stock tablesThe global financial markets have been rocked in recent years by revelations of market manipulations involving personnel from some of the world’s largest financial institutions. The scandals have included alleged manipulation of the Libor benchmark rates, of the foreign exchange benchmark rates, and of the metals trading markets. Relatedly, there have also been allegations of market manipulation through high frequency trading and through trading on dark pool platforms. These revelations have been followed by massive regulatory investigations as well as by significant civil litigation.

 

The first of these follow-on civil actions to go forward, involving the alleged manipulation of the Libor benchmark rates, hit a significant roadblock in March 2013, when Southern District of New York Judge Naomi Reice Buchwald  dismissed the consolidated Libor antitrust action based on her determination that the plaintiffs had not alleged an antitrust injury (as discussed here). This ruling seemed to represent a setback for the claimants in the other market manipulation civil lawsuits as well.

 

However, a series of developments over the last several days in both the consolidated Foreign Exchange Benchmark Rates Antitrust Litigation and in the consolidated Libor antitrust litigation appear to have changed the environment for these cases. Notwithstanding Judge Buchwald’s 2013 decision in the Libor antitrust case, on January 28, 2015, Southern District of New York Judge Lorna Schofield denied the motion to dismiss in the consolidated foreign exchange benchmark rates case, in a decision that expressly said that Judge Buchwald’s reasoning on the antitrust injury issue was “unpersuasive.” A copy of Judge Schofield’s opinion can be found here.

 

In addition, in Libor antitrust litigation, a unanimous January 21, 2015 opinion written by Justice Ruth Bader Ginsburg, the U.S. Supreme Court ruled that the Second Circuit had erred in dismissing the appeal by the plaintiffs of Judge Buchwald’s dismissal ruling. A copy of the U.S. Supreme Court’s opinion can be found here. As a result, the plaintiffs’ appeal of Judge Buchwald’s ruling will now go forward in the Second Circuit. And as Alison Frankel suggests in her January 29, 2015 post on her On the Case blog (here), Judge Schofield’s analysis in denying the motion to dismiss in the foreign exchange litigation may provide the Libor antitrust lawsuit plaintiffs a “roadmap” of arguments to follow in seeking to have Judge Buchwald’s dismissal of their case overturned.

 

The Consolidated Foreign Exchange Benchmark Rates Antitrust Litigation  

In this consolidated action, the plaintiffs allege that the twelve defendant banks conspired to manipulate the benchmark rates for the foreign currency exchange market. The plaintiffs allege that the defendants used a variety of concerted trading strategies to manipulate the daily benchmark currency exchange rate (the “Fix”) which is published each afternoon by WM/Reuters. Among other things, the plaintiffs allege that currency traders for various of the defendant banks communicated through online chat rooms with names such as “The Cartel,” “The Bandits Club,” and “The Mafia.” The plaintiffs allege that the defendants’ concerted activities violated the Sections 1 and 3 of the Sherman Antitrust Act. The defendants moved to dismiss.

 

In her January 28 opinion, Judge Schofield denied the defendants’ motion to dismiss, finding that the plaintiffs had sufficiently alleged the existence of a conspiracy and that all of the defendants were part of that conspiracy. Among other things, she noted that names of the traders’ chat room groups, as well as the settlements several of the defendants have reached in the parallel regulatory investigations to support the inference of anticompetitive activity. She said that the plaintiffs allegations “plausibly alleges a price-fixing conspiracy among horizontal competitors, a per se violation of the antitrust laws.”

 

In concluding that the plaintiffs had also sufficiently alleged an antitrust injury, Judge Schofield declined to follow the analysis of Judge Buchwald in her ruling dismissing the Libor antitrust litigation. Judge Schofield “respectfully disagreed” with Judge Buchwald’s conclusion about the absence of antitrust injury, saying that Judge Buchwald’s analysis “blurs the lines” between two analytic categories (that is, the sufficiency of the pleading under Twombley and antitrust injury).

 

Judge Schofield also said that Judge Buchwald’s conclusion that the antitrust injury analysis should be conducted at the pleading stage is “unpersuasive” because it relied on two “inapposite” U.S. Supreme Court cases – Atlantic Richfield v. USA Petroleum and Brunswick v. Pueblo Bowl-o-Matic — neither of which, Judge Schofield said, addressed the sufficiency of a complaint on a motion to dismiss. In the Atlantic Richfield and Brunswick cases, the U.S. Supreme Court based its decision on a factual record following the completion of discovery. Judge Schofield noted that if Judge Buchwald’s reasoning in the Libor case “would doom almost every price-fixing claim at the pleading stage.”

 

Judge Schofield also noted other differences between the conspiracies alleged in the two cases, including the competition for customers among traders in the foreign currency exchange market, even while the defendants allegedly were conspiring to rig the “Fix.” Judge Schofield concluded that the result of the plaintiffs alleged from the price-fixing conspiracy represented “the quintessential antitrust injury.”

 

The Libor Antitrust Litigation 

Judge Schofield’s ruling followed shortly after a significant development in the Libor antitrust litigation. On January 21, 2015, a unanimous U.S. Supreme Court ruled that the Second Circuit had erred in refusing to hear the plaintiffs’ appeal of Judge Buchwald’s dismissal ruling in their case. The Court held that Judge Buchwald’s dismissal with prejudice of the plaintiffs’ antitrust claims triggered the plaintiffs’ right to appeal even though other claims in the multidistrict litigation pending before Judge Buchwald are continuing to go forward.

 

The case has now been returned to the Second Circuit, which will now hear the plaintiffs appeal. Other litigants whose antitrust claims were also dismissed by Judge Buchwald’s ruling but who have other claims continuing in the district court have asked Judge Buchwald for leave to participate in the appeal, as discussed in a January 26, 2015 Law 360 article (here, subscription required).

 

As Alison Frankel noted in her blog post to which I linked above, Judge Schofield in her ruling in the foreign exchange litigation “provided the Libor plaintiffs with invaluable guidance for their arguments before the 2nd Circuit.” Judge Schofield’s opinion, the title of Frankel’s article suggests, provides the Libor litigation plaintiffs with a “roadmap” for their appeal. Judge Schofield’s reasoning, Frankel said, “should give the 2nd Circuit something to think about when it hears the Libor appeal.”

 

Discussion 

There was a time when the prospects for the various market manipulation cases did not appear particularly promising, as I noted in an earlier blog post (here). The claimants nevertheless continued to press on, and indeed new claimants have even joined the fray (refer here). The recent developments s seem to have breathed new life into the market manipulation cases. While the plaintiffs in the Libor antitrust litigation have merely won only the right to appeal and are still a long way from seeing their antitrust claims reinstated, Judge Schofield’s ruling may give them reason to be positive.

 

The Libor plaintiffs may be hoping they can follow a similar path to the one that the plaintiffs in the Libor scandal-related securities class action lawsuit that Barclays shareholders filed against the company and certain of its directors and officers. As discussed here, Southern District of New York Judge Shira Scheindlin had originally granted the defendants’ motion to dismiss in that case. However, as discussed here, on appeal, the Second Circuit reversed the district court’s dismissal of the securities lawsuit. In October 2014, after the case was remanded to the district court, Judge Scheindlin denied the defendants’ renewed motion to dismiss (as discussed here).

 

As apparent recognition that the prospects for the claimants in the market manipulation cases may have improved, some of the defendants are taken steps to reach settlements with the plaintiffs. As discussed here, in October 2014 (that is, even before the more recent developments in the case), Barclays notified the court that it had reached an agreement with the plaintiffs in the consolidated Libor antitrust litigation to pay $19.975 million to settle the claims against the bank. And on January 30, 2015, J.P. Morgan filed a motion with the court seeking approval for its agreement to pay $99.5 million in settlement of the claims against it in the Foreign Exchange Benchmark Rates Antitrust Litigation, as discussed here.

 

At a minimum, these individual settlements will provide the claimants with a war chest to draw upon to continue wage their battles with the other defendants. More generally, the settlements, along with the developments described above, will hearten the claimants and encourage the claimants to press on.

 

It is interesting to note that though many of the Libor rate-setting banks are located outside the U.S., so far the civil litigation arising out of the scandal has been concentrated in the U.S. There are signs that some of the foreign banks may be facing claims outside the U.S. as well (refer for example here).

 

In any event, it seems clear that civil litigation surrounding these various market manipulation scandals will continue. There undoubtedly are many other significant procedural developments in these cases ahead. It will be interesting to see whether other individual banks decide that it is might be in their best interests to seek to a settlement of the claims against them.

 

Special thanks to a loyal reader for providing me with a copy of Judge Schofield’s opinion.

 

The Week Ahead: This week, I will be attending the annual Professional Liability Underwriting Society D&O Symposium in New York. While I am on travel, there will be a brief interruption in The D&O Diary’s publishing schedule. The regular schedule will resume at the end of the week.

 

I know that many readers will also be at the Symposium. If you see me at the conference, I hope you will take a moment and say hello, particularly if we have not met before. I always enjoy the chance to meet readers in person.

 

In the afternoon on Wednesday, February 4, 2014, I will be moderating a panel at the conference on International D&O. Joining me on the panel will be my friends Arati Varma (Chubb Singapore), Cris Baez (QBE Paris), Marcus Smithson (Generali, Sao Paulo) and Andrea Orviss (Marsh Vancouver). We have spent a great deal of time and effort preparing for this session (in several conference calls that set a record for sheer time zone complexity). Everyone attending the Symposium will want to sure to attend the panel, which is going to be excellent. I am looking forward to this session as much as any other event I have ever participated in.

 

I look forward to seeing everyone in New York.

floridaIn prior posts, I have noted the growing phenomenon of companies adopting various types of bylaws as a self-help version of litigation reform. Delaware’s courts have already approved the facially validity of both forum-selection bylaws and of fee-shifting bylaws, although measures pending in Delaware legislature in 2015 could address the fee-shifting bylaw. Other courts have considered mandatory arbitration bylaws as well (as discussed here). Now, add another type of bylaw to this list – the minimum-stake-to-sue bylaw.

 

As Alison Frankel noted in a January 21, 2015 post on her On the Case blog (here), life insurance settlement company Imperial Holdings has adopted an “apparently unique tactic to rein in suits by shareholders.” The company has amended its bylaws to require shareholders to deliver written consents representing at least three percent of the company’s outstanding shares in order to bring a class action or derivative suit.

 

Imperial Holdings has itself previously been the target of a derivative lawsuit. The case ultimately settled for $13.6 million (although as Frankel notes most of the settlement amount was paid to resolve a parallel securities class action lawsuit). After the earlier case settled, the company adopted the minimum-stake-to-sue bylaw, which a company representative told Frankel was “intended to stop shareholders without a real financial interest in the outcome of their own case from hijacking deals and forcing the company to defend meritless litigation.” Frankel quotes the company’s chairman as saying that “the bylaws are like a cooling-off period. We’re saying ‘Slow down, get support from other shareholders.’” Frankel’s article also notes that a similar minimum-stake to sue bylaw has been adopted by two other companies on whose boards Imperial’s Chairman also serves.

 

At least one Imperial Holdings shareholder has a problem with the new bylaw. On January 16, 2015, the named plaintiff from the earlier lawsuit filed a new action against the company and its directors in the Palm Beach County (Florida) Circuit Court, seeking a judicial declaration that the minimum-stake-to-sue bylaw was adopted illegally under Florida law, as well as an injunction against the provision’s enforcement.

 

The complaint in the new lawsuit (which can be found here) alleges that the bylaw was adopted in breach of the directors’ fiduciary duties because their “sole intent was to reduce their risk of being held accountable to the Company or its shareholders for any violation of law, including criminal law, breaches of fiduciary duties or other misconduct.” The complaint asserts that the pre-filing requirement is “so onerous” that it “effectively guarantees that, notwithstanding the provisions of state and federal law, no class or derivative action can be filed against Defendants, no matter how egregious their conduct may be.” The complaint alleges that the directors “acted disloyally and in bad faith and placed their own interests in avoiding liability to shareholders over the interests of both the Company and the public shareholders to who they owe fiduciary duties.”

 

In her article, Frankel quotes a statement from the company’s Chairman as saying that the new lawsuit is “exactly what the bylaw is supposed to prevent.” He also noted that the bylaw had been adopted with the advice of counsel and that the company’s shareholders will have a chance to vote on the measure at the company’s shareholder meeting in the spring. The plaintiffs counsel, in turn argues that the bylaw should have been put to shareholder vote before it was adopted. He also argues that even if a majority of shareholders approve the bylaw, it is still impermissible, arguing that “the federal and state securities laws do not permit the tyranny of the majority when it comes to shareholder rights.”

 

The complaint in the lawsuit has only just been filed; indeed, at the time Frankel spoke to the company’s Chairman, the company still had not yet even been served with the complaint. It remains to be seen how the lawsuit challenging the bylaw will fare. The case will of course be decided primarily on the basis of Florida law, so the outcome of the case will not necessarily be determinative of the question whether or not companies organized under the laws of other states could adopt a minimum-right-to-sue bylaw. Many publicly traded companies in the U.S. are organized under the laws of Delaware and at least at this point there is not way of knowing whether a bylaw of this type would survive scrutiny under Delaware law.

 

While it remains to be seen how the new lawsuit will fare and whether or not the validity of this type of bylaw will be upheld as a matter of Florida law, it is in any event clear that companies are continuing to experiment with the possibilities of litigation reform through bylaw revision. The fact that this case involves a Florida corporation and Florida law underscores the fact that these issues involve more than just considerations of Delaware law, and even the pending developments in the Delaware legislature regarding fee-shifting bylaws will not necessarily be determinative of the issue, as developments in other states could overtake the developments on these questions.

 

At a minimum, this company’s adoption of these new types of litigation reform bylaws shows that the phenomenon of the adoption of litigation reform bylaw has significant momentum. It is clear that companies will continue to experiment and new types of litigation reform bylaws are likely to continue to appear. Whether the various types of bylaws ultimately will survive judicial scrutiny remains to be seen, but if the courts confirm the validity of any of the various litigation reform bylaws under discussion, there could be some various significant changes in the shareholder litigation environment. Stay tuned, because depending on how all of this plays out, the D&O litigation arena could be entirely transformed.

 

Federal Preemption and Fee-Shifting Bylaws: While as noted above the various kinds of litigation reform bylaws under discussion could transform the litigation environment, there are a number of important considerations that could militate against this transformation. As discussed in a January 26, 2015 post on the CLS Blue Sky Blog (here), Columbia Law School Professor John Coffee believes that few companies will attempt to use board-only approved fee-shifting bylaws, because the major proxy advisory firms have made it clear that they will oppose the re-election of any board that approves the adopting of such a bylaw. Accordingly, Coffee suggests that the likelier future scenario is that IPO companies will insert fee-shifting bylaw provisions in the corporate charters.

 

Coffee contends that the attempt to adopt these kinds of bylaws through corporate charter provisions raises a number of concerns, including the possibility that this issue may be preempted by federal law, at least with respect to the application of such a provision in federal court. Coffee notes that the federal preemption issues will inevitably have to be litigated regardless of what the Delaware legislature ultimately does on the pending fee-shifting bylaw issues, because even if the Delaware legislature votes to curb the use of fee-shifting bylaws by Delaware corporations, issuers organized under the laws of other jurisdictions have already adopted these kinds of provisions.

 

As the type of bylaw discussed above, this issue is not just a question of the laws of one particular jurisdiction and is not just a question of one type of bylaw. The whole topic of litigation reform bylaws is likely to continue to percolate for some time to come. As Professor Coffee’s article demonstrates, there are a number of questions surrounding the enforceability of these types of bylaws that will have to be sorted out. But at this point, the smart money is betting that these issues will become increasingly common and that courts will increasingly be called on to address these kinds of issues.

 

I will say that the developments involving litigation reform bylaws may be among the most interesting developments in the corporate and securities litigation arena in many years.

Boeck_head_shot[1]Without a doubt, during 2014, cyber security emerged as one of the critical topics for discussion. In the following guest post, Bill Boeck, who is  senior legal and claim resource worldwide for cyber and executive risk coverages and claims at Lockton Financial Service, takes a look at the top cyber risk developments to watch in 2015. This guest post previously appeared as a Lockton white paper available here. 

 

I would like to thank Bill for his willingness to publish his article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to readers of this site. Please contact me directly if you would like to submit an article for consideration as a guest post. Here is Bill’s guest post. 

 

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Cyber breaches, cyber attacks, and related developments frequently dominated the news in 2014.   Looking back can help us anticipate and prepare for what may happen in 2015.  Here are the most important developments of 2014 and the trends we are likely to see in 2015 related to cyber risk and insurance. 

 

1.    Big Data Breaches 

 

Any look back at what happened in 2014 would have to begin with the large number of significant payment card data breaches that hit retailers including Target, Home Depot, and, Staples.  Apart from the effects these breaches have had on the companies involved (such as lost income, executives losing their jobs, and shareholder lawsuits) these  large breaches may be most noteworthy for their effect of raising the level of attention given to cyber risks within companies, and for spurring changes to payment card systems in the U.S. and beyond.  These breaches have also had important ramifications in the cyber insurance market. 

 

While payment card data breaches grabbed most of the headlines, it is important to note that other significant breaches took place involving other types of data. 

 

In May 2014, eBay announced that employee login credentials had been breached which could allow criminals to access personally identifiable information (PII) of eBay users. 

 

JPMorgan Chase disclosed that information for 83 million accounts had been breached.

 

On the healthcare front, roughly 4.5 million patient records were breached at Community Health Systems.  That could be the largest reported breach of protected health information (PHI) ever.  The breach reportedly was the result of a cyber attack originating from a country more often associated with industrial espionage than the compromise of individuals’ personal information. 

 

2.    Aggressive Regulators 

 

2014 saw US regulators become even more aggressive with respect to data privacy and security issues.  The FTC at least temporarily weathered a challenge by Wyndham Hotels to its ability to regulate cyber security matters, and has continued to be very active in this space.  Notable FTC actions last year include: 

 

•      The first enforcement action involving the Internet of Things

 

•      Increasing focus on enforcing companies’ compliance with their information privacy policies

 

•      Bringing an action against a company and its former CEO in connection with the collection of health information (unusual because the claim is brought against a corporate officer and because the Office of Civil Rights (OCR) in the federal Department of Health and Human Services typically gets involved with PHI risks, not the FTC)

 

•      Actions against Apple and Google in connection with in-app purchases by children without parental consent 

 

The Federal Communications Commission (FCC) showed up at the cyber security regulators party last year, and has issued millions of dollars in fines.  The fines stem from companies’ failure to implement appropriate protections for consumer information, use of consumer information for marketing purposes, and do not call list violations.  The FCC could be a significant regulator going forward. 

 

The Office of Civil Rights (OCR) in the Department of Health and Human Services has stated that they are bringing more data privacy and security enforcement actions than ever.  They aren’t focused only on big breaches either.  For example, the OCR reached a settlement with QCA Health Plan, Inc. involving a stolen laptop with unencrypted PHI of only 148 people.  This resulted in a $250,000 fine and a number of corrective measures. 

 

The SEC has also joined the party.  In 2011 the SEC issued guidance on cyber security issues for companies.  In 2014, they took action.  In April, the SEC Office of Compliance Inspections and Examinations (OCIE) announced that it would be auditing 50 broker-dealers and investment advisors to assess their cyber risks and preparedness.  The SEC has made clear what it expects companies to do to prepare for cyber risk;  well-informed commentators say that this is a prelude to enforcement actions in 2015. 

 

Regulators outside the US are also gearing up to become more aggressive.  A few examples:

 

The European Parliament has updated its laws to provide for fines of up to €100 million for violation of data protection laws. 

 

In Germany, the Commissioner for Data Protection and Freedom of Information for the state of Rheinland-Pfalz imposed a fine of €1.3 million on Debeka Health Insurance AG (Debeka) to resolve issues regarding misuse of protected consumer data.  Debeka also agreed to pay €600,000 to endow a university chair to study data protection. 

 

The Australian government has amended the Privacy Act of 1988 to include the Australian Privacy Principles.  The Office of the Australian Information Commissioner (OAIC) has published guidance for data breach notifications that stress the ability of the OAIC to bring enforcement actions and assess fines where appropriate.

 

In the UK, the Information Commissioner’s Office has continued to be active in enforcing data privacy rights and obligations. 

 

3.    The Right to Be Forgotten 

 

2014 was a year when the “right to be forgotten” took important steps forward.  In May, the European Court of Justice ruled that Google must remove information about an EU citizen that was no longer relevant and that could reflect badly on him.  Since then, Google and others have received hundreds of thousands of requests to remove information that was once public.  While the EU has issued guidelines to assist companies in deciding what to remove, the difficulties the requests present for companies receiving them are nevertheless significant. 

 

Lest anyone think the right to be forgotten is a non-US issue, it is worth noting that aspects of it are creeping into US laws.  As of January 1, 2015, California law requires websites to include an “eraser button” that allows children under the age of 18 to delete information they have created on web sites where they are registered users. 

 

4.    NIST Cyber Security Framework 

 

In February 2014, the U.S. National Institute of Standards and Technology (NIST) published its Framework for Improving Critical Infrastructure Cybersecurity.  The Framework is intended to provide companies with a description of what a comprehensive cyber security program should contain.  Further development of the Framework by NIST is encouraged in the recently passed Cybersecurity Enhancement Act of 2014.  Given that the NIST Framework is quickly becoming a baseline for companies to follow, the Framework will be important to watch in 2015.

 

5.    Cyber Extortion On the Rise 

 

As Brian Krebs of KrebsOnSecurity.com put it, 2014 was the year cyber extortion went mainstream.  2014 saw significant growth in extortion scams by criminals that infected a victim’s computer system with ransomware that will corrupt or delete data unless the ransom is paid.

 

A typical scam would be one where the victim’s files are encrypted and cannot be restored without the encryption key.  The criminals provide the key in return for the ransom payment.  Unfortunately, the ransom demanded is often small enough that companies elect to pay it (often by Bitcoin) rather than take on the expense and headache of recovering data by other means.

 

While there were notable successes in combatting cyber extortion scams in 2014, such as the takedown of the botnet that made distribution of the Cryptolocker ransomware possible, as long as extortion scams continue to succeed, their prevalence in 2015 seems assured.  The moral of the story is (a) back up your data, and (b) carry cyber policies that will respond to an extortion event. 

 

6.    Mobile Payments and Digital Wallets 

 

In 2014, Apple introduced Apple Pay.  For those unfamiliar with it, Apple Pay involves giving your credit card information to Apple which will then place a token associated with that number in an encrypted chip on an iPhone 6.  The phone can then be used to pay for purchases without the credit card or credit card number ever being disclosed to the merchant or to criminals that have compromised the merchant’s systems.  Apple Pay, and other existing or upcoming systems designed for the same purpose, appear likely to reduce or eliminate the risks inherent in using payment cards today.  These systems seem certain to become more widely adopted in 2015, with the result being that payment card data breaches should eventually become smaller and less severe. 

 

7.    EMV Payment Card Migration 

 

One of the most important events that will take place in 2015 is the migration of payment cards in the U.S. from magnetic stripes to chip-and-pin EMV cards.  EMV cards are considered more secure because they require thieves to have more than the card number to make fraudulent charges.  To make a charge with an EMV card the user must also input a PIN associated with the card. 

 

The migration to EMV cards will take place this year because the card brands are imposing a liability shift on October 1, 2015.  If a merchant has not installed equipment to handle EMV card payments, and a customer has an EMV card, the merchant will be liable for any resulting fraud on the customer’s account.  If the merchant has installed the necessary equipment to handle EMV card transactions, but the customer’s bank hasn’t issued him or her an EMV card, the bank is liable.  If the merchant is set up to handle EMV cards, if a customer uses an EMV card, and if fraud nevertheless takes place, the card brands will be liable. 

 

The importance of the EMV card migration and the liability shift cannot be overstated.  It is absolutely essential that every business that accepts payment cards understand and prepare for this now. 

 

8.    International Conflicts Over Privacy Rights 

 

In 2014 the US and EU collided over the disclosure obligations of Microsoft concerning data pertaining to EU citizens that Microsoft stores in the EU. 

 

A  US Government agency (we don’t know which one) served Microsoft with a search warrant for the content of an individual’s email account.  The contents are stored on a server in Dublin, Ireland. 

 

Microsoft has resisted the warrant on the grounds that US search warrants don’t apply to locations outside the United States.  As Microsoft’s Deputy General Counsel put it, the “U.S. government doesn’t have the power to search a home in another country, nor should it have the power to search the content of email stored overseas.” 

 

Predictably, the European Commission agrees.  The EC takes the view that the information can only be obtained via established legal frameworks that provide access to it. 

 

The US government has argued (successfully so far) that the warrant applies to any location under Microsoft’s control. 

 

Microsoft (with the active support of Ireland and the EU) is continuing to resist efforts to obtain the data because providing it would violate EU law.  This battle will continue in 2015 and will be interesting to watch, given the ramifications the case is likely to have on the legal frameworks governing the cross-border transmission of information subject to privacy protections. 

 

9.  Physical Damage From Cyber Events 

 

Many people will recall the Stuxnet worm that infected computers in Iran that controlled nuclear centrifuges and physically destroyed a large number of them.  In 2014 it was reported that an attack on a steel mill in Germany resulted in serious damage to blast furnaces there.  The possibility of similar future attacks on industrial control systems is real and must be taken seriously.  This will be an issue to watch in 2015. 

 

10.  Changes In the Cyber Insurance Market 

 

As a consequence of the large and expensive retail breaches over the past year, the cyber insurance marketplace changed dramatically in late 2014. 

 

Cyber coverage for companies with payment card data is becoming more expensive and harder to get.  Underwriters are asking deeper questions and are asking for more information than they have in the past.  Some insurers are no longer willing to cover such companies; others are reducing the policy limits they are willing to provide.  In addition to underwriting becoming more stringent, pricing is going up (even on, and sometimes especially on excess layers).  All of this comes at a time when there is unprecedented demand for cyber insurance. 

 

Companies that don’t have payment card data exposures are not facing the same problems.  For them the availability and cost of cyber insurance has changed little in the past year. 

 

Cyber underwriters continue to innovate.  In 2014, AIG introduced its CyberEdge PC policy that for the first time in a form for general use can cover property damage and bodily injury resulting from a cyber event.  It does this by providing excess DIC coverage over a company’s existing insurance programs.  Some underwriters continue to be willing to push the envelope on cyber policy terms and conditions in order to provide solutions, not just policies, to clients.  That is essential at a time when the cyber risks companies face are so dynamic. 

PrintNew corporate and securities lawsuit filings and enforcement actions were down for the third consecutive year in 2014, according to the latest annual report from the insurance information firm, Advisen. According to the report, which is entitled “D&O Claims Trends: 2014 End of Year Wrap-Up,” and which can be found here, the decrease in the number of new filings was spread across almost every major lawsuit and enforcement action category. The report does note that though the number of lawsuits and enforcement action is down compared to the immediately preceding years, the activity levels are still elevated compared to the years immediately preceding the financial crisis.

 

Unlike other published litigation reports, many of which track only securities class action lawsuit filing and settlement activity, the Advisen report attempts to track filing trends across several types of corporate and securities litigation, including but not limited to securities class action lawsuit filing activity. However, readers should be cautioned that the report uses its own unique names to describe the various different categories of litigation and enforcement activity. Because of this definitional issue, the report must be read very carefully.  

 

According to the report, the number of new corporate and securities lawsuit and enforcement action filings declined by ten percent between 2013 and 2014, from 1,492 in 2013 to 1,342 in 2014. These figures for both years are well below the 2011 peak of 2,059. While the 2014 activity was below recent years, the 2014 activity level still exceeds the totals from the period before the financial crisis prior to 2009. The report suggests that the decline in activity can be attributed to a number of factors, including the continued wind down of the financial crisis-related litigation and the fact that there are fewer U.S. public company litigation targets.

 

The report notes that the sector with the greatest number of corporate and securities lawsuit filings during 2014 was the financial sector, as has been the case every year since 2006. However, the spike in actions against companies in this sector during the period 2008 through 2011 has subsided.

 

With respect to securities class action lawsuits, the report notes that while the number of filings in the category has remained steady over the past three years, the number of 2014 filings (183) remained well below the 10-year annual average of 199. (To see my commentary on the significance and possible interpretation of the drop in filings below the long-term historical average, please see my own report on the 2014 securities class action lawsuit filing activity, here). The report notes that for many years, the number of securities class action lawsuit filings as a percentage of all corporate and securities litigation had been declining, as other types of litigation and enforcement activity increased. For example, in 2010, securities class action lawsuit filings represented only ten percent of all corporate and securities lawsuit filings. However, in the past three years, the securities class action lawsuit filings as a percentage of all corporate and securities filings has been increasing. The 183 securities class action lawsuit filings that Advisen tallied in 2014 represented 13.6 percent of all corporate and securities lawsuit filings during the year.

 

According to the report, the number of shareholder derivative lawsuit filings has “declined every year since 2011.” The 164 shareholder derivative lawsuit filings in 2014 is nearly 30 percent below the ten year annual average number of shareholder derivative lawsuit filings of 233. The number of derivative lawsuit settlements has declined as well; Advisen tracked only 38 derivative lawsuit settlements in 2014 compared to 64 in 2011. But though the number of derivative lawsuit settlements has been decreasing, the number of jumbo derivative settlements has increased. The report notes that during 2014, two massive shareholder derivative settlements were announced – the $275 million settlement in Activision, the largest derivative settlement ever, and the $137.5 million Freeport McMoRan settlement, the third largest derivative settlement every. (My discussion of the Activision settlement can be found here. My discussion of the Freeport McMoRan settlement can be found here. My running tally of the largest derivative lawsuit settlement can be found here.)

 

The report contains a number of interesting observations about FCPA enforcement activity. Among other things, the report notes that the number of FCPA enforcement actions increased by 57 percent in 2014, from 7 filings in 2013 to 11 in 2014. The number of settlements of FCPA enforcement actions also increased, from 11 in 2013 to 16 in 2014. Companies also paid more in 2014 than ever before to settle FCPA actions, including the $772 that Alstom agree to pay in settlement with the SEC, the $135 million that Avon Product agreed to pay, and the $97.3 million that Weatherford International agreed to pay. The report also  notes that anticorruption enforcement has become a priority area in a number of other countries, including China, Brazil and Canada.

 

The report includes a number of interesting comments from my friends Joe Monteleone of the Rivkin Radler law firm, Rick Bortnick of the Traub Lieberman law firm, and Priya Cherian Huskins of Woodruff Sawyer.

 

Discussion of 2014 Litigation Trends: On January 28, 2015, I will be participating in an Advisen webinar discussing the 2014 Corporate and Securities Litigation Trends. The webinar, which will take place at 11:00 am EST, is free. The webinar panel will also include Steve Shappell of JLT Specialty, Kathryn Walker, of Travelers, and Jim Blinn of Advisen. Information about the webinar including instructions on how to register can be found here.

cornerThe number of securities class action lawsuit filings in 2014 was about the same as in 2013, but the cases that were filed were smaller than in the past, according to the annual securities litigation report from Cornerstone Research. However, the likelihood that a public company will be the subject of a filing remained above the historical average in 2014, as it has in each of the past five years.

 

The Report, entitled “Securities Class Action Filings: 2014 Year in Review,” can be found here. Cornerstone Research’s January 27, 2015 press release about the report can be found here. My own analysis of the 2014 securities class action lawsuit filing can be found here.

 

According to the report, there were a total of 170 securities class action lawsuit filings in 2014. While this figure represents an increase of four lawsuits over 2013, it is ten percent below the 1997-2913 average annual number of 189 filings.

 

However, while the annual number of filings is down compared to the historical average number of filings, the number of publicly traded companies has declined significantly from the early years in the measuring period. The report notes with respect to the decline in the number of annual filings compared to historical average, “The declining long-term trend in the total number of filings from the late 1990s through today is a result of a decline in the number of public companies rather than a decreased likelihood of being the subject of a class action.”

 

To put the relative likelihood today of a U.S.-listed company being hit with a securities lawsuit into perspective, the percentage of U.S. listed companies hit with securities suits was 3.6% in 2014, compared to the annual average percentage of 2.9% during the period 1997-2013. In other words, though the annual number of filings overall is down in more recent years  compared to the historical annual average number of filings, due to the lower number of public companies, “the likelihood that a public company was the subject of a filing remained above the historical average in each of the past years.”

 

But while the overall likelihood of a U.S.-listed company becoming involved in a securities class action lawsuit is above long-term historical averages, companies in the S&P 500 were less likely to be targeted by a securities class action lawsuit in 2014 than in any year since 2000. Only 2.2 percent of S&P 500 companies were hit with lawsuits in 2014, compared to the annual average during the period 2000-2014 of 5.7%. In addition, the size of the S&P 500 companies involved has also changed. In the past, the larger companies in the S&P 500 were more likely to be targets of securities suits. However, during 2014, only 1.3 percent of the S&P 500 market capitalization was subject to new filings in 2014, the lowest on record, and well below the historical annual average of 10.1%.

 

As a general matter, the sizes of the companies and of the disputes involved in the lawsuits were smaller in 2014 compared to prior years. The report’s measure of the largest amount that plaintiffs, in the aggregate, might seek to recover  from cases filed in 2014 (what the report calls Maximum Disclosure Dollar Loss) sank to the lowest level since 1997. In a press release accompanying the report, a Cornerstone Research spokesman is quoted as saying that “for the first time since 1997, there were not mega filings with investor losses of greater than $5 billion at disclosure.” 

 

The press release also quotes Stanford Law School Professor Joseph Grundfest as saying that “although the number of lawsuits filed is little changed, the cases filed are much smaller and will lead to smaller recoveries for the plaintiff class down the road.” Professor Grundfest suggests that the data raise an interesting question of whether “large-scale securities class actions against corporate America are on the decline.”

 

While the long-term trend has been toward a declining number of publicly traded companies, the number of listed companies actually increased in 2014, due to increased IPO activity. According to the report, there were 206 IPOs in 2014, representing an increase in the number of IPOs in 2013 of 31%, and representing the highest level of IPO activity since 2000. However, number of IPOs during 2014 was still well below the 1996-2000 average annual number of IPOs of 458 IPOs. The report notes that the IPO activity in 2014 has “potential implications for future litigation.”

 

The report also contains an analysis of the status and disposition of securities class action lawsuit filings during the period 1996-2014. Among other things, the analysis shows that “dismissals were increasingly common for filings in the cohort years after 2003.” The aggregate dismissal rate for cases filed during the years 2003-2012 was 52 percent, compared to percentage well below that level prior to that period. The report suggests that the “underlying characteristics of the complaints” may help explain this increase. During the years 2008-2012, there were significant numbers of filings involving Chinese Reverse Merger companies, M&A lawsuits and credit crisis cases. These three categories of cases were dismissed at a 58% rate, compared to a 50% rate for all cases excluding these three categories. Other characteristics that can affect the likelihood of dismissal are: how quickly the case was filed, the length of the class period, and the size of the potential claims.

 

The number of filings against non-U.S. companies increased to 34 in 2014, well above the average historical average from 1997 to 2013 of 22 filings. The percentage of filings against foreign issuers was 20 percent in 2014 compared to the 1997-2013 historical average of 11 percent.

039aThe D&O Diary was on assignment in Germany this past week, with stops for meetings in Cologne and for a conference in Frankfurt. January, it turns out, is a less than optimal month in which to visit Northern Europe. The conditions are generally cold, grey and dark. When composing their timeless folk tales the Brothers Grimm undoubtedly assembled their story ideas throughout the year but waited until the third week in January to put pen to paper, in order to summon just the right mood of forbidding gloom.  

 

The Rhine river city known as Colonia to the Romans, Cologne to the Rhineland-coveting French, and Köln to the natives, presently has a population of about 1 million. The predominant (and omnipresent) landmark in Cologne is its towering, dark cathedral, in German called the Kölner Dom(pictured at the top of the post, with the Rathaus, or City Hall, to the left of the cathedral’s twin spires). The Dom is just about the only building in the city that survived the war, its structure preserved because allied bomber pilots depended on the sight the twin spires rising about the flat Rhine basin as a navigational reference.

 

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In prior visits to Cologne, I wondered how the city planners had allowed the major railroad lines and the main railroad terminal (the Hauptbahnhof) to be built literally right next to the Dom (as depicted in the two pictures below). It turns out that the railroad lines actually were completed before the Dom. Though construction on the Dom commenced in 1248, work paused in 1473 for, oh, about four hundred years, until a nineteenth century wave of romantic enthusiasm for the Middle Ages and a flood of Prussian money finally brought the Dom to completion in 1880, after the railroad lines were well established.  

 

 

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Beyond the Dom, the rest of Cologne was rebuilt almost in its entirety after the war – which creates a challenge for 21st century visitors to many German cities. The unavoidable question is: how do you feel about historic reconstructions? The façades and structures of many of the “old” buildings in both Cologne and Frankfurt are restored versions of historic buildings destroyed in the war. This aesthetic problem is not unique to Germany; the Temple of Heaven in Beijing is a 19th century reconstruction. The fabulous fortress city of Carcasonne to be seen today in southwest France is essentially a 19th century enhancement of an older structure. Just the same, the reconstructed older building problem is omnipresent in Germany because so much of its urban fabric was obliterated between 1941 and 1945. There is something less than satisfying about the city centers in places like Cologne and Frankfurt where the rustic, half-beamed houses in each city’s Altstadt are barely 60 years old.(The pictures below reflects the restored buildings in old town in Frankfurt.)  

 

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I have visited Cologne several times before. It is actually (and perhaps unusually) one of my favorite cities in Europe. It is sufficiently familiar that I have favored routine when I visit. For me, no visit to Cologne would be complete without a vigorous walk along the Rhine. Fleets of barges work in both directions on the river, with south-bound vessels struggling powerfully against the strong north-bound current.

 

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 A series of traffic and rail bridges now traverse the waterway, crossing the riparian barrier that two millennia ago arrested the Roman imperial advance at the river’s western shore. (A fascinating museum in the city center preserves the remnants of the Roman outpost that guarded the river frontier against the menacing Teutonic tribes on the river’s far shore.) The paved pathway that now runs along the river’s east side leads quickly into the countryside and rolls for miles and miles to the South. On a different occasion, I would have welcomed the chance to follow the path wherever it might eventually go, who knows, perhaps all the way to the river’s headwaters in the Alps. As it was, frigid temperatures and frosty winds imposed certain time limits. After an interval of brisk riverside walking, a retreat to a quiet table and a glass of beer seemed like a much better idea.    

 

016aAnd drinking beer in Cologne is a particularly good idea, because Cologne is the only place in the world where beer called kölsch (pronounced “kulsh”), a distinctive pale lager, properly may be brewed (according to the Kölsch-Konvention of 1986). Traditionally, the beer is served in slender cylindrical glasses. In one of the world’s greatest beer-drinking customs, the waiter will replace your empty glass with a full one (marking your coaster each time to keep a tally the number of cumulative rounds) and continue to do so until you signal you have had enough by taking your coaster and placing it over the top of your empty glass. On a prior visit, before I learned the code, the constantly replenishing supply of lager just about inundated me. This time, I soon shifted the coaster to the top of the glass out of a healthy sense of self-preservation – and an awareness that I had a train to catch early the next morning.

 

 

 

021aThere was a bit of a surprise on Saturday morning as I readied to leave Cologne. A sudden but serious snow storm hit town just before I left for the train station. Fortunately, the quickly accumulating snow had no effect on the train schedule. I took the high-speed Deutsche Bahn Intercity-Express (ICE as the locals know it), which glided smoothly southward. The deceptively quick train took only 55 minutes to cover the 120 miles between Cologne and the Frankfurt Airport. Earlier this month, The Economist had an article critical of this type of highly subsidized transport, but all I can say is that it is a remarkably civilized and stress-free way to move quickly between cities.

 

 

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039aFrankfurt is a modern, prosperous city, located on the Main River (pronounced “Mine”). Unusually for a European city, its center city has a skyline of tall steel and glass office buildings. The local joke, invoking both the river’s name and the phalanx of office towers, is to refer to the city as “Mainhattan.” The river, which the Franks long ago forded, giving the city its name, runs east to west and joins the Rhine at Wiesbaden, and traditionally was the border dividing catholic Southern Germany from Protestant Northern Germany. Frankfurt has long been a financial center for continental Europe; the Rothschild banking firm, for example, started there in the late 18th and early 19th centuries. Today, the European Central Bank and the Deutsche Bundesbank are both located there, as are the headquarters of a host of commercial banks.

 

Saturday was propitious day to have arrived in Frankfurt, as it was market day. The central, pedestrianized shopping district was thronged with shoppers, undeterred by the chilly, wet snow that started to fall shortly after I left my hotel to explore the city.

 

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056aBecause of the raw weather, I was happy to make my way into the Kleinmarkethalle, a covered market with butchers, fish mongers, bakers, florists and green grocers. In no hurry to head back out into the snow, I decided to have lunch at a small restaurant on the second floor of the market hall. I confess that on this trip to Germany I had poor luck trying to order off of the restaurant menus. It seemed that no matter what I ordered, what arrived was a fried breaded pork cutlet with potatoes. So for this lunch I tried a different approach. I asked the waiter “Was empfehlen Sie?” (What do you recommend?) He suggested the daily special, which he said was very good, so I agreed to give it a try.

 

 

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The daily special turned out to be a large sausage on a bed of dark green mush. The sausage presumably included some form of meat product, but I am not sure what the green mush involved. It wasn’t bad; I suppose it is all part of the adventure of traveling. At least it wasn’t a breaded pork cutlet.

 

011aOn Sunday, I decided to attend the church service at the Frankfurt Cathedral (officially Kaiserdom Sankt Bartholomäus, pictured left). I missed the early service (it began at 10 am rather than 11 am as I had assumed ) so I walked along the river until the time for the Noon service. I was surprised when I arrived a few minutes before Noon; the sanctuary was packed. It was literally standing room only. I was in for another surprise when the service, a Catholic mass, began. The priest was only a few words in before I realized he wasn’t speaking German. Not that it mattered much, since I know very little German. But I couldn’t figure out what language he was speaking. It sounded like Russian, at first. But then some other words sounded Italian. It was as if it was Russian being spoken by an Italian. I thought, maybe it is a Balkan language, one of the South Slav tongues.

 

The final clue came during the sermon, when the priest, saying some numbers, used three words that I recognized: he said “jedan, dva, tri” which I recognized as one, two, three in Croatian. (It is a very long story about how I happen to know a few Croatian words). Sure enough, on the way out, the sign outside the door confirmed that the service was “kroatisch.” It was quite something; the sanctuary was full, there were several hundred people there. Most everyone, except for a few interlopers like me, participated in all of the hymns and prayer responses. Unknowingly, I had wandered into a large gathering of the Croatian community in Frankfurt.

 

After the service, and after a bit more strolling, I made my way to a café near the river. I arrived after the lunch rush, so I had a chance to try to chat with the waitress. I have only recently tried to learn German.  I had to overcome an irrational bias against the language based on a childhood of watching black-and-white World War II movies in which vulpine Wehrmacht officers shouted single-word German imprecations at their troops, their horse, their prisoners. The German spoken by the pretty waitress with the shy smile at the café was a different language entirely. If I had heard her speak her language when I was, say, about 14 years old, I would have devoted myself then to learning the language without restraint. Unfortunately, having started to try to learn German only recently, my ability to chat with the waitress was comically constrained. I had pretty much exhausted my selection of phrases after I got past “What is your name?” and “Where are you from?” After that — unless I wanted to say “I would like to buy some batteries” or “Is this the train for Düsseldorf?” — I really had nothing else to work with. So I tried to suffice with a few smiles and head nods. She smiled in return, but I could read the thought-bubble over her head – it said, “Are there even more morons back in America like this one?”

 

The Frankfurt conference itself, focused on the topic of litigation financing, was quite an interesting event. A group of very sharp lawyers, financiers, and representatives of institutional investors gathered on Monday to discuss the latest developments in collective actions in Europe and around the world. Given my demonstrated incompetence in German, I was fortunate that the sessions were largely conducted in English. The threatening snow storm gathering in the East coast of the U. S. managed to thoroughly disrupt my return travel plans, which in turn cut into my ability to attend all of the sessions, as I beat a premature retreat back to the States to try to get ahead of the storm.

 

Despite the wintry weather both in Germany and at home, I had a great trip to a couple of great German cities. Next time, however, I think I will try to travel in, say, June, rather than January.

 

 

Here’s a picture with my good friend and former colleague, Ed Mrakovcic of Gen Re (based in Cologne), sharing a couple of glasses of kölsch.  

 

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business reportWhen Congress enacted stiff executive compensation clawbacks as part of the Dodd-Frank Act, the assumption was that the adoption of these kinds of measures would reduce the number of corporate restatements and increase investor confidence in financial reports. However, a new study focused on companies that have adopted clawback measures suggests that these gains may prove more illusory than assumed. As discussed in a January 20, 2015 Accounting Today article entitled “Clawbacks Can Lead to Accounting Gimmicks” (here), study by three academics from Hong Kong shows that while the clawback provisions may discourage one type of accounting manipulation, they may encourage another.

 

Section 954 of the Dodd-Frank Act requires the SEC to adopt rules requiring the national securities exchanges to prohibit the listing of the securities of any company that does not develop and implement provisions specifying that if the company restates its financial statements, the company will recover from any current or former officer of the company any incentive based compensation the officer received during the three-year period prior to the restatement. The SEC still has not issued the implementing regulations but many companies have voluntarily adopted clawback provisions.

 

The authors of the study referenced in the article analyzed financial reports from companies in the Russell 3000, comparing data from companies that adopted clawback provisions over the five year period preceding the passage of the Dodd-Frank Act with an equal number of non-adopters closely matched with them in other respects.

 

The authors found that the clawback provisions reduces the incidence of one kind of earnings manipulation – that is, “accruals management” – only to increase the incidence of another type of earning manipulation that if anything is more adverse to investors – “real-transactions management.” The first type, accruals management, refers to the manipulation of the various balance sheet items that require some element of estimation, such as bad debt reserves or estimates of inventory valuation.   Real transactions management involves altering actual expenditures to achieve a temporary earnings boost, such as by cutting research and development or by slashing prices or easting credit terms to boost sales.

 

Crawback provisions deter earnings manipulation through accruals management because high accruals tent to attract the attention of regulators and auditors, increasing the likelihood of a restatement that would trigger the clawback. Managing transactions, while obviously sub-optimal from a business perspective, are unlikely to attract the attention of auditors and regulators. Manipulating the transactions may produce a short run earnings and stock price upswing, but will likely be followed by downturns in subsequent years.

 

The authors found that the patterns of increased transaction manipulation was particularly pronounced among two types of companies – that is, companies with high-growth opportunities (and therefore likelier to experience a sharper stock price decline if they were to miss forecasts) and those with a high degree of transient institutional ownership (that is, the kinds of investors that focus on short-term earnings targets).

 

The authors of the study concluded that “mandating clawbacks, as Dodd Frank does, is at best of dubious value and may actually be counterproductive in its encouragement of management practices.” The authors added that “since the clawback mandated by Section 954 is more rigorous than what many firms have adopted on their own, it is reasonable to anticipate that the negative effects we saw in our study will come to pass when the law is fully enforced.”

 

Break in the Action: The D&O Diary will be on travel for the next few days so there will be an interruptoin in the normal publication schedule. Regular puiblication will resume later next week.

NERAThe number of securities class action filings in 2014 was level with recent years’ filings but the number and dollar value of settlements during the year plunged, according to the latest annual report from NERA Economic Consulting. This year’s report is quite detailed and contains a number of new analyses of lawsuit filings and case resolutions. The January 20, 2015 report, entitled “Recent Trends in Securities Class Action Litigation: 2014 Full-Year Review” can be found here. NERA’s January 20, 2015 press release about the report can be found here. My own report about the 2014 securities class action lawsuit filings can be found here.

 

Number of Securities Lawsuit Filings: According to the report, there were 221 securities class action lawsuit filed in 2014. (Please see my note at the end of this post about NERA’s lawsuit counting methodology and how it differs from the methods used in other reports). The number of 2014 filings was essentially level with that of recent years; in 2013, there were, according to NERA, 222 filings, and 2012 and 2011 there were 212 and 228, respectively. The number of filings during the period 2009-2014, during which there was an annual  average number of annual filings of 220,  showed “remarkable stability.”

 

Increased Likelihood of Being Sued: While the number of filings has remained relatively stable in recent years, the likelihood of any one company with a listing on U.S. exchange experiencing a securities class action lawsuit has in fact increased significantly compared to historical levels. The reason for this greater likelihood is that while the number of lawsuit filings has remained relatively stable, the number of companies with listings on U.S. exchanges has declined significantly. In 1996, there were 8,783 companies with listings on U.S. exchanges. In 2014, there were 5,209 U.S. listed companies, representing a decline of 41%. This decline in the number of companies has, according to the report, “implications for the average probability of being sued.” This probability has increased from 2.3% over the 1996-1998 period to 4.2% in 2014.

 

Changing Mix of Cases: While the annual number of lawsuit filings has remained relatively stable in recent years, the mix of cases has changed. For example, in 2010, merger objection cases accounted for 31% of all securities class action filings during the year, whereas during 2014, merger objection cases accounted for only 18% of securities suit filings. At the same time, “traditional” securities lawsuit filings (that is, cases alleging violations or Rule 10b-5, Section 11 or Section 12) increased – the number of traditional filings increased 11% in 2014 compared to 2013 and 30% compared to 2010.

 

Impact of Halliburton Pendency on Filings: The report has an interesting observation about the possible effect of the pendency of the Halliburton case on the number of securities class action filings. Readers will recall that the Halliburton was a potentially important U.S. Supreme Court case that could have but that ultimately did not have a significant effect on securities class action litigation (about which refer here). The report notes that the number of securities class action filings was slow while Halliburton was pending, but that during the July-November period after the Supreme Court issued its opinion in the case, the average monthly number of filings increased 25%. The low number of filings during December brought down this monthly average, but even with this reduction the post-Halliburton monthly average number of filings was 14% higher than the monthly average while the case was pending. The NERA report carefully comments that “while we note the temporal correlation, we are not suggesting how much, if any, of the change in the filing activity is due to these decisions since we have not considered confounding factors.”

 

Aggregate Investor Losses: The aggregate value of investor losses represented by the 2014 securities lawsuit filings was at its lowest level during the period 2005-2014. (The investor loss variable is a proxy NERA uses for the aggregate amount investors lost from buying the defendant’s stock rather than investing in the broader market.) The $154 billion aggregate investor losses associated with the 2014 cases is just below the $159 billion in investor losses in 2013 but well below the $234 billion in 2012. The report notes that the lower number of aggregate investor losses in more recent years is “explained mainly by the almost complete absence of cases with very large investor losses.”

 

Motion to Dismiss Outcomes: The report notes that motions to dismiss are filed in 95% of all securities class action lawsuits, although courts rule on only about 80% of all motions filed (in other cases, the lawsuits settle or are withdrawn prior to court ruling). During the period 2000-2014 in cases in which rulings were issued on motions to dismiss, the motions were granted in 48% percent of cases, granted in part and denied in part in 26% of cases, and denied in 21%.

 

Changing Dismissal Rates: The rate at which cases have been dismissed has changed over time. The report notes that the dismissal rate for cases filed during the period 2000-2002, the dismissal rate was 32-36%; during the period 2004-2006, the dismissal rate was 43-47%; and the dismissal rate for cases filed during the period 2007-2009, the dismissal rate was at least 45%-52%. The reports authors are cautious about drawing conclusions based on this apparent rising trend in the dismissal rate  due to “the large fraction of cases awaiting resolution among those filed in recent years, and the possibility that the dismissals will be successfully appealed or re-filed.”

 

Outcome of Class Certification Motions: The report also has some information that is interesting to consider when evaluating the possible impact of the U.S. Supreme Court’s Halliburton decision. The report notes that 73% of cases are settled or dismissed before a motion for class certification is filed. In cases in which a motion for class certification has been filed, the court reaches a decision on the motion 56% of the time. Of the class certification motion rulings, 75% were granted and 12% were denied (with mixed rulings in other cases). The report notes that of the three post-Halliburton cases of which the authors aware in which the defendants sought to oppose class certification in reliance on the type of price impact evidence Halliburton authorized, that the motions were granted and the classes certified despite the price impact evidence.

 

Declining Number of Settlements and Slowing Case Resolution: The number of cases settled during 2014 declined for the third consecutive year and was at or close to an all-time low since the passage of the PSLRA. Overall, the number of cases resolved through settlement or dismissal also has been low for three years. At the same time, since 2011, the number of pending cases has been increasing, reaching 653 in 2014, a 19% increase from the lowest  pending number of pending cases in 2011 (547). This increase in the number of pending cases during a period when the number of filings was roughly constant suggests “a slow-down of the resolution process during that period.”

 

Declining Average and Median Settlements: Just as the number of settlements has declined in recent years, the average and median settlement amounts have also declined. Excluding merger objection cases, IPO laddering cases, and settlements over $1 billion, the average settlement in 2014 was $34 million, compared to $55 million in 2013 (adjusted for inflation), a decline of 38%. Even more interesting, the median settlement (excluding merger objection suits, IPO laddering cases and settlements in which the class received $0) during 2014 was only $6.5 million, the lowest median in ten years and adjusted for inflation the third lowest since the passage of the PSLRA. By contrast, the median in 2013 was $9.3 million and in 2012 was $12.6 million (both figures adjusted for inflation).

 

Declining Aggregate Plaintiffs’ Fees and Expenses: Mirroring this decline in average and median settlement value, the aggregate annual plaintiffs’ fees and expenses during 2014 of $619 million was far below that of 2013 (when equivalent figure was $1.164 billion). This figure was at its lowest level during 2014 since 2004 (when the aggregate amount was $487 million).

 

This detailed report contains a wealth of other information and analysis and it merits a complete reading at length and in full.

 

Readers will want to carefully note the “counting” methodology used in the NERA report to understand how the filing figures in the report differ from other published figures. In a footnote, the report’s authors explain that if multiple actions are filed against the same defendant and the same allegations but are filed in different circuits, the separate actions are treated as separate filings (and if they are later consolidated, the tally is revised accordingly). This methodology is different than that used in other published analyses, which count lawsuits against the same defendant and the same allegation only once regardless of whether or not there are separate complaints filed in different circuits. Also the NERA report also includes with the tally lawsuits that alleging only breach of fiduciary duty or other violations of the common law or that only involve claims under foreign or state law. Other published tallies only include a lawsuit in the count if it alleges a violation of the federal securities lawsuit. 

hbr4The fiduciary duties of members of corporate boards are usually invoked in connection with directors’ potential liability exposures. However, in their January 2015 Harvard Business Review article entitled “Where Boards Fall Short” (here), Dominic Barton, global managing director of McKinsey & Co., and Mark Wiseman, President and CEO of the Canada Pension Plan Investment Board, invoke directors’ fiduciary duties as a guidepost to help boards fulfill their “core mission” of “providing strong oversight and strategic support for management’s efforts to create long-term value.”

 

As the article’s title suggests, the authors believe that boards currently on falling short on this core mission. It isn’t just the authors themselves who think this; according to the authors’ survey of over 600 executives and directors, company officials think so, too. According to their survey, the most frequently identified source of pressure most responsible for their organizations’ over-emphasis on short-term financial results, cited by 47% of respondents, was the company’s board. An even higher percentage of respondents (74%) who identified themselves as corporate board members “pointed the finger at themselves.”

 

The answer to the short-termism problem, the authors suggest, is not “another round of good-governance box checking and hoop jumping.” A better starting point, they suggest, would be “to help everyone firmly grasp what a director’s ‘fiduciary duty is.” The law in most jurisdictions stresses two core aspects of fiduciary duty, loyalty and diligence. Nothing, the authors note, “suggests that the role of a loyal and prudent director is to pressure management to maximize short-term shareholder value to the exclusion of any other interest.” To the contrary, “the logical implication is that he or she should help the company thrive for years into the future.

 

If directors can keep their fiduciary duty firmly in mind, “big changes in the board room should follow.” If directors are focused on their fiduciary duty

 

They will spend more time discussing disruptive innovations that could lead to new goods, services, markets, and business models; what it take to capture value-creation opportunities with a big upside over the long-term; and shutting or selling operations that no longer fit. And they will spend less time talking about meeting next quarter’s earnings expectations, complying with regulations (although that must, of course, be done), and avoiding lawsuits.

 

In order to facilitate the “mental discipline of keeping long-term value creation in mind,” which would “help clarify choices and reform board behaviors,” the authors suggest four areas where “change is essential.”

 

First, the authors emphasize the importance of selecting the right people as directors. In particular, the authors suggest, “too many directors are generalists.” Boards all too often do not think about “attracting the right business expertise.” Boards that “combine deep relevant experience and knowledge with independence can help companies break through inertia and create lasting value.”

 

Second, boards should spend more quality time. The starting point is here is to first spend enough time. The authors suggest that public company directors “need to put in more days on the job and devote more time to understanding and shaping strategy.” Directors of large, complex firms should spend at least two days a month, or 24 days a year, on board responsibilities, in addition to attending regular board meetings. But more than the precise number of days, what “matters most” is “the quality and depth of strategic conversations that take place.” The example the authors give involves a company whose board members traveled to China before the company launched its Chinese initiative several years later. The board, the authors suggest, was anticipating and exploring directions that the company might later go.

 

In addition, the authors suggest that boards should develop nonfinancial metrics that will help guide strategy, particularly when the financial statements do not tell the entire story. Metrics the authors suggest include keys for gauging progress on key development activities, such as “implementing capital spending plans; achieving environmental, health and safety goals; and maintaining a healthy, well-funded balance sheet.”

 

Third, the authors suggest should engage with long-term investors, whose ownership position makes them “a counterforce” to the marketplace forces that encourage a short-term outlook. The survey respondents suggested that regularly communicating long-term strategy and performance to key long-term shareholders “would be one of the most effective ways to alleviate the pressure to maximize short-term returns and stock prices.”

 

Finally, the authors suggest that companies should restructure the way directors are compensated for their board service. The authors recommend a move toward “longer-term rewards.” The authors suggest that the way “to really get directors thinking and behaving more like owners, ask them to put a great portion of their net worth on the table.” The authors suggest a combination of giving directors incentive shares that only vest some years after the directors step aside, and requiring incoming directors to purchase equity with their own money. The goal is to insist on a material investment that more directly ties a director’s financial incentives to the company’s long-term performance.

 

I found the authors’ analysis interesting. I was particularly interested in the author’s use of fiduciary duty principles as a way to encourage better board performance. Fiduciary duty principles are invoked only as a potential source of director liability. (Ironically, the authors suggest that if directors spend more time focused on their fiduciary things, among the things that boards will spend less time worrying about is “avoiding lawsuits.”) The authors’ creative use of fiduciary duty  principles can help to “bring about a deep shift in culture, behavior and structure of public company boards,” to help companies to “deliver the kind of sustained value creation that long-term shareholders expect and that our society deserves.”

 

The Little Prince: From the web page of Jim Gelcer:

 

prince 

 

nystate1In the latest round in the long-running battle over whether there is D&O insurance coverage for the amounts Bear Stearns paid in settlement of an SEC enforcement action for alleged market timing, the D&O insurers may have finally found an issue on which they may be allowed to try to dispute coverage. Even though, in its January 15, 2015 opinion (here), the N.Y. Supreme Court, Appellate Division, First Department, affirmed the trial court’s dismissal of the carrier’s affirmative defense based on the “Dishonest Acts Exclusion,” the intermediate appellate court modified the trial court’s dismissal of the carriers’ affirmative defense based on the public policy doctrine precluding coverage for losses caused by intentionally harmful conduct. The intermediate appellate court has, however, already been reversed once before in this protracted coverage battle, so it remains to be seen where this latest development ultimately will leave the parties.  

 

Background

In 2006, the SEC notified Bear Stearns that the agency was investigating late trading and market timing activities that units of Bear Stearns allegedly had undertaken for the benefit of clients of the company. Bear Stearns ultimately made an offer of settlement and –without admitting or denying the agency “findings” – consented to the SEC’s entry of an Administrative Order, in which, among other things, Bear Stearns agree to pay a total of $215 million, of which $160 million was labeled “disgorgement” and $90 million as a penalty. Among other things the SEC Order expressly stated that “The findings herein are made pursuant to [Bear Stearn’s] Offer of Settlement and are not binding on any other person in this or any other proceeding.”

 

At the relevant time, Bear maintained a program of insurance that totaled $200 million. Bear Stearns sought to have the carriers in the program indemnify the company for the $160 million amount in the settlement labeled as “disgorgement.”  The carriers refused to pay, relying on several policy exclusions and public policy grounds, as well as on the doctrine providing against insurance for amounts that are in the nature of disgorgement. J.P. Morgan, into which Bear Stearns merged in 2008, filed an action in New York state court seeking a judgment declaring that the carriers’ policy provided coverage for the $160 million portion of the settlement, as well as the approximately $14 million paid to settle the parallel securities class action lawsuit, and defense fees.

 

The disgorgement issue went forward first. The trial court denied the defendants’ motion to dismiss finding that there was a question whether the $160 million Bear Stearns had agreed to make were for improperly acquired funds and thus truly in the nature of disgorgement. The N.Y Supreme Court, Appellate Division, First Department reversed the trial court, saying that the settlement documents “are not reasonably susceptible to any interpretation other than that” Bear Stearns facilitated late trading and that the settlement of the allegations “required disgorgement of funds gained through that illegal activity.”

 

However, as discussed here, in June 2013, the New York Court of Appeals reversed the appellate court, and denied the defendants’ motion to dismiss J.P. Morgan’s declaratory judgment action, holding that the language in the settlement documents did not “decisively repudiate Bear Stearns’ allegation that the SEC disgorgement payment amount was calculated in large measure on the profits of others,” as opposed to ill-gotten gains by Bear Stearns itself.

 

On remand, J.P. Morgan moved for summary judgment based on the Dishonest Acts exclusion and based on the public policy doctrine precluding insurance coverage for monies paid by the insured as a result of intentional harm to others. In a February 28, 2014 opinion (here), New York (New York County) Supreme Court Judge Charles E. Ramos granted J.P. Morgan’s motion to dismiss the affirmative defenses based on the Dishonest Acts Exclusion on, finding that the SEC’s administrative order did not represent a final adjudication so as to trigger the Dishonest Acts Exclusion or the public policy defense. The insurers appealed.

 

The Dishonest Acts Exclusion provides that the policy does not apply to claims “based upon or arising out of any deliberate, dishonest, fraudulent or criminal act or omission … provided, however, such Insured(s) shall be protected under the terms of this policy … unless judgment or other final adjudication thereof adverse to such Insured(s) shall establish that such Insured(s) were guilty of any deliberate, dishonest, fraudulent or criminal act or omission.”

 

The January 15 Opinion

On January 15, 2015, in a 22-page opinion written by Associate Justice Angela M. Mazzarelli for a unanimous five-judge panel, the N.Y. Supreme Court, Appellate Division, First Department, affirmed the trial court’s ruling dismissing the carriers’ affirmative defense based on the Dishonest Acts Exclusion, but modified the trial court’s ruling as to the carriers’ affirmative defense based on public policy grounds.

 

The appellate court said that the insurers stressed the issue whether the resolution of the SEC enforcement action represented an “adjudication” for purposes of the exclusion, the insurers ignored the part of the exclusion requiring that any adjudication “establish” that the insureds were guilty of the precluded conduct. The dictionary, the court noted, defines establish as “to put beyond doubt,” adding that:

 

It can hardly be said that the SEC Order … put Bear Stearns’s guilt “beyond doubt,” when those same documents expressly provided that Bear Stearns did not admit guilt, and reserved the right to profess its innocence in unrelated proceedings. Again, in interpreting the policy we are guided by reason, and the defendants’ position that the settlement documents “establish” guilt is not reasonable.

 

However, while the appellate court held that the trial court had “properly dismissed” defendants’ affirmative defense based on the Dishonest Acts exclusion, the appellate court said that the trial court should not have dismissed the affirmative defense based on “the doctrine precluding, on public policy grounds, insurance coverage for monies paid by the insured as a result of intentional harm to others.”  

 

In addressing the apparent inconsistency in refusing to rely on the “findings” in the SEC Order as a basis to support the enforcement of the Dishonest Acts Exclusion while referring to the same findings as possible support for the invocation of the public policy doctrine, the appellate court said “we have a stronger interest in enforcing public policy than we do in regulating private dealings between insurance companies and their customers that do not have an impact on public policy.”

 

The court added that it is not the business of courts to prevent companies and their regulators “from agreeing to submit to language in consent order that preserves claims of innocence for the purposes of avoiding exclusions like the one at issue here.” At the same time, the court said, “courts should not countenance the use of such language for the purpose of preserving coverage for wrongful acts intended to harm others.”  The intermediate appellate court added that the N.Y. Court of Appeals had said that “one of the two situations in which the contractual language of a policy may be overwritten is where an insured engages in conduct ‘with the intent to cause injury.’”

 

Discussion

This case’s shuttle between the various levels of the New York state court system is the kind of thing that drives litigation parties and other non-lawyers absolutely nuts. The piecemeal appellate review of the parties’ disparate arguments not only has resulted in a protracted procedural history, but each stage seems to extend the eventual time of the ultimate resolution of this case further and further out into endless future. It would be one thing if this case were now going to go back to the trial court for further proceedings on the question of whether or not the provision of insurance for the SEC settlement would be against public policy. However, if the prior history of this case is any indication, it seems probable that if J.P. Morgan can find a basis to appeal, it will seek to have the N.Y. Court of Appeals address the intermediate appellate court’s ruling allowing the carriers to assert their affirmative defense on public policy issues.

 

If J.P. Morgan were to seek a further review by the Court of Appeals, the company likely will argue among other things that the intermediate court of appeals ruling here on the public policy issues arguably depends on a strained distinction that allowed the intermediate appellate court to reject the applicability of the SEC’s “findings” for purposes of triggering the Dishonest Acts Exclusion, yet rely on the very same “findings” as a sufficient basis from which to allege that Bear Stearns had an intent to cause harm sufficient to trigger the public policy doctrine.   J.P. Morgan has an incentive to pursue the review if it is able, if for no other reason than the last time around it was able to convince the Court of Appeals to reverse the intermediate appellate court.

 

For practitioners in this area, the intermediate appellate court’s consideration of the carriers’ defense based on the Dishonest Acts Exclusion makes for interesting reading. In particular, it is noteworthy not only that the appellate court considered whether or not the entry of the Consent Order represented an “adjudication” within the meaning of the exclusion. It is also noteworthy that the court emphasized the question of whether the entry of the consent order – even if it constituted an “adjudication” – “established” that Bear Stearns had been guilty of the precluded conduct. The word “established” is not often a focus of the discussion of the issues arising under this type of exclusion. This ruling underscores the fact that it is not alone sufficient that there may have been an adjudication, but the adjudication must establish that the exclusion applies.

 

The one thing that is clear at this point is that this long-running proceeding will go on. The SEC first launched its investigation in 2003. Bear Stearns entered the settlement with the SEC in March 2006. The insurance coverage case is already on it second passage through the appellate court system. But this dispute is far from over. The fundamental problem for everyone is that there is just too much money at stake. Anytime you have sums of money running approaching a fifth of a billion dollars in dispute, the possibility of compromise is going to prove elusive, if not impossible.