federal depositOn March 14, 2014, In the latest development in the long-running saga of the Libor scandal, the FDIC in its capacity as receiver of 38 banking institutions that failed between 2008 and 2011, has filed a massive new lawsuit in the Southern District of New York against the U.S. dollar Libor rate-setting banks and against the British Bankers’ Association and related entities, alleging that between 2007 and mid-2011, the defendants conspired to manipulate the USD Libor rate. A copy of the FDIC’s complaint can be found here.

 

The defendants in the lawsuit include sixteen USD Libor benchmark rate setting banks and related entities, as well as the British Bankers’ Association and related entities. During the relevant time-period the BBA sponsored and facilitated the setting of the Libor benchmark rates. The rate-setting banks named as defendants include banks from the U.S., U.K., Canada, Switzerland, France, German, the Netherlands and Japan.

 

The FDIC in its capacity as the failed banks’ receiver alleges that the defendants manipulated and suppressed the U.S. dollar Libor benchmark rate from as early as August 2007, allegedly to create the impression that the banks were healthier than they appeared and in order to benefit individual trading positions at the various banks. The complaint includes detailed allegations drawing heavily upon the admissions of and the internal communications from the rate-setting banks that have reached regulatory settlements (specifically, UBS, Barclays, RBS and Rabobank).

 

The FDIC’s allegations against the BBA and related entities are that the organization allegedly participated in the scheme to protect revenue streams the organization derived from selling Libor licenses and to appease the panel banks.

 

The complaint alleges that the defendants’ manipulative conduct restricted the price of products tied to Libor, limited consumer choice, and suppressed the rates paid on Libor benchmarked financial products, including in particular products in which the rate-setting banks themselves where counterparties. The complaint alleges that the closed banks were “injured in their business and property and have suffered damages in an amount presently undetermined.”  

 

The complaint alleges that “financial institutions around the world, including the closed banks, reasonably relied on Libor as an honest and accurate benchmark of a competitively determined interbank lending rate.” The FDIC alleges that the “Defendants’ wrongful conduct … caused substantial losses to the closed banks.” The FDIC also alleges that the rate-manipulation resulted in higher prices for Libor-based financial products.

 

 

The closed banks on whose behalf the FDIC is proceeding as receiver in this action closed between 2008 and 2011, and include both some the largest failed banks (including WaMu, the largest bank failure in U.S. history), as well as numerous other smaller failed banks. Obviously, by aggregating the claims of nearly four dozen failed banks, the FDIC hopes to be able to magnify the scale of prospective damages.

 

The complaint asserts twenty-four separate substantive counts, including ten counts for breach of contract and two additional contract related counts. In these contractual violation counts, the FDIC alleges that various specified contracting banks entered into various pay-fixed swaps or other interest-rate sensitive financial products. The FDIC alleges that the manipulative conduct breached the specified defendant(s) contract(s) with the specified failed bank, resulting, among other things, in an underpayment of interest due under the contracts.

 

Counts XIII through XXII of the complaint assert that by their alleged manipulative conduct the various defendants committed a variety of torts, including fraud, aiding and abetting fraud, civil conspiracy to commit fraud, negligent misrepresentation, tortious interference with contract (and related tortious interference claims).

 

Count XXIII alleges a violation of Section 1 of the Sherman Act, and Count XXIV alleges violations of the Donnelly Act (which is the primary antitrust law of New York).

 

The FDIC is not the first U.S. governmental agency to file a massive civil complaint for damages against the Libor benchmark rating setting banks alleging that the banks had manipulated the benchmark. For example, as noted here, in March 2013 Freddie Mac filed an action in the Eastern District of Virginia against the Libor rate setting banks as well as against the BBA, alleging both antitrust violations as well as breach of contract claims.

 

Similarly, in October 2013, Fannie Mae sued nine of the Libor rate-setting banks alleging that they had manipulated the rates causing Fannie Mae to lose money on mortgages and other instruments, and seeking over $800 million in damages.

 

In addition, as discussed here, in September 2013, in a complaint that in many way foreshadowed the FDIC’s Libor-related complaint, the National Credit Union Administration acting as receiver of five failed credit unions filed an action in the District of Kansas alleging that the defendant rate-setting banks  manipulated the benchmark, costing the failed institutions millions of dollars in lost interest income. Interestingly, however, the NCUA’s complaint asserts claims based only on alleged antitrust violations.

 

In its complaint, the FDIC, by contrast to the NCUA, chose not to feature its antitrust allegations, although the FDIC did include antitrust claims. The FDIC’s promotion of its other claims  in preference to its antitrust allegations is hardly surprising in light of the fact that, as discussed here, in March 2013, Judge Naomi Reece Buchwald ruled in the consolidated Libor antitrust action pending in the Southern District of New York that the claimants lack antitrust standing, She ruled that the defendants’ alleged actions did not affect competition, as the rate-setting banks were not in competition with one another with respect to Libor rate-setting. Judge Buchwald said ““the alleged collusion occurred in an arena in which defendants never did and never were intended to compete.” (Judge Buchwald’s ruling is on appeal to the Second Circuit).

 

In the wake of Judge Buchwald’s decision, other claimants have opted to file their Libor manipulation claims in state court, alleging state law claims (as shown for example here), or to try to proceed on other legal theories – for example, under the federal securities laws. The FDIC appears to have adopted this model, by contrast to the approach of the NCUA, which elected to proceed on the basis of the antitrust allegations alone.

 

The continuing accumulation of Libor scandal-related litigation is interesting. Though the regulators have scored some very impressive regulatory settlements, the related civil litigation has so far been unproductive for the damages claimants. Not only was the consolidated antitrust action dismissed, as noted above, but in addition the securities class action lawsuit filed against Barclays was also dismissed (about which refer here). So far at least, the damages claimants have little to show for their efforts. It remains to be seen if the FDIC’s sortie on behalf of the failed banks will fare any better.

 

A March 14, 2014 Bloomberg article regarding the FDIC’s lawsuit can be found here.

 

cornerMergers and acquisition activity continued to attract litigation in connection with virtually every transaction during 2013, and for the first time during 2013 the litigation filing rates for smaller transactions was as great as for larger transactions, according to a study recently released by Cornerstone Research. The study, entitled “Shareholder Litigation Involving Mergers and Acquisitions: Review of 2013 M&A Litigation” can be found here. Cornerstone Research’s March 13, 2014 press release about the study can be found here.

 

According to the report, during 2013, plaintiffs’ attorneys filed lawsuits in connection with 94 percent of all M&A deals announced during the year and valued at over $100 million, representing a total of 612 lawsuits. In the past, smaller deals (described in the report as those valued between $100 million and one billion), attracted litigation at a lower rate than larger deals (defined as those with a value over $1 billion). However, for the first time during 2013, the percentage of deals attracting litigation was the same for both the “smaller” deals and the “larger” deals – both attracted lawsuits about 94% of the time.

 

As has been the case for several years, most deals attracted multiple lawsuits, with an average of five lawsuits for those valued between $100 million and $1 billion, and an average of 6.2 lawsuits for deals valued over $1 billion. The Dell, Inc. buyout transaction attracted 26 lawsuits, the most for any single deal during the year.

 

As has also been the case for several years, deals are attracting lawsuits in multiple jurisdictions. 62 percent of 2013 deals were litigated in more than one court – with 54% of 2013 deals litigated in two jurisdictions and eight percent of 2013 deals litigated in three jurisdictions. (The percentage of deals litigated in three or more courts has declined by half over the last two years.) The Linn Co//Berry Petroleum Deal was challenged in a record six jurisdictions. The most active courts outside of Delaware for M&A litigation were New York County, NY (with 39 deals litigated); Santa Clara County, CA (30 deals); and Harris County, TX (27 deals).

 

During 2013, three quarters of the M&A deal lawsuits were resolved before the deal closed. Of the cases that were resolved before the deal closed, 88 percent were settled, 9 percent were withdrawn by the plaintiffs, and three percent were dismissed by the court. Looking at the cases filed in prior years, with regard to cases that did not settle prior to closing, the lawsuits remained pending for as long as four years. None of these deals the lived on after the closing went to trial , and all judgments (whether summary judgment or judgment on the pleadings) went to defendants.

 

The 2013 M&A litigation data in the Cornerstone Research report is consistent with the information previously published by Professors Cain and Davidoff, as discussed here. The Cornerstone Research report’s statistics about what happens to the M&A lawsuits that are not disposed of prior to deal closing is consistent with the analysis discussed in my prior post (here) about the “curse” of M&A lawsuits post-closing. With the proliferation of M&A related litigation, it is now more advisable than ever for companies involved in transactions to take steps in connection with the deal to try to reduce the improve the companies’ abilities to defend themselves in the inevitable lawsuit, as discussed here.

skaddenlogoThe Halliburton case now before the U.S. Supreme Court could potentially change the securities class action litigation landscape in the United States, as the Court considers whether or not to dump the fraud on the market theory.  However, based upon the oral argument in the case on Wednesday, March 5, 2014, it appears that the Court may be unlikely to dump the fraud on the market theory altogether, bur rather adjust the way it is applied by modifying the way it is to be applied, as discussed here. The transcript of the oral argument can be found here.

 

In the following guest post, Jen Spaziano and Allon Kedem of Skadden, Arps, Slate Meagher & Flom’s Washington, DC office break down the Halliburton oral argument and detail their conclusion that the Court is likely headed toward a procedural approach that will allow defendants to opportunity to try to rebut the presumption of classwide reliance under the fraud on market theory. A verson of this article previously appeared on Law 360, here.

 

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

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By now, most of us have heard about argument in Halliburton v. Erica P. John Fund, No. 13‑317, which took place before the Supreme Court last week.  Of course, it is impossible to know how the Court will rule when it issues its opinion later this year—likely in June.  However, analysts generally have agreed upon two takeaways from the argument.

First, despite some recognition by the Justices that the efficient market theory underlying Basic Inc. v. Levinson, 485 U.S. 224 (1988), is not perfect, there did not appear to be sufficient support for overruling Basic outright and doing away with a presumption of classwide reliance derived from the fraud-on-the-market theory. 

Second, it appears that at least some of the Justices are considering a middle ground that would leave Basic substantially intact but require something more at the class certification stage.  In particular, numerous questions were asked of both parties and the United States regarding the “midway position”—as Justice Kennedy described it—articulated in an amicus brief submitted in support of Halliburton by two law professors.  The professors’ brief advocates replacing Basic’s focus on market efficiency with an event study that would look for market distortion due to an alleged misrepresentation. 

So, although many expected the argument to focus on the economic theory underlying Basic and traditional principles of stare decisis (a term that was mentioned just once during the argument), much of the discussion instead focused on the practical realities of securities litigation, including the procedures available to defendants to rebut Basic’s presumption of reliance and the percentage of cases that make it to summary judgment and trial.  Below is a summary of some of the key points raised by counsel and the Court, which strongly suggest that, if Basic’s presumption of classwide reliance survives, something needs to be done to ensure that its equally strong mandate regarding the presumption’s rebuttability is given effect. 

Is the presumption of reliance rebuttable?  Without a doubt.  Basic plainly states (among other things):  “Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance.” 485 U.S. at 248.  As Justice Ginsburg recognized at argument:  “[I]t’s not a question of is it rebuttable. . . .  It’s a question of when.”  (03/05/2014 Hearing Tr. (“Tr.”) at 9:11-13.)

Is the presumption rebutted in practice?  Frequently not.  As Halliburton’s counsel explained, “[i]t’s very unusual outside of the context of the Second Circuit which allows rebuttal with respect to price impact.”  (Tr. at 8:22-24.)  If a defendant is not entitled to rebut the presumption at the class certification stage, the upshot is that “it is virtually impossible” for a defendant to rebut the presumption following class certification.  (Tr. at 8:21-22.)  Quoting an amicus brief, Halliburton’s counsel elaborated:  “Outside of [the Second Circuit] . . . they’re as rare as hen’s teeth.”  (Tr. at 8:24-9:1.) 

Why is this?  Because, as Justice Scalia asked rhetorically, “[o]nce you get the class certified, the case is over, right?”  (Tr. at 23:6-7.)  In fact, as Halliburton’s counsel noted, “only 7 percent” of securities fraud class actions make it to the summary judgment stage, “because once the case gets past class certification . . .  there is an in terrorem effect that requires defendants to settle even meritless claims.”  (Tr. at 51:5-9.)  The rate is even lower with respect to trial:  “less than one third of one percent actually go to a verdict.”  (Tr. at 23:8-9.)

What percentage of class certification motions are granted?  According to Halliburton’s counsel, “[t]he most recent studies by NERA and Stanford show that 75 percent of class certification motions are granted in securities cases; and that number is much, much higher with respect to New York Stock Exchange companies that essentially have no way to dispute market efficiency.”  (Tr. at 50:17-22.)

When is class certification typically decided?  The Chief Justice asked this question, and the Fund’s counsel correctly responded that “[g]enerally, you have summary judgment after class certification.”  (Tr. at 37:3-7.)  In fact, class certification frequently is decided long before summary judgment—in some cases even before merits discovery has begun.  This is consistent with Federal Rule of Civil Procedure 23(c)(1)(A), which states that “[a]t an early practicable time after a person sues or is sued as a class representative, the court must determine by order whether to certify the action as a class action.”  (Emphasis added.)

Can a defendant move for summary judgment at an earlier point in the case?   The Fund’s counsel asserted that “there’s nothing that prevents a defendant from making a motion for summary judgment” at an earlier stage of the litigation; he also offered that “[y]ou could have summary judgment at the class certification stage.”  (Tr. at 37:9-15.)  While counsel’s statements are technically correct, they ignore two procedural hurdles to obtaining summary judgment at an early stage.  First, Federal Rule of Civil Procedure 56(d) allows a nonmoving party to seek denial or deferral of the motion for summary judgment “when facts are unavailable to” it.  So, if a defendant were to move for summary judgment at the class certification stage (which often happens before discovery has concluded), the plaintiff could (and likely would) argue that the motion is premature.  The Fund’s counsel appeared to concede this very fact:  “[B]ut the issue on the merits is that if you don’t have discovery, you can’t decide these issues obviously.”  (Tr. at 37:19-21.)  Second, litigants do not have an automatic right to file successive summary judgment motions, and, in most cases, it is within the district court’s discretion whether to permit successive motions.  See, e.g., Hoffman v. Tonnemacher, 593 F.3d 908, 911 (9th Cir. 2010) (holding that “district courts have discretion to entertain successive motions for summary judgment”); Local Civil Rule 56(C) (E.D. Va.) (“Unless permitted by leave of Court, a party shall not file separate motions for summary judgment addressing separate grounds for summary judgment.”).  Accordingly, if a defendant were to move for summary judgment in an effort to rebut the fraud-on-the-market presumption at the class certification stage, the defendant might be precluded from later filing a motion for summary judgment on other key elements of a securities fraud claim.  For these reasons, absent judicial guidance sanctioning the use of summary judgment motions to rebut Basic’s presumption, defendants may be reluctant to utilize this procedural tool.

To sum up:

  1. 1.                  A defendant has the right to rebut Basic’s presumption of classwide reliance based on the fraud-on-the-market theory.
  2. 2.                  As a practical matter, if a class is certified, most cases settle, such that Basic’s presumption is rarely, if ever, tested following class certification.
  3. 3.                  Basic’s presumption could be tested through a summary judgment motion at the class certification stage, but the plaintiff likely would argue that any such motion is premature, and the defendant runs the risk (however remote) that it will be precluded from filing a successive summary judgment motion at a later stage of the case.

What does this mean?  As a practical matter, if a defendant is not entitled to rebut the presumption at the class certification stage, Basic’s directives regarding ways in which the presumption can be rebutted often remain untested.    

Is there a solution?  Justice Kennedy correctly recognized that under the “Basic framework, at the merits stage there has to be something that looks very much like an event study” and aptly asked, “since you’re going to have it anyway, why not have it at the class certification stage?”  (Tr. at 18:8-11, 14-16.)  The Fund’s counsel appeared to resist this approach, asserting that “the cost and expense at the class certification stage and the time delay would increase enormously, because now you would have to have these detailed event studies not just to prove efficiency of the market,” but also “to show what the impact was of the particular allegedly culpable misrepresentation and disclosure.”  (Tr. at 37:21-38:4.)  The Deputy Solicitor General, however, appeared to have a different take.  When asked for his views regarding adoption of the event study approach, he stated that “if anything, that would be a net gain to plaintiffs, because plaintiffs already have to prove price impact at the end of the day.”  (Tr. at 50:8-10.)

*     *     *

The procedures and percentages discussed during the Halliburton argument demonstrate that, if Basic survives, something should be done to ensure that defendants have a meaningful opportunity to rebut Basic’s presumption of classwide reliance.  This could be accomplished by requiring more of the plaintiff at the class certification stage or approving the defendant’s use of an early summary judgment motion to test the presumption.  Although the law professors’ event study approach would require a greater showing by the plaintiff at the class certification stage than is required in many courts today, practical questions remain about the approach—for instance, who would bear the burden of proof and whether a showing of market distortion could be rebutted at the class certification stage.  The answers to these questions could go a long way to giving further meaning to Basic’s clear directive that the presumption of reliance is rebuttable.

—By Jen Spaziano and Allon Kedem, Skadden, Arps, Slate, Meagher & Flom LLP

Jen Spaziano is a partner and Allon Kedem is an associate at Skadden, Arps, Slate Meagher & Flom’s Washington, DC office.

georgiaAs part of our beat here at The D&O Diary, we have to read a lot of judicial decisions. We are well acquainted with the fact that court rulings vary quite a bit, but every now and then we read an opinion that makes us stop and say – “What?” That was our reaction to a recent set of rulings out of the District of Georgia in an insurance coverage action relating to an FDIC failed bank claim.

 

One of the regular features of FDIC failed bank litigation – going all the way back to the S&L crisis – has been that frequently the FDIC’s liability claim often is accompanied by a parallel action in which the agency or the failed bank’s D&O insurer seek a judicial declaration that the FDIC’s claims are or are not covered under the failed bank’s policy. While this kind of insurance coverage litigation has been a staple of failed bank litigation landscape for decades — during which scores of failed bank insurance coverage suits have gone forward — the FDIC has now decided to argue that under FIRREA’s anti-injunction provision, the carrier cannot pursue a coverage action against the agency in its capacity as receiver of the failed bank. Not only that, but the FDIC has managed to convince a federal district court judge to go along with this interpretation.

 

In a series of two decisions, Northern District of Georgia Judge Richard W. Story has held that a failed bank’s D&O insurer’s declaratory judgment action against the FDIC as receiver of the failed Habersham Bank and against the failed bank’s former directors and officers were precluded by the “jurisdictional  bar” in Section 1821(j) of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA). Section 1821 (j) provides that “no court may take any action, except at the request of the Board of Directors by regulation or order, to restrain or affect the exercise of powers or functions of the [FDIC] as conservator or a receiver.”

 

Judge Story’s initial March 28, 2013 ruling can be found here and his March 5, 2014 ruling denying the D&O insurer’s motion for reconsideration can be found here.

 

Habersham Bank of Clarkesville, Georgia failed on February 18, 2011. On August 25, 2011, the FDIC as receiver for Habersham Bank sent a claim letter to certain of the failed bank’s former directors and officers, in which the agency asserted that the individuals had breached their duties to the bank in connection with certain loan transactions and therefore are liable for alleged damages. The failed bank’s D&O insurer initiated an action seeking a judicial declaration that, based on a number of grounds, there is no coverage under its policy for the FDIC’s claims.

 

The FDIC filed a motion to dismiss the D&O insurer’s declaratory judgment action, arguing that the Court lacks jurisdiction over the action under Section 1821(j). The agency argued that the action would “restrain or affect” the FDIC’s powers as receiver because it would impede or interfere with its power under FIRREA to “collect all obligations and money due the institution.”

 

In his initial March 2013 ruling, Judge Story granted the FDIC’s motion, based on his determination that “the FDIC has a future interest in the D&O coverage” and that “issuing a declaratory judgment on Plaintiff’s claims would affect the FDIC’s ability to collect money due to Habersham,” and therefore that the declaratory judgment action is “barred” under Section 1821(j). He ruled further that because the D&O insurer cannot proceed against the FDIC, its declaratory judgment action against the individual officers cannot proceed either, because it would “affect the FDIC’s interests in the policy if and when the FDIC attempts to assert its rights to the policy.” In reaching this decision, Judge Story relied on a Northern District of Illinois (the “Wheatland” decision) in which the court had similarly held that Section 1821 (j) operated as a jurisdictional bar to a D&O insurer’s declaratory judgment action.

 

Judge Story added that the application of Section 1821(j)’s “jurisdictional bar” does not leave the D&O insurer without a remedy. The D&O insurer, he said, can pursued its declaratory judgment action through FIRREA’s administrative processes, and if the D&O insurer’s “claims are not adequately addressed through the administrative process, it is entitled to de novo review in federal district court.”

 

The D&O insurer filed a motion for reconsideration and for leave to file an amended complaint from which the FDIC would be dropped as a party, so that the action for declaratory judgment could proceed against the directors and officers alone. In making this motion, the D&O insurer referenced the further proceedings in the Wheatland action, in which the Northern District of Illinois had held that the insurer’s declaratory judgment action could proceed after the insurer amended its complaint to remove the FDIC as a party to the action.

 

In his March 5, 2014 order, Judge Story denied the insurer’s motion for reconsideration.  Among other things, Judge Story rejected the insurer’s attempt to rely on the further proceedings in the Wheatland case, ruling that the insurer’s efforts to amend its complaint and proceed with its declaratory judgment action in that case were unopposed, which was not true of the Habersham case.

 

Discussion

I would have thought that perhaps Judge Story might have been more skeptical of the FDIC”s novel theory that Section 1821(j) presents a jurisdictional bar to a D&O insurer’s declaratory judgment action. Surely, it seems, he might ask how it could be possible if this provision bars jurisdiction for the declaratory judgment action since there have been literally scores of insurance coverage declaratory judgment actions involving the FDIC since FIRREA was enacted – some of them, as noted below,  in Judge Story’s own courtroom. Indeed, the FDIC itself has initiated many of these actions.

 

I am equally surprised by the ease with which he concluded that the insurer’s declaratory judgment action would “restrain or affect the exercise of power or functions” of the FDIC as the failed bank’s receiver because it would affect the agency’s rights under FIRREA to “collect all obligations and money due the institution.” The insurer’s declaratory judgment action doesn’t restrain or affect anything if there is no coverage under the policy, because there is obligation or money due if there is no coverage. The purpose of a declaratory judgment action is to determine whether or not an obligation exists, not to interfere with an existing obligation. 

 

Judge Story’s determination to apply the jurisdictional bar regardless of these seeming logical restraints didn’t stop there; he went on to rule that the bar applies even if the D&O insurer were to amend its complaint to remove the FDIC as a party, on the theory that if the FDIC were to establish liability against the individuals, that a ruling in the declaratory judgment action would affect the FDIC’s rights as receiver.

 

Judge Story’s suggestion that the D&O insurer can just pursue administrative remedies and if its claims are not “adequately addressed” seek de novo review in a federal district court is equally surprising. Think of it this way – Judge Story is saying that though there is an absolute  jurisdictional bar to a declaratory judgment action, if the insurer’s goes through the exercise of disputing coverage with the agency in the agency’s own administrative processes, then the insurer can proceed in district court with the otherwise jurisdictionally barred action. That the declaratory action might go forward in the district court in the end anyway but only after going through an odd bit of kabuki theater suggests just how strained and illogical the FDIC’s inexplicable assertion of the supposed jurisdictional bar is here.

 

John McCarrick of the White & Williams law firm is quoted as saying in a March 10, 2014 Law 360 article (here, subscription required) that Judge Story’s decision, “seems to fly in the face of accepted understanding of how these cases work,” and he questioned whether something might be going on behind the scenes.

 

There is a particularly odd aspect to the fact that it is Judge Story is the one to issue this unexpected decision. Last year he was the author of a decision holding – without any jurisdictional constraints — that under the applicable D&O insurance policy’s insured vs. insured exclusion that coverage is precluded for the FDIC’s claims as receiver of a failed bank against the bank’s former directors and officers. (Refer here for further details about Judge Story’s coverage ruling.) This significant ruling is one on which D&O insurers likely would seek to rely in seeking a declaratory judgment that there is no coverage under their policies for an FDIC failed bank lawsuit. Judge Story’s determination that FIRREA imposes a jurisdictional bar to the declaratory judgment action would seem to present a significant barrier to a carrier’s attempt to rely on the insured vs. insured ruling.  

 

Judge Story’s suggestion that the insurer’s remedy if it believes there is no coverage is to pursue an administrative claim would, if followed by other courts, present the insurers with quite a dilemma. The carrier would have to decide whether to go through the seemingly meaningless formality of the administrative process, as while the administrative action is going forward, the carrier would likely have to be funding the former directors’ and officers’ defense fees. The delays associated with the administrative process might mean that the policy’s limits of liability could be substantially depleted if not exhausted while the administrative process unfolds.

 

It may be that this decision proves to be an outlier and that other courts will find this interpretation of Section 1821(j) to be strained and unconvincing. However, the landscape of failed bank insurance coverage litigation would be substantially altered if other courts were to reach the same conclusions as Judge Story here.

 

Special thanks to the several readers who sent me copies of Judge Story’s rulings.

  

ScotussealThe U.S. Supreme Court has added yet another lawsuit to its growing list of securities law cases by agreeing to take up the IndyMac MBS securities suit, to consider whether the filing of a class action lawsuit tolls the statute of repose under the Securities Act (by operation of so-called “American Pipe” tolling) or whether the statute of repose operates as an absolute bar that cannot be tolled. The U.S. Supreme Court’s March 10, 2014 order granting the petition of the plaintiff for a writ of certiorari in Public Employees’ Retirement System of Mississippi, v. IndyMac MBS can be found here.

 

As discussed below, this case could have a number of important practical implications, including whether or not putative securities class members can wait to decide whether or not to opt-out of the class action lawsuit, or must act earlier on in order to avoid the running of the statute of repose.

 

The statute of limitations for claims brought under the Securities Act of 1933, which is set out in Section 13 of the Act, provides that all claims under the Act must be brought within one year of the discovery of the violation or within the three years after the security involved was first offered to the public. Under the tolling doctrine established in the U.S. Supreme Court’s 1974 decision in American Pipe & Construction Co. v. Utah, the filing of a securities class action lawsuit tolls the running of the one-year statute of limitations. The question presented in the IndyMac MBS case is whether or not under American Pipe tolling the filing of a class action lawsuit tolls the three-year statute of repose.

 

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 intervenors the Second Circuit’s holding that the filing of a class action lawsuit does not toll the statute of repose is inconsistent with the idea of class action litigation in which the initiating class representative acts on behalf of all absent class members. Under these principles, the intervenors argued, the timely filing of a class action complaint should operate to satisfy all of Section 13’s timeliness requirements.

 

In opposing the cert petition, the defendants (the offering underwriters from the IndyMac securities offerings) not only argued that there was no need for the Supreme Court to take up the case, but also argued that the Second Circuit’s ruling was correct.  The defendants argued under existing U.S. Supreme Court case law that statutes of repose are intended to operate as an absolute “cutoff” to all liability. They also argued that American Pipe tolling was not intended to apply broadly to all time limitation but rather to apply only to statutes of limitation. The statute of repose, they argued, provides litigants with substantive rights that cannot be overridden by equitable principles or even under procedural rules regarding class action litigation.

 

Even though this case involves technical issues involving statutes or repose and seemingly arcane legal doctrines, the case has potentially significant practical implications.

 

First and foremost, if the filing of a class action lawsuit does not toll the statute of repose, current practices regarding class action opt outs could be significantly affected. As reflected in an amicus brief filed on behalf of certain institutional investors and in support of the intervenors’s cert petition, institutional investors rely on class action claims filed by other claimants to prevent their claims from being time barred. They argue that the Second Circuit’s decision would require institutional investors to incur significantly higher litigation expenses as they would have to intervene earlier or otherwise act to protect their interests. They argue that they would have to become actively involved more frequently than they do now.

 

More to the point, the institutional investors also argue that it would impair their right to opt-out from the class litigation. Up until now, the institutional investors argue, they have been able to rely on American Pipe tolling await receipt of notice of claim and of the terms of prospective settlements before determining whether or not they believe the class representatives have adequately represented the class and protected their interests, or whether they feel that their interests are best served by opting out of the class. Without the benefit of American Pipe tolling with regard to the statute of repose, the institutional investors will have to monitor the many cases in which there interests are involved more closely and intervene or file individual actions in order to preserve their interests.

 

In other words, if the U.S. Supreme Court were to affirm the Second Circuit, current practices regarding class action opt-outs would change. Opt-outs have been an increasingly important part of securities class action litigation in recent years, but many of these practices would end or at least change if the institutional investors can’t simply wait until the class action has been settled to decide whether or not they want to opt out.

 

On the other hand, if the current practices where some investors can sit back and await the outcome of the class action before deciding whether or not to opt out were to be undercut, it could make it easier for defendants to secure a global settlement without worry that later opt outs will undermine the value of the class settlement or even trigger the “blow” provisions in the class action settlement agreement.  

 

Because the outcome of this case may well depend on the differences between statutes of limitations and statutes of repose, the outcome of this case could well have an impact beyond just the context of class action litigation under the Securities Act of 1933. The outcome could affect the determination of whether or not other statutes of repose are or are not absolute – including the Securities Exchange Act of 1934 and other statutes unrelated to the securities laws. In addition, the Court’s determination of the impact of the filing of a class action complaint on questions of timeliness would likely have an impact on class litigation outside of the securities law context as well.

 

In any event, the Supreme Court has now taken on yet another case under the securities laws. As I noted just a few days ago when the Court agreed to take up the Omnicare case, the Court has for whatever reason seemed within recent years seemed very interested in securities cases. In the past, years would pass between Supreme Court securities cases. Now the Court not only has the potentially significant Halliburton case on this year’s docket, but already has two cases on the docket for next year, the Omnicare case and the IndyMac MBS case. In fact, both Omnicare and the IndyMac MBS case involve claims under Section 11 of the Securities Act of 1933.

 

The body of Supreme Court securities laws decisions is expanding rapidly, and as a result securities law jurisprudence has evolved significantly just in the last several years. It is clear that with these latest cases on the Supreme Court’s docket, the laws will continue to evolve quickly.

 

 

dandbThe indictment last week of the top officials from the collapsed Dewey &  LeBouef law firm is merely the latest development in the long-running sequence of events following the law firm’s demise. The indictment (and the accompanying SEC enforcement action) paints a vivid picture of the desperate efforts of the law firm’s top officials to avert financial disaster, which in turn allegedly led them to mislead the law firm’s partners, creditors and investors. As I have previously noted in connection with the legal proceedings following the firm’s collapse, these latest developments raise important issues surrounding management liability insurance for law firms.

 

In many respects, the Manhattan District Attorney’s indictment is not a complete surprise. As detailed in James B. Stewart’s fascinating (yet deeply disconcerting) October 14, 2013 New Yorker article about the events leading up to the law firm’s demise entitled “The Collapse” (here), the criminal investigation had commenced even before the law firm filed for bankruptcy in May 2012.

 

Dewey & LeBoeuf was the product of the ill-fated 2007 merger between the storied Dewey Ballantine law firm and the LeBouef Lamb Greene & McRae law firm. At the time, the wisecrack was that “Dewey married money, LeBoeuf married up,” but the New Yorker article shows that turmoil and fear at LeBoef and declining firm fortunes  at Dewey had driven the firms to the alter. A potent mix of outsized partner compensation guarantees, infighting and the economic downturn led to serious financial problems in the first full year after the merger.

 

According to the indictment (here), as a result of the revenue downturn in 2008 and the pressure of the guaranteed partner payments, the company was out of compliance with certain covenants in its bank line of credit. In order to create the false impression that it was in compliance, the firm’s managers initiated a series of steps that one internal email cited in the indictment described as “accounting tricks.” The firm’s CFO described the process in another email as “cooking the books.”  The indictment describes a variety of different accounting ruses the top firm managers orchestrated to falsify the firm’s apparent financial condition.

 

These efforts were compounded in 2010, when the firm completed a $150 million private placement bond offering. The offering documents relied on financial statements that overstated the firm’s 2008 and 2009 revenues by tens of millions of dollars. According to the allegations, following the offering, the firm’s senior managers provided the bond investors with fraudulent quarterly certifications.

 

The criminal indictment names as defendants the firm’s former Chairman Steven Davis, former executive director Stephen DiCarmine and former Chief Financial Officer Joel Sanders. (A fourth individual is also named as a defendant in one count of the indictment for falsifying entries). A parallel SEC enforcement action (about which refer here) asserts securities fraud charges against Davis, DiCarmine and Sanders, as well as two members of the firm’s accounting staff. For readers that are interested, the New Yorker article linked above provides a lurid  picture of involvement of Davis and DiCarmine in the events that led up to the merger and then to the combined firm’s eventual collapse.

 

As discussed in Alison Frankel’s detailed March 6, 2014 post on her On the Case blog about the regulatory and criminal charges against the former Dewey firm managers (here), both the indictment and the SEC action are unprecedented. While there have previously been law firm managers that have been indicted before, those charges have mostly involved brazen self-enrichment through embezzlement or the like. Here, the criminal charges were the result of the actions the firm’s senior managers took in the course of their duties as leaders of the firm to try to stave off disaster after the global financial crisis.

 

But as Frankel also points out, the allegations may be unprecedented, but the precedent has now been set. The circle of potential claimants against law managers has just been widened, and the kinds of allegations that might be asserted against law firm managers have just expanded.

 

As I pointed out in a prior post about the settlement of various civil charges asserted in the law firm’s bankruptcy proceeding (here), among the many implications from the events surrounding the Dewey & LeBoeuf collapse are important implications in connection with management liability insurance for law firms.

 

First and foremost, the events following the law firm’s collapse underscore the importance for law firms of a separate program of management liability insurance. Every attorney is well aware of the need to have errors and omissions insurance in place (what they would typically think of as malpractice insurance). But while attorneys know they need insurance to protect them against claims that they erred in the delivery of client services, they may be less aware of (or persuaded of) the need for management liability insurance to protect their firm’s managers from claims for alleged wrongful acts committed in the  management of the firm.

 

As the latest regulatory and criminal proceedings arising out of the Dewey & LeBoeuf collapse demonstrate, law firm managers face the possibility of potential claims from a broad variety of potential claimants. Indeed, as the most recent developments underscore, the range of potential claimants includes creditors, vendors, suppliers, and even, as happened here, regulators and prosecutors. Indeed, at this point, the various claims that have arisen against the former Dewey & LeBoeuf provides something of a catalog of the kinds of claims law firm managers may face, which if nothing else will help law firm managers to understand why they need management liability insurance in place.

 

The events following the Dewey & LeBoeuf collapse also have important implications for law firms when they consider how much management liability insurance to buy.  Most law firms do not need to be persuaded that they need to carry significant limits of liability on their E&O insurance program, but they may underestimate their needs when it comes to management liability insurance. The cascade of claims that have been asserted against the former Dewey & LeBoeuf managers underscores the fact that in catastrophic circumstances the insurance requirements could prove to be extensive. In my prior post, I detailed how the settlements of the various claims in bankruptcy threatened to exhaust the limits of liability of the firm’s management liability insurance program. The new regulatory and criminal charges represent even more significant demands on the insurance program (or what may be left of it). This situation shows the importance of thinking about what might be required to ensure that the law firm’s managers do not run out of insurance protection before all of the claims against them have been resolved.  At a minimum, the sequence of events here ought to encourage some law firms to take a look at the possibility of increasing the limits of liability for their management liability insurance program.

 

The filing of regulatory and criminal charges against the law firm’s former management also raises important considerations with respect to the terms and conditions in a  law firm’s management liability insurance program. For starters, the criminal indictment has important implications for the program’s definition of a “Claim” under the policy. The typical definition of “Claim” in a management liability insurance policy will include as a covered claim a criminal proceeding after indictment or the return of criminal information. In the past, the wording of this particular provision in the law firm management liability policy may not have seemed as of high as a priority. But now the possibility of criminal indictment of law firm managers has emerged, this provision should take on added importance and receive greater attention.

 

The SEC’s filing of securities fraud charges may represent a particular concern. On the one hand, it is unusual for a law firm to conduct the type of offering that Dewey & LeBoeuf completed (and in light of how it played out, both law firms and investors may shy away from any future offerings of that type). On the other hand, it may make just as much sense for a law firm to try to raise capital through an offering as it does for any privately held enterprise (indeed, in Australia, there is at least one law firm that is publicly traded). The possibility of this type of offering raises a question about the availability of converge under the policy for claims arising from an offering of this type.

 

Most management liability policies for privately held organizations contain an exclusion precluding coverage for claims related to securities offerings. The sequence of events at the Dewey & LeBeouf highlights the fact that law firms might attempt to raise capital through a securities offering and that claims might arise in connection with such an offering. Again, given what happened with Dewey & LeBeouf, I don’t expect that there are going to be a lot of law firms rushing to try to raise capital through an offering of this type nor would I expect there to be much investor demand. Nevertheless, the possibilities for an offering and of claims related to the offering are there. These events suggest that the securities offering exclusion in the law firm management policy, which in the past may not have been the subject of a great deal of attention, may need to be reexamined. Of course, in light of what happened at Dewey & LeBeouf, the carriers providing law firm management liability insurance may now be particularly wary of adjusting the securities exclusion.

 

Many observers have chosen to interpret the demise of the Dewey & LeBoeuf law firm as a sort of a morality tale about the wages of supposed greed and excess. While some may find enough from the law firm’s demise to support that kind of an interpretation, it would be unfortunate if those lessons were the only ones drawn from these events. Even if the law firm’s collapse is the result of the firm’s own peculiar set of circumstances, there are still important lessons for other law firms, even those that consider their circumstances to be different from those of the late lamented Dewey & LeBoeuf firm. Among the lessons that every firm would do well to heed is the message about the importance of management liability insurance for law firm managers.

 

Start Spreading the News: For many years, since I spent a few months a very long time ago as a summer associate at one of the prestigious New York law firms, I have thought that one of the great curses on people who have been drawn to New York to seek their fortunes can be found in the lyrics of Frank Sinatra’s song “New York, New York.”

 

During my summer in New York, I often found myself in East Side watering holes full of crowds of young professionals. Inevitably, at some point (usually very late in the evening) somebody would cue up the Sinatra song and everyone in the crowd would sing along, with particular emphasis on the line that goes “If I can make it there, I’ll make it any where.” 

 

The song obviously is something of an anthem – as well as a battle hymn. Many do not succumb, but for some the compulsion to “make it there” turns the ordinary challenges of professional life into an existential struggle for self-validation. As the New Yorker’s account of this law firm’s demise demonstrates, the struggle to prove that you are “king of the hill, top of the heap” can, when things go wrong, lead to desperate behavior. Even in less extreme cases,   those who have discovered the steep downside to living “in a city that doesn’t sleep,” find themselves unable to make a tactical retreat for self-preservation, for fear that leaving town represents defeat and humiliation.

 

The amount of human misery accumulated out of a desperate effort to “make it there” and to get to and to stay “on top of the heap” is beyond calculation. It is a song for the winners, but even in New York, not everyone can win, and even in New York, not everyone can win all of the time. 

ScotussealOn Wednesday March 5, 2014, the U.S. Supreme Court heard oral argument in the closely watched Halliburton case, which, as discussed at length here, potentially could change the face of securities litigation. At issue is whether or not the Court will set aside the “fraud on the market” presumption of reliance at the class certification stage in Section 10 misrepresentation cases that the Court first recognized in its 1988 decision in Basic v. Levinson.

 

Unfortunately, I was not able to attend the oral argument. Fortunately, Alison Frankel was able to attend, and she has a detailed rundown of the argument on her On the Case blog, here. In addition the transcript of the oral argument in the case can be found here. A Bloomberg summary of the argument can be found here.

 

To the extent that the outcome of a Supreme Court case can be discerned from the oral argument, it does not appear that the Court will be setting aside the fraud on the market theory. Of course, the oral argument may not be a true indicator of the ultimate outcome.  But at least at oral argument it appears that the Justices were drawn more to the second of the two questions on which the Court granted cert: that is, whether or not the defendants ought to be able to rebut the fraud on the market presumption at the class certification stage.

 

Justice Kennedy, looking for a “midpoint” between dumping the fraud on the market theory and simply keeping it unchanged, wanted to discuss the position advocated in the amicus brief submitted on behalf of two law professors – U. Chicago Law Professor Todd Henderson and Michigan Law Professor Adam Pritchard – contending that there should be an event study to establish that the allegedly misleading statement distorted the company’s share price, in order for there to be a presumption of reliance at the class certification stage.  

 

Under this “price impact” approach, the plaintiff’s entitlement to a presumption of reliance based on the fraud on the market theory would depend on the question of whether an event study showed that the misrepresentation had distorted the share price. Several Justices, including Justice Breyer asked questions about the costs and value of an event study at the class certification stage, while Justice Sotomayor questioned whether there would be any need to perpetuate the efficient market hypothesis with the fraud on the market theory if an event study were to be required.

 

Counsel for Halliburton showed a clear willingness to accept an outcome for a requirement of an event study at the class certification stage to show that the misrepresentation had distorted the share price and argued that it would be a proper burden to place on the plaintiffs that sought to rely on the presumption of reliance.

 

When asked about the possibility of looking at price impact, counsel for the plaintiffs sought to argue that the price impact ought to be a merits question that would be very difficult and expensive to discern, because there are “confounding factors” that may complicate the question of what affected the share price.

 

Even though much of the argument was given over to the “price impact” discussion and even though there was a lot of discussion of the possibility of requiring an event study, there is nothing that says that either of those features ultimately will be reflected in the court’s decision.

 

The one thing that is interesting is that none of the Justices – even those that had in the Amgen case shown an interest in revisiting the Basic presumption and the fraud on the market theory – seemed particularly primed during oral argument to try to completely overturn Basic. Counsel for Halliburton didn’t seem to get support on that point from any of the Justices you would have expected to be supporting him there.  In addition, several of the Justices – particularly Chief Justice Roberts – seemed very reluctant to wade into the economic debate surrounding the question of whether or not the markets are efficient.

 

As I said above, it remains to be seen how this case ultimately will turn out. The Court’s decision is due before the end of the Court’s current term in June. 

omnicareAs if it were not enough that the Court is already considering a case that could change the face of securities class actions (that is, the Halliburton case, which will be argued this week), the U.S. Supreme Court has now agreed to take up yet another securities case.

 

In a March 3, 2014 order (here), the Court granted the defendant’s petition for writ of certiorari in Indiana State District Council of Laborers v. Omnicare, to determine 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 they are not required. The case is potentially important because the absence of allegations of knowledge of falsity is a frequent basis for dismissals of Section 11 suits in the Second and Ninth Circuits, where the vast preponderance of securities suits are filed. As it is, the current split would allow cases to go forward in the Sixth Circuit that would not survive in the Second and Ninth Circuits.

 

Background

 

Omnicare provides pharmaceutical care services to long-term care facilities. The plaintiffs allege that Omnicare was engaged in various illegal activities including kickback arrangements with pharmaceutical companies and the submission of false Medicare and Medicaid claims. The plaintiffs allege that in connection with its December 15, 2005 stock offering, the company’s offering documents falsely stated that its arrangements with the drug companies were “legally and economically valid.”

 

As detailed here, the case, which was first filed in February 2006, has a long procedural history, and has made two separate trips to the Sixth Circuit. The most recent trip followed after the district court had dismissed the case, holding that the plaintiffs were required to but had failed to plead knowledge of falsity on the defendants’ part. The plaintiffs appealed.

 

In a May 23, 2013 opinion (here), a three-judge panel of the Sixth Circuit, in an opinion by Judge R. Guy Cole, Jr. reversed the district court (in relevant part), holding that “Under Section 11, if the defendant discloses information that includes a material misstatement, that is sufficient and a complaint may survive a motion to dismiss without pleading fraud.” The Sixth Circuit reasoned that a showing of knowledge of falsity was not necessary for claims under Section 11, which imposes strict liability for material misrepresentations in offering documents. The court said that “no matter the framing, once a false statement has been made, a defendant’s knowledge is not relevant to a strict liability claim.” 

 

The Sixth Circuit expressly declined to follow the Ninth Circuit’s 2009 ruling in Rubke v. Capitol Bankcorp and the Second Circuit’s 2011 decision in Fait v. Regions Financial, which had held that in order to survive a motion to dismiss, a Section 11 plaintiff must allege that the allegedly misleading statement was both objectively false and subjectively false – that is, that the statement was untrue and that the defendant disbelieved the statement at the time it was made.

 

In the Sixth Circuit’s view, the Second and Ninth Circuit decisions were based a faulty reading of the U.S. Supreme Court’s 1991 decision in Virginia Bankshares v. Sandberg. The Sixth Circuit said that in its reading the Virginia Bankshares case did not require the outcome that the Second and Ninth Circuit had reached. The Sixth Circuit said that “The Virginia Bankshares court was not faced with and did not address whether a plaintiff must plead knowledge of falsity in order to state a claim. It therefore does not impact our decision today.”

 

The defendants filed a petition for a writ of certiorari, seeking to have the U.S. Supreme Court determine whether for purposes of a Section 11 claim it is sufficient for a plaintiff to plead that that a statement of opinion was objectively wrong (as the Sixth Circuit held) or whether the plaintiff must also allege that the statement was subjectively false—requiring allegations that the speaker’s actual opinion was different from the one expressed – as the Second and Ninth Circuits require.

 

In their cert petition, the defendants argued that the Sixth Circuit both misread and failed to follow the Virginia Bankshares decision. The defendants also argued that the Sixth Circuit’s approach “threatens dangerous and far-reaching consequences” because it “would expose corporations, auditors, underwriters, and other professionals to a sharp increase in the cost of litigation, as certain types of federal securities claims – particularly those under Section 11 – would become far more difficult to resolve at the pleading stage.”

 

In their brief in opposition to the cert petition, the plaintiffs argued that the Supreme Court’s prior case law holds that Section 11 imposes strict liability in issuers for misrepresentations in offering documents, without regard to fault or knowledge. The plaintiffs also argue that Virginia Bankshares was a Section 14 case, not a Section 11 case and therefore is not controlling, and that in any event its principles should not be extended to the Section 11 strict liability context.

 

Discussion

 

At one level, it is not surprising that the Supreme Court granted cert in this case, in light of the circuit split on the question whether a plaintiff must plead subjective falsity in a Section 11 case. As things stand, a case that would be dismissed in the Second or Ninth Circuit could proceed if it were filed in the Sixth Circuit, allowing inconsistent outcomes based on nothing other than where a case was filed. In addition, the fact that the split is attributable to differing interpretations of a Supreme Court case precedent underscores the need for the Supreme Court to step in and sort out this circuit split.

 

Nevertheless, while I understand why the Supreme Court might take up this case, the Supreme Court’s recent fascination with securities law issues remains inexplicable to me. As I have said before, when the time comes for future academics to write the history of the Roberts Court, one of the things they will have to explain is why in beginning in the middle of the first decade of the 21st Century, the Supreme Court suddenly became so keen to take up securities cases. Until recemtly, years would pass between securities cases at the Supreme Court. Now there are one or two securities cases every term.

 

The Supreme Court just issued its opinion in the Amgen case a year ago. Last week, it issued its opinion in the Chadbourne & Parke case (about which refer here). On Wednesday, the Court will hear oral argument in the Halliburton case. And now the Court has agreed to take up the Omnicare case.

 

Indeed, the Omnicare case may take on heightened significance depending on how the Halliburton case turns out. Many commentators have suggested that even if the Supreme Court’s decision in the Halliburton case throws out the fraud on the market theory, plaintiffs will still be able to file securities class actions under Section 11, as the fraud on the market theory only applies to Section 10 misrepresentation cases.

 

If the lower pleading bar to Section 11 cases that the Sixth Circuit described in its Omnicare opinion is the standard to be applied the dismissal motion stage, Section 11 cases will indeed likely be an attractive alternative for prospective securities plaintiffs (or at least those that purchased their share in a securities offering). On the other hand, if the Supreme Court rules in the Onnicare case that the higher pleading bar described by the Second and Ninth Circuit applies, it will be more difficult for Section 11 complaints to survive the dismissal motion, and so Section 11 will be a less attractive alternative.

 

It is always hard to predict what the Supreme Court will do, even given the current Court lineup with a majority of Justices having a conservative inclination. Though the Supreme Court has often taken a business friendly and conservative approach to securities cases, it does not always do so – as may be seen for example in the Amgen case or the recent Chadbourn & Parke case. There is no way to know what the Court will do here.

 

The plaintiffs’ bar likely will criticize the position urged by Omnicare for in effect trying to import a scienter requirement into Section 11 claims. The defense bar has been sharply critical of the Sixth Circuit’s Omnicare opinion for overlooking the fact that as a matter of common sense a statement of opinion cannot be “false” unless the speaker truly did not hold the opinion. For a particularly good discussion of the defense perspective on the Sixth Circuit’s Omnicare decision and the issues it raises, please see Claire Loebs Davis’s August 12, 2013 post on the D&O Discourse blog (here) (the Omnicare Court’s misreading of the Virginia Bankshares decision “an abrupt wrong turn”).

 

Whatever the outcome, the Omnicare case will be important. The precedent in Second and Ninth Circuit’s holding that a Section 11 plaintiff must allege knowledge of falsity has been the basis of numerous dismissals in district courts in those circuits. If the Supreme Court were to hold that that a Section 11 plaintiffs does not need to plead knowledge of falsity, many cases in those jurisdictions that are now dismissed would survive. However, it remains to be seen which view of Section 11 pleading will prevail.

 

The Supreme Court will consider the Omnicare case in the court term beginning in October 2014.

buffOne of the most highly anticipated events in the annual business cycle is the March release of Warren Buffett’s letter to the shareholders of Berkshire Hathaway. Many investors and observers look forward to the letter for the business and investment insights that Berkshire’s Chairman provides, as well as for his plain-spoken style and homespun humor. This past Saturday morning, Berkshire released this year’s shareholder letter along with the company’s 2013 annual report. Though there is much in this year’s letter that will be familiar to long time Buffett fans, the letter contains a number of interesting new observations as well – about Berkshire, about the U.S. economy, and about investing. (Full disclosure: I own BRK B shares, although not as many as I wish I did.)

 

Much of the attention on Buffett’s letter and the Berkshire annual report will be on the company’s financial performance during 2013 – and rightfully so, as the company’s diverse operations performed well. As Buffett himself says in his shareholder letter, “just about everything turned out well for us last year – in certain cases very well.” Full-year profit rose 31 percent to $19.48 billion, or $11,850 per Class A share, while operating profit rose 20 percent to $15.14 billion, or $9,211 per share.

 

Notwithstanding these results, it would be a mistake just to focus on the company’s relative performance during a single 12-month reporting period. Obviously, it is inherent in the nature of annual reports that the company in question will be considered in an annual snapshot perspective. But if Berkshire is only considered on this annual reporting period basis, a much more meaningful message might be overlooked. Simply put, Berkshire Hathaway is an astonishing company, and it is becoming even more so all the time.

 

Let’s start with the company’s balance sheet. The company reported year end assets of $484.4 billion (representing an increase of about 12% from the end of 2012.). It is not just that the company now has assets of nearly a half a trillion dollars; the company’s assets have grown by an astounding 63% in the five year period ending in 2013. With the acquisition of a 50% interest in Heinz, the company now owns 8 ½ companies that if they were stand alone businesses would be in the Fortune 500.

 

The company ended the year with cash and cash equivalents of $42.6 billion, which at first glimpse might seem to be unchanged from $42.3 billion with which the company ended 2012. The thing is, the company ended 2013 with $42.6 billion in cash, even after spending almost $18 billion acquiring NV Energy and a 50% interest in Heinz; after spending $3 billion on what Buffett called “bolt-on” additions to existing businesses; after significantly increasing the company’s stock holdings in what Buffett called the company’s “big four” investments (Wells Fargo), American Express, IBM and Coca-Cola). After these and many other investments and expenditures, that the company ended the year with what might appear to be an unchanged cash position is remarkable.

 

The company’s  BNSF railroad operation (which is by far Berkshire’s largest acquisition ever) carries about 15% of all U.S. inter-city freight (whether transported by rail, truck, water air or pipeline) and is according to Buffett “the most important artery in our economy’s circulatory system.” The company now has 330,745 employees. On the one hand, that is not nearly as many employees as Wal-Mart has, on the other hand, Berkshire does now own 1.8% of Wal-Mart.

 

Buffett is himself famously self-effacing, but he feigns no modesty when he talks about his company. He refers to what he calls the company’s “supreme financial strength” – which, he adds, “we will always maintain.” He illustrates the importance of the company’s financial strength by examining what would happen if the insurance industry were to experience a $250 billion catastrophe loss, a loss that would be “triple anything it has ever experienced.” Were that to happen, Berkshire “as a whole would likely record a significant profit for the year because of its many streams of earnings,” while “all the other major insurers and reinsurers would meanwhile be far in the red, with some facing insolvency.” 

 

Berkshire’s promises, Buffett states, “have no equal,” a fact that has been “affirmed in recent years by the actions of some of the world’s largest and most sophisticated insurers,” who have sought to “cede” liabilities, particularly those involving asbestos claims. When insurers seek to shed themselves of long-lived liabilities, “almost without exception, the largest insurers seeking aid come to Berkshire.” To illustrate this point Buffett details the largest transaction of this type, the company’s 2007 transaction with Lloyd’s.

 

Another thing that is clear about Berkshire from this year’s report is how substantially its operations have changed and expanded. For many years, Berkshire was a sophisticated investment company operating in the guise of an insurance holding company. Berkshire’s insurance operations are massive. But the company is now much more diversified. It is now a manufacturing, utilities and industrial holding company as much as it is an insurance company. Indeed, just the company’s railroad, utilities and energy business produced almost as much revenue in 2013 ($32.7 billion) as the insurance operations ($36.6 billion in annual earned premium). BNSF alone produced more in net earnings ($3.79 billion) as the entire insurance operations produced in terms of underwriting gains, even though the insurance operations produced a remarkable $3.09 billion in underwriting profit – the eleventh consecutive year the insurance operations have produced an underwriting profit. (The insurance operations does also produce “float” which creates an opportunity to produce investment gains on top of underwriting profit, which has to potential – particularly for Buffett – to produce even greater overall profits over time.)

 

Among the more interesting features of this year’s letter is Buffett’s lavish praise of the U.S. economy. Buffett is clear that Berkshire’s prosperity derives from its opportunity to invest in the economy of the United States. After recalling that at the time of Berkshire’s acquisition of BNSF in 2009 – in the midst of “the gloom of the Great Recession” – he called the transaction an “all-in wager on the economic future of the United States,” Buffett said that he and the Berkshire co-Chair Charlie Munger “have always considered a ‘bet’ on ever-rising U.S. prosperity to be very close to a sure thing.” Buffett asks rhetorically, “who has ever benefitted during the past 237 years by betting against America?” Buffett says that “the dynamism embedded in our market economy will continue to work its magic.” Even more encouragingly, he adds, “America’s best days are ahead.”

 

Indeed, in a short discourse about investing (which was previously published as an excerpt on the Fortune magazine website), Buffett recommends that unsophisticated investors make regular investments over time in a low-cost S&P 500 index fund, in order to own a cross-section of  businesses. Even though some businesses might disappoint, as a group they are certain to do well, particularly over the long haul.  As Buffett asks, with respect to the possibility that financial turmoil might cause some investors to sell valuable assets as some investor did during the recent financial crisis, “Could anyone really believe the earth was going to swallow up the incredible productive assets and unlimited human ingenuity existing in America?”

 

Buffett does, however, sound one cautionary note about the U.S. financial environment. Local and state governments face daunting financial challenges, largely because the various entities made pension promises they cannot afford. Buffett includes within Berkshire’s annual report a letter he wrote to the Washington Post’s Katherine Graham in 1975 about the pitfalls of pension promises. (“Rule number one regarding pension costs has to be to know what you are getting into before signing up.”) As Buffett puts it in the shareholder letter, “During the next decade, you will read a lot of news – bad news – about public pension plans.” He stresses “the necessity for prompt remedial action where problems exist.”

 

 

Berkshire naysayers may seize upon Berkshire’s “underperformance” according to Buffett’s own measure comparing the change in the company’s per share book value relative to the change in the value of the S&P 500. The S&P 500 has beaten Berkshire four out of the last five years according to this measure, and in 2013, because of the S&P 500’s strong performance, the stock index (which increased 32.4%) outperformed the Berkshire per share value change by a difference of 14.2 percentage points.

 

Buffett points out that “both Berkshire’s book value and intrinsic value will outperform the S&P in years when the market is down or moderately up,” adding that “we expect to fall short, though, in years when the market is strong – as we did in 2013.” Buffett adds that “we have underperformed in ten of our 49 years, with all but one of our shortfalls occurring when the S&P gain exceeded 15%.” (Indeed, in the four of the last five years when the S&P 500 outperformed, the index’s gain exceeded 15%).

 

Anyone who thinks Berkshire shareholders are getting shortchanged will want to examine what happened in the years where the S&P 500 underperformed Berkshire. In those years, Berkshire’s results far outperformed the S&P 500. In the financial crisis year of 2008 for example, both the S&P 500 and the per share value of Berkshire declined, but while Berkshire declined by 9.6 percent, the S&P 500 declined by 37%, meaning that Berkshire outperformed by a difference of 27.4 percentage points. In 2002, when the S&P 500 declined 22.1%, Berkshire’s per share value increased 10 percent, a difference of 32.1 percentage points.

 

The fact is, Berkshire will have a hard time matching in the future its compounded annual gain of 19.9% for the period 1965-2013. Indeed, during the period 1999-2013, the company exceeded the 19.9% compounded annual gain only twice (2003 and 2009) – and in both of those years, the company’s change in per share value underperformed the S&P. The company has reached a size where it will be very difficult to achieve significant annual increases in per share value or even for the change in per share value to outperform the S&P 500 — except in years where the S&P 500 declines in value. Just the same, because Berkshire’s per share value is unlikely to decline as much as the S&P 500 in down years, the company will still outperform over the long run – just not as dramatically as it did in the years between 1965 and 1999.

 

 

There are many other interesting details in Buffett’s letter. For example, the list of Berkshire’s fifteen common stock investments with the largest market value has changed slightly from 2012. Two companies have dropped off the list and two have been added. The two that dropped off the list are POSCO (market value at the end of 2012 of $1.2 billion) and ConocoPhillips ($1.399 billion). The companies that joined the list are ExxonMobil (market value at the end of 2013 of $4.1 billion) and Goldman Sachs ($2.3 billion). It is interesting to note in light of Berkshire’s ownership of General Re that among Berkshire’s top fifteen common stock investments is an 11.2 percent ownership share of Gen Re’s big European rival, Munich Re (market value $4.4 billion). It is also interesting that of the top fifteen common stock investments, only one carries a market valued below cost – Tesco, with a cost of $1.699 billion and a market value of $1.666 billion. Overall, Berkshire’s fifteen investment holdings have an aggregate cost of $56.5 billion and an aggregate market value of $117.5 billion.

 

Buffett also has some interesting comments in his letter about Gen Re, which still remains Berkshire’s second largest acquisition. He is full of praise for the reinsurance unit’s recent performance. However, he adds that “It can be remembered that soon after we purchased General Re, the company was beset by problems that caused commentators – and me as well, briefly – to believe I had made a huge mistake. That day is long gone. General Re is now a gem.” While flattering of the company now, this statement also conveys Buffett’s lingering ill feelings about the unit’s former management, who had to contend with the fallout from 9/11 and who then resigned amidst a variety of legal proceedings and investigations. I am sure my former colleagues at Gen Re are glad to receive Buffett’s current praise, but I suspect that his implicit rebuke of former management gives many of them a chill. Those of us who can remember will recall that there was a time when Buffett lavished praise on the now former-management as well.

 

As fascinating as both the shareholder letter is in many ways, it does have a certain repetitive quality. Once again, Buffett blasts the rest of the insurance marketplace for its lack of discipline, even repeating for the third year in a row his criticism of GEICO-competitor State Farm, which incurred an underwriting loss in nine out of the last twelve years through 2012 (the last year for which State Farm’s results are available). Like a talkative dinner guest, Buffett trots out the well-worn story about Rose Blumkin and the Nebraska Furniture Mart, and how as an immigrant she built up a very successful business. Not only that, but parts of his letter are nothing more than advertisements for Berkshire businesses. He not only announces the opening of a new Nebraska Furniture Mart store in Texas and broadcasts the formation of the new Berkshire Hathaway Specialty Insurance unit, but he even includes the phone number to obtain a GEICO insurance quote.

 

But while Buffett is sometimes repetitive and though his tone can sometimes edge toward hucksterism, he exhibits other traits that no other CEO displays. Buffett is brutally honest and self-critical about his 2007 decision to invest in Energy Future Holdings (a decision he admits he made without consulting his sidekick, Charlie Munger), which resulted in a $873 million before-tax loss. In the context of a company with revenues of over $180 billion and profits of $19.4 billion, there is no reason for Buffett to call attention to this one investment loss, even at $873 million. Many CEOs made dreadful mistakes in the run up to the financial crisis. How many other CEO’s would call themselves out on a misstep like this, where there was no need to do so?

 

Buffett’s track record is unparalleled and he has earned the high regard that he enjoys. But the question everyone will ask is – how much longer can he keep it up? Buffett does take pains in his shareholder letter to lavish praise on his two investment protégés, Todd Combs and Ted Wechsler, both of whom we are told not only outperformed Buffett in 2013, but outperformed the S&P as well. They each now run portfolios exceeding $7 billion. But are they ready to manage Berkshire’s entire investment portfolio and future investment strategy?  And even if they can manage the investments, who will run the company? The shareholder letter is full of the names of various Berkshire unit Presidents, many of whom may are highly successful. Just the same, the question of management succession at the top will only grow louder and more insistent. My household happens to include someone exactly Buffett’s age, and all I can say is that I sure hope Berkshire’s board is keeping a very, very close eye on Buffett.

 

For now, Buffett and his company remain virtually synonymous. But the day is coming when Berkshire shareholders will have to confront the reality of Berkshire without Buffett. When that day comes it will mean many changes — not the least for many of us, it will mean the end of the invaluable annual letter to shareholders. For now, then, let us celebrate the letters while Buffett is still producing them.  Buffett closes this year’s letter noting that next year’s letter will be the fiftieth and that he intends to use the letter to review the company’s prior 50 years and “to speculate a bit about the next 50.” That sure sounds like a perfect opportunity for a valedictory production to me.

 

 

043aNext Monday, March 3, 2014, the Hong Kong New Companies Ordinance will go into effect. The Hong Kong Legislative Council enacted this overhaul of the existing companies laws provisions in July 2012, and on October 25, 2013, the Secretary for Financial Services and the Treasury published the requisite notice to implement the upcoming March 3 effective date.

 

According to a January 24, 2014 Directorship article (here), the new statutory provisions “represent a major milestone in a comprehensive exercise to rewrite and modernize Hong Kong’s Companies Ordinance.”  The New Companies Ordinance introduces a number of changes, including new provisions codifying the duties and liabilities of directors of Hong Kong companies.  As discussed briefly below, these new provisions may have important D&O insurance implications.

 

The text of the New Companies Ordinance (NCO) can be found here. Part 10 of the New Companies Ordinance, which contains the new provisions regarding directors’ duties and liability, can be found here. A January 2014 PricewaterhouseCoopers summary of the changes in the NCO can be found here. A January 2014 summary from the Vistra firm of the NCO provisions pertaining to directors’ duties and liabilities can be found here.

 

With respect to the directors’ duties, in Section 465, the NCO codifies directors’ duties to exercise “reasonable care, skill and diligence.” The statutory provisions specify both objective and subjective standards for directors’ duties. A director is required to exercise the care, skill and diligence “that may reasonably expected of a person carrying out the functions carried out by the director in relation to the company,” as well “the general knowledge, skill and experience that the director has.”

 

As noted in the February 27, 2014 memo from the Meyer Brown JSM law firm (here), “directors are required to achieve at least the objective standard set out in Section 465 and the standard will be higher if they possess particular knowledge or skills.”  Section 465 provides that the remedies for breach of the duty are the same as at common law or equity – that is, compensation or damages. Because the directors’ duties are owed to the company, “any claim is likely to be brought by shareholders or liquidators by way of derivative claim.”

 

With respect to the potential liability of officers, the NCO introduces the concept of a “Responsible Person,” who is a director or officer of the company who “authorizes or permits, participates in, or fails to take all reasonable steps to prevent” the violation of the NCO. Because the NCO removes the “willful” misconduct threshold that applies under the current Companies Ordinance, the NCO lowers the threshold for the imposition of liability and potentially increases directors and officers liability exposure.

 

The NCO permits companies to indemnify directors for liabilities incurred to third parties, subject to specified conditions. However, as is the case under the existing Companies Ordinance, the NCO prohibits companies from indemnifying directors for liabilities to the company itself or an associated company, as well as “any liability incurred “in criminal proceedings.  

 

Significantly, Section 468 (4) NCO expressly provides that the NCO’s indemnifications provision “does not prevent a company from taking out and keeping in force insurance for a director … against any liability attaching to the director in connection with any negligence, default, breach of duty or breach of trust (except for fraud” in relation to the company or associated company” or “any liability incurred by the director in defending any proceedings.”

 

In light of the new codification of the directors duty of care, skill and diligence and the NCO’s “new formulation of “Responsible Persons,” directors will, according to the Meyer Brown JSM memo, face “a risk of increased exposure.”  Moreover, because the NCO prohibits indemnification under certain circumstances, “directors must therefore rely on the protection afforded by Side A of the D&O Insurance and should ensure that the cover extends to any breach of statutory provisions,” such as the NCO.

 

In addition, because the NCO permits indemnification of directors for liabilities to third parties, “companies should ensure that the reimbursement cover under Side B of the D&O insurance is sufficient to cover any reimbursement.” I know our Hong Kong colleagues are well aware that these changes have been coming but for the rest of us, it is important to know that these changes are about to take effect.

 

As for Hong Kong itself, it is a great place, as I noted in my Travel Post (here) about my visit to the city. I took the picture at the top of this post from Victoria Peak while I was there.