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

Over the years, legislative reforms of the U.S. securities laws have cycled back and forth, between initiatives, on the one hand, to discourage abusive litigation and, on the other hand, to restrain corporate misconduct. In the current Wall Street bailout, post-Madoff environment, sentiment may be running high for legislative reforms that could expand liabilities under the federal securities laws. But though the time for reform may be now, the window of opportunity may be short.

According to a January 2010 Wall Street Lawyer article by Boris Feldman of the Wilson Sonsini firm entitled "The Coming Counter-Reformation in Securities Litigation" (here), the best shot for reforms favorable to the plaintiffs’ bar "may be right now—before the mid-term elections in 2010 can create a filibuster firewall in the Senate." In his article, Feldman looks at the most likely areas of reform and the likelihood of the initiatives’ success.

The "most important priority for the plaintiffs’ bar" will be the institution of private securities liability for aiding and abetting violations of the securities laws. (There are in fact already current Congressional initiatives to accomplish that very change, about where refer here and here.) This change, were it enacted, would made the biggest difference in the "big frauds," where the "primary wrongdoer is usually bust." If the company’s professionals were "on the hook," then the "entire calculus would change," as the "pot" would then "consist of more than a claim in bankruptcy and some D&O insurance policies."

The "real battle" about prospective aiding and abetting liability, according to Feldman, will be how -- not whether-- it is instituted. Questions such as who bears the burdens of proof and persuasion and the state of mind required for liability "will determine whether aiding and abetting liability is a measured response to the current situation or a license to subject outside advisors to in terrorem risk."

The next likely target for the plaintiffs’ lawyers, Feldman suggests, is the discovery stay, which has been one of the PSLRA’s "great frustrations" for the plaintiffs’ bar. Feldman suggests that the plaintiffs’ will seek to modify the discovery stay, rather than try to have it overturned. He suggests that one alternative might be a "good cause" exception to the stay. Another alternative is the creation of an exception to the stay for documents already produced to governmental authorities.

Feldman also suggest that the plaintiffs’ bar may attack the PSRLA’s pleading requirements, or alternatively seek to rely on initiatives to set aside the "facial plausibility" pleading standard of Twombley and Iqbal (about which refer here).

Finally, Feldman suggests that the plaintiffs’ bar may see to limit the impact of Dura Pharmaceuticals, perhaps through reforms specifying that the loss causation issue is to be addressed only at the summary judgment or trial stage.

One area Feldman suggests that plaintiffs are unlikely to seek reforms is with respect to the PSLRA’s lead plaintiff requirements. Though these provisions were controversial when first enacted, the plaintiffs’ bar has now "adapted happily" to the requirements, and with institutional investor relationships firmly in place, there is "no incentive for the plaintiffs’ bar to tinker with these provisions."

Feldman closes by noting that the "electoral clock is ticking," with the likelihood of legislative action, if any, before fall 2010. He confesses "surprise" that the legislative reforms were not launched a year ago, when the 2008 electoral results were still fresh. Feldman notes that the fact that the plaintiffs’ bar missed this opportunity "may have something to do with absences in their leadership ranks in recent years."

Feldman suggests that the "most likely" way these reforms may come about is through the activities of the Financial Crisis Inquiry Commission, which, Feldman notes, has "strong ties to the plaintiffs’ bar" (about which refer here), a fact that may allow the plaintiffs’ bar "to try to get some of their reforms into the recommendations of the Commission."

I note that Feldman published his article before last week’s special election in Massachusetts. The election of Republican Scott Brown to the Senate seat vacated by the late Edward Kennedy seems to have scrambled everything. Although I don’t profess to have any particular insight into Congressional dynamics, I wonder whether the possible November effect Feldman anticipates in his memo has now been pushed forward through the calendar. The "filibuster firewall" may already be gone. Without a doubt, every member of Congress facing election this fall is proceeding with significantly greater wariness in the wake of the recent Massachusetts senatorial election. All of which makes me wonder whether or not the window of opportunity on some of these legislative proposals may have been substantially narrowed, if not altogether closed.

Opt-Outs Down and Out: Much has been written (refer for example here) about the growing phenomenon of class action securities lawsuit settlement opt-outs – that is, the investor class members who choose not to participate in the class action lawsuit settlement and instead pursue their own individual claims. One of the recurring themes has been how much better the opt-outs do than they would have if they remained in the class.

However, as shown in the outcome of a recent case involving Aspen Technology, there is no guarantee that the opt outs will do better by proceeding separately.

Aspen and several of its directors and officers had been sued in a securities class action lawsuit in November 2004 (about which refer here). The securities class action lawsuit ultimately settled for $5.6 million, but several class members representing 1.4 million shares of common stock opted out of the class action settlement and filed their own "direct action" lawsuit against the defendants in Massachusetts state court.

As reported on the Securities Litigation Watch blog (here), the Aspen Technology investors’ direct action lawsuit didn’t go so well for them. In a January 13, 2010 opinion (here), Massachusetts (Suffolk County) Superior Court Justice Judith Fabricant ruled that "no fraud occurred" and that "defendants are entitled to judgment on all counts of the complaint." In a memo about the decision (here), Skadden, the defense firm in the case, reports that Justice Fabricant also awarded defendants recovery from the plaintiffs of their costs in the case.

Options Backdating Securities Suit Dismissal Affirmed: One of the 39 options backdating related securities class action lawsuits involved claims against Jabil Circuit. The case may have been among the more noteworthy options backdating-related securities lawsuit filings, because Jabil Circuit was among the small group of companies specifically mentioned by name in the original March 2006 Wall Street Journal article ("The Perfect Payday") that launched the options backdating scandal. Among other things, the article calculated the likelihood that the Jabil options grants occurred randomly as "one in a million."

As noted in an earlier post (here), the Jabil Circuit options backdating-related securities lawsuit was dismissed without prejudice in April 2008. In a January 2009 order (here) on the defendants’ renewed motion to dismiss, the complaint was dismissed with prejudice.

In a January 19, 2010 decision (here), the Eleventh Circuit Court of Appeals affirmed the lower court’s dismissal of the case, holding the plaintiffs’ allegations "fail to meet the heightened pleading standards" under the PSLRA.

Among other things, the court said that "the allegations of misrepresentations, responsibility for granting misdated options, and personal profiteering fail to raise a strong enough inference of scienter" and that "the allegations contained in the complaint do not create an inference of scienter that is at least as probable as a non-fraudulent explanation—namely that none of the Appellees knew of the accounting errors until the investigation began in 2006"

I have updated my table of the outcomes in the Options Backdating-related lawsuits to reflect the Eleventh Circuit’s decision in Jabil Circuit. The table can be accessed here.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

In an earlier post (here), I discussed legislation that Senator Arlen Specter introduced in July 2009 to legislatively overturn the U.S. Supreme Court’s decision in Stoneridge and allow private actions for aiding and abetting liability. Though this proposed legislation is a matter for serious concern, there was always the possibility that given everything that Congress has on its plate, this particular initiative might not make the cut.

There is, however, some significant likelihood that some form of financial reform legislation eventually will be enacted into law. Indeed, as discussed here, the House of Representatives has already passed its version of financial reform legislation.

The Senate has yet to act, but among the leading proposed Senate financial reform bills under consideration is Senator Chris Dodd’s proposed "Restoring American Financial Stability Act of 2009" (here).

As noted in a January 4, 2009 memo by K. Stewart Evans, Jr. of the Pepper Hamilton law firm (here), the bill contains a provision "hidden on page 795 of 1,136" that amends the ’34 Act to provide liability for any person that "knowingly or recklessly provides substantial assistance" to a person whose conduct violates the securities laws. Evans notes further that the provision would impose liability without the claimant having to even prove that reliance on the secondary actors’ statements.

My concerns about the possible imposition of aiding and abetting liability are reflected in my prior post. Evans has his own concerns, arguing that the proposed amendment would be "dangerous and destructive to American business."

But regardless of the merits of the proposal, the fact that it proposed amendment creating private aiding and abetting liability is no longer just its own free-floating suggestion, but has now been incorporated into a comprehensive piece of financial reform legislation does seem to suggest that the proposal could be that much closer to being enacted into law.

Of course, there is still a long way to go before we know whether or not the Senate will get around to enacting any financial reform legislation, much less what form that legislation might ultimately take. In addition, any bill passed by the Senate would have to be reconciled with the House’s bill, so what might finally emerge is at the point anybody’s guess.

But all of that said, the incorporation of the aiding and abetting provision into Dodd’s proposed Senate bill does seem to suggest the possibility that the aiding and abetting initiative will not simply fall by the wayside as the proposed legislation goes forward. Rather, at this point it looks like somebody is going to have to affirmatively knock the proposal out to prevent it from remaining in.

Dismissal of BAE Bribery Civil Suit Affirmed: As I have noted in prior posts (most recently here), allegations of bribery in connection with BAE’s fighter aircraft contract with Saudi Arabia – and in particular the UK’s election not to investigate the allegations due to national security concerns -- not only have proven highly controversial, but also has generated follow on civil litigation.

As discussed in a recent post on the FCPA Blog (here), on December 29, 2009, the Court of Appeals for the D.C. Circuit affirmed the lower court’s dismissal of the derivative lawsuit that had been filed against BAE, as nominal defendant, and certain of its directors and offices Judge Edwards, writing for the court found that under the 1843 English case of Foss v. Harbottle, 2 Hare 461, 67 E.R. 189, "the company, not a shareholder, is the proper plaintiff in a suit seeking redress for wrongs allegedly committed against the company."  The court further found that the BAE case did not come within any exceptions to the rule.

And Speaking of U.S. Lawsuits Against Foreign Companies: According to a January 6, 2010 Law.com article by Andrew Longstreth (here), the three-month long securities class action jury trial against Vivendi and certain of its directors and officers is drawing to a close. According to the article, the parties are now completing their closing statements, and the case will be submitted to the jury later this week.

Look for A Lot More Cases Like This in 2010: Though thecomplaint was actually filed in the Northern District of Georgia on December 31, 2009, the plaintiffs’ lawyer press release is dated January 4, 2010, and the investor lawsuit involving a failed bank make prefigure many more lawsuits of the same kind in the months ahead in 2010.

The lawsuit arises out of the failure of Haven Trust Bancorp, whose operating banking subsidiary was taken over by the FDIC on December 12, 2008. On February 23, 2009, the holding company filed for bankruptcy. The defendants include certain former officers of the holding company and the bank. The plaintiffs allege that the defendants misrepresented the bank’s financial condition and lending practices in order to induce the plaintiff investors to invest in the holding company. The plaintiffs assert claims under the federal securities laws, Georgia securities laws, as well as certain common law claims.

 In light of the 140 banks that failed during 2009, there undoubtedly will be more claims like this to come, both filed on behalf of investors and on behalf of the FDIC as receiver of the failed institutions.

• Email This
• Print
• Comments
• Trackbacks
• Share Link

On December 11, 2009, the U.S. House of Representatives approved by a 223-202 vote "The Wall Street Report and Consumer Protection Act of 2009," H.R. 4173 (here). The sprawling 1279-page Bill, which must be reconciled with competing financial reform legislation pending in the Senate, would institute a number of reforms and initiatives that would have a dramatic effect on the financial services industry.

In addition to the many higher profile institutional reforms, the Bill also incorporates a number of revisions and amendments that could significantly impact both SEC enforcement actions and private securities litigation.

The House Financial Services Committee’s two-page summary of the Bill can be found here. The Committee’s three page list of the Bill’s "highlights" can be found here.

The Bill’s high profile reforms include, among other things, the creation of a Consumer Financial Protection Agency; the creation of a Financial Stability Council to identify large, interconnected firms that could put the financial system at risk; the creation of a single federal banking regulator; and the introduction of various regulatory reforms regarding financial derivatives and credit default swaps. The Bill also required hedge funds and private equity funds to register with the SEC.

As reflected on the RiskMetrics Corporate Governance Risk & Governance Blog (here), the House Bill also introduces a number of corporate governance reforms, including an annual "say on pay" mandate and authorization for the SEC to issue a proxy access rule. The bill includes a permanent exemption for small issuers (those with less than $75 million in market cap) from the outside auditor attestation requirements of the Sarbanes-Oxley Act.

In addition to these higher profile initiatives, the House bill also incorporates variety of legislative revisions to the federal securities laws that could affect securities litigation. Some of these initiatives were the subject of separate legislative proposals that have now been incorporated into the larger financial reform legislation.

The House Bill’s provisions that potentially could impact securities litigation include the following:

1. Credit Rating Agencies (Section 6003): Clarifies the pleading standard applicable to private securities actions under the ’34 Act against "a nationally recognized statistical rating organization" by specifying that "it shall be sufficient for purposes of pleading any required state of mind for purposes of such action that the complaint shall state with particularity facts giving rise to a strong inference that the nationally recognized statistical rating organization knowingly or recklessly violated the securities laws."

The Section also specifies that NRSRO’s credit rating opinions "shall not be deemed forward looking statements."

2. Mandatory Arbitration (Section 7201): Gives the SEC authority to "prohibit, or impose conditions or limitations on the use of, agreements that require customers or clients of any broker, dealer, or municipal securities dealer to arbitrate any future dispute between them arising under the Federal securities laws."

3. Whistleblower Incentives and Protection (Section 7203): Gives the SEC authority to "pay an award or awards not exceeding an amount equal to 30 percent, in total, of the monetary sanctions imposed in the action or related actions to one or more whistleblowers who voluntarily provided original information to the Commission that led to the successful enforcement of the action."

4. Aiding and Abetting Liability (Section 7207): Amends the ’33 Act and the Investment Company Act of 1940 to provide that for purposes of an action brought by the SEC, "any person that knowingly or recklessly provides substantial assistance to another person in violation of a provision of this Act, or of any rule or regulation issued under this Act, shall be deemed to be in violation of such provision to the same extent as the person to whom such assistance is provided."

Section 7215 also clarifies that recklessness is a sufficient basis on which to impose aiding and abetting liability under the ’34 Act

5. Extraterritorial Application of the Federal Securities Laws (Section 7216): Amends the ’33 Act, the ’34 Act and the Investment Advisors Act of 1934 to clarify that federal court jurisdiction for securities cases includes cases that involves "conduct within the United States that constitutes significant steps in furtherance of the violation, even if the securities transaction occurs outside the United States and involves only foreign investors" or "conduct occurring outside the United States that has a foreseeable substantial effect within the United States."

6. Deadlines for Enforcement Investigations and Compliance Examinations (Section 7209): Introduces, subject to certain specified exemptions, certain time requirements within which the SEC must complete enforcement investigations and compliance examinations. Among other things, the Section provides that, other than with respect to certain "complex action," within 180 days after serving someone with a Wells Notice, the SEC must either initiate an action against the person or provide notice that it does not intend to file an action.

The House Bill also dramatically increases SEC funding, doubling the agency’s budget in five years. The Bill also expands the agency’s subpoena powers and its ability to share and access information gathered by other regulatory and investigative bodies and agencies.

Readers of this blog will also be interested to know that Section 8802 of House Bill also creates a Federal Insurance Office within the Treasury Department. The new Federal Insurance Office would not replace state regulation of insurance. Rather, the new agency would monitor the insurance industry; designate insurers for stricter oversight; assist in the administration of TRIA; coordinate on international insurance regulation; and consult with states on insurance matters of national importance.

It remains to be seen whether any of these provisions will survive the forthcoming legislative process and actually become law. The Wall Street Journal’s front page article about the House Bill (here) indicates that Democratic leadership in the Senate has committed to having a reconciled agreement in principle about the financial reform legislation by the end of December, to have a bill enacted in the first half of 2010.

While the legislation that finally emerges will undoubtedly reflect further changes, it is interesting to observe even at this preliminary stage how some of the proposed initiatives have fared.

For example, though it contains provisions addressing the SEC’s authority to enforce aiding and abetting liability under the ’33 Act and under the Investment Advisors Act, the House Bill, at least, does not contain any provisions along the lines of those proposed last summer by Senator Arlen Specter to overturn Stoneridge. Nor does the House Bill contain any provisions reflecting Senator Specter’s initiative to overturn Iqbal. Of course, because those initiatives originated on the Senate side, they may still be incorporated into the Senate version of the financial reform bill and perhaps even in the final version of the reform legislation that ultimately emerges.

As noted above, the House Bill does incorporate suggested provisions that would clarify federal court jurisdiction in matters involving companies or persons outside the U.S. These provisions mirror the proposed legislation that Representative Paul Kanjorski introduced earlier this fall (as discussed in a prior post, here.) This jurisdictional provision, if enacted, could make the National Australia Bank case, on which the U.S. Supreme Court recently granted a petition for writ of certiorari, of considerably less potential significance, as jurisdictional issues raised in the case would be controlled in future by the new statutory provisions.

Given the current political climate, it seems probable that some form of financial reform legislation will be enacted prior to the 2010 congressional election. The ultimate version may be far different that the Bill approved by the House on Friday. However, if the House Bill is any indication of what might finally emerge, there could be some enormous changes ahead, including among other things significant changes relating to securities litigation and enforcement.

Random Thought: Is there anything more unintentionally ironic and completely self-negating than the phrase "This Page Intentionally Left Blank"? (This Internet being what it is, there is actually a website devoted to the phrase, here.)

• Email This
• Print
• Comments
• Trackbacks
• Share Link