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

Settlement opt-outs have been always been a feature of securities class action litigation. However, as part of the settlements of the huge cases filed during the era of corporate scandals at the beginning of the last decade, opt outs became more prevalent and they represented an increasingly significant part of the case resolution. Many of the opt out recoveries during that period were substantial, both in absolute dollars and in terms of recovery percentages, a phenomenon that occasioned much commentary and even some discussion about whether the rise in class action opt outs represented a fundamental change in the securities class action lawsuit paradigm.

But after a seeming cascade of opt out settlements as the securities cases associated with the corporate scandals were resolved, the phenomenon seemed to die down, or at least fade into the background. However, it seems that in connection with the larger cases associated with the credit crisis, the phenomenon of significant opt out cases may be back, at least if recent developments in one case are representative.

The securities lawsuit in question is the case filed by shareholders of Countrywide, which previously settled for $624 million. One of the questions I asked at the time was whether or not the class settlement, as large as it was, would be “enough” to keep the class intact. As it turned out, a number of large institutional investors opted out of that settlement and on July 28, 2011, they filed their own collective action against Countrywide and certain of its directors and officers in the Central District of California. (A copy of their massive 425-page complaint can be found here.)

The lengthy list of plaintiffs is interesting. The list includes the California Public Employees Retirement System (CalPERS). There are pension funds from Guam and Montana; Dutch pension funds; and investment funds from the Nuveen, American Century, T.Rowe Price, BlackRock and TIAA-CREF fund families; and many others. The list of plaintiffs alone is seven pages long. So if this isn’t a class action, then it is a group action of sorts, for sure.

In earlier interview (summarized here), counsel for the opt out plaintiffs was quoted as saying that the opt out litigants losses were “far greater than what they would have received in the proposed settlement” and that they were unwilling to settle for just "pennies on the dollar. " The attorney said that his clients, "are fully committed to recovering the substantial damages caused by the fraudulent conduct at Countrywide,” adding that "the conduct by the former officers of Countrywide was particularly egregious. And prominent institutional investors were completely blind-sided by [its] pervasiveness."

It certainly was the case with respect to many of the opt out cases filed in the wake of the class settlements associated the corporate scandals that many of the opt out litigants claimed to have recovered substantially more than they would have if they had remained in the class. It remains to be seen whether the Countrywide opt outs will fare as well.

But while the value of opting out of the Countrywide settlement for these institutional claimants remains to be seen, the spectacle of all of these institutional investors leaving the class and heading out on their own has to be truly daunting for both plaintiff and defense counsel in the other large unresolved credit crisis cases. At least in the large credit crisis cases where there is either a solvent or successor entity, the challenge that counsel on both sides will face is trying to come up with a settlement that is practically feasible yet  also “large enough” to keep the institutional investors in. And meanwhile, while the counsel struggle to complete a settlement, legal costs mount on both sides.

 If large institutional investors conclude that their interests are served by proceeding outside the class, the class action could quickly become a sideshow. Indeed opt outs get to a critical level, it could trigger the “blow up” provision that is a part of many settlement agreements. Even if the class action litigants can pull a class settlement together, the defendants may not achieve the finality and repose that are among the usual reasons for settling cases in the first place. Instead, the defendants may face the possibility of continuing litigation with a well-financed subset of the original class.

To be sure, the actions of the Countrywide opt outs may or may not be representative of the actions that institutional investors in the other large credit crisis cases will take. Nevertheless, with the apparent reemergence of the institutional investor class lawsuit opt out action, it seems  hard to disagree with the words of Columbia Law Professor John Coffee who called the emergence of the large class action opt-outs “probably the most significant new trend in class action litigation.”

Victor Li’s July 29, 2011 Am Law Litigation Daily article discussing the institutional investors Countrywide action can be found here.

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NYSE Commission on Corporate Governance: On September 23, 2010, the NYSE Commission on Corporate Governance issued a report (here) following a two year review of governance issues and considerations. The Commission, chaired by Larry Sonsini of the Wilson Sonsini law firm, included more than two dozen members representing a broad range of constituencies, and its report presents an interesting and thoughtful review of the issues and statement of principles. The NYSE’s September 23, 2010 press release concerning the report can be found here.

The report’s centerpiece is its statement of ten principles of corporate governance, but in addition to distilling its analysis down to these ten principles, the report also helpfully reviews the history of events leading up to is report, including the recent history of corporate governance reform. In explaining its ten principles, the report states the Commission’s belief that "the respective roles of boards, management and shareholders needed greater understanding," and the principles primary focus is the respective roles of each of these three groups.

The board’s role, according to the report, is "to steer the corporation towards policies supporting long-term sustainable growth in shareholder value." While noting that other factors may affect long-term shareholder value, the report states (significantly in my view) that "shareholders have the right and responsibility to hold a board accountable for its performance in achieving long-term sustainable growth in shareholder value."

The report notes the critical role of management in establishing proper corporate governance, emphasizing that "successful governance depends heavily upon honest, competent, industrious managers." The report also noted that "constructive tension" between the board and management, if properly modulated, may be a characteristic of good corporate governance.

With respect to shareholders, the report takes a firm stand against short-termism. The report notes that investors have a responsibility to vote their shares in a "thoughtful manner." In a couple of different places, the report also expresses concern about the possibility of investors’ over-reliance on proxy advisory firms, noting that the decision to rely on advisory firms "does not relieve institutions from discharging their responsibility to vote constructively, thoughtfully and in alignment with the interests" of their clients.

The report is interesting, relatively brief and worth reading in its full length. Hat tip to the CorporateCounsel.net blog for the link to the report.

Norwegian Bank Files Individual Securities Suit Against Citibank: Citigroup may have settle the subprime-related enforcement action and even managed to get the court to accept the $75 million settlement (even if with certain provisos), but a separate subprime-related securities class action lawsuit on behalf of Citigroup investors remains pending. Despite the continuing existence of the class action, Norges Bank, which manages investments for the $450 billion Norwegian sovereign wealth fund, has now filed its own securities lawsuit, seeking separately to recover for the fund’s losses.

According to Victor Li’s September 24, 2010 Am Law Litigation Daily article (here), Norges filed a complaint in the Southern District of New York against Citigroup and 20 of its current and former directors and officers (including its current CEO, Vikram Pandit). The complaint alleges that because of the defendants’ misrepresentations about the company’s subprime exposure, Norges purchased Citi shares at inflated prices from January 2007 to January 2009. The bank claims it paid over $2 billion for the shares and claims to have lost over $835 million.

There are a number of interesting aspects to this case. The first is that the bank concluded that notwithstanding the existence of the shareholder class action lawsuit, its interests were better served by proceeding separately from the class. The other thing about the lawsuit is the sheer size of the claimed losses – its losses alone are far greater than the collective investor losses in most securities class action lawsuits.

The massive size of Norges’s claimed losses explains its desire to pursue litigation, but the initiation of a separate suit can only be explained either by Norges’s assumption that it will fare better separately than within the class, or perhaps that it will pay lower fees – or perhaps both.

The Norges lawsuit follows on the heals of the separate opt-out lawsuit filed against Merrill Lynch on behalf of the New York pension funds, about which I commented here. The phenomenon of large institutional investors electing to pursue their own claims was a characteristic of many of the lawsuits arising from the corporate scandals during the last decade. Though these kinds of cases had seemed to have died down for a while, the New York lawsuit against Merrill and the Norges suit suggest that the individual lawsuits may be back – and that large institutional investors may be considering them in preference to class actions.

The seeming rise of this phenomenon has been a matter of significant discussion and some concern, as the prospect of multiple individual lawsuits could overwhelm the putative procedural advantages and effectiveness of the class action process.

The magnitude of Norges Bank’s claimed losses may be sufficiently unusual to raise a question whether there may be other investors similarly motivate to pursue separate lawsuits – there simply are going to be few individual investors in few circumstance with losses of that magnitude. Of course, there is always the possibility of smaller investors with smaller losses getting into the act, which they might do if they too believe they will fare better separately rather than within the class.

The prospect for other investors to conclude that their interests are better served through an individual action is a prospect that could pose a host of challenges and represents a "worrisome trend," as I have previously discussed here.

My previous post discussing the Norwegian sovereign wealth fund can be found here.

More Credit Union Troubles: On September 24, 2010, the National Credit Union Administration announced a series of moves, including the seizure of three wholesale credit unions, as part of an overall effort to shore up the country’s credit union industry. The move also included the creation of a $30 billion guarantee to backstop the credit union industry in an effort to stave off further losses. The Wall Street Journal’s September 25, 2010 front page article about the NCUA’s actions can be found here.

Wholesale credit unions provide back office services to retail credit unions. Since March 2009, bad investments in mortgage-backed securities have resulting in the government takeover of five of the country’s 27 wholesale credit unions.

At least one of these wholesale credit union failures has resulted in a civil action by the NCUA against former directors and officers of the failed institution. As discussed here, on August 31, 2010, the NCUA initiated an action against former directors and officers of Western Corporate Federal Credit Union of San Dimas, California.

It is unclear from the NCUA’s latest announcement and actions whether the NCUA might pursue additional lawsuits against the directors and officers of other failed institutions. However, it is clear that the same kinds of difficulties that have beset the commercial banking sector are also troubling the credit union industry as well, and these troubles at a minimum additional may mean regulatory seizures and also present at least the possibility of further claims.

Finally, the NCUA’s moves are a reminder that two full years out from the most tumultuous moment of the credit crisis, the reverberations continue to vex the financial services industry.

Layoffs Mean More Job Bias and Disability Claims: According to Nathan Koppel’s September 24, 2010 Wall Street Journal article (here), layoffs arising from the economic downturn are resulting in a "rising number of claims" that companies "illegally fired workers on account of age, race, gender or medical condition." Among other things, the article cites EEOC statistics showing that for the six months ended April 30, 2010, more that 70,000 people had filed claims alleging job discrimination, which represents a 60% increase in bias claims compared to the same period a year earlier.

The article also notes that companies are also facing "a rising tide of disability claims," noting that more than 21,000 people filed disability claims last year, which represented a 10% increase over the prior year and a 20% increase over 2007. The article notes the difficulties financial troubled companies may face trying to accommodate disabled employees.

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A couple of years ago, a "worrisome trend" developed in securities class action litigation, in which large institutional investors began routinely opting out of plaintiff class to separately pursue their own individual claims under the securities laws. The settlement of these individual opt out actions in many cases rivaled, in the aggregate, the amount of the class action settlement, and often exceeded the class settlement in terms of percentage of shareholder losses recovered.

These developments caused some observers to question whether we were headed toward a two-tiered system of securities litigation, where the large institutional investors separately pursued their own claims and the class action proceeded on behalf of other investors.

As it turned out, however, the phenomenon of the large individual opt out settlement separate from the class has ceased to be as prominent as it briefly was during the period 2006 to 2008. Since that time, there have been fewer high profile opt out settlements, and the predictions about fundamental alterations of securities class action litigation have died down.

However, in a development that seems to raise the possibility that the high profile opt-out action may be back, on July 22, 2010, New York Comptroller Thomas P. DiNapoli announced that he had filed two separate individual actions on behalf of New York state pension funds against Merrill Lynch and Bank of America and their respective individual directors and officers.

In the Merrill Lynch complaint (a copy of which can be found here), DiNapoli alleges that between October 17, 2006 and December 31, 2008, the defendants misrepresented the company’s "true exposures to poorly underwritten subprime mortgages, as well as the value of the Company’s subprime-exposed assets and liabilities and the effectiveness of Merrill’s risk management. The complaint alleges beginning in October 2007 the company began a series of stair step writedowns of the value of the company’s toxic assets, and that ultimately the company was forced to merge with Bank of America as a result of its exposure to subprime mortgages.

In the Bank of America Complaint (a copy of which can be found here), DiNapoli alleges in the documents for BoA’s merger with Merrill, the company and three of its senior executives failed to disclose Merrill’s massive fourth quarter 2008 losses and also failed to disclose BofA’s and Merrill’s agreement to permit Merrill to pay up to $5.8 billion in bonuses. The Complaint also alleges that the defendants violated the securities laws through a series of misleading statements and omissions during the period September 15, 2008 (when the merger was announced) and January 21, 2009 (when the information about the fourth quarter losses and the bonuses were made public).

The New York State Pension funds owned 17.7 million BofA shares at the time of the merger and acquired another 3 million between September 15, 2008 and January 21, 2009.

The circumstances described in DiNapoli’s complaints have previously been the subject of extensive litigation. Among other things, the allegations in DiNapoli’s complaint against the Bank of America defendants previously were the subjective of a high profile SEC enforcement action that ultimately resulted in a $150 million settlement. (For a discussion of the events surrounding this SEC settlement, refer here.)

In addition, there previously have been securities class action lawsuits filed against both the Merrill defendants and Bank of America defendants. The Bank of America class action lawsuit is in fact being driven by a group of public pension fund defendants, led by Ohio Attorney General Richard Cordray on behalf of Ohio public pension funds.

The circumstances referenced in DiNapoli’s Merrill Lynch complaint were also the subject of a separate securities class action lawsuit, about which refer here. Indeed, the parties to the Merrill Lynch lawsuit have already entered a $475 million settlement on behalf of the class, which the Southern District of New York Judge Jed Rakoff approved on August 4, 2009.

In bringing his separate lawsuits on behalf of the New York public pension funds, DiNapoli has made a conscious and deliberate decision to opt out of the preexisting class action litigation against the two sets of defendants. Public statements by representatives of DiNapoli’s office made it clear the reason he took the separate action on behalf of the public pension funds is because "our attorneys believe this gives us a chance to get a better recovery." The possible recovery on behalf of the funds could reach "tens of millions of dollars."

DiNapoli’s action to opt out of the class action on the theory that the funds’ recovery will be greater if they proceed individually rather than part of the class is exactly what commentators had been predicting a couple of years ago, before the opt-out phenomenon faded into the background. DiNapoli’s action is all the more noteworthy with respect to the Merrill Lynch suit is all the more noteworthy, given the fact that the class has already entered a massive $475 million settlement. DiNapoli’s action not only raises the question whether other institutional plaintiffs might opt out in these cases, but whether the plaintiffs will opt out in other cases as well.

The interesting thing about the public explanations for DiNapoli’s action is that the decision seems to be the result of persuasion from the attorneys who convinced DiNapoli’s office to opt out. The presence of an entrepreneurial group of plaintiffs’ lawyers motivated to try to obtain individual institutional investor representations by convincing the investors to opt out of the class suggests that, even if the prevalence of high profile opt out actions may have faded into the background, we are likely to continue more of these kinds of developments going forward. The political motivations of public pension fund representatives clearly support these developments.

Of course, it remains to be seen if the New York funds will actually fare better than the classes in these cases. As Adam Savett pointed out in an interesting January 22, 2010 post on the Securities Litigation Watch, even if some claimant fare better by opting out, there can also be a "downside." The post refers to the claimants that opted out of the Aspen Technology class action (which settled for $5.6 million) but ultimately had their claims dismissed based on lack of proof of fraud, and so received nothing.

Nevertheless, if other institutional investors are persuaded that they will do better by proceeding individually, securities class action litigation could become even more complicated than it already is. The existence of separate proceedings could both drive up total litigation costs and increase both the cost and complexity of case settlements. My prior discussion of the potential problems the opt-out phenomenon might represent can be found here.

DiNapoli’s decision to separate the New York funds from the Bank of America class action, in which the Ohio Attorney General is taking the lead, presents an interesting contrast to DiNapoli’s actions in connection with the securities litigation pending against BP, in which the Ohio AG and DiNapoli are collaboratively pursing the class action litigation on behalf of their respective states’ pension funds, and, as reflected here, are in fact together seeking lead plaintiff status in the litigation. Whatever else might be said, it seems that DiNapoli has not been persuaded that the New York funds will always do better outside of the class action process.

Understanding the Global Economy: If like me you find so much about the current circumstances of the global economy confusing, you will want to watch the following John Clark and Bryan Dawe video in which they summarize the basics in an admirable fashion, particularly the way the unbroken chain of governmental borrowing ultimately presents unanswerable questions. (Special thanks to the CorporateCounsel.net blog for the link to this entertaining video.)

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The heightened pace of securities lawsuit filings in 2008 (as previously noted here) continued in April, when there were 22 new securities class action filings. The subprime litigation wave was a significant factor in the filing activity level, as ten of the 22 cases were subprime or credit crisis related. Of the 10 subprime cases, seven pertained to auction rate securities.

The heightened April activity followed the increased activity levels in March. The March and April combined two-month total of 48 new securities lawsuit filings represents the largest two-month filing total since July and August 2004, when 51 new cases were filed.

According to Cornerstone Research (here), the average annual number of new securities class action lawsuit filings for the period 1996 through 2006 was 194. The total number of new 2008 year to date securities class action lawsuit filed through the end of April is 75. If the filing levels for first four months of 2008 were to continue for the remainder of the year, the year end 2008 total of new filings would be 225, which not only exceeds the 1996 to 2006 average, but is approximately the same number of filings as in 2002, the year of the corporate scandals. If the IPO Laddering cases are excluded from the analysis, the 2002 filing level represented the highest annual number of filings since the passage of the PSLRA.

First-Filed Tyco Opt-Out Case Partially Settles: As detailed on the Securities Litigation Watch blog (here), the first filed Tyco Opt-Out action has partially settled. The lawsuit was filed on behalf of the State of New Jersey and several NJ pension funds (refer to the plaintiffs' 373-page second amended complaint, here).

According to the New Jersey Attorney General's April 30. 2008 press release (here), Tyco itself agreed to pay $73.25 million to settle the plaintiffs' claims against the company's former GC Mark Belnick and four former Tyco directors. The settlement does not relate to the plainiffs' claims against former Tyco CEO Dennis Kozlowski or former CFO Mark Swartz, as well as the plaintiffs' claims against another former Tyco director and the company's former auditor, PricewaterhouseCoopers. A May 1, 2008 Law.com article discussing the settlement can be found here.

I have added the Tyco opt-out settlement to my table of opt-out settlements, which can be accessed here. A detailed list of the various pending Tyco opt-out cases, compiled by Adam Savett of the Securities Litigation Watch, can be found here.

Section 404 Compliance Costs Decline: According to a recent Financial Executives International survey of 185 publicly traded companies (press release here), Section 404 compliance costs were lower in 2007 compared to prior years. Because the study depends on survey results, and the composition of the survey participants varies from year to year, the survey does not permits absolute costs comparisons on a year to year basis. However, the survey does show that the number of internal and external people hours required to comply with Section 404 declined for survey respondents in 2007 compared to the prior hear. The auditors annual attestation fees also decreased as a percentage of the annual audit fee.

A May 1, 2008 Wall Street Journal article commenting on the survey report can be found here. The FEI Financial Reporting Blog discusses the survey report  here.

Noises Off: While no one will mistake his letters for those of Warren Buffett, the annual letter of A.S. Perloff, the Chairman of Panther Securities P.L.C. register high on the entertainment value scale. The latest letter, part of the Panther 2007 year-end preliminary financial report, can be found here. To my ears at least, Perloff’s “ramblings” sound rather like the discourse from someone who might have had one glass of claret too many, but the letter is no less entertaining for that. Read and enjoy.

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