627 million Wachovia bondholders settlement, about which refer here. Other settlements include the following: Merrill Lynch Mortgage Backed Securities, $315 million (refer here); Lehman Brothers offering underwriters settlement, $417 million (refer here); Washington Mutual, $208.5 million (refer here); Wells Fargo Mortgage Backed Securities, $125 million (refer here); National City, $168 Million (refer here); Colonial Bank, $10.5 million (refer here); and Lehman Brothers executives, $90 million (refer here) and E*Trade, $79 million (refer here).

If you include the Lehman Brothers’ offering underwriters’ settlement, the various subprime and credit crisis lawsuit settlements total about $4.432 billion. The average settlement so far is about $110 million, although that figure is clearly driven upward by the largest settlements. If the Countrywide, Wachovia bondholders and Lehman offering underwriters’ settlements are removed from the equation, the average settlement drops to about $74.7 million.

As impressive as these settlement numbers are, there are still many more cases pending. Of course, a certain number of the pending cases will ultimately be dismissed. But many will not, and eventually those remaining cases will be settled. Although it is impossible to conjecture how large the total tab for all these cases ultimately will be, the implication from the cases that have settled is that the total amount will be massive. 

The possibilities here may have significant implications for D&O insurers. Of course, not all of these amounts will be covered by D&O insurance. But a significant chunk will be. Indeed, a number of the recent settlements will be funded entirely or almost entirely by D&O insurance, including the D&O portion of the WaMu settlement, the Colonial Bank settlement, the E*Trade settlement and the Lehman Brothers executives’ settlement. Interestingly, the Lehman executives’ settlement will come close to exhausting what is left of Lehman’s $250 million insurance tower.

In other words, the D&O insurers have had some very large bills to pay. Signs are that there will be further amounts due in the months ahead.

4. Costs Incurred in Connection with Informal SEC Investigation Held Not Covered: One of the perennial D&O insurance coverage questions is whether or not a D&O insurance policy provide coverage for defense expenses and other costs incurred in connection with an informal SEC investigation. In October 2011, in a case that was closely watched in the D&O insurance industry, the Eleventh Circuit  issued a per curiam opinion affirming a lower court holding that costs Office Depot had incurred in connection with an informal SEC investigation and investigating an internal whistleblower complaint were not covered under its D&O insurance policies.

The sheer dollar value of the costs for which Office Depot had sought coverage underscores the extent of the problems involved. Office Depot had incurred tens of millions of dollars in expense before the SEC investigation became formal. Under the circumstances presented and based on the policy language at issue, the district court held and the Eleventh Circuit affirmed that Office Depot did not have insurance coverage for these costs. The holding was a reflection of the specific policy language at issue, but D&O insurers undoubtedly will try to rely on the holding in other circumstances in which coverage is sought for costs incurred in connection with informal SEC investigations.

Meanwhile, the insurance marketplace has evolved in recognition of policyholders’ interest in having insurance coverage for the costs of informal SEC investigations. Recently, some carriers have been willing to provide coverage for costs individuals incur in connection with informal SEC investigations. In addition, at least one carrier now offers a separate insurance product that provides coverage for costs that the entity itself incurs in connection with an informal SEC investigation. Although this entity protection for informal SEC investigative costs is subject to a large self-insured retention and to coinsurance, the fact remains that if such a policy had been available to Office Depot and if Office Depot had had such a policy in place, at least a significant part of Office Depot’s costs of responding to the informal SEC investigation might have been covered.

Policyholder advocates undoubtedly will take the position that the Eleventh Circuit’s opinion in the Office Depot case does not represent the final word on the question of D&O insurance coverage for costs incurred in connection with informal SEC investigation. In making these arguments, the policyholder advocates undoubtedly will seek to rely on the Second Circuit's July 2011 opinion in the MBIA case, in which the court held that costs incurred in voluntarily responding to a governmental investigation are covered. (The MBIA case is itself also a reflection of the policy language involved and circumstances presented, including in particular the fact that most of the costs at issue were incurred after the SEC had issued a formal investigative order, by contrast to the Office Depot case, where most of the costs were incurred before the investigation was formalized.)

These questions undoubtedly will continue to be disputed and even litigated. But it will be interesting to see how the marketplace continues to evolve as the industry continues to try to craft solutions to this recurring problem.

5. FDIC Litigation Against Failed Bank Directors and Officers Slowly Emerges: Since January 1, 2008, there have been 414 bank failures, including 92 in 2011 alone. Though the number of bank closures this past year represents a decline from the prior year’s total of 157, the likelihood is that there are further bank failures ahead in 2012, albeit at a reduced pace from recent years. (The January 3, 2012 Wall Street Journal comments that “failures will be a part of the landscape for many months, maybe years, as weak banks take a long time to recover or fail.”) But even if the number of new bank failures may finally be starting to decline, the FDIC’s pursuit of litigation against the directors and officers of failed banks may just be getting started.

During 2011, the FDIC stepped up its failed bank litigation activity. The FDIC filed 15 lawsuits against directors and officers of failed banks in 2011, bringing the total number of FDIC failed bank lawsuits to 17. Signs are that the number of FDIC lawsuits will continue to grow in the months ahead. According to the FDIC’s website, as of December 8, 2011, the FDIC has authorized suits in connection with 41 failed institutions against 373 individuals for D&O liability for damage claims of at least $7.6 billion. These figures representing the authorized lawsuits contrast starkly with number of lawsuits that the agency has actually filed: So far, the agency has filed only 17 lawsuits against 135 former directors and officers of 16 failed financial institutions. Given the discrepancy between the number of suits authorized and the number of suits filed, there clearly are many more suits in the pipeline, with even more lawsuits likely to be authorized in the months ahead.

As the FDIC’s failed bank lawsuits have begun to emerge, settlements of these cases are also slowly developing. The most noteworthy of the settlements so far is the well-publicized resolution of the FDIC’s lawsuit against three former WaMu officers. Although widely reported as having a value of $64.7 million, the cash value of the settlement was actually about $40 million, as discussed here. All but a very small portion of the cash component was paid for out of WaMu’s directors and officers’ insurance coverage. Although it is interesting that the individual defendants were called upon to contribute out of their own assets toward the settlement, the fact is that D&O insurance represented almost all of the cash component of the settlement.

The point here is that as the FDIC failed bank lawsuits accumulate in the coming months and as the filed cases move toward resolution, D&O insurers could be called upon to contribute amounts toward defense and resolution of these cases that in the aggregate could be massive.

6. Eurozone Crisis Includes Corporate Liability Exposures: The financial crisis gripping the European economic community has many dimensions. As governments wrestle with concerns about sovereign debt of Eurozone countries, as well as unemployment and unrest, companies exposed to European sovereign debt face perils of their own. As the fallout from the collapse of MF Global demonstrates, the hazards these companies face include, among many other concerns, liability exposures stemming from the companies’ investments in European sovereign debt.

Among the many disturbing features of MF Global’s demise is the speed of its collapse. And inevitably its collapse was immediately followed by an onslaught of securities class action lawsuit filings against the firm’s directors and officers. MF Global collapsed because of its exposure to European sovereign debt. The company is of course far from the only enterprise exposed to European debt. A host of other financial institutions and banks are also exposed and many more enterprises are exposed to the companies with European debt exposure. The possibility of sovereign debt rating downgrades or even debt write-offs looms over the firms carrying these assets on their balance sheets. 

Though the larger problems for the global financial marketplace clearly are of a much higher order, these issues also pose a challenge for D&O insurance underwriters. As noted above, there is not just the question of whether or not a company is exposed to European sovereign debt. There is also the far more difficult to discern question of whether or not a company is exposed to a company that is exposed to European sovereign debt. If the European difficulties were to evolve from a crisis to a disaster  – for example, though the withdrawal of one or more countries from the Euro – the aftereffects could be even more widespread. As MF Global’s rapid demise illustrates, these kinds of concerns are sufficient to quickly send a company into bankruptcy.

There is no way to know for sure, but I suspect strongly that as the New Year progresses, there will be a lot more to be said about European sovereign debt risk, at both the global and individual company levels.

7. Whistleblower Rules Go Into Effect, Whistleblower Lawsuits Emerge: The SEC issued its implementing regulations with respect to the Dodd-Frank whistleblower provisions in August 2011. In November 2011, the agency released its first report to Congress, as required by the Dodd-Frank Act, on whistleblower activities, as of the end of the 2011 fiscal year end on September 30, 2011.

Though the SEC’s report reflected only a seven week time period, it revealed a heightened level of whistleblower reporting. In just the first seven weeks, the program recorded 334 whistleblower reports, which implies an annualized level of nearly 2,500 reports. Interestingly, about 10 percent of all whistleblower reports during the period reflected in the study originated outside the United States. The SEC made no whistleblower bounty payments during the period reflected in the study, as permitted under the Dodd-Frank Act. It seems likely that as the agency makes bounty payments additional whistleblowers will be motivated to come forward.

With the implementation of provisions for potentially rich whistleblower bounties under the Dodd-Frank Act, there have been concerns that the incentives will not only lead to increased numbers of reports and increased enforcement activity, but that the regulatory action will in turn generate follow-on civil litigation.  As discussed here, a December 2011 securities class action lawsuit filed against Bank of New York Mellon give a glimpse of how heightened whistleblower activity could lead to increased follow-on civil litigation.

The lawsuit followed whistleblower reports that the company engaged in a scheme to fraudulently overcharge its customers for foreign currency exchange transactions. Although the whistleblower allegations first emerged in separate whistleblower lawsuits, the foreign currency exchange allegations are also the subject of whistleblower reports to the SEC. In addition to the securities class action lawsuit, the whistleblower allegations have also triggered multiple regulatory actions. The train of events that the BNY Mellon whistleblower allegations set in motion shows how the revelation of whistleblower allegations can lead not only to significant regulatory action but also to significant follow on civil litigation.

Given the substantial bounties for which the Dodd-Frank Act provides, it seems likely there will be increased numbers of reports to the SEC, which in turn could mean increased levels of enforcement activity. Along with all other concerns these possibilities present, there is also the concern that the increased number of reports and increased enforcement activity could, following the same sequence illustrated in connection with the BNY Mellon whistleblowers, lead to a surge in follow-on civil litigation. As we head into 2012, we will have to watch whether increased whistleblowing will lead to increased follow-on civil litigation, similar to the suit against BNY Mellon.

8. Aggrieved Overseas Investors Seek Litigation Alternatives Outside the United States: For many years, the United States was the forum of choice for aggrieved investors to seek redress, regardless of whether or not the investors purchased their shares in the United States. However, the U.S. Supreme Court’s June 2010 decision in Morrison v. National Australia Bank abruptly and unexpectedly eliminated access to U.S. courts for investors who purchased their shares outside the U.S. As a result, these investors increasingly are seeking alternative means to pursue their claims. Though we are still in the earliest days following the Morrison decision, there seem to be significant indications that aggrieved investors are developing a new playbook that includes resort to non-U.S. courts.

Investors’ pursuit of claims outside the United States was not long in coming after the Morrison decision and as its implications began to emerge in the lower U.S. courts. For example, in January 2011, after investors’ claims in U.S. court against Fortis were dismissed based on the Morrison decision, investors filed an action in Dutch court seeking remedies under Dutch law, but raising the same allegations that previously had been asserted in U.S. courts. Similarly, in December 2011, hedge funds and other investors whose action against Porsche had been dismissed from U.S. courts based on Morrison filed an action raising the same allegations against the company and its management in a German court.

Developments in other jurisdictions also reflect investors’ efforts to develop alternative remedies in the absence of access to U.S. courts. Among other things, at least two class actions pending in Canadian courts have not only survived dismissal motions but have had global classes certified. As discussed here, investors have also shown a willingness to pursue claims in a variety of other countries, including, for example, Germany and Australia. Recent statutory amendments in other countries (including, in particular, Mexico) may lead to investors in those countries to seek to pursue claims there.

Increased litigation and regulatory exposure outside the United States has a variety of implications, not the least of which concerns D&O insurance. As companies and their directors and officers face increased exposures on a global basis, D&O insurance policies will be called upon to respond in new and unusual situations. These developments in turn will require policies that are well adapted to the changing circumstances.

9. Judge Rakoff Rejects Settlement of SEC Enforcement Action Against Citigroup: Southern District of New York Judge Jed Rakoff’s November 2011 rejection of the $285 million settlement of the SEC’s enforcement action against Citigroup was not the first occasion on which Rakoff rejected a proposed SEC settlement. But this latest rejection has caused quite a stir, and not only because of the sharp rhetoric he used in rejecting the settlement (among other things, he derided the settlement because it “shortchanged” investors.) The most significant aspect of Rakoff’s rebuff is his refusal to accept a settlement in which Citigroup neither admitted nor denied the SEC’s allegations.

The SEC, perhaps stung by the Rakoff’s sharp words, and even more concerned about the possibility that it might be constrained from the entry into future no admit/no deny settlements, has appealed Rakoff’s ruling to the Second Circuit.  The SEC is right to be concerned about the implications of Judge Rakoff’s ruling. Following Judge Rakoff’s ruling, at least one other court has questioned a proposed SEC settlement that contained the “neither admit nor deny formulation.”

The problem for the SEC is that if proposed settlements cannot be approved unless the target defendants admit to wrongdoing, it may become significantly more difficult to settle cases and the SEC will be forced to take more enforcement actions to trial. This would not only put an enormous strain on the agency’s resources, but it could result in an overall reduction in the agency’s enforcement reach as it is forced to concentrate both more time and means on fewer enforcement actions.

The inability to enter into a no admit/no deny settlement presents a highly unattractive picture for target defendants as well. If fewer enforcement actions settle and more enforcement actions are forced to trial, the costs of defending an SEC enforcement action could escalate substantially. Target defendants unable to avoid the risks and uncertainty of trial without admitting wrongdoing will have to consider the possible effects of any admission on separate private civil actions. Any admissions in the enforcement actions could undermine their defenses in the separate civil actions. Moreover, depending on what is admitted, the admissions could have the further also undermine the target defendant’s insurance coverage by triggering a conduct exclusion on the defendant’s insurance policy.  

For these and a host of other reasons, the SEC’s appeal of Judge Rakoff’s ruling to the Second Circuit will be very closely watched. Crucially, however, the Second Circuit has not yet agreed whether or not it will actually hear the appeal of Judge Rakoff’s ruling. In additiona, there is always the possibility that Citigroup and the SEC will reach an agreement that Judge Rakoff finds acceptable (a footnote in his opinion rejecting the initial settlement does lay out a schematic for a settlement that would be acceptable to him, as I discuss here). Depending on how it all finally goes down, this case has the potential to be one of the top stories of 2012, as well.

10. A Big Fee Award in Delaware Gets Everybody’s Attention: Sometimes in litigation, a case that results in a big number is interesting in and of itself. And on that score, Delaware Chancellor Leo Strine’s October 2011 post-trial damages award of $1.263 billion in a lawsuit arising out of Grupo Mexico’s 2005 sale of Minerva Mexico to Southern Peru Copper Corporation certainly qualifies as interesting. (The later addition of pre-judgment and post-judgment interest increased the amount of the award to $2 billion). But what really has drawn attention to the case is Strine’s award to the plaintiffs’ of fees amounting to 15% of the damages and interest – that is, $300 million. A December 28, 2011 Wall Street Journal article entitled “Christmas Comes Early for These Lawyers” (here) describes the award.

As noted in a December 28, 2011 WSJ.com Law Blog post (here), the $300 million fee award may be the largest fee award ever in a shareholders’ derivative suit. Indeed it appears to be one of the largest fee awards in any corporate or securities case, approaching in order of magnitude the awards in the massive Enron and World Com cases (where the fees awarded were $688 million and $336 million, respectively).

Grupo Mexico undoubtedly will appeal both the damages award and the fee award. Whether or not the $300 million award ultimately withstands scrutiny, there are reasons to be concerned about the award. As noted above with respect to M&A litigation, Delaware’s courts are facing competition and appear to have been losing “market share” for corporate litigation. At least some interpreters have concluded, as reported in the Journal article linked above, that the plaintiffs’ fee award is a not-so-subtle signal to plaintiffs’ lawyers that Delaware’s courts are “open for business.” Other interpreters suggested that the fee award represents a “message to the plaintiffs’ bar.”

It is an obvious concern if Delaware’s judges feel obliged -- in order remain competitive in the jurisdictional competition and to try to preserve declining corporate litigation market share -- to prove that plaintiffs’ lawyers will be rewarded for resorting to the state’s courts.

Bloggers of the World, Unite!: Everyone here is pretty much reconciled to the fact that writing a blog is not exactly accorded equal dignity with, say, writing for The New Yorker. So we were all very gratified by the article in December 31, 2011 issue of The Economist entitled "Marginal Revolutionaries" (here), in whch the magazine reports that "the financial crisis and the blogosphere have opened up mainstream economics to new attack." Among other things, the article cites "the power of blogging as a way of getting fringe ideas noticed." The article recounts the experiences of the "invisible college of bloggers" whose revolutionary economic analyses have moved from the fringe to become part of the central economic dialog of our times.

In the immortal words of  the theme song of revolutionaries everywhere , "Allons enfants de la patrie, Le Jour de gloire est arrivé!" 

Perspective: Those worried about the troublesome events of the day may want to spend a few minutes contemplating "The Hisory of the Earth as a Clock" (here). In the grand scheme of things, the current crises are a mere passing cloud. (Source: UW-Geoscience).

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Surging levels of M&A-related litigation and a wave of lawsuits involving U.S.-listed Chinese companies drove federal securities class action lawsuit filings during 2011 to the highest levels since 2008. However, due to the growing wave of M&A-related litigation, much of which is filed in the state courts, the federal securities lawsuit filing statistics, while interesting, represent only a part of the overall corporate and securities litigation story. State court litigation, particularly state court M&A-related litigation, represents an increasingly important part of the picture.

According to my count (about which see more below), there were 218 securities class action lawsuit filings in 2011, well above the 176 filed in 2010, and also above the 1997-2009 average number of filings of 195, but below the 2008 credit crisis fueled total of 223. The 2011 filings were fairly evenly balanced throughout the year, with 113 in the year’s first half and 105 in the year’s second half.

The single largest factor driving the increase in 2011 filings were merger-related lawsuits. Sixty-one of the 218 filings during 2011 (or about 28%) were merger-related. By way of comparison, the M&A-related lawsuits represented slightly less than 20% of all 2010 filings, While these federal court filings represented an important part of the year’s overall federal securities class action lawsuit filings, these federal court filings represented only a fraction of all M&A-related litigation, most of which was filed in state court. Taking all of the cases, state and federal, into account, the number of M&A related lawsuits now greatly exceeds the number of federal securities class action lawsuits that are not merger-related. As discussed further below, the counts and relative comparisons can get tricky.

A second significant factor driving the 2011 securities class action lawsuit filings is the number of filings against non-U.S. companies, particularly U.S.-listed Chinese companies. 55 (or about 25%) of the 2011 federal securities filings involved non-U.S. companies.  The targeted non-U.S. companies are domiciled in 12 different countries. 39 of these 55 foreign companies are U.S.-listed Chinese companies (or U.S. listed companies that have their executive offices or principal places of operation in China). These 39 alone represent about 18% of all 2011 filings. Though the 39 lawsuit filings involving Chinese companies were heavily weighted to the first part of the year, there were still 13 in the year’s second half (which is more the 10 total filed against U.S.-listed Chinese companies during all of 2010) -- including two in December.

At one level, the fact that a quarter of all 2011 securities class action lawsuit filings involved non-U.S. companies is surprising, given that it seemed probable that the U.S. Supreme Court’s decision in the Morrison v. National Australia Bank case would result in a reduction in litigation involving non-U.S. But the 2011 actions involving non-U.S. companies either (like the cases involving the Chinese companies) involved firms with shares or ADRs listed on U.S. exchanges – and that therefore come within the requirements of Morrison – or were filed only on behalf of shareholders who purchased their shares in the U.S. The November 2011 action on behalf of the very few Olympus Corporation shareholders who purchased their Olympus ADRs over the counter in the U.S. is a good example of this latter kind of case. The Olympus case, which involves only a very small fraction of the company’s shareholders, show that Morrison is still having a very significant impact on filings, notwithstanding the number of filings involving non-U.S. companies.

The merger cases and the cases involving U.S.-listed Chinese companies together represented 100 of the 218 securities class action lawsuit filings during 2011, or nearly 46% of all filings. Clearly these two lawsuit phenomena were significant factors in driving 2011 filings, and more than account for all of the increase in 2011 filings compared to filing levels in 2010 and 2009.

The companies targeted in the 2011 securities class action lawsuit filings were very diverse, representing 114 Standard Industrial Classification (SIC) code categories. Unlike recent years in which filings against companies in the financial services industries predominated, filings against companies in the 6000 SIC code category (Finance, Insurance and Real Estate) represented only about 12% of all filings, compared to 2010, when filings against companies in that group represented about 20% of all filings, and 2009, when suits against financial companies accounted for over half of all filings.

This decline in the percentage of cases involving financial companies is largely due to the winding down of the subprime and credit crisis-related litigation wave. But while the wave is fading, it is not yet completely gone. There were still four new subprime relates securities class action lawsuit filings in 2011. However, none of these were filed during the year’s second half, which suggests that we could be very close to the end of the litigation wave, at least in terms of new filings.

There really was no SIC code classification that predominated in the 2011 filings. However, as always seems to be the case, there were a large number of cases involving companies in the life sciences sector. The SIC code classification with the single largest number of filings was SIC Code classification 2834 (Pharmaceutical Preparations), in which there were 11 lawsuits in 2011. Overall there were 13 lawsuits in SIC Code Group 283 (Drugs). There were another 5 companies sued in SIC Code classifications 3841 (Surgical and Medical Instruments) and 3845 (Electromedical and Electrotheropeutical Apparatus), meaning that overall there were 18 new lawsuits filed against life sciences companies, or about 8% of all 2011 filings. These 2011 figures were down from filings against companies in the SIC Code categories in 2010, when there were 27 lawsuits against companies in these sectors, representing about 15% of all filings.

Another sector that had a significant number of filings was SIC Code Group 737 (Computer Programming, Data Processing and Other Computer-Related Services). There were a total of 21 lawsuits involving companies in this group. There were also another 11 lawsuits filed against companies in SIC Code Group 367 (Electrical Components and Processors), including nine in SIC Code classification 3674 (Semiconductors) alone. Together, these various technology categories accounted for 32 of all 2011 filings, or about 15%. 

The 2011 securities class action lawsuits were filed in 47 different federal district courts, although a few courts accounted for most of the filings. 48 of the filings, or about 22%, were in the Southern District of New York (both the merger filings and the lawsuits against Chinese companies helped to swell the number of filings in this judicial district). The Central District of California accounted for 33 of the filings (again swollen by filings involving Chinese companies), and the Northern District of California accounted for 16, largely as a result of the number of lawsuits involving technology companies. These three districts together accounted for 97 of the 2011 filings, or nearly 45% of the total.

Discussion

My tally of the 2011 securities class action lawsuit filings will differ from other published counts of the 2011 lawsuits. My count is larger than the tally of the Stanford Law School Securities Class Action Lawsuit Clearinghouse, because I included all federal court merger objection lawsuits while the Stanford web site chose to omit some. My count is smaller than that of NERA Economic Consulting (about which refer here) for a number of reasons, primarily because I count multiple lawsuits involving a corporate defendant only once, whereas NERA will count multiple lawsuits in multiple jurisdictions involving the same company multiple times, unless the separate lawsuits are consolidated in a single case in a single jurisdiction.

The differences in counting the M&A lawsuits underscores a recurring general difficulty with trying to count federal securities class action lawsuits. There is an inevitable definitional issue, as deciding whether or not to “count” individual cases presents recurring questions abut exactly what it is that you are trying to count. The M&A related cases present a particularly challenging category of cases, because increasingly a single merger transaction will give rise to multiple lawsuits in multiple different jurisdictions, sometimes based on a differing legal theories. Because there cases are sometimes filed in different states’ courts, or in both federal and state courts, there are recurring and vexing issues involved with trying to count these cases, all of which is compounded by the fact that it can be very difficult to accurately track the state court filings.

Though I have elected to include all federal court M&A-related lawsuit filings in my tally, these filings represent only a fraction of all M&A-related lawsuit filings in 2011. The vast majority of 2011 corporate and securities lawsuits – particularly the merger objection cases – were filed in state court. The fact that my 2011 count, like most of the published securities class action lawsuit filing counts, is based on federal filings necessarily means that it omits numerical recognition and analysis of the state court filings. At least from a frequency standpoint, the exclusively federal court focus could lead to a distorted impression of corporate and securities litigation activity levels.

At the same time, my inclusion of the federal merger objection lawsuits could result in a distortion the other way as well. There is a very legitimate argument that these cases should not be included, or at least many of them should not be included, in a tally of federal securities class action lawsuit filings. Some of them may not allege a breach of the U.S. securities laws. For that reason, the Stanford website omits some of these cases. I decided to go ahead and include all of them and not just some of them, first, because it can become extraordinarily difficult to make selections at the individual case level. The categorical distinctions are not always apparent. But the larger reason I decided to include these is that I felt that without including these cases, the overall levels of federal court litigation might appear understated.

There is another significant way in which the federal court litigation may be understated, at least as a matter of analysis. That is, most analysis of federal securities lawsuit filings levels focus exclusively on the absolute numbers of filings. Though the absolute number of annual filings has fluctuated over the years, they have generally held pretty steady, even allowing for the occasional annual blip up or down. But a simple focus on the absolute numbers of filings levels does not consider the relative filing levels – that is, the number of filings relative to the number of public companies.

The fact is that there are significantly fewer public companies than there were only a few years ago, due to bankruptcies and mergers, along with declining numbers of IPOs. As I discussed here, by one estimate, there are 40% fewer public companies than there were in 1997, yet the annual number of new securities class action lawsuits is more or less consistent with that earlier time. All of which supports the argument that because absolute filing numbers have held steady while the number of publicly traded companies has declined, overall filing levels have actually increased over time. In any event, regardless of what you make of this argument, I think that consideration of relative filing levels is a part of the analysis that is routinely omitted from the consideration of the changes in annual litigation activity.

Looking ahead to 2012, it seems probable that the wave of new lawsuits involving Chinese companies will wind down, since sooner or later the plaintiffs’ lawyers will simply run out of companies to sue. However, there seems to be no reason to expect that the surge of M&A-related litigation will not continue to grow. The procedural and substantive barriers to traditional securities litigation and the prospects for quick settlements and attorneys’ fee recoveries in the M&A suits have encouraged many of the smaller plaintiffs’ securities firms to adapt M&A litigation as their new business approach. The vexing problems this type of litigation presents will increasingly challenging in the New Year. My own view is that the growth in M&A litigation represents a secular rather than a merely cyclical change.

The bottom line is that with growing levels of M&A-related litigation and relatively greater frequencies of federal securities class action lawsuit filings, the likelihood that any particular public company will get hit with a serious corporate or securities lawsuit has never been greater (as I analyze in greater detail here).

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In a prior post (here), I examined the mounting problems associated with the increasing levels of M&A-related litigation. A recent academic paper takes a closer look at these issues and concluded, among other things, that M&A-related lawsuit filings now outnumber federal securities class action lawsuit filings, and M&A-related litigation has “replaced traditional stock drop cases as the lawsuit of choice for plaintiffs’ securities lawyers.”

In her article entitled “Securities Class Action Lawsuits in State Court” (here), Lewis & Clark Law School Professor Jennifer Johnson examines a database of class actions filed in state court between 1996 and 2010. Her analysis shows that as a result of several Congressional enactments in recent years – particularly SLUSA and CAFA – the prevalence of many types of state court securities class action filings has declined. However, the number of state court class action lawsuit filings involving M&A transactions has been “skyrocketing” and now even outnumber federal securities class action lawsuit filings.

Indeed given that the database of state court filings on which Professor Johnson relied almost certainly understates the number of state court filings, it is probable that the number by which the state court M&A-filings exceeds the number of federal court filings is even greater than her analysis shows.

According to Professor Johnson, the growth of M&A-related litigation is a consequence of the various Congressional enactments intended to restrict traditional securities class action lawsuits to federal court. As legislative enactments like SLUSA and CAFA drove plaintiffs’ lawyers away from federal court, “dispossessed plaintiffs’ lawyers increasingly have turned to filing alternative class actions in state court” – particularly M&A-related class actions. As a result, M&A-related class action lawsuits “have replaced traditional stock drop cases as the lawsuit of choice for plaintiffs securities lawyers,” particularly because the cases are filed and resolved quickly, owing to the pressure on the defense attorneys’ to complete the underlying transaction.

While the increased numbers of M&A-related lawsuits has led to an increase in the numbers of filings in Delaware state court, “the relative percentage of Delaware cases compared to those in other jurisdictions has fallen.” Increasingly, plaintiffs’ lawyers are choosing to file cases outside the defendants’ state of incorporation. At the same time, while the growth in M&A-related litigation has primarily been a state-court phenomenon, there have also been growing numbers of federal court M&A related lawsuit filings as well.

The proliferation of M&A-related litigation outside of Delaware is in part due to the fact that increasingly any one M&A event is likely to “induce multiple filings.” During 2010, for example, each M&A event spurred an average of 1.8 filings, but this statistic is “slightly misleading” as larger entities often faced suits in 4 or 5 different jurisdictions.

The reasons for increase in M&A-related filings outside of Delaware may include concerns among plaintiffs’ attorneys that Delaware’s courts are “increasingly diligent in policing the conduct of lead counsel and the award of attorneys’ fees.” There may also be a perception that Delaware is a “manager-friendly state” and that “settlement values may be higher outside of Delaware state court.”

The growing levels of multi-jurisdiction litigation “makes it difficult for courts to manage cases, as there is no prescribed orderly procedure for consolidation as would exist in the federal courts.” There are also no mechanisms for coordination between states or between state and federal courts.  The phenomenon of multi-jurisdiction M&A litigation “wastes judicial resources,” leads to “obvious inefficiencies and increased costs” for defendants, and even leads to problems among plaintiffs’ counsel “as they jockey for position and ultimately for fees.”

Johnson observes that “effective coordination” between the courts could help ameliorate these difficulties. She also reviews various proposals that have been offered for corporations to amend their charters to include clauses specifying the forum for specifying intra-corporate disputes. But, she also speculates, “absent a major change,” the concerns associated with the proliferation of multi-jurisdiction M&A related litigation “is likely to come to the attention of Congress.”

Johnson suggests that Congress might attempt to address these concerns through an outright repeal of the so-called “Delaware Carve-Out” from SLUSA, which preserves state court jurisdiction for state law claims involving shareholder communications involving voting rights, such as in M&A transactions, forcing the class actions into federal court. Alternatively, Congress might revisit SLUSA and restrict the carve-out to preserve state court jurisdiction for the courts of an entity’s state of jurisdiction (which, Johnson speculates, would have the effect of making Delaware the sole forum for the majority of cases).

Discussion

Johnson’s article further substantiates the alarms being sounded in connection with the exploding levels of M&A-related litigation. The growth of M&A-related litigation is a vexing and costly problem, and her article helps to substantiate the growth and seriousness of the problem. However, her speculation about possible solutions may be optimistic. The inability of the current Congress to confront even matters of the greatest urgency is hardly reassuring about its ability to deal with issues of the type involved here.

But even Congress were to address these issues, I am skeptical that Congress would outright eliminate the Delaware Carve Out from SLUSA and make all corporate litigation into federal litigation. It is relatively likelier that Congress might be willing to revise the carve-out to restrict the preserved jurisdiction to the court of the state of an entity’s incorporation, but even there I have my doubts that Congress would be willing to act in a way that would so clearly favor the courts of a single jurisdiction.

Even if we assume for the sake of discussion that Congress will eventually be able to address these issues, that action could well be a long time coming. In the meantime, courts and litigants face a growing and costly problem. Courts and litigants alike will have to continue to grapple with these problems. Absent a congressional directive, informal cooperation between and among the courts and parties involved will be the only practicable solution available – a solution that admittedly could be frustrated in any specific case by a recalcitrant party or court.

Setting aside the questions of what to do about it, it is important simply to recognize that the problems associated with the growing levels of M&A-related litigation activity exist. As Johnson’s article documents, corporate and securities litigation overall is changing. It is no longer sufficient to focus just on federal securities class action litigation. M&A related litigation is an increasingly important part of the overall mix of corporate and securities litigation. For anyone whose tasks include understanding the risks and exposures associated with corporate and securities litigation, this is an important development with significant implications.  

Special thanks to a loyal reader for forwarding a copy of this article.

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

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

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

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

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

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

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

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

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

Discussion

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

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

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

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

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One of the most noteworthy recent trends in corporate and securities litigation has been the dramatic growth in the frequency of lawsuits relating to mergers and acquisitions activity. These lawsuits are not only becoming increasingly more common, but also increasingly more costly. The growth in this litigation activity has been so rapid that the significance of these trends may remain underappreciated.

In this post, I first set the stage to examine these trends by reviewing the current landscape for traditional securities class action litigation, which differs in many ways from current conventional wisdom, and which provides a context for assessing the merger-related litigation trends. I then review important recent developments in M&A related litigation activity, both in terms of increasing frequency and escalating severity. I conclude with a review of the implications of these developments.

The Current Securities Class Action Litigation Environment

Traditionally, any discussion of corporate and securities litigation focused primarily (and sometimes exclusively) on securities class action litigation. In many ways, this makes perfect sense, as these kinds of lawsuits were for many years the most frequent and the most severe type of corporate and securities lawsuit.

More recently, the relative significance of securities class action litigation as a percentage of all corporate and securities litigation risks has shifted. As the insurance information firm Advisen has well-documented (refer here), securities class action litigation activity as a percentage of all corporate and securities litigation has declined dramatically over the past several years. Whereas securities class action lawsuits once represented among the most likely sources of litigation, in 2010 securities class action lawsuits represented less than 16% of all corporate and securities lawsuit filings.

As Advisen has also documented and as is discussed below, one reason for this relative decline is the growth in M&A-related litigation filings. Moreover, as is also discussed below, securities class action litigation is not the only source of corporate and securities litigation severity exposure; M&A-related lawsuits also represent a growing severity risk.

But, to set the stage for the discussion of M&A-related litigation trends and their significance, there are some important misperceptions about traditional securities class action litigation activity that I want to address.

A frequently recurring question is whether overall securities class action litigation filings are declining. Usually this discussion focuses exclusively on the absolute number of annual new securities class action lawsuit filings. In 2010, depending on the source to which you are referring, the absolute number of new lawsuit filings either declined compared to historical averages ( e.g., refer here regarding  the 2010 Cornerstone Research study) or held steady or perhaps grew (refer here regarding  the 2010 NERA Economic Consulting  study). The reasons these studies reach different conclusions are worthy topics for a separate blog post. But regardless of the conclusions about the absolute numbers of annual lawsuit filings, the key fact often  missing from the analysis is a consideration of how the absolute number of filings relates to the changing number of public companies.

The fact is, since, 1999, the number of companies listed on U.S. exchanges has declined every year. If you refer to the annual data from the World Federation of Exchanges (here), you will see that the number of companies listed on U.S. exchanges has declined from over 8,500 in 1999 to about 5,100 in 2010 – a decline of about 40%.

When the absolute number of annual lawsuits is compared to the declining number of companies trading on U.S. exchanges, it is clear that the frequency of securities class action lawsuit filings has not declined, but arguably is increasing, and at a minimum is at least holding steady.

But while frequency has not declined, median severity has increased. In 2010, the median securities class action settlement was $11.1 million, which is well over double the 1999 median settlement of $5.0 million and triple the 1996 median settlement of $3.7 million. These figures are not adjusted to account for the effect of economic inflation, but these figures nevertheless reflect a  substantial increase.

In short, even amidst the changing litigation landscape in which securities class action lawsuit filings have declined as a percentage of all corporate and securities litigation, the threat of securities class action litigation remains a very serious litigation exposure for publicly traded companies.

It is against this backdrop that the growth in M&A litigation must be considered.

The Exploding Growth in M&A-Related Litigation

Whatever else you want to say about M&A-related litigation, it is clear that there is a lot more of it now than there used to be, both in terms of absolute numbers of lawsuits filings and also relative to the number of merger transactions. Indeed, Advisen has commented that the number of M&A-related lawsuits has “skyrocketed “in recent years.

Reported data (refer for example here and here) show that as recently as ten years ago, there were only a handful of M&A related lawsuits filed each year. For example, in 2001, there were only four M&A related lawsuits filed, compared to the 341 filed in 2010 (up from “only” 191 the year prior). Just in the four- year period ending in 2010, the annual number of merger-related lawsuit filings has increased over 600%.

These numbers are even more startling when it is considered that these lawsuit filings are increasing even as the number of merger transactions is declining. The number of merger targeted companies declined in each of the three years from 2008 to 2010, yet the absolute number of merger-related lawsuits increased in each of those three years relative to the prior year. In 2010, there were 214 fewer companies targeted for mergers than there were in 2007, representing a decline of over 37%. Yet the number of merger-related lawsuits filed in 2010 was more than triple the number filed in 2007. Today, one out of every two companies announcing an acquisition is sued, and that is true whether or not the acquisition is friendly or hostile, and even whether or not the board of the target company has accepted or rejected the proposed acquisition.

There are a host of possible explanations for these filing trends. The first is that a changing case law environment has made securities class action litigation a more challenging game for plaintiffs (for example, as a result of the U.S. Supreme Court’s holdings in the Tellabs case and the Morrison case). In addition, the declining number of public companies over the past several years means that there are fewer prospective securities class action litigation targets. These developments may have encouraged plaintiffs’ lawyers to seek out an alternative business model.

And in the M&A related litigation, the plaintiffs’ attorneys seem to have found relatively easy money, as these cases often involve a quick resolution (due to the fact that the parties are often highly motivated to complete the underlying transaction) and the payment of plaintiffs’ attorneys’ fees, which average around $400,000 per case. These attributes of M&A related litigation were discussed in an August 27, 2011 Wall Street Journal article, written from the shareholders’ perspective, entitled “Why Merger Lawsuits Don’t Pay” (here) and in a July 12, 2011 Fox Business article entitled “M&A Lawsuits Skyrocket as Fee-Hungry Law Firms Smell Easy Money” (here).

The surest sign that M&A-related litigation represents an attractive proposition for the plaintiffs’ lawyers is the level of lawsuit competition that merger transactions increasingly are engendering. Increasingly, the announcement of a merger can trigger multiple separate lawsuits filed by separate plaintiffs’ firms in multiple separate jurisdictions, producing complicated procedural and jurisdictional issues (refer for example here and here) and also adding dramatically to the cost of litigation.

This latter point, about the costs involved, brings us to the heart of the matter. Not only are M&A cases increasingly more frequent, they are increasingly more costly, in a number of ways. I emphasize the costs involved because there is a perception in certain quarters that while M&A lawsuits may be numerous, they represent only a minor nuisance. To put this in insurance terms, M&A lawsuits are described as a high frequency, low severity risk. In fact, this is something I myself have said in the past. However, the truth now is, when all of the costs are considered on an all-in basis, that the cases actually are quite expensive, and increasingly are becoming more so.

Start with defense expenses. Because these cases often involve high stakes and short fuses, their defense often can trigger an explosion of legal fees. When you add in the additional expense involved when there are multiple cases in multiple jurisdictions, the expenses multiply. And when you add in the fact that these cases increasingly are continuing on even after the underlying merger transaction has closed, the defense costs can increase exponentially. Much of the time, these defense expenses are borne by the target company’s D&O insurer.

The D&O Insurers not only absorb the sometimes massive defense expenses, but they also often have to absorb the plaintiffs’ fees as well, as the payment of the plaintiffs’ attorneys’ fees often is a covered component of the case settlement. (Refer here for a recent discussion of the issues surrounding D&O coverage for a plaintiffs’ fee request in a derivative lawsuit settlement.)

The plaintiffs’ fees alone can sometimes be staggering. In the August 2010 Morgan Kinder lawsuit, the plaintiffs’ fee requests amounted to as much as $50 million (that is, 25% of the $200 million settlement, refer here). The plaintiffs’ fee request in the September 2011 Del Monte settlement was $22.3 million (refer here). And in the May 2010 settlement of the Atlas Energy case, the plaintiffs’ fee request was as much as $17.25 million ($25% of the $69 million settlement, refer here).

It should be emphasized that the plaintiffs’ fee request can be substantial even where there is otherwise no cash component to the settlement. For example, in the April 2010 XTO Energy settlement, in which there otherwise was no cash component, the plaintiffs’ fee request was $8.8 million (refer here) . In the September 2009 Pepsi Bottling settlement, which otherwise did not involve a cash payment the plaintiffs’ fee request was $7.7 million (refer here). Similarly in the February 2011 Atlas Energy case, the fee request was $4.0 million (refer here).

And beyond that – and the most important point here – it is increasingly common for the settlement of these cases to also involve significant cash payments. Indeed, the settlements in many of these cases suddenly are starting to resemble in order of magnitude the settlements of securities class action lawsuits. Thus, the Kinder Morgan case, as referenced above,  settled in August 2010 for $200 million (refer here); the Del Monte case, as noted above,  settled in September 2011 for $89 million (refer here); the May 2010 ACS settlement was $69 million (refer here); and the 2011 Intermix Media settlement was $45 million (refer here). In many instances, where these settlement amounts are not designated as an increase in the acquisition price, these settlement amounts may be insurable.

And not only have these cases become more expensive in every way, there are signs that the competition between jurisdictions could even further exacerbate this situation. At November 11, 2011 Columbia Law School conference about the Delaware Chancery Court, various observers commented on the question of whether the Delaware courts, the traditional forum for this type of litigation, were losing “market share” to other jurisdictions’ courts, possibly because plaintiffs’ lawyers believe they (and their clients too, don’t forget) think they can do better elsewhere.  Francis Pileggi has a good summary of the discussion at the conference in a November 11, 2011 post on his Delaware Corporate & Commercial Litigation blog (here).

As Alison Frankel discussed in a November 14, 2011 post on her Thomson Reuters News and Insight blog, here, this debate compelled one Delaware jurist to conduct a visual demonstration to try to prove that plaintiffs’ lawyers can expect to recover substantial fees in Delaware courts. It is an obvious concern if Delaware’s judges feel obliged -- in order remain competitive in the jurisdictional competition and to try to preserve declining market share -- to prove that plaintiffs’ lawyers will be rewarded for resorting to the state’s courts.

Discussion

Contrary to popular perception, the new M&A litigation model represents both a high frequency and a high severity risk. The severity risk is particularly acute given the exacerbating effects of escalating defense expenses and rising plaintiffs’ attorneys’ fees. Increasingly, M&A litigation is a recurring and very expensive feast for which D&O insurers are picking up increasingly larger tabs.

Another important point that should not be lost here is what the increasing risk of M&A related litigation means in combination with the ongoing risk of securities class action litigation. When all of the factors are considered – including the declining number of public companies and the increasing absolute number of lawsuits – it is apparent that publicly traded companies today  face a significantly increased risk of serious corporate and securities litigation than they did in the recent past.

Indeed, the probability of a U.S.-exchange listed company facing a merger lawsuit or a securities class action lawsuit in 2010 was more than double what the equivalent probability was as recently as 2006, as the number of public companies has declined and the number of lawsuits has increased. To be specific, the probability in 2006 that any given public company would get hit with a merger lawsuit or securities class action lawsuit was 2.8%; the equivalent probability in 2010 was 5.7%.  The probability of any given company being involved in serious corporate and securities litigation has never been greater.

All of these developments mean that publicly traded companies’ litigation risks represent an increasingly  serious and expensive problem, and that M&A-related litigation is increasingly a big part of that problem – in general, of course, but also for the companies’ D&O liability insurers as well.

Now, I am not the first to make some of these points about M&A-related litigation. But I think there still is a perception that if M&A-related litigation represents a problem for the D&O insurance industry, it is principally a problem for the insurers that are active in providing primary D&O insurance (refer for example here), and that this is not a problem for the carriers that confine their public company D&O exposures to the excess layers. The point I hope the above analysis gets across is that when you take into account the defense expenses, the plaintiffs’ fees and the M&A related indemnity exposure, the M&A-related litigation increasingly represents a risk for all of the carriers in companies’ D&O insurance programs. M&A litigation increasingly involves a threat of a flame-through loss, increasingly approaching the order of magnitude of securities class action litigation.

With both increasing frequency and severity, the casual observer might well assume that pricing for D&O insurance would also be increasing. The casual observer’s assumption would, however, fail to take into account the iron laws of supply and demand. There are more D&O insurers now than there were ten years ago, representing in the aggregate much greater levels of insurance capacity, while at the same time, there are many fewer public companies. What you have are increasing numbers of D&O insurers chasing decreasing numbers of public company D&O insurance buyers.  As a result, overall industry pricing has declined steadily since 2003.

It might well be asked how long this combination of circumstances in the D&O insurance marketplace can continue. Some commentators are already proclaiming that they thing they see a market turn on the horizon. I am making no predictions. I have been in this business one way or the other for nearly three decades and I think that every single day during that period someone has been predicting a hard market. We are still waiting. All I know is that if someone were looking around for reasons to explain increasing D&O insurance pricing (if it were in fact increasing), they wouldn’t have to struggle to find explanations. However, I also know that the insurance industry rarely changes as an act of will – it usually changes only as a matter of necessity. Until necessity requires, then, the D&O insurance industry likely will continue on in the same direction – even as the dashboard indicator lights flash caution.

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Overall levels of corporate and securities litigation declined during the third quarter of 2011 relative to recent quarters but 2011 annualized filings remain above historical levels, according to a recent report from the insurance information firm Advisen entitled “Securities Litigation Activity Dips, An Advisen Report: Q3 2011,” which can be found here. My own survey of the third quarter 2011 securities litigation filing activity can be found here.

Preliminary Notes

It is critically important to recognize that the Advisen report uses its own unique vocabulary to describe certain of the corporate and securities litigation categories.

The “securities litigation” and “securities suits” analyzed in the Advisen report include not only securities class action lawsuits, but a broad collection of other types of suits as well, including regulatory and enforcement actions, individual actions, derivative actions, collective actions filed outside the U.S. and allegations of breach of fiduciary duty. All of these various kinds of lawsuits -- whether or not involving alleged violations of the securities laws -- are referred to in the aggregate in the Advisen report as "securities suits."

One subset of the overall collection of "securities suits" is a category denominated as "securities fraud" lawsuits, which includes a combination of both regulatory and enforcement actions, on the one hand, and private securities lawsuits brought as individual actions, on the other hand. However, the category of "securities fraud" lawsuits does NOT include private securities class action lawsuits, which are in their own separate category ("SCAS").

Due to these unfamiliar usages and the confusing similarity of category names, considerable care is required in reading the Advisen report.

The Report’s Findings

There were 316 “securities suits” (as that phrase is used in the Advisen report) during the third quarter of 2011, which is down from the 367 “securities suits” filed in 2Q11 and 421 filed in 1Q11. This quarterly decline is attributable in part to the decline of breach of fiduciary duty suits (primarily merger objection suits) in 3Q11, when there were 76 breach of fiduciary duty suits filed, compared to 130 filed in the year’s second quarter.

In addition, the quarterly decline in overall corporate and securities lawsuit filing activity is also due in part to the decline in 3Q11 compared to 1Q11 in what the Advisen report calls “securities fraud suits” (which as noted above encompasses both regulatory actions as well as private securities lawsuits brought as individual rather than class actions). According to the study, the number of these so-called “securities fraud suits” declined to 109 in the third quarter, compared to 156 in the first quarter and 101 in the second quarter.

According to the Advisen study, the number of securities class action lawsuits filed during the third quarter was also down relative to the second quarter. The Advisen study reports that there were 56 securities class action lawsuits filed during 3Q11, compared to 61 during the second quarter. Though the third quarter filings were down relative to the prior quarter, the third quarter filing activity level was higher than the 2010 quarterly filing average of 47. Over 70 percent of Q311 class action lawsuit filings named companies in four sectors as defendants: information technology, healthcare, financial and industrial.

Litigation involving non-U.S. companies, filed both in the U.S. and elsewhere, was an important part of “securities suit” filings during the third quarter and overall during 2011. In the first three quarters of 2011, 16 percent of all “securities suits” were filed against non-U.S. companies, compared to 11 percent for both 2009 and 2010. During the third quarter, fifteen percent of all “securities suits” were filed against non-U.S. companies, down from 19 percent during the second quarter.

With respect to this activity involving non-U.S. companies, an increasing percentage of this “securities suit” activity is outside the U.S. The study reports that in the first three quarters of 2011, there were 55 “securities suits” filed in courts outside the U.S., 17 of which were filed during the third quarter. These 55 cases represent five percent of all YTD “securities suits,” which is “higher than the 3-percent level recorded in most recent years.”

Many of the cases involving non-U.S. companies in U.S. court involve Chinese companies. The number of “securities suits” filed in U.S. court involving Chinese companies has rise from five in 2009 to 24 in 2010, and up to 55 during the first three quarters of 2011.

Even though we are now well past the peak of the credit crisis (at least as a temporal matter if not as an economic matter), overall corporate and securities litigation activity remains highly concentrated in the financial sector. According to the Advisen report, 35 percent of all “securities suits” filed during the third quarter targeted companies in the financial sector. A large portion of the “securities suits” filed against financial companies in the third quarter involve regulatory actions, as 48 percent of all “securities suits” filed against financial companies involved regulatory actions.

But while the filing activity concentration in the financial sector remains elevated, the 3Q11 “securities suits” were “more broadly dispersed” during the quarter “than in previous years, especially compared to 2008 and 2009.” Suits against information technology firms and healthcare companies each represented 13 percent of all “securities suits,” while suits against industrials represented 11 percent of all such suits.

The average value of settlements of “securities suits” during the third quarter was $17.4 million, down from $22.8 million in the second quarter and from $18.2 million for all of 2010. The average securities class action lawsuit settlement during the quarter was $45.7 million.

Advisen 3Q11 Securities Litigation Webinar: On Thursday November 17, 2011 at 11:00 am EST, I will be participating in one-hour long Advisen webinar to discuss third quarter 2011 corporate and securities litigation filing activity. The panelists for this free webinar will also include Steve Gilford of the Proskauer law firm, Alliant Insurance’s Susanne Murray, and Advisen’s Dave Bradford. The panel will be moderated by Advisen's Jim Blinn. More information about this free webinar, including registration information, can be found here.

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Turns out that while some of us were wondering when the lawsuits arising out of the current bank wave would really start to accumulate, the FDIC itself was busy filing lawsuits -- they just didn’t tell anybody about it, at least not until now. Specifically, the FDIC filed three more lawsuits in August than had previously come to light. At a minimum, these lawsuits suggest the FDIC has been more active in pursuing its litigation strategy than may have been perceived. The suits also suggest that the FDIC’s declarations about its planned litigation strategy are very much in earnest.

The three newly publicized lawsuits, each of which were filed by the FDIC in its capacity as receiver of a failed bank, are as follows:

First, on August 8, 2011, the FDIC filed a lawsuit in the Eastern District of Michigan against a single former loan officer at Michigan Heritage Bank, of Farmington Hills, Michigan, which failed on April 24, 2009 (about which refer here). A copy of the complaint in this lawsuit can be found here. The complaint alleges that the individual, whom the complaint alleges had been CEO of a different Michigan bank that failed in 2002, caused the bank to incur losses in excess of $8.2 million. The complaint, which asserts claims of negligence, gross negligence and breach of fiduciary duty, alleges among other things that the lending officer “failed to conduct due diligence and analysis prior to originating and recommending approval of 11 commercial loans that resulted in losses” and “failed to adequately inform [the Bank’s] board of directors and senior management of deficiencies with respect to those loans.”

Second, on August 9, 2011, ,the FDIC filed a lawsuit in the District of Kansas against six former officers and directors of the Columbian Bank and Trust Company, of Topeka, Kansas, which failed on August 22, 2009 (about which refer here). The FDIC’s complaint in this lawsuit can be found here. The FDIC seeks to recover losses of at least $52 million the bank allegedly suffered because the defendants allegedly “negligently, grossly negligently, and in breach of their fiduciary duties originated and/or approved poorly underwritten large commercial and commercial real estate loans … and failed to properly supervise the Bank’s lending function.” The FDIC also alleges that the defendants (one of whom owned or controlled the bank’s holding company) “failed to heed the warnings of bank supervisory authorities.”

Third, on August 10, 2011, the FDIC filed a lawsuit in the Eastern District of North Carolina against nine former directors and officers of the Cooperative Bank, of Wilmington, North Carolina, which failed on June 19, 2009 (about which refer here). The FDIC’s complaint in this action can be found here. The complaint alleges that defendants “failed to manage the inherent risks associated with their aggressive growth strategy” and “permitted a lax loan approval process.” The complaint further alleges that through out the period 2005 through the bank’s failure, state and federal regulators “repeatedly warned” the bank’s management and board “about the risks associated with its high concentrations in speculative loans and weaknesses in lending functions,” yet the bank’s board “permitted and approved” the bank’s continued lending practices. The FDIC alleges that the defendants’ negligence, gross negligence and reckless conduct “ultimately led to the bank’s failure.”

There are a number of interesting things about these three new lawsuits, beyond the fact that they were filed on three successive days in August. For one thing, all three involved banks that failed more than two years before the complaints were filed. The timing of the filings relative to the earlier closures says something about the FDIC’s internal timetable for working up potential lawsuits. Another thing about these lawsuits are that the involve banks in states that have not been particularly hard hit during the current bank failure. By and large the bank failures have involved banks in just a few states, particularly Georgia, Illinois, California and Florida. Hard to know for sure what it signifies, but it is interesting that none of these suits involve banks from those hard hit states.

Another interesting thing about these suits is that all three involve relatively small banks. The Michigan Heritage bank lawsuit  involves a single mid-level lending officer and relatively modest losses on a relatively small number of loans. The implication seems to be that the FDIC intends to be very thorough and that there are not going to be cases that are too small to bother with. This is a salvage operation, pure and simple, and the FDIC is going to recover everything it can, no matter how small.

In any event, when these three additional lawsuits are taken into account, the total number of lawsuits that the FDIC has filed against former directors and officers of failed banks as part of the current bank failure wave is now up to fourteen, five of which were filed in August, and half of which were filed since June 30, 2011. The fact that these suits were filed in August and are just coming to light now suggests the possibility that there could be other FDIC lawsuits that have been filed but that have not yet surfaced.

Whether or not there are other filed but not yet publicized suits out there, it is clear there are many more lawsuits to come. On its website, the FDIC has said that as of September 13, 2011, the agency has approved lawsuits involving suits in connection with 32 failed institutions against 294 individuals with damage claims of at least $7.2 billion. The FDIC’s fourteen lawsuits to date involve only 103 directors and officers. The implication is that there are at least 18 more lawsuits yet to be filed – and that is only taking into account the lawsuits that have been approved as of September 13, 2011. There undoubtedly will be many lawsuits approved in the months ahead, with additional filings to follow after that.

Given the two year lag time between failure date and filing date that these three lawsuits described above demonstrate, and given the fact that the pace of bank failures only really accelerated during late 2009 and early 2010, it seems likely that the failed bank filings will not only continue well into at least 2012, but that over the next few months the pace of failed bank lawsuits could really take off. 

Indeed, one of the clear implications of the FDIC’s lawsuit filings during August of this year is that the agency’s declared litigation strategy is for real. The FDIC clearly does intend to pursue the active litigation strategy it has laid out on its website. And in light of these latest filings, the FDIC’s litigation approach clearly will not be limited just to the largest banks, but could well involve many smaller failures as well.

To be sure, the FDIC’s approach does not necessarily require an actual lawsuit in every case. Early on in connection with many of the bank failures, the FDIC has submitted notices of claim to the failed banks’ former directors and officers and to the failed bank’s D&O insurance carriers. In many cases, the FDIC may attempt to try to negotiate a settlement with the former directors and officers and the D&O carriers, without the actual filing of a civil action.

Reliable sources advise me that that is in fact exactly what happened in connection with one large failed bank in Florida. Apparently, the FDIC was able to negotiate a settlement in connection with the failed bank without actually filing a lawsuit against the failed bank’s former directors and officers. To the extent the FDIC pursues this approach in other cases and succeeds in negotiating settlements, there could ultimately be fewer complaints. In view of the fact that this approach would avert the erosion of the D&O insurance limits of liability by the payment of defense expenses, this approach could actually result in improved recoveries.

But though there may be cases where actual lawsuit filings are averted, the likelier scenario in many cases is that there will be an FDIC lawsuit. With the revelation of the FDIC’s August lawsuit filings, and the suggestion that the FDIC is now actively pursuing its litigation strategy, it is clear that the game is on. For months to come, one of the predominant stories on the directors and officers’ liability scene will be the FDIC’s pursuit of growing numbers of failed bank lawsuits against the former directors and offices of the failed institutions

.

One final note. The FDIC’s website makes it clear that its litigation strategy is not limited just to suits against former directors and officers. The site says that the agency has “also has authorized 20 fidelity bond, attorney malpractice, and appraiser malpractice lawsuits. In addition, 175 residential malpractice and mortgage fraud lawsuits are pending, consisting of lawsuits filed and inherited.”

Active Self-Defense: As discussed in prior posts (refer for example here), the individuals dragged into the failed bank lawsuits will rely on a number of theories in order to try to defend themselves. Former Indy Mac Chairman and CEO Michael Perry is taking a different approach. He has launched a website called “Not Too Big to Fail” (here) on which he is attempting to defend himself against charges the FDIC has asserted against him and other former IndyMac executives.

As discussed here, in July 2011, the FDIC filed a lawsuit in the Central District of California against Perry. The FDIC alleges that Perry acted negligently when he allowed IndyMac to generate and purchase $10 billion in loans when the secondary mortgage market was becoming illiquid. When IndyMac was later unable to sell the loans, the bank transferred them to its own investment portfolio, which then caused over $600 million in losses. Perry has also been named as a defendant in other lawsuits arising out of IndyMac’s July 2008 failure.

On his website, Perry asserts that “not one of the lawsuits against me has merit.” He says that “I and the management team and directors of IndyMac Bank made prudent and appropriate business decisions based on the facts available to us at the time and always with the primary goal being to keep IndyMac bank safe and sound.”

The name of the site is taken from Perry’s complaint that IndyMac did not receive government bailout funds that were made available to other banks. He asserts that this occurred because IndyMac was “not too big to fail.”

Though Perry’s website represents a rather impressive display of self-justification, it seems unlikely that his Internet-based public relations campaign will accomplish much. I suppose though for someone in Perry’s position there is some satisfaction involved with telling off the regulators, even if it is unlikely to change the outcome of any of the claims against him. The one thing that is clear is that Perry is both unrepentant and defiant.

Well, Maybe Next Year: For those who missed the allusion in the title of this blog post, the reference was to the lyrics of the song “Send in the Clowns,” from Stephen Sondheim’s Broadway musical A Little Night Music. The lyrics include these lines: “Sorry my dear/ But where are the clowns?/Quick, send in the clowns/Don’t Bother, they’re here.”  

Although many have sung this tune, it is has perhaps become most closely associated with Judy Collins. There are actually a surprising number of verions on You Tube of Judy Collings singing this song. Here's an audio only version:

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Every fall since I first started writing this blog, I have assembled a list of the current hot topics in the world of directors’ and officers’ liability. This year’s list is set out below. As should be obvious, there is a lot going on right now in the world of D&O, with further changes just over the horizon. The year ahead could be very interesting and eventful. Here is what to watch now in the world of D&O:

1. How Massive Will the Total Cost of the Subprime and Credit Crisis Litigation Wave Turn Out to Be?: Even though the subprime and credit crisis-related litigation wave is now well into its fifth year, only a small number of the cases have settled. But in recent weeks, a number of cases have settled in quick succession, and these settlements have been very substantial.

The recent settlements include the largest so far in subprime and credit crisis-related cases, the $627 million Wachovia bondholders settlement, about which refer here. Other settlements include the following: Washington Mutual, $208.5 million (refer here); Wells Fargo Mortgage Backed Securities, $125 million (refer here); National City, $168 Million (refer here); Colonial Bank, $10.5 million (refer here); and Lehman Brothers executives, $90 million (refer here).

With these latest settlements (many of which are subject to court approval), there have now been a total of 29 settlements collectively representing a total of almost $3.4 billion, for an average settlement of $116 million (although that average is obviously skewed upward by the $627 million Wachovia bondholders settlement and the $624 million Countrywide shareholders settlement)

As impressive as these cumulative numbers are, there are still many more cases pending. Of course, a certain number of the pending cases will ultimately be dismissed. But many will not, and eventually those remaining cases will be settled. Although it is impossible to conjecture how large  the total tab for all these cases ultimately will be, the implication from the cases that have settled is that the total amount will be massive.

The possibilities here may have significant implications for D&O insurers. Of course, not all of these amounts will be covered by D&O insurance. But a significant chunk will be. Indeed, a number of the recent settlements will be funded entirely by D&O insurance, including the WaMu settlement, the Colonial Bank settlement and the Lehman Brothers settlement. Interestingly, the Lehman settlement will come close to exhausting what is left of Lehman’s $250 million insurance tower.

In other words, the D&O insurers have had some very big bills to pay and could have some even bigger bills to pay in the months ahead. To the extent the ultimate loss amounts are fully reserved, these funding requirements will not cause a problem. But to the extent the carriers have not adjusted their loss reserves in anticipation of these losses, the cumulative impact of the coming settlements could be disruptive.

2. How Extensive Will the FDIC’s Failed Bank Litigation Efforts Become?: Since January 1, 2008, 392 banks have failed, including 70 so far in 2011 (as of September 2, 2011).  Fortunately, though the closures are continuing to mount, it appears that the failures finally may be starting to wind down. Since the current wave of bank closures began, there have been concerns that, just as it did during the S&L crisis in the late 80s and early 90s, the FDIC will again aggressively pursue claims against the directors and officers of the failed banks. At least so far, the FDIC’s litigation activity has been relatively modest. However, the signs are that the FDIC has merely been gearing up, and that substantial numbers of failed bank lawsuits could be just ahead.

As of September 2, 2011, there have been a total of eleven FDIC lawsuits against the directors and officers of failed banks. A number of these were filed in quick succession in August, raising the possibility that the apparent backlog of FDIC lawsuit filings may finally be starting to work out. There clearly are more cases to come. The FDIC’s website states that the agency has authorized suits in connection with 30 failed institutions against 266 individuals for D&O liability with damage claims of at least $6.8 billion. The eleven cases the FDIC has filed so far involve only 77 individuals. Even just taking account of the lawsuits that have already been authorized, there are many more suits to come, and undoubtedly even more lawsuits will be authorized.

The latest round of failed bank litigation has been very slow to develop. But at this point it seems likely that for the next several years there is going to be a very significant amount of FDIC litigation involving the directors and officers of failed banks. Moreover, the litigation will not be limited just to cases brought by the FDIC. Many of the failed banks were publicly trade or otherwise have broad and diverse ownership, and in many instances the bank failures have been followed by shareholder litigation. These shareholder suits represent competing claims for the D&O insurance policy proceeds. The competing claimants will be vying to secure the dwindling limits, adding a layer of complexity both for the defendants and for the FDIC.

3. Will the Failed Bank Litigation Be Accompanied by a Wave of Coverage Litigation?: During the S&L crisis, the FDIC was involved in extensive litigation to try to establish coverage under D&O insurance policies. Many of the leading cases on the Insured vs. Insured exclusion arose out of this litigation (about which refer here), and the Regulatory Exclusion was also extensively litigated (refer here).

The signs are that there could be extensive coverage litigation this time around too. Indeed, when the FDIC recently filed a lawsuit against the former directors and officers of the failed Silverton Bank, it included the bank’s D&O insurers as named defendants. As discussed here, the FDIC’s claims against the D&O insurers in the lawsuit involve the insurers’ attempt to deny coverage for the claim under the Regulatory Exclusion.

The FDIC may not be the only litigant involved in D&O insurance coverage litigation. As multiple defendants struggle with the problems associated with too many claims and too many insured persons, the various defendants will want to sort out their entitlement to the policy proceeds. For example, as discussed here, a subsidiary of the failed IndyMac Bank, which is a defendant in a number of lawsuits arising out of the bank’s failure, recently attempt to obtain a judicial declaration of coverage in order to sort out who was entitled to what under the bank’s D&O policies. Although the subsidiary’s claims were dismissed for lack of standing, the case does show that a variety of parties may be interested in using litigation as a way to establish their rights to the proceeds of D&O insurance.

The coverage litigation will hardly be limited just to D&O insurance. A recent coverage action in Alabama involved the coverage disputes involving a failed bank’s bond (refer here). There are also likely to be coverage disputes involving errors and omissions insurance. And as other outside professionals, such as accountants and lawyers, get dragged into these cases, there will likely be coverage litigation involving their professional liability policies.

For those of us who were involved in the failed bank coverage litigation during the S&L crisis, the return of these types of coverage cases has a very familiar feeling.

4. Will the Dodd-Frank Whistleblower Provisions Lead to More Claims? And How Will the D&O Insurers Respond?: Among the parts of the Dodd-Frank Act that may have a significant impact on claims is the Act’s whistleblower provisions. The whistleblower provisions include the creation of a new whistleblower bounty pursuant to which individuals who bring violations of securities and commodities laws to the attention of the Securities and Exchange Commission or the Commodities Futures Trading Commission will receive between 10 percent and 30 percent of any recovery in excess of $1 million. The SEC recently promulgated rules implementing these provisions.

While it is too early to tell what impact the bounty provisions will ultimately have, most observers expect that the substantial incentives provided by the whistleblower provisions will lead to an increased number of whistleblower reports and that these reports will lead to investigations and enforcement actions. In some instances, the revelations in the whistleblowers’ reports will also lead to follow-on civil litigation, as aggrieved shareholders or others pursue claims for misrepresentation or mismanagement. These follow on claims represent one type of potential increase claims exposure arising from the whistleblower provisions. But the possibility of increased numbers of investigations and enforcement actions present their own sets of issues.

One of the perennial issues in D&O coverage litigation is the question of policy coverage for regulatory investigations. Individual directors and officers typically covered (depending on policy wording) for both informal inquiries and requests for information, and civil, criminal, administrative or regulatory investigations commenced by either the issuance of a Target Letter or Wells Notice, or after the service of a subpoena. The company itself rarely has coverage for these types of investigations, except when it was named with an individual directors and officer in a “formal” SEC investigation. There typically is no coverage for the Company for responding to informal inquiries and requests for information from the SEC.

Many of these issues were discussed in the Second Circuit’s July 1, 2011 opinion in the MBIA case (about which refer here), which held that, under the specific policy language at issue and under the circumstances presented, MBIA’s D&O insurance policies covered the investigative and special litigation expense the company incurred during a regulatory investigation of its accounting practices.

Recently, one D&O insurance carrier introduced a new insurance product intended to provide entity coverage for these costs of investigation, as discussed here.  Due to problems of cost, as well as to the high deductibles and coinsurance that the carrier is requiring, this product is still looking for widespread acceptance. But the product’s introduction shows that the D&O insurance industry is working to try to find insurance solutions to the growing need for solutions addressing the regulatory investigation risk. To the extent the new whistleblower provisions mean increased numbers of investigations, companies will be increasingly interested in finding insurance products that address these risks.

5. What Will be the Next “Hot” Litigation Target?: From time to time, a sector or industry will find itself as the target of plaintiff securities class action attorneys. Last summer, for a brief period, the hot sector was the for-profit education section. Since then, the hot target has been U.S.-listed Chinese companies. This year alone, there have been 32 cases filed against U.S-listed Chinese companies (through September 2, 2011).

This surge of litigation involving Chinese companies has arisen out of accounting scandals, many of which were first revealed by online analysts, many of whom have short positions in the companies they are attacking. The Chinese companies have attempted to deflect the assertions of accounting improprieties by charging that the online attacks were merely rumors started by those with a financial incentive to drive down the companies’ share price. Fair or not, the online reports seem to be leading directly to shareholder litigation, as in many cases the shareholder plaintiffs are simply quoting the online analysts’ reports in their complaints.

For now, the phenomenon shows no sign of letting up, as the lawsuits involving the U.S.-listed Chinese companies have continued to accumulate as the year’s second half has progressed. Indeed, between July 1, 2011 and September 2, 2011, there were a total of 6 of these Chinese companies sued in new securities class action lawsuits in the U.S.

The recent litigation outbreak involving the U.S.-listed Chinese companies is a reminder of circumstance-specific events that can drive securities class action lawsuit filings. Many things determine filing levels, many of which cannot be captured or predicted in historical filing data. As a result, it can be misleading to try to generalize from short term trends about future filing levels. Simply put, the numbers vary over time, because, for example, contagion events and industry epidemics happen.

6. Will M&A Litigation Continue to Surge?: One of the more interesting phenomena in the world of corporate and securities litigation has been the changing mix of litigation. As recently as just a few years ago, securities class action lawsuits represented a significant percentage of all corporate and securities lawsuits. The insurance information firm Advisen has documented that in more recent years, class action securities litigation has represented an increasingly smaller percentage of all corporate and securities lawsuits. One area that has been growing as a percentage of all corporate and securities litigation has been M&A related litigation.

According to Advisen, in 2010, there were 353 lawsuits challenging corporate mergers filed in state and federal courts, which represents a 58% increase over 2009. As of August 27, 2011, 352 M&A related lawsuits had already been filed, putting this year’s filings to far exceed last year’s.

As discussed in an August 27, 2011 Wall Street Journal article entitled “Why Merger Lawsuits Don’t Pay” (here), these lawsuits rarely produce substantial damage awards. Often, the most they succeed in accomplishing is a delay in the merger or slightly improved disclosures about the deal’s terms. The reason these lawsuits continue to be filed, and indeed continue to be filed in increasing numbers, is that these cases are good business for the plaintiffs’ firms. These firms can collect fees that range from $400,000 for typical cases to millions of dollars for bigger cases.

In the past, these types of cases have not represented a significant claims exposure for D&O insurers. However, now that so many more of them are being filed, and now that individual merger deals are now attracting multiple claims, these cases are becoming a much bigger problem for the D&O insurers, particularly those that are the most active as primary insurers. A basic assumption of the D&O insurance industry is that D&O claims represent a low frequency, high severity threat. But these M&A claims are exactly the opposite – they represent a high frequency, low severity exposure, for which the D&O insurers likely did not price and almost certainly cannot underwrite. And even if the typical case settles for relatively modest amounts, the claims costs including defense fees are now in the aggregate becoming an issue for the D&O insurers.

In the current competitive marketplace (about which see more below), the D&O insurers may not be able to do much about this problem, but this might among the first areas to which D&O insures turn if the market does start to firm. Among other things, the D&O insurers might require higher self-insured retentions for these types of claims, on the theory that they really represent a cost of doing business rather than a true third-party liability exposure.

7. Will the U.S. Supreme Court Continue Its Inexplicable Willingness to Take Up Securities Cases?: Years from now, when the history of the Roberts Court is finally written, perhaps the historians will be able to explain why during the second half of the first dozen years of the 21^st Century, the Court was so eager  to take up securities cases. The Supreme Court is just coming off a term in which the Court heard three different securities cases, and it has already agreed to take up one more case in the term that is about to begin.

The case that the Court has already agreed to hear next year is the Credit Suisse Securities case, and it involves statute of limitations issues arising in connection with Section 16(b) claims for short-swing profits. This narrow, technical issue is unlikely to have widespread significance. But what is significant is that yet again this Court has taken up a securities case. There doesn’t seem to be any particular member of the Court that is driving the Court’s interest in securities cases. But for whatever the reason, the Court’s docket increasingly includes these types of cases. Though there is only one case now on the Court’s docket in the upcoming term, the Court can always choose to hear others – which is something the Court seems inclined to do.

The current Court does not always rule in the favor of the defendants. For example, this last term, in the Matrixx Initiatives case (refer here), the court rejected the defense argument that plaintiffs must show “statistical significance” in order to establish materiality in a securities lawsuit. In an earlier term, in the Merck case, the court rejected the defendants’ statute of limitations arguments (refer here). But many of the Supreme Court’s recent securities law decisions  have been in the defendants’ favor, and the Court’s rulings in recent terms in such cases as Janus Capital (refer here), Morrison (refer here), and Tellabs (refer here) represent significant defense victories that have or will have a significant impact in many cases on the plaintiffs’ ability to pursue securities claims.

The overall cumulative impact of the Court’s interest in taking up securities cases has been favorable to companies and unfavorable to plaintiffs. There is some speculation that the increased difficulty of successfully maintaining a securities class action lawsuit through the motion to dismiss may be one reason for the shift in the mix of corporate and securities litigation away from securities class action lawsuits and toward other types of litigation (like the M&A litigation, discussed above).

8. Will the Implementation of the U.K Bribery Act Mean Increased Anti-Bribery Enforcement Activity?: On July 1, 2011, the U.K Bribery Act became effective, as discussed here. The Act has a broad reach, regulating prohibited conduct that takes place within the U.K. or that involves a company or person that carries on business in the U.K., regardless of where the prohibited activity takes place. The Bribery Act is broader than the U.S.’s Foreign Corrupt Practices Act, reaching a broader range of prohibited activities and providing for greater possible liabilities for those at companies involved in these activities, even if not directly involved in the prohibited conduct.

From the time the Act received Royal Assent, one of its features that has been the focus of particular concern has been Section 7 of the Act. Section 7 creates a new offense which can be committed by commercial organizations that fail to prevent persons associated with them from committing bribery on their behalf. Commentators have been concerned that this provision seemingly would subject any firm --even non-U.K. companies that have operations in the U.K. – to liability under the Act for violative conduct taking place any where in the world.

Because the Act has only just become effective, it is not yet known how aggressively it will be implemented or what its overall impact will be. At a minimum, it seems likely that the Act will lead to an increase in enforcement activity. It is also possible that as has proved to be the case with enforcement actions under the U.S. Foreign Corrupt Practices Act, follow-on civil litigation will follow in the wake of regulatory enforcement activity.

As companies confront these developments, among the issues that are likely to arise are questions concerning coverage for these proceedings under their D&O insurance policies, as discussed in a prior guest post on this blog.  The Act’s fines and penalties are not likely to be covered under typical policies. Whether investigative costs and defense fees will be covered will depend on a large variety of circumstances, including who is the target of the investigation. How serious these problems will turn out to be will depend a lot on the Act’s implementation, a development that will be worth watching.

9. What Impact Will the Changing Corporate Governance Requirements Have?: Largely due to the 2010 enactment of the Dodd-Frank Act, we have entered a watershed period of corporate governance reform. Processes now afoot have wrought a transformation in the relations between corporate boards and corporate shareholders. These changes have not only created additional burdens on affected companies but they have also resulted in some cases in a change in the corporate litigation environment as well.

Among the changes the Dodd-Frank Act implemented is the requirement for an advisory shareholder vote on executive compensation. As a result of Section 951 of the Dodd Frank Act and the requirements of SEC rules that went into effect January 25, 2011, all but the smallest public companies had to put their executive compensation practices to an advisory shareholder vote this past proxy season. As it turns out, about 40 companies experienced a negative shareholder vote. In some cases the negative “say on pay” vote have been followed by shareholder litigation, by activist investors seeking to reform executive compensation practices, as discussed here.

The requirement for a shareholder “say on pay” is only one of many current corporate governance reform under discussion. Other areas include the question of proxy access – that is, the question whether shareholders can have their board candidates listed on the annual proxy form. The D.C. Circuit recently struck down the SEC’s rules requiring proxy access, but the issue is not likely to go away.

As discussed at length here, other current corporate governance issues include reforms such as board declassification and majority voting. Other issues that loom ahead as other provisions of Dodd-Frank go into effect include requirements that companies disclose the ratio between total annual compensation of their CEO and the median annual compensation of their employees (rules implanting these provisions are required to be adopted before the end of 2011).

Another provision of the Dodd Frank Act requires to SEC to direct the national exchanges to impose new listing standards directing public companies to implement compensation clawback provisions. Under Section 954 of the Dodd Frank Act, companies making accounting restatements of prior financials must recover from any current or former officer all incentive-based compensation paid during the preceding three-year period above what would have been paid without the misstated financials. These provisions are to be implemented by this year-end.

These various provisions will affect different companies in different ways. But it is clear that these changes are here to stay and that as a result companies and their management are operating in a challenging environment. Companies that resist these governance developments may face heightened levels of scrutiny, both from shareholders and from the media. Moreover, as corporate governance standards change, boards will be held to standards of conduct reflecting the changed governance norms and expectations. And in an era of growing shareholder empowerment, that reality may translate into increased judicial expectation for boards to address shareholder initiatives.

Taken together, these changes in the corporate governance environment mean heightened scrutiny, changing shareholder expectations, and even an increased litigation risk. How extensive these changes ultimately will prove to be remains to be seen as the additional provisions of Dodd Frank are put into effect in the months ahead.

10. What Does All of This Mean for the D&O Insurance Marketplace?: Given all of these trends and developments, an outside observer might reasonably expect that the marketplace for D&O insurance would be becoming more restrictive. And certainly with respect to certain categories, such as U.S.-listed Chinese companies and commercial banks, the marketplace for D&O insurance is challenging. However, outside of those very particularized categories, the marketplace for D&O insurance remains generally competitive. Most financially stable companies continue to be able to obtain broad terms and conditions at relatively attractive prices.

There is nothing specific to suggest that the generally competitive environment is about to change, at least immediately. But there are a number of considerations that could lead to change. The first is the cumulative impact of the year’s catastrophic losses. The various natural disasters this year, from the earthquakes in New Zealand and Japan to Hurricane (and tropical storm) Irene, have had an impact on the insurance industry’s collective balance sheet. If there were to be another significant event in the four remaining months of the year, the accumulated losses could be enough to force a pricing increase or to cause carriers (or at least some of them) to pull back.

Given the catastrophe events that have already occurred this year, carriers are likely to be scrutinizing their books. Many of the developments discussed above will undoubtedly lead the various carriers to take a close look at their D&O portfolios. The mounting losses from the subprime meltdown and the credit crisis; the looming impact of the wave of failed banks; and the difficulties and uncertainties associated with a changing litigation and legal environment are all likely to raise concerns. These concerns inevitably lead to questions about pricing adequacy, risk selection, and scope of coverage.

In light of all of these considerations, it would be very rational for the D&O insurance marketplace to enter a more restrictive phase. In some sectors that may already be happening. For example, even relatively healthy commercial banks are seeing increased pricing and reduced limits. Several carriers are pulling back in that space.

At the same time, though, the overall marketplace remains competitive. As long as capacity remains ample and competition active, most companies outside of the most troubled sectors apparently will continue to enjoy the benefits of a competitive marketplace for D&O insurance. The question is how long these conditions will continue. Time will tell of course, but if the wind blows or the earth shakes again, among the consequences could be a harder market for insurance generally and for D&O insurance in particular.  

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Labor Day has come and gone. The kids are back in school. The air is cooler and the nights are longer. There’s a definite autumnal feel in the air. It is time to get back to work. Fortunately, The D&O Diary kept its eye on things over the summer. So if you are feeling the need to get caught up on what happened while you were at the beach, don’t worry, we’ve got you covered. Here is a quick summary of what you missed on The D&O Diary while you were away.

Key Insurance Coverage Decisions: There have been several important D&O insurance coverage decisions in the last few months, two of them in the federal circuit courts. Probably the most significant decision of the summer is the Second Circuit’s July 1, 2011 ruling in the MBIA case, in which the Court held that the company’s D&O insurance policies cover the investigative and special litigation committee expense the company incurred during a regulatory investigation of its accounting practices.

The Fifth Circuit issued another important coverage ruling on August 5, 2011 when it held that where a policyholder has accepted a compromise payment from a primary carrier of less than the limit of liability of the primary policy, the excess carrier’s payment obligations were not triggered and the excess carriers has  no obligation to pay the policyholders‘ loss.

In another interesting coverage decision, the Judge William Q. Hayes of the Southern District of California held in an August 15, 2011 decision (refer here) that the D&O insurance policy at issue covered the attorneys’ fees of non-party employee witnesses.

Significant Developments in the Subprime and Credit Crisis-Related Litigation Wave: The subprime litigation wave began over four years ago but only a small number of the cases have been settled. As reflected in my running tally of subprime cases, even now only 29 of the cases have settled. But a number of these settlements were announced just in the past few weeks, and there is a definite sense that the movement of these cases toward settlement is gaining momentum.

The recent settlements in subprime and credit crisis-related cases included the largest subprime securities lawsuit settlement so far, the $627 million Wachovia bondholders settlement, about which refer here. Other subprime securities lawsuit settlements this summer included the following: Washington Mutual, $208.5 million (refer here); Wells Fargo Mortgage Backed Securities, $125 million (refer here); National City, $168 Million (refer here); Colonial Bank, $10.5 million (refer here); and Lehman Brothers executives, $90 million (refer here).

In other developments in the subprime and credit crisis cases, two appellate courts affirmed the lower courts’ dismissals of a couple of subprime cases. On May 24, 2011, the Eleventh Circuit affirmed the dismissal of the HomeBanc case (refer here), and on August 23, 2011, the Second Circuit affirmed the dismissal of the action that had been brought on behalf of the Regions Financial trust preferred securities holders (refer here).

There were also dismissal motion denials in two of the higher profile cases. First, on July 27, 2011, Southern District of New York Judge Lewis Kaplan denied the motion to dismiss in the Lehman Brothers case (about which refer here; as noted above, the Lehman Brothers executives settled the case against them shortly thereafter). And as discussed here, on July 29, 2011, Southern District of New York Judge Kevin Castel granted in part and denied in part the renewed motions to dismiss in the BofA/Merrill Lynch merger case.

FDIC Failed Bank Litigation Mounts: The current wave of bank failures is now several years old. Over 390 banks have failed since January 1, 2008. Yet the FDIC has filed lawsuits involving former directors and officers of failed banks in only a very small number of instances. In the past several weeks, however, the FDIC has launched several new lawsuits and there is a definite sense that the lull in FDIC lawsuit filings may be over.

Just in the last few weeks, the FDIC has filed lawsuits involving the former CEO of IndyMac bank (about which refer here); former directors and officers of Haven Trust bank (refer here); former directors and officers of Silverton bank (refer here); and First National Bank of Arizona (refer here). The Silverton bank case is particularly interesting because, as I discuss in my blog post about the lawsuit, the defendants that the FDIC named in the lawsuit include the bank’s D&O insurers.

With these latest filings, the FDIC has now filed a total of eleven cases involving former directors and officers of failed banks. But the likelihood is that there are more cases to come, perhaps many more. The FDIC’s own website states that the agency has authorized suits in connection with 30 failed institutions against 266 individuals for D&O liability with damage claims of at least $6.8 billion. The lawsuits the FDIC has filed so far involve only eleven failed institutions and 77 individuals. Even just taking account of the lawsuits that have already been authorized, there are many more suits to come, and undoubtedly even more lawsuits will be authorized.

Mid-Year Securities Litigation Studies Released: All of the leading statistical services issued their respective studies of securities class action lawsuit filings for the first six months of 2011. My post about the Cornerstone Research study can be found here; the NERA Economic Consulting study, here; and the Advisen study, here. My own analysis of the first half filings can be found here.

Supreme Court Issues Key Rulings: It already seems like a long time ago, but at the end of the Supreme Court’s term in June, the Court issued its opinions in several key cases. First, in a June 6, 2011 opinion (about which refer here), the Supreme Court held in the Halliburton case that proof of loss causation is not required at the class action certification stage. On June 13, 2011, the Court held in the Janus Capital case (refer here) that a mutual fund management company cannot be held liable for the alleged misstatements in the prospectuses of the mutual funds that the management company administered.

And finally, on June 20, 2011 the Court held in the Wal-Mart Stores v. Dukes case (refer here) that the gender discrimination claimants did not allege a companywide pattern of discriminatory practices and therefore their case could not proceed as a class action. (Earlier in the year, the Supreme Court also issued its opinion in the Matrixx Initiatives case, refer here, in which the Court rejected the “statistical significance” test for securities suit materiality.)

Consistent with the inexplicable interest the Court has shown in recent years in taking up securities cases, the Court has already granted a writ of certiorari for yet another securities case to be heard in the upcoming term. As discussed here, the Court has agreed to hear the Credit Suisse Securities case, which involves statute of limitations issues in Section 16(b) short-swing profits cases.

Litigation Against U.S.-Listed Chinese Companies Continues to Surge: As I have noted in several posts, most recently here, one of the most distinct securities litigation trends over the last twelve months or so has been the surge in litigation involving U.S.-listed Chinese companies. Signs are that this litigation surge is continuing, as the filings involving these companies have continued to accumulate so far in  the second half of the year, about which refer here. While some have questioned the merits or value of these cases, at least one of these cases recently survived a motion to dismiss, as discussed here.

These cases raise a number of important D&O insurance issues for these companies. A July 14, 2011 Client Advisory that I co-authored (about which refer here) examines the critical D&O insurance issues that these companies face and reviews the questions these companies should be asking about their D&O insurance.

Keynote Speeches at the Stanford Directors’ College: In June, I attended the Stanford Law School Directors’ college as a member of the event faculty. While there I was able to monitor the keynote speeches, about which I reported in a series of blog posts. The key note speakers included SEC Commissioner Troy Paredes, about whose presentation I wrote here; Delaware Supreme Court Chief Justice Myron Steele, whose speech I wrote about here; and SEC Enforcement Division head Robert Khuzami, about whose presentation I wrote here.

Debating Director Liabilities: As part of this blog’s continuing mission to explore the issues surrounding the liabilities of corporate directors and officers, I posted a couple of commentaries this summer discussing  whether and to what extent directors should be held responsible when problems occur at their companies.

First, on June 13, 2011, I published a post here examining the question of whether or not directors should be held liable more often. And on August 5, 2011 (here), I reviewed the question of whether or not directors at companies that have failed should be stigmatized for their association with the failed companies. Finally, on a related topic, in an August 15, 2011 post, I took a look here at issues surrounding the potential liabilities of former directors of failed banks.

Guest Posts: One of the great privileges of maintaining this site is that from time to time I am honored to be able to publish guest posts from leading commentators and observers. Over the course of this summer, I was fortunate to be able to publish several guest posts, including posts from the following authors and on the following topics: Anjali Das on the U.K. Bribery Act (here); Angelo Savino on the applicability of the Morrison decision to SEC enforcement actions (here); Rick Bortnick and Micha J.M. Knapp on the significance and implications of the Second Circuit’s decision in the MBIA case (here); Anjali Das again, on the issues surrounding the lawsuits against Chinese reverse merger companies (here); and Paul Ferrillo on the question of insurance coverage for investigative costs in light of the revisions of the Dodd-Frank Act (here).

Finally, just this past week, I published a post (here) by Mary Gill, Robert Long and Todd Chatham about the issues and concerns surrounding the defense of former directors and officers of failed banks in FDIC litigation.

I am very grateful to all of these authors for their willingness to publish their articles on this site. I am interesting in receiving guest post submissions from responsible commentators on topics of interest to readers of this blog. If you are interested in submitting a guest post, please contact me.

Coming Attractions: Tomorrow I hope to post my annual fall survey, “What to Watch Now in the World of D&O.” Obviously due to their significance, many of the items referenced above will also appear in tomorrow’s post, albeit discussed in greater depth, and there will be many additional topics as well.

ABA TIPS Commemorates 9/11: In recognition of the tenth anniversary of 9/11, the Tort, Trial and Insurance Practice Section (TIPS) of the American Bar Association is sponsoring a series of educational events. Among these events will be a teleconference sponsored by the TIPS Professionals, Officers and Directors Committee scheduled for September 16, 2011 from 12:00 to 1:30 Eastern Time, entitled “9/11 Attacks on the World Trade Center: Duties of Corporate Directors and Officers in the Preparation and Executive of Disaster Avoidance and Recovery,” which will be moderated by my friend Perry Granof. Complete information about this series can be found here. Registration for the September 16 teleconference can be found here. 

It’s a Long, Long While from May to December, But the Days Grow Short When You Reach September: Summer, it was great having you around. We are sorry to see you go. Please come back again next year. We will be thinking about you while you are gone. One thing, though. Next year we can do without the heat wave, hurricanes, earthquakes, tornadoes, and tropical storms, O.K.?

It is hard to believe that it is already September. There is something about heading into September and moving past Labor Day that always makes me feel blue. The feeling is captured in the classic soulful “September Song,” sung here by the incomparable Sarah Vaughn, with Teddy Wilson Quartet. Oh, the days dwindle down to a precious few. 

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As numerous commentators have noted, one of the most distinctive litigation developments over the last twelve months has been the emergence of U.S. securities litigation against Chinese companies that obtained their listings on U.S. exchanges that a “reverse merger” with a publicly traded U.S. shell company.

Given the prominence of these issues, I am very happy to publish the following guest post from Anjali C. Das, who is a partner in the Chicago office of the Wilson Elser law firm. Many thanks to Anjali for her willingness to publish her article here. I welcome guest posts from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly.

Here is Anjali’s guest post:

D&O Spotlight on China: Claims Against China-Based Reverse Merger Companies: A Tempest in a Teapot of Gunpowder Green Tea?

Introduction

These days, nearly everything to do with China has grabbed the spotlight – not least of all the country’s extraordinary and seemingly unstoppable economic growth. Not surprisingly, many U.S. investors have been pouring millions of dollars into Chinese companies with the hopes of gaining super-sized returns. However, naysayers have long predicted a bursting of the China bubble. At least for investors in China-based issuers, perhaps that time is now. Not unlike the bursting of the internet bubble in the 1990s fueled by explosive growth and investment in “dot.com” companies, investors and regulators may now have reason to fear the rapid rise and fall of Chinese companies that have accessed U.S. capital markets through reverse mergers. While short-sellers are publicly denouncing the purported fraud at these companies (and making big bucks shorting the stock), U.S. regulators are investigating the rash of accounting scandals at these companies which have caused some auditors to abruptly resign. Meanwhile, D&O insurers have to contend with the collateral damage resulting from the multitude of claims against China-based issuers and their directors and officers. This article highlights the following topics involving Chinese reverse merger companies: 

PCAOB's Research Note on Chinese reverse mergers

SEC's investigation of China-based issuers and their auditors

NASDAQ's proposed new listing requirements for reverse merger companies

SEC's Investor Bulletin on reverse merger companies

Moody's "Red Flags" report on China-based companies

D&O insurance coverage issues for claims against China-based issuers

PCAOB Issues a Report on China Reverse Mergers

On March 14, 2011, the Public Company Accounting Oversight Board ("PCAOB") issued a report examining the audit implications for reverse mergers involving China-based companies. A copy of the report can be found here. As explained in the PCAOB report, a reverse merger is an acquisition of a private operating company by a public company shell company. While the public shell company is the surviving entity, the  private company's shareholders typically control the surviving company or hold publicly traded shares in the company.  A perceived benefit of a reverse merger is that it enables a company to become an SEC reporting company with registered securities without having to file a registration statement under U.S. federal securities laws.

The PCAOB report identified 159 companies from China that accessed the U.S. capital markets in a reverse merger transaction from 2007 through March 2010, representing 26% of all reverse mergers during the period. Reportedly, the market capitalization of these companies was $12.8 billion as compared to a $27.2 billion market cap of the 56 Chinese companies that completed initial public offerings in the U.S. during that same period. 

Reverse merger entities listed on U.S. exchanges are required to file audited financial statements with the SEC, and the auditors of the financial statements are required to be registered with the PCAOB. According to the PCAOB, U.S. firms audited 116 or 74% of the China-based reverse merger companies, while Chinese registered accounting firms audited 38 or 25 of companies. The PCAOB report raises concerns that some U.S. firms are not conducting proper audits of China-based companies, including handing off the audit work to a local Chinese accounting firm without verifying the accuracy of the results. The PCAOB has identified various "key considerations" to determine the appropriate level of oversight of firms that performs audits of foreign companies with the aid of assistants outside the firm, including:  the ability to supervise outside assistants; whether the outside assistants have appropriate language skills, and whether the auditor would have the ability to comply with the PCAOB's documentation requirements.

SEC Launches Investigation of China-Based Issuers and Auditors

In response to a congressional inquiry by House Representative Patrick T. McHenry, Chairman of the Committee on Oversight and Government Reform, SEC Chairman Mary L. Schapiro issued a letter on April 27, 2011 seeking to assure Congress and the public that the SEC "has moved aggressively to protect investors from the risks that may be posed by certain foreign-based companies listed on U.S. exchanges" -- particularly those companies based in China.  As SEC Chairman Schapiro noted in her letter, there has been a recent marked increase in China-based companies listed on U.S. exchanges through the process of a reverse merger.

Last summer, the SEC reportedly launched a "proactive risk-based inquiry into U.S. audit firms" which have a significant number of issuer clients based outside the U.S.  Among other things, the SEC has requested auditors to provide information concerning the firms' compliance with U.S. audit standards for foreign-based reverse merger companies based in China.  Since the SEC launched its investigation, dozens of China-based companies have disclosed auditor resignations and accounting problems.  Since February 2011, Big Four accounting firms have resigned or been dismissed from at least seven Chinese companies listed in the U.S., as reported here. These auditors have reportedly experienced difficulty obtaining independent bank confirmations of a company's bank accounts, balances, and transactions, as reported here.   In at least one case, the auditor purportedly received false information directly from the bank itself, prompting the auditor to resign. 

In an effort to protect U.S. investors, the SEC has reportedly suspended trading in several China-based reverse merger entities.  In addition, the SEC has revoked the securities registration of many other China-based reverse merger companies.  In some instances, the SEC is also pursuing these companies' auditors for improper audits.   As the SEC Chairman observed, the Dodd Frank Wall Street Reform and Consumer Protection Act ("Dodd Frank") has enhanced the SEC's ability to obtain audit documentation in connection with its investigations of issuers based in China and other countries. 

NASDAQ Proposes New Listing Requirements for Reverse Mergers

On June 8, 2011, the NASDAQ filed proposed rules with the SEC to adopt additional listing requirements for companies that become public through a reverse merger. Under the proposed rules, which can be found here, a company that is formed by a reverse merger shall only be eligible to submit an application for initial listing if the combined entity can satisfy the following conditions: 

traded for at least 6 months in the U.S. over-the-counter market, on another national securities exchange, or on a foreign exchange following the filing of all audited financial statements;

maintained a bid price of $4 or more per share for at least 30 of the most recent 60 trading days;

in the case of a U.S. domestic issuer, the company has timely filed its two most recent financial statements (i.e., Form 10-Q or 10-K);

in the case of a foreign based issuer, the company timely files comparable financial statements (i.e., Form 6-K, 20-F or 40-F) that includes an interim balance sheet and income statement presented "in English"

In support of its proposed enhanced listing requirements, the NASDAQ cited the "extraordinary level of public attention to listed companies that went public via a reverse merger," and "allegations of widespread fraudulent behavior by these companies, leading to concerns that their financial statements cannot be relied upon." The NASDAQ believes that these new listing requirements will protect investors and "discourage inappropriate behavior" by companies. 

SEC Issues an Investor Bulletin on Reverse Mergers

On June 9, 2011, the SEC issued a bulletin cautioning investors of the potential pitfalls of investing in reverse merger companies. The bulletin can be found here. Among other things, the SEC observed that many reverse merger companies ("RMCs") "either fail or struggle to remain viable following a reverse merger"; there have been instances of fraud and other abuses involving RMCs; and some RMCs have been using smaller U.S. auditing firms that may not have sufficient resources to conduct adequate overseas audits. The SEC bulletin also cited recent examples where it suspended trading of RMCs due to accounting irregularities and/or revoked the securities registrations of RMCs due to the companies' failure to timely file required periodic financial statements.

Moody's Issues its "Red Flags" Report on China-Based Companies

To address investors' increasing concerns with the quality of financial reporting from publicly listed Chinese companies, on July 11, 2011 Moody's credit rating agency issued a "Red Flags" report for China-based companies. The report examines 20 red flags grouped into five categories that identify possible governance or accounting risks for China-based companies, including:

            Weaknesses in corporate governance: short track record of operations and listing history,         murky shareholders' background, large and frequent related-party transactions;

            Riskier or more opaque business models: unusually high margins compared to peers,     concentration of customers, complicated business structures;

            Fast-growing-business strategies: very rapid expansion, big capital investments resulting         in large negative free cash flow and intangible assets;

            Poorer quality of earnings or cash flow: discrepancy between cash flows and accounting             profits, disjointed relationship between growth in assets and revenues, large swings in working capital, insufficient tax paid compared to reported profits;

            Concerns over auditors and quality of financial statements: a switch in auditing firm or    legal jurisdiction of auditor's office, delay in reporting, or adverse comments from      auditors.

Moody's applied its red flags analytical framework to 61 rated Chinese companies. According to Moody's report, due to the rapid growth of Chinese companies, nearly all Chinese high-yield issuers tripped red flags related to aggressive business and financial strategies and quality of earnings. Moody's observed that fast-growing companies put pressure on managerial and financial resources. Additionally, these companies may make large capital investments that could negatively impact cash flow for a prolonged period of time. Also, due to the prevalence of strong founding families, many Chinese companies tripped the red flag for concentration of family ownership which may reflect weaknesses in corporate governance.  Moody's also noted the so-called arms-length related-party transactions were not always transparent. Interestingly, according to Moody's report, concerns over auditors arose less frequently compared to other red flags. 

Shorts-Sellers Creating Havoc

Meanwhile, short-sellers are wreaking havoc on China-based issuers' stock and publicly accusing these companies of fraud. In several instances, detailed reports issued by short-sellers have triggered a wave of internal investigations, investigations by regulators, and shareholder litigation against companies. While some companies have gone to lengths to deny short seller's often unsubstantiated accusations, the damage is done when the investors get spooked and the company's stock price spirals downward. 

All of the negative publicity has impacted Chinese companies across the board, regardless of whether specific allegations of fraud have been asserted. Where investors were once rushing to dump huge sums of money into any business with ties to China, they are now rushing to liquidate their stock holdings at the slightest sign of any trouble. The fallout has had a devastating impact on the number of reverse merger transactions of Chinese companies. Not surprisingly, some Chinese companies have postponed plans to sell shares in the U.S., either through reverse mergers or initial public offerings ("IPOs"). As reported here, compared to 47 reverse merger transactions in the first half of 2010, there have been only 29 for the first half of 2011.  At least for now, Chinese companies are no longer the darling of Wall Street.

The Rise of Shareholder Litigation

Approximately 30 shareholder suits were filed in the first half of 2011 against China-based companies listed on U.S. exchanges and the companies' directors and officers. On the surface, many of these suits are classic securities class actions alleging securities fraud and violations of Section 10(b) of the Securities Exchange Act of 1934 ("1934 Act") for materially false and misleading financial statements and related derivative actions.  However, suits against China-based companies may pose unique hurdles and added expense to the defense of shareholder claims in the U.S. For one thing, many or most of the individual defendants, corporate documents, and key witnesses may reside in China. Moreover, testimony and documents may need to be translated from Chinese to English. As such, defense costs can escalate rapidly. Also, given the current regulatory climate and increased suspicion of China-based issuers, the company may also be the subject of parallel proceedings or investigations by the SEC and other regulators. In some situations, the company's Board may simultaneously launch an internal investigation – particularly if the company's outside auditor abruptly resigns without issuing a clean audit opinion. That could also trigger a wave of management departures, putting added strain on the company's already stretched resources. 

D&O Insurance Coverage Issues

Claims against China-based issuers and their directors and officers may raise a host of coverage issues under traditional Directors and Officers (“D&O”) liability insurance policies including, but not limited to: 

Reasonable and necessary defense costs

Coverage for parallel proceedings and investigations

Rescission

Known Claim exclusion

Fraud and personal profit exclusions

Severabiity of the policy exclusions and application

D&O policy limits for public companies are typically eroded by defense costs. This may occur more rapidly in suits against Chinese companies in light of the complexities of transnational discovery. As such, it is in the interests of D&O insurers and insureds alike to ensure that these claims are being defended with maximum efficiency to minimize the possibility that the D&O insurance is significantly impaired or even exhausted by defense costs alone. While many large defense firms now have outposts in China, it is still imperative to gain an understanding of the anticipated division of labor between the U.S. based lead defense attorneys and their colleagues in China with respect to discovery, document collection, witness interviews, and other matters. Additionally, there should be an objective assessment to determine whether it is cheaper and more efficient to outsource certain discovery-related tasks such as collection and translation of documents.

Shareholder litigation against Chinese companies may spawn multiple parallel proceedings and investigations by the government, regulators, the Board, a Special Litigation Committee, and others. A key issue is whether such investigations constitute covered Claims or Securities Claims under the D&O policy. Historically, many D&O policies narrowly limited the availability of coverage for investigations, such as formal investigations by the Securities and Exchange Commission (“SEC”) commenced by service of a subpoena on a director or officer. However, in the past few years, some D&O policies began to offer enhanced coverage, including coverage for both formal and informal investigations by regulators. Nowadays, the definition of a Securities Claim is less standard and may contain many subtle, yet critical nuances impacting coverage. Not surprisingly, there has been a significant amount of litigation and reported decisions with respect to coverage for investigations under D&O policies. However, many of these decisions are fact-specific and driven by now obsolete D&O policy language and definitions which continue to evolve. 

Recently, on July 1, 2011, the Second Circuit Court of Appeals issued an opinion in MBIA, Inc. v. Federal Ins. Co., 2011 U.S. App. LEXIS 13402 (2d Cir.), that sets forth a comprehensive analysis of coverage for various investigations under a D&O policy. In that case, the policy definition of a covered Securities Claim included “a formal or informal administrative or regulatory proceeding or inquiry commenced by the filing of a notice of charges, formal or informal investigative order or similar document.” First, the Second Circuit held that investigations commenced by the SEC and the New York Attorney General (“NYAG”) were covered under the policy definition of a Securities Claim. The court observed that the issuance of a subpoena by NYAG was, at a minimum, a “similar document” related to a “formal or informal investigative order”. The court also opined that requests for information by the SEC pursuant to oral requests and subpoenas were covered because they were connected to the SEC’s formal order of investigation. The court also concluded that fees incurred by an independent consultant retained by MBIA in the context of negotiating a settlement with the SEC and NYAG were also covered.

Second, the Second Circuit concluded that legal fees incurred by MBIA’s Special Litigation Committee (“SLC”) to determine whether to pursue or terminate pending shareholder derivative actions were covered and did not clearly fall within the policy’s sub-limit of liability for shareholder derivative demands. Prior to the filing of the derivative actions, a shareholder demand on MBIA’s Board had been made and ultimately rejected. After the shareholder derivative suits were filed, the SLC sought and obtained dismissal of the lawsuits. The Second Circuit determined that the legal fees incurred by the SLC arguably fell within the policy’s coverage for “costs ‘incurred in . . . investigating’ ‘Claims’ or ‘Securities Claims,’ respectively, each of which is defined to expressly include lawsuits.” The Second Circuit also determined that that the insurer had failed to carry its burden of proving that the SLC’s legal fees were not covered under the policy definition of Loss which excluded “any amount incurred by [MBIA] (including its board of directors or any committee of the board of directors) in connection with the investigation or evaluation of any Claim or potential Claim by or on behalf of [MBIA]”. 

To the extent claims against China-based issuers and their directors and officers allege accounting improprieties and false and misleading financial statements, D&O insurers might have a potential rescission argument if the policy was issued in reliance on these false financials. In some instances, D&O policies and/or applications contain a Known Claim Exclusion which might serve as a basis for denying coverage if an insured knew and/or failed to disclose a fact, circumstance, act, error, or omission that might give rise to a Claim under the policy. Also, standard D&O policies contain fraud and personal profit exclusions that might apply; however, these exclusions are usually restricted to a finding “in fact” or “final adjudication” that the insured committed fraud or unlawfully profited. In addition, both the application and the exclusions might be “severable,” such that the knowledge or wrongful acts of one insured cannot be automatically imputed to other insureds except in limited situations.

Conclusion

Some might conclude that the spotlight on China-based reverse merger companies is merely a tempest in a teapot, as compared to the global financial crisis precipitated by the subprime market meltdown and collapse of numerous financial institutions at home and abroad. Nonetheless, the reality is that many China-based issuers have been targeted by regulators and investors alike for purported securities and accounting fraud that could ultimately cost D&O insurers millions in losses. At least for now, this trend seems to be gaining traction. Until the pot is done brewing and the tea leaves are read, D&O insurers should tread carefully in handling claims against their China-based issuers.

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In the most recent of the securities litigation analyses, on July 26, 2011, NERA Economic Consulting issued its report on the securities class action lawsuit filing during the first six months of 2011. In a report entitled “Recent Trends in Securities Class Action Litigation: 2011 Mid-Review” (here), NERA  suggests, perhaps contrary to other recently published reports, that securities suit  filings during the first half of the year were  “on the rise” and “indeed unusually high.” As I discuss below, the seeming variance among the various published reports is a reflection of different counting methodology. I have comments about that below.

According to NERA (and by rather stark contrast to the conclusions of the analyses of the recently released Cornerstone Research report), during the first half of 2011 “securities class action lawsuits were filed at the second highest semi-annual rate in the last eight years.” According to NERA, there were 130 filings in the first half of the year. If the filing rate were to continue at the same pace for the rest of the year, “there would be 260 filings in 2011, the highest level since 2002, and the fourth highest in the 16 years since the passage of the Private Securities Litigation Reform Act.”

According to NERA, a decline in the year’s first six months was offset by a “surge in suits targeting Chinese companies.” Over a third of the lawsuits during 2011’s first half were filed against foreign domiciled issuers, a rate which is “extraordinary by historical standards,” and “more than double the prior peak of 2004.”

The filings themselves has “continued to migrate from the Second Circuit to the Ninth Circuit,” as the mix of companies targeted has shifted away from financial companies and toward technology companies. Filings against companies in the financial sector has declined from a 2008 peak of 49 percent to just under 20 percent in the first half of 2011. Filings in against companies in the electric technology and technology services sector represented 22 percent of filings in the year’s first six months.

The NERA report notes that filings activity continues to be positively correlated with market volatility. Controlling for market returns, volatility is positively and statistically significantly correlated with quarterly filings from the second quarter of 1996 through the second quarter of 2011. However, the correlation is “not one-for-one.” Indeed, market volatility and market returns together explain only about 20 percent of the variance in quarterly filings. In other words, volatility is important but it does not come close to telling you everything you need to know.

In looking at the status of cases from the 2000 filing year, the NERA report shows that about 63% of all cases from that year have settled and about 37% percent have settled.

With respect to the 245 credit crisis cases filed as of June 30, 2011, 79 have produced “current dismissals” and “only 23 settlements. “

With respect to first half 2011 settlements, the average settlement was $23 million, which is sharply down from the 2010 average settlement of $108 million. The median settlement during the year’s first six months was only $6.3 million, down sharply from the all time high median settlement of $11 million in 2011. The proportion of cases settling for less than $10 million reached a post-2006 high during the first half of 2011, when 58 percent of cases settled below $10 million , up from 41 percent in 2010.

The report speculates that one reason for the lower settlement levels may be that during the first half of 2011 “cases may have been more apt to settle within insurance limits, possibly due to defendants’ reduced ability to pay.” Of the 15 out of the 48 first half settlements for which NERA was able to determine the insurance contribution, insurance paid all of the settlement in eight cases, between 71 and 81 percent in three and an unspecified rate in the remaining four.

The full report, which has a wide variety of other interesting and useful information, warrant reading at length and in full.

Discussion

It is  purely coincidental that the NERA report’s publication came in such close conjunction with the publication of the Cornerstone Research report. But because they appeared so close in time, it is impossible not to compare the two reports’ findings. The contrast between the reports’ conclusions is striking. The Cornerstone Report suggested that securities class action laws filings are in decline and trending toward historically lower levels. The NERA Report, by contrast, suggests that filings “are on the rise” and “unusually high.”

What in the world is going on? Aren’t these two reports supposed to be analyzing the same thing?

The casual reader will be forgiven for assuming that the two reports are analyzing the same thing. But careful reading of the small print and footnotes will disclose that the two reports are not analyzing the same thing. Or to put it more accurately, they are not counting the same things in the same ways. I suspect there are even more differences in what is counted and how it is counted than can be discerned from the reports themselves. But even just based on what can be gleaned from the reports,, the NERA Report (as described in its footnote 1), counts separate filings against a company in separate circuits as separate lawsuits, at least until they are consolidated. Cornerstone, by contrast, counts each target defendant company only once. Cornerstone also counts separate lawsuits brought by separate classes of securityholders separately, at least until consolidated.

I know from my own experience that another very difficult category has to do with the lawsuits arising from M&A-related transactions. Whether or not to include these cases can only be decided on a case by case basis, and reasonable people almost certainly might reach different conclusions , which could produce significantly different lawsuit counts.

My point here is that how you count affects what you count. And what you count affects the ultimate outcome of your count. The net effect is that we have two very reputable analytic firms reaching quite different conclusions about the level of securities class action lawsuit filing activity during the first six months of 2011. Truthfully, that is the reason I keep my own count, because I find it too confusing trying to make sense out of the conflicting conclusions of the reporting firms.

The problem for everyone is that these conflicting conclusions get picked up in the mass media and reported as if they representing absolute conclusions rather than alternative analyses based on mixed data. These conflicting reports create a great deal of confusion among the general public.

I think part of the problem here as the respective commentators act as if they are publishing their data in a vacuum. Nothing could be further from the truth. I suspect to a very high degree of moral certainty that every single reader that reads any one of these report reads them all. Not only that, but the authors of these reports read each others reports and they know that everyone that reads their reports reads all the reports.

 It would be extraordinarily helpful if the authors would acknowledge this reality up front (not in footnotes, not in reduced text, not in text buried deep within the document) in a simple cover page statement that declares the counting methodology used and that explains how that contrasts with counting methodologies used in other published reports. It would be even more helpful if this initial disclosure explained how the methodology selected affects the ultimate count.

By making these remarks here, I hope that no one concludes that I am being critical of anyone. To the contrary, I am one of many people who are very grateful that these high-powered analytic firms are willing to publish their reports and make their analyses available for free. These reports are extraordinarily valuable and helpful. My point is simply that these reports would be even more useful if the reports were to recognize the context within which they are read.

Finally, I want to be sure to acknowledge the incredibly fine work that the folks at these firms produce. On behalf of myself and everyone else that devours these reports as soon as they are published. I would like thank everyone associated with the production of these reports. And since this particular post is about the NERA report, I would like to salute all my friends at NERA and to thank them for another fine report. I hope no one interprets my curmudgeonly remarks as anything other than a friendly suggestion.

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Decreased credit crisis-related filings partially offset by an influx of new filings related to M&A transactions or involving Chinese companies resulted in slightly decreased overall levels of securities class action litigation filings during the first half of 2011, according to a recent report entitled “Securities Class Action Filings: 2011 Mid-Year Assessment,” jointly published by Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse. The report can be foundhere and the accompanying July 26, 2011 press release can be found here. My own analysis of the first half filings can be found here.

According to the report, there were 94 securities class action lawsuit filings during the first half of 2011, compared to 104 in the second half of 2010. The 94 first half filings annualizes (using calendar days rather than months) to 190 filings, which is slightly below the 1997-2010 annual filing average of 194. (Cornerstone’s lawsuit count may differ slightly from other published tallies because, among other things, it counts multiple complaints against the same defendants only once and because it does not count state court filings.)

The report notes that the quarterly number of filings has generally declined during the past twelve months. Quarterly filings decreased from 56 in the third quarter of 2010 to 48 in the fourth quarter of 2011, 46 in the first quarter of 2010 and 48 in the second quarter of 2011.

One factor driving the first half 2011 filings was the upsurge in lawsuits against Chinese companies. There were 24 securities class action lawsuits against Chinese companies in the first half of 2011, with 23 of those actions involving reverse merger companies, up from 12 filings against Chinese companies, nine involving reverse merger companies, in all of 2010. By the same token there were 21 M&A-related filings in the first six months of 2011, “continuing a new pattern” that emerged in the second half of 2010, when there were 27 M&A-related lawsuits.

The lawsuits involving Chinese companies and M&A-related activity collectively represent a very substantial part of all securities class action lawsuit filings in the first six months of 2011. These two groups of lawsuits together represented 46.8 percent of all filings in 2011’s first half, up from 32.7 percent in the second half of 2010. Excluding these two categories, there were otherwise only 50 securities class action lawsuits in the first half of 2011, 70 in the second half of 2010 and 57 in the first half of 2010. These figures, the report notes, are “similar to the low number of filings seen in 2006 and 2007.”

The report notes that the its own annualized projection for the 2011 year-end number of securities class action lawsuit filings assumes that the pace of new filings against Chinese companies seen in the year’s first half will continue in the second half. However, the report notes, the number of U.S.-listed Chinese reverse merger companies is finite, and the current level of new filings involving Chinese companies is unlikely to continue indefinitely. The report reckons, “at one extreme,” that if there were no new lawsuits involving Chinese companies in 2011’s second half and other filings continue at the same pace as in the year’s first half, there would be only a total of 166 filings this year, “making 2011 the second lowest year in filings activity during 2006.”

The report contains some interesting analysis of the frequency of new lawsuit filings involving S&P 500 companies. The report notes that only 8.5 percent of the first half of 2011 filings named companies in the S&P 500 index, down from 15.4 percent in the second half of 2010. Overall, eight companies, or about one out of every 63 companies in the S&P 500 Index, were defendants in a class action filed in the first half of 2011, compared with about one out of every 19 S&P 500 companies during the full year of 2010. Only one out of 81 companies in the S&P 500 Financials sector was named as a defendant in the first half of 2011, compared to an average of 11.7 percent of Financials sector firms named in class actions between 2000 and 2010.

The losses in market capitalization associated with adverse disclosures at the end of the class periods remains low compared to historical levels. The total disclosure loss during the first half of 2011 of $48 billion is well below the historical average of $64 billion occurring between 1997 and 2010. The market cap declines during the class periods also remained low during 2011.

Discussion

The report clearly substantiates that the number of lawsuits against Chinese companies and involving M&A transactions were a significant factor driving securities class action litigation activity during the first half of 2011. The report’s exploration of the counterfactual question of what the litigation levels might have looked like without these two categories of litigation activity is interesting. But the report’s implicit suggestion that – but for the anomalous Chinese company and M&A transaction lawsuits –  securities litigation filings are actually trending toward the lower levels that prevailed during the “lull” years of 2006 and early 2007 warrants scrutiny.

The lawsuits involving Chinese companies and M&A-related transactions may reflect short term filing patterns. But it has long been the case with securities class action lawsuit filings that they are substantially driven by short term filing patterns. For years, class action lawsuit filings have been reflected sector slides, contagion patterns, or industry events. The Internet bubble was followed by the telecom industry crash and that was filed by the era of the corporate scandals, which was followed by the mutual fund industry market timing scandal, and then came options backdating scandal and after that the subprime meltdown and then the credit crisis. Each one of these events involved an associated influx of securities class action lawsuits.

So while it is true that the current litigation activity is largely being driven by short-term trends, there is nothing unusual about that. There always seems to be something driving securities class action litigation activity and it seems likely that even after the current round of securities lawsuits involving Chinese companies winds down, the plaintiffs lawyers will find something else to agitate about. (And as for whether the pattern of lawsuits against Chinese companies is going to wind down soon, I note that there have already been four new securities class action lawsuits filed against U.S.-listed Chinese companies already this month, so there is no current suggestion that the filing phenomenon has started to slow down.)

The other thing about the “lull” period, from about mid-2005 to mid-2007, is that while securities class action lawsuit filings may have declined compared to historical norms during that period, overall litigation levels did not decline. The options backdating scandal unfolded during that period, and many more of the options backdating lawsuits that were filed during that period were filed as shareholder derivative suits (over 160) than were filed as securities class action lawsuits (only about 40). So while there may have been a decline in new securities lawsuits during that period, overall litigation levels remained at or near historical norms. It is important to keep this fact in mind when attempting to discern filing patterns over time, especially when considering the possibility that filing levels are or are not actually trending toward a putative lower level.

My own view, which is substantially dependent upon the assumption that the plaintiffs’ lawyers will always find the next new category of lawsuits to pursue, is that securities class action lawsuit filings are not trending toward some lower level. More specifically, I do not think that the mid-2005 to mid-2007 filing levels represent some sort of “new normal” to which filings levels are generally trending but for short-term anomalies that obscure the overall pattern. To the contrary, I think the lower securities class action filing levels during the 2005 to 2007 period represent the anomaly, and it is an anomaly that is entirely explainable by the plaintiffs’ bar’s temporary diversion into shareholders derivative lawsuit filings during the options backdating scandal.

As I have said before, fish gotta swim, birds gotta fly, and plaintiffs’ lawyers have to file lawsuits. The fish and the birds can be counted upon to continue their traditional activities, and so can the plaintiffs’ lawyers.

An important consideration to keep in mind along those lines is that going forward the lawsuit filings driving corporate and securities litigation may or may not involve securities class action lawsuits. As the insurance advisory firm Advisen has well documented in its periodic reports on corporate and securities litigation (refer for example here), securities class action lawsuits increasingly represent a declining percentage of all corporate and securities litigation. So it may happen, as was the case during the so-called “lull” period, that securities class action lawsuit filings may decline while overall litigation levels remain unchanged or even continue to increase.

Responding to Negative Say on Pay Vote: Although only a very small companies experienced a negative say on pay vote during this past proxy season (as detailed here), a number of the companies that did sustain negative votes wound up in litigation. For companies that find themselves in this position, the question arises of how the company and its board should respond.

In an interesting July 24, 2011 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation blog (here), Paul Rowe of the Wachtell Lipton law firm examines the question of the how companies that have experienced a negative say on pay vote should respond.

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Overall levels of corporate and securities litigation during the second quarter and first half of 2011 remained at elevated levels despite a decline in regulatory and enforcement activity during the quarter, according to the latest Advisen quarterly litigation report. A copy of the report can be found here. My own survey of the second quarter and first half securities class action litigation activity can be found here.

Preliminary Notes

It is critically important to recognize that the Advisen report uses its own unique vocabulary to describe certain of the corporate and securities litigation categories.

The “securities litigation” and “securities suits” analyzed in the Advisen report include not only securities class action lawsuits, but a broad collection of other types of suits as well, including regulatory and enforcement actions, individual actions, derivative actions, collective actions filed outside the U.S. and allegations of breach of fiduciary duty. All of these various kinds of lawsuits, whether or not involving alleged violations of the securities laws, are referred to in the aggregate in the Advisen report as "securities suits."

One subset of the overall collection of "securities suits" is a category denominated as "securities fraud" lawsuits, which includes a combination of both regulatory and enforcement actions, on the one hand, and private securities lawsuits brought as individual actions, on the other hand. However, the category of "securities fraud" lawsuits does NOT include private securities class action lawsuits, which are in their own separate category ("SCAS").

Due to these unfamiliar usages and the confusing similarity of category names, considerable care is required in reading the Advisen report.

The Report’s Findings

According to the report, the annualized level of all corporate and securities litigation activity during the first half of 2011 remained “on par with the record-setting year of 2010,” notwithstanding a decline in the number of new regulatory actions against financial services firms, as enforcement activity in the wake of the global financial crisis waned.

Advisen tracked a total of 332 new actions across all categories of corporate and securities lawsuits during the second quarter, compared to 398 during 1Q11. Despite the falloff, the second quarter activity remained as a “high level” and the first half activity annualizes to a record level of corporate and securities litigation activity.

One category of litigation activity driving these numbers is the group of lawsuits alleging breach of fiduciary duties. Many of these breach of fiduciary duty lawsuits are merger objection lawsuits, the filing of which has been “mushrooming” in recent years. The number of merger objection suits has grown from only 21 in 2001 to 353 in 2010, and with 176 merger objection suits in the first half of 2011, the pace of merger objection litigation remains in line with 2010 levels. The report includes a chart on page 6 illustrating the dramatic growth in merger objection litigation activity.

According to the Advisen report, there were 63 new securities class action lawsuit filings during the second quarter, which is flat with the previous quarter, but above the 2010 quarterly average of 48 per quarter and in line with the 60 suits per quarter during 2009. Securities class action lawsuit filings as a percentage of all corporate and securities lawsuit filings remains down from historical levels although up slightly from 2010 levels. Class action securities lawsuits represented as much as a third of all corporate and securities litigation activity as recently as 2006, but during the second quarter, securities class action lawsuits represented only 19 percent of all corporate and securities lawsuits, which while below historical levels is up slightly from the 14 percent such suits represented in 2010. Three industrial sectors accounted for over 60 percent of all securities class action lawsuit during the first half: information technology, consumer discretionary, and industrial.

Actions involving companies in the financial services industry accounted for a smaller percentage of all corporate and securities litigation activity during the second quarter compared to recent periods. Financial firms counted for 45 percent of all corporate and securities litigation in 2008 and 45 percent in 2009. The number fell to 34 percent in 2010 and during the second quarter of 2011, the number fell to 25 percent. Despite the decline, the financial services industry still remains the “leading sector” for attracting corporate and securities litigation activity.

One prominent trend has been the growth in corporate and securities litigation activity involving non-U.S. companies. A certain amount of this litigation involving non-U.S. companies involves proceedings outside the U.S. The Advisen study reports that during the first half of 2011, there were 38 corporate and securities lawsuits filed outside the U.S., 18 of which were filed during the second quarter. Corporate and securities lawsuits involving non-U.S. companies, whether filed in the U.S. or elsewhere, have accounted for about ten percent of all corporate and securities litigation activity since 2005. But in the first half of 2011, corporate and securities lawsuit activity against non-U.S. companies accounted for 17 percent of all corporate and securities litigation activity, and during the second quarter of 2011, the figure for non-U.S. companies was up to 20 percent.

A substantial part of this rise in activity involving non-U.S. companies has been the rise in the number of corporate and securities lawsuits involving Chinese companies, of which there were 44 during the first half of 2011.

Discussion

Advisen’s report takes a broader view of corporate and securities litigation, because its scope reaches beyond just securities class action lawsuits to include all corporate and securities litigation, and not just in the U.S, but outside the U.S. as well. But even with this broader scope, it is apparent that a couple of identifiable factors are currently driving corporate and securities litigation activity, as is also the case with securities class action litigation – that is, the high levels of litigation largely  is a factor of the suits connected to merger and acquisition activity  and by lawsuits involving Chinese companies.

The table in the report depicting merger objection litigation filings dramatically illustrates the growth in this type of litigation activity in recent years. This development has a number of implications, including for the D&O insurance carriers that often wind up picking a significant part of the defense expenses and settlement amounts associated with these kinds of lawsuits. Even though these cases taken individually do not present a significant severity risk, taken collectively that represent a significant claims loss burden for the carriers, particularly those that are the most active in the primary layers.

As the mix of litigation has shifted away from higher severity claims such as securities class action lawsuits and toward higher frequency claims such as merger objection suits, the D&O carriers’ claims experience has shifted as well. As I noted in my own report on second quarter litigation activity, this is an under-discussed issue.

The burden these costs represent may be all the more painful for the carriers because the exposures involved with these kinds of suits likely are not priced into the risk premium. In addition, it is tough to underwrite the likelihood that any one company will be acquired. But because the discussion of carriers’ loss exposures tends to focus on the higher severity risk of securities class action litigation, there is relatively little consideration given to the higher frequency exposure that these merger objection lawsuits represent. This is one of those issues that just doesn’t get the airtime it deserves – at least not so far.

One interesting development involving these kinds of merger objection lawsuits is that the judges in the Delaware Chancery Court have started to show some resistence to the fee awards to plantiffs' counsel in cases that do not produce a material benefit for shareholders. The Wall Street Journal has a July 19, 2011 article (here) discussing these developments. The flip side of this judicial resistence is that in some instances the Delaware courts have proven more willing to approve larger fee awards where the court concludes the plaintiffs have produced substantial benefit for shareholders.

The surge in litigation involving U.S.-listed Chinese companies also has important D&O insurance implications, as noted in a recent Client Advisory I co-authored with Pillsbury Winthrop’s Peter Gillon, about which refer here. Alison Frankel has a July 18, 2011 post on the same topic on her Thomson Reuters News & Insight blog, here.

Second Quarter Litigation Update Webinar: And speaking of first half 2011 litigation filing trends, on Tuesday July 19, 2011 at 11 a.m. EDT, I will be participating in the Advisen's "Q2 Securities Litigation Webinar."  My fellow panelists will include Anderson Kill's Bill Passanante, Navigators' Scott Misson, and Willis’ John Connolly. The panel will be moderated by Advisen's Jim Blinn. Information about this event, which is free, can be found here.

Outside Directors and SEC Enforcement Actions: A July 16, 2011 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation entitled “SEC Enforcement Actions Against Outside Directors Offer Reminder for Boards” (here) takes a look at recent SEC Enforcement actions targeting outside directors. The article concludes with respect to the recent SEC enforcement actions that “when taken together, the cases signal the commission’s continued interest in bringing enforcement actions against directors of publicly traded companies who personally violate securities laws or egregiously disregard their duties.”

Among other implications, the article notes the importance for board members of considering the coverage available through their company’s D&O insurance program for regulatory investigations and enforcement actions.

Cordray for Consumers? : Many readers may have seen the news that President Obama has nominated former Ohio Attorney General Richard Cordray to head the new Consumer Financial Protection Bureau. Cordray will be a familiar figure to readers of this blog, as I have commented in the past on Corday’s actions while Ohio Attorney General in pursuing securities class action lawsuits on behalf of Ohio’s pension funds.

Reactions to Cordray’s nomination to head the new consumer agency include concerns regarding Cordray’s connections to the securities class action bar. In a July 18, 2011 post on his Full Disclosure blog on the Forbes website, Daniel Fisher takes a look at the campaign contributions Cordray received in the past from prominent members of the securities class action litigation bar and comments that Cordray’s “record of taking money from lawyers who profit from private litigation that often follows closely on the heels of government investigations could provide fodder for his enemies.”

Ross Todd has a July 18, 2011 post on the Am Law Litigation Daily on the same questions about Cordray.

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Largely driven by M&A-related litigation and securities suits against U.S.-listed Chinese companies, federal securities class action lawsuit filings continued to mount during the second quarter of 2011. With 48 new securities suits during the second quarter, the year-to-date total mid-way through the year stands at 105. The 2011 filings are on pace to finish the year with about 210 new lawsuits, which is well above the 1997-2009 average of 195.

The M&A lawsuits included in my tally are those that were filed in federal court and that allege a violation of federal securities laws. There were ten M&A-related federal securities lawsuits during the second quarter, or about 20% of all second quarter filings.  

Many of the M&A-related lawsuits are being filed in state court and so don’t enter into the count of federal securities suits. In addition, there are a number of federal court M&A-related lawsuits that don’t allege violations of the federal securities laws; these suits typically allege breaches of fiduciary duties.

M&A-related litigation overall, including all state and federal court suits, continues to surge. Because many of these suits are filed in state court, it is difficult to get complete information. But based on the filings I have been able to track, and counting all state and federal suits of which I am aware, there have been a total of at least 125 merger-related lawsuits YTD involving as many as 90 transactions (some transactions have drawn multiple lawsuits). While this information may be incomplete, it is clear that there are many more merger-related lawsuits now being filed than traditional securities class action lawsuits. This mix of litigation has some important implications, discussed below.

But the most interesting story line relating to 2011 securities class action lawsuit filings is the number of new filings involving U.S.-listed Chinese companies. As I have previously noted (most recently here), lawsuits filings against these Chinese companies have been surging, particularly during the second quarter. There have been a total of 26 securities suits against Chinese companies so far in 2011, 19 of them filed during the second quarter. The 26 lawsuits represent almost one-quarter of all 2011 securities class action lawsuit filings. The 19 securities suits filed against Chinese companies during the second quarter represent almost 40% of all new securities lawsuit filings during that period.

Signs are that the lawsuit filings against U.S.-listed companies will continue as we head into the year’s second half. Plaintiffs’ lawyers have published news releases that they are “investigating” additional U.S.-listed Chinese companies (refer for example, here). These types of releases usually precede lawsuit filings.

Lawsuit filings against foreign companies in general have been a significant part of the 2011 securities lawsuit filings. Although the vast majority of the suits against foreign companies have involved Chinese companies, lawsuits have been filed against a number of companies from other non-U.S. jurisdictions. There have been a total of 34 lawsuits against foreign companies so far this year (about 32% of all YTD 2011 filings), involving companies from eight different countries.

These filings against non-U.S. companies are all the more notable given the U.S. Supreme Court’s June 2010 decision in the Morrison v. National Australia Bank case, which seemingly would have produced a decline in the number of new securities suits involving non-U.S. companies. But because the shares of most of these foreign company defendants trade on U.S. securities exchanges, the Morrison decision poses no barrier to the shareholder plaintiffs suing these foreign companies in U.S. courts.

Although the year-to-date filings are largely characterized by the features noted above, the suits are in other ways remarkably diverse. For example, the 105 companies named as defendants represent 70 different Standard Industrial Classification (SIC) Code categories. The SIC Codes with the highest number of filings are SIC Code Category 7372 (prepackaged software), and SIC Code Category 6022 (state commercial banks), each of which has had six securities suits during the first six months of 2011.

Though there were a number of filings in the year’s first half against banking institutions, overall far fewer of the first half filings involved financial institutions than was the case in recent years in the wake of the credit crisis. However, as I noted in a recent post, there are still lawsuits coming in that are based on credit crisis-related events. By my count, there were at least four credit crisis-related lawsuits in the year’s first half.

The first half lawsuit filings were also quite dispersed geographically. The securities suits in the year’s first six months were filed in 32 different U.S. districts. The districts with the highest number of filings in the first half were the Central District of California, with 24 filings, and the Southern District of New York, which had 19.

Discussion

As is always the case and as I have frequently noted, definitional issues significantly affect the lawsuit count. For example, if I were to include the federal court M&A lawsuits that do not involve securities law allegations, I would be reporting 113 first half lawsuits, rather than 105. On the other hand, by including the federal court merger objection suits that have securities allegations, the count arguably is inflated in the other direction. (I have struggled for some time to decide whether or not the merger objection suits properly belong in this tally.) In other words, my count may vary from other published figures, largely due to these kinds of definitional issues.

The growing wave of M&A litigation is an under-discussed issue. Even though the M&A cases cases tend to be resolved quickly and usually don’t involve significant financial settlements, taken collectively they still impose an enormous cost on the system. Even if the settlement in any one case is modest (usually just the payment of the plaintiffs’ attorneys fees), there are still the defense expenses to consider. In the aggregate this litigation imposes a huge expense on the financial system. In the aggregate they are also imposing significant costs on D&O insurers, or at least those that are most active as primary insurers. Sooner or later these kinds of costs have to start taking a toll on the carriers.

The burden these costs represent may be all the more painful for the carriers because the exposures involved with these kinds of suits likely are not priced into the risk premium. In addition, it is tough to underwrite the likelihood that any one company will be acquired. But because the discussion of carriers’ loss exposures tends to focus on the higher severity risk of securities class action litigation, there is relatively little consideration given to the higher frequency exposure that these merger objection lawsuit represent. This is one of those issues that just doesn’t get the airtime it deserves – at least not so far.

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As the worst days of the financial crisis (if not their ill effects) receded into the past, the accompanying credit crisis-related litigation wave appeared to lose its momentum. By late 2010, new credit crisis-related lawsuit filings seemingly had dwindled away. But now at the midpoint of 2011, two new credit crisis related lawsuit have arisen. These new lawsuits raise a number of interesting issues, as discussed below.

The Latest Filings

Deutsche Bank: According to their June 21, 2011 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the Southern District of New York against Deutsche Bank and four of its directors and officers. The complaint, which can be found here, purports to be filed on behalf Deutsche Bank common shareholders who purchased their shares between January 3, 2007 and January 16, 2009.

The complaint, which alleges that the defendants “concealed the Company’s failure to write down impaired securities containing mortgage-related debt,” asserts that the defendants concealed that:

(a) defendants failed to record adequate provisions for losses on the deterioration in mortgage assets and collateralized debt obligations on Deutsche Bank’s books caused by the high amount of non-collectible mortgages included in the Company’s portfolio; (b) Deutsche Bank’s MortgageIT subsidiary was issuing and had issued billions of dollars of mortgage loans which did not comply with stated lending practices, leading to thousands of defaults; (c) Deutsche Bank’s internal controls were inadequate to ensure that losses on residential mortgage-related assets were accounted for properly; and (d) Deutsche Bank had transferred billions of dollars in defaulting, or soon-to-default, mortgages to unwitting investors and government programs due to its disregard of adverse findings by outside consultants.

Carlyle Capital Corp.: On June 21, 2011, a plaintiff filed a securities class action complaint in the U.S. District for the District of Columbia against certain individual officers and directors of the now defunct Carlyle Capital Corp. (CCC), its investment manager and related entities. The complaint, which can be found here, purports to be filed on behalf of all those who purchased CCC shares between June 19, 2007 and through March 17, 2008.

The complaint alleges that CCC was organized under the laws of Guernsey to profit from the spread between the its portfolio of residential mortgage-backed securities (RMBS)and the cost of financing those assets through short term repurchase agreements and other forms of financing. Its principal place of business was in Washington, D.C. The complaint alleges that the entity was a “house of cards” because it was committed to acquiring “volatile, risk-securities that could only be purchased using massive borrowing with the securities purchased serving as collateral.” The company’s RMBS portfolio deteriorated during 2007, even prior to the company’s July 2007 IPO on Euronext. The complaint alleges that the deterioration and the liquidly issues associated with the companies repo agreement financing were not disclosed to investors.

The complaint alleges that following the offering, the defendants continued to misrepresent the company’s financial condition, particularly with respect to its RMBS portfolio. Despite the deteriorating market for RMBS, CCG continued to acquire additional RMBS. The complaint alleges that as the marketplace nearly reached a “meltdown” in August 2007, the company did not recognize its portfolio losses. In early 2008, a cascade of margin calls forced the company’s managers to put the company into liquidation under the authority of the Royal Court of Guernsey.

Discussion

These two cases have more in common than just the fact that they both related (each in their own way) to the global financial crisis. First, they both involve entities organized under the laws of non-U.S. jurisdictions. Second, the complaints were first filed well after the end of the purported class period. In each of these two cases, these case attributes may present some interesting challenges for the plaintiffs.

Deutsche Bank is of course a domiciled in Germany. However, the company’s Global Registered Shares are listed on the NYSE. Its shares also trade on the Frankfurt Stock Exchange. The complaint purports to represent all investors that purchased the company’s common shares during the class period. The complaint does not explicitly restrict its class to those investors that purchased their shares on the NYSE, but the question undoubtedly will arise under Morrison v. National Australia Bank whether the relief available under the U.S. securities laws will extend to those who purchased their shares outside the U.S.

Though CCC had its principle place of business in Washington, D.C., CCC was organized under laws of Guernsey and its shared traded on the Euronext Exchange. Euronext is based in Amsterdam and has affiliates in Belgium, France, Netherlands, Portugal and the U.K. The defendants undoubtedly will seek to argue, in reliance on Morrison v. National Australia Bank, that because the transactions in which the purported class of investors purchased their shares took place outside the U.S., their alleged injuries are not cognizable under the U.S. securities laws.

The plaintiff in the CCC case, no doubt anticipating this argument, alleges in his complaint that since April 2007 Euronext has been owned by the NYSE; that most of the alleged misconduct too place in the U.S.; that a substantial majority of the CCC shares were owned by U.S. residents, and that U.S. investors “with typical brokerage accounts” access Euronext shares the same as they would NYSE or NASDAQ shares. These considerations notwithstanding, the question under Morrison is where the “transaction “ took place, and in light of the post-Morrison case law, the CCC plaintiff may face significant challenges overcoming the defendants’ Morrison-based motion to dismiss. The defendants undoubtedly will argue that Morrison expressly rejected the very kind of “conduct and effects” arguments on which the plaintiff apparently intends to rely.

The belated nature of both of these cases also presents some rather interesting issues. The Deutsche Bank case was filed about two and a half years after then end of the purported class period. The CCC complaint is even more belated, having first been filed more than three years after the class period cut off.

The timing of the Deutsche Bank complaint may have to do with the timing of the U.S. Department of Justice’s recently announced suit against the bank related to the its  alleged misrepresentations about its mortgage loans. The recently filed class action complaint, specifically references the DOJ action and the May 4, 2011 Wall Street Journal article about the DOJ complaint. The securities class action complaint appears to have followed in the wake of and in reaction to the filing of the DOJ complaint. But while the timing of the filing of the class action complaint may be understood as related to the timing of the DOJ complaint, the plaintiffs should anticipate that the defendants’ dismissal motion will include a motion to dismiss the case on statute of limitations grounds.

The CCC plaintiff’s complaint expressly anticipates the likelihood of a statute of limitations dismissal motion. The complaint contains numerous paragraphs raising the delays that the Liquidation authority faced in trying to investigate the causes of CCC’s collapse. The complaint alleges that the defendants and other related Carlyle parties “undertook deliberate and affirmative steps to conceal… facts sufficient to apprise Plaintiff and the Class of the existence of potential claims against the Defendants.” The complaint cites purported statements of the Liquidator that the defendants “repeatedly obstructed their efforts” to obtain CCG’s books and records.

On July 7, 2010 the Liquidators commenced a civil action against the defendants in multiple jurisdictions, asserting that the defendants breached their fiduciary duties to CCC. The plaintiff alleges that the defendants’ “fraud was effectively and indefinitely concealed from the public at least until July 7, 2010.”

It remains to be seen whether the CCC plaintiff’s fraudulent concealment argument will prove sufficient to overcome statute of limitations concerns. But the belated nature of these cases and the presence of the statute of limitations concerns underscore why the credit crisis-related litigation wave has largely petered out, and why we are unlikely to see very many more credit crisis-related lawsuits. Even if these cases manage to overcome the statute of limitations hurdle, any other potential case that has not yet been filed will facing even more daunting timeliness problems.

It is interesting to note how both of these cases embody filing trends that seemed to have completely played out some time ago, or at least to have dwindled out. As I noted at the outset, both of these cases are credit crisis-related, a litigation trend that seemed to have mostly played out a year ago. But these cases are “flashes from the past” in other ways as well. They are both “belated” cases, in that they were filed more than a year after their purported class period cutoff. There were a host of “belated” cases in late 2009 and early 2010 (about which refer here), but the belated cases flings seemed to have gone away some time ago.

And both cases involved companies organized under the laws of non-U.S. jurisdictions, and whose shares trade in whole or in part on exchanges located outside the U.S. In the wake of the U.S. Supreme Court’s June 2010 Morrison v. National Australia Bank case, there was widespread speculation that filing of securities class action lawsuits in the U.S. against non-U.S. companies would become a thing of the past. Of course, lawsuits against foreign companies whose shares trade on the U.S. exchanges have continued, and that may explain the Deutsche Bank suit. The CCC case seems to be another matter.

It really is interesting that, notwithstanding Morrison, how many of the 2011 securities class action lawsuit filings involve non-U.S. companies. About 33 of the approximately 109 (roughly 30%) securities class action lawsuits filed so far during 2011 involve non-U.S. companies, compared to 15.9 percent during all of 2010. To be sure, a large part of the 2011 filings involve U.S.-listed Chinese companies. But regardless of the reason, the fact is that contrary to expectations, one year after the Morrison decision, the securities class action lawsuit filings against non-U.S. companies as a percentage of all filings has actually increased.

In any event because of the issues that these two recent cases present, they will interesting to follow. It will also be interesting to see if there are any more credit crisis related lawsuit filings ahead. I have in any event added these two cases to my running list of credit crisis-related lawsuit filings, which can be accessed here.

Final Notes:  Although the credit crisis related litigation wave largely played out early in 2010, a trickle of credit crisis-related cases has continued to come in. In fact the two cases above actually bring the number of credit crisis-related cases so far in 2011 to at least four (categorization issues of course always come into these kinds of analyses, but by my categorization there have been at least four, others may categorize and therefore count differently). The prior two 2011 credit crisis-related cases are the Bank of America foreclosure documentation case (refer here) and the United Western Bancorp case (refer here).

And finally, these two cases are not the only “belated” cases filed so far in 2011. By my count, there have been at least five “belated” cases far this year, counting these two. The other three belated cases are Frontpoint Partners (here), Oilsands Quest (here) and Elan Corp. (here)

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Corporate and securities litigation filing activity reached a “crescendo” in the first quarter of 2011, according to the most recent quarterly report from Advisen, the insurance information firm. The filing rate in the year’s first three months if annualized would represent a record –settling annual level of corporate and securities litigation activity. A copy of the Advisen report can be found here. My own survey of the first quarter 2011 securities class action lawsuits filings can be found here.

Preliminary Notes

In considering the Advisen report, it is critically important to recognize that the report uses its own unique vocabulary to describe certain of the litigation categories.

The “securities” litigation analyzed in the Advisen report includes not only securities class action litigation, but a broad collection of other types of suits as well, including regulatory and enforcement actions, individual actions, derivative actions, collective actions filed outside the U.S. and allegations of breach of fiduciary duty. All of these various kinds of lawsuits, whether or not involving alleged violations of the securities laws, are referred to in the aggregate in the Advisen report as "securities suits."

One subset of the overall collection of "securities suits" is a category denominated as "securities fraud" lawsuits, which includes a combination of both regulatory and enforcement actions, on the one hand, and private securities lawsuits brought as individual actions, on the other hand. However, the category of "securities fraud" lawsuits does NOT include private securities class action lawsuits, which are in their own separate category ("SCAS").

Due to these unfamiliar usages and the confusing similarity of category names, considerable care is required in reading the report.

The Report’s Findings

According to the report there were a total of 363 corporate and securities lawsuits filed in the first quarter of 2011, which is up from the 342 filed in the fourth quarter of 2010 but below the quarterly record level of 386 set in the third quarter 2010. If the first quarter filing levels were to continue for the rest of the year, that would imply a 2011 year-end total of 1,448 corporate and securities lawsuits, which, according to Advisen would represent a “record-setting year.” Just to put this level of filing activity into perspective, prior to the credit crisis “new filings averaged less than two-thirds of this annualized level.”

According to Advisen’s tally, there were 61 securities class action lawsuits in the first quarter of 2011. However, securities class action lawsuits as a percentage of all corporate and securities lawsuit filings continue to decline. As recently as 2006, corporate and securities lawsuits represented as much as one third of all corporate and securities litigation, but in the first quarter of 2011, the securities class action suits represented only 17 percent of all corporate and securities lawsuit filings.

With respect to the securities class action lawsuit filings, 85 percent of the suits were filed against companies in just five sectors: financial, information technology, consumer discretionary, energy and industrial. With respect to all corporate and securities litigation generally, financial firms continue to be the most frequently sued albeit at a lower level in recent years. Financial firms were named as defendant in 34 percent of all corporate and securities lawsuits in the first quarter, compared to 45 percent in 2008 and 40 percent in 2009.

Breach of fiduciary duty suits, many of which are filed in state court and many of which are filed shortly after the announcement of a proposed merger or acquisition, represent a growing area of corporate and securities litigation. These breach of fiduciary duty suits represent about a third of all corporate and securities lawsuit filings in the first quarter of 2011, up from only eight percent of all corporate and securities filings as recently as 2004. Over 60 percent of the first quarter breach of fiduciary duty suits were filed in the state court.

Corporate and securities litigation activity outside the U.S. has also been on the increase. During the first quarter of 2011, Advisen recorded 17 of the corporate and securities lawsuits filed outside of the United States.

By the same token, 16 percent of all corporate and securities lawsuits filed during the first quarter involved non-US companies, compared to only 11 percent in 2009 and 2010. These figures were largely driven by cases involving Chinese companies whose shares trade on the U.S. exchanges. Cases against Chinese companies in U.S. courts “mushroomed” in 2010, and continued in the first quarter, when there were 11 new securities lawsuits in the U.S. against Chinese companies. (This trend of filings against Chinese companies has continued into the second quarter as well, as I noted in my recent posts, here and here.)

Finally, with respect to settlements, the Advisen report notes that the average securities class action lawsuit settlement announced during the first quarter of 2011 was $54.6.

Quarterly Advisen Conference Call: On Thursday, April 21, 2011, I will be participating in an Advisen conference call to discuss the first quarter 2011 filing statistics and trends. The free one-hour conference call will take place at 11 am EDT. The conference call panel will include a number of distinguished speakers, including Dan Bailey from the Bailey Cavalieri law firm, Carol Zacharias from ACE, Carolyn Polikoff from the Woodruff Sawyer firm and David Bradford from Advisen. Information about the session including registration information can be found here.

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For several years, Friday has been the day when the latest bank closures are announced (about which see further below). More recently, Friday also seems to be the day when the latest securities class actions involving Chinese companies are announced. This past Friday alone, three more securities suits involving Chinese companies were announced. Signs are that there are more to come. A brief description of the three latest cases follows.

Puda Coal: The first of the three latest Chinese suits involves Puda Coal, Inc., an NYSE company that is a Delaware corporation but which has its headquarters in Shanxi Province in China. There have actually been two separate lawsuits filed against Puda, one in the Southern District of New York (refer to the complaint here), and one in the Central District of California (here).

As reflected in plaintiffs’ counsel’s press release (here), the allegation is that Puda’s assets were transferred to a subsidiary of which Puda’s Chairman of the Board obtained control through a series of transactions, enabling the Chairman to profit personally from the sale of a minority interest in the subsidiary to a private equity firm. Following an internet website’s disclosures of the transactions, the company’s share price declined. In an April 11, 2011 press release (here), the company announced that its board had adopted the recommendation of the company’s audit committee to investigate the Chairman’s “unauthorized” transactions involving the subsidiary.

Subaye, Inc.: According to their April 15, 2011 press release (here), plaintiffs’ lawyers have initiated a securities class action lawsuit in the Southern District of New York against Subaye, Inc. and certain of its directors and officers. Subaye is a Delaware Corporation with its headquarters in Guangdong, China.

According to the press release, the complaint (which can be found here) was filed in the wake of the company’s April 7, 2011 announcement that its auditor PricewaterhouseCoopers Hong Kong had withdrawn and that prior to its resignation the audit firm had identified matters that might affect the fairness of the company’s previously issued financial statements. The press release states that

PwC’s was unable to obtain information and supporting documentation to verify: (a) cash settlements from sales agents to Subaye, (b) the end customer subscriptions for the Company’s services and the services rendered to the end customers, (c) marketing and promotion activities performed by sales agents in return for fees paid to such agents and recorded as expenses of the Company. PwC also stated that Subaye provided insufficient explanations regarding commonalities between certain customers and vendors. Lastly, PwC could find no evidence of any business tax payments by the Company for services rendered in China.

Universal Travel Group: According to their April 15, 2011 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the District of New Jersey against Universal Travel Group and certain of its directors and officers. Universal Travel is a Nevada corporation based in Shenzen, China.

The Universal Travel group lawsuit follows a March 2011 securities analyst’s report raising questions about the company’s business, its reported cash balances and revenues, and its relationship with an online travel service. The report stated that there were large differences between the revenues that a newly acquired subsidiary had reported to Chinese authorities and the revenues that Universal Travel reported.

 In an April 14, 2011 press release (here), the Company announced that it had hired a new auditor after its prior auditor resigned because “it was no longer able to complete the audit process” due to “the Company’s management and/or the Audit Committee being non-responsive, unwilling or reluctant to proceed in good faith and imposing scope limitations on [the auditor’s] audit procedures.”

These three new securities class action lawsuits follow closely on the heels of the four accounting-related  lawsuits involving Chinese companies filed earlier this month, as I noted in a prior blog post (here). With these three  latest lawsuits, there have now been a total of 14 securities class action lawsuits filed against Chinese and China-liked companies in 2011, out of a total of about 61 securities lawsuits that have filed so far this year, meaning that the suits against Chinese companies represent about 23% of all securities lawsuits filed so far this year. Ten of these have been filed just in the last 30 days.

The signs are that this recent outburst  of new lawsuit filings involving Chinese companies will likely continue. Plaintiffs’ law firms continue to publish press releases that they are “investigating” still other Chinese companies (refer for example, here and here) For that matter, the cascade of news raising questions about accounting practices involving some Chinese companies shows no signs of abating.

As Walter Pavlo notes on his White-Collar Crime blog on Forbes.com (here), many of the Chinese  companies involved in this rash of lawsuits obtained their U.S. listings through reverse mergers with a publicly traded U.S. shell company. In a later post (here), he also noted that many of these firms have the same auditors and used the same investment bank in their reverse merger transaction.

In an April 4, 2011 speech (here), SEC Commissioner Luis Aguilar noted that the problems arising involving Chinese companies that have obtained U.S. listing are a serious concern and that the SEC in cooperation with other organizations including the PCAOB is investigating the concerns that have arisen. Among other things, he noted that “a growing number” of these companies “are proving to have significant accounting deficiencies or being vessels of outright fraud.”

According to Commission Aguilar, since January 2007 over 150 Chinese companies have obtained U.S. listings using what he characterized as “backdoor registrations.” While not all of these companies are engaged in the kinds of activities described in the case summaries above, there definitely seems to be a pattern of involvement in conflicts of interest or accounting issues. The rash of recent resignations of the outside auditors from these companies suggests that the audit firms have had their consciences   raised about the dangers of becoming associated with these kinds of firms and accounting issues they may be having.

In any event, it seems likely that there will be further lawsuits involving these Chinese companies. David Bario’s April 4, 2011 Am Law Litigation Daily article profiling the plaintiffs’ lawyer behind many of these lawsuits can be found here.

Bank Failures Not Over Yet: Speaking of bank failures (as I was at the outset of this post), it now appears that my recent prediction that the bank failure wave may finally be over might have been premature. This past Friday night, the FDIC closed six more banks, bringing the year to date total number of bank closures to 34. While that is fewer than the 49 banks that had been closed at this point last year, the closure of six banks at one time does cut against the suggestion that the FDIC is winding down its bank closure activities.

With the addition of the latest six bank closures, the total number of banks that have failed since January 1, 2008 stands at 356. Of this total, 51 involve banks located in Georgia (including two of the six banks closed this past Friday night). After a while you do start to wonder if there how there could be any banks left in Georgia.

As I have noted elsewhere, the FDIC has still only brought a total of six lawsuits involving former directors and officers of the bank. However, on April 13, 2011, the FDIC did update the Professional Liability Lawsuits page on its website, to indicate the number of persons against who lawsuits have been authorized has been increased by 187 (up from the prior month’s total of 158). However, the six lawsuits filed to date involved only 42 individual defendants, which suggests that there are quite a number of lawsuit in the pipeline and yet to be filed. The updated page also notes that the FDIC has also authorized “11 fidelity bond, attorney malpractice, and appraiser malpractice lawsuits.”

Special thanks to the loyal readers who alerted me to the most recent bank closures and to the recent update to the FDIC website.

105 Years Ago Today: A rare 35 mm film of San Francisco just four days before the April 18, 1906 earthquake has been “found.” The person that send me a YouTube link to the file reports that “This film was originally thought to be from 1905 until David Kiehn with the Niles Essanay Silent Film Museum figured out exactly when it was shot --from New York trade papers announcing the film showing, to the wet streets from recent heavy rainfall & shadows indicating time of year & actual weather and conditions on historical record, even when the cars were registered (he even knows who owned them and when the plates were issued!).”

The film, which was shot by mounting a camera on the front end of a cable car, is simply amazing. The clock tower at the end of Market Street at the Embarcadero wharf is still there. The number of automobiles on the road in 1906 is staggering. The absolute chaotic traffic suggests that rules of the road were a later invention.

There is an element of sadness too in the film, as so much of the city was destroyed days later and as many as 3000 people died in the quake and in the fire that followed. The film is a remarkable piece of history. Special thanks to the loyal reader who sent me the link.

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A number of trends that had predominated in recent years diminished during 2010 while new trends emerged, according to PwC’s 2010 Securities Litigation Study, which can be found here. 2010 may also mark “the start of a new era” as a consequences of a new regulatory and enforcement environment take effect, which “could lead to a reinvigorated volume of reported securities violations and associated class actions.” PwC’s April 7, 2011 press release about its report can be found here.

In many ways the 2010 securities litigation filing activity was characterized by the  reversal of a number of trends. Thus, for example, the declining numbers of credit crisis related cases meant that fewer cases were filed against financially related companies than in the immediately preceding three years (although financial companies remained the most frequent litigation target in 2010). In addition, accounting-related cases continued to decline in 2010, as did the number of new cases against Fortune 500 companies.

On the other hand, the reversal of these trends was “offset” by other trends that emerged during the year, leading to an overall jump in the number of cases. The focus of activity shifted from an “overwhelming focus on the financial services industry” to a “medley of issues across a variety of industries.”  Increasing numbers of cases against companies in the health industry, a surge in M&A related cases, a jump in cases against Chinese companies and a rash of cases against for-profit education companies all contributed to the increased litigation activity.

Overall, the total number of federal securities class action filings rose 12 percent during 2010 compared to 2009, from 155 to 174. (PwC’s count may vary from other published reports as a result of its counting methodology, pursuant to which “multiple filings against the same defendant with similar allegations are counted as one case.”). There were more filings in the third and fourth quarters of 2010 than in either of the first two quarters. Among other things, the increase in filings in the year’s second half reflected the “increasing domination o f non-financial crisis-related cases and the decline in financial-crisis related cases.”

Among the principle drivers of the increased number of filing in the second half of 2010 was the increase in the number of M&A related cases. Overall, M&A cases represented 24 percent of all securities filings in 2010, compared to only 4 percent in 2009.

Health industry cases increased from 17 percent in 2009 to 21 percent in 2010, representing the second highest percentage of for any industry in 2010. The filings included cases against pharmaceutical, medical device and health services companies. (My recent post discussing 2010 securities filings against life sciences companies can be found here.)

The percentage of cases raising accounting-related allegations (including overstatement of revenues, understatement of expenses and liabilities and overstatement of assets) fell from 37 percent in 2009 to 35 percent in 2010, which represents the lowest level of accounting-related cases in 15 years. The report speculates that one possible reason for this decline in accounting-related cases could be “the effectiveness of SOX in combating accounting fraud.” On the other hand, the decline in the number of cases involving accounting allegations could also just be a reflection of the changing mix of cases; the options backdating cases that predominated a few years ago were replete with accounting-related issues, but the increasing numbers of M&A cases in 2010 rarely involved accounting allegations.

Surprisingly, in light of the U.S. Supreme Court’s June 2010 decision in Morrison v. National Australia Bank, the number of filings involving foreign issuers increased during 2010 by 35 percent, and of the 27 cases filed in 2010 involving foreign issuers, 16 (or 59 percent) were filed after the Morrison decision was announced. The percentage of cases involving foreign issuers as a percentage of all filings increased during 2010 from 13 percent in 2009 to 16 percent in 2010.

Of these 27 cases involving foreign issuers, 12 cases (44 percent) involved Chinese companies. Eleven of the 12 cases against Chinese companies involved accounting allegations.

The average settlement of securities related cases during 2010 decreased by 11 percent compared to 2009, from $34 million to $30.1 million.(PwC ‘s figures may differ from other published reports as PwC assigns the settlement to the year of the “primary settlement announcement,” and any subsequent announcements are attributed to the primary announcement year.” PwC also excludes zero dollar settlements.)

 However, the average settlement value of cases settled for more than $1 million and less than $50 million increased by 21 percent, from $10.7 million in 2009 to $12.9 million. In addition, median settlements increased by nearly 35 percent, from $7.5 million to $10.1 million.

The PwC report concludes with a survey of the changing liability  environment arising from  the new regulatory mandates introduced by the Dodd-Frank Act. Because enforcement activities “are likely to increase” and the new Dodd-Frank whistleblower provisions “could produce a surge in allegations of securities violations,” the financial regulatory environment is “vastly different in 2011 from what it was just one year ago, and companies will have to devote significant resources to understanding and adapting to its new topography.”  The decade ahead has “the potential to yield yet more transformations.”

My analysis of the 2010 securities class action litigation filing can be found here. My more recent study of first quarter 2011 filings (here) shows that many of the trends that emerged in 2010 continued in the first quarter, including in particular the heightened level of M&A related litigation. In addition, as I recently noted (here), the wave of accounting-related litigation involving Chinese and China-linked companies has also continued in 2011.

WaMu Subprime-Related Securities Lawsuit Settlement in the Works: In case you missed the news last week, the WaMu subprime-related securities lawsuit apparently has settled. According to the Court’s  April 6, 2011 minute order (here), the parties have advised the court that the lead case has settled, and the Court has suspended all of the schedules dates and motions. The settlement papers have not yet been filed so the details of the settlement are not yet known, but an April 6, 2011 Seattle Times article by Sanjay Bhatt (here) reports that the amount of the settlement “is in excess of $200 million.”

The WaMu case, of course, relates to the facts and circumstances surrounding the largest bank failure in U.S. history. The case itself did not necessarily unfold smoothly from the plaintiffs’ perspective. In a May 2009 opinion that was sharply critical of the plaintiffs’ pleadings (about which refer here) , Western District of Washington Judge Marsha Pechman has initially granted the defendants’ motion to dismiss. However, the plaintiffs’ amended pleadings survived the renewed motion, and now the parties apparently have settled the case.

The details of the settlement, once they are finally released, will be interesting in and of themselves, but they may be even more interesting in light of the recent action that the FDIC filed against three former WaMu executives and the wives of two of the officials (about which refer here). The possibility that the WaMu securities suit settlement could involve the payment of  hundreds of millions of dollars raises the possibility that the settlement would consume the remaining limits of WaMu’s D&O insurance policy, possibly leaving the defendants in the FDIC without insurance remaining for them to defend themselves against and to try and settle the FDIC claims.

So The D&O Diary is interested in a number of details about the settlement, beyond just the settlement’s dollar value. We are interested to see how much of the settlement will be funded by D&O insurance, and whether any of the settlement is to be funded out of the individual defendants’ assets. We are also interested to see if the settlement documents show whether the settlement exhausts the remaining D&O insurance limits. Along the same lines, it will be interesting to see (if possible) what kind of a release the insurers are getting in exchange for the insurance payment, if any, and whether it is a policy release or just a claim release.

In any event, the WaMu settlement is just the first of what I think will be a wave of subprime-related securities lawsuit settlements during the course of 2011. The WaMu settlement also vividly illustrates the competition for insurance policy proceeds that the FDIC will face as it seeks to pursue lawsuits against directors and officers of failed banks, particularly as in many cases the shareholders have been actively pursuing their claims while the FDIC has proceeded much more deliberately.

Speakers’ Corner: On Thursday April 14, 2011, I will be a panelist at the Professional Liability Underwriting Society Southwest Chapter’s Educational Event in Englewood, Colorado. The title of the even t is “Winds of Change in Executive and Professional Liability,” and I will be speaking on panels on the topics of Governmental Investigations and D&O Liability Developments. Information about the event can be found here.

If you are a part of the Southwest Chapter, I hope you are planning on attending. And if you are attending I hope you will take a moment to say hello, particularly if we have never met before.

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With four more securities suits involving Chinese or China-linked companies this past Friday, the phenomenon of securities class action lawsuits against these firms has emerged as one of the most distinct securities litigation trends so far this year. The filing trend actually first emerged in the second half of 2010, but it has continued into 2011 and appears to have gained significant momentum in recent weeks following recent revelations of accounting irregularities involving Chinese companies.

The four latest suits involving Chinese-linked companies are as follows:

1. China Electric Motor, Inc.: According to their April 1, 2011 press release (here), plaintiffs’ lawyers have initiated a securities class action lawsuit in the Central District of California against China Electric Motor, a Delaware corporation with its principle place of business in China, as well as the certain of its directors and officers and the underwriters who underwrote the company’s January 29, 2010 IPO.

According to the Complaint (here), the lawsuit follows the company’s March 31, 2011 announcement that it is forming a special committee to investigate accounting discrepancies “concerning the Company’s banking statements” identified by the company’s auditors. The company has delayed release of its fourth quarter and year end financial statements and trading in the company’s securities has been halted.

2. Advanced Battery Technologies, Inc.: In their April 1, 2011 press release (here), the plaintiffs’ lawyers state that they have filed a securities class action lawsuit in the Southern District of New York against Advanced Battery and certain of its directors and officers. According to the complaint (here), the company is a Delaware corporation with offices in New York that, through subsidiaries, owns two Chinese operating companies.

The complaint alleges that the company made misleading statements about its ownership interests in certain Chinese operating companies and that it failed to disclose or fully disclose certain related party transactions involving the company’s CEO. The complaint also alleges, relying heavily on a securities analyst’s report , that the company made false statements about its supposed investment in a company that may not even exist.

3. China Intelligent Lighting and Electronics, Inc.: According to the their April 1, 2011 press release (here), plaintiffs’ attorneys have filed a complaint in the Central District of California against the company, certain of its directors and officer and the investment banks that underwrote the company’s June 18, 2010. (One of the investment banks, Westpark Capital, was also involved in the China Electric IPO described above.) The company is a Delaware Corporation with its principle place of business in China. A copy of the complaint can be found here.

The lawsuit follows the company’s March 29, 2011 press release in which it announced the termination of its auditor, MaloneBailey LLP; its auditor’s resignation and withdrawal of the audit opinion it issued in connection with the prior year end financial statement; and the formation of a special investigation committee. The press release also discloses that the SEC has launched a formal investigation of t he company.

In the press release, the company also discloses that MaloneBailey resigned “due to accounting fraud involving forging of the Company’s accounting records and forging bank records.” The auditors also allegedly stated that the “accounting records at the company have been falsified.” 

4. China Century Dragon Media: According to their April 1, 2011 press release (here), plaintiffs lawyers have filed a securities class action lawsuit against the company, certain of its directors and officers and against its offering underwriters. Among the offering underwriters named as defendant in the case is the Wespark Capital firm, which was involved in the China Electric Motor and China Advanced Lighting offerings described above. A copy of the complaint, which was filed in the Central District of California, can be found here.

The China Century Dragon Media lawsuit follows the company’s March 28, 2011 announcement of the resignation of its auditor, MaloneBailey LLP (the same firm as withdrew from auditing China Intelligent Lighting, as noted above), and the firm’s withdrawal of its prior audit opinions. The press release discloses that the auditor has resigned as a result of “irregularities” that may indicate that the company’s “accounting records have been falsified.” The discrepancies could also indicate material errors in the company’s prior financial statements. The company also disclosed that its shares have been delisted and the SEC has commenced a formal investigation.

These four new lawsuits join the seven suits that had previously been filed so far in 2011 against Chinese and China-linked companies. Of these eleven total lawsuits, six have been filed just since March 18, 2011. The eleven suits against Chinese-related firms already exceed the ten lawsuits that were filed against Chinese companies in 2010. Signs are that there may be further suits to follow shortly, as the law firm that filed all four of the above described lawsuits issued an April 1, 2011 press release (here) that it is investigating possible securities law violations involving Keyuan Petrochemicals (a Nevada corporation with its principal place of business in China), following the company’s April 1, 2011 announcement that it was delaying filing its year end financial statements and initiating an audit committee investigation of certain “concerns.” 

The rash of lawsuits has arisen at the same time that the Public Company Accounting Oversight Board raised concerns in a March 14, 2011 report (here) about accounting and auditing standards at Chinese companies that have conducted IPOs in the U.S. or that have become U.S. publicly traded companies through reverse mergers. The report identifies a number of factors that may undermine the ability of audit firms to complete their audit functions completely or effectively. In light of the concerns in the PCAOB report, it hardly comes as a surprise that accounting concerns are coming to light in connection with some of these Chinese firms.

The allegations raised in these cases, like the allegations in the four cases described in detail above, fall into two basic categories: Inadequate disclosures involved related-party transactions (see especially Tongxin [here], China Valves Technology [here], and China Integrated Energy [here]), and accounting irregularities or accounting improprieties (see especially China Media Express [here], China AgriTech [here], ShegndaTech [here] and NIVS Intellimedia Technology Group [here].

Another familiar theme running through at least a few of these cases is that the lawsuits followed the resignation of the MaloneBailey firm as the defendant company’s auditors. The audit firm’s resignation preceded the lawsuits filed against NVIS Intellimedia Technology Group, China Intelligent Lighting and Electronics, and China Century Dragon Media.  MaloneBailey is identified in Table 8 of the PCAOB report as the U.S.-based firm with the most Chinese reverse merger company clients. In addition, a number of the companies named as defendants in these suits conducted offerings with the investment bank Westpark Capital, Inc as one of their offering underwriters.

These firms’ involvement may well be purely coincidental. The larger pattern is that there seems to be a growing number of Chinese and China-linked companies that are announcing concerns related to the accounting and reported financial statements. Whether these issues will continue to emerge will remain to be seen. But for now, a securities litigation filing trend that first developed in the second half of 2008 seems to be going strong as we head into the second quarter of 2011. 

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Largely as a result of a flood of M&A related lawsuits, there were a significant number of new securities class action lawsuits filed in the first quarter of 2011, and even factoring out the M&A lawsuits, the first three months of the year still represented an active period for securities lawsuit filings.

Taking the merger objection suits into account, there were a total of 55 new securities class action lawsuits filed in the first quarter. That would imply an annualized rate of 220 securities suits for the year, which would be well above both the 176 filed in 2010 and the 1996-2009 annual average of 195 filings. However, the rash of merger suits filed during the first quarter does complicate the numeric analysis, as the changing mix of cases may make the year to year measures somewhat of an apples- to-oranges comparison.

There were 20 federal court merger objection lawsuits in the first quarter. (There were even more state court merger objection lawsuits, as discussed further below.)  Subtracting the federal court merger objection lawsuits from the first quarter securities class action lawsuit filing tally would reduce the number of first quarter filings from 55 to 35, which would be idenitcal to the 35 new securities suits filed in the first quarter of 2010. Obviously, the process of determining what to include in the lawsuit count has a huge impact on the ultimate tally.  I have further observations about “counting” the securities suit filings below.

The 55 securities suits in the first quarter represent a surprisingly diverse range of kinds of companies. The companies targeted in the 55 suits represent 42 different Standard Industrial Classification (SIC  Code categories. Only two SIC Code categories had as many as three companies sued – SIC Code Category 2834 (Pharmaceutical Preparations) and SIC Code Category 3674 (Semiconductors and Related Devices.).

By interesting contrast to recent years' filing patterns, the first quarter filings included relatively few companies in the 6000 SIC Code group (Finance, Insurance and Real Estate). While the credit crisis litigation wave was unfolding and lawsuits against financial companies flooded in, suits against companies in the 6000 SIC Code group predominated. The relative decline of litigation activity in this category provides even further proof that the credit crisis related litigation wave has largely played out. I count a total of only three cases in the first quarter that might even arguably be categorized as credit crisis related. Among these three were  two new securities suits in the first quarter involving failed or troubled banks, which is a filing phenomenon that seems likely to continue in the weeks and months ahead.

Among the 55 first quarter cases were nine suits filed against companies domiciled outside the United States. In addition to these nine, there were two additional companies sued that were incorporated in the United States but that have their principle place of business outside the U.S. These eleven total cases represent about 16.3% of all first quarter filings, a percentage that is above the approximately 12% of 2010 filings that involved non-U.S. companies. This relative increase in the incidence of filings against non-U.S. companies is frankly unexpected in light of the U.S. Supreme Court’s June 2010 decision in Morrison v. National Australia Bank (about which refer here).

The persistent elevated level of filings against non-U.S. companies is largely attributable to the surge in lawsuits involving Chinese companies. Four of the nine lawsuits filed in the first quarter against non-U.S. companies were filed against Chinese companies. Three additional lawsuits involved companies incorporated elsewhere but with their principle places of business in China. These seven suits together represent about 12.7% of all first quarter filings. Indications are that this phenomenon of suits involving Chinese companies is likely to continue, as in recent days, plaintiffs’ lawyers have issued numerous press releases (for example, here and here)  indicating that they  are “investigating” certain other Chinese companies (a development that usually presages a subsequent lawsuit filing.)

As the new filings have shifted away from financially related companies, the jurisdictions in which lawsuit filings have been concentrated have also shifted. During the credit crisis litigation wave, lawsuit filings were concentrated in the Southern District of New York. Indeed, there were nine new securities suit filings in the Southern District of New York during the first quarter 2011, but for the first time since 2007 there were more quarterly filings in a federal district other than the Southern District of New York. Specifically, there were ten new securities lawsuit filings in the Central District of California, and another five in the Northern District of California, a changing jurisdictional mix that reflects the shifting mix of companies that are getting sued.

More About the Merger Objection Lawsuits: As I noted above, there were twenty new federal court merger objection lawsuits filed during the first quarter of 2011. A total of at least 63 different M&A transactions produced merger objection litigation in the first quarter, but many of the lawsuits relating to these transactions were filed in state court rather than in federal court. In addition, some of the transactions provoked lawsuits in both state and federal court, and some provoked multiple different lawsuits in different states.

Breaking all of this M&A related litigation down, and counting both the state and federal merger objection lawsuits,  there were a total of at least 81 different lawsuits relating to at least 63 different transactions. OF these 81 lawsuits, 20 were filed in federal court and 61 were filed in state court. As indicated above, some transactions produced multiple lawsuits in different jurisdictions.

A Note About Counting: Some readers may note that my count of 55 first quarter securities lawsuits differs substantially that the 39 lawsuits reported as of today on the Stanford Law School Securities Class Action Clearinghouse website. There are two reasons for this difference. One is timing, as I have counted suits that have not yet made it onto the Stanford site’s list. The other is counting protocol, as I have included 11 federal merger objection suits on my list that are not included on the Stanford website list.

As I have noted numerous times in the past on this site, one of the most challenging parts about keeping a running tally of securities class action lawsuit filings is deciding what you are going to count. As part of my counting protocol used during the first quarter, I have chosen to “count” all federal court securities suits, including all merger objection suits. This has produced a count that differs in certain particulars from the Stanford website count. However, I should hasten to add that my count includes all of the cases noted on the Stanford site. It just includes a few more.

These differences underscored the importance of definitional consistency when making comparisons across time. The comparisons are only meaningful if the counting protocols are consistent over time.

Finally, and whatever else might be said about the increasing numbers of merger related lawsuits, it seems apparent that the mix of cases is decidedly shifting. While there may be fewer traditional securities class action lawsuits being filed than in some prior years, the amount of total litigation activity is at or above historical averages when the merger objection litigation is taken in to account. And it also seems to be the case that at least as a matter of percentages of all filings, the merger objection lawsuits now outweigh the tradtional securities class action lawsuits.

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Though the average dollar value of securities class action settlements approved in 2010 declined slightly compared to 2009, the median settlement amount reached record levels, according to Cornerstone Research’s annual 2010 Securities Class Action Settlement Study. Cornerstone’s March 10, 2010 press release about the study can be found here, and the study itself can be found here.

Largely as a result of the decline in the number of mega-settlements, the average securities class action lawsuit settlement approved in 2010 declined to $36.3 million, compared to S37.2 million in 2009. Both of these figures are well the 1996-2009 average settlement of $54.8 million. Even if the post-Reform Act settlement average is "normalized" by excluding the top-three settlements during that era, the 2010 average is still below the adjusted 1996-2009 average of $38.8. (All historical averages are adjusted for inflation.)

The median average class action lawsuit settlement approved in 2010 increased to $11.3 million from a 2009 median of $8.0 million. This 40% increase represents the largest single year increase in the median settlement in the last ten years.

The sizeable gap between the averages and medians is a reflection of the presence of a few significant larger settlements During the post-Reform Act era, more than half of the securities class actions have settled for less than $10 million, about 80% have settled for under $25 million.. Only 7 percent of cases have settled for more than $100 million. Thus, "while large settlements tend to receive substantial attention, they tend to occur infrequently."

The Cornerstone study reports the number of securities class action lawsuit settlements approved during 2010 is the lowest in ten years. The "more likely cause" for this decline is combination of the substantial drop in the number of new securities class action lawsuit settlements and the fact that the credit-crisis suits have taken longer to settle. The average time to settlement for cases settled in 2010 was 4.1 years, compared to 3.9 years for the cases settled in 2009.

Obviously, the most significant factor with respect to the overall size of securities suit settlements is the overall amount of investor losses (although the proportionate relationship between the size of the settlement and the size of investor losses decreases as the size of "plaintiff-style" damages increases.)

There are a number of other lawsuit features that present statistically significant differences in the size of the settlements. First, cases involving accounting allegations are resolved with larger settlements than cases without accounting allegations. For example, cases involving a restatement settled during the 1996-2010 period settled for 3.9% of "plaintiff-style" damages, but cases without a restatement settled for 3.1% of those amounts. In addition, filings that do not involve accounting allegations are more likely to be dismissed than filings with accounting allegations.

The report goes on to observe that the increased complexity of cases involving accounting allegations means these cases may take longer to resolve, which may be a factor contributing to the increased interval between the filing date and the settlement date observed over time.

Second, the presence of public pension plans as lead plaintiffs is associated with higher settlements as well. Though this observation could be explained by these investors choosing to participate in stronger cases, the study reports that even controlling for observable factors that affect settlement amounts, "the presence of a public pension plan as a lead plaintiff is still associated with a statistically significant increase in settlement size."

Other lawsuit features that are associated with statistically significant settlement amounts are the presence of Section 11 and/or Section 12(a)(2) claims; the presence of a remedy of a corresponding SEC action; and the presence of companion derivative claims. On the latter point, the report notes that class actions accompanied by derivative actions tend to be associated with other factors important to settlement amounts, such as accounting allegations, the presence of related SEC action and the involvement of public pension fund plaintiffs.

The credit crisis cases have settled more slowly than "traditional cases." There have also been relatively few settlements of these cases to date, as well. Of the credit crisis cases that have settled so far, they have tended to settle for larger amounts (median settlements of $31.3 million and average settlements of $103.1 million) but for lower percentage of estimated "plaintiff-style" damages (3.2% on average compared to 4.9% for all cases). My compilation of all credit-crisis settlements can be accessed here.

Some readers may note slight variations between the averages and median settlement figures reported in the Cornerstone report compared to those reported elsewhere. Thought there are differences, the figures are directionally consistent. The differences may be due to a combination of timing and methodology. The Cornerstone report designates the settlement year as the year in which the hearing to approve the settlement was held. Cases involving multiple settlements are reflected in the year of the most recent partial settlement (subject to certain additional considerations).

Though all of the report’s findings are interesting and important and the report is well worth reading at length and in full, for me the most significant finding is the report’s conclusion about the dramatic increase in the size of the median settlement. Averages can be driven by outliers, but medians are more reflective of the overall direction of settlements in general.

The rapid increase in the median settlement amount has important implications for corporate insurance buyers as well as for their insurers, particularly at a time when costs of defense are also escalating rapidly. For buyers, the rising median settlement amount clearly has important implications for purposes of limits selection and limits adequacy. I think the unmistakable conclusion is that the questions of limits adequacy may now involve larger levels of insurance than may have been the case in the past.

For insurers, and particularly those insurers who more typically are involved in the excess layers, the rising median may have important implications for likely loss experiences. The clear implication is that higher attaching excess layers are increasingly likely to be called upon to participate in case resolution, particularly in light of rising costs of defense. Losses are likelier to push up into higher layers.

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So your flight was cancelled and you weren’t able to make it to New York for the PLUS D&O Symposium? Have no fear, my flight managed to get through and I made it to the conference, and so I am able to report here on the first day’s proceedings.

It may be cold consolation for those of you who didn’t make it, but you should know that you are not alone. There were quite a few empty seats in this morning’s sessions, and even a couple of speakers were unable to make it. Fortunately, the conference organizers were able to locate some able substitutes, and the show is going forward.

The day’s opening session was, as is customary, devoted to current corporate and securities litigation trends. The session was chaired by Bruce Angiolillo of the Simpson Thacher law firm, who substituted into the role at the last minute. The other panelists included leading members of both the plaintiffs and defense bar, as well as Columbia Law Professor John Coffee.

There were a number of recurring themes during the opening session, one of the most interesting of which was the recurring suggestion that the nature of securities class action litigation has been changing. For example, Professor Coffee noted that the source of the wrongdoing has changed; whereas in the past, the typical securities case would involve allegations of financial fraud, now there are many more cases involving alleged product defects or operational deficiencies than there are cases alleging financial fraud or restatements. Plaintiffs’ attorney Michael Dowd of the Robbins Geller firm, while acknowledging that filings of new financial fraud cases may have declined more recently, stated that he "has faith" that the financial fraud cases "will be back."

Other panelists echoed this suggestion that securities cases are changing, although they invoked different points of reference. Bill Grauer of the Cooley law firm noted that cases are becoming "much more complex" and "much more fragmented," particularly as one set of circumstances can and often does give rise to a multitude of separate regulatory and litigated proceedings.

In focusing on the past year’s most significant developments, the panel extensively discussed the U.S. Supreme Court’s decisions in the Morrison case (about which refer here) and in the Merck case. With respect to the Morrison case, among the topics discussed were the as yet unanswered questions that will have to be resolved in the wake of Supreme Court’s decision.

For example, Professor Coffee noted that questions remain on the question whether Morrison will apply to liability claims under Section 11 of the ’33 Act as well as to the Section 10(b) type claims that were involved in the Morrison case itself (at least one court has said that Morrison does extend to the ’33 Act, refer here). He also noted that the applicability of Morrison to tender offer litigation also remains to be answered. Finally, he noted that we are all waiting to find out what impact, if any, the Morrison opinion will have on the jury verdict entered in the Vivendi case (about which refer here).

Jay Eisenhofer of the Grant & Eisenhofer firm also noted some additional questions that remain in the wake of Morrison, including whether or not Morrison will preclude claims of persons who purchased American Depositary Receipts in the U.S (at least one court has held that at least with respect to ADRs purchased over the counter, as opposed to on an exchange, Morrison does preclude the applicability of Section 10(b)). He also noted that it will remain to be seen whether plaintiffs who bought their shares outside the U.S. can pursue claims under the law of the non-U.S. company’s home country, and whether or not plaintiffs can and will attempt to pursue claims under the common law.

The panel also extensively discussed the U.S. Supreme Court’s decision in the Merck case (about which refer here). Several panelists noted the difficulty defendants will now have, in the wake of Merck, showing that the plaintiffs had access to information sufficient to trigger the running of the statute of limitations, the result of which may be to keep cases alive much longer. Professor Coffee asserted that while the Merck decision may not be as important as the Morrison decision, it will "have an impact," and Dowd agreed that Merck will "have an impact on the quantity and quality of cases."

The panel also discussed the rising levels of merger and acquisition related litigation. As a preliminary matter, Eisenhofer expressed some skepticism whether there really is an increase in the level of M&A activity, suggesting that the apparent increase may simply be a refection of the fact that these types of suits may not have been fully "captured" in litigation statistics in the past, and that M&A litigation generally will "rise and fall" with the level of economic activity.

One attribute of the M&A related litigation that is arising is that it is often characterized by multiple proceedings in separate jurisdictions, a development that created logistical and cost issues for all concerned, which represents another manifestation of corporate and securities litigation. Several panelists suggested that one reason that these cases may be "migrating" away from Delaware is that the Court of Chancery has proved to be skeptical of many of these cases and therefore unwilling to award plaintiffs significant attorneys fees, particularly where the ostensible benefit to the defendant company as a result of the litigation is slight.

The panel discussed the question of whether or not companies can use forum selection clauses in their by laws to try to designate in advance to forum in which litigation involving the Board must go forward. The problem is that at least one court (in the Oracle case, about which refer here, scroll down) has found that a by-law forum selection clause is not enforceable.

The panel debated whether or not the whistleblower provisions of the Dodd-Frank Act will be significant. While some panelists expressed the view that the whistleblower provisions could have a significant impact on securities litigation, others were less sure. Professor Coffee noted that at least in the short run, the SEC’s budget constraints and the unwillingness of Congress to fund many activities mandated in Dodd-Frank may constrain the significance of whistleblowing at least for now.

As far as what may lie ahead in 2011, the panel discussed at length the cases now pending on the U.S. Supreme Court’s docket, particularly the Halliburton case, which will examine the question of whether or not the loss causation issue must be determined at the class certification stage. Eisenhofer expressed the view that the Halliburton case is "the big case of the Supreme Court term."

Professor Coffee stated that he believed, consistent with the holding in the Seventh Circuit and with the amicus brief filed by the Solicitor General, that far from loss causation being an issue that must be determined at the class action certification stage, as the Fifth Circuit has held, the issue of loss causation is a "common issue" that does not have to be proven at the class certification stage because it is not related to the Rule 23 predominance requirement.

Dowd, the plaintiffs’ attorney, noted that one consequence of this these efforts to drive issues that appropriately should be dealt with later in the case into a point earlier in the case is that defense expenses accrue much more quickly and much earlier in the case, sometimes creating impediments to later settlement because defense fees have substantially exhausted the available insurance.

Angiolillo had an interesting comment on what may be interfering with case settlement. He suggested that over the last ten years or so, it has become increasingly common for company’s D&O insurance to be structured into a tower of as many as twelve layers of insurance, and that as defense fees and prospective settlement amounts move progressively through the towers, points of resistance emerge that interfere with settlement efforts. Angiolillo suggested that the process participants "need to do a better job getting everyone on the same page" because this "structural issue …inhibits settlements."

And For Those Who Want More: Those home-bound due to weather and therefore unable to attend this conference and want more about what is going on with respect to directors and officers liability and insurance issues can refer to the several recent blog posts I have added on that very topic, including The Top Ten D&O Stories of 2010 (here), What to Watch Now in the World of D&O (here), A Closer Look at the 2010 Securities Class Action Filings (here), and The Latest Status on the Subprime and Credit Crisis-Related Securities Litigation (here).

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In recent days, I have published a series of posts with analysis of and commentary on recent trends in securities class action litigation. As part of this continuing series of posts, I thought it would be useful to include commentary from the plaintiffs’ perspective. With that in mind, I reached out to Max Berger at the Bernstein Litowitz Berger & Grossman firm, and Max graciously agreed to participate in an interview for this blog in the form of a Q&A exchange.

By way of background, Bernstein Litowitz is one of the country’s leading plaintiffs’ class action law firms. Max is a partner in the firm and is also head of the firm's litigation practice. He prosecutes class and individual actions on behalf of the firm’s clients. He and his firm have been involved in some of the highest profile securities class action lawsuits in recent years. Max has indicated with an asterisk in the text of his answers below some of the cases in which his firm has been involved. My questions to Max appear in italics, and his answers appear as indented text (Please note that Max's portion of the content also includes the indented text following his final answer.)

Q.: What do you think were the most important securities litigation trends or developments in 2010?

A.: There are several trends we have seen throughout 2010 that are really continuations of developments from prior years. Central among those, from our perspective representing institutional investors as plaintiffs in these cases, is that the challenges investors face in successfully prosecuting federal securities claims continue to grow. On virtually every element of our clients’ claims, including scienter, loss causation, class certification and standing, we have seen the hurdles increase as a result of court decisions adverse to investors. One notable exception is the statute of limitations, an issue where the Supreme Court provided a favorable ruling this year in Merck.* Of course, that ruling was influenced by the heightened requirements for pleading scienter in a securities fraud action that make it virtually impossible for an investor to assert a claim of fraud until there is clear evidence of fraudulent intent.

While the obstacles to bringing and prosecuting securities cases have dramatically increased, we have seen the scope of the wrongdoing become exponentially larger. Investors have obtained several large recoveries, even as restatements by public companies have declined. Subprime litigation – by which I refer to the full panoply of cases tied to high-risk lending, mortgage securitization and sales of mortgage-backed securities in the last five or six years – remains front and center. The scope and egregiousness of a number of those cases has prompted significant private institutions that have not previously engaged in securities litigation to file claims, and it will be interesting to see whether the involvement of such institutions in these types of cases is a trend that continues. The recent warnings from the FDIC about the financial condition of many midsized banks, coupled with the initiation of securities class actions against several regional banks at the end of 2010, suggests that investors have not yet learned the full truth about the reckless lending and loan management practices of the banks in which they have invested.

Finally, toward the end of 2010, we began to see a resurgence of merger and acquisition activity. For investors in public companies, that trend underscores a need to increase vigilance over the terms of these transactions to ensure that shareholders’ interests are being protected. Indeed, there has been an increase in transactional litigation, and we do expect that trend to increase along with the number of significant deals projected in 2011.

Q.: What impact do you think the Dodd-Frank whistleblower provisions will have on private securities litigation? Are there other aspects of the Dodd-Frank Act that you think will have an important impact on securities litigation?

A.: In our experience, the whistleblower provisions of Dodd-Frank have not yet had a significant impact on private litigation. As in cases outside the securities arena, there are very high hurdles faced by whistleblowers when they decide to take on a former employer. They risk becoming pariahs in self-protecting industries and often imperil their current employment and future employment prospects. Nonetheless, other significant recoveries that whistleblowers have helped obtain – such as in the recent GlaxoSmithKline case, in which a whistleblower who helped the government recover billions of dollars, stands to recover nearly $100 million for herself – may incentivize whistleblowers to take advantage of the protections afforded by Dodd-Frank. In light of the important role that whistleblowers can play in PSLRA litigation, where plaintiffs need to satisfy exacting pleading requirements without access to formal discovery, these provisions of Dodd-Frank certainly have the potential to be very significant if they lead to more witnesses coming forward and providing the kind of information that plaintiffs need to plead sustainable securities fraud claims.

The Dodd-Frank whistleblower provisions, of course, mark a return to the steps taken in the wake of the last round of major corporate scandals at the start of the last decade. Those cases led to Sarbanes-Oxley which included its own whistleblower provisions – provisions which, in our experience, did little to encourage whistleblowers to come forward or to discourage corporate misconduct. We hope that Dodd-Frank will prove more effective, though we are still awaiting significant clarification and rule-making on many of its central provisions.

Q.: I have heard you say that you think the settlement in the Pfizer derivative suit represents an important development and may serve as a model for future settlements in derivative cases. What is it about the settlement that you think is important?

A.: The resolution in Pfizer is unique in many respects. That case involved allegations of systemic and widespread violations of the drug marketing laws that were not being controlled by Pfizer’s board and senior executives, who also rewarded employees that engaged in these practices with bonuses and allowed retaliation against employees who were trying to stop them. These unlawful marketing activities were responsible for Pfizer paying the largest fine in United States history. Our derivative suit accused the board and officers of breaching their fiduciary duties to Pfizer shareholders. Our challenge was not to just return dollars to Pfizer from these individuals because it would have hardly affected their corporate behavior. We wanted to effect long-lasting institutional change at Pfizer to prevent this conduct from occurring in the future.

In crafting the settlement, our objective was to implement a true prophylactic protection for Pfizer shareholders going forward – something with teeth that would prevent the recurrence of conduct that, as we alleged, certain defendants engaged in repeatedly. We also wanted to provide a template for other companies engaged in similar behavior.

To achieve that result, we worked with a renowned corporate governance expert – Professor Jeffrey N. Gordon from Columbia Law School – to address our core allegations and concerns. 　The settlement requires the defendants to create a new regulatory board committee with a broad mandate to oversee Pfizer’s drug marketing practices for at least five years.　 Significantly, this committee will have the power to order its own studies and investigations, and can retain independent experts.　 To carry out this mandate, the new committee has access to its own funding – under the terms of the settlement, the defendants’ insurance carriers agreed to pay $75 million into a fund that will be exclusively used to pay for the committee’s work and attorneys’ fees awarded by the court.　 The agreement to provide that funding is one of the most remarkable aspects of this settlement, and it is one that we view as a critical element, if the committee is to be both independent and effective. The settlement also requires the board’s compensation committee to review Pfizer’s compensation policies for employees and consultants with the new regulatory committee to make sure those policies are consistent with compliance requirements, and to discuss possible clawbacks from employees who directly supervise illegal practices in the future.　 The settlement also requires the creation of an ombudsman program to give Pfizer employees a way to alert the company about potential illegal practices and improper pressure from supervisors without fear of retaliation. Incidentally, the fact that we included this ombudsman provision may say something about our view of the whistleblower protections provided by Dodd-Frank, discussed above. Finally, the Committee is to be chaired by an independent director and regular reports of the Committee’s work are required to be made to the full board and the shareholders. The Committee and its structure have been embraced by two former SEC Chairs, Harvey Pitt and Richard Breeden.

While Pfizer is not the first case in which the defendants agreed to implement corporate governance reforms as a component of a settlement, we feel that the mechanisms provided for in this settlement will make it the most effective reform of corporate governance achieved through shareholder derivative litigation, paralleling the reforms implemented at Texaco in the wake of the landmark employee discrimination action against that company.*

Q.: Many of the subprime and credit crisis-related securities cases are now working their way through the system. Some have been dismissed while others have survived the preliminary motions. Are there any generalizations that can be drawn from the rulings in these cases so far? Can you make any generalizations about the settlements so far in these cases?

A.: Our perspective is that, as the courts and the public have become more sophisticated about the subprime mortgage collapse and the ensuing financial crisis, there is increasing recognition of the fact that the bursting of the housing bubble and the economic meltdown were not the result of some unpredictable tsunami. Rather, many of the companies that have been the subject of securities actions contributed to the bubble and subsequent collapse. For example, Judge Buchwald’s recent decision sustaining fraud claims against Ambac and its officers described the defendants’ claims that they were simply the victims of the financial collapse—an argument that has been made repeatedly and which we have seen in a number of our cases—as being "premised on a convenient confusion of cause and effect." According to Judge Buchwald, in that case, if the plaintiffs’ allegations were true, "Ambac [was] an active participant in the collapse of their own business, and of the financial markets in general, rather than merely a passive victim."*

Similarly, while some observers responded to the collapse of Lehman Brothers as an unforeseeable result of a credit crisis driven by the housing market, the report of the bankruptcy examiner has made clear that Lehman and its auditor violated basic accounting rules to manipulate Lehman’s balance sheet.* In the subprime and related litigations where plaintiffs are able to marshal these kinds of facts demonstrating that the financial crisis, rather than some force of nature, was in many ways the result of widespread misconduct by corporations and individuals, courts are receptive to investors’ claims that are based on that misconduct. Accordingly, we are seeing fewer dismissals in what we consider to be meritorious cases as well as larger recoveries in many of these cases. The fact that Bank of America agreed to pay almost $3 billion to Fannie Mae and Freddie Mac is a good recent example. Even though some have questioned the amount of that settlement, it does show that these claims have teeth.

The only generalization one can really make about the subprime and credit-crisis related securities actions is that they are no different from other securities actions: generally, we are seeing cases dismissed where the plaintiffs cannot muster the evidence required to meet the heightened requirements of pleading scienter or where loss causation cannot be established, while most well-pleaded cases are moving forward and often resulting in significant recoveries as in New Century* (particularly given that, like New Century, many of the issuers at the heart of the subprime fiasco are now bankrupt). That said, as with other securities litigation, we have seen some dismissals of cases that we consider meritorious, but those situations do not appear unique to the subprime arena.

Q.: What impact has the U.S. Supreme Court’s opinion in Morrison v. National Australia Bank had on securities litigation? How has it changed your firm’s approach to cases involving foreign domiciled companies? Is your firm considering alternative approaches on behalf of foreign claimants, such as pursuing claims in courts outside the U.S.?

A.: There is no question that Morrison has had, and will continue to have, a significant impact on investors and on the function of the capital markets more broadly. Through that decision, the Supreme Court has largely denied investors—including U.S. investors who purchase securities abroad—the protections of the federal securities laws, regardless of the extent to which foreign companies engaged in misconduct within the United States. There are a number of what we consider to be very significant cases, where the claims of fraud have real merit, in which U.S. investors may be left with no practical recourse. We will need to see how investors, plaintiffs’ counsel and the courts respond in the coming years, and whether Congress, in turn, takes steps to correct this narrowing of the federal securities laws.

Many of the institutions we represent are considering different avenues to protect themselves. In the Toyota securities litigation,* for example, the Maryland State Retirement and Pension System as Lead Plaintiff has asserted claims under Japanese law on behalf of investors who purchased Toyota shares on the Tokyo exchange, in addition to the Exchange Act claims asserted on behalf of purchasers of Toyota securities on the New York exchange. It is also possible that Morrison will lead to an increase in foreign litigation, as well as individual domestic actions brought under state law, which was not impacted by the Supreme Court’s ruling in Morrison. The recent Fortis filing in the Netherlands certainly indicates that U.S. and foreign investors are open to considering litigation outside of the U.S., but whether investors will find the same protections in foreign litigation that they have found here remains to be seen. Many significant cases that are subject to Morrison are still working their way through the District Courts and we will see what other strategies investors pursue in response to Morrison as those courts, and the appellate courts, render guidance interpreting the Supreme Court’s decision.

Q.: If you were a D&O underwriter, what would you be interested in knowing about a company that you were underwriting? What do you think the most important risk indicators would be?

A.: My focus would be on the company’s leadership and the corporate governance structure that is in place. Are the directors independent and are critical board committees comprised of independent directors? Most importantly, are a majority of the directors on the compensation, compliance and audit committees independent? It is critical that directors have relevant industry experience. While service on other corporate boards may bring relevant experience, I would also be wary of directors who are concurrently serving on multiple boards. Finally, with regard to management, I would examine the compensation structure. Is executive compensation tied to performance? If so, are the metrics being used objective or subject to manipulation? And significantly, are executives being rewarded for achieving long-term objectives rather than short-term goals? As we have seen repeatedly, incentivizing executives to achieve near-term benchmarks for growth or performance can create a motivation to manipulate results to achieve compensation goals, whereas long-term incentives can bring the interests of management in line with the objectives of the company’s shareholders.

Q.: There have been a lot of changes in the environment surrounding securities litigation in recent years, all the way from important court decisions to changes in the plaintiffs’ bar. What do you think the most important changes have been and why?

A.: The principal changes we have seen over the past 15 years have been the legislative and judicial actions to raise imposing hurdles to prosecuting securities cases, particularly as class actions. Those hurdles have dramatically raised the bar for effective prosecution and private enforcement. As a result, these cases have become much more expensive and problematic. I am not the first to observe that in many securities cases, the evidence that must be marshaled in order to survive a motion to dismiss is more than what you would need to get some other cases past summary judgment, and that requires a significant investment of time and resources in cases that may not be sustained. This, in turn, has resulted in a culling of the herd of law firms prosecuting these cases. In many ways, I feel we have also seen the plaintiffs’ bar rise to meet these challenges and the level of practice among the plaintiffs’ firms is far more sophisticated than it was before the PSLRA. Frankly, firms unable to rise to meet these challenges cannot succeed under the regime that has been implemented since 1995.

Whether as a result of that increased sophistication, the heightened hurdles to advancing beyond the pleading stage, the nature and scope of the cases we are seeing or some combination of those elements, we are certainly seeing higher recoveries in the cases that are being prosecuted. And not only higher absolute recoveries, but a better percentage of investor losses being recovered in the cases that we consider meritorious. In WorldCom, for example, bond purchasers received $0.65 on the dollar; in Cendant, the recovery was $0.60 on the dollar; in Refco, about $0.50 on the dollar.*

Finally, private enforcement of the securities laws is now more important than ever because regulatory recoveries have been wholly inadequate to compensate investors victimized by fraud.

Q.: What do you think are the most important trends or developments to watch as we head into 2011?

In the coming year, the U.S. Supreme Court—which has in the recent past exhibited an unusual interest in securities fraud actions—will be considering several cases that have the potential to reshape a significant area of our practice. Several commentators have noted that business interests have found a receptive ear on the Roberts’ Court, and have been quite assertive in gaining that audience. Two cases the Court recently agreed to hear regarding the standards for class certification under Rule 23 of the Federal Rules of Civil Procedure—Wal-Mart v. Dukes, which examines the standards for class certification in an employment discrimination action, and Erica P. John Fund v. Halliburton, whichlooks at whether and to what extent investors will be required to demonstrate loss causation at the class certification stage—exemplify such an effort. I believe the decisions in these cases have the potential to profoundly impact the ability of not only investors—but also workers, consumers, patients and employees—to hold corporate wrongdoers accountable in court.

The Supreme Court also recently heard arguments addressing the appropriate standards for measuring materiality of information that executives are required to disclose to investors in Matrixx Initiatives v. Siracusano—a question that has ramifications not only for the pharmaceutical and biotechnology industries, which have been the subject of a number of significant decisions in recent years, but potentially for virtually every securities fraud action. The court is also considering another case in which the liability of "behind-the-scenes" defendants—by which I mean third parties that are alleged to have a role in carrying out a fraud, even though the allegedly false and misleading statements cannot be readily attributed to them. Specifically, in Janus Capital Group v. First Derivative Traders,the Court is consideringwhether claims under Section 10(b) can be asserted against a subsidiary mutual fund advisor entity that is alleged to have orchestrated the fraud, even though its parent mutual fund actually made the false and misleading statements. While I believe the circumstances of this case may be unique to the mutual fund industry, the Court certainly has the opportunity to set forth a broad rule of law even if it could narrowly decide the question under the specific facts before it.

Another important development for investors to focus on during the coming year will be the ongoing implementation of the Dodd-Frank financial reform legislation. In one recent report, Securities and Exchange Commission officials complained that the agency lacked the proper funding to undertake the significant new responsibilities it was assigned under Dodd-Frank, and had in fact shifted resources used to fund ordinary expenditures—such as the hiring of expert witnesses—to other programs in order to meet its new obligations under the legislation. The perception of how successful the SEC is in fulfilling its mission under Dodd-Frank will likely impact how Congress and the courts view the role of private enforcement of the securities laws, as well as the extent to which investors have been given the proper legal tools to hold wrongdoers accountable.

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Finally, in all honesty, anyone interested in securities litigation trends and developments should read your blog, which is always objective, incisive and very intelligently written. Congratulations, Kevin, and thank you for keeping us all so well informed!

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*In the interests of full disclosure, I note that Bernstein Litowitz Berger & Grossmann LLP serves or has served as lead or co-lead counsel in a number of the above-referenced cases, including Merck, Pfizer, Texaco, Ambac, Lehman Brothers, New Century, Toyota, WorldCom, Cendant and Refco.

Many thanks to Max for his willingness to participate in this exchange.

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Every year, the Stanford Law School Securities Class Action Clearinghouse, in conjunction with Cornerstone Research, releases its annual overview of securities class action lawsuit flings. As I noted in a post last week, this year’s version introduced a number of innovations and reflected a host in interesting observations. (The full 2010 Stanford/Cornerstone report can be found here.)

Because the securities class action litigation environment clearly is going through a significant transition, I thought it would be worthwhile to check in with the Stanford Law Professor Joseph Grundfest, who oversees the Stanford website. Professor Grundfest was gracious enough to agree to participate in an interview for this site. The interview, in the form of a Q&A, is reproduced below. My questions appear in italics, followed by Professor Grundfest’s responses.

Q. What do you think were the most important securities class action litigation trends during 2010?

            A: The dramatic increase in merger related federal class securities fraud litigation. These cases were traditionally filed only in state court, but the decline in traditional securities fraud litigation appears to have generated a demand in the securities fraud plaintiff bar to find new cases to fill the litigation pipeline. Also, plaintiffs may discover that it is easier to control this litigation if they can bring cognizable federal claims, even if those claims are quite weak.

Q. What do you think were the most important judicial trends concerning securities litigation in 2010?

            A: The implications of the Supreme Court’s Morrison decision continues to reverberate in the lower courts, and many observers are surprised by the vigor with which the lower courts are dismissing actions related to foreign market activity. Morrison is not being interpreted narrowly.

Q. What impact do you think that the Dodd Frank Act will have on securities litigation? Do you think the Dodd Frank whistleblower provisions will lead to significantly increased SEC enforcement activity? Are there other provisions of the Act that you think are particularly important from a litigation or enforcement activity standpoint?

            A: Dodd-Frank’s bounty provisions are the joker in the deck here. If the presence of the bounty causes a material increase in SEC enforcement actions, it is reasonable to expect an increase in parallel private actions. After all, that’s the way the market works now: if the SEC files a claim that plaintiffs haven’t yet pursued, it’s only a short matter of time before a very similar private complaint is on file in federal court. There’s no reason that the market won’t work that way in response to SEC actions instituted in response to whistleblower information.

Q. You are in regular contact with directors at some the leading companies in the country. What are directors most concerned about these days? Are there particular liability exposures that you think directors are worried about?

            A: Thoughtful, honest directors are most concerned with the implications of Dodd-Frank’s bounty provisions. In an ideal world, these directors would want all employees with information about potential violations to report those concerns to the appropriate authorities within the company, including the audit committee, so that prompt remedial activity (including potential self-reporting to the SEC) could take place as quickly as possible. Now, however, these directors find themselves in competition with the SEC which stands ready to offer significant financial rewards for the provision of information that might otherwise go to compliance authorities within the corporation. Honest directors, standing ready to remedy all violations brought to their attention, will now be frozen out of the information market because they simply can’t compete with the significant bounties available under Dodd Frank.

 

Q. You have been systematically observing securities class action litigation now for many years. What do you think are the most important securities class action trends and developments in recent years, and why?

            A: It’s a business. The business responds to the forces of supply and demand, and reacts to exogenous shocks in the form of financial crises and revelations of backdating. If you analyze the securities litigation process from a purely economic perspective, otherwise mysterious behavior becomes far more transparent.

Q. Several years ago you suggested that there had been a “permanent shift” to lower securities class action litigation activity levels. I wonder what you think of that suggestion now with the benefit of the passage of time and of the opportunity to review intervening events.

            A: To formally test this hypothesis, we still need several more years’ worth of data. With that caveat firmly in mind, I would like to suggest that this years’ data are consistent with that observation. The “core rate” of litigation, i.e., the number of companies named as defendants in traditional securities fraud actions, is well below the pre-Sarbanes Oxley level, once we net out the merger disclosure cases that inflate this year’s census. This observation suggests that fewer issuers are engaged in the sorts of conduct that would have stimulated litigation prior to Sarbanes Oxley. To be sure, plaintiff counsel can point to a variety of legal developments that arguably raise the bar for plaintiff recovery, but the cases likely precluded either reflect attempts to expand the scope of liability beyond the contours set by the Supreme Court, or involve weaker, more remote claims. The strong cases alleging clear frauds are, in my view, being prosecuted as strongly as ever.

Q. Are there pending cases or ongoing issues that you are watching that you think will be particularly important in the months ahead?

            A: There are three securities cases pending before the Supreme Court this term and any or all of them could lead to decisions that would have significant implications for the securities fraud litigation market. Also, the Supreme Court has a busy class action procedure docket, and decisions in those non-securities cases could have profound implications for the prosecution of class action securities fraud litigation.

Q. Do you have any predictions about 2011 securities litigation activity, as far as anticipated levels or trends?

            A: I would expect the core rate to remain constant, and from there I would expect a bump up as even more merger disclosure litigation finds its way to federal court and a bump down as Morrison reduces the incidence of claims targeting foreign trading activity. Farther down the road, I would not preclude an increase in litigation activity attributable to whistleblower “tag along” cases that will be filed shortly after the Commission announces litigation or settlements arising from Dodd Frank bounty hunter disclosures.

Q. If you were to be called upon to serve as a D&O insurance underwriter, what are the most important things you would want to consider when reviewing a particular company, and why?

            A: I would only insure issuers who promise not to file any claims :)

I would like to thank Professor Grundfest for his willingness to participate in this dialog. I know there are many D&O insurance underwriters who earnestly wish they could implement his proposed D&O insurance underwriting philosophy.

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As a result of a spike in second half filings, the number of new securities class action lawsuits increased slightly in 2010 compared to the year before, although the 2010 filing levels remained below historical averages, according to the annual study released jointly by Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse. This year’s version of the study, entitled "Securities Class Action Filings: 2010 Year in Review," introduces some innovations that provide some interesting perspectives on securities class action lawsuit filings.

The study can be found here, and the joint January 20, 2011 press release about the study can be found here.

According to the study, there were 176 securities class action lawsuit filings in 2010, up 4.8% from 2009, but 9.7% below the 1997-2009 average number of filings (195). The increased number of filings in 2010 was largely due to the increased filing activity in the second half of the year, when 104 new securities suits were filed (compared to only 72 in the first half).

A significant factor in the increased number of 2010 filings was the number of lawsuits related to merger and acquisition transactions. According to the report, there were 40 filings with allegations related to M&A transactions, which represents a 471 percen increase from the seven M&A-related filings in 2009.

This increase in M&A-related litigation cannot be explained simply as reflection of increased M&A activity, since M&A activity increased only 20 percent in 2010. The increase, the report suggests "may be largely a result of changes in plaintiff law firm behavior rather than changes in underlying market forces." The press release quotes Stanford Law Professor Joseph Grundfest as saying that "plaintiffs lawyers are scrambling for new business as traditional fraud cases seem to be on the decline," adding that "there is little reason to believe that this trend will reverse or slow down."

The report also notes a number of trends that have previously been noted elsewhere, including the decreasing number of credit crisis-related lawsuits during the year, and the spate of lawsuits involving for-profit education companies and also involving Chinese companies.

With regard to the surge in lawsuits involving Chinese companies, the press release quotes Professor Grundfest as saying that this litigation is arising as "some Chinese issuers struggle to conform to Western market norms, adding that at the same time others might engage in outright fraud." The report itself adds the observation that most of the Chinese companies sued in 2010 were only recently listed on major U.S. exchanges; eight out of the 12 Chinese companies sued were listed during 2009 or 2010, while the remaining three issuers were listed toward the end of 2006, 2007 and 2008. On average these companies were sued within 1.4 years of their listing dates.

The report includes a status update for the credit crisis related filings. The report confirms an observation I had previously noted, which is that the credit crisis cases seem to be reaching the settlement stage more slowly than compared to securities cases generally. The report states that credit crisis filings "have significantly lower settlement rates compared to non-credit-crisis filings," largely as a result of the cases pending in the Second Circuit. The report shows a 9.8 percent settlement rate for credit-crisis filings compared to 24.1 percent for non-credit crisis filings. However, the dismissal rates for credit crisis-related filings "do not appear to be different from non-credit-crisis-filings."

A new feature added to this year’s report is an analysis of the litigation exposure following initial public offerings. The report analyzed the likelihood that a company would be sued in the eleven year period after its IPO, and compared that likelihood to the possibility that a company in the S&P 500 would be sued during that same eleven year period.

The report found that the exposure to securities class actions is the highest during the first few years after an IPO, although the exposure diminishes over time as the companies mature. The analysis showed that there is more than a 10 percent chance that firms would be hit with a securities suit within three years of an IPO, with the highest risk in the second year after an IPO, when they faced a 4.1 percent chance of being sued.

Interestingly enough, at least with respect to IPO companies that survived for eleven years, the possibility of those companies being sued during that eleven year period is actually lower than for the S&P 500 companies during that period. The S&P companies had a 49.9 percent chance of a suit during that period, compared to only 28.7 percent for the IPO companies. The report speculates that this lower risk over the longer period may be explained by the fact that the IPO companies tend to be much smaller than S&P 500 companies, and therefore represent less attractive targets for the plaintiffs’ lawyers.

One particularly interesting aspect of the report’s IPO review is its analysis of the survivability of IPO companies. The report shows that only 39.4% of IPO companies survived for the full eleven year study period (compared to 65.1% of S&O 500 companies).Indeed, more than 35 percent of companies failed to survive four years after their IPO (compared to less than 15% of the S&P 500 that failed to survive the first four years of the study period).

The report’s industry analysis shows that as filings against financial companies declined due to the diminution of the credit crisis litigation wave, filings against companies in the health care sector spiked.

The report also notes that as the number of M&A related cases has increased, the phenomenon noted in recent years of belated filings (in which the filing date came well after the stock price decline that precipitated the suit) has largely abated.

Overall, the report contains a number of interesting observations and findings, and the report warrants reading at length and in full.

Two final notes: First, the lawsuit count reflected in the Cornerstone report may differ from other published figures, as the Cornerstone report counts multiple filings against the same defendants as a single filing (compared to other commentators that may count separate complaints separately until they have formally been consolidated).

Second, while securities class action lawsuit filings may have been down in 2010 compared to historical averages, the overall level of corporate and securities litigation during the year was actually up – indeed, at "record" levels" – at least according to Advisen’s recently issue report about 2010 litigation activity, about which refer here.

My own analysis of the 2010 securities class action lawsuit filings can be found here.

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Though securities class action lawsuit filings were below historical averages, overall corporate and securities litigation reached "record" levels during 2010, according to a report from the insurance information firm, Advisen. The report, which was released on January 19, 2011 and is entitled "2010 a Record Year for Securities Litigation," can be found here.　

 Preliminary Notes

In considering the Advisen report, it is critically important to recognize that the report uses its own unique vocabulary to describe certain of the litigation categories.

The litigation analyzed in the Advisen report includes not only securities class action litigation, but a broad collection of other types of suits as well, including regulatory and enforcement actions, individual actions, derivative actions, collective actions filed outside the U.S. and allegations of breach of fiduciary duty. All of these various kinds of lawsuits, whether or not involving alleged violations of the securities, are referred to in the aggregate in the Advisen report as "securities suits."

One subset of the overall collection of "securities suits" is a category denominated as "securities fraud" lawsuits, which includes a combination of both regulatory and enforcement actions, on the one hand, and private securities lawsuits brought as individual actions, on the other hand. However, the category of "securities fraud" lawsuits does NOT include private securities class action lawsuits, which are in their own separate category ("SCAS").

Due to these unfamiliar usages and the confusing similarity of category names, considerable care is required in reading the report.

The Report’s Analysis

According to the latest Advisen report, there were a total of 1196 corporate and securities lawsuits field in 2010, which is slightly above the 1171 corporate and securities lawsuits filed in 2009, and represents a "record."

According to the report, there were 193 securities class action lawsuits filed in 2010, down from 233 in 2009 (Advisen’s securities class action lawsuit counts may differ from those of other published sources because the Advisen count, unlike those of other sources, include state court securities class action lawsuits as well as federal court lawsuits). The 193 securities class action lawsuits is 2010 is well below the 2004-2009 average of 227. The Advisen report attributes the relative decline to "a sharp drop in credit crisis suits."

The proportion of all securities class action lawsuits as a percentage of all corporate and securities lawsuits has been, according to the report, "steadily trending downward." Thus, prior to 2006, securities class action lawsuits represented as much as one third of all corporate and securities lawsuits. However, in 2010, securities class action lawsuits represented only 16 percent of all corporate securities lawsuits, and only 14 percent during the fourth quarter of the year.

Two growing categories of corporate and securities litigation are breach of fiduciary duty lawsuits and shareholders derivative lawsuits.

Breach of fiduciary duty lawsuits have grown rapidly as a category of all corporate and securities litigation. As recently as 2004, fiduciary duty suits represent only 8 percent of all corporate and securities lawsuits, whereas they represented about a third of all corporate and securities suits in 2010, and 40 percent in the fourth quarter of 2010. Many of the breach of fiduciary duty cases filed in 2010 are related to merger and acquisition transactions.

Similarly, derivative lawsuits filings increased to 129 in 2010, up from 93 in 2009. In 2011, the derivative lawsuits represented 11 percent of all corporate and securities lawsuit filings.

Financial firms remained the most frequently sued companies in 2010, although filings against financial firms were down relative to prior years. Overall, 30 percent of the corporate and securities lawsuits in 2010 were filed against financial firms, compared to 40 percent in 2008 and 2009. The remaining 2010 lawsuits were more widely dispersed than in recent years.

The report notes that the average settlement value of all corporate and securities lawsuits in 2010 was $37 million, compared to $29 million. In considering this information it is critically important to consider that this figure aggregates regulatory and enforcement settlements with private lawsuit settlements. In that regard it is important to note that the report states that average securities class action settlement in 2010 was $32 million, the average breach of fiduciary duty settlement was $17 million, and the average derivative settlement was $11 million. In each case the private lawsuit settlements averages are substantially influenced by outlier settlements.

The Advisen report also notes that securities litigation has been "on the rise" in recent years outside of the U.S. The report notes that there were 36 "securities suits" in courts outside the U.S., which is ‘in line" with 2006-2008 totals.

Discussion

The data point to which most discussions default in trying to gauge the level of corporate and securities litigation activity is the level of securities class action lawsuit filings. Indeed, a number of commentators (including this blog) release annual studies of securities class action lawsuit filing levels, which typically trigger discussions about whether or not lawsuits are up or down.

The Advisen study makes it clear that if the discussion is focused solely on securities class action litigation activity, then there may be a misleading impression about the level of overall corporate and securities litigation.

The fact is that securities class action litigation is an increasingly smaller part of all corporate and securities litigation. So even though the number of securities class action lawsuits filed in 2010 was down relative to recent annual averages, the overall level of corporate and securities litigation was up in 2010 – in fact, according to the Advisen report, it was at "record" levels.

There are probably a few caveats that need to be supplied with these overall observations about filing levels. First, some readers may object to the conflation of regulatory and enforcement actions with private civil lawsuits. One obvious concern is that the conclusion that corporate and securities litigation overall is reaching "record" levels may simply be a reflection of the fact that regulatory authorities have ramped up their enforcement activities – indeed, there is no doubt that that is at least part of what is going on.

Along those lines, I think it is fair observation that the Advisen analysis would be improved if the regulatory and enforcement actions were separated out from the overall analysis. In that regard, it is particularly unfortunate that the "securities fraud" category is both confusingly named and also incorporates both regulatory actions and securities lawsuits not brought as securities class action lawsuits, eliminating any chance that a reader might try to filter out the regulatory and enforcement activity from the private litigation activity.

Another concern is that even if securities class action lawsuit filing levels are down relative to historical norms and as a percentage of all corporate and securities lawsuits, securities class action lawsuits remain the most significant source of severity risk – at least in terms of private civil litigation, as distinct from regulatory and enforcement actions.

However, from the perspective of the likelihood of litigation, and in particular from the perspective of the claims experience of D&O insurance carriers most active in the primary layer, the increasing incidence of other types of corporate and securities litigation is a very significant development. An analysis focused solely on securities class action litigation would miss the significance of the increase claim frequency coming from these other kinds of claims, and the resulting claim exposure for companies and for the D&O insurers.

My own analysis of the 2010 securities class action lawsuit filings can be found here.　 

2010  Securities Litigation Overview Webinar: On Friday January 21, 2011, at 11:00 am EST, I will be participating in a free webinar on the topic "Year End 2010 Securities Litigation Overview," sponsored by Advisen, to discuss 2010 securities litigation trends and developments.. Other panelists participating in the webinar include David Bradford of Advisen, Kevin Mattesich of the Kaufman Dolowich law firm and Gerald Silk of the Bernstein Litowitz firm. Further information about the webinar, including registration instructions, can be found here. 

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As detailed in the accompanying blog post, all signs are that the FDIC will be filing increasing numbers of civil actions against former officials of banks that have been closed as part of the current round of bank failures. With this possibility in mind, it seems like it is time for The D&O Diary to initiate yet another of its litigation tracking lists.

A list reflecting the civil lawsuits that the FDIC has filed in its capacity as receiver against former officials of failed banks can be found here.

I will be updating this list periodically as I become of aware of additional civil lawsuits that the FDIC has filed. This list is a community resource for readers of this blog, and I hope that readers will help maintain the value of this resource for the community by advising me of any new lawsuits that have been filed and of any omission from the list. As I update the list, I will indicate at the top of this blog post the last date on which the list was most recently updated.

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The first subprime-related securities class action lawsuit was filed in February 2007, and so the subprime and credit crisis-related litigation wave will soon enter its fifth year. With the anniversary date just ahead, it seems like an appropriate time to step back for an updated interim status update. I have set out below a numerical overview of the case filings and case resolutions so far, followed by some observations about how the cases are developing.

New Case Filings

Though the depths of the financial crisis is now mercifully receding further into the past, credit crisis-related cases still continued to arrive during 2010, albeit in significantly diminished numbers.

As I noted in my overview of the 2010 securities class action lawsuit filings (here), the credit crisis cases were a significant part of all filings during the years 2008 (when there were 102 credit crisis-related lawsuit filings) and 2009 (62).

By contrast during 2010, there were only 23 new credit crisis-related securities lawsuits, representing about 13% percent of the total. Of these 23 new credit crisis cases, only nine of these cases were filed in the year’s second half, and only one was filed after August 2010. The subprime and credit crisis litigation wave, it seems, is winding down.

One factor complicating efforts to continue to track the filings is that over time it has become increasingly difficult to maintain definitional clarity about what exactly constitutes a subprime or credit crisis-related case. For that reason, published reports of the number of subprime and credit crisis securities suits vary. But the various reports generally agree that there are about 230 securities class action lawsuits have been filed since the beginning of the subprime litigation wave. For statistical simplicity, I have used the number 230 for analytical purposes in this post.

Dismissal Motion Rulings

Since the very first of these cases moved through the preliminary motions, I have tried to track the dismissal motions rulings. My running tally can be accessed here. As the number of rulings have accumulated it has become increasingly challenging to meaningfully sort out the rulings, but some generalizations are possible.

Not counting the handful of cases that have been voluntarily dismissed and not refiled, there have been dismissal motion rulings in a total of 106 of the cases, or about 46% of all of the subprime and credit crisis-related securities class action lawsuits lawsuits. (The counting gets a little complicated because some cases have had multiple rulings, and others have had only partial rulings).

For purposes of determining how the dismissal motions have been running, I have counted as dismissals all cases in which dismissal motions have been granted, regardless of whether the dismissal was with or without prejudice, but not counting as dismissals those cases where the dismissal motion was initially granted without prejudice and then subsequent dismissal motions were denied on rehearing. I count a case in which any part of the plaintiff’s claims survive as a dismissal motion denial, even though the motion may have been granted in substantial part.

Using these principles to categorize the various dismissal motion rulings, it appears that dismissal motion rulings have been granted in 53 cases, or half of all dismissal motion rulings so far. Of these 53 dismissals, 39 were granted with prejudice and 14 were granted without prejudice. In addition to these 53 dismissals, there were an additional seven cases in which dismissal motions were initially granted without prejudice but in which renewed motions to dismiss were subsequently denied.

Dismissal motions have been denied, in whole or in part, in 53 of the cases.

Based on the dismissal motions that have been heard so far, the dismissal rate on these cases is running at 50% compared to historical dismissal rates of securities class action lawsuits of about 40%.

Before jumping to any conclusions about the subprime lawsuit dismissal rate compared to more typical dismissal rates, it should be recalled that I have included in the subprime lawsuit dismissal rate even cases that were dismissed without prejudice. Some of these cases may yet survive renewed dismissal motions, as have several other subprime and credit crisis cases that were initially dismissed but that ultimately survived. Some prominent examples of these cases include the Washington Mutual case (refer here), the BankAtlantic case (here), the PMI Group case (here), and the Credit Suisse case (here).

It is also important to note that dismissal motions still have not yet been heard in over half of the subprime and credit crisis-related cases. It is entirely possible that the dismissal motions were ruled upon more quickly in many of the least meritorious cases, and that as other cases move toward ruling on the preliminary motions the dismissal rate move revert toward historical norms.

One final note about the dismissal motion rulings is that appellate courts have affirmed the dismissals of at least three cases: NovaStar Financial (here), Centerline (here) and Impac Mortgage (here).

Settlements (and a Trial)

So far, 17 of the subprime and credit crisis-related securities class action lawsuits have settled, representing aggregate settlement amounts of $1.930 billion. The average settlement amount is $113.54 million.

These settlement figures are substantially inflated by a few larger settlements. Indeed, just three settlements account for $1.335 billion of the aggregate settlement amount – Countrywide ($624 million), Merrill Lynch ($475 million) and Charles Schwab YieldPlus ($235 million). If these three jumbo settlements are removed from the calculation, the average settlement drops to $42.51 million – still a very large number but not quite as astonishingly large.

Only 17 cases have settled even though dismissal motions have been denied in 53 cases. Not only are there but a very few settlements overall, but the settlements are emerging at a very slow rate. Thus for example., during 2010, there were only eight settlements of subprime and credit crisis-related securities class action lawsuits, only two of which were announced after August 1, 2010.

It is worth keeping in mind that every now and then there is an occasional case that isn’t dismissed that doesn’t settle either. Not many securities class action lawsuits go to trial, but at least one subprime and credit crisis-related securities lawsuit so far has gone all the way through to a jury verdict.

In November 2010, a jury in federal court entered a plaintiffs’ verdict in the subprime-related securities class action lawsuit against BankAtlantic Bancorp and certain of its directors and officers. The jury awarded damages of $2.41/share, which published sources have suggested could be worth as much as $42 million. Interestingly enough, this case was one of those that was initially dismissed but that survived the renewed motion to dismiss.

Observations

Even if it is valid to observe that the subprime and credit crisis-related cases are being dismissed more frequently than is generally the case for securities class action lawsuits, it is also clear that the highest profile cases generally are surviving. Among other cases that have survived are those involving Citigroup (refer here), AIG (here), Countrywide (here), Fannie Mae (here), Washington Mutual (here), New Century Financial (here), Sallie Mae (here) and Bank of America (here).

In general, it seems that courts have proven to be wary of many allegations of fraud, in light of the global financial crisis. Courts have required specifics in order to allow cases to proceed. Where plaintiffs have been able to show, using internal documents or confidential witness testimony, that there was a mismatch between what a company was telling investors and what its people were saying internally, the cases have been allowed to proceed. Courts have been most receptive to this suggestion in the highest profile cases.

Some examples of cases where courts’ skepticism, arising from the extent of the global financial crisis, has been most pronounced have included the Security Capital Assurance case, in which (as discussed here), Southern District of New York Judge Deborah Batts wrote in her March 31, 2010 dismissal motion ruling that "defendants, like so many other institutions floored by the housing market crisis, could not have been expected to anticipate the crisis with the accuracy plaintiffs enjoy in hindsight."

Similarly, and as discussed here, in his March 17, 2010 opinion in the CIBC subprime-related securities suit, Southern District of New York Judge William H. Pauley III observed that:

The Complaint describes an unprecedented paralysis of the credit market and a global recession. Major financial institutions like Bear Stearns, Merrill Lynch, and Lehman Brothers imploded as a consequence of the financial dislocation. Looking back, a full turn of the wheel would have been appropriate. That CIBC chose an incremental measured response, while erroneous in hindsight, is as plausible an explanation for the losses as an inference of fraud. …CIBC, like so may other institutions, could not have been expected to anticipate the crisis with the accuracy Plaintiff enjoys in hindsight

An example of a case in which courts have been persuaded to allow cases to proceed, notwithstanding these kinds of concerns, due to alleged gaps between what was been communicated externally and what allegedly was being said or done internally, is the Citigroup subprime-related securities lawsuit, where Southern District of New York Judge Sidney Stein noted in his November 9, 2010 opinion that the company allegedly was "taking significant steps internally to address increasing risk to its CDO exposure but at the same time it was continuing to mislead investors about the significant risks those assets posed. This incongruity between word and deed establishes a strong inference of scienter."

Another case where a court found a similar "incongruity" is the Fannie Mae subprime related securities lawsuit, in which (as discussed here) Judge Paul Crotty said in his September 30, 2010 order denying the defendants’ motion to dismiss as to one part of the plaintiffs’ allegations that certain emails on which the plaintiffs rely showed that "Fannie may have been saying one thing while believing another."

One particular type of allegation that has had success in a number of cases involving mortgage originators and against the organizers of mortgage loan pools or trusts is that, contrary to public statements about the underwriting discipline utilized in creating the mortgages, the mortgage originators had "systematically disregarded" their mortgage underwriting guidelines. An example of a case in which this allegation was sufficient to allow a case to survive a dismissal motion is the DLJ Mortgage Capital/ Credit Suisse subprime-related securities lawsuit (about which refer here) in which Southern District of New York Judge Paul Crotty denied the motion to dismiss solely as to plaintiffs’ allegations that the mortgage originator’s alleged ""systematic disregard of the mortgage underwriting guidelines."

There have been a number of dismissal motion developments that seem likely to be relevant in other dismissal motion rulings.

The first is that the U.S. Supreme Court’s opinion Morrison v. National Australia Bank clearly will be relevant to Section 10(b) cases filed against foreign domiciled companies. In the Morrison case, the Court found that Congress had not intended the ’34 Act to apply extraterritorially and that Section 10(b) applies only to transactions on U.S. exchanges and to domestic transactions in other securities.

There have already been rulings in at least two subprime cases in which courts have, in reliance on Morrison, granted motions to dismiss cases pending against non-U.S. companies. As discussed here and here, respectively, the subprime-related securities cases against both Swiss Re and Société Générale were dismissed in reliance on Morrison.

Many of the subprime and credit crisis-related securities class action lawsuits involve companies domiciled overseas. It may be anticipated that foreign-domiciled defendants in pending ’34 Act cases will seek to have the cases dismissed, or at least narrowed, in reliance on Morrison, which could affect a number of pending cases.

Another dismissal motion ruling that could affect a number of pending cases is Southern District of New York Judge Miriam Goldman Cedarbaum’s October 14, 2010 ruling in the case pertaining to Goldman Sachs-related entities mortgage-backed securities. The court held that the plaintiffs had not alleged "cognizable injury" where they had not alleged that they failed to receive payments due under the securities, but rather they have alleged that their investments have declined in value or are now riskier than when purchased.

As far as I am aware, Judge Cederbaum’s ruling is the first in which mortgage-backed investors’ Section 11 claims have been dismissed for lack of cognizable injury based on a failure to allege that payments due under the securities had been terminated or interrupted. There were quite a few of these mortgage-backed securities lawsuits filed during 2008 and 2009, and Judge Cedarbaum’s decision potentially could be quite significant in these other cases, at least where the investors have not alleged that payments due under the instruments have failed.

Another recent ruling that may suggest problems that many plaintiffs asserting Section 11 claim may fact is the dismissal on statute of limitations grounds of many of the claims asserted in the Barclays subprime related class action lawsuit (about which refer here). The ruling suggests that the statue of limitations could be a significant issue in many ’33 Act cases, particularly where the referenced offerings may have taken place well before the filing date of the lawsuit.

Many of the subprime and credit crisis-related securities lawsuits are yet to reach to the dismissal motion ruling stage. From the comments of many of the judges who have issued rulings, it is clear that the courts are struggling with the complexity and magnitude of these cases..

For example, Judge William Pauley noted in denying the motion to dismiss in the Sallie Mae subprime related case that the complaint was a "behemoth" containing "labyrinthine allegations." Similarly, in his dismissal motion ruling in the Citigroup subprime-related securities suit, Judge Stein emphasized length and even the weight of the complaint, noting that it "536 pages long, contains 1,265 paragraphs, and weights six pounds." In his dismissal motion ruling in the Raymond James Financial subprime case, Judge Robert Patterson Jr. bemoaned the amended complaint’s "extreme length," which, he said, represents "an independent ground for dismissal."

The courts may feel oppressed by the sheer mass of the plaintiff’s pleadings, but plaintiffs do face formidable obstacles in trying to build complaints sufficient to overcome the initial procedural hurdles. And the fact is that many of these cases are highly complex, implicating as they do the most exotic creations of Wall Street’s fevered imaginations.

In addition to daunting the courts, the sheer size and complexity of many of these cases may be delaying case resolutions, including settlement. The relatively small number of settlements of these cases so far may well be a reflection of the complexity of the cases. Despite these challenges, the cases will continue to grind their way through the system. Certainly the remaining cases will move toward the dismissal motion stage. And it seems likely that many more case will move toward settlement. 2011 promises to be a year when many more of these cases are resolved – though this process is also likely to continue for many years to come.

U.S. Supreme Court Grants Cert in Halliburton Case: It used to be relatively rare for securities cases to come before the United States Supreme Court. Now it seems that there are two or three important securities cases every term. The Court has already agreed to hear several securities cases during this term. And now the Supreme Court has agreed to hear yet another securities case.

As reflected on The 10b-5 Daily blog (here), on January 7, 2011, the Supreme Court granted the petition for writ of certiorari in the Halliburton case out of the Fifth Circuit. The case will address the question whether or not loss causation is a relevant issue at the class certification stage. I hope to have an opportunity to review this development at greater length in a future blog post. In the meantime, The 10b-5 Daily has done a good job linking to all of the relevant materials.

The First Bank Closures of 2011: We can all hope that the worst of the current wave of bank failures is behind us, but banks are nevertheless continuing to fail. After taking control of 322 banks between January 1, 2008 and December 31, 2010, this past Friday night the FDIC completed the first two bank closures in 2011 when it took control of banks in Arizona and Florida, as reflected here. We can certainly hope that there will be fewer bank closures overall in 2011, after the 157 bank failures last year (the highest number of bank failures since 1992).

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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2010 was an eventful year in the world of D&O liability. Congress passed massive financial reform legislation, the Supreme Court issued landmark decisions in important cases and numerous claims emerged as the litigation landscape continued to evolve. With so much going on, it is a challenge to narrow the year’s events down to just the ten most significant developments.

With appropriate humility about the limitations of all year-end inventories, here is my list of the top ten D&O developments of 2010.

1. Securities Suits Pick Up in Year’s Second Half: As I detailed in my 2010 securities litigation overview (here), after a filing downturn in the year’s first half, the number of securities lawsuit filing picked up in the last six months of the year. Among other things, as the year progressed, filing activity shifted away from credit crisis-related cases and toward a broader range of other types of cases.

Although at least some of the litigation activity in the year’s second half was driven by limited or short term events (as was the case, for example, in the rash of cases filed against for-profit education companies and against Chinese domiciled companies), the shift away from credit crisis cases could suggest that the heightened pace of securities suit filings may continue as we head into 2010.

2. The Changing Mix of Corporate and Securities Lawsuits: As insurance information firm Advisen has well documented, the mix of corporate and securities lawsuits has been evolving over the past several years. The most important feature of this changing mix of cases has been the decreasing prevalence of class action securities lawsuits as a percentage of all corporate and securities cases.

As the percentage of class action securities lawsuits has declined, other types of lawsuits, particularly breach of fiduciary duty cases, have grown in relative frequency. Many of these breach of fiduciary duty cases are related to mergers and acquisitions activity. Indeed, as I noted in my year-end review of 2010 securities lawsuit filings, even many of the cases that are categorized as securities class action lawsuits involve merger objection cases.

It is important to keep this changing mix of cases in mind when considering the various year end reports on securities litigation activity. These reports will show that overall 2010 securities class action lawsuit filings are down compared to post-PSLRA averages. However, it would be mistake to conclude that the relatively reduced number of securities class action lawsuits means that claims activity in general is down. To the contrary, overall claims activity is actually up. The mere fact that securities class action lawsuits are down does not mean that fewer companies are being sued or that overall claims exposure has diminished, either for companies or insurers. Rather, what is happening is that the claims exposure is changing, away from securities class action lawsuits and toward other types of claims.

This shift away from traditional securities class action lawsuits as a percentage of all claims activity has important implications for the insurance marketplace. The shift toward higher frequency, lower severity type of claims could have a significant impact both on primary and excess carriers. Primary carriers may experience an increase in overall claims frequency, with consequences for their loss experience. Excess carriers, particularly higher excess carriers, may experience relatively fewer claims piercing their layers, possibly producing a positive impact on the excess carriers’ results.

3. Banks Fail, Lawsuits Loom: 157 banks failed during 2010, the largest annual number of bank failures since 1992. The total number of bank closures since January 1, 2008 is 322. In addition, in the FDIC’s most recent Quarterly Banking Profile (refer here), the FDIC identified 860 banks, or about one out of nine of all banks, as "problem institutions."

Given the magnitude of these problems in the banking industry, it is hardly surprising that litigation involving failed and troubled banks is increasingly significant. Indeed, 13 of the 177 securities class action lawsuits filed in 2010 involved failed or troubled banks. In addition, aggrieved investors in failed or troubled privately held banks also filed a variety of other lawsuits, primarily in state courts.

It may be anticipated that the FDIC will also actively pursue claims against failed banks’ former directors and officers. However, to date, the FDIC has instituted only two D&O claims as part of the current round of failed banks (refer here and here).

It appears that it will only be a matter of time before the FDIC launches further suits against former officials of failed banks. Widely circulated news reports have quoted FDIC officials as saying that the FDIC has authorized civil actions against more than 80 directors and officers of failed banks. In addition, the Wall Street Journal reported in November that the FDIC is conducting fifty criminal investigations against directors, officers and employees of failed banks.

While we may hope that the current round of bank failures may begin to wane as we head into 2011, it appears that the failed bank litigation may only just be getting started.

4. Credit Crisis Lawsuit Settlements: The Dog that Didn’t Bark This Year: The subprime and credit crisis-related litigation wave will be heading into its fifth year early in 2011. Since 2007, there have been over 230 subprime and credit crisis related securities lawsuits filed. Many of these cases continue to work their way through the system.

As some of these cases have survived the preliminary motions, they have moved toward settlement. There were several noteworthy credit crisis related securities class action lawsuit settlements during 2010, including Countrywide ($624 million, refer here), Schwab Yield Plus ($235 million , refer here), and New Century Financial ($124 million, refer here).

But while there have been a few noteworthy settlements of these cases this year, the more striking observation is how few of these cases have settled so far, particularly given how far along we are in the subprime and credit crisis litigation wave.

By my count, only 17 of the over 230 subprime and credit crisis-related securities class action lawsuit have settled, and only eight of these 17 settlements were announced in 2010. (My list of subprime and credit crisis-related lawsuit resolutions can be accessed here.)

NERA Economic Consulting stated in its year-end report on securities litigation that of the approximately 230 credit crisis securities suits, only 8% have settled, 29% have been dismissed, and 63% remain unresolved.

Of the 63% of unresolved cases, some of course will wind up being dismissed. But many more will settle, eventually. Given the now long duration of the credit crisis litigation wave, it can be anticipated that there may be many more settlements of these cases in 2011. The likelihood is that D&O insurers’ aggregate claims losses for these claims will mount, perhaps rapidly.

The question is whether the materialization of these losses will come as a surprise or has already been fully anticipated in the carriers’ prior years’ loss reserves. This answer to this question could have important implications for the D&O insurers’ 2011 calendar year results.

5. Megasettlements of Shareholders’ Derivative Lawsuits Surge: There was a time when the settlement of a shareholder derivative lawsuit involved the payment of little or no money, other than in connection with the payment of the plaintiffs’ attorneys’ fees. However, one of the more striking developments in recent years has been the emergence of jumbo settlements of shareholders derivative lawsuits, in which millions of dollars are paid to or on behalf of the company involved.

This emerging trend continued to develop in 2010, with at least two huge shareholder derivative lawsuit settlements: the $90 million AIG/Greenberg settlement (about which refer here) and the $75 million Pfizer settlement (refer here).

These 2010 settlements join a growing list of other jumbo derivative settlements in recent years, including the UnitedHealth Group settlement ($900 million, refer here); Oracle ($122 million, refer here); Broadcom ($118 million, refer here); and the first AIG derivative settlement (refer here).

The striking thing about these settlements is not only their size, but also the fact that in each case the company involved is solvent. The significance of this fact is that these settlements represent instances in which the companies’ D&O insurance potentially could have been called upon to fund an A Side loss outside of the insolvency context. These kinds of settlements provide concrete evidence of the value to policyholders of Side A insurance protection even outside of the insolvency context, and underscore the importance of added Side A protection in a well-designed D&O insurance program.

From the carriers’ perspective, these settlements suggest that Side A losses can mount outside of insolvency. Only the carriers themselves can answer the question whether or not they are actually pricing their Side A products for this loss exposure.

One final note about the Pfizer derivative lawsuit settlement concerns the unusual funding mechanism the settlement implemented. In many derivative lawsuit settlements the companies involved agree to institute corporate governance reforms. What was unusual about the Pfizer settlement is that the settlement agreement created a dedicated fund intended to finance the company’s agreed upon governance reforms. If the advance funding of corporate governance reforms were to become a standard feature of derivative lawsuit settlements, the cash cost of derivative settlements could increase substantially. This is a potential development worth watching closely.

6. Rare Securities Lawsuit Trials Result in Plaintiffs’ Verdicts: Very few securities class action lawsuits actually go trial. Most are settled or dismissed. But in 2010, two cases made it all the way through to jury verdicts. In January, the jurors in the Vivendi case entered a verdict on behalf of the plaintiffs against the company (about which refer here), and in November, the jurors entered a verdict for the plaintiffs in the BankAtlantic subprime-related securities suit (refer here).

In addition to these jury verdicts, in June 2010, the Ninth Circuit issued an opinion overturning the trial court’s post trial ruling in the Apollo Group case, a ruling that had set aside the jury’s $277.5 million jury verdict in that case. Refer here regarding the Ninth Circuit’s opinion in the Apollo Group case.

All three of these cases remain subject to further proceedings. The Vivendi case in particular is the subject of significant post-trial motions having to do with the composition of the plaintiffs’ class in the wake of the U.S. Supreme Court’s decision in the Morrison v. National Australia Bank case (about which refer to these prior guest blog posts, here and here. See also item 10, below).

The defendants in the Apollo Group case have filed a petition with the U.S. Supreme Court for a writ of certiorari (about which refer here). And the BankAtlantic case has now moved on to post-trial motions, and depending on the motions’ outcome, possible appeal.

But while the ultimate outcome of these cases remains to be determined, it is striking that all three of these cases not only involve rare trials, but all three resulted in jury verdicts for the plaintiffs. To be sure, there have also been recent securities lawsuit trials that have resulted in defense verdicts, as was the case for example in the JDS Uniphase trial (about which refer here).

According to information compiled by Adam Savett, the Director of Securities Class Actions at the Claims Compensation Bureau, there have now been ten securities class action lawsuit trial post-PSLRA and involving post-PSLRA facts. The scoreboard currently reads: Plaintiffs 6, Defendants 4. The scoreboard is of course subject to revision pending further proceedings. Nevertheless, the juries themselves seem to have been favoring the plaintiffs, a phenomenon that may make plaintiffs’ threats to push a case to trial represent a particularly threatening tactic.

7. Assessing Coverage for "Bump Up" Claims: As noted above, a significant and growing number of corporate and securities lawsuits arise out of merger and acquisition activity. Often, the goal of this litigation is to try to increase the transaction consideration. One recurring question is the availability of D&O insurance coverage for amounts paid in settlement of so-called "bump up" claims.

In October 2010, the First Circuit entered an opinion in coverage litigation involving Genzyme Corporation, discussing the question of the preclusive effect of a D&O policy’s "bump up" exclusion. The First Circuit overturned the lower court’s decision that had held that the company’s D&O insurance policy did not provide coverage for additional amounts paid to claimants who asserted they did not received adequate consideration in a share exchange.

Though the First Circuit reversed the lower court’s holding of noncoverage, the First Circuit did not invalidate the bump up exclusion and agreed that the exclusion precluded entity coverage for bump up amounts.

The First Circuit remanded the case to the lower court for further allocation proceedings (that is, because the First Circuit held that the bump up exclusion precluded coverage only under the policy’s entity coverage provision, further proceedings are required to determine whet portion if any of the underlying settlement is allocable to settlement of liabilities of persons insured under other insuring provisions of the policy).

Of critical importance is that the First Circuit found that exclusion is enforceable and is effective to preclude coverage according to its terms. The holding clearly will be relevant to questions of coverage in future cases involving settlements of "bump up" claims, at least where the implicated D&O insurance policies include bump up exclusions.

8. D&O Insurance Coverage for Informal SEC and Internal Investigations: Among the perennial D&O insurance issues are the questions of coverage for informal SEC investigations and for internal investigations. In either case, the question is whether or not there is a "claim" as required to trigger coverage under the policy.

In one of the year’s most noteworthy D&O insurance coverage decisions, Southern District of Florida Judge Kenneth Marra, applying Florida law in a summary judgment ruling in coverage litigation involving Office Depot, held there is no coverage under the company’s D&O insurance policies for either of these categories of expenses.

Though the holding in the Office Depot case is direct reflection both of the specific policy language involved and the facts presented, the decision nevertheless could be influential in future claims involving questions of coverage for informal SEC investigations and internal investigations. The Office Depot decision suggests that policy definitions of the terms "Securities Claim" and "Claim" are critical, particularly with respect to the definitional references to "investigations" and "proceedings." Refer here for a more detailed discussion of the case and the decision.

The Office Depot ruling is hardly the final word on these issues, but it clearly will loom large in future consideration of questions of coverage for these kinds of expenses. Insurers undoubtedly will seek to rely on the decision to try to preclude coverage for costs incurred in connection with informal SEC investigations and internal investigations.

On a related note, a separate court held in the MBIA coverage case that there is coverage under the D&O insurance policy at issue for special litigation committee expenses, as discussed here.　

9. Is a Whistle the Sound of the Future?: The massive Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 enacted in July will affect virtually every aspect of our financial system, in ways that may only become clear over time. But among the Act’s innovations that seem likeliest to have a significant litigation impact are the Act’s new whistleblower provisions.

The whistleblower provisions include the creation of a new whistleblower bounty pursuant to which persons who first bring securities law violations to the attention of the SEC will receive between 10 percent and 20 percent of any recovery in excess of $1 million.

Give the magnitude of the fines paid in many recent SEC enforcement actions, particularly those involving Foreign Corrupt Practices Act violations (about which refer here), the prospective size of potential bounties is enormous. These bounty provisions seem likely to encourage a flood of whistleblower reports to the SEC. This could create an administrative nightmare for the SEC, and the agency is already struggling with funding limitations that may constrain its ability to implement the whistleblower requirements. On the other hand, the SEC, under pressure to rehabilitate its regulatory credentials after its failure to detect the Madoff scheme, will face significant pressure to pursue whistleblower claims.

Another 2010 development that seems likely to encourage an entirely different sort of whistleblower activity is the series of WikiLeaks disclosures. The extensive media attention give to the disclosures, as well as the suggestions of WikiLeaks founder Julian Assange that future disclosures will expose corporate misconduct, raise the possibility of that other self-appointed corporate scourges will launch similar guerilla campaigns involving the disclosure of internal corporate communications.

These two types of prospective whistleblower risks arguably represent an entirely new level of corporate exposure that could leave companies and their senior officials susceptible to claims of wrongdoing based on public or regulatory disclosures by persons inside the company with access to sensitive information. Indeed, companies and their senior officials could even be susceptible to claims for the alleged failure to implement and maintain sufficient controls to prevent embarrassing or harmful disclosures. Regardless, companies could face the prospect of significant risks involving person inside (or with access to) their own operations.

10. Foreign Companies, U.S. Courts: In June 2010, the U.S. Supreme Court issued its long-awaited decision in the Morrison v. National Australia Bank case, holding that Section 10(b) of the Securities Exchange Act of 1934 applies only to transactions taking place on the U.S. securities exchanges, or domestic transactions in other securities.

Among other things, the Morrison decision seems to represent the end of so-called "f-cubed" claims, involving foreign claimants who bought their shares in foreign companies on foreign exchanges.

Lower courts are now wrestling with Morrison’s implications, including, for example, the question of whether or not Morrison precludes claims under the U.S. securities laws against companies whose American Depositary Receipts trade on U.S. exchanges. (Surprisingly, at least one court has held that case has that effect, as discussed here.) Other courts have struggled to determine what falls within Morrison’s second prong relating to "domestic transactions in other securities." Clearly, there will be much further lower court activity as these kinds of issues are sorted out.

In the meantime, one consequence that seemed likely in the wake of Morrison is that there might be fewer (or at least only narrower) cases filed in U.S. courts involving non-U.S. companies. Contrary to expectations, however, there were quite a number of securities cases filed in U.S. courts involving foreign-domiciled companies in 2010, including many filed after the Supreme Court issued its Morrison opinion.

As reflected in my recent year-end analysis of 2010 securities lawsuit filings, there were 19 new securities class action lawsuits filed in 2010 involving foreign domiciled companies, representing 10.7% of all 2010 securities lawsuit filings. Of these 19 cases, 12 were filed after the Supreme Court issued its opinion in Morrison.

One possibly temporary factor driving many of these filings is the rash of new cases filed against Chinese- domiciled companies. There were ten new lawsuits against Chinese companies in 2010, eight of which were filed post-Morrison. It should be noted that the shares of many of these Chinese companies trade on U.S. exchanges and in fact many of the cases directly relate to the companies’ securities offerings in the U.S., facts which made these companies susceptible to securities lawsuits in this country even under Morrison.

The lower courts will continue to interpret and apply Morrison in the months ahead. In the meantime, it seems that lawsuits involving non-U.S. companies will continue to arise, at least where the companies’ shares trade on U.S. exchanges.

A Final Note: Readers of this blog post may also be interested in my September 2010 post entitled "What to Watch Now in the World of D&O," which can be found here.

Ten Top Ten Lists: Top ten surveys proliferated at year end, and so it seems like a list of ten top ten lists would be the appropriate accompaniment to The D&O Diary’s own top ten list:

The Year’s Top Ten Insurance Coverage Decisions

Top Ten YouTube Videos of 2010

Top Ten Annoying Things British Men Do While Abroad

Top Ten New Species (International Institute for Species Exploration)

Top Ten Goals from the 2010 World Cup

Top Ten TV Commercials of 2010

Top Ten Encyclopedia Britannica Queries 2010

Top Ten Must-Reads in the Law, 2010

Princeton Review Top College Ranking 2010-2011

Time Magazine’s Top Ten of Everything List

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2010 was a year of transition for securities class action lawsuit filings, as a number of trends that have been dominant in recent years diminished as the year progressed, while at the same time other trends emerged. Overall, the number of filings during the year was up slightly from last year, although below long term averages. But as noted below, the securities class action lawsuit filing levels are only part of what has been happening from an overall claims frequency standpoint.

Overall Numbers

By my count, there were 177 new securities class action lawsuit filings during 2010. (Please see my notes below regarding counting methodology.) The 2010 total is up from the 168 new securities suits in 2009, although below the 1997-2008 average of 197.

The 2010 filings were weighted toward the year’s second half, as there were only 74 new securities class action lawsuit filings the first six months of the year, compared with 103 during the last six months.

There were a number of different factors behind the relatively greater number of filing in second half of the year.

2010 Filing Trends

Perhaps the most significant factor behind these annual filing numbers is the diminishing numbers of subprime and credit crisis related cases during year.

The credit crisis cases had been a significant of all filings during the years 2008 (when there were 102 credit crisis-related lawsuit filings) and 2009 (62). By contrast during 2010, there were only 23 new credit crisis-related securities lawsuits, representing about 13% percent of the total. Of these 23 new credit crisis cases, only nine of these cases were filed in the year’s second half, and only one was filed after August 2010. Clearly, the credit crisis litigation wave is winding down.

Similarly, another important factor in recent years’ filings has been the phenomenon of belatedly filed cases. These cases, filed more than a year or more after the proposed class period cutoff date, had surged during 2009. The belated filings did continue in 2010, as there were 17 of these belated cases during the year. However, there were only three of these cases were filed in the year’s second half, and none were filed after September. Again, the phenomenon of belatedly filed class action seems to be winding down.

While these dominant trends from prior years diminished in the second half of 2010, a number of other trends emerged that largely explain the increase in filings during the last six months of the year.

First, a significant percentage of all 2010 filings were lawsuits related to mergers or acquisitions. These merger objection cases involve acquisitions, going private transactions or management buyouts, or allegations of proxy violations in connection with these kinds of corporate activities. There were 37 of these cases in 2010, representing more than one-fifth of all 2010 filings. 23 of these cases were filed in the year’s second half. These merger objection cases were a significant part of the increased number of filings in the year’s second half.

Second, there were several sector specific contagion events that resulted in a rash of cases against a number of companies in a specific category. As I have previously noted on this blog, these contagion events include an outbreak of lawsuits against for-profit education companies (as discussed here), and against companies domiciled in China (as discussed here).

By my count, 12 for-profit education companies were sued during 2010, all of them after August 1, 2010. These cases against for-profit education companies represent 6.7% of all new 2010 filings.

Similarly, there were 10 Chinese domiciled companied sued during 2010, eight of them in the year’s second half. These cases against Chinese companies represented 5.6% of all 2010 filings.

Together the cases against companies in these two categories were a significant factor in the increase in second half filings, as they represent nearly 20% of all filings in the year’s second half.

Another significant category of cases during the year are those involving failed and troubled banks. There were 13 cases filed against banking institutions during 2010, representing 7.3% of all 2010 filings.

One other 2010 filing trend worth noting is the securities class action lawsuit headline hit parade. In a sequence that was well-established this year, securities class action lawsuit filings followed almost immediately for companies suffering significant adverse publicity events. Companies hit with class action lawsuits this year as part of this pattern include Toyota, Massey Energy, Goldman Sachs, BP and even Lender Processing Services (a company caught up in the foreclosure process scandal). Indeed, it could be argued that the wave of suits against the for-profit education companies fit this same pattern.

Recurring Filing Trends

While some recent trends diminished during the year and other new trends emerged, there were some long-standing patterns that continued during the year. Among the most distinct of these continuing trends is that life sciences companies continued to attract plaintiffs’ lawyers’ attention as they have in past years (about which refer here).

During 2010, securities class action lawsuits were filed against 18 companies in the 283 Standard Industrial Classification (SIC) Code Group (Drugs), and against nine companies in the 384 SIC Code Group (Surgical, Medical and Dental Instruments). These 27 companies represent about 15% of all securities lawsuit filings during the year. By way of comparison, life sciences companies were sued in about 10% of all filings in 2009.

In addition, as has been the case for the last several years, financially-related companies also remained a prominent securities litigation target. There were 34 companies in the 6000 SIC Code series (Finance, Insurance and Real Estate) named in securities suits during the year. In addition, there were 18 other entities named as defendants to which no SIC code designation has been assigned. Most of these entities lacking SIC Codes are financially related. These two groups together represent a total of 52 of the 2010, or 29.3% of the total (compared with 37% during 2009).

But while there were concentrations in certain industry categories, the 2010 filings overall involved a surprisingly broad array of kinds of companies. Overall, the companies targeted in the 2010 represented 80 different SIC Code categories.

The 2010 filings were also generally geographically dispersed. The 2010 securities cases were filed in 47 different U.S. district courts. However, there were certain courts that saw high levels of new filings during the year. 35 of the cases ( nearly 20%) were filed in the S.D.N.Y., 19 (10.7%) were filed in the Northern District of California, and 19 (10.7%) were filed in the Central District of California. Together the cases filed in just these three courts represent more than 41% of all 2010 filings.

19 (or 10.7%) of the cases filed during 2010 involved companies domiciled outside the U.S. Surprisingly, 12 of these cases were first filed after the U.S. Supreme Court’s June 2010 decision in the Morrison v. National Australia Bank case, which narrowed the availability of U.S. courts for the claims of some claimants with claims against non-U.S. companies (about which refer here). As noted above, many of these cases against non-U.S. companies involved Chinese companies. There were cases filed against companies domiciled in eight other countries as well.

Looking Ahead

While it may be safe to say that the filings during 2010 represented some form of a transition, it is difficult to say what the year’s developments may portend as we head into 2011.

On the one hand, the upswing in cases in the year’s second half might be interpreted to suggest that 2011 will be an active year for new securities lawsuit filings.

On the other hand, the upswing in the second half was in many ways a reflection of outbreaks of litigation activity related to very specific and short term events, such as the scandal involving student lending in the for-profit education sector. Similarly, the uptick in cases filed against Chinese companies may signify nothing more than a reflection of the fact that an increased number of Chinese companies recently have sought U.S. listings. The litigation in the second half of the year from these kinds of events and activities may or may not continue to lead to litigation activity in 2011.

There are certain 2011 litigation trends that do seem relatively likely to continue in 2011. The merger related litigation activity show no signs of slowing down. Given the continuing surge of bank failures, it seems likely that we will continue to see new filings involved failed and troubled banks. And there doesn’t seem to be any reason to assume that the historically elevated levels of litigation activity involving life sciences companies will not continue into next year as well.

Some Observations About "Counting"

Although the process of counting lawsuits would seem like a relatively straightforward exercise, there are a number of issues that complicate the process and that can significantly affect the outcome. First and foremost you have to decide what "counts." For purposes of my analysis, I count each claim against a company raising the same allegations only once, regardless of the number of complaints that are filed. This counting method means that my lawsuit count will appear lower than that of other observers, like for example NERA Economic Consulting, which will count different complaints against the same company in different jurisdictions as separate lawsuits (at least until the complaints are consolidated).

Another issue is what kind of lawsuit to count. In general, I try to count class action lawsuit alleging violations of the federal securities laws. One particular category I have always struggled with are the merger objection lawsuits, which may be framed as class actions and may allege violations of the securities laws, but generally are based on allegations of that some aspect of a merger or acquisition is unfair to investors, by comparison to the more traditional stock-drop-disclosure-violation lawsuit.

In the past I have tended against including the merger objection lawsuits. I opted to include these lawsuits this year, in part because without including them my lawsuit count would diverge materially from other public reports about the 2010 filings. Indeed, if I had not included the merger objection lawsuits in my 2010, I would be reporting only about 140 new securities class action lawsuit filings this year. It is arguable that by including the merger objection lawsuits in my 2010 count, I have inflated the reported number of filings.

Another category of cases that I have included in my 2010 count but about which reasonable minds might differ are the cases involving private or other nonpublic entities. I have wrestled with this question every year, as the inclusion of these kinds of cases in the count arguably could have the effect of overstating the frequency risk to the companies that are most concerned about securities class action litigation activity levels, namely publicly traded companies.

A total of 17 of the 2010 filings involved private entities. The nature of these cases varies. But the inclusion of these kinds of cases arguably also overstates the securities class action litigation activity levels, at least as respects publicly traded companies.

The inclusion of the private company claims and the inclusion of the merger objection cases have a very material impact on the reported number of overall filings. Without these cases, the reported number of filings would have been substantially lower (that is, it would be 123 rather than 177). Again reasonable minds could dispute whether or not these categories of cases should be considered. Regardless, in considering the level of 2010 securities class action litigation activity, it is important to understand how these categories of cases are treated.

On a final note, the treatment of one other category of cases had the effect of deflating the reported number of filings. That is, by my count, there were five new cases filed involving ETF funds during 2010. Cases involving ETF funds were a significant part of 2009 securities class action litigation activity. However, in April 2010, Southern District of New York Judge John Koeltl entered an order consolidating all of the ETF lawsuits, including those filed in 2009 and 2010, into a single case (refer here). Accordingly, because the ETF cases are no longer separate suits, I have not counted the five new 2010 ETF lawsuit filings as separate cases for purposes of my 2010 lawsuit count.

A Final Note About Securities Class Action Frequency

As insurance information firm Advisen has well documented, the mix of corporate and securities lawsuits has been evolving over the past several years. The most important feature of this changing mix of cases has been the decreasing prevalence of class action securities lawsuits as a percentage of all corporate and securities cases.

According to Advisen, securities class action lawsuits represented less than 20 percent of all corporate and securities class action lawsuits during the first three quarters of 2010, which represents a significant decline from more traditional patterns in which securities class action lawsuits represented half or more of all corporate and securities lawsuits.

As the percentage of class action securities lawsuits has declined, other types of lawsuits, particularly breach of fiduciary duty cases, have grown in relative frequency. Many of these breach of fiduciary duty cases are related to mergers and acquisitions activity. Indeed, as I noted in my year-end review of 2010 securities lawsuit filings, even many of the cases that are categorized as securities class action lawsuits involve merger objection cases.

It is important to keep this changing mix of cases in mind when considering the various year end reports on securities litigation activity. These reports typically will show that overall 2010 securities class action lawsuit filings are down compared to post-PSLRA averages. However, it would be mistake to conclude that the relatively reduced number of securities class action lawsuits means that claims activity in general is down. To the contrary, overall claims activity is actually up. The mere fact that securities class action lawsuits are down does not mean that fewer companies are being sued or that overall claims exposure has diminished, either for companies or insurers. Rather, what is happening is that the claims exposure is changing, away from securities class action lawsuits and toward other types of claims.

Coming Attractions: Tomorrow I will be posting my list of the Top Ten D&O Stories of 2010. Those who have read this post closely will recognize at least two of the top stories on tomorrow’s list, as there is some overlap between today’s post and the first two items in tomorrow’s list. A certain amount of overlap was unavoidable, but rest assured that most of tomorrow’s post reflects additional and comprehensive observations about the events of 2010.

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On Wednesday December 29, 2010 at 1 p.m. EST I will be participating in a free webcast sponsored by Securities Docket, entitled "2010 Year in Review: Securities Enforcement, Litigation & Compliance."

The webcast panel, which will include Compliance Week editor Matt Kelly, Francine McKenna (re: The Auditors) , Mike Koehler (aka the "FCPA Professor"), Francis Pileggi (Delaware corporate law guru), Tracy Coenen (The Fraud Files), Lyle Roberts (The 10b-5 Daily) and Securities Docket's Bruce Carton, will look back at 2010's most significant events and trends in the areas of corporate compliance, auditor issues, the Foreign Corrupt Practices Act, Delaware corporate law, D&O insurance issues, white collar fraud issues, securities class actions and SEC enforcement.

For further information and to register, please visit the Securities Docket webinsar webpage, here.

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On December 14, 2010, NERA Economic Consulting released its annual year-end study of securities class action lawsuit filings and settlements. The report, entitled "Trends 2010 Year-End Update," can be found here. Among other things, the NERA study reports that class action filings "picked up substantially" in the second half of 2010, and that median class action settlements reached an all-time high in 2010.

There are a couple of important considerations to be taken into account with respect to the NERA report. The first is that its analysis is with respect to filings and settlements through November 30, 2010. The report does incorporate a number of projections to account for the year’s final month.

In addition, the NERA report’s "counting" methodology, as reflected in footnote 3 of the study, may differ from the methodology used in other publicly available analyses of securities class action filings.

The NERA report states that "until cases are consolidated, we report multiple filings that potentially are related to the same allegations if complaints are filed in different circuits." And until cases are consolidated, "we report multiple filings if different cases are filed on behalf of investors in common stock and other securities." If the cases are ultimately consolidated, the data are adjusted. NERA’s methodology differs from that used by other observers (including The D&O Diary), and may result in a filing count that is higher than reported elsewhere.

The study does report a number of interesting findings, including the fact that class action filings accelerated in the second half of 2010. In fact, the study reports, the number of new class action filings in September (25) represents the highest monthly total of new "standard"  filings since August 2004.

According to the NERA report, there were a total of 219 filings in the year’s first eleven months. NERA projects a total of 239 filings by year end, which would represent an increase over the 220 filed in 2009 and would be "broadly consistent with the long-term average."

Though companies in the financial sector remain the most frequently targeted, the number of credit crisis-related lawsuits continues to decline. There were only 31 credit crisis related filings in 2010, compared to 57 in 2009 and 103 in 2008. More than half of the new lawsuits against companies in the financial sector in 2010 were unrelated to the credit crisis. About 40% of all 2010 cases named companies in the financial sector, which, while well below the peak of 72% in 2008, still remains above the 28% in 2005 and 2006, prior to the credit crisis.

Other sectors that also saw significant amounts of securities class action litigation included health technology firms, electronic technology and technology services sector. As I previously noted (here), there was also a sharp upturn in cases against companies in the for-profit education sector.

Despite the U.S. Supreme Court’s holding in Morrison v. National Australia Bank (about which refer here), the anticipated drop in cases against non-U.S. companies did not really materialize, largely do to the "spate of suits against Chinese-domiciled companies" (about which I recently commented here).

On the other hand, the number of belated filings of securities lawsuits declined in the second half of 2010. As I previously noted, there had been an upsurge in new case filings reflecting a substantial time lag between the date of filing and the proposed class period cutoff. The NERA study reports that for 2010 filings, the median time to file was only a month, compare to nearly six months for cases in the second half of 2009.

Among trends in factual allegations, the NERA study reports that filings of cases alleging breach of fiduciary duty more than doubled in 2010. Many of these cases were related to mergers or acquisitions.

With respect to case resolutions, the NERA study reports a number of interesting filings. Among other things, the study reports that the average settlement for cases settled in 2010, adjusted for outlier settlements, was $42 million, which is in line with 2009’s record high but well above the $30.4 million average for the period 2003 to 2010.

Even more significantly, the NERA study reports that in 2010, the median settlement jumped to $11.1 million, which not only represents an all-time high, but is more than a third higher than the 2009 median of $8.5 million. However, the report also notes that median investor losses for cases filed in 2010 were down substantially and more in line with pre-credit crisis cases. These more recently filed cases may push median settlements down in future years closer to the historical median.

Consistent with this last point, though average and median settlements are elevated, the settlements as a percentage of investor losses were consistent with similar ratios going back to 2002. The percentage in 2010 was 2.4%, well within the 2.2% to 3.1% range between 2002 and 2009.

One factor that may affect average and median settlements in the near term is the substantial overhang of unresolved subprime and credit crisis-related lawsuits. Even though several high-profile credit crisis cases have been resolved, many more remain pending. The NERA study reports that of the 230 credit crisis-related securities class action lawsuits, only about 8% have been settled, and another 29% have been dismissed, but fully 63% remain unresolved. These cases will continue to work their way through the system in the months ahead.

The NERA report is full of a wide variety of interesting information and insights, and is worth reading at length and in full. I hope to have my own study of the 2010 filings shortly after year end.

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The astonishing pace of legislative and judicial changes - just over the last few months alone - underscores how rapidly the liability exposures in the directors and officers arena can be transformed. In the latest issue of InSights (here), I take a look at the current hot topics in the world of directors’ and officers’ liability. There is much to discuss in the world of D&O, with further changes just over the horizon. The year ahead could be very interesting and eventful. The latest InSights article reviews what to watch now in the world of D&O.

The Latest Bulletin From Our San Francisco Bureau:  Our SF correspondent filed this report before last night's game (names removed to protect privacy, swear words modified to conform with the family-oriented approach of this blog):

So living with a wacko Giants fan is actually really fun right now. Yesterday {name removed} and her mom and godmother went kayaking outside the stadium and it sounds like SO MUCH FUN. I have added it to my to-do list of things while I live in the Bay.

Anyway, aside from kayaking (and drinking, and eating, and singing while kayaking) Giants fans wear these ugly fake beards to mimic the "rally beards" that the pitchers have (well, all the pitchers except Lincecum). And they have t-shirts that say "Fear the Beard." I have seem some television footage of very small children and very blonde women in beards. Very strange.

Also, just to prove that Tim Lincecum really could never play on any team except the Giants or the A's, everyone knows he smokes pot like it's his job, and the fans wear shirts that say "Let Timmy Smoke." I very much doubt that would be the public reaction ANNNYwhere else. Also he doesn't cover his mouth when he swears, so "F*ck Yeah" t-shirts are also very popular.

Unfortunately, I'm still not overly interested in the BASEBALL...just the funny things that San Franciscans do while they WATCH baseball.

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Overall levels of corporate and securities litigation remained at elevated levels in the most recent quarter even as securities class action filing levels remained flat, according to the third quarter 2010 report of the insurance information firm, Advisen. The October 2010 report can be found here. 

Preliminary Notes 

The litigation analyzed in the Advisen report includes not only securities class action litigation, but a broad collection of other types of suits as well, including regulatory and enforcement actions, individual actions, derivative actions, collective actions filed outside the U.S. and allegations of breach of fiduciary duty.

In considering the Advisen report, it is critically important to recognize that the report uses its own unique vocabulary to describe certain of the litigation categories.

For example, the report uses the phrase "securities fraud" lawsuits to describe a combination of both regulatory and enforcement actions, on the one hand, and private securities lawsuits brought as individual actions, on the other hand; however, the category of "securities fraud" lawsuits does NOT include private securities class action lawsuits, which are in their own separate category (SCAS").

In addition, both "securities fraud" lawsuits and securities class action lawsuits, as well as all of the other categories of lawsuits described in the report, are subparts of the aggregate group of corporate and securities litigation the report refers to as "securities suits."

Due to these unfamiliar usages and the similarity of category names, considerable care is required in reading the report.

The Report’s Analysis

According to the Report, corporate and securities litigation "remained at inflated levels" in the third quarter. There were 284 "securities suits" in the third quarter, which is slightly higher than the 278 filed in 2Q10 and the 276 filed in the third quarter of 2009. The filings for the first three quarters of 2010 annualize to 1,024 lawsuits, by comparison to the 1,105 filed in 2009 and 928 in 2008. These annual figures are significantly above the roughly 800 per year lawsuits filed in 2007 and 2006.

The new lawsuit filings have remained at elevated levels even though the number of securities class action lawsuit and "securities fraud" action (that is, enforcement actions and individual securities suits) have remained essentially flat. The heightened litigation activity levels is largely due to the number of breach of fiduciary duty suits, which "have grown rapidly as a percentage of all securities suits," now representing 34 percent of all "securities suits," compared to as little as 8 percent as recently as 2004. These breach of fiduciary duty lawsuits "often are filed in the wake of a merger or an acquisition by shareholders of the acquired company who believe the directors did not obtain an adequate price."

Securities class action lawsuits as a percentage of all "securities suits" has, by contrast, declined in recent years and now represents less that 20 percent of all corporate and securities lawsuits. According to the Report’s counting methodology, there were 144 securities class action lawsuits filed in the first three quarters of the year, which annualizes to 192 lawsuits. This annualized number compares to the 234 securities class action lawsuits filed in 2009. According to the Report, there average number of securities class action lawsuit filings during the period 2004 to 2009 is 226.

The Report attributes the relative decline of securities class action lawsuit filings in 2010 to the drop in the number of new lawsuits related to the credit crisis. But though the credit crisis lawsuits have declined, financial firms remain the most frequently named in securities class action lawsuits. Overall, though, the securities class action lawsuit filings "were much more broadly dispersed than in previous quarters." The two largest categories of lawsuit defendants after financial firms are companies in the consumer discretionary and healthcare categories.

My own analysis of third quarter securities class action lawsuit filings can be found here.

Advisen's Third Quarter Litigation Overview: On October 15, 2010 at 11:00 a.m. EDT, I will be participating in an Advisen webinar reviewing the firm's third quarter securities litigation report. Other participants in this webinar include Steve Carabases of ACE, Adam Savett  of Claims Compensation Bureau and David Bradford of Advisen. The session will reveiw Advisen's analysis of third quarter 2010 securities litigation and discuss the implications for brokers, underwriters and risk managers. Information about the session, including registration information, can be found here.

In BofA/ Merrill Case, Judge Castel Denies Motion for Reconsideration and Immediate Appeal: In an October 7, 2010 order (here), Judge Kevin Castel denied the defendants’ motion for interlocutory appeal or for reconsideration of Judge Castel’s August 27, 2010 order denying in part and granting in part the defendants’ motions to dismiss. Refer here for background regarding his August 27 ruling, which as noted here, has proven to be controversial, to the extent it seemed to suggest that BofA could not be liable under the federal securities for omission allegedly made at the direction of Secretary of the Treasury Paulson. That aspect of Judge Castel’s ruling, which clearly favors the defendants, was the subject of defendants’ motion.

Rather, as discussed in Alison Frankel’s October 12, 2010 Am Law Litigation Daily article (here), the defendants relied on three specific issues: "Did BofA have a duty to disclose Merrill's (disastrous) interim financial results; do shareholders of an acquiring comany have causation claims; and are covenants of a private merger agreement actionable under federal securities laws? "

Judge Castel denied the request for interlocutory appeal, noting that granting the motion would "grind this action to a halt." He also held that the defendants had not presented sufficient grounds for reconsideration.

Welcome to the Blogosphere: I am pleased to note that my friend Joe Monteleone of the Tressler law firm has joined the blogosphere with his new blog, The D&O and E&O Monitor, which can be found here. The new blog is off to a great start and it looks like a worthy new addition to the blogosphere. All I can say is that Joe will soon learn that a blog is harsh mistress.

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New securities class action lawsuit filings in the third quarter of 2010 remained below longer term historical averages, although consistent with filing levels in more recent quarters. There were 39 new securities class action lawsuits filed in the third quarter, bringing the 2010 YTD total number of new filings to 125, as of September 30, 2010.

The 125 new filings through the end of the third quarter compares with the 129 that were filed in the first three quarters of 2009, and implies a total of about 166 by year end 2010 (compared to 169 in 2009). The implied 2010 total is well below the annual average of 197 new securities class action lawsuits filed during the period 1996 to 2008.

Though the overall 2010 YTD filings levels remain below historical levels, new filings did turn up slightly in September 2010, when there were 21 new securities class action lawsuits filed, the highest monthly number of filings since 2008.

New filings against companies in the financial services sector remain an important component of new securities class action lawsuits. During the third quarter there were eight new filings in the 6000 SIC Code series (Finance, Insurance and Real Estate), and an additional three new filings involving firms without SIC Codes but that are financially related. These eleven total new filings against financially related firms represented about 28% of third quarter filings.

Subprime and credit crisis related securities class action lawsuits continue to be filed in the third quarter of 2010. Seven, or about 18%, of the third quarter filings were subprime or credit crisis-related.

While filings against financially related companies continue to predominate as they have since 2007, there were a number of other areas of concentration in the third quarter as well. As I have noted elsewhere, there was a proliferation of filings in the third quarter against for-profit education companies. A total of six for-profit educational companies were sued in the third quarter.

In addition, as has been the case over time, new filings against life sciences companies was also an important part of the third quarter filings. There were a total of seven new filings against companies in the life sciences sector, including four against companies in the 2834 SIC Code category (pharmaceutical preparations). .

For the first three quarters of 2010, there have been 26 new securities lawsuits filed against companies in the 6000 SIC Code series and another 15 against financially-related companies without SIC codes, for a total of 41 new lawsuits against financial companies, or about one third of all 2010 filings. 22 (or about 17.5%) of all 2010 filings have been subprime or credit crisis-related.

Filings against life sciences companies have also been a significant component of 2010 YTD filings. There have been 19 new securities lawsuits filed against companies in the life sciences industry, including 13 against companies in the 2834 and 2835 SIC Code categories. (SIC Code 2835 include in vitro and in vitro diagnostic substances).

There have been ten new securities class action lawsuits filed this year against foreign-domiciled companies, or about eight percent of the total. Interestingly, there have been four new securities class action lawsuits filed against foreign-domiciled companies since the U.S. Supreme Court issued its opinion in Morrison v. National Australia Bank.

Of the 125 YTD filings, 17 (or about 13.6%) represented so-called "belated filings" – that is, cases in which the filing date came more than a year after the proposed class period cutoff date. Though there have been a significant number of these belated filings this year, the number of these filings has slowed as the year has progressed. Only four of these 17 belated cases have been filed since June 30, 2010.

Apple Turnover: You may have missed it this past week, but the parties to the long-running Apple Computer options backdating-related securities class action lawsuit have reached a settlement, as reflected in their September 28, 2010 memorandum in support of their settlement stipulation. The Apple case is one of the last of the 39 options backdating related securities class action lawsuits to finally be resolved.

The Apple settlement incorporates a rather unusual feature. On the one hand, the parties have agreed to settle the case for two conventional settlement terms -- a payment of $14 million in cash for the benefit of the plaintiff class and the company’s agreement to adopt certain corporate governance reforms. But in addition, the company has agreed to make payments totaling $2.5 million to 12 educational institutions’ corporate governance programs.

These payments work out to approximately $208,333 for each of the twelve institutions. The memorandum in support of the parties’ settlement stipulation reports that the lead plaintiff selected the twelve institutions "after conducting a review of corporate governance programs nationally."

While these corporate governance programs undoubtedly represent worthy causes, you do have to wonder about this settlement feature, which arguably provides no benefit either to members of the class or to current Apple shareholders. It also raises questions about compelled corporate philanthropy at shareholders’ expense.

I have in any event added the Apple settlement to my running table of options backdating related case resolutions, which can be accessed here.

Advisen’s Third Quarter Litigation Overview: On October 15, 2010 at 11:00 a.m. EDT, I will be participating in an Advisen webinar reviewing the Third Quarter Securities Litigation. Other participants include Scott Meyer from ACE, Adam Savett of Claims Compensation Bureau, and Dave Bradford of Advisen. The session will review Advisen's analysis of third quarter 2010 Securities litigation and settlements and discuss the larger implications for underwriters, brokers and risk managers. Information about the free webinar, including registration instructions, can be found here.

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Among the very, very latest trends in securities class action lawsuit filings are suits against for-profit educational companies. Just since the middle of last week, at least five companies in this sector have been tagged with new lawsuits, four of which were securities class actions.

These lawsuits have been accumulating in the wake of an August 3, 2010 Government Accountability Office report (here) which alleged that several companies in the for-profit education industry encouraged fraud and engaged in deceptive advertising. The report was prepared in connection with the August 4, 2010 hearing before the Senate Committee on Health, Education, Labor and Pensions.

The GAO report said that undercover tests revealed that at least four schools encouraged fraudulent practices and all 15 tested made deceptive or questionable statements to the GAO’s undercover applicants. The fraud involved encouraging falsified financial aid applications. A summary of the report can be found here. A statement of the report’s highlights can be found here.

Though no specific companies are named in the report (or perhaps because no specific companies are named in the report), the share prices of many of the publicly traded for-profit education companies fell after the news about the GAO report circulated. And, perhaps inevitably, the lawsuits started coming in.

As far as I am aware, at least four for-profit education companies have been named in securities class action lawsuits just since the end of last week. These companies include the following:

Education Management Corp., against which the first suit was filed on August 11, 2010. A copy of the complaint filed in the Western District of Pennsylvania can be found here.

American Public Education, against which the first suit was filed on August 12, 2010. A copy of the complaint filed in the Northern District of West Virginia can be found here.

Lincoln Educational Services, against which the first suit apparently was filed on August 13, 2010. A copy of the complaint can be found here.

Apollo Group, Inc., against which the first suit apparently was filed on or about August 16, 2010. A copy of complaint can be found here.

In addition to these securities class action lawsuits, a separate class action lawsuit against Alta Colleges, Inc. (parent of Westwood College) and related entities and persons was filed on August 11, 2010 in the District of Colorado alleging violations of the Colorado Consumer Protection Act. A copy of the Alta/Westwood complaint can be found here.

With five suits in already, it seems safe to predict that other publicly-traded for-profit education companies could also get hit with one of these suits. This seems to be one of those classic contagion events that produces an epidemic of similar lawsuits that comes up every now and then. Last year it was ETFs (refer here); this year it seems to be for-profit educational companies.

The name Apollo Group may be familiar to many readers, as the company was the target of a prior securities class action lawsuit that has achieved a certain amount of notoriety because it is one of the few securities cases that has actually gone to trial. The trial resulted in a plaintiffs’ verdict, although the presiding judge later set the verdict aside in a response to a post-trial motion. More recently, the Ninth Circuit reversed the trial court’s ruling and remanded the case to the district court for further proceedings, a development that has sparked significant interest and discussion.

Unfortunately for Apollo Group, all of the long-running drama in the prior case was no shield against another case being filed.

It remains to be seen how these cases will fare. But this industry-specific litigation outbreak is a reminder of the many odd and circumstance-specific events that can drive securities class action lawsuit filings. Many things determine filing levels, many of which cannot be captured or predicted in historical filing data. As a result, it can be misleading to try to generalize from short term trends about future filing levels. Simply put, the numbers vary over time, because, for example, contagion events and industry epidemics happen.

New Securities Suit Based on FCPA-Related Allegations: Regular readers know that I have frequently commented that one result of increased Foreign Corrupt Practices Act enforcement has been the growth in the number of follow-on private civil lawsuits based on the underlying corruption allegations.

The latest example of this phenomenon is the lawsuit filed against SciClone Pharmaceuticals and certain of its directors and officers. According to the plaintiffs’ lawyers’ August 16, 2010 press release (here), the complaint they filed in the Northern District of California alleges that:

defendants were engaged in illegal and improper sales and marketing activities in China and abroad regarding its products. This ultimately caused the Company to become the focus of a joint investigation by the Securities and Exchange Commission ("SEC") and the Department of Justice ("DOJ") for possible violations of the Foreign Corrupt Practices Act ("FCPA"). It was only at the end of the Class Period, however, that investors ultimately learned the truth about the Company's operations after it was reported that the SEC and DOJ were investigating the Company for violations of the FCPA. At that time, shares of the Company declined almost 40% in the single trading day.

This case presents further support for the proposition that increased anticorruption enforcement activity represents a growing area of liability exposure for company executives.

Thought for the Day: "Time flies like an arrow. Fruit flies like a banana." (Often attributed to Groucho Marx, but although it seems as if he would have said it, he apparently did not.)

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Overall levels of corporate and securities litigation increased during the second quarter of 2010, according to a new study released on July 15, 2010 by the insurance information firm Advisen. A copy of the report can be found here.

Preliminary Notes

The litigation analyzed in the Advisen report includes not only securities class action litigation, but a broad collection of other types of suits as well, including regulatory and enforcement actions, individual actions, derivative actions, collective actions filed outside the U.S. and allegations of breach of fiduciary duty.

In considering the Advisen report, it is critically important to recognize that the report uses its own unique vocabulary to describe certain of the litigation categories.

For example, the report uses the phrase "securities fraud" lawsuits to describe a combination of both regulatory and enforcement actions, on the one hand, and private securities lawsuits brought as individual actions, on the other hand; however, the category of "securities fraud" lawsuits does NOT include private securities class action lawsuits, which is its own separate category (SCAS").

In addition, both "securities fraud" lawsuits and securities class action lawsuits, as well as all of the other categories of lawsuits described in the report, are subparts of the aggregate group of corporate and securities litigation the report refers to as "securities suits."

Due to these unfamiliar usages and the similarity of category names, considerable care is required in reading the report.

The Report’s Analysis

Even though subprime and credit crisis case filings during the second quarter were well below 2009 levels, overall corporate and securities litigation activity was up in the quarter – "nearly 30 percent higher than the first quarter and about 19 percent above the very active second quarter."

The report also notes that securities class action litigation activity was up in the quarter as well, largely as a result of litigation relating to the government investigation of Goldman Sachs and the Deepwater Horizon oil spill.

However, in what may be the report’s most significant observation, securities class action litigation is becoming an increasingly smaller percentage of all corporate and securities litigation. The report notes that this percentage has been trending downward for several years; securities class action lawsuits, which represented more than half of all corporate and securities lawsuits before 2006, represented only 23 percent of these suits in 2009 and only 19 percent in the first half of 2010.

In addition to the relative number of securities class action lawsuits, the absolute number of securities class action suits also declined in the first half of the year. According to the Advisen report, there were 85 securities class action lawsuits in the first half of 2010, which annualizes to 170 cases. The average annual number of securities class action filings during the period 2005-2009, according to the report, is 213. The 2010 decline "is due substantially to a sharp drop in subprime/credit crisis cases."

The report also notes that the average time between the end of the class period and the date the lawsuit was filed is lengthening, from 126 days in 2008 to 228 days in the first half of 2010.

Though new subprime and credit crisis cases continue to decline, companies in the financial sector remain the most frequent corporate and securities litigation target. According to the report, financial firms were named in about 34 percent of all corporate and securities lawsuits in the second quarter.

Though securities class action lawsuit filings as a percentage of all corporate and securities lawsuits have declined, lawsuits alleging breach of fiduciary duty are becoming an increasingly larger percentage of all corporate and securities lawsuits, primarily in connection with merger and acquisition activity. Breach of fiduciary duty cases represented only eight percent of all corporate and securities lawsuits in 2004, but 32 percent of all such litigation in 2009.

Discussion

The public dialog about securities litigation tends to concentrate on securities class action lawsuit filings. Though securities class action litigation remains the most costly type of corporate and securities litigation, from a frequency standpoint, securities class action litigation is becoming increasingly less important. According to the Advisen report, more than 80 percent of all corporate and securities litigation in the first half of 2010 involved types of litigation other than class action securities litigation.

Moreover this movement of litigation activity away from securities class action litigation is now well-established, having persisted (and indeed accelerated) for well over five years now.

The fact is that companies and their senior managers face an increasingly diverse range of potential litigation exposures. The changing landscape of corporate and securities litigation may have important implications for companies’ management liability insurance decisions. At a minimum, the changing mix of litigation suggests that companies should carefully consider potential liability exposures beyond just those involved with possible securities class action litigation.

The changing mix of litigation also provides an important context within which to interpret apparent declines in securities class action litigation activity. Even if fewer class action lawsuits are being filed (at least lately, anyway), that does not mean the overall threat of litigation has declined. To the contrary, the Advisen report shows that the threat of corporate and securities litigation generally continues to increase. The litigation threat is not declining, it is simply changing.

The more interesting question is what the future may hold for securities class action litigation. In all likelihood the apparent recent decline in new securities class action lawsuits is merely cyclical – there have certainly been prior periods where new securities class action lawsuits fell below historical levels (for example, during the period from mid-2005 to mid-2007). On the other hand, some recent activity – for example, the increase in the number of belated lawsuit filings – suggests that a variety of forces and factors are at work.

My own view is that, as has always been the case in the past, the litigation cycle will eventually turn and filing activity levels will revert to the mean. There is an entrenched industry of highly entrepreneurial plaintiffs’ securities class action lawyers who have every incentive to continue to file lawsuits. I suspect strongly that one factor in the current relative downturn in new securities class action filings is that the plaintiffs’ lawyers are simply swamped trying to keep up with the massive wave of complex lawsuits they filed in the wake of the subprime meltdown and the credit crisis. Eventually the decks will clear and they will resume their normal activities, particularly if there are headline-grabbing events that provide litigation fodder.

My own prior analysis of first half 2010 securities class action litigation filing activity can be found here. The Advisen report’s analysis of securities class action lawsuit filings in the year’s first half is directionally consistent with my own observations.

Advisen Securities Litigation Webinar: At 11:00 am EDT on Friday July 16, 2010, I will be participating in a free, one-hour Advisen webinar to discuss the firm’s Second Quarter Securities Litigation Report. Joining me for the webinar panel discussion will be Carl Metzger from the Goodwin Proctor firm; Carol Zacharias from ACE, and Louise Pennington of Integro. Information about and registration instructions for the webinar can be found here.

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Suit Against Auction Rate Securities Investor Dismissed: When plaintiff investors first sued Mind M.T.I. and certain of its directors and officers in the Southern District of New York in August 2009, I noted at the time that the new suit seemed to reflect two securities class action lawsuit filing trends: first, the case presented an example of a "belated" lawsuit filing, where the initial filing came more than a year after the proposed lawsuit date; and second, the case represented another instance where a company’s shareholders had filed suit due to their company’s investment auction rate securities.

The case, however, failed to surmount initial pleading thresholds, and July 2, 2010 was dismissed with prejudice.

Unlike many auction rate securities cases, which typically were brought against the firm that had sold the plaintiffs the securities, this suit (like others, refer here) was brought against a company that had invested in the auction rate securities.

The lawsuit pertained to the company’s 2006 purchase of $22.8 million in auction rate securities. The securities the company purchased were issued by the now-infamous Mantoloking CDO, about which refer here.

The plaintiffs alleged that the defendants "knowingly and recklessly concealed that most of Mind’s reported cash position was comprised of illiquid Auction Rate Securities (ARS)" and that the company’s internal controls for monitoring, accounting and reporting of the Company’s investments in cash equivalents and/or short-term investments were materially deficient." The defendants moved to dismiss on the grounds that plaintiffs’ had not sufficiently pled scienter.

In a July 2, 2010 order (here), Southern District of New York Judge Richard M. Berman, granted the defendants’ motion to dismiss with prejudice, holding that the plaintiffs had failed to allege sufficient facts showing a motive and opportunity for the fraud, and also had failed to alleged facts sufficient to constitute strong circumstantial evidence of conscious misbehavior or recklessness.

In concluding that the plaintiffs had not sufficiently alleged scienter, the court noted that the defendants had argued that the company "rather than acting with scienter, was itself defrauded by its investment bankers into believing its investment was a safe, liquid alternative to bank deposits." Judge Berman found that the plaintiffs allegation do not offer any factual explanation in contradiction of this contention. According, he concluded that the plaintiff had failed to raise an inference of scienter that is cogent and at least as compelling as any opposing inference of nonfraudulent intent.

After the marketplace for auction rate securities froze in February 2008, plaintiffs’ lawyers launched a barrage of lawsuits against the investment banks and other firms that had sold investors these securities. By and large, these cases against the auction rate securities have fared poorly, particularly with respect to the financial firms that separately entered regulatory settlements intended to provide small investors relief regarding their illiquid securities investments.

For example, the securities suit filed on behalf of auction rate securities investors against UBS, which had entered into a auction rate securities-related regulatory settlement was initially dismissed with prejudice. After the plaintiffs amended their pleading, the court granted the defendants’ renewed dismissal motion but allowed the plaintiffs leave to attempt to further amend their pleadings. However, on July 7, 2010, after the plaintiffs failed to file further amendments within the allotted time, the court entered judgment on behalf of the defendants.

The poor track record in the auction rate securities cases has not been limited just to companies that had entered regulatory settlements, as was demonstrated, for example, in the dismissal granted in auction rate securities suit filed against Raymond James (about which refer here).

Similarly, the dismissal granted on the Merrill Lynch auction rate securities suit in March 2010 (about which refer here) did not depend on Merrill’s entry into a regulatory settlement, but was on the merits.

But the suits filed against the financial firms that had sold the auction rate securities represented only one type of auction rate securities lawsuit. In addition, there were a number of suits filed against the companies that had purchased the securities, in which it was alleged that the companies had misrepresented the companies’ financial condition by failing to disclose its investment. The dismissal of the Mind C.T.I. suggests that these suits against auction rate investors may fare not better than the many suits filed against the auction rate securities investors.

2010 Securities Suit Filings at the Year’s Midpoint: In a publication issued this past week, Charles River Associates issued its review of the Second Quarter 2010 securities lawsuit filings, including an analysis of the 2010 filings for the first half of the year. Though different in some details, the Charles River report is directly consistent with the observations noted on my recent post (here) on first half filings.

Among other things, the report notes that though second quarter 2010 filings were up 25% compared to the second quarter of 2009, the filings in the first half of 2010 were down 9% compared to the first half of 2009, and down 38% compared to the first half of 2008.

The report also notes that though the second quarter filings involved companies in a wide range of industries, the filings were "primarily concentrated in the financial services and oil and gas sectors." The report also notes that a number of the second quarter filings involved class periods that ended more than a year prior.

Special thanks to Christopher Noe of Charles River for providing a copy of the report.

The Dodd-Frank Bill and Securities Litigation: If the Dodd-Frank Wall Street Reform and Consumer Protection Act is finally enacted into law, we can all look forward to months of commentaries beginning like this: "A little noticed provision of the financial reform legislation may have unexpected implications." The sheer sweep of the Bill’s 2,500-plus pages and countless provisions virtually ensures that for months and years the legislation will be slowly revealing sometimes unexpected implications.

Among many other subjects that the Bill touches upon is securities litigation. Though the Bill does not reach as far as it initially appeared it might, the Bill does contain a number of provisions with securities litigation implications. These implications are helpfully catalogued in a couple of recent law firm memos.

First, in a July 9, 2010 article entitled "The Impact of Financial Reform on Securities Litigation Enforcement" and posted on the Harvard Law School Forum on Corporate Governance and Financial Regulation blog (here), several attorneys from the Wachtell Lipton firm catalogue the Bill’s various provisions.

Second, in a July 9, 2010 memo entitled "Securities Litigation Implications of the Dodd-Frank Bill," the Paul Weiss firm takes a look at the Bill’s securities litigation provisions and also review the various additional proposed provisions that did not make it into the Bill’s final version.

Finally, a July 6, 2010 memo by the Katten Muchin law firm entitled "Dodd-Frank Wall Street Reform and Consumer Protection Act Corporate Governance and Disclosure Provisions" reviews the Bill’s various provisions relating to corporate governance and disclosure practices.

These memos are detailed and helpful. Just the same, the massive Bill seem likely to have yet other sections that may involved undiscovered implications that will only be revealed in the fullness of time.

World Cup Final Notes:

1. I agree with my sixteen year old son's assessment -- I am sorry the World Cup is over. Notwithstanding those damn vuvuzelas.

2. The Spaniards should be proud, they scored and they won. Iker Casillas, Spain's goalie, played just well enough to allow his team to win. But truth be told, the tournament's final match was not a very good game. It was marred by unnecessary violance and poor sportsmanship, not to mention astonishing failures by both teams to capitalize on scoring opportunities.

3. The consolation round game on Saturday was a much better game, which I am very glad I watched. It was an exciting, fair match well played by both Uraguay and Germany. And it literally came down to the last tick of the clock. A great game all the way around.

4  I aboslutely concur in the award of the golden ball to Diego Forlan of Uraguay. He had a great tournament and he is an exciting player to watch. Rumors that he is about to sign with the Miami Heat apparently are totally unfounded.

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While many courts are showing a greater willingness to grant motions to dismiss in subprime-related securities class action lawsuits, some cases are surviving dismissal motions and others are settling for hundreds of millions of dollars, as a result of which the "watchword is uncertainty until a more consistent and predictable pattern emerges," according to a recent study.

In a June 2010 report entitled "Subprime Class Actions Revisited," Jonathan Eisenberg of the Skadden law firm examines 14 new subprime-related securities lawsuit rulings issued during the first five months of 2010. This report updates Eisenberg’s prior analysis of 16 dismissal motion rulings entered in 2009.

Eisenberg’s overall conclusions are that "courts are showing more evidence of subprime fatigue and a greater willingness to grant motions to dismiss even in cases that do not require proof of scienter," but while "recent trends have been more favorable for defendants, the results are by no means one-sided, and the final chapters of the subprime class action story have yet to be written."

Eisenberg notes that, by contrast to his earlier study, "more than half of the recent dismissals occurred in non-scienter Securities Act claims." Eisenberg also notes that courts continue to dismiss many of the Section 10(b) claims asserted in the subprime securities class action, "principally, but not exclusively, on the ground that the allegations of scienter are inadequate." Court has also found a number of the allegedly fraudulent statements immaterial as a matter of law.

With respect to the cases that have survived dismissal motions, the basis "overwhelmingly" are allegations related to "declining underwriting standards." In light of the numbers of cases that have survived the dismissal motions, as well as the significant dollar figures involved in some of the settlements, "while the story in the aggregate is positive for defendants, much risk remains in these cases." Overall, Eisenberg finds that he has "not found a single factor that explains the outcomes across all cases."

My running tally, listing (with links) dismissal motions rulings and settlements in all subprime and credit crisis-related lawsuits, can be accessed here. All of the decisions referenced in Eisenberg’s article are listed with links in my tally.

One interesting aspect of Eisenberg’s paper is with respect to his discussion of the difficulties plaintiffs face in trying to allege that defendants were "slow to recognize the enormity of the subprime crisis." He recites data from Bloomberg’s tally of subprime-related write downs showing that "less than three-tenths of one percent of the more than $1.75 trillion of global write-downs between 2007 and 2009 occurred prior to the third quarter of 2007." The rest occurred incrementally from the third quarter from the 2009.

Eisenberg suggests these data show that Judges "are and should be skeptical of the types of claims that could be made against virtually any financial institution that was late to recognize the damages ultimately inflicted by the subprim tsunami."

Special thanks to Jon Eisenberg for providing a copy of his article.

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Though some observers have reported a downturn in 2010 securities class action lawsuits compared to prior years, at least very recently there has been a flurry of filing activity, with six new securities suits in the past week, by my count. With these latest filings coming in, it seemed worthwhile to take a look at the most recent cases, to try to get a handle on where these latest suits are coming from. It does in fact appear that certain discernable factors are driving the recent filings.

1. The Headline Hit Parade: It is a truth universally acknowledged that a public company facing a public relations crisis must be in want of a securities class action lawsuit – or at least that seems to be the perspective of the plaintiffs’ bar. This pattern started earlier this year when Toyota’s sudden acceleration debacle led to a host of securities class action lawsuit filings (refer here). The pattern has been perpetuated in connection with the most recent public relations disasters.

Massey Energy sustains a coal mining disaster? Wham, in comes the securities class action lawsuit.

Goldman Sachs is target in a high profile SEC enforcement action: Pow, in comes the securities class action lawsuit.

Transocean is prominently involved in what may be the worst oil spill in U.S. history? Of course, a securities class action lawsuit filing followed closely behind. (The Transocean securities class action lawsuit filing follows closely on the heels of the shareholders’ derivative lawsuit filed against BP in connection with the Deepwater Horizon disaster, which I previously noted here.)

To find out which company will be next in line for one of these insult-to-injury lawsuits, just keep a close eye on the headlines – that seems to be what the plaintiffs’ lawyers are doing.

2. The Delayed Reaction Phenomenon: Another category of recent lawsuits look completely opposite from the headline driven lawsuits described above. Beginning around the middle of 2009, one phenomenon that developed was the emergence of belated lawsuits, where the filing date was as much as a year or more after the proposed class period cutoff date. Several of the most recent filings reflect this belated filing pattern.

For example, on May 11, 2010, plaintiffs’ lawyers initiated a securities class action lawsuit in the Southern District of New York against Pfizer and certain of its directors and officers. The proposed class period cutoff date is January 23, 2009, nearly 16 months prior to the initial filing date.

Similarly on May 12, 2010, plaintiffs’ lawyers initiated a securities class action lawsuit in the Western District of North Carolina against CommScope and certain of its directors and officers. The proposed class period cutoff date is October 30, 2008, more than 18 months before the initial filing date.

And on May 6, 2010, plaintiffs’ lawyers filed a complaint in the District of Delaware against Heckmann Corporation and certain of its directors and officers, in which the proposed class period cutoff date is May 8, 2009, just short of one year before the filing date.

Similarly belated filings have been an important aspect of the 2010 YTD securities class action lawsuit filings. Of the approximately 60 securities class action lawsuit filings this year, eleven (or about 18%) have been first filed at least one year after the proposed class period cutoff date. Perhaps more significantly, many of the most recent filing in May 2010 have been among these belated cases.

An interesting question related to these belated filings is whether the U.S. Supreme Court’s recent statute of limitations decision in the Merck case (about which refer here) will lead to the filing of even more superannuated suits. Reliable sources have suggested to me that it will.

3. Because That’s Where the Money Is: Since the beginning of the subprime-related litigation wave in 2007, lawsuits against financial services companies have predominated all filings. Though the proportion of filings against financial firms began to diminish around mid-2009, lawsuits against financial companies still represent the largest proportion of securities class action filings so far in 2010.

Thus, while the roughly 60 entities against which securities class action lawsuits have been filed so far this year represent 29 different Standard Industrial Classification (SIC) Code categories (and ten of the 60 lack any SIC Code classification), 17 of the 60 (or about 28%) involve companies in the 6000 SIC Code series (Finance, Insurance and Real Estate). Indeed, most of the entities lacking SIC Code designations are also financially related, and lawsuits filed against these two groups (that is, the 6000 SIC Code series entities and the entities without SIC Code designations) represent about 45% of all 2010 lawsuits.

The most noteworthy difference among the 2010 lawsuit filings involving financial companies compared to the most recent prior years’ filings is the number of commercial banks among the financial companies that have been sued. Indeed, several of the most recent filings have targeted failed or troubled banks, including, for example, the May 12, 2010 lawsuit filed against BancorpSouth (here), the May 7, 2010 lawsuit against First Regional Bancorp (here), and the April 15, 2010 lawsuit against Frontier Financial (here).

As I have recently noted, this lawsuit trend involving failed and troubled banks is likely to continue in the months ahead.

4. When All Else Fails: Though lawsuit filings against financial companies have continued to predominate among all securities suit filings, lawsuits against life sciences remain a familiar and important accompanying theme. With six lawsuits so far this year in the 283 SIC Code series (Drugs) and four more in the 384 SIC Code series (Surgical, Medical and Dental Instruments), lawsuits against life sciences companies remain an important part of 2010 lawsuit filings, as they have been in the past.

Several of the most recent lawsuit filings have involved life sciences companies, including the May 11, 2010 filing against Pfizer noted above, and the May 11, 2010 filing against NBTY. Indeed, 2010 filings that don’t involve either a financial services company or a life sciences company are in the distinct minority.

NERA Updates Options Backdating Securities Settlement Study: Earlier on in the evolution of the Options Backdating litigation, NERA Economic Consulting had reported (refer here), based on the handful of settlements at that time, that the options backdating cases were settling for lesser amounts than NERA’s analysis of all securities class action lawsuit settlements would predict. At the time, NERA proposed two possible alternative explanations – either the weaker backdating cases were settling first or suits alleging backdating were weaker than securities cases as a whole.

With many more of the options backdating securities class action lawsuits having settled (including the recent $173 million Maxim Integrated Product options backdating securities suit settlement), NERA has updated its analysis. In a May 12, 2010 report entitled "Do Options Backdating Class Actions Settle for Less – May 2010 Update" (here), NERA has taken a look at the 31 options backdating settlements and compared them to what their database model would predict.

Based on their analysis, NERA concluded that actual settlements were about 71% of predicted settlements. As a statistical matter they are unable based on the data to reject the hypothesis that "settlements in backdating class actions are, on average, no different than settlements in other shareholder class actions." This conclusion supports the corollary hypothesis that the "early settlements were relatively low because the weakest backdating class actions tended to settle most quickly."

The report includes a detailed list of each of the 31 options backdating related securities class action settlements to date.

Special thanks to Branko Jovanovic of NERA for permission to cite and link to the NERA backdating article.

SEC Settlements Update: And speaking of NERA updates, on May 14, 2010, NERA released its latest update on SEC settlement trends (here). In it last semiannual report, NERA reported that the SEC settled with 354 defendants in the first half of fiscal 2010, compared to 328 defendants in the second half of fiscal 2009 and 290 in the first half of 2009.

The first half of fiscal 2010 included two particularly noteworthy SEC settlements, the $314 million State Street settlement and the $150 million Bank of America settlement. The State Street settlement is the seventh largest SEC settlement since the passage of the Sarbanes Oxley Act.

Who’s On First/ In Whose Possession is First Base?: When I first conceived the title for this blog post, I recognized that I must construct the caption carefully or I would earn the scorn of vigilant grammarians. After careful review of the vast literature addressing the who’s/whose conundrum, I believe the caption is correct. It is always hard to tell who’s right and who’s wrong on these issues. But after all, whose blog is this? Who’s to tell? Whose views should prevail?

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On April 14, 2010, the insurance information firm Advisen released its analysis of first quarter 2010 securities litigation filings and trends. The quarterly report, which is entitled "Securities Suits Ease Back to Normal Following a Frantic Two Years," can be accessed here. As detailed below, the Advisen report concludes that the securities lawsuit filing activity "floated back to earth in 2010, to a pre-credit crisis plateau."

Before any attempt can be made to try to read the Advisen report, it is absolutely indispensible to understand that the Advisen report uses its own 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" cases that many readers might not think of as "securities claims," including claims alleging "common law torts, contract violations and breaches of fiduciary duties."

The Advisen report uses the term "securities lawsuits" basically to mean any type of corporate or securities litigation (other than ERISA litigation), regardless 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, in addition to regulatory and enforcement actions, 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

Though the Advisen report’s title suggests that "securities litigation" is "back to normal," overall what the report seems to show is that "securities litigation" declined in the first quarter relative to recent periods.

Thus the report shows that there were 178 "securities lawsuits" (again, as that term is very broadly defined in the report). This first quarter filing rate for this broad category of litigation is down 34 percent from the final quarter of 2009 and 39 percent compared the year prior first quarter. This relative reduction in filing activity appears to be due to the decline in the number of credit crisis and Madoff-related lawsuits.

The 178 "securities lawsuits" in the first quarter represents an annualized filing rate of 712 "securities lawsuits," which would be 29 percent below the 2009 total number of "securities lawsuits" of 1,003.

This filing decline also affected the number of securities class action lawsuit filings as well. (Again, securities class action lawsuits, or "SCAS," represent a subset of "securities lawsuits.") According to the Advisen study, there were 38 securities class action lawsuits filed in the first quarter, which would represent an annualized filing rate of only 152 lawsuits. (Just by way of comparison, Cornerstone reports that the annual average number of securities class action lawsuits during the period 1996 to 2008 was 197.)

In continuation of a recent trend, the proportion of securities class action lawsuits as a percentage of all "securities lawsuits" continued to decline in the first quarter of 2010. Securities class action lawsuits represent 21 percent of all "securities lawsuits" in the first quarter of 2010, down from 23 percent in all of 2009, and 28 percent in 2004.

Though the decline in quarterly filing activity is attributable to the decline in Madoff and credit crisis-related lawsuit filings, financial firms remained the most frequently targeted. Financial firms were named as defendants in 31 percent of all "securities lawsuits," down from 39 percent in 2009 and 42 percent in 2008.

In addition to this still significant but declining level of filings involving financial companies, the report also notes "a wider spread of suits by industry sector," including the following sectors, indentified by their prevalence as targets as a percentage of all "securities suits"; "information technology (14 percent), consumer discretionary (13 percent), healthcare (11 percent), and industrials (11 percent).

Seventeen (or ten percent) of first quarter 2010 "securities lawsuits" were filed against non-U.S companies, down from 12 percent in all of 2009. The report states that there was "one large suit [against a non-U.S. company] filed in a non-U.S. court." The report does not define what is meant by "large."

Advisen Webinar: On Friday On Friday April 16, 2010, I will be participating in an Advisen webinar, entitled "First Quarter Securities Litigation Review," to discuss first quarter 2010 securities lawsuit filings as well as other first quarter securities litigation developments. Other participants in the webinar, which will take place at 11:00 am EDT, include Ken Ross from Willis, ACE’s Scott Meyer, Wilkie Farr’s Michael Young, and Advisen’s David Bradford. Advisen’s Jim Blinn will moderate. Registration information for the webinar can be found here.　

Reader Advisory: Terminology Matters!

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It has now been over three years since the first subprime-related securities class action lawsuit was filed in February 2007, yet many of the cases filed in the ensuing litigation wave are still only in their earliest stages. While the vast majority of these cases are still unfolding, there have been some important recent developments, suggesting that the evolving litigation wave has passed some significant milestones. With that possibility in mind, it seems appropriate to check in for a status report on the subprime and credit crisis-related litigation wave.

In the latest issue of InSights (here), I take a look at the developments to date as the subprime and credit crisis-related cases have worked their way through the system, including trends in motion to dismiss rulings and settlements, as well as with respect to issues such as gatekeeper liability and defense expense costs.

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On January 27, 2010, NERA Economic Consulting released its updated annual review of Canadian securities class litigation entitled "Trends in Canadian Securities Class Actions: 2009 Update" (here). The report presents an interesting study of the evolution of class action litigation in a jurisdiction outside the U.S.

According to the report, there were eight new securities class action lawsuits filed in 2009, which is fewer that the ten filed in 2008 "but still greater than filings in previous years." With the addition of the eight new cases, there are now 23 pending securities class actions, representing more than $14.7 billion in claims. Most of these cases were filed in the last three years although some of the pending cases were filed almost 10 years ago.

Though the number of new filings is noteworthy, the more significant developments may be the class certifications in three cases and the ruling allowing the IMAX securities class action plaintiffs leave to proceed under the new Ontario securities laws. (My prior detailed discussion of the rulings in the IMAX case can be found here.). The NERA report comments that these rulings "may ultimately prove to be an inflection point" for securities class action litigation in Canada.

Though there were significant new filings in 2009, one noteworthy feature of the cases that were filed is the "absence in Canada of class actions filings relating to the credit crisis." This absence may be due in part to the relatively smaller impact of the credit crisis in Canada compared to the U.S. and the negotiated $32 billion restructuring of the Canadian Asset Backed Commercial Paper market, which may have preempted further litigation.

Six cases settled in 2009 for a total of approximately $51 million, for an average of approximately $8.5 million and a median of approximately $9 million (which is roughly comparable to the median settlement of U.S. securities class action lawsuits). 2009 settlements averaged 13.7% of the amount of claimed damages. Cases with cross-border litigation counterparts in the U.S. tended to settle for larger amounts both in terms of absolute dollars and as a percentage of claimed damages.

According to a January 27, 2010 article in the Vancouver Sun (here), the number of filings and the procedural developments (including the rulings in the IMAX case) are "a wake up call for publicly traded companies." Law firms are "advising their clients to revisit their compliance and corporate-governance procedures to protect against similar suits."

One lawyer quoted in the article says that he is also advising his clients to review their corporate insurance, as well. He goes on to state that "We’ve seen over the years there are a lot of problems in terms of clients don’t really have the type of coverage they need."

Yet, as for the question of whether there may be a flood of litigation, one plaintiffs’ attorney quoted in the article sounds a note of caution. The attorney, Dimitri Lascaris, who is one of the lead attorneys in the IMAX case, notes that that the Canadian system still provides for adverse costs, and even the liberalized standard under the new Ontario law are time consuming and expensive. So, he says, "we’re never going to achieve the level of activity in securities class actions that we see in the United States."

In light of these developments and their potential significance regarding insurance coverage, the session planned for the upcoming PLUS D&O Symposium (scheduled next Wednesday and Thursday in New York) on the topic of Canadian Securities Class Action Litigation is quite timely. The panel will be moderated by my friend Dave Williams from Chubb (Canada) and planned speakers include a number of prominent players in the area in Canada, including Dimitri Lascaris. Information about the Symposium can be found here.

The Securities Litigation Watch blog has a post about the NERA study here.

Excess Side A Carrier Contributes to Options Backdating Settlement: On January 25, 2010, a judge in the Western District of Pennsylvania preliminarily approved the settlement of the options backdating lawsuit that had been filed against Black Box, as nominal defendant and certain of its directors and officers. As part of the settlement, the company agreed to pay plaintiffs’ counsel $1.6 million and the company agreed to adopt certain corporate governance measures.

As reflected in the parties’ stipulation of settlement (here), as part of the settlement, the company is to receive a payment of $1.5 million from its Excess Side A carrier as well as another $500,000 from its EPL carrier.

According to a January 25, 2010 article about the settlement in the Pittsburgh Tribune-Review (here), the company also separately settled a claim against the company by its former CEO, who left the company in connection with the options backdating related matters. At the time he left, the CEO claimed, the company took away over $19.6 million in options related compensation. The company settled these claims for its agreement to pay $4 million.

The Black Box settlement marks the second instance of which I am aware in which an Excess Side A carrier contributed toward an options backdating related derivative lawsuit settlement. (The first instance is the Broadcom settlement, about which refer here.) This is yet another instance where Excess Side A insurance is being called on to provide protection outside of the insolvency context. As I have previously noted, the Excess Side A carrier’s contribution to these settlements may be a significant development for the carriers, who have offered the product in a largely low loss environment, at least outside the insolvency context.

The settlement with the CEO is an odd component of this settlement. There aren’t many of these cases where the former CEO who left as a result of backdating related issues walked away with a cash payment.

I have in any event added the Black Box settlement to my table of options backdating related lawsuit settlements and dismissal motion rulings, which can be accessed here.

SEC Will Issue Guidance on Climate Change Disclosure: On January 27, 2010, the SEC voted 3-2 to provide interpretive guidance on existing dislosure requirements to require climate change related disclosure under certain circumstances. The SEC's January 27 release can be found here. The SEC's release states that the interpretive release will be posted on the SEC web site as soon as possible. The news release identifies several examples of situations that might trigger disclosure requirements, including: impact of legislation and regulation; impact of international accords; indirect consequences of regulation or business trends; and physical impacts of climate change.

Suit Against Rating Agencies Dismissed, But Without Reaching First Amendment Issues: According to a January 27, 2010 Am Law Litigation Daily article by Andrew Longstreth (here), Judge Lewis Kaplan has granted the motions of Moody's and S&P to be dismissed from a securities lawsuit filed by certain investors who had invested in certain mortgage-backed securities underrwitten by Lehman Brothers. Judge Kaplan has not yet issued a written opinion but according to the article his opinion was based solely on the fact that the rating agencies didn't have anything to do with the offering documents at issue in the case. HIs ruling reportedly did not reach the rating agencies first amendment defenses (about which refer here.)  

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In my year-end analysis of the 2009 securities class action lawsuit filings, I noted a number of filing trends that developed in the second half of the year, including the incidence of new filings against leveraged Exchange Traded Funds (ETFs) and the surprising numbers of belated securities suit filings where the filing date came well after the proposed class period cut-off date. If the lawsuit filings in the first two weeks of January are any indication, these trends have continued into the New Year.

First, this past week, plaintiffs’ lawyers launched two new lawsuits on behalf of leveraged ETF fund investors, the UltraBasic Materials ProShares Fund (refer here) and the Direxion Energy Bear 3X Shares Fund (refer here). My prior post discussing the phenomenon of securities class action lawsuits and including a link to a running list of the ETF-related suits can be found here. I have updated the list to include these most recently filed suits.

Second, in the first 2010 instance of the belated lawsuit filing phenomenon, on January 15, 2010, plaintiffs’ lawyers filed a securities class action lawsuit against Stryker Corporation and certain of its officers and executives. The plaintiffs’ lawyers’ January 15 press release about the case can be found here.

The class period cut-off proposed in the Stryker complaint is November 13, 2008, well over a year before the lawsuit was filed.

We may have entered a new calendar year, but at least a couple of last year’s securities suit filing trends appear to have carried over from year-end, at least so far.

Galleon Out as Lead Plaintiff: Among the stranger circumstances surrounding the Galleon Management insider trading scandal is the fact that just two weeks before the scandal surfaced Galleon had been reaffirmed as lead plaintiff in the Herley Industries securities class action lawsuit. My prior post discussing these circumstances can be found here.

However, according to a January 15, 2010 Bloomberg article (here) written by Thom Weidlich, Galleon has now dropped out as lead plaintiff in the case.

In a January 15, 2010 order (here), Eastern District of Pennsylvania Judge Juan R. Sanchez permitted Galleon to withdraw as lead plaintiff. According to the Bloomberg article, Galleon’s counsel had advised the court that it had "become clear that the now-defunct Galleon can no longer continue in this role."

Delaware Chancery Court Tosses Bribery Follow-On Civil Suit: In numerous prior posts (most recently here), I have noted as along of the increasing number of antibribery enforcement actions has come the increasing incidence of follow-on civil litigation in the wake of the bribery enforcement action.

As reflected in a January 15, 2010 post on The FCPA Blog (here), a recent Delaware Chancery Court decision dismissing a case involving Dow Chemical contains language that may be important in future bribery enforcement follow-on civil actions.

The Dow suit arose after the Kuwaiti parliament acted to rescind the purchase of certain Dow assets (in a transaction known as K-Dow) based on the suspicion of profiteering and improper commissions paid to the Kuwaiti state owned enterprise that was the actual buyer. The plaintiffs filed suit in Delaware alleging that the Dow board "failed to prevent bribery in connection with the K-Dow transaction."

In a January 11, 2010 opinion (here), Chancellor William B. Chandler III dismissed the action on the grounds that the plaintiffs "do not allege that the board knew about or had reason to suspect bribery."

The FCPA Blog points out that in a footnote "that may have important consequences beyond this case," the court said that Dow’s compliance program was evidence that the board had met its fiduciary duty to prevent overseas bribery. The Chancery Court specifically referenced the company’s Code of Ethics prohibiting any unethical payments to third parties. The FCPA Blog concludes that this case provides "a powerful reason for directors and officers to insist on robust antibribery compliance programs that include regular reports back to the board."　

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Securities class action lawsuit filings were "down sharply" according to the annual study of securities class action litigation released jointly today by the Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research. The full report can be found here and the January 5, 2010 press release accompanying the report can be found here.

According to the study, which found that there were a total of 169 securities class action lawsuit filings through December 21, 2009, the 2009 filings were both 24% below the 223 filings in 2008 and 14% below the annual average of 197 filings during the years 1997 through 2008.

The Stanford study reports a lower lawsuit count than previously published studies of the 2009 securities lawsuit filings, including the prior report of NERA Economic Consulting (refer here) as well as my own prior analysis (refer here). I discuss these differences below.

The relative decline in the number of lawsuit filings in 2009 compared to prior years, according to the Stanford report, is attributable in part to the decline in subprime and credit crisis related filings. Among other things, the report notes that there were only 17 subprime and credit crisis related lawsuits in the second half of 2009.

The press release accompanying the report also quotes Dr. John Gould of Cornerstone Research as saying that the observed decline is consistent with the decline in stock market volatility during 2009, noting that after increasing during the preceding two years, volatility declined both in the first and second halves of 2009.

The study also details the large number of filings that were characterized by "a substantial lag between the end of the class period and the filing" date, a phenomenon about which I written extensively in the past (most recently here). The report notes that the percentage of filings with a lag of more than a year has increased steadily from 5% in 2005 to a historical high of 18% in 2009.

According to the study, historically, class action lawsuit with longer filing lags "have been dismissed at a higher rate than class actions with shorter filings lags," at a rate of 55% for the one-year lag filings versus 42% for filings with a lag between one year and six months, and 36% with a lag of less than six months.

The study also notes that the lag filings are largely the work of the Coughlin Stoia law firm, which was "involved in 63% of the filings with lags longer than six months and 58% of filings with lags longer than a year." This activity levels compares to the firms involvement in 39% of all filings and 29 percent of filings with lags shorter than six months.

The press release quotes Stanford Law Professor Joseph Grundfest as saying, with respect to the lag filings, that the belated filings suggest that "plaintiffs are trying to fill the litigation pipeline by bringing older lawsuits that weren’t attractive enough to file while the firms were busy pursuing financial sector claims," adding that "these lawsuits are more likely to be dismissed and can therefore be characterized as lower quality claims" and that the filings may "reflect factors idiosyncratic to one large plaintiff firm’s strategy, and have little to do with larger market forces."

In addition to tracking the overall number of filings, the report also notes the number of lawsuits filed against unique issuers, which declined even more sharply than the overall number of filings. Thus, while the report found that overall filings declined by 24% between 2008 and 2009, the total number of unique issuers involved in securities lawsuits decreased by 32 percent. The difference in the attributable to the number of multiple filings against the same target, as well as the relatively large number of filings against private companies and other non-exchange traded entities.

The report further notes that of all exchange traded companies, 1.8 percent were defendants in federal securities class action lawsuits filed in 2009 compared to 2.6% in 2008 and compared to a 2.4% annual average for the 12 years ending December 2008.

The number of lawsuits against foreign issuers also declined in 2009, according to the study. After peaking at 16.4% of all filings in 2007, the percentage of filings against foreign issuers declined to 12.4% in 2009. The study attributes the relative decline to the falling off of the credit crisis lawsuits, because so many of the suits against foreign companies were related to the subprime and credit crisis.

Finally, the decline in 2009 credit crisis filings was also associated with a decline in market capitalization losses in 2009. The disclosure dollar loss attributable to 2009 class actions was $83 billion, a 62 percent decrease from 2008.

Some Thoughts about the Numbers: As noted above, the Stanford study’s 2009 lawsuit count varies from previously published figures, including my own. NERA reported 235 filings in 2009, and I reported 189 (I discuss the difference between my count and NERA’s in my prior post, here), compared to the 169 reported by Stanford.

I know that part of the explanation lies in the fact that the Stanford report cutoff at December 21, 2009, which meant that the Stanford study missed at least three more lawsuits filed before year end.

The Stanford study also counts multiple filings related to the same allegation against the same companies only once. This provides a partial explanation for the differences between the Stanford study and the NERA study, which separately counts separate actions in separate circuits unless and until the lawsuits are later consolidated.

Another difference between the studies may be the fact that the NERA study reported a projected year end number, as the result of an extrapolation from filings through mid-December. Though the Stanford study ended prior to year end, it did not incorporate any extrapolation for cases filed after the cutoff date and before year end.

All of these factors clearly are relevant but even collectively they don’t seem sufficient to explain the entire difference. Of course, another factor may simply be differences in information, but given that the plaintiffs’ lawyers put out press releases when they file lawsuits, the information differences likely account for only a small part of the differences in lawsuit counts.

All of this underscores a point that I made at length in connection with my own study of the 2009 filings, which is that readers would benefit enormously from knowing more about what protocols the various study publishers use when the are deciding what "counts."

The Stanford analysis is certainly easier to decode in this respect that other reports since the Stanford Clearinghouse publishes its list of lawsuits on its website — for free, which is a tremendous public service for which all of us should be grateful. But merely knowing which cases were put on the list does not tell us why those cases were included, nor does it tell us what other cases might have been omitted and why. (Indeed, the reason I continue to do my own count and analysis every year, even though Stanford publishes its own list for free on the web, is the uncertainty about what the list does and does not include.)

The Stanford report also gets high marks for stating right on its cover what it is included in its "research sample," which is very helpful and very commendable. But even taking this very explicit information into account, it still seems like there must be more going on that would explain the differences between the various reports.

Here are some illustrations of questions that would be helpful to know: Are securities lawsuits filed in state courts included? Are merger objection suits included? Are proxy solicitation misrepresentation cases included? How about lawsuits filed separately on behalf of equity shareholders and bondholders – one lawsuit or two? How about lawsuits that only allege state securities law violations? What kinds of cases are omitted from the count? What other sorting criteria are used?

The more of this type of information that readers are provided, the more helpful the published reports would be for readers. The approach that would be most helpful to readers would be for the reports to identify the way that their counting protocols differ from those used by other studies, in order to help readers understand the differences.

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On December 15, 2009, NERA Economic Consulting released its annual study of securities class action litigation trends. The study, entitled "Recent Trends in Securities Class Action Litigation: 2009 Year-End Update," and written by my friends Stephanie Plancich and Svetlana Starykh, can be found here. The study concludes that, notwithstanding the decline in credit crisis related filings in the second half of 2009, the projected year-end filing levels will be within historical norms. Average and median securities class action settlements are also consistent with recent trends.

According to the study, credit crisis related filings, which predominated class action filings during 2007 and 2008, "gradually declined" as 2009 progressed. Despite this decline, the total number of securities suit filings has not dropped off, "as other types of cases replaced credit crisis filings."

Based on NERA’s own counting methodology (which, as is explained in footnote 2 of the report, counts separate filings in separate circuits as separate lawsuits until the cases are consolidated), NERA counted 215 securities class action lawsuit filings through November 30, 2009, which projects to 235 filings by year end. Though the projected total of 235 would be below the 2008 level of 253 filings, it is well within the 1997-2004 average of 231 annual filings.

Although the 2009 filing levels look as if they will fall within historical levels, the 2009 filings were swollen by at least a several phenomena that may be short lived. Thus, for example, 36 of the 2009 filings involve Ponzi schemes. Though there may continue to be Ponzi scheme revelations as we head into 2010, it does seem likely that there may be fewer of those stories ahead.

Similarly, the 2009 filings were also increased by 13 new cases related to leveraged ETFs. (My prior post about ETF-related lawsuits can be found here). Though there may be further ETF cases yet to come, this group of cases seems likely to decline, as virtually all of these filings relate to a single family of funds and all relate to a single set of disclosures about the funds’ performance over time.

A third filing pattern that may not continue going forward is the number of cases in which the filing date falls well after the proposed class action cutoff date. (My most recent post about these apparently belated securities suit filings can be found here.) The NERA study shows that during the second half of 2009, the average time between the end of the class period and the date of the first filing lengthened to 279 days (versus a period of 161 days for suits filed during the preceding three years). The NERA study speculates that this may be a reflection of the fact that plaintiffs firms have been "focused on the large credit crisis cases over the last two years," but that they are "now able to focus on bringing other, non-credit-crisis cases with older class periods."

The NERA study reports that cases in 2009 continued to be clustered in the financial sector, with 53% of all filings naming a defendant in the finance sector. Another sector that has continued to see substantial activity is the health technology and services sector.

As far as case resolutions, the NERA study reports that for cases that were filed in 2000, 36% have been dismissed and 61% have settled, but that "even almost a decade after filing, there are still approximately 3% of cases that have yet to reach a final resolution," which underscores the fact that in some instances these cases can take as much as a decade or more to resolve.

Of course, the majority of cases filed in recent years remain pending. For these most recent cases, a higher proportion of resolutions have been dismissals rather than settlements, which the NERA study notes "is unsurprising, as motions to dismiss are usually fled relatively early in the litigation process, often before settlement discussions commence." Ultimately however, the NERA study comments, "we expect that a higher proportion of these recent filings will result in settlements."

With respect to the credit crisis cases, the NERA study notes that over 80% of the cases remain pending, with only 15% of the cases dismissed compared to only 4% (nine cases that have settled.) My running tally of subprime case resolutions can be accessed here. The NERA report comments that this pattern is consistent with observed patterns in which early on more cases are dismissed but that ultimately over time a large proportion of cases settle than are dismissed.

As far as settlements, the NERA study reports that the average securities class action settlement in 2009, if the IPO laddering settlement is removed from the equation, was $42 million, which is substantially above the 2003-2009 average of $29 million, but which is consistent with the overall trend, which is that "there has been a general increase in the average settlement values since 1996."

But though the average settlements continue to increase, median settlements have held relatively steady. In 2009, the median settlement was $9 million, similar to the medians in 2007 ($9.4 million) and 2008 ($8.0 million).

Over the past several years, the ratio of settlement to investor losses has held steady at around 2.5%. The NERA study speculates that because this ratio has held reasonably steady and because investor losses historically have been correlated with settlement values, the fact that investor losses in cases filed during 2007 and 2008 were significantly higher than prior years may be "a signal of potentially higher settlements in the future," as the 2007 and 2008 cases move toward settlement.

As always, the 2009 version of the NERA study provides interesting and thorough analyses. It is worth noting that, because the NERA study "counts" separate filings in separate circuits as separate filings as separate cases, the NERA filing will differ from (and almost certainly be higher than) the figures that other commentators may report in their year end reports.

One thing about the average and median settlement figures that I think all observers should keep in mind is that these figures do not include defense expense, which can be considerable and in many cases can represent a significant percentage of the settlement amounts. In addition, these class settlement figures do not reflect the value of any separate opt-out settlements, nor do they reflect the amounts of other litigation settlements, such as might be incurred in connection with parallel derivative or ERISA class action lawsuits.

My point is that as impressive as the settlement figures reflected in the NERA report are, they represent only a portion of the litigation exposure that the affected companies may have faced, and therefore represent only a partial and incomplete measure, for example, of what insurance limits may be sufficient to protect companies and their directors and officers from their claim exposures.

NERA’s December 15, 2009 press release regarding the 2009 study can be found here.

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On December 7, 2009, NERA released its most recent update on trends in the numbers and values of settlements of SEC enforcement actions. The latest study, which is as of September 30, 2009 and complete through the end of the SEC’s 2009 fiscal year, shows that the number of settlements during the year declined for the second straight year, but the average settlement amount increased, and the median settlement amount held steady. NERA’s December 7 press release regarding the study can be found here.

As the report notes, because the 2009 settlements largely relate actions initiated in earlier periods, they may or may not be indicative of what reasonably may be expected in the SEC’s current heightened enforcement environment.

In addition, the reports observations about the high frequency of individual participation in the settlement of SEC enforcement actions may provide important additional context for Judge Rakoff’s recent high profile rejection of the proposed settlement of the SEC’s enforcement action involving the Merrill Lynch bonuses.

First, with respect to the numbers of settlements, the report shows that there were 626 settlements in fiscal 2009, compared to 673 in fiscal and 717 in fiscal 2007. Among other things, the report notes that fiscal 2009 was a year characterized by staff turnover and transition for the agency’s top leadership, which may be relevant to understanding the relative decline in the numbers of settlements.

Monetary payments were a component of 58.6% of company settlements and 58.9% of individual settlements for FY 2009. The average monetary SEC settlement during fiscal 2009 was $10.7 million, compared to only $4.7 million in fiscal 2008, but the increased 2009 average is largely a reflection of several very large settlements during fiscal 2009, including, for example, the $350 million Siemens paid in settlement of the FCPA enforcement action the agency filed against the company. Removing the settlements in excess of $100 million reduces the FY 2009 average to $4.4 million.

By contrast to the average, the median SEC enforcement settlement was about $1.0 million, about equal to the prior fiscal year’s median.

Among largest source of SEC enforcement actions are cases involving alleged misstatements. In an interesting analysis of the relationship between individual and corporate settlements in misstatement cases, the report notes that between the enactment of SOX and the end of FY 2009, the SEC had reached settlements in 353 cases involving alleged misstatements by corporate companies. Of these 353 settlements, 62 involved only the company, 99 cases involve only individual directors or employees, but the remaining 192 cases involved both the company and individuals.

In other words, individuals participate to a greater or lesser extent in the vast majority of SEC enforcement actions involving misstatements. As the report points, this pattern presents interesting additional context for Judge Rakoff’s high profile rejection of the SEC’s proposed settlement of the Merrill Lynch bonus enforcement action. Judge Rakoff faulted the proposed settlement because it fined the company (and its shareholders) but not the supposedly blameworthy individuals.

The report notes that this outcome is likely to spur the SEC to pursue individuals with "renewed vigor" and indeed SEC officials have made statements to that effect. The SEC’s own settlement patterns show that in general it is the agency’s practice to involve individuals in settlement of restatement cases.

The report reflects a number of different interesting findings, and also contains some helpful and interesting tables, including lists of the ten largest corporate and individual post-SOX settlements, as well as interesting data showing relating to the number of insider trading settlements – somewhat unexpectedly, the number of inside trading settlements hit a post-SOX low during fiscal 2009.

The report concludes with the observation that the full impact of the reforms that the SEC has only just begun to initiate "is likely yet to be seen." The report suggests that the trends observed in the most recent report are likely to change in the periods ahead.

SEC Files Enforcement Action Against Former New Century Officials: Perhaps as a reflection of the newly more active SEC, on December 7, 2009, the SEC filed an enforcement action in the Central District of California against three former New Century Financial Corporation officials.

The SEC’s complaint, which can be found here, alleges that the three defendants violated the securities laws failed to disclose important negative information, including dramatic increases in early loan defaults, loan repurchases, and pending loan repurchase requests. Defendants knew this negative information from numerous internal reports they regularly received, including weekly reports ominously referred to internally as "Storm Watch." The SEC’s December 7 litigation release about the action can be found here. 

The timing of the SEC's enforcement action against the three New Century officials stands in interesting contrast to the private securities class action lawsuit filed against certain former New Century officials. The private securities, which was the first of the subprime related securities class action lawsuits when it was first filed in February 2007, is nearly three years old. The court denied the defendants' motion to dismiss almost exactly a year ago.

 The more interesting question is whether the filing of the New Century action represents the first in a series of enforcement actions related to the subprime meltdown and credit crisis. In light of the new environment at the agency and the pressure it is under to reestablish its regulatory credentials, there may well be further actions yet to come.

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Bankruptcy cases filed in the U.S. federal courts continued to surge in the twelve months ended September 30, 2009, according to statistics released on November 25, 2009 by the Administrative Office of the U.S. Courts. The statistical release, which can be found here, shows that for year ending on September 30, 2009, there were 58,771 business bankruptcy filings, up 52 percent from the 38,651 business filings in the 12-month period ending September 30, 2008.

Data accompanying the release show that the number of filings has increased in the 12-month periods preceding the quarter end for each quarter since the end of the third quarter of 2006.

Though the twelve-month data show a rising number of bankruptcy filings, the quarterly data for the most recent quarter show a slightly different picture, suggesting that the number of bankruptcy filings may have peaked earlier this year, and that during the most recent months the number of business-related bankruptcy filings may even have begun to decline slightly, at least from their 2009 year-to-date highs.

Thus, according to the Administrative Office’s monthly filing data (which can be found here), there were 15,177 business-related bankruptcies in the third quarter of 2009, compared to 16,098 during 2Q08, which represents a third quarter filing decline of about 5.7%. The highest monthly total during 2009 was in April 2009, when there were 5,621 business-related bankruptcy filings, compared to 4,853 in September 2009.

But while the 3Q09 business filings were down slightly from the preceding quarter, the third quarter filings nonetheless remained at very high levels. Thus, by way of comparison, the third quarter business bankruptcy filing total of 15,177 filings is considerably higher than the quarterly totals in 4Q08, when there were 13,021 filings, and in 1Q04, when there were 14,425 filings.

Whether or not bankruptcy filing peaked earlier this year, the number of bankruptcy filings remains significant. The possibility of bankruptcy remains a significant threat for financially troubled businesses. As I have previously noted (here), among the events that often follows after the filing of a bankruptcy petition is the arrival of claims against the bankrupt firm’s directors and officers.

Bankruptcy associated-claims present a host of complications, not least of which is the intricate way that D&O insurance policies respond in the bankruptcy context. One recent development illustrating the difficulties that can arise in the bankruptcy context was the July 2009 decision in the Visitalk case (about which refer here), in which the Ninth Circuit upheld the carriers’ denial of coverage for a lawsuit brought by a company as debtor in possession against former directors and officers of the company, as a result of the policies’ insured vs. insured exclusion.

These kinds of complications underscore the need for D&O insurance policies to be closely scrutinized for their ability both to withstand and to respond to claims arising in the context of bankruptcy.

Hat tip to the SOX First blog (here) for the link to the bankruptcy statistics.

More About FCPA Enforcement and Pharmaceutical Companies: As I recently noted (here, scroll down), both the DoJ and the SEC have indicated that Foreign Corrupt Practices Act enforcement has a high priority and that FCPA enforcement in the pharmaceutical industry is a particular focus.

A November 24, 2009 memo from the Latham & Watkins law firm entitled "U.S. Department of Justice Announces Stepped-Up Criminal Enforcement of Foreign Corrupt Practices Act Against Pharmaceutical Industry" (here) takes a closer look at these prosecutorial priorities.

The memorandum explains that among other reasons for the new focus on pharmaceutical companies is that "many foreign health systems, are regulated, operated and financed by government entities, and competition is intense, which creates more opportunities to ‘pay off foreign officials for the sake of profit.’" Of particular concern is the fact that it may not always be obvious which medical functionaries are "foreign officials" within the meaning of the FCPA.

The article includes a variety of suggested practical steps that pharmaceutical companies can take in light of these concerns.

Special thanks to Adam Savett of the Securities Litigation Watch for providing a copy of the law firm memo.

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Where securities class action lawsuits are concentrated tends to vary over time. At various times over the past several years, companies in the high tech sector, telecommunications category and, more recently, in the financial services industries, have found themselves for a period to be the most popular targets for plaintiffs’ securities class action attorneys. However, beginning in August of this year and accelerating since then, exchange-traded funds (ETFs) appear become among the hottest new targets for securities class action lawsuits. Signs are that there could be more ETF-related securities suits ahead.

By my count there have been at least eight or nine and arguably as many as eleven (or more) new securities class action lawsuits filed against ETFs since August. (See my note below about the difficulty in counting these cases.) Though these lawsuits are separate and are separately filed on behalf of separate investors against separate ETFs, the allegations of these suits are quite similar – indeed, in many cases, virtually identical.

Two recent cases filed against ProShares Ultra Short Dow 30 Fund (refer here) and Direxion Shares Daily Financial Bear 3X Fund (refer here) illustrate the nature of this category of securities suits. The lawsuits overall, like these two, generally are filed against some variation of the funds themselves, the funds’ investment advisors or managers as well as the funds’ distributors, and the funds’ individual trustees. The ETFs themselves allegedly were designed to provide some multiple of the return (or of the inverse of the return) of some benchmark index or measure.

The complaints basically allege that the defendants failed to disclose to investors the risks associated with the investments, and in particular allegedly did not disclose the significant likelihood of losses to the value of the funds’ shares if held over time or even just for more than a single day, nor did the funds disclose the extent to which the funds’ results would likely diverge from their benchmark over time.

Though there have been many of these ETF-related securities lawsuits filed recently, there may be many more yet to come. Among other things, as inevitably seems to happen when plaintiffs’ lawyers start racing to stake out their piece of a hot property, at least one plaintiffs’ firm has issued a press release (here) announcing that it is investigating a whole raft of ETFs – indeed, the particular plaintiffs’ firm’s press release lists 75 different ETFs the firm is investigating.

Whether these cases will ultimately succeed or fail of course remains to be seen, but the plaintiffs’ firms’ actions clearly suggest that they think they are on to something.

These lawsuits already represent a significant part of the total number of securities class action lawsuits this year (depending on how you count, between five and ten percent of the total). If as seems likely at this point new ETF-related cases continue to be filed, the ETF cases will not only represent an even more significant portion of the total number of new securities cases this year, but they could also produce a material increase in the overall number of lawsuits that are filed this year.

But whatever the ultimate number of ETF-related cases ultimately proves to be, I believe that we have already reached the point where these cases represent their own separate phenomenon and therefore worthy of tracking on that basis.

Accordingly, I have created a separate list of the ETF lawsuit filings, which can be accessed here.

It is entirely possible that this list is incomplete, and I would be grateful if readers would let me know about any cases I may have missed. I will be updating this list as new ETF-related cases come in.

I should add that trying to keep track of these cases and to tell them apart is a particularly vexing task. Many of the ETFs have bewilderingly similar names, and some of the lawsuits purport to file claims on behalf of investors in multiple ETFs. Figuring out which suits are separate and which are duplicates is a considerable challenge. For each case presented separately on this list there have been multiple other apparently duplicate other filings that I have not listed. Some of these cases do overlap and there may well be consolidation of some (or, who knows, perhaps many or all) of these cases before all is said and done. I have tried as best as I can to identify separate cases separately. I welcome readers’ observations and comments about the list.

Though there have been a number of these suits, and though there could be many more, most of these suits are filed against ETFs within one single fund family. As a result, the extent of the contagion effect from this lawsuit outbreak so far has been relatively isolated. This concentration of many suits within a single fund family may diminish the insurance impact of this category event, as the single fund family likely carried only a single insurance program for all of the funds in the family. I stress that I have no direct knowledge one way or the other, but it is relatively unlikely that each new lawsuits represents a significant new insurance related loss or loss exposure.

Perhaps the Theory is "Better Late Than Never"?: In recent posts (most recently here),  I have noted another trend, which is the apparently belated filing of securities class action lawsuits, where the date of the proposed class period cut off is well in the past. For example, the new suit filed on October 28, 2009 against Pitney Bowes (refer here) has a proposed class period cut off date of October 29, 2007, suggesting that the case was filed just prior to the expiration of the two-year statute of limitations cut off date.

Well, if the cases I previously discussed could fairly be described as "belated," then the securities class action filed in the Southern District of California on October 30, 2009 against Avanir Pharmaceuticals and certain of its directors and officers can only be described as superannuated. Or more succintly, old. Perhaps even stale.

The actiion purports to be filed on behalf of persons who acquired shares of the company's stock between July 1995 and October 31, 2006. That is, the complaint (a copy of which can be found here) was not filed until nearly three years after the proposed class action cutoff date.

There is no way of telling from the face of the complaint how the plaintiffs intend to try to overcome the rather obvious statute of limitations objection that the defendants will raise, expecially given that the complaint expressly alleges that the company's true condition was revealed in an October 31, 2006 disclosure.  It will be interesting to see how the plaintiffs attempt to respond to the statute of limitations defense.

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It is always useful to look at aggregate securities lawsuit filing data to try to determine what trends and themes can be discerned, but occasionally it is also useful to look at a single new filing whether it might suggest anything. To choose one example, a closer look at a new securities class action lawsuit filed on October 14, 2009 in the Eastern District of Pennsylvania against Advanta Corporation and certain of its directors and officers seems to reflect a variety of different securities litigation tendencies and motifs.

Advanta at one time was the country’s largest issuer of Visa and MasterCard credit cards, through its subsidiary, Advanta Bank Corp. As reflected in the plaintiffs’ lawyers’ October 14, 2009 press release (here), the lawsuit alleges that the defendants failed "to disclose the impact of the economic environment and the deteriorating credit trends on its business and that the Company failed to adequately and timely record losses for its impaired loans and customer delinquencies, causing its financial results to be materially false."

Specifially, the complaint (which can be found here) alleges that:

(a) Advanta’s assets contained tens of millions of dollars worth of impaired credit card receivables for which the Company had not accrued losses; (b) prior to and during the Class Period, Advanta had been extremely aggressive in granting credit to customers without verifying the customers’ ability to pay, to such a degree that by the summer of 2009, Advanta customers’ default rate would be almost six times worse than industry average; (c) Advanta’s manipulation of its cash rewards program angered customers and caused the Company to lose good, creditworthy customers; (d) Advanta’s credit receivables were unduly risky due to the Company’s practice of issuing credit cards to small business owners without, in many instances, verifying income; (e) defendants failed to properly account for Advanta’s continuing delinquent customers and the credit trends in the Company’s portfolio, resulting ultimately in large charges to reflect impairments; and (f) the Company was not on track to be profitable in 2008.

The complaint alleges that the company’s share price plunged after its October 2007 disclosure that it was experiencing a higher rate of delinquencies. The complaint alleges that thereafter the news only got worse, and in May 2009 the company announced in May 2009 the cancellation of "millions of cards held by small businesses." On June 30, 2009, the FDIC entered a cease and desist order (here) against Advanta Bank following allegations of unsafe and unsound banking practices.

Though the complaint references these more recent events, the putative class period proposed in the complaint runs from October 31, 2006 through November 27, 2007.

This complaint is of course a reflection of the specific circumstance alleged with respect to this one company and its banking subsidiary. Nevertheless, the complaint also reflects a number of different securities litigation themes and trends, some of which are well-established and some of which may only just be emerging.

First, this case is yet another example of the kinds of litigation that may emerge in connection with the growing numbers of troubled banks. As I have noted in numerous posts (most recently here), though the level of litigation involving failed and troubled banks is still well below what might be expected given the number of distressed institutions, a number of lawsuits have begun to emerge and there may yet be more in the future.

Second, while I have noted elsewhere that as 2009 has progressed the wave of subprime and credit crisis related litigation definitely seems to have slowed (or even just merged into larger litigation developments to the point that it may no longer be its own separately identifiable category of litigation), this case suggests that it is far too early to declare that the litigation wave has ended. Obviously, there may yet be other cases that raise similar credit related lawsuits in the months ahead.

This case also demonstrates with respect to the subprime and credit crisis-related litigation wave that the lawsuits encompass a wide variety of kinds and categories of credit, including, as shown here, credit card debt. As noted here with respect to the litigation involving American Express, there have been prior credit crisis securities lawsuits filed with respect to issues concerning credit card debt.

Third, the 23-month gap between the end of the proposed class period and the filing of this lawsuit is yet another example of the significant number of filings in the second and third quarter of 2009 that involve class period cutoff dates in the distant past. As noted in prior posts (most recently here), this phenomenon might suggest that while the plaintiffs’ lawyer were previously preoccupied filing numerous credit crisis and Madoff related lawsuits, they developed a backlog of cases that they have now started to work off.

Indeed, just in the past several days there have been several other cases with long past class period cutoff dates, including the lawsuit recent filed involving RHI Entertainment (filed on October 8, 2009, class period cutoff of June 19, 2008); Men’s Wearhouse (filed on October 8. 2009, class period cutoff date of January 9, 2008); and EnergySolutions (filed October 9, 2009, class period cutoff date of October 14, 2008).

Apparently, as the Advanta case suggests, the backlog may even include other credit crisis cases, which is yet another reason that, as noted above, there may be still other credit crisis cases yet to come.

In any event, I have added this case to my list of subprime and credit crisis-related securities lawsuits, which can be found here. If this case is any indication, there could be others credit crisis securities cases yet to come.

Courtroom Drama: While we all remain interested in the developments in the ongoing trial in the Vivendi securities class action lawsuit, there is certainly nothing new about courtroom drama, and some of the most compelling courtroom tales have an ancient and venerable pedigree.

A particularly engaging tale of courtroom drama is told in The Life and Times of Constantine the Great, a biography of the Roman emperor by D.G. Kousoulas. During Constantine’s reign, Athanasius, the bishop of Alexandria and one of the protagonists in the long-running Arian controversy, was accused by his foes of murder. An inquest of bishops and imperial officials was convened.

At the inquest, the accusers presented their case against Athanasius, and even produced a blackened hand, allegedly that of the victim, Arsenius. Kousoulas describes the scene:

After the accusers had enjoyed a moment of triumph as they passed the blackened hand around, Athanasius asked in a quiet voice if any of those present knew Arsenius personally. A number of bishops claimed to have known the murdered bishop well. Would they recognize him if they saw him, Athanasius asked. Certainly, they replied, "if he were alive." At that point Athanasius signaled to a man who was standing near the doorway, his face covered with his cloak. The man, his face still covered, moved to the front. "Lift your cloak," Athanasius said. The man removed the cloak and [as a contemporary account noted] "lo and behold it was Arsenius himself." Athanasius moved closer and drew first one and then the other sleeve. Aresenius had both of his hands. "Has God given a man more than two hands?" Athanasius asked with a sarcastic smile.

***

For a moment there was stunned silence. Then one of the accusers declared loudly that all this was sorcery and devil’s work. The man was not Arsenius although he had his face, he was not even human but an illusion produced by Athanasius with his knowledge of black magic. Athanasius asked the bishops to come and touch the man he was accused of having murdered. The meeting turned into a brawl, and Dionysius, the imperial officer attending the meeting on orders from Constantine, had to hurry Athanasius out to save his life.

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Lawsuits alleging violations of the securities laws showed a strong comeback in the third quarter of 2009, according to an Advisen report released on October 14, 2009 (here). The report, the latest in a quarterly series from Advisen, reports that securities lawsuit filings were up "solidly" in the third quarter after a relative decline in the second quarter. Advisen’s report is directionally consistent with my own prior analysis of third quarter securities class action lawsuit filings, which can be found here.

One absolutely critical thing to understand about the Advisen report is that it uses its own unique terminology. As reflected on page 2 of the report, the report uses the term "securities suit" to describe a broad range of lawsuits beyond just securities class action lawsuits. As used in the report, the term "securities suits" includes, beyond the class actions, regulatory and enforcement actions; collective actions outside the United States; lawsuits alleging common law torts, contract law violations and breaches of fiduciary duty; derivative actions; and any other "securities-related suit" that impacts management liability insurance policies other than ERISA liability suits.

In addition, the report uses the phrase "securities fraud suits" to describe regulatory and enforcement actions brought by the SEC and other regulatory and enforcement agencies. Importantly this category of "securities fraud suits" also includes "cases brought by private parties alleging violations of securities laws that are not styled as class actions."

The report notes with respect to the broader category of "securities suits," as that term is used in the report, that there were 169 "securities suits" in the third quarter, which represents an 11 percent increase over the second quarter of 2009.

The report also notes that there were 55 new securities class action lawsuits in the third quarter of 2009, up from 38 cases in the second quarter, but down from 59 in the third quarter of 2008. The securities class action filing rate through the first three quarters of 2009 annualizes to 220 new lawsuits, which is "below the 230 filed in 2008 but well within its historical range."

The class action securities cases were, however, only the second largest subcategory among the larger group of "securities cases" (as that term is used in the report) filed in the third quarter. The largest subcategory among "securities cases" in the third quarter was "securities fraud cases" (which, again, is the term that the report uses to describe securities-related regulatory and enforcement actions, as well as private securities suits that are not filed as class actions), of which there were 70, up from 50 in 2Q09.

Overall, the securities class action lawsuits continue to represent an increasingly smaller proportion of all "securities suit" filings. The report notes that the proportion of securities class action lawsuit filings as a percentage of all "securities suits" has "been on a long downward trend." Whereas in the past, securities class action lawsuits have represented a majority of all "securities suits," in the third quarter, securities class action lawsuits represented just 33 percent of all "securities suits."

The report also notes that though filings against financial firms "remained strong" in the third quarter, new filings were more "widely dispersed" among other sectors than in the first half of the year. The report also notes that new Madoff and credit crisis-related suits "dropped substantially" in the third quarter compared to the first half of the year.

The report also notes the "long-term trend of growing numbers of suits against non-U.S. companies." Specifically, the report notes "the number of large securities suit filings against non-U.S. companies" are on a "long-term growth path."

With respect to potential insurance, the report notes that there is a growing number of "securities suits" that potentially trigger insurance coverage other than D&O insurance. The report notes that this trend "started in 2008 and continued in 2009," largely due to the filing of credit crisis and Madoff-related lawsuits. These cases may even be excluded by D&O policies but covered by E&O or fiduciary liability policies.

The Advisen report introduces a couple of nifty new features this quarter. First, the report includes a "Sector Impact Metric," which is designed to show the degree to which "securities suits" hit various industrial sectors over the past decade. The other new feature is the "Market Cap Impact Metric," which measures the market capitalization loss experienced by companies with securities class action lawsuits.

Speaker’s Corner: On Friday, October 16, 2009 at 11 am EDT, Advisen will be hosting a webinar to discuss the third quarter, in which I will be participating along with Arthur J. Gallagher’s Phil Norton, Zurich’s Paul Schiavone, and Advisen’s David Bradford. The session will be moderated by Advisen’s Jim Blinn. In addition to reviewing trends of securities litigation during the third quarter, the panel will discuss appropriate D&O limits.Registration for the webinar can be found here.

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After a brief lull during the second quarter, securities class action lawsuit filings during the third quarter were closer to historical norms, although the filings levels did drop again during September.

By my count, there were 49 new securities class action lawsuits during the third quarter. For reasons discussed below, my count could vary significantly from third quarter tallies that others may publish. But the 49 third quarter filings brings the year to date total through September 30, 2009 to which brings the year to date total of new securities class action lawsuit filings to 143.

The annualized equivalent of the filings for the first nine months of 2009 projects to a twelve-month filing rate of 191, which is slightly below but still well within range of the average of 197.7 annual filings during the 13-year period between 1996 and 2008.

After a decline in filings during April and May at the end of the second quarter, when there were monthly filing totals of 11 and six respectively, there were 20 new securities lawsuit filings in June. But the number dropped to 17 in July and only 12 in September. Clearly, the filing activity levels have fluctuated month to month so far during 2009.

There may be any number of reasons for this fluctuation, but I continue to believe that the fluctuations are largely due to the fact that the plaintiffs’ lawyers are jammed up with the mass of lawsuits they filed over the last three years. As I have detailed at length elsewhere (here), many of the third quarter filings have proposed class period cutoffs well in the past, in some cases more than a year in the past. These filings may suggest that the plaintiffs’ lawyers have been so preoccupied with the other cases and with the Madoff lawsuits that they developed a backlog, which they are now getting around to working off.

The filings during the third quarter were not nearly so concentrated in the financial sector as during the first half of the year. In the first six months of 2009, about two thirds of the target defendant companies were in the financial sector. However, in the third quarter, only 12 of the 49 new securities lawsuit involved companies with Standard Industrial Classification Codes in the 6000 series (Finance, Insurance and Real Estate). There were also nine new securities class actions involving firms without SIC codes, most of which were financially related companies.

Even if all nine of those companies lacking SIC Codes are counted as financial, that still makes only 21 out of the 48 third court suits in the financial sector. Thus less than half of the third quarter filings were against companies in the financial sector, as compared to over two-thirds in the first half of the year.

One contributing factor in the relative decline in the number of new securities suits against financial companies may be the declining number of new lawsuits relating to the subprime meltdown and credit crisis. Thus, while there have been nearly 200 securities lawsuits filed since February 2007 related to the subprime and credit crisis litigation wave, including as many as 58 total in 2009, only about seven of subprime and credit crisis related cases were filed in the third quarter (depending on how you count).

As I noted in my recent interim update of the subprime and credit crisis related litigation (here), this apparent decline in the cases related to these phenomena may be due to the changing financial circumstances. What started several years ago with the subprime meltdown has evolved into a global financial crisis, affecting all companies across the entire economy. As a result of these developments, it has become increasingly difficult to define precisely what constitutes a subprime and credit crisis-related lawsuit. It may not be so much that the subprime and credit crisis litigation wave has crested as it is that the wave has merged into a larger tidal movement and is no longer its own separately identifiable phenomenon.

The high incidence of lawsuits involving companies without SIC Codes is a reflection of the number of new cases involving unusual lawsuit targets. There were, for example, several filings during the third quarter involving ETF Funds (refer here, here and here, for example). There were also new lawsuits filed involving closed end investment funds (refer here) and mortgage trusts (refer here and here). These actions are a continuation of the filing activity we have seen for several quarters, as a wide variety of complex financial firms and investment vehicles have been and continue to be drawn into securities litigation.

But though the third quarter filings, as was the case with the filings in the first half of the year, involved a number of these unusual targets, many of the companies named in third quarter lawsuits are more representative both of the larger economy and of more traditional securities litigation targets. Overall the companies named as defendants represented over 30 different SIC Code categories. For example, six of the third quarter filings involved life sciences companies in the 2830 SIC Code category and three involved filings against medical device companies in the 3840 SIC Code category.

By contrast to the first six months of the year, relatively few of the third quarter filings involved foreign domiciled companies. Thus, while 18 of the first half lawsuits involved foreign companies, only two of the third quarter lawsuits involved foreign companies. Many of the foreign targets in the first half of the year were financial companies, so the relative decline in filings against foreign companies may simply be a reflection of overall reduction in lawsuits against financial firms.

The new securities lawsuit filings in the third quarter were not nearly so heavily concentrated in the Southern District of New York as in the first half of the year. Thus, while in the six months of 2009, 45 out of 94 (or nearly half) of the new securities lawsuits were filed in the Southern District, only 12 of the 48 third quarter filings (or only 25%) were initiated in the S.D.N.Y. Again, this relative decline may be a reflection of the reduced number of lawsuits involving financial companies.

About Counting: As has been the case in recent quarters, the process of "counting" new securities lawsuits continued to be quite challenging during the third quarter. As has been the case in the past, I have not counted breach of fiduciary duty/merger objection lawsuits. In addition, I have also excluded from my count the "failure to register securities" lawsuits when these suits have been filed in state court (refer for example here), or even if filed in federal court assert only state law claims (refer for example here). In addition, the recurring phenomenon of lawsuit involving nontraditional financial vehicles makes it extremely challenging, given the outward similarity of many of these vehicles and their names, to tell whether or new complaint represents a new or a duplicate lawsuit.

These kinds of sorting issues inevitably result in some line drawing and some marginal categorization issues. Reasonable minds clearly could differ on many of these sorting concerns.

The bottom line is that my lawsuit count for the third quarter and for the first nine months almost certainly will differ from similar tallies that other may publish – indeed, for the same reason, the various other tallies will also likely disagree with each other as well. Certainly, anyone trying to come up with their own count that were to include, for example, merger objection suits or failure to register claims, would reach a substantially different number than the one I came up with.

I emphasize these counting issues, as I have in the past, as a way to try to explain the differences that may appear in the various published accounts. No one should be surprised by the differences, although consumers of the counting data have every right to know what has been included and excluded from any given count in order to understand how and why the count differs from other published versions.

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It is now over two and a half years since the first subprime-related securities class action lawsuit was filed in February 2007, yet many of the cases filed as part of the ensuing litigation wave are still only in their earliest stages. But there have been some important developments recently – for example, the Eighth Circuit’s recent decision affirming the dismissal of the NovaStar Financial subprime lawsuit – suggesting that the evolving litigation wave may have reached a passed a significant milestone. With that possibility in mind, it seems appropriate to check in for a status report on the subprime and credit crisis-related litigation wave.

Filing levels

There have now been a total of 199 subprime and credit crisis-related securities class action lawsuits, of which 57 have been filed so far in 2007. A compete list of the lawsuits can be accessed here. While the subprime and credit crisis securities suits continue to be filed, in recent months the pace has definitely slowed. Of the 2009 filings, the bulk of them were filed in the first quarter, and there have only been a handful since April. Of course, the pace of filling activity could return at any time, but at least at this point there seems to be some possibility that the subprime and credit crisis litigation wave may have already crested.

Another circumstance suggesting that the litigation wave may be ebbing is changing mix of companies that are the targets of the latest securities class action lawsuits. In the first half of the year, approximately two thirds of the new securities lawsuits involved companies in the financial sector. But of the 37 new securities lawsuits filed in July and August 2009, only 13, or slightly more than a third, involved companies in the financial sector. In other words, the proportion of lawsuits against financial companies versus nonfinancial companies seems to have completely reversed.

Of course, another possibility to explain the recent filing patterns is that the litigation has changed as the nature of the financial circumstances changed. What started several years ago with the subprime meltdown has evolved into a global financial crisis, affecting all companies across the entire economy. As a result of these developments, it has become increasingly difficult to define precisely what constitutes a subprime and credit crisis-related lawsuit.

A good illustration of this definitional challenge is the case recently filed against MGM Mirage as a result of construction delays and financing issues relating to the company’s CityCenter project in Las Vegas. Whether this case should be grouped with earlier subprime and credit crisis-related cases depends on whether or not the company’s difficulties relate to a categorically separate set of issues or are simply a reflection of the overall economic turndown. In other words, it may not be so much that the subprime and credit crisis litigation wave has crested as it is that the wave has merged into a larger tidal movement and is no longer its own separately identifiable phenomenon.

Dismissal Motion Rulings

Even after two and a half years, there have still only been a handful of dismissal motion rulings in the subprime and credit crisis related lawsuits. For that reason, and because among the few rulings so far there are some that have gone one way and some that have gone the other way, it is difficult to generalize. Just the same, there have been some recent rulings suggesting that, even though there are still dismissal motion rulings going in the plaintiffs’ favor, on balance the rulings seem to be favoring the defendants, and recent rulings could be particularly useful for defendants going forward. (A complete list of the subprime and credit crisis-related lawsuit dismissal motion rulings can be accessed here.)

The most prominent among these recent developments is the Eighth Circuit’s September 1, 2009 decision in the NovaStar Financial case affirming the district court’s dismissal of the plaintiffs’ complaint, about which refer here.

There have also been a series of recent rulings in which the courts have granted motions to dismiss in recognition that the defendant company’s difficulties were the result of economic downturn, not fraud. Thus for example, in both the lawsuit that Luminent Mortgage Corporation filed against Merrill Lynch (refer here) and in the First Marblehead subprime-related securities class action lawsuit (refer here), the courts quoted with approval language from a prior RICO case in which the Second Circuit said "when the plaintiff’s loss coincides with a marketwide phenomenon causing comparable losses to other investors, the prospect that plaintiffs’ loss was caused by fraud decreases."

This latter argument – that is, if the plaintiffs were harmed, it was due to the global financial downturn, not to defendants’ supposed misconduct – could prove useful to defendants in a wide variety of subprime related cases. Given the magnitude of the economic downturn, which was nearly universally unanticipated, this argument could well be extended to many if not most of the subprime and credit crisis-related lawsuits. The extent to which the defendants are able to exploit this argument in other cases remains to be seen, but for now defendants seem to have established a significant formula for dismissal motion success in these cases.

Another development that suggests the balance may be shifting in defendants’ favor is the number of recent cases were district courts granted renewed motions to dismiss after plaintiffs had filed amended complaints seeking to cure pleading defects noting in the initial dismissal rulings. Renewed dismissal motions were recently granted in both the Downey Financial and Centerline cases (about which dismissals refer here, scroll down)– although, to be sure, the renewed dismissal motion was denied in the BankAtlantic case, where the plaintiffs’ amended complaint survived the renewed motion to dismiss, as discussed here.

Another significant recent development suggesting that defendants may have developed an advantage at the dismissal stage is the dismissal granted in the CBRE Realty case. As discussed at greater length here, the district court granted the dismissal motion even though the plaintiff asserted only claims under the ’33 Act, and therefore did not have to satisfy the more rigorous initial pleading requirements that apply to ’34 Act claims (as for example the need to plead scienter). This development may be particularly significant because many of the subprime and credit crisis-related lawsuits, particularly many of those filed in 2009, assert only claims under the ’33 Act. Of course, it remains to be seen whether or not the complaints in these other cases will be found to be similarly deficient as the one in the CBRE Realty case, but for now (based on admittedly few data points) the balance seems to be in the defendants’ favor on these cases.

One final note is that the apparent pendulum swing in defendants’ favor at the motion to dismiss stage is that it is not limited just to the subprime and credit crisis-related securities cases. As shown by the recent dismissals in the Citigroup subprime related derivative lawsuit (refer here, scroll down) and in the Citigroup subprime related ERISA lawsuit (refer here, scroll down), the recent development suggest that defendants may be faring well at the dismissal motions stage in these other kinds of cases as well.

To be sure, there are also cases in which the motions to dismiss recently have been denied, as for example in the Levitt Corp. subprime related securities lawsuit (about which refer here, scroll down). The dismissal motion rulings are by no means all going in defendants’ favor and the outcome of the dismissal motions in any particular case is by no means predetermined. There are many more dismissal motions yet to be heard.

Settlements

If there are only a few dismissal motion rulings in these cases so far, there are even fewer settlements, and it is even more difficult to generalize.

By far the most attention-grabbing feature of the settlements so far is the series of eye-popping settlements in subprime lawsuits involving Merrill Lynch. The three Merrill Lynch settlements so far are the three largest subprime-related lawsuit settlements. The $475 million securities lawsuit settlement (refer here), the $150 million bond action settlement (refer here) and the $75 million ERISA action settlement (refer here) stand out among the few other, more modest settlements.

It is not just their size that may set these Merrill Lynch settlements apart. The fact that these enormous settlements were entered before the motions to dismiss were heard in each of these cases and also shortly after Bank of America acquired Merrill Lynch suggests that following its acquisition of Merrill, Bank of America moved quickly to clear the decks of Merrill litigation that predated the merger, even if substantial sums proved to be required to accomplish that goal. Because of the possibility that these settlements may represent the outcome of their own unique settlement dynamic, they may be of little guidance with regard to possible settlement ranges of other cases.

There have been other significant settlements in other cases, from which some generalizations may or not be able to be drawn. Thus, for example, the RAIT Financial subprime-relates securities lawsuit recently settled for $32 million (refer here) and the Accredited Home Lenders case recently settled for $22 million (refer here). Both of these cases had survived the defendants’ motions to dismiss, which suggests that while it may difficult for these cases to survive dismissal motions, when the cases do survive they can be quite costly to resolve.

Two other noteworthy recent settlements include the $37.25 million settlement in the American Home subprime-related lawsuit (refer here) and the $30.5 million settlement in the Beazer Homes subprime related lawsuit (refer here). These settlements are notable because in both instances the cases settled before the motions to dismiss had been ruled upon. While each of these cases had their own particular features and each was resolved for reasons particular to each case, they do suggest that resolving more serious cases can be prove costly to settle. These cases also suggest that when the claims are sufficiently serious the plaintiffs may be able to avoid the initial pleading hurdle altogether.

So while the defendants may have won some important recent victories in the courtroom at the motion to dismiss stage, the overall costs of defending and settling these cases taken in the aggregate nevertheless continues to look as if it will be enormous. By any measure, the subprime and credit crisis-related litigation wave continues to represent a tremendous loss exposure for D&O insurers.

In any event, a complete list of settlements in the subprime and credit crisis-related lawsuits can be accessed here.

Gatekeeper Liability

One of the characteristics of many of these subprime and credit crisis related lawsuits is the extent to which the plaintiffs are seeking to impose liability on the gatekeepers of the target companies. The gatekeepers named as defendants include not only the directors and officers of the target companies, but also the companies’ auditors and offering underwriters, as well as the rating agencies that provided rating on the companies’ securities offerings.

The plaintiffs have shown particular willingness to pursue claims against the auditors. Thus, for example, the trustee for New Century Financial Corp. has initiated a claim against KPMG, the company’s former auditor (refer here). KPMG is also named as a defendant in the New Century subprime securities lawsuit, and the district court in that case specifically denied KPMG’s motion to dismiss (refer here). In addition, in the Countrywide subprime-related securities lawsuit, the district court found denied KPMG’s renewed motion to dismiss the claims against KPMG in the plaintiffs’ amended complaint (refer here, scroll down).

The possibility that these gatekeeper claims could prove valuable for claimants was highlighted in the recent $37.25 million American Home settlement. As here, the total settlement fund included contributions of $8.5 million from the seven offering underwriter defendants and $4.75 million from the company’s auditor, Deloitte & Touche. While it is always dangerous to try to generalize from a single settlement, the American Home settlement does at least suggest the possibility that resolving gatekeeper liability could be an important and costly part of subprime and credit crisis litigation wave’s overall consequences.

Another significant development in terms of gatekeeper liability is Judge Schira Scheindlin’s September 2, 2009 ruling in the Cheyne Financial case denying the rating agency defendants’ motions to dismiss. Although, as discussed at length here, there could be limitations on the overall impact of Judge Scheindlin’s ruling, the ruling could influence the many other cases in which plaintiffs are seeking to impose gatekeeper liability on the rating agencies.

One final note about the gatekeeper liability developments is that at least so far the claimants seem to have shown little inclination to try to pursue claims against the attorneys that may have been involved in the underlying circumstances. There is precedent for plaintiffs to pursue these kinds of claims against the attorneys; in a case involving a commercial mortgage backed securities transaction that took place in the 90’s, certain claimants are now pursuing claims against the Cadwalader firm, which had been the law firm that created the transaction documents (refer here for more details about this case). Significantly, the claimants did not initiate that claim until many years after the fact and only after extensive litigation involving other parties. All of which suggests that the claims against the attorneys, even if not yet filed, could be yet to come.

Defense Expense

In addition to the potential costs of settlement, these cases are in most instances proving enormously expensive to defend. The most substantial illustration of this proposition is the State Street’s August 10, 2009 announcement (here) that the approximately $625 million subprime-related litigation expense reserve the company had established in January 2008 was as of June 30, 2009 already down to $193 million, and further that there could be no assurances that the remaining amount would be adequate for the company’s continuing litigation.

The potential cost of serious corporate litigation was also highlighted in the recent Broadcom options backdating derivative lawsuit settlement (about which refer here). Among other things, the settlement papers reflected recitals that the company’s litigation expense to date in connection with company’s various options backdating related legal proceedings was in excess of $130 million. Even though the Broadcom case related to options backdating and not to subprime litigation, the defense expenses accumulated in that case underscores how expensive serious corporate litigation can become.

Many of the subprime and credit crisis related cases are equally as complicated and equally serious. And while the $130 million in litigation expense in the Broadcom case may be an extreme case, it is not unusual any more for costs of litigation in complex corporate and securities cases to run into the tens of millions of dollars. The costs of litigation alone have become staggering.

All of which is a long way of saying that in addition to the costs associated with settling these cases, the overall cost of these lawsuit also will include massive amounts of defense expense. These enormous defense expenses will add to the overall aggregate burdens of this litigation for the D&O insurance industry, as well as for the company’s themselves. Though it has been a while since anyone has attempted to calculate the overall cost to the D&O insurance industry from the subprime and credit crisis litigation wave, by any measure the aggregate cost included defense and settlement amounts will be enormous.

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Each fall for the last three years I have taken a look at the current trends and hot topics in the world of D&O. There are of course the perennial topics that always remain important. However, this overview is intended to address the most significant concerns of current interest for D&O insurance professionals and their clients. My list of the current issues to watch is set out below.

Will Rising Corporate Bankruptcies Produce Increased D&O Claims?

According to the Administrative Office of the U. S. Courts (refer here), the number of business-related bankruptcies increased 63% (to 55,021 from 33,822) during the year ended June 30, 2009. Although there are some encouraging signs that the overall economy may be beginning to recover, significant numbers of individual companies could continue to face the risk of bankruptcy for some time to come.

Among other problems associated with bankruptcy filings is the risk of increased claims against officials at the bankrupt firms. For example, in its 2008 year end report on securities litigation activity, Advisen noted that since 1995, roughly 35 percent of the large public companies (defined as having assets of over $250 million in 2008 dollars) that filed for bankruptcy also sustained securities class action lawsuits against their directors and officers. During 2007 and 2008, the percentage increased to 77 percent. The directors and officers of private companies also face a heightened claims exposure when their companies file for bankruptcy.

Bankruptcy associated-claims present a host of complications, not least of which is the intricate (and sometimes problematic) way that D&O insurance policies respond in the bankruptcy context. One recent development illustrating the difficulties that can arise in the bankruptcy context was the July 2009 decision in the Visitalk case (about which refer here), in which the Ninth Circuit upheld the carriers’ denial of coverage for a lawsuit brought by a company as debtor in possession against former directors and officers of the company, as a result of the policies’ insured vs. insured exclusion.

These kinds of complications underscore the need for D&O insurance policies to be closely scrutinized for their ability both to withstand and to respond to claims arising in the context of bankruptcy.

One final concern is that the rising tide of corporate bankruptcies could trigger increased losses under Excess Side A insurance that many companies now carry. This possibility is one of several factors, many of which that are discussed below, that could represent a changing environment for carriers offering Excess Side A insurance. The increased number of bankruptcies in any event further reinforces the proposition that Excess Side A insurance is an indispensible part of a complete D&O insurance program for any corporate insured, whether public or private.

Will the Growing Number of Bank Failures Produce a Wave of Failed Bank Litigation?

The number of 2009 year to date failed banks is now up to 89 (as of September 4, 2009, about which refer here), and the total number of bank failures since January 1, 2008, is up to 114. Alarmist commentators have made predictions that as many as 1,000 banks could fail by the end of 2010, as discussed here. Whether or not the number of bank closures will come anywhere near that level, it is clear that we are in the midst of the most significant wave of bank failures since the S&L crisis.

The question remains whether this time around we will see the same level of litigation activity as we saw during the last failed bank wave. Somewhat surprisingly, so far the FDIC has initiated relatively little litigation to try to recoup its losses from the directors and officers of the failed financial institutions. However, for now the FDIC is preoccupied dealing with further bank closures. And even during the S&L crisis, the FDIC and the other regulatory agencies usually did not act until statutes of limitations were just about to expire. There could yet be another round of failed bank litigation, in a 21^st Century edition.

Private litigants might also be expected to get in the act -- for example, investors who lost their entire investment when a bank closes might well be expected to pursue claims. There has been a certain amount of that (refer here). There has also been some securities class action litigation activity involving failed banks whose shares were publicly traded. Of the 25 banks that failed in 2008, six of them are involved in securities class action litigation, even though only 11 of them were publicly traded.

However, the securities class action litigation involving the failed banks has not fared particularly well so far. For example, in the Downey Financial securities class action lawsuit (about which refer here), the district court recently granted the renewed motion to dismiss following the plaintiffs’ attempt to amend their complaint to try to remedy the pleading defects noted in the initial dismissal without prejudice. In addition, in the Fremont General securities lawsuit (refer here), the court also granted the defendants’ motion to dismiss, albeit with leave to amend.

These early returns potentially could be discouraging some potential litigants. Nevertheless, if for no other reason than the fact that there was so much failed bank litigation last time around, it seems likely that when all is said and done, the growing number of bank failures will at some point lead to an extended round of failed bank litigation.

Whether or the failed bank litigation ultimately emerges, the D&O insurers have responded defensively to the wave of bank failures. Many financial institutions, including even smaller community banks, are facing significantly more challenging circumstances when trying to renew their D&O insurance. Many banks find that they can obtain coverage, if at all, at significantly greater cost for significantly restricted terms and conditions, and in many instances with significant new limitations such as reduced limits of liability or the addition of additional exclusions, such as a regulatory exclusion. The wave of failed banks has already had a significant impact in the D&O insurance marketplace.

Will the Rising Number of Derivative Lawsuit Mega Settlements Mean Significant Excess Side A Losses?

Within the last several years, there have been a rising number of unprecedented mega settlements in shareholders’ derivative lawsuits, particularly during the last 12 to 24 months. These massive derivative lawsuit settlements include the $900 million UnitedHealth Group options backdating settlement (refer here); the $118 Broadcom options backdating settlement (refer here); and the $115 AIG settlement (refer here).

One consequence of this outbreak of massive derivative lawsuit settlements is that now for the first time Excess Side A carriers are being called upon to contribute significantly toward settlement outside of the insolvency context. The recent Broadcom settlement, in which the Excess Side A insurers collectively contributed $40 million to settlement, appears to represent a milestone development in that regard. While there may well have been prior occasions on which Excess Side A insurance contributed toward settlement outside of insolvency, the Broadcom settlement is by far the most public example. Based on the reactions I have heard, the Broadcom settlement has been a wake up call of sorts for many players throughout the D&O industry.

Among other things, the Broadcom settlement underscores the value for companies and their directors and officers of the Excess Side A product, which, along with the insolvency related considerations noted above, should further encourage policyholder take up of this product. As also noted above, Excess Side A protection increasingly will become a standard part of any well designed D&O insurance program.

The Broadcom settlement also represents a significant development for D&O insurers as well, who until now have enjoyed the opportunity to offer Excess Side A insurance in a relatively low loss cost environment, particularly outside the insolvency context. The Broadcom settlement highlights the potential for Excess Side A insurers to sustain significant claims losses on this product, even outside of the insolvency context. The increasing incidence of mega derivative lawsuit settlements underscores the growing possibility of these kinds of losses.

Another significant side effect of the Broadcom settlement is that the plaintiffs’ lawyers clearly will now have developed an appreciation of the value of presenting claims that trigger the Excess Side A coverage. The question arises whether they might now attempt to craft claims for the express purposes of accessing the Excess Side A limits. The attempt to pursue this strategy would face considerable challenges – derivative lawsuits, for example, are subject to formidable defenses, including the demand requirement and the business judgment rule defense. Nevertheless, the possibility of claims targeted expressly at the Excess Side A limits is a consideration that should not simply be disregarded.

Will Securities Lawsuit Filings Return to Historical Levels?

As discussed in a prior post (here), securities class action lawsuit filings dropped during the second quarter of 2009. This decline was largely due to the low filing activity during May (when there were only 11 new securities class action lawsuits) and during June (when there were only six new securities lawsuits), compared to historical monthly filing levels in the range of 15 to 20 new lawsuits a month.

At least to this point in the third quarter, it seems as if the second quarter filing decline was just a temporary dip that has already ended. There were at least 20 new securities class action lawsuits in July, and at least 17 in August, both of which monthly filing levels are well within historical norms.

Another interesting attribute of the most recent lawsuit filings is that so far the third quarter filings are not nearly as concentrated in the financial sector. During the first half of the year, about two-thirds of the securities class action lawsuit filings involved financial companies. However, of the 37 securities lawsuits filed in July and August, only about 13 (or roughly a third) involved financial institutions. In other words the proportion of lawsuits filed against financial companies to lawsuits filed against nonfinancial companies seems to be completely reversed from the first half of the year.

The other interesting thing about the third quarter filings is the extent to which the cases involve proposed class period cutoff dates that are well in the past, sometimes by as much as a year or more prior to the actual filing date. As I have previously noted on this blog (most recently here), these belated filings suggest that while the plaintiffs lawyers were scrambling to file subprime and credit crisis-related lawsuit against financial companies in the first part of the year, they were also developing a backlog of other cases that they are now working off.

All signs indicate that by the end of this year, securities class action filing levels will likely have returned to historical levels after the brief and apparently temporary decline in the second quarter. The concentration of filings in the financial sector also seems to be abating, with distribution of filings by industry starting to look more like historical norms.

How are Plaintiffs Faring in the Subprime and Credit Crisis-Related Securities Lawsuit?

We are now more than two and a half years into the subprime and credit crisis-related litigation wave, yet in many respects the cases are still only in their earliest stages. But there have been a number of recent significant developments suggesting that the evolving subprime litigation wave recently may have passed a significant milestone, and that it could be an appropriate time to take a closer look at the status of the subprime and credit crisis cases. For that reason, I will be publishing a post within the next few days providing a detailed status report on the litigation wave. I will update this post with a link when the status report is available. UPDATE: My September 8, 2009 status report on the subprime and credit crisis related litgation can be found here.

In the meantime, though the wave is still in its early stages, it is possible to make a number of generalizations. First, it seems like the defendants again have the upper hand at the motion to dismiss stage. Among other things, the Eighth Circuit’s recent decision affirming the district court’s dismissal in the NovaStar Financial case (about which refer here) represents a significant victory for defendants. The Downey Financial dismissal, discussed above in connection with the failed banks is another example. The recent dismissals in the Citigroup subprime-related derivative lawsuit (refer here) and Citigroup ERISA lawsuit (refer here, scroll down) also suggest that plaintiffs may be faring poorly in those cases as well.

On the other hand, there have also been some significant recent settlements suggesting that if the plaintiffs can survive motions to dismiss in these cases, the cost of settlement can be significant. Along those lines, the recent $32 million settlement in the RAIT Financial case (refer here) and the $22 million settlement in the Accredited Home Builders case (refer here) illustrate how costly it can be to try to settle cases that survive motions to dismiss.

Two equally significant settlements in cases in which the dismissal motions had not yet even been heard – the $37.25 million settlement in the American Home case (refer here) and the $30.5 million settlement in the Beazer Homes case (refer here) – suggests that in cases that are sufficiently serious the plaintiffs may be able to avoid the initial pleading hurdle altogether.

The American Home settlement may be particularly noteworthy because in that case both the offering underwriter defendants and the company’s auditor contributed substantially toward the cost of settlement. That, together with the Judge Scheindler’s September 2, 20009 partial denial of the motion to dismiss the claims against the rating agencies in the Cheyne Finance lawsuit (about which refer here), could suggest that in at least some of these cases the possibility of gatekeeper liability could be an important part of the overall claims resolution.

The final point is that these cases are proving to be extremely costly to litigate. The most dramatic illustration of this point is State Street’s August 10, 2009 announcement (here) that the approximately $625 million subprime-related litigation expense reserve the company had established in January 2008 was as of June 30, 2009 already down to $193 million, and further that there could be no assurances that the remaining amount would be adequate for the company’s continuing litigation.

So while the defendants may have won some important victories in the courtroom, the overall costs of defending and settling these cases taken in the aggregate nevertheless continues to look as if it will be enormous. By any measure, the subprime and credit crisis-related litigation wave continues to represent a tremendous loss exposure for D&O insurers.

Will the SEC’s Renewed Aggressiveness Expand Individual Liability Exposures for Corporate Officials?

The SEC is under considerable pressure to reestablish its regulatory credentials and to try to restore its tarnished reputation. As a result, the SEC recently has shown a renewed aggressiveness and even an apparent willingness to try to expand the weapons in its arsenal, in ways that may pose increased threats to corporate officials.

Two recent enforcement actions underscore this pronounced new aggressiveness. First, in July 2009, the SEC launched an enforcement action against the CEO of CSK Auto. As discussed here, the SEC is seeking to clawback the compensation the CEO earned during the period for which the company later restated its financial statements. Significantly, the SEC is pursuing this claim even though the CEO is not alleged to have engaged in any wrongful misconduct or even to have had any role in or knowledge of the issues that triggered the company’s restatement.

The second example of the SEC’s recent aggressiveness is the July 2009 enforcement action filed against two corporate officials at Nature’s Sunshine Products. As discussed here, the SEC sought to impose control person liability on the two officials for the company’s activities that violated the Foreign Corrupt Practices Act, even though the two individuals were not themselves alleged to have been involved in or even aware of the corrupt activities.

Though the SEC’s apparently needs no further encouragement to pursue liability claims against individuals, the agency nevertheless is facing significant additional pressure to target individuals as part of its enforcement activities. Indeed, among other reasons that Judge Jed Rakoff has questioned the proposed settlement of the enforcement action involving the Merrill Lynch bonuses is that the settlement does not involve any specific allegations against or claims against the individuals who caused the alleged wrongdoing to take place. (Refer here for additional details regarding Judge Rakoff’s objections). Regardless of the outcome of the Merrill Lynch settlement, going forward the SEC likely will have to anticipate this objection and incorporate targeted allegations against individuals in an effort to forestall further objections of this kind.

The bottom line is that as a result of these developments, corporate officials could find themselves increasingly on the firing line. Of particular concern is that the CSK Auto and Nature’s Sunshine Products enforcement actions evidence an arguably disturbing willingness on the SEC’s part to try to impose liability on corporate officials even in the absence of culpable involvement in or even awareness of the alleged wrongdoing.

Will Claimants Increasingly Target Outside Directors?

The $61.55 million settlement earlier this year of the claims against the outside director defendants in the Peregrine Systems securities lawsuit is merely the latest example where outside directors have found themselves required to contribute toward a separate settlement of significant liability claims against them. As discussed at greater length here, at least some of the outside director defendants appear to have been required to contribute toward the Peregrine Systems settlement out of their own assets.

As was also shown in the now infamous Just for Feet settlement (about which refer here), the threat that outside directors will be targeted and could be called upon to contribute toward settlement out of their own assets is a growing concern, and one that is significantly increased in the bankruptcy context. Given the growing number of corporate bankruptcies, outside directors could find increasingly find themselves on the front lines of D&O claims.

These developments underscore yet again the need for alternative insurance structures such as Excess Side A insurance to be included as an important part of the corporate D&O insurance program. Indeed, among the defendants whose potential liabilities were settled by the Excess Side A insurers’ contribution in the Broadcom options backdating derivative lawsuit settlement were several of that company’s outside directors.

These cases also highlight the extent to which the outside directors’ liability exposures and interests should be separately considered as part of the construction of a company’s D&O insurance program. Simply put, the outside directors’ interests and the interests of the company’s officers may or may not be completely aligned. These developments and considerations suggest that the non-officer directors could be well advised to have their insurance interests independently reviewed, in order to ensure that their interests are appropriately addressed in the way the company’s insurance program is constructed, as I discuss at greater length here.

What Will be the Next Industry Event for the D&O Insurance Industry?

It is commonly understood that the D&O insurance industry’s historical experience is characterized by a sequence of industry events – for example, we went from the bursting of the Internet bubble to the era of corporate scandals, and we went from options backdating to the subprime litigation wave.

So what will be the next industry event? It might be one or more of the issues discussed above, like the failed bank litigation wave, or the rising number of derivative lawsuits. Or it could be a further extension of existing trends, like the rising numbers of FCPA follow-on civil lawsuits. Or it could be something entirely new, like lawsuits arising from climate change related disclosures.

Only time will tell for sure what the next industry event will be. The one thing that is for certain is that there will another event that will emerge and define the industry’s experience in the months and years that follow.

Is the D&O Insurance Marketplace Headed for a "Hard Market"?

Earlier this year, Advisen took the bold and provocative step of predicting that the D&O insurance marketplace is headed toward a "hard market" as early as late 2009 or early 2010, as discussed at greater length here. Whether or not we are actually headed to an overall harder insurance market remains to be seen, though as 2009 progresses, the possibility to that we will see a hard market earlier rather than later seems less and less likely.

To be sure, the D&O insurance marketplace for companies in the financial sector is definitely harder than for the rest of the marketplace, and some financial institutions are now "hard to place." The speed with which the D&O marketplace for community banks firmed up shows how quickly conditions can change.

Nevertheless, for most companies, particularly those that are financially stable, the D&O marketplace remains competitive, with ample capacity and coverage available on favorable terms and conditions. The pricing declines that have characterized the marketplace over the last several years have largely ended, but outside the financial sector significant pricing increases (at least for financial stable companies) remain the exception.

That is not to say that the possibility of a generalized harder market is completely out of the question. The losses and defense expense associated with the subprime and credit crisis related litigation wave, in combination with several years’ of pricing declines and coverage expansions, could start to affect carriers’ overall results and trigger pricing increases and marketplace restrictions. Whether and when these circumstances might arise remains to be seen.

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I hate to sound like a broken record a broken record, but as the third quarter securities lawsuit filings continue to come in, certain definite trends are clearly emerging. As I previously noted (here), the most recent filings are characterized by a high number of new lawsuits against companies outside the financial sector and by proposed class period cutoff dates in the distant past. Last week’s new filings reflect these previously noted trends, which I think both explain the second quarter filing "lull" and suggest what we might expect for the balance of the year.

The following table shows the filing date for four of the new class action securities lawsuits filed last week (each of the company names in the table below is hyperlinked to a web page providing further information about the respective lawsuit):

As shown in the table, each of these new lawsuits has been filed against companies outside the financial sector and each of them has a proposed class period cutoff date well over a year and a half ago.

These latest filings, taken together with the filings noted in my prior post on this topic (here), represent growing data supporting my theory that during the run-up in securities lawsuits against financial companies in connection with the subprime and credit crisis litigation wave, the plaintiffs’ lawyer accumulated a backlog of cases against companies outside the financial sector, and they are now starting to work off that backlog.

Indeed, even with respect to recent filings that have a more recent proposed class period cutoff date, the filings are largely with respect to companies outside the financial sector, as reflected in the new lawsuit recently filed, for example, against Huron Consulting (refer here); Repros Technology (here); Textron (here); and Allscripts-Misys Healthcare Solutions (here).

All of which leads me to a number of conclusions: the filing "lull" noted in the second quarter is over; part of the reason for the lull was that plaintiffs’ lawyers hit a logjam because of credit crisis and Madoff-related litigation activity, as a result of which they accumulated a backlog of cases against companies outside the financial sector, that they are now starting to work off; and as a result we are seeing a rush of new lawsuits against companies outside the financial sector.

Furthermore, I strongly suspect that this observed third quarter trend of new lawsuit filings against companies outside the financial sector will continue for the balance of the year, and many of these new lawsuits will be characterized by proposed cut-off dates approaching the two-year period of the statute of limitations. Notwithstanding the second quarter filing lull, by year end the annual rate of new filings for 2009 will be consistent with, if not slightly above historical norms.

In support of this final point about likely year end filing levels, I note not only the conjectured lawsuit backlog discussed above, but also the recent heightened level of SEC enforcement activity and the marketwide run-up in share prices since March, which could position some individual companies for the kind of sudden and conspicuous share price decline that attracts the unwanted attention of the securities class action plaintiffs’ attorneys.

Another Trend Noted: The lawsuit noted above that was filed last week against MIND C.T.I. Ltd. also represents another securities lawsuit filing trend I have described previously (refer for example here) – that is, the investor lawsuit regarding a company’s balance sheet exposure to auction rate securities.

The typical ARS-related lawsuit is brought by an ARS purchaser against the firm that created or sold the security. However, in contrast to this more typical ARS lawsuit, the suit filed against MIND alleges that the company misrepresented or failed to fully disclose the company’s balance sheet exposure to ARS investments. That is, rather than suing the ARS seller, the type of suit filed against MIND is brought against the ARS buyer.

As I noted in my most recent post (here) about auction rate securities litigation, numerous public companies continue to face surprisingly large balance sheet exposures to ARS, and some of them may be potentially vulnerable to this type of investor over the companies’ ARS-related disclosures.

It is interesting to note that MIND’s auction rate securities investments included investments in the infamous Mantoloking CDO, about which I previously wrote here. As I noted in my prior post, this single CDO has spawned an enormous amount of litigation, including even (as I noted in the prior post) a FINRA arbitration initiated by MIND against the creators and sellers of the Mantoloking CDO.

Insolent Sprat: When I told my then 15-year old son that he sounded like a broken record, he said "What does a broken record sound like?"

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My suggestion (here) that the apparent second quarter securities lawsuit filing lull was due in part to the fact that plaintiffs’ lawyers have a backlog of cases outside the financial sector has proven controversial. All I can say that there is an increasing amount of evidence consistent with the backlog hypothesis. Specifically, a significant number of recently filed securities lawsuits propose class period ending dates that are well in the past, in many cases well over a year in the past. Three cases filed this past week reinforce this observation.

To cite the most recent example, on August 7, 2009, plaintiffs’ lawyers initiated a securities class action lawsuit in the Southern District of Texas against Flotek Industries and certain of its directors and officers. As reflected in the plaintiffs’ lawyers’ August 7 press release (here), the ending date of the proposed class period in their complaint (which can be found here) is January 23, 2008, well over a year and a half before the complaint was filed.

Similarly in the class action securities lawsuit filed in the Southern District of New York on August 6, 2009 against Conseco, Inc. and certain of its directors and officers, the proposed class period ending date is March 17, 2008, as reflected in the plaintiffs’ lawyers August 6 press release (here).

And, to cite another example just from among the complaints filed during this past week, the ending date for the class period proposed in the lawsuit filed on August 4, 2009 against Allscripts-Misys Healthcare Systems (refer here) is February 13, 2008.

These cases join a large number of other recently filed cases in which the proposed class period cutoff date is well in the past. Thus, the purported class period in the July 30, 2009 securities class action lawsuit filed against International Game Technology (refer here) ends on October 30, 2008. The proposed class period ending date in the lawsuit filed on July 22, 2009 against Accuray (refer here) is August 19, 2008.

An even more noteworthy example is the class period proposed in the securities class action filed on July 17, 2009 against Bare Escentuals (about which refer here), in which the proposed class period end date is November 26, 2007. Similarly, in the securities class action lawsuit filed on July 14, 2009 against Ambassadors Group and certain of its directors and officers, the proposed class period end date is October 23, 2007 (refer here).

Other recent cases in which the class period cutoff date is at least six months prior to the filing date include the lawsuit filed on July 10, 2009 against Tronox (refer here).

These cases were all filed during July and August, though every single one of them might have and could have been filed earlier. The seeming delayed timing of the filing of these cases might be due to any number of factors. But at a minimum, the seeming delay alone could account for the supposed class action lawsuit filing "lull" observed during 2Q09. The rapid accumulation of these cases during the third quarter suggests that the supposed lull is over. It also suggests that when all is said and done by year’s end, the 2009 securities lawsuit filings levels will likely be consistent with historical norms.

Another thing these lawsuits have in common is that, with the exception of the Conseco case, they all involve companies outside the financial sector. It is generally recognized that for some time going well into last year, securities lawsuit filings have been largely concentrated in the financial sector. This noteworthy recent accumulation of seemingly dated cases against companies outside the financial sector strongly suggests that while lawyers were racing to the courthouse over the past couple of years to file lawsuits against financial companies, they were also building up a backlog of cases against companies outside the financial sector, and that they are now actively working off that backlog. Indeed, this process may have started earlier this year (refer here), but it now appears to be picking up considerable momentum.

For D&O underwriters, the possibility of lawsuits over long past events may pose a particularly difficult underwriting challenge, as it makes it particularly tricky to determine when a company that has experienced problems is "out of the woods." Compounding the difficulty is the fact that while the D&O insurance market for financial sector companies has "hardened" as a result of economic and related litigation developments, the market for companies outside the financial sector remains competitive, and underwriters may face pressures to compete even for a company with past problems, not withstanding these underwriting uncertainties.

It would be all to easy, based on a review of the various recently released mid-year securities litigation reports, to conclude that securities class action lawsuit filing activity is both concentrated in the financial sector and declining. As I have suggested before (here), it is premature to conclude that overall securities litigation activity is in some sort of secular decline. By the same token, it would be incautious to conclude that the securities litigation threat is largely confined to the financial sector. The recent lawsuit filings in fact confirm that companies outside the financial sector continue to face considerable securities litigation exposure.

D&O Insurance in Troubled Times: An August 7, 2009 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation blog (here) incorporates a memorandum from the Wachtell, Lipton law firm summarizing the critical D&O insurance issues in the current era of "historically significant dislocation." The memo provides a good but brief summary of critical issues, emphasizing the importance of Side A excess insurance, as well as considerations relating to the financial condition of insurers.

Among other things, the memo notes that "it may make sense to spend more for coverage from insurers that appear well-capitalized and financially strong."

Apologies for Service Issues: In recent days, some readers may have experienced problems attempting to access some documents to which I have linked on this site. In a sequence of events characterized both by lack of foresight and poor communications, the web address for a server I was using to host some documents for this site was changed without my knowledge, breaking the link to the URLs I used to link to the documents. I have fixed the most important links, but it will take a while to fix all of them. Readers may experience broken links on some older pages on this site for the next week or ten days while I fix the problem.

I encourage anyone who needs a particular document that they are unable to access as a result of this problem to contact me directly and I will provide you with a .pdf of the document. I apologize for this service glitch. I also note that anyone who thinks it would be easy to maintain a blog isn't reckoning, among other things,  with the infinite potential for other people to radically screw things up.

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In a July 31, 2009 report , Advisen became the latest group to confirm that securities litigation declined in the second quarter of 2009, noting in its report entitled "Securities Litigation Drops in Q2 2009" (here) that securities lawsuit filings "fell off in the second quarter from the frantic first quarter." Advisen’s July 31, 2009 press release describing its study can be found here.

But while the Advisen report is consistent with the report released earlier by Cornerstone Research (refer here), NERA Economic Consulting (refer here), as well as my own prior report (here), the Advisen report takes a slightly different approach to the topic and as a result contributes an important additional perspective.

It is absolutely critical to note at the outset that in using the term "securities lawsuit," the Advisen report is describing a category broader than just securities class action litigation. In addition to the securities class action litigation, the Advisen report uses the term "securities lawsuit" to include shareholder derivative litigation; breach of fiduciary duty litigation; "securities fraud" litigation, which includes regulatory actions brought by the SEC; as well as other kinds of litigation.

Using this broad definition, the Advisen reports that there were 121 "securities lawsuit" filings in the second quarter, down from 212 in the record-setting first quarter. Overall the first half "securities lawsuit" filings were within although slightly below historical norms.

The Advisen report notes that there were 37 new securities class action lawsuit filings in the second quarter, down from 70 in the first quarter. The 107 first half securities class action lawsuit filings would translate into 214 filings on an annualized basis, "in line with most recent years."

In speculating on the reasons for the first half decline, the Advisen report comments that the first half filings seem to have been "frontloaded" into the first quarter of the year. The report also states that "the second quarter could represent a lull in litigation activity while law firms worked on the flood of suits from the first quarter." The report does note (as I also observed, here) that "the first few weeks of the third quarter have seen a surge in securities suits once again."

The Advisen report also states that there were 41 settlements/awards in securities lawsuits in the second quarter of 2009, including the $2.9 billion jury award against Richard Scrushy in the HealthSouth shareholders’ derivative lawsuit. Taking the Scrushy award into account, the average settlement/award in the second quarter was $101.5 million, but if the Scrushy award is disregarded the average settlement/award drops to $60.0 million. The average securities class action settlement in the second quarter was $74.5 million, a quarterly average amount the report describes as "quite high."

The report has a number of other interesting observations, many of which have been noted in the previously released reports, including the concentration of the litigation activity in the financial sector; the increasing level of litigation involving foreign domiciled companies; and the elevated levels of activity involving the Ponzi scheme allegations.

Advisen Webinar: Advisen will be hosting a free webinar to discuss the findings in its second quarter report on August 3, 2009 at 11 am EDT. I will be participating in the call along with David Bradford and John Molka of Advisen, Randy Hein of Chubb and Tripp Sheehan of Marsh. For further information about the call and to register, refer here.

About Those July Securities Filings: The Advisen report mentions that in the first month of the third quarter, securities class action lawsuit filings seem to have ramped up again. Just to detail that point, by my count, there were at least 16 new securities class action lawsuits filed in July, which is a filing rate that is back at historical levels.

With respect to the new July filings, it is also interesting to note how few of these new lawsuits were in the financial sector. While five of the new lawsuits involve financial companies, the other eleven did not, which is sort of the exact opposite of the equivalent proportions for the first half of the year. Of the eleven new suits involving nonfinancial companies, as many as seven involved companies involved in the life sciences sector.

The other interesting thing about these July filings is how many of them involve purported class periods ending dates that are well in the past, as I previously noted here. To cite the most recent example, the purported class period in the July 30, 2009 securities class action lawsuit filing against International Game Technology (refer here) ends on October 30, 2008.

The July filings seem to me to be consistent with the hypothesis that the downturn in securities class action filings during the second quarter was just a temporary lull. In addition, the July filings are inconsistent with the hypothesis that the plaintiffs’ lawyers are running out of targets to sue. Rather, the July filings suggest to me, as I have speculated elsewhere, that the plaintiffs’ lawyers ran into a logjam during the second quarter and as they ran up a backlog of cases to be filed against nonfinancial companies. All of the evidence so far in the third quarter is entirely consistent with this final hypothesis.

One Thing the Plaintiffs’ Lawyers Were Up to During the First Half: As I also noted elsewhere, though the plaintiffs’ lawyers’ may not have been filing new securities class action lawsuits during the second quarter, they were by no means idle. A July 31, 2009 press release (here) by the Tramont Guerra & Nunez firm, issued in response to the various published reports regarding the decline in second quarter filings, provides some insight into at least one particular way the plaintiffs’ lawyers were otherwise occupied during the second quarter.

According to the press release, Finra’s dispute resolution statistics show an 82% increase in the arbitration claims for the first half of the year, with the majority of claims filed for breach of fiduciary duty and misrepresentation. Finra’s statistics can be found here. As I said, the plaintiffs’ lawyers were not idle.

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On July 27, 2009, NERA Economic Consulting became the latest to publish a mid-year analysis of the year to date securities litigation developments. The NERA report, written by Stephanie Plancich and Svetlana Starykh, is entitled "Recent Trends in Securities Class Actions Litigation: 2009 Mid-Year Update," and can be found here. The NERA Report joins the earlier mid-year report of Cornerstone Research (refer here). My own mid-year review can be found here.

The NERA report seemingly reports a higher number of securities class action filings than the earlier reports, although the seeming difference requires some explanation; on closer review, the apparent difference arguably becomes more apparent than real. In addition to an analysis of the first half lawsuit filings, the NERA report also includes a review of the first half securities lawsuit settlements as well.

For the first six months of 2009, NERA reports that there were 127 new securities class action filings. This tally is quite a bit higher than the 87 first half filings that Cornerstone reported in its recent study of first half filings. However the difference may be attributable to a difference in counting methodology. As explained in footnote 2 of the NERA report, "unless cases are consolidated, we report all filings potentially related to the same alleged fraud, if the complaints are filed in different Circuits or if different securities are alleged to be affected by the fraud." Since many of the complaints filed in the first half involve duplicated allegations with multiple complaints filed in different circuits, NERA’s reported number of filings is quite a bit higher than other published reports. NERA notes that "if cases are ultimately consolidated, the data are adjusted." Hence, my statement that the seeming difference in the number of filings may be more apparent than real.

The NERA report notes that the first half filings are on an annualized pace of more than 250 filings, which would be more than in 2008. Consistent with earlier reports, the NERA report does note that the number of filings declined in the second quarter. The NERA report also notes that the first half filings were largely driven by the credit crisis cases and new lawsuits relating to the Ponzi schemes. Over 40% of first half filings were credit crisis related and over 20% were related to the Ponzi scheme allegations. About 67% of first half filings named at least one financial company as a primary co-defendant.

In addition, the NERA report notes that accounting firms have been named as co-defendants in 17.3% of filings, which represents a significant increase from prior years. Cases against foreign domiciled defendants have also increased, with 19 cases or 15% of all cases naming a foreign company as a primary defendant, the highest percentage since the passage of the PSLRA.

In terms of drivers affecting the pace of securities class action lawsuit filings, the report confirms that the filing rate is correlated to overall market volatility, but the relationship is "not tight" and in fact volatility accounts for only about 28% of the variability in quarterly filing levels.

In looking at case resolutions, the report attempts to determine how long on average it takes for these cases to be resolved. Looking back at the cases filed in 2000, the report finds that on average, the time to resolution is 2.9 year, with an average time for dismissals of 1.7 years and settlements it was 3.5 years. Most of the more recent cases, particularly those related to the subprime meltdown and the credit crisis still remain only in their earliest stages, and so it is too early to tell how these cases ultimately will be resolved.

In analyzing case outcomes overtime, the report finds that a higher fraction of cases have been dismissed since the U.S. Supreme Court’s 2005 ruling in Dura Pharmaceuticals, consistent with the hypothesis that defendants are more likely to prevail in a motion to dismiss as a result of that decision.

With respect to settlements so far this year, the NERA report finds that the median securities class action settlement is $8 million, which is about the same as in 2008. Median values have remained very consistent for the past five years.

The average securities class action settlement during the first half of the year has been $43 million, about even with last year’s average and slightly below the average of $49.6 million for the period 2003 to 2009. The high average relative to the median is driven by large outlier settlements. If the settlements above $1 billion are removed, the average for the period 2003 to 2009 drops to $27.6 million, although the year to date average for 2009 settlements remains at $43 million. A substantial number of settlements this year have been over $100 though less than $1 billion.

Median investor losses for cases filed in 2009 ($600 million) are much higher than for cases settled in 2009 ($289 million). Since settlement amounts traditionally have been "strongly correlated" to investor losses, this would seem to suggest that the 2009 cases would be much higher than more recently settled cases. However, given that the companies affected by the credit crisis "may no longer have …substantial resources to make …large settlement payouts" the traditional relationship of settlement amount to investor losses may or may not hold.

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As I have shown (here) and has been detailed by others (here), the number of securities class action lawsuits declined during the first half of 2009 compared both to last year and to historical norms. There is a lot that might be said about the decline and its causes. However, the mainstream media (refer, for example, here) has latched onto the message that the number of securities suits is declining because the plaintiffs are "running out of people to sue."

Let’s be honest -- fish gotta swim, birds gotta fly, and plaintiffs’ lawyers make their living filing lawsuits. The fish and the birds can be counted upon to continue their traditional activities, and so can the plaintiffs’ lawyers. The very idea that the plaintiffs have run out of targets is a flawed conclusion built on a faulty premise.

Before I get started on this topic, I think it would be useful to review why this question matters. Once before, the idea circulated that the securities class action plaintiffs’ lawyers were going out of business. This hypothesis turned out to be very wrong and it proved to be a very expensive mistake.

After the PSLRA was enacted at the end of 1995, some D&O insurers assumed the statute’s passage would mean that many fewer securities lawsuits would be filed, and so they slashed their insurance pricing. The marketplace followed. When securities litigation ramped back up, the D&O insurance industry suffered hundreds of millions of dollars in losses. The industry paid a lot of tuition to learn that what plaintiffs’ lawyers do is file lawsuits. Given how expensive the lesson was, it would seem unwise to start assuming now that anything has changed.

But with respect to the recent decline in securities lawsuits, let’s at least get the facts straight. The number of lawsuits did not decline during the entire first six months of the year. During the period January through April, the number of new securities lawsuit filings was more or less at normal levels. The drop took place in May and June. Now, looking at the ebb and flow of securities lawsuit filings during the last 14 years, there arguably is nothing noteworthy about a two-month decline. It could just be a blip. It may or may not continue; only time will tell. It does seem important (to me at least) that so far in July, there have already been at least twelve new securities lawsuits, more than were filed in either May or June.

The other thing about the first half of 2009 is that it was not as if the plaintiffs’ lawyers were idle -- they were just otherwise occupied. Among other things, they were busy filing lawsuits related to Madoff, the Stanford Financial Group and other Ponzi schemes. Indeed, my list of Madoff-related lawsuits (which can be accessed here) now runs to some 23 pages, with more than 40 new cases filed during May and June.

This other extensive litigation activity is highly relevant, because of the similarity to what happened back in the period mid-2005 to mid-2007. That was the period when there was a sustained "lull" in new securities class action lawsuit filings. During that period as well, the plaintiffs’ lawyers were also otherwise engaged. Then, they were busy filing options backdating-related shareholders’ derivative lawsuits, eventually filing 168 of them (as shown here).

That prior "lull" in new securities lawsuit filings motivated some observers to speculate that the move to lower securities litigation levels might represent a "permanent" change. Subsequent history has shown that in fact there was no permanent change, and indeed the securities lawsuit activity returned with a vengeance.

Of course, it is possible that plaintiffs’ lawyers have indeed run out of targets and that lower level of new securities class action filings will persist going forward. Only time will tell. Just based on what history has shown, though, both after the passage of the PSLRA and after the so-called "lull," I think it would be unwise to bet that hereafter the plaintiffs lawyers will file fewer securities lawsuits.

My own theory about why the number of lawsuits has dipped is that the plaintiffs’ lawyers have been busy, not just with the Madoff lawsuits, but also dealing with the extraordinary number of lawsuits they previously filed in connection with the subprime meltdown and credit crisis. Many of these lawsuits are uncommonly complicated and they have in many cases entered procedurally demanding stages.

The main reason I believe that the plaintiffs’ lawyers have just been jammed up is that I think there is evidence that they are dealing with a backlog of cases, a point that I have made before (here). Recent filings even further reinforce the conclusion that the plaintiffs’ lawyers are now starting to work off a backlog.

Many of the recent filings have proposed class periods that are well in the past, sometimes years in the past. For example, the securities lawsuit filed on July 14, 2009 against Ambassador Group (refer here) has a proposed class period cutoff date of October 23, 2007. The securities lawsuit filed on July 17, 2009 against Bare Escentuals (refer here) has proposed class period cutoff date of November 26, 2007. The securities lawsuit filed on July 22, 2009 against Accuray (refer here) proposes a class period cutoff of August 19, 2008. Other recent filings though not quite as superannuated involve class period cutoff dates that well over six months past (refer, for example, here).

If you notice from the cases I have listed above and in my prior post, these cases not only involve a time gap, but they also are all outside the financial sector. It seems as if the plaintiffs lawyers have been so preoccupied with the race to the courthouse in lawsuits against the financial sector, they are just now getting around to filing the cases against the other kinds of companies.

The way I look at it, the plaintiffs’ lawyers have not had a shortage of targets, they have just had a shortage of time. But evidence suggests that they are getting caught up and they are now getting around to working off the backlog that has been accumulating. The one thing I know for certain is that they will continue to file lawsuits. Consider how reliable the birds and fishes are, and I think you will see what I mean.

One line of analysis that does give me pause is the suggestion that the lawsuit filings declined because of diminished stock market volatility. According to this theory, there is a correlation between overall market volatility and the level of securities lawsuit activity. This theory may have something to it; it is certainly the case that an individual lawsuit is directly related to the target company’s experience of volatility in its own share price. If this market volatility theory is true and if the lower volatility persists, then we could be in for a period of lower numbers of security lawsuits. We had a lull before, we could certainly have one again.

Because of the possibility that persistent lower market volatility might mean reduced lawsuit filings for awhile, I am not making any absolute predictions. I am just saying that I wouldn’t make any bets based on the assumption that the plaintiffs lawyers have run out of people to sue.

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While the number of securities class action filings through the year’s first half still project to an annualized filing rate consistent with historical averages, there was a noticeable slackening in the number of new securities lawsuits filed as the second quarter of 2009 progressed. New filings in the second quarter were well below the number of filings in the first quarter as well as in last year’s second quarter. There were few new filings in May and even fewer in June.

Overall, the filings continue to be largely concentrated in the financial sector. In addition, as discussed below, a significant number of the securities lawsuit filings in the first half of 2009 did not involve publicly traded companies, but instead involved other types of entities, such as private investment partnerships and mutual funds.

Based on my review of the securities filings through June 30, 2009, there were 94 securities class action lawsuits filed in the first half of 2009. (Please see my comments below on the topic of “counting” the lawsuits during the year’s first half.) The 94 first half filings represent an annualized filing rate of 188, which is slightly below but within range of the average number of filings of 197.7 during the 13-year period between 1996 and 2008. The annualized rate of 2009 filings is also below the average filing level of 204.7 for the most recent seven year period of 2002 through 2008.

The filing level during the second quarter of 2009 was below both the first quarter of this year and last year’s second quarter. There were only 35 new securities lawsuit filed during the second quarter of 2009, compared to 59 during the first quarter of this year and 56 in the second quarter of 2008.

The lower filing level during the second quarter of 2009 reflects the low number of new securities class action lawsuit filings during the months of May and June. There were just eleven new securities lawsuit filings in May and only six in June. The June filings represent the lowest monthly number of new filings since December 1996, when there were just five new securities class action filings.

But though there were fewer new securities class action filings during the second quarter of 2009, the total number of filings for the twelve-month period ending June 30 remains within historical annual averages. There were 205 new filings during the twelve month period ending on June 30, 2009, which, though below the 219 new filings during the twelve month period ending on June 30, 2008, is consistent with the average annual number of filings noted above.  

In addition to the filing activity levels, the first half filings were characterized by the relatively unusual types of claimants involved. For example, as many as ten of the first half lawsuits were filed on behalf of holders of preferred or subordinated securities. As I noted at greater length here, these are relatively unusual claimants.

The securities class action litigation targets during the first half were also unusual. An uncharacteristically high number of the first half lawsuit defendants were entities other than public companies, including private investment partnerships, mutual funds, and other nonpublic entities. As many as sixteen of the new first half lawsuit filings involved primary defendant entities that lacked Standard Industrial Classification code (SIC) designations. As many as eight of the new filings in the first half involved mutual funds (many of them in the Oppenheimer mutual fund family).

One characteristic that the first half filings did have in common with the filings in immediately preceding periods is that the new filings continue to be concentrated in the financial sector. Though the first half filings represented 38 different SIC Code classes, fully 51 of the first half filings against entities with SIC Codes involved companies in the 6000 SIC Code series (Finance, Insurance and Real Estate). In addition, virtually all of the 16 actions involving entities that lacked SIC codes also involved enterprises in the financial sector, so that more than two-thirds of the new first half filings involved financial services entities of one kind or another.

The concentration of the filings in the financial sector is largely a result of the continuing subprime and credit crisis litigation wave. By my count, 51 of the first half filings involved subprime and credit crisis related allegations. My complete list of all subprime and credit crisis securities lawsuit filings can be accessed here.

Another factor contributing to the concentration of securities lawsuit filings in the financial sector is the number of new securities class action lawsuits that were filed in the first half related to the Madoff scandal. By my count there were 11 new Madoff-related securities lawsuit in the first half, although there were many more duplicate Madoff-related lawsuits filed during that same period as well. My complete list of the Madoff related lawsuit filings can be accessed here.

The first half securities lawsuit filings were filed in 26 different courts, but fully 45 of them, or nearly half, were filed in the Southern District of New York.

Eighteen of the first half lawsuit filings involved foreign domiciled companies, representing ten different countries. The country with the largest number of first half filings was the United Kingdom. However, a number of these lawsuits against foreign-domiciled companies involve multiple separate lawsuits against a single target. For example, the six lawsuits filed against U.K. companies actually involve just two different companies, Royal Bank of Scotland and Barclays.

Of the actions against U.S.-domiciled companies, the first half lawsuits involved companies from 22 different states, with the largest number in New York (28) and California (12).

Why the Apparent Slowdown?: There may be any number of possible reasons for the relative slowdown in the number of filings during the second quarter. My own theory is that the plaintiffs’ lawyers may have found themselves in a logjam, due to two factors. One factor is the onslaught of Madoff-related litigation (which is not fully reflected in the above numbers but has nevertheless been massive) Another factor is the sheer quantity of previously filed subprime and credit crisis-related litigation, which in many instances has reached critical procedural stages.

If I am correct about the reasons for the second quarter slowdown, then the downturn could proved to be temporary and filing levels could ramp back up as plaintiffs’ lawyers circle back and attempt to work off the backlog. (Indeed, I have previously noticed signs that plaintiffs lawyers could already have been working off backlogs from earlier periods, as noted here). My view is that we will soon see filing activity return to historical norms. Of course, only time will tell.

Some Comments on “Counting”: The various litigation statistical services will also be issuing their counts for the first half of 2009 and their counts almost certainly will vary from mine. Because the Stanford Law School Securities Class Action Clearinghouse publishes all of the actions that it includes in its running tally, it is easiest for me to compare my count with theirs, and so I already know that my count differs from theirs, as I have both omitted lawsuits Stanford Clearinghouse has counted and I have counted lawsuits that the Stanford Clearinghouse omitted.

I have set forth these differences below not because I think I am right and alternative version wrong, but simply so readers might be able to understand the differences. Reasonable minds might well reach different conclusion as to whether the items mentioned below should or should not be recognized in any count.

Thus, I have omitted at least a couple of cases from the Stanford Clearinghouse list that to me appear to represent double counting of lawsuits that were counted elsewhere in the Clearinghouse’s list. (Refer for example here and here for examples of cases previously counted in the Stanford Clearinghouse tally.) Also, because I only count class actions seeking damages for disclosure violations under the federal securities laws, I have omitted merger objection lawsuits (refer for example here).

By the same token, I have included federal securities class action lawsuits that were filed in state court (refer for example here), which the Stanford Clearinghouse did not. I have also included a number of other actions that do not appear on the Stanford Clearinghouse list, including lawsuits involving Metaldyne (here); Royal Bank of Scotland Series Q preferred shares (here), Deutsche Bank Alt-A Securities (here); Merrill Lynch Mortgage Pass-Through Certificates (here); FM Multi-Strategy Investment Fund (here); Citigroup 8.125% Non-Cumulative Preferred Stock, Series AA (here); Agape World (here); Wells Fargo Mortgage Pass-Through Certificates Series 2006 et seq. (here); Citigroup 8.50% Non-Cumulative Preferred Stock (here); and Thornburgh Mortgage Pass-Through Certificates (here).

During the first half of 2009 the seemingly simple process of counting new lawsuit filings was extraordinarily complicated. As the filings have continued to emerge involving different classes of securities, it is increasingly challenging to determine whether or not each additional complaint represents a duplicate lawsuit or a separate action. In addition, the flood of Madoff-related litigation has involved an enormous number of similar or overlapping lawsuits.

If you would like a particularly challenging example of the difficulties involved in “counting,” refer to this June 30, 2009 press release in which plaintiffs’ counsel describe the class complaint they filed in the Eastern District of California on behalf of holders of derivative interests in bonds issued by the California Infrastructure and Economic Development Bank. To greatly oversimplify the action, the lawsuit alleges that the bond documents misrepresented certain bond attributes, for which the plaintiffs seek to recover damages under the federal securities laws. It is an investor class action lawsuit seeking to recover damages under the federal securities laws, and for that reason I included it in my count. On the other hand, it involves public financing authority rather than a public company; others might not count it. Read the press release and I think you will see what I mean. This is not simple.

Whether or not to count any of these complaints as a new action or as a duplicate lawsuit, or at all, is enormously challenging and reasonable minds almost certainly would reach differing results. The various published versions of the number of lawsuits filed during the first half of 2009 almost certainly will vary, perhaps substantially.

Securities Docket Mid-Year Litigation Update Webcast: On July 9, 2009, at 2:00 P.M. EDT, I will be participating in a Securities Docket webcast entitled “2009 Mid-Year Review: Securities Litigation and Enforcement.” The webcast will be moderated by Bruce Carton of Securities Docket and the panelists will also include Francine McKenna of the Re: The Auditors blog; Lyle Roberts of The 10b-5 Daily blog; and Tom Gorman of the SEC Actions blog. Further information and registration instructions can be found here.

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Most of the cases filed in the subprime and credit crisis-related litigation wave are still in their earliest stages, but as the early returns have trickled in, one recurring question as been how the cases are faring. More than once (refer here for example) I have questioned whether the plaintiffs are doing poorly in dismissal motions in these cases, although more recently plaintiffs do seem to have been doing a little better (refer here and here).

My analysis of the plaintiffs’ success levels has been rather subjective and impressionistic. As an alternative to this unscientific approach, blogger Cliff Shnier on his eponymous blog (here) has applied more arithmetic rigor to the analysis and reached the conclusion that plaintiffs are in fact doing better on dismissal motions in recent months.

Using the data from The D&O Diary’s running tally of credit crisis securities lawsuit dismissal motion rulings, which can be accessed here, and applying the methodology similar to that used by blackjack players to count cards, Shnier has performed a quantitative analysis of the trend in credit crisis cases securities lawsuit dismissal motion rulings.

In order to perform the analysis, Shnier assigned a numeric value to each dismissal motion outcome, ranging from a score of minus one for a dismissal with prejudice to a score of plus one for a denial of a motion to dismiss, with intermediate values assigned for inconclusive outcomes such as dismissals without prejudice. Shnier then arrived at a running count by adding together all of the scores, and plotting the running count on a graph showing how the aggregate score has varied over time.

The resulting graph, shown on the left (a more legible image is linked on Shnier’s blog) shows that beginning in November 2007 and for the following twelve months “the running count started out in the negative numbers,” which is “favorable to defendants.” But the trendline crossed into positive numbers – more favorable to plaintiffs – and has stayed there ever since December 2008. Schnier’s conclusion? The “trendline is moving upward in favor of dismissals being denied.”

Shnier concedes that the outcome of this exercise may reflect the values he has assigned to various outcomes, particularly dismissals without prejudice. But even if more conservative values are assigned to these determinations, the trendline is still favorable to the plaintiffs.

There are of course many ways to analyze a range of case outcomes, and a numerical analysis is just one approach. And in any event, these cases are still mostly in their early stages, so any analysis at this point may be premature. Nevertheless, Schnier’s blackjack counting approach is interesting, and is certainly different, and it may have advantages over more subjective or impressionsitc approaches to the question. It will be interesting to continue to monitor Shnier’s analysis as the credit crisis-related securities cases continue to develop. 

The Infamous “Suzanne Researched This” Commercial (Circa 2006): How a lot of people wound up with more debt than they could afford and living in a house that is too big and beyond their means.

Clusterstock comments (here) that the “the commercial touts the fact that your Century 21 broker will team up with your browbeating wife and guilt you into buying the home you can't afford. It must be watched. We still think it kind of might be a parody.”

If it is a parody, it is a perverse kind of unconscious self-parody. All I know is that the words “You guys can do this” were used far too frequently in that era.

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By now, it is well-established that the recent heightened securities lawsuit filing activity has been largely concentrated in the financial sector. However, litigation involving companies in other sectors has by no means gone away. In addition, recent filings suggest that while the plaintiffs’ lawyers have been concentrating on the financial sector, a backlog of actions against other companies may have been piling up, and that the plaintiffs’ lawyers are now getting around to working off the backlog by initiating long-deferred cases against companies outside the financial sector.

The most recent example of this apparently postponed activity against nonfinancial companies involved the online auction company, Bidz.com. As reflected in their May 7, 2009 press release (here), plaintiffs’ counsel has initiated a securities class action in the Central District of California against the company and one if its officers. Though the case was just launched this past week, the purported class period runs from August 13, 2007 to November 26, 2007. That is, the proposed class period ends more than a year and half before the case was filed.

The Bidz.com action joins several other recently filed securities class action lawsuits filed against nonfinancial companies where the end of the proposed class period is well before the date on which the cases were first filed.

For example, the securities class action first filed in the Southern District of New York on April 28, 2009 against fashion apparel company Liz Claiborne and certain of its directors and officers (about which refer here) has a proposed class period of February 28, 2007 through April 30, 2007. The proposed class period end is nearly two full years prior to the date on which the action was finally commenced.

In addition, in the securities action first filed on April 14, 2009 in the Southern District of New York against Coach, Inc., the fashion accessory and leather goods company, the class period proposed runs from January 23, 2007 to October 22, 2007 (refer here for background about the case).

These cases join other securities suits filed earlier this year against nonfinancial companies in which the filing date came considerably after the proposed class period end. The Sprint Nextel action (here), first filed on March 10, 2009, has a proposed class period of October 26, 2006 through February 27, 2008. The Rackable Systems case (here), first filed on January 16, 2009, has a proposed class period of October 30, 2006 through April 4, 2007.

At one level, there may be nothing remarkable about the timing of these actions’ filings, given the applicable statute of limitation (refer here), which allows actions to be brought up to two years after the discovery of the alleged fraud. These lawsuits are in that sense by no means "stale."

But as a practical matter, it is noteworthy that these lawsuits are only now arising, in some cases as much as nearly two years after the supposed revelation of the underlying events. Particularly when these cases are viewed collectively, there is a definite suggestion that these cases may have been deferred while plaintiffs’ lawyers were preoccupied with other things.

All of which raises the possibility that while the plaintiffs’ lawyers were caught up in the litigation frenzy concentrated in the financial sectors following the subprime meltdown and the credit crisis, they were also building up a backlog of deferred cases against other companies, to which they are now finally getting around.

Of course, this flurry of apparently belated activity against nonfinancial companies could be purely coincidental. Time will tell. The challenge in the interim for D&O underwriters is that the perennial problem of assessing the continuing litigation risk for a company that had some adverse news some time ago may be even trickier now. It is always difficult to know for sure when a company that has had a problem is "out of the woods," and with the possibility that plaintiffs’ lawyers may now be working off a backlog, this assessment may be dicier than ever.

The suggestion that plaintiffs’ lawyers may be working off a backlog of cases against nonfinancial companies raises the possibility that the focus of securities litigation activity in coming months may shift to companies outside the financial sector. And as I recently noted (here), the mounting number of corporate bankruptcies may also drive litigation activity outside the financial sectors. Of course, it remains to be seen whether or not these apparent trends will continue to emerge. But the prospect for increased securities litigation involving nonfinancial companies is certainly one of the critical issues to watch as the year progresses.

Climate Change and D&O Issues: Regular readers know that I have in the past written extensively (more recently here) about the possibility of a growing D&O exposure arising from climate change-related disclosure issues. My good friend Carol Zacharias, General Counsel of ACE Professional Risks, has written an article published in the Spring 2009 issue of The John Liner Review entitled "Climate Change is Heating Up D&O Liability" (here) that provides a comprehensive overview of the topic, including a review of related litigation that has already arisen.

Along with her many interesting observations, Zacharias concludes that "the question is no longer whether there will be actions arising out of how a company and its leadership assess, quantify, and disclose climate change risks, but rather how extensive the litigation will be and when it will be lodged against directors and officers."

Hat tip to Mason Power at MAPO Online (here) for the link to the article.

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In prior posts (most recently here), I discussed the fact that while litigation against the financial sector has predominated recent securities lawsuit filings, plaintiffs’ attorneys also have targeted other sectors, including in particularly the life sciences sector. An April 2009 memorandum by David Kotler of the Dechert law firm entitled "Dechert Survey of Securities Fraud Class Actions Brought Against Life Sciences Companies" (here) takes a closer look at the 2008 life sciences securities lawsuits and analyzes the allegations on which the claims are based.

The memo notes that the 23 securities lawsuits filed against life sciences companies in 2008 is about the same number as the 25 life sciences securities lawsuits filed in 2007. However, the report also notes that the 2008 life sciences securities lawsuit filings represented only 10% of all securities lawsuit filings during the year, compared to 14% in 2007. The report attributes this slight drop to the fact that securities lawsuits in the financial sector "skyrocketed" in 2008.

The memo reports that, similarly to prior years, half of the life sciences companies sued in 2008 were very small, with market capitalizations below $250 million. However, by contrast to 2007, when nearly half of the life sciences companies sued had market capitalizations greater than $10 billion, on 2008 "only 13% of total actions were brought against the largest companies."

With respect to the allegations raised in the new lawsuits, the memo notes that in 2008, the majority of claims "pertained to accounting improprieties and/or misstated or misleading financial results and forecasts, by comparison to the 2007 filings, where industry-specific issues such as product safety, efficacy or marketing predominated.

The memo does note that about 25% of the 2008 filings contained allegations of alleged misrepresentations or nondisclosure regarding the commercialization or marketing of the product, and about 25% alleged that the defendants had made false and misleading statements about the safety of their product.

The memo also notes that one trend observed in 2007 had continued in 2008; that is, the plaintiffs’ lawyers are continuing to include key research personnel as defendants, on the apparent theory that these individuals "had a high level position within the company and access to internal information," and therefore "they knew and failed to disclose the allged adverse non-public information." The memo reports that key research personnel were named as defendants in five of the 23 life sciences securities lawsuits filed in 2008.

With respect to the likelihood of future litigation in the sector, the memo notes that life sciences companies "are particularly vulnerable to securities lawsuits because of their inherently volatile stock prices, often driven by a drug or device product life cycle that is fraught with potential for adverse and unpredictable events." That vulnerability "may increase in coming months and years when the boom of securities class actions in the financial sector busts." The memo speculates that "once plaintiffs’ targets in the financial sector dry up, other sectors, including life sciences, may see an increase in lawsuits aimed their way."

In discussing the 2007 version of Dechert’s life sciences securities litigation report, I had raised (here) the question whether or not the numerous lawsuits against life sciences companies actually were successful, and in particular, I asked whether or not the cases were dismissed more frequently than other securities lawsuits. The 2008 Dechert memo addresses these questions by taking a look at how the 2007 life sciences securities lawsuits have fared so far.

The 2008 memo reports that of the 25 life sciences securities lawsuits filed in 2007, eleven have been dismissed and two have settled. The memo states that the two settlements are "within the standard range" for securities lawsuit settlements generally, and that the dismissal rate "mirrors that of securities class actions in general."

The dismissals largely have been based on the plaintiffs’ failure to fulfill the requirements for pleading scienter. The memo comments that "though plaintiffs may be given multiple opportunities to amend their complaints, they will not be able to survive a motion to dismiss with general, conclusory or generic allegations of knowing misconduct."

The Dechert memo’s tally of 23 life sciences securities lawsuits in 2008 squares with my own count. I note that in preparing my count of the life sciences lawsuits, I had used a rather narrow definition of the category, limiting the "life sciences" companies to those either in SIC Code series 283 (Drugs) or SIC Code series 384 (Surgical, Medical and Dental Instruments and Supplies).

The memo, which concludes with practical risk minimization suggestions, is quite good and merits reading at length and in full.

Special thanks to the author of the Dechert memo, David Kotler, for providing me with a copy of the memo.

The Rise and Fall of Bill Lerach: The Professional Liability Underwriting Society (PLUS) has posted its acclaimed video, "The Rise and Fall of Bill Lerach," on the members’ section of its website. PLUS members can access the video here. The video alone might justify cost of membership. A trailer of the video can be found on the Securities Docket site, here.

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On April 1, 2009, PricewaterhouseCoopers issued this year’s version of its annual study of securities class action litigation (here). The PwC report differs in certain particulars from previously released studies of the 2008 securities lawsuit filings, but the overall findings are directionally consistent with the prior reports. The PwC report also adds some interesting observations of its own.

My own analysis of the 2008 securities lawsuit filings can be found here. Cornerstone’s previously released study of 2008 filings can be found here and Cornerstone’s study of the 2008 securities lawsuit settlements can be found here. NERA’s 2008 study can be found here and Advisen’s can be found here.

The PwC study found, consistently with the prior reports, that as a result of the financial crisis, the number of securities class action lawsuits rose for the second year in a row in 2008. The PwC report tallied 210 securities lawsuits in 2008, a number that is notably below the numbers reported by other studies. The 2008 total represents a 29 percent increase over 2007. The report found that the filings were steady throughout the year, with a slight uptick in the fourth quarter.

The report found that the majority of the 2008 filings were related to the financial crisis. Indeed, the report noted that "for the first time since the PSLRA, in 2008 the plaintiffs’ bar filed more federal securities lawsuits against the financial services industry group (banking, brokerage, financial services and insurance) than any other industry." By the same token, for the first time since the PSLRA’s passage, high tech companies were not the most frequently targeted.

The number of filings against companies in the pharmaceutical industry remained consistent with 2007, with 21 lawsuits in the sector in both years. My own analysis of the 2008 securities filings in the life sciences sector can be found here.

Filings against companies in the Fortune 500 were up in 2008, with 37 filings during the year, or 18% of all cases filed. The average annual percentage of filings against Fortune 500 companies since the PSLRA’s enactment is 13%. The majority (65%) of the Fortune 500 companies sued in 2008 were in the financial sector.

The report notes that the profile of financial companies sued in 2008 changed from those named as defendants in 2008. The focus changed from loan originators in 2007 to entities involved in loan securitization in 2008. (I might add parenthetically that the loan securitizers remain a target in 2009.) In 2008, the auction rate securities lawsuits were a significant part (38%) of the suits filed against entities involved in loan securitization.

According to the PwC report, securities lawsuits in the United States against foreign issuers "reached an all-time high in 2008, with 36 cases representing 17 percent of the total federal securities class actions filed." These filings against foreign issuers represent the highest percentage of the total cases in any year since the enactment of the PSLRA. 15 (or 42%) of the 36 cases filed against foreign issuers involved companies in the financial services industry, and 32 out of the 36 of the suits against foreign issuers were filed in the Second Circuit. The countries whose companies were sued most frequently were Canada, China and Switzerland.

The report notes that the number and aggregate dollar value of securities lawsuit settlements declined in 2008. However, if the $3.2 billion Tyco settlement is excluded from the 2007 numbers, the remaining total value of the 2007 settlements ($3.3 billion) is 9 percent less than the total value of the 2008 settlements ($3.6 billion).

The average 2008 settlement of $41 million represented a substantial increase from 2007’s average of $28.3 million, but the 2008 average was still well below the 2005 average of $67.6 million. The median 2008 settlement of $8 million was unchanged from 2007.

The report has an interesting statistic showing that the 2008 average for settlements greater than $1 million but less than $50 million was $11.2 million, which not only represents an increase over the equivalent 2007 average of $9.6 million, but also represents the highest such average since the PSLRA’s enactment.

The report also has extensive additional interesting analysis regarding the prevalence and type of accounting allegations, and their impact on settlement; the nature of SEC enforcement activity; and the increase in foreign regulatory activity.

The report concludes by noting that there are three areas in which "companies will want to remain especially vigilant," which are "institutional plaintiff activity (particularly activity relating to public and union pension funds), internal controls accounting-related allegations, and FCPA enforcement." The report ends with the observation that "securities litigation activity in 2009 is likely to reflect [the] new era of accountability and oversight, particularly if the regulatory environment is overhauled, as most think inevitable."

An interesting interview discussing the PwC report can be found here.

Special thanks to a loyal reader for providing me with a link to the PwC report.

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Largely driven by litigation in the financial sector arising from the ongoing credit crisis, the heightened pace of securities filings continued during the first quarter of 2009.

There were a total of 57 separate, new securities class action lawsuits filed during the first quarter. The 57 new securities lawsuits represents an annualized pace of 228 filings, which would be basically unchanged from the 226 lawsuits filed in 2008. (My analysis of the 2008 filings can be found here.)

However, the 57 first quarter filings do represent a decline from the 67 new lawsuits that were filed in the fourth quarter of 2008, when the Madoff-related filings that came in at year end and increased the quarterly numbers.

The filings during the first quarter 2009 were driven by the filing of new subprime and credit crisis-related securities lawsuits. Of the 57 first quarter suits, 35 (61% of the total) were subprime and credit crisis-related. A spreadsheet of the 2009 subprime and credit-crisis related securities lawsuit filings can be found here. A table of all of the subprime and credit crisis securities cases filed during the period 2007 to 2009 can be found here.

The first quarter lawsuit filings targeted entities in 26 different Standard Industrial Classification (SIC) code categories. But consistent with the predominance of the subprime and credit crisis cases, most of cases were filed with SIC codes in the financial sector. A total of 30 of the 57 cases (52%) involved companies in the 6000 SIC Code (Finance, Insurance and Real Estate) series. Indeed, 21 of the 57 cases (37%) were filed against companies in just three SIC Codes: SIC Code 6021 (National Commercial Banks), 9 filings; SIC Code 6029 (Commercial Banks not elsewhere classified), 6 filings; and SIC Code 6189 (Asset Backed Securities), 6 filings.

Not only were the first quarter cases largely concentrated in the financial sector, but many of the cases involved very specific kinds of financial transactions. At least 12 of the 57 cases were based upon the offerings of subordinated, preferred or other specialized classes of the issuer-defendants’ securities. (Some entities, for example, Deutsche Bank, were hit with multiple distinct suits relating to different securities offerings, as discussed further below.)

In addition at least five of the new filings involved actions against the issuers of mortgage pass-through certificates.

The various Ponzi scheme frauds were also a material factor in the first quarter filings. For example, the Madoff and Stanford Financial frauds accounted for a least six distinct cases among the first quarter filings. (There obviously were multiple additional duplicate filings involving these frauds, a source of one of the many counting problems associated with the first quarter filings.)

A significant number of the first quarter filings did not involve publicly traded companies. For example, the first quarter securities lawsuit filings targeted mutual funds, private investment firms or investment partnerships, and other private entities. At least eight of the 57 first quarter filings involved entities that lacked an SIC code designation.

Thirteen of the 57 new filings (or about 23%) involved foreign-domiciled companies, representing six different countries. However, many of these cases involved separate suits filed against the same companies. For example, while there were five separate lawsuits filed against U.K.-based companies, only two different companies, RBS and Barclays, were actually involved in those five separate cases.

The 57 cases were filed in 25 different courts, but 29 of them (about 51%) were filed in the Southern District of New York. Only one other court, the Northern District of California (5 filings) had more than two.

Even though the 57 first quarter filings represent a heightened level of litigation activity, the impact of those cases on D&O insurers will be more muted than might otherwise be expected, due to the nature and distribution of the filings.

First, the litigation activity was predominantly concentrated in the financial sector, which means that carriers that have not been active in this sector have largely avoided significant claims activity so far in 2009. The carriers that were active in the sector are not as fortunate, but that represents only a subset of the overall D&O insurance marketplace.

Second, the incidence of multiple distinct lawsuits against the same company, which was a significant part of the first quarter lawsuit activity, means that the maximum potential aggregate insurance exposure from the new lawsuits is likely substantially less than if 57 separate lawsuits had been filed against 57 complete separate companies.

Third, a certain percentage of the cases, particularly the Ponzi scheme cases, are likelier to produce E&O losses rather than D&O losses, so the impact on the D&O insurers from these cases could be more limited than might otherwise be the case for the more typical securities class action lawsuits.

All of that said, the pace of litigation activity certainly shows no signs of abating. There are still reasons to believe that the current litigation wave will spread more generally beyond the financial sector. The likelihood of litigation from corporate insolvencies also threatens continued heightened litigation activity as the year progresses.

Counting: A final word about counting the filings. I suspect that other observers have or will likely reach differing counts than I have for the first quarter filings. Part of the difference is a result of the perennial counting problems – for example, whether or not to count merger objection lawsuits or lawsuits where the main allegation is that the defendant failed to register securities (neither of which categories I count).

But beyond these recurring issues, the kinds of cases that were filed in the first quarter made counting particularly uncertain. The cases themselves made it very challenging to determine whether or not a new complaint represent a duplicate lawsuit or a new lawsuit.

For example, how many different lawsuits can there be regarding Deutsche Bank preferred securities? Is a lawsuit involving a different class of preferred securities a duplicate or distinct?

The multiple Madoff-related lawsuits post a particularly difficult categorization challenge, as the protean mix of defendant feeder funds targeted in the lawsuits present a dizzying array of combinations.

Just to cite one specific counting challenge, I refer to the complaints that have been filed in connection with Wells Fargo’s Mortgage Pass-Through Certificate offerings. One lawsuit represent certificate investors was filed in January 2009 (refer here). A second complaint was filed in March 2009 also brought on behalf of Mortgage Pass-Through Certificate investors (refer here). The March complaint related largely (but not exclusively, as far as I can tell) to different specific offerings of Mortgage Pass-Through Certificates. Reasonable minds (particularly reasonable minds with an abundance of time to undertake an intense textual comparison between the two complaints) might reach a different conclusion, but upon consideration of the different offerings involved, I counted these as two distinct filings rather than as duplicate filings.

These are not easy issues and different people could and probably will reach far different conclusions. I have at least tried to be internally consistent with my own counting. In any event, don’t be surprised if other securities lawsuit counts published elsewhere vary from my own. Even if the precise numbers differ at the margins but the general findings should be generally consistent.

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

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

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

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

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

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

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

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

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

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

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

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

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

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2008 was a remarkably eventful year, from the dramatic developments during the fall that rocked the financial markets to the changing of the guard in the Presidential election.  Many of the events had a profound impact in the world of D&O insurance.  In all likelihood, significant developments will continue to emerge during 2009 that will have implications for the D&O insurance marketplace.

In the latest issue of InSights (here), I review the past year’s most noteworthy events in the context of the D&O insurance marketplace.  The article’s first section reviews the top ten developments in the world of D&O insurance during 2008.  The article concludes with a perspective on what may lie ahead in 2009, including, in particular, a consideration of the impact that last year’s events could have on D&O pricing and coverage. 

A separate addendum to the InSights article takes a closer look at the 2008 securities class action lawsuit filings.As the addendum details, the pace of shareholder lawsuit filings increased significantly in 2008. There were 224 new securities lawsuits filed in 2008 , which represents a 30% increase over the 172 securities lawsuits filed in 2007, and an 88% increase over the 119 filed in 2006.

The 2008 filing total also represents the highest annual filing total since 2004. Further, all signs seem to indicate that the heightened filing levels will continue into 2009.

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As a result of recent legislative changes, Canadian securities litigation filings increased substantially in 2008, according to a January 26, 2009 Report by NERA Economic Consulting entitled "Trends in Canadian Securities Class Actions: 1997-2008" (here). A January 26, 2009 press release describing the report can be found here.

According to the Report, plaintiffs filed a record nine new securities class action lawsuits in Canada during 2008, which represented an 80% increase over the previous annual maximum and a 125% increase over the prior year.

This level of filing activity is still "miniscule" compare to the securities litigation filings in the U.S., even allowing for the fact that the Canadian securities markets are in the aggregate much smaller than those in the U.S.

However, in recent years, four Canadian provinces have introduced "continuous disclosure" regimes and have enacted civil liability provisions as well. These provisions include certain "gate keeping" mechanisms (including, for example the requirement that the plaintiffs seek leave of court to pursue a class action), but plaintiffs nevertheless seem interested in pursuing relief under these new statutory regimes.

For example there have now been a total of twelve new securities lawsuits filed in Ontario since the 2006 revisions to the relevant laws. (The Ontario Securities Act, as amended, can be found here.)

One of these Ontario cases involves IMAX Corporation, which is also the subject of a U.S. securities lawsuit. As I discussed in a prior post (here), the prospect for Canadian securities actions may have, as the NERA Report puts it, "received a boost" with a ruling in the IMAX case, which permitted the plaintiffs in that case to conduct a certain amount of discovery at the pre-approval state.

As NERA Report observes, "for parallel US-Canada actions, the IMAX ruling may enable plaintiffs to do an end-run around the discovery stay provisions of the PSLRA by brining an action north of the border."

The NERA report also observes that the recent filing in Ontario of a class action against AIG may be an example of this tactic. My prior post discussing the Ontario securities action against AIG and its possible tactical purposes can be found here.

The NERA Reports that among the Canadian filings are cases demonstrating the impact of several trends that have also driven U.S. securities litigation. That is, the 2008 cases include lawsuit filings related to the credit crisis (against CIBC and AIG), as well as cases based on allegations of options backdating.

Nearly one-quarter of the Canadian class actions involve companies in the financial sector, and nearly one fifth involve resources companies.

The Report states that there have been twenty securities class action settlements, but only one (the Southwestern Resources case, which settled for CAN$15.5 million) involved a case brought pursuant to new securities legislation. The Report shows that cross-border cases tend to result in larger settlements than Canadian-only cases.

Overall the Report notes that while the plaintiffs’ bar is "more active than ever" and filed a record number of new lawsuits in 2008, "it remains to be seen whether the gate-keeping aspects of the new amendments to the legislation, as interpreted by the courts, will meaningfully hinder the ability of plaintiffs to prosecute class actions in Canada."

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

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

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

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

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

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

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

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

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

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

The answer is – less than a single day.

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

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

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

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

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

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

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Because of the dramatic events in the financial and credit markets, 2008 will undoubtedly go down in history as a dark and difficult year. 2008 was a challenging year for bloggers, too. So much happened of such significance that trying to find the time to comment and the words to express it all were almost overwhelming blogging challenges.

But dramatic headline events do not always make the best blog posts, because high profile events are exhaustively reported in the mainstream media. The blog posts that stand out in retrospect are those that analyze a specific detail of larger events reported elsewhere; that draw connections between otherwise disparate events; or that highlight developments that otherwise would be lost in the noise.

I have set out below my own list of The D&O Diary’s Top Ten Blog Posts of 2008. I have used a simple standard in determining which posts to include; I listed posts that stand up best to re-reading now. The Top Ten posts are presented chronologically.

1. "CDO Squared" Securities Lawsuit Hits MBIA (January 13, 2008): MBIA is only one of several bond insurers to get caught up in the subprime litigation wave. But the lawsuit against MBIA arose at a time when all of us were still just becoming acquainted with some of the complex financial instruments that have caused so much trouble.

This post attempted to explore the then-unfamiliar CDO-squared instruments, incorporating into the exercise both a detailed study of Warren Buffett’s condemnation of derivative securities as "financial weapons of mass destruction," as well as a reflection of the possible lessons for the current crisis from the near-collapse of Long Term Capital Management ten years earlier.

Little did I suspect at the time how relevant my observations about derivative securities or the lessons of LTCM would become later in 2008. (As an aside, I must note how instructive I found it to reread now all of January 2008’s posts. What an astonishing year 2008 was.)

2. Auction Rate Securities: The Next Subprime Litigation Wave? (February 13, 2008): This post commented on "a developing breakdown in an obscure corner of the credit market involving debt instruments called ‘auction rate securities.’" The post accurately foresaw the coming wave of auction rate securities litigation, which according to my tally involved at least 21 companies in new securities lawsuits during 2008. (My subprime and credit crisis-related litigation tally, which includes auction rate securities litigation, can be found here.)

Litigation involving auction rate securities remained one of the top securities litigation stories throughout 2008 (as reflected here, for example), and the lawsuits were a significant factor in the upsurge in new securities filings in 2008. My complete overview of the 2008 securities filings can be found here.

3. A Single "Toxic" CDO, A Multitude of Subprime Lawsuits (March 9, 2008): So many of 2008’s dramatic events were so large and their effects were so sweeping that they defy easy comprehension. An alternative way to try to understand what happened is to look at a single investment vehicle – in this case, a collateralized debt obligation (CDO) called "Mantoloking" – and examine the difficulties and litigation that has followed in its wake.

The extent and magnitude of the problems from just this one investment structure (among other things, it played a role in Bear Stearns’ demise) helps put some context around the problems now besetting the global financial marketplace.

4. D&O Insurance: Defense Expense and Limits Adequacy (June 2, 2008): Every now and then a set of circumstances come along that helps illustrate one of the perennial problems in D&O insurance. In this instance, the case involved was the criminal prosecution arising from the collapse of Collins & Aikman. The particular problem involved was the possibility that defense costs alone threatened to exhaust the company’s entire $50 million insurance program before the criminal case even went to trial.

As discussed in the post, the increasing possibility that defense costs could deplete or exhaust available insurance undermines traditional notions of limits adequacy and underscores the importance of issues involving program structure as part of the insurance acquisition process.

5. Section 11 Lawsuits: Coming Soon to a State Court Near You (July 21, 2008): One of the more interesting (yet little noted) features of the subprime and credit crisis-related litigation wave has been the frequency with which plaintiffs’ lawyers in reliance on the ’33 Act’s concurrent jurisdiction have chosen to file Section 11 lawsuits in state court rather than federal court.

As I speculated elsewhere (refer here), these state court lawsuits arguably represent an involved form of forum shopping. They also may represent an attempted end run around the PSLRA’s procedural requirements. But whatever the motivation may be, the plaintiffs’ bar has shown a heightened interest in proceeding in state court and have even has some success in opposing removal to federal court.

In the general hubbub of the current financial turmoil, this litigation development has not attracted nearly as much attention as it deserves. The anomalous phenomenon of federal class action litigation going forward – in significant volume – in state court represents a trend that deserves greater attention. As I have noted in this blog post, some "recalibration" may be required.

6. A Closer Look at the Fed’s $85 Billion AIG Bailout (September 17, 2008): Both the significance and consequences of the AIG bailout are still emerging, as reflected in Carol Loomis’s December 24, 2008 Fortune article (here). But in rereading a blog post written in the immediate aftermath of the first announcement of the AIG bailout, it appears that many of the continuing questions were immediately apparent.

7. WaMu: A Thrift Falls in the Forest: (September 28, 2008): It is one measure of the massive scale of this fall’s events that the largest bank failure in U.S. history is almost a footnote to the year’s events. Even though WaMu’s failure may be overshadowed by other events, that does not mean that the event lacks significance. Indeed, many of the consequences of WaMu’s collapse still have yet to emerge.

Moreover, WaMu was only one of 25 bank failures in the U.S. during 2008. Though overshadowed by other more dramatic events, these bank failures portend further difficulties in 2009.

8. More Damn Things to Worry About (September 30, 2008): So many things happened so quickly in September 2008 that we were all left wondering: what else could go wrong? This post embodies sheer frustration we felt at the time and the depth of the concern about what may lie ahead. Many of the specific fears expressed have indeed come to pass. Though written quickly and at a very late hour, the post withstands scrutiny now.

9. Reading the New Buffett Bio (October 8, 2008): In the midst of this Fall’s financial crisis, it was a reassuring pleasure to read about Warren Buffett’s life. I enjoyed Alice Schroeder’s new biography of Buffett, and I enjoyed writing about her book. Writing a book review is something of a departure for this blog, but it stands out perhaps for that very reason. Given everything that was happening at the time, it was a relief just to read a book.

10. The Evolving Credit Crisis Litigation Wave (December 3, 2008): As we head into 2009, it is critically important to understand that as 2008 progressed, not only did the credit crisis itself evolve into something much more extensive and dangerous, but so too did the related litigation wave. In an earlier post (here), I speculated that the litigation wave might have reached an "inflection point." Further lawsuit filings confirmed that the litigation wave has spread beyond the financial sector.

Because this litigation wave is likely to continue to spread in the weeks and months ahead, this development represents an important and noteworthy trend for the New Year.

And Finally: In addition to my favorite blog posts, I also had a favorite video of the year, the viral video Where the Hell is Matt? I not only smile every time I watch this video, I like it a little bit more with each viewing. YouTube reports that the video has been viewed over 16 million times. Matt’s website (here) reports that the video was shot in 42 countries and took 14 months to videotape and edit.

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UPDATE: A regularly updated list of all Madoff investor litigation, including in particular Madoff "feeder fund" litigation, can be accessed here.

As further proof that the losses associated with the Madoff fraud scheme will trigger a wave of litigation, on December 23, 2008, plaintiffs’ lawyers initiated a lawsuit in the Southern District of New York on behalf of investors in the FM Low Volatility Fund, against Family Management Corporation ( the Fund’s general partner and manager) and certain of FMC’s directors and officers; three "fund of funds" in which FMC invested investor funds (Andover, Beacon and Maxam); and the Funds’ auditor.

The complaint, which can be found here, alleges violations of the federal securities laws and related stated and common law violations, and also asserts derivative breach of fiduciary duties on behalf of the Funds.

According to the plaintiffs’ lawyers’ December 24, 2008 press release (here), FMC

concentrated more than half of the Fund’s investment capital with at least three funds of funds ("FOFs") -- Andover, Beacon and Maxam -- that, in turn, all heavily invested in entities managed by Bernard Madoff ("Madoff") or Madoff-related entities. Investors who entrusted their savings to FMC suffered millions in damages as a result of Madoff’s fraudulent scheme.
 

The complaint further alleges that the defendants failed to perform requisite "due diligence" and "knew or should have known" about Madoff’s Ponzi scheme.

The plaintiffs’ also allege that FMC and its defendant directors and officers issued misleading offering documents that

falsely stated that FMC would not invest more than 35% of the Fund’s net asset value with any one investment vehicle, but, in reality, more than 60% of the Fund’s assets were funneled through three FOFs – Defendants Andover, Beacon and Maxam – and invested in Madoff-related entities. The Offering Memorandum also falsely stated that FMC would (i) endeavor to verify the integrity of each manager of a FOF in which the Fund was invested; (ii) attempt to monitor the performance of each manager; and (iii) request detailed information regarding the historical performance and investment strategy of each of the selected investments for the Fund. Plaintiffs allege that Defendants, with no or inadequate due diligence or oversight, abdicated their responsibilities and entrusted the Fund’s assets to Madoff-run investment vehicles.

Even More Madoff Investor Litigation: In earlier post (here), I noted the class action lawsuit that had been filed against Tremont Group Holdings, certain of its directors and officers, and its corporate parents, on behalf of investors in the American Masters Prime Fund, whose assets Tremont managed and that had suffered losses due to Tremont’s investment of those funds with Bernard Madoff and his firm.

On December 23, 2008, plaintiffs filed a similar but separate lawsuit against Tremont and related entities, but on behalf of the class of investors in the Rye Funds, who also claim that they lost their investment due to Tremont’s investment with Madoff and his firm. The Rye Funds complaint also includes as a defendant Tremont’s auditor, KPMG. A copy of the Rye Funds’ investors’ complaint can be found here. A copy of the plaintiffs’ lawyers December 23 press release can be found here.

In addition, according to a December 24, 2008 Bloomberg article (here), New York University has initiated a New York state court lawsuit against J. Ezra Merkin, Gabriel Capital, and Ariel Fund, in which it alleges that $24 million of endowment investments due to the defendants’ investment of the assets with Madoff and his firm. A copy of the NYU lawsuit complaint can be found here.

An earlier class action lawsuit that previously had been filed against Gabriel and related defendants can be found here.

Special thank to Adam Savett of the Securities Litigation Watch (here) for providing a copy of the Rye Funds Complaint.

Keeping Track: By my tally, the Family Management Corporation case is at least the seventh federal class action lawsuit filed in the wake of the revelation of the Madoff fraud. Of these, six of these seven are directed against so-called "feeder funds," the seventh directly against Madoff and his firm. In addition, there are several other state court lawsuits, including the one identified above and the earlier lawsuit filed against the Fairfield Greenwich fund firm (about which refer here).

If the early returns are any indication, there could be a flood of litigation yet to come. Of course it remains to be seen whether or to what extent any of these claims succeed. But in the meantime, indications are that these Madoff-related lawsuits will continue to mount.

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Securities lawsuit filings reached a six-year high in 2008, according to a year-end report released today by NERA Economic Consulting. The report, entitled "2008 Trends in Securities Class Actions" (here), was written by NERA economists Stephanie Plancich and Svetlana Starykh, and reports that through December 14, 2008, there were 255 securities class action filings, up from only 131 filings in 2006 and 195 filings in 2007. NERA's December 18, 2008 press release regarding the report can be found here.

If the "atypical" cases (e.g., IPO laddering) are excluded from the comparison, the 2008 filings are "on pace to reach a 10-year high." The filings are also on pace for a 37% increase over 2007 and the highest annual increase since 2002 (the year of the corporate scandals).

The report attributes the "surge" in filings to the credit crisis. Of the 255 YTD filings, 110 were credit crisis related, and almost 50% of cases involved defendants in the financial sector, as compared to only 16% of cases in the 2005-06 period. (My table of the credit crisis-related securities lawsuit filings can be accessed  here.)

But while the financial sector saw increased litigation activity, "other sectors also saw continued filing activity." For example, though lawsuits against companies in the health technology sector declined as a percentage of all filings, the absolute number of filings against companies in the health technology sector increased, as there were 29 filings against health technology companies in 2008, compared to only 19 in 2006.

The 2008 filings have been concentrated in the second and ninth circuits. The second circuit filings were increased by the large number of filings in the Southern District of New York, particularly financial companies domiciled there.

Though the pattern of increased filing activity in 2008 is clear, "there have been no clear increasing or decreasing trends in the patter of resolutions." The report notes that median settlements have "remained relatively stable." The 2008 median settlement of $7.5 million is slightly below the 2007 median of $9.4 million, but above the 2006 median of $7.0 milllion.

Average settlements, which can be substantially affected by large settlements, were up in 2008 relative to 2007. The average settlement in 2008 was $38 million, up from $31 million in 2007, but well below the post-Sarbanes Oxley average from 2003 to 2008 of $45 million. (The annual average settlement has ranged from $21 million to $82 million during this six-year period.)

The report does observe that over time there has been an increase in the dollar value of claimed investor losses, from about $120 million ten years ago, to around $340 million during 2008. However, the ratio of median settlement to median investor losses has "stayed relatively steady in the 2-3% range over the past few years."

Looking forward, the report notes that there could be "two opposing factors" that could determine whether or not average or median settlements will increase in the future. On the one hand, investor losses associated with the credit crisis lawsuits in 2008 are very large, which could be "an indicator of big settlements to come." On the other hand, the credit crisis has "dramatically shrunk the size of many defendants’ pockets." Lower financial wherewithal might operate as a downward force on settlement values.

The report concludes that "only time will tell if the huge investor losses for credit crisis filings may put upward press on median settlements in the future, or if the financial distress faced by defendant companies may pull median settlement values down."

My own observations on the 2008 securities litigation activity will be detailed in my year-end analysis, which will be forthcoming after the first of the new year. UPDATE: My year end analysis can be found here. For now, I note a few things.

First, this has been an extraordinarily difficult year in which to just try and count the cases. For example, many litigation targets have been sued multiple times by different claimants, whether they are shareholders who acquired their shares over different time periods, or they are security holders with different classes of equity interests. Whether a new filing should or should not be "counted" has been difficult. Further complicating this has been the large number of state court filings, which are difficult just to find. I emphasize this point simply because there is going to be a significant variation in the various commentators’ year-end reports about how many filings there were this year. My own count is lower than NERA’s.

Second, while the 2008 filings were significantly increased by filings against companies in the financial sector, as the year has progressed and the impact of the credit crisis has become more widespread, the credit crisis-related filings have spread outside the financial sector (refer for example here).

Third, you may see comments elsewhere that the 2008 filings were inflated by one-time sector events, like the auction rate securities lawsuits. While this is true, the recent surge of litigation activity involving the Madoff victims demonstrates that in many ways the pace of securities litigation activity is simply a reflection of a series of supposed one-time events. The mere fact that there is an identifiable event arguably may be irrelevant to analyses of current or future filing trends.

Fourth, the NERA report makes no projections about what is likely to happen to the pace of filing activity in 2009. My own view is that the current active filing pace is likely to continue well into 2009 and perhaps beyond. Among other things, filing activity has been elevated over the last several weeks, which is unusual for December, historically a slow month. The continued spread of credit crisis filings outside the financial sector is likely to continue in 2009. Moreover, the impacts of the financial downturn will begin to emerge as company’s report their 2008 results and as the year progresses, which could contribute to litigation activity.

As I said, my own report will be forthcoming. I am very interested in hearing readers’ thoughts and reactions in the interim.

Special thanks to Ben Seggerson of NERA for providing me with a copy of the NERA report.

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As the year end approaches, various commentators will be issuing their retrospectives on the year’s securities litigation activity. The lead story undoubtedly will be that the wave of subprime and credit crisis-related lawsuits continued to flood in during the year. With some 94 new subprime and credit crisis related securities lawsuits so far in 2008 (by my count, which can be accessed here), the litigation wave undoubtedly is an important part of the story. But it is not the whole story. The danger is that the wave of credit crisis-related litigation has become so predominant that other important developments may be overlooked.

This past week illustrates my point. There were seven new securities class action lawsuits filed during the week of December 8, which is noteworthy in and of itself, as December historically is a slow month for securities class action lawsuit filings.

Among this past week’s seven new securities lawsuits was one new credit-crisis related filing. On December 11, 2008, plaintiffs’ lawyers filed a class action lawsuit against GS Mortgage and certain of its directors and officers, on behalf of purchasers of mortgage pass-through certificates and asset-backed securities the company issued. (GS Mortgage is an affiliate of Goldman Sachs, which is also named as a defendant.)

According to the plaintiffs’ press release (here), the GS Mortgage complaint alleges a variety of misrepresentations in the instruments’ offering documents, including with respect to the underwriting standards and appraisals used in the origination of the underlying mortgages.

But while the seven lawsuits filed last week did include this one subprime-related lawsuit, the other six lawsuits appear completely unrelated to the subprime or credit crisis-related events.

The remaining six companies named include a Canadian mining company, Crystallex International, allegedly facing regulatory issues in Venezuela (about which refer here); two medical device companies, Medtronix and Atricure (refer here and here); a media conglomerate, CBS Corporation, that announced non-cash impairment charges to intangible assets and goodwill (refer here); a laser and technology manufacturer, GSI Corp., that restated its financials due to revenue recognition issues (refer here), and a Chinese agricultural company, China Organic Agriculture, facing allegations regarding its development of organic products (refer here).

These six lawsuits represent a diverse mix of companies and allegations. The point here is that none of these six lawsuits is related to the subprime meltdown or credit crisis. Similarly, during the past year, while there have been a host of credit crisis-related lawsuits filed, there have also been many other lawsuits that are totally unrelated to the credit crisis.

Given the nature and magnitude of the financial developments this year, it is hardly surprising that there has been significant litigation activity involving the financial sector. What may be even more noteworthy is that notwithstanding the predominance of the financial events, there have been a significant number of lawsuits having nothing to do with the credit crisis or the financial sector.

I will detail these observations in my own forthcoming year-end analysis of securities litigation activity. In the interim, particularly as the various year-end reports emerge, it is important to keep in mind that 2008 securities litigation activity was not just about the credit crisis alone, nor was it confined just to the financial sector.

Does This Sounds Familiar?: Our age is not the first to have to contend with the consequences from cultural excess fueled by speculation, debt and deficit spending enabled by “financial wizardry.” A similar pattern also appeared in the events leading up to the French Revolution. In his book, Revolutionary France, 1770-1880 (here), historian François Furet details the country’s astonishing accumulation of indebtedness, and the consequences that followed.

In particular, Furet explores the way the French monarchy, led by Finance Minister Jacques Necker, financed its participation in the American war of independence by increasing state-guaranteed life annuities, fueling a speculative bubble and enabling borrowing backed by inflated values. Furet writes:

In total, between 1776 and 1781, 530 million in loans of all kinds fed the Treasury and financed a war that was all the more popular because it was painless. Money continued to flow in, and the resale of annuities enriched Parisian speculation. Even if the state was seriously compromising its future, Necker retained his popularity. In 1781, to counter-attack court intrigues … he published the Compte rendu, a statement of accounts which concealed the expenditure of the extraordinary budget and revealed an apparent surplus revenue of ten million livres.

As Furet observed, “after three years of war and no new taxes, that was truly  financial wizardry!” The problem is that, contrary to Necker’s assurances, “the real deficit lay in the region of eighty million.”

Similar deficit financing by Necker’s successors furthered the French government’s financial challenges. A successor minister, Charles Alexandre de Calonne, “found, out of 600 million livres in annual revenue, 176 million committed in advance, 250 million absorbed by debt service, and 390 million in accounts in arrears to be settled.” What was Calonne’s response? “He borrowed money on all sides, even more and at a higher rate than his predecessors.”

Among other things, this massive indebtedness enabled the illusion of prosperity; “one would need to reconstruct the entire circuit of money borrowed by Calonne to understand how these years were without doubt the most dazzling in court civilization.” But, as Furst notes, “sinking borrowed money into the parasitic round of court life proved eventually to be the downfall of this aristocratic sleight of hand.” This “artifice” unleashed “one of the most gigantic crashes in history.”

As we face the consequence of the collapse of our own era of debt-fueled prosperity, with its accompanying speculation, asset-valuation bubbles and financial wizardry, there is something sobering in realizing that once again the response consists of “borrowing money on all sides.” The ever-cumulating deficits have reached the point where figures of billions and trillions have lost all meaning. I am sure I am not the only one with the uneasy  feeling that we may be sinking borrowed money into parasitic hands and that we could be “seriously compromising our future.”

PLUS D&O Symposium: The Professional Liability Underwriting Society (PLUS) will be holding its annual D&O Symposium on February 25 and 26, 2009, at the Marriott Marquis in New York City. I will be co-Chairing the event again this year, along with my good friends, Tony Galban of Chubb and Chris Duca of Navigators Pro. There will be a terrific line up of speakers, including the keynote speakers Madeline Albright and New York Insurance Commissioner Eric Dinallo .

The panels will include all of the familiar favorites, such as the securities litigation update panel, to be chaired again by Boris Feldman of the Wilson Sonsini firm, and View from the Top panel, featuring the heads of the leading D&O underwriting facilities. Other panels will also address issues surrounding the governmental bailouts and increased business failures. An added bonus is that the fascinating video The Rise and Fall of Bill Lerach will be shown during the conference. (View a trailer of the video here).

Further information about the 2009 PLUS D&O Symposium, including registration information, can be found here. This event sells out every year, so early registration is advised.

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