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

As the dramatic events in the financial marketplace during fall 2008 recede further into the past, the wave of related litigation activity has also clearly started to slow. But a newly filed lawsuit arising directly from the financial crisis suggests that there may still be further credit crisis cases yet to come, particularly as plaintiffs’ lawyers continue to initiate class action litigation with proposed class period cut-off dates well in the past.

As reflected in their November 10, 2009 press release (here), plaintiffs’ lawyers have launched a securities class action lawsuit in the Southern District of New York against certain former officers VeraSun Energy Corp., a of South Dakota-based ethanol producer that filed for bankruptcy on October 31, 2008.

According to the press release, the complaint (a copy of which can be found here) alleges that the defendants failed to disclose that:

(i) VeraSun was, in part, a speculative commodities trader in addition to an ethanol producer; (ii) VeraSun engaged in speculative and risky derivate transactions that exposed the Company to substantial financial and liquidity risk; (iii) VeraSun experienced substantial loses on speculative derivative transactions causing margin pressures on the Company; (iv) as a result of margin pressures from bad speculative derivative transactions, the Company sold out of a large short position in corn and incurred substantial losses; (v) the Company entered into highly risky "accumulator" contracts that obligated VeraSun to purchase increasing amounts of corn after the price of corn fell in price per bushel; and (vi) VeraSun’s financial condition and especially its liquidity were negatively impacted as a result of speculative commodity transactions, ultimately causing the Company to file for bankruptcy.

The complaint further alleges  that:

On September 16, 2008, VeraSun announced that it commenced a public offering of 20 million shares of its common stock to raise money for "general corporate purposes." The true purpose of this public offering was to raise capital in an effort to prevent a disastrous impact from the huge losses experienced by the Company as a result of its speculative trading and risky bets on the price of corn.

Not only are these events all well over one year ago, but the proposed class period also covers a segment of time that is also well past -- the complaint purports to be filed on behalf of a class of persons who purchased VeraSun shares between March 12, 2008 and September 16, 2008.

The complaint’s allegations resemble the facts and circumstances alleged in a number of credit crisis-related cases that were filed last fall, where (as described here) the defendant companies were alleged to have suffered significant financial reverses due to wrong way bets on commodities or currencies, often (as was the case with VeraSun) in connection with hedging transactions. In each case, the sudden and dramatic events in the financial markets during September and October 2008 produced a magnified impact on financial condition of these companies.

The prior lawsuits generally were filed closer in time to the events involved, while the VeraSun case has only just been filed. The lapse in time between the events alleged and the VeraSun lawsuit filing is, however, consistent with the filing pattern that has emerged during 2009, where (as noted here) numerous newly filed complaints have proposed class period cutoff dates that fall well before the filing date.

I have previously speculated that these seemingly belated filings may perhaps reflect a filing backlog that developed as plaintiffs’ lawyers were caught up in the rush of credit crisis related lawsuits and Madoff related litigation. The VeraSun case filing suggests that this apparent backlog may even include yet to be filed credit crisis-related lawsuits, which in turn suggests that there there may be more credit crisis suits yet to come.

The VeraSun case is also the latest example of a securities class action lawsuit arising in the wake of a corporate bankruptcy. The surging numbers of business-related bankruptcies may further contribute to the further instigation of securities class action litigation. The possibility of these kinds of cases arising, like the VeraSun case, well after the bankruptcy date suggests these cases could continue to arrive for some time to come.

All of which suggests to me that, even of the pace of new credit crisis-related securities lawsuit filings have declined, the litigation fallout from the global financial crisis is likely to continue to accumulate in the months ahead.

I have in any event added the VeraSun case to my list of credit crisis related cases, which can be accessed here.

Another Options Backdating-Related Securities Suit Settlement: Another one of the remaining options backdating-related securities lawsuits has settled. As reflected in their October 15, 2009 stipulation of settlement (here), the parties to the Sonic Solutions options backdating-related securities suit have agreed to settle the case for $5 million.

A complete list of the options backdating-related lawsuit resolutions can be accessed here.

Adam Savett of the Securities Litigation Watch blog has been tracking (here) the options backdating related settlements.Adjusting his data to take account of the Sonic settlement would mean that 30 of the 39 options backdating-related securities class action lawsuits have now been resolved, with nine of these cases having been dismissed and twenty-one of them having been settled. Prior to the Sonic settlement, the average settlement amount was $77.8 million – or $33.23 million if the outsized UnitedHealth settlement is disregarded.

UPDATE: The Securities Litigation Watch has updated its options backdating settlement tally and analysis to reflect the Sonic settlement, here.

My Dinner with Bill: I am in Chicago this week at the PLUS International Conference, where the keynote speaker was none other than Bill Clinton. Let me just say that he though he is now "only" a former President, he retains all of his rhetorical powers. His speech was entertaining, thought-provoking, funny and serious, and impressive.

During the Q&A, one of the questions he was asked is a rather conventional parlor game question: if you could have dinner with any historical figure, who would you choose and why? Perhaps because it was a conventional question, he gave a rather conventional, almost undergraduate-approval-seeking type answer. And being a politician, he couldn’t name just one person – he named three: Socrates, Jesus, and Genghis Kahn. Clinton had his reason for each of the three.

I will grant you that Genghis Kahn is an interesting answer, but the other two are safe, predictable and, well, kind of boring. I will stipulate that everyone if they had a chance would want to meet Jesus. Socrates is pretty much in the same category. (Same with Gandhi and Winston Churchill) So if we all agree that Jesus and Socrates (and Gandhi and Churchill) are not available, which historical figure would you want to have dinner with?

Because Clinton gave himself three choices, I am going to give myself three as well.

First, I would choose Charles Maurice de Talleyrand-Perigord, also known as the Bishop of Autun. Talleyrand lived through some of the most interesting events in all of human history and somehow not only managed to be involved in them all, but what is perhaps a more impressive feat, to have survived them all. He was involved in the French revolution from the start and even acted as foreign minister to the revolutionary government. He later managed to become a key advisor to Napoleon, until they fell out over policy. Ultimately, he became one of the key players in the Bourbon restoration. Though often reviled as unprincipled and cynical, I believe he may have been one of the most interesting people in the grand march of history, and he certainly led one of the most interesting lives.

Second, I would choose Moshe ben Maimon, now known as Maimonides, the Jewish theologian, physician and philosopher. He also lived at an incredibly interesting time, having been born in Islamic Spain in the twelfth century and then fled persecution through Northern Africa. His wisdom, scholarship and knowledge of languages have shaped European thought up until this very day. He was among the first Europeans both to appreciate and advocate Aristotle. His rationalist philosophy would still appeal to most moderns, which to me is a reflection of what an original and powerful thinker he was.

Having chosen two historical figures, I feel I should be a little bolder and unconventional with my last choice. So my third selection is John Lennon. He was a radical advocate for peace whose art and originality touched the lives of millions.

A dinner with all three of these persons simultaneously would be chaos. But a dinner with any one of them (language and cultural issues aside) would be fascinating.

So, now you have Bill Clinton’s choices and my choices. Who would you choose? And why? If you are attending the conference and you have views on this question, I hope you will stop me and let me know your thoughts. And if you are not at the conference, I hope you will use the comment function on this blog to let me and other readers know what you think.

The one final thought I have to add is that , after having heard Bill Clinton speak today, honestly, I think a dinner with him would be pretty damn interesting, too.  I suspect we could talk about Talleyrand and Maimonides and even John Lennon or Genghis Kahn and it would be memorable and entertaining.

UPDATE: My friend and former colleague Marty Hacala provided the following e-mail answer to my dinner guest question: 

I agree that Clinton's answer was boring and conventional. We are after all talking about a dinner party and not a lecture. Who wants to listen to a failed carpenter and a suicidal Greek talk about the hereafter while picking at their food? Genghis Khan is an interesting choice if only because he might tire of the conversation and dispatch the first two before dinner has even begun.

My invitations would go to Oscar Wilde, Abraham Lincoln and Groucho Marx. (I could substitute Churchill for Lincoln, but I fear the alcohol wouldn't last and so the meal would end on an unhappy note.) Just imagine the stories they would tell? I see myself sitting there mesmerized listening to Wilde and Marx trade high and low-brow barbs, while Lincoln tells long stories of how they remind him of mostly made up characters from his youth. It would be an evening to remember. 　

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Earlier this week, I suggested (here) that the UBS auction rate securities lawsuit dismissal did not spell the end of the auction rate securities litigation. Two of the categories of likely future litigation involving auction rate securities I mentioned were lawsuits involving institutional investors (who are not covered, at least immediately, by many of the regulatory settlements) and lawsuits involving auction rate securities buyers that are targeted by their own investors.

As if to prove my point about the likelihood for continuing auction rate securities litigation, two significant auction rate securities lawsuits have arrived just since I added my post earlier this week.

First, in a lawsuit against an auction rate securities buyer, on March 31, 2009, PIMCO mutual fund investors filed a securities class action lawsuit in the Central District of New York against the funds’ investment manager and the funds’ sub-advisor, certain of the managers’ directors and officers (including bond investing guru Bill Gross). A copy of the complaint can be found here.

The complaint alleges that the funds concealed from the investors that

(a) The Funds lacked effective controls and hedges to minimize the risk of loss and risk of liquidity from auction rate securities ("ARS") which affected a large part of their portfolios; (b) The Funds lacked effective internal controls to ensure that the Funds would remain in compliance with restrictions and limitations related to their investment portfolios and strategies; (c) The extent of the Funds' liquidity risk due to the illiquid nature of a large portion of the Funds' portfolios, including ARS, was omitted; and (d) The extent of the Funds' risk exposure to ARS was misstated.

The PIMCO mutual fund lawsuit joins recent lawsuits filed against Perrigo Company (about which refer here) and NextWave Wireless (refer here), as examples of cases in which auction rate securities buyers are targeted by their own investors for their exposure to the instruments. These lawsuits differ from the more standard auction rate securities lawsuits, in which the auction rate securities buyers were the plaintiffs and the defendants were the broker-dealers or others that had sold the instruments.

PIMCO’s woes with its funds’ investments in auction rate securities have been well-documented in the press in recent days, as the funds’ managers have struggled to manage problems stemming from the investments. A recent Wall Street Journal article discussing the funds’ woes can be found here.

The second of the two new auction rate securities lawsuits involves an institutional investor buyer, brining an action against the broker-dealers that sold the company the instruments. On April 1, 2009, Texas Instruments filed an Original Petition in Texas (Dallas County) District Court against Citigroup Capital Markets, BNY Capital Markets and Morgan Stanley, in connection with the company’s purchase of $524 million of auction rate securities backed by student loans. A copy of the Petition can be found here.

The Petition alleges that despite the defendants’ "assurances of liquidity and low risk," the company is now stuck with auction rate securities that it "cannot liquidate." The Petition alleges that the defendants "downplayed any risk of failed auctions" and "misrepresented the market demand" for the securities by omitting to disclose "the extent to which the entire ARS market depended on continued bidding and purchasing by the Defendants and other broker-dealers."

Beyond these more general allegations, the complaint contains some very case specific allegations relating to the defendants’ alleged failure to disclose that as 2007 progressed securities issuers (including issuers of securities that Texas Instruments held) were waiving the maximum interest rate limitations in connection with auctions of their securities. The company alleges that had it been advised of these waivers, it would have been alerted to the weakening demand for the instruments. The company alleges these omissions and affirmative reassurances induced it to continue to buy and hold the securities.

The Petition alleges violations of the Texas securities laws and seeks rescission of the securities purchase transactions as well as prejudgment interest.

Interestingly, the Petition does not mention the various regulatory settlements that Citigroup and others have reached with respect to the auction rate securities, presumably because the settlements do not provide relief (at least not immediately) to an institutional investor like Texas Instruments.

In any event, it is evident that the auction rate securities litigation is far from over.

Hat tip to the Courthouse News Service for the link to the Petition. Special thanks to Adam Savett of the Securities Litigation Watch for a link to the PIMCO lawsuit.

Dismissal Motion Ruling in Options Backdating-Related Securities Lawsuits: The options backdating cases continue to grind through the courts. On March 27, 2009, District of Arizona Judge Robert Broomfield issued a 138-page ruling (here) on the pending dismissal motion in the options backdating-related securities lawsuit against Apollo Group and several of its directors and officers. (Background regarding the case can be found here).

Judge Bloomfield’s ruling is very painstaking and detailed. He parsed the allegations against each of the defendants extremely finely. The outcome is rather complex, and it would require a spreadsheet to explain with respect to each of the plaintiffs' substantive claims which defendants have been dismissed with prejudice, which have been dismissed without prejudice, and which have had their dismissal motions denied. The most critical aspect of his ruling is that the Court denied the motion to dismiss the plaintiffs’ claims under Section 10(b) against the Company and its most senior officers.

Apollo Group was also involved in a separate, rather notorious securities class action lawsuit that resulted in a January 2008 plaintiffs’ jury verdict that was overturned by the trial judge in August 2008 on a post trial motion. Refer here for background on this separate case.

I have in any event added the Apollo Group decision to my table of settlements, dismissals, and dismissal motion denials, which can be accessed here.

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On February 23, 2009, Advisen released its Report of 2008 securities litigation entitled "Securities Litigation in 2008: Implications for the D&O Market in 2009 and Beyond" (here, $ required). The Advisen Report’s numerical securities litigation analysis is directionally consistent with prior reports of the 2008 lawsuits, although the Report also contributes its own unique observations to the dialog. The Report also provides a number of specific comments about the lawsuits themselves as well as about likely future trends, including in particular reflections on the implications for D&O insurers.

Advisen’s February 26, 2009 press release describing the Report can be found here.

Largely as a result of the way it counted the lawsuits, the Advisen report concludes that securities class action lawsuits as such did not substantially increase in 2008 compared to 2007, although both years’ activity did increase compared to 2006. Pertinent to these conclusions, the Advisen Report provides a lengthy explanation of its "counting" methodology, which is helpful in understanding how Advisen’s numbers differ from those reflected in prior reports. The Advisen Report correctly notes that the phrase "securities class actions" is "increasingly inadequate for categorizing and explaining securities suits."

The Advisen Report is consistent with previous released studies in its conclusion that during 2008 securities litigation was concentrated in the financial sector. The Report notes that "fully half of securities lawsuits filed in 2008 named financial firms and their directors and officers as defendants." Specifically, the Report finds that banking, finance and insurance companies accounted for half of the securities lawsuits in 2008.

The Report stresses that the nature of many of the suits filed in 2008 differs from what may have been standard form in prior years. Many of the suits were not filed against public companies for their financial disclosures, but rather were filed against companies that structured or sold securities, and were being sued for representations about the securities themselves. The auction rate securities lawsuits are one illustration of this new category.

In addition, Advisen reports that during 2008, many of the suits were filed not as securities class action lawsuits as such, but rather in the form of lawsuits for breach of fiduciary duty, breach of contract, or common law torts. Many of these lawsuits were filed in state court.

The Report notes that as the economy continues to deteriorate, "at some point in 2009, the idea of ‘subprime and credit crisis’ as a category of suits will fade away as the credit crisis simply becomes ‘the economy’." Among other things, the Report speculates that the spreading economic woe could cause the growing litigation wave to spread outside the financial sector.

The deteriorating economic conditions could also lead to increased bankruptcies, a development the Advisen Report notes "almost certainly will be accompanied by an increase in securities lawsuits." The Report notes that since 1995, roughly 35 percent of large public companies (defined as having more than $250 million in assets, measured in 2008 dollars) that filed for bankruptcy were also named in securities class action lawsuits. However, in 2007 and 2008, the percentage increased to 77 percent.

The Report also notes a number of factors contributing toward escalating costs of defense, including the complexity of the cases being filed, the novelty of many of the legal theories, and the coincidence of multiple, simultaneous proceedings.

The Report reviews the implications of these developments and trends for D&O carriers. The Report also contains interesting comments from several D&O mavens, including John McCarrick, Rick Bortnick and Joe Monteleone. The Report is interesting, well-written and well-documented, and well worth reading in its entirety.

My own overview of the 2008 securities lawsuit filings can be found here.

Remember Options Backdating?: The cases from the last wave of corporate scandals still remain, although fewer and fewer or them all the time. On February 27, 2009, the parties to the Sunrise Senior Living securities lawsuit, one of the remaining options backdating related securities class actions, agreed to settle the case for $13.5 million. A copy of the stipulation of settlement can be found here.

I have added the Sunrise settlement to my running table of the options backdating related lawsuit settlements, dismissal and dismissal motion denials. The table can be accessed here.

Special thanks to Adam Savett of the Securities Litigation Watch for providing me with a copy of the Sunrise settlement stipulation.

Now I Have Seen Everything: According to a March 2, 2009 story on Bloomberg (here), former AIG Chairman and CEO Maurice "Hank" Greenberg has sued AIG alleging that "material misrepresentations and omissions" caused him to acquire AIG shares in his deferred compensation profit participation plan at an inflated value, and later to lose nearly his entire investment after AIG's losses became known.

A March 2, 2009 Reuters story about the lawsuit (here) says that Greenberg acquired the shares on January 30, 2008, when AIG shares traded at $54.37. The company’s shares closed today at 42 cents. Greenberg seeks the difference between what he paid for the shares and what he said the shares were worth, as well as reimbursement of more than $70 million of taxes.

The defendants in the lawsuit include, in addition to the company, Greenberg’s successor as CEO, Martin Sullivan, as well Joseph Cassano, who headed AIG’s Financial Product (AIGFP) division. Both men worked for Greenberg prior to Greenberg’s departure.

I wonder if his lawsuit would be barred from coverage under AIG’s D&O insurance program (assuming for the sake of argument that it is not otherwise exhausted by prior claims)? As a former officer and director of the company, he still qualifies as an "insured" and so his lawsuit potentially at least could trigger the "insured vs. insured" exclusion typically found in most D&O policies. On the other hand, he left the company in March 2005, and so his claim might come within a coverage carve back in the exclusion, depending on how the applicable provision is worded.

If one were to assume that insurance would not be available, then defense expenses (both for the company and for the individuals, who would be indemnified by the company) would come from AIG itself, which owes the U.S. government approximately a gazillion dollars. The same would go for any uninsured settlements or judgments. I leave to others to comment on whether or not taxpayers ought to have to incur the costs associated with this lawsuit.

Perhaps pertinent to the question whether or not taxpayers should have to bear the cost of Greenberg's lawsuit, in comments published today (here), the current AIG CEO, Edward Liddy, said that Greenberg is partially responsible for AIG’s current woes. Among other things, Liddy said "The formation of the AIGFP unit, which has literally brought us to our knees, that happened on his watch. The compensation systems that have gone astray, happened on his watch. I don’t think it’s as clean and simple as sometimes Hank would like to portray."

And Finally: This week’s Time Magazine has several interesting article about the current economic crisis, including an article highly critical of former SEC Chairman Christopher Cox, entitled "The Inside Story on the Breakdown at the SEC" (here).

In addition, this week’s issue also has a fascinating story entitled "One Bad Bond" (here), which explains how losses have compounded exponentially in connection with a CDO-cubed created in March 2007 and called Jupiter High-Grade CDO V. This poster-child of financial engineering excess was originally rated AAA, but now nearly 59% of the instrument’s investments are worthless. Among Jupiter’s investments is an interest in the Mantoloking CDO, a toxic investment vehicle about which I blogged a year ago, here.

The article is worth tracking down in its original print version, because the print version is more detailed and is accompanied by graphics that are not available online but that do a particular good job in showing how the complexity of these instruments compounded the losses as the underlying mortgages have faltered.

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In the latest preliminary ruling in a subprime or credit crisis-related securities lawsuit, Southern District of Florida Judge Ursula Ungaro in a December 11, 2008 opinion (here) granted the defendants’ motion to dismiss the plaintiffs’ complaint, with leave to amend.

Background

BankAtlantic Bancorp is a bank holding company that offers consumer and banking lending services, through its wholly-owned subsidiary. The plaintiffs complaint alleged securities law violations against the holding company and five present and former directors and officers of the holding company or of the subsidiary. The plaintiff purports to represent persons who purchased the holding company’s stock during the period November 9, 2005 though October 25, 2007. Background regarding the case can be found here.

As summarized in the December 11 opinion, the complaint alleges that the company "sought to capitalize on the Florida real estate boom through expansion of its commercial real estate loan portfolio." To fuel the growth, the company "cut corners" including "ignoring the Company’s internal lending guidelines." The company also allegedly "failed to adequately reserve for loan losses" in its commercial real estate loan portfolio, "resulting in material misstatements in the Company’s financials." After the Florida real estate market "entered a free fall in 2007," borrowers "began defaulting" and the company was "forced to reveal the true extent of the Company’s exposure in its real estate portfolio."

The Opinion

In her December 11 opinion, Judge Ungaro held that the complaint "adequately alleges misrepresentations and omissions in a manner sufficient to withstand a motion to dismiss," and that the complaint "is legally sufficient in so far as it pleads loss causation." However, she found that the complaint did not adequately allege scienter.

As a preliminary matter, Judge Ungaro addressed the complaint’s reliance on confidential witness statements. She found that "there is no specific information as to the confidential witnesses’ positions in the Company, their employment duties, the foundation or basis for their knowledge, or whether they were even employed with the company during the relevant time period." Accordingly, she concluded that she is "unable to give any significant weight to the allegations made by those confidential witnesses.

She then considered the scienter allegations against the individual defendants. With respect to the allegations against the Vice Chairman, the current CEO and the Chairman, she found that the "factual allegations do not give rise to a strong inference of scienter." She said that even assuming the confidential witness statements could be given weight, the allegations are insufficient; "the confidential witness’s vague and conclusory assertion that it was ‘common knowledge’ that the Company had risky loans on its books is not the type of particularized allegations required under the PSLRA."

She also noted that the defendants’ "knowledge of the company’s lending or accounting practice by virtue of their high-level positions…does not create a strong inference of scienter." She also found that the fact that these individuals received "Exception Reports" establishes "nothing about what these Defendants knew or should have known about the Company’s lending practices."

Judge Ungaro also rejected the contention that the defendants’ $7.8 million in insider stock sales established scienter, because the complaint "does not allege that the amount or percentage of shares sold …were unusual," nor does the complaint alleged "that the sales were inconsistent with their prior trading history."

With respect to the scienter allegations against the company’s former and its current CFO, Judge Ungaro concluded that the complaint "does not contain factual allegations that would support a finding that [the defendants’] statements were made with scienter." The complaint "lacks particularized allegations" that these two officials "played a role in approving loans or in setting loan loss reserves," and the complaint does not allege that they were "presented with information that would have shown the falsity of the Company’s financial statements or that they were confronted with concerns regarding the Company’s lending practices or loan loss reserves."

Finally, with respect to the company (but without reference to more generalized theories regarding "collective scienter"), Judge Ungaro held that the plaintiff "has not adequately pled scienter as to any of the Individual Defendants; therefore, Plaintiff has failed to adequately pled [sic] scienter as to BankAtlantic."

The court’s grant of the defendants’ dismissal motion is without prejudice and the plaintiffs have 20 days in which to file an amended complaint.

Discussion

The BankAtlantic case joins a growing list of subprime and credit crisis related securities cases that failed to survive preliminary motions. To be sure, the dismissal motions in the Countrywide subprime securities case (refer here) and the New Century Bankcorp subprime securities case (refer here) were both recently denied in strongly worded opinions. But as reflected in my running tally of subprime and credit crisis-related securities lawsuit settlements, dismissal and motion denials (which can be accessed here), a greater number of dismissal motions have been granted than denied.

It should be noted that at this point only a handful of dismissal motions have been resolved one way or the other. And many of the dismissals that have granted have been without prejudice. The plaintiffs in these cases may yet successfully amend their complaints and survive a subsequent motion to dismiss. Nevertheless, the early returns seem to suggest that many of these cases are facing judicial resistance.

On a related note, I have observed elsewhere (refer here) that the growing wave of bank failures could lead to an increased number a new wave of "dead bank" litigation. To the extent these cases do emerge, the Bank Atlantic opinion may suggest that the cases could face significant pleading hurdles.

In any event, I have added the BankAtlantic opinion to my running tally of subprime and credit crisis-related lawsuit settlements, dismissals and dismissal denials, which can be accessed here.

Court Rejects KLA-Tencor’s Special Litigation Committee’s Motion to Dismiss Backdating Case: In a December 11, 2008 opinion (here) that is extensively redacted due to its reliance on evidence submitted under seal, Judge James Ware of the Northern District of California denied the motion of KLA-Tencor’s Special Litigation Committee (SLC) to dismiss the options backdating derivative lawsuit pending against the company, as nominal defendant, and certain of its directors and officers.

The plaintiffs had filed a complaint alleging that the defendants "permitted senior KLA insiders to unlawfully manipulate the grant dates associated with KLA stock options, resulting in hundreds of millions of dollars of losses to KLA." (Background regarding the options backdating allegations at KLA-Tencor can be found here.) In response to the filing of the complaint, the company’s board formed the SLC and appointed two directors to serve as its members. The SLC prepared a report and filed a motion to dismiss the derivative action, concluding that the derivative action "is no longer in the interests of KLA or its shareholders."

Judge Ware considered the motion under Delaware law. Because of the redactions in his opinion, his reasoning is not always entirely evident. Basically, he was concerned that one of the SLC members "was on the Board and on the Audit Committee at a time when continued backdating may have been occurring at KLA." This raises the "possibility" that the one SLC member was "tasked with investigation corporate malfeasance that he had previously, if unintentionally, approved," which in turn raised questions about his independence.

Because of the independence concerns, the Court was also "concerned by the overall size of the SLC, as it consisted of only two members." On these grounds, the court found that the SLC had not carried its burden, noting that

Although no single factor is dispositive in the Court’s determination, evaluation of the totality of the circumstances, including the size of the SLC, questions surrounding its independence, and the depth and focus of its inquiry leads to this conclusion.

Accordingly, the court denied the SLC’s dismissal motion, denied certain individual defendants’ proposed (unspecified) settlements, and scheduled the case to go forward.

Without having statistical evidence to support the observation, I note that it is relatively unusual for a court to reject an SLC’s recommendation to drop a derivative case. On the other hand it is also unusual for an SLC to have only two members, and these two unusual features wound up being related. A December 17, 2008 Law.com article discussing these aspects of Judge Ware's opinion can be found here.

In any event, I have added the KLA-Tencor decision to my table of options backdating related lawsuit settlements, dismissal and dismissal denial, which can be accessed here. KLA-Tencor’s $65 million settlement of the options backdating securities class action lawsuit that had been filed against the company is discussed here.

Are European Investor Groups Turning to U.S. Court for Subprime Claims?: A December 16, 2008 post (here) on PomTalk, the blog of the securities plaintiffs’ firm Pomerantz Haudek Block Grossman & Gross, noting that "pension funds around the globe have lost hundreds of billions of dollars" in the credit crisis, as a result of which "increasingly, they are turning to U.S. courts to seek recovery of losses."

The article notes that "in recent years, European funds have begun to play a more prominent role" in U.S. class actions, and that according to a U.K. pension fund group, "23% of British pension funds have now actively participated in a U.S. securities class action."

The article suggests that European funds "will be particularly affected by three categories of suits": suits against financial services companies; suits involving structured financial instruments; and suits involving agency obligations and preferreds (this latter category is a reference to the securities of government sponsored entities). The article concludes by noting that "European funds are certain to remain a fixture in U.S. securities class action."

Readers of this blog may be interested to read the article’s observations in connection with litigation against financial services companies:

A major question in suits against banks is whether they have the ability to satisfy a large judgment or enter into a reasonable settlement. Many banks have already gone under or are hanging by a thread. But even failed banks generally have D&O insurance, and there may be other viable defendants like underwriters.

Ah, yes. Round up the usual suspects. Be sure to frisk them for insurance, as well as the presence of any professional advisors.

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As I noted in a prior post (here), NERA Economic Consulting, in a May 15, 2008 paper (here), had asked the question whether options backdating-related securities class action lawsuits were settling for less than data from prior class action settlements would predict. In the May 15 paper, looking at the settlements to date, NERA found that the options backdating-related securities lawsuit settlements were well below predicted amounts.

NERA has now published an October 22, 2008 paper (here) that revisits its earlier analysis in light of intervening options backdating-related securities settlements.

With respect to the previously observed expectations gap, NERA had hypothesized in its earlier paper that either suits alleging backdating are generally viewed as weaker or the weakest cases had simply settled most quickly.

In its most recent paper, NERA revisits these hypotheses in light of three recent settlements – Brocade Communications, UnitedHealth Group and Monster Worldwide – finding that there may be support for the conclusion that the initial settlements may have been low because the weakest cases settled first. In these three more recent dispositions, the settlements were either at or well above predicted ranges. Indeed, NERA found that the UnitedHealth Group case was as much as five times greater than the predicted amount.

At the same time, NERA noted that four of the more recent settlements were more consistent with prior observations, in that the settlements were below predicted ranges.

In its earlier report, NERA had concluded that on average the options backdating cases were settling for about 38% of the predicted amount. With the addition of the intervening settlements the average settlement is up to about 74% of predicted amounts. However, this increase is largely driven by the inclusion of the UnitedHealth Group settlement. Without the UnitedHealth Group settlement, the average of the options backdating settlements drops to 43% of the predicted amounts.

Nevertheless, based on its analysis (and I am simplifying here), NERA still cannot reject the hypothesis that options backdating-related securities settlements are on average no different than settlements in non-backdating cases with similar level of investor losses and other similar traits.

NERA notes that of the overall options backdating-related securities lawsuits, 17 remain to be settled, which represents a larger group of cases than the 15 cases that have settled to date. It remains to be seen whether or not these remaining cases will or will not settle within expected ranges.

My table showing all options backdating related case dispositions, including settlements and dismissals both for all options backdating-related securities lawsuits and options backdating related derivative lawsuits, can be found here.

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Even though the current subprime litigation wave seemingly has swept the prior scandal into the past, lawsuits based on options backdating allegtions stubbornly continue to come in. Within recent days, plaintiffs’ lawyers have filed two new options backdating-related derivative lawsuits. The options backdating scandal may now be well over two years along, but it continues to generate new litigation activity and controversy.

First, as described in an August 1, 2008 article in the Seattle Intelligencer (here), on July 17, 2008, a shareholder filed a lawsuit in King County (Wash.) Superior Court on behalf of Costco Wholesale Corp. against 20 of its current and former directors and officers. According to the article, the suit seeks “unspecified financial damages and internal company reforms.” A copy of the complaint can be found here.

Second, as discussed in a July 30, 2008 Kansas City Star article (here), on July 29, 2008, a shareholder of Epiq Systems filed an options backdating-related shareholders derivative lawsuit on the company’s behalf against nine current and former directors and officers. A copy of the complaint can be found here.

The Epiq complaint alleges that the company “has secretly backdated millions of options to its top officers and directors for nearly a decade, reporting false financial statements and issuing false proxies to shareholders.”

With the addition of these two most recent lawsuits, my current tally of the total number of options backdating-related derivative lawsuits now stands at 168. The number of options backdating-related securities class action lawsuits stands at 39, including two new lawsuits filed in 2008. My updated list of the options backdating-related lawsuits can be found here.

Regular readers know that I have also been tracking options backdating-related case dispositions and settlements (here). Though the list of dispositions and settlements is now quite lengthy, the reality is that the vast majority of the options backdating cases are yet to be resolved. The fact that so many remain unresolved, together with the fact that new lawsuits continue to be filed, suggest that it will be quite some time before all of the options-backdating litigation is finally put to rest.

Special thanks to a loyal reader for the link to the Epiq article and for information about the Costco case.

Thoughts About Crisis Longevity: It is worth contemplating the likely long duration of the options backdating phenomenon in the context of the current subprime and credit crisis litigation wave. The subprime and credit crisis problems are so much more pervasive and so much more serious, and it likely that the related litigation will continue to emerge for months and perhaps years to come. It may be correspondingly even longer before the full dimensions of the subprime-related litigation wave can be fully assessed.

Indeed, in the Financial Times August 3, 2008 first anniversary retrospective of the subprime crisis (here), the paper specifially notes, "A year later, there is still no sign of an end to these problems. Instead, the sense of pressure on western banks has risen so high that by some measures this is now the worst financial crisis seen in the west for 70 years."

We may have options backdating litigation around for quite a while yet, but we will be living with the consequences of the subprime crisis for years to come.

Cross-Eyed Bear: When the history of the subprime crisis is finally written, the collapse of Bear Stearns will be a key part of the narrative. By the same token, the litigation involving Bear Stearns will also be a key part of the litigation history. The amount of litigation involving Bear Stearns is massive, but an August 4, 2008 Fortune article helpfully provides a comprehensive list and overview, here.

As the article correctly notes, "fortunately for former senior Bear executives like Jimmy Cayne, Alan Greenberg and Alan Schwartz, J.P. Morgan Chase agreed to indemnify Bear's officers and directors for six years against these lawsuits."

Really Big Box Stores: I was surprised to learn, while writing this post, that Costco is as big of a company as it is. The companies’ current market capitalization is approximately $27 billion, with annual sales (2007) of $64 billion.

By most measures, those statistics would qualify Costco as a big company. But its competitor big box retailer Wal-Mart Stores manages to make Costco look modest by comparison. Wal-Mart’s current market cap is $230 billion and its 2007 sales were $378 billion.

If Wal-Mart were a country, and if its revenue were supposed to be equivalent to GDP, Wal-Mart would be the 25^th largest economy in the world (according to the rankings of the International Monetary Fund, here) --  larger than Saudi Arabia, Austria or Greece. Or as big as Kuwait, New Zealand and Algeria combined. That’s big.

If you are still straining to comprehend how big Wal-Mart truly is, you may want to check out this amazing animation video (here) depicting the efflorescence of Wal-Mart stores across a map of the United States. Wal-Mart is amazing, this video simply makes that fact easier to grasp.  

A very special hat tip to Tom Kirkendall at the Houston’s Clear Thinkers blog (here) for the link to the cool Wal-Mart growth video. Kirkendall’s site also links to this very cool BBC video (here) tracking electronically the balletic conduct of commerce in the British Isles.

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In two recent federal district court decisions, two options backdating-related securities class action lawsuits – one involving Witness Systems and one involving Jabil Circuit – were dismissed.

First, in the Witness Systems case, on March 31, 2008, Judge Clarence Cooper of the United States District Court for the Northern District of Georgia granted the defendants’ motion to dismiss, with prejudice. A copy of the Order can be found here. Background regarding the case can be found here.

The complaint alleged that seven options grants in 2000 and 2001 were backdated and that four grants in 2004 were springloaded. Oddly, the plaintiff alleged that he company’s financial statements during the period April 23, 2004 to August 11, 206 were misleading because of the 2000-2001 backdating. The allegedly misleading statements allegedly began earlier and continued through the class period.

Judge Cooper found that

Plaintiff has failed to allege sufficient, particularized facts to support a “cogent and compelling” inference of scienter as to Witness or as to each Individual Defendant. Although the [amended complaint] is lengthy, the details contained therein are simply insufficient to support a strong inference of scienter. Specifically, the allegations are in the nature of a theory that Defendants must have known that the 2004 and 2005 financial statements were misstated due to backdating that occurred in 2000 and 2001. The [amended complaint] never explains when, or how, any or all Defendants learned about the circumstances pertaining to any backdated option grants. (Citations omitted.)

Judge Cooper went on to observe that “nothing is alleged that would demonstrate that these individuals had any knowledge that disclosures during the class period might require further adjustments based on options grants made in 2000 and 2001.”

Judge Cooper further found that the defendants’ stock sales did not support an inference of scienter. Judge Cooper specifically found that the defendants’ “pattern of regular dispostions was inconsistent with allegations of scienter, and the two defendants who sold significant share percentages only joined the company as a result of a merger after the alleged backdating. Judge Cooper also found that the plaintiffs had not adequately pled loss causation.

In the Jabil Circuit case, on April 9, 2008, Judge Steven Merryday of the United States District Court for the Middle District of Florida granted defendants’ motion to dismiss, but with leave to amend. Plaintiffs have until May 12, 2008 to file an amended complaint. A copy of the April 9 order can be found here. Background regarding the Jabil Circuit case can be found here.

The Jabil Circuit case may be of some interest because the company was one of the several companies whose option grants were reflected in the charts that accompanied the  original March 18, 2006 Wall Street Journal article entitled “The Perfect Payday” (here) that launched the options backdating scandal.

The crux of Judge Merryday’s decision is his conclusion that the plaintiffs’ allegations failed to establish that any grant was backdated. Judge Merryday said:

Although the complaint specifies the offending statement and identifies when and where the defendants issued the statement, the complaint includes deficient allegations concerning the falsity of the statement. The plaintiffs purport to allege repeated instances of backdating by stating the dates of “suspiciously timed” option grants and the individual defendants who received the grants. However, the plaintiffs never allege the any specific grant of stock to any specific individual defendant was backdated. The issuance of suspiciously timed options fails to convert the [company’s compensation policy] representation into a false and misleading statement.

Having found that the complaint did not adequately allege backdating, Judge Merryday was able to dispose of plaintiffs’ allegations that the company had not properly accounted for the option grant or made misrepresentations when company officials later denied that there had been backdating.

Judge Merryday also found that the plaintiffs’ scienter allegations were insufficient because the complaints’ allegations of “knowledge of non-public information fails to raise an inference of scienter with respect to any defendant.” The insider trading allegations were insufficient because the complaint failed to allege the percentage of total shares sold or to compare the share sales to sales before and after the class period. The defendants’ alleged receipt of option grants was also found insufficient.

Judge Merryday also found that the complaint’s allegations of GAAP, IRS and SEC violations were insufficient “because the complaint fails to adequately allege a basis for the claim of backdating.” Similarly, with respect to the issue of loss causation, Judge Merryday found that “having failed to adequately allege the falsity of the backdating-related statements, the plaintiffs fail to sufficiently plead loss causation as to those statements.” Judge Merryday also rejected plaintiffs’ claims of proxy misstatements based on the plaintiffs’ failure to adequately allege backdating.

I have added these two dismissals to my table of options backdating lawsuit settlements, dismissals and denials, which can be accessed here. These two dismissals may be noteworthy because they appear to be the first options backdating securities lawsuit dismissals outside of the Ninth Circuit. They are also the first dismissals granted in an options backdating securities lawsuit in several months. But while some of these options backdating securities suits have now been resolved, many more remain pending.

As reflected on my running tally of the options backdating lawsuit filings (which can be found here), there were a total of 36 options backdating-related securities class action lawsuits filed. And as reflected in my table of options backdating lawsuit case dispositions (linked above), of these 36 cases, eight have settled, six have had their motions to dismiss denied, and five have been dismissed (albeit some with leave to amend). That leave 17 cases on which no action has yet been taken, and with the six dismissal denials, 23 cases that remain pending – not to mention the cases on which amended pleadings or appeals may give new life.

These cases appear to have a very long way to run yet. But the high degree of skepticism shown in these two opinions is striking, and would not bode well for these cases were this general view to become widespread.

Special thanks to an alert reader who prefer anonymity for providing copies of the two opinions.

Another Subprime-Related D&O Loss Estimate: On April 9, 2008, Fitch’s Ratings released a report entitled “Subprime Mortgage Exposure for Property/Casualty Insurers.” A link to the repor can be found in this Business Insurance article (here), but registration is required for access to the report.

The report repeats prior estimates of industry-wide insured subprime-related losses in the range of $3 to $4 billion (although also noting that estimates have ranged as high as $9 billion). The report states that “Fitch believes that the majority of these losses will be borne by the larges writers of primary and excess D&O.”

The report also states that “Fitch believes that the near-term impact from the subprime issues will have a stabilizing or modestly positive effect on professional liability rates, especially within the financial services sector, but are unlikely to result in broad hardening.” The report warns though that “if the credit contagion spreads into sectors not directly tied to the subprime mortgage market or if the weakening economy leads to increased bankruptcies, current loss estimates will prove to be inadequate and there could be adverse reserve development that could have a larger impact on rates going forward.”

Fitch’s estimates and comments are largely in line with prior D&O loss estimate, about which I previously commented here.

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