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

Securities class action lawsuit filings were down “sharply” in 2012 compared to the prior year and to historical average, according to Cornerstone Research’s annual report. The study, published in conjunction with the Stanford Law School Securities Class Action Clearinghouse and entitled “Securities Class Action Filings: 2012 Year in Review,” can be found here.  A short, single-page graphic summary of the report’s conclusions can be found here. The two organization’s January 23, 2013 press release discussing the report can be found here. My own analysis of the 2012 securities suit filings can be found here.

 

According to the report, there were 152 securities class action lawsuits filed in 2012, which is below both the number of filings in 2011 (when there were 188) and the 1997-2011 annual average number of filings (193). The 152 filings in 2012 represents a 19 percent decrease from 2011 and a 21 decrease from the 1997-2011 annual average.

 

A significant factor in the reduced number of filings in 2012 was the decline in filing activity during the year’s second half, particularly during the fourth quarter. There were only 64 filings in the second half, compared with 88 in the first half. The filing level in the second half of 2012 was “lower than all semiannual periods other than the historic low observed in the second half of 2006.” The 25 filings in the year’s fourth quarter was “the lowest number of filings in any quarter in the last 16 years.” The report notes that these observations are consistent with “a declining trend since the first half of 2010.”

 

The report states that the decrease in 2012 filings was “largely due” to declines in federal mergers and acquisitions objection litigation and in the number of lawsuits involving Chinese companies (particularly Chinese companies that obtained a U.S. listing through a reverse merger transaction). According to the report, on a year-over-year basis, M&A filings decreased 70 percent (as plaintiffs appeared to prefer state court forums for this type of litigation) and filings related to Chinese reverse merger companies decreased by 68 percent. The report also noted that for the first time since 2007 there were no new securities class action lawsuit filings related to the credit crisis.

 

The number of filings against foreign issuers dropped from 61 in 2011 to 32 in 2012 (a 48 percent drop). Though filings against foreign issuers represented only 24 percent of all 2012 filings, compared to 32 percent in 2011, the 2012 percentage “reflects a level that is greater than al prior years other than 2011.” The continued elevated level of filings against foreign issuers in 2012 is largely due to filngs related to Chinese firms. There were a total of 18 filings against Chinese companies in 2012 (including Hong Kong companies) compared to 40 in 2011.

 

Larger companies were less likely to be the target of a securities suit in 2012 compared to recent years. 3.4% of S&P 500 companies were named in securities suits in 2012, compared to an annual average of 6.1% for S&P 500 companies during the period 2000 to 2011. The 2012 level is comparable to the 13-year low observed in 2011 (3.2%).

 

The most targeted industrial sector in 2012 was Consumer Non-Cyclical, representing 32% of all filings. Health care and life sciences companies comprised 67 percent of all Consumer Non-Cyclical filings (33 filings), compared to 62 percent (28 filings) in 2011. Filings against companies in the financial sector continued a declining trend with 15 filings in 2012, compared with 43 in 2010 and 25 in 2011.

 

As I noted in my own analysis of the 2012 securities suit filings, it is too early to tell whether the late-year decline in filings represents a trend or just a temporary dip in the general ebb and flow of securities suit filings. The report noted that the previous low semiannual filing level was in the second half of 2006, which was quickly followed by the onslaught of the subprime meltdown and credit crisis-related litigation wave.

 

One obvious factor in the overall 2012 decline was the absence of any episodic even driving filing levels. Indeed, Dr. John Gould, one of the report’s authors, is quoted in the press release as having said that “the absence of a filings trend…influenced the total number of new cases,” by comparison to recent years when filing levels have been dominated by “observable filings types,” such as, more recently, the M&A related litigation and litigation involving U.S.-listed Chinese companies.

 

While it is hard to know whether the trend will continue, the press release identifies at least one development that could result in a possible increase in future securities lawsuit filings. The press release quotes Stanford Law School Professor Joseph Grundfest, who notes that the upsurge in SEC whistleblower reports raises the questions whether the SEC will translate these reports into enforcement actions, and, if so, whether “private-party plaintiffs will be successful in prosecuting ‘piggyback’ claims that copy the Commission’s complaints.”

 

One factor that could also explain the declining number of 2012 filings is the plaintiffs’ securities bar’s continuing shift to diversity their inventory. Going back to the options backdating cases in 2006, the plaintiffs lawyers have been pursuing types of litigation other than securities class action litigation (in part due to unfavorable U.S. Supreme Court decisions). While the Cornerstone Report notes the absence of any new credit crisis-related securities class action lawsuit filings in 2012, there were a host of credit crisis-related lawsuits filing as individual actions in 2012. It is hard to tell, but it seems likely that this diversifying trend will continue.

 

Finally, it is worth noting that, as one reader observed in a comment to my blog post analyzing the 2012 securities suit filings, Superstorm Sandy could have had an impact on fourth quarter filings, since the storm basically closed New York’s downtown business district for several weeks during the fourth quarter.

 

Jan Wolfe's January 22, 2013 Am Law Litigation Daily article about the Cornerstone Research report can be found here.

 

 

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In what is as far as I am aware the first class action settlement in the current wave of subprime-related securities lawsuits, on October 14, 2008, WSB Financial Group announced (here) that it had entered into a settlement agreement of the class action lawsuit pending against the company and certain of its directors and officers.

 

 

As detailed in greater length here, on October 30, 2007, plaintiffs’ lawyers’ had initiated a securities class action lawsuit in the Western District of Washington. A copy of the plaintiffs’ consolidated complaint can be found here.

 

 

WSB Financial Group is the parent company of Westsound Bank. The lawsuit alleged that the offering documents associated with the company’s December 21, 2006 IPO contained material misrepresentations or omissions. Among other things, the complaint alleges that the offering documents stated that the company “focused on originating and maintaining a high-quality loan portfolio and had rigid underwriting policiesdesigned to ensure the credit quality of the Company's portfolio. In reality, however, WSB Financial originated hundreds of high-risk loans in violation of the Company's stated policies for a total amount of at least $90 million.”

 

 

In its October 14 press release, the company stated that the parties had agreed to a settlement of $4.85 million. The press release also states that the company’s D&O insurance policy would contribute $4.45 million toward the settlement and had previously contributed approximately $350,000 toward the cost of the settlement. The proposed settlement is subject to court approval.

 

 

As a relatively small settlement of one of the smaller, lower profile cases in the current litigation wave, this settlement is likely to have relatively little direct influence on other pending cases. The significance of this settlement may simply be that it has happened at all. With so many of the subprime and credit crisis-related cases only in their earliest stages, the likelihood of settlements emerging seemed like a distant prospect. It may yet be a considerable time before the higher profile cases move toward the settlement stage, even assuming they survive preliminary motions. This settlement suggests that at least some cases will move more quickly toward resolution.

 

 

Nevertheless, anyone who thinks that the current litigation morass might quickly be cleaned up may need to curb their enthusiasm. An October 13, 2008 Law.com article entitled “New Wave of Class Actions Filed in Wake of Subprime Collapse” (here) quotes a plaintiffs’ securities class action attorney as saying that he anticipates that subprime litigation “will keep us busy for seven or eight years.”

 

 

In any event, I have added the WSB settlement to my table of subprime and credit-crisis related case dispositions, which can be accessed here.

 

 

A Different Approach: In our country, the most important issue in any crisis is figuring out who to blame. Refined distinctions are not a necessary part of this blame assignment process, and blame can be assigned indiscriminately. (If you doubt this assertion, please refer to the public statements of any U.S. politician during the current financial turmoil.) Our transatlantic cousins apparently take a different approach, which I must say has much to recommend it.

 

 

According to an October 14, 2008 Law.com article (here), the nationalized British lender Northern Rock has announced that it will not bring legal action against its former directors and officers, after having concluded that "there are insufficient grounds to proceed with a negligence action against the ex-directors." The article also reports that "the bank's auditors are off the hook."

 

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The full consequences of the dramatic recent events in the financial markets may take years to emerge, but one direct effect has already appeared – the collapse of several large financial institutions has turned preferred shareholders into securities class action plaintiffs.

 

Historically, securities class action lawsuits have been pursued on behalf of common shareholders, and to a lesser extent, the holders of public debt securities. Preferred shareholders only infrequently became involved in this type of litigation, for several interrelated reasons.

 

In the United States, the issuance of preferred shares largely has been limited to REITs, financial institutions and utilities (as noted here). Investment in these types of securities generally is limited to institutional investors. Moreover, the offering of these kinds of securities is even further limited as a practical matter to companies regarded as likely to fulfill their preferred dividend commitments (although less financial stable companies can still attempt a preferred stock offering by including a higher dividend rate).

 

Companies issuing these securities, therefore, are typically financially stable companies in industries with historically lower securities class action frequency levels. Moreover, institutional investors, who typically buy preferred securities, were, at least until the last several years, less likely to become involved in this kind of litigation. (To be sure, these generalities are not invariable, and there are certainly prior examples of securities litigation involving preferred shareholders.)

 

The remarkable recent failure of several of the most prominent financial institutions apparently has changed all that, and within the space of a few short weeks, there has been a sudden influx of securities class action lawsuits filed on behalf of failed financial institutions’ preferred shareholders.

 

Here are the four specific cases to which I am referring:

 

1. Fannie Mae Preferred Stock, Series T: The first of these recent lawsuits was filed on September 17, 2008 in the Southern District of New York on behalf of purchasers of Federal National Mortgage Association’s ("Fannie Mae") May 13, 2008 offering of 8.25% Non-Cumulative Preferred Stock, Series T. The complaint names as defendants the five offering underwriters and four directors and officers of Fannie Mae. Background regarding this case can be found here.

 

2. Freddie Mac Preferred Stock, Series Z: On September 23, 2008, plaintiffs’ counsel filed a securities class action lawsuit in the Southern District of New York on behalf of purchasers of Federal Home Loan Mortgage Corporation’s ("Freddie Mac") November 29, 2007 offering of 8.375% Non-Cumulative Perpetual Preferred Stock, Series Z. The complaint names as defendants only the three offering underwriters. For background, refer here.

 

3. Lehman Brothers Preferred Series J Stock: On September 24, 2008, plaintiffs’ counsel initiated a securities class action lawsuit in the Southern District of New York on behalf of purchasers of Lehman Brothers’ February 5, 2008 offering of Preferred Series J Stock. The complaint names as defendants certain Lehman Brothers directors and officers and the offering underwriters. For background, refer here.

 

4. Fannie Mae Preferred Stock, Series S: On October 8, 2008, plaintiffs’ counsel filed a securities class action lawsuit in the Southern District of New York on behalf of investors who between December 14, 2007 and September 5, 2008 purchased Fannie Mae’s 8.25% Fixed-to-Floating Rae Non-Cumulative Preferred Stock, Series S. The complaint names as defendants several former Fannie Mae directors and officers as well as the offering underwriters. For background, refer here.

 

These four lawsuits have several things in common, in addition to the fact that each plaintiff represents a class of preferred shareholders. All of these lawsuits involved companies that failed shortly before the lawsuits were filed. They were all filed in the Southern District. All of the lawsuits assert claims under the ’33 Act (the fourth of the lawsuits also asserts claims under the ’34 Act).

 

Another common thread of these lawsuits is that they all involve companies that already had been hit with one or more securities lawsuits filed on behalf of common shareholders. The existence of a separate plaintiff class at least potentially represents an opportunity for a different plaintiffs’ firm that may be shut out of the earlier class lawsuit to participate in the litigation assault on the affiliated persons left standing following the companies’ collapse. The existence of the separate class potentially represents a bite at the apple for these plaintiffs’ firms.

 

In earlier posts (here and here), I suggested that the volcano of events in the financial markets that began in September 2008 potentially could represent an "inflection point" in the ongoing subprime and credit crisis-related litigation wave. I suggested that as a result of these events a new group of defendants potentially could be drawn into the litigation wave. The four cases described above further suggest that a whole new group of litigants also could become involved as plaintiffs, starting with the emergence of preferred shareholders and other investor classes as class action litigants. The sheer magnitude of the losses sweeping through the marketplace undoubtedly will draw out these new classes of claimants, as these aggrieved parties seek to shift their losses "upstream" (a process I discussed here).

 

In the interests of accuracy, I should acknowledge that preferred shareholders class actions are not unknown. Indeed, just a few months ago, in June 2008, investors in Fremont General Corporation’s 9% Trust Originated Preferred Securities filed a securities class action lawsuit in the Central District of California (about which refer here). One might argue that this earlier case merely represents the advance guard for the squadron of lawsuits that came later.

 

While there may have been prior preferred shareholder lawsuits, the filing of four preferred shareholder class actions lawsuits in quick succession as a direct result of the collapse of several larger financial institutions represents a separately identifiable and categorically distinct phenomenon. It also undeniably represents a direct consequence of the unprecedented turmoil in the financial markets that began in September 2008.

 

The massive investment losses triggered by these September (and following) events are distributed across a wide variety of types and classes of investors, representing individuals and institutions, as well as holders of many types of debt and equity in many different forms and classes. Some of these aggrieved persons will seek to recover their losses in court. Further company failures (a distinct possibility) will only amplify these trends. All of which reinforces the view that one of the consequences of the enormous events of the past several weeks is a litigation wave "inflection point."

 

Run the Numbers: With the addition of the most recently filed lawsuits, my running tally of subprime and credit-crisis related securities class action lawsuits (which can be accessed here) now stands at 122, of which 82 have been filed in 2008.

 

In addition, I have added to my list of subprime and credit crisis-related derivative lawsuits (which can be accessed here), the shareholders’ derivative lawsuit filed on October 7, 2008 against Perini Corp., as nominal defendant, and several of its directors and officers. A copy of the Perini derivative complaint can be found here. (Hat tip to Courthouse News for the Perini derivative complaint.) I previously wrote here about the securities class action lawsuit that was filed earlier against Perini.

 

With the addition of the Perini complaint, my current tally of subprime and credit crisis-related derivate lawsuits now stands at 25.

 

One thing that has happened as the credit crisis has grown, spread and become a more generalized financial crisis. That is, it has become increasingly more difficult to proceed with definitional certainty about exactly what I am "counting." As the economic downturn affects more and more companies in an ever broader variety of ways, and as the general conditions become increasingly remote from the subprime-related causes, the related lawsuits are becoming less and less categorically distinct. At some point, the distinctions may no longer exist, and the counting exercise will have to be redesigned or even cease all together.

 

Who could have anticipated where all of this would lead when the subprime litigation wave first started to emerge back in February 2007?

 

Are State Court ’33 Act Cases Removeable to Federal Court?: In prior posts (most recently here), I have discussed the fact that plaintiffs’ attorneys’ have been filing subprime related ’33 Act cases in state court, in reliance on the ’33 Act’s concurrent jurisdiction provisions.

 

Lyle Roberts notes on his 10b-5 Daily blog (here), that on September 24, 2008, the Southern District of New York refused to remand the Harborview Mortgage case (which I previously discussed here) back to state court. Roberts does note that this holding is contrary to the Ninth Circuit’s decision in Luther v Countrywide earlier this year. I discuss the Luther case here.

 

With this split in the decisions there is now fertile ground for further jurisdictional wrangling. Even less clear is the reason why plaintiffs are so intent on pursuing a federal securities lawsuit in state court in the first place.

 

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Among the many consequences of an increasingly global economy is that investor interest in pursuing claims for securities wrongdoing has become a more nearly universal phenomenon. While collective-style lawsuits largely had been restricted to claims in U.S. courts under U.S. law, a growing list of countries are adopting at least some elements of U.S.-style securities lawsuits. Several recent articles, discussed below, have examined these developments.

First, in a May 19, 2008 article entitled “Global Realm of Securities Class Actions” (here), John J. Clarke Jr. and Keara M. Gordon of the DLA Piper law firm suggest that as U.S. courts “more carefully define the limits” of subject matter jurisdiction for securities lawsuits brought by foreign investors, “a growing list of nations in Europe and elsewhere are adopting procedures akin to American-style class actions.”

The authors find that the recent case law trend suggests “some reluctance by U.S. federal courts to assert jurisdiction over claims of securities fraud” brought by or on behalf of foreign investors who bought their shares in foreign-domiciled companies on foreign exchanges (so-called “f-cubed” litigants, about whom I have previously written here and here). At the same time, the authors note, “a number of nations have adopted procedural mechanisms similar to U.S. class actions in several respects.” The authors specifically examine developments in Australia, Canada, England and Wales, Germany and The Netherlands.

Second, an April 25, 2008 article by Sandeep Savla of Dewey & LeBoeuf entitled “Securities Class Actions in London” (here) suggests that “companies listed on a London exchange must prepare for a wave of securities lawsuits that will increasingly be instituted in England.” Savla cites three reasons why he predicts increasing numbers of English securities lawsuits:

1. A recent English judicial decision in which the court held that a third-party could buy a litigation claim, continue to pursue and fund the litigation and retain any damages awarded. Savla suggest that this decision will incent hedge funds and others to buy and sell securities claims and then litigate the cases for a profit.

2. Apart from acquiring an entire claim, third-parties can now, as a result of other English case law developments, fund litigation in exchange for an opportunity to share in litigation proceeds. Savla believes that private equity firms, hedge funds and other financial firms will be interested in funding litigation in exchange for a large cut of the damages, and that the availability of this funding will remove some of the litigation disincentives of the English “loser pays” attorneys’ fee principles.

3. New statutory liability of misstatements and enhanced rights to bring derivative claims under the Companies Act of 2006 will, Savla asserts, “spur class actions and derivative suits.”

Third, the recent subprime and credit-related crisis may provide an important impetus to these developments. A May 21, 2008 post (here) on the Pom Talk blog (which is published by the plaintiffs’ firm of Pomerantz Hudek Block Grossman & Gross) notes that “several large European banks have been hit with considerable losses stemming from their exposure to U.S. debt,” and these banks “will likely face intense regulatory scrutiny and a wave of litigation.” Many of these suits may wind up in courts outside the U.S. – “if a U.S. court bars foreign investors from suing here, their only recourse would be to sue the banks on their home turf.”

Notwithstanding the traditional reluctance of many countries’ courts to support this type of litigation, “the severity of the subprime impact and resultant losses could prompt otherwise hesitant investors to take action.”

Clearly, a key component of the developments outside the U.S. is the question whether or not the U.S. courts will or will not exercise subject matter jurisdiction over these claims involving foreign investors. A scholarly overview of the U.S. jurisdictional issues can be found in an article in the Winter 2008 issue of the New York International Law Review entitled “Ebb and Flow: The Changing Jurisdictional Tide of Global Litigation” (here).

The article, written by Perry Granof of Chubb and Richard Hans, Samaa Haridi and Jennifer Kozar of Thacher, Profitt and Wood, examines the extend to which “defendants are increasingly seeking to avoid securities class action litigation in the United States – employing both jurisdictional and forum non conveniens arguments.” At the same time, the authors note, “several courts have expressed concern that too restrictive an approach may render U.S. courts ineffective in addressing fraud in an increasingly global securities market.”

Auction Rate Securities Lawsuit Notes: In a recent post (here), I raised questions about the flood of auction rate securities class action lawsuits that have been coming in since mid-March. (My current tally of companies named as defendants in auction rate securities lawsuits, which may be accessed here, now stands at 17.) A May 27, 2008 Bloomberg article entitled “Auction Failure Damages Face Burden of Proof Eluding Lawyers” (here) raises the possibility that the lawyers filing these lawsuits “may be unable to prove their clients lost money or collect fees themselves.”

Among other things, the Bloomberg article quotes a former SEC attorney as saying, with respect to the penalty interest rates that many of the auction rate securities are now paying, “I don’t see how you can get around the fact that, for the most part, the investors are now doing better.” To be sure, investors’ biggest grievance is not the interest rate but the fact that they can’t sell the instruments right now, about which the article quote Columbia Law School Professor John Coffee as saying “I don’t know that you can easily measure liquidity.”

A separate issue pertaining to auction rate securities is how the instruments are to be valued for balance sheet purposes in the absence of a viable marketplace to trade the securities. As I recently noted (here), this problem afflicts a number of publicly traded companies, included quite a few companies entirely outside the financial sector.

A May 27, 2008 Wall Street Journal article entitled “Auction-Rate Securities Give Firms Grief” (here) reports that “hundreds of U.S. companies still are struggling to clean up the problems caused by the auction-rate securities.” The article reports that over 400 companies hold instruments originally valued at over $30 billion, and that “while some companies have written down the value of their auction-rate holdings, many others haven’t, even though market prices have fallen substantially.”  

Hat tip to the WSJ.com Law Blog (here) for the link to the Bloomberg article.

Updating the Options Backdating Lawsuit Count: As a result of a recent post (here) about options backdating settlements, I have had extensive communications with several individuals at NERA Economic Consulting about the total number of options backdating-related securities class action lawsuits. Based on the information NERA provided, I am revising my count of options backdating-related securities class action lawsuits from 36 to 38, by adding to the list Cyberonics (amended complaint here) and The Children’s Place Retail Stores (complaint here).

The revised list of all options backdating related lawsuits can be found here.

Special thanks to Svetlana Starykh and her colleagues at NERA for their friendly and helpful communication on this topic.

 Speak Not, Memory: A May 21, 2008 article in the Cleveland Plain Dealer entitled “Beachwood Man Reports Rate Ability Not to Forget” (here) describes a Beachwood, Ohio resident with a very rare and perhaps enviable talent. (Coincidentally, Beachwood is also the location of The D&O Diary’s intergalactic headquarters.) The article reports that:

Give Rick Baron a date, any date on the calendar, and neurons start firing. He leans his head back and flips through a mental calendar. Then, in an instant, the recollections spurt out.

It's not just that Baron remembers. He says he can't forget.

Dates and details sear into his mind with amazing clarity, so much so that he's being studied by researchers at the University of California-Irvine. He's one of only three people identified so far with such phenomenal autobiographical memory.

Seemingly trivial details from his life -- such as sitting for his sixth-grade picture (Oct. 10, 1968) or going on a date to Euclid's Lakeshore Cinema to catch the forgettable movie "Problem Child" (Sept. 5, 1990) -- easily flow from memory to mouth.

He delights in recalling historical events with near-encyclopedic precision. He says he remembers anything he reads, hears or sees. "Try me," he says. "Ask me anything."

When was Johnny Carson's last show? ("An easy one -- May 22, 1992.") When did militants seize the U.S. Embassy in Iran? ("You playing with me? Nov. 4, 1979.") When did former Cleveland Indian Duane Kuiper hit his only career home run? ("Aug. 29, 1977, off Steve Stone.")

"I don't dwell on the past," said Baron, 50. "It's just there."

Always.

At first impression, Mr. Baron, with his vast and perfect memory, seems like a truly enviable person. The frustrations of an unreliable memory are a fact of life for many of us, and are a reality that only becomes more insistent with age. The inconvenience of an occasional memory lapse usually sparks regret that we cannot remember more. Imagine how convenient it would be if we could now recall our college calculus as well as we knew it then, or we could recite procedural rules as precisely as we learned them for the bar exam.

The simple truth is that, for most of us at least, our brains are not wired to remember everything, and life would be immeasurably more difficult if we did.

In his short story, “Funes the Memorius,” Jorge Luis Borges explores these fundamental attributes of memory. In Borges’ story, Funes loses consciousness after falling from a horse. After recovering, he couldn’t forget anything he had seen or heard.

He remembered the shape of the clouds in the south at dawn on the 30th of April of 1882, and he could compare them in his recollection with the marbled grain in the design of a leather-bound book which he had seen only once…He could remember all his dreams, all his fancies. Two or three times he has reconstructed an entire day. He told me: I have more memories in myself alone than all men have had since the world was a world.

But this fabulous talent was not in the end an advantage for Funes; it was paralyzing:

I suspect that he was not very capable of thought. To think is to forget a difference, to generalize, to abstract. In the overly replete world of Funes, there were nothing but details, continuous details.

Indeed, the Plain Dealer article about Mr. Baron suggests some of the problems that a perfect memory might involve. The article reports that:

One of the others with the ability - a California woman named Jill Price, who recently released a book titled "The Woman Who Can't Forget" - described it as paralyzing. She likened her memories to home movies playing nonstop in her head.

Baron bristles at Price's portrayal of what he calls a gift. However, he acknowledged feeling like "an oddball" given his unusual talent.

He also described his days as "empty."

Our memories must be selective in order for us to be able to function. Our brains must sort and sift, to clear away until only what remains is that which matters. Imagine a marriage where your spouse remembered with clarity your every frailty and shortcoming. Or how hard it would be if you couldn’t put setbacks and defeats behind you, but had to remember them, eternally and perfectly. We forget our college calculus, and even the name of that girl across the classroom whose eye caught yours for that sweet and blessed instant so long ago, because we have to move on.

The process of forgetting is a kind of refinement, a distillation of the essence, that permits us to see our lives not as a crazy quilt of sights and sounds, but as a progression that has a more general meaning and purpose. If we saw all at once, we could not see the center.

And the most important thing about memory, the thing we must never forget, is …um…

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When the United States Supreme Court issued its June 21, 2007 opinion in the Tellabs case, media commentators generally viewed it as a defense victory. My own view (expressed here), was that the decision represented more of a draw, and that the practical impact would vary from Circuit to Circuit. The suggestion that Tellabs was not a comprehensive defense victory was arguably reinforced in the ongoing Tellabs case itself, when (as discussed here) the Seventh Circuit, reconsidering the case on remand from the Supreme Court, reaffirmed its prior reversal of the district court’s dismissal of the case.

An April 16, 2008 opinion (here) from the First Circuit in the Boston Scientific securities lawsuit provides even further support for the view that Tellabs by no means put the plaintiffs’ lawyers out of business, and indeed, that in some circuits – the First Circuit, for example – Tellabs may even put the plaintiffs in a better position than the were prior to Tellabs. I discuss the First Circuit’s opinion in the Boston Scientific case in detail below, but the critical point here is that the while the district court, applying the First Circuit’s pre-Tellabs standard, had dismissed the case, the First Circuit, applying the Tellabs standard, reversed the district court and remanded the case for further proceedings.

The background regarding the Boston Scientific case can be found here. In a nutshell, the complaint alleges that in late 2003, the company became aware of serious problems in Europe with its TAXUS stent, which at the time had not been introduced in the U.S. The company allegedly experienced serious problems, allegedly of the same kind as the prior problems in Europe, after the stent was introduced in the U.S. in March 2004. The plaintiffs allege that the company sought to soft-pedal the problems by representing that they were due to physician unfamiliarity with the stent, while the company allegedly knew that the problems were actually due to manufacturing defects. The defendants allegedly withheld the true information while TAXUS sales drove up the company’s share price, allegedly in order to permit the defendants to unload their shares of the company’s stock at the inflated prices. After the company announced a series of stent recalls, its share price fell and the securities litigation ensued.

In an opinion dated June 21, 2007 (here), issued ironically the same day as the U.S. Supreme Court issued its opinion in the Tellabs case, the district court granted the defendants’ motion to dismiss. Among other things, the district court held that the plaintiff failed, as required under the PSLRA, to plead facts supporting a “strong inference” that as of the time of the stent recall and manufacturing changes, the defendants had the requisite scienter. The plaintiffs appealed.

The First Circuit, in an opinion written by Judge Sandra Lynch, noted that “the district court did not have the benefit of the Tellabs opinion, which reversed a higher standard for scienter imposed by the prior law of the circuit. We apply Tellabs and that leads us to a different result.” The court went on to note that “while there is support for the defendants’ inferences, we think, at this stage, that plaintiff’s inferences are at least equally strong.”

The First Circuit also reversed the district court’s holding as to reliant on the view that the plaintiffs’ allegations were essentially just “fraud by hindsight.” In addition, the First Circuit said that while the plaintiffs’ insider trading allegations are “on the weaker end of the spectrum…a finder of fact could reasonable ask why [the defendants] would have sold so much stock at a time when the company appeared to be soaring on the strength of TAXUS.” On these and other bases, the First Circuit concluded that “plaintiff has pled enough to give rise to inferences that are at least as strong as any competing inference regarding scienter.”

In reversing the district court, the First Circuit expressly acknowledged that Tellabs has reversed “a higher standard” that the First Circuit itself had previously “imposed” as the “law of the circuit.” This specific statement is an explicit recognition that, in the First Circuit at least, the Tellabs standard not only did not advance the defendants’ interests, but it arguably aids’ plaintiffs’ interests by imposing a lower threshold pleading requirement.

At a minimum, the First Circuit opinion in the Boston Scientific case underscores that the Tellabs opinion represents something less than that the watershed defense victory it was initially portrayed to be. The decision also highlights that even after Tellabs, in certain circumstances, plaintiffs will be able to continue to meet the PSLRA’s pleading requirements – particularly in certain circuits.

Another Options Backdating Securities Lawsuit Dismissal: In the latest dismissal motion ruling in an options backdating-related securities lawsuit, Judge Susan Illston of the United States District Court for the Northern District of California, in an April 14, 2008 opinion (here) in the UTStarcom case (about which refer here), granted the defendants’ motion to dismiss, and directing the plaintiff to file an amended complaint by May 16, 2008.

Judge Illston found that while the plaintiff had adequately pled loss causation, he had not adequately pled scienter. In rejecting the plaintiff’s scienter allegations, Judge Illitson found that “none of these factual allegations is cogent and compelling…because each could equally support the inference that the stock option had been backdated through innocent bookkeeping error.”

The UTstarcom dismissal is the latest in a series of options backdating-related securities lawsuit dismissals, as discussed in my recent post (here) commenting on other recent dismissals. I have added the UTStarcom dismissal to my running tally of the options backdating lawsuit dismissals, denials, and settlements, which can be accessed here.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for copies of the Boston Scientific and UTstarcom opinions.

A Reflective Moment: The coincidence that both of the opinions cited above were both written by women made me wonder something – how many female members of the federal judiciary are there? The answer, determined after a little bit of Internet research, is that there are a lot of female federal judges, although women clearly are still underrepresented on the U.S. Supreme Court, the First Circuit, and several other federal courts. A slightly outdated list of women in the federal judiciary can be found here.  

The list includes, among others, Leonie M. Brinkema, now a district court judge on the United States District Court for the Eastern District of Virginia. I had the privilege of seeing Judge Brinkema, while she was still known to some as “Dee Dee”, appear in court when she was an AUSA (and I was a clerk for a federal judge). She was the most skilled and effective advocate I ever saw in action.  

I learned many things from watching her, including the lesson that you did not have to be loud or obnoxious to be an effective advocate, a very important lesson for a young attorney to learn. If others of my brethren (and sistren) at the bar could also have learned the same lesson, I might still be involved in the active practice of law. Judge Brinkema is perhaps best known for presiding over the trial of 9/11 conspirator Zacharias Moussaoui, whom she told at his sentencing to life imprisonment that he would "die with a whimper."

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A lawsuit filed late last week against First Marblehead Corporation underscores that the current lawsuit onslaught so often referred to as the “subprime” litigation wave is, and really has been for awhile, about so much more than just subprime. Although we are probably stuck with the “subprime” label as a shorthand way to describe these developments, the label encompasses a credit crisis that goes far beyond subprime lending.

First Marblehead is a Massachusetts-based company in the business of underwriting, packaging and securitizing student loans. Operating out of First Marblehead’s offices is a nonprofit organization called The Education Resources Institute (“TERI”) that provides guarantees of student loans that First Marblehead originates. On April 10, 2008, plaintiffs’ lawyers filed a securities class action lawsuit in the United States District Court for the District of Massachusetts against First Marblehead and certain of its directors and officers. A copy of the plaintiffs’ counsel’s April 10 press release can be found here. A copy of the complaint can be found here.

The complaint alleges that during the class period of August 10, 2006 to April 7, 2008, the defendants made material misrepresentations “concerning the performance and quality of First Marblehead’s securitizations, its ability to perform additional securitizations, TERI’s ability to adequately guarantee [First Marblehead’s] student loans, and the Company’s financial results and its ongoing operations.” The complaint alleges that the company “misrepresented the level of default rates in its portfolio,” and “disregarded that TERI was underreserved and unable to adequately insure” the company’s loans. According to the complaint, TERI filed for bankruptcy protection on April 7, 2008, and the company’s stock plunged.

The First Marblehead lawsuit has nothing directly to do with subprime lending itself. Indeed, the occurrence of credit-related litigation essentially unrelated to subprime lending is really nothing new – First Marblehead is not even the student loan company to be sued in a securities class action lawsuit as part of the current litigation wave, given the lawsuit filed in January 2008 against SLM Corporation (“Sallie Mae”), about which refer here.

The student lending cases, like the auction rate securities litigation, are about the secondary and tertiary consequences in the credit marketplace following on the consequences first triggered by the subprime lending meltdown. But the spread of litigation to other types of credit and other kinds of companies underscores the dark possibilities for a crisis that began in the residential real estate lending sector to spread across the entire economy and activate a much broader array of litigation.

It is probably worth noting that the turmoil that has hit the student lending sector is not limited just to the student loan organizations themselves; companies that invested in student loan-backed securities are also experiencing financial and accounting difficulties as a result of their investment in these securities. For example, in a situation that encompasses both the student loan problems and the breakdown of the auction rate securities marketplace, Winnebago, in its March 20, 2008 fiscal second quarter earnings release (here), disclosed that it owned $54.2 million of auction rate securities collateralized by student loans. As a result of the auction rate securities market failure, the company deemed these securities as not currently liquid, and reclassified them on the company’s balance sheet as long-term investments. In its April 9, 2008 10-Q (here), the company recorded a temporary impairment charge to these securities of $3.4 million.

The fact that the student loan turmoil would affect a company as unrelated to the sector as Winnebago demonstrates how far afield the effects of the current crisis have and may yet spread. The essential point here is that as long as observers continue to describe and think about the current developments as merely subprime-related, they will not only fail to appreciate the extent of what has already happened, but also likely underestimate the possibilities of what may lie ahead.

Another Auction Rate Securities Lawsuit: And speaking of auction rate securities, on April 11, 2008, plaintiffs’ lawyers filed yet another lawsuit on behalf of auction rate securities investors against the companies that sold them the investments. As reflected in the plaintiffs’ lawyers’ press release (here), the latest lawsuit involves Oppenheimer Holdings. The Oppenheimer lawsuit is the twelfth of these auction rate securities lawsuits to be filed.

Run the Numbers: Like everyone else, I too am trapped by the now-established convention of referring to the current credit-related lawsuit onslaught as the “subprime” litigation wave, and as a reflection of that convention, I have added the First Marblehead and Oppenheimer lawsuits to my running tally of the “subprime”-related litigation, which can be accessed here. With the addition of these two new lawsuits, the current tally now stands at 70, of which 30 have been filed in 2008. As noted, 12 of these lawsuits involve class action auction rate securities litigation.

Subprime Litigation: The Grandaddy of Them All?: Although the crisis commonly referred to as the “subprime” meltdown is relatively recent, subprime loans have been around for a while. Indeed, problems with subprime loans are also nothing new. Even though the current wave of subprime-related litigation did not get started until February 2007, there were subprime-related lawsuits before that. These earlier lawsuits may provide some interesting perspective on the current round of litigation.

As described in an April 9, 2008 Wall Street Journal article entitled “Subprime Lender’s Failure Sparks Lawsuit against Wall Street Banks” (here), American Business Financial Services was in the subprime loan origination business. It funded its operations through the securitization of loans, but, in addition, it also raised operating cash by selling notes through direct sales to individual investors.

According to the allegations in subsequent litigation, ABFS underestimated the number of its loans that would be paid off early as a result of refinancing, reducing the company’s cash flow, and ultimately leading to the company’s bankruptcy. The noteholders, of which there may have been as many as 22,000, lost millions.

The Journal article describes the Pennsylvania state court lawsuit that the bankruptcy trustee has filed against the Wall Street banks that sponsored ABFS’s securitizations, as well as against the company’s former directors and officers. But this trustee lawsuit follows two earlier lawsuits, one brought by the company’s shareholders and one brought on behalf of the company’s noteholders.

The ABFS shareholder securities litigation, background about which can be found here, was initiated in January 2004, following the company’s disclosure that the Department of Justice was investigating the company’s loan transactions and securitization agreements. The plaintiff shareholders alleged that the company and certain of its directors and officers misrepresented the company’s financial condition by artificially altering the company’s loan default ratio, to understate the level of the company’s troubled loans. In a June 2, 2005 memorandum opinion and order (here), the court granted the defendants’ motion to dismiss, on the ground that the plaintiffs did not adequately allege that the statements at issue materially misleading, nor did the plaintiffs’ allegations create a “strong inference” that the defendants acted with scienter.

The noteholder litigation, by contrast is going forward, albeit in a narrowed state. The background regarding the ABFS noteholder litigation can be found here. The noteholders also claimed that the defendants misrepresented the company’s financial condition. In two orders (here and here), the court dismissed the plaintiffs’ allegations concerning the company’s loan delinquency rates, as well as the plaintiffs’ solicitation claims under Section 12. A much-narrowed case is going forward.

The course of these earlier lawsuits casts an interesting light on the current wave of lawsuits. The ABFS shareholder lawsuit dismissal is a reminder that even a lawsuit involving a bankrupt company that is the subject of a DoJ investigation, and in connection with which shareholders lost substantially all their investment, still has to survive the formidable pleading requirements to which securities lawsuits are subject. Even the noteholders, whose plight may be particularly sympathetic, have seen their petition for redress of grievances substantially narrowed.

The fate of these earlier lawsuits is a reminder that merely because lawsuits are filed, even lawsuits filed in the context of significant financial losses and regulatory investigations, does not mean that the lawsuits will succeed. It may be important to keep in mind as the current wave of lawsuits continues to accumulate that these lawsuits will face the same formidable pleading barriers as did the ABFS lawsuits, and some of these lawsuits, like the ABFS lawsuits, will not survive or will only survive on a greatly narrowed basis.

Tellabs in the Ninth Circuit: Readers interested in following the implementation of the Supreme Court’s Tellabs decision in the lower courts will want to review the April 10, 2008 decision (here) in the Skechers USA securities litigation, in which the Ninth Circuit affirmed the district court’s dismissal of the lawsuit, in reliance on Tellabs.

However, the complications that may yet attend the implementation of the Tellabs decision in the lower courts is also suggested by the dissenting opinion in the Skechers appeal (here), in which the dissenting judge, applying the same Tellabs standard to the same facts, reached the opposite conclusion, finding that the district court’s dismissal ought to be reversed.

In the end however, while the Ninth Circuit’s majority and dissenting opinions in the Skechers case are interesting, they ultimately are of little value to the larger question of how Tellabs may be implemented in the lower courts, because the majority opinion is designated as “Not for Publication,” as a result of which it may not be cited. I have previously (here) decried the truly regrettable practice of courts designating opinions as not for publication or citation. Our entire system of jurisprudence relies on the usefulness of prior decisions to help resolve future cases, and it is fundamentally inconsistent with this arrangement for courts to try to remove decisions from this time-honored tradition and process.

Special thanks to a special friend of The D&O Diary for copies of the Ninth Circuit opinions.

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

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

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

Judge Cooper found that

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Regular readers know that I have been tracking subprime-related class-action lawsuits (here). In a recent post, I noted my interest in trying to develop a similar list of subprime-related derivative lawsuits. In response to my request, a number of readers supplied helpful information, and as a result I have been able to develop a list of subprime-related derivative lawsuits, which can be accessed here.

The list is accurate but it may not be complete. Readers aware of any other subprime-related derivative lawsuits are encouraged to let me know, so that I can address any omissions. I will update the list as new lawsuits come in or as new information becomes available.

The table of cases I have compiled lists the companies that have been named as nominal defendants in shareholders’ derivative lawsuits. Some of the companies listed actually have been sued in multiple derivative suits, and some companies have been sued in multiple jurisdictions. However, where the allegations relate to substantially similar allegations, each company has only been listed once, regardless of the number of actual derivative lawsuits pending. Where I have been able to supply relevant links (in most cases to the actual complaint), the link pertains to the first filed suit.

As the list reflects, a total of 20 companies have been sued as nominal defendants in subprime-related derivative lawsuits. The derivative suits against seven of these companies were first filed in 2008, the rest in 2007. Most (but not all) of the companies named in the derivative suits have also been named in subprime-related securities class action lawsuits. Most of the companies sued in the derivative lawsuits are in the lending and banking industries, but the list also includes insurance companies, home builders, and REITs, among other.

Special thanks to Adam Savett of the Securities Litigation Watch (here) for providing information and links to several of the lawsuits, and thanks to all readers who provided information and suggestions in response to my inquiry.

Another Auction Rate Securities Lawsuit: On April 8. 2008, plaintiffs’ lawyers filed another purported securities class action lawsuit on behalf of auction rate securities investors against the companies that allegedly sold them the securities, in this case Raymond James Financial. A copy of the plaintiffs’ lawyers’ April 8 press release can be found here, and a copy of the complaint can be found here.

This brings the total number of auction rate securities lawsuits to eleven. My prior post discussing the auction rate securities lawsuits can be found here. I have been tracking the auction rate securities lawsuits as part of my running tally of subprime-related class action lawsuits, about which more below.

Adjusting the Subprime-Related Class Action Litigation Tally: Also as a result of my efforts to build the list of subprime-related derivative lawsuits, I received additional information regarding three previously filed securities class action lawsuits. In the past, I had determined that these three lawsuits were not appropriately categorized as subprime-related. However, upon further inquiry and based on conversations with some readers, I have now added these three additional lawsuits to my running tally of subprime-related securities class action lawsuits. The three added lawsuits related to Municipal Mortgage & Equity (about which refer here), WSB Financial Corp. (refer here), and CBRE Realty Finance (refer here).

With the addition of these three lawsuits, and with the addition of the Raymond James auction rate securities lawsuit referenced above, my running tally of subprime-related lawsuits now stands at 68. One unfortunate consequence of my decision to add these three cases is that now my running tally may no longer agree with others’ tallies, such as the Stanford Law School Securities Class Action website (here). There is an inherent categorization problem in trying to track the subprime lawsuits. Reasonable minds will disagree about whether a case is or is not appropriately categorized as subprime related. There are almost always going to be some disagreements at the margins.

Many thanks to the readers who supplied the information and commentary about the three class action lawsuits.

Subprime ERISA Lawsuit Update: As most readers know, I have also been tracking subprime-related ERISA lawsuits (here). As a result of my research and inquiries regarding subprime derivative lawsuits, I identified three additional subprime-related ERISA lawsuits of which I previously had been unaware. These three additional ERISA lawsuits pertain to Huntington Bankshares (refer here), National City Corp. (refer here), and Impac Mortgage (refer here).

With the addition of these three suits to my list, the number of subprime-related ERISA lawsuits now stands at 14, five of which have been filed in 2008, and the remainder of which were filed in 2007.

Two Options Backdating Case Developments: Two courts recently issued rulings on motions to dismiss in options backdating-related lawsuits.

First, on March 31, 2008, in the Juniper Networks option backdating-related securities litigation (about which refer here), Judge James Ware of the United States District Court for the Northern District of California largely denied the defendants’ motion to dismiss, except that he granted the motion (with leave to amend) as to one individual defendants, and he granted the motion to dismiss all alleged misrepresentations that took place prior to July 14, 2001, as time barrred. A copy of the March 31 order in the Juniper Networks case can be found here.

Second, and also on March 31, 2008, in the Microtune options-backdating related derivative litigation, Judge Richard Schiff of the United States District Court for the Eastern District of Texas granted the defendants’ motion to dismiss, albeit with leave to amend as to certain individuals on certain claims. A copy of the Microtune opinion can be found here. Judge Schell first concluded the Congress had not created a private right of action under Section 304 of the Sarbanes-Oxley Act, and dismissed that claim. Judge Schell also granted the dismissal with prejudice of claims of allegedly misleading proxy statements as to the individual defendants who were not on the board at the time of the proxy. The proxy allegations were dismissed without prejudice as to the remaining individual defendants. Similarly, the plaintiffs’ claims based on Section 10(b) were also all dismissed, but with prejudice as to some defendants and without prejudice as to others. The court declined to exercise jurisdiction over the plaintiffs’ state law claims.

I have added these two decisions to my table of options backdating related case dispositions, which can be accessed here. Readers are encouraged to let me know about case dispositions of which they become aware so that I can add them to the list.

Special thanks to Nick Even of the Haynes and Boone firm for the link to the Microtune decision.

New Century Updated: In an earlier post (here), I noted that the court had granted (with leave to amend) the defendants’ motion to dismiss in the first-filed subprime related securities class action lawsuit, involving New Century Financial Corporation. On March 24, 2008, the plaintiffs filed their amended complaint (here), which names as defendants not only certain former directors and officers of the company, but also the company’s former auditor, KPMG, and the company’s offering underwriters.

Readers will recall that in connection with the New Century bankruptcy proceeding, the bankruptcy examiner recently released a detailed report (about which refer here) in which, among other things, the examiner reviewed the question of the auditors’ and the company's directors and officers' potential responsibility for certain accounting practices and statements at the company. In light of the bank examiner’s report, the plaintiffs sought (and the defendants’ agreed not to oppose) leave to file a second amended complaint, which the court granted. The plaintiffs’ must file their second amended complaint by April 30, 2008. The court also set a briefing schedule for the anticipated motion to dismiss, to be argued September 8, 2008. A copy of the court’s order granting leave and setting the scheduling can be found here.

A German Securities Trial?: The Securities Litigation Watch has an interesting post (here) about the apparent mass securities lawsuits trial that has commenced in Germany involving Deutsche Telecom. An April 7, 2008 Business Week article discussing the trial can be found here.

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

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On January 16, 2008, a civil jury in the Apollo Group securities lawsuit in the United States District Court for the District of Arizona entered a verdict in favor of the plaintiff class on all counts, awarding damages of $5.55 per share, an amount that according to Bloomberg (here) could reach as much as $277.5 million. The Bloomberg report also states that Apollo is responsible for 60 percent of the plaintiffs' losses, former Apollo CEO Tony Nelson is responsible for 30 percent, and former CFO Kenda Gonzales is responsible for 10 percent. The company's statement about the verdict can be found here. The plaintiff's counsel's statement about the verdict can be found here.

Background

Apollo Group is the parent of the University of Phoenix (UOP), the largest for-profit provider of higher education in the United States. According to the plaintiff's amended complaint (here), in 2003, two former UOP employees filed a False Claims Act action against UOP alleging that UOP received U.S. Department of Education funding in violation of laws specifying the way company educational recruiters may be compensated. Background regarding the False Claims Act case can be found here.

The Department of Education initiated an investigation of the issues raised in the False Claims Act action, and on February 5, 2004, a Department of Education employee issued a "Program Review Report" that accused UOP of violating the Department of Education rules with respect to education employees' compensation. The plaintiff in the securities case alleges that the violations in the report could have resulted in the limitation or termination of Department of Education funding to UOP.

On September 7, 2004, Apollo agreed to pay the Department of Education $9.8 million to settle the program review. The settlement agreement (a copy of which can be found here) specified that Apollo's entry into the agreement did not constitute an admission of wrongdoing or liability. News of the allegations in the Department of Education report first became public on September 14, 2004. The price of Apollo's stock fell significantly on September 21, 2004, when a securities analyst issued a report expressing concern about the company's possible exposure to future regulatory issues.

The Lawsuit

The lead plaintiff in the case is the Policemen's Annuity and Benefit Fund of Chicago, on behalf of a class of persons who purchased Apollo stock between February 27, 2004 and September 14, 2004. The case was pending before Judge James A. Teilborg.

In a September 11. 2007 order (here), Judge Teilborg denied the parties cross-motions for summary judgment. The defendants had sought summary judgment arguing that they had no duty to disclose an interim regulatory report (which they believed to be both unauthorized and false). The court found that while the defendants "may not have an affirmative duty to disclose the interim regulatory findings they do have 'a duty to disclose material facts that are necessary to make disclosed statements...not misleading.'" Judge Teilborg found that there was a jury issue as to whether any of the defendants' statements between the February delivery of the report and the September disclosure were misleading. Judge Teilborg also found that there were jury issues on the question whether the interim report was material and whether the defendants' acted with scienter in withholding information about the report.

In a particularly interesting holding, Judge Teilborg also found that there was a jury issue on the question of loss causation. The defendants argued that that there was no jury issue because the company's stock price did not react to the September 14 disclosure of the settlement. But the plaintiffs argued that the corrective disclosure was actually a cumulative process that included the analyst's September 21 report. Judge Teilborg said he could not conclude as a matter of law that the analyst report was not part of the corrective disclosure. The judge said it was a jury question whether or not the corrective information was fully absorbed into the marketplace before the analyst's report issued. (This mattered because there was no significant stock price drop until the report came out.)

Trial commenced on November 14, 2007. During the trial the plaintiff called both Nelson and Gonzalez to the stand to testify as hostile witnesses for the plaintiff. (Calling adverse parties as hostile witnesses is an unusual move, but it has the advantage of allowing the examining attorney to use leading questions and other techniques of cross-examination, which would otherwise not be allowed on direct examination.) According to news reports (here), Gonzalez testified that the company withheld the report from investors to avoid news coverage about the allegations. The news reports quote Gonzalez as having said that "when we received the program review report, we felt very strongly we did not want it basically tried in the press." The news reports also state that Nelson testified that the company's lawyers advised the company against disclosing the report, and that he thought disclosing it would have caused the company's stock price to drop.

The jury began deliberation on January 10, 2008 and returned a verdict on January 16. The jury found for the plaintiff on all counts. In its statement on the verdict (here), the company said that the case was premised on the company's "supposed failure to disclose unsubstantiated allegations from a preliminary government report." The company's counsel is quoted in the statement as saying that the "law does not require the disclosure of preliminary or unproven damages." The statement also says that "the ultimate disclosure of the report's contents caused no statistically significant movement in Apollo's stock price."

Discussion

According to the Securities Litigation Watch blog (here), 19 securities lawsuits have gone to trial since 1996. Of these, six cases (including the Apollo Group case) involving post-PSLRA conduct have reached a jury verdict, with three verdicts going in favor of the plaintiffs and three going in favor of the defendants. The Ninth Circuit recently reversed one of the three defense verdicts, as noted further below. Among the six verdicts is also the November 27, 2007 defense verdict in the JDS Uniphase trial (about which refer here).

It is important to keep in mind that this case is not over - indeed, it may have a long way yet to go. The defendants undoubtedly will pursue an appeal to the Ninth Circuit if their post-trial motions are unsuccessful. On appeal, both parties will look with interest (and in the defendants' case, concern) on the Ninth Circuit's November 26, 2007 opinion in the Thane International case (here), in which the Ninth Circuit reversed and remanded a trial verdict that had been entered on behalf of the defendants in that case. (Refer here for my prior discussion of the Thane International case). While the ultimate outcome of any appeal in the Apollo Group case remains to be seen, there may well be significant issues on appeal, particularly with respect to the defendants' obligation to disclose the report; scienter; and loss causation. (Of course, the parties always have the opportunity of entering into a post-trial settlement, as well...)

It is worth asking why all of a sudden securities cases are going to trial. It is not clear why the Apollo Group case did not, like most of these cases, settle. The parties may simply have been unable to reach a mutually acceptable compromise. The Apollo Group case does seem like an odd case for the plaintiff to have pushed to trial since there were no insider trading allegations or other suggestions that the individual defendants personally benefited - although the jury verdict obviously validates the decision (to the extent there was an active decision) to try the case, and the absence of individual benefit clearly did not influence the ultimate outcome.

There is at least potentially an interesting insurance coverage question, which is whether the jury verdict represents an adjudication of fraud sufficient to trigger the fraud exclusion that typically is found in directors and officers liability insurance policies. I have not been able to obtain a copy of the questionnaire the jury used to see what specific factual findings the jury made, but to the extent the jury found knowing misrepresentations, the verdict could preclude coverage, although the possibility of an appeal could also affect this issue. (The possibility of a jury verdict triggering the fraud exclusion is one reason why so few securities cases go to trial.) It should also be noted that the amount of damages could exceed any amounts of insurance that are available. (I want to emphasize in making these insurance observations that I have no knowledge of any kind about the particulars of Apollo Group's insurance, and so I am merely speculating not expressing any insurance opinions.)

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On January 15, 2008, in a 5-3 majority opinion (here) written by Justice Kennedy (pictured to the left), the U.S. Supreme Court affirmed the Eighth Circuit in the Stonridge Investment Partners, LLC v Scientific Atlanta case. The Court concluded that the implied right of action under Section 10(b) did not reach the respondent companies' conduct because the investor claimants did not rely on the alleged deceptive conduct. Justice Stevens, joined by Justices Souter and Ginsberg, dissented. Justice Breyer, as previously disclosed, did not take part in the case.

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In prior posts (most recently here), I have written about the increasing importance of opt-out settlements in the context of securities class action litigation. Along the way, numerous readers have inquired whether I am aware of a publicly available resource that is tracking the securities lawsuit opt-out settlements. I am not aware of any public resource, but because there clearly is an interest in having this information available, I have gone ahead and compiled all of the opt-out settlement information of which I am aware. My list of the opt-out settlements can be found here.

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