trasOfficials across a range of federal regulatory agencies have made it clear that promoting cyber security is an increasing priority. A critical part of the federal officials’ message has been the message that cyber security should be a corporate governance priority for company executives and corporate boards. For example, in a June 2014 speech, SEC Commission Luis Aguilar highlighted the cyber security oversight responsibilities of corporate boards. Nor are the regulators’ efforts in this regard limited to speech-making; the Federal Trade Commission’s recent action against Wyndham Worldwide related to cyber breaches the company experienced underscores that these regulatory concerns may translate into enforcement action.

 

Deputy Treasury Secretary Sarah Raskin, the second-ranking official at the agency, in a December 3, 2014 speech to the Texas Bankers’ Association (here), reiterated many of these same messages. In her speech, Raskin, who previously served as a member of the Federal Reserve Board, presents ten questions that that company executives and corporate boards should be asking with respect to cybersecurity concerns. Her speech, which is addressed in particular to the cyber security oversight issues that banking institutions face in the current environment, provides a particularly good overview of the topic.

 

The ten questions that Raking poses are organized into three categories of activities: (1) baseline protections; (2) information sharing; and (3) response and recovery.

 

Of particular interest to readers of this blog is one of the questions that Raskin posed within the first category of baseline protections. Among the questions that she asks is what amounts to a ringing endorsement for companies to adopt cyber risk insurance.

 

Her fourth question overall in her list of ten questions suggests that senior officials at banking institutions should be asking “Do we have cyber insurance? And if we do, what does it cover and exclude?” She adds that officials should also be asking “Is our coverage adequate based on our cyber risk exposure?”

 

Raskin’s comments include the observation that though the market for cyber insurance is relatively new, it is growing. She notes that more than fifty carriers now offer some type of cyber insurance, and that cyber insurance products now exist for companies of all sizes. She also noted that “policyholders can now find coverage to match a broad array of cyber risks ranging from liability and costs associated with data breaches to business interruption losses and even tangible property damage caused by cyber events.”

 

Raskin noted that while cyber insurance cannot protect institutions from cyber incidents, it “can provide some measure of financial support in case of a data breach or cyber incident.” She also observed that the underwriting processes for cyber insurance can “help bolster your cybersecurity controls,” because “qualifying for cyber risk insurance can provide useful information for assessing your bank’s risk level and identifying cybersecurity tools and best practices that you may be lacking.”

 

Raskin also notes that officials at the Treasury department have been thinking about how to “encourage an environment where market forces create insurance products that enhance cybersecurity for businesses,” noting that “we can imagine the growth of a cyber insurance market as a mechanism that bolsters cyber hygiene for banks across the board.” (Raskin defines “cyber hygiene” as the engagement in “fundamental practices to bolster the security and resilience of your networks and systems.”)

 

Raskin is far from the first governmental official to suggest that cyber risk insurance should be an important part of companies’ efforts to try to address their cybersecurity exposures. For example, in its October 2011 release provide guidance on cyber risk disclosures (here), the SEC specifically noted that among the things that companies should be disclosing with respect to the company’s cyber risk exposures is a “description of relevant insurance coverage.”

 

While in many respects Raskin’s speech represents a reiteration of messages that other agencies and corporate officials have already made, it is nevertheless a very good summary of the responsibilities of corporate officials with respect to cybersecurity issues. Among other things, her speech emphasizes the fact that the adoption of appropriate cyber risk insurance should be a key part of companies’ response to the growing risk of cyber security exposures.

 

One final observation about Raskin’s speech is to note her emphasis that cybersecurity risk is a problem not just for the largest companies and financial institutions. It is not just a problem for “the other guy,” it is a problem for all companies. She states at the outset of her speech, which is focused on financial institutions, that the threat of a cyber breach “creates a persistent and complex challenge for financial institutions spanning the sector, including financial institutions of all types and sizes.”

 

A December 5, 2014 Law 360 article about Raskin’s speech can be found here (subscription required).

latestgavelMy post earlier this week about the $275 million Activision Blizzard shareholder derivative lawsuit settlement – and in particular my suggestion that the Activision settlement may be the largest derivative suit settlement ever – provoked an interesting flurry of emails and conversations about the lineup of other large derivative lawsuit settlements. To address the various questions I have received on the topic, I have set out below my unofficial list of the derivative suit settlements involving the largest cash components. My purposes in posting this list are two-fold: first, in response to several requests, to share the information I have; and two, to encourage others who may have different or additional information to share the information so that I can update or supplement the list as appropriate.

 

Here is my list of the  largest derivative lawsuit settlements of which I am aware (last updated June 9, 2025):

$735 million  Tesla Board Compensation Derivative Suit (2023).

$500 million Alphabet Competition Shareholder Derivative Suit (2025). {See Note 4 below.}

$310 million      Alphabet/Google #Me Too Derivative Suit (2020) (nominal value of payment over ten years) {See Note 1 Below}

$300 million      Renren Derivative Settlement (2021) (settlement amount subject to "true up" process that could increase the ultimate amount of the settlement). The settlement was ultimately approved in June 2022 (here).

$286 million      American Realty Capital Partners/Vereit (2020)

$275 million       Activision Blizzard (2014)

$240 million      Wells Fargo Phony Account Derivative Suit (2019) (total stated value of settlement = $320 million inclusive of $240 cash component) 

$237.5 million   Boeing 737 Max Air Crashes Derivative Suit (2021)

$197 million     Broadcom (inclusive of total value of all settlements) (2011)

$180 million       FirstEnergy Corp. (2022)

$175 million      Insys (2023)

$175 million      McKesson Corp. (2020)

$167.5 million   CBS/Viacom (Paramount Global) (2023)

$150 million       AIG (sham reinsurance transaction)

$139 million       News Corp. (2013)

$137.5 million   Freeport-McMoRan (2015)

$124 million      Cardinal Health, Inc. (2022)

$123 million      Walmart (2024)

$122 million       Oracle (2005)

$117 million       Altria Group (Juul investment) (2022){See Note 2 below}

$115 million       AIG (2002 lawsuit) (2008)

$100 million       NCI Buildings System, Inc. (2021)

$90 million       L Brands (2021) (nominal value of settlement over five years) {See Note 3 below}

$90 million       21st Century Fox (2017)

$90 million      PG&E (2017)

$89.4 million     Del Monte Foods (2011) (Note: Questions whether this case involves settlement of a derivative claim, refer here).

$87.5 million     Charter Communications (2023)

$85 million        Madison Square Garden Entertainment, Corp. (2023)

$79.5 million     Goldman Sachs/1MBD (2022)

$75 million           Pfizer (2010)

$72.5 million   HSBC (2020)

$71 million       Premier, Inc. (2024)

$62.5 million      Bank of America (Merrill Lynch Acquisition) (2012)

NOTE 1: It could be argued that the $310 amount is not the amount of the settlement of the derivative action; It is rather the total amount of money that Google/Alphabet agreed to spend over 10 years in connection with various therapeutics. As Vice Chancellor Glasscock said in approving the settlement: “I don’t think the $310 million set-aside of company funds to promote both the laudable diversity ends achieved in this settlement is at all a measure of the benefit. It’s a cost to the company. It may very well be a wonderful investment, and I suspect it will be, but it doesn’t represent a tangible benefit flowing to the company. It’s a cost from the company.”

NOTE 2: The $117 million figure represents the amount of money that the company  agreed to spend on various therapeutics over a period of several years. It is a cost to the company, not a benefit. It arguably does not represent the value of the settlement.

NOTE 3: The $90 million figure represents the amount of money that the company  agreed to spend on various therapeutics over a period of several years. It is a cost to the company, not a benefit. It arguably does not represent the value of the settlement.

NOTE 4: The $500 million figure represents the amount of money the company has agree to pay over a period of 10 years toward to the specified corporate governance reforms. It is a cost to the company. The $500 million value of the settlement does not represent the present value of the settlement, which is to be paid over time rather than a single payment of outset of the settlement period.

 

I suspect strongly that there have been settlements with values between the $62.5 Bank of America settlement and the $110 million El Paso-Kinder Morgan settlement. I am hoping readers that are aware of any derivative suit settlements with values in that range, or any other settlements that ought to be on this list, will please let me know. UPDATE: Several readers reminded me of the $89.4 million Del Monte Foods derivative lawsuit settlement and the $75 million Pfizer shareholder derivative lawsuit settlement, which I have added to the list above. The Pfizer settlement is discussed in greater detail here. FURTHER UPDATE: After receipt of comments from readers, I have removed the $110 milllion El Paso settlement from the list as it was originally published. Upon review, I was persuaded that the case had not been filed as a derivative action bur rather as a direct action on behalf of a shareholder class for damages. (For further detail refer here).

 

These settlements are of course all dwarfed by the $2.876 billion judgment entered in June 2009 against Richard Scrushy in the HealthSouth shareholders’ derivative lawsuit in Jefferson County (Alabama) Circuit Court, but that judgment represents its own peculiar point of reference, It also was of course a judgment following trial rather than a settlement.

 

Another peculiar point of reference is the $1.262 billion judgment that Chancellor Leo Strine entered in October 2011 the Southern Peru Copper Corporation Shareholder Derivative Litigation (about which refer here). That case also represents its own form of litigation reality, and it too represents a derivative suit judgment following trial, rather than a settlement.

 

Another derivative lawsuit resolution that is worth considering in the context of the “largest ever” question is the December 2007 settlement of the UnitedHealth Group options backdating-related derivative lawsuit. As discussed here, the lawsuit settled for a total nominal value of approximately $900 million. However, while the press reports at the time described the settlement as the largest derivative settlement ever, the value contributed to the settlement consisted of the surrender by the individual defendants of certain rights, interests and stock option awards, not cash value in that amount.

 

In the past, going back ten years or so, shareholders’ derivative suits typically did not present the possibility of significant cash payouts, at least in terms of settlements or judgments. The cases did present the possibility of significant defense expense and also of the possibility of having to pay the plaintiffs’ attorneys’ fees, but by and large there was usually not a cash settlement component. As the significant examples above show, that has clearly changed in more recent years.

 

This trend gained particular momentum with the options backdating scandal. Many of the options backdating cases were filed as derivative suits rather than as securities class action lawsuits (largely because the options backdating disclosures did not always result in the kinds of significant share price declines required to support a securities class action lawsuit). Many of the options backdating cases settlements included a cash component, and as illustrated by the Broadcom case mentioned above, some of the options backdating derivative suit settlements included very substantial cash components

 

It is interesting to note how many of the derivative settlements listed above were entered in connection with lawsuits objecting to a merger or acquisition transaction – the Activision Blizzard Settlement, the Freeporr-McMoRan settlement, the El Paso-Kinder Morgan settlement, and the BofA/Merrill Lynch settlement all related to lawsuits arising out of merger or acquisition transactions. Indeed, the News Corp. settlement related at least in part to objection to a transaction involving one of Rupert Murdoch’s children. The rise of merger objection litigation has been the target of a great deal of criticism but the number of recent large settlements involving merger or acquisition transactions highlights the fact that among the many cases that are filed there may be at least a few that are more serious.

 

As I have noted in the past in connection with the increasing numbers of jumbo derivative lawsuit settlements, the upsurge in the number of derivative suit settlements that include a significant cash component undoubtedly is being viewed with alarm by the D&O insurance industry. For many years, D&O insurers have considered that their significant severity exposure consisted of securities class action lawsuits. The undeniable reality now is that in at least some circumstances, derivative suits increasingly represent a severity risk as well. And the settlement amounts themselves represent only part of the D&O insurers’ loss costs. The D&O insurers also incur millions and possibly tens of million of defense cost expense in these derivative suits.

 

The increasing risk of this type of settlement represents a significant challenge for all D&O insurers, but particularly for those D&O insurers concentrating on providing Excess Side A insurance. Those insurers will have to ask how they are to underwrite the risks associated with these kinds of exposures, and how they are to make certain that their premiums adequately compensate them for the risk.

gavelOne of the great litigation curses in recent times in the corporate litigation arena has been the rise of merger objection litigation. These kinds of lawsuits, which these days arise in connection with almost every M&A transaction, often are settled for nothing more than an agreement to make additional disclosures and to pay the plaintiffs’ attorneys fees. However, from time to time, there are merger objection lawsuits that settle on more substantial terms.

 

Within the past few days, two merger objection settlements – one involving Activision Blizzard, Inc. and the other involving Freeport-McMoRan, Inc. — have been announced involving massive cash payments, much of it reportedly to be paid by D&O insurers. The Activision settlement may represent the largest cash settlement payment ever in a shareholder derivative lawsuit.

 

The Activision Settlement: On November 19, 2014, Activision, which is the maker of the popular videogames “Call of Duty” and “Worlds of Warcraft,” announced (here) the $275 million settlement of the shareholder derivative lawsuit that had been filed in Delaware Chancery Court. The lawsuit had been filed in connection with the transaction announced in July 2013 whereby Activision and an entity controlled by Activision‘s two senior officers acquired over 50% of Activision‘s outstanding shares from Vivendi S.A., its controlling stockholder, for approximately $8 billion in cash.

 

After the transaction was announced, several Activision shareholders filed lawsuits challenging the stock purchase. The defendants in the litigation included members of the Activision board (including six members of Activision board that had been designated by Vivendi); the senior Activision officers that were participating in the transaction and the corporate vehicles through which they were purchasing the Activision shares from Vivendi; and Vivendi itself. Among other things, the shareholders contended that the transaction should be put to a vote of the Activision shareholders.

 

The Delaware Chancery Court had put the transaction on hold pending a shareholder vote, but the Delaware Supreme Court, in an interlocutory appeal, reversed the ruling, allowing the transaction to go forward. The lawsuit, seeking damages, went foward. The November 15, 2013 Delaware Supreme Court opinion addressing the interlocutory appeal — and that describes the transaction and the lawsuit in greater detail — can be found here.

 

In its press release, Activision said that the $275 million settlement amount was to be paid to Activision itself by “multiple insurance companies, along with various defendants.”  Ashby Jones’s November 19, 2014 Wall Street Journal article describing the settlement (here) states that Vivendi is among the parties that will be contributing to the settlement payment.

 

The Activision press release also states that as part of the settlement two unaffiliated directors would be added to the company board; the plaintiffs’ attorneys would be paid their “reasonable and customary fees and costs”; and there would be an adjustment made to voting rights. The deal must be approved by Delaware Chancellor Travis Laster.

 

According to the November 19, 2014 Reuters article by Tom Hals (here), the Activision settlement is “the largest of a shareholder derivative lawsuit,” exceeding last year’s $139 million News Corp. settlement.

 

The Freeport-McMorRan Settlement: According to Liz Hoffman’s December 1, 2014 Wall Street Journal article (here), Freeport-McMoRan is nearing a settlement of more than $130 million to resolve a 2013 shareholder derivative lawsuit that had been filed in connection with the company’s  purchase of two oil-and-gas companies.

 

The settlement would resolve allegations by Freeport’s shareholders that the company overpaid when it bought McMoRan Exploration and Plains Exploration & Production companies for a combined $9 billion. The shareholders had alleged that the Freeport board had conflicts of interest while negotiating the company’s summer 2013 purchase of McMoran and Plains.

 

According to the Journal article, the shareholders alleged that the deals had been an effort by Freeport management to rescue struggling McMoRan, in which Freeport, its board members, and key executives owned shares. The shareholder plaintiffs alleged that Freeport had agreed to acquire McMoRan at too high a price as a way to bail out a struggling company. The two companies shared six directors including each company’s CEO. Nine Freeport directors owned about 6% of McMoRan stock between them. The overlap between the two companies was a relic of the companies’ past, as McMoRan had split from Freeport in the 1990s. Plains owned 31% of McMorRan and had the ability to block the sale of the company.

 

The Journal article reports that under the settlement agreement, which is subject to court approval, much of the more than $130 million to be paid in the settlement would be paid to the Freeport shareholders in the form of a special dividend. The total amount of the dividend is likely to exceed $100 million.

 

According to the Journal article, “most of the cost of the settlement would be paid for using a special type of insurance policy that covers directors and executives, according to some of the people. Freeport would pay the rest.”

 

According to a December 1, 2014 WSJ MoneyBeat blog post about the settlement (here), this type of settlement providing for a dividend payment to shareholders is the “first example” of this type of settlement payout.

 

Discussion

One of the main criticisms of the recent wave of merger objection litigation is that the lawsuits often accomplish little except the transfer of cash to the plaintiffs’ lawyers that file the suits. Indeed, until recently, settlements of shareholders’ derivative lawsuits of all kinds rarely involved the payment of significant amounts of cash. However, as I noted at the time of the $139 million News Corp. settlement (here), in more recent times there have been a number of derivative lawsuit settlements that have involved very significant cash payments.

 

These two recent settlements described above show that at least under certain circumstances, even the settlement of shareholder lawsuits involving merger objections can involve the payment of significant cash amounts.

 

The common feature of these two cases that may account for the magnitude of the cash payments seems to be the conflicts of interest that were alleged to be part of the challenged transactions. In the Activision case, two senior Activision officials allegedly were active participants in the acquisition of the company’s shares from Vivendi. In the Freeport-McMoRan case, Freeport’s acquisition of McMoRan and Plains allegedly involved the company’s supposed overpayment for companies in which senior company officials had financial interests and with which the Freeport board had overlapping memberships.

 

Another common element with respect to these two settlements is that at least according to press reports the settlements will involve significant cash contributions by D&O insurers. I have not yet been able to get my hands on the settlement documents for either of these settlements so I have been unable to determine how much of either of these settlements was to be paid by D&O insurers.

 

An interesting question about the D&O insurers’ contribution is – exactly whose D&O Insurance will be making the contribution? In the Activision case, the defendants involved included both Activision and its board but also Vivendi. The Journal article describing the settlement said that Vivendi was contributing to the settlement; it isn’t clear whether or to what extent Vivendi’s D&O insurer might be contributing. The Activision press release about the settlement didn’t say whether the insurers that were contributing were Activision’s insurers or Vivendi’s insurers (or some combination).

 

The information in the Journal about the Freeport-McMoRan settlement doesn’t say whether the D&O insurers that would be making the payment were Freeport’s or if the insurers for one of the target companies are also contributing.

 

The fact that the $275 million cash in the Activision settlement will be paid to Activision itself raises the question whether the D&O insurers’ contribution to the shareholder derivative settlement would be a Side A payment (and, if it is a Side A payment, whether Activision’s Side A/DIC insurers might have been called upon to contribute to the settlement). To the extent Vivendi’s insurers contributed to the settlement, Vivendi’s insurers’ contribution would not likely be a Side A contribution.

 

The fact that most of the settlement cash in the Freeport case will be paid to the Freeport shareholders in the form of a special dividend raises an interesting question about the role of the D&O insurance. I can see that many D&O Insurers would be very uncomfortable with the idea that one of their insured companies might want to finance a special dividend to its shareholders with the proceeds of the D&O insurance policies. Even if the dividend is to be paid in the settlement of a D&O lawsuit, the use of insurance to finance a dividend is a notion that arguably does not sit comfortably with the usual purposes and role of liability insurance. I would be very interested in others’ thoughts about this aspect of the Freeport-McMoRan settlement.

 

In any event, as I said at the time of the $139 million News Corp. settlement, shareholders derivative litigation is becoming a severity risk for companies and their directors and officers – and for their D&O insurers. The News Corp. settlement was funded entirely by D&O insurers and the Activision and Freeport McMoRan settlement were funded at least in part by D&O insurance. There was a time when the severity exposure for D&O insurers did not involved derivative litigation, but those days seem to be gone now. The rise of jumbo shareholder derivative lawsuit settlements has a number of implications. Among other things, it is a topic that will have to be taken into account as D&O insurance buyers consider how much insurance they will need to ensure that their interests are adequately protected.

delaware sealEarlier this year, after the Delaware Supreme Court upheld the facial validity of fee-shifting bylaws in the case of ATP Tour, Inc. v. Deutscher Tennis Bund (as discussed here), a legislative initiative quickly emerged to restrict the case’s holding to Delaware non-stock companies. However, the initiative proved to be controversial, and the legislative proposal was tabled until early 2015. It appears that now, while the proposed legislation remains pending, institutional investors are mounting a concerted effort in support of legislative action “to curtail the spread of so-called ‘fee-shifting’ bylaws.”

 

As detailed in Alison Frankel’s November 26, 2014 post on her On the Case Blog entitled “Big Pension Funds Mobilize Against Delaware Fee-Shifting Clauses” (here), the Council of Institutional Investors and a coalition of public pension funds have launched a letter writing campaign to Delaware politicians and other key players. For example, on November 24, 2014, the groups sent a letter to Delaware Governor Jack Markell, in support of the legislative efforts to restrict the use of fee-shifting by law. The letter notes that over 30 companies have already adopted such bylaws, and contends that the bylaws “effectively make corporate directors and officers unaccountable for serious wrongdoing.”

 

The letter urges that the Delaware General Assembly must “act promptly to restore confidence in Delaware’s credibility in developing a balanced corporate law, preserve shareholders’ access to the court system, and make clear that directors and officers cannot insulate themselves from accountability under the guise of unilateral bylaw provisions.”

 

As reflected on the Council of Institutional Investors website (here), the groups also sent letters to a number of legal groups and to investment advisory firms. As Frankel summarized in her blog post, the letters contend that fee-shifting bylaws are bad corporate governance that, in the long run, will discourage investment in Delaware corporations and undermine the legitimacy of Delaware’s courts.

 

Arrayed against the efforts of these institutional investors are the advocacy exertions of the U.S. Chamber of Commerce’s Institute for Legal Reform, which had argued that the use of proposed legislation would “only protect frivolous lawsuits” and that the use of fee-shifting bylaws “gives corporations a way to protect shareholders against these costs of abusive litigation.” A November 14, 2014 Wall Street Journal op-ed piece by the Institute’s President and presenting the Institute’s position can be found here.  

 

In their letter to the governor, the institutional investor groups contend that these arguments in support of fee-shifting bylaws are “directly contrary to the interests of investors in publicly traded Delaware corporations.” Far from protecting against frivolous litigation, the fee-shifting provisions would “effectively bar any judicial oversight of misconduct of corporate directors.” The provisions “undermine the most fundamental premise of the corporate form – that stockholders, simply by virtue of their investment, cannot be responsible for corporate debts.”

 

In conjunction with the campaign, the Kessler Topaz law firm has put together a list of the more than three dozen companies that have already adopted some form of the corporate bylaws. The list underscores the fact that while many companies are holding back awaiting the outcome of the pending Delaware legislative action, other companies have pressed ahead with bylaw changes. Frankel’s blog post quotes an attorney from the Kessler Topaz firm as saying that if the Delaware legislature or judiciary say explicitly that fee-shifting bylaws are legal for companies with public shareholders, “you’ll see a flood of these bylaws.”

 

The institutional investors are not the only ones critical of the advent of fee-shifting bylaws. In a November 24, 2014 post on the CLS Blue Sky Blog (here), Columbia Law School Professor John Coffee expresses a number of concerns about the efforts to advance the adoption of fee-shifting bylaws. First, he notes that many of the bylaws that have been adopted have been drafted “very aggressively” so as to “chill any prospect of litigation of any kind.” Coffee argues that these kinds of bylaws go “beyond a proper purpose” by “intentionally seek[ing] to discourage meritorious litigation,” which “may prove too much for Delaware, which … has little desire to ensure the extinction of intracorporate litigation.”

 

Coffee also argues that the “new theory of shareholder consent” on which the validity of the both fee-shifting and forum selection bylaws has been upheld “could lead to extreme possibilities.” Coffee argues that if the theory is valid, then company boards could adopt all sorts of provisions; Coffee invokes a parade of horribles by suggesting that if the theory is valid, boards could adopt, for example, by law provisions requiring shareholders to subscribe for additional shares or to pay the company’s costs associated with a proxy fight. In the end, Coffee contends, the theory of shareholder consent is fundamentally inconsistent with the basic notion of shareholders’ limited liability because they impose financial liability on shareholders.

 

Coffee suggests that Delaware has a number of alternatives. The state could, he suggests, provide that a “loser pays” provision could only be adopted by shareholder vote. Alternatively, he suggests, the state could place some form of ceiling on fee-shifting, or moderate the bit of the “loser pays” rule by limiting the fee-shifting to costs incurred up to the decision on the motion to dismiss. Coffee concludes by noting that the absence of any action on this issue by the SEC is telling; Coffee notes that “the SEC”s continuing passivity adds to the growing sense that it is not the agency that it once was.” UPDATE: For a presentation of a view that the SEC should not get involved in the fee-shifting bylaw issue, pleease see the October 16, 2014 post of Keith Paul Biship on his California Corporate & Securities Law blog, here.

 

There is definitely as sense in which, in the absence of any action from SEC, the action of the Delaware General Assembly alone will not put an end to this ongoing debate, regardless of what happens there. As I noted in a post discussing the adoption of a fee-shifting bylaw by recent IPO company Alibaba (here), Alibaba is a Grand Cayman company, to whom developments under Delaware law are irrelevant. In addition, legislative and judicial developments in other jurisdictions could have their own impact; as I noted in a recent post, Oklahoma’s legislature recently adopted a provision authorizing Oklahoma corporations to extend loser-pays to all shareholder suits involving board members. It is entirely possible that these kinds of developments could simply overtake legal developments in Delaware, as companies could seek to form or reconstitute themselves in jurisdictions that allow fee-shifting bylaw.

 

As I have noted in prior posts on this topic, the larger issue is whether or not these developments portend a significant revision of what is known as the American Rule, whereby it has been the practice in this country that each litigation party will bear its own costs. As companies increasingly seek to introduce their own form of litigation reform through revision of their own bylaws, and as courts and legislatures evolve their response to these kinds of bylaw provisions, there is a possibility that these developments could work a major change to the traditional American Rule on attorneys’ fees. Which in turn could have a significant impact on the corporate litigation environment.

tescoAfter U.K.-based Tesco PLC’s announcements of accounting “irregularities” and the subsequent departure of the company’s Board chair, investor lawsuits soon followed. But as discussed here, these lawsuits were filed in the United States, on behalf of investors who had purchased American Depositary Receipts in the United States. In light of the U.S. Supreme Court’s holding in Morrison v, National Australia Bank – which held that the U.S. securities laws do not apply to securities transactions that take place outside the U.S. – the class of investors on whose behalf the U.S. lawsuits were filed did not include investors who had purchased Tesco shares on London Stock Exchange.

 

The fact that investors who purchased their Tesco shares on the LSE are closed out of the U.S. litigation raised the question of what these investors could do to seek redress. (Indeed, I received emails from several of these investors who were wondering what they could do after they had learned they could not be a part of the U.S. lawsuits.)

 

It was in this context that on November 25, 2014, a London-based law firm announced that it is preparing to file a separate legal action in the U.K. against Tesco. The law firm’s press release can be found here. A post of Tristan Hall of the Sedgwick law firm on the firm’s Insurance Law Blog discussing the lawsuit announcement can be found here.

 

The law firm’s lawsuit press release states that the prospective U.K. lawsuit on behalf of Tesco investors “relates to compensation for shareholders who suffered a loss as a result of the overstatements of profit recently revealed by Tesco.” The claim will allege that “directors and senior management knew or were reckless as to whether Tesco’s statements to the market were untrue or misleading and/or dishonestly concealed the true position, in breach of the Financial Services and Markets Act.”

 

The law firm’s press release quotes one of the firm’s partners as saying that “We expect to issue proceedings against Tesco in the High Court in London within 6 months. We do not intend to await the outcome of the SFO investigation which may take some years.”

 

There are a number of interesting things about the law firm’s announcement of this prospective law suit. The first is that the law firm that made the announcement is already presently involved in the pending group action brought by investors against RBS and certain of its directors and officers (about which refer here). Indeed, the law firm’s own press release states that the firm is “currently acting for over 300 institutional shareholders in the multi-billion pound RBS Rights Issue litigation.” The suggestion is that at least one law firm is committed to exploring the existing U.K. law and attempting to establish that the law supports the rights of aggrieved investors to seek to recover damages for investment losses based on alleged misrepresentations.

 

The second interesting thing about the law firm’s press release is that it includes the disclosure that the initiative to pursue litigation in the U.K. against Tesco is being financed by a litigation funding firm, Bentham Ventures B.V. Indeed, the funding firm itself published its own press release about the lawsuit, which can be found here. According to the funding firm’s press release and associated documents, Bentham Ventures B.V. is a Netherlands-based joint venture company involving Australia-based IMF Bentham Ltd and subsidiary entities of funds managed by Elliot Management Corporation, a US based advisory firm. The press release states that the funding firm has “agreed to fund legal action on behalf of shareholders.”

 

The press release also notes that ”in order for the claim to proceed a sufficient number of shareholders will need to join the action.” The funding firm describes those eligible to participate as “”those who acquired at least 10,000 Tesco shares during the period 17 April 2013 to 22 October 2014 (inclusive) and who had not sold all of those shares prior to the market announcements made by Tesco on 29 August, 22 September or 23 October 2014.” In addition, information on the funding firm’s website states that the funding firm will only fund proceedings on behalf of those investors that enter into the a Tesco Funding Agreement, Stewarts Retainer Agreement and Litigation Funding Agreement Guarantee before the cut-off date of Friday 23 January 2015. The referenced documents are described in an FAQ page on the funding firms website.

 

The funding firm’s involvement is interesting. It shows how the increasing involvement of litigation funding (in the U.K. and elsewhere) is supporting efforts to develop litigation remedies. While there are going to many differences between the UK litigation and the parallel U.S. litigation (for example, the U.K. litigation will not involved a class action procedure and will proceed on the U.K. “loser pays” model), the U.K. litigation does represent a development to try to afford investors outside the U.S. access to remedies of the type available to U.S. investors.

 

Whether or not the remedies will be viable for U.K. investors remains to be seen. As the Sedgwick law firm’s blog post notes, the existing RBS litigation is based on Section 90 of the Financial Services and Markets Act 2000. It seems likely, the blog post notes, that the Tesco claim will also proceed under Section 90 of the SFMA, which covers misstatements or omissions in an issuer’s periodic financial disclosures or in information published in the market by means of a recognized information service. (Indeed, the funding firm’s overview of the prospective claim, here, expressly references Section 90.) The existing RBS case and the projected Tesco case represent the first attempts to test the remedies afforded to investors by the FMSA.

 

As the blog post notes, the outcome of the RBS and Tesco cases will be of significant interest to UK publicly traded companies, their directors and their D&O insurers, as they cases represent significant efforts to determine the viability of the remedies available under Section 90. If one or both of these two lawsuits succeed, other investors in other cases may be encouraged to try to pursue their own claims for redress.

 

It is significant that these efforts to test the viability of these statutory remedies are being financed by the litigation funding firms. The involvement of the funding firm in these cases underscores how the growth of litigation funding is shaping and driving legal developments, in the U.K. and elsewhere. To the extent the RBS and the Tesco cases succeed, they could encourage future litigation funding opportunities for the firms that financed these litigation efforts (and for the funding firms’ own investors as well).

 

As interesting as is the prospective Tesco litigation in the UK courts, the role of the investment funding firm arguably is even more interesting. The growing involvement of and importance of litigation funding in corporate and securities litigation is one of those behind-the-scenes that has great potential significance for future developments in the corporate and securities litigation arena.

 

D&O Diary Named to American Bar Association Journal’s List of Top 100 Law Blogs: I am pleased to report that once again The D&O Diary has been voted onto the American Bar Association Journal’s list of the top 100 law blogs, as detailed here. I am very honored to be included on this list once again as the list includes many of the blogs that I regularly follow. It is quite privilege to be included in the same list as all of the other fine blogs.

Now that the 2014 top law blawg list has been decided, what comes next is the voting for the best in category. The D&O Diary is contending for the title of best in the Niche blog category (for some reason the ABA Journal’s editors seem to think that D&O liability and insurance is niche topic). I would be grateful for any readers who would be willing to take the time to vote for my blog as the best of the Niche category. Best in category voting ends at the close of business on December 19, 2014. TO vote, please refer here.

 

Thanks to everyone who already voted for my blog to be included in the ABA Top 100 Blawg list for 2014. Congrats to all of the 2014 honorees.  

 

fdicThe banking industry had a “positive quarter” in the third quarter of 2014, according to the FDIC”s latest Quarterly Banking Profile. Banks continue to improve and are performing  better than during the same period a year ago. In the aggregate during the quarter, banks reported income growth based on growing revenue rather than just lower loan-loss provisions. However, the challenges of operating in a low interest rate environment continue. And even six years after the height of the financial crisis a significant number of problem institutions remain. The FDIC’s Quarterly Banking Profile for the third quarter of 2014 can be found here. The FDIC’s November 25, 2014 press release about the publication can be found here.

 

According to the FDIC, almost two thirds of all reporting institutions reported year-over-year growth in quarterly earnings during the third quarter. The proportion of banks that were unprofitable during the quarter fell to 6.4 percent from 8.7 percent a year earlier. In the aggregate, total loan balances increased and noninterest income was higher. Asset quality indicators also continued to improve as banks charged off $2.4 billion less from a year earlier and as noncurrent loans flee by 5.3 percent during the quarter.

 

The FDIC’s Chairman is quoted in the agency’s press release as saying that despite the continued improvement there are “challenges ahead.” Among other things, margins remain under pressure due to the low interest rate environment, which in turn is motivating institutions to extend asset maturities, creating vulnerabilities due to interest rate risk. Many banks, the Chairman also noted, are “increasing higher-risk loans to commercial borrowers.” All of these concerns, the Chairman noted, are “matters of ongoing supervisory attention.”

 

In addition, despite the positive news and the passage of six full years since the peak of the financial crisis, a significant number of problem institutions remain. According to the latest report, there are still 329 “problem institutions” on the agency’s list. (A “problem institution” is a bank that the FDIC ranks as a 4 or a 5 on its scale of financial stability. The agency does not release the names of the banks its regards as problem institutions.)

 

To be sure, the number of problem institutions has continued to decline. The third quarter of 2014, when the number of problem banks decreased to 329 from 354 at the end of the year’s second quarter (a decline of 7%), represents the 14th consecutive quarter that the number and assets of problem institutions has declined. The number of problem banks is now 63 percent below the post-crisis high of 888 at the end of the first quarter of 2011 and the number of problem banks at the end of the third quarter of 2014 is the lowest number of problem institutions since the end of the third quarter of 2009, when there were 305.

 

However, it is important to keep in mind that the number of banks overall is also declining, as banks fail or merge out of existence and as few new banks emerge. As recently as the end of 2007, there were 8,534 institutions reporting to the FDIC. At the end of the third quarter 2014, the number of reporting institutions was down to 6,589, representing a decline of over 1,945 (a decline of over 22%). While the banking sectors as a whole is improving, the number of problem institutions isn’t necessarily decreasing because the problem banks are getting better; in many cases, the problem banks simply no longer exist due to closures or mergers.

 

So, while the absolute number of problem institutions is down, because the overall number of reporting institutions is also declining, the percentage of problem banks remains surprisingly high given that we are now six full years past the peak of the financial crisis. As of the end of the third quarter, fully 5% of all banks continue to be ranked as “problem institutions.”

 

And indeed while the number of bank failures also continues to decline, banks are continuing to fail. The quarterly banking profile notes that there were only two bank failures during the third quarter, three others have failed so far during the fourth quarter, and 17 total have failed so far this year (albeit only five so far during the year’s second half). To be sure, the industry is on track for fewer bank failures this year than last year (when there were 24) – yet the problem institutions persist as do the bank failures, even as the number of failures continues to decline.

 

Though the number of bank failures is indeed declining, as the bank closures continue to come in, the period during which the FDIC will continue to be filing new failed bank lawsuits will also extend out into the future. As of the latest report on the agency’s website, the agency has already filed a total of 102 failed bank lawsuits, with 18 filed this year alone (although none since September). The agency’s website notes that it has authorized lawsuits in connection with 146 failed banks, suggesting that there are many more lawsuits yet to be filed. As the banks continue to fail, the number of authorized and filed lawsuits seems likely to continue to increase for some time to come.

 

The quarterly banking profile contains a wealth in interesting information. Among other things, the report details the distribution of U.S. banking institutions by size. Interesting, it turns out that 89.6 of all U.S. banks have assets less than $1 billion. Only 113 banks, representing 1.7 percent of all institutions, have assets greater than $10 billion. The problem of “too big to fail” is a serious issue, but there may also be problems in our banking industry owing to the sheer number of banks, particularly small banks. (For my prior discussion of a possible “too small to succeed” issue, refer here.)

Richard Bortnick (2)The derivative lawsuit filed against the board of Wyndham Worldwide Corporation in connection with the series of cyber breaches the company had experienced was being closely watched as possibly representative of a potential new area liability exposure for corporate directors and officers. However, as I discussed in a prior post (here), on October 20, 2014, the Court granted the defendants’ motion to dismiss the complaint.

 

In the following guest post, Rick Bortnick of the Traub Lieberman law firm takes a look at the court’s dismissal of the Wyndham Worldwide derivative suit. This post previously appeared on the CyberInquirer blog (here). I would like to thank Rick for his willingness to publish his post on this site. I welcome guest post contributions from responsible authors on topics of interest to this blog’s readers. If you think you would like to submit a guest post, please contact me directly. Here is RIck’s guest post.

 

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

 

In the first of what is certain to become a cottage industry of derivative lawsuits involving alleged inadequate cybersecurity and deficient public disclosures, on October 20, 2014, a New Jersey federal court granted a motion to dismiss filed by Wyndham Worldwide Corporation’s directors and officers based on its finding that Wyndham’s Board has duly considered and dismissed the plaintiff’s demand that the company sue its directors and officers.  Palkon v. Holmes, et al, Case 2:14-cv-01234-SRC-CLW.

 

In Palkon, plaintiff presented the demand following a series of three security breaches through which hackers obtained personal information of over 600,000 Wyndham customers. (This is the same series of events that gave rise to the well-known lawsuit where Wyndham is challenging the FTC’s jurisdiction).

 

Wyndham’s Board met to discuss plaintiff’s demand as well as the status of the FTC action. At that time, the Board voted unanimously not to pursue a fiduciary duty lawsuit and thereby rejected plaintiff’s demand.

 

Plaintiff thereafter sued, alleging that the security breaches, together with the Board’s and management’s inadequate handling, damaged Wyndham’s reputation and cost it significant fees.

 

In moving to dismiss, defendants relied on the business judgment rule. They also asserted that plaintiff had failed to state a claim and that the damages alleged were speculative in any event.

 

Ruling on Delaware law, the court granted Wyndham’s motion, finding that plaintiff had failed to meet his burden of rebutting the business judgment rule. In other words, plaintiff was unable to raise a reasonable doubt as to whether Wyndham’s D&Os had acted (1) in good faith, or (2) based on a reasonable investigation.

 

In so doing, the court identified the following facts as relevant to its determination that Wyndham’s D&Os’ investigation had been reasonable:

 

The Board discussed cyber-related issues, including the company’s security policies and proposed enhancements, at fourteen meetings between October 2008 and August 2012 (the breaches occurred between April 2008 and January 2010):

 

  • The Board’s Audit Committee reviewed the same matters in at least sixteen meetings during the relevant period;
  • During its series of ongoing meetings, Wyndham’s Board addressed and affirmed the implementation of recommendations from the company’s retained technology firms;
  • Wyndham’s Board was well-versed in the substance of both the FTC litigation and plaintiff’s demand;
  • There was “ample information” that that Board had at its disposal when it rejected plaintiff’s demand; and
  • The Board already had investigated the issues presented by plaintiff’s demand, as his attorney himself had presented an identical demand which had been rejected for the same reasons.

 

From the inside looking out, there is nothing special or unique about Palkon. It affirms the business judgment rule’s presumption of propriety and enumerates the types of facts that one court found relevant as to whether an internal investigation was reasonable.

 

From the outside looking in, however, the decision sets precedent as to the types of activities of which a Board should be mindful when evaluating and implementing information governance and cybersecurity regimes as well as in responding to a cyber breach (including through public disclosures). We regularly hear from clients asking about pre-breach avoidance strategies. Now there is court guidance ratifying the value of a proactive approach in the context of a derivative litigation.

 

As we’ve said before, you can pay now or pay more later And as should now be self-evident, whether or not you’re the director or officer of a private company or a public company, it will be far more costly to postpone and/or delay the employment of a robust cybersecurity regime. There no longer is an excuse for waiting. Unless, of course, you like to pay lawyers and other vendors more to be reactive as opposed to what it would have cost had management been proactive.

 

 

cornerstone reserach pdfBecause securities class action lawsuits under Section 10 of the Securities Exchange Act of 1934 and Rule 10b-5 so rarely go to trial (a topic I addressed in a recent post, here), questions about how damages are calculated are not often addressed directly. Section 28(a) of the ’34 Act specifies that no plaintiff shall “recover … a total amount in excess of [that person’s] actual damages.” However, the statute does not define “actual damages” and courts have adopted a variety of approaches to the question.

 

A November 19, 2014 paper published by Cornerstone Research and the Goodwin Proctor law firm entitled “Limiting Rule 10b-5 Damages Claims” (here) takes a look at the way that courts have addressed this issue. As discussed in the paper, the beginning point for analysis of the damages issues is the amount of “inflation” – that is, the difference between the defendant company’s actual stock price and what the price would have been absent the alleged fraud. The authors note that the administrative processes following a settlement, or more rarely, a verdict, involve several adjustments. These adjustments can reduce individual class members’ claims as well as plaintiffs’ estimates of classwide damages. However, the authors found, there are inconsistencies in the ways that courts apply these adjustments.

 

The authors suggest that the aggregate effect of these adjustments “can be quite large and may often be underestimated or overlooked by defendants.”  The authors contend that these adjustments can be inform defense strategies in settlement negotiations and could be influential on prospective settlement opt-outs on their decision whether or not to participate in class settlements.

 

In order to analyze these issues, the authors reviewed the plans of allocation reflected in publicly available settlement claims forms and notices for sixty-five Rule 10b-5 class action settlements occurring during 2012 and 2013. They also review the verdicts in the Vivendi and Household Financial cases, both of which cases resulted in jury trial verdicts. The authors also drew upon their own experience in the post-judgment proceedings in the Apollo Group securities litigation.

 

Based on this analysis, the authors identified three approaches to adjusting damages:

 

1. Offsetting recognized losses with gains from price inflation caused by the alleged fraud. (Inflation Gains Offset)

2.  Adjusting recognized losses with nominal gains. (Nominal Gains Offset)

3. Limited per-share recognized losses to nominal losses. (Nominal Loss Cap)

 

The starting point of the authors’ analysis is the recognition that an investor suffers a loss if he or she purchases a share at an inflated price and then later sells the share after a corrective disclosure eliminates the share price inflation. Say, for example, the investor purchases a share at a price of $27 with a $7 price inflation, and then after the corrective disclosure sells the share for $20, realizing a $7 dollar loss.

 

The authors suggest that this calculation should be adjusted to take other possible factors into account.

 

First, the investor’s losses on the sale of the share should be offset by any gains the investor realized as a result of the share inflation. Say, for example, the same investor purchased a share prior to the class period at $20 and then sold it during the class period at the price of $27 (reflecting the increased price due to the inflation.). The authors argue that the investor’s $7 loss on the post disclosure sale should be offset by the investor’s $7 gain during the class period, resulting in a conclusion that the investor suffered $0 in losses.

 

The authors contend that it is “economically rational” to subtract the gains from inflation from losses from inflation in calculating the harm to an investor. The authors found that the courts in the Household Finance case recognized the need to offset losses from gains from inflation. However, they also noted that “this seemingly well-recognized legal principle does not, however, explicitly appear in any of the sixty-five settlements the authors reviewed.” This offset can be calculated only when an individual investors’ purchase and sale information are available, as would usually be the case in opt-out litigation or sometimes for lead plaintiffs.

 

The gains from inflation cannot always be calculated accurately when performing plaintiff-style aggregate damages calculation. What can be calculated using publicly available information is the maximum adjustment to a plaintiff-style aggregate damages calculation. The “bank “of these available offsets is “often substantial and perhaps underestimated in the settlement negotiations.” The “economic logic and legal basis for this adjustment is strong and provides an argument for defendants negotiating smaller settlements.”

 

Second, the authors contend that recognized losses should be offset with nominal gains. In this example, the investor that experienced the $7 post disclosure loss also purchased a share during the class period at $27 dollars a share, reflecting the $7 price inflation, and sold the share during the class period at $28 per share, also reflecting the $7 per share price inflation. The authors contend the investors $1 gain on the class period transaction should be offset against the $7 loss, resulting in a net loss of $6. The authors note that a nominal gain offset was not mentioned in either the Household Finance or Vivendi verdicts, perhaps, the authors note, because “a nominal gains offset is likely to be smaller than a gain from inflation offset.”

 

The authors note that the while the nominal gains offset can be calculated when an investor’s trading data are available (for example with opt-outs or named plaintiffs), the adjustment cannot be determined reliably for the class using plaintiff-style aggregate damages models. The authors contend, however, that nominal gains from shares purchased during the class period are able to be offset against losses from inflation. While the nominal gains will not exceed losses from inflation, calculating the maximum reduction in damages due to nominal gains can “still be helpful for settlement discussion purposes.”

 

Third, the authors also contend that per-share recognized losses should be limited to nominal losses. This calculation takes in to account the PLSRA’s 90 day look-back period, which limits a plaintiff’s damages to the difference between the purchase price and the mean trading price of the security during the 90 days following a corrective disclosure. In this example, if the investor purchased a share with a $7 price inflation during the class period at $27 and sold the share after the corrective disclosure at $25, the damages are only $2, not $7. The 90-day rule creates what the authors call a “nominal loss cap.”

 

The nominal loss cap can be applied with respect to investors, such as opt-out claimants and named plaintiffs, where trading data are available. The authors also contend that “an estimate of the effect of nominal loss caps can and should also be applied to plaintiff-style damages estimates.”

 

The authors contend that all three of these adjustments can and should be applied in settlement negotiations to estimate recognized losses. The authors contend that the incorporation of these types of adjustments into class settlement could influence prospective opt-outs decision whether or not to remain in the settlement class.

 

In my view, the authors’ analysis should be of interest not only to defendants engaged in settlement negotiations, but also to the D&O Insurers whose financial interests could be affected by the negotiations. In the press release accompanying the report’s release, Dan Tyukody of the Goodwin Proctor law firm is quoted as saying “Besides lawyers and judges, these findings should definitely be of considerable interest to the insurance industry” – a statement that is clearly correct. I think that D&O insurers’ claims managers will want to review this report closely, to understand the authors’ analysis and to consider how this analysis could be incorporated into securities lawsuit settlement negotiations. The authors’ analysis clearly seems to suggest settlement negotiations approaches that could be used to argue for lower settlements reflecting the kinds of damages adjustments the report details.

 

Special thanks to Katie Galley of Cornerstone Research for sending me a copy of this report.

longtopAs noted in a post yesterday, last Friday a federal jury held Derek Palaschuk, the former CFO of Longtop Financial, liable for the company’s financial misrepresentations. On Monday, the jury deliberated further on the percentage of investors’ damages for which Palaschuk is responsible. According to Nate Raymond’s Nov ember 24, 2014 Reuters article (here) the jury held the CFO responsible for only one percent of the investors’ damages. The jury assigned 49 percent of the responsibility to Longtop itself and 50 percent to the company’s former CEO, Wai Chau Lin. Max Stendahl’s November 24, 2014 Law 360 article about the jury’s division of responsibility for investors’ damages can be found here.

 

The jury did not determine the dollar value of Palaschuk’s one percent responsibility. The plaintiffs’ lawyer in the case is quoted in the press coverage as saying that the value of the jury’s 1% responsibility finding against Palaschuk has a value of somewhere between $5 million and $8.82, although the way the plaintiffs’ lawyers came up with this figure is by applying the percentage against the amount of the default judgment that Southern District of New York Judge Shira Scheindlin previously entered against the company and the CEO (as discussed here).

 

It should be noted that the damages amount in the default judgment was based solely on an uncontested proffer by plaintiffs’ counsel in connection with the plaintiffs’ motion for default judgment against defendants that failed to appear and defend. The Reuters article quotes Palaschuk’s counsel as saying that the plaintiffs’ counsel’s estimate of the dollar figure that the one percent responsibility allocation represents as “pie-in-the-sky.” The exact dollar value of one percent damages calculation is subject to further proceedings.

 

However, the Reuters article does also note that on Monday the jury did find that Longtop’s american depositary shares were inflated due to the securities law violations from Feb. 10, 2010 to May 17, 2011, by $11.89 to $19.51 per share. The Reuters article also reports that Palaschuk’s lawyers plan to ask a judge to set the verdict aside.

 

D&O Diary Named to American Bar Association Journal’s List of Top 100 Law Blogs: I am pleased to report that once again The D&O Diary has been voted onto the American Bar Association Journal’s list of the top 100 law blogs, as detailed here. I am very honored to be included on this list once again as the list includes many of the blogs that I regularly  follow. It is quite privilege to be included in the same list as all of the other fine blogs.

 

Now that the 2014 top law blawg list has been decided, what comes next is the voting for the best in category. The D&O Diary is contending for the title of best in the Niche blog category (for some reason the ABA Journal’s editors seem to think that D&O liability and insurance is niche topic). I would be grateful for any readers who would be willing to take the time to vote for my blog as the best of the Niche category. Thanks to everyone who already voted for my blog to be included in the ABA Top 100 Blawg list for 2014. Congrats to all of the 2014 nominees.

 

longtopOn November 21, 2014, after a securities class action trial that lasted less than three days and after less than a day of deliberation, an eight-person jury entered a verdict holding former Longtop Financial Technologies CFO Derek Palaschuk liable for the company’s alleged misrepresentations about its financial condition. According to Nate Raymond’s November 21, 2014 Reuters article about the verdict (here), the jury will return on Monday, November 24, 2014 to determine the damages to be awarded to investors. Max Stendahl’s November 21, 2014 Law 360 article about the verdict can be found here (subscription required).

 

As detailed below, trials in securities class action lawsuits are extremely rare – there has not been a trial in a securities class action lawsuit to reach a verdict since 2011. As also discussed below, there were a number of other unusual features about this case, including both the brevity of the trial and the dearth of witness testimony and other evidence.

 

Background

During the period 2010 to 2012, plaintiffs’ lawyers rushed to file a wave of securities suits against U.S.-listed Chinese companies, including against the Xiamen, China-based Longtop Financial (as detailed here). Unlike many of U.S.-listed Chinese companies caught up in the wave of securities litigation, Longtop Financial did not obtain its U.S. listing through a reverse merger, but instead it became a public company through a conventional IPO in 2007. Its shares traded on the NYSE. At one point, its market capitalization exceeded $1 billion.

 

Questions began to dog the company after Citron Research published an April 26, 2011 online report critical of the company. Among other things, the report questioned the company’s “unconventional staffing model,” alleged prior undisclosed “misdeeds” involving management, and referenced “non-transparent” stock transactions involving the company’s chairman, among other things. Other critical research coverage followed.

 

Longtop’s problems took another turn for the worse in May 2011 when, in advance of the high profile IPO of Chinese social networking company, Renren Network, Longtop’s CFO, who sat on Renren’s board as chair of the audit committee, resigned from the Renren Network board to prevent the questions at Longtop from affecting Renren’s IPO.

 

Then on May 23, 2011, in a filing with the SEC on Form 6-K, the company announced that both its CFO and its outside auditor, Deloitte Touche Tomatsu (DTT) had resigned. In its accompanying press release (here), the company said that DTT stated in its May 22, 2011 letter of resignation that it was resigning as a result of, among other things,

 

(1) the recently identified falsity of the Company’s financial records in relation to cash at bank and loan balances (and possibly in sales revenue); (2) the deliberate interference by certain members of Longtop management in DTT’s audit process; and (3) the unlawful detention of DTT’s audit files.

 

DTT further stated that it was “no longer able to rely on management’s representation’s in relation to prior period financial reports, and that continued reliance should no longer be place on DTT’s audit reports on the previous financial statements.” 

 

A copy of Palaschuk’s terse May 19, 2011 resignation letter can be found here.

 

Securities class action lawsuits followed. The actions were consolidated before Judge Shira Scheindlin in the Southern District of New York. The defendants in the lawsuits included the company, certain of its directors and officers and Deloitte Touche Tohmatsu. The plaintiffs alleged that the company had falsified its financial results by exaggerating revenues, underreporting bank loan balances, and transferring employee expenses to an off-balance sheet entity.  

 

In April 2013, Judge Scheindlin dismissed the claims against the audit firm. As discussed in detail here, on November 14, 2013, Judge Scheindlin entered a default judgment order including a damages award of $882.3 million against the company and its former CEO, Wai Chau Lin.

 

Following the dismissal of the auditor and the entry of default judgment against the company and the CEO, the sole remaining defendant left in the case was Palaschuk, the former CFO, whom the plaintiffs were able to serve in Canada in 2012 and who filed a motion to dismiss the plaintiffs’ claims against him. In a June 29, 2012 opinion (here), Judge Scheindlin, though acknowledging that the online research reports may well have been biased owing to the online analysts’ financial interests as short sellers of Longtop’s stock, denied Palaschuk’s motion. Among other things, she found that the plaintiffs had sufficiently alleged that in various company press release and financial filings, Palaschuk had made misleading statements about the company’s financial condition and the basis for its growth.

 

According to Nate Raymond’s Reuters article, in a July hearing, Palaschuk told the Court that he saw no reason “to have my insurance company pay for something where I wasn’t reckless.”

 

The Trial  

Trial in the plaintiffs’ case against Palaschuk commenced on Wednesday, November 19, 2014. The entire trial took less than three days, as investors were unable to call witnesses in China. Palaschuk himself was the only fact witness.

 

Palaschuk reportedly testified that in a May 2011 telephone conversation Lin, the company’s former CEO, had confessed to fraud, but that prior to that phone call, he (Palaschuk) didn’t know about the supposed false accounting. He claimed in his trial testimony that he acted in good faith and took steps to investigate the factual allegations as they arose.

 

According to the Law 360 article, the plaintiffs counsel argued in her closing argument that Palaschuk had repeatedly ignored warning signs of a “culture of fraud” at Longtop. The red flags included fake contracts and reports by outside analysts claiming the company’s revenues were too good to be true. The article quotes counsel as having argued that “when confronted with these warning signs – with these warning signs that begged for investigation – defendant Palaschuk failed to adequately respond. The lack of action the defendants took to find the truth is truly mind-boggling.”

 

The case went to the jury on Friday, November 21, 2014, and later that same day the jury entered a liability verdict in favor the plaintiffs and against Palaschuk. Damages in the case will be determined in separate proceedings that will begin on Monday, November 24, 2014.

 

Discussion 

As I noted at the outset, trial in securities class action lawsuits are extremely rare. According to information compiled by Adam Savett, Director, Class Action Services, Kurtzman Carson Consultants (KCC), LLC, including the trial against Palaschuk, there have been only 24 securities class action lawsuits that have gone to verdict since Congress enacted the Private Securities Litigation Reform Act (PSLRA) in December 2005. There have only been 13 trials during that period involving post-PSLRA conduct.

 

To put this into perspective, according to NERA (here), between January 1, 1996 and December 31, 2013, a total of 4,226 securities class action lawsuits were filed, meaning that only about one half of one percent of all cases filed during that period went to trial.

 

Taking post-trial proceedings into account (including post-verdict appeals), 12 of the 24 cases that have resulted in a verdict have gone for the plaintiffs and 12 have gone in the defendants’ favor.

 

Those familiar with securities class action litigation know that the cases that are not dismissed or otherwise resolved on procedural grounds almost always settle. It appears that this case did not settle because Palaschuk believed he did nothing wrong. You can certainly see that Palaschuk’s might conclude that he was being targeted on a sort of last-man-standing basis. It is hard to tell how much the difficulty of accessing witness testimony and other evidence hamstrung his efforts to defend himself. But his strategy to fight rather than settle seems to have backfired.

 

Of course, the trial verdict is only one procedural phase; Palaschuk can still attempt in post-trial motions and on appeal to have the verdict overturned. For now at least his decision to fight clearly didn’t play out as he had hoped. Depending on what happens in the damages phase, his decision to fight could wind up looking even worse.

 

Among the many reasons that these kinds of cases almost always settle is that the defendants recognize that they can’t run this risk of a jury verdict that might trigger the fraud exclusion typically found in D&O insurance policies (and that are usually only triggered “after adjudication” of fraud –meaning that a jury verdict is the potential trigger). Ironically, Palaschuk’s reason for refusing to settle (at least according to the July statement cited above) is that he didn’t think his insurer should have to pay anything even though he hadn’t acted recklessly. Depending on exactly what the jury actually decided here, Palaschuk’s decision to push this case to trial could wind up depriving him of any insurance, if the jury ruled that he had acted fraudulently (rather than merely recklessly). The jury verdict form has not yet been posted to the Court’s electronic docket so there is no way to determine exactly what was decided.

 

The insurance question is not only important to Palaschuk, it is important to the plaintiffs. It is extremely unlikely that the plaintiffs will collect a single penny of the cartoonishly inflated default judgment. If the jury verdict precludes coverage for Palaschuk under Longtop’s D&O policy, the plaintiffs will be left trying to enforce collect in Canada on his personal assets on the judgment entered against him. A judgment collection effort against a foreign domiciled individual seems likely to be an unpromising and possibly unrewarding project.

 

Just the same, it will be interesting to see what happens in the damages phase of this case. Post-trial proceedings seem likely. In any event, there is little about this case or about the mixed record of class action securities lawsuit trial verdicts that would encourage other defendants to try to push the cases against them to trial.

 

UPDATE: Dan Berger of the Grant & Eisenhoffer law firm and one of the trial counsel for the plaintiff at this trial communicated the following information to me: “the default judgment was not ‘cartoonishly inflated’ but rather computed by an expert using a typical event study; and we only tried a recklessness case against Palaschuk, so the judgment we have is not for intentional fraud and in theory should not be excluded by his D&O policy.”

 

What’s Next? Crowdsourced Litigation Financing, Apparently: In prior posts on this site (most recently here), I have noted the rise of litigation financing. Given this trend, and in the age of the Internet, it was perhaps inevitable that a litigation funding website facilitating crowdsourced litigation funding would arise. In any event, whether inevitable or not, a site for crowdsourced financing is now here.

 

According to its November 19, 2014 press release (here), a new venture called LexShares has launched “an online marketplace for investing in litigation.” The company’s website can be found here. According to the press release, the company’s online platform “connects accredited investors with plaintiffs in commercial lawsuits in order to make an equity investment in a specific case.” If the plaintiff wins, the investor will received a portion of the proceeds commensurate with the investor’s investment. If the plaintiff loses, the investors lose their investment.

 

According the press release, all legal claims investment opportunities to be posted on the LexShares website are “reviewed by its legal and securities professionals” and are to be offered to investors through a registered broker-dealer. Plaintiffs seeking to have their cases funded through the website must apply to have their cases posted on the site. Once the cases are posted, investors (who must have established their credentials as accredited investors) can review the case and decide if they want to invest. Investors who choose to invest can track the case on the site. The press release states that LexShares has already funded a case with a claim value of more than $40 million and currently has multiple other legal claim investment opportunities available for investment.

 

The press release quotes University of Minnesota Richard Painter as saying that “Litigation funding is maturing. The next logical step is using a technology platform like LexShares to broaden access to this asset class and equalize access to the legal system.”

 

A November 20, 2014 Bloomberg article about LexSource can be found here. A November 19, 2014 TechCrunch article about the site can be found here.