areusAmong the more interesting recent securities litigation developments outside the United States was the announcement earlier this month that institutional investors had reached a 11 billion yen ($92 million) settlement of shareholder lawsuits they had filed in Japan against Olympus. Among the many interesting details about the settlement was the involvement of global securities litigation firm DRRT in the Japanese litigation settlement. Following the settlement news, I reached out to Alexander Reus of DRRT to see if he would agree to participate in a Q&A for publication on this site, to which he agreed.

 

Alexander is the managing partner of DRRT. DRRT is an international law firm and litigation funder with offices in Miami and several other international locations specializing in representing institutional investors in shareholder litigation and loss recovery. DRRT has special expertise in the increasingly important non-U.S. jurisdiction and is handling over a dozen cases worldwide.

 

I would like to thank Alexander for his willingness to participate in this Q&A. The Q&A is set out below. My questions are in bold, and Alexander’s answers are in plain text.

 

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The mechanisms for private securities and investor litigation are well-established in the United States (and Canada) but not nearly as well established outside of the U.S. – yet many of the cases in which your firm is involved have been filed in non-U.S. courts. How did this come about and what do you think the opportunity is for your firm? When your firm is involved in a case outside of the U.S., what is your firm’s role?

 

We have always focused on creating value for our clients and acting opportunistically in doing so. While the US / CAN class action system are well established and function well for anybody, even without being active, most non-U.S. systems do not know or accept class actions “opt-out style”. Hence, it is either “do nothing, get nothing” or “do something, in order to get the chance for a recovery”. Representing first mostly European institutions, it was logical and natural to also focus on European “class action alternatives”, and we have been pioneers in this field.

 

We identify a potential case, research the local laws and procedures, identify and qualify a local firm, evaluate the economic feasibility and then put together a legal and economic concept for the risk-free, funded representation of institutional investors. That involves a lot of hands on legal work both in the run-up to an actual filing, as well as the hand-holding of the local firm and the strategic guidance during the litigation. Of course, it also involves the funding of the litigation.

 

When your firm becomes involved in a case outside of the U.S., how does your firm go about selecting the cases in which it become involved, and what are the criteria for selection? Are there countries or jurisdictions that you prefer to avoid, and if so, why?

 

The jurisdiction must allow litigation funding and/or success fees, and have a legal and procedural framework which makes the handling of a case for 50-100 institutions possible. It cannot have too much economic risk from adverse costs or local lawyer or court fees, or must have some insurance mechanism to insure against the high economic risks. Also, such as China and Hong Kong, it cannot make litigation funding illegal and subject to criminal persecution.
 

Your firm was involved in the cases that were filed in Japan on behalf of nearly 100 investors relating to the Olympus accounting scandal and that recently settled for 11 billion yen ($92 million). How did your firm become involved in these cases and what was its role? What did that litigation involve and how was the settlement reached? What do you think is the significance of these cases and of the settlement?

 

It involved 2 related cases filed in 2012 and 2013 for two large groups, as well as another group of non-litigating clients who were included in a mediation. The groundbreaking moment in this litigation was the foresight of one of the senior lawyers within the law firm handling Olympus’ litigation matters to discuss possible mediation options and procedures with me, which resulted in an October 2013 tentative settlement. Nevertheless, it has been a challenge ever since to get the details and mechanics of the settlement worked out for over 16 months. Significant is the fact that a large settlement was reached BEFORE an actual court decision in Japan, which is something unheard of.

 

One of the biggest current scandals outside the U.S. involves the Brazilian oil company, Petrobras. There have been securities lawsuits filed against the company and its executives in the U.S. on behalf of investors who purchased their Petrobras securities on U.S. exchanges, but many more of the company’s shareholders purchased their shares on Brazilian exchanges and therefore can’t be a part of the U.S. securities litigation. Are there steps that can be taken on behalf of these investors who purchased their shares in Brazil? What are the features of the situation that might complicate efforts to pursue claims in Brazil on behalf of these other investors?

 

Yes, and we are on this case, just like we have been working on a similar, but smaller scale corruption case in Italy involving Saipem. We are not only filing lawsuits for our clients with significant exposure to US traded securities, but also preparing litigation in Brazil in the near future. Litigation in Brazil in this specific case, and as an interesting twist to what some companies would like to also implement in the U.S., will have to take place within an arbitration setting at the Market Arbitration Chamber of the BOVESPA, as dictated by Petrobras’ bylaws.

 

I know your firm was involved in the landmark Royal Dutch Shell settlement entered in the Netherlands courts using the procedure available under Dutch law for collective settlements the Dutch Collective Settlement of Mass Damages Claims Act, known as WCAM. At the time of the Royal Dutch Shell settlement many observers thought that the Netherlands courts might become the focus of global investor claims asserted in reliance on the Dutch collective settlement procedures. While there have been other settlements reached involving this procedure, the prediction that the Netherlands might become a magnet for investor claims has not really happened. Why do you think that is? Do you think it could still happen that the Netherlands courts could become a preferred forum for investor claims?

 

I always knew that the NL would not become the “European mecca” of class action securities litigation. However, what it can be and become is a very useful settlement place for willing parties to avoid European litigation. Suing in the NL still requires jurisdiction so it is not suitable for any lawsuits against any company.

 

What do you think the future may be for collective investor actions outside of the U.S.? Do you have any predictions for developments we can expect? Are there particular countries where you expect to see significant developments in the future?

 

Some countries are seriously considering implementing opt-.out class action systems, and the EU is also working on collective redress mechanisms. However, they can be 5-10 years out still. I believe that small investors will be left out while large investors can always “band” together and create institutional investor groups of 50-100 with a critical mass of damages to make a group action economically feasible. With more litigation funding available in England and the rest of Europe and with other countries accepting this notion as well, there will be more and more cases filed outside of the US. Don’t forget also the amount of cases being filed in Canada and Australia, where the opt out system exists but is not used, yet where a test case for opt outs is set to be ruled on this year.

stock pricesIn its June 2014 opinion in the Halliburton case, the U.S. Supreme Court held that securities lawsuit defendants may introduce evidence at the class certification stage to try to show that the alleged misrepresentation on which the plaintiffs rely did not impact the defendant company’s share price. To show the absence of price impact, defendants typically will rely on “event study” methodology to analyze factors affecting a company’s share price. The event study methodology has a well-established academic pedigree. But in a recent paper, two authors ask the question “Are event studies in securities litigation reliable?”

 

In their March 19, 2015 paper, “Event Studies in Securities Litigation: Low Power, Confounding Effects, and Bias” (here), Duke Business School Professor Alon Brav and J.B. Heaton of the Bartlit, Beck, Herman, Palanchar, & Scott law firm identify several problems in the way event studies are used in securities litigation. Their longer academic paper is summarized in a shorter April 14, 2015 post on the CLS Blue Sky Blog (here).

 

Event studies are used in securities litigation to try to answer two questions: First, was an alleged misrepresentation or corrective disclosure associated with a price impact? Second, if there was a price impact, how much of it was caused by the alleged misrepresentation or corrective disclosure as opposed to other, unrelated factors?

 

The problem with the use of event studies in securities litigation, as the authors see it, is that the methodology used in court differs from the methodology used in academic research. In general, the studies used in court are single-firm event studies, while almost all academic research event studies are multi-firm event studies. As the authors note, “importing a methodology that financial economists developed for use with multiple firms into a single-firm context creates substantial difficulties, and review of the case law suggests that courts and litigants often have failed to recognize these problems.”

 

The problem with using single-firm event studies is that they lack “statistical power” to detect price impacts unless the price impacts are “quite large.” This has the effect of giving a “free pass” to some economically meaningful price impacts and may encourage more small- to mid-scale fraud. The use of statistical significance concepts that are appropriate to multi-firm event studies “implements a legal regime where the probability of incorrectly exonerating securities defendants is much higher than the probability of incorrectly finding securities defendants liable.”

 

A second problem with the use of event studies in securities litigation is that when a single-firm event study does detect a price impact, “it reflects confounding effects that are unrelated to the fraud.” It is well known that stock prices move for a variety of reasons, many of them unrelated to news about the company. So the stock price moves reflect a component related to the event and a component unrelated to the event. There is, however, no mathematically precise way to separate the two components. Single-firm event studies “do not average away confounding effects.”

 

The low statistical power of single-firm event studies and the presence of confounding effects means that there is a “sizeable upward bias in detected price impacts and therefore in damages.” That is, if the event study measures a price impact large enough to be detected, the detected price impact “may be substantially higher than the true price impact.”

 

The authors suggest three steps for improving the use of event studies in securities litigation. First, the authors suggest courts should require litigants and their expert witnesses to report the results of a statistical power analysis for the event study. A power analysis will “tell the court whether the litigant’s event study was reliable for detecting price impacts of various sizes.” The authors add that a “securities litigant should not be heard to say that a misrepresentation or corrective disclosure caused no price impact based on a text that had little or no power to detect a price impact that the court determines to be material.”

 

Second, to address the confounding effects problem, the authors suggest that courts should allow litigants flexibility to present other evidence to prove that a price impact from misrepresentation or corrective disclosure did or did not occur. This evidence might include, for example, intraday analyses and quantitative analysis of other news about the firm that day, as well other factors, to value posited confounding effects.

 

Third, courts and litigants should recognize that statistically significant price impacts determined through a single-firm event study are “biased estimates of true impacts” and that because of this bias, detected price impacts are more likely to overestimate price impact than underestimate it.

 

It is important to note that events studies have long been used for other purposes in securities lawsuits. Indeed, one of the reasons that the Halliburton court agreed to allow price impact evidence at the class certification stage is that it would make no sense to allow price impact evidence for, say, the purpose of establishing that the company’s shares trade on an efficient market, but to preclude the evidence that the alleged misrepresentation did not actually affect the share price and therefore that the fraud-on-the-market presumption should not apply. Price impact evidence is also used for purposes of materiality and reliance, and to determine the existence or absence of loss causation and the amount of damages.

 

Because price impact evidence can be relevant to multiple issues in a securities case beyond just the question of class certification, the defects with the way that event studies are used in securities litigation can affect a number of issues and determinations. For that reason, it is, as the authors suggest, important for courts and litigants to have a “firmer basis for considering evidence based on single-firm event studies.”

 

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CozenOConnor-Logo-RGBIn the following guest post,  Elan Kandel, who is a member of the Cozen O’Connor law firm, takes a look at the SEC’s recent investigative interest in the way private equity firms disclose their fees. He also reviews the insurance issues these types of SEC investigations and enforcement actions raise. A version of this article previously was published as a Cozen O’Connor client alert. I would like to thank Elan for his willingness to publish his article on my site. I welcome guest post contributions from responsible authors on topics of interest to readers of this site. Please contact me if you would like to submit a guest post. Here is Elan’s article.

 

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On April 3, 2015, The Wall Street Journal reported that private equity adviser Fenway Partners LLC (Fenway) received a Wells Notice from the U.S. Securities and Exchange Commission (SEC) in March 2015 regarding Fenway’s treatment of fees and expenses incurred by its sponsored funds’ portfolio companies.[i] Specifically, the SEC is apparently investigating how Fenway Partners handles fees and expenses, including payments made for consulting services by portfolio companies, and how such payments are disclosed to fund investors.[ii]

Fenway is the latest in a string of private equity advisers to face SEC scrutiny concerning the adequacy of its disclosure of fees and expenses incurred by a private equity adviser to fund investors. Two days prior to The Wall Street Journal’s report, on March 30, 2015, the SEC’s Enforcement Division commenced public administrative and cease and desist proceedings against private equity investment adviser Lynn Tilton (Tilton), Patriarch Partners, LLC, Patriarch Partners VIII, LLC, Patriarch Partners XIV, LLC and Patriarch Partners XV, LLC (collectively, Patriarch). The SEC alleges that Tilton and Patriarch breached their fiduciary duties and defrauded investors in three of Patriarch’s sponsored collateralized loan obligation investment funds (the Zohar Funds) and improperly collected nearly $200 million in management fees and other expenses.

According to the SEC’s order instituting an administrative proceeding, since 2003, Tilton and Patriarch have breached their fiduciary duties and defrauded investors in the Zohar Funds by failing to value assets using the valuation methodology set forth in the documents governing the Zohar Funds. The Zohar Funds reportedly raised more than $2.5 billion since 2003 from investors and used this capital to make loans to distressed companies. The loans made to distressed companies (the Zohar Funds’ portfolio companies) by the Zohar Funds are the Zohar Funds’ primary assets. Over the past several years, however, many of the Zohar Funds’ portfolio companies have not made interest payments, or have only made partial payments to the Zohar Funds.

As required by the Zohar Funds’ governing documents, Patriarch regularly provided information to the funds and their investors concerning the funds’ performance. Instead of applying the valuation categorizations required under the Zohar Funds’ governing documents, the SEC contends that, at Tilton’s direction, Patriarch did not assign a lower valuation category to an asset unless and until Tilton “subjectively decides to stop ‘supporting’ the distressed company.” As a result of Tilton’s undisclosed and subjective valuation methodology, nearly all of the asset valuations remained unchanged since the time they were acquired. Importantly, had Tilton and Patriarch applied the required valuation methodology, the SEC alleges that “management fees and other payments to Tilton and her entities would have been reduced by almost $200 million, and investors would have gained more control over the Funds’ activities … By applying her own undisclosed discretionary valuation methodology, Tilton created a major conflict of interest.”

The SEC further alleges that the quarterly financial statements for the Zohar Funds were not prepared in conformity with generally accepted accounting principles (GAAP) despite the certification made by Tilton and Patriarch to the contrary.

The disclosure of possible SEC action against Fenway and commencement of enforcement proceedings against Tilton and Patriarch came on the heels of reports in February 2015 that private equity giant KKR & Co. reportedly issued “fee credit” refunds in early 2014 to investors in some of its buyout funds in the wake of an unfavorable SEC examination. KKR & Co.’s fee credit refunds were issued around the same time as the SEC’s commencement of enforcement proceedings against Clean Energy Capital (CEC) and its main portfolio manager, Scott Brittenham (Brittenham) in February 2014.

In the CEC/Brittenham action, the SEC alleged that CEC and Brittenham improperly allocated more than $3 million of CEC’s expenses that CEC managed. The SEC alleged that such allocations were made without adequate disclosure to investors, and therefore constituted a misappropriation of assets from CEC’s funds. On October 17, 2014, CEC and Brittenham agreed to pay $2.2 million in disgorgement and civil penalties to settle the action.

Roughly one month prior to the CEC/Brittenham settlement, on September 22, 2014, the SEC entered into a cease and desist order against private equity adviser Lincolnshire Management (LMI) finding that LMI breached its fiduciary duty to its funds. The SEC charged LMI with failing to allocate expenses properly after LMI integrated portfolio companies of two affiliated private equity funds. The SEC alleged breach of fiduciary duty and failure to adopt and implement written policies and procedures reasonably designed to prevent violations of the Investment Advisers Act of 1940 arising from the integration of the two portfolio companies owed by separately advised LMI funds. LMI paid $2.3 million to settle the SEC’s charges in disgorgement and civil penalties.

The SEC has touted the CEC/Brittenham action as its “first-ever” action arising from its focus on fees and expenses charged by private equity firms. The agency’s recent pursuit of Tilton/Patriarch and Fenway confirms that the private equity industry’s fees and expenses and valuation practices, and the perceived lack of disclosure to fund investors, remain on the SEC’s radar. As such, in the coming months, additional disclosures by private equity advisers and the SEC of investigations and possible enforcement actions against private equity advisers should be expected.[iii] In an effort to avoid becoming ensnared by the SEC, private equity advisers should consider examining and clarifying, when applicable, their disclosures of valuations, fees, and expenses and other practices.

From an insurance coverage standpoint, private equity advisers and their insurers should note that depending upon the specific wording of the implicated private equity management and professional liability policy, SEC enforcement actions and the investigations that precede them, may raise a panoply of coverage issues.

As a threshold matter, while the policy’s definition of “claim” is generally defined to include enforcement actions and formal administrative and regulatory investigations, not all policies extend the claim definition to include “informal investigations.” This is particularly relevant when the SEC’s formal investigation does not commence (if at all) for months (or in some cases years) after the informal investigation. For example, according to the civil action filed by Tilton and Patriarch in federal court against the SEC, seeking removal of the enforcement action to federal court, the SEC issued its first document request on December 15, 2009, but did not issue a Wells Notice until October 4, 2014. It is unclear whether the SEC issued its December 2009 document request pursuant to a formal notice of investigation or whether the request was issued in connection with an informal investigation. In the event that the document request was issued as part of an informal investigation, unless the applicable policy’s definition of claim includes informal investigations, the policy would not provide coverage for fees and expenses incurred by the private equity adviser or any of its directors and officers in order to respond. Fees and expenses incurred in connection with an SEC investigation can be significant.

Questions regarding the scope of indemnity coverage may also arise because the monetary remedies sought by the SEC are limited to disgorgement, civil fines and penalties.[iv] In most policies, the “loss” definition contains language excluding “matters deemed uninsurable under the law pursuant to which this policy is construed.” Some policies also expressly exclude “disgorgement or restitution” from the definition of loss, but often subject to certain limitations. Where the definition of loss does not expressly exclude disgorgement or restitution, there is a well-developed body of case law holding that disgorgement is uninsurable as a matter of public policy (even in the context of a settlement agreement as opposed to a judgment or award). It should be noted, however, that some more recently decided cases have rejected insurers’ attempts to deny coverage where it is less than clear that the settling parties were the recipients of the disgorged funds.

Depending upon the wording of a policy’s “fraud and dishonesty” exclusion, an SEC settlement may also raise the potential applicability of a policy’s fraud and dishonest conduct exclusion. Specifically, the fraud and dishonesty exclusion found in most policies requires a “final adjudication” for the exclusion to apply. Coverage issues may arise over precisely what constitutes a final adjudication, particularly in the context of an SEC settlement agreement and implementing order. For example, in J.P. Morgan Securities v. Vigilant Ins. Co.,[v] the insured’s professional liability insurers sought to invoke the policies’ “dishonest acts” exclusions in order to preclude coverage for $250 million in penalties and disgorgement imposed by the SEC against now-defunct investment bank Bear Stearns & Company in a SEC consent order and related New York Stock Exchange stipulation of settlement. The insurers argued that the dishonest acts exclusion was applicable because by consenting to the entry of administrative orders that contained detailed “findings” and requiring Bear Stearns to make “disgorgement” payments and pay penalties, Bear Stearns had been adjudicated a wrongdoer. In its January 15, 2015 decision, the Appellate Division (First Department) of the New York State Court rejected the insurers’ argument, on the basis that the SEC and NYSE settlement agreements expressly provided that Bear Stearns “did not admit guilt, and reserved the right to profess its innocence in unrelated proceedings.” As such, the Appellate Division held that the settlement agreements and their incorporated findings did not constitute final adjudications for purposes of the policies’ dishonest acts exclusions. Accordingly, when entering into settlement agreements with the SEC, policyholders and insurers are advised to keep in mind the potential applicability of the fraud/dishonesty exclusion.

In view of the SEC’s ongoing heightened scrutiny of the private equity industry, private equity advisers are encouraged to examine their disclosure practices closely. Private equity policyholders and their insurers alike are advised to review their applicable insurance policy wording so that the potential risk and exposure associated with matters stemming from such practices may be adequately explored.

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[i] Ryan Dezember, “SEC Warns Fenway Partners of Possible Action,” Wall. St. J., April 3, 2015, available at http://www.wsj.com/articles/sec-warns-fenway-partners-of-possible-action-1428073087.

[ii] Chris Witkowsky, “SEC Investigates Consulting Fees, GP Clawback at Fenway Partners,” pehub.com, April 6, 2015, available at https://www.pehub.com/2015/04/sec-investigates-consulting-fees-gp-clawback-at-fenway-partners.

[iii] Private equity advisers and their insurers should also anticipate the possibility that disgruntled investors will separately file civil actions asserting claims under federal and state securities law as well as under common law to the extent that undisclosed or inadequately disclosed treatment of fees and expenses, valuations or other practices is material.

[iv] The definition of “loss” generally expressly excludes fines and penalties. Given that an SEC settlement agreement typically expressly delineates that a portion of the relief compromised constitutes fines and penalties, the lack of coverage for such relief is difficult for policyholders to reasonably dispute based on the loss definition. 

[v] 126 A.D.3d 76, 2 N.Y.S.3d 415 (1st Dept. 2015).

pwc3On April 10, 2015, PwC released the latest in what is now a series of annual securities class action litigation reports. PwC’s report is generally consistent with the reports previously published by Cornerstone Research and NERA. What makes the PwC report noteworthy is its commentary on the trends the report’s authors believe could contribute to future securities litigation. The PwC report, which is entitled “Coming into Focus: 2014 Securities Litigation Study” can be found here. PwC’s April 10, 2015 press release about the report can be found here.

 

My prior posts about Cornerstone Research’s annual securities litigation reports can be found here and here, and about NERA’s report can be found here. My own analysis of the 2014 securities class action lawsuit filings can be found here.

 

Review of 2014 Securities Class Action Litigation

Number of Securities Suit Filings: According to the PwC report, securities suit filings during 2014 were below longer-term filing levels, although with 169 filings during the year, the 2014 filings were above both 2013 (160 filings) and 2012 (149 filings). The report speculates that perhaps because of the suspense involved in waiting for the U.S. Supreme Court’s ruling in the Halliburton case in early 2014, there were fewer securities suits filing in first half of 2014 (79) than in the year’s second half (90 cases).

 

Inverse Relation between Securities Suit Filings and Stock Market Performance: The PwC report’s authors note the “countercyclical nature of federal securities class action filings relative to stock market performance.” In years in which the stock market outperforms the preceding year, the number of securities suit filings declines. When the stock market underperforms the prior year, the number of filings increases. The authors note that this pattern held in 2014; even though the stock market’s performance during the year was positive, it was below that of 2013, and the number of securities suit filings in 2014 increased compared to the year before.

 

Accounting-Driven Securities Suit Filings Increase: As the financial crisis-related litigation has wound down, accounting-driven securities class action lawsuits have increased, largely as a result of regulators’ actions. Accounting-related securities suits increased during 2014 both in the total number of cases (53, up from 46) and as a percentage of all cases filed (31%, up from 29%).

 

Twenty of the 53 accounting-related cases filed during the year included allegations of improper revenue recognition. Another scheme that can be used to boost reported earnings is to understate expenses; of the 53 accounting cases filed in 2014, 16 cases alleged the understatement of liabilities or expenses (up from seven filings in 2013). Another common trend in accounting-related securities suit filings is an allegation of lack of adequate controls over financial reporting. 31 of the 53 accounting-related cases alleged inadequate control over financial reporting.

 

Health Industry Targeted: The health industry (including pharmaceuticals, medical devices and health services) again had the highest number of securities class action lawsuits. 44 of the 2014 securities suits involved companies in the health industry, representing 26% of all securities suit filings during the year, compared to 36 (23%) in 2013.

 

Smaller Companies Hit Hard: Two-thirds (66%) of all companies named as defendants in securities suits in 2014 were “small-cap” companies (market caps of $2 billion or less). About one quarter of all 2014 securities suit filings involved “micro-cap” companies (market caps under $300 million).

 

Filings Against Non-U.S. Companies Increased: 21% of the 2014 securities suit filings involved foreign domiciled companies, compared to 19% of cases in 2013. Companies headquartered or incorporated in China were the most frequent target, accounting for 11 of the 35 cases filed against foreign issuers.

 

Anti-Corruption Enforcement Driving Securities Suit Filings: In 2014, six federal securities class action lawsuit filing following the public disclosure of SEC or DoJ investigations related to potential FCPA violations. There were also at least three securities suits filed in the U.S. following the disclosure of a regulatory or anti-corruption investigation outside of the U.S.

 

IPO and M&A Activity and Securities Suit Filings: The number of IPOs during 2014 (288) was at its highest level since 2007. Securities suit filings related to IPOs also increased during 2014. According to the report, there were 19 non-accounting federal securities class action lawsuits related to IPOs in 2014, compared to 13 in 2013. The elevated levels of M&A activity during 2014, along with the increasing complexity of many of the deals, also contributed to the 2014 securities class action lawsuit filings. During 2014, there were 15 securities suits filed in response to deals, which was the same number as in 2013.

 

Average, Median, and Aggregate Total Settlements Declined: The 2014 average securities suit settlement (based on the date the settlement was announced) was $40 million, down from $50.8 million in 2013. The 2014 median settlement was $6.7 million, down from $9.1 million in 2013. The total value of settlements in 2014 decreased “fairly sharply” to about $2.9 billion, down from $3.3 billion in 2013 and (excluding outliers) the lowest total in 10 years. Only 35% of settlements were above $10 million, well below the average of 50% during the previous four years.

 

Trends Likely to Drive Future Securities Suit Filings

Regulatory Activity Likely to Continue to Drive Securities Litigation Filings: Consistent with their observation that much of the 2014 securities litigation activity was “largely driven by the actions taken by regulators,” the PwC report’s authors suggest that the regulatory enforcement – and in particular, accounting enforcement — could continue to grow in the years ahead, leading to further securities class action litigation. In particular, the report suggests that the SEC’s increased focus on financial and reporting fraud is likely to lead to increased regulatory enforcement activity, with an attendant likelihood of increased follow on securities class action litigation activity.

 

Several current and likely future trends suggest the likelihood of increased regulatory enforcement. First, the SEC has deployed innovative analytic tools (such as the SEC’s Financial Reporting and Audit Task Force’s Accounting Quality Model) to detect anomalous patterns in financial reporting, supporting increased enforcement activity. Second, increased whistleblower activity encourage by the Dodd-Frank Act’s provision for whistleblower bounties is also likely to contribute to increased enforcement actions. Third, the increased attention to anti-corruption enforcement, both within the U.S. and abroad, is likely to continue.

 

The enforcement patterns suggest that, in addition to involvement in bribery or corruption schemes regulators will continue to be focused on targeting companies that lack comprehensive, accurate and reliable controls over financial reporting; have problematic accruals and reserves, valuation questions, revenue recognition issues, and frequently revised financial statements. When regulators target companies with these issues, “more often than not” the enforcement action is followed by securities class action litigation.

 

Cybercrime is a Growing Concern and Increasingly a Litigation Exposure: A company experiencing a data breach can attract regulatory scrutiny and even a regulatory enforcement action. In addition, “a successful cyber-attack also represents a potential liability exposure for corporate directors and officers via derivative lawsuits.” However, the report also notes that “it is not clear yet whether the continuing wave of data breaches will be a source of viable claims brought by the plaintiffs’ bar.” Nevertheless, “it is clear that company boards and senior management will continue to face scrutiny from a number of stakeholders for cybersecurity issues.”

 

IPO Activity and M&A Activity Will Continue to Drive Litigation: As long as the market for IPOs remains active, IPO-related litigation will continue to accrue. The PwC report notes that a factor contributing to the increased numbers of IPOs is the availability of the JOBS Act’s IPO on-ramp procedures, which, among other things, relieve “emerging growth companies” of certain disclosure and financial reporting requirements in connection with their offering. The PwC report states that this means “less transparency in the registration process,” which, taken together with the fact that the newer companies are “inherently higher-risk ventures” and “more susceptible to negative surprises” could mean “an increase in IPO-related federal securities class action litigation in the years ahead.

 

The increased size, complexity, and geographic scope of the merger and acquisition deals are also likely to contribute to increase levels of M&A-related litigation. The report’s authors also note that “with M&A volume predicted to be higher in 2015 than in recent years, it appears M&A-related securities litigation will remain robust and a significant business risk for yet another year.”

 

Discussion 

Although the various published securities litigation reports are directionally consistent, many of the specific numbers reported differ, in some cases substantially. Most of the differences can be explained by differences in the methodology used. For example, in counting the number of securities class action lawsuit filing, the PwC report counts multiple filings against the same defendant with similar allegations as one case, whereas other reports count multiple filings against the same defendant as separate claims where the filings occur in different judicial circuits, unless or until the separate cases are consolidated. Similarly, in calculating average, median and aggregate settlement amounts, PwC assigns settlements to a particular year based on the date the settlement was first announced; other reports assign the settlements according to the year the settlement was judicially approved.

 

As I noted in my own analysis of the 2014 securities lawsuit filings, it can be somewhat misleading to consider only the absolute numbers of securities suit filings in isolation from the number of companies listed on U.S. exchanges. The absolute number of filings, which in 2014 was below long-term average annual numbers of filings, might suggest that securities litigation activity is down. However, the number of companies listed on U.S. exchanges has declined substantially since the mid-1990s. Relative to the number of publicly traded companies, securities lawsuit filing activity is actually above long-term filing rates. Or, to put it another way, the likelihood that any given U.S.-listed company might experience a securities class action lawsuit is above long-term levels.

 

The PwC reports authors’ suggestion that there is likely to be increased levels of IPO-related litigation ahead corresponds to a prediction I made earlier this year. This projection is based on the assumption that increased IPO activity means increased IPO-related litigation. However, as I noted in a recent post, the number of IPOs completed in the first quarter of 2015 was well off from the levels of IPO activity seen in 2014, and the number of companies filing draft registration statements was also down during the first quarter as well. The significant numbers of IPOs completed during 2013 and 2014, as well as the usual lag between the IPO date and the date an IPO-related lawsuit complaint is filed, means that we will probably continue to see heightened levels of IPO-related litigation for some time yet. However, if the fall off in IPO activity that we saw in the first quarter of 2015 continues, the level of IPO-related litigation could start to fall off in time.

 

One area where I definitely agree with the PwC report’s authors is their suggestion of the likelihood that increased regulatory activity will continue to drive securities class action litigation. The SEC’s heightened monitoring for accounting fraud, the increased numbers of whistleblower reports, and the increased levels of anti-corruption enforcement are likely to continue to lead to follow-on civil litigation. One point the PwC report makes that is particularly important to note is the fact that regulatory outside of the U.S. has increased as well and this increased activity by regulators abroad has led to securities litigation in the U.S. (For example, consider the recent cases that have been filed against Petrobras, and Chemical & Mining Company of Chile, Inc.)

 

I also agree with the PwC authors’ inclusion of cyber security as an area of possible future litigation activity, but I agree also with their suggestion that it remains to be seen whether or not the plaintiffs’ lawyers will figure out a way to make money filing D&O lawsuits against the boards of companies that experience a data breach. There were two high profile derivative lawsuits filed in 2014 against companies that had been hacked (Target and Wyndham Worldwide), but there haven’t been any subsequent D&O lawsuits filed despite a number of very high profile hacks in the interim (e.g., Home Depot, Anthem, Sony Pictures). In addition, the Wyndham case was dismissed (as discussed here). The plaintiffs’ lawyers haven’t yet figured out how they are going to make money from the cyber breaches. That doesn’t mean that there won’t be viable data breach-related D&O lawsuits in the future, but for now, at least, the scourge of data breaches and hack attacks is not contributing significantly to the numbers of corporate and securities lawsuits.

 

The Problem with Plaintiffs’ Attorneys’ Fee Awards in Securities Class Action Litigation: The amount of the fees to be awarded to the plaintiffs’ attorneys’ in connection with securities class action lawsuit settlements is one of those recurring and troubling issues that never seems to be resolved. One of the goals of Congress in enacting the Private Securities Litigation Reform Act was to encourage class representatives to take a more active role in negotiating and monitoring plaintiffs’ attorneys’ fees. But that hasn’t really happened, according to a recent academic study.

 

In their February 11, 2015 paper entitled “Is the Price Right: An Empirical Study of Fee-Setting in Securities Class Actions” (here) Lynn Baker and Charles Silver of the University of Texas and Michael Perino of St. John’s University examined 434 securities class action settlements that were announced between 2007 and 2012. Their overall conclusion is the current system for setting plaintiffs’ attorneys’ fees is “deeply flawed.” The authors found that in the vast majority of cases, fees are determined after the fact, based only on the size of the settlement and the biases of the court. Congress’s goal in the PSLRA of encouraging lead plaintiffs to take a more active role in negotiating and monitoring plaintiffs’ fees has not been met.

 

Among other things, the authors found that in 85 percent of the cases, the plaintiffs’ lawyers were simply awarded the fees they asked for. With respect to the remaining 15 percent of cases in which the fees were cut, the authors could not find a meaningful way to predict why judges cut fees. The absence of readily identifiable factors for fee cuts suggests that the fee reductions are “for all intents and purposes random events.” The authors suggest that the cuts arguably reflect little other than the judges’ biases. The authors suggest that in order to avoid the problems with plaintiffs’ attorneys’ fee awards, the lead plaintiffs should be more active in negotiating the attorneys’ fees at the outset of the case.

 

Alison Frankel has a very good summary and discussion of the authors’ academic article in an April 10, 2015 post on her On the Case blog (here).

 

An Interesting Article about Cyber Insurance: There is no shortage of articles and other information about the cyber security threat, or even about cyber insurance. At this point, many of the articles on these topics have a certain repetitiveness about them. Just the same, I found an April 9, 2015 article published on the Cybersecurity Docket to be interesting. The article, entitled “Cyber Insurance: A Pragmatic Approach to a Growing Necessity” (here) and written by John Reed Stark and David R. Fontaine, suggests that rather than the standard approach to the process of acquiring cyber insurance, companies should “begin with a review of actual cyber-attacks experienced by others.”

 

The authors suggest that by analyzing and understanding the “workstreams” those companies have had to implement to respond to data breaches, companies can then “collaborate with its insurance brokers and originators to allocate risk responsibly and determine, before any cyber-attack occurs, which workstream costs will be subject to coverage; which workstream costs will fall outside of the coverage; and which workstream costs might be uninsurable.” I found the article interesting and worth reading.

 

 

doj1In one of the more troublesome recent developments for corporate officials who find themselves targeted by government investigations, both the U.S. Department of Justice and the Southern District of New York U.S. Attorney’s Office have made it clear that as part of the settlement of civil fraud actions, the governmental authorities intend to seek both admissions of misconduct as well as sanctions against the corporate executives involved. These developments are not only troublesome in and of themselves but also for the collateral consequences they could have for related proceedings. In addition, the admissions could have important implications for the continued availability of D&O insurance for the companies and executives involved.

 

As discussed in an April 6, 2015 article entitled “DOJ’s Pursuit of Admissions – And the Risks of Settling” (here) by Matthew Previn, Michelle Rogers and Ross Morrison of the Buckley Sandler law firm, both the DOJ and the S.D.N.Y. U.S. Attorney’s office have made it clear that they will “increasingly require” admissions of misconduct and individual accountability in the form of sanctions against corporate executives in resolving civil fraud actions.

 

The most recent example of this phenomenon the authors cite is the March 19, 2015 settlement that the S.D.N.Y. U.S. Attorney’s Office reached with Bank of New York Mellon in connection with the government’s allegations that bank engaged in fraud and other misconduct in providing foreign exchange services to its customers, in violation of FIRREA. The bank not only agreed to pay $714 million as part of the settlement, but the settlement also included specific admissions from the bank and one of its executives with regard to the alleged misconduct. For its part, the bank agreed that it would “admit, acknowledge and accept responsibility for” certain of the allegations as part of the settlement. The executive involved, David Nichols, agreed that he “admits and accepts responsibilities for” conduct the government had alleged in its complaint. The bank also agreed to terminate “certain executives,” including Nichols. The U.S. Attorney’s Office’s March 19, 2015 press release about the settlement can be found here.

 

As the authors note, the S.D.N.Y. U.S. Attorney’s Office has “been a leader among U.S. attorney’s offices in requiring such admissions in civil fraud settlements.” The Manhattan U.S. Attorney’s Offices has obtained admissions of wrongdoing in several recent civil fraud cases. For example, as part of the office’s July 1, 2014 settlement with HSBC bank relating to the bank’s alleged failure to monitor fees submitted for mortgage-related services, the bank not only agreed to pay $10 million, but it also “admitted, acknowledged and accepted responsibility” for certain misconduct specified in the settlement agreement.

 

It is worth noting for purposes of the discussion below about the collateral consequences of admissions, that the U.S. Attorney’s Office’s press release about the HSBC settlement highlights the fact that the civil fraud action followed a private whistleblower lawsuit that had been filed under seal under the False Claims Act, and even following the settlement of the civil fraud action the whistleblower suit remains under seal as the government continues its investigation.

 

As the authors also note in the article, the DoJ has also “increasingly insisted on admissions in civil fraud settlements.” Among other examples the authors cite is the DoJ’s August 2014 settlement with Bank of America of the government’s civil actions against the bank relating to its mortgage-backed securities practices. According to the DoJ’s August 21, 2014 press release (here), the bank not only agreed to pay a total of $16.65 billion as part of the settlement, but it and its Countrywide unit made admissions that “they were aware of that many of the residential mortgage loans they had made to borrowers were defective, that many of the representations and warranties they made to the [government sponsored entities] about the quality of the loans were inaccurate, and that they did not self-report to the GSEs mortgage loans they had internally identified as defective.”

 

Because the governmental policies behind the requirements for admissions of wrongdoing include a commitment toward “holding individuals accountable for alleged misconduct,” the DoJ and the Manhattan U.S. attorney’s office have not only “increasingly named corporate executives as defendants in civil fraud actions,” but it have in fact “recovered significant monetary penalties from executives, separate and apart from any such penalties imposed on the corporate employer.”

 

Among other examples of that that the authors cite is the December 31, 2014 settlement the S.D.N.Y. U.S. Attorney’s office reached with Golden First Mortgage Corporation relating to the government’s allegations with respect to the company’s participation in the FHA lender program. Both the company and its owner and President, David Movtady, not only “admitted, acknowledged and accepted responsibility for” the conduct the government alleged, but Movtady agreed to a $300,000 payment, in addition to the $36 million judgment to which the company agreed. The U.S. Attorney’s office’s December 31, 2014 press release about the settlement can be found here.

 

The fact that the DoJ and the U.S. Attorney’s office likely will “increasingly seek admissions of misconduct and individual accountability in civil fraud cases” makes the decision for companies and for their executives on whether or not to settle with the government “more complicated decisions.”

 

For the individuals involved, these issues are particularly fraught. The admissions of the type the government is requiring can have important consequences for the individuals. It is not just the employment implications, as was the case with the individual involved in the Bank of New York Mellon foreign exchange settlement referenced above, whose employment was terminated as part of the settlement. These kinds of admissions can, as the memo’s authors point out, put both the corporate and individual defendants in a position where they “could face increased exposure to criminal charges,” which is a particularly concern with respect to allegations of wrongdoing under FIRREA, as “its underlying predicate acts are violations of criminal charges.”

 

In addition, the “collateral consequences” from the kinds of admissions that the government is requiring include possible complication of parallel proceedings that are not resolved as part of the settlement with the government. A good example of this kind of problem is the False Claims Act action referenced in connection with the HSBC settlement described above; the settlement with the government did not resolve the whistleblower’s False Claims Act case, which remains pending and obviously was aided by the admissions the government required as part of the settlement. Many of these governmental civil fraud actions are accompanied by parallel civil litigation, such as shareholder litigation or other type of claims, that in most instances would not be resolved in a settlement with the government. The admissions the government and the individuals are required to make in their settlements with the government often will be helpful to the claimants in the parallel cases, often substantially so.

 

Another potential concern has to do with the D&O insurance of the companies involved. In most instances, there would be no coverage for the fines and penalties paid as part of the settlements. But the deeper concern for the entities and individuals forced to make these kinds of admissions in reaching settlements with the government is that the admissions might possibly trigger exclusions in the company’s D&O insurance policy. The triggering of the exclusions might not only preclude coverage going forward defense expenses but could also cause the insurer to seek to recover amounts that have already been paid. The loss of going forward defense cost coverage could be a particular concern where there are further parallel proceedings that will continue even after the settlement with the government. The individuals and the entity might face the prospect of having to fight continuing proceedings without insurance.

 

Whether a particular admission could trigger an exclusion will depend both on what specifically was admitted and on the specific wording of the exclusion involved. A careful litigant aware of these concerns might be able to negotiate admissions that are acceptable to the government but that might not trigger the exclusion. (For example, if the exclusion is only triggered if there were “deliberate” misconduct, the admission could be crafted to avoid any admission that the misconduct was “deliberate.”) Another factor in determining whether or not the exclusion is triggered where the exclusion has an “adjudication requirement” will depend on the procedures surrounding the admission; the carriers may seek to argue where the admissions are incorporated into the court’s judgment that the “adjudication” requirement has been met. Obviously, this concern also could be relevant during the settlement negotiations with respect to the specific forms in which the admissions will be made.

 

It is clear that the government authorities will increasingly seek to require admissions in connection with the settlement of civil fraud actions. As the memo’s authors state, given this likelihood, “corporate and individual defendants now more than ever need to weigh the possible consequences of a settlement incorporating those elements against the risks of litigating against the government.” Among the consequences that corporations and individuals will have to consider are the possible D&O insurance consequences.

Lebovitch_Mark_300dpiOne of the more significant recent developments in the corporate and securities litigation arena has been the emergence of the debate over fee-shifting bylaws following the Delaware Supreme Court’s May 2014 decision in ATP Tour, Inc. v. Deutscher Tennis Bund. Draft proposed legislation is now being considered by the Delaware legislature that would address fee-shifting bylaws, among other issues.

 

As part of this debate, Mark Lebovitch and Jeroen Van Kwawegen of the Bernstein, Litowitz, Berger & Grossmann law firm wrote a March 16, 2015 paper entitled “Of Babies and Bathwater: Deterring Frivolous Stockholder Suits Without Closing the Courthouse Doors to Legitimate Claims” (here) in which they contributed their views as plaintiffs’ attorneys on the fee-shifting bylaw controversy. A summary version of their longer article appears in an April 8, 2015 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation (here).

 

After reviewing their paper, I approached Mark to see if he would be willing to participate in a Q&A for this website, discussing his views on the topic. Mark agreed to participate, and our exchange is reproduced below. My questions are in boldface, Mark’s responses are in plain text.

 

By way of background, Mark is a partner at the Bernstein, Litowitz, Berger & Grossmann law firm. He heads the firm’s corporate governance litigation practice, focusing on derivative suits and transactional litigation. Since becoming a shareholder-side lawyer after leaving Skadden Arps as a senior associate, Mark has served as lead plaintiffs’ counsel in several of the highest profile and most successful shareholder lawsuits. I would like to thank Mark for his willingness to participate in this Q&A, which follows below. 

 

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I know your recent article opposes the Delaware Supreme Court’s opinion in the ATP Tour case for a wide range of policy and legal reasons. What was your immediate reaction to the opinion? At what point did you see the case as a threat to the viability of shareholder litigation itself?

When I first read the opinion, I was stunned. The Court justified bylaws adopted by the board of a member corporation that forced plaintiff-members to fund the board’s defense costs unless the plaintiff-members obtained substantially all the relief sought in their complaint. I kept waiting for the “but here’s the limitation” moment when the ruling would be cabined in some way so it would not apply to public companies. That moment never came. Instead, the opinion affirmatively said that “deterring litigation” was itself a proper purpose for a bylaw, without even including the word “frivolous.” As a result, the opinion seemed to invite boards to limit their accountability to the shareholders whose assets they manage by adopting fee-shifting bylaws. This outcome seemed totally inconsistent with everything I had believed about Delaware law. (I will note that the Chief Justice recently stated, publicly, that the Court did not contemplate that public companies would seize upon the ruling.)

Fee shifting provisions at public companies is just impossible to justify. They eliminate the ability of stockholders to pursue meritorious claims because you are letting corporations make an individual plaintiff seeking to achieve a benefit for a class of plaintiffs bear unknown and massive personal liability risk. Nobody would file suit knowing that the longer the case goes on, the larger the black hole of personal liability the stockholder will face if the case fails to get a complete and total victory. The deck is just stacked so fully against you that it would never make sense to begin the fight.

To me, it was just a matter of time before corporate CEOs, even those who generally mean well and try to do right by their shareholders, would be telling their executives and boards that by unilaterally passing a simple bylaw, they could now manage massive amounts of other people’s money without any fear of accountability to those investors. And sure enough, within days, certain corporate firms started recommending these bylaws to their clients, albeit nicely dressed up in some Orwellian terms that made the bylaws seem like a modest step.  

 

Since the Delaware Supreme Court issued its ATP Tour opinion, the question of whether or not corporate boards should be able to unilaterally adopt fee-shifting bylaws has been actively debated. What is your core disagreement with the reasoning of the Delaware Supreme Court in the ATP Tour case? If fee-shifting bylaws should not be allowed, are fee-shifting provisions in a company’s articles of incorporation OK?

My core problem is that ATP seemed to ignore the inherent conflict of interest in allowing a board of directors to pass a resolution and, voila, become effectively immune to shareholder enforcement of fiduciary and related duties. That conflict is very real.

To take a slightly theoretical perspective, giving directors broad power to use bylaws to affect core stockholder rights conflicts with former U.S. Supreme Court Chief Justice Oliver Wendell Holmes’ “Bad Man” theory of how you set up the law. I may be oversimplifying, but Holmes wrote that when you craft laws that regulate conduct, you do so with a bad actor in mind, not the moral person of high integrity, who will naturally behave in a socially acceptable way with or without the lines drawn by law.

The business judgment rule conforms to Holmes’ theory. Courts will not generally intervene or second-guess director decisions. But that presumption of normalcy goes away, and courts expose decisions to various degrees of judicial scrutiny, when there is some misaligned incentive or other logical basis to fear the directors may not act solely for the best interests of the shareholders whose assets they oversee. In other words, the law typically presumes directors are good people. Yet, when there’s a basis to fear self-interested conduct or signs of a misalignment of interests, the corporate law is realistic about the situation, and provides judicial protection against abuse by the “bad man.”

The ATP opinion was troubling because it applied the business judgment presumption to a context where the conflict of interest just seems so obvious. If directors can benefit themselves at the expense of stockholders by simply writing a bylaw insulating themselves from accountability, then you not only empower the “bad man” directors and officers that we all know exist, but you may even push good actors, the vast majority of directors who have integrity and truly want to do the “right thing,” towards harmful and conflicted conduct.

That gets us to your question about charter provisions. I think Professor Larry Hamermesh got it right in a recent article that considers the issue of consent from the perspective of reasonable investor expectations. Public company investors are entitled to have some basic expectations about how their companies operate, and the ability to enforce fiduciary duties sure seems to me to be at the very heart of the corporate structure itself. People simply cannot invest their savings and retirement money with public company boards if those boards are immune from accountability, whether or not the charter creates that circumstance. The idea that shareholders implicitly consent to fee-shifting provisions by buying securities rests on a misconception as to why investors buy securities in the first place. Nobody buys stock with a future lawsuit in mind; they buy because they believe the securities will increase in value. So while I don’t think it is conceivable that disinterested shareholders would ever agree to consciously impose fee-shifting on themselves, I also think that the economic proposition that is the public corporation just doesn’t work without enforceable fiduciary duties.

 

Do you also think that forum selection bylaws are inappropriate? If you are OK with forum selection bylaws, what is the difference?

I don’t have a fundamental problem with the end goal of getting shareholders to bring identical lawsuits in a single competent jurisdiction. But I question the means the corporations have used to achieve that end.

Traditionally, bylaws were like the “Robert’s Rules of Order” aspect of the corporate structure – they told you how to call a meeting, who could vote, how many make a quorum, and so on. Bylaws truly addressed the internal functioning of corporate affairs. Letting directors amend bylaws did not typically raise conflict of interest concerns. Using bylaws to dictate where stockholders could bring a lawsuit, which is the essence of the forum selection issue, still relates to an internal affairs issue, but it comes closer to affecting shareholders’ personal rights.

To be clear, I’m not saying you reject that use of bylaws. Frankly, a forum selection provision does not impair any shareholder’s right to hold his or her agents on the board accountable. And in the post-Chevron world, any debate on the issue is beside the point anyway. But once the Delaware courts allowed the use of bylaws to dictate where a lawsuit is filed, you have to ask where the line is drawn and worry about unintended consequences. If judicial forum selection is within the proper function of a bylaw, would discovery limits also qualify? How about forcing arbitration? Holding requirements to sue? Each of these potential consequences would impair shareholder rights to hold boards accountable. So I had no problem with the end achieved through the Chevron ruling, but I did worry about the means used to achieve that end because it opened the foor for boards to push the envelope on this.

 

What is your view of the proposed amendment that has been submitted to the Delaware legislature, which would bar public companies from adopting fee-shifting provisions in their bylaws or charters?

I think the proposed amendment is a helpful clarification that the ATP ruling approving fee-shifting bylaws does not apply to stockholder corporations, and should be approved without delay. That said, the proposal is clearly limited only to fee shifting and does not otherwise limit what can be achieved through bylaws. So while it fixes the fee shifting problem, I’m concerned that we’ve opened a Pandora’s Box and not fully gone back to the status quo. Overly aggressive directors and corporate advisors are now actively exploring creative ways to use bylaws to impair core stockholder rights.

Just consider how aggressive directors have become in using bylaws as a weapon against their shareholders to impede proxy contests. The once routine stockholder notice and nomination process has been transformed, via the latest generation of advance notice and nomination bylaws, into a complex labyrinth that requires hundreds of pages of disclosures and provides all sorts of pretexts for a board to reject a stockholder nominee. So I think that the fighting over the proper use of and role for bylaws is going to continue.

 

Delaware is not the only state where developments involving fee-shifting bylaws are underway. For example, Oklahoma’s legislature has enacted a statute authorizing companies organized under that state’s laws to adopt fee-shifting bylaws. Isn’t it inevitable that there will have to be some type of federal action on the topic of fee-shifting bylaws?

It seems to me that the Oklahoma fee shifting statute was a political outcome driven by people who really do want to eliminate board accountability altogether. Oklahoma’s statute appears to have been adopted in direct response to a ruling by an Oklahoma court sustaining a derivative breach of fiduciary duty claim. Denying a pleadings motion should not cause a legislative overhaul, but it seems the defendants may have had some influence with the Oklahoma legislature and used it to escape accountability for their alleged misconduct.

Anyway, I think that if the Delaware legislature approves the proposed legislation, it can send a powerful message and forestall calls for federal intervention. A failure to pass the statute, on the other hand, will increases pressure on the SEC, which was largely silent on the issue until its Chairwoman recently discussed fee shifting bylaws and suggested that state laws allowing fee shifting provisions would be subject to preemption in the federal securities context. Getting back to your comment about Oklahoma, I think that the Delaware legislature can make it harder for other states to engage in a destructive “race to the bottom.” The legislature could make clear that it rejects corporate fee shifting because you can’t have a credible and balanced legal regime that leaves investors at the complete mercy of their fiduciaries, without any real ability to take action in response to serious wrongdoing.

 

The context for all of these developments is that that many observers feel there has been an upsurge in frivolous litigation (or if frivolous is too strong a word, then unmeritorious litigation). Do you have any suggestions for ways that frivolous litigation can be deterred or discouraged while allowing meritorious lawsuits to go forward?

I’ve said and written for years that there are, in fact, problems in the field of stockholder litigation. It makes no sense that so many public company deals trigger a lawsuit. But that does not mean that you do away with shareholder litigation altogether. Look, just because there’s some mold in the basement, you don’t burn down the whole house. Or, to use a medical analogy, a good doctor observes the symptoms, diagnoses the disease, and then selects the treatment. It seems to me that because of the overblown hyperbole about the symptom – too much litigation – the corporate world skipped the diagnosis stage and proposed treatments that just kill the patient.

So I think you need to address frivolous litigation without preventing meaningful litigation. As we write in the article, quoting professor Coffee, don’t throw out the baby with the bathwater. By allowing supposed cures that do not differentiate between frivolous cases and cases that may have merit, you lose the benefit of meaningful stockholder litigation. I truly believe that the cases in which I invest my and my partners’ time and resources arise from real misconduct that genuinely warrants a meaningful remedy, and/or raise important policy issues that broadly affect the interests of stockholders in public corporations.

My partner and co-author, Jeroen van Kwawegen, and I, propose some changes to the litigation practice that could deter a majority of the M&A litigation that is filed today. We suggest ways to make the disclosure-only settlement far less attractive for plaintiffs and defendants alike. Our proposal, which has support in Delaware law, requires that disclosures providing the consideration for a settlement actually be material as a matter of law, and that the release be limited, absent good cause, to the nature of the disclosures provided. If you don’t have material disclosures, you don’t have consideration. And if you link the scope of the release to the disclosures, you have a fair quid pro quo. I think the demanding scrutiny on the materiality of disclosures and narrowed scope of releases, combined, would deter the filing of the weakest 50-65% of merger lawsuits going forward.

I’m sure others may have better ideas. But the key is to be targeted. Fix problems. Don’t use problems as cover to fundamentally change the relationship between shareholders and their boards, and thus make bigger problems.

 

In the last few years there has been an increase in the number of shareholder derivative settlements involving the payment of substantial cash amounts. Is there a reason we have been seeing more of these derivative suit settlements involving large cash payments? What are the factors that you think lead to a derivative suit settlement involving a large cash component?

There are a couple of factors, but I think the growth in derivative settlements finds a parallel in the securities class action field. You have been writing about the declining numbers, in volume and dollar value, of securities class actions. Plenty stock drops don’t even trigger lawsuits. That is because the pleading standards keep getting tighter, and people don’t really want to invest their own time in cases that are extremely likely to die on the vine. From the PSLRA, to Dura, Tellabs, Stoneridge, and more recent cases, the ability of investors to bring lawsuits, even some that appear to be meritorious, has consistently been narrowed. The result, which I think reflects an improved quality in the lawsuits that are actually filed and prosecuted, is an increase in the relative recovery per settlement, notwithstanding fewer settlements. It’s harder to bring a suit, but if a case gets past the pleading stage, it more likely than not does have some merit.

I think the same dynamic exists in the derivative litigation practice. It’s tougher to get a case past the motion to dismiss stage. In fact, it feels like the courts have been tightening the standards and showing a willingness to dismiss cases that I think might have survived in prior years. This also means that cases that are sustained are more likely to have merit. Also, the Chancery Court has shown that it recognizes when plaintiff’s lawyers are willing to assume real risk and litigate aggressively. So when lawyers have a good case, they know they will be rewarded for fighting for the last dollar.

The other reason for increased settlements may be better advice on the defense side. I’m sure there are plenty of defense lawyers who lose a motion to dismiss in a derivative case and tell their clients that the judge got it wrong or the law is too permissive. I’m sure some of those lawyers even believe what they say. But I think it’s a credit to the D&O counsel and better defense advisors that beneath their posturing, they recognize that some cases have merit and should rationally be settled (even at significant levels) to avoid devastating adverse legal rulings.

 

californiaThe federal False Claims Act imposes liability on those who defraud the government. The law also allows third-parties to bring so-called qui tam actions in the form liability claims under the Act; if the qui tam actions are successful, the third-party can receive a portion of the recovery. When a third-party files a qui tam action, the Act requires that the complaint remain under seal for at least sixty days and that it “not be served on the defendant until the court so orders,” so that the government can decide whether it wants to intervene and pursue the action. Even if the government declines to intervene, “the person who initiated the action shall have the right to conduct the action.”

 

The practical effect of these procedural requirements is that there is sometime a protracted lag between the date the qui tam action complaint is filed and the date it is served. These procedural aspects of the qui tam action process fit awkwardly with the standard management liability insurance policy provisions. Indeed, the coverage questions these kinds of cases present are recurring issues.

 

As discussed in a recent decision from the Northern District of California, the qui tam action process can raise basic questions about whether and when the qui tam action is a “claim” within the meaning of the policy, and, if it is a claim, when the claim is “first made.” In an April 3, 2015 decision, Judge Jon S. Tigar held that a qui tam action complaint that had been filed but not yet served represented a “claim” but had not yet been “first made,” and therefore that the defendant company’s management liability insurer’s duty to advance defense expenses had not yet been triggered.  NOTE: The link to the opinion  has been removed. The court’s docket state’s that the opinion is currently under seal and not available to the general public.

 

Background                       

In February 2012, the Department of Justice issued subpoenas to Braden Partners, LP, doing business as Pacific Pulmonary Services, requesting documentation related to Braden’s sales practices and claims for payment from federally funded healthcare programs. In August 2013, Branden obtained a redacted copy of a qui tam complaint that had been filed against it. The complaint alleged violations of the federal and California False Claims Act. The underlying complaint remains under seal and the court has not yet entered an order authorizing service of the complaint on Braden.

 

At the times Braden obtained the various subpoenas and later when it obtained the redacted complaint, Braden submitted them to its management liability insurer, which had issued a general partners’ liability policy to Braden for the policy period August 15, 2011 to June 1, 2012. The insurer denied that it had an obligation to advance Braden’s costs of responding to the subpoenas and in connection with the redacted complaint on a number of grounds, including its contention that the neither the subpoenas nor the unserved redacted complaint represented “claims” and that in any event the claim if any has not yet been “first made.”

 

In April 2014, Braden filed an action alleging that the insurer had breached the policy by refusing to advance the defense costs for the subpoenas and the underlying complaint. In an earlier ruling, Judge Tigar granted the insurer’s motion with respect to the subpoena-related costs. The insurer moved for judgment on the pleading with respect to Branden’s claims related to the underlying complaint.

 

The Relevant Policy Provisions

The policy at issue provided that the insurer “will pay on behalf of the Partnership all Loss which the Partnership shall become legally obligated to pay as a result of a Claim first made against the Partnership and reported to the Insurer during the Policy Period.”

 

The policy defines a “Claim” as:

 

(a) A judicial or other proceeding against a General Partner for a Wrongful Act in which such General Partners could be subject to a binding adjudication or liability for compensatory monetary damages or other civil relief, including an appeal therefrom, or (b) a written demand against a General Partner for compensatory money damages or other civil relief on account of a Wrongful Act.

 

Section (IV)(G) of the policy provide further that a “Claim shall be deemed to have been first made against a General Partner on the date a summons or similar document is first served upon such General Partner.”

 

The policy’s notice of claim provision provides, among other things, that

 

If during the Policy Period the General Partners or the Partnership become aware of a specific Wrongful Act that may reasonably be expected to give rise to a Claim against any General Partner… then any Claim subsequently arising from such Wrongful Act duly reported in accordance with this paragraph shall be deemed under this Policy to be a Claim made during the Policy Period.

 

The April 3 Decision 

In his April 3, 2015 Order, Judge Tigar granted the insurer’s motion for judgment on the pleadings, holding that while the underlying complaint is a “Claim” within the meaning of the policy, because it has not yet been served on Braden the claim has not yet been “first made,” and accordingly the insurer has no duty to advance defense expenses.

 

In ruling that the underlying complaint is a “Claim,” Judge Tigar rejected the insurer’s argument that because the complaint had not yet been served, it is merely a “threatened claim” and that Braden may never face liability. Judge Tigar said that “the Policy’s plain language merely requires the possibility of liability by adjudication, rather than absolute certainty.” He noted also that the policy “only references ‘service’ with regard to when a ‘Claim’ is deemed to have been ‘first made’ – not to determine whether the definition of ‘Claim’ is met.”

 

With respect to the “first made” question, Judge Tigar said that the policy’s provisions “unambiguously require service of summons or similar document to trigger coverage of a claim,” adding that “The Policy explicitly requires either service of summons or a similar document for a Claim under subpart (a) of the Policy definition to be deemed ‘first made’” Because the underlying complaint remains sealed and unserved, the “Claim” has not been “first made.”

 

Finally, Judge Tigar rejected Braden’s argument that the notice provision alters the requirement of a service of a summons for a claim to be “first made.” Judge Tigar said that “nothing in the language of the notice provision indicates that it functions to nullify, contradict or serve as an exception to the requirement that a ‘Claim’ be ‘first made’ by service of summons in order to qualify for coverage.”

 

Judge Tigar dismissed Braden’s complaint wihtout prejudice, noting that Braden may refile its complaint if necessary after service of the complaint in the underlying suit.

 

Discussion

As a noted in an earlier post discussing a coverage dispute involving a False Claims Act case, the qui tam case procedures are an uncomfortable fit with the typical management liability policy provision. The fact that a qui tam complaint can be filed but remain sealed and unserved for an extended period of time can be a particular problem, as the lag can extend across several policy periods – during which, as here, the company that is the target of the complaint is incurring legal expenses.

 

A particular problem here could be that even if Braden is eventually served with the qui tam complaint, the claim will be “first made” at the time of service. The policy under which Braden is seeking coverage had a 2011-2012 policy period. On its face, it might look like the claim was not “first made” during the policy period of the claims made policy. That is point where the “deemer” language in the policy’s notice provision would become relevant. Under the notice provision, when the complaint is finally served, it will be deemed to have been first made at the time of Braden’s initial notice, which did take place during the policy period. Judge Tigar’s opinion states that “the parties do not dispute that the requirements of the notice provision were met,” so it would seem that by that point, the insurer’s advancement obligations would finally be triggered.

 

Unlike the insurer in the coverage dispute discussed in the prior blog post to which I linked above, the insurer here would not be able to argue that coverage for the claim would be precluded by the prior and pending litigation exclusion, because the qui tam action had not been “filed or commenced on or before … the effective date of this policy.” The Braden qui tam action was “filed or commenced” after the policy period commenced. But while Braden might not have to fight over the prior and pending litigation exclusion, it could have other battles; Judge Tigar’s opinion recites that when Braden first submitted the redacted complaint to the insurer, the insurer denied coverage “based on several policy exclusions.” The policy exclusions on which the carrier was relying are not identified in the opinion.

 

Even if the policyholder here were able to overcome all of the hurdles and the insurer were to agree to advance defense expenses, the policyholder likely will still be stuck with all of the defense expenses that have and that will have accrued before the complaint was served. In more recent management liability policies, the definition of claim expressly references the service of a subpoena as a claim under a policy; in a policy with this more contemporary wording, an insured might be able to advance to an earlier time the point at which the carrier will start picking up the defense expenses.

 

Based on the case decisions that have come across my desk dealing with the issue, it looks as if the carriers are pretty invested in fighting coverage for qui tam actions. At one level, I understand this – as I noted at the outset, the qui tam action procedures are an awkward fit with many of the basic management liability insurance policy provisions. But it is not as if the carriers are coming right out and saying — as I think they should if they really don’t intend to cover these kinds of claims — “this policy provides no coverage from Loss arising from claims alleging violations of the federal False Claims Act or its state equivalents.” If the carriers are not taking the position that qui tam actions are simply not covered, then I think the industry needs to do a better job addressing the recurring issues qui tam actions present – particularly since we are basically talking about defense cost coverage here. There may need to be a specific policy provision addressing qui tam claims — for example, specifying modified definitions of the terms “Claims” and “first made” for purposes of claims alleging violations of the federal False Claims Act or state equivalents, and also making sure that prior and pending litigation issues are addressed as well.

 

Of course, it could be that the carriers feel that their policies simply do not cover False Claims Act claims, but if that is their position they should say so in an express policy exclusion, rather than depend on a thicket of miscellaneous policy provisions to deny coverage.

 

About the Judge — and His Father: Northern District of California Judge Jon S. Tiger has been a U.S. District Court Judge since January 2013. Before that, he was a state court judge in California. He is the son of the prominent criminal defense attorney,  Michael Tigar. When I was a very young attorney, I had the opportunity to meet Michael Tigar and to see him in action in the courtroom. The experience has stayed with me, because Michael Tigar was teriffic.

 

There is an interesting story about Michael Tigar. In 1966, after his graduation from U. Cal Berkeley law school, he had been hired to work as a law clerk for Justice William Brennan of the United States Supreme Court. However, after only a week, Brennan fired him  following complaints made by conservative columnists and FBI director J. Edgar Hoover, because of Tigar’s activist background as an undergraduate and law student at Berkeley. Despite this early setback, Tigar went on to have a very successful legal career (including a stint as a partner at Williams & Connolly). He eventually become a law professor at the University of Texas law school, among other things. The elder Tigar’s criminal defense clients included Angela Davis, Lynne Stewart, Terry Nichols, and John Demjanjuk.

 

In a March 12, 1990 New Yorker article about Justice Brennan entitled “The Constitutionalist” (here), the article’s author, Nat Hentoff, recounts asking Brennan about what happened with Tigar’s clerkship. The article quotes Brennan as saying about Tigar and the clerkship that “That was a very sad occasion for both of us at the time. Mike and I have remained good friends. He’s a great guy, a wonderful lawyer. What actually happened was a deluge. The right wing deliberately set up a program—a system of pressure—that involved Abe Fortas, who was on the Court then; J. Edgar Hoover; and, more particularly, Hoover’s right-hand man, Clyde Tolson. They bombarded me with all kinds of letters—all having to do with Mike’s participation in the Helsinki youth meeting. Probably, if I had just continued to face it down, the investigation would never have happened. But they had twenty-eight or more congressmen protesting Mike’s appointment. Clyde Tolson came over to see Fortas, and Fortas came in to see me to tell me that if I went through with this there might well be an inquiry, which would be most embarrassing to Tigar and to me—and to the Court.”

 

The interview recounted in the article continues as follows, with Brennan speaking first and Hentoff asking  responding questions and commenting:  

“I must say I’ve had a number of second thoughts,” he said. “I suppose I should have treated it as something that would go away, but I didn’t. I was very much concerned that—in the atmosphere of those days—if we got into this kind of thing it certainly would not have done the Court any good. That’s what I said in the discussion I had with Mike at the time. A clerkship simply could not have that much significance—if it was going to hurt the institution.”

“Did Tigar understand that?”

“Oh, Mike understood it perfectly.” Brennan paused. “That’s the only instance of anything like that I’ve had in all my years here.”

All that Professor Tigar will say is “I have enormous respect for Justice Brennan.”

 

 

stock pricesIt has been three years since Congress passed the JOBS Act in the hope that aiding “Emerging Growth Companies” would help create jobs. Among other things, the Act’s IPO on-ramp provisions were designed to encourage fledgling companies to go public, on the theory that that would boost employment. As discussed below, the legislation’s jobs creation track record is generally positive but also a little vague. There is no doubt, however, that the IPO market has been active since the Act was passed. Most of the companies that have gone public during that time have taken advantage of the Act’s IPO provisions, as detailed in a recent study also discussed below. But while there were more U.S. IPOs in 2014 at any time since the dot com era, IPO activity so far in 2015 is well off last year’s pace.

 

The JOBS Act’s IPO on-ramp provisions were designed to help emerging growth companies – firms with less than $1 billion in annual sales — to go public. The Act permits these companies to submit their initial filings to the SEC confidentially and to have expanded discussions with investors before the SEC has approved their offering documents. In addition, the eligible companies are relived from certain accounting and disclosure standards.

 

 

The purpose of these measures was to encourage job creation, and there appears to be some reason to think the Act has helped to spur employment. An April 3, 2015 Wall Street Journal article (here) reports that that “tens of thousands of related jobs have been created” by the Act, but “it’s a challenge to say just how many owe their existence to the bill.” The Journal says that the U.S. companies that completed offerings under the JOBS Act provisions added about 82,000 jobs since they completed their offerings, an increase of roughly 30% from their pre-IPO head counts.

 

However, attributing all of this job growth to the JOBS Act is a little questionable, since many of the companies would have gone public even if the JOBS Act had not been enacted. In addition, the impact if any has been concentrated in a few companies — more than 40% of the positions were created by just ten JOBS Act companies. The Journal article notes that “Economists say it is still too early to tell whether the law will lead to large-scale U.S. employment gains.”

 

While the Act’s impact on job creation may be uncertain, there is no doubt the Act’s IPO provisions have proven to be popular. The Journal reports that of the nearly 660 companies that have gone public since the Act became law, 539 companies (about 82%) have completed their IPOs under the JOBS Act’s provisions. Of those 539 companies, 454 were U.S. companies and 85 were domiciled outside the U.S.

 

It is certainly clear that the number of IPOs since the JOBS Act was enacted has jumped to the highest level in years. According to Renaissance Capital (here), 275 companies completed IPOs in 2014, compared to 222 in 2013 and just 128 in 2012 (the year the Act became law). The increased numbers of completed offerings are clearly due to the recovering economy and the healthy state of the equity markets. But even if the JOBS Act is not the direct cause of the increased IPO activity, its provisions are helping to facilitate the activity.

 

An interesting March 17, 2015 report from the Proskauer Law firm entitled “2015 IPO Report” (here) takes a very detailed look at last year’s IPOs, by focusing on the 119 U.S.-listed IPOs completed in 2014 with a deal size of $50 million or greater. The 144-page report analyzes these larger IPOs based on a number of criteria, including whether or not the offering priced in the target range; how many comments the SEC has about the companies’ offering documents; how much the companies incurred in fees and expenses; and how the companies fared post-offering.

 

The report also examines the extent to which the IPO companies took advantage of the JOBS Act provisions in connection with their offering. The report notes that of the 119 IPOs analyzed, 77% were emerging growth companies. 60% of the firms that qualified as emerging growth companies took advantage of the JOBS Act provision allowing them to submit only two years of audited financials and 52% took advantage of the JOBS Act provision allowing them to submit only two years of selected financial data. (Firms that do not qualify as emerging growth companies are required to include three years of audited financials and five years of selected financial information.)

 

The JOBS Act provision that the emerging growth companies really like is the Act’s provision allowing them to submit their draft registration statement on a confidential basis. Of the IPOs the law firm analyzed that involved emerging growth companies, fully 96% elected to submit their draft registration statement confidentially. The report also notes that on average, the emerging growth companies that submitted their draft registration statement confidentially made their first pubic filing 76 days after their first confidential submission and their offering priced 49 days after the public filings.

 

Interestingly, the report notes that a greater percentage of emerging growth companies priced above range than companies that did not qualify as emerging growth companies, and also that the emerging growth companies generally outperformed non-emerging growth companies.

 

Though 2014 was the most active year for IPOs since the go-go days of the dot com era, there are early signs that may suggest that the robust level IPO activity is waning, as noted in an April 3, 2014 Wall Street Journal MoneyBeat article entitled “Companies Saying ‘No’ to IPO” (here).

 

According to Renaissance Capital (here), through April 3, 2015, only 35 IPOs have priced year-to-date, a decline of 51% from this same point last year. The 34 offerings completed in the first quarter of this year is the lowest quarterly total since the fourth quarter of 2012, when there were 29 offerings completed. The decline in total offering proceeds for the year-to-date IPOs is even steeper. The 35 offerings completed through April 3, 2015 have raised a total of only $5.5 billion, compared to $12.6 billion raised as of the same date last year, a decline of 56%. The number of filings during the first quarter of the year was also off; the 49 filings in 1Q15 were the lowest quarterly number of filings since the first quarter of 2013 (when there were 36).

 

The Proskauer report suggests a possible reason for these declines. The report notes that there were important differences between the IPOs completed in the first half of 2014 compared to those completed in the second half. 45 percent of the second-half deals priced below range, compared to 25 percent of first-half deals. Second-half deals also generally underperformed first-half deals in the aftermarket. Either the quality of the deals declined during the year or investors lost their appetite for IPOs. Either way, the market for IPOs became tougher as 2014 progressed and we may be seeing the effects in the form of reduced IPO activity so far in 2015.

 

It is far too early to call the end of the current IPO wave. There is still a long way to go this year, and during the current wave the pace of IPO activity has ebbed and flowed a little bit. Even with the lower level of IPO activity in this year’s first quarter, the IPO pricings are on pace for 136 IPOs by year end, which would still be a higher number of IPOs than were completed in 2012. Renaissance Capital’s analysis of the current IPO market remains upbeat; in their 1Q15 IPO analysis (here), the firm said that “the solid performance of recent IPOs combined with a large active pipeline should support a more active second quarter.” But in light of the reduced number of IPO filings in the year’s first quarter, it does seem probable that there will be fewer IPOs completed this year than were completed in either 2013 or 2014.

 

As I have noted previously on this blog, increased IPO activity means increased IPO-related litigation. The year-to-date securities class action litigation filings bear this out, as eight of the 46 securities class action lawsuit filings so far this year (about 17%) have involved companies that completed IPOs in either 2013 or 2014. Given the usual lag between the IPO dates and lawsuit filings dates, we will probably continue to see significant numbers of IPO-related securities suit filings for some time. (There were, after all, 497 IPOs in 2013 and 2014.) But if the current slump in IPO pricings and filings continues, a decline in IPO-related litigation could follow.

del1One of the more distinct litigation phenomena in recent years has been the rise of multi-jurisdiction litigation, particularly in connection with merger objection litigation. Corporate advocates and defense attorneys have decried this development, as it has forced companies facing litigation to have to fight a multi-front war and to incur increased defense expense. At its worst, multi-jurisdiction litigation can also hazard the possibility of inconsistent rulings in different jurisdiction. The usual focus of any discussion of the problems of multi-jurisdiction litigation has been on the challenges it creates for the corporate defendants. However, as recent developments in the derivative litigation involving Wal-Mart stores and the scandal surrounding its Mexican operations shows, multi-jurisdiction litigation is not just a problem for defendants – it can also be a serious problem for competing sets of plaintiffs’ lawyers as well.

 

The Wal-Mart litigation relates to allegations of improper payments and of an alleged cover up relating to supposed improper payments the company’s Mexican operation paid to ensure approval or building permit for the company’s stores in Mexico. The allegations first came to light in an April 12, 2012 New York Times article entitled “Wal-Mart Hushed Up a Vast Mexican Bribery Case” (here). Following the publication of the Times article, various shareholders launched lawsuits against the company and its directors and officers. For example, plaintiff shareholders filed a series of securities class action lawsuits against the company and certain of its directors and officers that were consolidated in the Western District of Arkansas.

 

Plaintiff shareholders also filed derivative lawsuits based on the Mexican operations bribery scandal. All told, plaintiffs filed seven derivative suits in the Western District of Arkansas, where Wal-Mart’s corporate headquarters are located. The various Arkansas derivative actions ultimately were consolidated into a single proceeding. In addition, a separate plaintiff filed a books and records proceeding in Delaware, in light of that state’s courts’ well-known preference for prospective claimants to first review the corporate records before filing derivative lawsuits in Delaware’s courts. (Wal-Mart is organized under the laws of Delaware.)

 

Wal-Mart moved to stay the Arkansas action while the Delaware books and records proceedings went forward. While the Arkansas judge agreed to stay the cases in her court, in December 2013, the Eighth Circuit ruled that the Arkansas cases should proceed.

 

The Arkansas case then went forward, and on March 31, 2015, Western District of Arkansas Judge Susan O. Hickey, applying Delaware law, granted the defendants’ motion to dismiss, based on her determination that the plaintiffs had failed to made the requisite demand on the Wal-Mart board that the corporation should pursue the litigation and further had failed to establish demand futility. Among other things, Judge Hickey said that “Plaintiffs have failed to plead with particularity that [a majority of the] Director Defendants face a substantial likelihood of personal liability so that their ability to consider a demand impartiality would be compromised.”

 

A copy of Judge Hickey’s March 31 opinion can be found here. The FCPA Professor blog has a detailed review of the issues addressed in Judge Hickey’s ruling in an interesting April 2, 2015 post, here. The Arkansas plaintiffs’ lawyers have indicated they intend to appeal Judge Hickey’s ruling to the Eighth Circuit.

 

Judge Hickey’s ruling in the Arkansas litigation is obviously welcome news for Wal-Mart and for the individual defendants. It is very bad news for the claimants in the Delaware proceeding and their counsel. The claimants involved in the Delaware proceedings have been fighting actively for three years to try to obtain all of the documents sought in the books and records action. Now it seems likely that the Delaware claimants will be barred from pursuing their claims before they have even had a chance to file a complaint.

 

With the benefit of Judge Hickey’s ruling in hand, Wal-Mart and the other defendants will likely have the means to move to dismiss any lawsuit the Delaware claimants might seek to file. The defendants will likely be able to argue that under the principles of collateral estoppel, any action filed in Delaware courts would be precluded by the Arkansas ruling. In making these arguments, the defendants would be substantially aided by the Delaware Supreme Court’s 2013 ruling in the Allergan litigation, in which the Court held that an earlier dismissal by a California court was preclusive of an action in Delaware courts by a different set of plaintiffs, as discussed in detail here. (The likelihood that Wal-Mart would raise the arguments is significantly enhanced by the fact that its counsel representing Wal-Mart in the Delaware books and records proceedings is the same attorney that represented Allergan.)

 

As you might predict, the plaintiff’s counsel in the Delaware proceeding is unhappy about this turn of events. Indeed, it is fair to say that the lead Delaware plaintiffs’ lawyer, Stuart Grant of the Grant & Eisenhofer, is livid, as very colorfully described in Alison’s Frankel’s excellent April 1, 2015 post on her On the Case blog (here).

 

I should emphasize here that while Frankel’s post contains numerous quotes from Grant in which he is critical of the Arkansas plaintiffs’ counsel, her post also contains extensive statements from the lead Arkansas plaintiffs’ counsel defending their actions, refuting Grant’s remarks, and emphasizing the Arkansas plaintiffs’ intent to appeal Judge Hickey’s ruling. In the interests of balance and fairness, I encourage readers to read Frankel’s post in full, and in particular to read the statements of the Arkansas plaintiffs’ lawyer there.

 

Frankel’s post, entitled “War Looms Between Plaintiffs’ Firms After Suit vs. Walmart Board is Tossed” includes statements attributed to Grant to the effect that he is considering filing a malpractice action against the Arkansas plaintiffs’ counsel. “If I were them,” Frankel quotes Grant as saying, “I’d be letting my malpractice carriers know.” (Whether a shareholder could derivatively pursue a malpractice claim is one of those theoretical questions that we may or may not ever get to see tested. The Arkansas plaintiffs’ counsel dismisses Grant’s remarks about a malpractice action as a “temper tantrum.”)

 

In her blog post, Frankel also quotes Grant as saying that while he has not yet filed a complaint owing to the battle he has been fighting with Walmart over the documents, because of the material he has collected, his complaint would have been “much stronger” than the one filed in the dismissed Arkansas suit. In fact, he argues, his complaint, which he apparently still intends to file, will show why the Arkansas plaintiffs’ lawyers “ill-served shareholders by moving forward with a case before conducting a books and records investigation.” He adds further, with reference to the Arkansas dismissal, that “This is a perfect example of what happens when you have a small shareholder running to a foreign jurisdiction filing a derivative suit without investigation,” adding that “I don’t believe this is the way Delaware wants things to be.”

 

If I may paraphrase Grant’s remarks in my own terms, I would say that what this case is a “perfect example” of is how multi-jurisdiction litigation can turn out to be a problem for everybody, depending on how things play out. Where this situation got off track was when the Eighth Circuit lifted the stay in the Arkansas proceeding. After the appellate court lifted the stay, there were two sets of proceedings going forward, which is always fraught and often produces problems for somebody. Just the same, as the earlier Allergan case demonstrates, this is not the first time proceedings in another jurisdiction have superseded proceedings in Delaware.

 

It may be that these kind of competing proceedings will become less frequent as more companies adopt exclusive forum bylaws, designating a specific court (usually in Delaware) to consider intracorporate litigation. If as Grant suggests that the sequence of events is “not the way Delaware wants things to be,” forum selection (or exclusive forum) bylaws could help avert these kinds of situations. In any event, this case underscores how the curse of multi-jurisdiction litigation potentially can be a problem for everyone, not just the defendants – although, to be sure, in this case, Wal-Mart probably at this point does not have a problem with the way things turned out, at least so far.

 

It is worth noting that the various derivative lawsuits filed against Wal-Mart and arising out of its Mexican operations represent a trend I discussed in a recent post; that it, the number of corporate and securities lawsuits arising out of anticorruption investigations in Latin America. It could also be argued that the Arkansas derivative suit dismissal illustrates another trend I have noted on this blog, which is that often the follow-on civil actions filed in the wake of antibribery investigations and disclosures do not always fare all that well and many do not survive motions to dismiss. However, in fairness, it probably should be noted that in the parallel securities class action litigation arising out of the Wal-Mart operations regarding its Mexican operations, Judge Hickey denied the defendants’ motion to dismiss, as discussed here.

 

Olympus Securities Fraud Claims in Japan Settled for $92 Million: Readers interested in developments in securities litigation outside the U.S. will want to note that the scandal-plagued Olympus Corporation has agreed to a $92 million settlement with institutional investors that had asserted claims against the company in following the companies disclosures of accounting improprieties, as discussed in an April 2, 2015 article on Law 360 (here, subscription required). The claims reportedly were resolved using alternative dispute resolution processes that had been advanced by a litigation funder, DRRT. The article contains relatively little detail about the processes employed, the claimants involved, or how the settlement was brought about, but clearly it is a significant development with respect to the assertion of securities fraud claims in Japan, and perhaps even elsewhere.

 

For reference, DRRT does say on its website with respect to the Olympus litigation that: “A case against Olympus was filed in the Toyko District Court, Japan, on behalf of 50 institutional investors with over $240 million in damages on June 28, 2012. A second case was filed on June 25, 2013 adding over 40 institutions with more than $160 million in claims.”

 

Background regarding the Olympus scandal can be found here. In addition to the claims in Japan, certain shareholders had also filed a securities class action lawsuit in connection with the scandal, as discussed here. However, only a very small fraction of the shares of Olympus traded in the U.S. and, according to reports, the U.S. action settled for a payment of $2.6 million.

prAccording to the FDIC’s website (here), as of March 24, 2015, 44 of the 106 failed bank lawsuits the agency has filed have settled. So there is nothing particularly newsworthy about the fact that the parties to another one of the failed bank lawsuit had reached a settlement. Just the same, however, the recent news that one of the failed bank cases had been settled caught my attention, both because of the higher-profile history of the case and because of the unusually detailed features of the settlement disclosed in the settlement documents.

 

The recent settlement relates to the lawsuit that the FDIC had filed as receiver for the failed Puerto Rican Bank, Westernbank. Regulators closed Westernbank on April 30, 2010, which, according to the FDIC, cost the insurance fund $4.25 billion. In October 2011, certain of the former Westernbank directors and officers sued the bank’s primary D&O insurer in state court in Puerto Rico, seeking a judicial declaration that the insurer must defend that against claims the FDIC had asserted against them  (about which refer here). The FDIC, as receiver for Westernbank, moved to intervene in the state court action, and on December 30, 2011, removed the state court action to the District of Puerto Rico. On January 20, 2012, the FDIC filed its amended complaint in intervention, in which it named as defendants certain additional directors and officers, and, in reliance on Puerto Rico’s direct action statute, the various D&O insurers in the bank’s D&O insurance program. A copy of the FDIC’s amended complaint can be found here.

 

One of the reasons that this case had a higher profile (in addition to the magnitude of the losses to the FDIC insurance fund) is that there were a series of coverage rulings in the case addressing the question of whether or not coverage under the D&O insurance policies was precluded by the policies’ insured vs. insured exclusion.

 

As discussed here, on October 12, 2012, Judge Gustavo Gelpi  ruled that the insured vs. insured exclusion did not preclude coverage for the FDIC’s liability action against the former directors and officers, in part because at least in this case the FDIC not only sought to enforce the rights of the failed bank to which it succeeded as the failed bank’s receiver, but also because the FDIC also sought to enforce the rights of “depositors, account holders, and a depleted insurance fund.” As discussed here, on March 31, 2014, the First Circuit affirmed Judge Gelpi’s ruling that the insurers were obligated to advance the directors and officers defense expenses.

 

The insurers subsequently renewed their motion in the district court for summary judgment on the insured vs. insured exclusion issue, while one of the directors moved for summary judgment on the issue of whether or not the FDIC’s claims against the directors and officers involved alleged wrongful acts that were interrelated with wrongful acts that had been alleged against the directors and officers in an earlier lawsuit. The earlier suits (the “Prior Suits”) were filed in 2007 and 2008 and triggered the bank’s 2006-2007 D&O insurance program. Payments in settlement of the Prior Suits substantially diminished the 2006-2007 insurance program.

 

As discussed here, on July 9, 2014, Judge Gelpi, applying Puerto Rico law, held that the FDIC’s claims against the former directors and officers of the failed Westernbank did not involve the “facts alleged” against the directors and officers in an earlier lawsuit, and therefore were not deemed made at the time of the earlier lawsuit. Because he found the FDIC’s claims to be unrelated, the claims were covered by the policy in effect at the time the FDIC filed the claims rather than the prior policy that had been substantially eroded by the earlier claim. However, in an unusual twist, Judge Gelpi did conclude that one part of the FDIC’s claim was related to the earlier lawsuit and therefore that that portion (and that portion alone) was deemed made at the time of the earlier suit. The upshot of the ruling is that both the earlier and the subsequent insurance programs were in play.

 

The parties to the case now apparently have reached an agreement to settle both the liability and the insurance coverage portions of the lawsuit. As discussed in a March 31, 2015 Law 360 article (here, subscription required), Judge Gelpi has signed off on the parties’ $34 million settlement of the case. The settlement is detailed in the parties Settlement and Release Agreement (here). According to the agreement, the insurers are contributing $33 million toward the settlement, and “some of the D&O defendants have contributed $1 million toward the settlement.” The agreement does not specify which individuals were contributing toward the settlement or in what amount.

 

The settlement agreement includes a detailed description of the two insurance programs that were at play in connection with this lawsuit as a result of Judge Gelpi’s July 2014 ruling. The 2006-2007 program has total limits of $50 million, arranged in a primary layer of $20 million and three excess layers of $10 million each. The settlement agreement does not say how much of $50 million 2006-2007 program had been eroded by the earlier claim. The 2009-2010 program (the one in force at the time the failed bank claim was launched) also has total limits of $50 million, arranged in a five layers of $10 million each. The lineup of carriers changed slightly between the two programs, though the same carrier is in the primary position on both programs; that same carrier also had 10 x 30 layer on the 2009-2010 program.

 

For those interested in a “inside baseball” look into how a case like this gets settled, the settlement agreement also details how much each of the carriers involved are contributing toward the $33 million insurance portion of the $34 million settlement.

 

All of the carriers involved in the two programs contributed at least something toward the settlement amount. The carrier that is primary on both programs and that also has an excess position on the 2009-2010 program is contributing the largest amount toward the settlement ($16.33 million). The two lower level excess carriers that are on both programs are each contributing $6.33 million, and the two carriers that are in the top level excess position on the two programs are each contributing $2 million.

 

The failed bank litigation wave is now nearly five years old, as the first of the FDIC’s failed bank lawsuit following the financial crisis was filed in July 2010. As noted at the top of the post, more than a third of the lawsuits have already settled, and more of them will be settling in the months ahead. I suspect that Judge Gelpi’s various rulings in this case provided a motivation for the carriers to try to settle this case (as in, the carriers had had just about as much of this fun as they could stand). But, just the same, if a contentious, complicated case like this one can settle, many of the other cases can be settled as well.

 

As the cases are gradually worked out, the failed bank litigation wave will slowly wind down. To be sure, the FDIC is still filing lawsuits. It has already filed two more failed bank suits in 2015, after filing nineteen in 2014. With new lawsuits still accumulating, it will be a while yet before the litigation has finally wound down. But because the pace of new lawsuits has definitely slowed and because many of the other cases are moving toward settlement, we definitely seem to have moved into the wind down phase of failed bank litigation phenomenon.