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

During the first quarter of 2013, new corporate and securities lawsuits and regulatory enforcement actions increased slightly compared to the fourth quarter of 2012 but remained well below annual averages over the last two years, according to a new report from Advisen, the insurance information firm. The April 2013 report, which can be found here, is entitled “D&O Claims Trends: 1Q 2013,” notes that “if the first quarter is any indication, it appears that this downward trend may continue throughout 2013.”

Reeders reviewing the Advisen report will want to be very careful to note that the report uses its own terminology. In particular, the report uses the term “securities suits” to refer to all categories of corporate and securities litigation. Among the subsets within this larger category of “securities suits” is what the report calls “securities fraud” suits, which as used in the report refers to actions brought by regulatory and enforcement authorities, as well as private securities suits that are not brought as class actions. The category of “securities fraud” suits does not include securities class action lawsuits, which have their own separate category of “securities class action” suits, which part of the larger category of “securities suits.” Readers will want to be very attentive to the report’s usage of these terms.

According to the report, the first quarter, which traditionally is a busy period for corporate and securities litigation, saw a 40 percent decrease in the number of new corporate and securities lawsuits compared to the first quarter of 2012. Though the activity in 1Q13 was up slightly from the fourth quarter of 2012, the quarterly total of new corporate and securities lawsuits (313) was the third lowest quarterly total since 2009. The leading type of new corporate and securities lawsuits during the first quarter was what the report calls “securities fraud” suits (that is, the regulatory and enforcement actions plus securities suits that are not brought as class actions), which were up 13 percent from the fourth quarter of 2012 but down 33 percent from the 2012 quarterly average.

Many readers of this blog are aware that there has been an upsurge in M&A-related litigation in recent years. Interestingly, the report notes that although M&A activity increased during the first quarter of 2013, the number of M&A-related suits decreased, which is, the report notes, “a development that will require further review.”

For several years, Advisen has noted in its reports that securities class action lawsuits as a percentage of all corporate and securities litigation has been declining, from 22 percent in 2007 to 11 percent in both 2011 and 2012. The percentage ticked up slightly in the first quarter of 2013, when securities class action lawsuits represented 12 percent of all corporate and securities lawsuits. However, in absolute terms, the number of securities class action lawsuits continued a downward trend during the fourth quarter of 2013. During the first quarter of 2013, there were only 36 securities class action lawsuit filings, compared to 50 during the first quarter of 2012 (representing a decline of 28 percent).

Companies in the financial sector experienced the most new corporate and securities lawsuits in the first quarter of 2013. New lawsuits against companies in the sector represented 26 percent of all new corporate and securities lawsuits in 1Q13. While still the sector with the highest level of new lawsuit activity, the percentage of suits against companies in the sector has actually declined. For the forth quarter of 2012, the equivalent percentage was 31 percent and the 2012 quarterly average was 28 percent. The report attributes this decline to the continuing winding down of the subprime and credit crisis-related litigation wave.

The Advisen report concludes with a closer look at the recent wave of “say on pay” and other compensation-related litigation.

Speakers’ Corner:On Tuesday, April 30, 2013, I will be participating in Advisen’s Quarterly D&O Claims Trends Webinar, in which, among other things, the Advisen report will be discussed. In this free webinar, which will take place at 11:00 am EDT, I will be participating on a panel with Paul Ferrillo of the Weil Gotshal law firm, David Murray of AIG, and Jim Blinn of Advisen. The panel will discuss claims trends and developments during the first quarter of 2013. Registration information for the webinar can be found here.

PwC Releases 2012 Securities Litigation Study: Earlier this month, PwC released its annual study of the securities class action litigation. I had not previously linked to the study because for a time the study was not available on the firm’s website. The April 2013 study, which is entitled “At the Crossroads, Waiting for a Sign: 2012 Securities Litigation Study” now can be found here.

As other reports have previously noted, the PwC study notes that securities class action litigation declined in 2012 compared to prior years and compared to historical averages. The report also notes that the decline during the year was largely concentrated in the year’s second half; while securities class action litigation filings were at or near historical levels in the first two quarters of 2012, the number of new filings declined sharply during the year’s second half.

The PwC study also notes, consistent with prior studies that the number and value of securities class action settlements declined in 2012.

How Would You Look With a D&O Diary Coffee Mug?: Only one way to find out. Refer here for details. (Including the fact that the mugs are free. That’s right. Free).

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What are the factors that affect the timing of securities class action lawsuit dismissals and that affect the timing and size of securities suit settlements? These are the questions examined in an April 2012 PLUS Journal article entitled “When Are Securities Class Actions Dismissed, When Do They Settle and For How Much? An Update” (here) by Stanford Law School Professor Michael Klausner and his colleagues Jason Hogland and Matthew Goforth. In this article, the authors update their earlier research on these same questions.

In order to examine these issues, the authors examined the 652 securities class action lawsuits filed between 2006 and 2010. Of the 652 cases, 119 (18%) are ongoing, 257 (40%) have settled, 206 (32%) have been dismissed with prejudice, and 74 (11%) have been voluntarily dropped. Disregarding amounts paid in settlement by third parties (such as offering underwriters), of the cases from this period that settled, the mean settlement amount is $36 million and the median is $9 million.

The authors followed the progression of these cases through the motion to dismiss stage. They found that, among other things, as a result of a combination of dismissal motion rulings, voluntary withdrawls and settlements reached before a dismissal motion ruling, over half of all securities class action lawsuits “end well before discovery and before even a second complaint is filed.”

In 25% percent of cases, the motion to dismiss is granted with prejudice, on average within 19 months of the date on which the complaints were first filed. An additional 9% of cases were voluntarily dropped before the dismissal motion was heard, and another four percent were dropped after the motion to dismiss was granted without prejudice. Thus, a total of 38% of cases “ended relatively quickly and painlessly for defendants.”

In addition, another 13% of cases settled before the motion to dismiss was heard and another 2% of cases settled after the court granted a motion to dismiss without prejudice but before the plaintiffs filed an amended complaint. These cases “entailed costs to defendants and their insurers, but they did not involve extended litigation.”

In 34% of cases, the court granted the motion to dismiss without prejudice, of which 85% of plaintiffs filed a second complaint. The outcome of the second complaint cases roughly parallels the outcomes at the first complaint stage. On average about 30 months passed between the initial filing and the resolution of these second complaint stages. Only five percent of cases reached the third complaint stage, and even fewer involve subsequent complaints. The authors conclude that “relatively few cases entail the filing of a second, third or later consolidated complaint.”

Of all cases that are ultimately dismissed with prejudice, 66% are dismissed at the first complaint stage, 28% are dismissed at the second complaint stage, and 6% are dismissed at the third complaint stage. (Only one case was dismissed at the fourth complaint stage and one was dismissed at the fifth complaint stage.)

Certain factors clearly affect the likelihood of dismissal. For example, when a securities suit involves a parallel SEC enforcement action, the class action was dismissed in only 12% of cases. Cases that involved restatements “were dismissed less frequently than cases that involve non-restatement accounting issues, which in turn were dismissed less frequently than are non-accounting cases.”

In looking at the timing of settlement, the authors categorized the procedural stages of the cases as early pleading (that is, up through the first dismissal motion ruling), later pleading (involving the pleading stages following the first ruling but before the final determination), and discovery (involving the period after the dismissal motion has finally been denied). Forty three percent of settlements occur in the early or late pleading stage, that is while there is still a possibility of dismissal. Just under 60% of settlements occur in the discovery stage, some shortly after the motion to dismiss is denied.

For cases that settle after the motion to dismiss is denied, the time it takes the cases to settle ranges from one month to 46 months, but the mean length of time for a case to settle after the dismissal motion is denied is 16 months.

The authors found that settlement size is related to settlement timing. Settlement size increases as the cases move through the early pleading stage to the discovery stage. The mean settlement for cases that settle in the discovery stage is over $60 million, while the mean settlement of cases that settle in the early pleading stages is less than $20 million.

However, though the settlements tend to grow larger as the cases progress, the settlements as a percentage of shareholder losses decline as the cases advance through the various stages. The authors attribute this seeming contradiction to company size, as larger companies tend to settle later than smaller companies. Though cases involving larger companies settle for larger amounts in terms of absolute numbers of dollars, smaller companies tend to settle for a larger fraction of shareholder losses.

The authors concluded by noting that their findings in this latest updated study are consistent with the finding in their prior study, which had focused on cases filed between 2000 and 2004. The authors note that “it appears that the forces shaping the patterns of dismissal and settlement over the past decade have remained stable.”

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In what is the largest settlement so far of an mortgage-backed securities class action lawsuit filed as part of the subprime and credit-crisis securities litigation wave, the parties to the consolidated Countrywide mortgage-backed securities suit pending in the Central District of California have agreed to settle the litigation for $500 million. The settlement is subject to court approval. The plaintiffs’ lawyers’ April 17, 2013 press release describing the settlement can be found here.

The consolidated litigation that has been settled involves several different lawsuits and several different sets of claimants. Background regarding the litigation can be found here.  All of the claimants allege that they purchased mortgage-backed securities that had been issued by Countrywide prior to its acquisition by Bank of America, and that the offering documents accompanying the offering contained misrepresentations and omissions about the mortgages underlying the securities. Among other things, the claimants alleged that the defendants had misrepresented the underlying process that had been used in the origination of the mortgages and the creditworthiness of the mortgage borrowers.

This litigation has a long and complicated procedural history. Among other cases that are consolidated in this litigation is the Luther v. Countrywide case, which I have written about several times in the past, as pertains to questions of concurrent state court jurisdiction under Section 22 of the ’33 Act. (Refer here for the background of the Luther case and a discussion of the jurisdictional issues involved.)

Further complicating the attempts to settle the case is that during the pendency of the case, Central District of California Judge Marianne Pfaelzer entered several orders dismissing certain groups of claimants on standing and tolling issues. These dismissed claimants preserved rights to appeal these rulings. However, all of the claimants claims are settled through this settlement, including even those whose claims had been dismissed and who might have appealed the dismissal rulings.

According to Steve Toll of the Cohen Milstein Sellers & Toll law firm, who is lead counsel for the class plaintiffs, a plan of allocation will have to be agreed to in order to apportion the settlement amount among the various groups of plaintiffs. The plaintiffs’ lawyers will have to negotiate a proposed allocation amongst themselves and submit a plan of allocation when the settlement papers are submitted to the court.

The $500 million settlement is by far the largest settlement of a mortgage-backed securities class action lawsuit (MBS) as part of the current subprime and credit crisis litigation wave. The next largest MBS securities suit settlement is the December 2011 $315 million Merrill Lynch mortgage backed securities settlement, followed by the $125 million Wells Fargo mortgage backed securities suit settlement. There have of course been larger subprime and credit crisis-related securities class action settlements, led by the massive $2.43 billion BofA/Merrill Lynch merger settlement, among others. However, these other larger settlements did not relate to mortgage backed securities, which, as the procedural history of these cases show, posed a different set of hurdles for the prospective claimants. Overall, this settlement ranks as the sixth largest settlement among all subprime and credit crisis-related securities suit settlements, as shown by the settlement table that can be found here.

I have in any event added the Countrywide Mortgage Backed securities settlement to my running tally of settlements and other case resolutions of the subprime and credit crisis-related lawsuits, which can be accessed here.

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The number of securities class action lawsuits filed against life sciences companies rose in both absolute and relative terms in 2012, according to a March 20, 2013 memorandum by David Kotler of theDechert law form entitled “Survey of Securities Fraud Class Actions Brought Against U.S. Life Sciences Companies.”   According to the report, a copy of which can be found here, life sciences companies “remain an increasingly popular target of securities fraud class action lawsuits.”

According to the report, 27 pharmaceutical, biotechnology and medical companies were hit with securities suits in 2012, representing about 18% of all securities suits filed during the year.  By comparison, in 2011, 17 of those companies had securities suits filed against them, representing just 9% (It should be kept in mind when comparing the two years that securities class action lawsuit filings overall declined significantly between 2011 and 2012, as discussed in greater detail here.) The 18% of all securities suits that life sciences companies’ filings represented in 2012 is “well above the percentage of securities fraud complaints filed in recent years.”

During 2012, the fillings against life sciences companies continued to be concentrated on smaller companies. During 2012, 50% of all life sciences securities suit filings involved companies with market caps of less than $250 million, as compared to 58% in 2011 and 31% in 2010.

Abut 43% of the 2012 life sciences securities complaints involved alleged misrepresentations or omissions regarding product efficacy. However, “complaints claiming financial improprieties and insider trading were still prevalent in 2012.”

Though life sciences companies continue to be the target of securities class action litigation, many of these cases are also dismissed. The report notes that “in 2012, life sciences companies continued to enjoy relative success in obtaining dismissals of the securities fraud lawsuits filed in recent years.” For example, the report shows that of the 23 securities lawsuits filed against life sciences companies in 2008, three remain pending, eleven were settled, and nine have been dismissed, or about 45% of all resolved cases.

However, as the report also notes, “it is equally worth noting that securities fraud lawsuits still carry a substantial risk of exposure, and even when settled can result in very large payments.” The report notes that the 2008 securities suit filed against Medtronic settled during 2012 for $85 million.

The report also discusses the U.S. Supreme Court’s February 2013 decision in the Amgen case (background about which can be found here). The report states that “the Supreme Court’s decision in Amgen is expected to have a profound impact on the critical class certification stage in securities fraud class action lawsuits filed against life sciences companies, especially in the Second, Fifth and First Circuits, where the previously required higher threshold for plaintiffs to overcome the class certification barrier now will be lessened.”

The report concludes with a number of practical suggestions for life sciences companies to take to minimize the risk of, and impact from, securities fraud class actions.

Very special thanks to David Kotler for providing me with a copy of the report.

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Though the number of securities class action lawsuit settlement approvals reached a 14-year low in 2012, aggregate and average settlement amounts increased compared to 2011, according to the annual securities suit settlement report of Cornerstone Research. The report, which is entitled “Securities Class Action Settlements: 2012 Review and Analysis,” can be found here. Cornerstone Research’s March 20, 2013 press release regarding the report can be found here. A one-page infographic of the report’s findings can be found here.

According to the report, courts approved 53 securities class action lawsuit settlements in 2012, compared to 65 in 2011 (itself a very low year) and compared to a 2002-2011 average of 98 settlement approvals per year. The report suggests that the low number of settlement approvals in 2012 may be due to the relatively low number of securities class actions filed in 2009 and 2010.

Though the number of settlement approvals was down in 2012, the aggregate amount of settlement approvals was up substantially compared to 2011. The total amount of all settlements exceeded $2.9 billion dollars in 2012, compared to about $1.4 billion in 2011. Mega-settlements (those involving settlement amounts of over $100 million) accounted for more than 75% of the 2012 settlement amounts.

The average reported settlement amount dramatically increased from 2011 levels—in excess of 150 percent (from the inflation-adjusted amount of $21.6 million in 2011 to $54.7 million in 2012). The median settlement amount increased more than 70 percent in 2012, from $5.9 million last year to $10.2 million.

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I am sure many readers were disturbed as I was by the February 19, 2013 New York Times article reporting that a Chinese army unit apparently has been executing a concentrated cyber-hacking program targeting U.S. companies and critical U.S. infrastructure. (The report of consulting firm Mandiant that was the basis of the Times article can be found here.) This story is part of a rising tide of media reports about cybersecurity risks. Indeed, concerns about these kinds of activities led President Obama’s February 12, 2013 Executive Order entitled “Improving Critical Infrastructure Cybersecurity” (here).

Although the recent disclosures are quite troubling, it is not news that cybersecurity risks represent a significant concern for just about every company involved in the current economy. Prior posts on this site (for example, here) have detailed the liability exposures that these risks represent for all of these companies and for their directors and officers. But while these issues are not new, it really seems that as we have headed into 2013, the volume on these issues has been turned up.. It now seems clear that cybersecurity is going to be one of the hot button issues for the foreseeable future, both in the media and for the affected companies.

The heightened scrutiny of cybersecurity issues has a number of important implications for potentially affected companies, and not just from an operational standpoint. These developments also have important implications for public company’s public disclosure statements, and, as a consequence, for the company’s potential regulatory and litigation exposures.

Indeed, according to a February 21, 2013 memo from the King & Spalding law firm entitled “Cybersecurity: The New Big Wave in Securities Litigation?” (here), “it is likely that this issue will continue to gain momentum among both government regulators and opportunistic plaintiff lawyers seeking to catch the next wave of shareholder litigation.” In particular, the failure to promptly disclose a cyber breach “may put a company at risk of facing formal SEC investigations, shareholder class actions, or derivative lawsuits.”

As the memo notes, the SEC “has already taken a firm stand on cybersecurity disclosures, and clearly views this issue as ripe for enforcement actions.” In October 2011, the SEC’s Division of Corporate Finance issued “Disclosure Guidance” on cybersecurity related issues. Among other things, the Guidance clarified that the agency expects companies to disclose the risk of cyber incidents among their “risk factors” in their periodic filings and also expects companies to disclose material cybersecurity breaches in their Management Discussion and Analysis.

The law firm memo notes that so far, the SEC’s Guidance “seems to have had little impact on corporate disclosure,” and that in many instances companies experiencing cyber breaches are “choosing to keep those events confidential.” However, “given the increasing awareness of this hot issue,” it seems “likely” that the SEC “will increase pressure on companies to disclose such events.” The memo adds that “companies that have experienced significant cybersecurity breaches should prepare themselves for potential SEC investigations and lawsuits.”

In addition to the risk of SEC enforcement action, companies experiencing cyber breaches also face the possibility of a securities class action lawsuit. However, the memo notes, a company experiencing a cyber breach “will likely not be a target of a securities class action unless the disclosure of the breach can be linked to a statistically significant drop in the company’s share price.” In that respect, it is worth noting that several high profile companies announcing cyber breaches have not experienced a significant drop in their stock price following the announcement. (For example, recent announcements by Facebook, Apple and Microsoft that they have been the target of sophisticated cyber attacks did not affect the companies’ share prices.) Nevertheless, it seems likely that at least some companies experiencing cyber breaches or subject to cyber attacks will also suffer a drop in their share price, and “thus result in securities class action litigation.” 

Companies that do not experience a share price decline following a cybersecurity incident may not get hit with securities class action litigation, but they are still susceptible to derivative lawsuits alleging, for example, that company directors breached their fiduciary duties by failing to ensure adequate security measures. As the law firm memo notes, shareholder may claim that senior management and directors “were either aware of or should have been aware of the breach and the company’s susceptibility to hacking incidents.” Of course, any lawsuit of this type would face significant hurdles, including the requirement to make a formal demand on the board as well as the business judgment rule.

In any event, it is clear that cybersecurity issues are going to be an increasing source of scrutiny for companies and their senior officials. This heightened scrutiny not only means that companies will be under pressure to take steps to ensure that their networks and information are secure, but also means that the companies will face pressure both to “disclose the risks associated with potential cybersecurity breaches and provide timely updates when actual breaches occur.” Companies that fall short on these disclosure expectations “will face a substantial risk of regulatory scrutiny and shareholder litigation.”

As Rick Bortnick of the Cozen O’Connor firm discussed in a prior guest post on this site (here), cyber security disclosures have already been the source of securities class action litigation, in the high profile case involving Heartland Payment Systems. Although that case was dismissed, Bortnick points out how different the circumstances and disclosures involved in that case might look if viewed through the prism of the SEC”s 2011 Disclosure Guidance.

Among other implications from these developments is that cybersecurity disclosure seems likely to be the subject of greatly increased scrutiny, suggesting that this disclosure – particularly precautionary disclosure forewarning investors of the possible adverse effects the company could expect in the event of a serious cyber attack – should become a priority for reporting companies.

Finally, these developments and the possible regulatory and litigation implications underscore the fact that cybersecurity exposures represent an important issue to be addressed as part of every company’s corporate insurance program. Indeed, the SEC itself considered the question of insurance for cybersecurity exposures to represent such a critical issue that, in its Disclosure Guidance, it specifically identified the insurance issue as one of the topics companies should address in their disclosure of cybersecurity issues.

The insurance issues related to cybersecurity include not only the question of whether companies should acquire dedicated cyber and network security insurance, but also includes the question of the protection available to the companies’ senior officials under their management liability insurance policies. The rapidly evolving nature of these issues and the related liability exposures underscores the importance for all companies to have a knowledgeable and experienced insurance professional involved in the design and implementation of their corporate insurance program.

Readers interested in the President’s recent Executive Order and its potential implications will want to take a look at the February 2012 article written by Lockton’s Bill Boeck entitled “Cybersecurity Executive Order: What We Know and What We Don’t Know” (here).

Those who are interested in the implications of these developments for corporate directors will want to review the recent guest post on this site by D&O maven Dan Bailey entitled “Cyber Risks: New Focus for Directors” (here).

Classic Rock Notes::In its February 23, 2013 review of new autobiography of record industry executive Clive Davis, the Wall Street Journal describes a critical incident that led Davis to become one of the recording industry’s most successful rock music producers. In June 1967, Davis attended the Monterey Pop Music festival, where he heard Janis Joplin deliver a version of Big Mama Thornton’s “Ball and Chain.” Davis described the event as “not merely one of Janis’s greatest moments onstage, but one of the classic performances in rock history. It was simply overwhelming.” Joplin was, according to Davis, “hypnotic” and “mesmermizing.” Davis says he thought on seeing her performance, “This is a social and musical revolution.”

Davis wasn’t exaggerating. Even in the grainy Internet video, Joplin’s performance will give you goosebumps. Crank up the volume on your computer and enjoy (watch for the cutaway shot of Mama Cass Elliot regarding Joplin in slackjawed amazement).

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A shareholder of the holding company for a failed Virginia bank, the Bank of the Commonwealth, has filed a securities class action lawsuit in the Eastern District of Virginia against the holding company and certain of the company’s directors and officers. The lawsuit, filed on January 22, 2013, follows after the July 2012 indictment of four of the bank’s officers, and the SEC’s January 9, 2013 filing of a civil enforcement action against three of the bank’s former officers. A copy of the shareholder’s securities class action complaint can be found here.

The Bank of the Commonwealth of Norfolk, Virginia failed on September 23, 2011. As discussed in a prior post (here, second item), on July 11, 2012, a grand jury returned an indictment (here) against the bank’s former Chairman and CEO, Edward Woodard, Jr.,  for conspiracy to commit bank fraud, bank fraud, false entry in a bank record, multiple counts of unlawful participation in a loan, multiple counts of false statement to a financial institution, and multiple counts of misapplication of bank funds. Three other former officers of the bank and two of its customers are charged with a variety of related charges. The FBI’s July 12, 2012 press release regarding the indictment can be found here.

As described in its January 9, 2013 press release (here), the SEC filed a civil enforcement action against Woodard, Cynthia Sabol, the bank’s CFO, and Stephen Fields, the bank’s former executive vice president. The SEC’s complaint, which can be found here, asserts claims for securities fraud against the three defendants for alleged “misrepresentations to investors by the bank’s parent company.” The SEC charged the three “for understating millions of dollars of losses and masking the true health of the bank’s loan portfolio at the height of the financial crisis.” The SEC alleges that Woodard “knew the true state” of the bank’s “rapidly deteriorating loan portfolio,” yet he “worked to hide the problems and engineer the misleading public statements.” Sabol also allegedly knew of the efforts to mask the problems yet signed the disclosures and certified the bank’s financial statements. Fields allegedly oversaw the bank’s construction loans and helped mask the problems.

Following just days after the SEC filed its enforcement action, a holding company investor filed a securities class action complaint in the Eastern District of Virginia on January 22, 2013. The complaint names as defendants the holding company itself, six of its former officers and seven directors. The complaint alleges that the defendants “concealed” the holding company’s and the bank’s “true financial condition in a number of ways,” including “fraudulently underreporting the Company’s allowance for loan and lease losses (‘ALLL’) and provision for loan and lease losses … in an effort to overstate the quality and nature of the Bank’s loan portfolio.”

The complaint further alleges that “the truth of the Company’s true financial condition emerged through partial disclosures,” and while the company announced increases in ALLL and the provision for loan and lease losses during the class period “it fraudulently attempted to do so with a ‘soft landing’ by failed to increase ALLL and the Provision to the full extent required, and at the same time issuing false reassurances to investors.”

The complaint alleges that the holding company, Woodard, Sabol, and Woodard’s successor as CEO, Chris Beisel, violated Section 10(b) of the Exchange Act. In a separate count, the complaint alleges that the remaining individual defendants are liable to the plaintiff class as Control Persons under Section 20 of the Exchange Act.

Among the individual defendants named in the complaint is Thomas W. Moss, Jr, a former director of the bank and presently the Norfolk City Treasure and a former speaker of the Virginia House of Delegates. A January 24, 2013 Virginian-Pilot article about the new lawsuit quotes Moss as saying that “the board is clean on this” and saying with respect to the plaintiff that “he doesn’t know what he’s talking about,” adding that “the feds haven’t found a thing wrong with the board.”

The named plaintiff in the complaint, Robert Bogatitus, accompanied his complaint with a certification stating among other things that he had purchased a total of 2000 shares in the bank holding company four separate transactions between May and September 2011. Interestingly, all four of the purchase transactions took place after the company filed its 2010 10-K on April 15, 2011. In the 10-K, the company revealed that “[a] federal grand jury is investigating the Bank and certain of its former and current officers regarding lending and reporting practices of the Bank and the manner in which certain loans and loan renewals were considered and approved.” In addition, the plaintiff purchased half of his 2,000 shares of holding company stock on September 26, 2011 – three days after the September 23, 2011 closure of the bank. The patterns of the plaintiff’s purchases seem to undercut the suggestion that he made his purchases in reliance on representations about the bank’s loan quality and financial condition.

In the wake of current wave of bank failures, much of the focus (including on this blog) has been concentrated on the lawsuits that the FDIC has been filing against former directors and officers of the failed banks. But as the circumstances involving this failed bank show, the post-failure legal proceedings can and sometimes do include a host of other kinds of actions, both civil and criminal. Indeed, at least as of today, the FDIC itself has not filed an action in its capacity as receiver for the failed bank against this bank’s former directors and officers.

The proliferation of legal proceedings here underscores the range of exposures that bank directors and officers can face following a bank’s failure, beyond just the risk of an FDIC D&O action. These proceedings also show the diversity of demands that can be put on a failed bank’s D&O insurance program. It is of course impossible to discern from the outside whether and to what extent this bank carried D&O insurance at the time it failed, and whether or not any insurance remained in place when these various actions have commenced. But to the extent the bank had D&O insurance in place that remained in effect as these various actions have arisen, the attorneys’ fees and costs from the various actions are likely to quickly erode the remaining limits of liability.

If nothing else, the various proceedings also underscore the range of exposures that face bank directors and officers. For those advising banks with respect to their D&O insurance – particularly with respect to publicly traded banks – the sequence of events here represents something of a cautionary example. The proceedings that have followed this bank’s failure provide a substantial example of the kinds of risks that the program should be designed to address.

Special thanks to a loyal reader for sending me a link to the Virginian-Pilot article linked to above.

The Beginning of Another Epic Journey for a Familiar Company? : As reflected in detail here, on June 18, 2002, plaintiff shareholders filed a securities class action lawsuit against Tellabs and certain of its directors and officers. The case would eventually makes its way all the way up to the U.S. Supreme Court, where in 2007 the Court would enter a landmark opinion decision defining the standards to be applied at the dismissal motion stage in a securities class action. The decision is widely viewed as a setback for securities class action plaintiff. After the Supreme Court decision, the case returned to the lower court for extensive further proceedings (including an important interlude in the Seventh Circuit). Finally in April 2011, nearly nine years after the case began, the parties settled the case for $7.375 million.

Whether or not the ultimate outcome was worth it after that tortuous journey, another set of plaintiffs are back at it again. As reflected in the plaintiffs’ lawyers’ January 23, 2013 press release (here), plaintiff investors filed a new securities class action lawsuit in the Northern District of Illinois against Tellabs and certain of its directors and officers. According to the press release, the Complaint alleges that:

the defendants failed to disclose, among others: (1) that in the fourth quarter of 2010, the Company was changing its distribution arrangement with a customer; (2) that this change to the distribution arrangement masked that Tellabs’ business was declining substantially faster than the Company had represented to the public; (3) that the Company's North American business was slowing at a greater rate than the Company had represented to the public; and (4) that, as a result of the above, the defendants' positive statements about the Company's business, operations and prospects lacked a reasonable basis.

It is always hard to know at the outset of a securities suit where it is going to lead, but I suspect that these plaintiffs do not expect another nine year marathon and certainly are hoping that they will not have to make another foray to the Supreme Court. In any event, when the company files its inevitable motion to dismiss, it will be able to rely heavily on the principles established in a Supreme Court decision with the company’s own name on it.

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On January 10, 2013, in a detailed and interesting opinion with features that may be helpful to other life sciences securities suit defendants, Middle District of Tennessee Judge Kevin Sharp granted the motion of Biomimetic Therapeutics to dismiss the securities class action lawsuit that had been filed against the company over its disclosures concerning developments in the clinical trials of its flagship product. A copy of Judge Sharp’s opinion can be found here.

The clinical trials were conducted in support of the company’s efforts to obtain FDA approval of its bone grafting product called Augment. Biomimetic conducted the clinical trial pursuant to protocols it had proposed and that had been approved by the FDA. As later became apparent, Biomimetic based its analysis of the testing results on a different patient population than had been identified in the FDA-approved protocols. The results associated with the different population were more favorable to the company.

The FDA expressed concerns to Biomimetic about the population used and other aspects of the clinical trials in a December 3, 2012 deficiency letter. The FDA also raised a number of concerns about the trials in a May 10, 2011 briefing document released in advance of the public expert panel meeting. Following the meeting, the expert panel narrowly voted in favor of approval of the Augment’s safety and efficacy.

Biomimetic’s share price declined 35% following the FDA’s May 10, 2011 disclosure of the testing concerns. Its share price declined a further 12% following the narrow expert panel vote, out of concerns that in view of the narrowness of the expert panel vote, FDA approval without additional processes was unlikely.

Following the share price decline, shareholders filed a securities class action lawsuit in the Middle District of Tennessee against Biomimetic and certain of its directors and officers. The shareholders alleged that throughout the class period, the defendants made unjustifiably positive statements about the Augment clinical trials and omitted to disclose the specific concerns that the FDA had raised about the trials.

According to the court, the “heart” of the plaintiffs’ allegations was that the defendants had engaged in a regulatory “bait and switch” by changing the patient population used to analyze its trial results in a way that allowed the company to report more favorable results that would have been shown if the original population were used. The plaintiffs also alleged that the defendants had failed to disclose the other problems with the clinical trials, including in particular that Biomimetic had failed to include processes to capture measurements on additional items that were of particular concern to the FDA.

The defendants moved to dismiss the plaintiff’s complaint.

The January 10 Opinion

In his January 10, 2013 opinion, Judge Sharp granted the motion to dismiss without leave to amend, finding that the plaintiffs’ allegations failed to meet the pleading requirements of the PSLRA.

Judge Sharp rejected the argument that the company’s use of a modified patient population to analyze the trial results violated the FDA-approved protocol. He also found that in a press release and in an earnings call, the company had “acknowledged the confusion that had been generated between the classifications of patient populations.” In light of these disclosures, the company’s statements about the patient populations “do not suggest a knowing and deliberate intent to deceive or defraud, let alone highly unreasonable conduct.”

In reaching this conclusion, Judge Sharp put particular emphasis on the fact that the company had “never suggested approval by the FDA was assured,” adding that “quite to the contrary,” the company “repeatedly and consistently warned that there were no guarantees that Augment would be approved.”

Judge Sharp also found that plaintiffs’ allegations that the defendants had deceptively omitted to disclose other clinical trial deficiencies were also insufficient. He concluded that “the alleged deficiencies and the omission in the clinical trials do not raise a strong inference of fraudulent intent as required by the PSLRA.”

In particular, Judge Sharp rejected, as insufficient, the plaintiff’s argument that the company was “cutting corners by failing to conduct certain tests or studies.” He noted that

The notion that [Biomimetic] would recklessly forego necessary tests and studies or hide adverse events makes little sense, even disregarding Defendants’ assertion that they poured their own money into the company. Plaintiffs’ own allegation is that Augment is [Biomimetic’s] flagship product and necessary to the companies [sic] success, begging the question why it would sabotage all of the company’s efforts on the point.

Along those lines, Judge Sharp noted that neither the company nor the individual defendants had engaged in securities sales after the company received the FDA’s deficiency letter.

One particularly interesting aspect of Judge Sharp’s opinion is his consideration of the plaintiffs’ allegations that the defendants had deceptively failed to disclosed the FDA’s concerns in the deficiency letter while at the virtually the same time had made positive statements about the progress of the Augment clinical trials. Judge Sharp noted that “a deficiency letter is not a final FDA decision, but a request for more information, and in fact, very few [applications] are approved without the issuance of a deficiency letter.” Judge Sharp then cited with approval language from a prior opinion to the effect that “it simply cannot be that every critical comment by a regulatory agency has to be seen as material for securities law reporting purposes.” He concluded that based on the overall factual allegations, the company “had a reasonable basis for optimism” notwithstanding the concerns noted in the deficiency letter.

Discussion

As I noted in my recent analysis of 2012 securities class action lawsuit filings, life sciences companies continue to be a favored target for securities class action litigation. The reason the companies attract securities suits has a lot to do with the complex and unpredictable regulatory process to which the companies are subject. The regulatory process is. As this case shows, many things can happen during the course of a clinical trial, which in turn can significantly affect investors’ perceptions of the prospects for the company involved.

There are several aspects of Judge Sharp’s opinion that should be heartening to life sciences companies that find themselves targeted by securities litigation as a result of setbacks the companies experience in the clinical trial process.

First, Judge Sharp showed an uncommon willingness to immerse himself in the complexities of the regulatory process and the science involved with the Augment clinical trials. Because of his willingness to understand the complex details, he was able to understand what had happened concerning the change in patient population used for analytical purposes. He was also able to understand the company’s disclosures about the populations used. Because he had this understanding, he was not persuaded by the plaintiffs’ characterization of the change in patient populations as a “bait and switch.” Of course, other life sciences securities suit defendants may not always have a court as wiling to do the hard work to develop those kinds of detailed understandings of the process and of the science. But this case does show the possibilities arising from trying to make those kinds of arguments to the court.

A second and more interesting aspect of Judge Sharp’s opinion has to do with his analysis of the plaintiffs’ allegations concerning the defendants’ alleged failure to disclose the concerns noted in the deficiency letter. Although he does not come right out and say that life sciences companies do not have an obligation to disclose an FDA deficiency letter, Judge Sharp’s opinion certainly will provide support for other life sciences securities suit defendants who want to argue that the mere fact that the FDA has sent a deficiency letter alone is not necessarily material and that the failure to disclose concerns identified in a deficiency letter does not by itself amount to securities fraud. This aspect of Judge Sharp’s opinion could prove to be quite helpful for other life sciences securities defendants.

Another important aspect of Judge Sharp’s opinion has to do with his analysis of the company’s precautionary disclosures. He clearly considered it important that the company avoided any suggestion that approval of Augment was assured and emphasized the possibility that Augment might not be approved. The company’s precautionary disclosures, along with the absence of any insider or company stock sales at sensitive times, seems to have gone a long way toward reassuring Judge Sharp that the defendants had not set out to deceive anyone. Judge Sharp’s opinion underscores the importance for life sciences companies to avoid overly optimistic statements about future regulatory outcomes as well as for the companies to use the disclosure documents to “bespeak caution” to investors about the uncertainties of the regulatory process.

One final note about Judge Sharp’s opinion has to do with the simple fact that the dismissal was granted. Because of the unpredictability of the FDA regulatory process and because of the resulting volatility of life sciences companies’ share prices, the companies tend to attract significant levels of securities litigation. But though the companies may attract lawsuits,  that does not always mean that the suits are always great cases for the plaintiffs. As one industry observer noted (refer here), “courts continued to grant with relative frequency life sciences companies’ motions to dismiss due to plaintiffs’ inability to sufficiently plead scienter.”

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Largely as a result of a slowdown in new filings during the fourth quarter, 2012 securities class action lawsuit filings were below the filing levels of recent years and below historical averages. Filing levels remained elevated in the natural resources, life sciences and computer services industries, and filings against non-U.S. companies, though off from 2011 record levels, remained above historical levels.

There were 156 new securities class action lawsuit filings during 2012. (Please see the comment below regarding my counting methodology.) The 2012 filing count is down from the 188 securities suits filed in 2011 and is well below the 1996-2011 annual average of 193.

The drop in 2012 filings is largely due to the decline in filings during the fourth quarter. There were 45, 45 and 41 filings during the first, second and third quarters, respectively. However, in the fourth quarter there were only 25 new securities class action lawsuit filings. The 66 new filings during the second half represented the lowest filing level for any half-yearly period since the first half of 2007, when 69 new securities suits were filed. (The lowest half-yearly filing period since 1996 was the second half of 2006, when there were only 55 new securities class action lawsuit filings. )

The 156 securities class action lawsuits filed during 2012 were filed in 45 different federal district courts, as well as two state courts. (The ’33 Act provides for concurrent state court jurisdiction for liability actions under the Act.) Though securities suits were filed in many different courts, there was a significant concentration of filings of new securities suits in the Southern District of New York. There were 43 new securities suits filed in the S.D.N.Y., representing 27.56% of all 2012 filings. Other courts with significant concentrations of new securities suits included the Northern District of California and the Southern District of California, each of which had 13 new filings during 2012; the District of Massachusetts (8); the Northern District of Illinois (7); and the District of New Jersey (6).  Filings in the S.D.N.Y., N.D. Cal., and S.D. Cal. together accounted for over 44% of all of the 2012 securities suit filings.

The 2012 securities suits were filed against companies in a broad variety of industries. The 2012 securities suits involved companies in 81 different Standard Industrial Classification (SIC) Code categories. There were, however, concentrations in certain industries. There were 27 new securities suits against companies in the life sciences industries (represented by companies in the 283 SIC Code group [Drugs] and the 384 SIC Code group [Surgical, Medical and Dental Instruments and Supplies]).These 27 new suits against life sciences companies represented 17.3% of all filing during the year. Of particular note is that there were 15 new filings in the SIC Code category 2834 (Pharmaceutical Preparations) alone, representing nearly ten percent of all 2012 filings.

There were 16 new securities suits against companies in the natural resources extractive industries, including mining (SIC Code categories 1000, 1040, 1220, 1221) and oil and gas production (SIC Code category 1311). And there were ten new securities suits in SIC Code group 737 (computer programming, data processing and other computer services).

There were 26 new securities suits in 2012 against non-U.S. companies, representing about 16.6% of all 2012 filings. Both the absolute number and percentage of suits involving non-U.S. companies are down from 2011, when there were 68 lawsuits against non-U.S. companies represented 36.2% of all filings. Though the 2012 filings against non-U.S. companies were down from 2011, the 2012 filings against foreign firms were at levels comparable to 2010, when there were 27 suits against non-U.S. firms representing 13.4% of all filings.

The record levels of filings against non-U.S. companies during 2011 were largely due to the flood of suits last year against U.S.-listed Chinese companies. There were 41 suits against Chinese-based companies in 2011. Though the number of suits against Chinese companies declined in 2012, there were still 14 suits filed against companies based in China, plus another three suits against companies based in Hong Kong. (Note: I am including in my count of suits against Chinese companies the lawsuit filed on December 31, 2012 in the Southern District of New York against Silvercorp Metals, which is a company with its headquarters in Canada but all of its operations in China.) Overall, the new suits filed against non-U.S. firms in 2012 involved companies based in six different countries. Following China, the country with the highest number of companies sued in U.S. securities class action lawsuits during 2012 was Canada, which had six companies hit with U.S. securities suits.

Discussion

My count of 156 securities suits during 2012 will be different from other published tallies of the securities suit filings. My count is slightly above that of the Cornerstone Research because my tally, unlike the Cornerstone Research tally, includes ’33 Act suits filed in state court pursuant to the Act’s concurrent jurisdiction provisions. At the same time, however, my count is below other tallies, such as, for example, the count of NERA Economic Consulting, because I only count related lawsuit filings once, regardless of the number of separate complaints filed. NERA and others count separate complaints filed in separate jurisdictions separately unless or until they are consolidated in the same judicial district. In addition, my count includes only lawsuits that seek to recover damages for alleged violations of the federal securities laws.  As a result, my tally will be lower than other class action  lawsuit counts that include suits  against corporations and their directors and officers that do no allege securities laws violations (for example, merger objection suits).

The decline in the number of new securities lawsuit filings during the fourth quarter of 2012 is interesting, but at this point it is hard to know what it might mean, and it is far too early to jump to any conclusions about possible permanent shifts in the level of securities suit filings. There have been periods before (for example, at the end of 2006 and the beginning of 2007) when there were lulls in the level of securities suit filings, but at least in the past, the lulls in filing levels have proven to be temporary and relatively short-lived. Indeed, the lull at the end of 2006 and the beginning of 2007 was followed by a surge of new securities filings during following periods, as securities suits related to the subprime meltdown and credit crisis came flooding in.

There seem to be a few possibilities to explain the drop off in securities suit filings in the fourth quarter. The first is the absence of any cyclical phenomenon driving filings. During the period 2007 to 2010, the total number of filings was driven by lawsuits relating to the subprime meltdown and the credit crisis. During 2011, there was a surge of filings against U.S.-listed Chinese firms. By contrast, during 2012, the really wasn’t any particular cyclical development to drive filings.

Another factor in the decline in filings during the fourth quarter may be that there were a significant number of lawsuits filed during that time period as individual actions (particularly many of the lawsuits recently filed alleging misrepresentations in connection with mortgage securities offerings, as well as many of the suits filed in connection with the mortgage put-back litigation). It may be that the individual suit filings distracted from class action lawsuit efforts.

A third factor behind the decline in securities suit filings may be that the plaintiffs’ securities bar is seeking to diversify its product line. As I have previously noted, the increase in M&A litigation and the surge in say-on-say litigation, among other things, may be understood in part as the efforts by at least certain members of the plaintiffs bar to find new opportunities in lieu of traditional securities litigation, which has both become more costly (owing to electronic discovery) and more difficult (owing to case law developments) to pursue. Of course, if some cyclical phenomenon presenting securities litigation opportunities were to emerge, these diversifying plaintiffs’ attorneys could return to pursue securities litigation again.

A final possible explanation for the fourth quarter decline is that the apparent slowdown is purely coincidental and that filing levels will quickly return to normal levels. Just to reinforce this point, though there were only five new filings in October and nine in November, there were seven new securities lawsuit filings just in the final ten days of December alone. It could be that the apparent lull during the fourth quarter was nothing more than a reflection of the natural ebb and flow of securities law suit filings that has characterized filings patterns since 1996.

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New securities class action lawsuit filing levels were comparable to historical norms during 2012, but the number of settlements and of dismissals were both down for the year, according to the analysis and projections of NERA Economic Consulting in their December 11, 2012 publication “Flash Update: 2012 Trends in Securities Class Actions” (here).

According to the report, there were 195 new securities class action lawsuits filed this year through November 30, 2012. NERA projects that there will be around 213 total lawsuit filings by year end. The projected number is slightly below the 2007-2011 average of 221. (It should be noted that NERA counts multiple actions in multiple jurisdictions against the same defendants as different filings, unless and until consolidated, so NERA’s initial lawsuit filing counts will be higher than those published by some other sources. NERA also notes in the report’s footnotes that it “counts” a case if it involves securities, even where the complaint alleges violations of the common law or breach of fiduciary duty. This criterion may also result in counts differing from other published sources, some of which “count” cases only if they allege violations of the federal securities laws.)

The report notes that the 2012 filing levels are more or less consistent with recent years, even though the credit crisis-related lawsuit filings have faded away. The report notes that in 2005-2006, just prior to the credit crisis, annual filing levels had been as low only about 160. The report notes that the number of filings has not declined to these prior lower levels, as “the plaintiffs’ bar has found new causes of action, with merger objection cases picking up much of the slack.”

Though filings levels have remained more or less level, the number of cases resolved during 2012 through dismissal or settlement has plummeted. (It is important to understand that the report measures the time of settlement as the date on which it is approved, so some high profile settlements that were announced in 2012 – such as the massive $2.43 billion settlement of the BofA/Merrill Lynch merger case – are not reflected in NERA’s analysis. The NERA report count of dismissals includes dismissals that are not yet final, such as dismissals without prejudice.)

According to the report, the 92 settlements that are projected to be approved in 2012 is the lowest number since 1996 and 25% lower than 2011. The 60 dismissals projected for the year represent the lowest level since 1998 and the 2012 total is 50% lower than 2011. The total of 152 cases that have been resolved (settled or dismissed) is also the lowest level since 1996. The report notes that part of the reason for these declines may simply be that there were fewer cases pending and therefore available to be resolved as 2012 began, the lowest level of pending cases since 2000. The report also speculates that the slowdown in the number of settlements and dismissals may also be due to “other changes in the legal environment.”

While the number of settlements may have declined, average and median settlements are up. The average securities class action settlement in 2012 was $36 million, compared to a 2005-2011 average of $42.1 million. But if the calculation excludes settlements over $1 billion, the IPO laddering cases and the merger objection cases, the 2012 average is $36 million, up from a revised average for the 2005-2011 period of $32 million. The median settlement in 2012 was $11.1 million, which is the largest ever annual median since 1996, and only the second year since 1996 that the median has exceeded $10 million.

FDIC D&O Lawsuits and D&O Insurance Coverage: Former directors and officers of failed banks who are sued by the FDIC may look to the bank’s D&O insurance to defend and protect themselves. However, the bank’s D&O insurer may assert defenses to coverage that could limit the availability of the insurance, according to a December 10, 2012 memorandum entitled “Not So Fast: Directors and officers Sued by the FDIC over Bank Failures Should Not Assume D&O Insurance Will Cover the Claims” (here) by Britt K. Latham and M. Jason Hale of the Bass Berry and Sims law firm.

As reflected in the memorandum, among other issues, the carriers are raising the “Insured vs. Insured” exclusion found in most policies as a defense to coverage for claims brought by the FDIC in its capacity as the failed bank’s receiver. The authors review the existing case law and observe that “this issue is expected to be hotly contested in the wake of continuing D&O lawsuits by the FDIC related to bank failures.”

My own overview of the impact of the Insured vs. Insured exclusion on the FDIC’s failed bank litigation can be found here. As I discussed in a recent post (here), in October 2012, a federal court in Puerto Rico held that the Insured vs. Insured exclusion does not preclude coverage for an FDIC’s claims as receiver of a failed bank against the bank’s former directors and officers.

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One of the more interesting story lines in the securities class action litigation arena in recent years has been the emergence of substantial class action opt-out litigation, whereby various claimants representing significant shareholder ownership interests select out of the class suit and separately pursue their own claims – and settlements. The class action opt-out litigation emerged as a significant phenomenon in the litigation arising out of the era of corporate scandals a decade ago. After attracting a great deal of attention and concern at the time, the phenomenon seemingly faded into the background -- that is, until several large public pension funds and mutual fund families opted out of the $624 million Countrywide subprime-related securities lawsuit settlement, about which I previously commented here.

Now more than a year after the high-profile Countrywide opt-out suit, some of the same claimants, represented by the same law firm, have now opted out of the class action Pfizer securities litigation pertaining to the company’s disclosures about the safety of its Celebrex and Bextra pain medication. In their November 15, 2012 complaint (here), seven public pension funds (including CalPERS and CalSTRS) and dozens of mutual funds from four separate mutual fund families have filed a separate lawsuit against the company and five of its individual directors and officers. The Pfizer opt-out litigation has a number of interesting features and raises a number of possible implications.

Pfizer’s disclosures and marketing practices relating to the two pain medications have already caused some serious problems for the company. On August 31, 2009, a Pfizer subsidiary agreed to plead guilty to a criminal felony charge. In order to settle the criminal charges, the company paid a fine of $1.195 billion, in what was at the time the largest criminal fine in U.S. history. The company also agreed to pay another $1 billion to settle related civil claims, and also agreed to pay an additional $894 billion to state governments and private litigants to settle the bulk of personal injury litigation and state government probes concerning the two pain medications.

In addition, since December 2004, the company has also been involved in securities class action litigation related to the company’s disclosures about the two pain medications, as discussed in detail here. The lead plaintiff in the pending class action securities suit is the Teachers’ Retirement System of Louisiana. Much has happened in this long-running case. On July 1, 2008, Southern District of New York Judge Laura Taylor Swain denied the defendants’ motion to dismiss (refer here), after which the parties proceeded to conduct discovery. On March 28, 2012, Judge Swain granted the plaintiff’s motion to certify a class (refer here, and refer here for the amended order of class certification). Judge Swain certified a class of shareholders who purchased their shares between October 31, 2000 and October 15, 2005. On September 7, 2012, pursuant to the notice sent to the class concerning the litigation, the opt-out claimants filed a request for exclusion from the class.

Though the opt-out claimants have selected out of the class suit, they enjoy numerous advantages in their separate lawsuits as a result of the years of class litigation. First, the opt-out claimants are actively relying on the long pendency of the class litigation in order to try to avoid possible statute of limitations concerns. In paragraph 548 and following of their separate complaint, the opt-out claimants contend the timely filing and pendency of the class litigation tolls the statute of limitations (through what is known as American Pipe tolling).

In addition, in their complaint the opt-out litigants expressly rely on information developed in the class litigation in support of their claims. In citing the sources on which they are relying as the bases for their allegations, the plaintiffs state in their complaint that they are relying on “documents and information, including internal emails produced by Pfizer, deposition testimony provided by its former officers and employees and court filings in related cases brought against the Defendants” in the consolidated securities (as well as other related cases filed against Pfizer). Of course, the opt-out claimants also get the res judicata benefits of the Judge Swain’s dismissal motion ruling as well.

Which is another way of saying that the opt-out litigants, like all of the other prospective class members, are the beneficiaries of the class action litigation which had been filed and was being litigated on their behalf.

Which does raise the question -- given that the class representative has been actively and successfully pursuing the class litigation on behalf of a class of shareholders including these opt-out claimants for almost eight years, why are the opt-out claimant selecting out of the class?

The answer is that the institutional investor opt-out claimants think the can do better for themselves by proceeding separately. In a November 15, 2012 Am Law Litigation Daily article (here), counsel for the opt out claimants is quoted as saying, among other things, that in other opt-out claims that his firm has filed in connection with other pending securities class action lawsuit, the firm has resolved the opt-outs claims for “multiples” of what they would have recovered as class claimants. The article explains that the firm has represented opt-out claimants in numerous cases, many of which have resulted in confidential settlements. In addition, based on counsel’s remarks in the news article, there has been a level of significant opt-out activity in recent years that has been going on beyond the radar scree -- indeed, the plaintiffs’ firm filing the Pfizer opt-out complaint reportedly has been involved in 14 additional opt-out suits just in the first nine months of 2012.

The comments in the Am Law Litigation Daily article suggest that institutional investors’ interest in opt-out litigation is growing, largely due to the growing perception that their recoveries will be increased by proceeding outside of the class. The opt-out claimants also avoid the cumbersome process and delays involved in the class settlement process. Mutual funds, which traditionally have not been involved in opt out litigation, have become more interested and involved in opting out. The article quotes Columbia Law Professor John Coffee as saying that “the trend is toward opting out,” and the article also notes that if the U.S. Supreme Court in the Amgen case currently pending before the court raises further barriers to securities lawsuit class certification, the trend toward individual securities suits could accelerate.

Though the Pfizer opt out suit is undeniably part of trend, it also is somewhat distinct and perhaps even unique, at least in certain respects. That is, in most of the other high profile opt-out litigation of which I am aware, the prominent opt-outs have chosen to select out of the class only after the class action lawsuit has already been settled. In this instance, the long-running securities suit remains pending.

The interesting challenge this poses for the opt-outs’ counsel is that without a class settlement already on the table, the opt-outs have no ready gauge of how a prospective settlement of their case might compare to the recoveries that will be available to the class when and if the class claims ultimately settle. That is, it will be harder for them to ensure that they did better or are going to do better by proceeding separately. Of course, it does remain to be seen whether or not the opt-out suit or the class action settles first.

The opt-out litigation raises much bigger problems for Pfizer and the other defendants. Not only does the existence of the opt-out litigation mean that they will only be able to fully resolve the now years-old litigation in a piecemeal process, but it also means that settlement talks will represent a complicated process built around the awareness that settlement of either the class or opt-out litigation will have an enormous impact on whichever piece remains unresolved. Given the likely fragmented and complex process, defense costs undoubtedly will mount, as well.

For many years, class action lawsuits have been a favored whipping boy for conservative commentators. But for all of the ills that the class action process can sometimes involve, the prospect of a litigation process in which mass group claims are fragmented and can only be resolved in a piecemeal fashionis no improvement. Given the apparently increasing institutional investor interest in pursuing claims separate from the larger investor class, we could very quickly be getting to the point where resolution of class litigation is only one part of a multistep process.

To be sure, it is only going to be in institutional investors’ interests to opt out in certain kinds of cases. As Adam Savett, the CEO of TXT Capital, notes in the Am Law Litigation Daily article, it will only make sense for institutional investors to opt out when the scale of shareholder losses are huge and where there is a solvent, deep-pocketed defendant available from whom to try to recover.

But even not every securities class action lawsuit will also involve parallel opt-out litigation, there have still been enough opportunities for some plaintiffs’ lawyers to develop a specialty and a growing practice in the opt-out suits. While this unquestionably represents an opportunity of sorts for the opt-out plaintiffs’ attorneys and their institutional investor clients, it creates a host of problems for other players in the securities litigation process.

The class plaintiff''attorneys will see their prospective class recoveries shrink as large institutional investors representing a significant part of the class pursue their own suits separate from the class. The class plaintiffs’ attorneys will watch their own prospective fee recoveries shrink commensurately even as the opt-out plaintiffs’ attorneys’ enjoy the benefits inuring from the class plaintiffs’ attorneys efforts. The defendants will not only incur the additional litigation costs associated with a multi-front war, but they will see their overall litigation resolution costs rise (perhaps significantly) as opt-out plaintiffs pursue separate claims seeking recoveries greater than would be available to the class. Even the courts will face added burdens as suits previously resolved in a single process are fractured into multiple parts. To the extent the added defense fees and settlement costs are insured, these increased costs will drive insurance losses.

For all of these concerns, however, it now appears that significant institutional investor opt out litigation increasingly will be a regular feature of securities class action litigation – which has important implications for all concerned. A key consideration to keep in mind while considering all of this is that sophisticated and well-informed institutional investors are opting-out because they believe that at least in certain cases they wil do better by proceeding outside the class. Which in turn raises serious questions about what that means for the investors remaining in the class.

Speciall thanks to a loyal reader for providing me with a copy of the Pfizer opt-outs' complaint.

Another Georgia Failed Bank Lawsuit: During the current wave of bank failures, Georgia has been the state with the highest number of bank failures. For that reason, it may be unsurprising that the state also has the highest number of failed bank lawsuits. But though the fact that Georgia more bank failure lawsuits than any other state might be expected, the number of lawsuits filed in Georgia is disproportionately high, higher than would be expected just from Georgia’s share of the total number of bank failure. And late this past week, the FDIC filed yet another bank failure lawsuit in Georgia.

On November 15, 2012, the FDIC, as receiver for the failed Community Bank of West Georgia, in Villa Rica, Georgia, filed a lawsuit in the Northern District of Georgia, against three of the bank’s former officers and eight of its former directors. The complaint asserts claims for both negligence and gross negligence “for numerous, repeated and obvious breaches and violations of the Bank’s loan policy and procedures, underwriting requirements, banking regulations and prudent and sound banking practices” as “exemplified” by 20 loans made between May 17, 2006 and October 7, 2007, that allegedly caused the bank losses in excess of $16.8 million. A copy of the FDIC’s complaint can be found here.

Interestingly, three of the individual defendants are named “only to the extent of liability insurance.” The complaint recites that the three individuals have each separately filed for Chapter 7 bankruptcy, and that in connection with each of the separate bankruptcy proceedings, the FDIC has obtained an order from the bankruptcy court allowing the agency to name the individuals as defendants “nominally and only to the extent of insurance coverage.” The FDIC expressly does not seek to recover from personal assets. (The question of whether or not a liability insurance policy can apply when the insured person can have no liability is an interesting one that I am sure will be addressed in the course of the FDIC’s suit.)

Another interesting feature of the FDIC’s suit is that it was filed well after the expiration of the three-year period following the bank’s closure. The bank was closed on June 26, 2009, but the FDIC did not filed its lawsuit until November 15, 2012 – which, all else equal, would seem to raise statute of limitations concerns. It seems likely that at some point prior to the expiration of the three year period that the parties entered a tolling agreement; however, the complaint says nothing either way in this regard.

There is one other interesting feature of the lawsuit, which is that the FDIC has included allegations of ordinary negligence. This is interesting because of the recent decision in the Northern District of Georgia in the Integrity Bank case, applying Georgia law and holding that because of their protection under the business judgment rule, directors cannot be held liable of ordinary negligence. More recently (as discussed here), in the FDIC’s lawsuit against former directors and officers of the failed Haven Trust bank, Northern District of Georgia Judge Steve C. Jones affirmed that Georgia’s business judgment rule is applicable to the actions of bank directors and officers. Based on that determination, Judge Jones dismissed the FDIC’s claims against the directors and officers for ordinary negligence and breach of fiduciary duty. In light of that earlier decision, it would seem that the defendants in the new lawsuit have a basis on which to seek to have the negligence claims against them dismissed. (The FDIC, undoubtedly anticipating this argument, included in its complaint specific allegations asserting that the defendants are not entitled to rely on the business judgment rule, at paragraph 55.) 

This latest lawsuit is the 11th that the FDIC has filed as part of the current bank wave involving directors and officers of a failed Georgia bank. Because the FDIC has not updated its online litigation page in over a month, I am not completely sure of the current overall number of lawsuits filed, but I believe that this latest suit represents the 36^th that the agency has filed against directors and officers of failed banks so far. In other words, over 28 percent of all the D&O lawsuits the FDIC has filed so far have been filed in Georgia. Of the approximately 440 banks that have failed during the current bank failure wave, about 80 were in Georgia, or about 18 percent of the total. For whatever reason, the FDIC’s D&O litigation activity is disproportionately concentrated in Georgia. By contrast, Florida, which also has seen a significant number of bank failures as part of the current bank failure wave, has only seen one lawsuit – so far.

Scott Trubey’s November 16, 2012 Atlanta Journal-Constitution article about the latest lawsuit can be found here. Special thanks to a loyal reader for providing me a link to Trubey’s article and alerting me to the latest lawsuit.

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On July 25, 2012, Cornerstone Research in conjunction with the Stanford Law School Securities Class Action Clearinghouse release it report entitled “Securities Class Action Filings: 2012 Mid-Year Assessment” (here). By contrast to other mid-year securities litigation reports, the Cornerstone Research study reports that securities class action litigation filings decreased by 6 percent in the first half of 2012,  compared to both the first half and second half of 2011. I discuss below possible explanations for the differences in the conclusion between the Cornerstone Report and other published studies of first half filings. Cornerstone Research’s July 25, 2012 press release about the report can be found here. My own analysis of the first half 2012 filings can be found here.

 

According to the Cornerstone Research report, there were 88 filings in the first half of 2012, which annualizes to 176 filings. This annualized figure is below the 1997 to 2011 average number of filings of 193, but in line with the 2009 to 2011 average of 177.

The slight decrease in the number of filings is due to the “substantial decline” in Chinese reverse merger filings and also to a decline on mergers and acquisitions related filings. Chinese reverse merger filings were down 79 percent in the year’s first half, compared to the first six months of 2011, and M&A related filings were down 67 percent. The press release quotes Stanford Law Professor Joseph Grundfest as saying with respect to the M&A related filings that in the second quarter of 2012, “the aggregate deal flow count reached the lowest level since the third quarter of 2009,” which obviously was a factor in the decline the federally-filed M&A litigation in the first half of 2012.

While litigation related to Chinese reverse merger companies and M&A activity declined in the first half, “traditional filings” increased 23 percent, offsetting the decline in the number of nontraditional filings. Filings against non-U.S. companies decreased in the first half of 2012 after a sharp increase in 2011 (when there were significant numbers of Chinese reverse merger filings) but remained above historical levels. In the first six months of 2012, 26 percent of all filings involved non-U.S. companies, compared to 36 percent in 2011, but also compared to 9 percent for the period 1997 to 2010.

Of the 88 securities class action lawsuits filings in the first half of 2012, 10 involved S&P 500 companies, compared to eight in the first half of 2011.

In terms of looking ahead, the press release quotes Professor Grundfest as saying that “the Libor-litigation industry is clearly a sector to watch for years to come.” Both the size of the potential exposures and the complexity of the claims mean that the Libor-scandal will “likely generate large amounts of litigation activity in may geographies.” Interestingly, Grundfest suggests that “much of the litigation activity will occur away from the U.S. class action securities sector, but more lawsuits are virtually assured.”

Discussion

The Cornerstone Research reports on securities litigation activity are unique, in that it is possible to go to the Stanford Law School Class Action Securities Class Action Clearinghouse website and identify exactly what their reports are “counting.” By comparing the filings listed on their website, it is possible to determine what they are – and more importantly, what they are not – counting in their tally. By comparing the list of cases on the website with my own list of cases, it is a simple matter to determine why the Cornerstone Research tally is lower than other published tallies, and why Cornerstone Research is report that filings are declining, which other observers are reporting that filings are holding steady or increasing.

Simply put, the difference has to do with the M&A related filings.  Further review reveals that Cornerstone Research is not including federal court merger objection cases that do not include a claim based on an alleged violation of the federal securities laws. For example, if a federal court merger objection suit contains only a claim for breach of fiduciary duty, but no claim for breach of the federal securities laws, it is not included in the Cornertone list.The exclusion of these cases accounts for a significant part of the differences between the Cornerstone Research tally and other published figures.

Another difference between the Cornerstone Research tally and other published figures is that, as the Cornerstone Research report states on the inner page following the title page of the report, in counting filings, the Cornerstone Research report takes the following approach: “Multiple filings related to the same allegations against the same defendant(s) are consolidated in the database through a unique account indexed to the first identified complaint.” Other published reports take a different approach, counting separate complaints in separate judicial districts separately, at least until formally consolidated in a single action or proceeding. These differences in counting methodology also account for apparent differences between the Cornerstone Research report and other published reports.

One final observation I have is that the discussion about filing activity and whether filings are up or down often relates exclusively to the absolute number of filings. In my view, the absolute numbers of filings alone, considered without respect to the changing numbers of public companies, can lead to some misleading conclusions. The fact is that the absolute numbers of annual filings over the last 17 or so years has remained within the same very narrow band, while the numbers of publicly trade companies has declined dramatically. The key fact that should not be lost sight of here is that for any given company with shares trading on the U.S. exchanges, the chances of getting hit with a securities class action lawsuit are much higher now than they were, for example, in the late 90s. Focusing solely on the absolute numbers of lawsuit filings is not sufficient to fully understand what is going on.

Professor Grundfest’s comments about the likely Libor-scandal litigation are very interesting. Because so many of the events and so many of the prospective defendants are located outside the United States, it does seem more likely that lawsuits would be brought outside the United States -- except for the fact that there are so many procedural advantages to pursuing claims in the U.S. It will be very interesting to see if, as Professor Grundfest has suggested, Libor-related litigation outside the U.S. will be a significant factor.

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The lead article in the November 17, 2010 Wall Street Journal reported that the FDIC is conducting 50 criminal investigations of directors, officers and employees of failed banks. Given that (as of November 19, 2010) 314 banks have failed since January 1, 2008, this report suggests that the FDIC is investigating possible criminal charges in connection with a pretty hefty percentage of the bank failures -- about 16%, if each of the 50 investigations relates to a separate bank.

These reports of as many as 50 criminal investigations are all the more striking because up to this point, the FDIC has not conspicuously pursued criminal charges. The most prominent criminal charges filed as part of the current wave of bank failures related to the May 2010 indictment of two former officials from Integrity Bank in Alpharetta, Georgia. Integrity Bank failed in August 2008, which was fairly early in the current failed bank wave. Many more banks have failed since then, and so the FDIC may just now be completing its investigations of many of the later bank failures.

In the meantime, banks are continuing to fail. Just this last Friday night, the FDIC closed three more banks, bringing the 2010 YTD total number of bank failures to 149. (The Journal article does note that FDIC officials "expect the failure wave to peak this year.")

Obviously, the FDIC has not even had an opportunity to investigate the most recent bank failures, which suggests that the figure of investigations could grow.

The Journal article quotes one FDIC official, speaking of possible civil actions to be brought against former officials of failed banks, "these numbers will continue to grow as time goes on." (The Journal article repeats the information, now widely circulated, that the FDIC has authorized civil actions against more than 80 directors and officers of failed banks.) The Journal article also reports that it takes up to 18 months for the FDIC to determine whether to bring an action, meaning that "the surge in scrutiny is likely to continue for years."

One particularly noteworthy step the FDIC has taken as it readies itself to pursue actions in connection with the failed banks is that it has begun to try to recover documents from outside law firms that were advising the directors and officers of failed institutions before they were closed.

As detailed in a November 20, 2010 Bloomberg story (here) the FDIC has sued one law firm and threatened to sue another in order to recover documents bank executives gave the lawyers before the institutions failed.

A copy of the November 9, 2010 complaint filed against the Bryan Cave law firm can be found here; a copy of the November 10, 2010 consent order attempting to resolve the matter can be found here. A November 12, 2010 Am Law Daily article about the dispute can be found here. .

In the dispute involving the second law firm, the law firm itself initiated an action, in the form of a November 17, 2010 declaratory judgment action. The law firm had received a letter from the FDIC demanding the immediate return of the documents their clients had supplied them.

It may be, as suggested in the Journal article, that the wave of bank failures will peak this year. But the FDIC’s recent actions seem to be preliminary to an onslaught of litigation activity (both civil and criminal) and suggest that the FDIC claims-related activities have only just begun but will be accelerating for some time to come.

Special thanks to a loyal reader for copies of the pleadings in the FDIC’s law firm related litigation.

Meanwhile, Investors Pursue Securities Suits Against Banks: While the FDIC’s moves toward litigation involving failed banks has been a long time coming, investors in failed and troubled banks have much more assertive. As I have previously observed, a noteworthy feature of the current round of bank failures has been the significant numbers of investor suits involving failed and troubled banks.

The numbers of investor related suits involving failed or troubled banks continues to mount. Just in the last week, investors filed two more securities class action lawsuits involving failed banks.

First, as reflected in their November 18, 2010 press release (here), plaintiffs’ lawyers have initiated a securities class action lawsuit in the District of Delaware against Wilmington Trust Corporation and certain of its directors and officers. A copy of the complaint can be found here.

Second, in a separate November 18, 2010 press release (here), another plaintiffs’ firm announced that they had filed a securities class action lawsuit in the Eastern District of Tennessee against Green Bankshares and certain of its directors and officers. A copy of the complaint can be found here.

With the addition of these two latest lawsuits, as many as thirteen of the approximately 154 new securities class action lawsuit filed during 2010 have involved commercial banks, or roughly 8.5% of all 2010 securities class action lawsuits. The banking related securities suit activity has been one of the most significant factors in 2010 securities filing activity (not even taking into account the claims that have arisen involving banking companies that were not publicly traded).

Perhaps the only other group of companies that has been so specifically targeted in lawsuits this year is the for-profit education sector, which has been hit with nine separate securities class action lawsuits this year, or about 6 percent of all 2010 securities suits.

Schwab YieldPlus Settlement Back On?: As I reported in an earlier post, the Charles Schwab Corporation had announced its decision to withdraw from the $235 Schwab YieldPlus Fund subprime-related securities class action settlement, due to a dispute about whether or not the settlement stipulation released the California state law claims of non-California class members.

However, according to November 18, 2010 news reports (here), the parties to the YieldPlus case have reached a revised settlement The revised settlement is intended to make it clear that all of the claims of the class are released, including the California state law claims of non-California residents.

A copy of the parties’ November 17, 2010 amendment to their settlement stipulation, reflecting the revised understanding, can be found here. A copy of the parties’ joint motion regarding the revised settlement stipulation can be found here. The parties’ amended settlement stipulation is subject to the approval of Northern District of California Judge William Alsup.

QE II: Here at The D&O Diary we have followed with interest the debate about the Federal Reserve’s latest round of "quantitative easing." Because we feel unqualified to comment on the Fed’s actions, we express no views of our own here about the wisdom of the Fed’s approach.

Others have not been as restrained.

In that vein, a video critical of the Fed’s actions has been making the rounds and I have attached it below. I want to stress that this video does not necessarily reflect my views, and I am linking to it here only because I think it is pretty amusing and because it has been a while since I have had occasion to link to a video on this site. Special thanks to a loyal reader for the link to the video. 

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While many courts are showing a greater willingness to grant motions to dismiss in subprime-related securities class action lawsuits, some cases are surviving dismissal motions and others are settling for hundreds of millions of dollars, as a result of which the "watchword is uncertainty until a more consistent and predictable pattern emerges," according to a recent study.

In a June 2010 report entitled "Subprime Class Actions Revisited," Jonathan Eisenberg of the Skadden law firm examines 14 new subprime-related securities lawsuit rulings issued during the first five months of 2010. This report updates Eisenberg’s prior analysis of 16 dismissal motion rulings entered in 2009.

Eisenberg’s overall conclusions are that "courts are showing more evidence of subprime fatigue and a greater willingness to grant motions to dismiss even in cases that do not require proof of scienter," but while "recent trends have been more favorable for defendants, the results are by no means one-sided, and the final chapters of the subprime class action story have yet to be written."

Eisenberg notes that, by contrast to his earlier study, "more than half of the recent dismissals occurred in non-scienter Securities Act claims." Eisenberg also notes that courts continue to dismiss many of the Section 10(b) claims asserted in the subprime securities class action, "principally, but not exclusively, on the ground that the allegations of scienter are inadequate." Court has also found a number of the allegedly fraudulent statements immaterial as a matter of law.

With respect to the cases that have survived dismissal motions, the basis "overwhelmingly" are allegations related to "declining underwriting standards." In light of the numbers of cases that have survived the dismissal motions, as well as the significant dollar figures involved in some of the settlements, "while the story in the aggregate is positive for defendants, much risk remains in these cases." Overall, Eisenberg finds that he has "not found a single factor that explains the outcomes across all cases."

My running tally, listing (with links) dismissal motions rulings and settlements in all subprime and credit crisis-related lawsuits, can be accessed here. All of the decisions referenced in Eisenberg’s article are listed with links in my tally.

One interesting aspect of Eisenberg’s paper is with respect to his discussion of the difficulties plaintiffs face in trying to allege that defendants were "slow to recognize the enormity of the subprime crisis." He recites data from Bloomberg’s tally of subprime-related write downs showing that "less than three-tenths of one percent of the more than $1.75 trillion of global write-downs between 2007 and 2009 occurred prior to the third quarter of 2007." The rest occurred incrementally from the third quarter from the 2009.

Eisenberg suggests these data show that Judges "are and should be skeptical of the types of claims that could be made against virtually any financial institution that was late to recognize the damages ultimately inflicted by the subprim tsunami."

Special thanks to Jon Eisenberg for providing a copy of his article.

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In a November 26, 2008 opinion (here), the Ninth Circuit affirmed the lower court’s dismissal of a lawsuit asserting securities law violations against InVision and certain of its directors and officers based on FCPA-related disclosures. The case is noteworthy not only for its involvement of FCPA-related allegations, but also for the appellate court’s consideration of "collective scienter" issues, as well as of the significance of Sarbanes-Oxley certification issues.

Background

On March 15, 2004, InVision announced it would be acquired by GE in a cash-for-stock transaction. That same day, the company filed its annual filing on Form 10-K to which the merger agreement was attached. On July 30, 2004, InVision announced that an internal investigation had revealed possible violations of the Foreign Corrupt Practices Act (FCPA). The company voluntarily reported the activities to the SEC and the DOJ. The company later entered negotiated arrangements with the DOJ and the SEC (refer here). GE later consummated the pending merger.

Shortly after InVision announced the FCPA concerns, shareholders initiated a securities class action lawsuit against the company and certain of its directors and officers. (Refer here for further background regarding the case). The plaintiffs based their claims on three alleged misstatements in the merger agreements, which InVision had attached to its 10-K.

The plaintiffs alleged that the merger agreement misleadingly stated that the company was "in compliance … with all applicable law"; in compliance with the "books and records" provision of the FCPA; and that that neither the company nor any of its officers, directors or employees had knowledge that the company had violated the FCPA’s antibribery provisions.

The district court dismissed the complaint and the plaintiffs appealed.

The Ninth Circuit’s Decision

The appellate court essentially assumed that the plaintiff had satisfied the requirement to plead falsity with respect to the three alleged misrepresentations stating that "even if [the plaintiff, Glazer] properly pled falsity, the district court’s dismissal would still be appropriate if Glazer failed to plead scienter adequately with respect to the three statements."

In order to satisfy the scienter requirement, the plaintiff urged the Ninth Circuit to adopt the "collective scienter" theory, following the Second Circuit’s recent decision in the Dynex Capital case (refer here) and the Seventh Circuit’s recent decision in the Tellabs case (refer here). Under this theory, as articulated by the Seventh Circuit, "it is possible to draw a strong inference of corporate scienter without being able to name the individuals who concocted and disseminated the fraud."

After reviewing the case law concerning corporate securities liability, including its own prior decision in the Nordstrom v. Chubb case (a decision that will be familiar to many of this blog’s readers), the Ninth Circuit ultimately concluded that this case did not require the court to decide whether or not to adopt the theory of collective scienter.

The court concluded that because of "the limited nature and unique context of the alleged misstatements" involved in the case, the "collective scienter" issue was not before the court. In reaching this conclusion, the court noted that

Glazer rests its securities fraud claim on three statements, all of which appear in a sixty-page legal document. If the doctrine of collective scienter excuses Glazer from pleading individual scienter with respect to these legal warranties, then it is difficult to imagine what statements would not qualify for an exception to individualized scienter pleadings. In fact, because the merger agreement warranted that the company was in compliance "with all laws," then under the collective scienter theory urged by Glazer, so long as any employee at InVision had knowledge of the violation of any law, scienter could be imputed to the company as a whole. This result would be plainly inconsistent with the pleading requirements of the PSLRA.

 

Accordingly, the Ninth Circuit held that in order to succeed on his claim, the plaintiff had to establish that individual defendants acted with scienter in making the statements in the merger agreement. The court said that "we see no way that [the defendant] could show that the corporation, but not any individual [director or officer] had the requisite intent to defraud." Only the company’s CEO and CFO had signed the merger agreement, and the plaintiff alleged scienter only with respect to the CEO, Magistri.

The court found with respect to Magistri, however, that Glazer had not pled any facts to demonstrate that "Magistri was personally aware of the illegal payments or that he was actively involved in the details of the details of InVision’s Asian sales."

The Ninth Circuit also refused to infer scienter from the CEO’s and the CFO’s signature of the Sarbanes-Oxley certifications, holding that the mere signature, without more, is insufficient to raise a strong inference of scienter.The Ninth Circuit followed prior decisions of the Eleventh and Fifth Circuits, concluding that there was no evidence that the SOX certification requirements were intended to alter the PSLRA’s pleading requirements. The Court said that "the Sarbanes-Oxley certification is only probative of scienter if the person signing the certification was severely reckless in certifying the accuracy of the financial statements.

Discussion

The Ninth Circuit’s decision is noteworthy for its discussion of the "collective scienter" issue, although in the end it is of limited significance on this point given the court’s conclusion that it did not need to reach that issue. The decision is also noteworthy for its discussion of the Sarbanes-Oxley certification issue, but in that respect it also merely followed existing precedent.

But perhaps the greatest significance about the Ninth Circuit’s opinion may be what it suggests about securities cases based on FCPA-related disclosures. The Ninth Circuit’s refusal to allow the claim to proceed in the absence of allegations that senior officials were aware of the improper conduct could present a significant hurdle for FCPA-related securities claims, at least in the circuits that have not adopted the "collective scienter" theory.

As the Ninth Circuit noted in the InVision case, "the surreptitious nature of the transactions creates an equally strong inference that the payments would have deliberately kept secret – even within the company." Obviously, payments of this kind invariably are of a surreptitious nature and of a kind that would be kept secret, even within the company. The implication is that in order for a securities claim alleging FCPA-related disclosures to survive the initial pleadings stage, the claimants may have to plead that the company officials who prepared the company’s public disclosures were aware of the improper activities.

In prior posts (most recently here), I have noted the increasing prevalence of follow-on civil litigation accompanying FCPA investigations, including the increasing frequency of follow-on securities litigation alleging misrepresentations in the FCPA-related disclosures. The Ninth Circuit’s decision in the InVision case suggests that, at least in jurisdictions that have not recognized the collective scienter theory, the ability of these follow-on securities lawsuits to get past the pleading stage may depend on the existence of allegations that senior company officials were aware of the improper payments. Given the invariably "surreptitious nature" of these payments, claimants may find this a challenging requirement to satisfy.

The SEC Actions blog has a thorough analysis of the Ninth Circuit’s discussion of the pleading issues in the InVision case, here. The FCPA Blog also has a good discussion of the case, here.

Special thanks to Neil McCarthy of Lawyerlinks.com for providing me with a copy of the Ninth Circuit’s opinion.

Another New Wave Securities Lawsuit: In a recent post (here), I noted that there have been several recent securities class action lawsuits in which the companies involved have been hit with significant losses due to wrong way bets on commodities or currencies.

The latest example of this type of securities litigation involves a case filed on November 26, 2008 in the Southern District of Florida against Brazilian forest products manufacturer Aracruz Cellulose S.A. and certain of its directors and officers on behalf of investors who purchased the company’s American Depositary Receipts on the NYSE., as well as purchasers of the company’s common stock, which trades on the Sao Paulo Bovespa.

According to the plaintiffs’ lawyer November 26 press release (here), the complaint alleges that

During the Class Period, Aracruz entered into undisclosed currency derivative contracts to purportedly hedge against the Company's U.S. dollar exposure. The Company characterized the use of these contracts as protection against foreign interest rate volatility and assured investors that this type of trading did not represent "a risk from an economic and financial standpoint." However, these contracts violated Company policy in that they were far larger than necessary to hedge normal business operations. As a result of Aracruz's clandestine and speculative currency wagers, credit rating agencies downgraded Aracruz, the Company's CFO resigned, and Aracruz's stock suffered a severe decline, plummeting to the lowest levels in 14 years.

As I noted in my prior post, many companies were also exposed to sudden and unexpected losses by dramatic changes in the commodities and currencies markets earlier this year. For example, the November 29, 2008 Wall Street Journal reported (here) on several airlines that have recently reported the negative impact from fuel cost hedges that generated huge losses. These kinds of developments and other unexpected fallout from the crisis roiling global financial markets are likely to affect a wide variety of companies, some of which may be subject to securities litigation.

It is interesting to note that the plaintiffs’ lawyers in the Aracruz case appear to have made a conscious decision to include within the class the Brazilian company’s common shareholders. Within this group are likely to be a number of shareholders domiciled outside the U.S. that bought their shares against the foreign company on a foreign exchange. The presence of these so-called "foreign-cubed" litigants could pose subject matter jurisdiction issues, at least as to those claimants.

My recent post discussing the Second Circuit’s recent "foreign-cubed" litigant ruling in the National Australia Bank case can be found here. The November 24, 2008 Southern District of New York decision granting the motion to dismiss the securities class action lawsuit that had been filed against Vodafone for lack of subject matter jurisdiction, in reliance upon the National Australia Bank decision, can be found here. (Note: Special thanks to the reader who pointed out that I had incorrectly referred to the Vodafone case as the Vivendi case. My apologies for any confusion.)

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There no longer seems to be a question whether European countries will adopt some form of collective action procedures. The questions now are what form the collective action mechanisms will take and to what extent will the processes will adapt or reject features of the U.S. class action model.

A November 6, 2008 article by NYU law professors Samuel Issacharoff and Geoffrey Miller entitled "Will Aggregate Litigation Come to Europe?" (here) takes a look at these questions and examines whether current European reforms are, in light of the extent of the aversion to the U.S. model, "likely to be effective in realizing their stated aims."

The authors begin their analysis by noting that while class actions were long "decried as the perversity of rapacious Americans," class actions are now "the focus of significant reforms in many European countries and even at the level of the European Union." Indeed, a "consensus" has emerged that "aggregate litigation will soon be the norm" in Europe. But by the same token, there is also a consensus that the European model of aggregate litigation "will not replicate American class action litigation with its domination of entrepreneurial plaintiffs’ attorneys."

The European movement toward aggregate litigation models has advanced because of the "need to create ex post accountability mechanisms" and the create mechanisms for the "efficient resolution of numerous intertwined claims." Aggregate litigation also mobilizes "efforts to foster prevention through the prospect of civil litigation."

The authors note that the criticisms of the U.S. model in many ways correspond with concerns raised inside the U.S. But the authors also ask whether or not the categorical aversion to the U.S. model may leave European reform efforts without the means to achieve desired results.

In order to assess whether the European rejection of the U.S. model sweeps too broadly, the authors examine the recurring criticisms of U.S. class action litigation. Among other things, the authors suggest that by framing the debate this way, the discussion will reflect both the weaknesses and the strengths of the U.S. approach and allow the reform process to benefit from the beneficial aspects of the U.S. approach.

The four criticisms of U.S. class action litigation on which the authors focus are:

(1) the danger that mass settlements may overgeneralize, by treating differently situated claimants as if they were similar, particularly where "an unsolicited and effectively unsupervised" agent resolves the case on behalf of absent class members;

(2) the most significant recovery is "often by successful class counsel, not by any class member;

(3) the uneasy relation between entrepreneurialism and avarice (as evidenced most recently by the criminal pleas of leading plaintiff securities attorneys); and

(4) the manipulation of the judicial forum for litigation gain (particularly through serial exploitation of "judicial hellholes").

The authors observe that what unifies these four controversies is "the role of private entrepreneurial lawyers" – which, the authors note, is "precisely what troubles Europeans about American class action practice." Nevertheless, motivated lawyer action is the "engine that fuels American aggregate practice." The authors ask whether the comprehensive rejection of the U.S. model "throws the baby out with the bath water" and whether "the controversies that arise in a system build on self-interest can be mitigated without disabling the entire undertaking."

In order to examine these questions, the authors look at the common features of European collective action reform efforts. While the legal reforms represent a broad spectrum of initiatives, there are three common features: (1) the tendency to allow only organizations to represent consumers in class actions; (2) the interaction between rules on litigation funding and class action procedures; and (3) the preference for "opt-in" rather than "opt-out" systems.

The authors find that there are potentially significant limitations to each of these unifying features. The authors also note that the evolving European efforts attempt to realize the benefits of collective action, but are "limited in their conception of how these processes will be realized."

The threshold issue that current European reform efforts must address is who will "organize, fund and lead the collective efforts." Both the strength and weakness of the American collective approach has been the "willingness to entrust a great deal of social regulation to private initiative and common law forms of adjudication." The authors express their concern that the European "cultural revulsion" to "accepting the reality of legal enforcement as entrepreneurial activity may leave the reforms without the necessary agents of implementation."

Discussion

The excesses of the U.S. class action system are a familiar hobby horse for social critics, both in the U.S. and abroad. Nevertheless aggrieved parties continue to pursue relief and redress through class litigation -- and not just consumers whose interests critics contend are hijacked by self-interested lawyers, but also well-financed institutional investors that are fully informed about their interests and fully able to act independently.

While Europeans disdain the excesses of the U.S. model, there have been periodic outbursts over the past several years where the need for collective action mechanisms has been so obvious that the local legal systems had to respond. Among the various corporate scandals that came to light earlier this decade were several instances where large group of aggrieved European investors were adversely affected and collectively sought redress. The current credit crisis underscores these issues. The further European development of collective action mechanisms does, as the authors note, seem to be inevitable.

On the other hand, the limitations of the U.S. model have been painfully apparent lately. The criminal sentencing of the leading plaintiff securities attorneys certainly highlights the corrupting potential of class litigation where the agent controls or even selects the principal.

There is also recent evidence that aggrieved parties involved in U.S-based litigation increasingly may perceive their interests to be best served outside of class litigation. Significant securities class action opt-out actions, in which would-be class members proceed independently to maximize their recovery and even to reduce counsel fees (about which refer here), suggest deep concerns about the utility of class litigation.

The authors may be correct that class litigation is most effective if it is driven by motivated entrepreneurs who can drive the process and maximize class results. Nevertheless, the lessons of the recent past in the U.S. highlight clearly how important it is for strict controls over class counsel.

The recent lessons also suggest the need for some modesty in advocating the U.S. class counsel model to Europeans. Indeed, rather than expecting the success of the European reforms to depend on European’s willingness to adopt aspects of the U.S model (such as the involvement of entrepreneurial counsel), perhaps it will be the case that the improvement of the current flawed U.S. model will depend on the adoption in the U.S. of existing or yet-to-emerge European innovations that develop as part of current European reform efforts.

Hat tip to the Point of Law blog (here) for the link to the article.

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In a recent post (here), I raised concerns about the possibility of U.S.-domiciled companies becoming subject to securities litigation under the Ontario Securities Act. Now, a recent decision by an Ontario Superior Court judge interpreting the Act’s provisions suggests the possibility of litigants using a parallel Ontario proceeding to circumvent the PSLRA’s discovery stay.

The decision arose in connection with the prospective securities action that claimants seek to pursue in Ontario court against IMAX and certain of its directors and officers. Under the provisions of Bill 198, enacted in 2005 and codified in Section XXIII.1 of the Ontario Securities Act (which can be found here), a preliminary procedure is required to determine whether a liability action under the Act can proceed.

Section 138.8 (1) of the statute, a liability action cannot be commenced "without leave of court granted upon motion with notice to each defendant." The court is to grant leave only "where it is satisfied" that the action "is being brought in good faith" and there is a "possibility" the plaintiff will prevail at trial.

The procedure specified for this determination is that the plaintiff and each defendant are to serve affidavits "setting forth the material facts upon which each intends to rely." The affiant may be "examined" on the affidavit "in accordance with the rules of the court."

The issue addressed in the recent decision in the IMAX case is the breadth of the examination that is to take place in connection with this authorization proceeding. In addressing this question, Madame Justice Katherine van Rensberg issued a ruling that potentially could compel defendants to answer questions under oath about a broad range of issues, even issues the claimants have not initially raised. A November 18, 2008 Globe and Mail article regarding the decision can be found here.

Justice van Rensberg wrote that the Act itself "provides no guidance as to the interpretation of the threshold test and what type, quality and quantity of evidence the court is to consider." IMAX had urged her to restrict examination to publicly available information. However, she found that shareholders seeking leave to proceed under the Act have "special powers" generally not available otherwise and she held that anyone being examined must answer questions that have a "semblance of relevance" even if it "might also reveal some other potential issues or wrongdoing not currently contemplated by the statutory claim."

The "semblance of relevance" test Judge Van Rensberg used is the threshold used in connection with discovery, the procedures with respect to which ordinarily apply once a case is underway. In effect, the Judge’s ruling permits discovery in the precertification stage, before the case has even been authorized to proceed. As comments quoted in the article note, defense advocates had militated in favor of inclusion of the precertification procedure in the Act as a way to bar frivolous claims, but now it appears that procedure can be used to compel defendants "to disclose evidence relevant to the merits."

This development, if it stands, not only seems to authorize plaintiffs to use the procedure to conduct a fishing expedition, it also could be used as a way to aid a parallel proceeding filed in U.S. courts, by allowing shareholders to examine company officials, even as to matters not raised either case.

As Adam Savett points out on his Securities Litigation Watch blog (here), this procedure, pursued in parallel with a U.S. filed lawsuit, could permit claimants to use the Ontario procedure to circumvent the PSLRA’s stay of discovery. Savett points out that IMAX itself is not only subject to the Ontario action but also to a separate action under the U.S. securities laws in the Southern District of New York, in which a motion to dismiss is pending. Savett observes that the Ontario court’s IMAX ruling "raises the specter of cases being filed cooperatively in Canadian and U.S. courts, with discovery in the Canadian action possibly being allowed to be used in the U.S. action."

This possible PSLRA discovery stay end-around takes on even greater potential significance in combination with the possibility of U.S.-domiciled companies and their directors and officers getting hauled into securities litigation in the Ontario courts. As I noted in my prior post (here), discussing the Ontario securities lawsuit recently filed against AIG, the prospect for U.S. companies of securities litigation outside the U.S. is unattractive. But perhaps even more unwelcome is the possibility of litigants using a parallel Ontario case against a U.S. company as a way to try to get material to be used to support a separate U.S. proceeding against the company.

If the recent IMAX ruling stands, U.S. securities litigators might have to become a great deal more familiar with Ontario’s securities laws and procedures.

Special thanks to Mark Renzel for providing me a link to the Globe and Mail article.

More about the AIG Lawsuit: A couple of interesting items about the AIG lawsuit appeared after I wrote my recent post about the case.

First, in a Guest Column on the Securities Docket (here), Dimitri Lascaris of the Siskinds law firm provides interesting additional detail about the "substantive and procedural advantages" offered to aggrieved claimants under the Ontario Act, as well as the potential damages available. The Siskinds firm is lead counsel in the Ontario proceedings filed against both AIG and against IMAX.

Lascaris also wrote in his column that "for a long time, America has largely dictated the standards by which issuers are obliged to conduct themselves in a globalized capital market. Like much else that is coming to an end in today’s capital markets, that era may be over. "

Second, Law.com has a November 19, 2008 article (here) about the case against AIG filed in Ontario. Among other things the article quotes Lascaris as saying that the AIG action is the first use of the use of the liability provisions of the Ontario Securities Act against a non-Canadian company.

And Finally: I would like to thank all of the many Canadian readers who commented to me about the AIG case. Numerous readers provided me with helpful additional information about the Ontario Act and about securities litigation in Canada. In that respect, several readers added helpful and interesting comments to the blog post about the AIG case, and I commend those comments to everyone's attention.

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Questions surrounding the susceptibility of foreign domiciled companies to U.S. securities laws and to the jurisdiction of U.S. court are frequently recurring issues, as I noted most recently here. However, a new case filed in Ontario under Ontario’s securities laws presents an interesting variation on these questions.

The Ontario Action Against AIG

According to its November 13, 2008 press release (here), the Siskinds law firm has filed a class action application and accompanying statement of claim in the Ontario Superior Court of Justice under the Ontario Securities Act against American International Group, American International Group Financial Products, and ten current or former AIG directors and officers. According to the press release, the claim is brought on behalf of Canadian investors who bought AIG securities between November 10, 2006 and September 16, 2008.

A copy of the application and statement of claim can be found here. According to the press release, the statement of claim alleges as follows:

The AIG class action arises out of AIGFP's credit default swaps and the crippling decline in AIG's stock price when the true effect of those credit default swaps became known to the investing public. The AIG disclosures out of which the class action arises are currently the subject of investigation by law enforcement authorities, and are alleged in the class action to have caused massive losses to Canadian investors.

The Ontario Securities Act

The action is brought under the investor protection provisions in Part XXIII.1 of the Ontario Securities Act. (Refer here for the provision of the Act.) The statutory provision specifies the liability standards in connection with "secondary market disclosure."

Section 138.3 of the statute provides a cause of action for damages on behalf of persons who trade in a company’s security -- "without regard to whether the person or company relied on the misrepresentation" -- where "a responsible issuer or a person or company with actual, implied or apparent authority to act on behalf of a responsible issuer releases a document that contains a misrepresentation."

The persons against whom the action may be brought are specified to include, among others, the issuer, "responsible" directors and officers, as well as persons who "knowingly influenced" the issuer or responsible persons.

Jurisdictional Issues

The plaintiff’s statement of claim takes great pains to emphasize that the action has "a real and substantial connection with Ontario." Indeed, in paragraph 155, the statement of claim alleges that the financial disclosures that are the basis of the action were "disseminated in Ontario"; that "a substantial proportion of the Class Members reside in Ontario"; that AIG "carries on business in Ontario"; that AIG considers its Canadian revenue as "domestic" for accounting purposes"; that "key AIG personnel charged with oversight of the above conduct were domiciled in Ontario and undertook part of that effort from Ontario."

The pains taken in the statement of claim to specify the claim’s connection to Ontario suggests an anticipation of a question whether the case properly belongs in Ontario courts. AIG is, after all, domiciled outside of Canada, and its shares do not trade on Canadian securities exchanges (or at least the plaintiff does not so allege). The alleged misstatements were prepared and issued outside of Canada.

On the other hand, the statement of claim does allege misconduct, harm and damages within Ontario. Without presuming the outcome, allegations of this type are of the kind that at least some U.S. courts have found a sufficient basis for the exercise of jurisdiction and the application of U.S. securities laws on companies domiciled outside the U.S.

Discussion

Setting aside these subject matter jurisdiction issues, and disregarding potential personal jurisdiction issues, there are some larger questions about this case. AIG faces extensive litigation in the U.S. on similar or related issues. Should any particular jurisdiction’s court have priority? Should courts defer to another jurisdiction’s courts?

These kinds of questions have come up before, for example, in connection with the Royal Dutch Shell cases, where there were also parallel proceedings in different countries (refer here). The way that these proceedings should coordinate is very much an evolving issue. But the noteworthy difference between that prior example and this instance is that here the target company is a U.S.-based company. It will be interesting to see whether that distinction makes a difference and how the respective cases unfold.

I also have these vague, unformed questions whether or not it makes a difference that AIG is now effectively owned by U.S. taxpayers. The taxpayers’ highest priority right now is getting repaid for the astonishing obligations to the U.S. treasury that AIG has recently undertaken. I haven’t worked it all out yet, but there does seem to be something inconsistent with the U.S. taxpayers’ interest in having the company’s limited resources siphoned off to defend and possibly to pay damages in a foreign jurisdiction. Canadian investors probably don’t care much about that, I suppose.

Of course, it might be argued that U.S. courts have been doing similar things to other countries’ companies (including Canadian companies) for some time now. Indeed, the plaintiff’s lawyers’ press release quotes one of the plaintiff’s attorneys as saying:

for many years, Canadian corporations have had to confront the long arm of America's justice system. But with the enactment of Part XXIII.1 of the Ontario Securities Act, Canadian investors can finally pursue remedies in our own Courts against American corporations that fail to respect Canada's securities laws. Canadian investors are entitled to have Canadian Courts hear their claims.

The one thing that is clear is that a class action under the Ontario securities laws is a serious matter. As I noted in a prior post (here), a prior class under the Ontario securities laws against FMF Capital recently settled for over CAN$28 million. This settlement apparently represents the largest securities class action settlement in Canada, and while the amount may seem small compared to some of the massive U.S. settlements, the amount did represent a very significant percentage of the investors’ claimed investment loss.

At a minimum, the FMF Capital settlement suggests that a claim under the Ontario securities laws represents a serious potential liability exposure. Along those lines, it should be noted that the press release states that the plaintiff class seeks damages of $550 million. (The press release does not state whether or not those are U.S. or Canadian dollars.)

UPDATE: Dimitri Lascaris of the Siskinds law firm has written a guest column on the Securities Docket blog (here), in which he explains the basis of jurisdiction in Ontario for the AIG lawsuit, as well as the operation and effects of the Ontario securities laws.

Two Final Observations

First, this new lawsuit represents yet another demonstration that the threat of securities litigation outside the United States continues to grow.

Second, this new lawsuit presents an interesting and potential dangerous expansion of this growing threat, which is the possibility that U.S. domiciled companies could find themselves the target of securities litigation in other jurisdiction’s courts under other jurisdiction’s laws.

To the extent it proves to be successful, the Ontario plaintiff’s new lawsuit against AIG could represent a very unwelcome and potentially complicated expansion of the liability exposures of U.S companies and their directors and officers.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the Ontario court application and statement of claim.

Now This: In this time of financial turmoil, it pays to be resourceful. And so, The D&O Diary is giving serious consideration to converting itself into a bank holding company, in order to be able to join other leading American business enterprises and participate in the bailout process.

While there might be those who would contend that we are not "too big to fail," we certainly are feeling the effects of the economic downturn, and recent 401(k) statements suggest that radical measures may be required. Capital infusions would be particularly welcome here.

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On November 10, 2008, NERA Economic Consulting released a report entitled "SEC Settlements: A New Era Post-Sox" (here) that details trends in the number of SEC settlements and of SEC settlement values in the six years since the enactment of the Sarbanes-Oxley Act.

The Report has a number of interesting findings, including the observation that prior to SOX’s enactment, the largest SEC enforcement action penalty was the April 2002 penalty of $10 million imposed against Xerox. However, the Report notes, after SOX, "the SEC has imposed penalties of $10 million against 115 parties, include 14 that were penalized at least $100 million." The Report includes a "top ten" settlements list, which is headed by AIG’s 2006 settlement of $800 million.

The Report also contains an analysis of the five most frequent allegations. Topping the list is microcap fraud (such as broker room operations or pump-and-dump schemes), followed by misstatement/omissions (including options backdating), and misappropriation of investor funds. The majority of cases against publicly traded companies involve allegations of misrepresentations or omissions.

The Report note that the SEC is on pace to reach 739 settlements in 2008, which would represent an increase in the number of settlements for the second straight year. The increase is driven largely by an increase in the number of individual settlements. The number of company settlements, by contrast, is declining. The number of company settlements is on pace to reach 171, which would represent the lowest number of company settlements since SOX was enacted.

The median 2008 company settlement through the end of the third quarter is $1.0 million, which is up from the 2007 median of $700,000, but well below the annual medians during the years 2004-2006, when the medians ranged from $1.1 to $1.5 million. The median individual settlement throughout the post-SOX era has been approximately $100,000.

Median settlements for public company misstatement cases have declined from a 2006 high of $50 million to a 2008 median (through the end of the third quarter) of $12.0 million. The report speculates that this decline may be due to the 2007 institution of a requirement for Commission approval prior to beginning negotiations in public company cases. (It is also probably worth noting that three of the top ten settlements took place in 2006, whereas none of the top ten has yet taken place in 2008.) The majority of public company misstatement cases settle for less than 1% of market capitalization.

The Report did note that of 197 companies the study identified as having settled SEC enforcement proceedings related to company misrepresentations or omissions, 181 had announced the existence of an investigation. The average time from the investigation announcement to the settlement for these 181 companies was 2.3 years.

The report also found that forty-three percent of company payments have been in the form of disgorgement, with 57% representing penalties. With respect to individual settlements, disgorgement represents 88% of payment amounts.

Relation Between SEC Settlements and Securities Class Action Lawsuits?:  The Report anticipated a question that formed in my mind as I read its analysis, which is the relation, if any, between SEC settlements and private securities class action litigation. The Report notes "it might be tempting to draw a comparison" between the number of class action filings, which increased in 2007, and the increase in the number of SEC settlements in 2007 compared to 2006. The Report notes that this comparison would be "misleading" in two respects:

First, the filing of a securities class action represents the first stage of class action legal proceedings, whereas SEC settlements are part of the last stage of the legal process. Because the SEC does not announce its investigations publicly, it is generally not possible to track the beginning of investigations. Instead this paper tracks settlements, which are often the first public information about an SEC matter. Second, most SEC settlements do not parallel shareholder class actions. In 2007, only 22% of SEC settlements were with public companies or their employees and related to misstatements, and were therefore closely comparable to shareholder class actions.

SEC Settlements and D&O Insurance, Briefly Noted: It is probably worth emphasizing that very little if any of the amounts involved in these settlements would have been insured under a typical D&O insurance policy. Most policies exclude from their definition of insured "Loss" such items as "fines and penalties" and disgorgements of amounts are typically excluded or do not otherwise represent insurable loss. However, in many instances, defense fees incurred in connection with the enforcement proceedings would be covered, depending on the applicable policy’s definition of the term "Claim."

New NERA Website: In addition to its Report, NERA also announced on November 10 the launch of its new website entitled "Securities Litigation Trends" (here) where NERA will be centralizing its own securities litigation analysis and also collecting other useful links (including related blogs).

Special thanks to Ben Seggerson at NERA for providing links to the NERA study and to the new web page.

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On October 23, 2008, in a much-anticipated decision addressing what it called "the vexing question of the extraterritorial application of the securities laws," the Second Circuit in the National Australia Bank (NAB) case ruled (here) that U.S. courts lack subject matter jurisdiction over the claims of foreign claimants in that case who bought their NAB shares on a foreign exchange. Although the Second Circuit did not, as friends-of-the-court had urged, pronounce a bright line rule against jurisdiction in such "f-cubed" claims, it nevertheless provided guidelines that will be relevant to similar cases going forward.

Background

NAB is Australia’s largest bank. Its shares trade on securities exchanges in Australia, London, Tokyo and New Zealand. Its American Depositary Receipts trade on the New York Stock Exchange. NAB has a mortgage servicing subsidiary, HomeSide, based in Florida. In 2001, NAB disclosed that it was taking a significant write-down due to a recalculation of the amortized valuating of HomeSide’s mortgage servicing rights. Following this announcement, the price of NAB’s shares and ADRs declined, and investors filed a securities class action lawsuit in the Southern District of New York.

The claim was initially brought by four plaintiffs. One of the four purported to represent domestic purchasers of NAB’s securities. The three other plaintiffs bought their shares abroad and sought to represent a class of non-U.S. purchasers. Background regarding the case can be found here.

On October 25, 2006, the District Court granted defendants’ motion to dismiss the complaint. The District Court held that it lacked subject matter jurisdiction over the foreign claimants claim. The court dismissed the domestic plaintiff’s action for failure to state a claim because the domestic plaintiff failed to allege that he suffered damages. The three foreign plaintiffs appealed. The domestic plaintiff’s claim was not before the Second Circuit, and so the appellate court was exclusively concerned with the jurisdictional issue.

The Second Circuit’s Opinion

In its October 23 opinion, written by Judge Barrington Parker, the Second Circuit noted that the "difficulty of the case was heightened by its novelty" – that is, the involvement of so-called "foreign-cubed" claimants. The appellees and several amici had urged the Second Circuit to adopt a "bright-line rule" by holding that in "foreign-cubed" securities litigation that mere domestic conduct should not be enough for a U.S. court to exercise subject matter jurisdiction where the conduct had no effect in the U.S. Links to the briefs for the parties and the amici can be found here. My prior post detailing the issues surrounding "f-cubed claims" generally can be found here.

The Second Circuit duly acknowledged what it characterized as the "parade of horribles" the friends-of-the-court invoked in favor of a bright line test, including the possibility that exercising jurisdiction in those cases could bring U.S. securities laws in conflict with those of other jurisdictions.

However, the Second Circuit observed that declining jurisdiction over all "foreign cubed" cases "would conflict with the goal of preventing the export of fraud from America." In particular, the Court was concerned that the U.S. should not be seen as a "safe haven for cheaters." The court said that "we are leery of a rigid bright line rule because we cannot anticipate all the circumstances in which the ingenuity of those inclined to violate the securities laws should result on their being subject to American jurisdiction."

Having rejected the bright line test, the Court went on to observe that "we are an American court, not the world’s court, and we cannot and should not expend our resources resolving cases that do not affect Americans or involve fraud emanating from America." The Second Circuit said that "in our view the ‘conduct text’ balances those competing concerns." Under the conduct test, subject matter jurisdiction exists "if activities in this country were more than merely preparatory to a fraud and culpable acts or omissions occurring here directly caused the losses abroad."

The Court then turned to applying the conduct test to the NAB case. The claimants urged that because miscalculation of HomeSide’s mortgage servicing rights had taken place in this country, U.S. courts could exercise jurisdiction. The Second Circuit nevertheless determined that U.S. courts lack jurisdiction, citing three factors: "the fraudulent statements at issue emanated from NAB’s headquarters in Australia; the complete lack of any effect on America or Americans; and the lengthy chain of causation between HomeSide’s actions and the statements that reached investors."

Discussion

Though the defendants in the NAB case prevailed, the case hardly means the end of f-cubed litigation. Arguably, in light of the Second Circuit’s refusal to adopt a bright line test, the jurisdictional standards remain largely unchanged, and litigants will continue to argue whether there is sufficient U.S. based conduct and U.S based effects to support the U.S. court’s exercise of jurisdiction.

Moreover, the Second Circuit made it clear that there will be circumstances in which it will be entirely appropriate for U.S. courts to exercise jurisdiction over the f-cubed claims. For that reason, and even though the Second Circuit held that the U.S. courts lacked jurisdiction of over the NAB case itself, foreign claimants likely will continue to try to assert claims against foreign-domiciled companies in U.S. courts.

That said, the claimants case against NAB did get tossed. The Second Circuit did caution against U.S. courts presuming to act as "the world’s court" and also cautioned against the exercise of jurisdiction over claims that do not affect Americans or involve fraud emanating from America. In other words, not all foreign claimants’ claims against foreign domiciled companies will go forward in U.S. courts.

Moreover, these issues are relevant not only at the motion to dismiss stage but also at the other procedural stages, including the lead plaintiff stage (refer here). As Adam Savett noted on the Securities Litigation Watch blog (here), courts have been increasingly willing to craft class certification to exclude foreign domiciled claimants at least in certain circumstances.

All of that said, the NAB decision will be grist for the mill in the onslaught of litigation involving foreign domiciled companies sued in connection with the current subprime and credit crisis litigation wave. The NAB decision necessarily implies a case-by-case determination and so litigants will continue to wrestle to determine whether these cases will go forward in U.S. courts. In the meantime, the cases will continue to be filed.

An October 23, 2008 Bloomberg article discussing the case can be found here.

Special thanks to George T. Conway, III of the Wachtell, Lipton law firm, who successfully represented NAB in the Second Circuit, for providing me with a copy of the opinion.

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In the latest of the decisions in which subprime and credit crisis-related securities lawsuits have failed to withstand preliminary judicial scrutiny, on October 6, 2008, Central District of California Judge Andrew Guilford granted (here) defendants’ motion to dismiss the plaintiffs’ second amended complaint in the IMPAC Mortgage Holdings case, with leave to amend.

As reflected here, the plaintiffs initially filed their purported class action complaint on August 17, 2007. The initial complaint was subsequently amended twice, and the October 6, 2008 ruling related to the plaintiffs’ second amended complaint. The second amended complaint essentially alleged that contrary to the company’s public statements, the company’s Alt-A loans were actually being sold to less creditworthy borrowers, so that the Alt-A loan portfolio was as risky as a portfolio of subprime mortgages. The plaintiffs further alleged that at the same time, the company misrepresented its true financial condition by its failure to write down the value of its loan portfolio.

In his October 6 opinion, Judge Guilford states that "plaintiff packs the Complaint with 30 pages of supposed misstatements or culpable acts, but none of them shows fraudulent intent or deliberate or conscious recklessness." The statements of the former employees on whom the plaintiffs sought to rely are, Judge Guilford found, "completely benign," or "so vague as to be meaningless."

Judge Guilford concluded that the plaintiffs’ allegations "do not provide any specifics, and they do not show fraudulent intent or conscious recklessness." The PLSRA, the court noted, "was intended to guard against exactly these sorts of vague, conclusory allegations." Judge Guilford therefore granted the defendants’ motion to dismiss, allowing the plaintiffs’ 21 days to file an amended complaint.

The plaintiffs in the IMPAC Mortgage case not only face a tight timeframe but also face an uphill battle to satisfy the shortcomings Judge Guilford identified. The complaint Judge Guilford rejected had already been amended twice, so it unlikely the plaintiffs held anything back or have a reservoir or additional powerful allegations to draw upon. The short work Judge Guildford made of their multifarious allegations could hardly be encouraging. In addition, Judge Guilford did not even reach the issues of whether the complaint adequately pled misrepresentation or appropriately relied on the group pleading doctrine, holding that his ruling on the scienter issue relieved him of the necessity to reach those other issues.

Judge Guilford’s approach in the IMPAC Mortgage case has appeared in a number of the preliminary rulings in the current wave of subprime and credit crisis-related cases. Even though we are still only in the very earliest stages of most of these cases, there have already been a number of cases where courts have been similarly skeptical of plaintiffs’ allegations. Some recent examples include the First Home Builders of Florida ruling (discussed here) or the NovaStar Financial ruling (here).

While there have of course been decisions going the other way, these skeptical courts have made it clear that they expect to see more than mere allegations that a mortgage loan portfolio underperformed prior expectations or that the lender’s financial condition has deteriorated. If the early returns are any indication, plaintiffs in many of the subprime and credit crisis-related cases may face similar skepticism in order on their preliminary motions.

In any event, I have added the IMPAC Mortgage decision to my table of subprime and credit crisis case dispositions, which can be accessed here.

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The economic crisis that began as the subprime meltdown has clearly entered a dark new phase. And just as the prior stages of the crisis generated waves of related litigation, this new phase already has produced its own distinctive round of lawsuits. Like the underlying economic circumstances, the new litigation phase also seems darker and more threatening.

As might have been predicted, shareholder lawsuits have already been filed against the directors and officers of some of the most prominent companies caught up in the recent events. For example, on September 15, 2008, Merrill Lynch shareholders filed a complaint (here) in New York state court against the company and certain of its directors and officers alleging that the company’s planned merger with Bank of America is the result of a "flawed process and unconscionable agreement" and that the defendants had breached their fiduciary duties.

Similarly, as reported on September 18, 2008 in CFO.com (here), shareholders have filed a Delaware Chancery Court lawsuit against certain current and former directors and officers of AIG. The lawsuit blames the defendants for the company’s "exposure to and grossly imprudent risk taking in the subprime lending market and derivative instruments." The lawsuit seeks the return to AIG of all compensation paid to AIG’s CEO and to its directors, among other things.

These lawsuits are perhaps the almost inevitable products of events reported in last week’s headlines. But along with these more predictable litigation consequences, there have also been additional developments and resulting litigation, and it is this further litigation that suggests that the credit crisis litigation wave my now have entered a new, more complex phase.

As widely reported last week, the Primary Fund money market fund of the Reserve Family of Funds "broke the buck" when its "net asset value" fell below one dollar a share. Reserve’s September 16, 2008 press release announcing that net asset value of the Primary Fund had fallen below one dollar can be found here. On September 18, 2008, plaintiffs’ counsel filed a securities class action lawsuit in the Southern District of New York (complaint here), on behalf of persons who purchased shares of the Primary Fund between September 28, 2007 and September 16, 2008, against the Fund’s underwriters, investment advisor, and officers and directors.

The complaint alleges that the Fund’s offering documents failed to disclose, among other things, "the lack of diversification of the Fund’s assets and exposure to, at a minimum, now largely worthless debt securities valued at $785 million of the now defunct Lehman Brothers Holdings, Inc."

The circumstances behind this lawsuit represent something of a second derivative of the subprime crisis. That is, the subprime meltdown led to problems with certain real estate assets and investments of Lehman Brothers, which ultimately led to Lehman’s collapse, which caused its debt securities to lose substantially all their value, which undermined the asset value of the Primary Fund and harmed its investors.

The reverberations of these second derivatives of the subprime meltdown are rippling through the economy, encompassing a broader array of participants, many of whom may have had little or no direct exposure to subprime-prime related investments per se. However, these companies had exposures to other companies that had exposures to mortgage backed assets.

The Primary Fund is far from the only market participant that has been harmed by its exposure to losses during this latest phase of the economic cycle. By way of illustration, on September 16, 2008, Conseco announced (here) that as of that date it held $108 million of securities of Lehman Brothers, AIG, and Washington Mutual, and that the company had during the third quarter realized losses of approximately $40 million on sales of securities of these issuers. Conseco’s shares fell over 40% the next trading day, although the share price has subsequently recovered somewhat.

Similarly, Japanese insurers have disclosed a combined $2.4 billion of potential losses from Lehman’s collapse (refer here).

On September 11, 2008, Progressive Corporation announced (here) August 2008 write-downs of $324 million (of which $278 million related to common and preferred stock investments in Fannie Mae and Freddie Mac), and also disclosed that the U.S. government’s take over of the companies produced an additional $171 million of September 2008 losses, bringing Progressive’s combined two month investment write-downs on its Fannie and Freddie holdings to nearly a half a billion dollars – a substantial amount even for a company with $20 billion in assets.

A multitude of other companies have announced or will be announced similar losses, and not just related to Lehman, but also in connection with Fannie Mae, Freddie Mac, AIG, and other companies whose securities have faced or that will face similar collapses. A September 18, 2008 CFO.com article entitled "Exposed and Disclosed: Filings Show Ties to Turmoil" (here) highlights recent filing in which companies have disclosed their exposure to investment declines as a result of adverse developments at these companies. A September 16, 2008 CFO.com article similarly identifying companies disclosing losses from the Lehman bankruptcy can be found here.

The losses on these investments are widespread and will affect a wide variety of market participants. The heroic (and astronomically expensive) bailout package that the Treasury department announced over the weekend (refer here) will not restore the value of these investments. In the weeks and months ahead, many other entities will be reporting losses or write-downs on these and other investments. In addition, in a completely different aspect of the current crisis, market participants who depended on Lehman for credit default protection will also be reporting the consequences of Lehman’s demise.

These announcements undoubtedly will trigger strong investor reactions for at least some of the disclosing companies, as was the case, for example, in connection with Conseco’s recent announcement. And in some instances, as was the case in connection with the Primary Fund, these announcements will also result in litigation.

Several months ago, I noted that the evolving litigation wave had long ago ceased to be just about the subprime meltdown. As lawsuits emerge from what I described above as the second derivative of the subprime meltdown, where companies lacking any direct exposure to subprime nevertheless experience losses because of exposure to other companies suffering credit crisis-related reversals, the ensuing litigation wave could threaten to become a generalized inundation deluging a substantial number of participants in the larger economy.

The ultimate wildcard is the impact that the current comprehesive Treasury bailout will have on litigation going forward. The analytic model for the current bailout plan is the formation of a government salvage operator along the lines of the Resolution Trust Corporation (RTC) during the Savings & Loan crisis. Those of us who were around then will recall that the RTC was an active litigant aggressively using litigation to try to recover taxpayer losses. Law.com has a September 22, 2008 article entitled "U.S. Could Emerge as Major Player in Suits Stemming From Financial Crisis" (here) that speculates on that the new government bailout agency could once again play an active litigation role.

How the current bailout package ultimately will shake out remains to be seen. But one of the important themes in the current dynamic is the urge to assign blame. Some congressional figures have already targeted executive compensation and compensation clawbacks as important considerations of the bailout effort. These kinds of considerations could well lead to an effort to target directors and officers as well as their professional advisors, as part of the overall bailout.

More Reserve Fund Litigation: Shareholders have raised an additional concern in connection with the recent events involving the Reserve Fund. In a separate September 19, 2008 lawsuit (complaint here), Fund investors have also alleged that the Fund tipped off "about a dozen institutional investors" to withdraw a total of $40 billion from the funds at one dollar a share immediately before the Fund’s announcement of the losses due to the Lehman investment’s drove the net asset value below one dollar.

In a September 19 order (here), Judge Paul Magnuson entered a temporary restraining order prohibiting the Fund from honoring withdraw requests of over $10,000, until an evidentiary hearing can be held. Among other things, Judge Magnuson’s order said that "plaintiffs would be irreparably harmed if Defendants were allowed to honor redemption requests of investors who were made privy to the bad news before the public was made aware." The court will hold further hearings on September 23, 2008.

Special thanks to a loyal reader for providing copies of the insider tipping complaint and the TRO.

Run the Numbers: I have added the AIG bailout lawsuit and the Merrill Lynch/BoA lawsuit to my list of subprime and credit crisis-related derivative lawsuits, which can be accessed here. With the addition of these two lawsuits, the current tally of subprime and credit-crisis related derivative lawsuits now stands at 23.

In addition, I have added the Reserve Fund lawsuit, together with a more conventional subprime-related lawsuit filed last week against the Canadian Imperial Bank of Commerce (about which refer here) to my list of subprime and credit crisis-related securities lawsuits, which can be accessed here. With the addition of these two new securities lawsuits, the current tally of subprime and credit crisis-related securities lawsuits now stands at 117, of which 77 have been filed in 2008.

Storm Surge: Plaintiffs’ securities attorneys were extraordinarily busy this past week. By my unofficial count, there were at least nine new securities class action lawsuits filed in the past week alone. And while some of this activity is directly attributable to the economic circumstances discussed above, a part of the activity is less directly connected.

Indeed the past week’s new lawsuits involve a broad variety of companies including clothing companies (refer here), wireless communications companies (refer here and here) and silicon wafer manufacturers (refer here).

We clearly are well past the securities lawsuit filing lull that prevailed from mid-2005 through mid-2007. The more troubling question now is whether we have entered a dangerous new phase of heightened litigation activity that includes but also extends well beyond lawsuits arising directly from financial difficulties attributable to turbulence in the credit markets.

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The heightened susceptibility of life sciences companies to securities class action lawsuits is a phenomenon that I and others have previously noted (refer here). But while life sciences companies may experience greater securities class action claim frequency, many of these lawsuits against life sciences companies are dismissed (as discussed here).

In a case the First Circuit itself called “paradigmatic” of securities cases involving life sciences companies, the appeals court recently affirmed the lower court’s dismissal of the securities lawsuit pending against Biogen Idec and certain of its directors and officers. The court’s analysis is noteworthy because of its emphasis of the issues that contribute to the vulnerability of these kinds of companies to securities lawsuits. But by way of contrast I also discuss below a recent Ninth Circuit opinion reversing the district court’s dismissal of a securities lawsuit involving Gilead Sciences.

The First Circuit’s Opinion in the Biogen Idec Case: On August 7, 2008, in an opinion written by Chief Judge Sandra L. Lynch, the First Circuit issued its opinion in New Jersey Carpenters Pension & Annuity Fund v. Biogen Idec (here). The case involves Biogen’s alleged misrepresentations and omissions pertaining to Tysabri, a new drug for multiple sclerosis and other autoimmune disorders.

In November 2004, the FDA granted accelerated approval of Tysabri. Less than three months later, on February 18, 2005, continuing clinical trials “revealed that two patients had contracted a type of infection perhaps associated with the drug.” One of the two patients died. On February 25, 2005, the company voluntarily withdrew the drug from the market. Its stock price dropped and several lawsuits were filed.

In their amended complaint, the plaintiffs alleged that, in order to facilitate their sale of shares of company stock at inflated prices, the defendants misrepresented the safety and efficacy of the drug. As the First Circuit summarized the case, the “key theme” of the lawsuit is that the defendants were “aware or at least recklessly unaware of greater safety risks with TYSABRI for opportunistic infections, particularly in combination with other MS therapies, than had been announced to the public,” and that defendants “intentionally failed to disclose this information in order to keep the share price high.”

The district court dismissed the complaint, finding that while the plaintiffs had alleged material misrepresentations and omissions with appropriate specificity, they had not alleged scienter with appropriate specificity. The plaintiffs appealed.

In evaluating the plaintiffs’ allegations, the allegations relating to the timing of defendants’ receipt of information were critical, because, as the First Circuit noted, “defendants cannot have committed fraud if they did not know at the time that the failure to provide additional information was misleading.” In that regard, the First Circuit found that “plaintiffs’ amended complaint fails to allege facts both (1) as to when defendant had information about non-PML opportunistic infection and (2) that the information available sufficiently suggested a causal connection between TYSABRI and non-PML opportunistic infections.”

The First Circuit expressed its willingness to consider factual allegations supported only by confidential sources, but the confidential sources’ allegations did not create a strong inference of scienter, because the allegations do not indicate when during the clinical trials information about infections became known.

The court also found plaintiffs’ allegations that defendants had fraudulently failed to disclose dangers of use of Tysabri in combination with other drug therapies were insufficient. Plaintiffs’ allegations that defendants had no reasonable basis to say that Tysabri was safe in combination with other drug therapies, the First Circuit found, were “not nearly so compelling as opposing inferences from the undisputed facts in the record.”

Because the First Circuit concluded that the plaintiffs had not “sufficiently alleged … that defendants had any reason to know their statements were misleading before February 18, 2005,” the Court disregarded all insider trading prior to that date. Only one insider sale was alleged on or after that date, a February 18 sale by the company’s General Counsel. But the General Counsel was not a defendant to the Section 10(b) claim, and the First Circuit held that based solely on the General Counsel’s trading “a strong inference of scienter on the part of Biogen and other individual defendants cannot be drawn.”

The First Circuit found that the plaintiffs’ allegations of scienter were not sufficient to support an alleged violation of Section 10(b), and affirmed the district court.

The court’s opinion was informed by its observations of the peculiar characteristics of securities lawsuits filed against companies involved in the drug and device development business:

The situation here is paradigmatic of securities fraud cases against drug companies where a promising drug or medical device is approved by the FDA and then later proves to have health risks which affect the market for the drug.

The court also noted that disclosures about regulatory developments provide an important context within which sudden stock price changes can occur:

The investing public is well aware drug trials are exactly that: trials to determine the safety and efficacy of experimental drugs. And so trading in the shares of companies whose financial fortunes may turn on the outcome of such experimental drug trials inherently carry more risk than some other investments.

With these comments, the First Circuit recognized the circumstances that make life sciences companies susceptible to securities lawsuits. These companies have volatile share prices that are vulnerable to sudden shocks due to the uncertainty of the regulatory process or to unexpected safety concerns. All too often these reverses result in securities lawsuits, supported only by allegations that the reverses occurred and therefore company management must have known about the problems from which the reverses arose.

The First Circuit’s opinion also evinced an appreciation of the fact that merely because a company has encountered these types of setbacks does not mean that the company has committed securities fraud. The First Circuit’s analysis helps explain why both life sciences may find themselves accused of securities fraud more frequently than other kinds of companies, and also why these cases are frequently dismissed.

Ninth Circuit Reverses Dismissal of Gilead Science Case: But while a number of the securities lawsuits filed against life sciences companies may be dismissed, that certainly does not mean that life sciences companies inevitably prevail. Indeed, there have been a number of significant settlements in securities cases involving life sciences companies (particularly large pharmaceutical companies).

Life sciences companies also face the same challenges involved in securities claims against any corporate defendant, including the possibility that a victory at the trial court level can be reversed at the appellate level. That is exactly what happened in the securities litigation involved Gilead Sciences. In an opinion dated August 11, 2008 (here), the Ninth Circuit reversed the lower court’s ruling dismissing the case for failure to adequately plead loss causation.

Gilead’s flagship produce, Viread, is an agent used with other drugs to treat HIV. The complaint alleges that the company actively marketed the drug for off-label uses, in violation of FDA rules. The company received a Warning Letter from the FDA on this topic, which the company disclosed on August 8, 2003. The company’s share price did not decline in response to this news; in fact, the share price was higher on the following trading days.

In order to address the absence of any share price decline, the plaintiffs alleged that it was not until October 28, 2003 that the public “finally realized the impact of the off-label marketing and the Warning Letter.” After market close that day, the company disclosed that Viread sales had fallen below expectations due to wholesaler overstocking during the quarter. Market analysts attributed the sales decline to “lower end-user demand.” The plaintiffs alleged that the reduced demand was “a direct result” of the Warning Letter, which exposed Gilead’s off-label marketing.

The district court found that the complaint failed to “connect the chain of events” between the failure to disclose the off-label marketing; that the decline in demand for Viread was due to the Warning Letter; and that the reduced sales caused a decrease in Gilead’s share price. The district court said there were “too many logical and factual gaps.” The district court said it could not make “the unreasonable inference that a public revelation caused a price drop three months later.” The district court dismissed the complaint for failure to adequately plead loss causation.

The Ninth Circuit, by contrast, found “the complaint sufficiently alleges a causal relationship between (1) the increase in sales resulting from the off-label marketing, (2) the Warning Letter’s effects on Viread orders, and (3) the Warning Letter’s effect on Gilead’s share price.”

The Ninth Circuit went on to observe that “perhaps what truly motivated the dismissal was the district court’s incredulity.” The Ninth Circuit said that a district court ruling on a motion to dismiss “is not sitting as a trier of fact,” and as long as plaintiffs allege a theory that “is not facially implausible, the court’s skepticism is best reserved for later stages … when the plaintiffs’ case can be rejected on evidentiary grounds.” The Ninth Circuit concluded that “a limited temporal gap between the time of the misrepresentation is publicly revealed and the subsequent decline…does not render a plaintiffs’ theory of loss causation per se implausible.”

The Ninth Circuit said the market “did react immediately to the corrective disclosure” which the plaintiffs claims to be the October 28 press release, the date on which it is alleged the market had complete information to process the revelations about off-label marketing.

It is hardly my place to comment on the merits of a judicial opinion. Suffice it to say that reasonable minds may differ whether the district court was guilty of “incredulity” or the Ninth Circuit of “credulity.” Reasonable minds may also differ whether the three months’ lapse between the disclosure of the Warning Letter and the stock price drop is a “limited temporal gap.” Reasonable minds may also differ whether plaintiffs’ Rube Goldberg explanation for the delayed market reaction “is not facially implausible.”

On the other hand, it seems apparent that the allegation of off-label marketing troubled the Ninth Circuit and it is certainly true that a company whose alleged reverses are not due to unexpected regulatory developments or unanticipated clinical outcomes but rather to marketing activities is in a less sympathetic postion. That is obviously why the plaintiffs strained so hard to try to make the stock price drop relate back to the off-label marketing Warning Letter, because that supposed connection put the defendants in a less favorable light. Regardless, I suppose, of whether or not the stock price drop was due to the wholesaler overstocking.

The one thing that is clear is that all litigants are susceptible to the vicissitudes of the litigation process, life sciences companies as well as any other kind of company. The plaintiffs in Gilead certainly established the value of continuing to fight, as you never know when an initially disfavored hand might still be just enough to take a trick. Of course, the plaintiffs must now go back to the district court and face a court whose skepticism even the Ninth Circuit acknowledged could justify rejecting plaintiffs’ case later.

The SEC Actions Blog has an excellent lawyerly analysis critical of the Ninth Circuit's opinion in Gilead, here.

More Drug News: Biogen Idec’s drug, Tysabri, which the FDA permitted the company to reintroduce to the market in July 2006, was back in the news recently. According to an August 1, 2008 Wall Street Journal article (here), two MS patients treated with the drug have recently contracted a potentially deadly brain infection. The article stated that the company “had no plans to recall the drug or restrict its use.”

The WSJ.com Health Blog also has a post (here) discussing this development. The comments following the post make for interesting reading. It is all too easy to consider these legal issues in a vacuum, but there are real patients whose only hope is the use of these kinds of drug therapies. The eloquent pleas of these patients for the drugs to remain available are moving and impressive.

But the adverse developments cannot be minimized, and in that regard it should also be noted that Biogen Idec also faces a lawsuit from the estate of one of the deceased patients. Recent procedural developments in the case were also discussed recently on the WSJ.com Health Blog (here).

All of that said,  this about business too, and it may come as no surprise that Carl Ichan viewed the stock price drop following Biogen’s recent advserse news as an opportunity to increase his holdings in the company’s shares, perhaps to advance his agenda of getting the company to sell itself, as discussed here.

There is a Balm in Gilead: Perhaps I am presuming too much, but for me the name Gilead Sciences evokes Jeremiah, Chapter 8, Verse 22: “Is there no balm in Gilead? Is there no physician there? Why then has the health of my poor people not been restored?” (New Revised Standard Version).

This line is memorably recalled in the African-American spiritual, There is a Balm in Gilead, whose refrain captures the soothing power of the song:

There is a balm in Gilead

To make the wounded whole;

There is a balm in Gilead

To heal the sin-sick soul.

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In recent days, settlements relating to two high-profile securities class action lawsuits were announced. Because there are some interest things about these two settlements, I take a closer look at each of them below.

Is the Qwest Securites Class Action Lawsuit Finally Settled?  In Qwest Communications  August 6, 2008 filing on Form 10-Q (here), the company announced that it would pay an additional $40 million, and that its former CEO, Joseph Nacchio, and its former CFO, Robert Woodruff, would “contribute a total of $5 million insurance proceeds,” to try to settle the long-standing consolidated Qwest securities litigation. These payments, together with amounts to which Qwest previously agreed, bring the total value of the class settlement to $445 million.

The court had previously approved the $400 million settlement, to which Nacchio and Woodruff were not parties, over Nacchio and Woodruff’s objections. Among other things, the two individuals contended that the prior settlement was structured to strip them of their indemnification rights. As I discussed here, on a January 16, 2008 opinion, the Tenth Circuit held that the two individuals had standing to challenge the settlement because provisions interfered with the two individuals’ potential rights and existing legal claims for indemnification. The Tenth Circuit remanded the case for the district court to provide further analysis of the individuals’ settlement objections.

According to the company’s 10-Q, the revised settlement resolves the class claims against the two individuals (in addition to all other defendants, the claims against who were resolved in the initial settlement), in exchange for which the two individuals withdrew their objections to the settlement and resolved their indemnification dispute with the company.

In a statement that is noteworthy in the larger context, the 10-Q reports that the company has “the right to terminate the settlement if class members representing more than a specified amount of alleged securities losses elect to opt-out.” The 10-Q provides no information as to what might constitute the “specified amount.”

This “blow up” provision, by which the deal is off if a specified percentage opts out, is not atypical, but it is interesting in the context of the Qwest settlement. As I noted in a prior post (here), the now superseded Qwest settlement had the distinction of being the first settlement (of which I am aware) in which the value of the individual opt-out settlements exceeded the value of the class settlement. (At that time, the aggregate value of the opt-out settlements totaled $411 million, compared to the $400 million class settlement).

The revised Qwest settlement value exceeds the aggregate value of the prior publicly disclosed value of the opt-out settlements. But given the magnitude of the prior opt-outs, there certainly is an interesting question of what greater quantity of opt-outs might be required to blow up the revised settlement? And are the prior opt-outs included in that equation? Along those lines, it should also be noted that in its October 30, 2007 filing on Form 10-Q (here), the company announced that the aggregate amount claimed by various persons then opting out from the class settlement is "in excess of $1.9 billion" (which presumably included the $411 million in opt out settlements entered to that point). And if that amount of opting out is not enough to blow up the settlement, then just how much is?

Whether or not this settlement finally resolves this class action, the entire sequence of events may be significant in another respect as well. The events have the potential at least to mark the end of an approach to securities class action case resolution that became fashionable during the era of corporate scandals – that is, to try to ensure that as part of the case settlement that the certain individual defendants were forced to pay out of their own assets to resolve claims asserted against them. The extreme cases reflecting this approach were Enron and WorldCom, where individuals were made to pay settlement amounts without recourse to insurance or indemnity.

The Qwest securities class action, and in particular the difficulties that the company encountered in trying to settle the case without resolving claims against Nacchio and Woodruff, could constrain future attempts to implement this approach. Of course, it may also be argued that the Tenth Circuit did not specifically disallow the prior settled that excluded the two individuals; it merely required the district court to provide further explanation of why it approved the settlement that arguably deprived the individuals of their indemnification rights.

One puzzling note about the amended settlement is the statement in the company's 10-Q’s that Nacchio and Woodruff were contributing $5 million “insurance proceeds.” The document does not specify the source of the insurance, nor how there could be further insurance available after prior settlements, defense expense and other litigation expense.

Another odd note about this insurance component of the settlement is the suggestion that the two individuals were "contributing" the insurance funds, as if the $5 million was drawn from funds that these two individuals alone controlled, or at least that they were in a position to direct. Given that this case first arose way back in 2001, it is relatively unlikely (albeit not impossible) that these individuals carried individual director liabiltiy (IDL) insurance or that the company carried separate Side A insurance (although if the company did carry separate Side A coverage, the company's refusal to indemnify would trigger the protection). The other possibiltiy is that earlier on the parties and the company's insurers reached some accomodation that dedicated certain insurance funds solely for these two individuals, an arrangement that would be unusual particulary in the context of a claim that would seem likely to exhaust all available insurance.

In any event, in the end, despite all the efforts to the contrary, the claims against Naccho and Woodruff were settled without these two individuals having to make a contribution out of their own assets. The Qwest securities class action, and in particular the difficulties that the company encountered in trying to settle the case without including the claims against Nacchio and Woodruff, could constrain future attempts to implement this approach. (Of course, it may also be argued that the Tenth Circuit did not specifically disallow the prior settled that excluded the two individuals; it merely required the district court to provide further explanation of why it approved the settlement that arguably deprived the individuals of their indemnification rights.)

An August 7, 2008 Rocky Mountain News article describing the revised settlement can be found here.

About the GM Securities Litigation Settlement: As noted on the 10b5-Daily blog (here), in the company’s August 7, 2008 filing on Form 10-Q (here), General Motors announced that on July 21, 2008, it had settled the securities class action lawsuit pending against the company and certain of its directors and officers. For background regarding the lawsuit, refer here. The company agreed to pay $277 million and its auditor, Deloitte & Touche, agreed to pay $26 million, bringing the total value of the settlement to $303 million.

The 10-Q also announced that on August 6, 2008, the parties had also reached an agreement to settle the related shareholders’ derivative lawsuit. The settlement agreement “requires our management to recommend to the Board of Directors and its committees that we implement and maintain certain corporate governance changes for four years.” The company also agreed not to oppose the derivative plaintiffs’ petition for attorneys’ fees and costs “not to exceed $7.465 million.”

The 10-Q states further that the company believes “that a portion of our settlement costs are covered by insurance.” The document states that the company anticipates “recording income of approximately $200 million in the third quarter with insurance-related indemnification proceeds for previously recorded indemnification costs” including “the cost incurred to settle the General Motors Securities Litigation suit.”

An August 8, 2008 Business Insurance article (here) reports that a GM spokeswoman clarified that only $100 million of the $200 million of insurance relates to the securities lawsuit settlement; “half” of the $200 million, the article reports that the spokeswoman said, “is for settlements of litigation the company is not disclosing.”

Notwithstanding the odd note about $100 million of insurance for the settlement of undisclosed litigation, the overall suggestion is that $177 million of GM’s contribution to the securities lawsuit settlement is uninsured – or perhaps $7.645 million more than that if the attorneys’ fees in the derivative lawsuit are to be paid by insurance.

An interesting aspect of this case is the identity of the lead plaintiffs. Despite the defendant company's iconic status as an American company, the lead plaintiffs were two overseas institutional investors, Deka Investment GmbH, an investment fund manager based in Germany, and Luxembourg-based fund manager Deka International S.A, both affiliates of DekaBank. The presence of foreign plaintiffs in U.S. class actions has become increasingly common, a trend that is likely to continue as U.S.-based plaintiffs firms expand their presence overseas. The Securities Litigation Watch has frequently discussed this trend, as noted here.

One additional interesting aspect of this settlement is that it the parties were able to resolve the case at such an early stage. According to an August 11, 2008 article on Law.com (here), the federal judge to whom the case was assigned sent the case to mediation while the defendants' motions to dismiss were still pending.

According to RiskMetrics data quoted in the Business Insurance article, the GM settlement ranks as the twenty-fifth largest securities fraud settlement ever. And again, citing RiskMetrics data, the August 9, 2008 Wall Street Journal reported (here) that the GM settlement is the third largest securities lawsuit settlement of 2008, after the $895 million UnitedHealth Group settlement and the $750 Xerox settlement.

Special thanks to a loyal reader for the link to the Business Insurance article.

D&O Funds Gone, Case Grinds On: In a prior post (here), I noted that in the criminal case arising out of the collapse of Collins & Aikman, one of the defendants had sought an early  trial date because of the approaching depletion of the D&O insurance policy limits, potentially leaving him without resources to fund his defense.

In an August 8, 2008 post on his Race to the Bottom blog (here), Professor Jay Brown reports that even though no date has yet been set for the criminal trial in the case, the D&O insurance policy limits are now entirely exhausted. Counsel for one of the defendants reportedly stated at a July 24, 2008 status conference in the case that “the fourth and final layer carrier has informed us that – basically not to assume that there’s going to be any money after invoices submitted on July 31^st.”

The possibility that $50 million in insurance limits might be exhausted before a trial date is even set is a nightmare scenario for any director or officer.

As I noted in my prior post, escalating defense expense is an increasingly important consideration in the D&O limits selection equation. The potential for defense expense alone to deplete all available insurance in a catastrophic claim like the one involving Collins & Aikman may seem like an extreme case, but D&O insurance ought to be able to respond and provide protection even in a catastrophic claim. However, increased limits along may not be the answer; rather, insurance structures, designed to ensure dedicated protection to specified individuals, may be the most important protection against the devastating potential of catastrophic D&O claims.

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Just when you thought it was safe to go outside again, the subprime litigation wave has struck once more. On August 7, 2008, plaintiffs’ lawyers filed a securities class action lawsuit in the Southern District of New York against KKR Financial Holdings LLC and certain of its directors and officers. A copy of the plaintiffs’ lawyers’ August 7 press release can be found here, and the complaint can be found here.

According to the complaint, KKR Financial Holdings LLC (KFN) is an affiliate of the private equity firm Kohlberg, Kravis, Roberts & Co. KFN is a specialty finance company that invests in multiple asset classes. The complaint relates to representations allegedly made in connection with May 4, 2007 merger and share issuance transaction associated with the affiliate’s conversion from a REIT to a limited liability company. In this transaction, investors holding shares in the predecessor company received an equal number of shares in the successor company.

The complaint asserts claims based on the Securities Act of 1933. According to the press release,

the Registration Statement was false and misleading in that it misrepresented and/or omitted material facts, including: (a) the problematic real-estate-related assets held by the Company were a much bigger risk to the Company than the Registration Statement had represented; (b) the Company’s capital would be insufficient given the deterioration in its portfolio which would necessitate capital preservation and the need to raise capital to the detriment of common stockholders; and (c) the Company was failing to adequately record loss reserves for its mortgage-related exposure, causing its balance sheet and financial results to be artificially inflated.

During May, June and most of July 2007, KFN’s stock traded above $25 per share. In late July, many mortgage-related companies’ stock prices declined, including KFN’s. Nevertheless, KFN’s stock closed at $18.02 per share on August 13, 2007. Then, on August 15, 2007, KFN issued a release which revealed that KFN would be selling $5.1 billion in mortgage backed securities at a loss. When this news was revealed, KFN’s stock price collapsed to as low as $9.39 per share, eventually closing at $10.52 per share, a decline from the prior day of 31%. KFN shares currently trade for approximately $10 per share, a 63% decline from the $26.90 per share at which they were sold to plaintiff and the Class.

After the last year and a half, when there has been a flood of new subprime-related lawsuits, there is perhaps nothing too surprising about the kinds of allegations in the KFN complaint. What may be a little bit surprising is that the disclosures on which the complaint is based, and the ensuing stock price drop, took place nearly a year ago.

While the subprime litigation wave has been unfolding, there have been occasional periods where it has seemed as if the plaintiffs’ lawyers are engaging in a little backing and filling, as if catching up with unfinished business that went unattended due to occasional logjams. Given the magnitude of the stock price drop associated with the disclosure (more than $1 billion), as well as the prominence of the company’s affiliated relations, this case seems like it might not have been overlooked.

But in any event, I have added this case to my running tally of subprime and credit crisis-related securities lawsuits, which can be accessed here. With the addition of the KFN lawsuit, the current tally of subprime and credit crisis-related securities lawsuits now stands as 103, of which 63 were filed in 2008.

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Over the past two days, plaintiffs’ attorneys have launched a couple of new securities lawsuits. Nothing particularly noteworthy about that, in and of itself. But upon closer review, there are some rather interesting things about these new lawsuits. I note my observations below after briefly describing each of the two new lawsuits.

The first of these lawsuits was filed on August 5, 2008 in the Southern District of Indiana against medical device manufacturer Zimmer Holdings, its CEO, and its CFO. A copy of the plaintiffs’ August 5 press release can be found here, and the complaint can be found here.

According to the press release, the Zimmer complaint alleges that:

defendants failed to disclose material flaws in the quality systems at Zimmer’s Dover, Ohio facility, which manufactured Zimmer Orthopedic Surgical Products. In addition, defendants failed to disclose that patients receiving the Company’s Durom Acetabular Component, used in total hip replacement procedures, disproportionately experienced cup loosening requiring additional corrective surgery after implantation. As a result of defendants’ materially false and misleading statements, Zimmer’s common stock traded at artificially inflated prices during the Class Period. When the true condition of the Company, its facilities, and its products began to come to light, the price of Zimmer stock declined, falling from $70.88 to $66.01 per share in one day.

The second of the two lawsuits was filed on August 6, 2008 in the Eastern District of Virginia against automobile retailer CarMax and certain of its directors and officers. A copy of the plaintiffs’ August 6 press release can be found here and the complaint can be found here.

According to the press release, the CarMax complaint alleges that:

during the Class Period, CarMax was not meeting internal sales targets and was facing a 55% shortfall in its net income for first quarter of fiscal year 2009, later prompting the Company to suspend its financial guidance for the rest of fiscal 2009. According to the complaint, CarMax publicly issued materially false and misleading statements and failed to disclose: (i) that CarMax was not positioned to meet its sales targets or earnings objectives for fiscal 2009; (ii) that the Company had completed a refinancing of its warehouse facility which had materially increased the Company’s funding costs; and (iii) as a result of the foregoing, defendants had no reasonable basis for their revenues and earnings guidance for fiscal 2009.

On June 18, 2008, the Company issued a press release announcing its financial results for the first quarter of fiscal 2009, the period ended May 31, 2008. The Company also announced that it was suspending its financial guidance for the rest of fiscal 2009. Upon this news, shares of the Company’s stock fell $2 per share, or approximately 11%, to close at $16.34 per share, on heavy trading volume.

The first noteworthy thing about these two lawsuits is the relative modesty of the stock price drops they allege. In general, plaintiffs’ lawyers’ try to rely on allegations of dramatic stock price drops to try to show that the marketplace was shocked by the unexpected revelation of previously withheld information. Stock price drops of 11% in CarMax’s case, and less than 7% in the case of Zimmer, are not really the type of dramatic share price declines that you might expect to attract plaintiffs’ lawyers’ attention.

In CarMax’s case, it clearly was not just the stock price decline that caught the plaintiffs’ attorneys’ eyes. CarMax was also the subject of a June 25, 2008 Wall Street Journal article entitled “CarMax Executives Sold Before Shortfall” (here), noting that CarMax insiders had sold $4.3 million in company stock in April and May 2008, ahead of the company’s June announcement of disappointing revenue.

The Journal article stated that the “had the insiders waited and conducted their transactions after the earnings report, their proceeds would have been just $2.7 million, a drop of nearly 40%.” As might be expected, the CarMax complaint quotes the Journal article extensively.

The Zimmer lawsuit is little harder to fathom. Not only does the complaint allege only a 7% stock price drop, but unlike the CarMax complaint, it contains no insider trading allegations. Perhaps even more significantly, not only was Zimmer’s stock price drop modest, but it has been completely erased in the eleven trading days following the company’s July 22, 2008 second quarter earnings release. Indeed, Zimmer’s stock closed today at 70.89, which is basically unchanged from the company’s share price of 70.88 preceding the stock drop.

To be sure, these are both large companies and even modest share price declines represent significant amounts in dollar terms. The two dollar share price drop alleged in the CarMax complaint represents a market capitalization loss of roughly $440 million. The $4.87 share price drop alleged in the Zimmer complaint represents a slightly more than $1 billion drop in Zimmer’s market cap – although all of that has been recovered in the eleven trading days since the decline. While these dollar figures represent undeniably impressive sums, as a percentage matter they make less of an impression.

The other interesting thing about these two lawsuits is what they do not involve. That is, they do not involve subprime or credit crisis-related allegations. As I discussed in recent posts (here and here), two recent studies confirmed that securities activity in the first half of 2008 was largely driven by subprime and credit crisis-related litigation. These two new lawsuits suggest that plaintiffs’ lawyers still have time to indulge in other pursuits.

But while these cases do not involve subprime or credit crisis-related allegations (at least not directly), the CarMax case does suggest that the more general economic decline is starting to burden companies and, in CarMax’s case at least, attract the unwanted attention of plaintiffs’ lawyers.

CarMax’s June 18, 2008 press release (here) that triggered its stock price drop quotes its CEO as saying that “the slowdown in the economy, the dramatic rise in gasoline and food costs and the related impact on consumer spending adversely affected our first quarter performance.” The release also states that “for the first time in more than two years, we experienced a modest decline in customer traffic in our stores. Additionally, credit availability from our third-party nonprime lenders declined slightly in the quarter.”

CarMax is far from the only company that in the weeks and months ahead will be reporting disappointing earnings as a result of the slowdown in the economy and declining consumer spending. Not all of the companies that report disappointing earnings will get sued. But if a stock price drop of 11%, or even just 7%, is enough to attract a lawsuit, there could be a period of heightened litigation activity ahead. Based on these two lawsuits, the plaintiffs’ securities bar seems primed for action – regardless of whether or not subprime or credit crisis-related issues are involved.

Politics on a New Plane?: A July 31, 2008 article in The Economist (here) reports the following about recent political events in India:

India’s coalition government went to outlandish lengths to win a vote of confidence in Parliament on July 22nd, a victory it hopes will prolong its life until early next year. To appease one politician, it even renamed the airport in Lucknow, a state capital, after his father. (The ingrate still voted the other way.) Asked to justify this ploy, India’s finance minister dryly remarked, “It will facilitate better take-offs and landings.”

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That sure didn’t take long.

GT Solar International completed its $500 million IPO on July 23, 2008. Then on August 1, 2008, a mere seven trading days later, the plaintiffs’ lawyers initiated a purported securities class action lawsuit in the United States District Court for the District of New Hampshire against the company and certain of its directors and officers, as well as the offering underwriters.

A copy of the plaintiffs’ lawyers August 1 press release can be found here. A copy of the complaint can be found here.

According to the press release, the proceeds of the IPO went to GT Solar Holdings, which in turn “intended to use the net proceeds … to make a distribution to its shareholders.” The press release also states that:

on July 25, 2008, before the market opened, LDK Solar Co., LTD (“LDK”), GT Solar’s largest customer, issued a press release announcing that it had signed a contract to purchase production equipment from one of GT Solar’s competitors. On this news, GT Solar’s stock price declined to as low as $9.30 per share before closing at $12.59 per share on July 25, 2008, losing 13% of its value in its second day of trading.

According to the complaint, the Registration Statement failed to disclose the true extent of the risks surrounding the Company’s relationship with LDK, including the fact that the Company was at imminent risk of losing out on a contract for future orders from LDK due to delays in shipping production equipment to LDK.

For whatever it may be worth, GT Solar’s amended filing on Form S-1 (here) did disclose the company’s dependence on a very few customers and consequent vulnerability (although there is no specific mention of any particular or imminent issues with LDK Solar); the risk factors in the company’s filing states:

We currently depend on a small number of customers in any given fiscal year for a substantial part of our sales and revenue.

In each fiscal year, we depend on a small number of customers for a substantial part of our sales and revenue. For example, in the fiscal year ended March 31, 2006 (on a combined basis), three customers accounted for 64% of our revenue; in the fiscal year ended March 31, 2007, three customers accounted for 70% of our revenue; and in the fiscal year ended March 31, 2008, one customer accounted for 62% of our revenue. In addition, as of March 31, 2008, we had a $1.3 billion order backlog, of which $769 million was attributable to three customers. As a result, the default in payment by any of our major customers, the loss of existing orders or lack of new orders in a specific financial period, or a change in the product acceptance schedule by such customers in a specific financial period, could significantly reduce our revenues and have a material adverse effect on our financial condition, results of operations, business and/or prospects. We anticipate that our dependence on a limited number of customers in any given fiscal year will continue for the foreseeable future. There is a risk that existing customers will elect not to do business with us in the future or will experience financial difficulties. Furthermore, many of our customers are at an early stage and many are dependent on the equity capital markets to finance their purchase of our products. As a result, these customers could experience financial difficulties and become unable to fulfill their contracts with us. There is also a risk that our customers will attempt to impose new or additional requirements on us that reduce the profitability of those customers for us. If we do not develop relationships with new customers, we may not be able to increase, or even maintain, our revenue, and our financial condition, results of operations, business and/or prospects may be materially adversely affected.

The lawsuit on the seventh trading day after GT Solar’s debut may represent some dubious kind of a record. Even Vonage Holding Company made it ten trading days before it was hit with a securities lawsuit (refer here for a more detailed discussion of the Vonage lawsuit). Indeed, Refco, which arguably represents the extreme example of an IPO flame out, was not hit with its first securities suit (about which refer here) until two full months after the company’s ill-fated IPO.

Historically, IPO companies have been more susceptible to securities lawsuits than the population of public companies as a whole. By my count, there have already been eleven securities lawsuits in 2008 alleging misrepresentations or omissions in connection with the defendant company’s IPO, even though 2008 has been an historically low year for IPO activity (although most of these eleven lawsuits relate to companies that completed their IPOs in 2007). Indeed, as I noted in my year-end analysis of the 2007 securities lawsuits (here), 29 of the 172 new securities lawsuits in 2007 were filed against IPO companies.

Because of IPO companies’ heightened susceptibility to securities lawsuits, a public company’s age (in terms of time since the company’s IPO) is one of the most important factors D&O underwriters consider in underwriting and pricing public company risks. The sudden turbulence GT Global has encountered certainly highlights the reason for that emphasis.

For a more detailed discussion of the considerations that D&O underwriters take into account in underwriting public company risk, refer here.

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On July 29, 2008, Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse released their mid-year 2008 report on securities litigation, entitled “Securities Class Action Filings: 2008 Mid-Year Assessment” (here). A July 29, 2008 press release describing the Report can be found here.

Although the Cornerstone Report differs in some details, it is otherwise entirely consistent with my own mid-year 2008 securities lawsuit filing report (which can be found here). Consistent with the observatoins in my prior report, the Cornerstone Report observes that securities filings in the first half of 2008 “continued the rebound that started in the second half of 2007.”

The Cornerstone Report states that there were 110 securities class action filings in the first half of 2008, which projects to an annualized total of 220. A year end total of 220 lawsuits would represent a 27.2 percent increase over 2007 and a 14.6 percent increase over the annual average for the 11 years ending in 2007.

The Report also notes that over half of the 2008 first-half filings (58) were driven by subprime and credit crisis-related allegations. Of these, 17 were related to auction rate securities.

The Report also notes that “market capitalization losses for defendant firms associated with filings in the first half of 2008 were higher than the average semiannual loss in the eleven preceding years,” and rival “the historical highs seen in 2000-02.” These market capitalization losses may well drive the value of future settlements in these recently filed securities lawsuits.

The Report also contains analysis suggesting that the so-called filing lull that prevailed from mid-2005 to mid-2007 “was partly due to a strong stock market with low volatility,” and that the more recently increased filing level was associated with increased volatility.

While the Cornerstone Report reflects analysis regarding the apparent connection between stock market volatility and securities lawsuit filings, the most recent Report omits analysis that appeared in Cornerstone’s mid-year 2007 report suggesting that the reduced filings during the period mid-2005 to mid-2007 was due to a “permanent shift” to a lower securities class action lawsuit filing level. As I noted at the time (refer here), I regarded the low stock market volatility as a much likelier explanation than any permanent behavioral shift as an explanation for the reduced filing levels.  

The Ultimate Solution to Stock Trader Misconduct: According to a July 27, 2008 Reuters report (here) , “A Chinese court upheld the death sentence of a former securities trader charged with embezzling 97.56 million yuan ($14.31 million).”

Hat tip to Kelly Rehyer for the link to the Reuters report.

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The intervening subprime meltdown makes it seem longer ago than it really was, but it was only a short time ago that regulatory reform was a very hot topic (as noted, for example, here). Dramatic intervening events have advanced other priorities. Indeed, efforts to increase rather than reduce financial markets regulation seem to be the current fashion.

Many of the same people whom only a short time ago were pleading that overregulation was harming U.S. financial markets’ global competitiveness are now clamoring for increased regulation. As former SEC Chairman Arthur Levitt noted in a March 21, 2008 Wall Street Journal op-ed piece entitled “Regulatory Underkill” (here), it is “ironic” now that the “most eminent voices in the business community” were “fixated on questionable measures of financial health” even while “the seeds of today’s market turmoil were being nourished not by regulatory excess, but by fundamental failures in oversight at almost every level.”

Even thought the climate unquestionably has changed, on July 24, 2008 the U.S. Chamber of Commerce’s Institute for Legal Reform released yet another call for reform, particularly with respect to securities class action litigation. The Institute’s Report, which is entitled “Securities Class Action Litigation: The Problems, its Impact and the Path to Reform,” can be found here. The Institute’s July 24 press release can be found here.

Among other things, the Report decries the “culture of abusive class actions” that is “eroding the competitiveness of U.S. capital markets at a time when the face perhaps their greatest threat from foreign competition.”

The Report is interesting and it is effective in summarizing the excesses and abuses of the current U.S. securities litigation system. The Report also contains some useful proposals. In particular, the Report focuses on the potential of abuses of a “pay to play” system where public officials responsible for public pension funds solicit campaign contributions from plaintiffs’ firms that are later selected to act as the pension funds’ litigation counsel. The Report advocates passage of the currently pending “Securities Litigation Attorney Accountability and Transparency Act” (H.R. 5463) to eliminate pay-to-play conflicts and other suspicious connections between attorneys and elected officials.

The Report also advocates a number of procedural reforms, including taking steps to ensure greater coordination between public and private enforcement, and enacting provisions to allow defendants whose motions to dismiss are denied to take immediate interlocutory appeals.

Overall, the Report’s recommendations are useful. There unquestionably is value in examining these issues, and the current litigation system unquestionably suffers from excesses and abuses. I question whether any of these kinds of reform proposals are likely to gain much traction in the current environment.

I also think that any reform initiative should also acknowledge several important additional considerations. The first is that our securities enforcement approach presumes active private litigation. As the Supreme Court noted in its 2007 Tellabs opinion, “meritorious private actions to enforce federal antifraud securities laws are an essential supplement to criminal prosecutions and civil enforcement actions.” While there unquestionably are excesses and abuses in the current system, any reform attempt should also acknowledge private securities litigation’s important role.

The other important consideration relates to the fundamental question of U.S. competitiveness in the global economy. Ultimately, the greatest advantage that the U.S. markets historically have enjoyed is their reputation for integrity. As Arthur Levitt wrote in the op-ed piece cited above,

Ultimately, those who were so concerned with Wall Street’s competitiveness need to realize that the true competitive advantage of America’s capital markets has long been their high quality. With that quality in doubt, leaders and policy makers need to put their ideological fixations aside and commit themselves to giving investors the levels of transparency and accountability they deserve and expect from the world’s strongest markets.

It may well be useful and even important to consider ways to improve our system of private securities litigation. But it is also critically important that any reform proposal appropriately take into account the very things that have historically given the U.S. markets their strength -- that is, their reputation for transparency and integrity, a reputation that U.S. financial markets already have much work to do to rehabilitate. Somehow, these rehabilitation efforts seem higher priority now than proposals for securities class action reform, no matter how meritorious.

Special thanks to several loyal readers for forwarding a link to the Institute’s Report.

More Credit Crisis Litigation: In prior posts (most recently here), I have detailed that the current litigation wave has spread far beyond the subprime lending arena where it first originated. A recently filed lawsuit underscores the extent of this spread.

As detailed in the plaintiffs’ counsel’s July 25, 2008 press release (here), plaintiff shareholders have filed a purported securities class action lawsuit in the United States District Court for the Southern District of New York against CIT Group and certain of its directors and officers. A copy of the complaint can be found here.

CIT is a commercial and consumer finance company whose share price fell in March 2008 after reports circulated about the possibility that the company would have to charge off loans made to students of Silver State Helicopter, which had filed for bankruptcy. The complaint alleges that the defendants made false statements about the company’s financial condition, and specifically that “CIT’s public financial statements failed to account for tens of millions of dollars in loans to [Silver State], which were highly unlikely to be repaid and should have been written off.”

These have been prior lawsuits as part of the current credit crisis litigation wave that have involved student loans. For example, both Sallie Mae (refer here) and The First Marblehead Corporation (refer here) previously have been sued in securities lawsuits arising from troubled student loans. Whether or not there will be further lawsuits relating to student loans, there undoubtedly will be further litigation involving other types of credit as the current economic turmoil unfolds.

In any event, I have added the CIT Group lawsuit to my running tally of subprime and credit crisis related litigation, which can be accessed here. With the addition of the CIT Group lawsuit, the current tally of subprime and credit-crisis related securities lawsuits now stands at 102, of which 62 have been filed in 2008.

Break in the Action: The D&O Diary will be on a reduced publication schedule for the next week. The D&O Diary will resume its normal schedule during the week of August 4^th.

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Lots has been written, even on The D&O Diary (most recently here), about the way the world is adjusting to investors’ growing desire to hold management accountable. At the same time, U.S. courts have proven increasingly reluctant to project the remedies available under its securities laws into situations where there is an insufficient connection to the U.S. (as discussed here).

But the lawsuit filed on June 12, 2008 against the European Aeronautic Defence & Space Co. (EADS) in the United States District Court for the Southern District of New York takes all of that and puts in into a truly interesting and potentially combustible mix   – the plaintiffs are U.S. citizens, but they exclusively bought their shares in this foreign-domiciled company outside the U.S. The company’s shares do not trade on any U.S. exchange.

The company and the individual defendants, all current and former directors and officers of EADS, are domiciled outside the U.S. EADS is a Netherlands company with its principle place of business in The Netherlands. This is a company that is foreign to the U.S. in every sense of the word and only the investor plaintiffs themselves have any connection to the U.S.

If there were ever a case to test the outer limits for the availability of U.S. courts for remedies under the U.S. securities laws, this case would appear to be the one.

The plaintiffs’ attorneys’ June 12, 2008 press release can be found here. A copy of the complaint can be found here.

As described in the press release, the complaint alleges that

EADS falsely assured the investing public that it would overcome the technical problems in the production of the Company’s Airbus A380 commercial jets (“A380”) and it would be able to meet its year-end delivery deadlines. Moreover, the Company issued numerous positive statements which described the Company’s increasing financial performance. According to the complaint, these statements were materially false and misleading because they failed to disclose and misrepresented the following adverse facts, among others: (i) that the Company was experiencing insurmountable delays in the manufacture of the A380 commercial jet; (ii) that the Company would be required to compensate its customers for these delays through discounts and certain customers would likely be canceling their entire orders; and (iii) that, as a result of the foregoing, the Company’s ability to receive new contract awards from commercial airliners and its ability to reap future revenues at the levels that it was projecting would be in serious doubt.

On June 13, 2006, the Company announced that its Airbus subsidiary was having production problems with the A380 commercial jet, which would cause a significant delay in delivery to its customers. The Company also issued a profit warning beyond 2006 which was attributable to these delays and announced that it anticipated annual shortfalls of €500 million, without taking into account possible contract terminations from existing customers.

What makes this case interesting is not the specific factual allegations, which, at least by U.S. standards, are not all that remarkable. What makes this case interesting is the putative class on whose behalf the claim is brought. According to the press release, the lawsuit is brought on behalf of “U.S. citizens who purchased the publicly traded stock of European Aeronautic Defence & Space Co. (“EADS” or the “Company”) on the Frankfurt (Frankfurt: EAD.F), Madrid (Mercado Continuo: EAD.MC) and/or Paris (Paris: EAD.PA) stock exchanges between January 17, 2005 and June 13, 2006, inclusive.”

There are several noteworthy points about this class description. First and foremost, the plaintiffs’ lawyers do not purport to represent foreign investors who brought their shares abroad, so they are consciously avoiding the so-called f-cubed litigant problem (foreign domiciled investors who bought their shares in a foreign domiciled company on a foreign exchange). But the class description underscores the fact that this company’s shares were not traded on a U.S. exchange. They were only traded on foreign exchanges.

This class description raises, in a fairly dramatic way, the ultimate question of how broadly the remedies available under the U.S. securities laws should reach. Do they reach even to a foreign company whose shares do not trade at all in the U.S?

The traditional standards, looking to whether there was (or were) fraudulent conduct or the effects of fraudulent conduct in the U.S., might post significant hurdles for the court to exercise jurisdiction in this case, except that those standards were developed to aid court to determine whether or not to exercise jurisdiction on behalf of investors domiciled outside the U.S. Courts have generally not hesitated to exercise jurisdiction, even against foreign domiciled companies, on behalf of U.S. citizens. But will the court be willing to exercise jurisdiction against a foreign-domiciled company whose shares do not trade in the U.S.?

There may well be prior cases that raise this particular set of issues, and if so I hope readers will let me know. To my knowledge this is a new angle on the perennial set of jurisdictional questions surrounding securities claims against foreign domiciled companies. If the U.S. court were to exercise subject matter jurisdiction here, it would in effect represent a projection of U.S court jurisdiction and U.S. style securities litigation to any company anywhere, as long as there is a U.S.-based investor. Maybe a court here will go for that, but it seems like a stretch to me.

Is there any company anywhere in the world that does not have U.S.-based investors? Should the mere presence of those investors in the U.S. courts allow U.S courts to exercise jurisdiction over all those companies, no matter where they are located and where their shares trade?

Finally, there is also the issue of personal jurisdiction over the individual defendants, and perhaps even over the corporate defendant. Have the defendants purposely availed themselves of the jurisdiction or otherwise established minimum contact with the forum such that the exercise of jurisdiction over them comports with traditional notions of substantial justice and due process?

There probably are also some very interesting questions here about the basic merits of the claim. But those questions may or may not ever matter. The first innings of this game are going to be the ones to watch. Make sure you have your beer and your hot dog and that you are in your seat for the national anthem, because this game is going to rock and roll from the very first pitch.

UPDATE: On June 13, 2008, a different plaintiffs' firm apparently initiated a separate lawsuit against EADS on behalf of a different plaintiffs' class. According to the firm's press release (refer here), this newest lawsuit "seeks to recover damages on behalf of all U.S. and non-U.S. purchasers of the publicly traded securities of EADS during the Class Period." The new lawsuit also names as defendants Lagardere and Daimler AG, EADS's largest shareholders. This second lawsuit presents faces even more significant jurisdictional barriers, since it purports to represent the so-called f-cubed claimants. Clearly these complaints are testing outer jurisdictional boundaries on the availability of remedies under the U.S. seecurities laws.

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 As I have previously observed, the current credit crisis is about more than subprime loans. Among the other kinds of credit are so-called Option ARMs, which frequently involve prime borrowers. These loans are adjustable rate mortgages where the borrower has the option of paying less than the full amount of interest due, with the unpaid balance added to the principle (that is, the loan can negatively amortize). My prior post describing and discussing the nature of Option ARM loans can be found here.

This negative amortization payment feature of Option ARMs only makes sense (if at all) at a time of rising home prices. At a time of declining home values, it can quickly put the borrower in a position where they owe more than the value of their home. As unattractive as this position is, it can get worse when the interest rate adjusts upwards, leaving the borrower in a position of paying even more to stay in a home that is worth less than the mortgage debt.

Unsurprisingly, borrowers are having difficulties with Option ARM loans, which in turn is leading to problems for lenders with Option ARM portfolios. These problems in turn are leading to litigation.

The latest company to be sued in a securities class action lawsuit arising out of problems with Option ARM loans is Wachovia Corporation, which was sued, together with certain of its directors and officers, on June 6, 2008 in the United States District Court for the Central District of California. The plaintiffs’ lawyers’ June 9, 2008 press release about the lawsuit can be found here. The complaint can be found here. UPDATE: As correctly noted in the reader comment, this case is actually pending in the Northern District of California, rather than the Central District as original text incorrectly stated.

According to the press release, the complaint alleges that:

Defendants misled investors by falsely representing that Wachovia had strict and selective underwriting and loan origination practices and a conservative lending approach that set it apart from other lenders. Such reassurances were repeated by defendants throughout the Class Period in order to artificially support Wachovia's stock price in the midst of a weakening mortgage market. In response to increased market concern with the mortgage lending industry, and Wachovia's option ARMs in particular, Wachovia falsely represented that its loan underwriting practices were much better than at other banks and that this would allow it to prosper while lenders with less exacting standards and procedures would fare much worse. In reality, Wachovia's actual lending practices differed materially from the description of those practices in statements made to investors. The Company's ability to weather the deterioration in the real estate and credit markets was grossly exaggerated by Defendants, at precisely the worst time, when analysts began to ask tough questions. The Company, moreover, had inadequate loan loss reserves and falsely represented that its capital position was sufficient to fund its dividend.

Shortly after last assuring the market of its liquidity, the strength of its underwriting practices, and the adequacy of its reserves, Wachovia reported a surprise quarterly loss, undertook emergency measures to increase capital, and cut its dividend. On April 14, 2008, before the open of ordinary trading, Wachovia reported a loss of $350 million, or $0.20 per share, for the first quarter of 2008. The Company attributed the results to: (1) a $2.8 billion increase credit loss reserves, including $1.1 billion specifically for ``Pick-A-Pay'' reserve build, the lending program highly touted by the Company during the Class Period. The need to increase Pick-A-Pay reserves was attributed to Wachovia's adoption of a ``refined reserve modeling'' that resulted in ``higher than expected loss factors on Pick-a-Pay''; and (2) $2 billion in mark-to-market losses for mortgage backed securities, including a ``$729 million loss on unfunded leveraged finance commitments.'' In order to shore-up its capital, Wachovia announced the following steps: (1) reduce the dividend 41% to $0.375; and (2) plan to raise capital by $7-8 billion through public offerings.

Wachovia is only the latest company to become embroiled in securities litigation arising out of Option ARM problems. Companies previously sued in securities lawsuits involving Option ARM allegations include Washington Mutual (about which refer here) and Downey Financial (refer here). It seems highly unlikely that these companies will be the only ones to become involved in lawsuits involving these concerns.

Indeed, as bad as the situation involving Options ARMs may now appear, circumstances are likely to deteriorate in the months ahead. As discussed in the June 5, 2008 Business Week article entitled “The Next Real Estate Crisis” (here), foreclosures on Options ARMs have already tripled in the last year, but could further hasten as “monthly options recasts are expected to accelerate starting in April 2009, from $5 billion to a peak of about $10 billion in January 2010.” The Option ARM loan defaults “could accelerate next year even if subprime defaults subside.”

The possibility of further Option ARM related securities litigation seems likely.

In any event, I have added the new Wachovia case to my running tally of subprime and credit-crisis related securities class action lawsuits, which can be accessed here. The current tally now stands at 89, of which 49 have been filed in 2008.

It is probably worth noting that this new case is the third in which Wachovia has become involved as part of the current credit-crisis related litigation wave. In addition to the new lawsuit, Wachovia was previously sued in an auction rate securities lawsuit (refer here), and in a Prospectus Liability case arising out of the company’s offering of certain Trust Preferred Securities (about which refer here).

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In prior posts (refer here), I have discussed the increasing reluctance of U.S. courts to exercise subject matter jurisdiction over securities claims against foreign-domiciled companies brought by foreign claimants who bought their shares on foreign exchanges (so-called “f-cubed” claimants).

In the most recent example of this, Judge Thomas Griesa of the United States District Court for the Southern District of New York, in a June 3, 2008 opinion (here), granted the defendants’ motion to dismiss the claims of “f-cubed” claimants against AstraZeneca and certain of its directors and offices.

The complaint essentially alleges that Exanta, a pharmaceutical being develop by the AstraZeneca (a U.K.-based company) “was not as safe or effective as defendants’ public statements made it out to be.” The plaintiffs’ claimed that these statements inflated the company’s share price. Refer here for background regarding the lawsuit.

The outcome of the subject matter jurisdiction question was probably tipped in the court’s opening observation that “over 90% of the members of the putative class are foreigners who purchased their shares on foreign exchanges.”

The court reviewed the propriety of its exercise of jurisdiction over claims brought on behalf of these foreign shareholders, by considering whether or not there were sufficient allegations of U.S.-based conduct causing sufficient U.S.-based effects. The court found that while there were sufficient allegations of U.S.-based conduct, plaintiffs “do not allege facts in support of the second prong of the test – that the United States conduct ‘directly caused’ plaintiffs’ losses.”

The court said that in order to establish this requisite causal link, the plaintiffs must have “sufficiently alleged that the foreign purchasers relied on United States based conduct when deciding to acquire the stock”. In order to establish this kind of reliance, the plaintiffs urged the court in effect to adopt a global “fraud-on-the-market” theory, arguing that “it is illogical to suggest that the fraud-on-the-market theory applies within the United States but not outside of it.”

The court noted that other courts had rejected the global fraud-on-the-market theory, out of concerns that it would “extend the jurisdictional reach of the United States securities laws too far.” The court further noted that the Second Circuit had not yet provided guidance on whether the fraud-on-the-market theory should apply to foreign countries, and “in the absence of clear authority in favor of a global fraud-on-the-market theory, the court declines to adopt such a theory.” The court dismissed the claims of the foreign claimants based on lack of subject matter jurisdiction.

The court further concluded that the plaintiffs had not sufficiently alleged that two foreign-domiciled individual defendants had the requisite “minimum contacts” with the U.S. for the court to exercise personal jurisdiction over them.

Finally, the court concluded that the plaintiffs had not sufficiently pled scienter, and dismissed the remaining claims on that basis. The court held that neither the allegations of insider trading nor the allegations relating to a secondary offering were sufficient to establish scienter.

The court further rejected the plaintiffs allegations that the defendants had consciously disregarded the truth, based on the court’s own review of the various disclosure documents on which the plaintiffs sought to rely. The court concluded that the plaintiffs “have not alleged anything to negate the idea that that defendants were attempting to develop a drug they thought beneficial and were do describing it to the public.” The court found that the plaintiffs had “not alleged an inference of scienter as compelling as the opposing inference.”

The fact that the case will not be going forward even as to the domestic shareholders reduces the impact of the court’s ruling to exclude the f-cubed claimants from the class. The dispersion of the class, with such an overwhelming percentage of f-cubed claimants in the purported class members may well have inclined the outcome on the jurisdictional issue in any event.

Plaintiffs’ attorneys in the most recently filed cases seem to be anticipating that courts are inclined to exclude these claimants from the putative class and increasingly are taking that into account in their initial pleadings. For example, as discussed here, when plaintiffs’ lawyers recently launched a U.S. securities lawsuit against Société Générale, they included in the purported class only U.S residents and investors who bought ADRs on U.S. exchanges. Their purported class by its own construction excludes foreign residents who bought shares on foreign exchanges.

The increasing exclusion of f-cubed litigants from U.S. securities class actions (whether voluntary or as a result of court action) is one of the reasons that interest in U.S.-style securities relief is increasing in other countries, as I discussed in a recent post (here).

In any event, the court’s dismissal of the AstraZeneca case also continues another trend, which is that while life sciences companies are frequently sued (compared to companies in most other categories), the cases filed against them are often dismissed, as I also discussed in a prior post (here)

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In October 2000, the SEC promulgated Rule 10b5-1 to provide company insiders with a way to trade their shares in company stock without incurring securities law liability, through the pre-trading adoption of a written trading plan. Despite the Rule’s protective purpose, concerns have arisen more recently about Rule 10b5-1 plan abuses, as I noted in prior posts (here and here).

Indeed, concerns about Angelo Mozilo’s possible Rule 10b5-1 plan misuse were an important part of the court’s recent refusal to dismiss the Countrywide subprime-related derivative lawsuit. (My prior post about the Countrywide dismissal denial can be found here. A more detailed analysis of the Countrywide court’s discussion of Rule 10b5-1 plan issues can be found on The Corporate Counsel.net blog, here.)

A May 27, 2008 paper by University of Chicago Law Professor Todd Henderson, Stanford Business School Professor Alan Jagolinzer, and Penn State Business Professor Karl Muller entitled “Scienter Disclosure” (here) looks at Rule 10b5-1 plans from a different perspective, asking what can be inferred from a company’s disclosure of its officials’ plans. The authors’ surprising conclusion is that the more detailed a company’s plan disclosure, the more likely are the subsequent trades to capture abnormal trading returns.

The starting point of the authors’ analysis is that, although Rule 10b5-1 itself does not require the plans to be disclosed, “disclosure can enhance the legal protection by increasing the likelihood of early dismissal of class action lawsuits.” This “litigation benefit” arises due to the fact a Rule 10b5-1 plan trading defense will only be available at to dismissal stage if the plan is identified and described in the company’s SEC filings (which a court may consider at the initial pleading stage). If the company fully discloses the plan details, “a court may better ascertain that the allegedly fraudulent trades fall within the Rule’s affirmative defense, thereby increasing the possibility of a low-cost dismissal.”

From this, the authors infer that companies perceiving a greater litigation risk are “more apt to disclose the existence and details of Rule 10b5-1 plans.” But there are costs associated with disclosing the plans, particularly “if investors infer a price relevant signal from disclosure or if disclosure enhances investors’ monitoring of insiders’ trade plan commitment.” The “signal” might encourage investor “front running” which could deprive the insider of anticipated trading profits. The monitoring “reduces the value of early termination options” the insider might have if a planned trade no longer appears desirable.

The authors hypothesized that insiders will nonetheless prefer Rule 10b5-1 plan disclosure if the “scienter disclosure” provides incremental litigation benefit – which is likely to be greatest precisely where the ability to trade provides the greatest opportunity to profit. That is, “pre-disclosure of trade may be strategic in the face of high legal risk if it mitigates legal risk and does not fully reveal privately held information.”

The authors examined company disclosures for hundreds of companies during the period between October 2000 and December 2006, and grouped the companies according to whether the companies had low, moderate or detailed Rule 10b5-1 plan disclosure. The authors then correlated the companies’ disclosure and “subsequent firm returns and earning performance.” The authors found that “more specific 10b5-1 plan disclosures are associated with more negative post-trade abnormal returns” and that “the association between sales transactions and subsequent negative performance is increasing in disclosure specificity, after controlling for other factors that are associated with firm returns.”

As a group, executives at those companies with the most detailed disclosure avoided an average of 12% loss in the companies’ trades relative to the broader market in the six months following their sales. The authors conclude that “voluntary Rule 10b5-1 plan disclosure is associated with the higher level firm legal risk and a proxy for insider’s potential strategic trade.”

In other words, the more detailed disclosure manifests insiders’ perception that subsequent trades are more likely to be advantageous – and therefore legal protection is more likely to be important, justifying the detailed disclosure.

These data suggest, and the authors hypothesize, that “investors should respond negatively to specific disclosures regarding 10b5-1 participation, if they infer that insiders have high strategic trade potential for which they seek high litigation protection.” However, the authors found that there is no observable negative investor response to Rule 10b5-1 disclosure.

The authors’ conclusions have a number of important implications. Obviously, investors may be missing an important signal related to 10b5-1 disclosure. Another important implication relates to the protection that the Rule affords; the authors’ conclusion that the companies with the most detailed disclosure are also the ones with the most fortunate timing suggests that, at least in some companies, transparency may be facilitating aggressive stock sales. The Rule was designed to provide company officials with a way to trade safely, but the authors’ study suggests that at least some company officials may be using the Rule as a shield to unload stock at an opportune time.

While I confess that initially I found the authors’ conclusions troubling, after further reflection I am less concerned. The problem here is not that insiders are using Rule 10b5-1 plans and plan disclosure strategically – after all, the whole idea of the Rule was to facilitate trading, and there is certainly no suggestion that trades made pursuant to the Rule cannot be advantageous. The problem is that at least so far, investors have missed the negative signal that Rule 10b5-1 plan disclosure implies.

The authors themselves speculate that the absence of negative investor reaction “may indicate that there are frictions to implementing strategies based on 10b5-1 disclosure signals or that investors do not understand 10b5-1 disclosure implications, which is possible if our same period reflects the transition period regarding 10b5-1 use.” To the extent, however, that the signal is better understood, the more the marketplace itself will discipline the process.

The greater likelihood that the mere announcement of a 10b5-1 plan could undermine a company’s share price could provide a missing disciplinary constraint on strategic trading and reduce company officials’ ability to capture abnormal returns. In other words, the whole mechanism will function better if investors appreciate the significance of 10b5-1 disclosure – an appreciation that the authors’ research clearly should facilitate.

A May 27, 2008 USA Today article discussing the authors’ study can be found here. An entry on the University of Chicago Law School Faculty Blog discussing the article can be found here.

Very special thanks to Professor Henderson for alerting me to the article and for providing me with a link.

Another Options Backdating-Related Class Action Settlement: In its May 8, 2008 filing (here), Kratos Defense & Security Solutions (formerly known as Wireless Facilities) announced that in March 2008, it had reached a tentative agreement to settle the options backdating-related securities class action lawsuit pending against the company and certain of its directors and officers. The amount of the settlement is $4.5 million, of which $1.7 million will come from the company and the balance of which will come from the company’s D&O insurer.

I have added this settlement to my table of options backdating-related lawsuit settlements and dismissals, which can be accessed here.

Hat tip to Adam Savett of the Securities Litigation Watch blog (here) for providing the heads’ up about the Wireless Facilities settlement

Not Just Immune, But Infallible: If you were immensely rich and powerful, you too might well, as did the Sultan of Brunei in 2004, amend the constitution to “declare himself infallible and immune from any obligation to appear in court …and to subject anyone who criticizes him to criminal punishment.”

Those curious to know how a court might actually apply a provision like this and related legal issues will want to refer to Francis Pileggi’s Delaware Corporate and Commercial Litigation Blog (here), in which Pileggi reviews a May 23, 2008 Delaware Chancery Court decisions involving the Sultan and his brother. Among other things, Pileggi notes that in the course of reaching its decision, the Court “recites the background facts of royal family battles that could be part of a movie script.”

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The subprime litigation wave has been rolling along for well over a  year, so it might be expected that by now we have seen many of the likely litigation variations. I suspect there are hosts of new variations yet to come, but the most recent subprime-related lawsuits are substantially similar to prior lawsuits. Yet each one, briefly noted below, also involves some interesting additional variations on previously established subprime litigation themes.

Royal Bank of Canada Auction Rate Securities Lawsuit: On May 12, 2008, plaintiffs’ counsel announced (here) an auction rate securities-related class action lawsuit against Royal Bank of Canada and its subsidiaries, RBC Dain Rauscher and RBC Capital Markets Corporation. A copy of the complaint can be found here.

While there have been numerous prior auction rate securities lawsuits (about which refer here) and while the allegations in the RBC lawsuit appear substantially similar to the prior auction rate securities lawsuits, this lawsuit does present a couple of additional interesting elements.

The first is the lawsuit’s timing. The preceding auction rate securities lawsuits came in a rush between March 17, 2008 and April 21, 2008. There had been no new auction rate lawsuits since April 21, and the lengthening interval might have been interpreted to suggest that the filing onslaught had played itself out. The RBC lawsuit suggests that we may not yet have seen the last of the auction rate securities lawsuit filings.

The other interesting thing about the RBC lawsuit is that RBC itself is, obviously, a Canadian company. At a PLUS Chapter event in Montreal last week, there was a great deal of discussion about whether Canadian companies will feel the litigation effects of the subprime meltdown. The lawsuit against RBC suggests that at least Canadian companies with U.S. operating units exposed to subprime-related issues may find themselves swept up in the U.S.-based subprime litigation wave.

Indeed, RBC is not even the first Canadian company to be named in an auction rate securities lawsuit, as Oppenheimer, another Canadian company, was hit with an auction rate securities lawsuit in April 2008 (about which refer here). Even if Canadian companies are not being sued in Canadian courts on subprime-related issues, they are finding themselves involved in U.S.-based litigation.

Huntington Bancshares/Sky Financial/Waterfield Mortgage:  Huntington Bancshares, a Columbus, Ohio-based bank holding company, has previously been sued in a subprime-related securities class action lawsuit (about which refer here). The plaintiffs alleged in the prior lawsuit that, due to Huntington’s July 2007 acquisition of Sky Financial, Huntington had a much greater exposure to subprime mortgages than it had disclosed, allegedly harming a class of person who acquired Huntington shares between the time of the merger and the end of the class period in November 2007.

On May 7, 2008, Huntington was sued in a separate lawsuit in the United States District Court for the Southern District of Ohio (complaint here). In this most recent lawsuit, Huntington is sued as successor in interest to Sky Financial. The lawsuit is filed on behalf of the former shareholders of Waterfield Mortgage Company, whose shares Sky Financial had acquired in an October 2006 stock for stock-and-cash merger transaction.

The May 7 complaint, which also names as defendants Sky Financial’s former CEO and former CFO, alleges that the Sky Financial and the individual defendants violated Sections 11 and 12 of the ’33 Act through alleged false and misleading statements in the registration and proxy documents issued in connection with the Waterfield acquisition. The complaint alleges that Sky Financial had an undisclosed lending relationship that resulted in a significant residential mortgage exposure for Sky Financial.

This most recent Huntington lawsuit involves a different set of plaintiffs asserting claims based on a different set of representations yet involving a defendant bank that has already been drawn into the subprime litigation wave. There will likely be other lawsuits like this one ahead, as litigation emerges to fill in the interstices of the circumstances surrounding the subprime meltdown. So far, the most noteworthy attribute of the subprime litigation wave has been its breadth. Perhaps in the months ahead, as the wave spreads to fill in other gaps, the most pronounced aspect of the litigation wave will be its depth.  

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for a copy of the Huntington/Sky/Waterfield complaint.

Run the Numbers: With the addition of these two new subprime-related securities class action lawsuits, the current tally (refer here) of subprime and credit-related lawsuits stands at 79, of which 39 have been filed in 2008. With the addition of the RBC auction rate securities lawsuit, there have now been 16 auction rate securities lawsuits, all of which have been filed in 2008.

Subprime Litigation Down Under: According to a May 12, 2008 Wall Street Journal article (here), Centro Retail Ltd. and its management company, and Centro Properties Company Ltd. and its management company, collectively  an Australian shopping center group, have been named as defendants in two class action lawsuits filed in Australian federal court based on alleged misleading statements in Centro’s disclosure documents between August 9, 2007 and February 15, 2008.

As discussed in the May 13, 2008 issue of The Australian (here), the recently filed lawsuits, brought by the Maurice Blackburn firm, are actually the second set of lawsuits announced against Centro. As discussed here, lawsuits had previously been announced against Centro and its property trust by the Slater & Gordon law firm. Both sets of lawsuits relate to Centro’s alleged misrepresentations regarding its leverage and its vulnerability to adverse credit developments, as a result of which the company experienced a severe share price decline.

While the spread of subprime-related shareholder class action litigation to Australia is interesting in and of itself, one specific aspect of these two sets of lawsuits is particularly interesting to me. That is, both sets of lawsuits are proceeding in reliance on third-party litigation funding.

According to Slater & Gordon’s April 22, 2008 press release (here), its lawsuits are being funded by “U.S based litigation funder Commonwealth Legal Funding LLC.” According to the press release, litigation funders “take a percentage of the net amount recovered, after expenses and after legal fees, for advancing all expenses and accepting the risk of any adverse award.” (The law firm itself recovers a court-approved hourly rate.)

The Maurice Blackburn firm’s separate set of actions is being funded by Australian-based IMF (Australia) Ltd. IMF is actually a publicly traded company whose shares trade on the Australian stock exchange. IMF’s May 9, 2008 press releases announced the filing of the lawsuits against Centro can be found here and here.

It isn’t clear how the existence of these two competing ventures will be reconciled. One might argue that the free market should be allowed to decide; along those lines, the Slater & Gordon press release touts the “significant” advantage its funder affords, in that “it takes a lower amount of the net amount recovered, from 15 to 30 percent, compared to the top rate of 40 per cent for the other proposal.”

One of the time-honored traditions in international financial circles is to rail against the excesses of the U.S. litigation system. But for all of our litigation extremes, litigation funding is one innovation that has not caught on in this country. It obviously has, by contrast, caught fire in Australia, and according to a March 20, 2008 Legal Week article (here), it also apparently has spread to the U.K.

As to whether litigation funding might catch on in the U.S., the WSJ.com Law Blog has an interesting post discussing the issue here. The Re: The Auditors Blog also has an interesting post on the topic here.

Australia has been setting the pace on innovation lately, as, among other things, the Slater & Gordon firm itself recently became the world’s first publicly traded law firm (refer here).

Opt-Out Options for the Little Guy: In a recent post (here), I discussed Columbia Law School Professor John Coffee’s recent paper in which he speculated that that we might be moving to a two-tier securities litigation system in which institutional investors with large financial interests at stake might increasingly seek to opt out from class litigation. The class itself, Coffee speculated, might increasingly be populated only by smaller investors whose financial stakes were too slight to justify opting out or to attract the interest of plaintiffs’ attorneys.

But an aspiring plaintiffs’ attorney’s recent publicity bid suggests that there may be enthusiasm for encouraging the little guys to opt-out too. In a May 12, 2008 press release suggestively entitled “Study Finds Many Bear Stearns Employees Should Opt-Out of Class Actions” (here), Brett Sherman of the Sherman Law Firm seeks to point out to Bear Stearns employees that investors who opted out of prior cases have had a higher percentage recovery of their investment losses.

The press release cites a variety of sources regarding opt-out litigation (including, in a twist that feels odd to me, my own InSights article about opt outs). None of the studies specifically find, as the press release title suggests, that Bear Stearns employees should opt out. Rather, Sherman himself asserts that “the only reasonable conclusion is that Bear Stearns employees with substantial losses have a dramatically better chance to recover a higher percentage of losses in individual opt out cases rather than as participants in class actions.”

Perhaps if, as Coffee speculates, institutional investors will increasingly opt out of class actions, and if, as Sherman advocates, the little guys decide to opt out too, no one will be left in the class. The issue here is clearly potential class members’ perception that opt-outs recover a greater percentage of their investment loss. To the extent that perception is widely shared, class counsel may face significant pressure to show a greater percentage recover of investment loss. Otherwise, the class action itself could become an empty vessel.

Of course it remains to be seen whether either large or small potential class members actually do opt out in material numbers. But assume for the sake of argument that they do. All those who have reviled the class action litigation procedure for so many years might want to contemplate the procedural morass that would attend a multitude of individual opt-out actions. Class litigation does offer certain efficiencies whose loss we might one day mourn.

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Add corporate debt to the type of lending caught up in the current credit crisis, and add both commercial real estate financing companies and private equity firms (or at least one that recently completed a high profile public offering) to the kinds of companies now ensnared in the current wave of lawsuits. The latest round of lawsuits suggests just how far afield these cases may spread before all is said and done.  

The iStar Lawsuit: The lawsuit filed on April 14, 2008 in the United States District Court for the Southern District of New York against iStar Financial and certain of its directors and officers represents these latest variants in the evolving course credit crisis litigation wave. A copy of the plaintiffs’ lawyers’ press release about the iStar lawsuit can be found here, and the complaint can be found here.

The iStar lawsuit is brought on behalf of shareholders of the company who bought their shares in the company’s December 13, 2007 secondary offering, in which the company raised more that $227 million. According to the complaint, the offering documents failed to disclose that the company was at the time of the offering experiencing negative effects from the credit market turmoil and failed to recognize more that $200 million of losses on its “corporate loan and debt portfolio.”

On February 28, 2008, the company reported (here) a fourth quarter 2007 loss of 478.7 million, due in part to $134.9 million in charges associated with the “the impairment of two credits that are accounted for as held-to-maturity debt securities in its Corporate Loan and Debt portfolio.” and due to the fact that the company had increased its loan loss provisions by $113 million.

The Blackstone Lawsuit: In another example of the far flung effects from the current market turmoil, investors who bought shares of The Blackstone Group, L.P in the firm’s June 25, 2007 IPO have filed a lawsuit in the United States District Court for the Southern District of New York against the company and certain of its directors and officers.

According to the plaintiffs’ lawyers’ April 15, 2007 press release (here), the complaint alleges that the offering documents failed to disclose that Blackstone’s “portfolio companies were not performing well and were of declining value and, as a result, Blackstone’s equity investment was impaired and the Company would not generate anticipated performance fees on those investments or would have fees ‘clawed-back’ by limited partners in its funds.”

The complaint (which can be found here) alleges that in the company’s March 10, 2008 announcement (here)of fourth quarter and year end financial results, the company announced “announced that it was writing down its investment in Financial Guaranty Insurance Company by $122 million.”

Financial Guaranty Insurance Company is a bond insurer that has been struggling due to downgrades of its own credit rating. FGIC’s travails have already resulted in a prior securities class action lawsuit against the company’s other significant investor, The PMI Group. My prior discussion of The PMI Group securities litigation can be found here.

These events and ensuing lawsuits represent the latest extension of the circumstances that originated with the subprime lending meltdown but now are increasingly widespread. I recently highlighted (here) the turmoil (and ensuing litigation) that had affected the student lending sector. The extension of the effects and of the litigation, first to the commercial lending sector and to a commercial real estate financing company, and next to a private equity firm that went public only a short while ago amidst great hoopla and now has been sued for it, are merely the latest developments in what clearly promises to be an increasingly encompassing phenomenon.

As I have noted before, observers who persist in viewing the credit crisis and ensuing litigation as an exclusively “subprime”-related problem will not only fail to comprehend what has already occurred, but will likely underestimate what may lie ahead.

Another Auction Rate Securities Lawsuit: Another related recent development in this area is the lawsuit filed on April 14, 2008 on behalf of auction rate securities investors against Wells Fargo & Co. The plaintiffs’ attorneys’ press release can be found here and a copy of the complaint can be found here.

With the addition of the iStar, Blackstone and Wells Fargo lawsuits, my current tally of credit crisis-related securities lawsuits, which can be accessed here, now stands at 73, 33 of which have been filed in 2008. Thirteen of 73 lawsuits are brought on behalf of auction rate securities investors.

More Suits Against Securitzers: In earlier posts (here and here), I noted the emergence of securities class action lawsuits brought on behalf of investors against the investment banks and related entities that securitized mortgages and other types of debt into financial instruments in which the investors invested and in which they lost money.

The latest of these lawsuits was brought on March 19, 2008 in New York Supreme Court by the City of Ann Arbor Employees’ Retirement System on behalf of investors who purchased Mortgage Pass-Through Certificates as part of a December 12, 2006 offering of the instruments. Named as defendants are Citigroup Mortgage Loan Trust, which organized the offering of certificates backed by pools of mortgages, and 18 mortgage loan trusts, in which the mortgages were held. The defendants have removed the lawsuit to the United States District Court for the Eastern District of New York. Background regarding the lawsuit can be found here. A copy of the removal petition, to which the complaint is attached, can be found here.

The complaint alleges that the offering documents misrepresented the underwriting standards used in connection with the mortgage origination, and also misrepresented the various criteria used to qualify loans and properties. As a result, the complaint alleges, the offering documents misrepresented the risk profile of both the secured assets and the certificates.

The Citigroup lawsuit is substantially similar to the lawsuits previously brought against affiliates of Nomura (about which refer here), Countrywide (refer here) and Wachovia (refer here). This latest complaint is also similar to those prior complaints in that the plaintiffs (who in each case are represented by the Coughlin Stoia firm) sought to initiate each lawsuit in state court. My detailed analysis of the jurisdictional issues involved can be found in the post linked above regarding the Nomura lawsuit.  

Though the defendants have uniformly sought to remove these cases to federal court, in the Countrywide case, the earliest of these cases to be filed, the federal court granted the plaintiffs’ motion to remand the cases to state court. As noted in my discussion of the Countywide remand decision here, the federal court’s remand of the case to state court was based on the grant of concurrent jurisdiction to state courts for ’33 Act liability cases, a jurisdictional grant the federal court found has not been eliminated by subsequent legislation.

I have previously speculated that the plaintiffs’ strategy for pursuing these cases in state court is to avoid the requirements of the PSLRA, an impression that is reinforced by the fact that the plaintiffs’ lawyers did not issue a press release at the time they filed these state court complaints. Whether other defendants’ attempts to remove these lawsuits to federal court will ultimately prove to be successful remains to be seen, but the prospect of significant nationwide securities litigation going forward in state court seems fraught with the potential for uncertainty, opacity and complexity.

You’re Such a Lovely Audience, We’d Like to Take You Home With Us: As your reward for reading this far, I am going to share a wonderful little secret with you. Stanford Law School, which has long maintained its excellent Securities Class Action Clearinghouse (here) has now started the Stanford Global Class Action Clearinghouse (here). The new site is devoted to tracking the development of class action litigation throughout the world. While the site is new and is only just getting started, it already has very interesting materials and shows great promise. We can only hope its sponsors and guardians develop and maintain this new site as well as the predecessor.

Hat Tip to my good friends at the Drug and Device Law Blog (here) for the link to the new site.

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On April 8, 2008, PricewaterhouseCoopers released its 2007 Securities Litigation Study, which can be found here. The PwC study follows prior reports from NERA Economic Consulting (refer here) and Cornerstone Research (refer here and here). The PwC study differs from the other studies in certain details but the studies are all directionally consistent.

The PwC study observes that “after a two-year decline and a sluggish start to the year, total federal class actions filed in 2007 against foreign and domestic companies increased once more, reversing the previous downturn.” The PwC has some interesting thoughts about the prior downturn and the causes of the reversal; the study speculates that “much of the decrease in the 2006 numbers” was due to “the preoccupation of the plaintiffs’ bar with stock options matters filed primarily as derivative matters.” The study also observes that the upswing in 2007 “comes as no surprise” given that “the stock options matters appear mostly to have dissipated.”

The report also notes that the deterrent effect of Sarbanes Oxley “may have led to a lower number of overall cases” but adds that the economy may also have been a factor and “during hard times, the increased pressure to produce good financial results is more likely to lead to bad behavior which could result in higher levels of litigation” as a result of which “over the next few years” we could see “above the recent average number of filings.”

The study has a number of interesting observations about the role of accounting issues in securities lawsuits. Among other things, the study notes that while there have been a “burgeoning number of restatements in recent years,” the number of restatements associated with federal securities class actions is “relatively small” – the report notes that in 2007, the number of securities lawsuits associated with restatements fell to 29, from 47 in 2006. The report notes that this analysis supports the view that “market reaction to restatements is declining” and also supports the view that “the market does not react to all restatements.”

Somewhat differently than the recently released Cornerstone Research settlement analysis (here), the PwC study finds that the total value of settlements did not significantly change between 2006 and 2007. The PwC study also reports an average 2007 settlement of $56.3 million, compared to an average settlement of $57.5 million in 2006. Due to the few number of billon dollar settlements in 2007, if settlements greater than $2.5 billion are excluded, the average 2007 settlement was $28.3 million, compared to $57.5 million in 2006. 

The study includes commentary on a number of interesting topics, including the growth of subprime-related litigation and the growing importance of institutional investors in securities class action litigation. The study also includes interesting commentary on the increased prominence of hedge funds, about which the study notes:

As the subprime fallout continues into 2008, this will be one area to watch. Not only could litigation against hedge funds by investors increase, but large institutional investors such as pension funds – which have added hedge funds to their portfolios over recent years and which are increasingly active in shareholder lawsuits – may also begin to focus with similar activism on hedge funds in order to recover losses associated with the subprime crisis.

The PwC also has extended discussion of the issue of the growing importance of Foreign Corrupt Practices Act investigations and enforcement proceedings, a topic on which I have frequently commented on this blog (most recently here).

The study also has an interesting discussion of concerns facing foreign issuers. Among other things, the study notes that “the number of foreign IPOs climbed to 55 in 2007, surpassing the record of 34 IPOs set in 2006.” China “accounted for 55% of the foreign IPOs.” With these foreign listings has come litigation activity. According to the study, the number of 2007 securities lawsuits against foreign issuers increased by 93%, to 27 cases, in 2007, from 14 cases in 2006 (but short of the 30 cases filed in the record year of 2004). The report states that ten of these cases were against Chinese companies, of which five involved IPO-related allegations. My prior post discussing Chinese IPOs can be found here.

The report also has an interesting discussion of the growth of “global class actions,” involving both securities lawsuits in the US involving foreign domiciled companies, as well as the increasing number of lawsuits now being filed outside the U.S.

One concluding observation about the PwC’s settlement analysis. The study’s analysis of class action settlement data is interesting and useful, but I am concerned that as a result of trends in opt-out litigation and settlements, the study of class action settlements alone may no longer be sufficient to understand the full extent of companies’ potential loss severity exposure. To refer to but one example, in connection with the Qwest securities litigation, the aggregate value of the individual opt out settlements actually exceeded the amount of the class action settlement. (see my prior analysis of the Qwest opt out settlements here).

While the emergence of class action opt outs as a material issue is relatively reason, and for that reason still relatively uncertain, consideration of possible opt out litigation appears to be an increasingly indispensible part of the analysis of potential litigation exposure and of the total cost of securities litigation. My discussion of the emergence of opt out issues can be found here.

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Driven by the growing wave of subprime-related litigation (particularly a spate of auction rate securities lawsuits), the number of new securities class action lawsuit filings surged in March 2008. The total number of new securities class action lawsuit filings -- 25 – matches the number of new filings in November 2007, which in turn represented the highest monthly total of new filings since January 2005.

The 25 new securities lawsuits in March included 14 new subprime-related suits, taking account the new auction rate securities filed against J.P. Morgan Chase on March 31, 2008 (about which refer here). Of the 14 subprime-related suits, eight (including the new J.P. Morgan Chase lawsuit) were brought on behalf of auction rate securities investors against the companies that sold them the instruments. The remaining lawsuits (both those that are subprime-related and those that are not) were brought on behalf of public company shareholders against the companies and their directors and officers, other than one lawsuit brought on behalf of mutual fund investors.  

Largely because of the subprime-related litigation, many of the March lawsuits were filed in the United States District Court for the Southern District of New York – a total of 11 of March’s 25 new securities lawsuits were filed in the S.D.N.Y. Six of the new securities lawsuits filed in March involved companies domiciled overseas.

With the addition of the 25 new lawsuits in March, the total number of new securities lawsuits filed in the first quarter of 2008 totaled 52, of which 24 are subprime-related. All of the auction rate securities lawsuits were filed in March. (A complete list of the subprime-related lawsuits can be found on my running tally of subprime lawsuits, which may be accessed here.)

The 52 new securities class action filings in the first quarter of 2008, if extrapolated across four quarters, imply an annual filing rate of 208 new securities class action lawsuits, which is consistent with historical norms. (According to Cornerstone’s year-end 2007 securities analysis, here, the average number of securities class action filings during the period 1997 to 2006 is 1994). However, while this filing rate is consistent with historical levels, it is well above the annual levels seen in the most recent years, particularly 2006 (116) and 2007 (166).

Again, largely due to the number of subprime-related filings, the S.D.N.Y had the largest number of first quarter filings, with 21. The federal district with the next highest numbers of filings, D.Mass., had only five.

The companies sued in new securities lawsuits in the first quarter represented 31 different Standard Industrial Classification (SIC) Code categories, which might suggest that a broad diversity of companies were sued, but in most of those 31 categories only a single company was sued. The SIC Code categories with the largest numbers of companies sued were SIC Code category 6211 (Security Brokers and Dealers), with 7 companies sued, and 6021 (National Commercial Banks), with 6 companies sued. In all 29 companies in the 6000 SIC Code series (Finance, Insurance and Real Estate) were sued in the first quarter.

Nine of the companies sued for the first time in the first quarter of 2008 were domiciled overseas, representing eight different countries (including Switzerland, in which two of the companies are domiciled; the other seven countries had only one each.)

Six on the companies sued for the first time in the first quarter of 2008 had completed an initial public offering less than 12 months before the date of the first-filed lawsuit.

A final word about my lawsuit count: I am largely dependent on publicly available sources for my information about securities class action filings, although I have been able to supplement my information with data and links supplied by readers. (I am always grateful when readers bring information to my attention). I have compared my count to the information available on the Stanford Law School Securities Class Action Clearinghouse website (here) and have elected to omit certain cases that the Stanford site has included, largely because at least three of the cases listed on the Stanford site do not involved publicly traded companies. I will say that the diversity and variation of cases that have arisen in the last few months have created some very difficult categorization issues, and reasonable minds clearly could differ as to whether any particular case should or should not be “counted.”

While the securities class action lawsuit filing rate has fluctuated since mid-2007, the evidence remains consistent that the "lull" in filings that occured between mid-2005 and mid-2007 is over. It does remain to be seen if the filings will continue at their current rate, especially whethter factors such as the auction rate securities crisis will continue to drive litigation. On the other hand, the litigation activity is being driven by so many different aspects of the current crisis, it seems probable that subprime and other credit-related litigation will continue to accumulate. The more interesting question may be the extent to whcih the credit crisis litigation will spread beyond the financial sector.

A Further Thought about Securities Class Action Settlements: Earlier today I posted about the new Cornerstone report on 2007 class action settlements. The report is interesting and includes useful analysis and information. But upon reflection, it occurred to me that it is increasingly the case that class action settlement data alone may not provide all of the information necessary to understand the costs involved in resolving securities lawsuits. As I have noted in numerous prior posts (refer here), class opt outs are an increasingly important part of securities lawsuit resolution, a development that gained considerable momentum during 2007. Indeed, as I note here, the aggregate amount required to settle the Qwest opt-out actions actually exceeded the amount of the class settlement, and the amount paid in settlement of other opt actions is also very substantial.

For that reason, any assessment of the total costs involved in securities case resolution cannot be limited to class action settlements alone. The costs involved with separate opt-out actions must also be considered.

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On March 31, 2008, Cornerstone Research released its review and analysis of 2007 securities class action settlements. Cornerstone’s press release can be found here and the full report can be found here. The Cornerstone Report differs in certain particulars from the previously released NERA Economic Consulting report (about which refer here), but the two reports are directionally consistent.

Cornerstone’s press release emphasizes that the aggregate dollar value of all settlements was down 60% compared to 2006, but the full report emphasizes that, when the four largest settlements are removed from the analysis, the aggregate value of all settlements in 2007 exceeded all prior years except the unprecedented year of 2006.

The full report also highlights that the median securities class action settlement reached an all-time high of $9.0 million in 2007, compared to a median of $6.9 million for the years 1996 through 2006. The increase in the median settlement in 2007 is “partly due to the fact that the percentage of cases settling for $10-20 million increased substantially from prior years.” On the other hand, the number of settlements in excess of $100 million declined from 14 in 2006 to only nine in 2007.

According to the Cornerstone report, the average securities class action settlement fell from $105 million in 2006 (excluding the Enron settlement) to $62.7 million in 2007. But the 2007 average still exceeded the average of $54.7 million for the years 1996 through 2006.

The Cornerstone report examines the factors affecting settlement amounts and concludes that the presence of institutional investors lead plaintiffs and the existence of parallel shareholders’ derivative lawsuits both tend to have an upward effect on settlement values.

The press release quotes Stanford Law Professor Joseph Grundfest as saying that “it seems clear that the aggregate dollar value of settlements over the next two or three years is likely to decline significantly because the inventory of large cases in the pipeline just isn’t there. The interesting open question is whether the subprime crisis will cause an uptick in securities fraud settlement activity that might, given the settlement cycles in the litigation industry, only become apparent three to five years from now.”

The differences between the analysis in the Cornerstone and NERA Economic Consulting reports appears to be due at least in part to the different methods the two studies used to categorize settlements by settlement year, with one report categorizing the settlements by the year in which the settlement was announced and the other report categorizing the settlement by the year in which it was approved.

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As the markets for various types of subprime-related assets have seized up, many companies find themselves faced with complicated issues concerning asset valuation and disclosure. These issues have in turn both subjected companies to the possibility of litigation and encouraged investors to target the entities and institutions that sold them the assets in the first place. The extent of the asset valuation and disclosure issues suggests that the turmoil, and the ensuing litigation, will continue to spread.

One example where the valuation and disclosure issues have already led to litigation involves the securities class action lawsuit filed in the United States District Court for the District of Minnesota on March 28, 2008 against MoneyGram International and certain of its directors and officers. A copy of the plaintiffs’ attorneys’ press release can be found here and a copy of the complaint can be found here.

The complaint against Moneygram relates to the company’s January 14, 2008 press release (here) in which the company stated that it had completed its valuation of its investment portfolio as of November 30, 2007, as a result of which the company said that it had “experienced net unrealized losses of $571 million from September 30, 2007, bringing cumulative net unrealized losses to $860 million.” The company also announced that it has commenced a process to “realign is portfolio away from asset-backed securities,” as a result of which it had realized in January a loss of $200 million on asset sales of $1.3 billion.

According to the plaintiffs’ lawyers’ press release, the complaint alleges that the defendants “concealed from the investing public” that:

(a) the Company lacked requisite internal controls to ensure that the reserves for the Company’s investments in asset-backed securities were adequate, and, as a result, the Company’s projections and reported results issued during the Class Period were based upon defective assumptions and/or manipulated facts; and (b) the Company concealed the extent of its potential losses arising from its exposure to asset-backed securities containing uncollectible debt.

The prospect of securities litigation arising from asset valuation and disclosure issues is a potentially very substantial problem, because so many companies are facing these same kinds of issues due to asset-backed securities in their investment portfolio. Similarly, companies holding auction rate securities are facing particularly challenging valuation and disclosure issues, and as I have previously noted (most recently here), these challenges are not limited to companies in the financial sector, but indeed are widely dispersed throughout the economy. For example, a March 28, 2008 Wall Street Journal article entitled “’Auction Rates’ Clip Tech Firms’ Profits” (here) discusses the financial impacts that a variety of technology companies are facing because of the companies’ inability to convert their auction rate securities holdings into cash.

One measure of the depth of the problems arising from the failure of the auction rate securities market is that it is not just companies whose balance sheets are under pressure. Many households and individuals are also now about to recognize their own personal balance sheet hits due to the auction rate problem. According to a March 29, 2008 Wall Street Journal article entitled “UBS Plans Auction-Rate Price Cut” (here), UBS is going to lower the values of the auction rate securities held by its customers. The reduced values, which will be based on computer models and “will range from a few percentage points to more than 20%” will be reflected on their customers’ forthcoming statements.

As I have previously noted (most recently here), investors have already filed a number of class action lawsuits against the companies that sold them auction rate securities, and on March 27, 2007, Citibank became the latest to be sued in a securities class action on behalf of investors for its sale of auction rate securities (see press release here and complaint here). The reduction of the carrying values of auction rate securities on investors’ statements will likely further bestir investors and could lead to even more litigation. But making no adjustments could create a different set of issues and lead to greater problems later.

The question of how best to reflect the valuation of assets for which there is no current market is one that potentially affect participants at all levels of the economy. And while there undoubtedly will be more lawsuits on behalf of investors against the companies that sold them the auction rate securities, a potentially greater litigation threat may arise from shareholders who may contend they were misled about a company’s balance sheet exposure to these kinds of assets. There could well be a great deal of litigation in which it is alleged, as asserted in the complaint in the MoneyGram case, that a company failed to disclose the “extent of its potential losses arising from its exposure to asset-backed securities containing uncollectible debt.”

The extent of the problem shall be revealed in the fullness of time. But meanwhile the subprime-related securities class action litigation still continues to accumulate. With the addition of the MoneyGram and Citigroup lawsuits, my running tally of subprime-related securities lawsuits (which can be accessed here) now stands at 61, 23 of which have been filed in 2008, and seven of which are filed on behalf of auction rate investors against the companies who sold them the securities.

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