Every year just after Labor Day, I take a step back and survey the most important current trends and developments in the world of Directors’ and Officers’ liability and D&O insurance. This year’s survey is set out below. Once again, there are a host of things worth watching in the world of D&O.
What do the Recent Developments in Delaware Portend for Corporate and Securities Litigation There?: Delaware is the second smallest U.S. state by area; only five states are smaller by population. But because so many U.S. corporations are organized under the state’s laws, legal developments in tiny Delaware loom large in the corporate and securities legal scene. And there were a number of important developments in Delaware this past summer that could and likely will affect corporate and securities litigation in the state.
First, as discussed here, on June 11, 2015, the Delaware House of Representatives overwhelmingly passed S.B. 75, which prohibits Delaware stock corporations from adopting “loser pays” fee-shifting bylaws and which confirms that Delaware corporations may adopt bylaws designating Delaware courts as the exclusive forum for shareholder litigation. Delaware’s Governor signed the bill into law on June 24, 2015. The bill’s provisions became effective on August 1, 2015. A copy of the bill can be found here. A discussion of the legislation and the questions it left unanswered can be found here.
The dust-up in Delaware over fee-shifting bylaws got started in May 2014, when the Delaware Supreme Court in the ATP Tours, Inc. v. Deutscher Tennis Bund case upheld the facial validity of a bylaw provision shifting attorneys’ fees and costs to unsuccessful plaintiffs in intra-corporate litigation. This development quickly caught the eye of litigation reform advocates, as the adoption of fee-shifting bylaws seemed to offer a way for companies to reduce the costs of and possibly curb burdensome litigation. At the same time, however, shareholder advocates became concerned that these types of bylaws could deter even meritorious litigation. Because of the debate over the issue, the proposed legislation stalled for a legislative term, but eventually the legislature passed the bill.
Though the legislation has been enacted, a number of questions remain, as discussed here. Among other things, the statute does not address other types of litigation reform bylaws, including, for example, bylaws requiring arbitration of shareholder suits and minimum stake to sue bylaws. In addition, the statute only relates to Delaware corporations. Other states may choose to take a different approach. (Indeed, the Oklahoma legislature has adopted a provision mandating the shifting of fees in derivative suits.)
There have also been a number of significant recent developments in Delaware concerning M&A-related litigation. One of the hot button issues in the world of corporate and securities litigation has been the rise of merger objection lawsuits. There have always been lawsuits relating to M&A transactions; what has changed is that we have now reached the point that virtually every deal now attracts at least one lawsuit. All too often, these cases are resolved on the defendants’ agreement to modify their disclosures about the transaction and to pay the plaintiffs’ attorneys’ fees. These kinds of settlements often are criticized as benefiting no one except the plaintiffs’ lawyers.
It appears that the members of the Delaware judiciary may have concerns about these kinds settlements as well. As discussed here, two recent decisions may suggest that the Delaware’s courts, at least, are no longer willing simply to accept the standard “disclosure only” settlements that typically resolve these kinds of cases.
First, in a July 8, 2015 decision in Acevedo v. Aeroflex Holding Corp., Vice Chancellor Travis Laster rejected an unopposed motion for a final settlement and attorneys’ fees in a lawsuit challenging Cobham PLC’s $1.5 billion acquisition of the microelectronics company Aeroflex. The parties had proposed to settle the case based on the defendants’ agreement to supplement the deal disclosures, some changes to the break-up fee, and other procedural deal terms, as well as the defendants’ agreement to pay the plaintiffs’ attorneys’ fees.
Laster, while noting that settlements of this type “have long been approved on a relatively routine basis,” refused to approve the settlement. He questioned whether the plaintiffs’ attorneys’ negotiation of the additional terms merited the $825,000 fee they sought. He also concluded that the relief obtained was insufficient to support the “intergalactic” settlement release the defendants sought, noting that it provided a “broad class-wide release” that extinguished all claims against the defendants.
On the same day as Laster’s ruling in the Aeroflex Holding case, Vice Chancellor John Noble withheld his approval of a shareholder settlement in a merger objection lawsuit arising from Roche’s $8.3 billion acquisition of InterMune. According to reports, Noble, who took the proposed settlement under advisement, was also concerned about the scope of the releases the defendants received in exchange for modest consideration.
Some commentators have said that that these developments suggest that the kinds of settlements that were routinely approved in the past may now face greater scrutiny. If merger objection suits become harder to settle, they may become less attractive to the plaintiffs’ lawyers, and fewer of them may be filed.
Another Delaware development suggests that while less meritorious cases may be more closely scrutinized, cases there with greater merit could result in the award of significant damages. In an August 27, 2015 post-trial opinion (here), Vice Chancellor Travis Laster held that Dole’s CEO David Murdock and its general counsel Michael Carter breached their fiduciary duties in connection with the November 2013 transaction in which an entity Murdock controlled acquired the 60% of Dole’s shares that Murdock did not already own. Laster found that Murdock and Carter engaged in “fraud” that prevented Dole’s shareholder from receiving a fairer price in the transaction. Laster held Murdock and Carter jointly and severally liable for damages of $148.1 million, plus pre- and post-judgment interest.
There are those who contend that Delaware’s courts are too hospitable to claimants. As discussed here, the August 3, 2015 Wall Street Journal carried a front-page article entitled “Firms Sour on Delaware as Corporate Haven” (here), the gist of which is that some corporate officials and representatives are questioning Delaware’s special status because, the naysayers assert, the state is not doing enough to protect against shareholder lawsuits.
Delaware’s position as the presumptive home to corporate America provides the state with significant benefits; the corporate fees Delaware garners represent a substantial portion of the state’s revenue. Other states want in on the action. For example, in a bid to challenge the often-cited superiority of Delaware’s Chancery courts, Michigan and Texas have established dedicated business courts with judges steeped in corporate law. Even Nevada is trying to hold itself out as a preferred forum, based on claims that its courts represent a streamlined and efficient alternative to those of Delaware.
The debate about Delaware’s predominance is likely to continue. Because there is still a default-to-Delaware mentality, it is unlikely that Delaware’s predominance will disappear any time soon. But it is clear that questions about Delaware’s role are growing, as the appearance of a front page Wall Street Journal article on the issue attests.
Will Companies Hit With Data Breaches Also Sustain D&O Lawsuits As Well?: Many observers, including this blog, have speculated whether the rising wave of data breaches and cyber security attacks will result in litigation against the directors and officers of the affected companies. Indeed, in 2014, there were two sets of lawsuits filed against the boards of companies that had experienced high-profile data breaches, Target Corp. (refer here) and Wyndham Worldwide (refer here). But the Wyndham lawsuit was dismissed in late 2014, and for a substantial time after that there really were no additional significant cyber security-related D&O lawsuits filed, even though there were a number of high profile data breaches in the interim (including, for example, Home Depot, Anthem and Sony Entertainment).
There were, however, signs that a possible data breach-related D&O lawsuit against Home Depot might be in the works, as a plaintiff initiated a books and records action in Delaware Chancery Court against the company. The wondering and waiting about whether or not there will be a Home Depot data breach-related D&O lawsuit recently came to an end. A Home Depot data breach-related shareholder’s derivative lawsuit has been filed in the Northern District of Georgia. On September 2, 2015, a plaintiff shareholder filed a redacted complaint in a lawsuit against Home Depot, as nominal defendant, and twelve Home Depot directors and officers, alleging that the defendants breached “their fiduciary duties of loyalty, good faith, and due care by knowingly and in conscious disregard of their duties failing to ensure that Home Depot took reasonable measures to protect its customers’ personal and financial information.” The redacted version of the plaintiff’s complaint can be found here.
The complaint alleges that company officials aware that because the company’s systems were “desperately out of date,” the company was aware that it was vulnerable to a data breach. The complaint alleges that the defendants were “complacent” leaving in place “vulnerabilities that not only allowed hackers to enter thee system undetected but permitted them to continue siphoning customer cardholder and personal data for almost five months without detection.”
The complaint further alleges that the individual defendants failed to ensure that the company effectively monitored its systems to detect and prevent unauthorized access to customer data. The complaint also alleges that there were also several high profile data breaches at other major retailers (Target, Neiman Marcus) which, the plaintiff alleges, should have alerted Home Depot to a heightened risk of a cybersecurity attack. The complaint alleges that:
The Individual Defendants’ abject failure to fulfill their fiduciary duties to oversee and manage risks at Home Depot related to data security was well evidenced, not only by the ease with which hackers were able to penetrate Home Depot’s systems and install malicious code, which enabled them to steal the personal and financial data of millions of Home Depot customers, but also by the length of time that the Breach was allowed to continue undetected.
The complaint asserts substantive counts against each of the individual defendants for breach of fiduciary duty and for waste of corporate assets. The complaint seeks to recover damages in favor of the company for all of the costs the company has incurred as result of the alleged breaches, as well as corporate governance reforms to protect against a repeat of a data security breach. The complaint also seeks restitution of compensation and benefits the individual defendants received.
In addition to the Home Depot lawsuit, another recent data breach-related D&O lawsuit was also recently filed, although this other complaint differs somewhat from that filed against the Home Depot executives. On August 5, 2015 plaintiff shareholders filed a class action lawsuit in California Superior Court against MobileIron, Inc.; certain of its directors and officers; and its offering underwriters. This lawsuit is one of the several recent IPO-related securities lawsuits filed in state court pursuant to the concurrent jurisdiction provisions of Section 22 of the ’33 Act. (For a further discussion of these state court securities suit, refer here and here.)
MobileIron is an information technology company that provides a platform for secure functioning on mobile devices. According to the plaintiff’s complaint (a copy of which can be found here), the day after MobileIron completed its IPO, press reports appeared stating that MobileIron’s customer, the UK-based insurance company Aviva, had its employees’ mobile devices hacked. The hack allegedly took place weeks before MobileIron’s IPO. The complaint alleges the company’s offering documents “failed to disclose the breach,” as a result of which, the complaint alleges, the company’s IPO offering price was materially inflated.
The sequence of events involves both a data breach and a subsequent related D&O lawsuit. But the company sued in the MobileIron lawsuit is different from the other major data breach D&O lawsuits that have been filed so far, in that MobileIron is not the company whose systems were breached; rather the company sued was a technology company that was providing security services. This lawsuit suggests another possible source of data breach-related D&O litigation, in which the sued company is not the one experiencing the breach, but rather the one that was responsible for providing security against the breach.
So, while there definitely was a lag between the time the Target and Wyndham D&O lawsuits were filed and the more recent filing of these lawsuits, the ultimate filing of the Home Depot and MobileIron lawsuits seems to support the view that there will be further data breach-related D&O lawsuits. Given that the data breaches themselves are almost certainly to continue, the probabilities are that data breach-related D&O litigation will become an increasingly important part of the corporate and securities litigation landscape.
To What Extent Will Companies Suffering Data Breaches Face Regulatory Claims?: While it remains to be seen whether data breach-related D&O lawsuits will become a substantial phenomenon, it is, as a result of a recent federal appellate court decision, now clear that companies experiencing data breaches could face a possible FTC enforcement action.
On August 24, 2015, in a ruling that was much-anticipated because of its potential implications for the regulatory liability exposures of companies that have been hit with data breaches, the Third Circuit affirmed the authority of the Federal Trade Commission to pursue an enforcement action against Wyndham Worldwide Corp. and related entities alleging that the company and its affiliates had failed to make reasonable efforts to protect consumers’ private information. This ruling confirms that, in addition to the disruption and reputational harm that may follow in the wake of a data breach, companies may also face a regulatory action from the FTC as well.
It is important to note that the question the court was asking was whether or not the FTC had the authority to proceed against Wyndham. While confirming that the FTC had that authority, the court did not rule that the FTC was entitled to prevail on its claims. The case will now go back to the district court for further proceedings on the basis of this ruling. The proceedings in the lower court will determine whether or not the agency’s claims are meritorious.
For publicly traded companies, these kinds of regulatory actions present insurance challenges. The only defendants in this action were the corporate parent company and certain of its operating subsidiaries. In a public company D&O policy, the corporate entity is provided coverage only for securities claims. Because the FTC’s enforcement action did not allege violation of the securities laws, an FTC action of this kind would not trigger the entity coverage found in most D&O policies.
While private company D&O insurance policies provide broader entity coverage, private company policies also often contain so-called “antitrust” exclusions that broadly preclude coverage for claims involving allegations of unfair or deceptive trade practices. The exclusions in some carrier’s policies expressly preclude coverage for claims under the Federal Trade Commission Act. Some carriers will remove these exclusion upon request, but others will not, while yet others will only provide so-called antitrust coverage on a sub-limited basis, or on a defense cost only basis. (Refer here for a more detailed discussion of the antitrust exclusion.)
Many carriers now offer separate cyber risk insurance policies that include third-party liability protection. The third-party liability protection available under these cyber risk policies usually include insurance protection for actions brought by regulators following a data breach, including even coverage for regulatory fines and penalties where insurable. However, the third-party regulatory protection available under many cyber risk policies is often subject to a sublimit.
The threat of a significant cyber breach presents a significant risk for companies; increasingly these risks include the possibility of litigation following a data breach — including the risk of litigation brought by shareholders or by regulators. These data breach litigation risks in turn may present potentially complex insurance coverage issues, which underscores the need for companies to consult with knowledgeable insurance advisers in connection with these developing litigation exposures.
Will Claimants Have Greater Success with Consumer Data Breach-Related Class Action Lawsuits?: One of the more distinctive features of the U.S. litigation system is the possibility of pursuing in a single lawsuit all of the similar claims of a similarly aggrieved group of persons, in the form of a class action suit. In recent months, there have been important class action litigation developments, as discussed in this item and the next. As discussed below, the Seventh Circuit’s recent decision in the Neiman Marcus consumer data breach class action could provide an important boost for future consumer data breach class action litigation.
In a July 20, 2015 decision, the Seventh Circuit reinstated the Neiman Marcus consumer data breach class action lawsuit, ruling that the district court erred in concluding that the plaintiffs’ fear of future harm from the breach was insufficient to establish standing to pursue their claims. As Alison Frankel said about the appellate court’s ruling in her July 21, 2015 post on her On the Case blog entitled “The Seventh Circuit Just Made it A Lot Easier to Sue Over Data Breaches” (here), “this is a really consequential decision.” The Seventh Circuit’s opinion in the Neiman Marcus case can be found here.
Neiman Marcus had sustained a data breach that resulted in the exposure of customer credit card information, and a consumer class action lawsuit followed, filed on behalf of the customers whose information had been exposed. The company moved to dismiss, arguing that because the plaintiffs could not allege any actual, present injuries, they lacked standing to pursue their claims under Article III of the U.S. Constitution. (In order to establish Article III standing, the party seeking to sue must personally have suffered some actual or threatened injury that can fairly be traced to the challenged action of the defendant and that is likely to be redressed by a favorable decision.) The plaintiffs in the case had alleged that they have standing based on two “imminent injuries”: an increased risk of future fraudulent charges and greater susceptibility to identity theft.
In reliance on the U.S. Supreme Court’s 2013 decision in Clapper v. Amnesty International U.S.A. (here), which held that “allegations of future injury are not sufficient” to establish Article III standing, the district court granted the company’s motion to dismiss. The plaintiffs appealed the dismissal to the Seventh Circuit.
In discussing the Article III standing issue, the Seventh Circuit said that “Clapper does not, as the district court thought, foreclose any use whatsoever of future injuries.” The Court quoted the Clapper decision as having said that “in some instances, we have found standing based on a ‘substantial risk’ that the harm will occur, which may prompt plaintiffs to reasonably incur costs to mitigate or avoid the harm.” The Seventh Circuit said that the Neiman Marcus customers “should not have to wait until hackers commit identity theft or credit-card fraud in order to give the class standing, because there is an ‘objectively reasonable likelihood’ that such an injury will occur.” The court added that “at this stage in the litigation, it is plausible to infer that the plaintiffs have shown a substantial risk of harm from the Neiman Marcus data breach,” noting that “presumably, the purpose of the hack is, sooner or later, to make fraudulent charges or assume those consumers’ identity.”
As Alison Frankel said in her blog post about the appellate court’s ruling, “it’s the first time a federal appeals court has looked at a data breach class action that was dismissed because the trial judge said it fell short of Clapper standing requirements.” Rather than concluding that Clapper precluded the plaintiffs’ suit, the appellate court said that Clapper “does not, as the district court thought, foreclose any use whatsoever of future injuries to support Article III standing.” In holding that these plaintiffs’ claimed imminent injuries were sufficient to satisfy Article III standing requirements, the Seventh Circuit is basically saying that the theft of the customers’ credit card information alone is sufficient to satisfy constitutional standing requirements.
The appellate court’s ruling is of course only binding within the Seventh Circuit itself, but as the first circuit court decision on the issue, it is likely to be influential on district courts in other circuits. To the extent the district courts in other circuits find the Seventh Circuit’s ruling to be persuasive, it could eliminate one of the consumer data breach class action lawsuit defendants’ more reliable means of trying to get the lawsuits dismissed.
How Will the Supreme Court Rule on the Question of “No Injury” Class Actions?: The question of standing for future injuries under Clapper is only one of the important threshold class action lawsuit issues circulating right now. The other current hot topic in the class action litigation arena is whether Congress may confer Article III standing on a plaintiff who had suffered no specific or concrete harm but who alleges a violation of a federal statute.
As discussed here, on April 27, 2015, in a development that could have significant implications for a wide variety of class action lawsuits, the United States Supreme Court granted the petition of for a writ of certiorari of online search firm Spokeo. The cert grant sets the stage for the Court to consider whether Congress may confer Article III standing on a plaintiff who had suffered no specific or concrete harm but who alleges a violation of a federal statute. Depending on which way the Court rules, it could have very significant impact on class action lawsuit under a wide range of consumer protection statutes.
In the Spokeo case, an individual sued the company under the Fair Credit Reporting Act, claiming that information Spokeo had gathered about him and published on its website was incorrect. Spokeo argued that the plaintiff lacked standing to assert his claim because he did not allege any concrete harm. The district court agreed and granted Spokeo’s motion to dismiss, holding that the plaintiff had failed to allege an “injury-in-fact” and therefore lacked Article III standing. However, in a February 4, 2014 opinion (here), the Ninth Circuit reversed the district court, holding that the plaintiff’s allegations that his statutory rights had been violated alone were sufficient to satisfy Article III’s standing requirement.
In its cert petition, Spokeo framed the question it sought to have the Supreme Court address as follows: “Whether Congress may confer Article III standing upon a plaintiff who suffers no concrete harm, and who therefore could not otherwise invoke the jurisdiction of a federal court, by authorizing a private right of action based on a bare violation of a federal statute.” The question the company has posed will affect class action lawsuits not only under the Fair Credit Reporting Act, but also the Telephone Consumer Protection Act, the Americans with Disabilities Act, the Truth-in- Lending Act and numerous other federal statutes authorizing consumers to file damages actions.
Several technology companies, including Facebook, eBay, Yahoo, and Google, submitted a joint amicus brief in support of Spokeo’s petition in which they argued that they would be particularly harmed if plaintiffs who have not been injured can file class action lawsuits for damages. They argue that if any of the hundreds of millions of their daily users can file a damages lawsuit based solely on alleged statutory violations without any actual injury, they could be subject to massive class actions filed purportedly on behalf of many users who suffered no harm and may even be unaware the alleged statutory violation took place.
If the Supreme Court reverses the Ninth Circuit and holds that a plaintiff must allege a concrete injury in order to establish Article III standing, and that a mere alleged statutory violation alone is insufficient to establish standing, it could, as discussed in an April 28, 2015 memo from the Troutman Sanders law firm (here), “mean the death-knell of ‘no harm’ class action lawsuits that have proliferated under statutes that allow for statutory damages without proof of actual harm.”
For their part, the plaintiffs’ advocates who oppose Spokeo’s position argue that the supposed distinction between injuries-in-fact and injuries-in-law are meaningless, and that the availability damages for violations of legal right has long been a part of our legal system. When Congress statutorily classifies identified matters as legally cognizable injuries, they argue, it is merely codifying principles of harm.
In any event, this case, which will be argued and decided during the Court’s term beginning in October 2015, will be one to watch. Big business has a rooting interest in this case, in which they hope to see Spokeo prevail. There is of course no way of knowing for sure, but the mere fact that the Court granted cert in this case could be interpreted to suggest that the Court will reverse the Ninth Circuit and lower the boom on these type of “no injury” lawsuits.
How Will the Increasing Prevalence of Litigation Financing Affect Corporate and Securities Litigation?: A recent Wall Street Journal article (here) noted that the “next act” for a hedge fund that previously had been involved purchasing troubled mortgage securities during the financial crisis will be to deploy a new litigation finance arm that has, according to the Journal, already “raised hundreds of millions of dollars” to “lend to law firms pursuing class-action injury lawsuits.”
Why would a hedge fund previously focused on financial securities get involved in litigation financing? For a very simple reason – litigation financing is profitable.
How profitable? Because several litigation financing firms are publicly traded, we don’t have to guess. For example, on March 18, 2015, Burford Capital Limited, the largest player in the growing U.S. litigation funding business and a publicly traded firm whose shares trade on the London Stock Exchange AIM Market, released its results for 2014, showing that the company’s revenue during the year rose by 35 percent to $82 million, with a 43 percent rise in operating profit, to $61 million. The company, which has assets of over $500 million under management, reports that since its inception it has produced “a 60% return on invested capital.”
Similarly, Bentham IMF, the U.S. arm of IMF Bentham Limited, whose shares trade on the Australian Stock Exchange, reported in December 2014 (here) that it had funded ten deals during the year, with client recoveries of nearly $100 million resulting from jury verdicts and settlements. The firm itself had gross returns of more than $31 million for the year, with a net profit of $17 million.
These kinds of results attract attention. The increasing involvement of financial firms in litigation-funding also attracts criticism. In a guest post on this blog entitled “The Real and Ugly Facts of Litigation Funding” (here), Lisa Rickard, the President of the U.S. Chamber of Commerce’s Institute for Legal Reform, said “Litigation funding is a sophisticated scheme for gambling on litigation.” She said further that the growth of litigation funding will lead to “more lawsuits, more litigation uncertainty, and higher settlement payoffs to satisfy cash-hungry funders, and in some instances, even corruption” (the latter comment referring to the Chevron case in Ecuador).
Despite the criticism and controversy, litigation funding continues to attract new entrants and investors. Litigation funding is already well-established in several other countries. As I have noted in prior posts on this blog, most recently here, litigation funding is an important part of the class action litigation landscape in Australia. As discussed here, litigation financing continues to play an important role in class action litigation in Canada.
Litigation financing may play an increasingly important role in the U.K.; as I discussed in a recent post (here), law firms acting with the financial support of litigation funding firms are trying to organize to mount a lawsuit in the U.K. on behalf of investors who bought their shares of the scandal-plagued U.K. grocery company Tesco on the London Stock Exchange.
There are important differences between the legal system in the U.S. and the legal systems in the other countries where litigation funding is now well-established. Canada, Australia and the U.K. all have a “loser pays” litigation model, where unsuccessful claimants must pay their adversary’s legal fees. In the U.S., by contrast, we follow the so-called American Rule, under which each party bears its own cost. In addition, most states in the U.S. allow contingency fees, by contrast to many other countries where contingency fees are not permitted. Because of loser pays model and the prohibition of contingency fees, there may be reasons why litigation funding is better established in other countries.
Just the same, litigation funding recently has been quickly developing in the U.S., perhaps because there is so much litigation and because litigation in the U.S. can be so expensive – which raises the question of what the rise of litigation funding may mean for civil litigation in the U.S.
The more positive spin may be that the availability of litigation funding will level the playing field for smaller litigants attempting to take on larger adversaries. At the same time, however, litigation funding raises a host of questions. First and foremost are the concerns about the possible conflicts between the litigation investors and the actual litigants. The funders’ investment objectives may diverge from the actual litigant’s litigation objectives – differences that could lead to diverging views about litigation tactics and even case resolution approaches.
A more fundamental question has to do with the possible effect of growing amounts of litigation funding on the litigation system. Will the availability of litigation funding fuel an increase in litigation? Will it encourage adversaries who might otherwise be able to reach a business resolution of their dispute to litigate rather than negotiate? And then there are the concerns about a field in which there apparently are huge sums to be made but few barriers to entry — will the outsize profits that are now being reported attract less scrupulous competitors who attempt to extract outsized returns at the expense of litigants? Will competition for the best cases encourage the players that are unable to attract the best cases to finance less meritorious cases?
In short, there are many unanswered questions about the growing presence of litigation financing on the U.S. litigation scene. There is no doubt that the current players’ returns will attract additional participants. Litigation funding seems likely to become an increasingly important part of commercial litigation in the U.S. I fully expect that we will continue to hear a lot more about this topic. But the point is – litigation funding is here, now. We had better recognize that, get used to it, and try to understand what it means.
Could the Current “Short-Termism” Debate Lead to Corporate Reporting Changes?: In recent months, commentators from across the political spectrum, largely in response to perceived excesses of activist investors, have called for changes to discourage “short-termism” – that is, the perceived excessive focus of businesses on short-term results rather long-term value creation.
For example, during a recent campaign speech, Democratic Presidential Candidate Hillary Clinton argued that “short termism” is harming the economy and called for a variety of reforms, saying that “today’s marketplace focuses too much on the short term, like second to second financial trading, and quarterly earnings reports, and too little on long-term investments.” And, while he differs about the steps to be taken in response to the phenomenon, outgoing Republic SEC Commissioner Daniel M. Gallagher in a recent speech also noted concerns about the effects of short-term thinking.
Though concerns about short-termism are bipartisan, there are still those who take a different view. In an August 9, 2015 Financial Times article (here), former U.S. Treasury Secretary Lawrence Summers, while calling generally for “long-termism,” sounded a note of caution, observing that “skepticism about whether all horizons should be lengthened is appropriate.” He noted that Japanese companies insulated by the keiretsu system from share price pressure proved to lacked market discipline and squandered market share leads in a wide variety of industries. In the U.S., companies that are dissipating the most value, such as General Motors before its 2009 government bailout, “have often been the most enthusiastic champions of long-termism.” Investors who are pouring money into Silicon Valley startups with bold plans but little revenue “may be putting too much, not too little, weight on the distant future.”
In an August 17, 2015 Wall Street Journal op-ed piece entitled “The Imaginary Problem of Corporate Short-Termism” (here), Harvard Law Professor Mark Roe takes these questions even further. Roe suggests that short-termism is “a small issue on which we could do better but that’s been blown out of proportion by those fearful of change.” Roe cites various evidence he suggests shows that overall stock markets don’t discourage long term business plans. Roe argues that “critics need to acknowledge that short-term thinking often makes sense for U.S. businesses, the economy and long-term employment.”
Based on these skeptics’ comments, there would appear to be a framework for a healthy debate on these issues. However, the possibility of a rare bipartisan political consensus about “short-termism” has encouraged some would-be reformers.
For example, prominent New York lawyer Martin Lipton of the Wachtell, Lipton, Rosen & Katz law firm recently caused something of a stir by calling for the end of quarterly reporting requirements. In an August 19, 2015 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation (here), Lipton cited European asset manager Legal & General Investment Management’s recent statement of support for the discontinuation of company quarterly reporting. Lipton also cited with approval to a report by Oxford University Professor John Kay, who said that “rigid quarterly reporting requirements can promote an excessively short-term focus by companies,” which in turn can “harm the interests of shareholders seeking long-term growth and sustainable earning.”
Lipton himself suggested that “the SEC should keep these observations in mind in pursuing disclosure reform initiatives and otherwise acting to promote, rather than undermine, the ability of companies to pursue long-term strategies.”
Lipton’s article has garnered significant attention, including an August 19, 2015 Wall Street Journal article (here) that led with an opening sentence saying that “Influential law firm Wachtell, Lipton, Rosen & Katz has an idea that may be music to the ears of its big corporate clients and a nightmare for some investors and analysts: end quarterly earnings reports.” Other discussions of the proposal have questioned how less reporting could benefit shareholders and suggested that attempts to try to eliminate quarterly reporting could face “an uphill battle.”
Whether or not proposal such as the suggestion to eliminate quarterly reporting present any realistic possibility of success is questionable at best. However, when a concept like “short-termism” becomes an issue in the presidential electoral campaign, the possibilities for practical action take on a greater significance – particularly when the issue attracts bipartisan consensus. The rare unity of diverse political voices might give the impression that there is agreement on this short-termism issue. However, a deeper look suggests that there are actually a diversity of views on the topic, and that skeptics have raised enough questions to suggest that it might be a good idea to slow the short-termism bandwagon down a little bit.
Will the Growing Global Corruption Crackdown Continue to Drive Corporate and Securities Litigation?: As I noted in my midyear analysis of securities class action lawsuit filings, a significant factor driving securities litigation filings so far this year has been the rising number of U.S. securities lawsuits involving non-U.S. companies. A number of different factors are contributing to the filing of these suits, but among the factors is the increasing numbers of U.S.-listed non-U.S. companies that have been caught up in corruption investigations in their home countries.
The highest profile company among the firms involved in corruption probes is the Brazilian petroleum company, Petrobras, which has been the target of the growing Operação Lava Jato (Operation Car Wash) corruption investigation in Brazil. Petrobras, whose ADSs trade on the NYSE, was hit with a class action securities lawsuit in the U.S. in December 2014 (as discussed here).
The continuing Petrobras investigation has spread to a number of other Brazilian companies, and has also led to other U.S. securities class action lawsuit against some of the companies caught up in the investigation.
As discussed here, on July 1, 2015, a plaintiff shareholder filed a securities class action lawsuit in the Southern District of New York against Braskem, S.A. and certain of its directors and officers. Braskem, which is based in Brazil, is Latin America’s largest petrochemical company. The complaint, which was filed on behalf of investors who purchased the company’s American Depositary Shares in the U.S., alleges that the defendants made materially false and misleading statements regarding the company’s business, operations, and compliance policies, and made false and misleading statements regarding the effectiveness of Braskem’s internal controls and procedures.
In yet another U.S. lawsuit involving a Brazilian company caught up in the Petrobras scandal, and as reflected in their lawyers’ July 22, 2015 press release (here), plaintiff securityholders filed a securities class action lawsuit in the Southern District of New York against Centrais Elétricas Brasileiras S.A. (Eletrobras) and certain of its directors and officers, based on alleged misrepresentations relating to the bribery investigation in Brazil. As discussed in recent press reports, in May, the company announced that testimony given in connection with the Petrobras investigation alleged that the CEO of a wholly owned subsidiary of Eletrobras received illegal payments from companies bidding on a power plant project. In June, the company announced that it had hired an outside law firm to investigate possible violations of the Foreign Corrupt Practices Act at the company, as well as possible violations of the company’s Code of Ethics.
These lawsuits are just the latest U.S. securities suits against a U.S.-listed Latin American company caught up in a corruption investigation in its home country. As discussed here, in March 2015, Chemical & Mining Company of Chile, Inc. (Sociedad Quimica y Minera de Chile, S.A, or SQM), was hit with a securities class action lawsuit relating to the company’s involvement in the to the ongoing corruption and tax evasion scandal involving the Chilean financial services firm, Banco Penta.
The phenomenon of civil litigation following in the wake of a corruption investigation is nothing new, at least in the U.S. What is different about these various lawsuits discussed above is that they involve non-U.S. companies sued in a U.S. securities class action lawsuit in connection with bribery or corruption activities and investigations in their home countries, brought by their home countries’ regulators or prosecutors.
As regulators in Latin America and around the world become increasingly more active, it not only become increasingly more likely that companies elsewhere could become involved in regulatory or even criminal investigations, but also, at least where the companies have securities trading on U.S. exchanges, increasingly more likely to become involved in a U.S. securities class action lawsuit.
The more interesting question is whether these developments will lead to claims against companies and their executives in their home countries. The claimants who purchased the companies’ securities on U.S. exchanges can pursue claims in U.S. courts under the U.S. securities laws, but investors that purchased shares outside the U.S. do not have that option. (Indeed, in the U.S. securities lawsuit involving Petrobras, Southern District of New York Judge Jed Rakoff determined that the Petrobras investors who bought their Petrobras shares on the São Paulo stock exchange must pursue arbitration, as required under the company’s bylaws.) The more limited availability of remedies in the companies’ home countries raises the ironic possibility that the U.S.-exchange purchasers could obtain compensation for their losses but the shareholders in the companies’ home countries might go empty-handed. These prospects raise the question whether investors in these other countries may push for legal reforms to allow them to pursue remedies in their home countries’ courts.
While the outcome of these kinds of questions remains to be seen, the developments in Brazil are already having an impact on the domestic Brazilian D&O insurance marketplace. As I learned in my recent visit to São Paulo, the ongoing Petrobras scandal and uncertainty about where it might lead has roiled the marketplace and provoked significant caution from the D&O underwriters there. The local carriers are tightening terms and conditions and seeking pricing increases. Even more difficult than the more restrictive marketplace conditions is the overall uncertainty. There are general concerns about what might be next. The resulting uncertainty creates very challenging conditions for the local D&O insurance professionals and the companies they must advise.
Brazil is of course not the only country cracking down on corruption. China, Australia, Chile Canada, Italy, South Korea and numerous other countries have stepped up their corruption enforcement. Increasingly, enforcement authorities are cooperating and collaborating cross-border as well. These activities create operational uncertainty for companies in these jurisdictions. They also create challenges for the local D&O insurance professionals.
What Impact Will the SEC’s New Executive Compensation Rules Have?: In recent weeks, as it was required to do by the Dodd-Frank Act, the SEC has released the final rules relating to pay ratio disclosure and also separately proposed rules regarding executive compensation clawbacks. When these two sets of controversial rules eventually take effect, they could have a significant impact on executive compensation disclosures, and could possibly even lead to executive compensation-related claims and enforcement action.
The more procedurally advanced of these two sets of rules are the rules the SEC recently released in final relating to pay ratio disclosure. As discussed in the agency’s August 5, 2015 press release (here), the rules, which the agency was required to adopt by the Dodd-Frank Act, “require a public company to disclose the ratio of the compensation of its chief executive officer (CEO) to the median compensation of its employees.” The press release contains a fact sheet about the rules. The final rules 294-page adopting release can be found here.
The rules are not effective until each reporting company’s first fiscal year after January 1, 2017. The requirements will not apply to emerging growth companies, smaller reporting companies, foreign private issuers, filers under the U.S.-Canadian Multijurisdictional Disclosure System and registered investment companies.
The agency’s delays in adopting the pay ratio disclosure rules had been the target of criticism from more liberal members of Congress. For example, as discussed here, Senator Elizabeth Warren sent SEC Chair Mary Jo White a scathing letter in which the Senator criticized White for, among other things, the delays involved in the final pay ratio disclosure rules’ release. However, as discussed here, the proposed rules were controversial from their very promulgation back in 2013. And in the end, when the final rules were finally issued this past week, they were only approved over stinging dissents from the two Republican SEC Commissioners Daniel Gallagher (whose dissenting statement can be found here) and Michael Piwowar (whose two dissenting statements can be found here and here).
There are those who think the introduction of the pay ratio disclosure rules will have a positive impact on corporate governance. For example, in an August 6, 2015 New York Times article (here), Gretchen Morgenson argues that the pay ratio disclosures will provide “an easily graspable and often decidedly shocking number,” that “may energize a cadre of new combatants in the executive pay fight.” Others have been more critical of the rules, particularly with respect to the costs associated with compliance and the likelihood that differing labor forces between companies will lead to widely differing reports that cannot be compared. Many are convinced that, as noted in an August 5, 2015 Law 360 article (here, subscription required) the rules are inevitably headed toward “courtroom showdown.”
The second set of executive compensation-related rules that the SEC released this summer, which were also required by the Dodd-Frank, were the agency’s proposed rules relating to executive compensation clawbacks. As discussed here, on July 1, 2015, a divided SEC voted 3-2 to propose rules directing the securities exchanges to create standards that in turn call for listed companies to adopt policies requiring the companies’ executive officers to pay back incentive-based compensation in the event the company restates its financials for the year in which the compensation was awarded. The proposed rules are subject to a 60-day comment period. The SEC’s 198-pages of proposed rules can be found here. The SEC’s July 1, 2015 press release (including a “fact sheet” summarizing the proposed rules) can be found here. Unusually, all five of the commissioners issued separate statements about the proposed rules, including two sharply worded dissents by Commissioners Michael S. Picower (here) and Daniel M. Gallagher (here).
It will be some time before these two sets of rules begin to have an impact on corporate disclosure and compensation practices. Only the pay ratio disclosure rules are final and they will not even take effect for some time. Moreover, the pay ratio disclosure rules could face substantial challenges in the courts. The executive compensation clawback rules are not yet final but have only been proposed. But while it will be some time before the impact of these rules will emerge, the rules themselves and the principles they embody are likely to remain at the forefront within the public debate over issues such as wage fairness and minimum wage policies and the larger debate over economic inequality.
Practitioners will want to note that the under the proposed compensation clawback rules issuers would not be permitted to pay premiums on an insurance policy covering an officer’s potential clawback obligations. There have been various efforts over the past several years within the D&O insurance industry to try to come up with insurance solutions that would address corporate officials’ risk of compensation clawbacks. The insurance-related provisions of the new rules would seem to suggest that these insurance measures are no longer feasible – except that the way the proposed rules are written, the provisions would only prohibit the company from paying the premium for the insurance; they do not appear to prohibit an individual from paying the premium for the insurance.
What Will Be the Impact of Consolidation in the P&C Insurance Industry?: Here at The D&O Diary, we write about the issues and developments affecting the liabilities of directors and officers, with a focus on D&O insurance. We generally avoid talking about specific companies in the insurance marketplace. But change has come to the Property and Casualty (P&C) insurance world in ways that could affect the D&O insurance marketplace, and so we find that must discuss what has been going on in 2015 at many companies in the marketplace.
The P&C insurance industry watchword for 2015 is “consolidation.” XL acquired Catlin. Tokyo Marine Holdings will acquire HCC Insurance Holdings. Fosun has acquired Meadowbrook and will acquire the portion of Ironshore that it didn’t already own. Endurance Specialty Holdings acquired Montpelier Re. Exor will acquire Partner Re. RSA Insurance has received a takeover offer from Zurich. And, in the biggest deal of all, ACE Limited will acquire The Chubb Corporation, in a deal worth $28.3 billion. (There is also significant consolidation going on in the Health Insurance arena as well, but that is happening for reasons specific to the Health Insurance sector.)
Taken collectively, the level of consolidation in the P&C insurance industry over the last several months has been nothing short of remarkable. Moreover, the process may not yet be complete; there certainly is speculation about which company or companies might be next.
Many of these deals have been announced but have not yet closed; the largest of them all, the ACE acquisition of Chubb, will not close until early 2016. So it is too early to begin the process of trying to figure out what the consolidation may mean for the industry. Based on what we know to this point, it is fair to say that not every one of these deals will affect the marketplace in the same way. Some of the buyers have made it clear that they intend to function purely as a holding company and allow the acquired company to continue to operate effectively as an independent company. Other buyers are clearly intending to merge operations.
The one thing we can say for sure now is that this wave of consolidation is going to have an effect. One of the deals that closed earlier this year, the XL acquisition of Catlin, is already having an impact as the two formerly separate companies go forward on a combined basis. As the other announced deals close, and perhaps as other deals are announced, there will be additional marketplace impacts to come.
These circumstances present the possibility that we could be entering a period of rapid and perhaps significant changes. All marketplace participants will have to adjust. For insurance buyers, these changes may mean that settled assumptions will have to be revisited. It may also mean that transactions that may have been routine in the past may require more time, attention, and effort in the future. There could be complications. All of these developments underscore the importance for insurance buyers of working with a knowledgeable and experienced insurance advisor, to help navigate these developments as they arise.