The high-profile bankruptcies of two of the country’s leading auto companies have dominated recent headlines, but for all their size, complexity and notoriety, the GM and Chrysler bankruptcies are only part of the recent wave of bankruptcies that have swept through economy. Numerous other companies have also found themselves in bankruptcy court. As these bankruptcies have spread, bankruptcy-related securities lawsuits against the bankrupt companies’ directors and officers have followed. Unlike much of the credit crisis-related litigation thus far, these latest bankruptcy-related securities lawsuits are not concentrated in the financial sector.

 

The most recent example of bankruptcy-related securities litigation is the securities class action lawsuit that was filed on June 1, 2009 in the Eastern District of Arkansas against the CEO, CFO and Chairman of Charter Communications. Charter, which filed for bankruptcy on Marsh 27, 2009, was not named as a defendant. The complaint, which can be found here, purports to be filed on behalf of all persons who acquired Charter shares between October 23, 2006 and February 12, 2009.

 

The complaint alleges that during the class period the defendants made a series of statements that misled the investing public about the company’s ability to service its debt, about its need to refinance or recapitalize, and about its cash resources. As reflected in plaintiff’s counsel’s June 1 press release (here), the plaintiff contends that "defendants failed to disclose, among other things, that Charter would not be able service its debt to September 2010, but rather Charter would file bankruptcy in March of 2009. Also, the Defendants issued misleading statements about Charter’s potential for mergers. As a result of defendants’ false and misleading statements, Charter’s securities traded at artificially inflated prices during the Class Period."

 

A second recently filed bankruptcy-related securities lawsuit is the action filed on May 18, 2009 in the Southern District of New York against the former CEO and former CFO of Nortel Networks. Nortel, which filed for bankruptcy on January 14, 2009, is not named as a defendant. The complaint, which can be found here, purports to be brought on behalf of persons who acquired Nortel shares between May 2, 2008 and September 17, 2008.

 

According the plaintiffs’ counsel’s May 19, 2008 press release (here), the complaint alleges that the defendants "failed to disclose material adverse facts about the Company’s true financial condition, business and prospects." Specifically, the complaint alleges that the defendants failed to disclose that

 

(i) that demand for the Company’s products was declining as carriers cut back their capital expenditures and other customers deferred purchase decisions; (ii) that the Company’s financial results were materially overstated as the Company was failing to properly write-down its goodwill; (iii) that the Company’s restructuring was not meeting with success as the Company was struggling to cut costs and improve profitability; (iv) and as a result of the foregoing, defendants lacked a reasonable basis for their positive statements about the Company, its business, operations, earnings and prospects.

 

These two actions join the bankruptcy-related securities lawsuits recently also recently filed against the directors and officers of Idearc (about which I previously wrote here) and MRU Holdings (about which I wrote here).

 

In addition to the common element of bankruptcy, and the fact that as a result of the bankruptcy in each of the cases the company was not names as a defendant in the lawsuits, the recent actions against Charter, Nortel and Idearc also share something else in common, which is that each of these companies is outside the financial sector.

 

As has been well-documented elsewhere (refer, for example, here), the securities litigation arising out of the credit crisis has to this point largely been concentrated in the financial sector. However, these recent actions suggest that the spread of adverse financial consequences from the current economic crisis will not only result in an increasing number of bankruptcies but also in an increasing number of bankruptcy-related securities lawsuits.

 

These bankruptcy-related securities lawsuits, like the ones described above, are likely to arise in a wide variety of business sectors, not just in the financial sector. Indeed, because the bankruptcies are and are likely to continue to be spread throughout the larger economy, it seems increasingly likely that going forward the litigation arising from the current economic crisis will not be concentrated just in the financial sector.

 

Whether or not these most recent lawsuits will be successful of course remains to be seen. The scienter allegations in the Charter and Nortel complaints are not overwhelmingly detailed. Neither complaint contains insider trading allegations; rather, the scienter allegations depend on assertions about what the defendants knew or must have known, without further elaboration showing that the defendants had contrary knowledge at the time of the allegedly misleading statements.

 

The other interesting detail about the Charter complaint is that a number of the allegedly misleading statements on which the plaintiff relies were actually made by a UBS media analyst. Neither UBS nor the analyst is named as a defendant; rather, the plaintiff alleges that the analyst was "directed" to make "statements related to Charter by the Defendants." The complaint further alleges that after making these statements and recommending Charter’s stock, the analyst "became Charter’s primary banker."

 

Allegations that securities litigation defendants misled the investing public through statements by third party analysts are certainly not unprecedented, but as a result of Regulation FD and other developments, these kinds of allegations have become relatively rare, particularly in private securities lawsuits. Whether and to what extend these allegations in the Charter case serves as the basis of liability will be interesting to monitor.

 

In a recent issue of Insights (here), I discuss at greater length the likelihood that more bankruptcies could result in increased securities litigation, and the D&O insurance issues that bankruptcy-related securities lawsuits could present.