In recent days, I have published a series of posts with analysis of and commentary on recent trends in securities class action litigation. As part of this continuing series of posts, I thought it would be useful to include commentary from the plaintiffs’ perspective. With that in mind, I reached out to Max Berger at the Bernstein Litowitz Berger & Grossman firm, and Max graciously agreed to participate in an interview for this blog in the form of a Q&A exchange.
By way of background, Bernstein Litowitz is one of the country’s leading plaintiffs’ class action law firms. Max is a partner in the firm and is also head of the firm’s litigation practice. He prosecutes class and individual actions on behalf of the firm’s clients. He and his firm have been involved in some of the highest profile securities class action lawsuits in recent years. Max has indicated with an asterisk in the text of his answers below some of the cases in which his firm has been involved. My questions to Max appear in italics, and his answers appear as indented text (Please note that Max’s portion of the content also includes the indented text following his final answer.)
Q.: What do you think were the most important securities litigation trends or developments in 2010?
A.: There are several trends we have seen throughout 2010 that are really continuations of developments from prior years. Central among those, from our perspective representing institutional investors as plaintiffs in these cases, is that the challenges investors face in successfully prosecuting federal securities claims continue to grow. On virtually every element of our clients’ claims, including scienter, loss causation, class certification and standing, we have seen the hurdles increase as a result of court decisions adverse to investors. One notable exception is the statute of limitations, an issue where the Supreme Court provided a favorable ruling this year in Merck.* Of course, that ruling was influenced by the heightened requirements for pleading scienter in a securities fraud action that make it virtually impossible for an investor to assert a claim of fraud until there is clear evidence of fraudulent intent.
While the obstacles to bringing and prosecuting securities cases have dramatically increased, we have seen the scope of the wrongdoing become exponentially larger. Investors have obtained several large recoveries, even as restatements by public companies have declined. Subprime litigation – by which I refer to the full panoply of cases tied to high-risk lending, mortgage securitization and sales of mortgage-backed securities in the last five or six years – remains front and center. The scope and egregiousness of a number of those cases has prompted significant private institutions that have not previously engaged in securities litigation to file claims, and it will be interesting to see whether the involvement of such institutions in these types of cases is a trend that continues. The recent warnings from the FDIC about the financial condition of many midsized banks, coupled with the initiation of securities class actions against several regional banks at the end of 2010, suggests that investors have not yet learned the full truth about the reckless lending and loan management practices of the banks in which they have invested.
Finally, toward the end of 2010, we began to see a resurgence of merger and acquisition activity. For investors in public companies, that trend underscores a need to increase vigilance over the terms of these transactions to ensure that shareholders’ interests are being protected. Indeed, there has been an increase in transactional litigation, and we do expect that trend to increase along with the number of significant deals projected in 2011.
Q.: What impact do you think the Dodd-Frank whistleblower provisions will have on private securities litigation? Are there other aspects of the Dodd-Frank Act that you think will have an important impact on securities litigation?
A.: In our experience, the whistleblower provisions of Dodd-Frank have not yet had a significant impact on private litigation. As in cases outside the securities arena, there are very high hurdles faced by whistleblowers when they decide to take on a former employer. They risk becoming pariahs in self-protecting industries and often imperil their current employment and future employment prospects. Nonetheless, other significant recoveries that whistleblowers have helped obtain – such as in the recent GlaxoSmithKline case, in which a whistleblower who helped the government recover billions of dollars, stands to recover nearly $100 million for herself – may incentivize whistleblowers to take advantage of the protections afforded by Dodd-Frank. In light of the important role that whistleblowers can play in PSLRA litigation, where plaintiffs need to satisfy exacting pleading requirements without access to formal discovery, these provisions of Dodd-Frank certainly have the potential to be very significant if they lead to more witnesses coming forward and providing the kind of information that plaintiffs need to plead sustainable securities fraud claims.
The Dodd-Frank whistleblower provisions, of course, mark a return to the steps taken in the wake of the last round of major corporate scandals at the start of the last decade. Those cases led to Sarbanes-Oxley which included its own whistleblower provisions – provisions which, in our experience, did little to encourage whistleblowers to come forward or to discourage corporate misconduct. We hope that Dodd-Frank will prove more effective, though we are still awaiting significant clarification and rule-making on many of its central provisions.
Q.: I have heard you say that you think the settlement in the Pfizer derivative suit represents an important development and may serve as a model for future settlements in derivative cases. What is it about the settlement that you think is important?
A.: The resolution in Pfizer is unique in many respects. That case involved allegations of systemic and widespread violations of the drug marketing laws that were not being controlled by Pfizer’s board and senior executives, who also rewarded employees that engaged in these practices with bonuses and allowed retaliation against employees who were trying to stop them. These unlawful marketing activities were responsible for Pfizer paying the largest fine in United States history. Our derivative suit accused the board and officers of breaching their fiduciary duties to Pfizer shareholders. Our challenge was not to just return dollars to Pfizer from these individuals because it would have hardly affected their corporate behavior. We wanted to effect long-lasting institutional change at Pfizer to prevent this conduct from occurring in the future.
In crafting the settlement, our objective was to implement a true prophylactic protection for Pfizer shareholders going forward – something with teeth that would prevent the recurrence of conduct that, as we alleged, certain defendants engaged in repeatedly. We also wanted to provide a template for other companies engaged in similar behavior.
To achieve that result, we worked with a renowned corporate governance expert – Professor Jeffrey N. Gordon from Columbia Law School – to address our core allegations and concerns. The settlement requires the defendants to create a new regulatory board committee with a broad mandate to oversee Pfizer’s drug marketing practices for at least five years. Significantly, this committee will have the power to order its own studies and investigations, and can retain independent experts. To carry out this mandate, the new committee has access to its own funding – under the terms of the settlement, the defendants’ insurance carriers agreed to pay $75 million into a fund that will be exclusively used to pay for the committee’s work and attorneys’ fees awarded by the court. The agreement to provide that funding is one of the most remarkable aspects of this settlement, and it is one that we view as a critical element, if the committee is to be both independent and effective. The settlement also requires the board’s compensation committee to review Pfizer’s compensation policies for employees and consultants with the new regulatory committee to make sure those policies are consistent with compliance requirements, and to discuss possible clawbacks from employees who directly supervise illegal practices in the future. The settlement also requires the creation of an ombudsman program to give Pfizer employees a way to alert the company about potential illegal practices and improper pressure from supervisors without fear of retaliation. Incidentally, the fact that we included this ombudsman provision may say something about our view of the whistleblower protections provided by Dodd-Frank, discussed above. Finally, the Committee is to be chaired by an independent director and regular reports of the Committee’s work are required to be made to the full board and the shareholders. The Committee and its structure have been embraced by two former SEC Chairs, Harvey Pitt and Richard Breeden.
While Pfizer is not the first case in which the defendants agreed to implement corporate governance reforms as a component of a settlement, we feel that the mechanisms provided for in this settlement will make it the most effective reform of corporate governance achieved through shareholder derivative litigation, paralleling the reforms implemented at Texaco in the wake of the landmark employee discrimination action against that company.*
Q.: Many of the subprime and credit crisis-related securities cases are now working their way through the system. Some have been dismissed while others have survived the preliminary motions. Are there any generalizations that can be drawn from the rulings in these cases so far? Can you make any generalizations about the settlements so far in these cases?
A.: Our perspective is that, as the courts and the public have become more sophisticated about the subprime mortgage collapse and the ensuing financial crisis, there is increasing recognition of the fact that the bursting of the housing bubble and the economic meltdown were not the result of some unpredictable tsunami. Rather, many of the companies that have been the subject of securities actions contributed to the bubble and subsequent collapse. For example, Judge Buchwald’s recent decision sustaining fraud claims against Ambac and its officers described the defendants’ claims that they were simply the victims of the financial collapse—an argument that has been made repeatedly and which we have seen in a number of our cases—as being "premised on a convenient confusion of cause and effect." According to Judge Buchwald, in that case, if the plaintiffs’ allegations were true, "Ambac [was] an active participant in the collapse of their own business, and of the financial markets in general, rather than merely a passive victim."*
Similarly, while some observers responded to the collapse of Lehman Brothers as an unforeseeable result of a credit crisis driven by the housing market, the report of the bankruptcy examiner has made clear that Lehman and its auditor violated basic accounting rules to manipulate Lehman’s balance sheet.* In the subprime and related litigations where plaintiffs are able to marshal these kinds of facts demonstrating that the financial crisis, rather than some force of nature, was in many ways the result of widespread misconduct by corporations and individuals, courts are receptive to investors’ claims that are based on that misconduct. Accordingly, we are seeing fewer dismissals in what we consider to be meritorious cases as well as larger recoveries in many of these cases. The fact that Bank of America agreed to pay almost $3 billion to Fannie Mae and Freddie Mac is a good recent example. Even though some have questioned the amount of that settlement, it does show that these claims have teeth.
The only generalization one can really make about the subprime and credit-crisis related securities actions is that they are no different from other securities actions: generally, we are seeing cases dismissed where the plaintiffs cannot muster the evidence required to meet the heightened requirements of pleading scienter or where loss causation cannot be established, while most well-pleaded cases are moving forward and often resulting in significant recoveries as in New Century* (particularly given that, like New Century, many of the issuers at the heart of the subprime fiasco are now bankrupt). That said, as with other securities litigation, we have seen some dismissals of cases that we consider meritorious, but those situations do not appear unique to the subprime arena.
Q.: What impact has the U.S. Supreme Court’s opinion in Morrison v. National Australia Bank had on securities litigation? How has it changed your firm’s approach to cases involving foreign domiciled companies? Is your firm considering alternative approaches on behalf of foreign claimants, such as pursuing claims in courts outside the U.S.?
A.: There is no question that Morrison has had, and will continue to have, a significant impact on investors and on the function of the capital markets more broadly. Through that decision, the Supreme Court has largely denied investors—including U.S. investors who purchase securities abroad—the protections of the federal securities laws, regardless of the extent to which foreign companies engaged in misconduct within the United States. There are a number of what we consider to be very significant cases, where the claims of fraud have real merit, in which U.S. investors may be left with no practical recourse. We will need to see how investors, plaintiffs’ counsel and the courts respond in the coming years, and whether Congress, in turn, takes steps to correct this narrowing of the federal securities laws.
Many of the institutions we represent are considering different avenues to protect themselves. In the Toyota securities litigation,* for example, the Maryland State Retirement and Pension System as Lead Plaintiff has asserted claims under Japanese law on behalf of investors who purchased Toyota shares on the Tokyo exchange, in addition to the Exchange Act claims asserted on behalf of purchasers of Toyota securities on the New York exchange. It is also possible that Morrison will lead to an increase in foreign litigation, as well as individual domestic actions brought under state law, which was not impacted by the Supreme Court’s ruling in Morrison. The recent Fortis filing in the Netherlands certainly indicates that U.S. and foreign investors are open to considering litigation outside of the U.S., but whether investors will find the same protections in foreign litigation that they have found here remains to be seen. Many significant cases that are subject to Morrison are still working their way through the District Courts and we will see what other strategies investors pursue in response to Morrison as those courts, and the appellate courts, render guidance interpreting the Supreme Court’s decision.
Q.: If you were a D&O underwriter, what would you be interested in knowing about a company that you were underwriting? What do you think the most important risk indicators would be?
A.: My focus would be on the company’s leadership and the corporate governance structure that is in place. Are the directors independent and are critical board committees comprised of independent directors? Most importantly, are a majority of the directors on the compensation, compliance and audit committees independent? It is critical that directors have relevant industry experience. While service on other corporate boards may bring relevant experience, I would also be wary of directors who are concurrently serving on multiple boards. Finally, with regard to management, I would examine the compensation structure. Is executive compensation tied to performance? If so, are the metrics being used objective or subject to manipulation? And significantly, are executives being rewarded for achieving long-term objectives rather than short-term goals? As we have seen repeatedly, incentivizing executives to achieve near-term benchmarks for growth or performance can create a motivation to manipulate results to achieve compensation goals, whereas long-term incentives can bring the interests of management in line with the objectives of the company’s shareholders.
Q.: There have been a lot of changes in the environment surrounding securities litigation in recent years, all the way from important court decisions to changes in the plaintiffs’ bar. What do you think the most important changes have been and why?
A.: The principal changes we have seen over the past 15 years have been the legislative and judicial actions to raise imposing hurdles to prosecuting securities cases, particularly as class actions. Those hurdles have dramatically raised the bar for effective prosecution and private enforcement. As a result, these cases have become much more expensive and problematic. I am not the first to observe that in many securities cases, the evidence that must be marshaled in order to survive a motion to dismiss is more than what you would need to get some other cases past summary judgment, and that requires a significant investment of time and resources in cases that may not be sustained. This, in turn, has resulted in a culling of the herd of law firms prosecuting these cases. In many ways, I feel we have also seen the plaintiffs’ bar rise to meet these challenges and the level of practice among the plaintiffs’ firms is far more sophisticated than it was before the PSLRA. Frankly, firms unable to rise to meet these challenges cannot succeed under the regime that has been implemented since 1995.
Whether as a result of that increased sophistication, the heightened hurdles to advancing beyond the pleading stage, the nature and scope of the cases we are seeing or some combination of those elements, we are certainly seeing higher recoveries in the cases that are being prosecuted. And not only higher absolute recoveries, but a better percentage of investor losses being recovered in the cases that we consider meritorious. In WorldCom, for example, bond purchasers received $0.65 on the dollar; in Cendant, the recovery was $0.60 on the dollar; in Refco, about $0.50 on the dollar.*
Finally, private enforcement of the securities laws is now more important than ever because regulatory recoveries have been wholly inadequate to compensate investors victimized by fraud.
Q.: What do you think are the most important trends or developments to watch as we head into 2011?
In the coming year, the U.S. Supreme Court—which has in the recent past exhibited an unusual interest in securities fraud actions—will be considering several cases that have the potential to reshape a significant area of our practice. Several commentators have noted that business interests have found a receptive ear on the Roberts’ Court, and have been quite assertive in gaining that audience. Two cases the Court recently agreed to hear regarding the standards for class certification under Rule 23 of the Federal Rules of Civil Procedure—Wal-Mart v. Dukes, which examines the standards for class certification in an employment discrimination action, and Erica P. John Fund v. Halliburton, whichlooks at whether and to what extent investors will be required to demonstrate loss causation at the class certification stage—exemplify such an effort. I believe the decisions in these cases have the potential to profoundly impact the ability of not only investors—but also workers, consumers, patients and employees—to hold corporate wrongdoers accountable in court.
The Supreme Court also recently heard arguments addressing the appropriate standards for measuring materiality of information that executives are required to disclose to investors in Matrixx Initiatives v. Siracusano—a question that has ramifications not only for the pharmaceutical and biotechnology industries, which have been the subject of a number of significant decisions in recent years, but potentially for virtually every securities fraud action. The court is also considering another case in which the liability of "behind-the-scenes" defendants—by which I mean third parties that are alleged to have a role in carrying out a fraud, even though the allegedly false and misleading statements cannot be readily attributed to them. Specifically, in Janus Capital Group v. First Derivative Traders,the Court is consideringwhether claims under Section 10(b) can be asserted against a subsidiary mutual fund advisor entity that is alleged to have orchestrated the fraud, even though its parent mutual fund actually made the false and misleading statements. While I believe the circumstances of this case may be unique to the mutual fund industry, the Court certainly has the opportunity to set forth a broad rule of law even if it could narrowly decide the question under the specific facts before it.
Another important development for investors to focus on during the coming year will be the ongoing implementation of the Dodd-Frank financial reform legislation. In one recent report, Securities and Exchange Commission officials complained that the agency lacked the proper funding to undertake the significant new responsibilities it was assigned under Dodd-Frank, and had in fact shifted resources used to fund ordinary expenditures—such as the hiring of expert witnesses—to other programs in order to meet its new obligations under the legislation. The perception of how successful the SEC is in fulfilling its mission under Dodd-Frank will likely impact how Congress and the courts view the role of private enforcement of the securities laws, as well as the extent to which investors have been given the proper legal tools to hold wrongdoers accountable.
Finally, in all honesty, anyone interested in securities litigation trends and developments should read your blog, which is always objective, incisive and very intelligently written. Congratulations, Kevin, and thank you for keeping us all so well informed!
*In the interests of full disclosure, I note that Bernstein Litowitz Berger & Grossmann LLP serves or has served as lead or co-lead counsel in a number of the above-referenced cases, including Merck, Pfizer, Texaco, Ambac, Lehman Brothers, New Century, Toyota, WorldCom, Cendant and Refco.
Many thanks to Max for his willingness to participate in this exchange.