texasThe U.S. Supreme Court’s July 2010 decision in Morrison v. National Australia Bank seemed to sound the death knell for so-called “f-cubed” litigation – that is, lawsuits brought in U.S. courts under the U.S. securities laws by foreign investors who bought their shares in a foreign company on a foreign exchange. However, in an interesting development in the massive securities litigation filed against BP in the wake of the Deepwater Horison disaster, a federal judge has ruled that the lawsuit alleging brought against BP and related BP entities by foreign investors who purchased their BP shares on the London Stock Exchange can proceed in U.S. court — even though the plaintiffs are asserting claims based on English law.

 

A number of factors in the court’s decision are unique to the circumstances surrounding the Deepwater Horizon disaster. Nevertheless, the case does represent a significant instance where foreign claimants whose U.S. securities laws claims were precluded by Morrison have found a way to be able to pursue claims in U.S. courts on an alternative theory. More to the point, the ruling does present an example where “f-cubed” investors have been able to pursue their claims in U.S. courts, notwithstanding Morrison. A copy of Southern District of Texas Judge Keith P. Ellison’s September 30, 2014 memorandum and order can be found here.

 

Background 

Following the April 20, 2010 Deepwater Horizon oil spill, BP shareholders filed a number of lawsuits against the company and certain of its affiliates and officials seeking to recover for their financial losses. Among these lawsuits was a securities class action lawsuit filed under U.S. securities laws. Many of the allegations in the securities class action lawsuit survived the motion to dismiss; however, as discussed here, in February 2012, Judge  Ellison, in reliance on the U.S. Supreme Court’s decisions in Morrison, granted the defendants’ motion to dismiss the claims of putative class members who had purchased BP common shares on the London Stock Exchange (LSE).

 

Many of the investors who purchased their shares on the LSE then filed individual actions in the Southern District of Texas against the defendants, asserting claims not under the U.S. securities laws, but rather under English common law. In simple terms, Judge Ellison divided these individual investor claims into what he called “tranches.” The first tranche of claims involved lawsuits filed by U.S. domiciled investors who had purchased their BP shares on the LSE. The second tranche of claims involved lawsuits filed by foreign investors who had purchased their BP shares on the LSE. The defendants moved to dismiss these individual lawsuits.

 

Judge Ellison first dealt with the defendants’ motion to dismiss the first tranche investors’ claims. As discussed here, on September 30, 2013, Judge Ellison denied the defendants’ motion to dismiss. He held that even though English law governs the first tranche claimants’ common law and statutory claims, he could not conclude that an English court is a more appropriate forum for the claims.

 

Judge Ellison then turned to the defendants’ motion to dismiss the second tranche investors’ claims – that is, the claims asserted by foreign investors who purchased their shares in BP on the LSE. The motion to dismiss required Judge Ellison to consider whether or not the fact the investor claimants were domiciled outside the U.S. changed his analysis in denying the motion to dismiss the first tranche investors’ claims. He concluded that it did not.

 

The September 30, 2014 Ruling

In his September 30, 2014 opinion, Judge Ellison did grant the defendants’ motion to dismiss as to certain of the allegedly misleading statements and as to certain of the individual defendants, but otherwise the motion to dismiss was denied. In particular Judge Ellison declined to exercise his discretion to dismiss the foreign investors’ English law claims on the grounds of foreign non conveniens.

 

In denying the defendants’ motion to dismiss on the ground of forum non conveniens, Judge Ellison held that while a foreign plaintiffs’ choice of forum ordinarily is entitled to less deference than that of a domestic plaintiff, “this forum” – that is, Judge Ellison’s court – “is where these types of claims – claims with a distinctively American bent — have been brought and are being litigated against the Defendants.” He added that “the Court is unaware of any other forum where similar claims have been initiated.” He concluded that “given the legitimate connection between the English law claims of foreign plaintiffs and this MDL, the Court affords the foreign plaintiffs substantially the same level of deference previously accorded to the domestic plaintiffs in the first tranche.”

 

In weighing the plaintiffs’ choice of forum against the public and private interests, he noted that very few factors he had considered with respect to the domestic plaintiffs “change in the context of foreign plaintiffs,” adding that “those that do are not significant enough to disturb the Court’s previous decision” (that is, with respect to the domestic plaintiffs). Among other things, he noted that given his ruling in the domestic plaintiffs’ claims, he is already going to be called upon to preside over claims in the case under English law. In closing, he noted that:

 

The Court expects that dismissal of foreign plaintiffs’ claims will appreciably and immediately relieve congestion on its docket. This factor, combined with the need to apply foreign law, is enough to tip the scale in favor of England. But the private and public interest factors must weigh heavily in favor of England to disrupt the foreign plaintiffs’ choice of forum. Because it does not, the Court once again declines to dismiss English law, securities fraud claims asserted in this MDL under the doctrine of foreign non conveniens.

 

Interestingly, Judge Ellison also denied the defendants’ motion to dismiss the claims based on SLUSA. While SLUSA might potentially require the dismissal of claims asserted under “State law,” he concluded that SLUSA did not apply to require the dismissal of plaintiffs claims based on foreign law. While he acknowledged that this outcome might be inconsistent with the spirit of SLUSA, Judge Ellison concluded that he could not apply SLUSA to these plaintiffs claims in light of the clear language of the statute applying the preclusive effect only to “State law” claims.

 

Discussion

In his prior ruling, Judge Ellison had already determined that the domestic investors English law claims could proceed in his court and would not be dismissed in preference to an English forum. In this decision, he simply extended his prior ruling to the foreign claimants’ claims. In both instances, the claimants had purchased their shares in a foreign company in a foreign country. In this ruling, he basically just held that it really didn’t make a difference to his analysis that these claimants are foreign domiciled.

 

Nevertheless, Judge Ellison’s ruling is very noteworthy because it represents a substantial instance where a set of foreign claimants whose U.S. securities laws claims were precluded under Morrison because they purchased their shares in a non-U.S. company on a foreign exchange were able to subject the non-U.S. company to a claim in U.S. courts. In other words, Judge Ellison’s ruling represents the rare instance when prospective foreign claimants have managed to side-step the implications of Morrison in order to subject a non-U.S. company to claims in a U.S. court. Indeed an October 1, 2014 Law 360 article about the case (here, subscription required) quotes counsel for certain of the foreign investors as saying that Judge Ellison’s ruling allowing the foreign investors claims to proceed “is a first-time occurrence in the wake of the Morrison decision in 2010.”

 

As I noted in discussing Judge Ellison’s denial of the defendants’ motion to dismiss the first tranche claimants’ claims (here), the plaintiffs’ success here in avoiding a dismissal on the ground of forum non conveniens is all the more noteworthy because in the separate BP Deepwater Horison shareholders’ derivate lawsuit, Judge Ellison had granted the defendants’ motion to dismiss on forum non conveniens grounds. As discussed here, in September 2011, Judge Ellison found that the balance of factors weighed in favor of the dismissal of the suit in preference for an English forum, as the derivative suit would involve considerations of the proper conduct under English law of the affairs of the board of an English company. Judge Ellison found that considerations of the internal affairs doctrine militated in favor of dismissal. As discussed here, in January 2013, the Fifth Circuit affirmed the dismissal of the BP Deepwater Horizon shareholders’ derivative lawsuit.

 

There are several factors that make it unlikely that the foreign plaintiffs’ approach here will become a playbook for other plaintiffs seeking to circumvent Morrison. There are certain factors of this case that are arguably unique. Among other things, there is a peculiarly local aspect of all of the Deepwater Horizon litigation – what Judge Ellison called referred to as the “distinctly American bent,” which, at least in Judge Ellison’s eyes, seemed to make it more reasonable for this case to go forward in his court. There is, he added, a “legitimate connection” between the foreign investors’ claims and the MDL Deepwater Horizon litigation already in his court. In the absence of these factors and connections, which are arguably unique to this situation, it seems likely that his analysis might have come out differently on the forum non conveniens analysis.

 

But while the plaintiffs’ approach here provides something less than a pattern of general applicability, Judge Ellison’s ruling nonetheless represents a noteworthy instance where foreign claimants whose federal securities law claims were barred under Morrison were still able to assert claims in a U.S. court against a non-U.S. company. It presents an occasion in which claimants may have succeeded in side-stepping Morrison in order to assert claims in a U.S. court against a non-U.S. company and is important for that reason.

 

There is one further aspect of this situation that makes this ruling noteworthy. That is, these lawsuits involve not only foreign claimants who purchased their shares in a foreign company on a foreign exchange, but they are asserting claims under foreign law. These are not only “f-cubed” claims, the foreign claims to the fourth power – yet they will still be proceeding in a U.S. court. Neither the claimant, the principal corporate defendant, the securities transaction nor the law on which the claimants are proceeding has any connection to the forum, yet because the oil spill happened nearby, the case will nonetheless go forward in Texas rather than England.

 

One final note about the fact that the foreign plaintiffs are asserting English law claims — that is the fact that the foreign claimants are relying on foreign law rather than on domestic U.S. law actually helped them keep their case in the U.S. court. If the foreign claimants had been asserting State law claims, then the claims would have been dismissed under SLUSA. Judge Ellison concluded that SLUSA does not preclude claims under foreign law, and so the foreign claimants’ claims will proceed – an ironic twist, where a factor that seemingly would make the case less likely to survive a dismissal motion actually helped to allow the case to go forward.

 

All of this underscores the fact that, as Judge Ellison’s ruling demonstrates, there are, notwithstanding Morrison, circumstances when foreign companies can still be hauled into a U.S. court to face claims by foreign investors who bought their shares in the company outside of the U.S. This is something for non-U.S. companies to note and consider as they assess their U.S. litigation risks, and it is something for their D&O underwriters to consider as they asses the risk profile of non-US. companies.  

 

floridaIn its long-awaited June 2014 decision in the Halliburton case, the U.S. Supreme Court declined to jettison the fraud on the market theory on which the presumption of reliance is based, but it did provide that defendants could attempt to rebut the presumption of reliance by showing that the alleged misrepresentation that is the basis of the plaintiffs securities claim did not impact the share price of the defendant company’s securities. Commentators have since debated what the opportunity for defendants to rebut the presumption of reliance by showing the absence of price impact will mean for securities cases.

 

While time will tell what the impact from this part of the Supreme Court’s holding in Halliburton will be, a September 29, 2014 order from the Southern District of Florida certifying a class in the Catalyst Pharmaceutical Partners securities class action lawsuit sheds some interesting light on the subject. The Court’s order can be found here.

 

Background 

On August 27, 2013, Catalyst issued a press release stating that its drug, Firdapse, which treats Lambert-Eaton Myasthenic Syndrome (LEMS), had been designated as a Breakthrough Therapy by the FDA and that there was no other effective and available treatment for LEMS. The company’s share price climbed 42% on the news. However, an article published on October 18, 2013 disclosed that another substance that had been available for years and that is nearly identical to Firdapse is an effective treatment for LEMS and is offered to LEMS patients free of charge. Following publication of the second article, the company’s share price declined 42%.

 

The plaintiffs filed a securities class action lawsuit against Catalyst and certain of its directors and officers on behalf of all investors who purchased their securities in Catalyst between August 27, 2013 and October 18, 2013. The plaintiffs filed a motion seeking class certification, which the defendants opposed, arguing among other things that the alleged misrepresentations on which the plaintiffs sought to rely did not impact the company’s share price.

 

Discussion

In her September 29, 2014 order, Southern District of Florida Judge Ursula Ungaro granted the plaintiffs’ motion for class certification with respect to the purchasers of the company’s common stock, but she denied the motion as to purchasers of the company’s other securities, as the plaintiffs had not shown that the other securities traded in an efficient market.

 

In granting the plaintiffs’ motion, Judge Ungaro held that the plaintiffs had established that they were entitled to a presumption of reliance in support of their motion for class certification, which the defendants sought to rebut by showing that the alleged misrepresentation had not impacted the share price of the company’s common stock.

 

In attempting to establish the absence of price impact, the defendants raised three arguments: (1) that the “truth” (that is, that the alternative LEMS therapy was effective and available) was already known to the public not have affected the company’s share price (the so-called “truth on the market” argument); (2) that the 42% spike in the company’s share price following the August 27, announcement was in response to the accurate announcement of Firdapse’s Breakthrough Therapy status: and the 42% decline in share price was due to bad publicity and market overreaction; (3) that expert testimony showed that the rise in the company’s share price was entirely consistent with the rise in market capitalization of other companies that have announced Breakthrough Therapy designation. Judge Ungaro rejected each of these arguments.

 

First, with respect to the defendants attempt to rely on the “truth on the market” theory, Judge Ungaro said that this argument, “stripped down, is merely an argument that the alleged misrepresentation was immaterial in light of other information in the market.” Were defendants to succeed with the truth-on-the-market defense, it would “defeat materiality as to every putative class member and would thus end this controversy in its entirety” and therefore, she said, citing to the U.S. Supreme Court’s 2013 decision in the Amgen case (about which refer here), “for purposes of determining at this early stage in litigation whether the alleged misrepresentation had any impact on the price of Catalyst stock, the Court must disregard the evidence that the truth was known the public.” That issue, she said, is a matter for trial or for summary judgment.  

 

Second, with respect to the defendants’ argument that aspects of the August 27, 2013 and October 18, 2013 disclosures other than the alleged misrepresentation accounted for the spike and decline in the company’s share price, Judge Ungaro basically said that even if the other aspects of the disclosures were “substantially more important” than the alleged misrepresentation that there existed no effective and available treatment for LEMS, it does not follow that the misrepresentation did not account for any of the change in the share price. The defendants, she said, have not shown that the disclosure of the other therapy as an effective and available alternative “had no impact on the price of Catalyst stock.”

 

Third, with respect to the expert testimony that the rise in the company’s share price following the announcement that Firdapse had been given the Breatkthrough Therapy designation is consistent with the rise in share price of other company’s announcing the Breakthrough Therapy designation, she said that the mere fact that the price movement was consistent with the price movement of other company’s does not show that the alleged misrepresentation did not contribute at all to the 42% spike in the company’s share price.

 

Discussion 

As Judge Ungaro herself noted, this was always going to be a tough case for the defendants to try to show absence of price impact. She noted that in this case the burden on the defendants of establishing the absence of price impact is “particularly onerous.” She observed that “not only is there a clear and drastic spike following the alleged misrepresentation and an equally dramatic decline following the revelation of the truth, but all agree that the publications containing the misrepresentation and its revelation respectively caused those price swings.”

 

She added that under these circumstances, “proving an absence of price impact seems exceedingly difficult, especially at the class certification stage in which it must be assumed that the alleged misrepresentation was material.”

 

While the Halliburton decision undeniably gave the defendants a theoretically valuable tool with which to try to rebut the presumption of reliance in order to defeat a motion for class certification, it is clear that the defendants will not always succeed in establishing the absence of price impact required to rebut the presumption. Indeed, as this case shows, in at least some cases, it will be very difficult for defendants to show that the alleged misrepresentation had no impact at all on the company’s share price.

 

It is, as Judge Ungaro herself observed, particularly significant at the class certification stage that the Court must assume that the alleged misrepresentation is material. Where, as here, there have been discernible price swings following the key disclosures, it will be, as Judge Ungaro noted “exceedingly difficult” for the defendants to establish the absence of price impact. Since many cases involve discernible price swings, the ability to rebut the presumption of reliance through a showing of the absence of price impact may simply not be available in many cases. It may turn out that there only be a narrow category of cases where the ability to try to show the absence of price impact will turn out to make a difference. In any event, it may prove to be quite significant that defendants will not be able to establish absence of price impact by showing (or trying to show) absence of materiality.

 

In the wake of Halliburton, one uniform prediction was that the ability of the defendants to attempt to rebut the presumption of reliance through a showing of the absence of price impact would increase defense expenses, perhaps significantly. There is no way to know how much the ability to make this argument added to defense costs here, as the defendants would have opposed the motion for class certification in any event. While the arguments over the absence of price impact arguably only contributed to defense expense incrementally, there were additional costs associated with the argument. Among other things the defendants did retain an expert to try to support their argument. In some cases these kinds of additional expenses could be substantial.

 

It will be interesting to monitor is how significantly the assertion of these arguments contribute toward defense expenses and what impact that has on the insurance dynamic. At this point, carriers have proven eager to show that they will cover these costs; indeed, even before the Supreme Court ruled in Halliburton one carrier came out with an endorsement providing that no retention would apply to costs associated with trying to establish the absence of price impact. Since the decision, other carriers have followed suit. It will be interesting to see as the costs associated with these kinds of motions come into focus whether the carriers remain as willing to absorb these costs, particularly if it turns out that the expenditure of the costs is effective in only a smaller number of cases.

 

Special thanks to a loyal reader for sending me a copy of the ruling in this case.

017aI was fortunate this past week to be a part of the very successful Regional Professional Liability Symposium of the Professional Liability Underwriting  Society (PLUS) in London. About 180 people attended the sold out event, which featured a key note address from David Bermingham, one of the NatWest Three. The event was both well-attended and well-run. It was a privilege and an honor to be a part of such an excellent event. I congratulate everyone on the Europe Committee for their successful event, particularly Committee Chair Des McCavitt of Aspen (London). I also want to acknowledge and thank the many table sponsors who helped make the event’s success possible.

 

It is worth noting that all three of the events PLUS sponsored this year as part of its initiative to expand its international footprint – the three events were held in Hong Kong, Singapore and London — were highly successful and bode will for the future. The success of these events ensures that PLUS will continue its efforts to become a truly international membership organization.

 

I have added some picture of the event below. Additional Pictures can be found on the PLUS blog, here.

 

PLUS London. Gibson Hall, London 29/9/14 London. Gibson Hall, London 29/9/14

 

 

PLUS London. Gibson Hall, London 29/9/14 London. Gibson Hall, London 29/9/14

 

It was a good week to be in London and not just because of the great PLUS event. The weather was great as well. According to news reports, this past month was the driest September on record. Whether or not the weather conditions actually set a record, the conditions were great for walking around.

 

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supctAs I had noted on this blog (here), one of the important securities law cases on the U.S. Supreme Court’s docket for the upcoming term involved the failed IndyMac bank. The Court had granted cert in the case to decide whether the three-year limitations period in Section 13 of the ’33 Act may be tolled by the filing of a putative securities class action (under a legal theory known as the American Pipe tolling doctrine), or rather is a statute of repose that cannot be tolled. Though seemingly technical, the case presented potentially significant issues.

 

The case was scheduled to be argued next Monday, October 6. However, on September 29, 2014, in an unexpected development, the U.S. Supreme Court entered an order dismissing the writ of certiorari as improvidently granted, based on settlement-related developments in the underlying case.

 

As discussed in greater detail here, the underlying securities lawsuit involves allegations that the failed IndyMac Bank misled investors in connection with its issuance of securities in over 100 different offerings. The District dismissed for lack of standing all claims in which the plaintiffs had not themselves purchased securities. Five investors who did purchase the securities sought to intervene. The district court denied the motion to intervene, on the grounds that the three year statute of repose had lapsed and was not extended by the American Pipe tolling doctrine and could not be extended under Fed. R. Civ. Proc. 15 (c). The proposed intervenors appealed.

 

In a June 27, 2013 opinion (here), the Second Circuit, in an opinion by Judge Jose A. Cabranes for a three-judge panel, held that the filing of a class action lawsuit does not toll Section 13’s statute of repose. The appellate court held that neither the equitable tolling principles under American Pipe nor the legal tolling principles could operate to extend the period of the statute of repose.

 

The proposed intervenors filed a petition with the U.S. Supreme Court seeking a writ of certiorari. The intervenors argued that the Second Circuit’s opinion conflicted with a prior holding of the Tenth Circuit that American Pipe tolling does apply to Section 13’s statute of repose. The intervenors also argued that the Second Circuit’s holding unsettled long-standing class action practices with regard to the principles of tolling. The Court granted the petition and the case was fully briefed and ready to be argued.

 

All was set for the Supreme Court to address these important legal issues under the federal securities laws. However, on September 22, 2014, the plaintiffs in the underlying case notified the district court that they had reached a settlement with the underwriter defendants in the underlying case. As discussed in a September 23, 2014 post in her On the Case blog (here), Alison Frankel reported that the amount of the settlement was $340 million dollars. The settlement is of course subject to court of approval.

 

The U.S. Supreme Court got wind of this development and the justices likely were asking themselves that if the case has settled is there anything left of the case for the Court to consider? So on September 23, 2014, the Supreme Court entered an order in the case directing the parties to submit letter briefs addressing the issue ““What should be the effect, if any, of the proposed settlement agreement now pending before the district court on the matter pending before this Court?”

 

In response, lawyers for all of the parties in the case  of suggested that the case could go forward in the Court because there remained claims against one of the underwriting firms sued in the case — Goldman Sachs & Co.  Goldman Sachs had been dismissed as a defendant in the class action and didn’t participate in the proposed settlement.

 

However, as discussed in a September 29, 2014 post on the SCOTUS blog (here), the Court seems to have concluded that as a result of the settlement there was not enough of the case left of the case for the Court to hear – although the Supreme Court’s terse order dismissing the writ of certiorari in the case contains precious little explanation for the Court’s action.

 

The most immediate consequence of the Court’s order is that the Supreme Court appeal in the case will not go forward, meaning that the Second Circuit’s order in the case will remain standing – which in turn means that the split in the circuits that was the basis on which the Court had granted cert in the first place will continue. Because such a vast preponderance of securities cases are filed in the Second Circuit, the Second Circuit’s ruling that the filing of a class action does not toll the ’33 Act’s statute of repose will remain operative with respect to a very large number of securities cases that are filed.

 

In the merits briefs filed with the Supreme Court and in certain of the amicus briefs that were filed in support of the plaintiffs, the plaintiffs and the amici had argued that if the Second Circuit’s decision were allowed to stand, class members in many securities class actions would have to make wasteful “protective filings” in order to maintain their right to proceed independently and avoid being time-barred if class certification was subsequently denied.  These filings would drain judicial resources and impose costs on putative class members without any countervailing benefit. (This position is discussed in greater detail here.) Whether or not this will happen remains to be seen, but there is  no doubt that the fact that the Second Circuit’s decision in the case will be allowed to stand could have a significant impact on class action practice in ’33 Act case in the Second Circuit.

 

Though the U.S. Supreme Court has dismissed the IndyMac case from its docket, that does not mean that there won’t be any securities law action in the Court’s upcoming term. The Court still has another securities case on its docket. On November 3, 2014, the Court will hear argument in the Omnicare case.

 

As discussed here, in March 2014 the Supreme Court granted cert in the Omnicare case to take up the question whether or not to survive a dismissal motion it is sufficient for a plaintiff in a Section 11 case to allege that a statement of opinion was objectively false, or whether the plaintiff must also allege that the statement was subjectively false – that is, that the defendant did not believe the opinion at the time the statement was made. The Supreme Court’s consideration of the Omnicare case will resolve a split in the circuits between those (such as the Second and Ninth Circuits) holding that in a Section 11 case allegations of knowledge of falsity are required; and those (such as the Sixth Circuit, in the Omnicare case) holding that it is not required.

 

So the Supreme Court will be hearing and deciding an important securities law case in the upcoming term. It just won’t be getting to the ’33 Act statute of repose issue, at least not this term. Those of us who find the American Pipe tolling doctrine fascinating will have to find some other way to amuse ourselves.

 

And Finally: Two camels in a car. For all of you who have been wondering what would happen if you tried to put two camels in a car.  

 
http://youtu.be/TbWEXb8TEsg

149aThe D&O Diary is on assignment in the United Kingdom this week, with the first stop in the venerable city of Edinburgh, for meetings and an event. Due to flight delays, cancellations and missed connections, my visit to Scotland’s capital city was cut short by a day, which compressed both my meetings and my opportunity to see the sights. Even with a shortened stay, I still managed to take in quite a bit of the city.

 

Edinburgh turned out to be quite a bit of surprise. Perhaps I was fortunate with the time of year of my visit and the pleasant weather that prevailed while I was there. Rather than the dark and gloomy domain perched on craggy peaks that I pictured, the city was (at least while I was there) bright, open and, while hilly, an uncommonly pleasant place in which to walk around.

 

With a population of about 470,000 (about the same size as145a Sacramento), Edinburgh is perched on the south side of the Firth of Forth, which opens out to the North Sea. The city’s name is pronounced with a distinctive Scottish flourish – it is “Edin-burra” not “Edin-burg.” The view within the city is dominated by the looming presence of the Edinburgh Castle (pictured at the top of the post), which stands at the top of the city’s Old Town. An architecturally interesting and beautiful cobblestone street, called the Royal Mile (pictured left), connects the Castle to the royal Palace of Holyroodhouse (pictured below). On a warm, sunny fall afternoon, the Royal Mile was thronged with tourists looking to buy kilts, tartans and whisky to take home with them.

 

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067aEdinburgh is a topographically complicated city owing to the several craggy outcroppings, the remnants of ancient volcanic activity, within and adjacent to the city. Looming beyond Holyroodhouse is the craggy peak known as Arthur’s Seat, the highest point among the rocky outcroppings of the Salisbury Crags. On a clear day, the view from Arthur’s peak seemed almost limitless. To the east, the Firth of Forth stretched out to the North Sea. About twenty miles away, the soft, rolling beauty of the Pentland Hills framed the view to the southwest. To the north, Edinburgh castle soared about the city below.

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Just days before my visit, Scotland had held a referendum on whether or057a not it should be an independent country. I saw the remnants of the independence campaign around the city. Though Edinburgh had voted “No” in much greater numbers that most of the rest of the country, most of the campaign remnants that I was were in support of the “Yes” vote. On Saturday evening, I was in a pub to which I had been drawn by the live acoustic music. Late in the evening, the musician played a song called “Caledonia.” Every single person in the place sang along to the lyrics that go like this: “Let me tell you that I love you/And I think about you all the time/Caledonia you’re calling me, now I’m going home/But if I should become a stranger/Know that it would make me more than sad/Caledonia’s been everything I’ve ever had.” And then when the song ended, in unison, everyone in the college age crowd in the pub stood and shouted “Yes! Yes! Yes! Yes!” It was so cool it gave me goosebumps and it also made me think that for many in Scotland the independence issue is not over and may never go away.

 

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Whenever I spoke to anyone there, after hearing my American accent, whoever I was speaking to would say that I must be there for the Ryder Cup golf tournament (which was played over the weekend at Gleneagles, about an hour outside Edinburgh). The next topic for discussion was where I was from in the United States, and when I said Ohio, the standard response was “Aye, you’re the first person I ever met from Ohio.” I wanted to reply that, in fact, Ohio is 50% larger geographically than Scotland and has more than twice as many people. Of course, I also thought to myself that Scotland’s history, heritage and culture are many times greater and more distinctive than that of Ohio or just about any other U.S. state you might care to mention. So I kept the comparisons  between Scotland and Ohio to myself.

 

103aWhile I was in Edinburgh, I took full advantage of the clement weather for some ambitious walking.  A friend back home upon learning that I was going to be visiting Edinburgh had told me that I had to make time to explore the footpath that winds along the Water of Leith, a stream that runs from the Pentland Hills to the port city of Leith. Though I didn’t walk the entire length of the walkway, I did walk from a point near my hotel all the way to Leith, Edinburgh’s historic port city, about five miles away. The pathway goes through a number of picturesque villages, including Stockbridge, Canonmills, and Dean Village. The stroll along the walkway’s heavily wooded, sunlight dappled pathway was quite a contrast to the crowded sidewalks near my hotel in the city’s shopping district.

 

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The city is actually full of green space. Just a bit south of the Royal Mile is the University of Edinburgh, which itself is adjacent to a large open parkland called the Meadow. I roamed around the area after my meeting089a on Friday afternoon, and as I walked back toward town on the Meadow Path, a footpath that connects the campus to the historic city, I came upon two grandmotherly women who were holding up a map and obviously trying to figure out where they were. From the accents, I could tell they were American, so I offered to help.

 

It turns out that the two women, whom I later learned are sisters and are named Edna and Alice, had gone AWOL from their tour group, and had intended to walk on their own from their hotel to the Royal Mile. They been given surprisingly useless directions – they were told to “turn left at the Starbuck’s,” which, given the fact that there is a Starbuck’s on just about every street corner, virtually guaranteed that they would get lost. They weren’t far away from their destination, but the Royal Mile was about a half a mile away – and straight uphill.  From their reaction, it was clear that they didn’t think that after all of their wanderings they had enough left in the tank to make it up the hill. I suggested that they should go in the pub just across the way and call for a cab to take them back to their hotel. It was pretty clear they weren’t sure at all about the idea of going in a pub (they didn’t look like the types who, say, made a habit of going on pub crawls), so I said I would accompany them. The Doctors pub (apparently named for its proximity to the medical school) was quiet on a Saturday afternoon, with a few men in a corner watching the Ryder Cup on television.

 

I told the ladies that we might as well get comfortable while they waited for the cab and I suggested that they should make the most of their pub experience and have a pint of ale. They laughed at the idea, but the spirit of adventure got ahold of them, and they agreed to try a pint. To their surprise, they liked the ales the bartender recommended them, and after a time of convivial conversation, they decided it was their turn to buy me a round. I wouldn’t have thought that spending an afternoon drinking beer with a couple of American grandmothers would be the best way to spend the day, but I have to say I enjoyed meeting them. After the second round, I had to remind them that they had intended to call a cab to go back to their hotel. As they were leaving, they said that the visit to the pub had been the most fun they had on their entire trip and they couldn’t wait to tell the others in the tour group about their adventure. As is often the case while traveling, the unplanned events and encounters often are the best part.

 

My time in Edinburgh was all too brief, and I soon had to leave to head on to London. But I am glad I had the chance to catch a little glimpse of the Scottish city. I enjoyed the entire experience. As much as I enjoyed climbing up to the top of Arthur’s Seat and hiking along the Water of Leith pathway, the afternoon in the pub with Edna and Alice might have been the best part of the visit for me as well.

 

More Pictures of Edinburgh:

093a

 

New Town

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Stockbridge

117a

 

 

 

120a

 

Leith

131a

 

Here’s a video of the song “Caledonia”

 

oklachomaOne of the most interesting recent developments has been the onset of innovative litigation reform efforts in the form of bylaw revisions. Among the most intriguing of these efforts involves fee shifting bylaws, whereby an unsuccessful claimant in intracorporate litigation must pay the other party’s costs. As discussed here, earlier this year, the Delaware Supreme Court upheld the validity of a fee shifting bylaw, a judicial decision that immediately triggered a legislative initiative to limit the effect of the decision to non-stock companies. As discussed here, the Delaware legislative initiative has now been tabled until early next year.

 

But while the Delaware legislative initiative is on hold, at least one legislature has gone forward to provide for the awarding of fees against unsuccessful derivative lawsuit claimants. As discussed by University of Denver Law Professor J. Robert Brown in a September 24, 2014 post on the Race to the Bottom blog (here), the Oklahoma legislature has adopted a bill providing that in a shareholder initiated derivative action against a domestic or foreign corporation, the court “shall require the nonprevailing party or parties to pay the prevailing party or parties the reasonable expenses including attorneys’ fees, taxable as costs, incurred as a result of such action.” A copy of the Oklahoma legislation can be found here.

 

Professor Brown notes that the Oklahoma arrangements are, in a sense, narrower than what the Delaware Supreme Court approved, as the Oklahoma legislation only applies to derivative suits, and it is more balanced, as it provides for the awarding of attorneys fees for successful derivative plaintiffs.

 

Nevertheless the “loser pays’ model that the Oklahoma legislation adopts is extraordinary —  It represents a significant departure from what is general known as the American Rule, under which each party typically bears its own cost. And unlike the fee-shifting bylaws being debated in Delaware –which would in any event require each company to decide whether it was going to adopt the bylaw (and might therefore be subject to shareholder scrutiny) — the Oklahoma legislation applies to any derivative action in the state, even if the company involved is not an Oklahoma corporation.

 

As Professor Brown points out in his blog post, derivative actions are often dismissed on procedural grounds (for example, based upon the failure to make a demand on the board, without a judicial determination that demand would be futile), meaning that derivative lawsuit plaintiffs often do not prevail. Under this statute, a shareholder plaintiff that does not prevail “will be forced to pay the other side’s fees, something that can result in dollar amount s that stretch into six and seven figures.”

 

The risk of this possibility, according to Professor Brown “provides a significant disincentive to file a suit against the board for breach of fiduciary duties” – which, it seems to me, was the Oklahoma legislature’s intent. I don’t have a good sense of how many derivative lawsuits are actually filed in Oklahoma’s courts, but whatever the number is, now with this legislation in place, there are certainly going to be fewer derivative lawsuits filed in the Sooner State than there were in the past.

 

I know there are some who might say that is a good thing. For his part, Professor Brown says the effect of these fee shifting provisions is “to insulate challenges to boards for breach of the duty of loyalty, for bad faith, or for wasting corporate assets. In other words, it has the potential to render boards unaccountable for their actions as directors.”

 

Professor Brown says that Oklahoma is the “first state to intervene in the debate” about fee shifting in derivative litigation. His use of the word “first” is telling – he did not say “only.” For starters, we know that Delaware is going to get into the mix on these issues sometime in 2015. In addition, as things stand, there is a Delaware Supreme Court decision holding that fee shifting bylaws are valid. If the Delaware legislature fails to act, or winds up taking a different action than originally proposed, fee shifting bylaws might well become a regular bylaw provision for Delaware corporations. And while we will have to wait to see what Delaware’s legislature  will do, perhaps other states will, like Oklahoma, adopt  a “loser pays” rule, or permit companies incorporated in their jurisdiction to adopt fee shifting by laws.

 

I don’t expect that every state’s legislature would be willing to adopt a bill like the one Oklahoma’s legislature passed, but there are some other states that might. If this kind of legislation becomes widespread, the environment for litigating derivative lawsuits in this country could be substantially altered. In any event, there will be many more developments ahead as this particular story unfolds.

 

Break in the Action: Due to Travel Requirements, the D&O Diary will not be published for the next few days. Regular publication will resume once I am back in the office toward the end of next week.

 

seclogoIn what is by far the largest whistleblower bounty award yet under the Dodd-Frank’s whistleblower provisions, the SEC on September 22, 2014 announced an award of between $30 and $35 million to a whistleblower who provided original information that led to a successful SEC enforcement action. In the SEC’s Order providing for the award (here), the name of the company against whom the report was made and the name of the award recipient are redacted. In addition to the sheer size of the award, there are a number of other interesting features about the award.

 

The SEC’s September 22, 2014 press release about the award can be found here. A September 22, 2014 press release from the law firm that represented the whistleblower can be found here.  

 

Section 922 of the Dodd-Frank Act created certain new whistleblower incentives and protections. The section directs the SEC to pay awards to whistleblowers that provide the Commission with original information about a securities law violation that lead to the successful SEC enforcement action resulting in monetary sanctions over $1 million.  The size of the award may range from 10 % to 30% of the amount recovered in the enforcement action. The section also prohibits retaliation against whistleblowers. By law, the SEC protects the confidentiality of whistleblowers and does not disclose information that might directly or indirectly reveal a whistleblower’s identity.

 

The SEC announced its rules implementing the Dodd-Frank whistleblower provisions in May 2011, but until now there still have been relatively few awards. According to the SEC press release, there have been a total of only 14 awards so far (including nine so far in fiscal 2014, which ends next week.) Until this latest award announced on Monday, the largest previous award under the program had been the agency’s October 2013 award of $14 million (about which refer here).

 

The latest award is more than twice as large as the prior record award. The percentage awarded is redacted from the SEC’s Order, but the dollar figure is specified in the Order, which states that “given the monetary sanctions thus far collected, [the percentage awarded] should yield a total award of between $30 million and $35 million.” The amount awarded implies that the amount of the enforcement order was between $300 and $900 million dollars. However, there are clues in the SEC’s Order suggesting that the enforcement award was at the lower end of the range.

 

The Order states that in determining the amount of the award, the agency took into account the significance of the information provided and the law enforcement interests at issue. However, the whistleblower objected to the percentage of the award, arguing that it was lower than the percentage of other awards the agency has made. The Order acknowledges that a downward adjustment was made based on the whistleblower’s delay in making the report.

 

The Order refers to the whistleblowers “delay in reporting the violations, which under the circumstances we find unreasonable. The duration of the delay has been redacted, but the Order does say that during  the period of the whistleblower’s delay in coming forward, “investors continued to suffer significant monetary injury that otherwise might have been avoided.” This discussion and the fact of the downward adjustment to the award percentage suggests that the percentage award was at the lower end of the range, which in turn suggests that the amount of the recovery from the target company was at the lower end of the conjectured range (that is, closer to $300 million).

 

One particularly interesting feature of this award is that the whistleblower is a foreign resident. According to the SEC’s press release this is the fourth whistleblower award to a resident of a foreign country, which the agency says “demonstrates the program’s international reach. “ The head of the SEC’s whistleblower office is quoted in the press release as saying that the award “shows the international breadth of our program as we effectively utilize valuable tips from anyone, anywhere to bring wrongdoers to justice.’” The whistleblower office head is also quoted as saying that “whistleblowers from all over the world should feel similarly incentivized to come forward with credible information about potential violations of the U.S. securities laws.” Neither the Order nor the press release says whether or not the company against which the report was made is a foreign domiciled company.

 

The fact that foreign residents have received whistleblower awards is in at least one respect not surprising. The SEC’s latest annual whistleblower report stated that nearly 12% of all whistleblower reports during fiscal 2013 were from non-U.S. residents. The size of this award seems likely to encourage others to come forward, both inside and outside the U.S. However, despite the size of this recent award, one factor that may discourage prospective non-U.S. whistleblowers is the recent holding of the Second Circuit (discussed here) in which the appellate court determined that the Dodd-Frank Act’s provisions protecting whistleblowers from retaliation do not apply to non-U.S. residents.

 

There is some irony in the number of whistleblower awards so far to foreign residents. That is, at least some other countries that have actively considered whether or not to have an active bounty system to provide monetary awards to whistleblowers have decided against it. As discussed here, the UK regulatory authorities recently rejected the idea.

 

There are several implications from this latest large award. The first is that this award, taken together with the $14 million award last October, shows that the agency is prepared to make some very large awards indeed. Which in turn seems likely to have the effect of encouraging others to come forward.  Along the same lines, it now seems that while it has taken a while to get going, the likely will be more awards announced more frequently, which again could have the effect of encouraging prospective whistleblowers.

 

The second is that the whistleblower program is leading directly to significant enforcement activity. In the press release accompanying this award, an agency spokesperson is quoted as saying that in the absence of the whistleblower report the underlying fraud would have been very hard to detect. The inference is that the program is promoting additional enforcement activity.

 

What remains to be seen is the extent to which the whistleblower program and the increased enforcement activity will lead to increased follow-on civil litigation. There have been recent cases (refer for example here) where securities class action litigation has followed in the wake of whistleblower reports, but so far to my knowledge there have been no cases where a follow on civil lawsuit  has followed after and because a whistleblower report to the SEC. Indeed, the SEC’s elaborate efforts to protect the identity of the whistleblower and the identity of the targeted company present impediments to this kind of litigation developing.

 

Nevertheless I think it is likely that the increased enforcement activity will lead to increased follow-on civil litigation, even if just as a result of the enforcement activity if not the whistleblower report itself. Before all is said and done the whistleblower provisions, could have a significant impact on the level of enforcement activity and on amount of civil litigation.

 

One final observation. The fact that this whistleblower was represented by a law firm  – which  published its own press release about this award – says something in and of itself. The law firm involvement clearly suggests a perception that there the whistleblower program represents a business opportunity. The involvement of counsel also suggests a way that follow-on litigation might still go forward notwithstanding the SEC’s efforts to protect the identity of whistleblowers.

paUnder which claims made D&O insurance policy is there coverage for a claim that was filed under seal years ago but not served on the policyholder until the policy period of the current policy? If you find the answer “no policy” as unsatisfying as I do, read on. In a September 15, 2014 opinion (here), a three-judge panel of the Superior Court of Pennsylvania affirmed the trial court’s grant of summary judgment holding that Amerisource Bergen’s D&O insurance policy’s prior and pending litigation exclusion precluded coverage for a False Claims Act lawsuit that was filed under seal in 2006 but not served on the company until 2010. In the discussion section below I try to sort out what happened here.

 

Background

On June 5, 2006, Kassie Westmorland filed a False Claims Act lawsuit against Amerisource Bergen and Amgen. The action alleged that the defendants had submitted false Medicare claims relating to a particular drug. Pursuant to the standard procedure for this type of action, the lawsuit was filed under seal, in order to permit the U.S. government to determine whether or not it would take up the suit. Amerisource did not learn of the existence of the matter until March 2008, when Amgen informed Amerisource that Amgen was under investigation. In February 2009, the Department of Justice informed Amerisource and Amgen that it was reviewing the allegations. In February 2009, the federal court permitted a redacted copy of the complaint on the court’s electronic docket. In January 2010, Amerisource received service of process of the lawsuit.

 

In July 2009 – that is, after the redacted complaint was available on the court docket but before Amerisouce had been served with the complaint – Amerisouce provided its primary D&O insurer with formal notice of a potential claim. The insurer had been the primary insurer on Amerisource’s D&O insurance program for the policy years 2007-08, 2008-09, and 2009-10. For the policy year 2006-07, the insurer had been in an excess position in Amerisource’s D&O insurance program and a different insurer had been in the primary position.

 

The insurer denied coverage to Amerisource under the 2009-10 primary policy and refused to pay Amerisource’s expenses incurred in defending the False Claims Act action. Amerisouce filed an action in Pennsylvania state court against its primary D&O insurer alleging breach of contract and bad faith. On July 16, 2013, the trial court granted the insurer’s motion for summary judgment, on the ground that both Exclusion L (“prior and pending litigation”) and Exclusion Y (“false, deceptive or unfair business practices”) precluded coverage. Amerisource appealed.

 

The 2009-10 policy defines the term “Claim,” in relevant part as a “civil proceeding against [Amerisource] seeking monetary damages … commenced by the service of a complaint or similar pleading” or a “written demand against [Amerisouce] for monetary damages.”

 

Exclusion L to the policy, the “Prior or Pending Litigation” exclusion, excludes any Claim

 

alleging, based on, arising our of, attributable to any prior or pending litigation, claims, demands, arbitration, administrative or regulatory proceeding or investigation filed or commenced on or before the earlier of the effective date of this policy or the effective date of any policy issued by [the Insurer] of which this policy is a continuous renewal or a replacement, or alleging or derived from the same or substantially the same fact, circumstance or situation underlying or alleged therein.

 

September 15 Opinion

In a September 15, 2014 Opinion written by Judge Patricia Jenkins for a three-judge panel,  the Superior Court of Pennsylvania affirmed the trial court’s ruling, holding that coverage was precluded under exclusion L.

 

The court began is analysis by citing with approval from an earlier federal district court opinion in which that court, explaining the purpose and operation of claims made insurance policies which provide coverage only for claims first made during the policy period, said that “claims made policies generally include a number of endorsements and exclusions intended to limit [the] front end risk by cutting off liability for claims ready, but not yet made, at the start of the policy period.” The appellate court noted that Exclusion L, the prior and pending litigation exclusion, in Amerisource’s D&O insurance policy is “one such exclusion intended to limit [the Insurer’s] front and risk for claims ready, but not yet made, at the start of the policy period.”

 

The appellate court rejected Amerisouce’s argument that the exclusion had not been triggered because, even though the lawsuit had been filed in 2006, the company was not served with the complaint until January 2010. The court said that, in order to be triggered, the exclusion requires only that the prior litigation has been “filed” or “commenced.” The court said that “we think it is clear that litigation is ‘filed’ or ‘commenced’ against an entity when it names that entity as a defendant, is filed with a court, and is docketed and given a case number. Nothing in the ordinary meaning of those terms requires service of original process or unsealing of the complaint in order for an action to be ‘filed’ or ‘commenced.’”

 

The appellate court also drew a comparison between the policy’s definition of “Claim,” which expressly references the requirement for the service of a complaint, and Exclusion L, which does not. The court said that “the explicit requirement in [the definition of “Claim”] demonstrates that the parties knew how to include a service requirement when they so desired.” The court added that “the absence of a service requirement from exclusion L demonstrates that the parties did not intend for ‘filing’ or ‘commencement’ of litigation in exclusion L to depend upon service of process.” 

 

The appellate court also rejected Amerisouce’s argument that the exclusion does not apply because the 2009-10 primary policy was part of a series of insurance policies that extend back to May 1, 2006, thus predating the June 2006 lawsuit. The court disagreed with Amerisouce’s contention that the claimant had filed or commenced her lawsuit on or after “the earlier of the effective date of the [2009-10 policy] or of any policy issued by [the Insurer] of which the [2009-10 policy] is a continuous renewal or a replacement.” The court said that the 2009-10 policy was a continuous renewal policy of the first of the primary policies it had issued in the 2007-08 policy period. The 2009-10 policy, the court said, was neither a continuous renewal policy nor a replacement of the carrier’s 2006-07 excess policy, as the 2009-10 policy did not “replace” the 2006-07 policy. The court noted that the language in the exclusion was written in the disjunctive, so it did not apply to a series of policies that included a combination of renewals and replacements.

 

Finally, because the appellate court found that exclusion L applies to preclude coverage, it did not need to review whether or not exclusion Y (“false, deceptive or unfair business practices”) applies.

 

Discussion

In thinking about the outcome of this case, it is probably worth keeping in mind that there might not have been coverage here even if Amerisource had been able to clear the prior and pending litigation exclusion hurdle. The appellate court did not reach the question of whether or not the deceptive trade practices exclusion applied, but the trial court had concluded that the exclusion also precluded coverage for this claim. So in the end there simply may not have been coverage for this claim under the D&O insurance policy in place when the claim was finally made.

 

Just the same, there is something particularly unsatisfying about the outcome of this case. Within the meaning of the claims made insurance policy itself, the “Claim” – in the form of the False Claims Act lawsuit – was not “made” against Amerisouce until it was served on the company in January 2010. Amerisouce had apprised the insurer of the potential claim shortly after the company itself had learned of the lawsuit. It couldn’t have provided notice before that, because it simply didn’t know of the details of the lawsuit’s existence. It is very hard not to regard this as a situation where the insurer avoided coverage because the policyholder got ambushed by a concealed lawsuit.

 

I suppose one way to look at this is that the prior and pending litigation exclusion operates to parcel out the risk that there might be a lawsuit out there that was already underway before the policy commenced but that nobody yet knows about. It could be argued that, as demonstrated in this case, the exclusion is set up so the risk that there might be a lawsuit out there falls on the policyholder and not the insurer.

 

In trying to pinpoint what is wrong with what happened here, it occurs to me that there is sort of a threshold theoretical problem with the application of the prior or pending litigation exclusion to the false claims act lawsuit. The prior and pending litigation exclusion is meant to address separate litigation, not the lawsuit for which coverage is sought. This just isn’t the sort of situation to which the prior and pending litigation exclusion was meant to apply.

 

I can think of several possible solutions. The first is that the prior and pending litigation exclusion could be amended to provide that the exclusion does not apply to False Claims Act complaints that were filed but not served prior to the effective date of the policy. The potential shortcoming of this solution is that there may be other types of lawsuits, beyond just False Claims Act claims, where the sequence of events that occurred here might also unfold.

 

So maybe the best way to avoid this problem would be to line up the language between the prior and pending litigation exclusion and the definition of claim, so that both require service of process. Of course carriers might not be willing to go so far, the standard prior and pending litigation exclusion is deliberately written broadly, so that carriers can restrict what the court here called the “front end” risk.

 

One thing occurs to me in thinking about the “front end risk” analysis that is the theoretical justification for the inclusion of a prior and pending litigation exclusion on a policy like this one. That is, a carrier arguably has a legitimate concern about “front end” risk when claim made coverage first incepts. But in subsequent policy years, the legitimacy of that concern diminishes –which is obviously the reason for the inclusion in the exclusion of the language about the earlier date of prior policy of which this policy is the continuous renewal.

 

While the “continuous renewal” language helps, what might make more sense is to say that at some point the prior and pending litigation exclusion should come off the policy altogether. Where a policyholder has had a continuous program of claims made insurance coverage in place over a period of time, the “front end risk” ceases to provide the theoretical justification for the inclusion of the prior and pending litigation exclusion, and it could be argued that the prior and pending litigation exclusion should no longer be a part of the policy.

 

I recognize that views about this situation may differ, and I welcome readers’ comments about this claim, particularly those on the carrier side who may take a different view of the policy exclusion and how it was applied here.

 

Very special thanks to Arthur Washington of the Mendes & Mount law firm for sending me a copy of this decision. (Mendes & Mount was not involved in the case.) I hasten to add that the views expressed in this blog post are exclusively my own.

 

UPDATE: A reliable source advises that this claim involved an E&O policy, not a D&O policy.

 

Insurance Panel Discussion in New York on October 15: H.S. Grace & Company, Inc. is sponsoring  a complimentary Insurance Update Breakfast event at the Princeton Club in New York City on October 15, 2014. My good friend Joe Monteleone of the Rivkin Radler law firm will be moderating a panel focused on Shareholder Derivative Litigation followed by a session discussing Representations and Warranties insurance. The event sponsor expects to receive 1.5 CLE credits in New York, which are also recognized in New Jersey. For more information about this event, please refer here.

tockertapeAll eyes may be on the record-setting IPO of Chinese Internet firm, Alibaba, but the real IPO story for 2014 may be the significant number of IPOs this year involving smaller companies. The number of companies completing IPOs this year  is on pace for the highest annual level since 2007, a surge in initial public offerings that, according to recent academic research, is due at least in part to the so-called IPO on-ramp procedures in the Jumpstart Our Business Start-Ups (JOBS) Act, which Congress enacted in 2012. Just the same, while most of the eligible companies appear to be taking advantage of the JOBS Act provisions, at least some commentators have raised concerns about the provisions’ long-term effects.

 

The JOBS Act’s IPO on-ramp procedures are designed to ease the process of going public for “emerging growth companies”(EGCs),  which the Act defines as companies with annual revenues less than $1 billion. Under these provisions, EGCs may submit their draft registration statements to the SEC confidentially and only need to disclose their intention to list their shares 21 days before they start investor roadshows. The EGCs can also release just two years of audited financial statements, rather than the standard three, and need only disclose the compensation of the top three executives rather than the standard five.

 

Many companies are taking advantage of these JOBS Act provisions. According to a study by Ernst & Young cited in a recent Wall Street Journal article (here), almost 80% of EGCs filing for IPOs have used the confidential filing provisions, 90% took advantage of the reduced compensation disclosures and 45% are using the provision that allows them to file only two years of audited financials.

 

An August 26, 2014 paper from three academics suggests that the IPO on –ramp procedures  are spurring companies to undertake and complete initial public offerings. In their paper entitled “The JOBS Act and IPO Value: Evidence that Disclosure Costs Affect the IPO Decision” (here), Michael Dambra of SUNY Buffalo, and Laura Casares Field and Michael Gustafson of Penn State report their findings that, controlling for market conditions,  the JOBS Act provisions have boosted listings by 21 companies annually, a 25 percent increase compared to the average number of IPOs from 2001 to 2011, while at the same time IPOs in other developed countries have remained below their pre-2012 numbers.

 

The JOBS Act provisions have been a particular boon for companies in certain industries, particularly biotech and pharmaceutical companies, as well as technology, media and telecommunications. According to data compiled by Bloomberg (here), there were twice as many biotech IPOs in 2013 than in any year since 2004.

 

Another sector whose offerings have been boosted is foreign-domiciled companies. According to an August 29, 2014 post on the MoFo Jumpstarter blog entitled “The Rise of Foreign Issuer IPOs” (here), foreign issuers have proven to be particularly keen to take advantage of the JOBS Act provisions.

 

The blog post reports that of the 222 IPOs completed in 2013, 37 involved foreign issuers (including30 EGCs, or 13.5% of all 2013 IPOs), compared to 21 foreign issuers (including 12 EGCs, or 9.3% of all 2012 IPOs) among the 128 companies that completed IPOs in 2012.In 2014, as of the date of the blog post, there have already been 44 foreign issuer IPOs in the U.S., raising $10.3 billion. The foreign companies completing U.S. listing during 2014 includes companies from sixteen different countries, with the largest number (15) from the Cayman Islands and China (12). In addition to the companies that have already completed IPOs in 2014, there are in addition nine foreign issuers in registration.

 

According to a recent Wall Street Journal article (here), the early results for EGC IPO companies have been impressive. Nearly 20% of the EGCs that went public in 2013 started trading above their expected price range, compared with about 10% for big company IPOs. In addition, in their first three months of post-IPO trading, shares in companies with less than $1 billion in revenues gained 38% versus a 15% average gain from 2000 until the JOBS Act took effect, which also beat last year’s average three-month post-IPO  gain of about 35% for bigger companies.

 

But while much of the news appears to be good, some apprehensions have started to emerge.  As discussed in a September 15, 2014 Wall Street Journal article entitled “Relaxed Rules for Small-Company IPOs Raise Concerns” (here), some commentators have started to worry about a “JOBS Act effect” in which the EGCs lead off with a share price increase but “start to fizzle” within a year. The article notes that while the smaller company IPOs often begin with a rising stock price, the pattern of gains often then reverts to historical trends, in which larger-company IPOs turn in a better long-term performance. Thus, among 2013 IPOs, larger-company IPOs have posted average gains of 40%, while returns from smaller companies is about 38%, the same pattern as before the JOBS Act.

 

Among the issues that seems to be weighing on the smaller company stock are concerns relating to the reduced information the EGCs supply with the registration statements. The Journal article quotes one commentator as saying that “less information and less transparency are ultimately negative.” The article cites specific concerns about the smaller companies’ executive compensation disclosures. Another risk for investors is that ‘economic growth and low interest rates have fueled the stock market, potentially masking the true effects of the JOBS Act.” It could be, according to Lynn Turner, the SEC’s former Chief Accountant, years before it is clear if the JOBS Act’s exemptions were worth it.

 

I don’t know whether or not there actually is a “JOBS Act effect” or whether EGCs will  in fact “start to fizzle.” There is no doubt that all companies, including EGC IPO companies, are enjoying the current benign market conditions, and there is no doubt that if, say, the Fed starts to raise interest rates, the market conditions could change for EGC IPOs along with everybody else.

 

But whether or not there is a JOBS Act effect, the one thing I know is that as the numbers of IPOs increases, the number of IPO-related lawsuits has also increased, as I documented in a recent post (here). When any IPO company has a stumble or hits an obstacle, the company’s share price tends to decline sharply. When that happens, a securities class action lawsuit often follows. It will be interesting to watch as the numbers of EGC IPO companies accumulates whether any lawsuits reference disclosure issues relating to the JOBS Act provisions. Another factor that will be interesting to watch is the extent to which the foreign issuer IPOs are drawn into IPO-related litigation.

 

In any event, given the typical post-offering lag between the IPO launch date and the usual timing of post-IPO litigation, it seems likely that as the numbers of IPOs have continued to grow during 2014, we will continue to see IPO-related litigation continue to accumulate at least into 2015.

BurkhardAlthough I try to include on this blog topics involving issues from outside the United States, because of my background and experience, U.S-related topics tend to predominate. That is why I am always grateful to have the opportunity to publish a guest post from a non-U.S. reader. I have published below an article discussing D&O insurance issues in Germany from Dr. Burkhard Fassbach who is a partner in  the Dusseldorf-based D&O advisory firm, Hendricks & Co. Burkhard is licensed to practice law in Germany and is standing legal counsel to the German operation of the London-based Howden Broking Group. 

I would like to thank Burkhard for his willingness to publish his guest post on my site. I welcome guest post submissions from responsible authors on topics of interest to readers of this blog. If you would like to publish a guest post, please contact me directly. Here is Burkhard’s guest post: 

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Preface 

In the wake of the financial crisis, leading corporate governance experts in the U.S. have urged the separation of the personal union of chairman and CEO, i.e. the CEO-duality. The advocates make reference to the perks that the German two-tier board system entails. Through proxy fights taking place in shareholders’ meetings, institutional investors and activist shareholders in the U.S. increasingly succeed in their endeavor to split the functions of chairman and CEO. The shareholders’ meeting in Germany is in charge of the decision whether to grant D&O insurance protection to the supervisory board members or not. Conflicts of interest almost invariably gain center stage in this context. The common goal of both debates is the split.

 

I. The German Stock Corporation Act’s authority regime regarding the granting of D&O insurance coverage 

Quoting to German literature and treatises on stock corporation law, Professor Christian Armbrüster of Berlin University has pointed to its authority rules according to which the decision whether to grant D&O insurance protection to the executive board members rests on the supervisory board. The granting of D&O insurance protection to the members of the supervisory board lies within the competence of the shareholders’ meeting. The executive board effectuates the conclusion of the insurance contract. See Armbrüster, VersR 2014, 1 seq.

 

It has been in the journal ‘The Supervisory Board’ (2nd issue, 2013) that the author has red-flagged the necessity of separate D&O protection for supervisory board members with a distinct insurance carrier in the German two-tier board system. In adherence to the above-mentioned authority rules, foreign institutional investors will also have a say in the decision. Hence, in Germany the shareholders are in the driver’s seat for this question.

 

In an article dating from May 10, 2013, published in the German daily newspaper F.A.Z. headed  “majority of DAX (German Share Index) companies in foreign ownership”, Gerald Braunberger, making reference to a pertinent academic study, demonstrated that the majorities of shares of the 30 companies listed in the DAX are owned by foreign investors. On average, foreign portfolios comprise 55 percent of these shares. For the most part, the foreign purchasers are wholesale investors such as pension and investment funds, banks, and insurers. The author points to the foreign shareholders’ exerting influence on German companies, such as in the case of the chairman of the supervisory board of Lufthansa. Just as palpable was the influence of foreign investors on the fate of Deutsche Bank, the author claims. It was foreign investors who appreciably contributed to the decision to refrain from Josef Ackermann’s inaugural to the office of the chairman of the supervisory board of Deutsche Bank after his removal from the office of chairman of its executive board. See Gerald Braunberger, Majority of DAX Companies in Foreign Ownership, F.A.Z., May 10, 2013, at http://www.faz.net/aktuell/wirtschaft/unternehmen/studie-dax-konzerne-mehrheitlich-in-auschlaendischem-besitz-12178297.html.

 

II. Activist shareholder 

The term ‘activist shareholder’ is defined as a shareholder who uses her stock ownership in order to exert pressure on management in public. The activists’ goals encompass both financial and ideational interests. In the former alternative, they seek to enhance the shareholder value by means of changing corporate policy and financial machinery, implementation of measures of cost cutting, etc.; in the latter alternative, they pursue goals such as disinvesting in certain countries or implementing a corporate policy that is more ecofriendly. Such activism manifests in various facets: proxy fights, public campaigns, resolutions of shareholders’ meetings, negotiation and litigation with management. See at http://en.wikipedia.org/wiki/Activist_shareholder. This article will discuss recent endeavors to implement quasi-dualistic board structures in the U.S. The impetus in the U.S. to separate the functions of CEO and chairman is rather unillumined in the German law society.

 

III. Severance of the CEO-duality in the U.S. 

A scenario that was subject to comprehensive news coverage emerged in May 2013 at the shareholders’ meeting of JPMorgan Chase & Co. in Tampa, Florida, where shareholders proposed the independence of the chairman drawing on the following rationale: ‘Is a company a sandbox for the CEO, or is the CEO an employee? If he’s an employee, he needs a boss, and that boss is the board. The chairman runs the board. How can the CEO be his own boss?’ See supporting statement of shareholder proposal 6 in the bank’s definitive proxy statement in 2013, here. James L. Dimon, CEO and chairman of JPMorgan, opposed the shareholders’ demand for independence.

 

The occurrences were kicked off on the backdrop of a trader of the bank causing a gigantic loss. As a result, the leadership function of the CEO was cast doubt upon. The shareholders were eager to improve corporate governance structures of the bank by having an independent chairman acting as a counterweight to the chief executive. Voting culminated and became a referendum on James L. Dimon himself. It has been through intense lobbying that he was able to prevail. Eventually, 32.2 percent of the shares supported a separation of the two leadership positions in the bank. See Jessica Silver-Greenberg  and Susanne Craig ‘Strong Lobbying Helps Dimon Thwart a Shareholder Challenge’, New York Times, May 21, 2013.

 

In just about every shareholder meeting of listed corporations in the U.S., shareholder activists speak out in favor of splitting the chairman from the CEO. Leading American economic journalists support this clear tendency. In the March 30, 2009 issue of the Wall Street Journal, Johann S. Lubin, under the headline ‘Chairman-CEO Split Gains Allies – Corporate Leaders Push for Firms to Improve Oversight by Separating Roles’, drew attention to an academic study conducted by the Millstein Center for Corporate Governance and Performance at Yale University School of Management. The study (Policy Briefing No. 4: Chairing the Board – The Case for Independent Leadership in Corporate North America) is available on the internet. See at http://web.law.columbia.edu/sites/default/files/microsites/millstein-center/2009%2003%2030%20Chairing%20The%20Board%20final.pdf. Endeavors to this effect are also continuously covered in the blog of the Harvard Law School Program on Corporate Governance. See at http://blogs.law.harvard.edu/corpgov/. Experts have proclaimed the independence of the chairman and issued an appeal to the NYSE and NASDAQ to make the independence of the chairman a mandatory listing standard.

 

In the March 12, 2013 issue of Fortune Magazine, Elizabeth G. Olson put the postulation in a nutshell:

 

‘Governance groups say that the corporate coziness – the CEO acts as his own boss because he reports to himself in his chairman role – allows unchecked risk taking that may produce spectacular short-term results but winds up harming the company.’ See Elizabeth G. Olson, ‘Why the CEO-chair split matters’, Fortune Magazine, March 12, 2013.

 

Meanwhile, activists in the U.S. have been producing overwhelming success. According to a paper written by Charles Tribbett printed in the journal ‘THE CORPORATE BOARD’, 44 percent of the S&P 500 corporations had implemented a split of the jobs of chairman and CEO in 2012. As regards the segment of NASDAQ 100, 62 percent of the corporations had a split in 2012. See Charles Tribbett, ‘Splitting the CEO and Chairman Roles – Yes or No?’, THE CORPORATE BOARD, November / December 2012.

 

IV. The German D&O two-tier trigger policy gaining interest in the U.S. 

The necessity of separate D&O insurance protection for the members of the supervisory board is predicated on conflicts of interest. In essence, the rationale is conterminous with the one that U.S. American shareholder activists rely upon in furtherance of the separation of CEO and chairman. So do they invoke conflicts of interest in order to substantiate their position. Except for in a limited number of monistic European Public Companies, management is institutionally separated from monitoring in the German board system. And yet, which strikes the observer as odd, members of both organs, i.e. the executive and the supervisory board, are collectively insured in Germany under the same policy with the very same insurer. This is the result of an unreflecting reception of U.S. American coverage concepts in Germany. D&O experts in the U.S. convey their interest in the latest discussion surrounding the two-tier trigger policy in Germany. See guest post in D&O Diary at https://www.dandodiary.com/2013/05/articles/international-d-o/guest-post-the-german-two-tier-corporate-board-structure-and-its-impact-on-do-insurance-cover/. The upshot of the essential reasoning underlying such a concept of a two-tier trigger D&O insurance structure is this:

 

Pursuant to the German Stock Corporation Act § 111(1), the supervisory board shall supervise the management of the company. As the monitoring of management rests with the supervisory board, any mistake (breach of duty) made by management can theoretically be converted into a mistake by the supervisory board. See Bachmann, NJW-Beil. 2014, 43 (44); see also BGHZ 117, 127 seq., BGH, ZIP 2007, 224 seq. Practice in damage case is permeated by the defendant members’ of the executive board serving third-party notices on the members of the supervisory board that acted on the basis of the ARAG-doctrine. In such a scenario, the insurer must refrain from simultaneously representing the opposing interests of the defendant executive board members and the notified supervisory board members. The insurer is ensnared in an inherent conflict of interest. See Schäfer/Rückert, German language interview on the Director’s Channel, at www.directorschannel.tv/do_-_versicherung_interessenkonflikt. If the insurer exerts his sole authority to conduct litigation, then, in accordance with the legal precedents set forth by the Federal Supreme Court, it shall protect the interests of the insured person in the same way a lawyer retained by that person would. See BGHZ 119, 276 (281); BGH r+s 2011, 499 (599). That is to say the insurer must not defend claims both on behalf of the executive and the supervisory faction.

 

V. Conclusion  

According to the German authority regime in the Stock Corporation Act, the decision whether to afford separate D&O insurance protection to the supervisory board members (two-tier trigger policy) is one to be made by the shareholders’ meeting in Germany. Thus, foreign investors in Germany – in particular from the U.S. – also have a say in this vital decision. Through their endeavors to sever the CEO-duality, activist shareholders in the U.S. are familiar with the rationale prompting the separate D&O insurance protection of supervisory board members in Germany. Conflicts of interest almost invariably become virulent in this context. The common goal of both debates, i.e. in the U.S. and Germany, is the split.