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

One of the most distinctive attributes of the 2009 securities class action lawsuit filings was the prevalence, particularly in the second half of the year, of new lawsuits in which the filing date came well after the date of the proposed class period cutoff. There has been much discussion over the cause of the belated filings. But whatever the reason may be for these filings, the phenomenon clearly has carried over into 2010, and at least so far seems to be a significant feature of the 2010 securities lawsuit filings.

The two new securities class action lawsuits filed on Friday, February 5, 2010 both represent this distinct class of cases.

First, as reflected in their press release (here), on February 5, plaintiffs’ lawyers filed a securities class action lawsuit in the Southern District of New York against Nokia and certain of its directors and officers, alleging that the defendants had misled the company’s ADR investors about delays and price competition the company was experiencing with respect to its communications handsets. Though the complaint (which can be found here) was not filed until February 5, 2010, the proposed class period cutoff date is September 5, 2008, well nearly a year and a half before the filing date.

Second, as reflected in their press release (here), on February 5, a different set of plaintiffs’ attorneys filed a securities class action lawsuit in the Southern District of New York against the Bermuda-based workers’ compensation insurer CRM Holdings, Ltd., and certain of its directors and officers, relating the company’s pricing and reserving practices. Though the complaint (which can be found here) was not filed until February 5, 2010, the proposed class period cutoff date is November 5, 2008, over a year before the filing date.

These latest lawsuit follow along behind two other seemingly belated lawsuits already filed this year. The proposed class period cutoff date in the securities class action lawsuit filed on January 15, 2010 against medical device company Stryker Corporation is November 13, 2008, over a year before the filing date.

The most extreme example among the belated 2010 filings is the securities class action lawsuit filed on January 21, 2010 against Motorola. The January 22, 2008 class period cutoff date is a full 1 year and 365 days before the filing date, bringing the new lawsuit just inside the two year statute of limitations for actions under the ’34 Act.

In addition to their apparent belatedness, these filings also have a number of other attributes. Most particularly, none of these cases seem related to the subprime meltdown and global credit crisis. Even though CRM holdings is in the financial services industry, the allegations in that case do not appear to related to the economic crisis.

To that extent at least, then, the belated securities lawsuit filings seem consistent with the theory, which some plaintiffs lawyers have advanced (as discussed here), that the reason for these lag filings is that throughout most of the last three years, the plaintiffs’ firms were preoccupied with filing subprime and credit crisis cases. Now that that filing wave has died down the plaintiffs firm, by their account, are turning back to cases that they backburnered.

The other theory about these belated cases, advanced most notably by Professor Joseph Grundfest (refer here), is that the plaintiffs’ lawyers are running out of meritorious cases so they are scraping the bottom of the barrel (my words, not his) to file cases that, based on his analysis of past lawsuit filings, are statistically more likely to be dismissed.

I don’t know for sure why these cases have been filed belatedly. All I can say is that it is a very distinct and observable pattern that clearly has carried over into the New Year. Among other things, these filing patterns create challenges for D&O underwriters, who will face a great deal of uncertainty about when a company that has experienced past issues may be "out of the woods." To borrow an auto racing analogy, it as if a yellow flag has been raised for all the cars on the track – proceed with caution.

One final note about these belated filings so far in 2010 is that at least the Nokia and the CRM holdings cases involve foreign domiciled companies – they are based in Finland and Bermuda respectively. The susceptibility of non-U.S. companies to securities litigation in U.S. courts is a hot topic right now, with the National Australia Bank pending before the U.S. Supreme Court and with the Vivendi jury verdict having just been returned. These latest lawsuits suggest that the incidence of U.S. securities lawsuits against non-U.S. companies will remain a hot button issue for the foreseeable future.

Fifth Circuit Stays Ruling that Stanford Group’s D&O Insurers Must Pay Defense Fees: As I noted in an earlier post (here), on January 26, 2010, Southern District of Texas David Hittner had ordered Stanford Financial Group’s D&O liability insurers to pay the defense expenses that former Stanford officers (including Allen Stanford) are incurring in connection with various legal matters arising out of the Stanford scandal.

However, according to a February 4, 2010 Houston Chronicle article (here), the Fifth Circuit Court of Appeals has entered a stay of Judge Hittner’s ruling. The article also reported that the Fifth Circuit has schedule oral argument on the legal issues in the case for February 25, 2010.

So the story goes on, with out any greater clarity on the question whether or not the individuals are entitled to have their defense fees paid by the company’s D&O insurance carriers. High-profile financial scandals make for some high stakes (and therefore fiercely litigated) coverage issues.

Hat tip to the Securities Docket (here) for the link to the Chronicle article

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

There is a balm in Gilead

To make the wounded whole;

There is a balm in Gilead

To heal the sin-sick soul.

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

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

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

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

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

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

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

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

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

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As the subprime crisis has unfolded, one of the recurring themes has been the conflicted role of the rating agencies. Last week’s announcement (here) of a negotiated resolution of the New York State regulatory investigation of the rating agencies reflects one aspect of the recurring questions surrounding the rating agencies’ role in the current crisis. These questions are likely to persist in light of the recent revelation (here) that Moody’s continued to assign mortgage-backed securities investment grade ratings despite a whistleblower’s alarm about potential problems with the ratings.

But while the questions about the rating agencies’ role have persisted, and while the agencies own shareholders have sued the rating agencies over the agencies’ own disclosures (about which refer here and here), to date subprime investors have not targeted the rating agencies for their rating activities, to the best of my knowledge.

As discussed in a prior post (here), case law suggests that the rating agencies enjoy First Amendment protection for their rating opinions and activities. And, as also discussed in my prior post, while thoughtful commentators have suggested bases on which these defenses might be overcome with respect to the rating agencies subprime-related investment rating activity, subprime investors have not targeted the rating agencies. Until now.

In a lawsuit filed on May 15, 2008 in New York Supreme Court (New York County), the New Jersey Carpenters’ Vacation Fund has filed a securities class action lawsuit under the ’33 Act on behalf of investors in the three HarborView Mortgage Loan Trusts. In a petition dated June 3, 2008, the defendants removed the case to the United States District Court for the Southern District of New York. A copy of the notice of removal, to which the original complaint is attached, can be found here.

The defendants in the lawsuit include the three HarborView mortgage pass-through certificate trusts; the Royal Bank of Scotland Group (“RBS Group”) and its subsidiary, Greenwich Capital Holdings and related entities, including Greenwich Capital Acceptance (“GCA”) and five individual directors of GCA; and the three rating agencies, Fitch’s Ratings, Moody’s Investor Services, and McGraw Hill, as corporate parent for Standard & Poor’s Rating Services.

The three trusts were issuers of bonds (the mortgage pass-through certificates) created by RBS Greenwich Capital. The offerings were collateralized with loans originated and underwritten by Countrywide Home Loans. The complain alleges that the Registration Statement issued in connection with the offerings failed to disclose “the true impaired and defective quality of the loans collateralizing the Bonds” and that the “loans were not originated pursuant to the underwriting guidelines stated in the Registration Statement.”

The complaint alleges that the rating agency defendants “failed to conduct due diligence and willingly assigned the highest ratings to such impaired instruments since they received substantial fees from the issuer.” The complaint alleges further that the rating agencies “issued the ratings based on an outdated methodology designed in about 2002.” The ratings were alleged to be misleading because the rating agencies “presumed that the loans were of high credit quality issues in compliance with the stated underwriting guidelines, when, in fact, Countrywide had systematically disregarded its stated Underwriting Guidelines.”

The rating agencies later downgraded the mortgage-backed securities. The complaint alleges that the rating agencies “admission that they had not used an appropriate rating methodology …resulted in a substantial decline in the value of the Bonds.” The plaintiff itself claims that its investment in the instruments has declined by 55 percent.

All of the claims asserted in the Complaint are based on the ’33 Act. In Count I of the Complaint, the plaintiff specifically alleges (in paragraph 98) that the rating agencies “served as appraisers” as defined in Section 11(a)(4) of the ’33 Act. The paragraph further alleges that the rating agencies “purportedly reviewed and analyzed each offering and provided the credit rating for each tranche of the HarborView Bonds.” The paragraph further alleges that the service of providing the ratings “was essential to pricing and marketing the Bonds,” and that the ratings were contained in the Prospectus.

As far as I am aware, the plaintiffs’ complaint in the HarborView Mortgage Loan Trust lawsuit represents the first occasion as part of the current subprime litigation wave where subprime investors have sought to hold the rating agencies liable for their ratings. The plaintiff’s allegations will face a number of hurdles, including the jurisdictional issue discussed below.

In addition, the rating agencies will undoubtedly assert a number of substantive defenses, including the First Amendment defense discussed in my prior blog post (here), as well as whether the rating agencies even owed the plaintiff any duties. The rating agencies will particularly dispute the plaintiffs’ attempt to rely on Section 11(a)(4) of the ’33 Act as a basis for the rating agencies’ liability.

The jurisdictional issue pertains to the plaintiff’s initiation of the lawsuit in state court pursuant to the concurrent state court jurisdiction in Section 22 of the ’33 Act. The HarborView case is just the latest of the state court ’33 Act lawsuits arising as part of the current subprime-related litigation wave, as discussed in my prior post (here). In each case, the defendants have sought to remove these cases to federal court, notwithstanding the express prohibition in Section 22 of removal of state court cases to federal court. In at least one of the prior cases, the federal court has remanded the case back to state court in reliance on Section 22’s express removal prohibition (refer here for a discussion of the prior remand case).

It remains to be seen whether or not these cases will go forward in state or federal court. Although it is not altogether clear why the plaintiffs have sought to pursue these cases in state court, the plaintiffs clearly perceive some advantage in doing so. In any event, the success of the plaintiffs’ attempts to hold the rating agencies liable for their investment in subprime-related securities will be interesting to watch. It will also be interesting to see if other investor plaintiffs similarly seek to hold the credit rating agencies liable.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the HarborView removal petition.

Run the Numbers: I have added the HarborView case to my running tally of subprime-related securities class action lawsuits. (My tally can be accessed here). According to my count, the addition of this case, as well as the case filed late last week against Franklin Bank Corp. (about which refer here), the current tally of subprime and credit crisis-related securities class action lawsuits now stands at 88, of which 48 have been filed in 2008.

Speakers’ Corner: On June 19 and 20, 2008, I will be co-Chairing the Mealey’s Subprime Mortgage & Insurance Coverage Litigation Conference at the Ritz-Carlton in Pentagon City, Virginia, with my good friend Matt Jacobs of the Jenner & Block law firm.

The agenda (which can be found here), includes many distinguished speakers and panelists, such as Andrew Carron of NERA Economic Consulting, Adel Turki of Cornerstone Research, Samuel Rudman of the Lerach Coughlin firm, Dan Bailey of Bailey & Cavalieri, John McCarrick of Edwards Angell Palmer & Dodge, David Hensler of Hogan & Hartson, and Mitchell Dolin of Covington & Burling.

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On April 1, 2008, the Wilmer Hale law firm released a report entitled “West Coast Securities Litigation & Enforcement” (here), in which the law firm reports, among other things, that “investors sued 44 public companies in the West in 2007, a striking 56 percent increase over 2006, reversing what some had hoped was a permanent post-Enron decline in securities class actions.” A copy of the law firm’s April 1 press release about the report can be found here.

The report attributes the “surge” in filings against West Coast companies to the “subprime crisis” which “precipitated lawsuits.” The report also attributes the apparent “upswing in filings” to the “increased capacity of the dozen-plus law firms that bring most of these class actions.”

The report notes that while there were more lawsuits filed, there were also more lawsuits dismissed (29) than settled (18) in the Ninth Circuit during 2007, from which the report happily concludes that “last year’s spike in filings was the product of opportunistic lawyers filing in a falling stock market, and not an indication that corporate malfeasance is on the rise.”

The report also considers 2007 settlement developments and concludes that “it has become cheaper to settle in the Ninth Circuit,” based on the fact that in 2007, the median West Coast settlement was $6 million, the “lowest point since 2004” and 40% below the national median of $9.6. The report concludes because of the lower settlement figures that “the recent wave of California cases appears weaker than those filed in New York and elsewhere and –as in the past – negotiated settlements reflect the financial condition of the defendant issuer or the magnitude of the market loss.” The report also notes that “favorable dismissal rates may have – indeed, should have – encouraged plaintiffs’ lawyers to scale back their expectations.”

The report also has a number of interesting observations about the backlog of pending options backdating cases. The Ninth Circuit courts have been “far less receptive to those cases than have courts in the other regions.” In addition, West Coast issuers “have successfully defended a large number of [options backdating-related] derivative actions; by year end, courts had dismissed 14 such cases and allowed only two to proceed.” The report notes that West Coast courts have thrown out a number of options backdating-related securities lawsuits, while courts in other jurisdictions have permitted these cases to go forward.

The report concludes with a number of observations about the activities of the SEC’s West Coast enforcement offices, which offices apparently remain active.

The law firm’s report is interesting, but many of the report's statistical observations consist of numerators yearning for denominators to give their existence meaning.

First, while the number of lawsuits against companies based in the Ninth Circuit may well have increased 56% percent between 2006 and 2007, lawsuits overall increased 43% (going from 116 lawsuits in 2006 to 166 in 2007, according to Cornerstone, here). The report’s feature stat would be significantly less compelling had the report more accurately stated that increase in the number of lawsuits on the West Coast in 2007 was 13% greater than the increase nationwide.

Second, the methodology used to conclude that California companies were 63% likelier to be sued than companies elsewhere in not revealed. For example, is report saying that the ratio of California companies sued to the total number of companies in California is 63% higher than the same ratio for all other states? Or is the report just making some comparison about the raw numbers of 2007 lawsuits against companies inside and outside California? It would have been helpful for the report to specify its methodology, because this particular conclusion is, well, challenging, given that 52 of the 166 securities lawsuits in 2007 were filed in the Southern District of New York, far more than any other federal district. (Refer here for my full analysis of the 2007 lawsuit filings.)

Third, the report seems to imply that the West Coast companies are being sued because they are located on the West Coast.. The report is written by the law firm's West Coast office and is clearly intended for West Coast companies, and the statistical analysis is clearly intended to convey meaning for those companies as West Coast companies.

But if plaintiffs’ lawyers really were targeting West Coast companies as West Coast companies in 2007, you would expect the lawsuits against the West Coast firms to have continued in 2008. Actually, the exact opposite has happened. While West Coast companies arguably were sued frequently in 2007, they have been sued infrequently in 2008. Through the first quarter of 2008, only six companies located in the Ninth Circuit have been sued in securities lawsuits, even though the number of filings overall in the first quarter  (52) was up compared the number of filings in 2006 and 2007, as I detailed in yesterday’s post.

The increased number of lawsuits against West Coast companies in 2007 can only have meaning for those companies as West Coast companies if the reduced number of lawsuits against West Coast companies so far in 2008 also has meaning for the companies as West Coast companies. The strong suggestion is that something other than geography alone explains both ends of this equation.

(As an aside, the potential role of geography in predicting securities lawsuit frequency was a recurring statistical question in my former life as a D & O underwriter. Brokers in the Midwest contended that Midwestern companies were less likely to be sued, and therefore all Midwestern companies should receive a D & O insurance premium discount. We could never prove that geography alone was an accurate predictor of securities litigation frequency; rather, what we found was that geography coincided with some other factor – usually industry – that was the true frequency predictor. An esteemed former colleague who taught me everything I know on this topic referred to this phenomenon as “multicollinearity “.)

The report also strains when it attempts to use the 2007 dismissals and settlements to analyze the 2007 filings.

Obviously, the cases that were dismissed or settled in 2007 were mostly filed before 2007. The fact that cases filed before 2007 were dismissed in 2007 really doesn’t tell you whether or not the cases filed in 2007 are meritorious or if “corporate malfeasance” is or is not “on the rise.” It is likely that the cases dismissed or settled in 2007 were actually filed over the course of several calendar years, so the raw numbers of dismissals, settlements and filings in a single calendar year may have little or no meaningful interrelationship, and further data (such as, for example, the total number and filing dates of pending cases) is required to make any useful comparisons or even to try to conclude, for example,  that West Coast courts have become "less receptive."  

The fact that median settlements in 2007 in the Ninth Circuit were lower than prior years’ median settlements tells you only that the median was lower. It does not tell you whether or not the 2007 settlements were “cheaper” than settlements in prior years in the Ninth Circuit or than 2007 settlements elsewhere, as these kinds of comparisons require not only the dollar figure at which the cases settled, but also the amount of investor loss that was at stake for each case category compared. Without further information, there is no way to know whether or not the lower 2007 median is simply due to smaller cases being settled in 2007 than in prior years in the Ninth Circuit, or in 2007 elsewhere. There is certainly nothing about the lower 2007 median alone that analytically supports the view that 2007 cases filed in California are “weaker than those filed in New York and elsewhere.”

The report’s commentary about the options backdating cases is interesting, and the most useful addition I can make to the report’s analysis about option backdating case dispositions is to refer readers to my running list of options backdating settlements, dismissals and denials, which can be accessed here.

And finally, because I can’t seem to write a concluding paragraph for this post without discretion making me hit the delete button, that’s a wrap.

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

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

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

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

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

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

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

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

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

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

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

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

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

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