2010 was an eventful year in the world of D&O liability. Congress passed massive financial reform legislation, the Supreme Court issued landmark decisions in important cases and numerous claims emerged as the litigation landscape continued to evolve. With so much going on, it is a challenge to narrow the year’s events down to just the ten most significant developments.
With appropriate humility about the limitations of all year-end inventories, here is my list of the top ten D&O developments of 2010.
1. Securities Suits Pick Up in Year’s Second Half: As I detailed in my 2010 securities litigation overview (here), after a filing downturn in the year’s first half, the number of securities lawsuit filing picked up in the last six months of the year. Among other things, as the year progressed, filing activity shifted away from credit crisis-related cases and toward a broader range of other types of cases.
Although at least some of the litigation activity in the year’s second half was driven by limited or short term events (as was the case, for example, in the rash of cases filed against for-profit education companies and against Chinese domiciled companies), the shift away from credit crisis cases could suggest that the heightened pace of securities suit filings may continue as we head into 2010.
2. The Changing Mix of Corporate and Securities Lawsuits: As insurance information firm Advisen has well documented, the mix of corporate and securities lawsuits has been evolving over the past several years. The most important feature of this changing mix of cases has been the decreasing prevalence of class action securities lawsuits as a percentage of all corporate and securities cases.
As the percentage of class action securities lawsuits has declined, other types of lawsuits, particularly breach of fiduciary duty cases, have grown in relative frequency. Many of these breach of fiduciary duty cases are related to mergers and acquisitions activity. Indeed, as I noted in my year-end review of 2010 securities lawsuit filings, even many of the cases that are categorized as securities class action lawsuits involve merger objection cases.
It is important to keep this changing mix of cases in mind when considering the various year end reports on securities litigation activity. These reports will show that overall 2010 securities class action lawsuit filings are down compared to post-PSLRA averages. However, it would be mistake to conclude that the relatively reduced number of securities class action lawsuits means that claims activity in general is down. To the contrary, overall claims activity is actually up. The mere fact that securities class action lawsuits are down does not mean that fewer companies are being sued or that overall claims exposure has diminished, either for companies or insurers. Rather, what is happening is that the claims exposure is changing, away from securities class action lawsuits and toward other types of claims.
This shift away from traditional securities class action lawsuits as a percentage of all claims activity has important implications for the insurance marketplace. The shift toward higher frequency, lower severity type of claims could have a significant impact both on primary and excess carriers. Primary carriers may experience an increase in overall claims frequency, with consequences for their loss experience. Excess carriers, particularly higher excess carriers, may experience relatively fewer claims piercing their layers, possibly producing a positive impact on the excess carriers’ results.
3. Banks Fail, Lawsuits Loom: 157 banks failed during 2010, the largest annual number of bank failures since 1992. The total number of bank closures since January 1, 2008 is 322. In addition, in the FDIC’s most recent Quarterly Banking Profile (refer here), the FDIC identified 860 banks, or about one out of nine of all banks, as "problem institutions."
Given the magnitude of these problems in the banking industry, it is hardly surprising that litigation involving failed and troubled banks is increasingly significant. Indeed, 13 of the 177 securities class action lawsuits filed in 2010 involved failed or troubled banks. In addition, aggrieved investors in failed or troubled privately held banks also filed a variety of other lawsuits, primarily in state courts.
It may be anticipated that the FDIC will also actively pursue claims against failed banks’ former directors and officers. However, to date, the FDIC has instituted only two D&O claims as part of the current round of failed banks (refer here and here).
It appears that it will only be a matter of time before the FDIC launches further suits against former officials of failed banks. Widely circulated news reports have quoted FDIC officials as saying that the FDIC has authorized civil actions against more than 80 directors and officers of failed banks. In addition, the Wall Street Journal reported in November that the FDIC is conducting fifty criminal investigations against directors, officers and employees of failed banks.
While we may hope that the current round of bank failures may begin to wane as we head into 2011, it appears that the failed bank litigation may only just be getting started.
4. Credit Crisis Lawsuit Settlements: The Dog that Didn’t Bark This Year: The subprime and credit crisis-related litigation wave will be heading into its fifth year early in 2011. Since 2007, there have been over 230 subprime and credit crisis related securities lawsuits filed. Many of these cases continue to work their way through the system.
As some of these cases have survived the preliminary motions, they have moved toward settlement. There were several noteworthy credit crisis related securities class action lawsuit settlements during 2010, including Countrywide ($624 million, refer here), Schwab Yield Plus ($235 million , refer here), and New Century Financial ($124 million, refer here).
But while there have been a few noteworthy settlements of these cases this year, the more striking observation is how few of these cases have settled so far, particularly given how far along we are in the subprime and credit crisis litigation wave.
By my count, only 17 of the over 230 subprime and credit crisis-related securities class action lawsuit have settled, and only eight of these 17 settlements were announced in 2010. (My list of subprime and credit crisis-related lawsuit resolutions can be accessed here.)
NERA Economic Consulting stated in its year-end report on securities litigation that of the approximately 230 credit crisis securities suits, only 8% have settled, 29% have been dismissed, and 63% remain unresolved.
Of the 63% of unresolved cases, some of course will wind up being dismissed. But many more will settle, eventually. Given the now long duration of the credit crisis litigation wave, it can be anticipated that there may be many more settlements of these cases in 2011. The likelihood is that D&O insurers’ aggregate claims losses for these claims will mount, perhaps rapidly.
The question is whether the materialization of these losses will come as a surprise or has already been fully anticipated in the carriers’ prior years’ loss reserves. This answer to this question could have important implications for the D&O insurers’ 2011 calendar year results.
5. Megasettlements of Shareholders’ Derivative Lawsuits Surge: There was a time when the settlement of a shareholder derivative lawsuit involved the payment of little or no money, other than in connection with the payment of the plaintiffs’ attorneys’ fees. However, one of the more striking developments in recent years has been the emergence of jumbo settlements of shareholders derivative lawsuits, in which millions of dollars are paid to or on behalf of the company involved.
This emerging trend continued to develop in 2010, with at least two huge shareholder derivative lawsuit settlements: the $90 million AIG/Greenberg settlement (about which refer here) and the $75 million Pfizer settlement (refer here).
These 2010 settlements join a growing list of other jumbo derivative settlements in recent years, including the UnitedHealth Group settlement ($900 million, refer here); Oracle ($122 million, refer here); Broadcom ($118 million, refer here); and the first AIG derivative settlement (refer here).
The striking thing about these settlements is not only their size, but also the fact that in each case the company involved is solvent. The significance of this fact is that these settlements represent instances in which the companies’ D&O insurance potentially could have been called upon to fund an A Side loss outside of the insolvency context. These kinds of settlements provide concrete evidence of the value to policyholders of Side A insurance protection even outside of the insolvency context, and underscore the importance of added Side A protection in a well-designed D&O insurance program.
From the carriers’ perspective, these settlements suggest that Side A losses can mount outside of insolvency. Only the carriers themselves can answer the question whether or not they are actually pricing their Side A products for this loss exposure.
One final note about the Pfizer derivative lawsuit settlement concerns the unusual funding mechanism the settlement implemented. In many derivative lawsuit settlements the companies involved agree to institute corporate governance reforms. What was unusual about the Pfizer settlement is that the settlement agreement created a dedicated fund intended to finance the company’s agreed upon governance reforms. If the advance funding of corporate governance reforms were to become a standard feature of derivative lawsuit settlements, the cash cost of derivative settlements could increase substantially. This is a potential development worth watching closely.
6. Rare Securities Lawsuit Trials Result in Plaintiffs’ Verdicts: Very few securities class action lawsuits actually go trial. Most are settled or dismissed. But in 2010, two cases made it all the way through to jury verdicts. In January, the jurors in the Vivendi case entered a verdict on behalf of the plaintiffs against the company (about which refer here), and in November, the jurors entered a verdict for the plaintiffs in the BankAtlantic subprime-related securities suit (refer here).
In addition to these jury verdicts, in June 2010, the Ninth Circuit issued an opinion overturning the trial court’s post trial ruling in the Apollo Group case, a ruling that had set aside the jury’s $277.5 million jury verdict in that case. Refer here regarding the Ninth Circuit’s opinion in the Apollo Group case.
All three of these cases remain subject to further proceedings. The Vivendi case in particular is the subject of significant post-trial motions having to do with the composition of the plaintiffs’ class in the wake of the U.S. Supreme Court’s decision in the Morrison v. National Australia Bank case (about which refer to these prior guest blog posts, here and here. See also item 10, below).
The defendants in the Apollo Group case have filed a petition with the U.S. Supreme Court for a writ of certiorari (about which refer here). And the BankAtlantic case has now moved on to post-trial motions, and depending on the motions’ outcome, possible appeal.
But while the ultimate outcome of these cases remains to be determined, it is striking that all three of these cases not only involve rare trials, but all three resulted in jury verdicts for the plaintiffs. To be sure, there have also been recent securities lawsuit trials that have resulted in defense verdicts, as was the case for example in the JDS Uniphase trial (about which refer here).
According to information compiled by Adam Savett, the Director of Securities Class Actions at the Claims Compensation Bureau, there have now been ten securities class action lawsuit trial post-PSLRA and involving post-PSLRA facts. The scoreboard currently reads: Plaintiffs 6, Defendants 4. The scoreboard is of course subject to revision pending further proceedings. Nevertheless, the juries themselves seem to have been favoring the plaintiffs, a phenomenon that may make plaintiffs’ threats to push a case to trial represent a particularly threatening tactic.
7. Assessing Coverage for "Bump Up" Claims: As noted above, a significant and growing number of corporate and securities lawsuits arise out of merger and acquisition activity. Often, the goal of this litigation is to try to increase the transaction consideration. One recurring question is the availability of D&O insurance coverage for amounts paid in settlement of so-called "bump up" claims.
In October 2010, the First Circuit entered an opinion in coverage litigation involving Genzyme Corporation, discussing the question of the preclusive effect of a D&O policy’s "bump up" exclusion. The First Circuit overturned the lower court’s decision that had held that the company’s D&O insurance policy did not provide coverage for additional amounts paid to claimants who asserted they did not received adequate consideration in a share exchange.
Though the First Circuit reversed the lower court’s holding of noncoverage, the First Circuit did not invalidate the bump up exclusion and agreed that the exclusion precluded entity coverage for bump up amounts.
The First Circuit remanded the case to the lower court for further allocation proceedings (that is, because the First Circuit held that the bump up exclusion precluded coverage only under the policy’s entity coverage provision, further proceedings are required to determine whet portion if any of the underlying settlement is allocable to settlement of liabilities of persons insured under other insuring provisions of the policy).
Of critical importance is that the First Circuit found that exclusion is enforceable and is effective to preclude coverage according to its terms. The holding clearly will be relevant to questions of coverage in future cases involving settlements of "bump up" claims, at least where the implicated D&O insurance policies include bump up exclusions.
8. D&O Insurance Coverage for Informal SEC and Internal Investigations: Among the perennial D&O insurance issues are the questions of coverage for informal SEC investigations and for internal investigations. In either case, the question is whether or not there is a "claim" as required to trigger coverage under the policy.
In one of the year’s most noteworthy D&O insurance coverage decisions, Southern District of Florida Judge Kenneth Marra, applying Florida law in a summary judgment ruling in coverage litigation involving Office Depot, held there is no coverage under the company’s D&O insurance policies for either of these categories of expenses.
Though the holding in the Office Depot case is direct reflection both of the specific policy language involved and the facts presented, the decision nevertheless could be influential in future claims involving questions of coverage for informal SEC investigations and internal investigations. The Office Depot decision suggests that policy definitions of the terms "Securities Claim" and "Claim" are critical, particularly with respect to the definitional references to "investigations" and "proceedings." Refer here for a more detailed discussion of the case and the decision.
The Office Depot ruling is hardly the final word on these issues, but it clearly will loom large in future consideration of questions of coverage for these kinds of expenses. Insurers undoubtedly will seek to rely on the decision to try to preclude coverage for costs incurred in connection with informal SEC investigations and internal investigations.
On a related note, a separate court held in the MBIA coverage case that there is coverage under the D&O insurance policy at issue for special litigation committee expenses, as discussed here.
9. Is a Whistle the Sound of the Future?: The massive Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 enacted in July will affect virtually every aspect of our financial system, in ways that may only become clear over time. But among the Act’s innovations that seem likeliest to have a significant litigation impact are the Act’s new whistleblower provisions.
The whistleblower provisions include the creation of a new whistleblower bounty pursuant to which persons who first bring securities law violations to the attention of the SEC will receive between 10 percent and 20 percent of any recovery in excess of $1 million.
Give the magnitude of the fines paid in many recent SEC enforcement actions, particularly those involving Foreign Corrupt Practices Act violations (about which refer here), the prospective size of potential bounties is enormous. These bounty provisions seem likely to encourage a flood of whistleblower reports to the SEC. This could create an administrative nightmare for the SEC, and the agency is already struggling with funding limitations that may constrain its ability to implement the whistleblower requirements. On the other hand, the SEC, under pressure to rehabilitate its regulatory credentials after its failure to detect the Madoff scheme, will face significant pressure to pursue whistleblower claims.
Another 2010 development that seems likely to encourage an entirely different sort of whistleblower activity is the series of WikiLeaks disclosures. The extensive media attention give to the disclosures, as well as the suggestions of WikiLeaks founder Julian Assange that future disclosures will expose corporate misconduct, raise the possibility of that other self-appointed corporate scourges will launch similar guerilla campaigns involving the disclosure of internal corporate communications.
These two types of prospective whistleblower risks arguably represent an entirely new level of corporate exposure that could leave companies and their senior officials susceptible to claims of wrongdoing based on public or regulatory disclosures by persons inside the company with access to sensitive information. Indeed, companies and their senior officials could even be susceptible to claims for the alleged failure to implement and maintain sufficient controls to prevent embarrassing or harmful disclosures. Regardless, companies could face the prospect of significant risks involving person inside (or with access to) their own operations.
10. Foreign Companies, U.S. Courts: In June 2010, the U.S. Supreme Court issued its long-awaited decision in the Morrison v. National Australia Bank case, holding that Section 10(b) of the Securities Exchange Act of 1934 applies only to transactions taking place on the U.S. securities exchanges, or domestic transactions in other securities.
Among other things, the Morrison decision seems to represent the end of so-called "f-cubed" claims, involving foreign claimants who bought their shares in foreign companies on foreign exchanges.
Lower courts are now wrestling with Morrison’s implications, including, for example, the question of whether or not Morrison precludes claims under the U.S. securities laws against companies whose American Depositary Receipts trade on U.S. exchanges. (Surprisingly, at least one court has held that case has that effect, as discussed here.) Other courts have struggled to determine what falls within Morrison’s second prong relating to "domestic transactions in other securities." Clearly, there will be much further lower court activity as these kinds of issues are sorted out.
In the meantime, one consequence that seemed likely in the wake of Morrison is that there might be fewer (or at least only narrower) cases filed in U.S. courts involving non-U.S. companies. Contrary to expectations, however, there were quite a number of securities cases filed in U.S. courts involving foreign-domiciled companies in 2010, including many filed after the Supreme Court issued its Morrison opinion.
As reflected in my recent year-end analysis of 2010 securities lawsuit filings, there were 19 new securities class action lawsuits filed in 2010 involving foreign domiciled companies, representing 10.7% of all 2010 securities lawsuit filings. Of these 19 cases, 12 were filed after the Supreme Court issued its opinion in Morrison.
One possibly temporary factor driving many of these filings is the rash of new cases filed against Chinese- domiciled companies. There were ten new lawsuits against Chinese companies in 2010, eight of which were filed post-Morrison. It should be noted that the shares of many of these Chinese companies trade on U.S. exchanges and in fact many of the cases directly relate to the companies’ securities offerings in the U.S., facts which made these companies susceptible to securities lawsuits in this country even under Morrison.
The lower courts will continue to interpret and apply Morrison in the months ahead. In the meantime, it seems that lawsuits involving non-U.S. companies will continue to arise, at least where the companies’ shares trade on U.S. exchanges.
A Final Note: Readers of this blog post may also be interested in my September 2010 post entitled "What to Watch Now in the World of D&O," which can be found here.
Ten Top Ten Lists: Top ten surveys proliferated at year end, and so it seems like a list of ten top ten lists would be the appropriate accompaniment to The D&O Diary’s own top ten list: