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

As I detailed in recent blog posts (here and here), these days virtually every public company M&A transaction is likely to involve M&A-related litigation. For that reason, M&A litigation represents a significant liability exposure for directors and officers of the companies involved in the M&A transaction and they have a keen interest in taking steps to try to reduce that exposure.

These concerns are the topic of a new paper from Chubb entitled “Director Liability Loss Prevention in Mergers and Acquisitions” (here). The paper was written by D&O maven Dan Bailey of the Bailey and Cavalieri law firm. (Readers know that The D&O Diary is a big fan of Dan’s; we recently published a guest post by Dan on Cyber Liability issues.) The paper “reviews the basic legal duties of directors in this context and summarizes many loss control procedures for directors when addressing a proposed M&A transaction.”

The paper notes at the outset that directors “are routinely rewarded” for their hard work on a proposed M&A transaction “by being sued.” The shareholder plaintiffs “typically allege the directors acted improperly in investigating, negotiating, approving, rejecting or disclosing the acquisition transaction, regardless of how thoroughly and prudently the directors acted.”  Though the lawsuits cannot be prevented, “directors can increase the defensibility of those lawsuits and improve the quality of their decision-making process with respect to a proposed acquisition by anticipating and implementing various loss prevention practices.”

The paper outlines the basic legal principles that define the standard of conduct for directors of the target company. The paper then goes on to outline the steps directors can take to try to manage their liability exposure. Among other things, the paper states that “directors should create a record demonstrating that they carefully and thoroughly considered relevant information regarding the proposed transact.” Directors should also “obtain advice from experienced, qualified and independent experts in each of the relevant substantive areas.” In addition, “only independent and disinterested outside directors should act on behalf of the company with respect to the proposed transaction.” In addition, “directors should seek to obtain the best value available for the company,” in the specific ways that the paper enumerates. Finally, the company must manage the timing and content of its disclosures of the transaction in order to try to minimize disclosure-related risks.

There are also a number of transaction-related pre-litigation strategies the company can implement to improve the companies ability to defend the inevitable litigation. These include, among other things, amending the by-laws to designate a specific jurisdiction as the exclusive venue for shareholder suits involving governance issues; retaining qualified defense counsel in advance of the transaction; develop an external communication protocol to reduce disclosure –related risks; and the provision of detailed directors training in anticipating of the takeover process, including the “likely sequence of events, recommended governance practices and various best practices related to the proposed transaction.”

Finally, the paper reviews the indemnification and insurance issues relevant in the M&A context.  Among other things the paper discusses the need for the target company to have in place prior to the closing “a prepaid, noncancelable, extended run-off policy that cannot be amended or affected in any way by the acquiring company or subsequent management.”

Another M&A related insurance topic that the paper does not discuss is the possible need for representations and warranties insurance protection. Readers may be interested to note that the Professional Liability Underwriting Society (PLUS is hosting a webinar on Tuesday March 19, 2013 at 11:00 am EDT on the topic of Representations and Warranties insurance coverage. Information about this free webinar can be found here.

D&O Year in Review: Once again, my good friends at Troutman Sanders have published their annual roundup of D&O insurance coverage decisions. The publication, which is entitled “D&O Professional Liability: A Year in Review,” which provides a comprehensive overview of coverage decisions from the world of D&O in the last year, can be found here.

Board Minutes: I recently was asked to attend a meeting of the board of directors of a large financial institution client. While I was in the meeting, one director asked my views about board meeting minutes: should the board minutes be very detailed? Or should they be bare-boned? Which was better from a risk management standpoint? From the way the director asked the question, I knew that that was a topic on which he himself had strong views, and his manner also suggested that this topic was an issue of some debate at the board level. I looked across the table to the company’s general counsel, to see how I should handle the question. Her face said “Don’t throw me under the bus.” So all I said was that the question of board minutes is an important topic that should be discussed with your in-house counsel and if needed your outside counsel.

The question about the appropriate level of detail in board minutes is a recurring question. There is, in fact, no single right answer. The correct answer will vary, depending on the age and size of the company, as well as the advice of the company’s counsel. There are a number of important considerations to keep in mind, which are reviewed in a March 6, 2013 JD Supra Law News article written by Stephen Honig of the Duane Morris firm and entitled “Director Liability: Corporate Minutes as Trojan Horse” (here). The article reviews the liability issues that may arise from the board minutes and also reviews how the ground rules change as companies mature and grow larger. The article reviews the legal touchstones and lays out the basic ground rules. The article concludes by saying that directors “should remember that they are protected if they utilize robust process in the board room and are well-served if they document that process.”

Is a Pending Appellate Decision Interpreting Morrison Off the Docket?: For some time, we have been awaiting a ruling from the Second Circuit in the hedge fund claimants’ appeal of a district court dismissal of their action against Porsche and certain of its directors and officers. The hedge funds, which had shorted Volkswagen stock in the belief that its share price would fall, claimed that Porsche misled investors by denying through much of 2008 that it intended to acquire VW. Porsche later disclosed that it had been positioning itself to acquire the company.

As discussed here, in a December 30, 2010 ruling, Southern District of New York Harold Baer granted the defendants’ motions to dismiss. In granting the motion, Baer relied on the U.S. Supreme Court’s decision in National Australia Bank v. Morrison. Judge Baer found that because the securities underlying the swap instruments the hedge funds had acquired were traded on the German stock exchange, acquiring the swaps was the “functional equivalent of trading the underlying shares on a German exchange."

The hedge funds filed an appeal of Judge Baer’s dismissal. As discussed here, while the appeal was pending, the Second Circuit issued a ruling in the Absolute Activist Value Master Fund case interpreting Morrison’s application to non-exchange traded securities. The court held that in order to pursue a securities claim in connection with a transaction in non-exchange securities, the claimant has to allege either “irrevocable liability was incurred or title transferred within the United States.” I noted at the time that the Absolute Activist Value Master Fund case The Second Circuit’s holding in the Absolute Activist Value Master Fund case, in which the Second Circuit said among other things that the identify of the securities involved in the transaction is not determinative, would seem to suggest that the district court’s holding in the Porsche case may not withstand scrutiny on appeal.

Ever since the Second Circuit issued its ruling in the Absolute Activist Value Master Fund case, observers have been awaiting the Second Circuit’s ruling in the Porsche case. However, on March 6, 2013, Bloomberg reported (here) that the hedge funds have filed a motion to withdraw their appeal in the Porsche case. The Second Circuit must grant the motion to withdraw, but assuming it is granted, it appears that the appeal would be withdrawn, meaning that the lower court dismissal of the case would stand. The Bloomberg article notes that four cases against Porsche and certain of its directors and officers remain pending in Germany. It appears that the hedge funds may have decided to focus their efforts on the Germany cases.

In any event, if the Second Circuit grants the motion to withdraw, the long-anticipated resolution of the hedge funds’ appeal of the dismissal will not be forthcoming. That would mean at a minimum that the Absolute Activist Value Master Fund ruling will continue to represent the standard for securities cases involving non-U.S. entity defendants whose shares do not trade on U.S. exchanges.

I can’t help having a “that’s too bad” reaction. I have been looking forward to seeing what the Second Circuit was going to do with the appeal in the Porsche case.

One Director Defendant in Latest FDIC Failed Bank Suit: As the FDIC has been ramping up its litigation against the directors and officers of failed banks, one of the things that has been hard to figure is how the agency decides who it is going to sue. Sometimes it files cases only against former bank officers, sometimes it includes director defendants. And now in the latest case to be filed, the FDIC has filed a suit against only a single director defendant. However, in this case, there is some information available to explain why the one director was the only defendant.

On February 22, 2013, the FDIC, acting in its capacity as the receiver of the failed Carson River Community Bank, filed an action in the District of Nevada against James M. Jacobs, a former director of the bank. A copy of the FDIC”s complaint can be found here. Regulators closed the bank on February 26, 2010, which means that the agency filed its compliant just before the third-year anniversary of the bank’s closure. The sole defendant is described in the complaint as the co-founder and as a stockholder of the bank, as well as a director in the bank. Importantly for purposes of the suit, the complaint also states that Jacobs also had ownership interests in certain Oklahoma banks that participated in some of the loans that the FDIC referenced in the complaint.

As detailed in a March 1, 2013 memo by W. Bard Brockman of the Bryan Cave law firm (here), according to the FDIC’s complaint, the three subject loans were participated out to two Oklahoma banks owned by Mr. Jacobs’ family and for which Mr. Jacobs served as a director. The other directors on the Senior Loan Committee knew about Mr. Jacobs’ interest in the participating banks, but they did not know that Mr. Jacobs allegedly had secretly arranged for the Oklahoma participating banks to have preferential rights to repayment upon default. The Oklahoma banks were ultimately paid in full and Carson River Community Bank sustained most of the loss on the loans. This conduct, the FDIC alleges, constituted a breach of Mr. Jacobs’ fiduciary duty to Carson River Community Bank.

Brockman speculates that there may be an additional reason why the other loan committee members were not named as defendants because “Nevada has a very forgiving standard of liability for corporate directors. Under the Nevada corporate code, a director is not liable unless it is proven that: (a) the director’s act or failure to act constituted a breach of his fiduciary duties; and (b) the breach of those duties involved intentional misconduct, fraud or a knowing violation of law.” Brockman suggests that the FDIC must not have had sufficient facts to support an allegation that the other directors had committed “intentional misconduct, fraud, or a knowing violation of the law.” Brockman concludes by noting that this case is “a true factual outlier and it does not signal a trend that the FDIC will target single director defendants.”

A Break in the Action: For the next few days, I will be traveling overseas on business. The D&O Diary’s publication schedule (such as it is) will be disrupted for the next few days. I hope to resume the normal publication schedule during the week of March 18, 2013.

And Finally: A recurring topic of interest to everyone here is the question of why The Netherlands is sometimes referred to as Holland. This topic is amusingly explained in the accompanying video (with more information on the topic than you might have thought possible). Enjoy. (Sorry about the short commercial at the beginning.)

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Plaintiff law firms continued to file lawsuits in connection with virtually every mergers and acquisitions transaction in 2012, according to an updated report from Cornerstone Research. The February 2013 report, which is entitled “Shareholder Litigation Involving Mergers and Acquistions” and which was authored by Robert M. Daines of Stanford Law School and Olga Koumrian of Cornerstone Research, shows that plaintiff law firms filed lawsuits on behalf of shareholders in 96 percent of M&A deals valued over $500 million and 93 percent of transactions valued over $100 million. Cornerstone Research’s February 28, 2013 press release regarding the report can be found here. The report itself can be found here.

According to the report, the litigation rate involving M&A deals in 2012 was essentially unchanged from 2011. In both 2011 and 2012, about 93% of all deals valued over $100 million attracted litigation, and 96% of all deals valued over $500 million attracted litigation. Deals valued over $100 million attracted an average of 4.8 lawsuits per deal in 2012 (down slightly from 5.3 per deal in 2011) and deals valued over $500 million attracted an average of 5.4 lawsuits in 2012 (down from 6.1 in 2011).

The report notes that after a contrary trend in recent years, in 2012 a larger percentage of cases were filed in Delaware. In 2012 39% of all M&A lawsuits were filed in Delaware compared to only 25% as recently as 2012. For Delaware Corporations, 16% of deals were challenged only in Delaware, compared with 9% in 2011 and only 2% in 2009.

Of the 58% of cases filed in 2012 that had been resolved, the majority (64%) settled. 33% of the resolved cases were dismissed and 3% were voluntarily withdrawn. (These case outcomes are roughly equal to prior years, although with a certain number of the 2012 cases yet unresolved the settlement rate is slightly higher than prior years.)

Of the 2012 cases that were settled, 81% of the settlements involved only additional disclosures (compared to 88% in 2011 and 76% in 2010). According to the report, “the parties in only one settlement acknowledged that litigation contributed to an increase in the merger price.” The deal termination fee was reduced in four cases and the parties reached agreement about appraisal rights in six cases. There were two large settlements in 2012, both relating to transactions announced in 2011: the $110 million settlement in the El Paso/Kinder Morgan case and the $49 million settlement in the Delphi Financial/Tokio Marine case.

The report includes a detailed table of the ten largest M&A lawsuit settlements during the period 2003-2012. As the report notes, most of the larger settlements in the table “included allegations of significant conflicts of interest.”

The average agreed-upon attorneys’ fee for the 2012 settlements was $725,000, The average fee in a disclosure only settlement was $540,000, down from $570,000 in 2011 and $710,000 in 2010. The report includes an analysis of the factors that influence the size of the fee request. The report notes that “plaintiff attorney fees appear to be influenced by the following factors: size of the settlement fund; other monetary benefit to shareholders; number of suits filed; time to settlement; and overall deal value.”

The report concludes with a review of the emerging litigation involving shareholder challenges relating to annual proxy votes and disclosures about executive compensation, which mounted quickly as 2012 progressed. The report notes that “as the 2013 proxy season approaches, this litigation may expand.”

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Litigation related to M&A activity continued at an “extremely high rate” in 2012, according to the latest research update from Ohio State law professor Steven Davidoff and Notre Dame business professor Matthew Cain. According to the professors’ analysis, presented in their February 1, 2013 paper entitled “Takeover Litigation in 2012” (here), 91.7% of all merger transactions that met the professors’ criteria attracted at least one lawsuit, compared to 91.4% in 2011.

The professors’ paper is the latest update on their research originally presented in their January 2012 article entitled “A Great Game: The Dynamics of State Competition and Litigation” (here), which I reviewed here. Following the original article’s publication, the professors updated their research with additional litigation data regarding M&A transactions that took place in 2011. Their latest paper updates their research with regard to 2012 transactions.

The professors have limited their analysis to merger transactions over $100 million involving publicly traded target companies with an offering price of at least $5 per share. The 2012 update includes only transactions there were completed as of January 2013. The professors intend to update their 2012 data in six months to incorporate information relating to the in process transactions.

It is probably worth noting that there were fewer deals that met the professors’ sorting criteria in 2012. There were only 84 deals with the defined characteristics in 2012, compared to 128 in 2011 (representing a year over year drop of 34%). But the percentage of deals attracting at least one lawsuit remained virtually unchanged, with 91.7% of deals attracting at least one suit, compared to 91.4%. The professors believe based on anecdotal evidence, that when they update their 2012 “the ultimate litigation rate will match or exceed the 91.7% figure.” Though the litigation rate is virtually unchanged from 2011, the 2012 rate is “almost 2.5% that of 2005,” when the litigation rate was only 39.3%.

The number of complaints brought per transaction remained at about 5.0 lawsuits per transaction, the same rate as in 2011 but more than double the mean number of lawsuits in 2005, when the figure was 2.2/ Multi-jurisdiction litigation “remained similar in 2012 with 50.6% of transactions with litigation experiencing litigation in multiple states,” compared to 53% in 2011.

87.5% of all 2012 cases that had settled involved “disclosure only” settlements, compared to 79.5% in 2011. The average attorneys’ fees were down substantially in 2012, but that may be driven by a few larger settlements in 2011. The median attorneys’ fee award was about the same both years -- $580,000 in 2011, $595,000 in 2012.

Delaware attracted a slightly reduced share of M&A litigation in 2012. The state attracted 46.7% of all litigation that could have been filed in there in 2012, compared with 52.8% in 2011. Delaware “also appears to be dismissing fewer cases, thus allowing more cases to be settled” – 76.9% of Delaware cases settled in 2012, compared with 61.5% in 2008. The authors note, referencing their original paper, that “when Delaware loses cases to other jurisdictions it historically has dismissed fewer cases and allowed more to settle, consistent with conduct designed to reattract litigation.”

Discussion

Because of the authors’ sorting criteria, their analysis and conclusion are most relevant to the larger transactions. However, based on my own observations, the authors’ conclusions are consistent even with respect to the smaller deals that do not meet their sorting criteria. The explosion of M&A-related litigation in recent years has not been limited just to the larger companies and transactions.

The surge in M&A related litigation in recent years has been one of the principal justifications the D&O insurance carriers have given as an explanation for their efforts to try to increase the insurance rates, particularly with respect to the rates for primary D&O insurance. In addition, the upsurge in M&A-related litigation has also affected the terms and conditions that the carriers are willing to offer. In particular, some carriers have been insisting on adding a separate, larger retention for M&A-related claims. The professors’ updated M&A-related litigation date seems to suggest that the carriers will try to continue to push rate and to try to include separate M&A-related claim retentions.

As I detailed in a prior post (here), the defense expenses and settlement amounts associated with M&A-related litigation represent a serious problem, for the companies involved and for their insurers. The prevalence of the multi-jurisdiction litigation is a particularly vexing problem, as the proliferating lawsuits are expensive to defend and difficult to resolve.  Unfortunately, based on the professor’s updated research, all signs are that these phenomena will remain a significant part of the corporate and securities litigation landscape for the foreseeable future.

Special thanks to Professor Davidoff for providing me with a copy of his latest paper.

Chinese Reverse Merger Cases: Is There a “China Discount”?: During 2010 and 2011, and to a lesser extent during 2012, the plaintiffs’ securities lawyers rushed to file securities class action lawsuits against Chinese companies that had obtained a U.S. listing through a reverse merger. But while these cases flooded the courts, they have not proven to be a huge bonanza for the plaintiffs’ lawyers or their clients. As I noted in a prior post, the settlement so far have been rather modest.

Michael Goldhaber’s February 12, 2012 Am Law Litigation Daily article entitle “Whither Chinese Reverse Merger Litigation?” (here) suggests that there may be a “China discount” in the Chinese reverse merger cases. The article quotes a defense attorney with the Sherman & Sterling law firm as saying that there is now a “critical mass of settlements between $2 million and $3 million” and that these lower settlements “may exert a gravitational pull on other settlements down the road.” The article notes that “the remarkable uniformity of the settlements suggests that $5 million D&O insurance policies are standard for this niche,” adding that a policy of that amount allows enough for defense fees and a settlement compromise with in the policy limit.

The two arguable exceptions to these generalizations both involve proceedings outside the U.S. The first is the $77.5 million Hong Kong arbitration award that C.V. Starr obtained against the founding shareholders of China MediaExpress Holdings (about which refer here) and E&Y’s $118 million December 2012 settlement of a Canadian class action arising out of its audit of Sino-Forest Corporation (refer here). Though these two exceptions each have their own distinct characteristics, these developments may hearten the claimants in the other cases and give them the incentive to continue to try to press on. The evidence so far, however, suggests the greater likelihood of the more modest settlements that have tended to become the norm.

A particularly interesting feature of the Am Law Litigation Daily article is a link to Sherman & Sterling document provided a comprehensive status summary of more than 75 disputes in U.S. forums relating to allegations of securities violations by Chinese parties, including more than 50 reverse merger companies. The summary document can be found here.

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In the following guest post, Kara Altenbaumer-Price (pictured) takes a look at two recent case decisions in which courts have declined attorneys’ fee awards in connection with non-cash class settlements. Kara is the Management & Professional Liability Counsel for insurance broker USI. 

Many thanks to Kara 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. 

Two recent cases striking down attorney fees awards raise questions about lawyer-driven class actions and the viability of suits aimed at garnering attorney fees rather than cash for the class plaintiffs. If the holding in either case gains traction, it could have a significant positive impact on D&O insurance, particularly in the area of merger-objection suits and efforts by carriers to stem the losses from these types of cases.    

In the first case, the Dallas Court of Appeals dealt a blow to plaintiffs’ lawyers pursuing so-called “bump up” cases in Texas state courts in September when it rejected a settlement that included cash to the lawyers, but none to the class of investors. Rocker v. Centex Corp. appears to have been a typical “bump-up” case in which shareholders of a company about to merge or be acquired file suit seeking to raise—or “bump up”—the purchase price of the company they hold shares in. 

The legacy of this case was thrown into uncertainty on November 30, 2012 when the Texas Supreme Court granted the review of the case without consideration of the merits and set aside the judgment pursuant to an agreement by the parties. Nonetheless, the case warrants discussion because the reversal did not call into question the merits of the lower appellate court decision.

The underlying case in Rocker v. Centex was not unusual, as it is not uncommon for the settlement of merger objection cases to include additional disclosures to the shareholders about the proposed deal, but no increase in share price and thus no cash to the shareholder class. Such settlements, however, usually involve hefty attorneys’ fees awards to the plaintiffs’ counsel. What was remarkable about Rocker v. Centex is that the Texas appellate court, however, refused to approve such a settlement, ruling that tort reform legislation passed several years ago in Texas prohibits such awards.

The court looked to a Texas Rules of Civil Procedure called the “coupon rule” that provides that “if any portion of the benefits recovered for the class are in the form of coupons or other noncash common benefits, the attorney fee awarded in the action must be in cash and noncash amounts in the same proportion as the recovery for the class.”   In Rocker v. Centex, the entire settlement to the class was a noncash benefit in the form of additional, material disclosures related to the deal. As a result, the court ruled that the plaintiffs’ attorneys could be awarded no cash—even if it meant that they had worked for free. The Centex case eliminates the incentive for plaintiffs’ counsel to bring cases—at least in Texas state courts—where the end goal is attorneys’ fees. If there really is a belief that the share price is too small, and the case causes a rise in the share price, then attorneys fees would still be justified and payable under the Centex ruling.

The second case actually arises in the context of privacy litigation, rather than securities class actions, but it tackled the same issue of class settlements than contain no cash to the class. A California federal district court rejected a settlement in a privacy class action against Facebook because the settlement included changes to Facebook, $10 million to organizations involved in internet privacy, and $10 million in attorneys fees, but no cash to the plaintiffs themselves. The court in Fraley v. Facebook  questioned the large size of the fee award. The court also rejected arguments by plaintiffs’ counsel estimating the value of the privacy changes to Facebook to the plaintiffs and questioned whether injunctive awards to plaintiffs can be assigned a value at all for assessing attorneys’ fees. Like the Rocker v. Centexcase, this case  potentially has huge implications for class actions pursued for the purpose of creating plaintiffs’ fee awards.

Both of these cases highlight the primary issue that defendants (and insurers) have with merger litigation (even though the Facebook case arose in another context, the principle is the same)—the notion that the cases exist not to ensure that the best deal is achieved for shareholders, but to make a quick and sizeable buck for plaintiffs attorneys. As Advisen wrote in its second quarter 2012 report that “it has been suggested, including by some judges presiding over these cases, that new filings are driven more by plaintiff’s attorneys seeking new sources of fee revenues than by the economics of mergers and acquisitions.” Companies, eager to close the deal, usually offer up a hasty settlement that includes large fee awards, to make the litigation go away. 

With 91 percent of merger deals above $100 million resulting in litigation according to Cornerstone, insurance carriers have taken note of this issue, which has turned D&O insurance from a low frequency, high severity product to a high-frequency product in the carrier’s view. Many have blamed the increase in M&A suits for the recent rise in D&O insurance rates. One solution to combat this issue is the introduction of separate M&A deductibles for public company D&O and exclusionary language for M&A cases that is creeping into 2012 and 2013 D&O insurance renewals.   Considering that coverage changes tend to lag behind the litigation trends, it will be interesting to watch this trend develop as carriers continue to try to manage losses associated with M&A cases.

Many have blamed the increase in M&A suits for the recent rise in D&O insurance rates. One solution to combat this issue is the introduction of separate M&A deductibles for public company D&O and exclusionary language for M&A cases that is creeping into 2012 and 2013 D&O insurance renewals.   Considering that coverage changes tend to lag behind the litigation trends, it will be interesting to watch this trend develop as carriers continue to try to manage losses associated with M&A cases.

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Much has been written recently (including on this blog) about the growing prevalence of M&A related litigation. These lawsuits, typically launched by the target company shareholders, are filed shortly after a merger announcement and usually object to some aspect of the proposed merger or of the merger-related disclosure. But the merger objection lawsuit is not the only kind of lawsuit that mergers can produce – there is also the kind of lawsuit that can arise post-merger when, it is alleged, the merger was not successful.

In a recent example of this second kind of merger lawsuit, on May 2, 2012, plaintiffs filed a shareholder class action lawsuit in the Northern District of Illinois against Allscripts Healthcare Solutions and two of its officers. Allscripts is, according to the complaint, the “corporate result” of the merger of Allscripts-Misys Healthcare Solutions and Eclipsys Corporation, which was announced on June 9, 2010.

The complaint references the company’s April 26, 2012 filing on Form 8-K (here), in which the company “shocked the market” by reporting earnings sharply lower than guidance, as well as the termination of the Chairman of the company’s board of directors; the resignations of three other directors; and the resignation of the company’s CFO. According to the 8-K, the termination and resignations followed board discussions regarding the leadership of the company. The complaint alleges that in reaction to the news the company’s share price dropped sharply.

According to plaintiff’s counsel’s May 2, 2012 press release (here), the complaint alleges that during the class period:

Allscripts concealed that: (a) the process of developing a unified product offering after the Merger had suffered debilitating setbacks, including major undisclosed schisms among the most senior levels of the Company, which ultimately resulted in the loss of key personnel and harmful upheaval in Company leadership; (b) a material portion of Allscripts' revenue and net income was predicated on the successful integration of these systems, and substantial business relationships had been destroyed by the Company's inability to make material progress in this area; and (c) as a result of the foregoing, Allscripts lacked a reasonable basis for its claims of progress in post-Merger integration, sound operations, profitable results, and continued growth.

This latest lawsuit exemplifies the second type of merger-related lawsuit, typically filed post-merger and typically alleging that the merger did not live up to expectations. Perhaps the highest profile example of this type of lawsuit is the litigation filed in July 2002 in the wake of the failed AOL Time Warner merger. That litigation ultimately resulted in a settlement of $2.5 billion (not to mention extensive additional opt-out settlements), which is the seventh largest securities class action lawsuit settlement of all time.  

Another high-profile case of this same type is the lawsuit that was filed in 2000 following the December 1998 merger transaction that led to the formation of Daimler Chrysler. That case ultimately settled for $300 million.

Nor are high-profile mergers the only types of transactions that can produce this type of merger-related litigation. For example, in September 2011, shareholders filed a securities class action in the Northern District of California against Equinix and certain of its directors and officers, in which the plaintiffs disclosed that the company was having difficult with the integration of Switch & Data Facilities Company, which Equinix had acquired in April 2010. (To be sure, in March 2012, the court granted the defendants’ motion to dismiss, albeit with leave to amend.)  

My point here is that the merger objection cases are not the only type of litigation that mergers and acquisitions activity can generate. As these examples show, there is also the possibility that to the extent the merger does not live up to expectations (or rather – allegedly does not live up to expectations) there could be post-merger litigation as well. These post-merger suits may either allege (as was the case in the Daimler Chrysler litigation) that the merger related documents contained misrepresentations, or that the company made misrepresentations regarding its post-merger operations or merger-related integration (as was the case in the Equinix case and in the recently filed Allscropts case). At some level it is hardly surprising that litigation might arise post-merger from time to time, given that – depending on who you ask – “mergers have a failure rate of anywhere between 50 and 85 percent.”

Indeed the possibility of a lawsuit alleging that the merger did not live up to expectations is itself not the only type of post-merger litigation that can arise. Another variant that can sometimes arise is the post-merger lawsuit alleging that the surviving company failed to properly account for the transaction or to properly present the financials of the combined companies. An example of this latter type is the July 2011 lawsuit filed against JBI, Inc. and certain of its directors and officers, in which the plaintiff alleged that the company did not properly account for certain media credits it had acquired in connection with an acquisition transaction.

All of which serves to underscore a point which has long been known to D&O underwriters – that is, the mergers and acquisitions transactions provide context out of which litigation sometimes (perhaps frequently) arises. The recent rise in merger objection litigation has certainly amplified this point. But as the examples in this blog post demonstrate, there are other types of lawsuits beyond the merger objection cases that can arise in connection with or following a merger transaction.

Are We There Yet?: One of the huge by-products of the July 2010 enactment of The Dodd-Frank Act is the huge rulemaking burden that the Act imposed on a variety of federal agencies. As I have noted in a prior post (here), the agencies have been laboring under the rulemaking burdens, and in many cases have fallen far beyond their rulemaking deadlines the Act required.

Although there obviously is no joy in the exercise, the Davis Polk law firm has been diligently tracking the agencies’ rulemaking progress. In its May 2012 Dodd-Frank Progress Report (here) the law firm details the current status of the agencies’ rulemaking efforts.

Among other things, the study shows that as of May 1, 2012, a total of 221 Dodd-Frank rulemaking requirement deadlines have passed. Of those 221, 148 (67%) have been missed and 73 (33%) have been met with finalized rules. Regulators have not yet released proposals for 21 of the 148 missed deadlines.

Of the total of 398 rulemakings that Dodd-Frank required, 108 (27.1%) have been met with finalized rules and 146 rules have been proposed that would meet the requirement  (36.7% more). Rules have not been proposed to meet 144 (36.2%) rulemaking requirements.

The Dodd-Frank Act’s rulemaking juggernaut grinds onward. Your government at work. At the direction of Congress.

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In their paper “A Great Game: The Dynamics of State Competition and Litigation” (here), Ohio State Law Professor Steven Davidoff and Notre Dame Finance Professor Matthew Cain analyzed the M&A related litigation during the period 2005 to 2010. I discussed this article in a prior post, here. In a newly released February 2, 2012 paper entitled “Takeover Litigation in 2011” (here), Professors Davidoff and Cain supplement their prior research with the preliminary statistics for takeover litigation in 2011.

The authors review all 2011 transactions involving U.S. exchange traded companies with a deal size over $100 million, an offer price of at least $5 per share, with a publicly available merger agreement and a closing date by January 12, 2012. There were 103 transactions that met these criteria, which represents a slight decline from the 124 transactions in 2010. However, the 2011 figures do not include pending transactions from 2011, so these figures could change as more of the deals are completed.

But while the absolute number of transactions declined slightly in 2011, the number of transactions that attracted lawsuits increased, at least as a percentage matter. The authors found that while 84.6% of mergers attracted litigation in 2010, the percentage rose to 94.2% in 2011. The authors noted  in their original paper that in 2005 only 38.7% of deals attracted litigation, so the litigation is now brought “at a rate almost 2.5 times that of 2005. The authors expect that as the pending 2011 deals are completed “we expect that the ultimate 2011 litigation rate will match or exceed the 94.2% figure.”

In addition, the mean number of complaints per deal remained basically constant in 2011, to with a 2011 per deal mean of 4.8, from 4.7 in 2010. These mean figures represent a doubling of the 2005 mean number of lawsuits of 2.2. The percentage of deals that attracted multistate litigation declined slightly to 47.4% in 2011, from 47.6% in 2010.

Disclosure only settlements increase to 84% of all 2011 settlements, compared to approximately 80 percent in 2010.

The authors note that “so far for 2011 average attorneys’ fee awards are down substantially.” The mean plaintiffs’ attorneys fees awarded in all settlements declined in 2011 to $784,000, from $1.255 million in 2010. The mean attorneys’ fee award was smaller in disclosure only settlements, with the 2011 mean disclosure only attorneys fee award of $530,000, down from$710,000 in 2010. The mean fee award for settlements that involved other consideration declined to $1.952 million in 2011, down from $3.284. However the decline in median fee awards for both disclosure settlements and other settlements was much slighter than the decline in the mean. The median 2011 disclosure only settlement fee award was $450,000, compared to $546,000 in 2010, and the median fee award in 2011 for settlements involving other consideration was $1.1 million, compared to $1.25 million in 2010.

Delaware drew a much larger share of M&A-related litigation in 2011. The state attracted 64.3% of all lawsuits involving target companies incorporated in Delaware or with their headquarters in Delaware, compared to 44.1% in 2010. The 2011 rate was “the highest rate in the seven years we have tracked these figures.”

Delaware also seems to be dismissing fewer cases, “thus allowing more cases to be settled.” 85.7% of Delaware cases settled in 2011, compared to 79% of 2010 cases. The authors note that this finding is consistent with the analysis in their earlier paper, noting that “when Delaware loses cases to other jurisdictions it historically has dismissed fewer cases and allowed more to settle, consistent with conduct designed to reattract litigation.”

Consistent with the overall 2011 attorneys’ fee award trends, Delaware awarded lower average fee awards in 2011. The mean 2011 Delaware fee award was $1.051 million, compared to $2.052 in 2010. Delaware did continue to award higher attorneys’ fees than other jurisdictions, as Delaware’s 2011 average of $1.051 million was substantially above the overall 2011 average of $784,000.  

The authors emphasize however that all of the 2011 statistics are preliminary “should be read with caution” particularly given the delay in the availability of some information (particularly with respect to attorneys’ fees). The authors expect to update their information as the year progresses.

Special thanks to Professor Davidoff for providing me with a copy of his latest paper.

A D&O Primer: Readers interesting in a good, basic overview of the D&O insurance policy will want to take a look at the recently published paper “D&O Insurance: A Primer” by Lawrence Trautman and our good friend  Kara Altenbaumer-Price. Their paper can be found here

2011 Securities Litigation Overview: The Haynes & Boone law firm has a February 3, 2012 memo entitled “Securities Litigation Year in Review 2011” (here) which has a detailed overview of 2011 securities litigation developments. The memo has several very interesting sections including a section on extraterritorial litigation; a section on litigation involving auditors; and a section on litigation involving rating agencies.  

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During last week’s PLUS D&O Symposium, several of the panels discussed the problems surrounding the current onslaught of M&A-related litigation – and appropriately so, as the surging levels of M&A litigation is one of the most distinct and troubling current litigation trends. During the course of the discussion at the conference, several of the speakers referenced developments, materials and statistics. I thought it might be useful to assemble these various references in one site. (I have linked to some of these resources in prior posts on this site.)

First, though, by way of background about M&A-related litigation developments, I thought it might be useful to reference and to link to a recent paper that provides a good introductory explanation of what the M&A-related litigation is all about. In a February 6, 2012 paper entitled “Anatomy of a Merger Litigation” (here), Douglas Clark of the Wilson Sonsini law firm and Marcia Kramer Mayer of NERA Economic Consulting walk through the litigation developments surrounding a single merger transaction, by way of illustration and as a vehicle to discuss and consider a variety of aggregate statistics regarding merger litigation. The paper provides a useful starting point for understanding the current M&A-related litigation phenomenon. NERA's related statistical analysis of M&A litigation can be found here.

With respect to the conference panels, I am sure that many attendees were as struck as I was by the statement of Stanford Law School Professor Michael Klausner that if you take state court M&A-related litigation into account, then corporate and securities litigation filings are at “an all-time high.” I have in fact made the same point myself, but it just has so much more credibility coming from Professor Klausner. In making these statements, Professor Klausner was referring (with respect to the state court M&A litigation) to the recent Cornerstone Research paper entitled “Recent Developments in Shareholder Litigation Involving Mergers and Acquisitions” (here).

In connection with the initial panel discussion of these litigation statistics, John Spiegel of the Munger Tolles law firm referred to a recent paper by Ohio State University Professor Steven Davidoff and Notre Dame University Finance Professor Matthew Cain. The January 1, 2012 paper, entitled “A Great Game: The Dynamics of State Competition and Litigation” can be found here. (I discussed Professors Davidoff and Cain’s paper in a prior post, here.)

Among the many issues discussed relating to the M&A-related litigation were the problems associated with multiple suits pending in separate jurisdictions relating to the same transaction. Among the suggestions that have been proposed as a way to avert the problems associated with multi-jurisdiction litigation and to discourage plaintiffs from forum shopping is the adoption by companies of a by-law amendment designating Delaware as the sole forum for all corporate and securities litigation. This suggestion has attracted a great deal of interest and a number of companies have adopted by-law amendments designating Delaware as the sole forum for corporate and securities litigation.

As several of the panelists mentioned during the conference, certain plaintiffs’ lawyers have now launched a litigation assault on these by-law amendments. On Monday and Tuesday this past week, the lawyers filed at least nine complaints against companies that had adopted these types of by-law amendments. Nate Raymond’s February 8, 2012 Am Law Litigation Daily article discussing the suits can be found here. Alison Frankel’s February 8, 2012 article on Thomson Reuters News & Insight about the cases can be found here. Francis Pileggi’s February 7, 2012 post about the cases on his Delaware Corporate and Commercial Litigation blog can be found here.

The nine companies targeted in the suits are: Chevron; Priceline.com; AutoNation; Curtiss-Wright; Danaher Corporation; Franklin Resources; Navistar International; SPX Corporation: and Superior Energy Services. An example of one of the complaints, which are substantially the same, can be found here.

The plaintiffs complain that the by-law applies to broad categories of kinds of litigation, is not limited just to derivative or class litigation, and applies to individual claims. But while the shareholders are required by the by-laws to bring their claims in Delaware, the bylaws provide no forum restrictions on the corporations themselves. The plaintiffs also complain that the bylaws seemingly require claim to be brought in Delaware even where there may not be personal jurisdiction over prospective defendants (for example, in connection with claims against individual directors and officers).

The plaintiffs in these suits seek a judicial declaration that the by-laws are invalid. The interesting attribute of the by-laws in dispute is that in each case, the by-laws were adopted by board action and not put to shareholder vote. So even if these particular board adopted by-laws are struck down, the cases may not address the question of whether a forum selection by-law that has been adopted by shareholder vote can be enforced (for example, on former shareholders, or even where there is no personal jurisdiction over prospective defendants).

It is worth noting that in the only judicial decision to date to consider a forum selection by-law, the by-law was found to be unenforceable. As discussed here (scroll down), in January 2011, Northern District of California Judge Richard Seeborg found Oracle’s forum selection by-law to be unenforceable, in part because it had not been put to shareholder vote. Because Seeborg was applying federal common law rather than Delaware law, his ruling may have only limited impact on the Delaware proceedings.

At least one member of the Delaware Chancery Court has voiced his approval at least of the concept of a forum selection by law; 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. The newly filed litigation may provide guidance on this important issue.

Finally, if you have not yet checked it out, the PLUS Blog has a number of video highlights from the PLUS D&O Symposium, including among other things an interview with yours truly.

Another FDIC Failed Bank Lawsuit: Another topic of discussion at the PLUS D&O Symposium was the growing wave of FDIC litigation against former directors and officers of failed banks. On Thursday, February 9, 2012, the FDIC filed its latest lawsuit in the District of Nevada, against four former officers of the failed Silver State Bank of Henderson, Nevada. The FDIC’s complaint can be found here.

The lawsuit is the 22^nd that the FDIC has brought as part of the current bank wave. Interestingly, this complaint was brought well over three years after the September 2008 failure of Silver State Bank. Informed sources advise that the parties had entered a tolling agreement. A February 10, 2012 Las Vegas Review-Journal article discussing the new suit can be found here.

A Preview of Warren Buffett’s Annual Letter to Shareholders: Berkshire Hathaway’s 2011 annual report will not be published for a few more weeks yet. But readers interested in a preview of Warren Buffet’s annual letter to Berkshire shareholders, which is the highlight of the company’s annual report, may want to take a few minutes to review an excerpt of the forthcoming letter that was published on February 9, 2012 in a blog on the CNN Money website (refer here). The basic thrust of the excerpt is that due to the impact of inflation and taxation, stocks outperform bonds and gold. The interesting excerpt is vintage Buffett.

“Investing,” Buffett writes, “is forgoing consumption now in order to have the ability to consume more at a later date.” Real risk then is not volatility, but the possibility that your investment will lose purchasing power -- that is, that you will actually only be able to consume less later. Investments denominated in currentcy, such as bonds or money market funds, though often charactized as "safe"  lose value due to the "inflation tax," not to mention actual taxes. Buffet says, "right now, bonds should come with a warning label." .

A Piano Duet: For today’s musical interlude, I feature a video of a 90-year old couple, playing an entertaining piano duet in the atrium of the Mayo Clinic. They have been married 62 years and they can still play a mean piano.

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The U.S. Supreme Court’s June 2010 decision in Morrison v. National Australia Bank looked like the end of securities claims in U.S. courts on behalf so-called “f-cubed” claimants – that is, foreign shareholders of foreign-domiciled companies who bought their shares on foreign exchanges. In the aftermath of Morrison, these foreign claimants have pursued a number of avenues to pursue their claims, including, for example, initiating litigation in the defendant company’s home jurisdiction.

Among the more creative approaches was the attempt to pursue – in U.S. courts – claims on behalf of non-U.S. claimants under the laws of the claimants’ home country. The highest-profile attempt along these lines emerged in the Toyota shareholder litigation pending in the Central District of California, where the plaintiffs had amended their complaint in shareholder arising from the company’s sudden acceleration problems to assert claims under the Japanese Financial Instruments and Exchange Act.  The plaintiffs had substantial incentive to pursue this approach since only a small fraction of the company’s shares (less than 10 percent) trade in the U.S. as American Depositary Shares.

However, in a July 7, 2011 opinion (here), Central District of California Dale Fischer made short work of this attempt to circumvent the impact of the Morrison decision. In her July 7 ruling, Judge Fischer rejected the plaintiffs’ argument that the court had original jurisdiction over plaintiffs’ Japanese law claims under the Class Action Fairness Act (CAFA). She further declined to exercise the court’s supplemental jurisdiction over the claimants’ Japanese law claims. He dismissed the plaintiffs’ Japanese law claims with prejudice.

In seeking to argue that the court had original jurisdiction over their Japanese law claims, the plaintiffs’ had contended that because Toyota shares were listed but did not trade on the New York Stock Exchange, they were not a “covered” security to which CAFA applied, and, because CAFA did not apply, they could assert claims in U.S. court under Japanese law even though they could not otherwise assert claims under U.S. law. (I have attempted to summarize the plaintiffs’ CAFA arguments as best I could; Alison Frankel has a more thorough discussion of these issues in her July 11, 2011 Thomson Reuters News & Insight article entitled “Morrison End Run Hits Brick Wall in Toyota Case” (here)). Judge Fischer declined to read into CAFA the requirements that plaintiffs urged, as “to do so would ignore the plain language of the statute.”

Judge Fischer’s refusal to exercise supplemental jurisdiction over the Japanese law claims is even more interesting, and is likely to spell the end of most future attempts by f-cubed claimants to try to assert claims in U.S. under foreign law. Among other things, because of the vast predominance of Japanese holders, “the damages analysis would focus overwhelmingly on these claims” and the Japanese law claims “unquestionably would dominate the litigation.”

Judge Fischer also found that the requirement of comity to Japanese courts “strongly argues against the exercise of supplemental jurisdiction.” He added that the respect for the rights of other countries to regulate their own securities markets “would be subverted if foreign claims were allowed to be piggybacked into virtually every American securities fraud case,” which would result in “imposing American procedures, requirements and interpretations likely never contemplated by the drafters of the foreign law.”

Judge Fischer did not say that there would never be an occasion when a U.S. court could properly exercise supplemental jurisdiction over foreign securities fraud claims. However, he specifically noted that “any reasonable reading of Morrison suggests that those instances will be rare.”

Whether or not any readers consider this outcome unexpected, the one thing that is clear is that the U.S. District Courts continue to take an expansive reading of Morrison. As Frankel put it in her article to which I linked above, the Toyota plaintiffs “fared no better than everyone else who’s tried to find any vulnerability in the Supreme Court’s ruling.”

M&A Litigation Soaring, For Sure: In my first half 2011 securities litigation analysis (here) one of the most distinctive trends I noted was the rise of M&A related litigation. Fox Business News has a July 12, 2011 article entitled “M&A Lawsuit Skyrocket as Fee-Hungry Law Firms Smell Easy Money” (here) which takes a closer look at the subject.

The article sounds themes that will be familiar to readers of this blog. However, the article is accompanied by a startling graphic that dramatically illustrates how massively the M&A-related litigation has ramped up since 2008. The article graphics also show how the M&A-related litigation has grown relative to M&A-related activity. In addition, the article provides numerical substantiation for the generalizations about the rising levels of M&A litigation.

I continue to believe that in the aggregate, these cases represent a serious problem for the D&O insurance industry, or at least for the carriers that are most active as primary carriers. I expect the increasing frequency of M&A –related litigation will be of increasing focus in the months ahead.

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 moderted by Advisen's Jim Blinn. Information about registering for this event, which is free, can be found here.

Parting Thought: Am I the only one that finds the new nickels, with Thomas Jefferson’s oversized and distorted face looming off to one side, weird and creepy?

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