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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

 

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

 

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

 

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

 

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

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

 

************************************************* 

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

 

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

 

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

 

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

 

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

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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.