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

Amidst all the subprime hoopla, it would be easy to forget that only a year ago, options backdating was the hot topic. Options backdating might now seem passé, but several considerations suggest that options backdating remains important and that we still have a long way to go before we can be sure we have seen all of the options backdating scandal fallout.

Accumulating Lawsuits: The first important consideration about options backdating in early 2008 is that the options backdating related lawsuits are still coming in. As I previously noted (here), last month shareholders filed an options-backdating related securities class action lawsuit against Teletech Holdings.

In addition, on February 6, 2008, plaintiffs' lawyers announced (here) that they had initiated a securities class action lawsuit in the United States District Court for the Northern District of California against Maxim Integrated Products and certain of its directors and officers. The lawsuit relates to Maxim's January 17, 2008 announcement (here) that, as a result of its Board's special committee's investigation of the company's stock option practices, the company would be restating its financial statements to record non-cash, pre-tax charges of between $550 and $650 million for additional stock-based compensation expense. The company also announced that investors should not rely on the company's financial statements for the fiscal years 1997 through 2005 and corresponding interim reporting periods through March 25, 2006.

The timing of Maxim's recent announcement is relevant here. The company had first announced its anticipated restatement nearly a year prior, in January 2007 (here), and the company's January 2008 announcement indicated that the company's review was not only not yet complete, but would have to be expanded backwards to include its 1995 and 1996 fiscal years. Maxim is surely not the only company that continues to struggle with the accounting clean-up from options backdating-related issues. There may well be additional options backdating related lawsuits filed in the months ahead.

But in any event, with the addition of the Maxim Integrated Products lawsuit to my running tally of options backdating related lawsuits (which can be found here), the current total number of options backdating related class action lawsuits now stands at 36. These 36 class action lawsuits are in addition to the 166 options backdating related derivative lawsuits that have also been filed.

Accumulating Settlements: The second important consideration about options backdating in early 2008 is that the settlements of the options backdating related cases are accumulating in a material way. Indeed, on February 8, 2008, HCC Insurance Holdings announced (here) that it had settled the options backdating-related securities class action lawsuit that had been filed against the company and certain of its directors and officers, for a payment of $10 million dollars (to be funded entirely by insurance). The company had previously announced on January 9, 2008 (here) that it had settled the options backdating related derivative lawsuit in which the company was involved, in exchange for an agreement to adopt certain governance reforms and the payment of $3 million of the plaintiffs' attorneys' fees.

As reflected in my table of options backdating-related lawsuits dismissals, denials and settlements (which can be accessed here), the HCC settlement represents the seventh of the options backdating-related securities class action lawsuits to settle. The aggregate amount of these seven settlements is $244.55 million. Three other options backdating-related securities class action lawsuits have also been dismissed, meaning that at this point, ten of the 36 options backdating related securities lawsuits have either settled or dismissed, with another 26 yet to be resolved.

As also reflected on my list of options backdating related case dispositions, there have also been a number of options backdating related derivative settlements. The value of some of these settlements has not publicly disclosed, but the value of the disclosed settlements - not counting the $900 million UnitedHealth Group derivative settlement - is over $61 million.
The sum of the value of these two categories of options backdating-related lawsuit settlements is over $300 million - and if the UnitedHealth Group settlement is included, the total value so far is over $1.3 billion. (It should be kept in mind that these figures do not reflect the derivative settlements that were not publicly disclosed). Of course, these figures do not include the costs the companies incurred to defend these cases, as well as to defend themselves and their senior officials against SEC investigations and other regulatory and criminal matters. And, perhaps most significantly here, there are many more of these cases yet to be resolved than have so far been settled or dismissed.

The Securities Litigation Watch blog has a more detailed analysis of the options backdating securities class action settlements here.

I have gone through this exercise to point out that when all is said and done, the options backdating scandal is going to have proven to have had a very significant event. While not all of the settlement and amounts and defense expenses represent covered loss (for example, the UnitedHealth Group would appear to be excluded from coverage under the typical D & O insurance policy), much of these amounts will be paid by D & O insurers.

As is clear from the fact that options backdating related lawsuits continue to emerge, and the fact that the vast majority of the options backdating-related cases are yet to be resolved, D & O insurers are going to continue to incur these losses for some time to come. And while it can certainly be hoped that the insurers' reserving practices fully anticipate future developments in these cases (and the cases yet to emerge), the possibility that options backdating might be a bigger deal than everyone has been assuming right now cannot be overlooked.

This analysis of the options backdating-related cases provides some significant context for the current rapidly unfolding subprime-related litigation wave. By any measure, the subprime wave represents a bigger threat than the options backdating related cases. There are going to be many more subprime-related securities class action lawsuits (right now, there are 43 subprime-related securities lawsuits vs. the 36 options backdating related securities lawsuits, and the subprime related lawsuits are going to be rolling in for the rest of this year and probably into the next); the subprime cases involve much more significant shareholder losses; the subprime cases will be very expensive to defend; and, due to their complexity, the subprime cases will take a long time to resolve.

Bottom line: the options backdating scandal and the subprime meltdown together represent adverse circumstances for D & O insurers - something you would never be able to discern from the current marketplace conditions.

Special thanks to Adam Savett of the Securities Litigation Watch for the link to the HCC settlement and for suggesting to me the aggregation of the options backdating related class action settlements.

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It has been such a while since a new options backdating securities lawsuit has appeared that it was with some surprise I noted the new case that has been filed against Teletech Holdings and certain of its directors and officers. According to the plaintiffs' counsel's January 25, 2008 press release (here), the lawsuit, filed in the Southern District of New York, relates to the company's November 8, 2007 press release (here), in which the company announced a "self-initiated review of accounting for equity-based compensation practices and likely restatement of prior period financial statements."

According to the company's filing on Form 8-K (here), also dated November 8, the company delayed the filing of its quarterly report for the quarter ending September 30, 2007, due to the company's Audit Committee's review of the company's "historical stock option and other equity-based compensation grant practices." The filing also states that based on the review completed to date, "management presently believes that it will be required to incur additional non-cash compensation charges for prior periods and that restatement of interim and annual financial statements for the periods 1999 through 2007 is likely." The filing also states that the company's interim and annual financial statements for the period 1999 through the second quarter of 2007 "should not be relied upon."

In light of the TeleTech lawsuit's allegations, I have, somewhat unexpectedly as this late date, amended my tally of options backdating-related lawsuits. The tally can be found here. With the addition of the TeleTech lawsuit, my count of options backdating-related securities lawsuits stands at 35.

Finding Orwell: I read with interest in the January 23, 2008 Wall Street Journal profile (here) of newly-appointed U.S. Attorney General Michael Mukasey that when he was a federal judge, Mukasey would require his new law clerks to read George Orwell's essay, "Politics and the English Language." Orwell's essay, which can be found here, is a declamation against the "vagueness and sheer incompetence" that Orwell believed to characterize contemporary prose, particularly political writing.

Orwell wrote that "the great enemy of clear language is insincerity. When there is a gap between one's real and one's declared aims, one turns to long words and exhausted idioms, like a cuttlefish spurting ink."

After providing many examples of bad writing, Orwell reduced his principles for clear writing to six rules, which undoubtedly are the reason Mukasey required his law clerks to read the essay. The six rules are:

1. Never use a metaphor, simile, or other figure of speech you are used to seeing in print.

2. Never use a long word where a short one will do.

3. If it is possible to cut a word out, always cut it out.

4. Never use the passive where you can use the active.

5. Never use a foreign phrase, a scientific word, or a jargon word if you can think of an everyday English equivalent.

6. Break any of these rules sooner than say anything barbaric.

The interior was dark and cool. The front room was crammed with wooden furniture. An empty teacup sat on the arm of an old planter's chair and the glass-fronted book cabinets were filled with old newspapers, their corners orange and crackling with age. Two grandfather clocks stood in opposite corners, each telling a different time.

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In its January 24, 2008 quarterly earnings release (here), KLA-Tencor also announced that it had entered into an agreement to settle the options backdating-related securities class action lawsuit that had been pending against the company and certain of its directors and officers for $65 million.

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A shareholders' derivative lawsuit that generated the most prominent judicial pronouncements about options "springloading" has been settled. According to the company's January 18, 2008 press release (here) and its filing on Form 8-K of the same date (here), the parties have settled the consolidated shareholders' derivative lawsuit that has been been pending since 2005 against Tyson Foods, as nominal defendant, and certain present and former directors and officers of the company.

Under the terms of the settlement agreement (here), Don Tyson (the company's former CEO) and the Tyson Limited Partnership, the Company's largest shareholder are jointly and severally liable to pay the company $4.5 million. No other defendant will make any payments. The company also agreed to implement or continue certain governance measures, as detailed in the settlement agreement. The plaintiffs will be seeking a fee award of $3 million from the company, out of the $4.5 million to be paid under the settlement. The Company has said it will contest the fee award, but will not contest any award up to $1 million.

The derivative complaint contained a variety of allegations, only some of them relating to the timing of the company's stock option grants. Other allegations related to certain consulting contracts, as well as to executive compensation and related-party transactions involving Tyson and his family. But what has drawn notoriety to the case are the complaint's allegations concerning options "springloading" (that is, the award of options in anticipation of an event expected to trigger an increase in the company's stock price). The opinions in the case regarding springloading are undoubtedly represent the leading judicial commentary on the practice.

In opinions dated February 6, 2007 (here), and August 15, 2007 (here), Chancellor William B. Chandler III used memorably scathing language in denying the defendants' motions to dismiss the springloading allegations. Among other things, Chandler said that in the August 15 opinion that the company's proxy disclosure describing the options grants displayed "an uncanny parsimony with the truth" that "raise an inference that the directors engaged in later dissembling to hide earlier subterfuge."

Chancellor Chandler added that he "may further infer that grants of springloaded options were both inherently unfair to shareholders" and that "the long-term nature of the deceit involved suggests a scheme inherently beyond the bounds of business judgment." He added that the Court "may reasonably infer that a board of directors later concealed the true nature of a stock option," from which it may further infer that the options "were not granted consistent with a fiduciary's duty of utmost loyalty."

My prior more detailed discussion of Chandler's August 15 opinion can be found here.

The settlement is of course still subject to court approval, a condition that may be a relevant consideration in this case, given the seeming disparity between the flights of the Court's rhetoric and the scale of the settlement.

In any event, I have added the Tyson Foods settlement to my list of options backdating lawsuit settlements, dismissals and denials, which can be accessed here.

A January 21, 2008 CFO.com article further discussing the Tyson Foods settlement can be found here.

Supreme Court Rejects Enron Appeal: Less than a week after issuing the Stoneridge decision, the Supreme Court has denied (here) the petition for writ of certiorari in the case Enron investors had brought against a number of investment banks. News coverage of the denial can be found here and here.

As noted in the 10b-5 Daily blog (here), the Supreme Court also vacated and remanded to the Ninth Circuit the "scheme liability" case of Avis Budget Group v. California State Teachers Retirement, "for further consideration" in light of the Stoneridge decision.

While the Enron cert petition denial was probably inevitable after the Stoneridge decision, it is also dicey to read too much into the denial. For example, as the Conglomerate blog points out (here), the Enron case was in an odd procedural posture, having come up to the Supreme Court from the Fifth Circuit where it was on an interlocutory appeal after the denial of class certification. The Supreme Court does not have to explain itself when it declines to act. The lower courts will have to live with the Stoneridge decision and work out its meaning in the context of specific cases without further guidance from the Supreme Court, for now.

Professor Larry Ribstein has further thoughts about the meaning (and limitations on the meaning) of the Enron cert petition denial on his Ideoblog, here. The SEC Actions blog, here, finds greater significance to the Supreme Court's actions in the wake of Stoneridge. The WSJ.com Law Blog has more "post-game" analysis on the Enron cert petition denial, here.

More About the Subprime Litigation Wave: Way back in July 2007, when I declared (here) that subprime litigation was "this year's model" (that is, the hot litigation trend driving lawsuit activity), I noted that "subprime litigation is arising in an ever-increasing variety of additional forms" and that "as the concentric rings from asset valuation issues spread outward, an increasing array of companies will become engulfed in the litigation wave."

Sounding similar themes in a January 22, 2008 article entitled "If Everyone's Finger-Pointing, Who's To Blame?"(here), the New York Times observed that

a wave of lawsuits is beginning to wash over the troubled mortgage market and the rest of the financial world. Homeowners are suing mortgage lenders. Mortgage lenders are suing Wall Street banks. Wall Street banks are suing loan specialists And investors are suing everyone.

The article mentions a number of different cases, including in particular a case brought last week by the Maher family against Lehman Brothers Holdings. The lawsuit is described in greater detail in the a January 18, 2008 Bloomberg.com article entitled "Lehman Clients Demand $1.1 Billion on Auction Dispute" (here). The allegations have been brought by two brothers, Brian and Basil Mahan, in an arbitration complaint filed with the Financial Industry Regulatory Authority.

The complaint alleges that the brothers relied on Lehman to invest proceeds from the family's sale of its ship container company, claiming that the family's stated investment objectives were to preserve capital and provide liquidity. Lehman allegedly put the money in auction-rate securities, which lost value due to the turmoil in the credit markets. The brothers seek to require Lehman to buy the illiquid securities and pay treble damages of $857 million. The complaint accuses Lehman of negligence, deception, breach of contract, making unsuitable investments, and supervisory failures.

Thanks to the several readers who sent me copies of or links to the New York Times article.

Now This: The turbulence in the financial markets is scary enough in and of itself. Of perhaps even greater concern is what it may signify. George Soros, the Chairman of Soros Fund Management, suggests in a column in the January 23, 2007 Financial Times (here) that we now face "The Worst Market Crisis in 60 Years."

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