gavelapril2013In a March 9, 2015 article entitled “Hedge Fund Manager’s Next Frontier: Lawsuits” (here), the Wall Street Journal described how the “next act” for EJF Capital LLC, a hedge fund run by Friedman, Billings, Ramsay Group’s former co-founder Emmanuel Friedman, will be to deploy a new litigation finance arm that has already, according to the Journal, “raised hundreds of millions of dollars” to “lend to law firms pursuing class-action injury lawsuits.”

 

The hedge fund’s foray into litigation financing is pretty far afield from the firm’s prior investments. According to the Journal, the fund’s last big investment successes involved purchasing troubled mortgage securities during the financial crisis and buying the federal government’s investments in smaller banks.

 

Why would a hedge fund focused on financial securities get involved in something like litigation financing? For a very simple reason – litigation financing is profitable.

 

How profitable? Well, because a number of litigation funding firms are publicly traded, we don’t have to guess. For example, on March 18, 2015, Burford Capital Limited, the largest player in the growing U.S. litigation funding business and a publicly traded firm whose shares trade on the London Stock Exchange AIM Market, released its results for 2014, showing that the company’s revenue during the year rose by 35 percent to $82 million, with a 43 percent rise in operating profit, to $61 million. The company, which has assets of over $500 million under management, reports that since its inception it has produced” a 60% return on invested capital.” My prior post about Burford Capital can be found here.

 

Similarly, Bentham IMF, the U.S. arm of IMF Bentham Limited, whose shares trade on the Australian Stock Exchange, reported in December 2014 (here) that it had funded ten deals during the year, with client recoveries of nearly $100 million resulting from jury verdicts and settlements. The firm itself had gross returns of more than $31 million for the year, with a net profit of $17 million.

 

These kinds of results attract attention. The increasing involvement of financial firms in litigation-funding also attracts criticism. In a March 26, 2014 guest post on this blog entitled “The Real and Ugly Facts of Litigation Funding” (here), Lisa Rickard, the President of the U.S. Chamber of Commerce’s Institute for Legal Reform, said “Litigation funding is a sophisticated scheme for gambling on litigation.” She said further that the growth of litigation funding will lead to “more lawsuits, more litigation uncertainty, higher settlement payoffs to satisfy cash-hungry funders, and in some instances, even corruption” (the latter comment referring to the Chevron case in Ecuador, noted below)

 

There is no doubt that the litigation funding industry has been involved in controversy. In a March 18, 2015 Bloomberg article entitled “Hedge Fund Betting on Lawsuits is Spreading” (here), Paul M. Barrett, discussing the rise of the litigation-funding in the U.S., notes that while Burford Capital has “helped move litigation funding into the corporate-litigation mainstream,” its funding ventures include its “most notorious – and least successful investment” relating to a class action oil pollution lawsuit against Chevron in Ecuador.

 

Barrett, the author of the Bloomberg article, and who is also the author of the 2014 book Law of the Jungle: The $19 Billion Legal Battle Over Oil in the Rain Forest and the Lawyer Who’d Stop at Nothing to Win (here), notes in the article that Burford invested $4 million in the Ecuador case in 2010. The plaintiffs, a group of Ecuadorians, won a $19 billion judgment in Ecuador against Chevron, but the oil company then “turned the tables” and persuaded a U.S. judge that the Ecuadorian suit involved coercion, bribery and fabricated evidence. By then, Burford had sold off its interest in the lawsuit and accused the plaintiffs’ attorney of deceit. As Barrett puts it in his article, the Ecuadorian episode “constituted a black eye for Burford” that continues to provide “ammunition for critics of litigation finance.”

 

Despite the criticism and controversy, litigation funding continues to attract new entrants and investors, as the recent entry of EJF Capital discussed above shows. Litigation funding is well-established in several other countries. As I have noted in prior posts on this blog, most recently here, litigation funding is an important part of the class action litigation landscape in Australia. As discussed here, litigation financing continues to play an important role in class action litigation in Canada. Litigation financing may play an increasingly important role in the U.K.; as I discussed in a recent post (here), the U.K. litigation involving Tesco is being supported by a litigation funding firm.

 

There are important differences between the legal system in the U.S. and the legal systems in the other countries where litigation funding is now well-established. Canada, Australia and the U.K. all have a “loser pays” litigation model, where an unsuccessful claimant must pay their adversary’s legal fees. In the U.S. by contrast, we follow the American rule, under which each party bears its own cost. In addition, most states in the U.S. allow contingency fees, by contrast to many other countries where contingency fees are not permitted. Because of loser pays model and the prohibition of contingency fees, there may be reasons why litigation funding is better established in other countries.

 

Just the same, litigation funding recently has been quickly developing in the U.S., perhaps because there is so much litigation and because litigation in the U.S. can be so expensive – which raises the question of what the rise of litigation funding may mean for civil litigation in the U.S.

 

The more positive spin may be that the availability of litigation funding will level the playing field for smaller litigants attempting to take on larger adversaries. At the same time, however, litigation funding raises a host of questions. First and foremost are the concerns about the possible conflicts between the litigation investors and the actual litigants. The funders’ investment objectives may diverge from the actual litigant’s litigation objectives – differences that could lead to diverging views about litigation tactics and even case resolution approaches and objectives.

 

Similarly, there is the question whether litigation funding is appropriate in the class action context. While the litigation funding unquestionably may help facilitate a recovery for the class, the amount to be paid to the litigation funder, in the form of commission or other payment, will reduce the amount of the recovery for the class. (To provide some perspective on this issue, in its report of its 2014 results, Bentham IMF reported that with respect to the recoveries in which it was involved, clients and outside counsel took 69%, with Bentham drawing the remaining 31%.) The absent class members cannot all be consulted in advance about such arrangements, which may or may not look fair after the fact.

 

A more fundamental question has to do with the possible effect of growing amounts of litigation funding on the litigation system. Will the availability of litigation funding fuel an increase in litigation? Will it encourage adversaries — who might otherwise be able to reach a business resolution of their dispute – to litigate rather than negotiate? And then there are the concerns about a field in which there apparently are huge sums to be made but few barriers to entry — will the outsize profits that are now being reported attract less scrupulous competitors who attempt to extract outsized returns at the expense of litigants? Will competition for the best cases encourage the players that are unable to attract the best cases to finance less meritorious cases?

 

There are, in short, a host of unanswered questions about the growing presence of litigation funding on the U.S. litigation scene. There is no doubt that the current players’ returns will attract additional participants. Litigation funding seems likely to become an increasingly important part of commercial litigation in the U.S. I fully expect that we will be continue too hear a lot more about this topic. But the point is – litigation funding is here, now. We had better recognize that, get used to it, and try to understand what it means.

 

SEC Chair Weighs in on Fee-Shifting Bylaws: In a March 19, 2015 speech at the Tulane University Law School (here), SEC Charman Mary Jo White offered a number of observations on a variety of topics, including fee-shifting bylaws. While she made it clear that the SEC is monitoring developments on the topic closely, the agency has not decided to take a position and she declined to comment on the merits of any particular position on the issue, she did say that “I am concerned about any provision in the bylaws of a company that could inappropriately stifle shareholders’ ability to seek redress under the federal securities laws. All shareholders can benefit from these types of actions.” She added that “If the Commission comes to believe that these provisions improperly hinder shareholders’ exercise of their rights, it may need to weigh in more directly in this discussion.”

 

More About Fee-Shifting Bylaws: In yesterday’s post, I linked to a couple of academic articles discussing litigation reform bylaws, and in particular, fee-shifting bylaws. I wanted to add another link on the topic. In an interesting March 19, 2015 paper entitled “The Intersection of Fee-Shifting Bylaws and Securities Fraud Litigation” (here) Arizona Law School Professor William Sjostrom, examines the possible effect of fee-shifting bylaws would have on securities litigation and then takes a look at whether a bylaw shifting fees for securities litigation would be valid under federal securities laws – Professor Sjostrom concludes that they would not. Professor Sjostrom further concludes that Congress should not validate fee-shifting bylaws. The article includes in an appendix a detailed list of the 43 companies that have adopted fee-shifting by laws since the Delaware Supreme Court issued its May 2014 decision upholding the validity under Delaware law of a fee shifting by law.

 

The Latest from China: I suspect that many of this blog’s readers, like me, also follow the China Law Blog, which is written by Dan Harris of the Harris & Moure law firm. Harris’s posts are reliably readable and interesting. On March 15, 2015, Dan had a particularly interesting post that I wanted to be sure to note here. The post, entitled “China’s Golden Age for Foreign Companies is Over” (here) details the increasing difficulties foreign companies are having operating in China and notes that many companies are shifting operations to Vietnam. As Harris details in his post, “There is no disputing that China’s golden age for foreign companies doing business in China is over. China today is just not nearly as favorable or easy for foreign companies as it was ten years ago.” While doing business in Vietnam is not without its own set of challenges and may not be the right choice for some companies, a number of companies are relocating operations or their entire business there. Harris’s post is interesting and I recommend reading the full post on his site.

 

Break in the Action: I will be on the road the week of March 23, 2015, and so there will be a brief hiatus in this blog’s normal publication schedule. Regular publication will resume the following week.

cyber2There has been extensive litigation filed in the wake of the many high-profile data breaches over the last several years, but by and large the lawsuits have been filed on behalf of consumers or employees. Along the way, there have also been lawsuits filed against the directors and officers of the companies that experienced the data breaches – for example, shareholders derivative lawsuits were filed against directors and officers at Target (about which refer here) and Wyndham Worldwide (about which refer here).

 

But there have not been D&O lawsuits filed involving many of the other recent high-profile data breaches. Indeed, as I noted in a recent post, there are a number of specific reasons why there may be no D&O litigation relating to the Sony Pictures Entertainment breach. In addition, and so far at least, there has been no D&O litigation relating to the Anthem data breach, the Home Depot data breach, and of the many other high profile data breaches that have occurred over the last few months.

 

So in assessing the data breach-related claims to date, we have a relatively few derivative lawsuits, a couple of which were mentioned above, but so far not much in the way of securities class action litigation. To be sure, in 2009, there was a securities class action lawsuit filed against Heartland Payments Systems and certain of its directors and officers related to the company’s massive data breach. (The court granted the defendants’ motion to dismiss in that case). None of the more recent high-profile data breaches have resulted in securities class action lawsuits.

 

However, despite the fact the wave of high-profile data breaches has not yet led to a uptick in securities class action litigation, in a March 17, 2015 post on his D&O Discourse blog (here), Doug Greene of the Lane Powell law firm says that he “remain(s) convinced that a wave is coming, perhaps a tidal wave.” Moreover, Greene predicts that the wave will not only include shareholders derivative lawsuits of the type that were filed against Target and Wyndham Worldwide, but also securities class action lawsuits and SEC enforcement matters.

 

In making this prediction, Greene first focuses on the usual reason given when the question is asked about why there hasn’t been more data breach-related securities class action litigation so far. The reason, it is often suggested, is that least to this point most of the high profile data breaches have not resulted in a significant drop in the affected company’s share price. Greene reviews the reasons usually given for this absence of price decline, which is that in a world in which all companies potentially are susceptible to a cyber attack, the occurrence of a data breach is basically random and doesn’t say much about the company’s business or it future financial performance.

 

Greene suggests that this dynamic is about to change. In effect, he is predicting that in the future news of a data breach may well affect the share prices of at least some of the companies involved. First, he predicts that in a world where companies are now working hard to improve their cyber security, the company’s cyber security standards may become a basis of competition. Some companies may seek to secure business or even investment based on the extent of their own cyber security. If cybersecurity become a competitive issue and in particular if companies start touting the extent of their cyber protection, the companies’ statements will be “susceptible to challenge as false or misleading if they suffer a breach.” If the company’s share price reflects a widespread perception that the company has a competitive advantage based on its cybersecurity, it share price might well decline, perhaps significantly, if the company’s experiences a problem.

 

Green adds that the SEC is focused on cybersecurity disclosure and “inevitably will start to more aggressively police disclosures.” In addition, he predicts that whistleblowers from IT departments will start to surface, and auditors will begin to prompt disclosures as they increase their focus on the financial impact of cybersecurity breaches.

 

I have no way of knowing whether or not there will be significant numbers of securities class action lawsuits in the future. Indeed, in answering his own question of whether or not data breach securities class action lawsuits will become a prominent type of securities class action lawsuit, Greene himself says “I doubt it.”

 

There are reasons to be modest about these types of predictions; there have been past predictions and speculations about possible data breach-related securities lawsuits, but so far, there has been little action in that department. But I do think there are reasons to be concerned that there may be significant securities class action litigation related to data breaches in the future.

 

In addition to all of the reasons Greene cites, I think there is at least one additional reason to be concerned about possible future data breach-related securities class action litigation. That is, the plaintiffs’ bar has an incentive to try to find a way to capitalize on the adverse publicity surrounding a company that has experienced a data breach. Some plaintiffs’ lawyers are now focused on the consumer and employee privacy breach-related claims. But the plaintiffs’ lawyers will also consider possible D&O claims as well, when the right circumstances arise.

 

Along those lines, at the PLUS D&O Symposium in New York in February, one of the leading plaintiffs’ securities attorney, when asked to make a prediction about future litigation trends, expressly said that he expects there to be significant data breach related litigation – and he added that he hope to be the one bringing the claims. In other words, when the right circumstances present themselves, the plaintiffs’ lawyers will not hesitate to file the claims. Up until now, they have simply been considering what their opportunity might be. I would expect them to act when they think they have found their opportunity.

 

I also agree with Greene that the SEC will play a significant role here. The SEC has made it clear that cyber security disclosure is a priority. It has been over three years since the SEC released its Disclosure Guidance on cyber security, but many companies still have not yet adapted their disclosure practices (as discussed here). Several of the individual SEC commissioners have made it clear in individual speeches that cyber security issues generally remain an agency priority (refer for example here). What active future steps the agency might take remains to be seen, but it does seem at possible that the agency might use an enforcement action as a more aggressive way to send a message on these issues. If agency uses its enforcement authority in that way, the plaintiffs’ lawyers will not be far behind.

 

In the immortal words of that astute sage, Yogi Berra, it’s tough to make predictions, especially about the future. Though the future remains uncertain, I do agree with Greene that when it comes to the possibility of future data breach-related securities class action litigation, “the risk is high enough that all companies need to pay more attention to their cybersecurity disclosures.” I also agree with him that insurers, brokers and risk managers need to be mindful of the potential securities class action risk in this area.

 

Questions About Delaware’s Proposed Fee-Shifting Bylaw Legislation: As discussed in a recent post (here, second item), the Delaware Corporation Law Council has recently proposed draft legislation that among other things would prohibit Delaware companies from adopting a fee-shifting bylaw . In a March 16, 2015 post on the CLS Blue Sky Blog (here), Columbia Law School Professor John Coffee takes a detailed look at the draft question. Among other things, he examines the provision of the proposed legislation that restrict bylaws that shift fees in connection with “an intracorporate claim.” Coffee questions whether this provision as worded would prohibit a bylaw shifting fees for a federal securities claim, as opposed to “Delaware-style” litigation.

 

Coffee then examines the issues that might arise if the Delaware statutory provision as adopted only prohibits the adoption of a bylaw shifting fees for Delaware-type litigation, and a company adopts a bylaw requiring fee shifting in connection with a federal securities suit. Coffee examines the various preemption and other issues that might arise under the PSLRA and otherwise if a company were to try to adopt such a fee-shifting bylaw.

 

The article is technical and interesting and suggests that even if the Delaware legislature adopts the proposed legislation, fee-shifting bylaw questions could continue to follow.

 

More About Litigation Reform Bylaws: Along with the fee-shifting bylaws, another litigation reform bylaw that has been under recent discussion has been the possibility of a bylaw requiring the arbitration of shareholder disputes, perhaps with a class action waiver. I have discussed the possibility of these types of bylaws in prior posts on this blog, most recently here.

 

In a March 18, 2015 post on the CLS Blue Sky Blog (here), Visiting Duke Law School Professor Ann Lipton examines the legal theory that has supported the assertion of the validity of these types of bylaw provisions. Basically, the courts that have upheld the validity of these arbitration bylaw provisions have subscribed to the view that the Federal Arbitration Act requires the enforcement of contractual bylaw provisions, and that a bylaw is essentially a contractual provision. In her article, Professor Lipton takes issue with both aspects of this analysis and argues that the Federal Arbitration Act is “incompatible” with corporate governance issues. 

 

lifesciencesLife sciences companies are “an increasingly popular target” of securities class action lawsuits, according to the annual securities litigation survey from the David A. Kotler of the Dechert law firm. According to the March 16, 2015 report, entitled “Dechert Survery of Securities Fraud Class Actions Brought Against U.S. Life Sciences Companies,” the number of 2014 securities suit filings against life sciences companies represents a “remarkable increase” compared to 2013. The Dechert law firm report can be found here. My analysis of the 2014 securities class action litigation filings, including the filings against life sciences companies, can be found here.

 

According to the Dechert report, in 2014, there were 39 different securities class action complaints filed against 38 different life sciences companies, representing approximately 23% of the 170 securities class action lawsuits filed during the year.

 

The number of suits and the percentage the suits represent of all securities filings represent a “sharp increase” compared to equivalent levels in recent years. For example, in 2013, only 11% of the 167 securities fraud lawsuit filings involved life sciences companies. The 2014 figures were also well ahead of 2012 (18%), 2011 (9%) and 2010 (16%).

 

The filings in 2014 followed trends that developed in recent years in which the securities litigation activity appears to be concentrated on companies with “relatively smaller market capitalizations.” In 2014, 57% of all life sciences companies hit with securities class action lawsuits had market capitalizations of under $500 million. Indeed, about 40% of the life sciences companies (15 out of 38) had market caps under $250 million.

 

At the same time, many of the 2014 lawsuits also involved larger companies as well. Life sciences companies with market capitalizations of at least $2 billion were named as defendants in about 21% of the 2014 lawsuits against companies in those industries.

 

The 2014 filings followed recent trends in other respects. The report notes that trend that began in 2011 of a return to “more industry-specific allegations” continued in “full force” in 2014. The kinds of allegations the report characterizes as industry specific are allegations such as “alleged misrepresentations or omissions regarding marketing practices, prospects/timing of FDA approval, product efficacy, product safety, manufacturing and other healthcare-related allegations.” Approximately 56% of the 2014 securities suits against life sciences companies involved these types of industry specific allegations, while claims of inaccurate financial reports/accounting improprieties were asserted in 44% of the 2014 life sciences securities suits. Some of the 2014 suits involved both types of allegations.

 

The report concludes with an analysis of how the 106 securities suits filed against life sciences companies between 2011 and 2014 have fared in the courts. The report notes that the defendants in these cases have “continued to enjoy relative success in obtaining dismissals.” However, the report also notes that “it is equally worth noting that securities fraud lawsuits still carry a substantial risk of exposure, and even when settled can result in very large payments.” To illustrate the later point, the report cites Pfizer’s January 2015 agreement to pay $400 million to settle the securities class action litigation pending against the company.

 

Belated St. Patrick’s Day Greetings: My travel schedule prevented me from posting on St. Patrick’s Day itself the following great St. Patrick’s Day mug shot sent in by Jim Sandnes of the Skarzynski Black law firm. I am pleased to see that the firm used a D&O Diary mug to hold some seasonally appropriate shamrocks at its main reception desk. Thanks to Jim for sending the mug shot along. Readers interested in reviewing other mug shots that I have posted should take a look here.

 

st pats Mugshot

 

 

circuitsCircuits Split on Pleading Loss Causation: In a December 16, 2014 opinion written by Judge Milan D. Smith, Jr. for a unanimous three-judge panel of the Ninth Circuit, the appellate court affirmed the dismissal of the securities class action lawsuit that had been filed against Apollo Group and certain of its directors and officers. In affirming the dismissal, the court addressed the question of whether or not in pleading loss causation in a claim under Section 10(b) and Rule 10b-5 a plaintiff must satisfy the pleading standards under Fed. R. Civ. Proc. 9(b) – which requires a party alleging fraud to plead with “particularity the circumstances constituting fraud or mistake” – or whether it is sufficient to satisfy the more basic pleading requirements of Fed. R. Civ. Proc. 8 (requiring only a “short plain statement” of the plaintiff’s claim).

 

The Ninth Circuit ruled that held that the heightened pleading standards of Fed. R. Civ. P. 9(b) apply to all elements of a securities fraud action, including loss causation. In holding that a plaintiff’s loss causation allegations must meet Rule 9’s pleading with particularity requirements, the Ninth Circuit joined the Fourth and Seventh Circuits, widening a circuit split in which the Fifth Circuit and certain other federal district courts have held that it is sufficient for pleading purposes for a plaintiff to satisfy Rule 8’s basic pleading requirements.

 

The circuit split is detailed in a March 6, 2015 New York Law Journal article (here) by Steven Paradise of the Vinson & Elkins law firm. In light of the circuit split, the more interesting question now is whether the existence of the circuit split might be sufficient to attract the attention of the U.S. Supreme Court to the issue. As Paradise notes in his article,

 

Given the Supreme Court’s recent enthusiasm for taking up securities cases, particularly where there is a circuit split, this issue may eventually make its way there. If the Supreme Court were to agree with the Fourth, Seventh and Ninth circuits and hold that Rule 9(b) applies to loss causation, then plaintiffs would be required to allege more highly particularized facts to satisfy this element and defendants could have even greater latitude to offer alternative explanations for the stock price decline to rebut a plaintiff’s attempt to satisfy its burden.

 

And Speaking of Circuit Splits on Securities Law Issues: As I noted in a recent post (here), there is a sharp circuit split between the Ninth and Second Circuits on the interesting question of whether or not the alleged failure to make a disclosure required by Item 303 of Reg. S-K is an actionable omission under Section 10(b) and Rule 10b-5. In the post, I noted that in light of the circuit split this question might soon make its way to the U.S. Supreme Court. After I published the post, several alert readers pointed out to me that the issue may come before the Supreme Court even sooner than I speculated, because one of the plaintiffs in the NVIDIA case (in which the Ninth Circuit held that Item 303 does not create a duty to disclose for purposes of an omission actionable under Section 10(b)) has filed a petition for writ of certiorari to the U.S. Supreme Court on the issue.

 

As reflected on the Court’s docket (here), the plaintiff filed his petition with the Court on February 9, 2015. A copy of the plaintiff’s cert petition can be found here. The time for the defendants’ response has been extended to April 15, 2015.

 

As noted in a March 3, 2015 memo by Robert Hickok and Gay Parks Rainville of the Pepper Hamilton law firm about the cert petition (here), the preponderance of securities class action lawsuits are filed in the Ninth and Second Circuits (and the Third Circuit, which, as the memo notes, has also weighed in on the issue), so the Supreme Court may grant cert in the NVIDIA case “in order to resolve this conflict so that public companies will have clear guidance for complying with their disclosure obligations under Item 303.”

 

Amy Leisinger’s February 17, 2015 post on the Jim Hamilton’s World of Securities Regulation blog about the cert petition in the NVIDIA case can be found here.

 

The law nerd part of my brain (which, I confess, occupies a rather large part of the whole) is quite excited about the possibility that these various securities law issues might actually make their way before the Supreme Court. Some day, when historians finally write the history of the Roberts Court, they may be able to explain why the Court suddenly became so inclined to take up at least one or two securities cases every term, after decades in which the Supreme Court only intermittently and infrequently weighed in on securities law issues. But whatever the reason for the Court’s recent enthusiasm for securities cases, the Court’s willingness to take up the cases makes for interesting and noteworthy developments in the securities law field. Great grist for the blog, too.

 

Arbitration Clauses and Consumer Claims: On Tuesday March 10, 2015, the Consumer Financial Protection Bureau released to Congress a report required by the Dodd-Frank Act analyzing the impact of mandatory arbitration clauses in consumer contracts for financial products and services like credit cards and checking accounts. The agency’s massive 728-page report can be found here.

 

As Alison Frankel details in her March 10, 2015 post on her On the Case blog (here), “the study’s findings are unequivocal: Class actions deliver cash relief to vastly more consumers – especially those with small dollar claims – than individual arbitration.” Frankel details the report’s statistical analysis in her blog post. She summarizes the statistical report this way: “To recap (in a ruthlessly reductive way): According to CFPB, four financial services consumers with small claims received cash compensation through arbitration. Thirty-four million received compensation through class actions.” As Frankel also noted, CFPB director Richard Cordray said at a public hearing on March 10, 2015 that the study showed the difference between class actions and arbitration as a vehicle for providing relief to consumers to be “stark.”

 

On the other hand, as Frankel also notes, quoting other observers, in many class actions consumers come up empty, and the report does not detail consumers’ actual recoveries even where consumer class actions resulted in a settlement. Frankel’s initial post drew numerous responses from observers and commentators who found fault with the CFPB’s report and its conclusions, as she summarized in a subsequent post, here.

 

The CPFB has not yet proposed any rules restricting financial institutions from requiring arbitration, but, as Frankel notes, but that is almost sure to come. As she also notes, if the CFPB does issue rules restricting arbitration clauses, it will be sure to draw sharp opposition from banks and other institutions.

 

If in fact the CPFB does issue rules restricting the ability of financial institutions to require consumers to arbitrate disputes, it could have a broader impact beyond just the CFPB’s bailiwick. There is an even larger context for the questions surrounding mandatory arbitration clauses. As I have detailed in prior posts (refer here, for example), the U.S. Supreme Court has shown a significant enthusiasm for mandatory arbitration clauses and a predisposition to uphold their enforceability. This in turn has led to some noteworthy experiments involving the requirement of mandatory arbitration, including, for example , the inclusion of mandatory arbitration clauses with a class action waiver in corporate bylaws (as discussed here).

 

While there would be no direct connection between any rules the CFPB might issue and the developments involving mandatory arbitration clauses outside of the CFPB’s immediate jurisdiction, I suspect that were the CFPB to issue rules restricting the use of mandatory arbitration clauses, it could have a broader impact. At a minimum, the rules (and perhaps more significantly, the assumptions behind the rules) could prove helpful for or at least provide support for those opposing the use of mandatory arbitration clauses in other contexts.

 

At a minimum, it will be interesting to see what happens next – that is, whether the CFPB will propose rules restricting the clauses and how the financial services industry will respond.

 

Shortest Class Period?: In a post last week (second item), I noted that a securities class action lawsuit had been filed earlier in the week with an unusually short class period of only three trading days. Alert reader Adam Savett sent me a note reminding me of a post that Lyle Roberts had on his 10b-5 Daily blog way back in March 2004 (here), in which Roberts reported on the “Shortest Class Period Even in a Securities Class Action Lawsuit.” The “winner” (so to speak) was the Corinthian Colleges class action lawsuit filed in December 2003, which was filed against the Nasdaq Stock Market on behalf of a class of persons who purchased the  shares of Corinthian Colleges between 10:46 a.m. and approximately 12:30 p.m. on December 5, 2003.  As Roberts noted, “That’s a proposed class period of a mere one hour and forty-four minutes.”  I am going to go out on a limb here and speculate that there has not been  a securities class action lawsuit filed with a shorter class period, although if there is a reader who knows of a lawsuit with an even shorter class period, I would gratefuly welcome the information.

 

What Happens if the Delaware Legislature Passes Legislation Forbidding Fee-Shifting Bylaws?: As I noted in a separate post earlier last week (here), the Corporate Law Section of the Delaware State Bar Association has submitted proposed legislation to the Delaware state egislature that  would among other things  limit the abililty of corporations to adaopt fee-shifting bylaws. The proposed legislation is the subject of intense debate and significant lobbying both for and against the legislation. In an interesting March 13, 2015 post on the Law 360 Securities section page entitled “Fee-Shifting May Disrupt Delaware’s Dominance”  by Anthony Rickey of the Greenhill Law Group (here, subscription required), the author suggests that if the legislation passes and Delaware corporations are prohibited from adopting fee-shifting bylaws. other states may take the initiative to allow fee-shifting by laws. The author suggests that fee-shifting may “unlock competition in the market for corporate charters,” and notes that “There is evidence that other states may already be eyeing Delaware’s lucrative revenue stream.” Among other things, the author cites Oklahoma’s adoption of legislation requiring fee-shifting for derivative lawsuits. The debate over the fee-shifting bylaws may represent a potentially disruptive moment for Delaware’s long dominance of the realm of corporate charters.

 

A Proposal to Fight IPO Lawsuits: As I have previously noted on this blog (most recently here), IPO activity on the U.S. securities markets is at its highest level in years. Among other things, the heightened IPO activity means that we are likely to see increase levels of IPO-related securities litigation (as discussed here).

 

In light of this likelihood of increased IPO-related litigation, a recent post on the Harvard Law School Forum on Corporate Governance and Financial Regulation by our good friend Boris Feldman of the Wilson Sonsini is particularly interesting. In his article, entitled “A Modest Strategy for Combatting Frivolous IPO Lawsuits” (here), Feldman points out that as a standard feature of many IPO transactions, many offering underwriters will require management and other shareholders to agree not to sell their shares for a specified period after the offering.

 

Feldman notes that an unintended consequence of these lock-up requirements is that it helps plaintiffs in IPO-related lawsuits under Section 11 to “trace” their shares to the offering and establish standing because following the IPO and until the lock-up period expires, all of the publicly available shares trading on the open marketplace can be traced to the offering, so all shareholders who purchased during this period can establish Section 11 standing and be part of the Section 11 class. If, on the other hand, there were no lock up and company employees were free to share their pre-IPO shares in the open marketplace, it would be more difficult for the post-IPO, open market purchaser to trace his or her shares to the IPO.

 

Feldman proposes a more nuanced approach as an alternative to the standard, one-size fits all lock-up provision that is now a part of the typical IPO transaction. In particular, he suggests that underwriters consider easing the lock-up requirement as a way “to enhance the potency of the standing defense in Section 11 claims.” Among other things, he suggests that underwriters might consider allowing some company employees(other than senior managers and directors) to sell their pre-IPO shares in the open market or to allow some holders to sell into the market subject to a cap on the number of shares that may be sold. He suggests that the many alternative options might be sorted out over time, but his point is that “by taking a fresh look at the scope and operation of lock-up agreements, regular players in the IPO process can reduce the risk from Section 11 claims that so often follow a decline in the stock price.”

 

Feldman’s perspective is interesting, but it does seem that this is the perspective of a litigator. While his concerns about the litigation consequences undoubtedly are legitimate, most underwriters will be significantly more concerned about the potential dilutive effect on the share price if pre-IPO shares are allowed to enter the marketplace earlier than they would be about theoretical potential effects on standing defenses if there were to be a post-IPO lawsuit. Just the same, Feldman’s ideas are interesting. There certainly is some merit to reconsidering the standard one-size-fits-all approach to the lock-up issue.

 

The Title Says it All: “Pictures of Guitar Solos Make a Lot More Sense When Guitars are Replaced with Giant Slugs.” Seriously, what is the Internet for if not to bring us guitar solos and giant slugs? See the article here. 

 

floridaIn a summary judgment ruling in a coverage lawsuit arising after a civil jury trial, a Southern District of Florida judge applying Florida law has ruled that there is no coverage under a D&O insurance policy for a jury verdict that included the award of treble damages based on the jury’s determination that the insured company had committed civil theft. The coverage opinion addresses a number of interesting issues but what makes the court’s analysis and rulings noteworthy is the fact that the coverage issues arose following a jury verdict, a relatively unusual circumstance, as discussed further below. Judge Robin L. Rosenberg’s March 11, 2015 opinion can be found here.

 

Background

CR Technologies (CRT) provided Voice over Internet Protocol (VoIP) services to businesses. U.S. Datanet Corporation (Datanet) and its subsidiary USD CLEC (CLEC) provide both VoIP and traditional communications services to customers. In March 2004, CRT and Datanet entered a Rental Agreement pursuant to which Datanet rented CRT’s hardware and software. At the end of the parties’ 42-month agreement, Datanet informed CRT it would not renew the agreement. A dispute then arose over who was entitled to retain possession of the system components. Datanet refused to return the system components to CRT.

 

CRT initiated a Florida state court lawsuit against Datanet and CLEC alleging breach of contract, conversion, civil theft, tortious interference with an advantageous business relationship, violations of the Florida Deceptive and Unfair Trade Practices Act and negligent misrepresentation. The jury returned a verdict in favor of CRT on all counts except the tortious interference claim. The total amount of the judgment was $644,746, inclusive of treble damages awarded against the defendants and of contractual interest. The judgment explicitly noted that the verdict amount was trebled because the jury found that Datanet and CLEC had committed civil theft.

 

CRT then sought to enforce its judgment against Datanet’s D&O insurer. The insurer filed an action seeking a declaratory judgment that its policy did not cover the judgment, based as it was on a jury finding of civil theft. CRT filed a cross-claim and third party complaint against the insurer. The parties filed cross motions for summary judgment.

 

The policy’s definition of Loss provides, among other things, that “Loss” does not include “taxes, fines or penalties imposed by law, the multiple portion of any multiplied damage award, or matters that may be deemed uninsurable under the law pursuant to which this Policy shall be construed.”

 

The policy’s exclusions included a provision stating that the policy shall not pay any Loss for any Claim:

 

based upon, arising from, or in any way related to any deliberately fraudulent or criminal act or omission or any willful violation of any law by the Insureds if a judgment or other final adjudication establishes such an act, omission or violation.

 

The policy’s exclusions also include a separate provision stating that the insurer shall not pay any loss for any Claim:

 

based upon, arising from, or in any way related to the gaining, in fact, of an personal profit, remuneration, or advantage to which the Insureds are not legally entitled if a judgment or other final adjudication establishes that such a gain did occur.

 

Finally, the policy’s exclusions also contain yet another provision stating that the insurer shall not pay any loss for any claim:

 

based upon, arising from, or in any way relating to any liability under any contract or agreement, provided that this exclusion shall not apply to the extent that liability would have been incurred in the absence of such contract or agreement.

 

The March 11 Ruling

In her March 11 opinion, Judge Rosenberg granted the insurer’s motion for summary judgment and denied CRT’s motion for summary judgment.

 

In ruling as a matter of law that there is no coverage under the policy for CRT’s judgment against Datanet and CLEC, Judge Rosenberg concluded that the “a Final Judgment for Civil Theft is not a ‘Loss’ as that term is defined” in the insurer’s policy. Citing the CNL Resorts case (about which refer here) and the Seventh Circuit’s opinion in the Level 3 case (here), Judge Rosenberg said that “as a matter of law, ‘Loss’ does not include the ‘restoration of ill-gotten gains.’” She added that “the Final Judgment for civil theft is not insurable as a matter of public policy” under Florida law. Finally she said that the treble damages awarded for civil theft represent “the multiplied portion of a multiplied damage award” which is “expressly excluded from the definition of ‘Loss.’”

 

Judge Rosenberg then went on to hold that even if the judgment met the policy’s definition of Loss, each of the three exclusions on which the insurer relied nevertheless preclude coverage for the judgment.

 

First, Judge Rosenberg concluded that coverage for the judgment amount was precluded by the criminal act or willful violation of law exclusion.

 

The insurer had argued that the jury concluded that Datanet and CLEC had acted with felonious intent to steal CRT’s property and than in any event the jury finding of civil theft was clearly within the criminal act or willful violation exclusion. CRT, by contrast, had argued that the exclusion does not preclude coverage for the portions of the judgment attributable to the causes of action other than the civil theft claim and that the damages awarded in the case had nothing to do with the civil theft claim.

 

Judge Rosenberg concluded that because a final judgment for civil theft is based upon, arising from or related to a deliberately fraudulent or criminal act or omission or a willful violation of law it “falls squarely within the express language” of the exclusion.

 

Second, Judge Rosenberg also concluded that coverage for the judgment is precluded by the personal profit or advantage exclusion.

 

The carrier had argued that the jury’s verdict represented an adjudication that Datanet and CLEC had appropriated CRT’s property for its own use and that the judgment represented a requirement for the companies to pay restitution. CRT argued that the judgment did not establish that the defendant companies had gained a profit or advantage, but only that Datanet had caused CRT to suffer the loss of its property.

 

Judge Rosenberg found that a final judgment for civil theft is based upon, arising from or related to the gaining of a personal profit, remuneration or advantage to which Datanet and CLEC were not legally entitled. She said that the final judgment “falls squarely within the express language of this exclusion.”

 

Third, Judge Rosenberg concluded that coverage is barred by the breach of contract exclusion.

 

The insurer had argued that the underlying action incorporated allegations detailing the contractual relationship and that ultimately the jury found that there was a breach of contract. CRT argued that the exclusion preserves coverage so that the preclusive effect does not apply where liability would have been incurred in the absence of contract. CRT argued that the underlying claim included numerous causes of actin that would have resulted in liability in the absence of contract.

 

Judge Rosenberg ruled that final judgment for civil theft, which “occurred at the end of a contractual relationship” between Datanet and CRT “falls squarely within the express coverage language” of the contractual liability exclusion.

 

Finally, Judge Rosenberg concluded that coverage under the Crime Coverage part of the insurer’s policy was not triggered the crime coverage section only reimburses an employer when its employees steal from the employer, but does not indemnify an insured for stealing from others. Judge Rosenberg also concluded that there was no coverage for the judgment under the general liability policy the same insurer had issued to Datanet and CLEC.

 

Discussion

There are a number of provisions typically found in management liability insurance policies that can only be triggered if the underlying claim goes all the way to verdict. Obviously, the conduct exclusions, which as worded these days typically contain an adjudication requirement, can only be triggered if there has been a trial or other adjudication. Even the treble damages provision typically found in the definition of Loss is going to be triggered only if a matter goes to trial and verdict. This coverage dispute presents the rare circumstances where these provisions were triggered because the coverage lawsuit arose after the jury had entered its verdict in the underlying claim.

 

(I should add parenthetically that the determination of coverage issues following a jury trial in the underlying claim may not be as rare as I previously might have assumed. This case is the second instance where I have had occasion recently to open the discussion of a coverage ruling by pointing out that the ruling arose in the relatively unusual context of a post-verdict set of circumstances. The recent prior occasion can be found here.)

 

It is worth pointing out that the potential post-verdict operation of the various relevant policy provisions is often one of the factors motivating parties to settle a claim before trial . That is, both the claimant in the underlying claim and the insured defendant have an incentive to avoid a trial determination that might trigger a coverage preclusive provision of the insurance policy. In this case, CRT found only after it tried to enforce the judgment against Datanet and CLEC’s insurer that it might have been a little too successful at the trial in the underlying claim. CRT might have had better luck obtaining insurance for the verdict amount (at least prior to trebling) if there had been no jury determination of civil theft – or better yet if it had managed to settle the case before it went to trial.

 

But given the fact that the jury did reach a verdict in CRT’s favor on the civil theft claim, it comes as little surprise that policy coverage was precluded. It could be anticipated that the carrier’s argument that providing insurance coverage for civil theft is against public policy would get a receptive hearing from the court. Given the jury’s determinations on the issue, it could also be expected that the insurer would seek to preclude coverage under the conduct exclusions, as well.

 

The one place where I have trouble with Judge Rosenberg’s rulings is with respect to her conclusions concerning the contractual liability exclusion. CRT asserted a number of claims against Datanet and CLEC some of which had nothing to do with the contract and several of which clearly could have resulted in liability in the absence of contract. As I have pointed out previously on this blog (most recently here), I think the way the contractual liability exclusion is worded and applied results in a unnecessarily overbroad and objectionable extension of the exclusion’s preclusive effect.

 

I have long thought that the most appropriate wording for the exclusion would employ the narrower “for” wording rather than the broader “based upon, arising out of” wording, because the broader wording as interpreted and applied by the courts results in an application of the exclusion that inappropriately results in the swallowing up of the very coverage the policy was designed to provide.

 

I believe that even where the contractual liability exclusion has the broad preamble, courts should take care to differentiate between claims that relate directly to the contract and claims that relate to other conduct. (For an example of a case where a court took this approach in determining that the exclusion’s preclusive effect does not apply to an alleged intentional misrepresentations that preceded and allegedly induced a contract, refer here.) Or to put it another way, I do not believe it is an appropriate application of the contractual liability exclusion – even an exclusion with the broad preamble – to preclude coverage for all claims merely because there is a transaction involved in the underlying circumstances.

 

In the end, however, Judge Rosenberg’s ruling with respect to the contractual liability exclusion arguably is not outcome determinative because she found that coverage was independently precluded on a number of other grounds.

 

I have to say that this is the first time I have run across a case where there actually was an adjudication that civil theft has taken place. I am sure there have been other cases, but this is the first case of which I am aware in which a court considered the application of a D&O insurance policy’s conduct exclusions in the context of a judgment following trial for civil theft. In fact, it is the first case of which I am aware in which a court considered whether public policy precludes coverage for a judgment following a jury verdict for civil theft. Based on the outcome of this case, at least, I think we should all presume that your basic D&O insurance policy does not provide coverage when there has been a liability determination of civil theft.

 

Readers interested in thinking further about whether or not there should be coverage for the settlement of a claim for “ill-gotten gains” – as opposed to coverage for a judgment on a claim for recovery of ill-gotten gains – will want to review my prior post (here), in which the court determined that coverage was not precluded under a D&O insurance policy for a bank’s settlement of claims for repayment of allegedly excessive overdraft fees.

 

dukeenergyOne of the hot topics in the world of corporate and securities litigation in recent years has been the rise of M&A-related litigation. Among the many themes that are part of the discussion of this topic has been the fact that the M&A lawsuits often settle for the defendant company’s agreement to additional disclosures about the merger, with no cash payment to shareholders. The disclosure-only settlements continue to be a concern, but at the same time there recently have been a number of merger-related lawsuit settlements in which there has been very significant cash components. Continue Reading In Latest Jumbo Merger Suit Settlement, Duke Energy Agrees to Pay $146 Million to Settle Suit Over “Boardroom Coup” Following Progress Energy Merger

paA question that frequently recurs when I am speaking to directors and officers of non-profit organizations is why – given that their firms have no shareholders – they need to bother with D&O insurance. The reality is that even though officials at non-profit firms don’t have to worry about the possibility of shareholder claims, non-profit officials still face other potential claims from other potential claimants.

 

These potential liability issues were underscored in a recent decision by the United States Circuit Court of Appeals for the Third Circuit. In a January 26, 2015 opinion in In re Lemington Home for the Aged (here), the appellate court, applying Pennsylvania law, affirmed the jury’s entry of a liability verdict for the benefit of a bankrupt non-profit nursing home’s creditors against the home’s directors and officers, including the entry of punitive damages against the officers. The appellate court reversed the award of punitive damages against the home’s directors.

 

As discussed in a March 3, 2015 memo from the Cadwalader law firm about the appellate court’s ruling (here), the court’s opinion “provides a cautionary tale for the corporate officers as well as board members of not-for-profit heath care organizations – for the most part, volunteers – that they may be held to the same standards of accountability as those of for-profit, public corporations.”

 

Background

The Lemington Home had a long history operating a nursing home under a number of prior names going back to 1883. From September 1997 until the Home closed, Defendant Mel Lee Causey acted as the Home’s Administrator and Chief Executive Officers. From December 2002, Defendant James Shealey acted as the Home’s Chief Financial Officer.

 

Though the Home had a long history, its more recent history involved a significant number of deficiency citations from the Pennsylvania Department of Health. A number of outside consultants recommended that the Home hire qualified staff and outside specialists. A 2001 study funded by a community foundation recommended that that the Home’s board replace its existing administrator with a “qualified, seasoned nursing home administrator.” The community fund provided a grant of over $175,000 to hire a new administrator; however, the board did not act to replace its administrator, and the grant funds were used for other purposes.

 

In 2004, the Pennsylvania Department of Health, citing the Home’s failure to properly maintain resident’s clinical records as well as lapses of care (which included the Department’s investigations of two patient deaths that occurred in 2004), concluded that the Home’s administrator “lacks the qualifications, the knowledge of the regulations, and the ability to direct staff.” Even though the administrator had by that time transitioned to a part-time status – in violation of Pennsylvania law – the board still did not replace the administrator.

 

In addition, the Home’s financial administration lacked appropriate processes and controls. Among other things, beginning in November 2003, the Home’s CFO had ceased to maintain a general ledger of accounting records. In addition, by omitting to bill Medicare, the CFO failed to obtain up to $500,000 in payments that were due for patient services.

 

In January 2005, the Home’s board voted to close the Home. However, the Home’s Chapter 11 petition was not filed until April 13, 2005. During the interim the patient census dropped significantly. In June 2005, the bankruptcy court approved the Home’s closure. It was later revealed that because the Home delayed until September 2005 filing its Monthly Operating Reports for May and June 2005, the Home did not receive nearly $1.4 million in Nursing Home Tax Assessment Payments (an amount, which if it had been paid might have increased the Home’s chances of finding a buyer).

 

In November 2005, the bankruptcy court authorized the Committee of Unsecured Creditors to file an adversary proceeding against Causey, Shealey and the individual members of the Home’s board. The committee asserted claims for breach of fiduciary duty, breach of the duty of loyalty, and deepening insolvency. The adversary proceeding had a long procedural history that included two prior trips to the Third Circuit.

 

In February 2013, following a six-day trial, a jury returned a compensatory damages verdict against fifteen of the seventeen defendants, holding the defendants jointly and severally liable for $2.250 million. The jury awarded punitive damages of $1 million against Shealey and $750,000 against Causey, as well as punitive damages of $350,000 against five of the director defendants.

 

The January 26 Opinion

In a January 26, 2015 opinion written by Judge Thomas I. Vanaskie for a unanimous three-judge panel, the Third Circuit affirmed the jury’s compensatory damages verdict and the award of punitive damages against Shealey and Causey, but vacated the award of punitive damages against the five director defendants.

 

Pennsylvania statutory law provides that “An officer shall perform his duties as an officer in good faith, in a manner he reasonable believes to be in the best interests of the corporation and with such care, including reasonable inquiry, skill and diligence, as a person of ordinary prudence would use under similar circumstances.”

 

The appellate court found with respect to Causey that the evidence presented at trial demonstrated that Causey “fell far short of fulfilling these responsibilities.” Throughout her tenure, the Home was out of compliance with state and federal regulations. The Home was repeatedly cited for failing to keep proper documentation. It also appeared that at the time of a patient’s death at the Home, Causey was not working full-time, despite holding the title of Administrator and drawing a full-time salary, and even though Pennsylvania law required the Home to employ a full-time administrator. At trial Causey tried to claim she was in fact working full-time, but when confronted with long-term disability benefits application she had submitted, in which she said she was working only “20 to 24 hours a week” at the Home, she admitted that she was working part-time.

 

The court also concluded that the jury was presented with sufficient evidence that Shealey breached his duty of care. The jury heard evidence from a consultant that a creditor had hired that Shealey had tried to evade inspection of the Home’s financial records until finally being forced to admit that the records simply didn’t exist, and that the Home had operated without a general ledger since at least June 2004. The testimony also showed that Shealey failed to bill Medicare after August 2004, as a result of which the Home failed to collect at least $500,000.

 

The appellate court concluded that the evidence supports a finding that the director defendants breached their duty of care by failing to take action to remove Causey and Shealey once the results of their mismanagement became apparent.

 

The appellate court also found that the Creditors Committee had introduced sufficient evidence to support the jury’s finding that the defendants had “deepened the Home’s insolvency.” (The appellate court had previously predicted that Pennsylvania’s courts would recognize the tort of deepening insolvency.) The Court found, among other things, that the delay in filing the bankruptcy petition after the decision to close the facility resulted in a depletion of the patient census resulted in a “slow death” of the facility’s ability to generate revenue. The board contributed to the facility’s inability to find a buyer by failing to preserve and record the Home’s entitlement to a $1.4 million Nursing Home Assessment Payment. The appellate court also said there was sufficient evidence to support the deepening insolvency verdict against Causey and Shealey, due to the failure to maintain financial records and to recoup Medicare payments that were due.

 

Finally, while the appellate court concluded that there was insufficient evidence to support the award of punitive damages against the director defendants, “we have no such concerns about the punitive damages assessed against the Officer Defendants.”

 

Discussion

It is very difficult to read the appellate court’s opinion without concluding that the Home was badly run for many years and that despite numerous concerns raised over the years, neither the officers nor board did anything to remedy the identified concerns – with tragic consequences for some of the Home’s residents. So to some extent the outcome of this case my simply be a reflection of the truly lamentable factual circumstances.

 

Just the same, there are a number of important lessons from this case. First and foremost, the case highlights the fact that even though non-profit organizations do not have shareholders, the organizations directors and officers can still face D&O claims – as illustrated here, where the claims against the Home’s former directors and officers were asserted by the Creditor’s Committee for the Home’s bankruptcy estate.

 

Second, even though an organization is a not-for-profit entity, its directors and officers are still expected to perform their duties in compliance with the applicable standard of care, and can be held accountable if their conduct falls below those standards. As the Cadwalader law firm put it in its memo about this decision, this case shows that “the risk that officers and directors of not-for-profit corporations may be personally liable for breach of fiduciary duty is real.” Moreover, the standard of care against which the non-for-profit entity’s directors and officers’ performance of their duty will be judged is the same standard as that applicable to the directors and officers of for-profit organizations.

 

Third, the most important job for the board of any organization is to make sure that the organization’s professional day-to-day management personnel are qualified to perform their duties and are indeed actually performing those duties. The board of this organization was informed repeatedly that the Home needed an Administrator that had the qualifications and experience required for the position, yet – even though the incumbent Administrator was working only part-time – the board did not replace the Administrator. Indeed, the organization even received a grant from a community foundation to replace the Administrator, yet the organization made no change and the funds from the grant were spent for other purposes.

 

Fourth, while many jurisdictions do not recognize or at least have not recognized the tort of deepening insolvency, the Third Circuit’s decision does highlight the fact that directors and officers of non-profit organizations may be held accountable for their actions after their organization has become insolvent. The board may owe duties to the organization’s creditors in addition to their fiduciary duties to the corporation. As the Cadwalader memo put it, “it is critical that entities facing financial challenges be mindful of the interests of all of their constituents in making decisions that impact creditor recoveries.”

 

One of the lessons of this case is that in general directors and officers of not-for-profit organizations will be held to the same standard of care as directors and officers of for-profit entities. However, at the same time, it is important to keep in mind that many states have adopted statutes providing individuals who serve as directors on nonprofit boards with limited immunity from liability, as discussed here. Whether or not this type of limited director immunity was available under Pennsylvania law for the Home’s directors was not discussed in the Third Circuit’s opinion. It is worth noting that the limited immunity available under these types of state statutes is typically limited to non-profit officials who are not compensated for their duties.

weilOne of the most immediate challenges when a company experiences a data breach is trying to figure out what has happened – how the breach occurred and how serious it is. Determining what has happened is also critical to re-establishing the company’s cybersecurity. In the following guest post Robert F. Carangelo and Paul A. Ferrillo discuss how important it is for a company to have developed a planned data breach response, well before any actual cyber-attack has occurred. They discuss how the involvement of certain key players will help to determine the effectiveness of the response. In particular, they discuss the critical importance of three key players: an experienced outside lawyer, a skilled cybersecurity forensic investigator, and the general counsel. A version of this article previously was published as a Weil client alert.

 

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

 

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Following detection of a cybersecurity breach or discovery of potential indicators of one, a company will face numerous challenges that must be addressed quickly. The situation can rapidly deteriorate, particularly because at that point in time, it is likely that the hackers have had access to the company’s network for months, if not longer. Additional data exfiltration could occur, surfacing previously undisclosed thefts of customer information or key intellectual property. Depending upon the intrusion, malware or wiperware could further damage both the network and physical infrastructure of a company. These are but a few of the ways that a cyber-breach can evolve from the point of detection, but they highlight the importance of a rapid response and investigation.

Companies need to consider this potential scenario, and the planned response, well in advance of an actual cyber-attack. Key to an effective response are three important actors: an experienced outside lawyer, a skilled cybersecurity forensic investigator, and the general counsel.

In previous articles we have emphasized the need for an incident response plan (IRP) that can be implemented and executed on short notice.[i] Here, we explore the interplay between the roles and responsibilities of a cyber forensic investigator, outside counsel, and the general counsel of the company during the investigation portion of an IRP following a breach. It can be crucial for a company to execute such an investigation in a coordinated and efficient manner, as it and the information it generates will be important when responding to various inquiries, as well as to potential lawsuits.

Role of Outside Counsel

Large companies typically have capable in-house legal staffs that can handle many stages of the investigative process after a cyber-breach is confirmed by the IT department. However, one of the most important reasons why a company should work with an outside lawyer in the event of a cyber-breach is it needs to ensure that it maintains attorney-client privilege and attorney work product protections. Doing so will help minimize issues regarding the capacity in which the in-house lawyers are acting, and will offer the best argument for protecting communications about the results of the data breach investigation, and related communications between the forensic investigators and the company.

Though scenarios will vary based upon the severity of the breach, there are many communications, actions, and potential disclosures that should be considered and coordinated between the company, the forensic investigator, and third-parties.

  1. If criminal conduct is a possibility (especially if the cyber-attack is suspected to have been perpetrated by either a nation-state or cyber-terrorist organization), it may be necessary to quickly contact the FBI and/or the U.S. Secret Service to assist with the investigation. Each has different investigative tools at its disposal to pursue cybercriminals, and one or both may have had experience with the same actor with respect to different targets. The government may have useful information that can assist in not only identifying the full nature of the breach, but also potentially in remediation efforts.[ii]
  2. If insiders are suspected of the theft of important information or funds, it may be necessary for outside counsel to conduct an internal investigation so that the facts of the potential insider theft can be determined.
  3. As is critical in most investigations, the outside lawyer and the forensic investigators must work together to forensically copy network servers and hard drives, secure all evidence necessary to assist with containment and remediation, and help all involved constituencies (law enforcement, regulators, and the public) understand the full extent of the breach.
  4. If personally identifiable information (PII) was stolen, data breach notifications to customers or patients may be necessary under federal and state law. Depending upon the industry, communications may be necessary with one or more regulatory authorities. If confidential personal employee information was hacked, disclosure and communications between the company, its HR department, and its employees likely will be necessary, as well.
  5. Finally, if the breach is substantial enough as to be deemed material under federal securities laws, public disclosure to investors is likely necessary.[iii] Outside counsel may also be helpful in drafting the appropriate disclosures and in responding to inquiries from the SEC and other regulators.

The Role of the Cyber Forensic Investigator

There are scores of cyber forensic investigators in the marketplace for both large and small companies, and many companies have pre-existing relationships with cybersecurity vendors. There are also a number of ways that an investigation should be tailored based upon the initial indicators of compromise that are detected internally, and based upon the size of the company. Below are factors to consider when selecting a cyber forensic investigator:

  1. Experience: There is nothing more important than experience. Today’s major breaches are carried out by sophisticated cybercriminals focused on the wholesale destruction or theft of millions of pieces of customer or patient data. The malware tools used are complex and have likely been masked throughout the breach process. The time-lag before discovery on the network gives hackers a huge head start. The forensic investigator should have major breach experience and also be able to identify and understand the various threat vectors and signatures that could have been used based upon other attacks. While each incident is different, and the choice of a forensic investigator will often depend on the magnitude of the breach, a more expensive (but experienced) vendor may be able to shorten the investigation, remediation, and recovery time necessary to fix the breach.[iv] As noted by one IT commentator, being able to apply analytics sets good cyber forensic investigators apart:

Analytics is about the ability to extract meaning, sort through masses of data, and in patterns and unexpected correlations. It’s not about knowing everything − it’s about finding what is relevant and getting closer to the right elements with the right people. To do that, you need to maintain a level of objectivity; set aside your personal and professional influences and biases and focus on the data. Forensics professionals cannot solely rely on technology to solve problems − they must build analytical skills that are learned and refined by thinking through trial-and-error.[v]

  1. Responsiveness: Building relationships with forensic investigators before a cyber-attack occurs will help achieve two main goals. It will increase the chances that the vendor will be available when needed on short notice, and the chances that it will be able to act faster.
  2. Credibility: Given the technical nature of a cyber-attack, it is necessary to rely heavily on the forensic investigator. It follows, therefore, that vendors with experience and strong references are a safer choice. Additionally, the forensic investigator likely will need to interact with regulators and possibly courts, so finding one with stature is imperative.
  3. User Friendly: Similar to using experts in other complex areas, one of the most important attributes of a good forensic investigator is to be able to translate complicated technical topics into plain English. Often, people who lack technical expertise will be making decisions and taking actions based on information provided by the forensic investigator, so the easier it is to understand the expert, the more informed the decision-makers will be.
  4. Retain the Right Team: When a company is the target of a large-scale cyber-attack, it needs the best forensic investigator possible. However, there are different levels of expertise within a forensic investigation firm, so it is important to ensure that the team that attends the initial meeting with the board and/or general counsel is the same team that will run the investigation. Pay particular attention to the number two person on the team because she likely will be the one carrying the laboring oar.

The Role of the Company’s General Counsel

The company’s general counsel or designated in-house lawyer will manage communications and disclosures that likely will be necessary in the event of a material breach. It is critical that the general counsel is one of the first individuals contacted by IT after there is a confirmed cyber-breach. Working hand-in-hand with the outside counsel, the following responsibilities should be promptly considered by the general counsel:

  1. Managing board and/or audit committee involvement and expectations.
  2. Determining what information was stolen, and if it was customers’ PII, consider disclosure obligations to customers, federal and state regulators, and law enforcement. If employees’ PII was compromised, internal communications to employees and others may be necessary.[vi]
  3. Overseeing an internal fact investigation by outside counsel and forensic investigators, particularly if it is suspected that an employee or former employee may be involved in the alleged breach.
  4. Working with a crisis management/public relations firm to draft appropriate disclosures aimed at reassuring customers and investors that the company has a firm grip on the problem and is resolving it as quickly as possible – especially given the potential for a cyber-attack to damage the company’s reputation with consumers, investors, and other constituencies.
  5. Working with outside counsel on SEC disclosures in the event that the cyber-attack is considered material under the federal securities laws.

Prepare In Advance

Many of the tasks and goals described above should be part of a company’s cyber IRP. By practicing and testing the IRP with all parties involved, real-life execution will run much more smoothly. The better the preparation, the better the response will be.

[i] See “The Importance of a Battle-Tested Incident Response Plan,” available here.

[ii] See Mandia, et al., “Incident Response and Computer Forensics,” (McGraw Hill, 2014), at 115.

[iii] See “CF Disclosure Guidance: Topic No. 2 (Cybersecurity),” Oct. 13, 2011, available here.

[iv] See “FireEye is ‘First in the Door’ on Big Cyberattacks,” available here.

[v] See “Tech Insight: What You Need To Know To Be A Cyber Forensics Pro,” available here.

[vi] See “M-Trends 2015: A View from the Front Lines,” at 5 (discussing rise in data breach disclosures), available here.

whistlesecIn recent years, one of the favored responses of legislative reformers and regulatory enforcement authorities to financial fraud and other corporate misconduct has been the encouragement of whistleblowing activity. Both the Sarbanes-Oxley and the Dodd-Frank Act contained elaborate provisions designed to encourage and even to reward whistleblowers. There seems to be no question that the provisions have in fact encouraged whistleblowing. But does all of this whistleblowing activity actually produce any benefits? What difference does all of this whistleblowing activity make?

 

As discussed in a March 4, 2015 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation entitled “The Impact of Whistleblowers on Financial Misrepresentation Enforcement Actions” (here), which in turn described their longer academic paper of the same title (here), four academics have examined the impact of whistleblowing activity on the outcome of regulatory enforcement actions for financial misrepresentation. The four authors are Andrew Call of the Arizona State University School of Accountancy, Gerald Martin of American University Business School, Nathan Sharp of Texas A&M University Accountancy Department, and Jaron Wilde of the University of Iowa Business School.

 

In order to examine these issues, the authors developed and analyzed a database of 1,133 enforcement actions by the SEC and DoJ from 1978 through 2012 involving allegations of financial misrepresentation. In order to identify whistleblowing activity, the authors obtained information from the Occupational Safety and Health Administration (OSHA), which agency the Sarbanes-Oxley Act tasked with fielding employee complaints of discrimination for blowing the whistle on alleged financial misconduct. The authors identified 934 allegations of financial misconduct in complaints filed with OSHA between 2002 and 2010. The authors also reviewed the enforcement complaints and other related documents to determine if any of the enforcement actions resulted from whistleblowing activity.

 

Through this process the authors determined that of the 1,133 financial misrepresentation enforcement actions between 1978 and 2012, 145 (or about 12.8%) were associated with at least one whistleblowing complaint.

 

The authors then developed a set of standards to identify the factors that determine the magnitude of the penalties and sanctions that were imposed in the cases in the database. For example, the factors included such items as the length of the period and magnitude of the financial misrepresentation. Based on this analysis, the authors developed a basis to predict the expected outcome of each case, and then compared this predicted outcome to the actual outcome of the cases in which whistleblowing activity was involved.

 

Using this approach, the authors identified “an association between whistleblowing involved and outcomes of enforcement actions,” which “suggests whistleblowers have an incremental impact on enforcement outcomes.”

 

First, the authors concluded that “whistleblowing involvement in an enforcement action is associated with a significant increase in penalties.” The authors concluded that whistleblower involvement increases penalties assessed against forms by an average of $76.96 million and that penalties assessed against employees average $39.29 million more when a whistleblower is involved.

 

The authors also concluded that in aggregate whistleblowers enabled regulators to obtain judgments (including penalties against both firms and their employees) of $16.86 billion beyond what they would have obtained without whistleblower involvement. The increase in monetary penalties attributable to whistleblower involvement accounts for approximately 56% of the $30.09 billion in penalties assessed against firms and employees with whistleblower involvement and 21% of the $79.46 billion in total penalties assessed in all enforcement actions from 1978 to 2012.

 

Second, the authors found that employees at targeted firms receive prison sentences that are on average 21.55 months longer than if no whistleblower had been involved.

 

Third, the authors concluded that these enforcement benefits come at a cost. The authors found that the total duration of an enforcement action increases approximately 10 months (or about 10.9%) with whistleblower involvement, as the involvement of whistleblowers has the effect of prolonging the enforcement process.

 

The authors also found that the existence of a whistleblower complaint significantly increases the likelihood that a firm will become involved in an enforcement action. Comparing the number of firms named in an enforcement action during the period covered by the enforcement action database to the number of companies listed during that period in the Compustat database, the authors found that the general risk of being involved in an enforcement action was 4.74%. However, when only the companies that were named in a whistleblower reports are considered, and taking into account how many of those companies were involved in an enforcement action, the authors found that the risk of an enforcement action increases to 20.49% — that is, the risk of an enforcement action is 4.78 times greater with a whistleblower complaint.

 

However, at the same time, the authors found that 520 out of the 654 (79.51%) firms named in at least one whistleblower complaint were not the subject of an enforcement action, “suggesting a large portion of whistleblower complaints either are frivolous, are not sufficiently informative to result in an enforcement action, or slip through the cracks. “ The authors note that the costs associated with these unproductive whistleblower reports likely offset some of the benefits gained through whistleblower involvement in enforcement actions.”

 

The authors’ extensive database of enforcement actions allowed them to make a number of observations about the enforcement activity during that period. Among other things, the authors concluded that a company executive was named as a respondent in the enforcement actions 84.1% of the time. The CEO is named as a respondent 60.8% of the time, other C-level executives 17.7% of the time, and a non-executive employee is named as a respondent 26.4% of the tie.

 

The authors also determined that the incidence of enforcement activity varied by industry. The most frequent industries with enforcement actions are Business Equipment (23.0%) of the time, Finance (14.0%), Wholesale, Retail and Services (12.4%), Manufacturing (9.0%) and Healthcare, Medical Equipment and Drugs (8.1%).

 

Given the disposition that legislators and regulators toward whistleblowing activity, it is reassuring to know that the track record so far seems to suggest that the involvement of a whistleblower seems to produce an improved enforcement outcome.

 

In addition, given the authors’ conclusion that the involvement of a whistleblower report seem to produce a much greater exposure for the companies named to become involved in an enforcement action, it appears to be the case that in at least some instances the occurrence of whistleblower activity results in the disclosure of at least some financial misconduct that might not otherwise come to light.

 

However, the authors’ analysis also suggests that the benefits associated with whistleblowing activity come at a cost. The added costs include not only lengthening of the enforcement process when whistleblowers are involved. The costs also include the burdens and expenses associated with the high number of whistleblower reports that do not result in enforcement activity. The authors concluded that fully four out of every five whistleblower reports were not associated with related enforcement activity. These unproductive reports impose costs on regulators and enforcement authorities. There may be no way to measure the aggregate burden associated with these unproductive reports. However, without taking the costs associated with these unproductive reports into account, it may be very hard to reach definitive conclusions whether the incremental benefits associated with the whistleblower activity outweigh the associated burdens. In that same regard, it should also be noted that the unproductive whistleblower reports not only involve burdens and expense for the regulators, they also mean distraction, burden and expense for the companies named in the whistleblower report.

 

A final question that needs to be asked given the high number of and the indeterminate magnitude of costs associated with unproductive whistleblower reports is whether in the end our social and political predisposition in favor of whistleblowing in fact means that there is less financial fraud. This seems like a question worth asking, because, even if we can’t determine with precision the extent of the burdens associated with the high number of unproductive whistleblower reports, it is clear that our social and political predisposition in favor of whistleblowing comes at a not insignificant cost.

 

Delaware Legislature Readies to Consider Litigation Reform Bylaw Legislation: As Francis Pileggi discusses in a March 6, 2015 post on his Delaware Corporate and Commercial Litigation Blog (here), the Corporation Law Section of the Delaware State Bar Association has submitted proposed legislation to the Delaware legislature that would limit the ability of corporations to adopt fee-shifting provisions in their charter and bylaws, but also provide additional support for adopting forum selection clauses in those same corporate documents. The proposed legislation can be found here, a memo describing the legislation can be found here, and a document addressing frequently asked questions can be found here.

 

Pileggi comments that this legislation will be the subject of enormous lobbying on both sides. He adds that “The only certainty about this proposed bill is that it will generate an enormous amount of commentary and discussion. I would not expect a final outcome until the last day of the session on June 30.” He concludes with the comment that “If some legislation is passed that ultimately limits the ability of a corporation to adopt fee-shifting bylaws, an interesting issue will be the impact, if any, that the legislation will have on those companies that already adopted fee-shifting provisions. Generally, there is a prohibition against ex post facto laws.”

 

minnOne of the more interesting issues that has emerged recently in the securities litigation arena is the question of whether or not the alleged failure to make a disclosure required by Item 303 of Reg. S-K is an actionable omission under Section 10(b) and Rule 10b-5. The Ninth Circuit, in its October 2014 decision in the In re NVIDIA Corp. Securities Litigation (here), held that it is not, but in January 2015, the Second Circuit held in the Stratte-McClure v. Morgan Stanley (here), held that it is.

 

These two appellate decisions represent a clear split in the federal circuits on the question, leaving the federal district courts to try to sort their way through these issues. In a March 4, 2015 decision in the Tile Shop Holding securities litigation (here), District of Minnesota Judge Ann D. Montgomery followed the Second Circuit’s ruling on the question and held that an alleged failure to make a disclosure under Item 303 can serve as the basis of a Section 10(b) securities claim. The ruling is interesting in a number of other respects as well, as discussed below.

 

Background

Item 303 of Reg. S-K states in pertinent part that in its periodic reports to the SEC, a company is to “[d]escribe any known trends or uncertainties that have had or that the registrant reasonably expects will have a materially favorable or unfavorable impact” on the company. Guidance provided by the SEC on Item 303 clarifies that disclosure is necessary where a “trend, demand commitment event or uncertainty is both presently known to management and reasonably likely to have material effects on the registrant’s financial conditions or results of operations.”

 

In its October 2014 decision in In re NVIDIA Corp. Securities Litigation, the Ninth Circuit held that Item 303 does not create a duty to disclose for purposes of Section 10(b). In reaching this decision, the Ninth Circuit relied on language in an earlier opinion written by then-Judge (and now U.S. Supreme Court Justice) Samuel Alito, when he was on the Third Circuit, stating that because the materiality standards for Rule 10b-5 and Item 303 differ significantly, a violation of Item 303 “does not automatically give rise to a material omission under Rule 10b-5.”

 

In its January 2015 decision in the Morgan Stanley case, the Second Circuit expressed its view that Judge Alito’s language merely suggested, without deciding, that in certain instances a violation of Item 303 could give rise to a material omission. The Second Circuit concluded that the language is consistent with its conclusion that an Item 303 omission can serve as the basis for a Section 10(b) securities fraud claim, but only if the other requirements to state a Section 10(b) claim – such as materiality and scienter – have been met. Ironically, though the Second Circuit held that an Item 303 omission can serve as the basis of a Section 10(b) claim, the appellate court nevertheless affirmed the dismissal of the plaintiff’s Section 10(b) claims, holding that the plaintiff had not adequately alleged scienter.

 

The Tile Shop Securities Suit 

Tile Shop is a specialty tile retailer. The company went public in August 2012, and conducted secondary offerings in December 2012 and June 2013, in which there were a number of selling shareholders including directors and officers of the company. The company sourced much of its tile product overseas, including from a company in China that the CEO’s brother in law had an ownership interest. The amount of tile product Tile Shop purchased from the Chinese company increased from 8.3 percent in 2011 to 32.2 percent in 2013. In addition to having the ownership in the Chinese tile manufacturer, the brother- in-law also worked for Tile Shop; beginning in 2011 and continuing until 2013, the brother in law was employed as Tile Shop’s purchasing supervisor.

 

In November 2013, a research analyst published a report identifying the connections between Tile Shop, its CEO and the brother in law and the Chinese supplier. The analyst report also stated that the company’s margins and profits were overstated due to favorable transactions between related parties. The company’s share price dropped 39% on the news. On November 15, 2013, plaintiff shareholders filed the first of several securities complaints filed against the company, certain of its directors and officers, and its offering underwriters. The defendants moved to dismiss.

 

The March 4, 2015 Order 

In a detailed, 36-page order dated March 4, 2015, Judge Ann D. Montgomery denied in part and granted in part the defendants’ motions to dismiss. Judge Montgomery’s order addresses a number of different substantive legal issues, two of which I touch on below.

 

First, Judge Montgomery denied in part and granted in part the plaintiffs’ claims under Section 10(b), in which the plaintiffs alleged that Tile Shop’s failure to disclose its dependence on companies controlled by the brother-in-law violated Item 303, by failing to disclose trends or uncertainties that would have a material impact on Tile Shop sales, revenues or income.

 

In denying the motion in part, Judge Montgomery considered the split between the Ninth and the Second Circuits on the question of whether a failure to make a required disclosure under Item 303 can serve as the basis of a claim under Section 10(b). Judge Montgomery reviewed both appellate courts’ reference to and analysis of Judge Alito’s Third Circuit opinion. She said that she found the Second Circuit’s reasoning “persuasive” and “consistent with” her own reading of the Third Circuit opinion.

 

However, the Second Circuit had gone on to state in the Morgan Stanley case that a violation of Item 303 can be actionable only if the other requirements to state a Section 10(b) claim – such as materiality and scienter – have been met. Indeed, in the Morgan Stanley case, the appellate court held that the plaintiffs had in fact not sufficiently pled scienter, and the court affirmed the district court’s dismissal of the case.

 

In the Tile Shop case, Judge Montgomery concluded that the plaintiffs had sufficiently pled materiality. In concluding that failure to disclose the trend of the company’s increasing reliance on the brother-in-law’s tile company was material, Judge Montgomery said that the “trend of consolidating the percentage of product sold to a single entity could have a material effect on Tile Shop’s financial condition if that relationship was somehow compromised.” She added that “given the significant reliance” of Tile Shop on the supplier “a disruption of this relationship would be reasonably likely to impact Tile Shop’s future performance.”

 

Judge Montgomery also concluded that the allegations of scienter were sufficient as to the CEO and as to the company itself, and accordingly she denied the motion to dismiss the Section 10(b) claims against the CEO and the company. However, she found that the scienter allegations were insufficient as to the other individual director and officer defendants, and she granted the motion to dismiss the plaintiffs’ Section 10(b) claims as to the other individual defendants.

 

Judge Montgomery also granted the motion to dismiss the plaintiffs’ Section 11 claims based on the June 2013 offering because none of the plaintiffs purchased securities in the June 2013 offering. The plaintiffs attempted to argue that they had standing to assert the claims related to the June 2013 offering, though they purchased no shares in that offering, asserting that because they had standing to assert Section 11 claims related to the December 2012 offering, they also had standing to represent the interests of those who purchase in the June 2013 offering because their claims implicated the same set of concerns. In making this argument, the plaintiffs relied on the Second Circuit’s 2012 decision in NECA-IBEW v. Goldman Sachs, in which the court held that a named plaintiff may have class standing to bring claims related to the residential mortgage-backed certificates that it had not purchased on behalf of absent class members who purchased them.

 

Judge Montgomery declined to follow what she called the Second Circuit’s “non-precedential position” on the matter, relying instead on a District Court opinion from the Central District of California in the Countrywide case, for the principle that a plaintiff must demonstrate standing for each claim he seeks to press.

 

Discussion

When a circuit split exists, the district courts located outside of the circuits that have ruled on the issue have to decide which line of circuit authority to follow. The two issues from Judge Montgomery’s opinion that I discussed above show how district courts must struggle with these issues where there are competing lines of authority. Interestingly, on the Item 303 issue, Judge Montgomery followed the Second Circuit’s reasoning, but on the Section 11 standing issue, Judge Montgomery declined to follow the Second Circuit, preferring not the reasoning of a different circuit court, but rather the reasoning of a district court.

 

While the general topic of circuit splits is interesting, the split between the Second and Ninth Circuits on the Item 303 issue is particularly interesting. These issues are going to come up in other cases and other district courts outside of the Second and Ninth Circuits will have to wrestle with these issues. At a minimum, under the current state of play, there is the obvious risk of inconsistent outcomes on the issue between the courts in the Second Circuit and the Ninth Circuit. The existence of this type of circuit split is precisely the kind of thing that can, if teed up the right way in a particular case, attract the attention of the U.S. Supreme Court. Indeed, given the existence of the circuit split and the keen interest the Supreme Court has shown over the last eight years or so in taking up securities cases, the Item 303 issue could well wind up in the Supreme Court, perhaps sooner rather than later.

 

In any event, unless and until the Supreme Court has an opportunity to reconcile the holdings of the Second and Ninth Circuits on this issue, it is going to be increasingly important for companies to be particularly attentive in their periodic reporting documents to highlight company and industry trends and uncertainties, so as to ensure proper disclosure and to try to avoid attracting the unwanted attention of plaintiffs’ lawyers.

 

Special thanks to a loyal reader for sending me a copy of this opinion.