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

Cablevision: On June 4, 2008, Cablevision Systems announced (here) that it had entered a stipulation to settle the options-backdating litigation pending against the company, as nominal defendant, certain of its directors and officers, and other defendants. Although the Cablevision settlement is only the latest in a growing list of options backdating-related lawsuit resolutions (as is detailed on my running tally, which can be accessed here), the settlement is noteworthy both regarding the nature of the allegations involved and regarding certain aspects of the settlement, particularly as pertains to the individuals’ contributions to the settlement.  

The options backdating problems at Cablevision drew a great deal of attention when first disclosed. The company revealed that it had awarded options to a Vice Chairman after his 1999 death, but backdated the options to make it appear that the grant was awarded when he was still alive. A front page September 22, 2006 Wall Street Journal article entitled “Cablevisions Gave Backdated Grant to Dead Official” (here) quoted Columbia Law Professor John Coffee as saying that “trying to incentivize a corpse suggests they were not complying with the spirit of the shareholder-approved stock-option plan.” The ISS Corporate Governance Blog referred (here)  to the awards as “Sixth Sense” options (“I pay dead people.”)

As if that were not enough, the company also disclosed that it had also awarded options to its outside compensation consultant, Lyons Benenson & Co., but the grant had been accounted for as if the consultant (Harvey Benenson) were an employee. As I noted in a blog post at the time (here), the derivative lawsuit allegations were amended to include allegations against the compensation consultant.

According to the Stipulation of Settlement (here), the Cablevision derivative lawsuit was settled for cash payments and other consideration that the parties have represented to the court has an aggregate value of $34.4 million. Specifically, the parties agreed that Cablevision will received a cash payment of $10 million from its D&O insurer, and “cash payments from and/or relinquishment of value and/or the waiver of specific claims by certain individuals” totaling $24.4 in valued. The plaintiffs’ counsel will seek payment of fees and expenses of no more that $7.116 from the settlement fund.

The description of the components of the individuals’ $24.4 million contribution makes for some interesting reading. First, the compensation consultant, Harvey Benenson, and/or his firm, Lyons Benenson, agreed to pay $2 million over three years, at 6 percent interest, secured by his Connecticut home. He will also forfeit $1.5 million severance he claimed.

The estate of former Vice Chairman Marc Lustgarten (the recipient of the Sixth Sense option grant) relinquished all claims to $4.9 million in stock options and restricted shares, including those granted improperly after his death.

A number of other individuals agreed to return specified amounts in connection with prior option grant exercises and to relinquish other unexercised options or waive other stock or share rights.

In addition to these individual contributions, and in what is to me the most interesting part of this settlement, Cablevision Chairman Charles Dolan agreed to make a $1 million cash payment to Cablevision, “to facilitate the resolution of the case.” His son, Chief Executive James Dolan, will also make a $1 million contribution, in addition to returning $366,250 for previously exercised options.

What makes this agreement of the two Dolans to pay $1 million each interesting is Section 3.4 of the Stipulation of Settlement, which provides that the Settling Defendants “will not seek insurance coverage, reimbursement, contribution or indemnification for any of the consideration they provide …from any source, including but not limited to Cablevision, other Settling Defendants, any of the Insurers, or any other Related Person.”

The various individual defendants’ returned options exercise proceeds or waived benefits arguably would not have been covered under the typical D&O policy in any event, as it appears to represent the return of compensation to which they were not entitled (coverage for which arguably would be excluded under most policies). However, there might well have been at least a colorable basis on which the Dolans might have been able to argue that their million dollar payments would be covered, assuming the typical D&O policy and assuming other potential policy provision did not otherwise preclude coverage. The language of Section 3.4 appears to represent a deliberate effort to ensure that the Dolans and the other defendants directly bore the cost of their settlement contributions.

There was a time following the Enron and World Com settlements when there was a concern that indemnity and insurance bar provisions might become a regular feature of the settlement of claims against corporate officials. These fears were largely unrealized, and the presence of an indemnity and insurance bar remains an unusual settlement feature. Nevertheless, the possibility that these provisions might become more commonplace is a concern for corporate officials and their advisors.

It remains to be seen whether these types of provisions will be a part of other options backdating settlements, but in light of recent judicial concerns about possible collusive options backdating settlements (refer here), litigants may feel some pressure to show that the settlement was both arms’-length and represents real value. To that extent at least, there could be some pressure for other options backdating litigants to consider incorporating settlement provisions like an indemnity and insurance bar.

A June 6, 2008 Newsday article describing the Cablevision settlement can be found here. A copy of the June 7, 2008 Wall Street Journal article about the settlement can be found here.

Marvell Technology: It its June 6, 2008 filing on Form 10-Q (here), Marvell Technology disclosed that on March 5, 2008, the company had entered a stipulation of settlement regarding the consolidated options backdating-related shareholders’ derivative lawsuit that had been filed against the company, as nominal defendant, and certain of its directors and officers. According to the 10-Q, the settlement includes “certain corporate governance enhancements and an agreement by us to pay up to $16 million in plaintiffs’ attorneys’ fees, an amount less than the $24.5 million that we received from a recent settlement with our directors’ and officers’ liability insurers.”

There are a number of interesting things about this settlement, particularly concerning the $16 million plaintiffs’ attorneys’ fee. At least in the absence of any other details about the settlement in any of the company’s disclosure document or even in the court filings to date, the amount of the plaintiffs’ attorneys’ fee seems, well, high. For example, compare the $16 million fee in the Marvell Technology settlement to the $7.116 million fee amount agreed to in the Cablevision case. The Cablevision case involved some fairly noteworthy complications, and the settlement of the Cablevision case resulted in the payment of significant amounts back to the corporation. By contrast, at least as far as can be discerned from the company’s recent 10-Q, the Marvell Technology settlement involved no cash payment to the company.

The $8.5 million increment of the insurance settlement in excess of the $16 million plaintiffs’ counsel’s fee is not explained in the 10-Q. It could be supposed that that $8.5 million represents a benefit to the corporation (although it could just as easily represent a reimbursement to the company for its own fees incurred in defense of the lawsuit). Even if the $8.5 million represents some benefit that accrued to the company as a result of the derivative lawsuit, the expenditure of $16 million in fees to recover $8.5 million seems like a poor exchange.

The question of what the company got out of the lawsuit is relevant and likely to be asked in light of the concerns that Judge Alsop raised in connection with the recent Zoran options backdating-related derivative lawsuit settlement (about which refer here). The Marvell Technology settlement could be argued to have the same issues as the Zoran settlement, in which, as Judge Alsop stated, “the corporation would receive no cash, all the cash is going to the counsel.” Of course, the $8.5 million insurance settlement increment could be argued to represent some cash to the company, but the ratio of the benefit to the corporation versus the benefit to plaintiffs’ counsel does not favor the settlement.

According to Marvell’s 10-Q, the settlement still requires court approval. Perhaps with the benefit of a full explanation of the settlement, the merits of the settlement might be more apparent. However, the description of the settlement in the 10-Q does at least suggest some serious questions.

A June 9, 2008 Law.com article discussing the Marvell Technology settlement can be found here. Special thanks to Zusha Elinson of The Recorder for providing a link to the 10-Q.

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As reflected in my running tally of options backdating lawsuit settlements (which can be accessed here), a number of the options backdating-related derivative lawsuits have settled for some combination of an agreement to pay the plaintiffs’ attorneys’ fees, some adjustment to the company officials’ options grants, and the company’s adoption of corporate governance reforms. But two April 7, 2008 opinions by Judge William Alsup of the United States District Court of the Northern District of California in separate options backdating derivative cases may raise potentially troublesome questions whether settlements in this form, without some cash payment directly to the corporation, are sufficient. As a minimum, the two opinions have important implications for the way settlements are presented to the court, and could also have important effects on the settlement dynamic in other cases going forward.

The first and most detailed of the two opinions relates to the options backdating derivative suit filed on behalf of Zoran Corporation, about which lawsuit I first wrote here. In a June 5, 2007 opinion in the Zoran case (here), Judge Alsup had previously denied the defendants’ motion to dismiss, as I previously discussed here.

Following the dismissal denial, the parties to the Zoran case entered settlement negotiations, resulting in a February 26, 2008 stipulation of settlement, which the parties presented to the court on March 3, 2008. At the preliminary approval hearing, the plaintiffs’ damages expert, at the court’s request, presented a report calculating the plaintiffs’ maximum damages as $16 million (including prejudgment interest), which incorporated both the alleged damaged cause to company by the defendants’ option grants as well as by option grants to the rank-and-file employees.

The proposed Zoran settlement involved: the payment of up to $1.2 million of the plaintiffs’ attorneys’ fees and costs; the repricing or cancellation of certain of defendants’ options, which repricing or cancelation was represented to the court to have a value of $1.65 million; the company’s adoption of certain corporate governance reforms; and the grant of a broad claims release.

In an April 7, 2008 opinion (here) that contains some remarkably harsh language, Judge Alsup denied the parties’ request for preliminary approval of the settlement.

The parties undoubtedly knew the settlement was in trouble when Judge Alsup opened his analysis by stating that the class action procedure can “lend itself to abuse” and “one form of abuse is a collusive settlement.” Judge Alsup said that a collusive settlement “usually comes with a cash award to counsel, a broad release of claims, and a cosmetic non-cash recovery for the abused shareholders.” Courts, Judge Alsup notes, must take care that absent shareholders are treated fairly; here, he concludes, the settlement “falls short of deserving preliminary endorsement.”

In considering the settlement, Judge Alsup turned first to the substance of the plaintiffs’ claims (the implication being that the claims appeared to be meritorious), and to a declamation upon the plaintiffs’ expert’s $16 million damages estimate. Judge Alsup then addressed each of the settlement components, finding each component lacking.

First, Judge Alsup noted that the parties were not proposing to restore to the corporation the gains the defendants made from the sale of options, but rather that certain other options would be canceled or repriced. The option cancelation was represented to have very substantial value to the corporation, but the two sides’ experts had reached different conclusions about the value. Judge Alsup found that by using the most conservative valuation method and valuation date, the value of the cancellation was only $216,955, a small fraction of the value both sides had represented to the court.

The court next turned to the repriced options, with respect to which Judge Alsup noted, with incredulity, that the options had actually been repriced in December 2006, which was not only over a year before the settlement was presented to the court, but was even before the plaintiff filed the consolidated amended complaint. The court said that “it should have been plainly disclosed that the defendants were proposing to settle based on an old concession rather than a new consideration.” The court went on to note that “even if the flaw could somehow be ignored,” the value of the repriced options had been “exaggerated.” If a “meaningful” valuation date were used, the value of the repriced options is “zero.”

Judge Alsup had similar concerns with respect to the corporate governance reforms, in that several of the reforms “were already adopted by Zoran’s board well before the parties sat down to discuss settlement terms.” The reforms in any event “do not compensate the company for damages suffered by the company as a result of defendants’ backdating.” The reforms are “hard to accept in lieu of some substantial portion of the $16 million in damages asserted by the plaintiffs’ expert.” Judge Alsup also found that the claim release was overbroad, and swept in circumstances that were not asserted in the amended complaint.

In concluding that the settlement was inadequate, Judge Alsup stressed that “the corporation would recover no cash, all the cash is going to counsel,” and even the supposed value of the $16 million of the foregone benefits is “illusory” and he concluded that this “low end settlement” did not deserve approval.

Judge Alsup was clearly troubled that he had been obliged on his own to ferret out the settlement’s weaknesses, many of which were contrary to counsels’ representations.

Judge Alsup concluded his opinion with a rather stern lecture on counsels’ “duty of candor,” which he said requires counsel to “lay out the weaknesses as well as the strengths” of the settlement. He also stressed that it is “unfair to try to slip a weak or collusive settlement past the judge, hoping he or she will sign off or will not stumble upon the right questions.” A $1.65 million settlement, while at the low end, might be adequate, but the “main vice is that the proposal does not come even close to the $1.65 million settlement it was advertised to be.”

Many of the problems the court identified clearly were the result of communications issues. The parties perhaps could have avoided some of the difficulties by making joint valuation presentations that were scrubbed and scrutinized ahead of time. The court was also clearly upset to discover upon inquiry (rather than being told) that some of the remedies proposed had been undertaken prior to the settlement agreement; better communication around these settlement components potentially could have averted some of the court’s concerns.

But there are other aspects of the court’s commentary that are not merely the consequence of poor communication. First and foremost, Judge Alsup appeared to be troubled by how little the corporation would be getting, and in particular that the corporation would be getting no cash. He was also troubled that the settlement’s putative $1.65 million value, even if valid, was at the “low end” of plaintiffs’ damages analysis. In a sign that may have important implications for other settlements, he was also clearly skeptical that the noncash portions of the settlement – including even the corporate governance reforms, to which he attached little value --had value commensurate with the claimed injuries to the corporation.

But while there clearly are important implications from Judge Alsup’s ruling in the Zoran case, before fully considering those implications, it is important also to review Judge’s Alsup’s opinion (here), also dated April 7, 2008, in the CNET Networks options backdating-related derivative lawsuit, which provides even further context.

In his CNET Networks opinion, Judge Alsup refused even to consider the parties’ proposed settlement. Judge Alsup had previously granted defendants’ motion to dismiss (refer here), on the grounds that demand was not excused, but stayed the case to allow the plaintiffs to seek discovery through the Delaware courts and to attempt to replead. In response to an inquiry from the court about status, the parties advised the court that settlement negotiations were underway, and the parties then presented a joint motion to lift the stay for the limited purpose of seeking a preliminary approval of a settlement. Judge Alsup said that it found these actions “disappointing” because the parties did not, as they had represented to the court they would, complete discovery, nor did plaintiff file an amended complaint. Instead the parties sought to settle the case, about which Judge Alsup said

any settlement, at this early stage, seems very premature, for the Court could not be in a position to evaluate a settlement until we know what claims are viable and what depositions, discovery, and damage assessments show about the strength and magnitude of those claims. At this stage, moreover, plaintiff has no standing at all to negotiate on behalf of the corporation and its shareholders. Plaintiff has never been excused from the demand requirement. Plaintiff is not in any way authorized to release claims on behalf of any shareholders or the corporation. It would be hard to see how plaintiff could do so intelligently without first framing the claims and then performing sufficient due diligence through formal discovery and investigation, including a full damage report. Now, any legitimate settlement reached later may be tainted by what could appear to have been collusion. To deal with this eventuality, all notes and materials generated by or during the recent settlement discussions should be preserved. For the Court’s views on collusive settlements see In Re Zoran Corporation Derivative Litigation.

Judge Alsup went on to note that “the best way to tee up this case for settlement is to find out first whether the plaintiff even has standing to sue (the demand issue) and thus to release claims on behalf of the corporation,” and then to evaluate which options were backdated and the dollar value to the corporation of these claims. “It would,” Judge Alsup said, “be very hard to evaluate a settlement without due diligence, including depositions and documents.”

Judge Alsup’s two opinions taken together represent a strong statement that, because of the court’s responsibilities to absent class members, the court must take its obligation to review proposed settlements very seriously. The court clearly should not be expected just to rubber stamp a settlement to which the parties’ representatives have agreed. In order to get settlement approval, and avoid the suggestion of collusion, the parties will have to show certain key considerations: first, and at a minimum, that the plaintiff even has standing to represent the class and enter the settlement; second, that the settlement is proportionate to the injury to the corporation that the plaintiff has claimed; third, that the claimed values to the corporation are supported; and fourth, that the corporation is fairly compensated for its damages and its release of claims.

Even though Judge Alsup’s opinions technically have no precedential effect beyond the immediate cases themselves, the strength of the language he used, the seriousness of the concerns he noted, and the possibility of similar questions undermining other settlements could well have an in terrorem effect on other litigants in other cases. Certainly no litigant would want to take a chance that a court might suggest that their proposed settlement could be “collusive.” Even though many of the aspects of these opinions are a reflection of the particular circumstance involved, the opinions also bespeak more general principles that could have broad influence. In particular, Judge Alsup’s statement in the CNET Networks case that he could not even consider a proposed settlement until the plaintiff first establishes its right to enter a settlement and presents an adequate factual record and damages analysis suggests that cases must have progressed past a certain stage before the parties can even proffer a proposed settlement to the court.

There are several interrelated issues arising from Judge Alsup’s requirement for a damages analysis, his requirement that the settlement be proportionate to the alleged harm, and his obvious concern in the Zoran case that no cash was going to the corporation. The overall suggestion is that a few gestures and payment of some legal fees may not be enough. There may actually need to be some cash going to the corporation, proportionate to the alleged harm. Judge Alsup’s unwillingness to recognize significant value to the corporation for the corporate governance reforms may be particularly troublesome.

As I noted at the outset, many of the options backdating derivative cases that have been settled so far have been resolved on terms similar in many respects to the components of the Zoran settlement. The likely reason why there is no cash payment to the corporation in many of these cases is that D&O insurers balk at funding amounts they contend represent a disgorgement or a return of an ill-gotten gain. The individual defendants, for their part, resist making out of pocket payments for which insurance is unavailable. The parties thus perforce attempt to cobble together an agreement that resolves the case without any cash transfer other than the payment of plaintiffs’ counsel’s fees.

Judge Alsup’s opinion, particularly his repeated use of the word “collusive” and statement that the value to the corporation from the Zoran settlement was “illusory” could introduce a great deal of tension into this negotiation dynamic. Both insurance carriers and individuals could face heightened pressure to make cash contributions to the corporation to resolve these cases. Insurers will likely continue to resist any payment on their part, owing to policy exclusions for disgorgement and the return of ill-gotten gains.

Another important implication is that the parties must be prepared to substantiate their settlement, and that discovery, depositions, damages assessments and other procedures may be required to satisfy these requirements. These procedures could prove costly for all concerned – particularly for the D&O insurers, who not only will foot the bill for increased defense expense, but also ultimately could be called upon to pay the plaintiffs’ fees as well, as part of any eventual settlement.

Notwithstanding the foregoing, of the parties involved, the participants that may face the biggest problems if these cases become more difficult to resolve are the plaintiffs’ lawyers. There is a suggestion in both of these cases that the plaintiffs’ lawyers are starting to find the cases tiresome and just want them to go away. Indeed, one of the things that clearly seemed to be bothering Judge Alsup in these cases is that the plaintiffs’ lawyers were settling (too) cheap or walking away without even doing what the Judge at least believes to be minimally required. The plaintiffs’ lawyers piled into these kinds of cases with enthusiasm but they may now be repenting their involvement. The implication of Judge Alsup’s opinion may be that the plaintiffs’ lawyers may be challenged to extricate themselves.

According to my tally (which can be found here), there have been a total of 166 options backdating lawsuits filed. To date, only a small portion of these cases (less than a third) have been settled or otherwise resolved. The vast majority, well over one hundred, of these cases remain pending. Of course it remains to be seen, but I suspect that Judge Alsup’s opinions in these two cases will prove to have introduced significant challenges for parties trying to move these pending cases toward resolution.

Very special thanks to Zusha Elinson of The Recorder for providing me with copies of these opinions. Elinson’s April 24, 2008 article in The Recorder about the opinions entitled “Alsup Rejects Easy Options Deals” can be found here (Full disclosure: I was interviewed in connection with the article).

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