In a December 23, 2013 ruling that will be surprising and unwelcome to D&O insurers and their insureds in New Zealand (and perhaps elsewhere) , the New Zealand Supreme Court has reversed the holding of an intermediate appellate court and ruled that, by operation of a statutory “charge” on insurance in favor of third party claimants, the former directors of the defunct Bridgecorp companies cannot have their defense costs paid under their company’s D&O insurance policies.

 

A copy of the New Zealand Supreme Court’s opinion can be found here. Special thanks to Francis Kean of Willis for sending me a link to his January 8, 2014 Willis Wire blog post about the New Zealand court’s ruling.

 

Background

The New Zealand Supreme Court’s opinion actually relates to consolidated appeals involving two defunct companies, Bridgecorp and Feltex Carpets Ltd. In both cases, directors of the failed companies seek access to their company’s D&O insurance in order to defend themselves from claims following in the wake of their company’s failures. Though the appeal involved two companies, most of the discussion in the Court’s opinion relates to Bridgecorp, and so my discussion below is focused on Bridgecorp.

 

The Bridgecorp group operated as a real estate development and investment firm. (For more information about the Bridgecorp group and its demise, refer here.) When it collapsed in July 2007, the group owed investors nearly NZ$500 million. The group’s former directors faced numerous criminal and civil claims arising out of the collapse. Several directors of Bridgecorp have been convicted of offenses under the New Zealand Securities Act of 1978. Bridgecorp’s receivers have sued the directors for damages in excess of NZ$340 based on allegations that the directors breached duties they owed the Bridgecorp companies and caused the companies loss.

 

At the time of its collapse, the Bridgecorp group carried NZ$20 million in D&O Insurance. The group also carried $2 million of statutory liability defense cost protection (the “SL policy”), but the limits of the SL policy were exhausted in payment of the directors’ attorneys’ fees. The directors then sought to have their fees paid under the D&O insurance policy. The D&O policy combines both indemnity and defense cost protection for the company’s directors and officers in a single policy subject to single aggregate limit of liability. Under the policy’s terms, defense costs are inside the limit – that is, the insurer’s payment of defense costs erodes the limit of liability.

 

The Bridgecorp receivers advised the D&O insurer that they assert a “charge” under Section 9 of the Law Reform Act of 1936, which they contend creates a priority entitlement in claimants’ favor over monies that may be payable under any insurance policy held by the person against whom the claim is made. The Bridgecorp group directors in turn initiated an action seeking a judicial declaration that Section 9 does not prevent the insurer from meeting its contractual obligation under the D&O policy to reimburse them for their defense costs.

 

As discussed here, on September 15, 2011, New Zealand High Court (Auckland Registry) Justice Graham Lang ruled in favor of the Bridgecorp’s receivers, holding that the receivers’ “charge” on the D&O insurance policy’s limits of liability under Section 9 “prevents the directors from having access to the D&O policy to meet their defence costs.”

 

Justice Lang stated that the provision provides a “procedural mechanism” to ensure that a claimant can “gain direct access to insurance monies that would have been available to the insured.” Justice Lang acknowledged that this result is “harsh” and even “unsatisfactory,” he reasoned that Section 9 was designed to “keep the insurance fund intact” for the benefit of claimants and that this legislative purpose should not be defeated merely because coverage for both defense costs and indemnity were combined in a single policy. The directors appealed Justice Lang’s ruling.

 

As discussed here, in a December 20, 2012 opinion, a unanimous three-Justice panel of the Court of Appeal of New Zealand quashed Justice Lang’s lower court ruling.In ruling that the Section 9 does not apply to the D&O policy’s defense cost coverage. The Court of Appeal noted that the policy provides coverage for “two distinct kinds of losses” that operate “independently.” The court reasoned that if the two coverages had been set up in separate policies, Section 9 could not have applied to the defense cost policy, and that the combination of the two coverages into a single policy should not affect the analysis. The court also reasoned that “it is irrelevant” that the policy proceeds would be depleted by payment of defense costs, as that is that is “the necessary consequence of the policy’s structure.”

 

The Court of Appeal also noted that the practical effect of Justice Lang’e ruling was to deny the directors of their contractual rights to defense cost reimbursement. The Court noted that a “charge” under Section 9 is “subject to the terms of the contract of insurance as they stand at the time the charge descends” and it “cannot operate to interfere with or suspend the performance of mutual contractual rights and obligations relating to another liability.” Bridgecorp’s receivers appealed the intermediate appellate court ruling.

 

The Supreme Court’s Ruling

The New Zealand Supreme Court overturned the intermediate appellate court’s ruling  in a 3-2 decision that included three different opinions. In the lead two-Judge opinion by Chief Judge Sian Elias and Judge Susan Glacebrook (in which Judge Noel Anderson separately concurred), the Court held that “the scheme, the text, the caselaw and the legislative history of Section 9 make it clear that the statutory charge attaches at the time of the occurrence of the event giving rise to the claim for compensation for damages in respect of the liability to third parties which is covered by the policy. Reimbursement to the directors of their defense costs is not within the statutory charge.” 

 

The insurer’s contractual obligation to pay defense costs as they arise is “immaterial” and the effect of the charge is such that the contractual obligation to pay the directors’ defense costs “can be met only at the peril of the insurer when there is sufficient insurance cover under the limit of the policy to meet both insurance obligations.”

 

In response to concerns that the Court’s holding would leave the directors without the means of defense, the lead opinion responded that “An insured would only be deprived of the ability of the ability to mount a defence if he or she had not other funds available for a defence and where no lawyer would act on a contingency basis. Further, an insurer may well have an incentive to fund a good defence out of its own funds as that would reduce the insurer’s exposure under the policy.”

 

In justifying the harsh result the Court’s ruling imposes, the lead opinion attempted to pin the blame for the result on the way the policy is structured. After first asserting (supported only with an obscure footnote reference) that “a combined limit is not necessarily the norm,” lead opinion then asserts that this combined limits structure is the cause of the problem:

 

These unusual cases arise because the policies in issue have made the defence costs the subject of cover in a policy that also covers third-party liability that gives rise to the defence costs. As a result, the statutory charge protects the third party claimant and prevents the performance of the defense cost obligation without risk to the insurer. This means that the insurer and the insured have struck a poor bargain because the policy has not been properly drawn, overlooking the effect of the statutory charge.

 

Judges John McGrath and Thomas Gault dissented from the lead opinion, essentially on the ground that Section 9 does not require an unproven claim to be given priority over an immediate policy obligation.

 

Discussion

As some level, the Supreme Court’s ruling is just the unfortunate outcome of a divided Court’s attempt to interpret a peculiar local statutory provision.

 

At another level, the Court’s ruling demonstrates the difficulties the D&O insurance industry faces as it attempts to deploy policies that will respond in jurisdictions where there is little developed case law interpreting the policies. The tortured procedural history of this case alone shows how unpredictable the contract’s performance can be when there is little local case law.

 

The tortured procedural history and the divided result in the Supreme Court also underscore how off target the lead opinion is in suggesting that the parties to the insurance contract struck a “poor bargain” by failing to take the operation of Section 9 into account. As if the parties should have known when they entered the contract how Section 9 would ultimately be applied, even though the various judges and courts that have looked at the question of how Section 9 should operate have been all over the map. (In that regard, Francis Kean notes in his blog post that of the nine New Zealand judges that reviewed these issues in the various New Zealand courts, five of them ruled that the Section 9 charge did not prohibit the insurer from paying the directors’ defense costs, and only four found that the charge prohibited the defense cost payment.)

 

To the extent the lead opinion’s analysis depends on its loose assertion that it is not the “norm” for D&O insurance policies to have defense expense and indemnity protection both provided in a single form, the Judges writing the opinion would have done well to consult someone –anyone—that actually knows anything about D&O insurance. It is in fact very much the norm for D&O insurance policies to combine the two coverages in a single form.

 

The lead opinion’s response to the suggestion that the Court’s holding will deprive the directors of the ability to defend themselves ignores the reality of directors’ position. The lead opinion’s suggestion that there are no problems because the directors can just defend themselves using their own assets  or get a lawyer to represent them on a contingency (say what?) ignores that fact one of the principal reasons that the insurance is even in place was so that the insurance would pay these very costs. To say, as the lead opinion does, that a director will only be deprived of an ability to defend themself “if he or she had no other funds available” simply ignores the very reason this kind of insurance exists. This insurance is catastrophe insurance. The insurance frequently operates as the insured persons’ last line of defense. The lead opinion’s “let them eat cake” dismissiveness of the position their ruling puts the directors in is, well, disappointing to say the least.

 

Perhaps it is owing to its antipodal provenance, but the lead opinion’s interpretation of Section 9 stands the very idea of liability insurance on its head. Liability insurance does not exist to protect claimants, it exists to protect the insureds. Insurance buyers procure the insurance to protect themselves from third party lawsuits. The very idea that a mere assertion of an unproven claim is enough to strip the insured under a liability policy of the protection they procured for themselves is questionable in its very approach to the insurance equation.

 

I hope that the New Zealand Parliament will give due consideration to the nature and purposes of liability insurance and make appropriate adjustments to Section 9 to ensure liability insurance can operate to protect the persons whom it was intended to protect – that is, the insured persons.

 

While awaiting a parliamentary revision (that may or may not ever come), the insurance industry will have to respond. I suspect the D&O insurance professionals in New Zealand are even now struggling to figure out how to try to structure D&O insurance policies going forward so that no other directors are put in the absolutely rotten position that these directors have been put in. One possibility is to set up the policy with defense outside the limits, so that the defense costs do not erode the limit. (Defense outside the limits is actually required in Quebec.) Another possibility is to structure the defense cost protection separately from the indemnity insurance.

 

As Francis Kean points out in his blog post, these possibilities may address the problem on future policies, but that doesn’t help on the policies that are already in place. Insureds with policies in force will understandably be concerned whether their policies will fund their defense. While companies could attempt to supplement their existing coverage to add defense cost protection, that is not going to help the companies that have pending claims.

 

I noted at the outset of my commentary that at one level this may all be just a reflection of a local problem under a New Zealand statute. But the impact of the New Zealand Supreme Court’s ruling may be felt in Australia as well. The New Zealand Supreme Court’s opinion expressly references a parallel proceeding pending in the courts of New South Wales that involves a nearly identical statute in that jurisdiction. Kean notes in his blog post that the High Court of Australia (the country’s highest court) is “due shortly to pronounce on an appeal under the equivalent legislation in New South Wales, and it is entirely possible that it will go down the same path as New Zealand.”

 

Since the U.S. Supreme Court agreed to revisit the “fraud on the market” theory by granting cert in the Halliburton case a few weeks ago, many commentators (including this blog) have considered whether the Court might wind up taking an intermediate position that addresses criticisms of the theory while preserving securities plaintiffs’ ability to try to establish reliance at the class certification stage,

 

In a December 2013 paper entitled “Rethinking Basic” (here), Harvard Law School Professors Lucian Bebchuk and Allen Ferrell suggest an intermediate path for the Court to take. They propose a “meaningful modification” of the Court’s holding in Basic, Inc. v. Levinson, to ensure that the reliance inquiry at the class certification stage avoids the “efficient market” debate and asks instead whether or not the alleged misrepresentation caused “fraudulent distortion” to the defendant company’s share price.

 

Background

Since its adoption by the Supreme Court in the Basic case, the fraud on the market theory has provided a way for securities plaintiffs to pursue their claims on behalf of similarly situated shareholders, without having to establish that each of the shareholders relied on the alleged misrepresentation. As Justice Ginsburg put it in her majority opinion in the Supreme Court’s 2013 Amgen decision, “the fraud-on-the-market premise is that the price of a security traded on an efficient market will reflect all of the publicly available information about a company; accordingly, a buyer of the security may be presumed to have relied on the information in purchasing the security.’

 

Among the many criticisms of the Court’s adoption of the fraud on the market presumption is that the “efficient market” premise on which the presumption is based is the subject of a heated and long-running debate. Coincidentally, the most recognized proponents of the two schools of thought in the “efficient market” debate were among the winners of the 2013 Nobel Prize for Economics – University of Chicago Business School Professor Eugene Fama, who is the leading proponent of the efficient market hypothesis, and Yale economist and business school professor Robert Shiller, who is the hypothesis’s leading critic.

 

From the time of the Basic decision, commentators have questioned whether the Supreme Court should be basing its decisions on disputed economic theories. Indeed, in his dissenting opinion in Basic, Justice Byron White expressed his concern that “with no staff economists, no experts schooled in the ‘efficient capital market hypothesis,’ no ability to test the validity of empirical market studies, we are not well-equipped to embrace novel constructions of a statute based on contemporary economic theory.”

 

The Authors’ Proposal

In their recent paper, the authors suggest a “reformulation” of Basic that shifts the judicial focus away from the debated issues of market efficiency to the issue of “fraudulent distortion.” The authors propose to limit class-wide reliance to “reliance on the market price of a security not being fraudulently distorted – that is, reliance on the market price not being impacted by (and thus reflecting) misstatements and omissions that produced a price different from what it would have been in the absence of fraud.”

 

In other words, the authors suggest that in order to determine whether the reliance requirement can be presumed to be satisfied, the focus should be on “whether the misrepresentation actually affected the stock price” – and not on whether the market in general or the market for a specific company’s securities are or are not efficient.

 

In order to establish whether or not “fraudulent distortion” has occurred, the authors advocate the use of “financial econometric tools” such as event studies to measure the impact of the alleged misrepresentation. The authors suggest that the burden with respect to the price distortion showing could either be on the plaintiffs or the defendants, but that either way the defendants would have the opportunity to attempt to rebut the showing. The authors suggest that their proposed approach would eliminate the problems of over-inclusiveness and under-inclusiveness in class litigation, and provide a means to eliminate frivolous suits as well.

 

An amicus brief has been filed with the Supreme Court in the pending Halliburton case on behalf of several law professors — not including the article’s authors — arguing (without express reference to the article) that that the fraud on the market presumption does not require dependence on the “efficient market” hypothesis, and that instead of the "efficient market" premise  the focus in the reliance inquiry should be on the effect of the alleged misrepresentation on the share price. The amicus brief can be found here.

 

Discussion

The authors’ proposal has much to recommend it. Among other things, it preserves the ability of plaintiffs to establish reliance at the class certification stage in Section 10(b) misrepresentation cases, and it would remove the Court from the uncertain challenge of taking sides in the “efficient markets” debate. It also allows the opportunity for defendants to try to rebut the basis for applying the “fraudulent distortion” presumption, which is an option defendants have sought with respect to the current fraud on the market presumption.

 

Certain objections to the authors’ proposal can be expected. In noting the possible objections here, I am simply attempting to identify potential issues, not criticize the authors’ analysis, as that is an exercise for which I am not qualified.

 

Among other things, it likely will be suggested that the authors’ focus on the impact of the alleged misrepresentation on the company’s share price may simply be raising by other means the issues of materiality and loss causation – both of which issues the Supreme Court recently has said are merits issues not appropriately taken up at the class certification stage. (The Supreme Court addressed materiality in its 2013 decision in Amgen, and it addressed loss causation in its prior consideration of class certification issues in the Halliburton case in 2011.)

 

The authors address both of these issues in their article. In a footnote, the authors contend that their suggested analysis is “not equivalent to a legal determination of materiality” because, among other things, the determination of materiality “involves the consideration of several specific legal issues.” Similarly, the authors reject the suggestion that their proposed analysis and particularly their proposed use of an event study in the fraudulent distortion determination “conflates loss causation.” The authors state that the question they propose and the loss causation question are simply different, contending that the fact that the share price has been fraudulently distorted does not establish that loss causation exists.

 

While the authors are satisfied that their proposed analysis does not involve issues the Supreme Court has already said are not appropriately considered at the class certification stage, concerns may nevertheless remain. The question whether or not a misrepresentation distorted a company’s share price does feel a lot like an inquiry whether or not the alleged misrepresentation was material.  The proposed use of an event study or other tool to determine whether or not the alleged misrepresentation caused a distortion in the company’s share price does feel a lot like a loss causation inquiry.

 

Indeed, there would be significant irony if the Supreme Court, having already said in the Halliburton case itself that loss causation is not an appropriate issue at the class certification stage, were now to come out and say — on reconsideration of class certification issues in the very same case– that in order to determine the issue of reliance at the class certification stage, the district court must determine whether or not the alleged misrepresentation caused a distortion in the company’s share price.

 

Critics of the authors’ proposed approach may also contend that the proposed use of “event studies” or similar tools present their own set of issues. What types of “financial econometric tools” can be used to determine whether or not there has been “fraudulent distortion”? What legal principles will govern the analysis of the econometric validity of the proposed tools? Doesn’t the proposed use of econometric tools raise the specter of substituting a different economic debate for the “efficient market” debate, as the parties vie for the use of their preferred econometric tool? And as a practical matter, wouldn’t the deployment of these tools introduce a potentially cumbersome, evidentiary-based process at the class certification stage that could be ungainly, time-consuming and costly?

 

While the authors’ proposal does raise a number of questions, it does provide a way for the Court to try to step out of the “efficient market” debate while preserving a way for securities plaintiffs to try to establish class-wide reliance at the class certification stage. For that reason, the authors’ proposal merits consideration.

 

Several members of the Court likely will be looking for an intermediate path that avoids eliminating altogether the ability of securities plaintiffs to pursue Section 10(b) cases on behalf of all similarly affected shareholders. The authors’ proposal may provide an attractive intermediate path for the Court.

 

While I have identified above a number of questions that may be asked about the authors’ proposal, I will stipulate that others are far more qualified than I am to discuss these issues and other questions the authors’ proposal may raise. I hope that readers with reactions to the authors’ proposal will add their thoughts to this post using the blog’s comment feature.

 

Special thanks to Professor Ferrell for providing me with a copy of the article.

 

More About Halliburton: One of the preferred arguments among those who want to keep the Basic presumption unchanged is that Congress modified the securities laws significantly in 1995, but did not set aside the fraud on the market theory or the presumption of reliance. Justice Ginsberg cited this fact in the majority opinion in Amgen, suggesting that Congress’s inaction on the issue amounted to Congressional approval of the approach. Justice Ginsburg wrote that rather than eliminating the presumption, “Congress rejected calls to undo the fraud-on-the-market presumption of classwide reliance endorsed in Basic.”

 

However, as Alison Frankel notes in a January 7, 2014 post on her On the Case blog (here), an amicus brief filed in the Halliburton case takes a contrary view on how to interpret Congress’s supposed inaction. The amicus brief (which can be found here) was filed by five former Republican members of Congress and seven former Congressional and Securities and Exchange Commission staffers, all of whom were involved in the passage of securities litigation reform in 1995. Frankel summarized the amicus brief as saying that “The 1995 law passed by both houses, overriding a veto by President Clinton, didn’t actually end up addressing the fraud-on-the-market theory of classwide investor reliance at all – which, according to the brief, should not be construed by the Supreme Court as a rejection of efforts to repudiate the precedent.”

 

“Congress did not answer any of the competing calls to overturn, modify, or codify the Basic presumption,” the amici argue. “Congress was simply silent in response to those various requests, and this court should not take Congress’s silence as implicit acceptance or rejection of Basic’s fraud-on-the-market theory.”

 

Another amicus brief filed by a separate group of law professors and former SEC Commissioners, including Stanford Law Professor Joseph Grundfest, argues that the correct legislative history for the Court to consider is the history regarding the original passage of the Exchange Act in 1934. These professors argue that “the 1934 Act’s legislative history leaves no doubt that, had the Seventy-Third Congress addressed the question, it would not have created a private Section 10(b) right unless that right required proof of actual reliance … That history further underscores that Congress would not have condoned a presumption of reliance.” Interestingly, the professors joining this brief, which can be found here, includes Professor Ferrell, one of the authors of the paper I discussed above.

 

A Day at Lloyd’s: On Monday, January 27, 2014 – that is, the day before the 2014 PLUS D&O Symposium – at the St. John’s School of Risk Management in New York, the American Bar Association Torts and Insurance Practice Section (TIPS) will be reprising its successful program on claims processes at Lloyd’s. This year’s program is entitled “A Day at Lloyd’s of London Part II and Alternative Dispute Resolution.” The program is “designed to encourage a greater understanding between the U.S. and international insurance market of how the Corporation of Lloyd’s of London works and the practical issues that arise.”

 

Among the program moderators is my good friend Perry Granof and the faculty includes an all-star casts of insurance professionals and claims attorneys. In addition, the program’s keynote speaker is Hank Greenberg, currently the Chair and CEO of C.V. Starr. Information about the program including registration information can be found here.

 

The world of directors and officers liability has long been characterized by rapid change. But even given these well-established dynamics, 2013 was a particularly eventful year, with several different developments that could impact the D&O arena for years to come. The list of the Top Ten D&O Stories of 2013 is set out below with an eye toward these future possibilities.

 

1. U.S. Supreme Court Agrees to Revisit the “Fraud on the Market” Presumption: In a development that has the potential to change the way securities class action lawsuits are litigated, the U.S. Supreme Court has granted a writ of certiorari in the long-running Halliburton case and  agreed  to revisit the “fraud on the market” presumption.

 

Since the U.S. Supreme Court’s 1988 decision in Basic, Inc. v. Levinson, securities plaintiffs seeking class certification in Section 10(b) cases have been able to dispense with the need to show that each of the individual class members relied on the alleged misrepresentation, based on the presumption that in an efficient marketplace, a company’s share price reflects all publicly available information about a company, including the alleged misrepresentation, and that the plaintiff class members relied on the market price. Without the benefit of this presumption, it would be very difficult for Section 10(b) plaintiffs to pursue their claims as a class action.

 

The possibility that the Court could set aside the Basic presumption means that the Halliburton case could be, in the words of leading securities plaintiffs’ attorney Max Berger of the Bernstein Litowitz firm (as quoted in Alison Frankel’s November 15, 2013 post on her On the Case blog) a “game changer.” As Jordan Eth and Mark R.S. Foster of the Morrison Foerster law firm noted in their November 15, 2013 memo about the Supreme Court’s cert grant in the case (here), Halliburton “has the potential to be the most significant securities case in a generation.”

 

There are, however, a range of possible outcomes in the Supreme Court’s consideration of the case. First, though it only requires four votes for the Court to take up a case, it takes five votes to determine the outcome. Based on the various Justices’ voting patterns in recent cases (particularly in the 2013 Amgen case), it isn’t clear at all that there are five votes to set aside the Basic presumption

 

Second, in addition to their question whether the Basic presumption should be revisited, the petitioners also sought to have the Court consider “Whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock.” Given this additional question, the Court might explain the ways in which (and when) the Basic presumption may be rebutted, if at all, at the class certification stage, rather than setting it aside.

 

Even of the Supreme Court sets the Basic presumption aside, private securities litigation will go on. Investors in some cases will still be able to bring class actions under Section 11 of the Securities Act of 1933, which does not require a showing of reliance but holds defendants strictly liable for material misrepresentations. Claimants who purchased their shares in public offerings will still be able to pursue their claims as class actions.

 

In addition, in securities cases based on alleged omission rather than alleged misrepresentations, plaintiffs do not need to rely on the Basic presumption in order to obtain class certification. As Alison Frankel pointed out in a November 27, 2013 post on her On the Case blog (here), in the Affiliated Ute case, the U.S. Supreme Court established that securities fraud plaintiffs do not have to establish reliance to sustain claims based on a defendant’s failure to disclose material information. In other words, even if the Supreme Court dumps the Basic presumption, securities plaintiffs will still be able to obtain class certification in Section 10(b) cases based on alleged omissions.

 

It is also worth noting that the way securities cases are being litigated was already changing in significant ways. Many of the securities suits filed in the wake of the financial crisis were filed as individual actions or group actions, not as class actions. The plaintiffs’ firms have established significant client relationships with pension funds and other large institutional investors whose claims could be aggregated to present a collective action on behalf of a group of investors, even if the lawsuit  might not be able to proceed as a class action.

 

That said, there is no doubt that if the Basic presumption were set aside, the way securities lawsuits are litigated in this country would be significantly changed. In Section 10(b) misrepresentation cases, it would become much more difficult – perhaps impossible — for plaintiffs to obtain class certification. Without the benefit of being able to hold out the threat of ruinously large class-wide damages, plaintiffs’ lawyers would be less able to extract the kind of massive settlements that have become a feature of private securities litigation.

 

Among the many consequences that would result if the Basic presumption were set aside, it seems likely that the way many public companies purchase D&O insurance would change. As Joe Monteleone noted on his D&O E&O Monitor blog (here), the end result could be that “there will be less of a need to buy large towers of D&O insurance, a likely reduction in rates and perhaps an overall shrinking of the D&O marketplace with fewer players and less revenue in both the insurer and brokerage communities.” Of course, if securities litigation were to mutate into something smaller but more complex, the impact on D&O purchasing patterns and rates could take a different turn.

 

There are a lot of possible outcomes here, but any way you look at it the Halliburton case has enormous potential significance for the D&O insurance industry. The case is set to be argued in March 2014 and the case should be decided by the end of the current term in June 2014.

 

2. D&O Insurance Funds Entire $139 Million News Corp. Derivative Litigation Settlement: In the past, going back ten years or so, shareholders’ derivative suits typically did not present the possibility of significant cash payouts for D&O insurers, at least in terms of settlements or judgments. The cases did often involve the possibility of significant defense expense and sometimes included the possibility of having to pay the plaintiffs’ attorneys’ fees, but by and large there was usually not a separate cash settlement component.

 

However, these past patterns appear to have changed, at least in some shareholders derivative lawsuits. In recent years, there have been a number of derivative suit settlements that have involved a very large cash component. Consistent with this more recent pattern, in April 2013, in what the plaintiffs’ lawyers claim to be the largest derivative lawsuit settlement ever, the parties to the consolidated News Corp. shareholder derivative litigation agreed to settle the cases for $139 million. The cash portion of the settlement was funded entirely by D&O insurance. (The details about the underlying lawsuit and about the settlement can be found here.)

 

The recent trend toward the inclusion of significant cash components in derivative settlements gained momentum with the options backdating scandal. Many of the options backdating cases were filed as derivative suits rather than as securities class action lawsuits. Some of the options backdating derivative suit settlements included very substantial cash components. For example, the Broadcom options backdating derivative lawsuit settlement included the D&O insurers’ agreement to pay $118 million (as discussed here).

 

The inclusion of a significant cash component has also been a feature of the settlements of some of the merger objection suits filed in the upsurge in M&A-related lawsuits in recent years. For example, the El Paso/Kinder Morgan merger-related derivative suit settled in September 2012 for $110 million (refer here).

 

This increase in the number of derivative suit settlements that include a significant cash component can only be viewed with alarm by the D&O insurance industry. Public company D&O insurers have long considered that their significant severity exposure to be limited to securities class action lawsuits. The undeniable reality is that in at least some circumstances, derivative suits increasingly represent a severity risk as well. And the settlement amounts themselves represent only part of the D&O insurers’ derivative litigation-related loss costs. The D&O insurers also incur millions and possibly tens of million of defense cost expense in these derivative suits.

 

An even more concerning aspect of the rise of significant cash settlements in derivative cases for D&O insurers is that these settlement amounts typically represent so-called “A Side” losses. That is, the losses are paid out under the portion or the D&O insurance policy that provide insurance for nonindemnifiable loss. A derivative suit settlement typically would not be indemnifiable, because if it were to be indemnified, the company would make the indemnity payment to itself.

 

The question for the carriers providing excess Side A insurance is whether or not the premiums they are getting are adequate to compensate them for the risks of the kinds of losses associated with large cash shareholders derivative settlements. By and large, the carriers providing this insurance consider that their most significant exposure is related to claims in the insolvency context. But as the News Corp. settlement and the Broadcom settlement mentioned above demonstrates, it is also possible that the Side A insurance can be implicated in a jumbo derivative settlement.

 

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

 

3. SEC Adopts New Policies Requiring Admissions of Wrongdoing in Enforcement Action Settlements: On August 19, 2013, in connection with its entry into a settlement with New York-based hedge fund adviser Phillip Falcone and his advisory firm Harbinger Capital Partners, the SEC for the first time implemented its new policy requiring defendants seeking to settle civil enforcement actions to provide admissions of wrongdoing, in contrast to the long-standing practice of allowing defendants to resolve the enforcement actions with a “neither-admit-nor-deny” settlement.

 

In addition, as part of its September 19, 2013 entry into a total of $920 million in regulatory settlements related to the “London Whale” trading loss debacle, and as part of the SEC’s new policy requiring admissions of wrongdoing in certain “egregious” cases, JP Morgan provided the SEC with an extensive set of factual admissions.

 

The SEC implemented its new policy a third time on December 19, 2013, as part of its $107.4 million settlement of fraud charges against brokerage ConvergEx for bilking its customers by inflated fees. (The company also agreed to pay a $43.3 criminal penalty as part of a related deferred prosecution agreement.) The brokerage unit and two individual traders admitted to wrongdoing in connection with the SEC settlement, and also separately admitted criminal charges as well, as discussed here. 

 

The SEC’s new settlement policy means that, at least in the SEC enforcement actions where the agency will require admissions in order to settle,  the cases will be much harder to settle. The defendants, wary of the possible impact the admissions could have in other proceedings, will be reluctant to provide admissions. One consequence of the new policy could be that the SEC will be compelled to try more cases, which could strain the agency’s resources. For those defendants providing admissions, the impact on related proceedings could be significant.

 

A defendant’s entry into admissions of wrongdoing could also have significant implications for the availability of D&O insurance. The specific question is whether or not the admissions would be sufficient to trigger the fraud and criminal misconduct exclusion in the D&O policy. These exclusions typically preclude coverage for loss arising from fraudulent or criminal misconduct, but only after a final adjudication determines that the preclusive conduct has taken place. If the admissions were found to be sufficient to trigger this exclusion, coverage would no longer be available for the wrongdoer, and the insurer could even have the right to try to recover amounts that had already been paid (for example, the attorneys’ fees the wrongdoer incurred in defending himself or herself in the SEC proceeding).

 

On the other hand, there would appear to be a substantial question whether the specific admissions to which the Harbinger defendants agreed rise to the level to satisfy the exclusion’s misconduct requirement. While the admissions represent an extensive concession that the defendants engaged in wrongdoing – and while the admissions expressly recite that the defendants acted “improperly” and “recklessly” — at no point to the defendants admit to “fraud” or to any other level of conduct that would expressly trigger the typical D&O policy’s conduct exclusion.

 

The defendants may be able to walk a fine line in providing admissions to the SEC that avoid many of these potential problems. J.P. Morgan’s settlement in the London Whale case may provide something of a roadmap in that regard. As Wayne State Law Professor Peter Henning noted in a post on the Dealbook blog about the J.P Morgan settlement, the admissions “will be of very limited utility to private parties suing the bank for violating the federal securities laws.” Indeed, in a September 19, 2013 post on her On the Case blog entitled “Don’t Get Too Excited About JP Morgan’s Admissions to the SEC” (here), Alison Frankel says that “JP Morgan has shown that it is possible to give the SEC an admission that will permit the agency to look tough without conceding much, if anything, in private litigation.”

 

Similarly, admissions of the type JP Morgan entered could present less of an insurance coverage concern. The JP Morgan admissions contain no specific admission of criminal or fraudulent misconduct. There would appear to be less of a basis for an insurer to contend in reliance on the conduct exclusion that coverage is precluded. So if the JP Morgan settlement were to become a “model” it at least would appear to present less a D&O insurance coverage concern.

 

The SEC’s new admissions policy is still relatively new and it is hard to know for sure how it will be implemented and what its effects will be. The question as the SEC implements the policy in the months ahead will be how specific the wrongdoing admissions must be and whether they will be of a kind that could have collateral impact on related litigation and have an effect on the continued availability of D&O insurance.

 

4. SEC Awards Whistleblower More Than $14 Million: The SEC’s regulations implementing the Dodd-Frank whistleblower bounty provisions went into effect in August 2011. The agency’s process for the deployment of bounty awards has proven to be quite deliberate. The agency still has made a total of only six awards overall. However, the agency’s October 1, 2013 award of over $14 million to one whistleblower – by far the largest award so far under the Dodd-Frank whistleblower bounty program – could signal that the whistleblower moment has arrived, especially given that whistleblower reports have continued to flood into the agency.

 

According to the agency’s annual Dodd-Frank Whistleblower Program report to Congress issued on November 15, 2013  (here), there were 3,238 whistleblower reports to the SEC during the 2013 fiscal year ending on September 20, 2013, brining the total number of whistleblower reports to the agency since the program’s August 2011 inception to 6,573.

 

Though the program has so far made only a few awards relative to the number of whistleblower reports, it seems likely that the number of awards will accelerate in the future. The very painstaking process the agency follows in making awards (described in the report to Congress) shows that the agency is being very deliberate in making awards. As the agency makes more awards, it seems likely that the program will attract more whistleblower reports, particularly to the extent that the agency makes more large awards on the scale of the recent $14 million award.

 

Another question that will be interesting to follow is whether or not there will be follow-on civil lawsuits in the wake of whistleblower reports (of the kind discussed here). The concern is that increased whistleblowing activity, encouraged by the availability of whistleblower bounties, could lead to an increase not only in SEC enforcement activity but also to an increase in follow-on civil litigation, including in particular securities class action litigation. In any event, it seems likely that there will be further whistleblower bounty awards in the months ahead.

 

5. Number of Banks Drops to Lowest Level Since the Great Depression: According to a December 3, 2013 Wall Street Journal article (here). the number of reporting institutions listed in the FDIC’s latest Quarterly Banking Profile (here) represents the lowest level for the number of banks since the Great Depression.

 

As of September 30, 2013, there were 6,891 federally insured banking institutions, down from 7,141 as of September 30, 2012. There had been 8,680 banking institutions as recently as December 31, 2006, meaning that there are 1,789 (or about 20%) fewer banks in the U.S. than there were a little less than seven years ago.

 

Two banking crises since 1984 account for a significant part of the decline in the number of banks since the Great Depression. Between 1985 and 1995, as a result of the S&L crisis, 1,043 institutions failed (as discussed here). More recently, the global financial crisis has taken its toll on the U.S. banking industry – since January 1, 2007, 534 banking institutions have failed, or more than six percent of all of the banks in business at the beginning of the period. But though there have been a huge number of bank failures in recent years, the closures alone do not account for the continuing decline in the number of U.S. banks.

 

According to the Journal article, the reasons for the continuing decline in the number of banks include “a sluggish economy, stubbornly low interest rates and heightened regulation.” These problems are particularly acute for smaller banks, which often depend on lower margin loans. Declining interest margins hurt smaller community banks more than larger banks, because the smaller banks’ business models – what the Journal describes as “traditional lending and deposit gathering”—rely on interest income. These pressures have caused a number of smaller institutions to merge or consolidate.

 

At the same time, no new banks are forming to replace the banks that are disappearing. According to the FDIC’s latest Quarterly Banking Profile, there was only one new banking institution formed in the first three quarters of 2013 (the first federally approved banking start up in nearly three years), while 159 institutions were merged out of existence and 22 institutions failed during that same period.

 

There is every reason to believe that consolidation in the banking industry will continue. Among other things, the FDIC and the banking industry are both still dealing with the fact that – even years out from the worst of the financial crisis – a large percentage of the remaining banks are “problem institutions.” On the positive side, the number of banks on the FDIC’s "Problem List" declined from 553 to 515 during the third quarter. (The agency calls those banks that it rates as a “4” or “5” on a 1-to-5 scale of risk and supervisory concern “problem institutions.”) On the other hand, problem institutions still represent about 7.5 percent of all reporting institutions, down from about 8 percent during the second quarter.

 

Even though the number and percentage of problem institutions is down from the low point during the worst of the financial crisis — there were 888 problem institutions at the end of the first quarter of 2011 – the number of problem institutions remains stubbornly high. Many of the remaining problem institutions are unlikely to leave the list based on their own financial improvement. Many are likely to drop off the list only by merging or by failing.

 

Of course, the vast majority of banks are not problem institutions. But whether healthy or not, most remaining banks are small. Of the 6,891 banks at the end of the third quarter, 6,223 (or slightly more than 90 percent) have assets of under $1 billion. Many of these institutions are thriving and will continue to thrive. But others will face economic and regulatory pressures that may lead them to merge and combine.

 

These developments have consequences for the D&O insurance industry. The carriers that are active in the banking sector are already reeling from losses arising from the wave of bank failures and related litigation. These banking-related losses are continuing to accumulate at the same time that the overall universe of potential banking-related buyers continues to shrink. The carriers are struggling to spread adverse loss experience across a shrinking portfolio. The accumulating losses from prior underwriting years and the shrinking customer pool means that it is harder for these carriers to show an underwriting profit on a current calendar year basis. The heightened loss experience and shrinking customer base suggests that these carriers will be facing pressure on their calendar year results – and therefore on premiums — for some time to come.

 

At the same time that the carriers are dealing with these forces, they are also dealing with another dynamic that will even further complicate things for them. A shrinking customer base means less business for everyone. Carriers worried about maintaining their portfolios will have to figure out how to respond as competitors go after their business. As much pressure as there may be to maintain premium levels, competition may force carriers to adjust their premiums to avoid losing business.

 

It is still a tough time for banks. It is also a tough time for their D&O Insurers as well.

 

6. FDIC Warns Banks to Check Their D&O Policies, Denounces Civil Money Penalties Coverage: In a highly  unusual step, the FDIC, the federal regulator responsible for insuring and supervising depositary institutions, weighed in on financial institutions’ purchase of D&O insurance. The FDIC’s October 10, 2013 Financial Institutions Letter, which includes an “Advisory Statement on Director and Officer Liability Insurance Policies, Exclusions and Indemnification for Civil Money Penalties” (here), advises bank directors and officers to be wary of the addition of policy exclusions to their D&O insurance policies and also reminds bank officials that the bank’s purchase of insurance indemnifying against civil money penalties is prohibited.

 

The FDIC is concerned that bank officials “may not be fully aware of the addition or significance of … exclusionary language.” Accordingly, the agency urges officials to apply “well-informed” consideration to the potential impact of policy exclusions. The agency urges “each board member and executive officer to fully understand” the protections available under their institution’s D&O policy, as well as the exclusions that have been added to their policy.

 

The letter also states that banks’ boards of directors should “also keep in mind” that FDIC regulations “prohibit an insured depositary institution or [holding company] from purchasing insurance that would be used to pay or reimburse an institution-affiliated party (IAP) for the cost of any civil money penalty (CMP) assessed against such person in an administrative proceeding or civil action commenced by any federal banking agency.”

 

The FDIC’s warnings about the need for bank officials to be well-informed about their D&O insurance and to be wary about the addition of policy exclusions are simply good advice. However, the FDIC was not just offering disinterested guidance. The FDIC didn’t say it, but it has a very specific concern in mind. The FDIC is worried about the inclusion in banks’ D&O insurance policies of a so-called “regulatory exclusion” precluding coverage for claims brought by regulatory agencies such as the FDIC. When a policy has one of these exclusions, the FDIC is unlikely to be able to recover under the policy for any claims the agency files against a bank’s directors and officers.

 

The FDIC is in the midst of filing and pursing a host of lawsuits against the former directors and officers of many of the banks that failed between 2007 and the present. In these lawsuits and in other suits that the agency might want to pursue, the FDIC may be stymied in trying to secure a recovery if the failed bank’s D&O insurance policy has a regulatory exclusion. The FDIC issued its advisory statement because it wants to try to enlist banking officials’ assistance in trying to ward off the inclusion of these kinds of exclusions on D&O insurance policies.

 

The problem for both bank officials and for the FDIC is that if a bank is sufficiently troubled, no amount of attentiveness will be sufficient to avoid the addition of exclusionary provisions. Banks that are in troubled condition are likely to find that they have few D&O insurance options and that the only coverage they can obtain is an insurance program that includes a regulatory exclusion or other coverage limiting provisions.

 

Nevertheless, while in some circumstances (especially with regard to troubled banks) there may be little that bank officials can do about the addition of coverage-narrowing policy exclusions, there is certainly nothing wrong with urging bank officials to be attentive to the changes in their coverage on renewal. The FDIC’s suggestion that bank officials stay informed about changes in their D&O insurance is, as noted above, good advice.

 

The agency’s separate statements about insurance for civil money penalties are interesting and represents something of a public clarification of a long-standing issue. By way of background, under FIRREA and related regulations, civil money penalties may be assessed for the violation of any law or regulation, as well as for a violation of any condition imposed in writing by the appropriate Federal banking agency in connection with any written agreement between a depository institution and the agency.

 

The agency’s issuance of the Advisory Statement and the clarification of the agency’s position with respect to insurance for civil money penalties means that the industry’s practices with respect to this type of coverage will change. Several leading carriers have indicated that they will no longer offer civil money penalties coverage and that they will remove it upon request.

 

7. Delaware Courts OKs By-Law Forum Selection Clauses: One of the more troublesome litigation developments in recent years has been the proliferation of multi-jurisdiction litigation, in which competing sets of plaintiffs’ lawyers filed lawsuits concerning the same circumstances and issues in different jurisdictions’ courts. This phenomenon has been a particular problem in litigation involving merger and acquisition activity. As one possible way to try to avert these kinds of multi-front disputes, some commentators suggested the companies should adopt by-law provisions requiring shareholder disputes to be litigated in a specified forum (usually Delaware).

 

This proposed remedy received a substantial boost on June 25, 2013, when Chancellor Leo E. Strine, Jr. of the Delaware Court of Chancery held that forum selection bylaws adopted by Chevron and Federal Express are statutorily and contractually valid. The companies’ by-laws designated Delaware as the sole forum for derivative lawsuits, lawsuits under the Delaware General Corporation Law and other lawsuits involving the “internal affairs” of the companies. A copy of the Chancellor’s opinion can be found here.

 

Chancellor Strine’s ruling undoubtedly will encourage other companies to adopt forum selection provisions in their by-laws similar to Chevron’s and Fed Ex’s. That possibility was significantly boosted when the plaintiffs in the Chevron and Fed Ex cases withdrew their appeal, leaving Strine’s ruling unchallenged.  There are, however, a number of unanswered questions remaining about the forum selection provisions. For example, it remains to be seen whether the courts of other jurisdictions will defer to the choice of forum specified in the by law provisions.

 

In a November 5, 2013 proceeding, Vice Chancellor Laster considered many of these remaining questions in a Delaware action filed by Edgen Group, to try to enjoin a separate merger objection lawsuit that had previously been filed in Louisiana. Edgen’s charter contained a forum selection clause designating Delaware as the forum for shareholder disputes. As reflected in a transcript of the Delaware proceeding (here), Vice Chancellor Laster declined to issue a temporary restraining order enjoining the Louisiana proceeding.

 

Vice Chancellor Laster observed that the case “exemplifies the interforum dynamics that have allowed plaintiffs’ counsel to extract settlements in M&A litigation and that have generated truly absurdly high rates of litigation challenging transactions.” Vice Chancellor Laster also observed that the case demonstrates why companies “have seen fit to respond” with the adoption of forum selection clauses “in an effort to reduce the ability of plaintiff’s counsel to extract rents from what is really a market externality.”

 

Laster went on to say that the Louisiana action is “quite obviously violative” of the forum selection provision in Edgen’s charter, which Laster found to be “valid as a matter of Delaware corporate law.” He also said that the filing of the Louisiana action “facially breached the exclusive forum clause” because the claim asserted in the Louisiana action “falls squarely within the clause.”

 

However, despite the showing of “irreparable harm,” Vice Chancellor Laster declined to grant Edgen’s request for injunction relief, among other things because of concern for “interforum comity.” He said, in consideration of Chancellor Strine’s opinion in the Chevron case, that the question of the enforceability of the forum selection clause should be made in the “non-contractually selected forum.”

 

The adoption of a forum selection clause offers one way to try to eliminate the curse of multi-jurisdiction litigation. However, as the Edgen case shows, one of the shortcomings of the clauses is that they are not self-enforcing. Even with a forum selection clause, there is nothing to prevent a shareholder plaintiff, like the one involved in the Edgen case, from filing an action in another jurisdiction.  The company still has to face the action in the other jurisdiction and hope that the other jurisdiction’s court will respect the requirements of the forum selection clause.

 

There are many issues yet to be worked out as companies seek to rely on forum selection clauses. The one thing that is clear is that the adoption of a forum selection clause alone will not be sufficient to eliminate the possibility that a company might still face shareholder litigation in other jurisdictions. Perhaps as time goes by a body of case law will develop in other jurisdictions’ courts establishing their willingness to enforce these clauses and to defer to the selected forum, but until that time the threat of multi-jurisdiction litigation will continue.

 

8. IPO-Related Suits and Regulatory Follow on Suits Boost 2013 Securities Lawsuit Filings: As detailed in my recent year-end analysis of 2013 securities class action lawsuit filings, new securities suit filings were up slightly for the year compared to 2012, although otherwise below historical averages. Among the more interesting developments was the rise of at least two categories of securities suits filings that helped drive filings during the year.

 

As I noted in a recent post (here), IPO activity in the U.S. during 2013 was at its highest levels since 2007. While the listing activity bodes well for the economy and the financial markets, the increased number of IPOs also led to an uptick in IPO-related securities litigation. There were a total of at least six new securities lawsuits filed between August 1 and year-end involving companies that had completed IPOs in 2012 or 2013. These IPO-related filings were a particular factor in the increase of securities suits filings in the year’s second half, compared to the two preceding six-month periods.

 

As I also noted in a recent post (here), another factor behind securities lawsuit filings in 2013 was the increase of regulatory activity triggering follow-on securities litigation. As many as 13, or almost eight percent, of the 2013 securities suit filings followed prior regulatory or enforcement activity against the defendant companies. While there have been these types of follow-on lawsuits in the past, what is different about these more recent cases is the broad array of investigative and regulatory actions that have preceded and triggered the lawsuits; the regulatory and investigative actions have involved, among other things: anticompetion investigations; alleged illegal arms trading activities; alleged trade in illegally harvested forest products; alleged Medicare fraud; and alleged corruption activities.

 

In addition, these lawsuits increasingly reflect the increasingly active efforts of regulators outside the U.S., both on the part of U.S. regulators as well as non-U.S. regulators. As regulators around the world step up their investigative and enforcement activities, the likelihood of these kinds of follow-on lawsuits will increase.

 

The follow-on lawsuits represented a significant part of 2013 securities litigation activity and may also represent a continuing securities suit filing trend in which increased numbers of securities class action lawsuit filings will arise in the wake of governmental investigative or regulatory activity. The impact of this trend will depend in part on the outcome of the Halliburton case, as discussed above; if class certification in Section 10(b) misrepresentation cases is no longer possible, many of the potential class action lawsuits will not be filed (at least as class actions). But if the Supreme Court does not set aside the Basic presumption and if securities class actions remain viable, securities suits following in the wake of regulatory activity could represent an important component of future filings.

 

9. As Dodd-Frank Provisions Stage In, Public Companies Acquire Additional Disclosure Requirements: Three and a half years ago, in the wake of the global financial crisis, Congress enacted the Dodd-Frank Act, a vast piece of legislation that included extensive reform measures. Many of the Act’s provisions were not self-executing, but instead required implementing regulations. As a result, many of the Act’s requirements are only just now staging into effect. For example, the so-called Volker Rule prohibiting depositary institutions from certain types of proprietary trading just went into effect in the final weeks of December.

 

The regulations implementing several other Dodd-Frank reforms also were proposed or went into effect during 2013. Many of these have significant implications for public company disclosures. Among the more significant of these new provisions is the proposed pay ratio disclosure requirement. The Dodd-Frank Act’s pay ratio disclosure provisions reflected a Congressional perception that CEO compensation has gotten out of line and a hope that increased disclosure might encourage greater pay equity.

 

At an open meeting on September 18, 2013, and by a vote of 3-2, the SEC approved the new proposed pay ratio rules for public comment. The SEC’s proposed pay ratio disclosure rule can be found here. The agency’s September 18, 2013 press release about the proposed new rules can be found here. The proposed rules are now subject to public comment. At this point it seems that the final rules will be adopted sometime in 2014, in which case the earliest that companies with calendar year-end fiscal years would have to report the pay ratio would be in their 10-K or proxy statement filings in 2016.

 

In coming up with rules to specify how companies should calculate and disclose the compensation ratio, the SEC had to decide who does and doesn’t count as an employee, and how median employee compensation is to be calculated.

 

With respect to the question of who is an employee, the SEC’s proposed rule takes an all-inclusive approach. Because Congress required the pay ratio to express the ratio of CEO compensation to the compensation of “all employees,” the proposed SEC rule includes all individuals employed by a company and any of its subsidiaries – including any “full-time, part-time, seasonal or temporary workers” as of the last day of the company’s prior fiscal year. Non-U.S. workers are included in the definition.

 

With respect to the method of calculating median employee compensation, the SEC opted not to mandate a specific methodology but to allow companies the discretion to use the most appropriate method of calculation base on the size and structure of its business and the way it compensates employees. Whatever methodology a company uses, it must include in its pay ratio disclosure a brief narrative description of the methodology employed.

 

While the pay ratio disclosure requirement may have derived from a belief that greater transparency might help to rein in CEO compensation and encourage pay equity, in the end, the pay ratio disclosure may prove to be of at best limited value. As the Troutman Sanders law firm noted in its September 19, 2013 memo about the SEC’s new proposed rule (here), “the SEC’s decision to provide a flexible approach to the calculation means that there will not be any meaningful way to compare the pay ratios of peer companies.”

 

In addition, the ways that different companies staff their operations will also make company to company comparisons difficult. As discussed in a September 20, 2013 Wall Street Journal article entitled “It’s Hard to Slice and Dice CEO Paychecks” (here), companies’ pay ratios “will vary based on differences in how companies deploy their workforces and how they’ll crunch the numbers.” Among other things, the ratios at companies with predominantly U.S. employees will be lower than the ratios for companies with more lower-paid workers overseas.

 

While the pay ratio disclosures may be of limited value, they could encourage opportunistic plaintiffs’ lawyers. Any time something is required to be disclosed there is an opportunity for plaintiffs’ lawyers to allege that the disclosure was incomplete or out of compliance with requirements. Indeed, just as the Dodd-Frank Act’s requirement for a non-binding shareholder vote on executive compensation led to a rash of “say on pay” shareholder litigation, it seems probable that the new pay ratio disclosure requirements will also stimulate a wave of pay ratio litigation.

 

Another set of Dodd-Frank Act disclosures provision that seems likely to have an impact in the months ahead are the Conflict Mineral Disclosure rules. The Act included a provision directing the SEC to promulgate rules requiring companies to disclose their use of “conflict minerals” originating in the Democratic Republic of Congo (DRC) or an adjoining country. It has taken some time for the regulatory process to unfold, but the conflict mineral disclosure requirements are now in effect.

 

On August 22, 2012, the SEC adopted the conflict mineral disclosure rules. The SEC’s August 22, 2012 press release can be found here and the rule itself can be found here. The specific minerals at issue are tantalum, tin, tungsten and gold. The countries covered by the disclosure rules are, in addition to the DRC, Angola, Burundi, Central African Republic, the Republic of Congo, Rwanda, South Sudan, Tanzania, Uganda and Zambia. Several business groups mounted a legal challenge to the rules, but in a July 2013 order, Judge Robert Wilkins of the District Court for the District of Columbia struck down the challenge. An appeal of the ruling remains pending. Companies are required to comply with the new disclosure rules for the calendar year beginning January 1, 2013; if the rules survive the pending appeal, the first disclosures are due May 31, 2014 and subsequent disclosures are due annually each year after that.

 

As discussed in a recent post (here), the conflict minerals determinations and disclosures present a significant challenge for many companies. First and foremost, companies face a serious potential PR risk. Companies found to be out of position on conflict minerals could face a publicity firestorm from humanitarian groups and activist investors. Although it remains to be seen, adverse publicity could prove to be a problem not just for companies that must declare their use of conflict minerals but even for those that are unable to declare themselves conflict mineral free.

 

There is also a significant litigation risk associated with the conflict minerals disclosure requirements as well. Companies compelled to reveal their use of conflict minerals could be the target of shareholder suits. A particularly difficult problem would involve companies that had declared themselves to be conflict free that are later shown have been using conflict minerals after all. The negative publicity and likely share price decline could be followed by a securities class action lawsuit. Activist shareholders could also launch derivative suits against companies based on allegations such as the failure to implement adequate procedures to ensure that the company’s products were conflict mineral free.

 

Along with the Dodd-Frank’s whistleblower bounty provisions, which as outlined above are beginning to have a significant impact, the pay ratio disclosure requirements and the Conflict Mineral Requirements could also have an impact on companies in the months ahead. Among the implications of these new requirements is the possibility of a heightened litigation risk. In coming months, we will be hearing more about companies’ struggles to ready themselves for these disclosure requirements. In addition, questions surrounding companies’ preparations to meet the disclosure requirements increasingly will become a part of the D&O insurance underwriting process.

 

10, SEC Proposes Crowdfunding Rules: While federal agencies have been busy staging in the requirements of the Dodd-Frank Act, many of the same agencies have also been struggling to propose regulations implementing the requirements the JOBS Act, which Congress enacted in April 2012. Among many other things, the JOBS Act contained so-called “crowdfunding” provisions providing exemptions under the securities laws allowing start-up ventures to raise equity financing from non-accredited investors using Internet fundraising platforms. The Act left many of the details to the SEC and directed the agency to release implementing regulations within 270 days.

 

On October 23, 2013, the SEC finally approved and released for public comment the proposed rules implementing the crowdfunding provisions. The rules will not become effective, subject to any revisions, until the end of a 90-day comment period, meaning that the rules will not go into effect until some time early in 2014. The SEC’s October 23, 2013 press release regarding the new rules can be found here. The proposed rules themselves can be found here.

 

Consistent with the Act’s provisions, the proposed rules specify that a company may raise no more than $1 million in any one 12 month period through crowdfunding. The rules also specify that investors may invest up to the greater of $12,000 or five percent of their annual income or net worth if both their annual income and net worth are less than $100,000, or ten percent of their annual income or net worth if their annual income or net worth are greater than $100,000. Securities purchased in a crowdfunding offering cannot be resold for one year.

 

The proposed rules specify the information companies must provide in the crowdfunding offering documents, including the identities of the company’s directors and officers as well as the identity of anyone owning more than 20 percent of the company; a description of the company’s business and intended use of the offering proceeds; and the target price of the offered securities and the intended size of the offering; The offering document must also identify related-party transactions and the financial condition of the company. The offering documents also must include the company’s financial statements.

 

The proposed rules also specify the issuing company’s ongoing reporting requirements after the completion of the offering. The proposed rules would require companies to file an annual report no later than 120 days after the end of their financial year, with the reports to be filed with the SEC and posted on the company’s website. Because the crowdfunding securities are freely tradable after one year, the reporting requirement would be continuous in order to provide potential future investors with information about the company.

 

Although it will be a few months before companies can commence crowdfunding financings, it will be interesting to see when we finally get there how much interest there ultimately will be in raising funds through these kinds of offerings. The limitations put on the amount of funds that can be raised as well as the information requirements for the offerings, along with the annual reporting requirements, may present burdens that some start up ventures may be unwilling to undertake (especially because they will almost inevitably require the association of outside professionals, including accountants and attorneys).

 

In addition, it is important to note that some of the JOBS Act’s provisions and related crowdfunding regulations include significant liability provisions. Section 302(c) of the Act expressly imposes liability on issuers and their directors and officers for material misrepresentations and omissions made to investors in connection with a crowdfunding offering. The crowdfunding provisions themselves may blur the clarity of the distinction between private and public companies. The crowdfunding provisions expressly contemplate that a private company would be able to engage in crowdfunding financing activities. Yet, at the same time, that same private company will be required to make disclosure filings with the SEC and could also potentially incur liability under Section 302(c) of the JOBS Act.

 

Many private company D&O insurance policies contain a securities offering exclusion. The wordings of these exclusions vary widely, and some wordings could be sufficiently broad to preclude coverage for crowdfunding activities. In addition, some private company D&O insurers have already introduced exclusions expressly precluding coverage for claims arising from crowdfunding.

 

As was the case with the Sarbanes-Oxley Act and the Dodd-Frank Act, the D&O insurance industry may face a long period where it must assess the impact of changes introduced by the JOBS Act. It will be interesting to see both how extensively the crowdfunding liability provisions are invoked and whether a market develops for insurance products providing crowdfunding companies and their directors and officers insurance protection for crowdfunding liability. It seems likely that the carriers will develop liability insurance products targeted at crowdfunding companies, but it will be interesting to see if crowdfunding companies are interested in using their limited funds to purchase the insurance.

 

Conclusion

As I noted at the outset, there is always a lot going on in the world of D&O liability and insurance, and 2013 was no exception in that regard, But what is interesting is how so many of 2013’s key developments foreshadow coming events in 2014 and beyond. The U.S. Supreme Court’s November 2013 decision to grant the petition for a writ of certiorari in the Halliburton case looms particularly large as we head into 2014. In the same way, the impact of many other key 2013 developments will only be fully realized in 2014 and beyond.

 

For that reason, we will have to wait to see the implications of many of the key events in 2013. The one thing that seems certain is that 2014 will be an eventful year.

 

The number of securities class action lawsuit filings was up slightly in 2013 compared to 2012, although the 2013 filings remained well below historical averages. While securities litigation picked up in 2013 compared to the year before, the more interesting question going forward is what the impact of the Halliburton case now pending before the U.S. Supreme Court will be; if the Court sets aside the presumption of reliance at the class certification stage based on the “fraud on the market” theory, the landscape for securities class action litigation could be changed entirely. Depending on the outcome of the Halliburton case, annual class action securities litigation tallies like this one could look very different in future years.

 

There were 165 securities class action lawsuit filings in 2013, compared to 152 in 2012, representing a year-over-year increase of about 8.5%. 2013’s 165 filings were about 13.6% below the annual average of 191 filings for the period 1997-2012. 2013 was the fifth year in a row that the annual filings have been below the historical average.

 

The increase in the number of filings in 2013 compared to 2012 was largely the result of the increased levels of filings in the second half of the year. There were 89 new securities class action lawsuits filed in the second half of 2013 compared to 76 in the first half and compared to only 64 in the second half of 2012.

 

The 2013 securities class action lawsuits were filed against a wide variety of kinds of companies. The 2013 securities suit filings involved companies in 90 different SIC code categories. There were, however, concentrations of securities litigation activity in certain industries.  

 

As has been the case in recent years, a significant number of new securities suits involved companies in the life sciences industries.  There were 34 new securities suits against companies in the life sciences industries (represented by companies in the 283 SIC Code group [Drugs] and the 384 SIC Code group [Surgical, Medical and Dental Instruments and Supplies]).These 34 new suits against life sciences companies represented more than one-fifth (20.6%) of all 2013 filings. Of particular note is that there were 17 new filings in the SIC Code category 2834 (Pharmaceutical Preparations) alone, representing about ten percent of all 2013 filings.

 

Another area of concentration involved natural resources companies. There were a total of 13 new securities class action lawsuits against companies in the Mining, Crude Petroleum and Natural Gas categories (represented by the 1000 SIC Code series). There were also a total of eight new securities lawsuits filed involving companies in the 737 and 738 SIC Code categories (computer services and business services).

 

The 2013 securities lawsuits were filed in 34 different federal district courts but the vast majority of the lawsuits were filed in just a few federal districts. 50 of the 2013 securities lawsuits, or around thirty percent of all 2013 securities suits, were filed in the Southern District of New York. Another 23 lawsuits (about 14%) were filed in the Northern District of California and 13 suits (about eight percent) were filed in the Central District of California. There were eleven new lawsuits, representing 6.7% of all lawsuits, filed in the District of Massachusetts. These four federal districts alone accounted for 97 of the 165 filings during the year, or about 58.8% of all 2013 filings.

 

27 of the 2013 securities suit filings involved non-U.S. companies, representing about 16.3% of all filings. These figures are below 2012 levels, when there were 32 filings against non-U.S. companies representing 21 percent of all filings, and 2011 levels, when there were 61 filings against non –U.S. companies representing 32 percent of all filings. However even though down compared to the two prior years, the level of filings against non-U.S. companies in 2013 remained elevated compared to historical levels. (The average number of filings against non-U.S. companies during the period 1997-2009 was 17, representing an annual average of nine percent of filings.)

 

The non-U.S. companies that became involved in U.S. securities litigation in 2013 represented twelve different countries. The two countries with the largest number of companies were sued Canada, with eight companies, and China, with seven companies.

 

Merger-related litigation remained an important part of securities litigation filings in 2013, although down from levels seen in recent years. There were 14 merger objection lawsuit filed in federal courts in 2013, representing about 8.5% of 2013 filings. (There were of course many more merger objection lawsuits filed in state courts, but these state court filings are not part of the present analysis.) The number of 2013 federal court merger objection lawsuit filings was comparable to the equivalent figures in 2012, when there were 13 merger objection lawsuit filings. However, the number of 2013 merger objection lawsuit filings was down sharply compared to 2010 and 2011, when there were 40 and 43 merger objection lawsuit filings, respectively.

 

Though merger objection cases are down from recent years, there has been an uptick in securities lawsuit filings involving IPO companies. As I noted in a recent post (here), IPO activity in the U.S. during 2013 was at its highest levels since 2007. While the listing activity seems to bode well for the general economy as well as for the financial markets, the increased number of IPOs also led to an uptick in IPO-related securities litigation. There were a total of six new securities lawsuits filed between August 1 and year end involving companies that had completed IPOs in 2012 or 2013. These IPO-related filings were one factor in the increase of securities suits filings in the year’s second half, compared to the filing levels in the two preceding six-month periods.

 

As I also noted in a recent post (here), another factor behind securities lawsuit filings in 2013 was the increase of regulatory activity triggering follow-on securities litigation. As many as 13, or nearly eight percent, of the 2013 securities suit filings followed prior regulatory or enforcement activity against the defendants companies. These new lawsuits clearly represented a significant part of 2013 securities litigation activity; however, the fillings may be even more significant to the extent they represent a securities suit filing trend in which increased numbers of securities class action lawsuit filings arise in the wake of governmental investigative or regulatory activity. As I noted in my prior blog post, these kinds of lawsuit filings are arising in the wake of an increasingly diverse array of regulatory activity, as governments around the world step up the efforts.

 

Discussion

It is interesting to note that securities class action filing activity picked up in 2013 compared to 2012. However, the significance of this development pales by comparison to the potential significance of the Halliburton case now pending before the U.S. Supreme Court. If the Court’s reconsideration of the fraud on the market theory were to result in the Court setting aside the presumption of reliance at the class certification stage, it could become impossible for plaintiffs to have a class certified in a Section 10(b) misrepresentation cases. If that were to happen, the private securities class action litigation landscape would be completely altered. Annual analyses of class action securities litigation like this one could look very different, or even go out of existence.

 

With these kinds of potential changes looming, the subtle shifts in 2013 filings activity seem less important. Nevertheless, there are some noteworthy things to keep in mind about the 2013 securities litigation filings.

 

Even though there were slightly more securities class action lawsuit filings in 2013 than there were in 2012, 2013 continues a now several years-long trend of lower than average securities class action lawsuit filings. There has only been one year in the last nine – the credit crisis year of 2008 – when securities class action lawsuit filings were above the longer-term historical averages.

 

In my view, care should be taken in considering this apparent decline. The figures on which this impression is based represent absolute filing numbers only – that is, the figures represent only the number of lawsuits filed per year. These figures do not take into account changes in the number of publicly traded companies. The fact is that even with the recent uptick in IPOs there are still well more than a quarter fewer publicly traded companies than there were ten years ago. (Bankruptcies, mergers and going private transactions account for the decline in the number of public companies.)

 

It is hardly surprising that as the number of public companies has declined that the absolute number of securities lawsuits has declined as well. Though the  165 lawsuit filings in 2013 represent around 30 percent fewer filings than there were in 2004, that decline in the absolute number of lawsuit filings in roughly in line (although slightly greater than) the decline in the number of publicly traded companies. The decline in the number of lawsuit filings relative to the number of publicly traded companies is far less than the apparent decline in the absolute number of lawsuit filings might seem to suggest.

 

There are of course other factors at work affecting the numbers of securities lawsuit filings, beyond just the decline in the number of publicly traded companies. As a result of case law developments, particularly at the U.S. Supreme Court, the securities plaintiffs face a much greater burden trying to survive a motion to dismiss. These case law developments undoubtedly have had some deterrent effect on securities lawsuit filings. The Halliburton case could of course dramatically amplify this effect.

 

Beyond these considerations another factor affecting the filing levels in 2013 was the absence of any cyclical trend or sector development of the kind that might drive securities litigation. The uptick in filings related to the credit crisis has long since faded, and there was nothing in 2013 like the Chinese reverse merger litigation (which accounted for so many lawsuit filings in 2011). The absence of these kinds of trends mean that there were fewer filings in 2013 than there were in years in which trends of this type drove litigation activity.

 

On the other hand, the rise in IPO-related litigation activity and the increase in securities litigation following-on after regulatory activity could both potentially represent important trends to watch in 2014 – depending of course on what happens with the Halliburton case.

 

It is generally understood that corporate directors act in a fiduciary role in performing their board duties. But to whom do directors owe their fiduciary duties? That was the question asked in a November 8, 2013 decision from the North Carolina Supreme Court, in which the Court reversed a trial verdict and post trial motion rulings and reaffirmed that directors’ duties generally are owed to the corporation itself rather than to the individual shareholders. A copy of the Court’s opinion in the case of Green v. Freeman can be found here. A December 20, 2013 memo by the Smith Anderson law firm can be found here. 

 

The case arose out of a failed business venture. The claimants sought to recover a total of $400,000 they had invested in the venture. At trial, the evidence showed that the various entities involved in the venture had not followed corporate forms. For example, the names of the entities were used interchangeably, there had been no shareholder or board meetings, and a corporate checking account was used to pay the personal expenses of the sole shareholder and chairperson of one of the entities.

 

The claimants sued the shareholder and chairperson as well as the other principals involved in the venture on a variety of theories. The jury found that the chairperson, Corinne Freeman, had controlled the entities involved in the venture and that the plaintiffs had been damaged by Freeman’s failure to discharge her duties as a corporate director or officer. The other claims against her were dismissed. Freeman appealed to the intermediate appellate court, which affirmed the lower court, and she appealed to the Supreme Court. The plaintiffs cross-appealed the dismissal of their other claims against Freeman.

 

In its November 8 opinion, the North Carolina Supreme Court, in a unanimous opinion written by Justice Mark Martin, reversed the lower court, holding that the claimants did not have a direct claim that Freeman had breached her fiduciary duties to them,  and remanded the case for further consideration of the dismissal of the plaintiffs’ other claims.

 

In reaching its decision, the Court confirmed that under North Carolina law directors are “required to act in good faith, with due care and in a manner they reasonably believe to be in the interests of the corporation.” If these duties are breached, a shareholder may sue the director – but in a derivative action only, not in a direct action. In general, under North Carolina law, shareholders and creditors “may not bring individual actions to recover what they consider their share of the damages suffered by the corporation.”

 

The only exceptions to these general principles are when the wrongdoer owed the claimant a special duty or the claimant suffered a special injury. The Supreme Court found that the plaintiffs were unable to bring themselves within either of these exceptions because they had never become shareholders. Even as creditors, the claimants had not produced sufficient evidence to bring themselves within these exceptions. In particular, the Court held that the plaintiffs had failed to present evidence that they had suffered an injury peculiar or personal to themselves sufficient to bring them within the persona injury exception.

 

The Court concluded that because the plaintiffs could not bring themselves within either of the exceptions to the rule that directors’ fiduciary duties generally are owed only to the corporation, the plaintiffs as a matter of law could not assert individual claims that belonged to the company. 

 

The Court did find that there was evidence sufficient to support the piercing of the corporate veil to allow the claimants to try to assert claims against Freeman. However,  the doctrine of piercing the corporate veil “is not a theory of liability” but rather “provides an avenue to pursue legal claims against corporate directors and officers” for which they would otherwise be shielded from liability by the corporate form. Because the Supreme Court had determined that the claimants breach of fiduciary duty claims were not viable, the Supreme Court remanded the case to the lower court for consideration of the issue of whether the piercing of the corporate veil would allow the claimants to recover under any of the other theories the claimants had asserted as the basis of liability.

 

The North Carolina Supreme Court’s decision is important (at least in North Carolina) because it confirms that, other than in exceptional circumstances, directors cannot be held liable in direct shareholder action for breaches of fiduciary duty, but can only be held liable derivatively to the corporation itself, because the directors owes fiduciary duties to the corporation, not to shareholders or creditors.

 

The clarification of these principles is important not only because it explainsto whom directors may be held liable, but it also clarifies the circumstances under which directors may be held liable as well. As the Smith Anderson law firm said in its memo about the case,

 

This distinction is important because under North Carolina law derivative claims are subject to more stringent requirements than direct claims face. Specifically, plaintiffs seeking to bring derivative claims must prior to filing suit make a demand on the company’s board of directors asking the company to assert the claim directly. Following such demand, if an independent committee of the board determines in good faith after conducting a reasonable inquiry that the claim should not be pursued, then the plaintiff cannot bring a derivative action asserting the claim.

 

The law firm concluded its memo by noting that the Supreme Court’s decision is “significant” because the Court, “which rarely has occasion to address corporate law issues, has reaffirmed the basic principles governing the duties of directors.”

 

Readers of this blog may find it useful to read the opinion in its entirety as the opinion provides a good review of the general principles governing the duties and liabilities of corporate directors. The case also underscores the importance of maintaining the corporate forms.

 

What could be more appropriate during this festive holiday season than another round of readers’ pictures of their D&O Diary mugs?

 

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 and here), I published prior rounds of readers’ pictures. I have posted the latest round of readers’ pictures below.

 

In our first picture, sent in by Mark Weintraub of Lockton  in Atlanta, depicts what appears to be a snowman cake holding a D&O Diary mug. However, Mark reports that the snowman is not made from cake, but rather from diapers, and was created for purposes a baby shower. Proving once again that the D&O Diary mug is suitable for every occasion, including some kinds of occasions that I certainly  never anticipated. (And can I just say, a snowman made of diapers?!?)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In yet another appropriate tribute to the season, Todd Richardson took this picture outside the HCC offices in Connecticut during the course of one of the many recent snowy days there.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In contrast to that snowy scene, Doug Esten of the LexisNexis Newsroom sent in this picture of his D&O Diary mug amidst a profusion of daisies. Doug reports that he took this picture in his garden in West Goshen, Pennsylvania, in mid-October.

 

 

 

 

 

 

 

 

 

 

 

The next mug shot was sent in by Ginny Fogg, the general counsel of Norfolk Southern. Ginny reports that the scene in the picture looks “over the Norfolk waterfront with the raised railroad bridge in the left background.”

 

 

 

 

 

 

 

 

 

 

 

 

 

Drew Kominos of the Denver Office of the Philadelphia Insurance Companies sent in this picture, taken in front of the City and County Building in Denver, which Drew reports is “center of life in the City.”

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Our final picture in this round was sent in by Tyler Smith and Brian Magnusson of Chubb. This picture, which depicts two D&O Diary mugs and as well as a host of other treasures, was taken at Chubb’s annual “mustaches for charity” competition. Brian reports that “by growing beards/mustaches over the last month, we raised over $10,000 for poverty-stricken, school children across the country.” Good for Brian, Tyler and their Chubb colleagues. All of us here at The D&O Diary are strongly in favor of moustaches in general, and particularly in connection with charitable endeavors.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Once again, I am absolutely delighted to see the range of pictures that readers have sent it. It is so much fun receiving back readers’ mug shots. My thanks to everyone that has sent in pictures.   

 

If there are still readers out there who would like to have a mug and have not yet ordered one, just drop me a note and I will be happy to send one along to you, as long as remaining supplies last. Just remember that if you order a mug, you have to send back a picture. Also, please be patient if you order a mug, it may be several days before we can mail out the next round of mugs.

 

Break in the Action: Over the next couple of weeks, The D&O Diary will be on a holiday publication schedule. We will resume our regularly publication schedule on January 6, 2014. Here’s wishing everyone a very festive and relaxing holiday season. I look forward to following up with everyone in the New Year.

 

For a period beginning in 2006, plaintiffs’ lawyers filed a wave of options backdating securities class action lawsuits. Almost all of these cases have now been resolved, although one case continues to grind through the appellate courts. Now that the cases are largely resolved, it may be time to calculate the final tally. In the accompanying guest post, Adam Savett, Director, Class Action Services at KCC, surveys the cases, their dismissal rates and their settlements. His guest post concludes with a link to his presentation on the options backdating-related securities litigation.

 

 

I would like to thank Adam for his willingness to publish his guest post on my site. I welcome guest posts and articles from responsible commentators on topics of interest to readers of this blog. If you are interested in publishing a guest post, please send me a note by e-mail. Here is Adam’s guest post:

 

 

 

Starting in 2006, and continuing for more than a year, a series of academic reports and articles in the Wall Street Journal suggested that a number of publicly traded companies had improperly retroactively dated the grant and exercise price of stock options issued to corporate officers to a time preceding a rally in the price of the underlying shares. The revelation of this practice, commonly called options backdating, led to much litigation. A substantial portion of that litigation took the form of securities class actions, typically filed against a publicly traded company (the issuer) and certain officers and directors of the issuer.

 

 

The first such securities class action was filed on May 19, 2005 against Brocade Communications.

 

 

Ultimately 39 federal securities class actions were brought which contained allegations that directors or officers had engaged in or allowed stock options backdating to occur.

 

 

Of those 39 cases, 31 ultimately settled and 8 were dismissed.

Some early prognosticators suggested that the entirety of the cases had little if any merit, and might ultimately collectively be settled for less than $1 billion. Though we appreciate any and all help from our prognosticators, most were significantly off in predicting outcomes in this group of cases.

 

 

The settlements were not insubstantial, having a combined value of more than $2.38 Billion, though a sizeable portion of that is from UnitedHealth Group’s $925.5 million settlement. The average of all of those settlements is approximately $77 million, while the median of the settlements is $18 million.

The dismissal ratio was also somewhat out of line with historical trends, with 82% settling, while historically only approximately 65% of securities class actions settle.

 

 

Now, nearly eight years later, the story is almost complete.

We have to say almost, as the plaintiffs in the Apollo Group litigation have appealed the dismissal of their complaint to the Ninth Circuit Court of Appeals.

 

 

Now, they are not the only plaintiffs to appeal, as plaintiffs in three of the other dismissed cases also appealed their dismissal orders. In the Cyberonics, Jabil Circuit, and Witness Systems, the plaintiffs all unsuccessfully sought reversal of the dismissal of their complaints. The dismissals in the Jabil & Witness Systems cases were affirmed by the Eleventh Circuit while the Cyberonics dismissal was affirmed by the Fifth Circuit.

 

 

While students of securities litigation know that each case is unique, and the Apollo Group case is pending before the Ninth Circuit, the decision to launch a fourth appeal after three defeats suggests a certain tenacity on the part of that law firm.

 

 

The opening brief was filed by the Plaintiffs on December 10, 2013 and the defendants answering brief is due to be filed in early January of next year. Oral argument has not yet been scheduled in the Apollo Group appeal for.

 

 

After the Ninth Circuit renders a decision, we will update our analysis to reflect the outcome. Our current analysis of these cases can be found here.

 

Of the different contexts within which securities class action lawsuits arise, one of the most significant is the bankruptcy context. As detailed in the following guest post from Michael Klausner and Jason Hegland of Stanford Law School, securities class action lawsuit arising in bankruptcy are different from cases involving solvent companies. Their guest post provides a detailed overview of the differences. The authors also reach some interesting conclusions about the importance of D&O insurance for the resolution of securities class action lawsuits arising in connection with bankrupt companies.

 

 

I would like to thank Mike and Jason for their willingness to publish their guest post on this site. I welcome guest posts from responsible commentators on topics of interest to readers of this blog. Anyone interested in publishing a guest post should contact me directly. Here is Mike and Jason guest post.

 

 

 

One out of every seven securities class actions filed since 2000 involves a company in bankruptcy. This important subset of class actions has some important features that warrant empirical examination. In this blog, we use our database of securities class actions filed from 2000 to the present to shed light on how cases involving bankrupt companies differ from cases against solvent corporations.[i] Specifically, we address the following questions.

 

·         Are cases involving bankrupt corporations more successful than cases against solvent corporations?

 

·         Is the timing of settlement affected?

 

·         How protective is D&O insurance for officers and directors when a company is bankrupt? Specifically, how much does D&O insurance pay out and how frequently do individual officers or directors make personal, out-of-pocket payments into a settlement?

 

·         Is there a basis for inferring that additional Side A coverage would have provided more protection for those individuals who paid into settlements?

 

Outcomes in Cases Involving Bankrupt Companies

As a company descends into insolvency, there may be incentives for management to shade financials or to describe its business in more rosy terms than is warranted. In addition, once a company has gone bankrupt, disclosures that were accurate when made may not look so accurate in hindsight. This could affect a judge’s ruling on a motion to dismiss and a jury’s view of a case if it went to trial. Thus, it would not be surprising to find that securities class actions involving bankrupt companies tend to be successful more often than cases against solvent companies.  On the other hand, perhaps plaintiffs’ attorneys over-rely on such hindsight bias—or are excessively affected by it themselves—and file weak cases against bankrupt companies only to see them dismissed for failure to plead intent with sufficient particularity. 

 

As shown in Table 1, the data indicate that cases involving bankrupt companies are in fact successful for plaintiffs more than are cases against solvent companies. Among cases filed since 2000, only 29% of cases involving bankrupt companies were dismissed or voluntarily dropped, compared to 46% of cases against solvent companies. The low rate of dismissal for these cases suggests that they may be more meritorious than cases against solvent companies. This inference is supported by the fact that cases involving bankrupt companies more often have parallel SEC enforcement actions in which severe penalties were imposed than do cases against solvent companies—specifically, 25% compared to 15%.[ii]

Table 1: Case Outcomes

(Cases filed 2000-2010 and resolved by 2013)

 

 

* Difference is rates of dismissal and settlement significant at the .001 level

Note: These are cases dismissesd on a motion to dismiss. Another 25 cases were dismissed on motions for summary judgment — one involving bankrupt companies and 24 involving solvent companies.

 

Settlement Timing

An explanation for the low rate of dismissal in these cases could be that they settle quickly, before the motion to dismiss is ruled on. The data show, however, that this is not the explanation. In fact, more often than cases against solvent companies, these cases tend to settle after the ruling on the first motion to dismiss.  Figure 1divides the litigation process into three phases: (a) early pleading, defined as the period before the ruling on the first motion to dismiss, (b) late pleading, defined as the period after an initial dismissal without prejudice but before a final ruling either to dismiss or to allow the case to proceed to discovery, and (c) discovery, defined as the period between a denial of the plaintiffs’ motion to dismiss and the end of trial. The graph shows that cases involving bankrupt companies tend to settle in the late pleading period and in the discovery period somewhat more often than do cases against solvent companies.[iii]  Moreover, our data also show that among cases that reach discovery, those involving a bankrupt company tend to settle later than do cases against solvent companies. 

 

Figure 1: Settlement Timing—By Phase of Litigation

(Settlements in cases filed 2000-2010)

 

 

 

 

At first glance, the fact that these cases do not settle earlier may be surprising, since the assets available for recovery by the plaintiff class and the plaintiffs’ attorney shrink as the case proceeds. Every dollar spent on defense costs is a dollar that will be unavailable in a settlement. On the other hand, the bankruptcy process and the involvement of separate defense lawyers for the company and for individual defendants may create complications that delay settlement. In addition, perhaps defense lawyers use the shrinking nature of potential settlement funds as leverage, continuing to threaten to extend the litigation (at no cost to themselves), in order to secure a lower settlement for their clients.

 

Individual Payments into Settlements

            Apparently reflecting plaintiffs’ attorneys’ search for deep pockets (or just pockets), more individual defendants are named in cases involving a bankrupt company than in cases involving a solvent company. On average, six individual defendants are named in cases involving a bankrupt company, compared to five individuals where the company is solvent.[iv] The same pattern appears with respect to naming outside directors as defendants. Where the company is bankrupt, outside directors are named in 43% of cases, compared to 39% of cases against solvent companies, and when outside directors are named, more of them are named in cases involving a bankrupt company.[v]  (The apparent search for pockets is reflected in the naming of third parties as well. Auditors and underwriters are named in 43% of cases, compared to 19% of cases involving solvent companies.)

 

            Being named a defendant, of course, does not mean an officer or director will have to contribute to a settlement. The D&O policy provides protection, so long as limits remain and a defendant’s conduct does not result in an exclusion from coverage under the terms of the policy. In total, across all cases involving bankrupt companies, insurers paid roughly $2 billion into settlements, for an average of $13,500,000 per case (or $17,000,000 if one excludes cases in which, for whatever reason, there was no insurance payment). This is a crude measure of the amount individuals would have paid out-of-pocket if they had no insurance, since settlement amounts could have been lower in the absence of insurance. But it is clear that without D&O insurance, individual officers and directors likely would have had to contribute toward settlement out of their personal assets much more frequently, and in some cases the costs to the individuals could have been severe.

 

            Table 2 shows that out-of-pocket payments are rare. But the incidence of out-of-pocket payments is greater where the company is bankrupt than where it is solvent—11% of cases compared to 3% of cases. A close look at the 19 cases in which individuals made out-of-pocket payments where the company was bankrupt reveals that in at least some of these cases, the explanation is either that the settlement was much larger than the policy limits one would expect, as in Enron and Global Crossing, or that the conduct involved was not covered, as in Refco, where individual defendants’ misconduct landed them in jail. There are a few cases, however, in which there were no reports of glaringly fraudulent conduct, where the settlement was not unusually large and where the carrier paid a portion of the settlement, and yet individuals paid as well. While some of these cases may have involved conduct-based coverage issues, the problem may have been insufficient limits.

 

Table 2:  Individual Payments into Settlements

(Settlements in cases filed 2000-2010)

 

Note: Significant at  .001 level

 

The experience of outside directors in these cases warrants analysis as well. In earlier publications, one of us investigated outside director liability in all types of litigation: securities class actions, state fiduciary duty suits and SEC enforcement actions.[vi]  The basic finding was that outside director liability is very rare. This is due to two factors: the protection provided by D&O insurance and the difficulty of proving a case against outside directors. Some people misunderstood that article to say that outside directors were not exposed to liability risk and therefore did not need D&O insurance—the opposite of the causal relationship I intended. As shown here, D&O insurance clearly protects outside directors from out-of-pocket payments.

 

            Table 3 provides data on the liability experience of outside directors. Consistent with the earlier research, settlements of securities class actions rarely result in payments by outside directors—a total of 12 cases out of 409 settlements in cases in which outside directors were named. All but one of these cases involved bankrupt companies. Thus, while liability for outside directors is rare, where it occurs it is nearly always when the company is bankrupt.[vii]

 

Table 3: Individual Payments by Outside Directors

(Settlements in cases filed 2000-2010 in which outside director was named)

 

 

 

 

Significant at .001 level

 

Side A Coverage 

            When a company is bankrupt, Side A of a traditional policy and in some cases a separate Side-A-only policy may be all that stand between a settlement demand and a personal, out-of-pocket payment. The fact that there have been only 19 cases since 2000 involving bankrupt companies in which individuals made such payments suggests that Side A protection is effective.  In nine of these 19 cases, insurance paid into the settlements—just not enough to cover the full settlement. On average insurance paid 73% of the total amount paid in those settlements. As stated above, it is possible that additional Side A limits would have protected some of the individuals that made out-of-pocket payments.

 

*****

            In sum, cases involving bankrupt companies are different from cases against solvent companies. They are dismissed less often and they therefore settle more often. They also take longer to settle than do cases involving solvent companies. Finally, and not surprisingly, officers pay into settlements in these cases somewhat more often than they do in cases against solvent companies. On the whole, however, D&O insurance provides substantial protection to individuals in these cases, and additional Side A coverage might have provided full protection for the individuals that paid out of pocket apparently.

[i] Cases included in this study were filed between 2000 and 2010 and resolved by 2013. There are 1,779 cases in the sample, 55 of which are ongoing and are therefore excluded for certain purposes below.

 

[ii] All comparisons in this paragraph are statistically significant at the .001 level in univariate tests and multivariate tests in which we control for factors that associated with dismissal.

 

[iii] This difference is of borderline statistical significance (p < .1), in univariate and multivariate tests, when comparing early pleading settlement vs. settlement in the two later periods. If we look at cases filed since 2005, the difference between cases involving bankrupt companies and cases involving solvent companies is somewhat greater.

 

[iv] Statistically significant at the .001 level.

 

[v] Statistically significant at the .005 level.

 

[vi] See Black, Cheffins & Klausner, Outside Director Liability, 58 Stanford Law Review 1055 (2006); Klausner, The Risk of Liability for Outside Directors, PLUS Journal 2006, p. 1.

 

[vii]There were two additional cases involving solvent companies, where individuals who were technically outside directors paid into settlements. In one of these cases, the individual was affiliated with the controlling shareholder and in another he was a founder and former CEO and therefore more involved in company management than a typical outside director.

 

The U.S. Supreme Court has already taken up a case this term that potentially could alter the way private securities cases are litigated. The Court has now granted cert in a different case that could have a significant impact on ERISA stock-drop litigation. On December 13, 2013, the Court granted the petition of defendant Fifth Third Bank for a writ of certiorari in order to consider the “presumption of prudence” that the lower courts have developed with respect to ESOP fiduciaries’ decision to invest in or to maintain investments in employer stock.

 

Many ERISA stock drop lawsuit defendants have been able to rely on the presumption – often called the Moensch presumption – to obtain dismissal of the cases against them. However, a split has developed in the circuit courts over the procedural stage at which the presumption applies and how the presumption may be rebutted. The way the Court decides this case could significantly affect the ability of many ERISA lawsuit defendants to rely on the presumption at the motion to dismiss stage to try to get the cases against them dismissed. Background regarding the presumption and the details of the circuit split can be found in a recent memo from the McDermott, Will & Emery law firm (here).

 

Congress has recognized that Employee Stock Ownership Plans (ESOPs) and Eligible Individual Account Plans (EIAPs), which invest in employer stock, further an important public policy goal by encouraging employee ownership. The courts in turn have held that fiduciaries of these types of plans should not be subject to liability for investing in employer stock, as that was the reason the plans were created, consistent with the Congressional objective of fostering employee ownership. In a 1995 decision, Moensch v. Robertson (here), the Third Circuit concluded that fiduciaries of plans that required or encouraged investment in employer stock were entitled to a presumption that they acted prudently under ERISA by investing in the employer stock. This presumption could only be overcome by a showing that the plan fiduciaries abused their discretion by continuing to invest in the employer stock.

 

Several circuit courts have adopted the Moench presumption of prudence; however, the courts continue to disagree on whether the presumption can be raised at the motion to dismiss stage and how the presumption can be rebutted. The Supreme Court has now agreed to take up a case that will address these questions – and could even address the question of whether there should be a presumption at all.

 

The case now before the Supreme Court involves Cincinnati-based Fifth Third Bank and arises out the events surrounding the global financial crisis. The plaintiffs in the case are employees of the bank and participants in the company’s profit sharing plan. Participants in the plan had the option of investing the funds in their plan accounts in several different investments, including the stock of Fifth Third Bank. The bank matched a portion of an employee’s investment in their plan account with stock of the bank, although after a period the employee was free to transfer the stock match investment to other authorized investments.

 

In their complaint, the plaintiffs allege that the bank, its CEO and the plan fiduciaries breached their fiduciary duties under ERISA by maintaining significant plan investments in company stock and maintaining company stock as an investment option at a time they knew that it was imprudent to do so. The company’s share price declined as the global financial crisis unfolded.

 

The district court granted the defendants’ motion to dismiss their complaint, holding that as ESOP plan fiduciaries the defendants were entitled to a presumption that their decision to remain invested in employer stock was reasonable. The district court also found that the plaintiffs had failed to allege facts sufficient to overcome the presumption.

 

The plaintiffs appealed to the Sixth Circuit, which reversed the district court. In a September 7, 2012 opinion written by Judge Jane Stranch for a three-judge panel (a copy of which can be found here), the Court held that the district court had erred in concluding that the presumption of reasonableness applied at the motion to dismiss stage. The Sixth Circuit considered the presumption to be evidentiary, subject to factual rebuttal, and therefor not appropriate to consider and apply at the motion to dismiss stage. The Sixth Circuit court also declined to adopt the more demanding standard for rebuttal of the presumption that certain other circuit courts have adopted – that is, that the presumption may be rebutted only by a showing that fiduciaries continued to invest in the employer stock though it faced a “dire situation” – preferring a test providing that in order to overcome the presumption the plaintiffs must  show that the “a prudent man acting in a like capacity” would not have undertaken or continued the investment.

 

In its cert petition, the bank argued that the Sixth Circuit’s rulings created a split in the circuits requiring the Supreme Court to step in. The bank also argued that the appellate court had interpreted the presumption in a way that unjustifiably puts ESOP fiduciaries at risk of liability and that is inconsistent with the Congressional policy of encouraging stock ownership. In their opposition, the plaintiffs argued that there is no circuit split and that in fact the seeming differences between the Sixth Circuit and the other circuit courts was simply a reflection of the underlying facts in the respective cases and the important differences between the various plans involved.

 

The U.S. Department of Labor filed an amicus brief in which the agency urged the Court to grant cert in the case on the grounds that a split exists between the circuits. However, rather than arguing for or against the position adopted by the Sixth Circuit, the DoL argued that there should be no presumption of prudence at all, saying that “ERISA’s text and purposes do not call for the application of a presumption at any stage of the proceedings.” The DoL argued further that the judge-created presumption of prudence is based “largely on policy considerations that extend beyond ERISA’s text and are unconvincing in their own right.”

 

Discussion

The Supreme Court’s decision to take up the Fifth Third Bank ERISA case potentially could prove significant for other ERISA stock-drop case defendants. As the Morrison Foerster firm said in its December 16, 2013 memo about the Supreme Court’s decision to take up the Fifth Third Bank case, the presumption of prudence is "an important first line of defense in ERISA stock drop litigation."  If the Court concludes that the presumption cannot be raised at the motion to dismiss stage or may be rebutted at the pleading stage based on the lower rebuttal standard defined and applied by the Sixth Circuit, it could prove to be more difficult for ESOP fiduciaries to obtain dismissal of the ERISA stock-drop lawsuit filed against them.

 

As Cleveland-based Keycorp (which itself has been the target of the same kind of ERISA stock-drop lawsuits) argued in its amicus brief in support of Fifth Third Bank’s cert petition, the standards the Sixth Circuit adopted have make it  “far too easy for plaintiffs to get a meritless claim under ERISA past the pleading stage.”

 

The problem for companies subject to these kinds of cases is that even if the cases are entirely lacking in merit, the underlying allegations often go to the heart of the employer’s business operations. Discovery in these cases can be wide-ranging and expensive. The cost of discovery alone can compel corporate defendants to try to settle the case.

 

In addition, there is a tension at the core of these cases. Imbedded in the underlying allegations is a suggestion that when a company suffers reverses or its stock price drops, the ESOP fiduciaries have fiduciary obligation to liquidate plan holdings in the company stock, the ownership of which was the very reason the ESOP was formed in the first place.

 

As the Employee Benefits Law Report blog noted in a recent post about the Fifth Third Bank case, “a Supreme Court ruling that the presumption of prudence does not apply at the initial stage, or a ruling that the presumption does not apply at all, would seemingly eviscerate the statutory boundaries that favor ESOPs and likely have a significant chilling effect. Employers would have to consider whether the ESOP model remains viable and is worth the risk.”

 

The risk that the Supreme Court might jettison the presumption cannot be disregarded. The presumption is a creation of the circuit courts; while lower courts have felt compelled to grapple with it, the Supreme Court will not be so constrained. The Supreme Court certainly is not constrained to the narrower question of when the presumption applies or how it may be rebutted.

 

The situation here may be analogous to the circumstances in which the Supreme Court took up the “cause and effect” test in the Morrison v. National Australia Bank case. There may have been decades of circuit court case law interpreting the “cause and effect” test for the determination of the jurisdiction of the U.S. securities laws, but the test itself was an invention of the lower courts — like the presumption of prudence here. The Supreme Court could, as it did in the Morrison case, simply disregard the work of the lower courts and examine the question afresh based on the relevant statutory language; the fact that the DoL has urged the court to take that approach could encourage the Court to do so.

 

In any event, those of us in the professional liability insurance world now have yet another U.S. Supreme Court case to watch out for this term. As the Morrison Foerster firm said in its memo about the case, "regardless of its outcome, the case bears watching by officers, directors, and employees whose responibilities may expose them to ERISA claims for breach of fiduciary duty in connection with employee investments in company stock." The case will likely be argued around March 2014 and will be decided be the end of the current term in June.

 

The Federal Insurance Office (FIO) has – nearly two years overdue – finally published its long awaited report to Congress on its recommendations for the modernization of insurance regulation in the United States. The broadly ranging 65-page report identifies limitations in the current state-based regulatory model but does not recommend that federal regulation should displace state regulation entirely. Rather, the report proposes a hybrid model, where the current state-based system is generally preserved except where the need for greater uniformity or the requirements of an increasingly global insurance industry are best served by regulation at the federal level.

 

The FIO’s December 2013 report, entitled “How to Modernize and Improve the System of Insurance Regulation in the United States,” can be found here. The FIO’s December 12, 2013 press release about the report can be found here.

 

Section 502 of the Dodd-Frank Act created the FIO as a unit within the U.S. Department of Treasury to monitor all aspects of the insurance industry and, among other things, to identify issues contributing to systemic risk. Section 502 (p) of the Act expressly provided that “not later than 18 months after the date of the enactment of this section, the [FIO’s] Director shall conduct a study and submit a report to Congress on how to modernize and improve the system of insurance regulation in the United States.” The Act was enacted in late July 2010, and the modernization report was officially due on January 21, 2012, nearly two years ago. In preparing the report the FIO solicited public comment and also held public hearings as well.

 

The Dodd Frank Act was of enacted in the wake of the global financial crisis, in order to try to address the issues that were thought to have caused the crisis. As the FIO’s recent report acknowledges, one of the critical developments at the peak of the crisis was the near collapse of insurance giant AIG. However, it is worth noting that the problems that led to AIG’s near demise did not involve its insurance operations (which were and are regulated at the state level), but rather involved the company’s alternative financial products division (which theoretically at least was regulated at the federal level).

 

Thus even though a critical part of financial crisis was the near collapse of one of the largest participants in the global insurance industry, that development in and of itself does not present a case for setting aside the current model of insurance regulation in the United States. Indeed, the insurance industry generally weathered the financial crisis in reasonable good order, which could be interpreted to make the case for preserving the current regulatory model.

 

On the other hand, as the FIO report notes, the current balkanized regulatory model, involving as it does 56 different insurance regulators (if the regulators in the District of Columbia and territories are included in the count) “creates inefficiencies and burdens for consumers, insurers, and the international community.” The report observed that “the need for uniformity and the realities of globally active, diversified financial firms compel the conclusion that federal involvement of some kind in insurance regulation is necessary.”

 

However, the FIO does not suggest that the limitations in the current system imply that a federal regulator should displace state regulation completely. The report observes that the creation of a new federal regulatory agency to regulate all or part of the $7.3 trillion insurance sector “would be a significant undertaking.” For the federal government to amass the “personnel, resources and institutional expertise to execute such an endeavor” would require a substantial and unequivocal commitment from the political branches of government.

 

The report concludes that “the proper formulation of the debate” is not whether insurance regulation should be state or federal, “but rather whether there “are areas in which federal involvement in regulation under the state-based system are warranted.”

 

With this approach, and based on an extensive overview of the current state of the industry and the current approach to regulation, the report recommends a number of steps that could be taking to modernize and improve the regulatory system. The steps are divided into two categories: short term steps for the states to take; and steps toward direct federal involvement in regulation in certain areas.

 

Among other things, the report suggests that states should come up with new policies related to resolving failed insurers; monitor the impact of different rate-regulation and market conduct examination practices; develop plans to reduce losses in natural disasters. The report also suggests that the states should develop a uniform regime for the oversight of reinsurance captives. In addition, the report suggests that the states “should move forward cautiously with the implementation of principles-based reserving.”

 

As far as regulation at the federal level, the report recommends, among other things, the development and implementation of federal standards and oversight for mortgage insurers; in order to effect uniform treatment of reinsurers, develop provisions for reinsurance collateral requirements; and identify issues or gaps in the regulation of large national and internationally active insurers. The report also proposes that the FIO will study and report on the use of personal information in insurance pricing. The FIO also proposes to make recommendations pertaining to the availability of certain types of insurance for military personnel and Native Americans. The FIO will also monitor state progress on modernizing the collection of surplus lines taxes “and determine whether federal action may be warranted in the near term.”

 

According to news reports (here), the industry has generally been supportive of the FIO’s approach, although there clearly is wariness of the steps toward federal regulation that the report recommends. In addition, as noted in a December 14, 2013 memo about the report from the Nelson Levine de Luca & Hamilton law firm (here), one of the more “surprising” aspects of the report is its suggestion that “if states do not reform their laws and processes to meet the recommendations of the report, they could face federal action. “ The memo went on to note that the report suggests that “Congress should strongly consider direct federal involvement if states do not implement the FIO’s recommendations.”

 

The report includes several recommendations that may be of particular interest to readers of this blog. For example, among the report’s recommendations for the state is the proposal that the states should “develop corporate governance principles that impose character and fitness expectations on directors and officers appropriate to the size and complexity of the insurer.” The report explains this recommendation by noting:

 

Many U.S.-based insurers are expanding rapidly in geography, size and complexity, thereby imposing even greater de­mands on leadership. For example, internationally active insurers are increasingly engaged in sophis­ticated enterprise risk management practices to measure and understand risks posed to the enterprise from any angle or perspective. With standards appropriately scaled to the size and complexity of the firm, state regulators should adopt director and officer qualification standards that require individuals serving in those roles to have the expertise to assess strategies for growth and risks to the enterprise. For an insurer that exceeds size and complexity thresholds, state regulators should adopt an approach designed to ensure that individuals nominated to serve in the firm’s leadership ranks have sufficient capacity to understand and challenge an insurer’s enterprise risk management.

 

Another recommendation in the report that will be of interest to this blog’s readers is its suggestion that “the National Association of Registered Agents and Brokers Reform Act of 2013 should be adopted and its implementation monitored by the FIO.” This proposed legislation, which can be found here, is intended to create a uniform agent and broker licensing clearinghouse is supported by the Independent Insurance Agents and Brokers of America. (More information about this proposed legislation can be found here.)

 

The FIO report contains a wealth of information, including some very interesting data showing how important the insurance industry is in the United States. Among other things, the report states that 2012 U.S. insurance premiums totaled $1.1 trillion, representing 7 percent of the country’s GDP. Insurers directly employ 2.3 million people in the U.S, representing 1.7 percent of non-farm payrolls. As of year-end 2012, insurers reported $7.3 trillion in total assets, including $6.8 trillion in invested assets

 

Special thanks to a loyal reader for sending me a copy of the FIO report.

 

And in the End: The Beatles ended their Abbey Road album with the simple song called “The End.” The song features short but memorable lyrics – “And in the end, the love you take is equal to the love you make – and a sonic quality that make the track truly unforgettable. In a December 13, 2013 post on Something Else Reviews entitled “Deep Beatles: ‘The End,’ from Abbey Road (1969)” (here), music journalist Kit O’Toole takes a closer look at the song, which she says “serves as more than a mere final track to an album”; the song, she says, “effectively summarizes [the Beatles’] career trajectory as well as the end of the 1960s.”

 

The song features one of the only drum solos that Ringo Starr has ever recorded, as well as the dueling guitar solos featuring the other three Beatles. As O’Toole says, “after the angst expressed in ‘Carry That Weight’ and the ‘You Never Give Me Your Money’ reprise, ‘The End’ injects pure adrenaline and joy in the proceedings.”

 

Even if you think you know the song, read O’Toole’s account of how the song was recorded and how the pieces came together, and then listen to the song again on the embedded video link below. (The video starts with “Golden Slumbers” and ends with “The End”.)

 

O’Toole ends her article quoting Paul McCartney as saying “I’m very proud to be in the band that did that song and that thought those thoughts and encouraged other people to think them to help them get through little problems here and there.” It really is a great song.

 

After you have watched the video, you might want to visit the website for Abbey Road Studios (here) which has a webcam set up on the famous Abbey Road cross walk. If you check out the webcam shot during the daytime (London time) you won’t have to wait long to see random groups of people trying to recreate their version of the Abbey Road album cover.

 

//www.youtube.com/embed/hc5YuMsDTRE