federal depositIn 2013, the number of lawsuits the FDIC has filed against the directors and officers of failed banks reached the highest annual level during the current wave of failed bank litigation, though the pace of litigation filings peaked in the second quarter and slowed as the year progressed, according to the latest report from Cornerstone Research. The February 13, 2014 report, entitled “Characteristics of FDIC Lawsuits against Directors and Officers of Failed Financial Institutions” (here), contains detailed analysis of the lawsuits that the FDIC has filed as well as the settlements the agency has reached so far. Cornerstone Research’s February 13, 2014 press release regarding the report can be found here.

 

Among other things, the report contains very interesting analyses of the extent to which former directors and officers have been called upon contribute out of their own pockets toward the settlement of FDIC claims, as discussed below.

 

According to the report, the FDIC filed 40 D&O lawsuits in 2013, which represents a 54 percent increase over the 26 lawsuits the agency filed in 2012. The FDIC filed more lawsuits (15) during the second quarter of 2013 than it had filed in any quarter since the current wave of bank litigation commenced in 2010. However, the number of D&O lawsuits the agency filed declined each quarter as the year progressed; the agency filed 11 lawsuits in the third quarter and only 3 in the fourth quarter. 

 

In total, from 2010 through year-end 2013, the FDIC filed 84 lawsuits involving 83 institutions. In January 2014, the agency filed three more lawsuits, but these latest lawsuits are not included in the Cornerstone Research analysis.

 

The increase in filing activity in early 2013 is consistent with the peak of the bank failures in 2009 and 2010, and in light of the three-year statute of limitations. FDIC lawsuits filed in 2013 primarily targeted institutions that failed in 2010 and to a lesser degree, 2009 (the suits involved with the earlier bank failures likely were the subject of an agreement tolling the statute of limitations). None of the 2013 lawsuits involved banks that had failed in years other than 2009 or 2010.

 

Overall, 17 percent of the 492 banks that failed between January 1, 2007 and year-end 2013 have been the subject of a D&O lawsuit. However, of the 140 banks that failed in 2009, the directors and officers of 64, or 46 percent, have been the subject of an FDIC lawsuit or have settled claims prior to a lawsuit. For the 157 banks that failed in 2010, the directors and officers of 53 institutions, or 34 percent, have been subject to a D&O lawsuit or have reached a settlement with the agency. Of the 92 bank failures during 2011, only one has been subject of a D&O lawsuit to date.

 

Though the peak numbers of bank failures was now over three years ago, banks have continued to fail, albeit at a diminished rate. During 2013, 24 institutions failed, representing a 53 percent decline in the annual number of failed banks from 51 in 2012. There were fewer bank failures in 2013 than there were in 2008, at the beginning of the financial crisis.

 

The number of bank failures declined during 2013 as the year progressed; there were twelve bank failures in the second quarter of 2013, six in the third quarter and only two in the fourth quarter. (There were an additional three bank failures in January 2014.) The banks that have failed more recently are smaller than the ones that failed earlier in the current bank crisis. The median total asset size of banks that failed in 2013 was $96 million, representing a 82 percent decline from the median total asset size of $528 million in 2008.

 

Of the failed bank lawsuits filed in 2013, 30 of the 40 lawsuits named inside and outside directors as defendants. Outside directors alone were named as defendants only in rare instances – in 8% of all lawsuits filed in 2013.

 

Fully 63 percent of the lawsuits filed between 2010 and 2013 involved failed banks from just four states – Georgia (19), California (12), Illinois (11), and Florida (11). It is hardly surprising that Georgia has the most failed bank lawsuits, as it is the state with the highest number of failed banks (88 through the end of 2013).  Directors and officers of all three of the failed banks in Puerto Rico have been hit with FDIC lawsuits, and half of the failed Nevada banks have been targeted in D&O lawsuits.

 

The Cornerstone Research report has very detailed and interesting analysis of the settlements that the FDIC has reached so far – not just in the litigated matters, but in the matters that were settled separately without litigation.  Including litigated matters and also including settlements with parties other than the former directors and officers of failed banks (for example, accountants, lawyers, adjusters, etc.), the agency has reached a total of 501 settlement agreements (which are available on the agency’s website).

 

The report has very detailed analysis (on page 14) of the 17 litigated matters that have settled so far. Settlements in the D&O lawsuits total $120 million. The agency has also reached settlements of an additional $314 million in claims involving directors and officers that did not involve a lawsuit.

 

In what may be the single most interesting and important observation in the study, the report notes from a review of the settlement agreements on the agency’s website, 39 of the 82 agreements that involve directors and officers (or 48 percent), involved out-of-pocket payments by the directors and officers. According to the report, directors and officers agreed to pay at least $42 million out of pocket in these cases.

 

Discussion

 

The Cornerstone Research has a wealth of interesting information and analysis about the FDIC’s failed bank litigation. However, as noted above, the most interesting observation to me in the report is the statement that in 48 percent of the FDIC’s settlements of lawsuits and claims involving directors and officers, individuals had to contribute toward the settlements out of their own pockets, and that total amount of their contributions is at least $42 million.

 

Aggregate figures are interesting and important, but they don’t tell much of a story. It is difficult to tell from the bare numbers why the individuals had to pay out of pocket toward the settlement, what underlying circumstances contributed to the need for the individuals to pay, or whether or not the aggregate figure predominantly represents a few large settlements or a series of smaller settlements. More importantly, the aggregate figures don’t capture the pain and financial sacrifice these settlements represent for the individuals involved.

 

In some (many? most?) cases where the individuals had to contribute out of their own pockets, insurance may not have been available or may not have been adequate to resolve the claims. It is hard to know at this point whether or not these individuals’ banks had insurance options prior to the claim that were available but turned down that might have protected them from having to contribute. It is however indisputable that the individuals at banks that carried adequate limits and more protective terms and conditions would be less likely to be called upon to contribute out of their own pockets toward the settlement of any claims.

 

The surprising extent to which individuals have been called upon to contribute out of pocket toward the settlement of FDIC claims underscores the importance for banks (and indeed for any enterprise) to ensure that they have adequate D&O insurance limits and that they have the broadest insurance available in the marketplace.

 

The information about the individuals’ contributions toward settlement highlights the fact that the placement of D&O insurance is an issue that potentially affects every individual director and officer. These individuals will want to ensure that their company has enlisted the assistance of a knowledgeable and experienced insurance broker in the placement of their insurance, to try to reduce to the maximum extent possible the chance that they might be called upon in the event of a claim to contribute out of their own personal assets toward settlement.

 

eeocDuring the 2013 fiscal year (ended September 30, 2013), the number of charges filed with the U.S. Equal Employment Opportunity Commission was down 5.7% compared with the previous fiscal year, but the EEOC’s FY 2013 monetary recoveries of $372.1 million through administrative processes were the highest ever in any single fiscal year. The EEOC’s February 5, 2014 press release regarding its release of the FY 2013 data can be found here. The charge statistics can be found here and the overall statistics regarding the monetary recoveries can be found here. The statistics regarding the EEOC’s merits lawsuits can be found here.

 

 

The Number of Charges and Level of Recoveries  

The total of 93.727 charges filed during FY 2013 was down from the 99,412 charges filed during FY 2012, but nearly ten percent above the 1997-2012 annual average of 85,373. The 2013 filing total was the fifth highest total number of annual filings since 1997. The number of filings did not exceed 90,000 during any one fiscal year prior to FY 2008, but the annual filings levels have stayed well above 90,000 since that point. The elevated filing levels since FY 2008 suggests that the recent levels are related to the economic downturn.  By the same token, it might be assumed that the decline in the number of charges filed during 2013 may reflect the nascent economic recovery.

 

For the fifth year in a row, allegations of retaliation was the most frequently cited basis for charges of discrimination, both as a matter of number of charges (38,539) and as a percentage of all charges (41.1%).  Both the number of charges and percentages represent an increase of retaliation charges since the year before.

 

The second most frequently cited bases for charges of discrimination was race discrimination, which was cited in 33,068 charges, representing 35.3 percent of all charges. The next most frequently cited basis was sex discrimination, including sexual harassment and pregnancy discrimination, which was cited in 27,687 charges (29.5 percent of all charges.), followed by discrimination based on disability, which was cited in 25,957 charges (27.7 percent).  Compared to the 2012 fiscal year, both race and disability discrimination charge filings decreased in absolute numbers but increased as percentages of all charges.

 

As Evan Shenkman  of the Ogletree Deakins law firm points out in his February 10, 2014 memo about the EEOC’s statistics (here), the overall percentage of “reasonable cause” findings (an initial finding in favor of the employee) dipped slightly in FY 2013 (from 3.8 percent to 3.6 percent). Charges brought under the Genetic Information Non-Discrimination Act (GINA) (8.8 percent) and sexual harassment charges (7.6 percent) proved the most likely to result in a cause finding, while race-based charges (2.8 percent) and charges brought under the Age Discrimination in Employment Act  (ADEA) (2.4 percent) were the least likely to result in a cause finding.

 

The four states with the highest number of EEOC charges were  with 9,068 charges, representing  9.7 percent of all charges filed; Florida, with 7,597 charges; California, with 6,892 charges; and Georgia, with 5,162 charges,

 

Through its administrative processes, the agency had monetary recoveries during the 2013 fiscal year of $372.1 million, representing an increase of $6.7 over the prior fiscal year. The monetary recoveries for FY 2013 represent the highest annual recoveries in agency history.

 

Merits Litigation 

During fiscal year 2013, the EEOC filed 131 merits lawsuits alleging discrimination, which represents an increase of about 7% compared to fiscal year 2012. (The term “merits suits” includes direct suits and interventions alleging violations of the substantive provisions of the statutes enforced by the Commission and suits to enforce administrative settlements.) But while the number of merits suits increased in FY2013 compared to the prior fiscal year, the number of merits suits is well below historical levels. During the period 1997 through 2012, the Commission averaged 323 merits suits per fiscal year, so the number of 2013 merits lawsuit filings is nearly 60% below the historical annual average.

 

During 2013, the most numerous were lawsuits filed under Title VII of the Civil Rights Act of 1964 (78). The EEOC also filed its first three suits asserting GINA claims in FY2013.

 

During fiscal year 2013, the agency resolved 209 merits lawsuits producing monetary benefits of $38.6 million. Both figures are down from the 2012 fiscal year, when there were 283 merits suits resolutions producing $44.2 million in monetary recoveries. The monetary recoveries in fiscal 2013 through merits lawsuits was well below the 1997-2013 annual average of $86.4 million of monetary recoveries in merits lawsuits.

 

Discussion  

For employers, there are some important time line takeaways from these figures. That is, even though the overall numbers of charges filed decreased, the number of retaliation charges increased. And the overall consequences for employers hit with charges increased to record levels. These trends underscore the importance for employers of developing and maintaining employment programs to keep their operations in compliance with statutory requirements and to take steps to avoid conduct that could trigger allegations of retaliation. In addition to an effective compliance program, well-advised employers will be sure to maintain a well-designed employment practices insurance policy.

Readers continue to send in pictures of their D&O Diary mugs taken at locations far and near, including some locations that I never could have imagined in a million years.

 

Readers will recall that in a recent post, I offered to send out a D&O Diary coffee mug to anyone who requested one – for free – but only if the mug recipient agreed to send me back a picture of the mug and a description of the circumstances in which the picture was taken. In previous posts (here, here, here, here, here, here, here, here , here, here, here,  here and here), I published prior rounds of readers’ pictures. I have posted the latest round of readers’ pictures below.

 

The first of the shots in this round was taken in connection with the recent Super Bowl. As we all know, the Super Bowl itself took place in New Jersey, but the NFL wanted the world to believe that the game was somehow being played in New York City. In the city itself, the media organizations transformed Broadway and Times Square into a sort of football Babylon they called Super Bowl Boulevard. Loyal reader Arthur Washington of the Mendes & Mount law firm sent in this shot of himself in front of the Fox Sports booth in Times Square.

 

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Our next set of pictures is a sort of photo montage sent in to us by Max Wescoe of IMA in Denver. Max describes the pictures, which are arranged clockwise from the top, as follows: “Mugshot of the nation’s largest public mass transit project from the 5th floor of IMA’s new home in Denver, Colorado; the mug viewing our building from the corner of 17th and Wynkoop on a snowy January day; mugging with IMA’s new digs from afar.  Viva Denver!”

 

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I have noticed over the last few months that as the seasons changed from spring to fall to winter, many of the mug shots sent in have been darker and less colorful. The winter months may not be the best time for outdoor photography. Fortunately, that is not universally true. There are still places – like, say, Bermuda — where the sun is still shining. Eliza Barry Riker of ACE Bermuda, who reports that “We’ve been enjoying the unseasonably warm weather (for us) here in Bermuda this winter,” sent in this picture of sunny Bermuda. Our warmest congratulations to Eliza on the birth of her child seven months ago.

 

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Bermuda is not the only place where the sun has been shining while the rest of us have been shivering. Apparently the sun has also been shining in San Diego as well. Cecelia Rutherford of the Johnson & Weaver law firm sent in this picture of the Skyfan at the San Diego Zoo.

 

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When I came up with the idea of soliciting readers’ mug shots, I had no idea what kind of pictures I might get back. Readers have submitted some really great pictures. People have sent in pictures from some pretty amazing places.  I have to say though that I never in a million years anticipated getting a picture quite like the one sent in by Andrea Brunson, who runs client relations and securities monitoring at the Nix, Patterson & Roach law firm in Dangerfield Texas.  I am not 100% sure what is going on in this picture (and I am not sure that I even want to know), so I will simply reproduce here Andrea’s description of the scene: “My Veterinary Science 4H kids attended an artificial insemination clinic at Stephen F Austin State University in Nacogdoches, Texas.  It was a cold morning that day, but the kids loved the hands-on experience.  These high school kids are enrolled in the Veterinary Science Project offered through 4H.  They have a dream of one day becoming a veterinarian.” So there you have it. I have had the privilege to publish mug shots taken at the Wailing, Wall, Cambodia, India, the U.S. Supreme Court — and at an artificial insemination clinic in Texas.

 

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I ordinarily only publish one picture that a reader sends in, but I felt that I had to also print this picture that Andrea also sent in of herself seeking inner peace with her D&O Diary mug.

 

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Our final entry in this round of pictures does not even include a D&O Diary mug. The fact is, I have run out of mugs! The last of the mugs has already gone out, but I still continue to get mug requests. When I got a recent request from Jason Sacha of the Ricketts Harris law firm in Toronto, I had to tell him that the mugs are all gone. I did invite Jason to submit a picture taken with one of his own firm’s mugs. So Jason sent in this picture of Toronto with his firm’s mug.

 

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I know there may be others who might have wanted a D&O Diary mug. I am sorry that they are all gone. But anyone who wants to is invited to do what Jason did and take a mug shot with one of their own company’s mugs.  If I get enough of these other mug pictures, I will run a separate post featuring alternative mug shots.

 

I would like to thank everyone who has sent in a mug shot. It has been so much fun getting the pictures and seeing the ways that readers have decided to photograph the mug. I hope those of you who have not yet had a chance to send in a mug shot will be inspired to sent in your own pictures. The mug shots are so much fun. Cheers to all. 

 

It is hard to prognosticate the outcome of the Halliburton case now before the U.S. Supreme Court. But while we can’t be sure what the outcome will be, we can start to think about what will happen if the Supreme Court overturns Basic. In an interesting February 7, 2014 post on the Harvard Law School Forum on Corporate Governance and Financial Regulation entitled “Halliburton: The Morning After” (here), Boris Feldman of the Wilson Sonsini  law firm take a look at how the plaintiffs’ bar may respond if the Supreme Court dumps the fraud on the market theory.

 

As Feldman put it, “those who think plaintiffs’ lawyers will go quietly into the night are, in my opinion, ignoring the lessons of history.”  Because of the many possible responses from a plaintiffs’ bar that has over the years proven to be resilient and adaptive, it could be years before the ramifications of a reversal of Basic is fully understood, and therefore “individual companies would be making a serious mistake if, in the face of a reversal of Basic, they cut back on their D&O insurance protection.”

 

Referring to the way that the plaintiffs bar overcame the hurdles Congress imposed in the PSLRA, Feldman contends that the plaintiffs’ bar has shown “persistence and resilience” as well as “creativity and entrepreneurialism.” Despite the PSLRA’s heightened pleading standards and other procedural impediments for the plaintiffs, securities litigation has continued. Feldman emphasizes that he is not saying that the PSLRA and other legislative reforms have had no impact. But, he says, the legislative reforms “did not put the plaintiffs’ bar out of business.”

 

Feldman suggests that “if recent history is a guide, then, even a strong decision in Halliburton is unlikely to make the plaintiffs’ bar give up.” The plaintiffs’ lawyers, Feldman contends, will “wage a multifront-war to survive even in the face of judicial abolition of the fraud-on-the-market presumption.”

 

The plaintiffs’ lawyers’ first line of attack, Feldman suggests, if the Court overturns Basic, is that the plaintiffs’ lawyers could seek to have Congress overturn Halliburton. Given the recent track record in Congress, that could be an uphill battle. But even if it could involve tough prospects, “there is no doubt the plaintiffs’ bar would give it a try.”

 

The second way plaintiffs might try to fight Halliburton is to try to “undermine it in the lower courts.” Securities plaintiffs’ lawyers, Feldman suggests, are “masters of the disingenuous pleading doctrine. They are skilled at using bad facts to influence judges’ application of precedents unfavorable on their face.” Feldman speculates that if Halliburton is overturned but Affiliated Ute stands, “one can confidently predict that all cases will be pleaded as omissions cases” (a possibility that is discussed at length here). Short of a broad ruling explicitly holding that class action securities class actions are not permitted because questions of individual reliance will always predominate, “plaintiffs will find ways to plead within the decision and persuade some courts not to throw the suit out at the threshold.”

 

Plaintiffs’ lawyers could also seek to engage the SEC, for example, by trying to get the SEC to amend Rule 10(b)-5 to include the fraud on the market presumption as an explicit way to establish reliance. The plaintiffs could also focus in on disclosure requirements or exchange-listing requirements (for example requiring companies to include in the periodic filings statements whether the company’s shares trade in an efficient market).

 

The bottom line is that the plaintiffs’ bar is not simply going to throw in the towel even if Basic is overturned. The business community, Feldman says “needs to prepare for the plaintiffs’ responses to the decision.”

 

Given the likelihood that the plaintiffs’ lawyers will adapt, “individual companies would be making a serious mistake if, in the face of a reversal of Basic, they cut back on their D&O insurance protection.” The fact that it will be some time before the implications are sorted out presents the possibility that for a time “shareholder suits are likely to be even more expensive to litigate than now.” And of course, conservative disclosure practices “should not be eased or abandoned until the promise of Halliburton becomes a reality.”

 

Feldman is correct when he refers to the plaintiffs’ bar’s adaptability. The plaintiffs’ bar has adapted to the PSLRA and to the adverse Supreme Court cases that have followed. Along those same lines, since the moment that the Supreme Court granted cert in the Halliburton case, there has been extensive commentary on the Internet and elsewhere about the ways the plaintiffs’ bar might be able to persist even if the fraud on the market theory is thrown out. Once the Court has ruled, this process will accelerate.

 

Feldman is also spot on in his contention that companies should not cut back on their D&O insurance even if Basic is overturned, at least until all of the decision’s  ramifications are fully understood. I would liken the situation (that is, if Basic is overturned) to the circumstances back in 1995 and 1996 after the PSLRA passed. There were those in the D&O insurance industry then who presumed that the PSLRA’s passage meant that the risks associated with class action securities litigation had been substantially diminished. There were even some insurers who jumped into the D&O insurance market with very aggressive pricing based on the ssumptions about the diminished risk of securities litigation. The rest of the D&O insurance market got sucked into a downward pricing spiral. Of course, securities litigation didn’t go away, and the D&O insurance industry pretty much got crushed during the underwriting years 1997 through 2001.  

 

The lesson from that era – both for insurance buyers and for the D&O insurers — is not to make insurance decisions based on assumptions about what might happen. The key point here is that everyone involved in the insurance process should proceed cautiously even if Basic is overturned. At a minimum, as Feldman states, until the ramifications are understood, it would be unwise for companies to start cutting back on their D&O insurance.

 

There Are Those Who Still Love the Fraud on the Market Theory: There is of course the possibility that the fraud on the market theory will survive. That is certainly the hope of a wide variety of groups and commentators who have filed amicus briefs urging the court to affirm Basic and uphold the fraud on the market theory. In an interesting February 6, 2014 post in her On the Case blog (here) , Alison Frankel reviewed the amicus briefs that have been filed with the Supreme Court arguing that the fraud on the market theory in securities class action litigation should be preserved. 

 

Frankel notes that the fraud on the market theory has  “received powerful support in amicus briefs from (among many others) the Justice Department; two former chairmen of the Securities and Exchange Commission (one Republican, one Democrat); 11 current and former members of Congress; and scholars of the doctrine of stare decisis, whose filing was authored by Harvard Law professor Charles Fried – the onetime U.S. solicitor general who wrote the Justice Department brief supporting investors in the original Basic case at the Supreme Court.” 

 

Frankel says that as a group “these briefs provide compelling legal and policy justifications for leaving Basic alone, arguing, in essence, that this Supreme Court would be overstepping its judicial bounds if it reversed its own precedent, defied Congress, and undermined the regulation and enforcement of the securities laws.”

 

The brief filed by the former members of Congress argues that, as the Court itself has acknowledged numerous times, including as recently as the Court’s 2013 decision in the Amgen case, that despite revising the securities laws on several occasions since the Supreme Court’s decision in Basic, Congress has left the fraud on the market theory unchanged, which, the former congressmen argue, is evidence that Congress wants Basic to remain good precedent.

 

The brief filed by Professor Fried argues that under principles of statutory stare decisis, it is not for the Court itself to alter its interpretations of statutes; rather, “the task of modifying decisions like Basic is best left to the branch that is best situated to evaluate the often complicated factual claims underlying the call of its repeal and the unavoidable political judgments those requests entail.” 

 

  

idahoIn a recent industry study concluding that health care organizations face increasing rates for management liability insurance, as well as tightening terms, one of the explanations suggested for these restrictive conditions is that the carriers are concerned that as health care organizations respond to the incentives and pressures of the Affordable Care Act – particularly as they seek to form Accountable Care Organizations (ACOs) with other health care providers as a way to try to control costs – that the health care organizations couldrun afoul of the antitrust laws. Among other things, the carriers are concerned that the ACA’s antitrust protections are “untested,” particularly in connection with private antitrust litigation. 

 

If a recent decision from the District of Idaho is any indication, there may be increased reason to be concerned. In January 24, 2014 findings of fact and conclusions of law (here), which were implemented in a January 28, 2014 order (here), District of Idaho Chief Judge B. Lynn Winmill ordered a hospital to divest itself of a local physicians’ practice it had acquired. As Eduardo Porter wrote in a February 5, 2014 New York Times article entitled “Health Law Goals Face Antitrust Scrutiny” (here), the ruling “underlined a potentially important conflict between the nation’s antimonopoly laws and the Affordable Care Act.”

 

In 2012, St Luke’s Health System, which operates multiple hospitals and other healthcare facilities in Idaho, acquired the Saltzer Medical Group (SMG), in Nampa, Idaho. Two competitors of St. Luke’s, as well as the FTC and the Idaho AG, filed lawsuits against St Luke’s and SMG, alleging that the acquisition violated the federal antitrust laws, and seeking to have the Court unwind the deal.

 

In its defense in the antitrust lawsuit, St. Luke’s contended that its acquisition of SMG was a critical part of its long-term plans, specifically arguing that it sought to improve care coordination and the development of an Accountable Care Organization (ACO) through the SMG acquisition. Judge Winmill acknowledged the value of the hospital’s efforts, saying that St. Luke’s “is to be complemented on their foresight and vision” and “to be applauded for its efforts to improve the delivery of health care.”

 

Judge Winmill nevertheless ordered the divestiture of the affiliation between St. Luke’s and SMG based on the conclusion that the acquisition would have “anticompetitive effects.” Specifically, Judge Winmill found that “Although possibly not the intended goal of the Acquisition, it appears highly likely that health care costs will rise as the combined entity obtains a dominant market position which will enable it to (1) negotiate higher reimbursement rates from health insurance plans that will be passed on to the consumer, and (2) raise rates for ancillary services (like x-rays) to the higher hospital-billing rates.”

 

According to a February 6, 2014 memo from the McGuire Woods law firm (here), the ruling represents the first time that a federal district judge has required the unwinding of a hospital’s acquisition of a physician group practice based on antitrust concerns. As a minimum, the ruling shows that hospitals’ acquisitions of physician group practices “are not immune from antitrust scrutiny and may require careful analysis under the antitrust laws.”  

 

But as the law firm memo also notes, the decision may also suggest that “health reform’s goals do not trump antitrust concerns,” and that even though Affordable Care Act encourages providers to form ACOs through horizontal and vertical integration “courts have not found these arguments to be sufficient justifications to overcome concerns of reduced competition on a given geographic area.” 

 

In a post on St. Luke’s hospital’s blog, St. Luke’s CEO David C. Pate says that “The court’s decision calls into question whether accountable care can be an option for the people of Idaho, and specifically those who live in towns like Nampa.”

 

The Court’s decision highlights the fact that, in the words of one of the ACA’s architect’s quoted in the Times article, “there is a tension between the benefits of coordinated care and the possible consequences of market power.”

 

The challenge for health care organizations is that economic reality and the incentives of the ACA both militate in favor of consolidation. The Times article underscores the fact that hospitals have been acquiring physician networks to improve their bargaining power with health insurers and to capture a larger share of the patient pool. The ACA provided extra motivation and a potential justification as well.

 

Given the economics and atmospherics, consolidation seems likely to continue. The challenge for the health care organizations – and for their insurers—is that the combinations could attract antitrust scrutiny, even if a combination is undertaken in order to form an accountable care organization under the ACA.

 

As I noted in my earlier post about the current insurance marketplace conditions for healthcare organizations, the management liability insurers active in this space have already been raising their rates for health care organizations, as well as restricting the coverage available under their policies for antitrust claims. Premiums have been increasing steadily since the fourth quarter of 2011. Coverage restrictions include in some instances the introduction of sublimits and/or coinsurance for antitrust claims. In addition, the insurers’ underwriting practices have changed as well. Insurers are seeking a great deal more renewal underwriting information, particularly with respect to ACO formation and strategy.

 

In an environment where the carriers are already proceeding defensively, the court’s decision in the St. Luke’s case can only serve to reinforce concerns. The Times article hopefully suggests that regulators could introduce regulations to complement the antitrust laws. For now, however, it seems likely that carriers will now proceed even more cautiously, and that increasingly restrictive conditions in the marketplace will continue. Health care organizations should be prepared to face additional rate increases as they renew their D&O insurance program in 2014 and to address underwriters’ questions about their strategies for the formation of ACOs. 

 

 

nyseThe number of companies with shares listed on U.S. stock exchanges increased last year compared to 2012, which is the first annual increase in the number of publicly traded companies in the U.S. since 1997, according to information from the World Federation of Exchanges. As reflected in a February 5, 2014 Wall Street Journal article entitled “U.S. Public Companies Rise Again” (here), the number of companies with shares listed in the U.S. has been declining since “the go-go days of the Internet boom,” so the 2013 increase represents something of an exception to a longer term trend. The question is whether it represents a one-time anomaly or a directional change.

 

According to the data from the WFE, there were 5,008 companies listed on the U.S. exchanges as of year-end 2013, representing an increase of 92 companies from the 2012 year-end tally of 4,916. The 2012 figure represented the smallest number of public companies since 1991. The number of public companies peaked at 8,884 in 1997. In other words, the number of companies with U.S. listings declined 3,968 (44%) between 1997 and 2012.

 

Though the increase in the number of companies in 2013 was slight (representing an increase of about 1.87%), it is nevertheless significant. The increase occurred because the number of new listing exceeded the number of delistings for the first time in many years. The number of new listings reflects a vibrant market for IPOs. According to the Journal article, there were 230 IPOs in 2013, which was the highest number of IPOs since 2007.  The increased number of IPOs during 2013 was due to soaring stock indices; the IPO on-ramp provisions of the JOBS Act; and a generally healthier economy.

 

 

The reduced number of delistings is also in part a reflection of a healthier economy, meaning that fewer companies are going bankrupt.  However, the reduced number of delistings in 2013 was also a reflection of reduced M&A activity compared to recent years. In the recent analysis of 2013 securities class action litigation filings (here, see Figure 11), Cornerstone Research showed that between 1998 and 2012, the number of M&A deals “greatly exceeded” the number of IPOs each year, which goes a long way toward explaining the sharp drop in the number of U.S. listed companies during that period. Obviously, the dot-com crash and the credit crisis took out quite a number of U.S. listed companies as well.

 

The Journal article identifies another factor that may have contributed to the decline in the number of publicly traded companies between 1998 and 2012, or at least acted as a restraint on possible growth. That is, “emerging markets such as China lured more companies to their exchanges.” Between 2000 and 2012, the U.S. averaged just 177 listings annually, while the number of listings in China nearly tripled to more than 4,000. The Journal suggests optimistically that the U.S. markets have “at least temporarily stanched the bleeding from listings lost to foreign exchanges.” The article notes that at least during 2013 non-U.S. companies showed a renewed interest in listing in the U.S., citing several examples of non-U.S. companies that listed their shares on U.S. companies during 2013.

 

The more interesting question is whether the growth in the number of publicly traded companies during 2013 represents a directional shift or whether it was just a blip in the larger trend toward fewer U.S.-listed companies. The market volatility in the early weeks of 2014 could mean that prospective IPOs could be facing a less predictable environment. Whether or not this will reduce the number of completed IPOs of course remains to be seen, but it sure doesn’t help. Another factor that will affect the number of U.S. IPOs is the question whether the U.S. exchanges will continue to be able to attract non-U.S. companies to list their shares here.

 

Another dynamic that could significantly affect whether or not the growth in the number of publicly traded companies will continue in 2014 is the level of M&A activity. 2013 was the first year in many years where the number of IPOs exceeded the number of M&A transactions. However, M&A activity could pick up in 2014. According to the Journal, U.S. companies are “sitting on vast piles of cash, giving them ammunition for takeovers that could swallow up public companies. “ Private equity firms are also reloading with multimillion dollar funds that “could also remove more companies from the ranks of listed names.”  

 

Because of all the considerations, there are a number of possible outcomes. For example, the trend toward shrinking numbers of publicly traded companies could resume. Alternatively, the number of public companies could stabilize at or about current levels. Or the number of companies listed in the U.S. could increase again; however, it seems likely that even if there were to be an increase in the number of U.S. public companies, the increase would be relatively modest. As the Journal article puts it, “a return to the peak years of the 1990s isn’t expected.”

 

A number of important consequences flow from the reduced numbers of public companies over recent years. The first is that fewer companies in general means that the likelihood that any particular company will be sued is greater than is it was a couple of decades ago. As NERA Economic Consultants put it in their 2013 analysis of securities class action lawsuit filings (here), the decline in the number of publicly traded companies since 1998 means that “an average company listed in the U.S. was 83% more likely to be the target of a securities class action in 2013 than in the first five years after the passage of the PSLRA.”

 

The decline in the number of U.S. listed publicly traded companies also has important implications for the U.S public company D&O insurance marketplace. It is not just that there the universe of buyers is 44% smaller than it was in the late 90s. During that same time period, the number of D&O carriers has been increasing, as has their available underwriting capacity. In other words, an increased numbers of players are chasing premiums from a much smaller pool of insurance buyers. Some of the effects of this dynamic have been offset because many insurance buyers now buy a lot more insurance than they used to. But the inevitable result of these circumstances is that D&O insurance pricing has been under pressure, as will happen when supply exceeds demand.

 

While the primary D&O insurers have been able to resist these forces over the last 24 months or so (in part because of their claimed losses based on the surge in M&A litigation), overall and taking excess pricing into account, the increased numbers of D&O carriers and the reduced numbers of public companies has translated into downward pressure on pricing over time.

 

The slight increase in the number of publicly traded companies in 2013 is a positive note, although the upswing in IPOs has also meant an increase in the number of securities suits involving IPO companies as well. And as positive as the increase in the number of listed companies during 2013 may be, the increase is not yet large enough to represent a sufficiently larger pool of insurance buyers to shift the demand/supply ratio.

 

In any event, it is important to keep the changing numbers of public companies in mind. The fact that the number of public companies is more than 40% smaller than it was in 1998 is a very important consideration that is too often overlooked. All too often, discussions of litigation rates and other key trends continue as if the number of companies were constant. The public company D&O insurance community needs to keep the reduced numbers of U.S. public companies in mind when they think about their marketplace.

 

 

great lakes
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History shows that the places commerce favors change over time. In the United States, many of the cities that prospered in the 19th century faded in the 20th century as the logic of business shifted the location of prosperity. That same process will unfold again in the 21st century. Seemingly unlikely places will thrive in the decades ahead, for reasons that might not be immediately apparent now. And places that are booming now will fade, just as happened in the century just ended.

 

This dynamic was underscored in an article in the February 3, 2014 issue of Bloomberg BusinessWeek entitled “Data Factories Spring Up in Santa’s Backyard” (here).  In the past, technology companies had located their data centers first near universities with the skilled staff needed to run the facilities, and later near major urban centers, to be closer to the customers using the facilities. But more recently companies such as Google, Microsoft and Facebook have chosen to locate massive data centers in Scandinavia, to take advantage of the availability of cheap hydroelectric power to run the centers and of the abundant chilly waters to cool the centers’ heat sensitive servers.

 

The article describes the Swedish city of Luleå, 70 miles south of the Arctic Circle, where Facebook has developed a 300,000 square foot data center, to take advantage of the city’s inexpensive hydroelectricity and cool air. The article describes the town’s prosperous main street as “flanked by a park, high-end clothing shops and hotels.”

 

At the same time as seemingly unlikely locations such as Luleå are prospering because of their natural advantages, other areas are being forced to confront their natural limitations. An article in the February 10, 2014 issue of Time Magazine entitled “California Drying” (here, subscription required) states that 2013 was the driest year in California since it became a state in 1853. Communities throughout the state may run out of water altogether in two to four months. The Sierra Nevada snowpack, a crucial water source, is just 20% of its average.

 

Of course, the drought conditions in California could improve, but there is also a risk, the article explains, that the current drought “may represent a return to California’s bone-dry history.” The geographic area encompassing the state has “had multiple megadrougthts that lasted 10 to 20 years, as well as one that started in A.D. 850 and stretched for 240 years.” As a result of global climate shifts, the American West is “likely to get even drier.” In his January 17, 2014 state of the state address, California Governor Jerry Brown warned that the current drought may be “a stark warning of things to come.”

 

As if it were not enough that business prosperity in California must try to survive a hostile environment, businesses in the Bay Area are also being forced to confront actual hostility. Another article in the same issue of Time Magazine explains the street protests and social tensions that are arising in San Francisco as the city’s tech boom drives up rents and forces lower and middle income residents to have to move out of the city.

 

As the Time article puts it, “A combination of exploding wealth and limited space has led to an affordability crisis. Much of the angst among the have-nots is directed toward the region’s booming tech sector, which is attracting well-paid workers who once settled around San Jose and now regard the City by the Bay as the only place to be.” The have-nots are not taking this shift quietly. Confrontations between displaced locals and the private bus services the tech companies use to ferry worker from the city to their job sites have become frequent.

 

There may be solutions to the social tensions that the booming tech economy are creating, such as through the construction of additional affordable housing. But California’s water problems, if they persist or even worsen, are not easily solved. Changing social conditions can be accommodated, but life without sufficient water is simply not possible.

 

For large parts of the 20th century, a great deal of effort in the United States was focused on getting water to places where people wanted to be. In the 21st century, this process may have to reverse itself. The people may have to move to where the water is. When people realize that this may have to happen, they are going to notice something really important. That is, 21% of the world’s fresh water – and 84% of North America’s surface fresh water – is located in the Great Lakes.

 

There are a lot of people in very dry places in the American West who might want fresh water from the Great Lakes brought to their communities. However, due to a very far-sighted set of agreements among the eight states in the Great Lakes region called the Great Lakes Water Compact, the water in the Great Lakes hydrological system cannot be removed by human means from the Great Lakes water basin. In other words, if you want the water in the Great Lakes, you have to come to the Great Lakes — the water isn’t coming to you.  

 

It makes sense that the tech companies are moving their servers to where the electricity is cheap and the air temperatures are cooler. It may make even more sense for companies to move their employees to a location where there are actually sufficient quantities of fresh water.

 

And not only does the Great Lakes region have fresh water, it has some of the most reliably sustained winds in the country (particularly when proximity to urban centers is taken into account), capable of providing a reliable source of renewable energy. The availability of modern natural gas extraction technologies also means that the abundant natural gas in the region can help provide low cost and relatively low carbon impact energy, as well.

 

If employers were to move their operations to Cleveland, the crowds of locals gathered at the private bus stops wouldn’t be there to protest; they would be there to celebrate. Everyone in Cleveland would be so happy to have the jobs and the economic activity.

 

I am not the only one suggesting that California’s future may be in Cleveland. As Matthew Yglesias put it in a December 13, 2013 Slate article entitled “Move Silicon Valley to Cleveland” (here), it is time for the tech companies to move where they will be appreciated.  Cleveland, as Yglesias points out, has plenty of affordable housing and plenty of available office space. It even has a Federal Reserve Bank.

 

The Great Lakes region is of course known for its harsh winters. As I type this blog post, I am looking out my window at a fairly impressive winter storm that has already dumped about eight inches of snow. But you know what? That eight inches of snow represents an astonishing quantity of water that has been brought to the Great Lakes from outside the region. The winter weather replenishes the hydrological system.

 

The winters here in the Great Lakes region are harsh. And they last a long time. But I grew up in Virginia, and I have managed to acclimate.There is something about having all four seasons that makes you more realistic about life. And then there is the great secret that few outside the Great Lakes region appreciate – that is, this area is absolutely beautiful for the rest of the year. (I have previously documented the splendid pleasure of a Great Lakes summer, here).

 

Here’s the thing. The time to get in on the coming Great Lakes region land rush is now. The abundant, low-priced real estate is not going to last once everyone figures out that they are going to have to move to Cleveland  (or Milwaukee or Toledo or Buffalo or Erie, Pa.) for the water. The smart money is already going there.

 

Sure, go ahead, laugh. When you get thirsty enough, you won’t think this is funny at all.

 

Do you want to talk about earthquakes now, or should we save that for later?

 

 

PrintEven though (as have been well-documented by other observers) securities class action litigation filings increased in 2013, overall corporate and securities litigation filings during 2013 declined for the second year in a row, according to a February 4, 2014 report from the insurance information firm, Advisen. Though the corporate and securities filing activity in 2013 was below levels seen in more recent years – as credit crisis-related litigation swelled litigation levels – the litigation levels last year were above historical averages as well as above pre-credit crisis levels. The report, which is entitled “D&O Claims Trends: 2013 Wrap-Up & Possibilities for 2014,” can be found here.

 

As a preliminary matter, it is important to understand the terminology that Advisen uses. Unlike some other public reports, which only analyze securities class action litigation, the Advisen reports includes a variety of other types of corporate and securities litigation in its analysis The Advisen analysis  also includes regulatory actions; individual securities actions; breach of fiduciary duty actions; merger objection cases; and derivative cases. In addition, unlike other public sources, the Advisen report includes actions filed in both federal and state court, as well as actions filed outside the United States. For these reason, the information in the Advisen report may appear different than other recently published reports on securities litigation  

 

The most significant finding in the report is that for the second year in a row, overall corporate and securities lawsuit filings were down in 2013 compared to the prior year. There were 1,344 new corporate and securities lawsuit filed in 2013, compared to 1,677 in 2012, a decline of about 20 percent. The filing levels for both of the two most recent years were well below the peak of 2,041 new corporate and securities lawsuit filings in 2011. However, the 2013 filings still exceed the filings for any year prior to 2009 and also exceed the ten-year average of 1,285. These figures suggest that while 2012 and 2013 involved a decline in annual filing levels, the figures for those years also represent an easing of the litigation activity that attended the credit crisis. While the filing figures are down from the elevated levels following the crisis, they remain eat higher levels compared to historical norms from years prior to  the crisis.

 

All categories of litigation that Advisen tracks declined in 2013, except for securities class action lawsuit filings, which rose slightly. The Advisen report suggests that, in addition to the winding down of the financial crisis litigation, the decline may be due to the fact that there are fewer publicly company targets. In addition, there were fewer merger objection cases filed in 2013 and in 2012 compared to 2011, because there were fewer merger transactions in those years than there were in 2013.

 

For several years, Advisen has tracked the decline in the number of securities class action lawsuits as a percentage of all corporate and securities lawsuits filed. As recently as 2007, securities class action lawsuits represented about 23 percent of all corporate and securities lawsuit filings. By 2011, however, this figure has dropped to 10 percent. In the last two years, this figure has risen slightly, and in 2013, securities class action lawsuit represented about 13 percent of all lawsuit filings. However, the report notes that “although in the past two years securities class actions have been creeping up slowly as a percentage of total events, they are still a long way away from pre-credit crisis levels.”

 

The number of settlements fell for the second year in a row as well. But while the number of settlements declined, the average settlement during the year rose significantly from $13.2 million in 2012 to $51.5 million in 2013. (It is important to keep in that the universe of cases that Advisen tracks is both broad and diverse and the averages are calculated across a wide variety of different kinds of cases.) The 2013 figures were largely a reflection of several very large securities class action lawsuit settlements. The average securities class action settlement in 2013 was $82 million, compared to $33 million in 2012.

 

The findings in the Advisen report, as well as the overall corporate and securities litigation trends in 2013 and the likely litigation possibilities in 2014, will be the subject of free one-hour Advisen webinar to be held February 4, 2014 at 11 am EST. I will be participating in the webinar, along with Jack Flug of Marsh, Dennis Kearns of QBE and Jim Blinn of Advisen. Information about the webinar, including registration, can be found here.

 

 

minnI have frequently noted that among the many exposures a company experiencing a data breach could encounter is the possibility of a shareholder suit alleging that the company’s board breached their fiduciary duties by failing to take sufficient steps to protect the company from a breach and its consequences. This possibility has now been realized in connection with the recent massive data breach at Target — shareholder plaintiffs have now filed at least two shareholder derivative suits against the company’s directors and officers, as well as against the company itself as nominal defendant.

 

Both of the lawsuits were filed in the United States District Court for the District of Minnesota. The first of the two complaints, which can be found here, was filed on January 21, 2014. The second, which can be found here, was filed on January 29, 2014. The first complaint alleges claims for breach of fiduciary duty and waste of corporate assets. The second complaint alleges breach of fiduciary duty, gross mismanagement, waste of corporate assets and abuse of control.

 

Though the second complaint asserts additional claims not raised in the first complaint, the two filings generally are similar. Basically, the two complaints alleged that the defendants were aware of how important the security of private customer information is to customers and to the company, as well the risks to the company that that a data breach could present. The complaints allege that the company “failed to take reasonable steps to maintain its customers’ personal and financial information,” and specifically with respect to the possibility of a data breach that the defendants failed “to implement any internal controls at Target designed to detect and prevent such a data breach.”

 

Both complaints emphasize not only the failure to take steps to prevent a breach, but also allege that the defendants “aggravated the damage to customers by failing to provide prompt and adequate notice to customers and by releasing numerous statements meant to create a false sense of security to affected customers.”

 

The complaints allege that the failure to prevent the breach and then to timely report accurate information about it have “severely damaged the company,” noting that the company is currently under investigation by the United States Secret Service and the Department of Justice, and has been hit with numerous consumer class action lawsuits. Both of the derivative suit complaints allege that the class action lawsuits threaten the possibility of hundreds of millions of dollars of damages to the company. The complaints seek monetary damages and injunctive relief “by way of significant corporate and managerial reforms to prevent future harm to the Company by disloyal directors and officers.”

 

Given the magnitude of the Target breach and the amount of publicity it has garnered, it may not be all that surprising that these complaints have been filed. Nor are these the first D&O lawsuits filed against directors and officers of a company that experienced a significant data breach; several D&O lawsuits were filed against Heartland Financial’s directors and officer after that company experienced a significant breach of credit card information. And it remains to be seen whether or not these lawsuits (and others that may be filed against Target officials relating to the breach) will prove to be successful; the defendants will have a number of defenses, including among other things the fact that the plaintiffs filed their suits without first bringing a demand to the board for the board itself to pursue the claims on the company’s behalf.

 

Just the same, these lawsuits are significant if for no other reason than that they show how a data breach can lead directly to a D&O claim. For some time now, the public discussion of about privacy and network security have included the message that these concerns are board level issues. As the Target D&O lawsuits show, among the consequences that can follow from a significant data breach is an attempt by the company’s shareholders to hold the company’s senior officials liable for the harm that the data breach caused the company.

 

These lawsuits are not the first D&O lawsuit based on a cyber security breach, but they surely will not be the last. Indeed, the terrible problems that Target has experienced following its breach clearly represent an important message to other companies about the disruptive effect a serious data breach can have, and highlight the importance for other companies’ executives to take steps to protect against a similar development at their companies. Shareholders at companies experiencing future data breaches may allege that “even after the massive problems at Target” the company’s executives failed to take steps to protect the company or failed to have a plan in place for the company to deal with the situation if the company did experience a breach.

 

It is particularly interesting that both complaints emphasize (and seek to have liability based upon) the company’s reactions to and public disclosures following the breach. These allegations highlight the fact that shareholders may seek to hold company officials responsible for the failure to prevent the breach but also for the way that the company conducts itself as it responds to the breach.

 

Special thanks to Rick Bortnick of the CyberInquirer blog for sending me a copy of the complaint in the first filed derivative lawsuit. Speaking of Rick Bortnick, you can find his thougthts, along with those of Ann Longmore of Willis and Jonathan Fairtlough of Kroll, on the topic of “D&O Liability in Data Privacy and Cyber Security Situation in the US” from the January 2014 issue of Financier Worldwide, here. 

 

California AG Law Suit for Late Data Breach Notification: As if the threat of shareholder litigation were not enough to worry about, there are other litigation concerns for companies experiencing data breaches to worry about as well. As discussed in a January 30, 2014 post on the Information Law Group blog (here), the California Attorney General’s office has filed a complaint against Kaiser Foundation Health Plan Inc. for the company’s alleged delay in providing notifications required under California law notification to affected persons following the company’s September 2011 loss of a hard drive containing sensitive personal information. It appears that the company delayed notification until it had completed its forensic investigation some months after the loss.

 

Among other things, the California AG’s recent suit shows that data security issues and requirements are becoming an increasingly important priority for regulators, as well as for shareholders. In addition, the lawsuit underscores the fact that the way that the company responds to a data breach can itself be a source of litigation exposure.

 

Game Notes:

1. Way to go, Denver. Now everyone knows what it would look like if the Cleveland Browns were ever to play in a Super Bowl. That is, a team in an orange uniform would fail to execute, turn the ball over (repeatedly), miss tackles (repeatedly), and give up big plays on special teams. Take nothing away from the Seahawks, they played great and absolutely deserved to win big. But Denver kicked their own butt. Peyton Manning picked an odd time to start channelling his inner Brandon Weeden.

 

2. Lousy game, lousy commercials. The only commercial that succeeded universally in our group was the Cheerios ad where the little girl negotiated for a puppy. The women in our group all liked the ad with the puppy and  the Clydesdale.  Every single person who had anything to do with the Stephen Colbert/pistacho ad should be fired, as should anyone that thought the Bud Lite/Arnold Schwarzenegger ad was a good idea. There were way too many truly awful ads. Who even knows what the ridiculous ad with the cross between the doberman the chihuahua was trying to sell? And can I just say, the exploitation of the American flag and of our need to stand by our vets in order to sell beer and cars makes me very  uncomfortable. 

 

3. Halftime conversation: “Who is Bruno Mars?” (Still unsure.)

 

4. What do you think Pete Seeger would think of Bob Dylan hawking Chryslers?  

 

As the March 5, 2014 date for oral argument before the United States Supreme Court in the closely-watched Halliburton case approaches, the briefing process in the case has continued to unfold. On January 29, 2014, the Erica P. John Fund, the respondent (the plaintiff in the underlying action) filed its merits brief in the case, arguing that the Court should uphold the fraud on the market theory. But while the plaintiff contends that the Court should preserve the status quo, other commentators are looking ahead considering what the securities litigation world might look like if the Supreme Court overturns Basic v. Levinson (the 1988 decision in which the Court first recognized the fraud on the market theory).

 

As well-analyzed by Alison Frankel in a January 30, 2014 post on her On the Case blog (here), the plaintiff has urged the court to uphold Basic based on the history of the securities laws and the principles of stare decisis, and out of deference to Congress and regulators. The plaintiff  side-steps the debate whether the “efficient market hypothesis” on which the fraud on the market theory is based is valid, arguing that the debate is “irrelevant” and contending  that at the heart of Basic v. Levinson is “the simple economic truth” in “the proposition that developed markets generally respond to material information.”

 

The plaintiff argues that in adopting the securities laws in the wake of the Great Depression, Congress recognized, consistent with the fraud on the market theory, that a company’s share price incorporates all publicly available information about the company. According to the plaintiff, the Supreme Court itself recognized as much in several cases prior to the Basic case. And since Basic was decided, the Court has expressly endorsed the fraud on the market theory several times – including just three years ago in a unanimous decision in the Halliburton case itself, when the case was previously before the Court.

 

In other words, the plaintiff argues, the Supreme Court could only dump the fraud on the market theory by reversing its own precedent and overlooking an established body of its own case law. For the Court to overturn its own statutory precedent is an event so rare that, according to the plaintiff, it has been over 50 years since the last time the Court did so.

 

Not only would the Court have to overturn its own precedent, but it would implicitly override Congress, which has revised the securities laws numerous times since Basic was decided but has not altered the fraud on the market theory. “Congress,” the plaintiff argues “has expressly considered overturning Basic, and could have done so at any time over the past quarter century,” but instead it left the current arrangements in place. In addition, the plaintiff argues, both the SEC and the Department of Justice rely on the fraud on the market theory in connection with their enforcement of the securities laws.

 

The most fundamental reason for leaving Basic alone, the plaintiff argues, is that if the fraud on the market theory is discarded, “securities-fraud class actions and many individual fraud actions simply could not be brought in 10(b) and 10b-5 cases based on affirmative misrepresentations.” As a result, “most defrauded investors would be left without any legal recourse from fraud.” Were this to happen, “the legal landscape would be worse for the change.”

 

The reason that the plaintiff emphasized the importance of the fraud on the market theory in misrepresentation cases in particular is that in a case based on alleged omissions rather than alleged misrepresentations, the claimant does not have to depend on the fraud on the market theory to establish a presumption of reliance. Instead, in an omissions case, the claimant simply does not have to establish reliance. In a case that preceded Basic, the 1972 decision in Affiliated Ute Citizens v. United States, the Supreme Court said that proof of reliance is not necessary to support a claim based on alleged omissions.

 

In light of this case law, many commentators have speculated that if the Supreme Court were to overturn Basic and make it impossible for plaintiffs to pursue Section 10(b) misrepresentation cases as class actions, the plaintiffs will simply recast their allegations and contend that investors were misled by the defendants’ omissions, instead of trying to contend that the defendants’ misrepresentations had misled investors.

 

However, it could be far trickier for the plaintiffs to pursue this approach that the commentators are suggesting. As Claire Loebs Davis notes in a January 28, 2014 post on the D&O Discourse blog (here), Affiliated Ute “does not offer a quick fix” to the potential elimination of the fraud on the market theory.   Rule 10b-5, she argues, does not simply create a cause of action for omissions as well as for false and misleading statements; rather, she emphasizes, the provision refers to “false or misleading statements and omissions of material fact necessary to make statements made not misleading.”

 

In other words, omissions are only actionable if they cause an affirmative statement to be false or misleading because of the information that was omitted. It is not enough for a plaintiff to argue that something material was omitted; the omitted information must have made an affirmative statement materially misleading. Accordingly, she argues, “plaintiffs cannot simply recast their securities fraud allegations as ‘omission’”; plaintiffs “may only state a claim under 10b-5(b) based on an affirmative misstatement – whether that affirmative statement was misleading because of what it said, or because of what it did not say.”

 

She concludes her post by noting ‘that “one thing is clear: Affiliated Ute does not offer a straightforward solution for plaintiffs’ lawyers if the Halliburton Court takes away the fraud-on-the-market presumption. Whether they phrase their allegations as claims of affirmatively false statements or statements made false by omission, they are still claims based on statements, not omissions, and current law requires that plaintiffs find a way to show class-wide reliance.”

 

Davis’s commentary is both noteworthy and very interesting. Some commentators considering the possible outcomes of the Halliburton case have tried to suggest that not that much would change if the Supreme Court were to dump the fraud on the market theory, since, they suggested, plaintiffs could simply plead their claims as omissions cases and rely on Affiliated Ute to avoid the reliance problem. Davis’s post suggests that it may not be that simple and that even in an omissions case the plaintiffs will have to establish class-wide reliance.