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

Litigation over executive compensation is nothing new. The long-running clash over Richard Grasso’s $187 million NYSE pay package is only one of many titanic legal battles compensation issues produced in the past. But executive compensation litigation recently seems to have entered a new phase, fueled by moral outrage.

Drawing on popular anger evidenced most recently in the outrage surrounding the AIG bonuses, these most recent compensation-related cases could represent an even more pronounced litigation threat than prior lawsuits over pay. The same forces driving the litigation have also produced a variety of other corporate and social responses, some of which may or may not fully serve the purposes of overall social utility.

Among other recently filed lawsuits involving executive compensation is the derivative complaint filed on April 1, 2009 in California (Los Angeles County) Superior Court against the current AIG CEO Edward Liddy and several other AIG directors and officers. The complaint (copy here) among other things alleges that "there was no rational business purpose or justification for these lucrative additional payments, particularly given AIG’s deteriorating financial condition and dismal financial performance," and described Liddy’s explanation of the bonus payments as "outrageous on its face" and "absurd." The complaint seeks to recover damages for corporate waste, breach of fiduciary duty, abuse of control and unjust enrichment.

The bonuses paid to Merrill Lynch employees at year end just prior to the consummation of the company’s merger with Bank of America also features prominently in the shareholders’ litigation filed against Bank of America earlier this year, following the revelation of Merrill’s massive and previously unreported losses.

The $68 million exit package awarded Citigroup CEO Charles Prince following his November 2007 departure from the company is the subject of one of the claims in a Delaware shareholders’ derivative suit against Citigroup’s board. The claim, which alleges waste, is particularly noteworthy, because in a February 24, 2009 decision (here) in which the Delaware Chancery Court otherwise dismissed the plaintiffs’ claims against the Citigroup board for failure to monitor the company, the court found that the claim related to Prince’s compensation had been adequately pled. Unlike plaintiffs other claims, the claim for waste survived the motion to dismiss. An April 2009 memo entitled "Executive Compensation Under Fire" (here) from the Greenberg Traurig law firm described the denial of the motion to dismiss in the Citigroup case on the waste issue as "an unusual move from the traditionally pro-business courts."

As noted on the CorporateCounsel.net blog (here), the Delaware Court’s ruling in the Citigroup case regarding the compensation claims could be the most significant part of the decision and could suggest a possible judicial receptivity to waste claims related to executive compensation. The Greenberg Traurig memo cited above comments that as a result of this decision, "don't be surprised if more companies face similar challenges to executive compensation in the future," adding that these challenges might include not only a derivative suit like the one involving Citigroup, but also shareholder demands on the board; books and records requests; and even proxy contests.

An April 6, 2009 Law.com article entitled "Executive Bonuses Triggering Lawsuits Nationwide" (here) observes that litigation triggered by executive compensation controversies not only include claims of excess compensation but also lawsuits ranging "from corporate officers who allege their companies reneged on bonuses to officers who believe they were fired for protesting them." The article, which cites several examples of each of these kinds of claims, also notes that "attorneys are bracing for more litigation and legislation involving executive bonuses and compensation matters."

In addition, another recurring theme currently surrounding executive compensation is the possibility of a clawback remedy, to recover compensation already paid, which is a topic I previously discussed here.

One positive consequence of the current furor over executive compensation is that at least some companies have become more solicitous of shareholders’ views on pay. Indeed, as discussed in an April 6, 2009 Wall Street Journal article entitled "Companies Seek Shareholder Input on Pay Practices" (here) reports that biotech firm Amgen invites its shareholders to complete a 10-question online survey to determine the shareholders’ views on whether the company’s compensation plan is based on performance and whether performance goals are clearly disclosed and understandable. The article identified other companies that are taking similar steps to consult or enlist shareholders.

That said, the actions taken based on current popular outrage over executive compensation issues also have an ugly side. The stones thrown through the home windows of former RBS chairman Fred Goodwin and the French workers’ recent seizures of local managers, among other recent examples, suggest the possibility that the current populist backlash could slip into far more dangerous manifestations, which is one of the dangers when politicians play to the galleries on these kinds of issues.

Popular anger over bonuses paid to money-losing managers is understandable. Indeed Goldman Sachs Chairman and CEO Lloyd Blankfein has said (here) that he recognizes why the public is angry and called for a reform of the way financial institution executives are compensated, particularly at companies receiving government bailout funds.

All the same, we should take care as a society that our proclivity for blamecasting and scapegoating does not unleash darker forces. Social disorder has arisen in past economic crises, and there is nothing that says that it can’t happen again.

An April 7, 2009 Wall Street Journal op-ed column considers (here) how generalized populist outrage can quickly transform into nationalist or ethnic rage.

My apologies to The Economist  for using the cover art from this week's issue of the magazine to lead this post. I figure that on the cover of last week's issue of the magazine, they shamelessly imitated the iconic Saul Steinberg Map of New York cover art from the March 29, 1976 issue of The New Yorker Magazine. In its original form, Steinberg's map reflected a view of the world as seen from New York's Ninth Avenue. On the cover of last week's issue, The Economist adapted Steinberg's map as a contemporary map of Beijing, adding an apology for the adaptation. I extend to The Econmist the same apology here for my adaptation of the magazine's cover art here.

Subprime Securities Litigation: Early Trends: Even though the subprime and credit crisis-related litigation wave recently entered its third year (as I noted here), and though there have been a few settlements as well as a few rulings on motions to dismiss (refer here), by and large, the cases remain only in their earliest stages.

Nevertheless some trends have begun to emerge, as detailed in the March 23, 2009 memorandum from the Gibson Dunn law firm entitled "Suprime-Related Securities Litigation: Early Trends" (here). The memo does a particularly good job categorizing the various kinds of allegations that plaintiffs have alleged as well as the defenses that defendants have asserted. As for what may lie ahead, the memo states that "there is unlikely to be any slowdown in the near future of new filings of securities cases related to the credit crisis."

The National Map of Bank Distress: The FDIC did not close any banks this past Friday night, so the number of year-to-date bank failures remains at 21, and the total number of bank failure since January 1, 2008 remains at 46.

Those readers who are tracking these banking-related developments closely may want to refer to this nifty interactive graphic (here) from TheStreet.com, on which they have plotted the bank closures since January 1, 2008 on a map of the United States. Cool.

Some Things in the Insurance Industry Never Change: In his enjoyable book about the rebuilding of London following the Great Fire of 1666 entitled London Rising, author Leo Hollis discusses the innovation Nicholas Barbon introduced when he launched "the first fire insurance company in the world." Hollis writes that

His scheme was brilliantly simple: it offered a defence against the risks of living in the city while also making him a healthy profit. For a premium of 2.5 per cent of the yearly rent for brick buildings and 5 per cent for wooden-frame structures he offered insurance against fire for terms of seven, eleven, twenty-one and thirty-one years. By the 1680s, he would have over four thousand subscribers.

However, insurance industry behavior pattern apparently were established even in the industry’s earliest days; Hollis notes that "the problem with innovation is that it is often copied and Barbon’s ideas were swiftly replicated." The City Corporation offered its own competing scheme and offered terms for life. Barbon "had to work hard to sell his services before the opposition stole his market," while the Corporation soon found "that it was offering too much to get customers."

So it may be said, with respect to the insurance industry’s apparently inexhaustible capacity for self-destructive competition, ‘twas ever thus.

And Finally: On behalf of everyone who has watched as much college basketball on TV over the last few weeks as I have, I would like to make a motion – that is, that every single person associated in any way with the production or distribution of the Taco Bell "nacho drag" commercial should be taken out and summarily shot, without benefit of clergy. All those in favor say "Aye."

• Email This
• Print
• Comments (1)
• Trackbacks (1)
• Share Link

When news of the federal government’s seizure of mortgage giants Fannie Mae and Freddie Mac became public, it became apparent that the government’s move was bad news for the holders of the companies’ common and preferred stock. 

The Wall Street Journal's front page September 8, 2008 article (here) commented that the government rescue is "likely to leave a trail of billions of dollars in losses for stock holders, including some major banks" because, among other things, the new government overseers "will eliminate dividends on billions of dollars of common and preferred stock," moves that are expected to further drive down the companies’ share prices. In addition, if the government exercised certain warrant rights, the common shares "will be drastically diluted."

In light of these developments and considerations, Fannie Mae’s share price declined sharply on Monday September 8, 2008. The company’s share price, which had closed at $7.04 on Friday, September 5, 2008, closed on Monday at $0.73, a drop of approximately 90%. Even though Fannie’s shares had been beaten down prior to September 5, the share price decline on September 8 alone represents approximately a $7 billion market capitalization loss.

In addition, news reports about the government takeover (for example, here) suggested that Treasury officials brought in to review the companies' accounting in connection with the government takeover found that the companies had been "playing games" with their accounting to meet reserve requirements.

Plaintiffs' lawyers lost little time reacting to these events. After the close of markets on Monday afternoon, plaintiffs’ attorneys issued a press release (here) announcing that on September 8, 2008 they had filed a securities class action lawsuit in the Southern District of New York on behalf of persons who purchased the publicly traded securities of Fannie Mae during the period November 16, 2007 through September 5, 2008. A copy of the complaint can be found here.

Interestingly, even though over 98% of Fannie Mae shares are held by institutions, the named plaintiff in this initial complaint is an individual. The publicly available copy of the complaint does not include the number of shares the named plaintiffs holds, nor is a copy of the named plaintiff’s certification attached to the publicly available complaint. The Complaint names as defendants four current and former directors and officers of Fannie Mae. Doubtlessly due to the fact that the company itself is now in a government conservatorship, the company itself was not named as a defendant. The company’s market capitalization decline during the purported class period is over $40 billion.

According to the press release, the Complaint alleges:

On July 7, 2008, a financial analyst at Lehman Brothers published a report suggesting that Fannie Mae might need to raise as much as $46 billion in capital, causing the Company’s stock price to plummet 16% in a single trading day. Following that disclosure, former St. Louis Federal Reserve Board President, William Poole, suggested that Fannie Mae was nearly insolvent and The New York Times disclosed that the federal government was making plans to place the Company into a conservatorship. On July 13, 2008, the Treasury Department announced that it was making a temporary line of credit available to Fannie Mae and would purchase an equity stake if necessary to provide more capital. From July 7 through July 14, 2008, Fannie Mae’s stock price declined over 48%. Finally, on Sunday, September 7, 2008, in the biggest government bail out in U.S. history, federal regulators seized control of Fannie Mae.

The press release also states that according to the complaint, during the class period, the defendants concealed from the investing public that:

(a) the decline in the U.S. housing market rendered Fannie Mae undercapitalized; (b) Fannie Mae’s December 2007 capital raise did not meet its capital needs; (c) Fannie Mae’s May 2008 capital raise did not meet its capital needs; (d) although Fannie Mae had more capital than its regulator required, it did not have "surplus capital" as defendants claimed; and (e) Fannie Mae’s publicly disclosed financial results misrepresented the financial condition of the Company.

Although it does not seem to be relevant to the allegations in this lawsuit, it appears that the Housing and Economic Recovery Act of 2008 provided Fannie's and Freddie's directors some limited lawsuit protection. As reported in a September 8, 2008 post (here) on the Blog of the Legal Times, the statute provides that "the members of the board of directors of a regulated entity shall not be liable to the shareholders or creditors of the regulated entity for acquiescing or consenting in good faith to the appoinment of the Agency as conservator or receiver for that regulated entity." Given the allegations in the lawsuit, this provision is unlikely to provide much protection for the defendants in that lawsuit.

The government takeover of Fannie and Freddie is among the most significant events so far in the wake of the subprime meltdown, and certainly the most dramatic development since the collapse of Bear Stearns. Just as was the case following the Bear Stearns takeover, the overall market reacted very positively to the news of the government rescue of Fannie and Freddie. In light of the growing significance of these events for the U.S. economy, one can certainly hope that the worst is now behind us.

There are reasons to be concerned that there may yet be further consequences from the government’s takeover of Fannie and Freddie. The Journal article notes that commercial banks and thrifts hold "high concentrations" of Fannie and Freddie preferred shares. The article also reports that approximately 16 of the institutions that the Office of Thrift Supervision regulates had "a concentration in common or preferred shares of Fannie Mae and Freddie Mac that surpassed 10% of their Tier I capital." While the regulator hopes to develop "capital restoration plans" there could be further fallout in the banking and thrift industries.

The sudden and dramatic loss of these entities’ share prices has undoubtedly hit other institutional investors as well. We will be hearing in the weeks and months ahead where these losses landed.

And as if all of that were not enough, Bloomberg also reported on September 8, 2008 (here) that the government rescue represents a credit event that may force investors to settle credit default swap contracts protecting more than $1.4 trillion of Fannie Mae and Freddie Mac bonds, which may represent the largest settlement of its type. Losses could actually be slight if the bonds themselves trade at or close to par. But the mere fact of this development and its size demonstrates the breadth and complexity of the consequences from the government's bailout. There undoubtedly will be other consequences, some of which may be significant and many of which may be as yet unforeseen.

Readers interested in a particularly good analysis of the government takeover will want to review Professor Davidoff's September 8, 2008 post on his Dealbook blog (here). Among other things, Professor Davidoff's post correctly forecast the arrival of the securities lawsuit. His post also contains a comprehensive list of completed, pending and contemplated government bailouts in connection with the current credit crisis.

Special thanks to a loyal reader for links to the Fannie Mae lawsuit press release and to the Bloomberg article regarding the credit default swaps.  

Run the Numbers: The new Fannie Mae lawsuit is actually not the first lawsuit to arise out of Fannie Mae's recent woes. Last month, investors who purchased Fannie Mae shares in the company's May 9, 2008 secondary offering filed a lawsuit in New York state court seeking damages under Section 12(a)(2) of the Securities Act of 1933. As I noted in my recent post (here) discussing this prior lawsuit, neither Fannie Mae nor any of its directors or officers were named as defendants in the state court suit; only the investment banks that underwrote the May 9 offering were named as defendants.

In any event, I have added the new Fannie Mae lawsuit to my running tally of the subprime and credit-crisis related shareholder litigation, which can be accessed here. With the addition of the Fannie Mae lawsuit, the current tally of subprime and credit crisis-related securities lawsuits now stands at 110, of which 70 have been filed in 2008.

Speaking of Subprime Litigation: The September 8, 2008 Financial Times had an interesting article (here) describing recent litigation brought by investors who lost significant money in connection with the collapse of structured investment vehicles (SIV). An August 26, 2008 Bloomberg article also discussing the litigation can be found here.

The articles describe in particular detail a lawsuit filed on August 25, 2008 by the Abu Dhabi Commercial Bank on behalf of itself and all others that between October 2004 and October 2007 invested in the SIV launched by Cheyne Finance plc. The SIV, which issued notes backed by subprime mortgages, collapsed last year. The lawsuit names as defendants Morgan Stanley, Bank of New York Mellon Corp., two units of the Moody's rating agency, and Standard & Poor's. The defendants are alleged to have mislead investors about the quality of assets the Cheyne vehicle bought and held.

The lawsuit specifically alleges fraud, negligent misrepresentation and unjust enrichment. The lawsuit alleges that the investment banks, motivated by fees based on the asset values in the SIV, misrepresented asset values. The investment banks are also alleged to have assisted in the selection of assets that went into the ill-fated SIV. Among other things, the SIV's assets included mortgages originated by New Century Bancorp.

The complaint alleges that the rating agencies, which allegedly received three times the fees for rating the SIVs than they received for corporate ratings, were paid only if they provided an investment grade rating and only if the deal closed with that rating.

The  Financial Times article also describes a prior lawsuit brought on behalf of investors by Oddo Asset Management in connection with two SIV-lites, Mainsail and Golden Key. The Oddo suit claims that Barclays in conjunction with the two SIV-lites' managers used the vehicles to buy impaired securities from the bank at inflated prices, using the vehicles "as dumping grounds for toxic assets that Barclays needed to quickly jettison." The Oddo lawsuit apparently also names the rating agencies as defendants in its lawsuit, alleging that the rating agencies "collaborated with their investment banking clients."

The Seeking Alpha blog has a very detailed and interesting article (here) describing in detail the purpose and function of SIVs and explaining the risks involved as well. It is clear that these vehicles carried a lot of risk and apparently a lot went wrong with them too.  The SIVs named in these lawsuits are far from the only vehicles that had problems. There may be many more of these kinds of lawsuits to come.

Call me pessimistic, but it seems to me that the subprime litigation wave has got a lot further to run yet.   

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

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

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