A group of former executives of a Lehman Brothers subsidiary   is seeking to block the bid by senior Lehman executives to use $90 million of the remaining D&O insurance proceeds to settle the cases pending against them. As discussed here, on August 24, 2011, the senior executives filed a motion with the Lehman bankruptcy court seeking access to $90 million in insurance funds to settle the securities suits pending against them. On September 8, 2011, seven executives of Lehman’s Structured Asset Securities Corp. (Sasco) objected to the requested $90 million drawdown, arguing that it would leave the Sasco executives without sufficient insurance funds remaining to settle the claims pending against them. A copy of the Sasco executives’ opposition papers can be found here.


The Sasco executives, like the senior Lehman executives who seek the $90 million, are defendants in a number of securities class action lawsuits involving events leading up to Lehman’s collapse. As I detailed in my prior post about the senior Lehman executives request for the $90 million in insurance proceeds, defense expenses and other costs (including an arbitration settlement) have already significantly eroded the $250 million insurance tower. The Sasco executives claim they now have an opportunity to settle the $4 billion claims pending against them for $45 million. They contend that if the senior executives draw down the $90 million they seek, there will be insufficient remaining insurance funds to settle the claims against them.


In their opposition papers, the Sasco executives argue that the $90 million drawdown would represent a “disproportionate and inequitable portion” of the remaining funds. They argue that “permitting one class of insureds to use such tactics to divert a disproportionate share of insurance proceeds for their benefit to the exclusion of other classes of insureds is inequitable, contrary to the purpose of the available D&O insurance and would have an adverse economic impact on the Debtors’ estate.”


The Sasco executives note that the fight is with respect to Lehman’s 2007-2008 tower of insurance, which originally totaled $250 million. (This tower is described in detail in an earlier post about Lehman’s D&O insurance, here.) The Sasco executives contend that their claim actually implicated the separate $250 million 2008-2009 tower,  as it was during that policy period that the claims were first made against them. However, the carriers in the 2008-2009 D&O insurance tower apparently contend that the claims against the Sasco executives relate back to claims first  made during the 2007-2008 insurance tower’s policy period, and therefore it is the 2007-2008 tower that is implicated with respect to the claims against the Sasco executives. The Sasco executives dispute this position of the insurers, but they note in the motion papers that they cannot establish their entitlement to the proceeds of the 2008-2009 tower without protracted and expensive coverage litigation.


It is worth noting that the senior executives request for the $90 million drawdown would not in and of itself deplete the amounts remaining in the $250 million 2007-2008 tower. As discussed in my post about the settlement, it looks as if the drawdown would leave about $50 million remaining, which would seem to be enough to fund the Sasco executives’ proposed $45 million settlement. In their motion papers, however, the Sasco executives assert that the senior Lehman executives “will quickly attempt to settle other claims asserted against them, exhausting the remaining limits under the 2007-08 D&O policy,” contending that the senior executives “seek to appropriate all of the remaining proceeds …for their own benefit, to the exclusion of the Sasco defendants.”


The Sasco executives argue that they have “an equal right to insurance protection” as the senior executives and that it “would be inconsistent with the purpose of D&O insurance to permit one class to monopolize the protection.” The Sasco defendants seek to have the bankruptcy court deny the senior executives’ motion for the $90 million drawdown and to enter an order adopting an “allocation scheme” that more equitably divides the remaining proceeds. They note that they are not arguing that the proposed $90 million settlement is “unreasonable,” they simply object to the fact that the senior executives’ requested drawdown would leave them using the remaining proceeds to enter a settlement of the claims against them.


This situation represents a classic example of the too-many-insured, too-many-claims, not-enough-insurance problem. These problems come up in all sorts of contexts, although rarely in cases as high profile as this. The most basic problem is that even with $250 million in insurance, there is not nearly enough insurance to defend and settle all of the claims involving insured persons. The question is how the insufficient insurance proceeds should be applied.


There are procedural mechanisms available to deal with these types of situations, such as interpleader, where the insurer(s) simply deposit the insurance with the court and the court sorts out the entitlements. The insurers themselves would have to initiate an interpleader action. The Sasco executives are hoping to enlist the bankruptcy court to perform an equivalent allocation on an equitable basis. In their motion papers, they reference an earlier bankruptcy case where the D&O insurance policy proceeds were allocated in a pro rata basis. This type of scheme might well be equitable, but the problem is that given the number of individuals involved and the seriousness of the claims against them, a per capita allocation might leave everyone with insufficient funds to settle any of the claims against them.


The one thing that seems likely if the Sasco executives are unable to secure for themselves a portion of the 2007-08 insurance tower to settle the claims pending against them, they will be under pressure to try to establish that they are entitled to proceeds of the 2008-09 tower. Such a bid would involve very significant questions regarding the interrelatedness of the claims made against them with the prior claims on which the carriers are relying to argue that the claim against the Sasco executives do not involve 2008-09 insurance tower, but instead relate back to the 2007-08 tower.


It will in any event be interesting to see how the bankruptcy court responds to these competing claims to the proceeds of the D&O insurance coverage. The situation certainly underscores the fundamental tension that arises from the fact that the D&O insurance must provide protection for a significant number of individual directors and officers, and the fact that in the event of a catastrophic claim, the various individuals can find themselves in competition for the D&O insurance policy proceeds. One way to address this problem of course is to buy more insurance. But as the Lehman example shows, there may be limits to how much can be accomplished simply by buying more insurance. If $250 million is not enough insurance, higher limits is not going to solve much for most companies.


This may be one of those problems that may not be susceptible to solution, but one possible approach to ameliorate this situation is through program structure. For example, if the outside directors had their own separate tower of insurance, those amounts could be applied toward defending and settling the claims against them while the proceeds of the main policy could be applied toward the settlement of the claims against the officers. Of course, even this arrangement would not have eliminated the possibility of the kinds of problems that have arisen here. It is at least one way to try to address problems due to the fact that so many individuals are entitled to and would want the benefit of the proceeds of the main D&O insurance policy’s protection.


A September 10, 2011 Wall Street Journal article about the Sasco executives’ motion can be found here.


SEC Seeks to Enforce Subpoena Against Longtop Financial Auditor: The SEC is going on the warpath to try to enforce a subpoena that it served on Longtop Financial’s former auditor, Deloitte Touche Tohmatsu (DTT), which is the Shanghai-based affiliate of the global accounting firm, Deloitte Touche. As discussed here, Longtop is one of the many U.S.-listed Chinese companies to be caught up in accusations of accounting impropriety in recent months. DTT resigned as Longtop’s auditor earlier this year.


The allegations surrounding Longtop attracted the attention of the SEC, and at least according to news reports, the company recently received a Wells Notice from the SEC. The SEC also apparently tried to subpoena DTT in connection with its investigation of Longtop. As reported in the SEC’s Sept. 8, 2011 press release (here), DTT failed to produce the requested documents and so the on September 8 the SEC filed a motion with the United States District Court for the District of Columbia requiring DTT to comply with the subpoena. The SEC’s motion papers can be found here.


The SEC’s motion papers report that DTT’s U.S. counsel had sent a letter to the SEC asserting that (1) the firm could not be compelled to produce documents created prior to July 21, 2010, the effective date of the Dodd-Frank Act, and (2) that in any event producing any documents could subject the firm to sanctions for violations of Chinese secrecy laws.


The SEC contends that DTT’s arguments are “apparently based on a misunderstanding of the legal basis for the subpoena,” arguing further that the subpoena was not dependent on the additional powers given the SEC in the Dodd-Frank Act but rather was based on the SEC’s long standing subpoena power. The SEC argued further DTT’s “vague assertions of possible conflicts with a foreign law provide no justification” for DTT’s “continued non-compliance with the Subpoena.” The SEC argued that DTT’s “speculative” assertion that compliance would subject it to sanctions is “illusory” and furthermore a risk DTT “knowingly accepted by availing itself of the U.S. securities markets.”


As detailed in Nate Raymond’s September 8, 2011 Am Law Litigation Daily article about the SEC’s motion to enforce the subpoena (here), this situation represents something of a test case for the SEC, as (according to one commentator quoted in the article) “the SEC for obvious reasons wants to know if it can get to these documents in the future.” Another commentator in a September 10, 2011 Wall Street Journal article (here) said that the SEC’s move to enforce the subpoena represents a “major escalation.” The Journal article also notes that the dispute also “highlights the shortcomings of regulation in China, which is complicated by vague laws, competing regulatory agencies and a tight rein on information.”


Whatever the significance of the SEC’s action ultimately may prove to be, it is clear that the SEC has ramped up its activity levels in seeking to take action in connection with the U.S.-listed Chinese companies caught up in the accounting scandals. In addition to the Wells notice recently served on Longtop, the SEC also recently served a Wells notice on the Chairman of another Chinese company, Puda Coal (about which refer here).


The other thing about the challenges the SEC is facing in trying to enforce its subpoena is that it shows how difficult it will be for any party to pursue legal action against many of these Chinese companies. If the SEC can’t even enforce a subpoena against an audit firm that is registered with the PCAOB, it obviously is going to be a challenge for private litigants to try to pursue discovery from China-based firms and individuals. Indeed, because many claimants have recognized these limitations, they have tried to focus their actions against the outside professionals (underwriters, auditors, attorneys) that have facilitated the Chinese companies’ entries into the U.S. securities markets. But as the SEC’s struggles to enforce its subpoena show, some of these professionals may also be difficult to pursue.


Lawyers’ Relief Act: If you have not had a chance to read Eric Dash’s September 8, 2011 New York Times article “Feasting on Paperwork” (here), I recommend taking a few minutes now to read it. Unbeknownst to the rest of us, the Dodd-Frank Act was actually a stimulus package intended to rescue lawyers from the impact of the economic crisis on their profession. The Act is, in the words of one commentator quoted in the article, “a full employment act” for lawyers and consultants. The article goes on to note that new regulation “has long been one of Washington’s unofficial job creation tools.”


I don’t know whether to be appalled at the brazen profit-extracting presumption that the lawyers quoted in the article unapologetically express or to be impressed by their naked opportunism. There is little wonder, as the article states, that lawyers and consultants “are salivating at the prospect of even more business opportunities.” The firms are, as noted by one lawyer quoted in the article, “only getting started.”


The overwhelming impression is the main consequence of the Act is the enrichment of a small number of professionals at the expense of the entire economy. And lawyers wonder why they do not enjoy a higher regard in our society. The article reminds me of the old joke about how research scientists are now going to use lawyers rather than rats in their scientific experiments — there aren’t enough rats; there is no danger that the scientists will become emotionally attached to the lawyers; and there are some things that rats just won’t do.


The Moral of the Ducks: Even when you are completely blown away by unexpected events, the thing to do is to regroup, quickly get it back together, and march on.