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

According to papers filed in the Southern District of New York on August 3, 2012, the parties to the Tronox securities litigation have agreed to settle the case for a total of $37 million. As I noted at the time that this suit was first filed back in July 2009 (here), the case, which alleged that the defendants had misrepresented Tronox’s environmental liabilities when the company was spun out of Kerr-McGee and thereafter, involved a host of recurring and interesting issues.

A copy of the parties’ stipulation of settlement can be found here. The settlement agreement is subject to court approval.

As discussed in greater detail here, the action was filed on behalf of those who purchased certain securities  of Tronox, Inc. between November 25, 2005 and January 12, 2009. The plaintiffs named as defendants certain former directors and officers of Tronox, as well as Kerr-McGee Corporation, Andarko Petroleum Corporation and certain Kerr-McGee executives.

As reflected in the their amended consolidated complaint (here), the plaintiffs alleged that Tronox’s IPO was a “scheme orchestrated by Defendant Kerr-McGee to foist the vast majority of its enormous environmental remediation and related tort liabilities, accumulated over decades, onto Tronox, so that Kerr-McGee could thereafter present itself for sale.” The plan, which allegedly involved spinning Tronox out as a separate company in an initial public offering, “reaped massive and almost immediate benefits when, on August 10, 2006, Defendant Anadarko acquired Kerr-McGee for $18 billion in cash and assumption of debt purportedly free and clear of any obligation for what had become, as of that date, Tronox’s environmental remediation and tort liabilities.”

The plaintiffs’ case survived, in whole or in part, multiple motions to dismiss, and following mediation, the parties agree to settle the lawsuit. As reflected in the parties’ stipulation of settlement, the $37 settlement consists of the following: Anadarko, Kerr-McGee and the Kerr-McGee director and officer defendants “shall pay, or shall cause their insurance carriers to pay $21,000,000”; the former Tronox individual director and officer defendants “shall cause their insurance carriers to pay $14,000,000”; and Tronox’s auditor, Ernst & Young, “shall pay $2,000,000.”

As I noted at the time the case was first filed, one of the interesting things about this case is that it presents the clear example of a securities claim based upon disclosures relating to environmental liabilities. The possibility of this kind of claim is often a key concern at the time of D&O insurance policy placement, as the question often arises whether the standard policy’s pollution exclusion will preclude coverage for a securities claim based on environmentally-related disclosures. As this case demonstrates, it is critically important for the standard pollution exclusion to be revised to carve back coverage for securities claims and derivative claims based on environmental disclosures. (It is probably worth noting that many of the modern Excess Side A DIC insurance policies often have no environmental or pollution exclusion, which could well have been relevant here, given that by the time these suits were filed, Tronox was in bankruptcy.).

Another interesting thing about this case is that it involved three corporate entity defendants (Tronox, Kerr-McGee, and Anadarko), but the securities of only one of the three, Tronox. The issue here has to do with the definition of the term Securities Claim in the standard D&O policy. In many policies, the term is defined to refer to any claim based upon the purchase or sale of the securities of the Insured Entity itself. The question here would be whether or not a claim involving the purchase or sale of Tronox’s securities would constitute a “securities claim” under the Kerr-McGee’s and Anadarko’s policies. Of course, the individual Kerr-McGee directors and officers would be entitled to coverage whether or not the lawsuit represented a “securities claim” within the meaning of the term; this question has to do with whether or not there would be coverage under the policies for the entities themselves.

In the end, it appears that the portion of the settlement pertaining to the liabilities of the former Tronox director and officer defendants is to be covered by insurance, and the portion relating to the liabilities of the Kerr-McGee director and officer defendants, as well as Kerr-McGee and Anadarko themselves, would be funded in whole or in part by insurance. This outcome suggests that in the course of negotiations these issues, if actually involved in this case, were worked out or compromised in the course of the settlement negotiations.

As I previously observed, the allegations in the underlying complaints are noteworthy because they represent specific examples of what I have previously identified (most recently here) as the growing disclosure risks public companies face regarding their environmental liabilities. Although more recently I have emphasized the growing risks surrounding climate change related issues, as this case demonstrates, the disclosure risks also include the risks associated with more conventional environmental liability exposures. The case also underscores the importance of addressing at the time of policy placement the possibility of securities claims arising based on environmental disclosures.

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A great deal of the analysis of securities class action lawsuit settlements revolves around measures of aggregate, average and median settlement amounts. These data, while useful, are relatively unhelpful in trying to anticipate the outcome of any particular case, particularly at the outset. To try to develop a way to predict likely case outcome at the outset of a securities class action lawsuit, four academics conducted a detailed statistical analysis of securities class action settlements in order to identify factors that affect outcomes.

In their April 30, 2012 paper entitled “Predicting Securities Fraud Settlements and Amounts: A Hierarchical Bayesian Model of Federal Securities Class Action Lawsuits” (here), Northwestern University Business Professor Blakeley McShane, Juridigm Principal and Vice President Oliver Watson, U. Penn Law Professor Tom Baker and Fordham University Law Professor Sean Griffith set out to create a “predictive model to forecast case outcomes based exclusively on information available at the time the lawsuit is filed.”

Their model, described in their paper, “estimates (i) the probability of the settlement versus dismissal of a securities class action lawsuit and (ii) the amount for which the class action will settle conditional on the settlement.”

A great deal of the authors’ paper is devoted to a description of the methodology used to derive the data on which their analysis is based. Another significant part of the paper is devoted to a description of their analytic methodology, which, as their title suggests, employs high level statistical approaches and techniques. A detailed description of the authors’ data derivation and statistical methodologies is beyond the scope of this blog (which is another way of saying that I know my limits).

For purposes of understanding the authors’ conclusions, it is useful to note that the authors derived a data set of nearly 1200 securities class action lawsuits and associated case resolutions. Among other critical steps taken to derive their data set, the authors focused exclusively on cases filed post-PSLRA that were filed five years or more before the starting date of their analysis. (The five year cut-off was used to ensure the likelihood that the cases in the data set had been finally resolved). Essentially, the authors looked at cases filed between 1996 and 2005 that otherwise survived the authors’ filters and sorting criteria.

The authors also derived several of their own measures using variety of data sources. For example, in order to determine the “notoriety” or “newsworthiness” of a particular company or case, the authors considered the number of Google News Archive hits associated with the company in the year prior to the lawsuit filing.

Using these and other data points and applying selected statistical methods to develop their model, the authors identified a number of variables predictive of whether a case is settled or dismissed, and variables predictive of the settlement amount if a case is settled.

The variables the authors identified that indicate that a case will most likely settle include “a number of classes or types of securities associated with the case, a higher return on the S&P 500 during the class period, whether or not GAAP violations were alleged and having an individual plaintiff listed.” Factors that indicate that a case is less likely to settle (that is, more likely to be dismissed) include “longer filing times, higher market capitalization, a higher company return during the class period, having an institutional plaintiff listed, and greater public notoriety (as measured by the number of Google hits in the year prior to filing).”

The variables the authors found that positively impact the settlement amount include “the total number of securities, the length of the class period, market capitalization, the company return during the class period, whether or not earnings were restated, whether or not the case was a Securities Act Section 11 case, whether or not insider trading was alleged, the existence of an institutional plaintiff, and the number of Google hits.” Factors associated with lower settlement amounts include “longer filing times and not having an institutional investor listed (i.e., having only an individual plaintiff listed or having no plaintiff listed).”

The authors also found that though GAAP cases are more likely to settle, the GAAP cases that do settle do not have higher settlement amounts. The authors speculate that this is likely due to the fact that an allegation of a GAAP violation significantly bolsters the merits of the case, which increases the chances the case will survive a dismissal motion. The authors suggest that this makes it more appealing for plaintiffs to take on a GAAP violation case even if the potential damage award is relatively low.

At the same time, Rule 10b-5 cases are less likely to settle (that is, more likely to be dismissed) but those that do settle have higher settlement amounts. The authors attribute this to the greater damages available to Rule 10b-5 plaintiffs. The authors suggest that plaintiffs rationally might be willing to pursue cases with a lower survivability probability when the cases are likelier to have larger settlements, assuming the cases survive dismissal. Cases without institutional plaintiffs are more likely to survive motions to dismiss, which the authors interpret to suggest both that institutional investors select the high potential value cases and that plaintiffs’ lawyers exercise more care regarding the merits of cases with only an individual plaintiff.

The authors also noted a number of differences among the various circuits and industries. For example, the authors note that the eleventh circuit appears to have modestly lower settlement amounts whereas the ninth and tenth circuits have modestly higher settlement amounts. Similarly, utilities have somewhat higher settlement amounts.

Discussion

I have necessarily summarized here the authors’ much more detailed analysis. The only way to fully understand and appreciate the authors’ predictive analysis, as well as the ways in which the authors’ conclude that the various factors are predictive, is to read their paper in full, which I recommend.

I do note that the ability to predict case outcomes at the outset is important for a number of process participants, including in particular the affected D&O insurers. Among other things, D&O insurers must have reliable means to assess and predict case outcomes at the outset in order to try and set case reserves appropriately. In addition, D&O insurers whose coverage attaches only in the excess layers will want to be able to assess cases at the outset in order to try to determine the likelihood that losses associated with any particular claim will penetrate their attachment point. For the involved D&O insurers, the authors’ predictive model could provide a useful tool.

The authors’ model could prove a useful tool for the defendant companies themselves as well as for their defense counsel. It is critically important for companies and their counsel in setting their litigation strategy to have an accurate understanding of the seriousness of the claim.  The authors’ model may provide a useful way for companies and their counsel to make a realistic assessment of the seriousness of the case in order to try to set defense strategy appropriately.

If I were to make one suggestion to the authors in order to make their analysis more accessible, it would be to expand their summary description of the relevant factors so that the factors are not only identified but also so that the nature of their relevance is more apparent. For example, it is of course important for the authors to state in the summary of their conclusions that, for example, “the length of the class period” is a relevant factor positively impacting settlement. It would be even more helpful for the non-mathematician reader for the authors to explain in the conclusion section how the variation of the length of the class period affects the settlement (that is, is it a shorter or a longer class period that positively affects the settlement?). A more detailed explanation in the paper’s discussion section of the authors’ specific conclusions with respect to each of the identified factors would make the authors’ otherwise somewhat intimidating paper more approachable to a wider variety of readers and would make the authors’ conclusions both clearer and more useful for those trying to understand the implications of the authors’ analysis.

I would like to thank Professor Tom Baker for providing me with a copy of this interesting paper.

UPDATE: Following my publication of this post, and in particular in response to my comments about the paper, one of the paper's authors, Blakeley McShane, contacted me with a supplement to the article, to provide further explanation of the paper and its conclusions. Because I think the supplement significantly aids an understanding of the paper, I have reproduced the supplement in full below. My thanks to McShane for taking the time to prepare a detailed supplement and for his willingness to allow me to publish it here. Here is the supplement: 

Thank you for your interest in our paper “Predicting Securities Fraud Settlements and Amounts: A Hierarchical Bayesian Model of Federal Securities Class Action Lawsuits” which is forthcoming in the Journal of Empirical Legal Studies. We really enjoyed reading your write-up of our results and wanted to follow up on your last paragraph where you requested a more friendly description of the effect of each variable. We will attempt to be as clear as possible and focus on our “best guess” of the effect of each variable (i.e., the dots in Figures 8a and 9a respectively). Of course our estimates are subject to uncertainty (indicated by the thick and thin lines of Figures 8a and 9a) but we will ignore that for the purpose of this discussion.

First, let’s begin by discussing the data. Our principal data source comes from the Riskmetrics Group’s Securities Class Action Services Division which tracks securities fraud class action lawsuits on a commercial basis. Nonetheless, as you mentioned, a substantial amount of processing as well as augmentation with data from other sources was required. This is detailed in Section II of our paper so we will just give a brief description of each of the variables that are “statistically significant” in either of the two stages of our model (i.e., the settlement versus dismissal stage and settlement amount conditional on settlement stage).

• Total Securities: The number of different securities (e.g. stocks, bonds, etc.) associated with the case.
• Filing Time: The length of time from the end of the class period until the filing date.
• Class Length: The length of the class period.
• Market Capitalization: The market capitalization of the plaintiff firm.
• Company Return: Roughly speaking, the percentage return on the plaintiff firm’s stock during the class period (see Section II.C for full details on how we constructed this variable).
• S&P 500 Return: The percentage return on the S&P 500 during the class period.
• GAAP: Whether or not GAAP violations were alleged in the case.
• Restated: Whether or not the allegation mentions that the company’s financial statements were restated.
• 10b5: Whether or not the case was a Rule 10b-5 case.
• Section 11: Whether or not the case was a Securities Act Section 11 case.
• Plaintiff: The plaintiff variable has three values. If one or more institutions are listed as the plaintiff, we set out Plaintiff variable equal to “Institutional”. If no institutions are listed but one or more individuals are, we set it equal to “Individual”. Finally, if nothing is listed in the database, we set it equal to “Unknown”. Of course, this does not mean there is no plaintiff in the case; rather, it means Riskmetrics has not obtained the information for this variable. This is potentially informative for whether or not a case settles and for how much it settles for if it does settle, but probably says more about Riskmetrics’ priorities in gathering data than anything else. In particular, given the nature of Riskmetrics’ business, they are most highly incented to collect complete data for cases which settle and especially those which settle for large amounts. Consequently, we would, for example, a priori expect Empty plaintiff cases (i) to be less likely to settle and (ii) to settle for less when they do settle.
• Insider Trading: Whether or not insider trading was alleged in the case.
• Google Hits: A measure of the newsworthiness or notoriety of the case. In particular, the number of Google News Archive associated with the company name in the year prior to the filing date (see Section II.E for full details on how we constructed this variable).

With the variables defined, let’s begin with the factors that predict settlement amount conditional on a case settling. We identified eleven “statistically significant” predictors of the settlement amount:
• Total Securities: A 1% increase in total securities is associated with a 0.25% increase in the settlement amount.
• Filing Time: A 1% increase in the filing time is associated with a 0.1% decrease in the settlement amount.
• Class Length: A 1% increase in the length of the class period is associated with a 0.1% increase in the settlement amount.
• Market Capitalization: A 1% increase in market capitalization of the plaintiff firm is associated with a 0.4% increase in the settlement amount.
• Company Return: A 1% increase in plaintiff firm’s return over the class period is associated with a 0.2% increase in the settlement amount.
• Restated: Restated financial statements are associated with a 20% increase in the settlement amount.
• Section 11: Securities Act Section 11 cases are associated with a 45% increase in the settlement amount.
• Individual Plaintiff: Individual plaintiff cases are associated with a 35% decrease in the settlement amount relative to cases with an institutional plaintiff.
• Unknown Plaintiff: Unknown plaintiff cases are associated with a 40% decrease in the settlement amount relative to cases with an institutional plaintiff.
• Insider Trading: Insider trading cases are associated with a 30% increase in the settlement amount.
• Google Hits: A 1% increase in the number of Google News hits is associated with a 0.05% increase in the settlement amount.

Many of these variables make intuitive sense. For instance, the total number of securities, market capitalization, and number of Google hits are associated with the size of the firm and hence how much damage can be done and how large a settlement can be extracted. Similarly, the longer the class length, the greater the number of securities traded during the period and, hence, the larger the damages. The higher damages for Section 11 cases (all other things being equal) may reflect the fact that plaintiffs do not need to prove scienter to succeed. The filing time result has a plausible basis as there is often a rush to file the “best” cases. Interestingly, some “merits” variables such as Restated and Insider Trading, which in theory should only affect whether or not a case settles or is dismissed, also impact the settlement amounts thus suggesting that decisions over whether or not there were damages versus how great those damages were may not be entirely independent. The Company Return finding is somewhat surprising, since a lower return during the class return would indicate larger damages from the alleged fraud. Our hypothesis is that that this finding is picking up on the capacity of the defendant to pay. Other things being equal, a company that recently made money is going to be better able to pay a settlement. Finally, the result for the identity of plaintiff is consistent with Riskmetrics’ business model as outlined above.

The interpretation of the significant coefficients for the model which predicts whether a case settles or is dismissed is somewhat more complicated than that for the settlement amount model. This is because each case is associated with a “latent score” giving the probability of dismissal: cases with high scores are very likely to settle and cases with low scores are very likely to be dismissed. The tricky part is that the relationship between the latent score and the probability is non-linear. Instead, it follows an S-shaped curve called a logistic curve:

With a logistic curve, the increase in the probability of settlement associated with a small change in the latent score depends on the original latent score: at the extremes, the change in probability is quite small whereas in the middle it is quite large. For example, an increase of 0.1 from -4.0 to -3.9 hardly changes the probability as can be seen in the above figure (the probability only goes from 1.8% to 1.9%). Similarly, an increase of 0.1 from 4.0 to 4.1 hardly changes the probability as can be seen in the above figure (the probability only goes from 98.2% to 98.4%). On the other hand, in the middle of the curve, small changes can have a substantial impact. For example, an increase of 0.1 from 0.0 to 0.1 changes the probability substantially from 50% to 52.5%. In the descriptions which follow, the increase in probability will be for the middle of the curve where the “action” is.

We identified ten “statistically significant” predictors of the probability of settlement:
• Total Securities: A 1% increase in total securities is associated with a 0.4% increase in the probability of settlement.
• Filing Time: A 1% increase in the filing time is associated with a 0.02% decrease in the probability of settlement.
• Market Capitalization: A 1% increase in market capitalization of the plaintiff firm is associated with a 0.02% decrease in the probability of settlement.
• Company Return: A 1% increase in plaintiff firm’s return over the class period is associated with a 0.15% decrease in the probability of settlement.
• S&P 500 Return: A 1% increase in plaintiff firm’s return over the class period is associated with a 0.3% increase in the probability of settlement.
• GAAP: Allegations of GAAP violations are associated with a 13% increase in the probability of settlement.
• 10b5: Rule 10b-5 cases are associated with a 25% decrease in the probability of settlement.
• Individual Plaintiff: Individual plaintiff cases are associated with an 8% increase in the probability of settlement relative to cases with an institutional plaintiff.
• Unknown Plaintiff: Unknown plaintiff cases are associated with a 60% decrease in the probability of settlement relative to cases with an institutional plaintiff.
• Google Hits: A 1% increase in the number of Google News hits is associated with a 0.02% decrease in the probability of settlement.

Again, many of these results have an intuitive basis. The result for filing has the same intuition as for settlement amounts: many of the “best” cases are filed early. While we had no a priori expectation for the market capitalization result, perhaps bigger firms are better able to defend themselves; regardless, the effect is weak. Nonetheless, this as well as the result for Google Hits may be a result of the “plaintiff selection effect” whereby plaintiffs select cases which are more likely to be dismissed but will settle for a large amount conditional on surviving the motion to dismiss. This is consistent with the results presented above. Not surprisingly, as the company’s return during the class period goes down (potential evidence of fraud), the likelihood of settlement goes up; this is exacerbated when the market as a whole (as measured by the S&P 500) goes up during the same period. GAAP violations are a classic merits variable and therefore associated with increased likelihood of settlement. A combination of Riskmetrics’ incentive in gathering data as well as the plaintiff selection effect are likely at play in explaining the plaintiff results (i.e., Riskmetrics’ is more likely to gather plaintiff information for cases which settle and, further, institutional plaintiffs are more likely to become involved in cases with larger damages potential). Riskmetrics’ incentives are also likely to explain the number of securities result, as Riskmetrics will be more likely to gather all of the securities information for cases that actually do settle. Finally, the lower probability of settlement of 10b5 cases likely reflects the greater difficulty of proving the knowledge required (scienter) as compared to, for example, Section11 cases.

We hope this is more interpretable and clarifies matters some. Thank you again for your interest in and coverage of our work

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In the latest eye-popping subprime-related securities class action lawsuit settlement, the parties to the National City Corporation securities class action lawsuit have agreed to settle the case for $168 million. The proposed settlement is subject to court approval. The August 8, 2011 press release of the New York Comptroller, acting on behalf of the New York State pension funds as lead plaintiff, can be found here.

The settlement papers are not yet available on PACER (indeed, that is the reason I waited for a day to publish a post about this settlement, in the hope that I might be able to run down copies of the papers. No luck so far – should I get my hands on them, I will post them to this site.) Jan Wolfe’s August 9, 2011 Am Law Litigation Daily article describing the settlement can be found here.

As detailed here, this case arises out of the financial woes that beset Cleveland-based National City as its portfolio of subprime related mortgages nearly dragged the bank down. In their 249-page consolidated amended complaint (here), the plaintiffs alleged that as the residential real estate market began to collapse in 2007, the bank’s residential mortgage and construction loan portfolio – which allegedly was of much lower quality than the bank had disclosed -- began to deteriorate much more rapidly than the company acknowledged publicly. The plaintiffs alleged further that the bank’s failure to recognize this deterioration rendered the bank’s financial statements and other disclosures materially misleading.

National City’s financial difficulties proved so severe that in October 2008, it was acquired at fire sale prices by PNC. The transaction was highly controversial at the time, and not just because it involved a takeover of a landmark Cleveland institution by a bank based in Pittsburgh. As discussed at greater length here, because PNC moved to acquire National City using TARP funds that PNC had only just received and only after TARP funds were withhold from National City.  The PNC acquisition was itself the subject of separate litigation, which was later voluntarily dismissed. PNC’s acquisition of National City means that the likely source of funds for this settlement was PNC itself, to the extent not otherwise funded by D&O insurance – hence my interest in seeing the settlement papers.

The parties to the related-ERISA class action previously settled that action for $43 million, as discussed at greater length here.

The $168 million National City securities class action lawsuit settlement follows close on the heels of the announcement of the $627 million Wachovia bondholders’ settlement. I have long wondered when the overhang of subprime-related securities class action lawsuit would finally start to work itself off. With these settlements, it seems increasingly likely that the time may now be here.

There have been larger settlements announced in connection with the subprime-related securities class action litigation wave, but the National City settlement is still attention-grabbing. Among other things, the National City settlement, if approved, would be the 53rd largest all-time securities class action lawsuit settlement. As was the case with the Wachovia settlement, the National City settlement was not (prior to the settlement) one of the highest profile subprime-related cases. But while these two cases may not have been at the center of the radar screen, these two nine-figure settlements in quick succession undoubtedly have gotten everyone’s attention.

The problem for the parties in the remaining subprime cases is that these settlements -- and the recent $125 million settlement in the Wells Fargo mortgage-backed securities cases – create an even more challenging environment in which to try to work out a settlement. The plaintiffs in these other cases undoubtedly will by try to rely on these settlements as a way to try to argue that the price of poker is going up.

Here We Are Now, Entertain Us: It may not be quite the same thing without Kurt Cobain, but still this is pretty awesome.

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On December 14, 2010, NERA Economic Consulting released its annual year-end study of securities class action lawsuit filings and settlements. The report, entitled "Trends 2010 Year-End Update," can be found here. Among other things, the NERA study reports that class action filings "picked up substantially" in the second half of 2010, and that median class action settlements reached an all-time high in 2010.

There are a couple of important considerations to be taken into account with respect to the NERA report. The first is that its analysis is with respect to filings and settlements through November 30, 2010. The report does incorporate a number of projections to account for the year’s final month.

In addition, the NERA report’s "counting" methodology, as reflected in footnote 3 of the study, may differ from the methodology used in other publicly available analyses of securities class action filings.

The NERA report states that "until cases are consolidated, we report multiple filings that potentially are related to the same allegations if complaints are filed in different circuits." And until cases are consolidated, "we report multiple filings if different cases are filed on behalf of investors in common stock and other securities." If the cases are ultimately consolidated, the data are adjusted. NERA’s methodology differs from that used by other observers (including The D&O Diary), and may result in a filing count that is higher than reported elsewhere.

The study does report a number of interesting findings, including the fact that class action filings accelerated in the second half of 2010. In fact, the study reports, the number of new class action filings in September (25) represents the highest monthly total of new "standard"  filings since August 2004.

According to the NERA report, there were a total of 219 filings in the year’s first eleven months. NERA projects a total of 239 filings by year end, which would represent an increase over the 220 filed in 2009 and would be "broadly consistent with the long-term average."

Though companies in the financial sector remain the most frequently targeted, the number of credit crisis-related lawsuits continues to decline. There were only 31 credit crisis related filings in 2010, compared to 57 in 2009 and 103 in 2008. More than half of the new lawsuits against companies in the financial sector in 2010 were unrelated to the credit crisis. About 40% of all 2010 cases named companies in the financial sector, which, while well below the peak of 72% in 2008, still remains above the 28% in 2005 and 2006, prior to the credit crisis.

Other sectors that also saw significant amounts of securities class action litigation included health technology firms, electronic technology and technology services sector. As I previously noted (here), there was also a sharp upturn in cases against companies in the for-profit education sector.

Despite the U.S. Supreme Court’s holding in Morrison v. National Australia Bank (about which refer here), the anticipated drop in cases against non-U.S. companies did not really materialize, largely do to the "spate of suits against Chinese-domiciled companies" (about which I recently commented here).

On the other hand, the number of belated filings of securities lawsuits declined in the second half of 2010. As I previously noted, there had been an upsurge in new case filings reflecting a substantial time lag between the date of filing and the proposed class period cutoff. The NERA study reports that for 2010 filings, the median time to file was only a month, compare to nearly six months for cases in the second half of 2009.

Among trends in factual allegations, the NERA study reports that filings of cases alleging breach of fiduciary duty more than doubled in 2010. Many of these cases were related to mergers or acquisitions.

With respect to case resolutions, the NERA study reports a number of interesting filings. Among other things, the study reports that the average settlement for cases settled in 2010, adjusted for outlier settlements, was $42 million, which is in line with 2009’s record high but well above the $30.4 million average for the period 2003 to 2010.

Even more significantly, the NERA study reports that in 2010, the median settlement jumped to $11.1 million, which not only represents an all-time high, but is more than a third higher than the 2009 median of $8.5 million. However, the report also notes that median investor losses for cases filed in 2010 were down substantially and more in line with pre-credit crisis cases. These more recently filed cases may push median settlements down in future years closer to the historical median.

Consistent with this last point, though average and median settlements are elevated, the settlements as a percentage of investor losses were consistent with similar ratios going back to 2002. The percentage in 2010 was 2.4%, well within the 2.2% to 3.1% range between 2002 and 2009.

One factor that may affect average and median settlements in the near term is the substantial overhang of unresolved subprime and credit crisis-related lawsuits. Even though several high-profile credit crisis cases have been resolved, many more remain pending. The NERA study reports that of the 230 credit crisis-related securities class action lawsuits, only about 8% have been settled, and another 29% have been dismissed, but fully 63% remain unresolved. These cases will continue to work their way through the system in the months ahead.

The NERA report is full of a wide variety of interesting information and insights, and is worth reading at length and in full. I hope to have my own study of the 2010 filings shortly after year end.

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RiskMetrics has issued its year-end 2009 scorecard of the Top 100 securities class action lawsuit settlements. The list, which is updated quarterly, can be accessed on the Securities Litigation Watch blog (here). The details in this very interesting tabulation support a number of interesting observations, discussed below.

The year-end Top 100 tally reflects the incorporation of 15 new settlements added to the list during 2009. However, because RiskMetrics identifies a specific case’s Settlement Year as "the year in which the hearing to grant final approval of the settlement or most recent partial settlement occurred," there were several high-profile settlements entered late in 2009 that are not, because they are not yet final, reflected in the most recent update, including the $225 million Comverse Technology settlement (about which refer here) and the $160.5 million Broadcom settlement (here).

The settlements added to the list during 2009 include the tenth largest all-time settlement, in the form of the $925 million UnitedHealth Group settlement (refer here and here). Among the all-time top 25 settlements are several other settlements added to the list in 2009, including the $586 million IPO Securities Litigation settlement (refer here), the $554 million HealthSouth settlement (refer here), the $475 Merrill Lynch settlement (refer here), the $445 million Qwest Communications settlement (refer here), and the $400 million Marsh & McLennan settlement (here).

The price of admission to the Top 100 list is steep. Taking into account the late-year Comverse Technology and Broadcom settlements, which presumably will be added to the list during 2010, future settlements will have to excess $80 million to crack the Top 100. And to break into the top 25, a settlement will have to exceed $400 million. (It should not be overlooked that there have been 25 settlements of $400 million or greater, which is a staggering fact all by itself.)

The Securities Litigation Watch blog also notes that the price of admission to the Top 100 list has doubled since the end of 2005; at year-end 2005, the 100^th largest settlement on the list was in the amount of $39 million. By year-end 2009, the 100^th largest settlement was $79.75 million.

Settlements related to options backdating securities cases are well-represented among the Top 100 settlements, including number 10 all-time, the UnitedHealth Group options backdating securities lawsuit settlement. Other Top 100 options backdating settlements include Brocade Communications Systems ($160 million) and Mercury Interactive ($117.5 million). The yet to be added Comverse Technology ($225 mm) and Broadcom settlements ($160.5 mm) also rank among the top all-time settlements. The separate $118 million Broadcom options backdating-related derivative lawsuit settlement, though not relevant to this list because it did not arise in a securities class action suit, is nevertheless noteworthy in this connection.

The Top 100 settlements also include two subprime-related securities class action settlements, the $475 million Merrill Lynch settlement and the $150 million Merrill Lynch bondholder settlement. Call it a hunch, but I am guessing that before all is said and done with the subprime and credit crisis-related securities lawsuits, there will be a lot more of those cases on the Top 100 settlements list.

The Top 100 settlements involve cases in 38 different federal district courts, with the largest number in the Southern District of New York (25). Other districts with significant numbers of settlements include the District of New Jersey (8), the Northern District of California (7), the Central District of California (6), and the Southern District of Texas (5).

Among the plaintiffs’ firms, the law firm with the highest number of Top 100 securities class action settlements is the Milberg firm (in its various manifestations), with 29, followed by the Bernstein Litowitz firm, with 26 and the Coughlin Stoia firm, in its various forms, with 14.

Of the Top 100 securities class action settlements, over two-thirds (68) were finalized in the most recent five year period between 2005 and 2009. The bar graph on page 5 of the report, which depicts the definite upward trend in the more recent years, strongly communicates the increasing severity of securities class action claims.

The inevitable implication of this inexorably increasing claims severity is that the price of poker is going up. This fact, taken together with the dramatic increases in the costs associated with defending securities suits, has important implications for D&O insurance limits selection. Simply put, commonplace notions about limits adequacy that have developed over time may have gone completely out of date in the most recent years.

The significant recent increase in the number of mega settlements suggests that the answer to the question "How much insurance is enough" may be categorically greater than even a short time ago. The inevitable ratchet effect from these settlement trends, creating ever greater measures of what "cases like this settle for," also suggests that these numbers will not be going back down either.

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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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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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