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

1. Damages: "The actual amount of damages payable cannot be determined until notices are published and shareholders present valid claims....Based on the plaintiffs' estimate, the damages could range between $166.5 million and $277.5 million. The Company...intends to record its best estimate of the potential loss, including future legal and other costs, in the second quarter of fiscal 2008."

2. Liability: "Liability in the case is joint and several, which means that each defendant, including the Company, is liable for the entire amount of the judgment." Apollo Group will be responsible for posting the appeal bond.

3. Insurance: "The Company does not expect to receive material amounts of insurance proceeds from its insurers to satisfy any amounts ultimately payable to the plaintiff class."

4. Defense Costs: Defense costs including legal fees total approximately $25 million. Although the company expects the insurers to make payments for defense costs, "the insurers have not waived their rights to object to coverage."

5. Company Credit: "If the judgment is not stayed or discharged within 60 days, it will constitute an event of default under the credit facility." The company "expects to cause the judgment to be stayed by filing any necessary bond in a timely manner."

While the company obviously intended this statement for other purposes, the statement is also a very powerful testament to why so few securities lawsuits go to trial. There is not just the trial risk of a significant adverse judgment (although this is obviously compelling in an of itself, particularly in light of the magnitude of the Apollo verdict.) There are other considerations, too: an adverse trial outcome creates accounting, reporting and disclosure issues; it potentially undermines the availability of insurance, perhaps even for defense expense; and it creates complications with creditors. All of these reasons are, of course, on top of the burden, distraction and expense a trial entails.

There may be other securities lawsuits that go to trial in the future, but I doubt that many defendants would voluntarily go to trial after reading considering the jury verdict in the Apollo Group case and reading the company's January 24 "clarification."

KLA-Tencor was among the companies mentioned in a front-page May 22, 2006 Wall Street Journal article entitled "Five More Companies Show Questionable Options Pattern" (here). The article described how the company's executives received stock option grants in 2001 on "unusually fortunate days." The article also said that the data the Journal reviewed suggested a "highly improbable pattern of option grants." The company's shares dropped over ten percent on the news, representing a drop in market capitalization of $935 million.

On May 24, 2006, the company announced (here) that its Board of Directors had formed a special committee to investigate the company's stock option practices between 1995 and 2001. On June 29, 2006, the company announced (here) that its Board "had reached a preliminary conclusion that the actual measurement dates for financial accounting purposes of certain stock option grants issued in prior years likely differ from the recorded grant dates of such awards."

On October 16, 2006, the company announced (here) that the special committee had completed its investigation, and that as a result of the committee's conclusions "the company will restate its financial statements to correct the accounting for retroactively priced stock options." The company said that it anticipates that the "additional non-cash charges for stock based compensation expenses will not exceed $400 million." The company also announced that it had terminated "all aspects of its employment relationship" with Kenneth Schroeder, who had been President and COO from 1991 to 1999, and CEO and a director from 1999 to 2005.

On June 25, 2007, the SEC announced (here) that it had filed a civil complaint against the company and Schroeder. Among other things, the SEC charged that Schroeder "repeatedly engaged in backdating after becoming CEO in 1999," including "pricing large awards of options to himself" that "were never disclosed to KLA-Tencor's shareholders." The SEC alleged that he even made one award in 2005, "after he received advice from company counsel that retroactively selecting grant dates without adequate disclosure was improper." KLA-Tencor agreed to the entry of a permanent injunction, without admitting liability.

The plaintiffs first filed a civil securities class action complaint against the company and certain of its officers and directors (including Schoeder) on June 29, 2006, in the United States District Court for the District of California (about which refer here). The company's $65 million settlement, which secured the release of all defendants (including Schroeder), represents the second-largest options backdating-related securities class action settlement. The only larger settlement so far is the $117.5 million Mercury Interactive settlement, which perhaps may be explained as an effort by Mercury's acquirer, HP, to put the case in the past.

The magnitude of the KLA-Tencor settlement may be a reflection of the prominence of the case (in light of the Journal article), the magnitude of the stock drop (many other options backdating cases do not involve a significant stock price drop), and the existence and apparent seriousness of the SEC complaint, as well as the company's public admissions about the backdating and its termination of Schoeder and others. Significantly, perhaps, the KLA-Tencor announcement of the settlement says nothing about insurance.

In any event, I have added the KLA-Tencor settlement to my table of options backdating settlements, dismissals and denials, which may be accessed here.

The court then turned to the question whether the plaintiffs had presented sufficient scienter allegations in connection with defendant Richard Notebaert, Tellabs' former CEO, about whom the court noted that "almost all of the false statements that we have quoted emanated directly from him." The court asked

Finally, the court noted that the complaint's reliance on confidential sources "does not invalidate the drawing of a stong inference from the informants' assertions." While acknowledging that there are circumstances when the accusations of anonymous informants would not be sufficient to meet the pleading requirements, the court distinguished the allegations in this complaint, observing that "the information that the confidential informants are reported to have obtained is set forth in convincing detail, with some of the information, moreover, corroborated by multiple sources."

The Seventh Circuit's decision is not only a victory for the plaintiffs in that case, it is also a refutation of the position, advanced by some at the time, that the Supreme Court's Tellabs decision represented a watershed victory for securities litigation defendants. As I wrote at the time about the Supreme Court's Tellabs opinion (here) "neither side has been handed a strategically decisive weapon, and so the battle will rage on, in many ways as before."

The Seventh Circuit's recent opinion also represents a victory for plaintiffs in two other important respects as well. First, it represents a strong affirmation that plaintiffs can, at least in certain circumstances and with sufficiently detailed support, fulfill the threshold pleading requirements in reliance on anonymous sources and informants.

Second, the Seventh Circuit's opinion represents an important recognition of the ability of plaintiffs to fulfill the pleading requirements as to corporate defendants by relying on allegations of "corporate" or "collective scienter." (My observations here about the corporate scienter portion of the Seventh Circuit's opinion draw on comments about the case by one of the leading members of the plaintiffs' bar whom I am sure would prefer anonymity - I emphasize this point just to acknowledge my gratitude for and to disclaim the originality of these observations.)

The court's holding that "it is possible to draw a strong inference of corporate scienter without being able to name the individuals who concocted or disseminated the fraud," is a vigorous endorsement of the "collective scienter" approach to pleading a corporation's state of mind. The question of plaintiffs' ability to satisfy the requirements for pleading scienter with allegations of collective or corporate scienter is precisely the issue that will be argued before the Second Circuit on January 30, 2008, in the Dynex Capital securities lawsuit.

In the district court proceedings in the Dynex Capital case, Judge Harold Baer, Jr. held in a February 10, 2006 opinion (here) that a plaintiff "may, and in this case has, alleged scienter on the part of the corporate defendant without pleading scienter against any particular employees of the corporation." In a June 2, 2006 ruling (here), Judge Baer denied the defendants' motion for reconsideration but granted the defendant's petition for leave to take an interlocutory appeal on the collective scienter issue. A wide variety of litigants and interested parties have filed amicus briefs in the case, the consideration of which will undoubtedly be influenced by the Seventh Circuit's most recent decision in the Tellabs case.

The final note about the Seventh Circuit's Tellabs decision has to be that while the plaintiffs have had some significant recent setbacks in the U.S. Supreme Court, they have not by any means been put out of businsess, and indeed, even the string of defense-oriented Supreme Court decisions clearly still allows plaintiffs room to maneuver.

After a week that included the Stoneridge decision, the jury verdict in the Apollo Group case and the Seventh Circuit's opinion on remand in the Tellabs case, it has to be asked --has there ever been a week as eventful as this past week in the annals of securities litigation? It is getting difficult for even the most diligent blogger to keep up...

Rick Bortnick and Emilio Boehringer at the Cozen O'Conner firm has written a good summary of and commentary on the 7th Circuit's opinion in the Tellabs case, here.

Tenth Circuit Says Further Details About Qwest Settlement Required: The appellate proceedings in another prominent case, the Qwest Communications securities lawsuit, were also in the news this past week (refer here and here). The case was before the Tenth Circuit on an appeal brought by Joseph Nacchio and Robert Woodruff, Qwest's former CEO and CFO. Nacchio and Woodruff were not included on the $400 million class settlement, but they appealed from the district court's rejection of their objections to the settlement.

Nacchio and Woodruff allegedly were informed that they would be included in the settlement only if they would pay personally into any settlement fund, which they refused to do, as a result of which they were excluded from the settlement. The settlement documents nevertheless contained a number of different features designed to preclude the two individuals' assertion of any rights to indemnification or contribution. The two individuals objected to the settlement based on these features, but the district court overruled their objections, specifically holding that the settlement was "fair, reasonable and adequate" as to Nacchio and Woodruff.

In a January 16, 2008 opinion (here), the Tenth Circuit found that the two individuals had standing to challenge the settlement, holding that they had suffered "legal prejudice," because the provisions of the settlement agreement "essentially strip, and in any event, palpably interfere with Mr Nacchio and Mr. Woodruff's preexisting rights and potential legal claims." The Tenth Circuit went on to hold that the district court's explanation of its reasons for overruling the individual defendants' objections were "insufficient." The Tenth Circuit said that "we are unwilling to guess at the path the district court followed in resolving serious legal issues....We need something to show how and on what basis the court analyzed Mr. Nacchio and Mr. Woodruff's objections." The Tenth Circuit remanded the case for the district court to provide further analysis of the individuals' objections to the settlement.

Even though the Tenth Circuit's ruling is purely procedural, the tenor of its decision strongly suggests the court's discomfort with the settlement agreement's elimination of Nacchio's and Woodruff's indemnification and contribution rights. Of course, it remains to be seen whether the district court can present an explanation sufficient to pass muster in the Tenth Circuit. The Tenth Circuit's opinion does underscore the complications that can arise when litigants attempt to compel individuals to contribute toward settlements without recourse to indemnification or insurance.

Securities Litigation Teleconference: On Friday January 25, 2008 at 11 a.m. I will be participating in a conference call sponsored by Risk Metrics entitled "Securities Litigation: What You Need to Know for 2008." The call will be moderated by Adam Savett, the author of the Securities LitigationWatch blog, and the panelists will also include Stuart Grant, Managing Partner of Grant & Eisenhofer, and Lyle Roberts, a partner at Dewey & LeBoeuf and author of The 10b-Daily blog. Registration for the conference call, which is free, can be accessed here.

Now This: We here at The D & O Diary have particular respect for Judge Posner, the author of the recent Tellabs opinion in the Seventh Circuit, not only because he is one of the most highly regarded jurists in the country, but also because he is a blogger. Posner writes widely read The Becker-Posner Blog (here), which he co-authors with Gary Becker, the Nobel prize-winning economist from the University of Chicago. Their presence raises the tone of the entire blogosphere. Judge Posner is also the only Circuit judge of whom I am aware who has a website containing a searchable database devoted exclusively to his opinions.

Judge Posner was also recently the subject of a profile on the WSJ.com Law Blog (here), which included this excerpt from another opinion Judge Posner wrote, containing good advice for all of us involved in any way with the insurance industry:

As discussed in a prior post (here), the investors claimed that Scientific Atlanta and Motorola had helped Charter Communications make its revenue targets through an arrangement whereby Charter overpaid its vendors for set-top cable boxes and the vendors agreed to return the overpayment by buying advertising from Charter. The vendors treated the two transactions as a wash sale, but Charter accounted for the transactions so that they favorably (and, the investors alleged, improperly) impacted its revenue and permitted the company to meet its revenue targets. Charter later restated is revenue to reclassify the revenue from the set-top deal.

Charter's investors separately sued Charter and its accountant in a case that later settled, but the investors also sued the vendors, alleging that the vendors knowingly entered the transaction in order to permit Charter to achieve a desired accounting outcome. The investors alleged that the vendors falsified documents and backdated contracts to facilitate the outcome.

The district court granted the vendors' motion to dismiss and the Eighth Circuit affirmed, holding that "any defendant who does not make or affirmatively cause to be made a fraudulent misstatement or omission ...is at most guilty of aiding and abetting and cannot be held liable under Section 10(b)."

The U.S. Supreme Court affirmed the Eighth Circuit, holding that the case against the vendors was properly dismissed. But the Supreme Court did not adopt the Eighth Circuit's reasoning; rather, the Court says, with respect to the Eighth Circuit's statement that Section 10(b) reaches only misstatements or omissions by one with a duty to disclose, that "if this conclusion were read to suggest that there must be a specific oral or written statement before there could be liability under Section 10(b) or Rule 10b-5, it would be erroneous." The Court would on to note explicitly that "conduct itself can be deceptive."

While the Supreme Court disclaimed the Eighth Circuit's reasoning, it still affirmed the Eighth Circuit's holding because the vendors' "acts or statements were not relied upon by the investors and that as a result liability cannot be imputed."

Thus the Court's decision turns on the absence of "reliance." The Court did note that there is a "rebuttable presumption of reliance" under two circumstances; first, if "there is a duty to disclose" and second, "under the fraud-on-the-market" doctrine, by which reliance is presumed when the statement at issue becomes public. The Court held with respect to these presumptions of reliance that

Neither presumption applies here. Respondents had no duty to disclose; and their deceptive acts were not communicated to the public. No member of the investing public had knowledge, either actual or presumed, of respondents' deceptive acts during the relevant time. Petitioner, as a result, cannot show reliance upon any of respondents' actions except in an indirect chain that we find too remote for liability..

The investors sought to overcome these considerations by urging that that respondents engaged in a scheme, contending that the vendors had "engaged in conduct with the purpose and effect of creating a false appearance of material fact to further a scheme to misrepresent" and that Charter's release of false financial statements "was a natural and expected consequence of" the vendors' deceptive acts.

The court rejected these "scheme liability" allegations, saying that the vendors' "deceptive acts, which were not disclosed to the investing public, are too remote to satisfy the requirement of reliance. It was Charter, not respondents, that misled its auditor and filed fraudulent financial statements; nothing respondents did made it necessary or inevitable for Charter to record the transaction as it did."

The majority opinion noted a number of additional considerations that it found militated against the investors' position; the Court found that:

1. Investors' position seeks to apply Section 10(b) "beyond the securities markets--the realm of financing business - to purchase and supply contracts - the realm of ordinary business."

2. Recognizing the position urged by the investors "would revive in substance the implied cause of action against all aiders and abettors except those who committed no deceptive act in the process of facilitating the fraud."

3. In enacting the PSLRA, Congress recognized an SEC enforcement cause of action for aiding and abetting, but did not recognize a private right of action for aiding and abetting. The Court said "we give weight to Congress' amendment to the Act restoring aiding and abetting liability in certain cases but not others."

4. Adopting the position urged by the investors "would expose a new class of defendants to these risks" who might "find it necessary to protect against these threats, raising the cost of doing business."

5. If the Court adopted investors' position, "overseas firms" would be "deterred from doing business here," and could "raise the costs of being a publicly traded company under our law and shift securities offerings away from domestic capital markets."

6. The implied right of action under Section 10(b) "should not be further expanded beyond its present boundaries." The Court said that its holdings is "consistent with the narrow dimensions we must give to a right of action Congress did not authorize when it first enacted the statute and did not expand it when it revised the law."

7. The SEC's enforcement power "is not toothless" and "both parties agree that criminal penalties are a strong deterrent." Moreover, there is an "express private right of action against accountants and underwriters under certain circumstances" and the "implied right of action in Section 10(b) continues to cover secondary actors who commit primary violations."

The dissent argues that the Court, having found that the Eighth Circuit's reasoning was incorrect, should at a minimum have remanded the case for further proceedings on the reliance issue. The dissent also faults the majority's "fraud on the market" analysis, saying that the doctrine does not require investors to be aware of the specific deceptive act to rely on the doctrine to establish reliance. Justice Stevens also argued that because the vendors' actions were undertaken with the expectation that Charter would rely on them in making fraudulent statements, the causal connection between their allegedly improper action was sufficient to support a finding of reliance.

The dissent also rejects the majority's finding regarding Congressional intent, arguing that Congress' actions (or rather, inactions) cannot be read to bestow immunity on an undefined class of actors from liability under Section 10(b). Finally, the dissent conclude with a lengthy affirmation of the right of court's to imply remedies, even in the absence of legislative action.

At its most basic level, the outcome of this case is unsurprising. The justices arrayed themselves just as I had speculated in my prior post. That is, the three justices still on the Court who were in the majority in Central Bank (Kennedy, Scalia and Thomas) were joined by the two recent appointees (Roberts and Alito), while the three justices who had been in the dissent in Central Bank (Stevens, Souter and Ginsberg) were also in the dissent on Stoneridge.

The majority's opinion also, again perhaps unsurprisingly, essentially adopts the position advocated by the Solicitor General on behalf of the U.S. Department of Justice (in his amicus brief, here); that is, as I noted in my prior post, the Solicitor General urged that, while the Eighth Circuit concededly erred in concluding that conduct itself could not satisfy the statute's deception requirement, the Supreme Court could nevertheless affirm the Eighth Circuit because the investors had not shown reliance - which was of course exactly what the majority held.

One aspect of the majority's opinion that is striking is that the opinion does suggest an awareness of, and perhaps even the influence of, arguably extrajudicial considerations such as the potential impact the investors' position might have had on the overall business environment or the relative competitiveness of U.S financial markets. These considerations, while undeniably important, arguably are irrelevant to whether or not these claimants have a remedy under the statute.

While the majority rejected the investors' "scheme liability" theories, the Court did not hold that "secondary actors" can never be liable. To the contrary, and consistent with Central Bank, the Court held that any person who employs a manipulative device may held as a primary violator, assuming all the requirements of Section 10(b) are met. And in any event , the SEC still has statutory authority to pursue enforcement actions based on "aiding and abetting" allegations.

The Court is certainly correct when it says that were investors' position recognized, then companies would seek to protect against the threats, which would raise the cost of doing business. Indeed, if companies had to procure insurance to protect against not only the securities liability arising from their own conduct but also with respect to every company with respect to whom they are a customer or vendor, the cost of liability insurance would have soared. (As an aside, the burden of trying to underwrite this exposure would have been enormous as well, not to mention extremely challenging.) These same points could also be made with respect to liability insurance for third-party professionals as well. The position that the investors urged, if successful, would have had a dramatic impact on the cost of liability insurance.

These practical considerations support the view that the Stoneridge case is a defense victory and represents a rejection of an expanded reading of Section 10(b). But the more expansive possibilities may never really have been in the cards, given the lineup of the court. Yes, the decision could have changed things, but in the end, it did not. In effect, Stoneridge represents a 5-3 vote for the status quo. So while a decision for the investors could have increased the cost of insurance, the actual outcome on behalf of the venors is unlikely to impact the cost of insurance.

News coverage of the decision can be found here and here. The Blog of the Legal Times reports a number of different reactions to the decision here.

Readers should understand that the opt-out information I have compiled is necessarily limited to the settlements of which I am aware and is limited to publicly available information. The information is also limited to recent prominent securities lawsuit opt out settlements; there may well be earlier or other cases that had opt out settlements of which I am simply unaware. As a result, the information on the linked document is undoubtedly incomplete. I welcome any additional information that any readers would be willing to provide, and I will endeavor to keep the data updated as new or additional information becomes available.

My most recent comprehensive overview of the opt-out settlements generally can be found here. My recent post detailing the Qwest opt-out settlements can be found here. Readers should be further aware that virtually all of the opt-out settlements identified in the linked document have been described or at least mentioned in prior posts on this blog, and these prior discussions can be retrieved by using the search box in the upper left hand corner of the blog home page.

Options Backdating Settlement: On January 4, 2008, Nabors Industries announced (here) that it had entered a settlement agreement in connection with the consolidated options backdating-related shareholders derivative lawsuit that had been filed against the company and certain of its directors and officers in the Southern District of Texas. In connection with the settlement, Nabors Industries agreed to "certain corporate governance reforms, a new equity award policy, and a modified Compensation Committee Charter." The company and its insurer also agree to pay up to $2.85 million to plaintiffs' counsel for the plaintiffs' attorneys' fees and expenses.

I have added the Nabors Industries settlement to my list of options backdating lawsuit dismissals, denials and settlements, which can be accessed here.

International Corporate Governance: Over at the Race to the Bottom blog, an excellent blog that I follow regularly, University of Denver Professor J. Robert Brown is running a series of blog posts (beginning here) taking a look at corporate goverance standards and issues in countries other than the United States, drawing on student research. So far, the blog series has featured posts on Norway and Board Diversity (here), and the first part of a two-part post on Corporate Governance and the United Kingdom (here). This series promises to be very informative and we look forward to following its progress.