scrutiny2Federal banking regulators have stepped up their interactions with and scrutiny of bank directors, according a recent Wall Street Journal article. The March 31, 2015 article, entitled “Regulators Intensify Scrutiny of Bank Boards” (here) details the ways in which regulators are “zeroing in on Wall Street boardrooms as part of the government’s intensified scrutiny of the banking system.” However, as the article also makes clear, the increased pressure is not limited just to the largest banks; smaller banks are also facing scrutiny. The level and intensity of the regulatory scrutiny, and of the regulators’ efforts to impose what amounts to performance standards, has raised concerns that the regulatory activity could encourage new director liability claims.

 

According to the article, the stepped up regulatory scrutiny is the result of concerns that that banking problems that contributed to the global financial crisis were due in part to the fact that banks’ boards did not understand the risks their firms were taking or did not exercise appropriate oversight. In the immediate aftermath of the financial crisis, regulators first focused on ensuring the banks had robust financial cushions. According to the article, in the last two years regulators have turned their attention to corporate governance and the role of directors to “ensure banks have the right culture and controls to prevent excessive risk taking.”

 

The practical result is that bank directors “have begun facing a new level of scrutiny.” The regulators are now focused on “whether directors are adequately challenging management and monitoring risks in the banking system.”

 

The article makes clear that the steps regulators are taking as part of this increased scrutiny are nothing short of extraordinary. It is clear from the article that that the specific steps regulators are taking varies from institution. But the range of actions regulators are taking is quite broad and arguably even intrusive in some cases.

 

Among other thing, according to the article, regulators are holding regular meetings with banks’ independent directors; “singling out boards in internal regulatory critiques of bank operations and oversight”; attending and sitting in on board meetings; meeting with board committee members; and even, in one case detailed in the article, dictating the makeup of the board by requiring the expansion of the board by the inclusion of additional independent board members.

 

In addition, regulators are reviewing information directors receive from bank management; asking about succession planning; and inquiring about how directors gauge the potential downsides of certain transactions.

 

Although the banking institutions mentioned by name — such as Goldman Sachs, Bank of America, J.P Morgan, and GE Capital – are among the world’s largest financial institutions, the article also emphasizes that “directors at smaller banks are also being pressed, including on how much they understand and the kinds of loans banks are making and the associated risks.”

 

It is little wonder then that, as stated by the Comptroller of the Currency Thomas Curry in the article, that “We have the independent directors’ attention.”

 

The heightened regulatory scrutiny has triggered alarm bells. According to one independent board member quoted in the article, the threat of being held accountable for failing to properly supervise management is “creating a ton of tension” for directors. Some regulatory moves have raised concerns that the banking supervisors are pushing directors to “take on managerial duties beyond their traditional roles as overseers.”

 

These concerns about the pressure on directors and the expansion of the directors’ roles have in turn raised concerns that the “new, material obligations” being placed on boards “could give rise to new director liability claims.” These fears about potential future director liability claims are reinforced by the wave of lawsuits the FDIC brought against the former directors and officers of failed banks in the wake of the financial crisis.

 

These concerns about potential personal liability have in turn raised concerns about whether banks might have trouble recruiting and retaining qualified directors. The Journal article quotes one commentator as saying that there are many qualified individuals who “simply … won’t serves as directors … because of fear” of personal liability. The article also quotes a federal regulator as conceding that regulators are sometimes guilty of placing too may requirements on boards.

 

Discussion

The suggestion that increased regulatory scrutiny and heightened regulatory expectations could lead to new liability claims against directors is not far-fetched. To the contrary, some regulators have made overt, express calls for the scope of fiduciary duties expected of bank directors to be expanded (at least for directors of systemically important financial institutions), as discussed, for example, here. These public statements, along with the level of regulatory expectations of directors, suggest that regulators may consider expanded director accountability to be appropriate. As the Journal article correctly points out, the FDIC failed bank lawsuit show not only that banking regulators intend to hold directors accountable and even to seek to impose liability on them.

 

Nor is it far-fetched to contend, as the Journal article suggests, the (apparently well-founded) fears of personal liability may deter qualified persons from serving on banking boards. As I discussed in a prior post (here), a recent survey of the American Association of Bank Directors found that existing and potential bank directors increasingly are unwilling to serve due to fear of personal liability. Among other things, the survey results showed that nearly a quarter of the survey respondents have had a director or potential director shun or shy away from board service based on personal liability concerns.

 

It is important to emphasize that, although the Journal article highlighted developments involving the largest Wall Street firms, the article also showed the increased scrutiny is not restricted just to the global financial firms. The increased scrutiny also extends to smaller institutions.

 

Among the more troubling items in the article is the suggestion that the banking regulators are creating written “regulatory critiques of bank operations and oversight” and that boards are being “written up” in supervisory reports. Although these type of reports are highly confidential and would be very difficult for non-regulatory claimants to obtain, the fact that they exist and the possibility that they might come to light in claims brought by third-party claimants adds an additional layer to the concern that the increased regulatory scrutiny could lead to increased personal liability for bank directors.

 

Given the magnitude of the problems at financial institutions that came to light in the global financial crisis, it may be no surprise the bank directors are facing heightened scrutiny. Just the same, the level of scrutiny, and the forms that the scrutiny is taking (as detailed in the Journal article), pose a significant challenge for banks, for bank directors, and for the banks’ D&O liability insurance carriers. The possibility that the current level of heightened scrutiny might foster new director liability claims is of particular concern.

 

Corporate Boards and CFO Hiring: The same Wall Street Journal issue that contained the article discussed above about regulatory pressure on bank directors and the directors’ changing roles included another article about the changing roles of corporate directors. An article entitled “Boards Join in CFO Picks” (here) discusses how “corporate boards are playing an increasingly pivotal role in choosing CFOs.” Companies identified in the article where directors played an active role in recruiting and hiring the firms’ Chief Financial Officer include Google, McDermott International, Avon Products, and Newell Rubbermaid. The article also notes that boards “also can help unseat underperforming finance chiefs.”

 

The increased board role in CFO hiring – and sometimes firing – is in part due to the heightened expectations of the Sarbanes-Oxley Act and in part due to the financial crisis, which underscored the importance of “having a veteran at the helm.” In addition, “directors are also assuming a stronger role because more finance chiefs now rise to the top job.” According to sources cited in the article, 12 of the Fortune 50 CFOs are former finance chiefs.

 

There is no doubt that the boards’ increased involvement in CFO hiring is a direct consequence of the changed environment in which boards conduct their business these days. Investors (and as discussed above, regulators) increasingly expect active board involvement, and in turn boards are increasingly engaged in company operations in ways they might not have been in the past. Overall, increased board involvement in CFO hiring should be a positive thing, particularly as it is portrayed in the Journal article.

 

But perhaps because I read the Journal article about increased board involvement in CFO hiring immediately after reading the article discussed above about bank director scrutiny, I immediately thought about whether increased board involvement in CFO hiring and firing might also lead to liability claims.

 

I can imagine these kinds of potential claims taking at least two forms. On the one hand, because, as the article details, some corporate boards are becoming actively involved in CFO firing, it is possible claimants might assert that the board of a company that sustained problems because of CFO misconduct breached its duties by failing to act quickly enough to discharge the deficient finance chief. By the same token, if a company were to sustain problems because of misconduct by a CFO that the board had proactively recruited and hired, claimants might try to assert that the board breached its duties through its negligent recruiting and hiring activities (for example, by failing to scrutinize the candidate or identify past problems).

 

All of which is another way of saying that in an era where boards are increasingly under scrutiny, even the actions of an active and engaged board can come in for criticism and challenge. Or to put it another way, in our hyper-litigious society, even a seemingly positive development could lead to litigation.

 

More About Shareholder Activism: In a recent post (here), I jumped into the ongoing debate about shareholder activism, a topic that has grown importance as level of shareholder activism has grown. Readers who are interested in the topic will want to read the cover article in the latest issue of the American Lawyer. The March 30, 2015 article, which is written by Michael Goldhaber and is entitled “Marty Lipton’s War on Hedge Fund Activists” (here, subscription required), frames the debate on shareholder activism in terms of the continuing battle between corporate champion Marty Lipton of the Wachtell Lipton law firm and the Harvard Law School Professor and corporate scourge, Lucian Bebchuk.

 

As the article states, the only thing the two can agree on is that, lately at least, “the activist hedge funds are winning the war.” As for whether or not this is a good thing, that “depends on which narrative you accept.” In Lipton’s view, the activists are short-term focused and very bad for the economy. In Bebchuk’s view, the activists’ efforts regularly create shareholder value that is sustained over the longer term.

 

The article quotes a chorus of voices suggesting that perhaps the real answer is somewhere in between. Among other things, critics arguing for the middle view suggest that while activists are not as evil as Lipton suggests, Bebchuk does not look at the effect of their activities on the economy as a whole, as they cut corporate spending by laying off workers and cutting R&D budgets. Others suggest that Lipton is too willing to overlook executive compensation excesses.

 

After laying out the parameters of the debate, the article concludes with reference to Delaware Supreme Court Chief Justice Leo Strine’s call for institutional investors to become more involved, particularly in making sure that short term thinking does not overwhelm strategic corporate decision-making. As the article quotes the venerable New York lawyer Ira Millstein as saying, “Companies and pension funds are getting smarter. If the real investors think the activists are wrong, then they don’t have to go along.” 

 

cornerstone reserach pdfThe number of securities class action lawsuit filings raising accounting allegations rose by 47 percent in 2014 compared to the prior year, according to a new report from Cornerstone Research. The March 31, 2015 report, entitled “Accounting Class Action Filings and Settlements: 2014 Review and Analysis,” can be found here. Cornerstone Research’s March 31, 2015 press release about the report can be found here.

 

The report tracks what it calls “accounting cases,” which are cases that include allegations related to Generally Accepted Accounting Principles (GAAP) violations, auditing violations, or weaknesses in internal controls over financial reporting.

 

According to the report, there were 69 accounting case filings in 2014, representing 41% of all securities class action filings during the year, compared with 47 accounting case filings in 2013, representing 28% of all securities suit filings during the year. The 69 accounting case filings in 2014 is roughly equal to the 2005-2015 average annual number of accounting case filings of 68. The increase in the number of accounting case filings “occurred against the backdrop of a year marked by essentially no change in the overall securities class action filings activity.”

 

The filing of accounting cases that also involved an SEC inquiry or action reached the highest level in 2014 since Cornerstone Research began tracking this factor in 2010. In 2014, 18 accounting cases related to an SEC inquiry or action, compared to only five in 2013. The report notes that the rise in the number of accounting cases with associated SEC action is “consistent with the SEC’s increased focus on identifying accounting-related fraud.”

 

The report also examines what it calls disclosure dollar loss, which is the dollar value change in the defendant firm’s market capitalization between the trading day immediately before the end of the class period and its capitalization immediately after the end of the class period. The report notes that the disclosure dollar loss declined significantly for all securities class action filings in 2014 compared to 2013, but the decline for accounting cases (35%) was less severe than for non-accounting cases (52%). In 2014, accounting cases amounted to 50 percent of the aggregate disclosure dollar losses for all securities suit filings, even though only 41 percent of all securities class action lawsuits were filed as accounting cases.

 

The number of restatement cases increased in 2014. There were 29 cases filed in 2014 involving restatements, representing 42% of all accounting cases filed during the year, compared to 19 restatement cases representing 40% of all accounting cases in 2013. The 29 restatement cases filed in 2014 was the highest number in the last seven years and is well above the 2009-2013 annual average number of restatement case filings during the period of 19. The increase in the number of restatement case filings during 2014 was “consistent with data showing that the number of restatements by accelerated filers (i.e., large companies that are heavily targeted in securities class actions) has increased in recent years.”

 

The report also notes that the median stock price drop surrounding announcements of financial statement restatements was “the second highest in the last 10 years.” The aggregate disclosure dollar loss for accounting case filings with restatements was over 80 percent greater than the average between 2005 and 2013.

 

For the past two years, the number of accounting case filings involving allegations of internal control weaknesses has increased; indeed, the number of accounting case filings alleging internal control weaknesses was higher in 2014 than any of the previous five years. Of the 29 accounting case filings that included a restatement, two in three also included allegations of weaknesses in internal controls.

 

The report also notes that accounting cases generally involve higher “estimated damages” (a simplified calculation of shareholder losses) that securities class action lawsuit filings without accounting allegations, a trend that continued in 2014. Overall, the report also notes that the median settlement for accounting cases has also been higher for accounting cases than for non-accounting cases. The presence of a restatement is a significant factor in explaining higher settlements amounts, and as is the existence of a related SEC action or inquiry. Cases involving restatements have settled for the highest percentage of “estimated damages.”

 

In 2014, there were 44 settlements of accounting cases, representing 70% of all securities class action settlements during the year, the highest proportion of settlements since 2010. The aggregate value of accounting case settlements as a portion of aggregate value of all securities class action lawsuit settlements represented an even greater proportion; the accounting suit settlements represented 85% of the total value of all securities class action lawsuit settlements.

 

My recent post on Cornerstone Research’s annual report on securities class action lawsuits generally can be found here.

 

 

004aThe D&O Diary rounded out its European visit last week with a quick weekend visit to Paris. In addition to a rendezvous with friends and family, the stopover included several long walks, two encounters with the Parisian contemporary art museum scene, and one extraordinary meal.

 

The best of the weekend’s walks was an energetic march through the Bois de Boulogne, the enormous park and preserve at the Western edge of the city of Paris, where the flowering plants and trees were blooming in the late March sunshine. At 2,090 acres, the Bois de Boulogne is nearly two and a half times larger than Central Park. Along the park’s east side are a winding set of pathways flanking a series of ponds. The ponds include a number of interesting and curious structures, including the Kiosk of the Emperor on an island in the Lac Inferieur (lower lake), as shown in the picture below.

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041aAs pleasant as our stroll was, the primary purpose of our visit to the park was to see the Louis Vuitton Foundation (pictured left), the new $143 million art museum designed by the famed architect Frank Gehry. The museum opened in late 2014. The glass, wood and stone structure is built in the shape of sailboat sails inflated by the wind. The glass exterior shapes enclose a central stone structure that includes a series of multilevel roof terraces. The terraces afford views of the Bois de Boulogne (first picture below), and, to the west, to La Défense, the agglomeration of modern, high-rise office buildings just outside the city (second picture below)

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020aThe two-story structure encloses eleven galleries of different sizes. The museum’s collection includes works of contemporary art assembled from a combination of works owned by LVMH and Bernard Arnault. The casual visitor will find the works on exhibit to be avant-garde, experimental and, often, obscure. All of the works are high-concept, mannered, and many are difficult (deliberately so, one can only assume). One work on display was a pile of metal ironing boards. Another room contained large paintings of canvases cut in basic geometric shapes, painted in a single color – a black rectangle, a red rhombus, a green parallelogram. A very large room on the ground level contained a massive audio system playing the music of Kanye West, with a video projected along the back wall. The video was created by the award-winning director Steve McQueen. In the video, Kanye walks around. Or looks around. Then he sits down. Then he stands up. Etc. The music is very, very, very loud.

 

022aThe building itself is a challenge for the art inside. The building is so massive and its style so flamboyant that the art inside is almost overwhelmed. The overall effect is that the art can seem insignificant and ephemeral.

 

Despite my skeptical remarks, I recommend a visit to the museum for any Parisian tourist. The building is striking and remarkable. Indeed, I would recommend visiting the museum sooner rather than later. Time could prove me wrong, but I fear that the beautiful white stone and the exposed wooden beams that affix the glass exterior to the interior stone building will not age well. In particular, I am concerned that time and weather will diminish the inspiring glimpses of the building’s complex structure from the terraces.

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051aAs much as I enjoyed my visit to the Fondation, in terms of the art on display, I have to say that I preferred the contemporary art collection in the Palais de Tokyo, which we visited early the next day. The Palais is located on the Seine, across the river and just upstream from the Eiffel Tower. The collection in the Palais is much larger, and the works are much more adventurous and even rebellious – and in at least some instances, deliberately humorous. The Palais opened in 1937 as the pavilion of modern art for the Universal Exposition held that year in Paris. The museum’s rather conventional 20th century building is the modest backdrop for the 21st century art within. On the day of our visit there were two particular interesting exhibitions; the first, L’Usage des Formes (The Use of the Form), explored the artistry of tools and instruments used in craftsmanship. The second, Le Bord du Mondes (The Edge of Worlds), featured contemporary art from around the world (particularly Southeast Asia).

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This Paris visit culminated in a very unusual dinner on Saturday night, in which ten friends gathered to discuss the philosophy of Epicureanism over an excellent French meal accompanied by a profusion of French wine and champagne. The hours-long discussion took place exclusively in French. Early in the evening, I felt like I was holding my own. But as the evening wore on and the empty bottles accumulated, I was content to listen and to try to keep up with the increasingly animated discussion. This was no mere intellectual exercise; passions were engaged as well. Indeed, late in the evening, one of the guests — after a heated exchange with another guest in which both were shouting “non, non, non, non, non” at each other in true Gallic fashion – suddenly got up and left, in a fit of philosophical rage. It was an extraordinary evening, but I have to confess that as I made my way to the Metro at the end of the evening, my head ached from trying to listen to and comprehend the French conversation for several hours.

 

For those readers who may have an interest in Epicureanism, I highly recommend Harvard Professor Stephen Greenblatt’s National Book Award-winning book The Swerve: How the World Became Modern, which tells the tale of how the Italian 15th century humanist  Poggio Bracciolini found  long-forgotten manuscripts of Lucretius’s epic philosophical poem De rerum natura, which contains the tenets and philosophy of Epicureanism, and how the philosophy influenced modern thought. I should add that the book was gift to me from my good friend, Perry Granof.

 

Lest anyone think my weekend in Paris involved only effete entertainments, I should add here that my visit also included an evening at the Moose Bar (a Canadian-themed watering hole in the Odeon district favored by ex-pats) watching the French national team lose 1-3 to the Brazilian team in an International Friendly soccer match. Late in the evening, after the soccer game ended, we had the unexpected experience of watching the start of an NCAA tournament basketball game deep in the heart of the Rive Gauche.

 

Every time I visit Paris I wish I had planned to spend more time there. Of course, if every visit to Paris is too short, a weekend visit is particularly so.

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065aThe D&O Diary was in London this week for meetings and a couple of industry events. Though my schedule on this visit was full, I did have a little time between meetings for a bit of touristing. I have been to London many times before, but I always try to make a little time to walk through the city’s many historic sites, like, for example, St. James’s Park (pictured left, looking toward the Old Admiralty Buildings).

 

I also always try to go somewhere I haven’t been before. This time, I managed to make time to visit Hampstead Heath, which covers 790 acres in the northern part of the city. I took the Northern Line Underground train to Kentish Town, and walked to Parliament Hill in the southern end of the park, which at an elevation of about 350 ft. is one of the highest points in the city. Even though it was a little hazy the day I visited, looking south from the hilltop back toward the city center, I could clearly make out Canary Wharf, the Gherkin, the Shard and St Paul’s Cathedral. Because of the haze and the sunlight to the south, the view was hard to photograph, but I have tried to depict the view in the first picture below. There is no consensus on how Parliament Hill (shown in the second picture below) got its name, but the likely explanation is that the Houses of Parliament could be seen from the hilltop (although on the day I was there I was unable to make out the actual Parliament building, which is about 6 miles away). I actually prefer the story that the hill got its name because Guy Fawkes and the other Gunpowder Plot conspirators retreated to the hill to watch the Parliament building blow up. (Their plot failed.) I will say that the Heath was an extraordinarily pleasant place to stroll on a sunny but chilly March morning. The third picture below is a view back across the Heath to Kentish Town. The final picture is a view back towards the Heath itself.

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078aOne other place I made some time to visit was St. John’s Wood, a  high-end residential area in the city’s northwest. The churchyard adjacent to the St. John’s Church that gave the area its name was also an agreeable place to visit on a sunny morning (as depicted in the picture to the left). The High Street in St. John’s Wood has a well-kept, prosperous feel to it (as depicted in the picture below). However, I wanted to visit the area for other reasons. The first was to see Lord’s Cricket Ground, which is located across the street from the church. The second, more important reason was the line in the Rolling Stones’ song, “Playing with Fire” (which was the B-side on the 45 rpm version of the Rolling Stones’ 1965 hit “The Last Time”). The lyrics to the song go like this: “Your mother she’s an heiress, owns a block in St. John’s Wood/And your father’d be there with her, if he only could/But don’t play with me, ’cause you’re playing with fire.” Given the suggestion in the song’s lyrics, I was not surprised to find that there actually are quite a few very high-end houses in the area, particularly on Avenue Road. Wikipedia reports that “in 2013, the price of housing in St John’s Wood reached exceptional levels. Avenue Road had more than 10 large mansions/villas for sale. The most expensive had an asking price of £65 million, with the cheapest at £15 million. The remainder were around £25 million.” St. John’s Wood is also the home of the Abbey Road recording studio the Beatles made famous in their 1969 album. It was difficult to get a picture zebra-striped crossing without a group of people in the cross-walk trying the recreate the album cover.

 

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013aBetween my meetings and my touring around, I managed to spend a fair amount of time during this visit on the Tube. There is nothing like the vacant time during a subway ride to allow your mind to wander and to contemplate things like, say, the interesting and odd assortment of place names in and around London. In the Underground with nothing else to distract, things occur to you, like, for instance, there probably once was a white chapel in what is now Whitechapel, and there were once black friars in what is now Blackfriars. But was there a ham in West Ham? Or, for that matter, East Ham? And what are we to suppose about the origins of such place names as Spitalfields, Cockfosters, Tooting Bec, Chigwell, Fairlop and Barking? And even without these mysteries to ponder, there are the other curious names – such as Shepherd’s Bush, Elephant and Castle, Mudchute, and Upminster?  Then there are the odd re-occurrences of similar sounding names. Not only is there an Underground station named Cannon Street, but also there is a Canning Town stop and a Canons Park stop, and there is both an Edgware stop and an Edgeware Road stop (the two stations are on different lines and nowhere near each other), and both a Kennington stop and a Kensington stop (not to mention West Kensington, South Kensington, and Kensington High Street). There’s an Ealing Broadway, a Fulham Broadway and Tooting Broadway. Also Bethnel Green, Stepney Green, Golders Green, Parsons Green, Turnham Green — and Green Park.

 

005aFor an American traveling on the tube, there are also the unfolding revelations about many of the place name pronunciations. For most uninitiated U.S. visitors, the most surprising station name pronunciation is that of Leiscester Square – not just the first word, which most Americans are surprised to discover is pronounced not “lye-chester” but “lester” – but also the second word, which is pronounced with two syllables, as “skway-uh.” Even a station name as seemingly straightforward as Earl’s Court turns out to involve sonic surprises – it is pronounced “ulls coat.” (The  Earl’s Court station is pictured left.) Even a familiar name like Arsenal can surprise – it is not “Ar-son-ul” as an American might expect but rather it is “Ah-snull.”

 

And beyond the place names, there are the street names – Crutched Friars, Mincing Lane, Seething Lane, Savage Garden. The street names sound vaguely like detective novel titles or rock band group names.

 

By the way, if you have ever wondered who that lady is that does the in-train station announcements on the London Underground, her name is Emma Clarke, a professional voice-over performer. Her website, with links to sample of her various announcements – including her silky smooth reminder to “Please mind the gap between the train and the platform” – can be found here.

 

My primary purposes for visiting London this time were to attend the C5 D&O Liability conference and to attend a reception co-sponsored with Beazley and the Mayer Brown law firm. On Thursday morning at the C5 conference, I participated on a panel discussion U.S. D&O liability developments along with my good friends Chris Warrior of Hiscox and Phil Norton of Arthur J. Gallagher (first picture below). At the Beazley event, I participated in a panel discussion with Tracy Holm and Adrian Jenner of Beazley, and David Chadwick of Mayer Brown (second picture below). Both events were a great success and I enjoyed them both immensely. I was particularly pleased to learn in my discussions with the attendees at both events how many of them follow The D&O Diary.

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I took the final picture below of the audience at the Beazley event. Adrian Jenner of Beazley had just asked me whether the pictures I have posted in my various travel posts were taken with a smart phone camera or with a digital camera. In response to the question, I pulled out my digital camera (which I was at the moment wearing in a holster on my belt) and snapped a picture of the audience. Immediately after I took the picture, we adjourned the panel discussion in favor of cocktails.

 

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weilIn the current environment, most organizations are aware of the potential threats to their firms from a breach of their data systems and networks. Among the ways companies can protect themselves from these types of threats is through improved employee awareness and training. In the following guest post, Paul Ferrillo and Randi Singer of the Weil, Gotshal & Manges law firm discuss the steps companies can take to avoid common lapses in employee judgment or awareness that can expose a company to a cyber-incident

 

I would like to thank Paul and Randi for their willingness to publish their guest post on my site. I welcome guest post submissions from responsible authors on topics of interest to readers of this site. Please contact me directly if you would like to submit a guest post. Here is Paul and Randi’s guest post.

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They may be based in North Korea, Russia, China, or the United States. They may call themselves “Deep Panda,” “Axiom,” Group 72,” the “Shell_Crew,” the “Guardians of Peace,” or the “Syrian Electronic Army.” But no matter how exotic or mundane the origins of a particular cyber-criminal organization, all that it needs to initiate a major cyberattack is to entice one of your employees to click on a malicious link in an email, inadvertently disseminate malware throughout the network servers, and potentially cause tremendous damage and loss of business.[i]

Indeed, “spear phishing” is a tactic used by cyber-criminals that involves sending phony, but seemingly legitimate, emails to specific individuals, company divisions, or even business executives, among other typically unwitting targets. Unlike spam, these emails usually appear to be from someone the recipient knows and in many cases can appear completely legitimate, or at least unassuming. If the recipient opens any attachments or clicks any links, havoc can ensue. Such spear phishing emails are suspected to have caused many of the recent major cyber attacks. Despite fancy-sounding defensive cybersecurity devices at companies and financial institutions, “spear phishing with malware attachments” is often the easiest route into a sophisticated network.[ii] One report recently noted that, “Compared to the ‘spam-phishing’ emails of days past, which most people have learned to identify and avoid over the years, spear-phishing emails are astronomically more effective. Whereas the current open rate for spam emails is a meager 3%, the open rate for spear-phishing emails is a staggering 70% (not to mention 50% of those who open these emails also click the links they contain). A study published by Cisco found 1,000 spear-phishing emails generate ten times more data revenue for hackers than sending 1,000,000 spam-phishing emails.”[iii] According to another recent study, 90 percent of all hacks in the first half of 2014 were preventable, and more than 25 percent were caused by employees.[iv]

For these reasons, it is absolutely crucial that a company provide training to its employees to detect and avoid spear phishing attacks, and more broadly, avoid common lapses in judgment or awareness that can expose a company to a cyber-incident. For example, companies can easily offer training that improves password protection, helps avoid workplace theft, and better protects employee-owned devices without password protection such as smartphones, laptops, and tablets. Though no one particular training regimen can provide guaranteed protection from a cyber-attack, statistics support their inclusion as a critical part of a company’s overall security posture.

Anti-Spear Phishing Training

Weeks after the announcement of the Anthem attack, which, like that on Sony Pictures, was likely caused by a sophisticated spear phishing operation, cybersecurity guru Brian Krebs noted that others were attempting to prey upon the misfortune of over 80 million patients by sending their own spoofed emails to affected customers.[v] Other “cold-calling” scams apparently were perpetrated at about the same time as the fake emails were sent:

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Now, if you were a terrified Anthem patient whose personal health information was potentially stolen, this sort of an email communication would not be unexpected, and would be very appealing; it would be natural to click the link. In reality, clicking on the fraudulent “free credit protection link” would only have touched off a whole new world of pain.

Here is another example illustrating the growing sophistication of spear phishing attacks. What if you were an existing customer of HSBC and received this email? Would you click on the link, or ignore it and potentially let your account be suspended by “the bank”?[vi]

 

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But the potential price for opening a link that does not appear to be obviously suspicious can be breathtakingly high. In an era where there is so much personal information about everyone on the Internet, it would not be hard for even a high-school student to create an authentic-looking email that could catch us when we least suspect a cyber-attack (especially the Anthem “customer email”). Even higher-level employees are vulnerable to spear phishing (often called “whaling” when high-level executives are targeted), and the corresponding damage can be exponentially worse.[vii]

How do you guard against a socially engineered spear phishing attack? You train and you train, and then you train some more. Many corporate IT departments already periodically send out fake emails to their employees hoping for a “bite.” Many more companies regularly train their employees monthly on anti-spear phishing using automated computer programs that send emails to employees from exact website addresses to see who will unwittingly click on the links.[viii] Records can be kept of successes (and failures). Some companies might award prizes to employees who religiously resist getting tricked, gaining loyalty while simultaneously lowering risk. Lowering the risks of an employee clicking on a malware-infected spear phishing email can be substantial.[ix]

Password Protection and Awareness

There has also been a tremendous amount of publicity over the inadequacy of employee passwords. A January 2013 report by Deloitte suggests that an astonishing 90 percent of user passwords are vulnerable to hacking.[x] There are a few rules of the road:

  1. Companies should force employees to change their passwords regularly (preferably every 30 days), without exception;
  2. Employee passwords cannot be common defaults such as “password” or “12345”;[xi]
  3. Employees should not store passwords on sticky notes placed on their computers or in a physical or digital file or folder called “password”;
  4. Employee passwords should be strong; rather than the first name of the employee’s child, dog or cat, it should contain unique patterns of letters, numbers and other signs, like “I li6e cho$hlat@”;
  5. Employees should be required to install passwords on any device used to access company email or any company resources, including home laptops, so that they remain secure as well;
  6. Companies should make sure that employees follow responsible “social media” practices with regard to company-specific information;
  7. Companies should provide privacy screens to employees to prevent “shoulder surfing” (reading over an employee’s shoulder); and
  8. Employees should receive frequent training on spear phishing, so no employee inadvertently gives up his password to an unauthorized third party.

Other Simple (Non-Hardware) Ideas to Protect Company Data

Finally, for any company, it is important for the IT department to reinforce the following best practices for the handling of company data:

  1. Follow least-access principles and control against over-privileging. An employee should only be given access to the specific resources required to do his or her job. Not every employee needs the keys to the kingdom.
  2. Make sure software patches and critical updates are made in a prompt and timely fashion so that no critical patch is left uninstalled for lack of time or budget.
  3. Every company should install within each employee a sense of “ownership” in the collective good of the company, one that requires him or her to be cyber-conscious and sensitive to the potential areas of susceptibility that we have described above.

Cybersecurity is the ultimate team sport, and every person in the company, from a director down to an entry-level employee, needs to be invested in its cybersecurity:

The infamous Sony hack, the systematic attacks of Heartbleed and Shellshock targeting core internet services and technologies, and the new wave of mass mobile threats have placed the topic of security center stage. Organizations are dramatically increasing their IT budgets to ward off attack but will continue to be vulnerable if they over-invest in technology while failing to engage their workforce as part of their overarching security solution. If we change this paradigm and make our workforce an accountable part of the security solution, we will dramatically improve the defensibility of our organizations.”[xii]

We cannot claim that any of these ideas are cure-alls for the hacking problem in the United States (in fact, none are complete solutions). We can only subscribe to the theory that failing to implement basic cybersecurity “blocking and tackling” practices is the functional equivalent of forgetting to lock the back door.

[i] See “Learning from the Mistakes of Others: Sony, NSA, G2O, & DoD Hacks,” available here; also see, e.g. “Data Breach at Health Insurer Anthem Could Impact Millions,” available here.

[ii] See “‘Spear Phishing’ Attacks Infiltrate Banks’ Networks,” available here.

[iii] See above at footnote 1.

[iv] See “Over 90 percent of data breaches in first half of 2014 were preventable,” available here; also see “The Weakest Link Is Your Strongest Security Asset,” available here (noting, “According to PwC, employees and corporate partners are responsible for 60% of data breaches. Verizon’s research suggests the number is even higher, at almost 80%.”).

[v] See “Phishers Pounce on Anthem,” available here.

[vi] See here.

[vii] See “Hacking the Street, FIN4 Likely Playing the Market,” available here.

[viii] See e.g. the anti-spear phishing training offered by a company called Phishme, available here.

[ix] See “KnowBe4 Security Awareness Training Blog: Train Employees And Cut Cyber Risks Up To 70 Percent,” available here.

[x] See “90 percent of passwords vulnerable to hacking,” available here.

[xi] See here.

[xii] See “The Weakest Link Is Your Strongest Security Asset,” available here.

kaganIn a March 24, 2015 opinion in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund (here), the U.S. Supreme Court set aside the Sixth Circuit’s ruling that allegations of “objective falsity” were sufficient to make a statement of opinion in securities offering documents actionable. The Supreme Court remanded the case to the lower court to consider whether the plaintiffs had sufficiently alleged that facts had been omitted from the opinion so as to make the statement of opinion misleading, in light of the entire context. The Court’s decision is briefly summarized in the accompanying guest post from the Skadden law firm.

 

The Omnicare case involves the standard for liability under Section 11 for statements of opinion in a company’s offering documents. The Supreme Court took up the case to determine whether or not it is sufficient to survive a dismissal motion for a plaintiff in a Section 11 case to allege that a statement of opinion was objectively false, or whether the plaintiff must also allege that the statement was subjectively false – that is, that the defendant did not believe the opinion at the time the statement was made. The Supreme Court’s granted the writ of certiorari in the Omnicare case because of a a split in the circuits between those (such as the Second and Ninth Circuits) holding that in a Section 11 case allegations of knowledge of falsity are required; and those (such as the Sixth Circuit, in the Omnicare case) holding that allegations of knowledge of falsity are not required.

 

In the Omnicare case, the plaintiff shareholders alleged that two statements in its registration statement filed in connection with its $765 million securities offering in December 2005 had been misleading – first, the statement by the company that “we believe” that the company’s contractual arrangements with various third parties are “in compliance with applicable federal and state law,” and second, the statement by the company that “we believe” that its contracts with pharmaceutical manufacturers “are legally and economically valid arrangements that bring value to the healthcare system.” The plaintiffs alleged, in reliance on separate enforcement actions the federal government filed against Omnicare alleging that the company had paid kickbacks, that these two statements were false and misleading.

 

The defendants moved to dismiss the complaint and the district court granted the motion to dismiss. However, the Sixth Circuit reversed the district court, holding that the shareholders complaint alleged that the two statements were “objectively false,” and further, that the defendants did not need to allege that anyone at Omnicare disbelieved the statements.

 

In its March 24, 2015 opinion, the Court vacated the Sixth Circuit’s opinion and remanded the case to the Sixth Circuit for further proceedings. The Court’s opinion was written by Justice Elena Kagan and in which all nine justices joined in the court’s judgment – although Justices Scalia and Thomas wrote concurring opinions voicing their separate concerns with aspects of the majority opinion.

 

Justice Kagan’s opinion divided the consideration of the case into two parts, based on two parts of Section 11, because she said, the two parts raise different issues. The first part of her analysis related to the portion of Section 11 making companies and corporate officials liable for “untrue statement[s] of . . . material fact” and the second part makes the same defendants liable if they “omitted to state a material fact . . . necessary to make the statements [in its registration filing] not misleading.”

 

Omnicare had tried to argue that a defendant can never be liable for a mere opinion. Justice Kagan rejected this argument, saying that “as even Omnicare acknowledges, every such statement explicitly affirms one fact: that the speaker actually holds the stated belief.”If the speaker did not hold the belief, then he or she can be held liable.

 

Moreover, she added, if the statement of opinion includes a “supporting fact” — such as the statement about patented technology in this statement of opinion: “I believe our TVs have the highest resolution available because we use a patented technology to which our competitors do not have access” – the speaker can not only be held liable under the false statement portion of the Section 11 if the “speaker did not hold the belief she professed” but also “if the supporting fact she supplied were untrue.”

 

The plaintiffs in this case, she noted, cannot avail itself of either of these two types of false statement liability, because the statements on which the plaintiffs rely are “pure statements of opinion.” Basically, Justice Kagan said, the statements on which plaintiffs rely amounted to the company’s saying “we believe we are obeying the law.” Plaintiffs argue that these statements turned out to be untrue because the company was paying kickbacks. But the mere fact that statements turned out to be untrue cannot serve as the basis of liability because “a sincere statement of pure opinion is not an ‘untrue statement of material fact,’ regardless whether an investor can ultimately prove the belief wrong.” Contrary to the plaintiffs’ argument and the Sixth Circuit’s opinion, Section 11’s false statement provision is not “an invitation to Monday morning quarterback an issuer’s opinions.”

 

Justice Kagan then went on to analyze the plaintiffs’ claims under Section 11’s omissions provision. The question, she said is, “when, if ever, the omission of a fact can make a statement of opinion like Omnicare’s, even if literally accurate, misleading to an ordinary investor.” In reaching the conclusion that a statement of opinion might under some circumstances support an omission claim, she said that “a reasonable investor may, depending on the circumstances, understand an opinion statement to convey facts about how the speaker has formed the opinion.” If, she said, “the real facts are otherwise, but not provided, the opinion statement will mislead its audience.” For example, a company might say “we believe our conduct is lawful” without having consulted a lawyer, which she said, would be “misleadingly incomplete.” Thus, she said, “if a registration statement omits material facts about the issuer’s inquiry into or knowledge concerning a statement of opinion, and if those facts conflict with what a reasonable investor would take from the statement itself, then §11’s omissions clause creates liability.”

 

Having said that an omission of material facts might give rise to Section 11 liability for an opinion, Justice Kagan then walked this observation back. She said that an opinion “is not necessarily misleading when an issuer knows, but fails to disclose, some fact cutting the other way,” adding that “a reasonable investor does not expect that every fact known to an issuer supports its opinion statement.” She said that “whether an omission makes an expression of opinion misleading always depends on context” because “the reasonable investor understands a statement of opinion in its full context, and §11 creates liability only for the omission of material facts that cannot be squared with such a fair reading.”If it were otherwise, she said, a company could “nullify” the statutory requirement simply by starting a sentence with “we believe” or “we think.”

 

Having said that the omissions clause in Section 11 can support liability for an opinion based on what a reasonable investor might understand, she added that to establish this type of claim, a claimant must allege the “failure to include a material fact has rendered a published statement misleading.” To be specific, she said,

 

The investor must identify particular (and material) facts going to the basis for the issuer’s opinion—facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have—whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context.

 

Because the Sixth Circuit had not considered the Omnicare case in light of this analysis, the Supreme Court remanded the case to the lower courts for further consideration with the “right standard in mind.” On remand, and with respect to any facts the plaintiff allege were omitted, the courts below “must determine whether the omitted fact would have been material to a reasonable investor.” If the plaintiffs clear those hurdles, then the courts have to consider whether Omnicare’s legal compliance opinions were misleading “because the excluded fact shows that Omnicare lacked the basis for making those statements that a reasonable investor would expect.”She added that “the analysis of whether Omnicare’s opinion is misleading must address the statement’s context” – that is, the other statements throughout the rest of the registration statement.

 

Justice Scalia filed a concurring opinion, joining the Court’s judgment but differing from the majority opinion on the circumstances in which omitted facts could support Section 11 liability for an opinion. Justice Thomas also joined the Court’s judgment but said that the majority should not have reached the omission question because it was not properly before the Court.

 

Discussion

The Supreme Court’s ruling represents, in its rejection of the Sixth Circuit’s “objective falsity” standard, a victory for the defendants. However, the Court’s conclusion that omitted facts could make a statement of opinion misleading and support Section 11 liability is more to the liking of those on the plaintiffs’ side of the aisle, even if the Court did set a rather high bar for stating a claim under the statute’s omissions prong. Even the false statement-part of the Court’s analysis arguably gives the plaintiffs something they can use, in the Court’s analysis of “supporting facts” in an opinion that might be misleading. At a minimum, the plaintiffs in this case have managed to live for another day, even though the Sixth Circuit’s ruling was set aside.

 

 

The Court seemed clear that there are basic differences between facts and opinions. However, an opinion might, we are told, might include “supporting facts.” And while Omnicare’s statement did not include supporting facts – the statements on which the plaintiffs rely, we are told, are “pure statements of opinion” – there could be “omitted facts” whose omission makes the statement of opinion misleading. Moreover, whether or not these omitted facts are sufficient to make the statement actionable depends on “context.” The difference between facts and opinions may be clear, but the two interact in complex ways.

 

Opinions often are involved in the allegations in Section 11 claims because financial statements contain many different types of opinions. Court have held that financial statement items such as reserves, goodwill and so on constitute opinions, and, at least until the Sixth Circuit decision in the Omnicare case, have been pretty comfortable saying that opinions are not actionable under Section 11 unless the speaker didn’t believe the opinion. Now, courts will have to consider whether the opinion included misleading “supporting facts,” and whether or not there were “omitted facts” sufficient to make the opinion misleading, taken in context of the entire Registration Statement. Maybe the lower courts will apply these standards without difficulty. I suspect some courts will labor, particularly on questions surrounding allegedly omitted facts and whether or not the alleged omissions were sufficient to make even a “pure statement of opinion” misleading, in light of the entire context.

 

These issues may be particularly important just now because of the increase in IPO activity in the securities marketplace in 2013, 2014 and continuing this year. As I have pointed out previously on this blog, more IPOs mean more IPO-related litigation. As plaintiffs in the IPO cases prepare their complaints, they will now be sure with respect to any statements of opinion to allege that the opinion omitted facts and were therefore both misleading and actionable. The Omnicare standards of liability for statements of opinion in registration statements are likely to get a workout in the district courts where the IPO-related lawsuits are filed.

 

Alison Frankel’s March 24, 2015 post on her On the Case blog (here) discusses how what she calls the Court’s “middle of the road approach” in the Omnicare case is consistent with several recent decisions from the U.S. Supreme Court. A March 24, 2015 memo from the Proskauer law firm discussing the Court’s decision can be found here.

skadden_logo_noLLP_bigAs I discuss in the accompanying post, on March 24, 2015, the U.S. Supreme Court issues its opinion in the Omnicare case. In the following guest post, the Skadden law firm summarizes the case and its holding. A version of the guest post previously was published as a Skadden client alert. I would like to thank the attorneys at Skadden for submitting this guest post and allowing me to publish it on this site. I welcome guest post submissions from responsible authors on topics of interest to readers of this blog. Please contact me directly if you would like to submit a guest post. Here is the Skadden guest post.

 

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In an opinion issued yesterday, the U.S. Supreme Court held in Omnicare, Inc. v. Laborers District Council Construction Industry Pension Fund that an issuer may be held liable under Section 11 of the Securities Act of 1933 for statements of opinion made in a registration statement if the issuer failed to hold the belief professed or failed to disclose material facts about the basis for the opinion that rendered the statement misleading. The Court granted certiorari to consider how Section 11 pertains to statements of opinion, and today’s opinion addresses the question as applied to misstatements and omissions. Justice Elena Kagan delivered the opinion of the Court, in which Chief Justice John Roberts and Justices Anthony Kennedy, Ruth Bader Ginsburg, Stephen Breyer, Samuel Alito and Sonia Sotomayor joined. Justices Antonin Scalia and Clarence Thomas each filed opinions concurring in the judgment.

 

The Court vacated and remanded the Sixth Circuit’s 2013 decision holding that a Section 11 plaintiff need only allege that an opinion in a registration statement was “objectively false,” notwithstanding the company’s understanding when the statement was made. In particular, the Court held that a statement of opinion in a registration statement may not support Section 11 liability merely because it is “ultimately found incorrect.” With regard to the prong of Section 11 that addresses alleged misstatements of fact (and always careful to note that materiality was being assumed), the Court held that “liability under §11’s false-statement provision would follow … not only if the speaker did not hold the belief she professed but also if the supporting fact she supplied were untrue.” Slip op. at 9. The plaintiffs below, however, limited their objection to two pure statements of opinion and, in expressly disclaiming and excluding any allegation sounding in fraud or deception, did not contest that the company’s opinion was honestly held. Importantly, the Court held that with respect to potential misstatement liability under Section 11, “a sincere statement of pure opinion is not an ‘untrue statement of material fact,’ regardless whether an investor can ultimately prove the belief wrong.” Id.

 

The Court thereafter considered “when, if ever, the omission of a fact can make a statement of opinion like Omnicare’s, even if literally accurate, misleading to an ordinary investor.” Slip op. at 10. As to this omissions prong of Section 11, the Court further held that an issuer may be liable under Section 11 for omitting material facts about the inquiry into or knowledge concerning a statement of opinion if those facts “conflict” with what a reasonable investor would “understand an opinion statement to convey” with respect to “how the speaker has formed the opinion” or “the speaker’s basis for holding that view.” Id. at 11-12. The Court clarified that an issuer need not disclose every fact “cutting the other way” against an opinion because “[r]easonable investors understand that opinions sometimes rest on a weighing of competing facts.” Id. at 13. Underscoring the importance of context, the Court held that issuers may be liable only where the omitted facts “conflict with what a reasonable investor would take from the [opinion] statement itself.” Id. at 12.

 

The Court reiterated that “an investor cannot state a claim by alleging only that an opinion was wrong; the complaint must as well call into question the issuer’s basis for offering the opinion.” Slip op. at 17. Specifically, the Court held that a Section 11 plaintiff must identify particular and material “facts about the inquiry the issuer did or did not conduct or the knowledge it did or did not have … whose omission makes the opinion statement at issue misleading to a reasonable person reading the statement fairly and in context,” which the Court described as “no small task.” Id. at 18. The Court remanded the case to the trial court for further proceedings and analysis consistent with the standard articulated by the Court.

 

By Jay B. Kasner, Matthew J. Matule, Edward B. Micheletti, Peter B. Morrison, Amy S. Park, Noelle M. Reed, Charles F. Smith and Jennifer L. Spaziano, Skadden, Arps, Slate, Meagher & Flom LLP

The opinions expressed are those of the authors and do not necessarily reflect the views of the firm, its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.

 

cornerstone reserach pdfThe aggregate amount of all securities class action settlements during 2014 declined to the lowest level in years and there also was a “dramatic” decrease in the average securities suit settlement amount during the year, according to a March 24, 2014 report from Cornerstone Research. The report, which is entitled “Securities Class Action Settlements: 2014 Review and Analysis,” can be found here. Cornerstone Research’s March 24, 2015 press release about the report can be found here.

 

According to the report, the number of securities suit settlements during 2014 (63) was just about the same as the number in 2013 (66). However the total amount of all securities class action lawsuit settlements during the year was $1.068 billion, compared to $4.847 billion in 2014, a decline of 78 percent. The 2014 total is the lowest level in sixteen years and was also 84 percent below the annual average for the prior nine years. (All figures in the report are adjusted for inflation. The settlement year for purposes of the report corresponds to the year in which the hearing to approve the settlement was held, rather than the year in which the settlement announced.)

 

In addition, the average settlement amount also decreased in 2014. The average settlement amount during 2014 was only $17.0 million, compared to $73.5 million in 2013, well below the annual average for the period of 1996-2013 of $57.2 million. The average settlement amount in 2014 was 64 percent below the annual average during the post-PSLRA period. The 2014 average settlement amount was the lowest level since 2000. The median settlement in 2014 of $6.0 million is only slightly below the 2013 median of $6.6 million, but more significantly below the 1996-2013 median settlement amount of $8.3 million.

 

The reason for the decline in the aggregate and average amounts during 2014 is that there were fewer large settlements. The largest settlement in 2014 was $265 million, compared to $2.5 billion in 2013. In 2014, all but one of the 63 cases (98 percent) settled for less than $100 million, and 11 percent settled for $2 million or less. In addition to the decrease in the number of very large settlements, there was also an increase in the proportion of settlements of $10 million or less. About 62 percent of all 2014 settlements were for $10 million or less, compared to 53 percent during the period 2005-2013.

 

The decline on the number of large settlements arguably is no surprise as the dollars potentially at stake in the cases that settled in 2014 were lower than was the case in recent years. Using what the report calls “estimated damages” as a way to measure amount plaintiff shareholders might seek to recover, the report notes that the “estimated damages” in the 2014 settlements were 60 percent lower than for 2013, and were the lowest in 12 years, which “contributed to the substantially lower average settlement amounts.” The report notes that the volatility of the stock market in recent years has been declining when compared to earlier years, which may have contributed to the smaller average “estimated damages” for cases settled in 2014. Moreover, as a result of the reduction during 2014 of the filing of cases with large market capitalization losses “may mean that the lower level of large settlements will persist in the future.

 

The report notes that settlements and “estimated damages” are typically smaller for cases involving only Section 11 and/or Section 12(a)(2) claims. There were only three cases that settled in 2014 that involved only ’33 Act claims, and there were another 7 cases that involved both ’33 Act and ’34 Act claims. The increase in IPO activity since 2013 and continuing this year “suggests that settlements of cases involving these claims are likely to be more prevalent in future years.”

 

The report notes a number of other factors that affect the settlement size. Cases involving accounting allegations are generally associated with higher settlement amounts and higher settlements as a percentage of “estimated damages.” Historically, cases with third-party codefendants (accountants or underwriters) have settled for substantially higher amounts as a percentage of “estimated damages.” However in 2014, cases with and without third-party defendants settled for similar percentages of “estimated damages.”

 

Companion derivative actions continue to be associated with higher class action settlements. In 2014, the median settlement for cases with an accompanying derivative action was 31 percent higher that for case without an accompanying derivative amount; in 2013, the difference was 78 percent, and in 2012, it was 387 percent. Cases that involved a corresponding SEC settlement are also associated with significantly higher settlement amounts, and also with larger settlements as a percentage of “estimated damages.” In 2014, the median settlement for cases with an SEC action was $8.4 million, compared to $5.5 million without.

 

The involvement of an institutional investor plaintiff is also correlated with higher settlement amounts, perhaps because the institutional investors only choose to become involved in cases with more serious allegations. (For example, in 2014, institutional investors were involved as lead plaintiff in seven out of the ten settlements that involved a corresponding SEC action.) The median settlement for cases with a public pension as lead plaintiff in 2014 was $13 million, compared to $5 million for cases without a public pension as a lead plaintiff. Interestingly, the percentage of settlements involving public pensions as lead plaintiff declined in both 2013 and 2014. In 2013, only 44% of settlements involved public pensions as a lead plaintiff, down from 47% in 2012, and in 2014, only 37% of settlements involved a public pension as a lead plaintiff.

 

For the cases that settled in 2014, the median and average time to settlement was three years; however, cases involving larger estimated damages and cases involving larger firms tend to take longer to settle. 

 

chileIn yet another U.S. securities class action lawsuit involving a non-U.S. company and a corruption investigation in the company’s home country, on March 19, 2015 a shareholder of Chemical & Mining Company of Chile, Inc. (Sociedad Quimica y Minera de Chile, S.A, or SQM), the world’s largest producer of iodine and lithium and a major potash producer, filed a lawsuit in the Southern District of New York against the company and certain of its directors and officers. A copy of the plaintiff’s complaint can be found here. The plaintiff’s lawyers March 19, 2015 press release about the lawsuit can be found here.

 

The case relates to the ongoing corruption and tax evasion scandal involving the Chilean financial services firm, Banco Penta. The prosecutors’ probe of the firm began with an investigation into whether the firm was using fake receipts to dodge taxes, but, as discussed in a March 4, 2015 Reuters article (here), the investigation has expanded into an inquiry whether or not receipts were also used to make illegal campaign contributions to the right-wing Independent Democratic Union (UDI) party. According to Reuters, the UDI party has links to the 1973-1990 dictatorship of Augusto Pinochet.

 

On February 26, 2015, SQM published the first of a series of press releases detailing the company’s increasing entanglement in the ongoing Banco Penta investigation that, as the securities class action complaint alleges, “ultimately culminated in the termination of the Chief Executive Officer and resignation of three SQM board members.” In the February 26 press release (here), the company announced that at the request of its Chairman of the Board, an “extraordinary” board meeting had been held to discuss the corruption and tax evasion investigation. The press release also announced that the Board had established a special committee to perform an investigation.

 

It is worth noting that SQM’s Board Chair is Julio Ponce Lerou, one of the wealthiest individuals in Chile and the former son-in-law of Augusto Pinochet. In September 2014, Chile’s securities regulator fined Ponce $70 million, a record sanction in Chile, in connection with an investigation of illegal securities trading, including trading in the shares of SQM.

 

On March 11, 2015, SQM disclosed in a press release (here) that its board of directors would be meeting the next day to evaluate a request from the Public Prosecutor for information relating to the Prosecutor’s “investigation into improper political campaign contributions.”

 

On March 12, 2015, SQM issued a press release (here) stating that its board of directors had met that same day in extraordinary session and had resolved to form an independent investigation with respect to the prosecutor’s request for information; to schedule another board meeting on March 16, 2015 to analyze the independent investigation report and “to make a decision regarding the voluntary delivery of the requested information”; to ratify the board’s “willingness to cooperate” with the prosecutor and to confirm that all of the requested information “is ready to be delivered when appropriate.”

 

In a March 16, 2015 press release (here), the company stated that it had turned over all of the information that the prosecutor had requested to the Chilean Internal Revenue Service, which the company stated was the proper authority to receive the information.

 

In a separate March 16, 2015 press release (here), the company announced that board, meeting that same day in extraordinary session, had “agreed to terminate” Patricio Contesse González, the company’s CEO. The press release also stated that the board had appointed Patricio de Solminihac Tampier as the new CEO effective immediately. The securities class action complaint alleges that in the weeks leading up to Contesse’s dismissal, he had “attempted to block the Company’s decision to turn over the documents.”

 

Finally, in a March 18, 2015 press release (here) the company announced the resignation of the three SQM board member designees of the Potash Corporation of Saskatchewan, Wayne R. Brownlee, José Maria Eyzaguirre and Alejandro Montero.

 

In its own separate March 18, 2015 press release (here), Potash Corp., which owns a 32 percent stake in SQM, stated that the Chilean prosecutor had made “serious allegations of wrongdoing” against SQM and its management, and that Potash’s board designees’ requests for full and voluntary cooperation “have been rejected by a majority of the Board.” The press release goes on to state that “it has become clear that given our minority and dissident position on the board, we are unable to ensure either that an appropriate investigation is conducted or that SQM collaborate effectively with the Public Prosecutor.” Accordingly, the three Potash Corp. designees had resigned. Wayne Brownlee, one of the three that resigned from the SQM board, is the Chief Financial Officer of Potash Corp.

 

Perhaps in response to the Potash Corp. press release, SQM issued a second March 18, 2015 press release (here), in which the company stated that it had “promptly initiated internal investigations” and created a special committee to complete an independent report; that it had contracted independent consultants in Chile and the U.S.; and that it “continue to provide information to the regulatory authorities as necessary.” The press release also stated that the company had terminated Contesse and voluntarily provided the Chilean Internal Revenue Service with the information the prosecutor had requested.

 

A March 18, 2015 Bloomberg article entitled “Potash Board Exodus Sinks SQM as Chile Company Fights Probe” (here) stated that on the news of the three individual’s resignation from the SQM board, the company’s share price on the Santiago stock exchange, which had already fallen on the prior new of the investigation, fell as much as 29%, the most in two decades. The price of the company’s American Depositary Receipts, which trade on the NYSE, fell 17%.

 

In their March 19, 2015 press release, plaintiff lawyers announced that they had filed a securities class action lawsuit against SQM, Contesse (the former CEO), Solminihac (the new CEO) and Ricardo Ramos, the company’s Chief Financial Officer. The complaint alleges that the defendants made false and misleading statements or omissions by failing to disclose that “money from SQM was channeled illicitly to electoral campaigns for [UDI], Chile’s largest conservative party” and that the company “lacked internal controls over financial reporting” and that as a result the company’s financial statement were false and misleading.

 

The Complaint asserts claims based on Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. The Complaint is filed on behalf of investors who purchased SQM’s American Depositary Shares on the New York Stock Exchange between March 4, 2015 and March 17, 2015.

 

The SQM lawsuit follows closely after the securities class action lawsuit filed in December 2014 against Petrobras and certain of its directors and officers in the wake of the massive scandal in Brazil surrounding the company (The Petrobras lawsuit is discussed here.) Both of these U.S. securities lawsuits involve Latin American companies whose shares trade on their home countries’ stock exchange and that also have American Depositary Shares trading on a U.S. exchange. In both cases, the lawsuits arising out of bribery or corruption investigation in their home countries and being pursued by prosecutors or regulatory authorities in their home countries.

 

Both of these lawsuits, in turn, follow after the securities class action lawsuit filed in April 2013 against Wal-Mart de Mexico SAB De CV (“Walmex”) and certain of its directors and officers, in the face of corruption allegations involving its operations in Mexico. The securities complaint quoted extensively from news reports that the company had falsified its financial records in order to conceal its widespread bribery activities. Walmex’s American Depositary Receipts trade on the New York Stock Exchange. (A separate action previously had been filed against Walmart Stores, Walmex’s U.S. parent, as discussed here).

 

The phenomenon of civil litigation following in the wake of a corruption investigation is nothing new, at least in the U.S. What is different about these various lawsuits, including the new lawsuit against SQM, is that they involve non-U.S. companies sued in a U.S. securities class action lawsuit in connection with bribery or corruption activities and investigations in their home countries, by their home countries’ regulators or prosecutors.

 

As I noted in a prior post, in recent months there has been a series of securities lawsuits filed in the U.S. against non-U.S. companies in connection with regulatory investigations in the companies’ home countries. For example, as discussed here, in January 2014, NuSkin Enterprises was hit with a securities class action lawsuit following news of an investigation in China of the company’s allegedly fraudulent sales practices there. In June 2014, China Mobile Games and Entertainment was hit was a U.S. securities class action lawsuit following news of a bribery investigation in China involving company officials.

 

As regulators in Latin America and around the world become increasingly more active, it not only become increasingly more likely that companies elsewhere could become involved in regulatory or even criminal investigations, but also, at least where the companies have securities trading on U.S. exchanges, increasingly more likely to become involved in a U.S. securities class action lawsuit.

 

Which of course immediately begs the question – what about investors in companies whose shares do not trade on U.S. exchanges? By the same token, what about the investors who purchased their SQM shares on the Santiago exchange? As a result of the U.S. Supreme Court’s decision in Morrison v. National Australia Bank, the investors who purchased their shares on exchanges outside the U.S. cannot assert claims under the U.S. securities laws. Will those investors seek to try to assert claims in their home country’s courts, under their home country’s laws? Will they seek to expand or reform their home country’s laws so that they can assert their claims there?

 

As I noted in a recent post, there have been moves toward the adoption of a form of collective litigation in a number of Latin American countries, including Chile. Will investors who bought their SQM shares on the Santiago exchange but who are closed out of the U.S. class action seek to pursue a claim or claims in Chile’s courts, under Chilean law? I hope that my readers in Chile and elsewhere in Latin America will let me know what they think about the possibility of a civil action in Chile on behalf of shareholders who purchase their SQM shares on the Santiago exchange.

 

(In another recent post, here, I discuss how the existence of the U.S. securities class action lawsuit involving non-U.S. companies can create something of a “double whammy” for investors who purchased their shares in the company on the company’s home country exchange, as the settlement of the U.S. lawsuits effects a form of “wealth transfer” to the investors who purchased their securities on the U.S. exchange.)

 

In any event, it is worth noting that non-U.S. companies with securities trading on U.S. exchanges continue to attract the attention of plaintiffs’ lawyers. As I discussed in my most recent annual review of U.S. securities class action lawsuit filings (here), non-U.S. companies continued to get his with securities litigation in numbers disproportionate to their representation on the U.S. exchanges. For example, in2014, about 19 percent of securities lawsuit filings involving non-U.S. companies, while non-U.S. companies represent only about 16 percent of a U.S.-listed companies. These same trends have continued in 2015, where eight of the 39 securities lawsuits filed so far this year (about 20 percent) have involved non-U.S. companies, while the non-U.S. companies continue to represent only about 16% of all U.S.-listed companies.

 

More About Fee-Shifting Bylaws: Over the last few days, I have linked on this blog to several recent articles on the topic of fee-shifting bylaws, most of them written by authors with an academic or a defense perspective. Readers interesting in a plaintiffs’ lawyers’ perspective on the topic will want to review the March 16, 2015 article from Mark Lebovitch and Jeroen Van Kwawegen of the Bernstein Litowitz law firm entitled “Of Babies and Bathwater: Deterring Frivolous Stockholder Suits Without Closing the Courthouse Doors to Legitimate Claims” (here). In their interesting paper, the authors suggest that “the ‘nuclear option’ of allowing boards of public companies to employ fee-shifting bylaws against stockholders whose interests they are supposed to represent is poor policy and departs from well-established legal principles.”

 

The authors also propose their own alternative as a way to try to reduce abusive shareholder litigation. They propose the adoption of “a two part test that would eliminate the weakest two-thirds of all stockholder litigation.” Under this two-part test, before approving a “disclosure only settlement,” the court would “affirmatively determine that: (1) the disclosures providing the purported consideration to stockholders are, in fact, material, and (2) subject to judicial discretion to approve a broader release for good cause shown, the release is limited to the benefit of the disclosures obtained, so as to ensure that meritorious claims that were not properly vetted by counsel are not inadvertently or thoughtlessly released.”

 

Finally, readers interested in the ongoing debate regarding the legislation proposed in Delaware to address fee-shifting bylaws will want to review Alison Frankel’s March 20, 2015 post on her On the Case blog entitled “Why Proposed Legislation in Delaware Won’t End Loser-Pays Fight” (here), in which she discusses Columbia Law Professor’s John Coffee’s recent CLS Blue Sky blog post about the proposed legislation, to which I linked earlier this week. She also mentions the Bernstein Litowitz’s authors’ paper as well.

 

Break in the Action: I will be traveling during the week of March 23, 2015, and there will be an interruption in this blog’s usual publication schedule while I am on the road. Normal publication will resume upon my return to the office the following week.

 

Among other things while I am traveling, I will be attending the C5 D&O Liability Insurance Forum in London. On Thursday morning, March 26, 2015, I will be participating in a panel entitled “The Latest U.S. Judicial Decisions, Litigation, and Exposures and Emerging D&O Liability Risks” with my good friends Chris Warrior of Hiscox and Phil Norton of A.J. Gallagher. I will also be moderating a panel at the C5 conference on Wednesday, March 25, 2015, on the topic “Lifting the Lid on Regulatory Investigations and Lessons Learned” with Robert Sikellis, the Chief Compliance Counsel at Siemens, and Richard Sims of Simmons & Simmons.

 

On Wednesday evening, March 25, 2015, I will be participating once again in the annual London event and reception that my firm co-sponsors with Beazley and (this year) the Mayer Brown law firm. This event usually draws most of the London D&O insurance marketplace and we hope it will be successful again this year.

 

If you see me this week at the C5 conference or at the Beazley event, I hope that you will be sure to say hello, particularly if we have not previously met. I look forward to seeing everyone in London. 

 

can flag 2A number of countries have procedural mechanisms allowing groups of aggrieved parties to pursue their legal claims in the form of a collective action. While no other country has a class action mechanism quite like that of the United States, another country that also has well-developed class action mechanisms is Canada. However, unlike the United States, in Canada there is no federal class action process; instead, class action claims must be brought in one of the provincial or territorial courts and invoke the relevant jurisdiction’s litigation processes.

 

One of the Canadian jurisdictions where class action litigation is active is Ontario. Since the province adopted Class Proceeding Act over twenty years ago, numerous class actions have been filed in the province. The Law Commission of Ontario is now undertaking a comprehensive review of the Class Proceedings Act, as discussed on the Commission’s website (here). As part of the Law Commission of Ontario’s review of experiences with the Class Proceedings Act, the Commission has asked for interested parties to submit comments .

 

In response to the Commission’s request for comments, the U.S. Chamber of Commerce Institute for Legal Reform and the Canadian Chamber of Commerce have prepared a paper that will be presented at an event in Toronto on March 23, 2015. The paper, entitled “Painting an Unsettling Landscape: Canadian Class Actions 2011-2014,” can be found here. The Institute for Legal Reform’s March 23, 2015 press release about the paper can be found here.

 

The paper takes a comprehensive look at class action litigation in Canada – not just in Ontario, but in all of the provincial and territorial courts as well. The paper describes a number of recent developments in the provincial courts, which the paper’s authors suggest “certainly will invite the filling of more class actions in Canada.”

 

The paper opens by noting that while there had been some reason to believe several years ago that Canada might be “stepping away from its long-standing liberal approach to class actions,” more recent developments suggest that this trend has “evaporated.” Canadian courts have, according to the paper, “their tradition of consistently lax class certification standards,” adding that “it is once again a relatively sure bet that a class proposed to a Canadian court will be certified.” This “increasingly favorable atmosphere” has been “readily apparent” in a number of substantive areas, including, for example, the antitrust and securities arenas.

 

In terms of how the cases fare once they go forward, the paper notes that class action trials are “occurring with increasing frequency.” Indeed, class trials are “much more likely to occur in Canada than in the U.S.” The paper notes that defendants have gained some notable trial successes. With respect to the cases that settle, the paper notes that “Canadian tribunals are more rigorously assessing whether class members are appropriate benefiting from settlements.” Some courts are “growing increasingly skeptical of class counsel fee applications.”

 

The paper evinces a particular concern with third-party litigation funding, which, the paper says, is “gaining greater currency in Canada, particularly in the class action context.” The paper expresses the concern that the increased use of third-party litigation funding “threatens to undermine the effectiveness of ‘loser pays’ policies adopted by some jurisdictions to discourage non-meritorious litigation.” The paper does express support for recent developments in Ontario where the courts have insisted that third-party funding arrangements be publicly disclosed and judicially approved. The paper argues that increased transparency and judicial scrutiny will help reduce “the prospects that funders will seek to satisfy their own financial goals in derogation of class member interests.”

 

Of interest to readers of this blog, the paper has a number of interesting comments about securities class action litigation in Canada. Among other thing, the paper comments, with reference to the recent Ontario court decision in the Canadian Solar case (about which refer here) , among others, that “recent decisions of Ontario courts have made it clear that the Ontario Securities Act may be applied extraterritorially.” However, the paper also notes that in Ontario Court of Appeal’s decision in the BP case, the court ruled that a putative class action involving securities that were purchased over a foreign exchange should have been stayed on forum non conveniens grounds.

 

The paper also notes that “recent decisions have confirmed that leave to pursue class claims under the Ontario Security Act is evaluated with minimal scrutiny.”

 

The Institute for Legal Reform’s press release about the Canadian class action paper contains a statement from the Institute’s President, Lisa Rickard. Among other things, Rickard says that “recent confirmation by Canadian courts of low class action certification standards, and the convergence of other factors … are setting the stage for increased abuse of this type of litigation across Canada.” Rickard adds that “the growth of third party litigation funding is also fueling class action lawsuit abuse in Canada because it is a sophisticated scheme for gambling on litigation that rewards those who invest in the lawsuits, or the gamblers, at the expense of the class members themselves.”

 

The paper concludes with a call for “meaningful legal reform” throughout the Canadian provinces. The paper calls on the litigation defense community to advocate for “more meaningful class certification requirements” and for measures to create “disincentives to the filing of non-meritorious actions.” The paper also calls for lawmakers to formalize third party funding safeguards, and at a minimum establish requirements for the disclosure of and requiring judicial approval for funding arrangements. The paper concludes with a call for the defense community to remain active in the Law Commission of Ontario review process to “ensure that the effort is not dominated by plaintiffs’ counsel perspectives.”