D&O insurance policies often address a policyholder’s particular circumstances. One way that D&O insurers sometimes address the fact that a company has experienced adverse circumstances is to incorporate into its policy a “known circumstances exclusion” precluding coverage for those circumstances. In an October 23, 2013 opinion (here), the First Circuit affirmed the opinion of the lower court that a known circumstance exclusion in a non-profit D&O insurance policy precluded coverage for the underlying claim. Although the holding itself is unsurprising in light of the exclusion, the case does underscore the critical importance of the wording used in creating these kinds of exclusions.

 

Background

The Clark School for Creative Learning is a non-profit educational institution located in Danvers, Massachusetts. The school faced financial difficulties, as it was running an operating deficit and its liabilities exceeded its assets. In May 2008, two parents of three of the school’s students (the Valentis) donated $500,000 to the school.

 

The school’s financial difficulties were disclosed at length in Note 8 to the school’s financial statements, which was entitled “Insufficient Net Assets.” Note 8 also referred to the Valentis’ gift:

 

Subsequent to the date of the accompanying financial statement, in May of 2008, the School was a recipient of a major gift totaling $500,000 (see footnote 7). The donation is unrestricted and will be used to support the School’s general operations as management’s plans for the School’s future are implemented and allowed time to succeed. Management feels that its plans and the subsequent major gift will enable the School to operate as a going concern.

 

The Valentis’ gift is further described in Note 7 of the school’s financial statements. Footnote 7 was entitled “Major Gift” and described the gift in detail.

 

In May 2009, the Valentis filed a lawsuit in Massachusetts state court against the school and its director alleging that the school had not followed through on alleged promises the school and the director allegedly made in soliciting the gift. The school eventually settled the Valentis’ lawsuit by agreeing to return a portion of the gift.

 

The school submitted the Valentis’ lawsuit as a claim under its D&O insurance policy. The insurance carrier denied coverage for the claim in reliance on an exclusion in the policy entitled “Known Circumstances Revealed in Financial Statement Exclusion.” The exclusion precluded coverage for any losses “in any way involving any matter, fact, or circumstance disclosed in connection with Note 8 of the [school’s] Financial Statement.”

 

The school initiated a lawsuit against the insurer seeking to have the insurer reimburse the school for the costs of defending and settling the Valentis’ lawsuit. The district court granted summary judgment in the insurer’s favor and the school appealed.

 

The October 23 Opinion

In an October 23, 2013 opinion written by Chief Judge Sandra Lynch for a unanimous three judge panel, the First Circuit affirmed the district court.

 

In her opinion, Judge Lynch observed that the known circumstance exclusion’s reference to Note 8 of the school’s financial statements is “both clear and broad,” that the exclusion precluded coverage for “any matter, fact, or circumstance disclosed in connection with Note 8 of the Financial Statement.” She added that

 

One matter, fact or circumstance disclosed in Note 8 is the Valentis’ gift, along with other information about the School’s troubled finances. And the loss and defense costs for which coverage is sought certainly “involve[es]” that gift, since the loss and costs were incurred in defending and settling litigation about the gift. The plain language of the Known Circumstances Exclusion excludes from coverage the losses from the suit brought by the Valentis about their gift.

 

The appellate court rejected the school’s argument that the exclusion was intended to apply only to the financial difficulties and going concern question discussed in Note 8, not to the Valentis gift, as well as the school’s argument that if the parties had intended for the exclusion to apply to the gift, the exclusion would have referenced Note 7. Judge Lynch said only that “the language here plainly is not limited to losses caused by financial difficulties,” adding that “the parties did reference Note 7: the discussion on the Valentis’ gift in Note 8 explicitly refers to Note 7.”

 

The appellate court also rejected the school’s argument that the application of the exclusion to preclude coverage deprives the school of coverage it reasonably expected. The school argued that it would not have expected the exclusion to reach the Valentis’ suit because the exclusion focused on the school’s financial difficulties and because the suit had not yet been filed and therefore could not have been a “known” circumstance.

 

In rejecting this argument, Judge Lynch said that “the footnote referred to the known circumstance of the gift and went further, describing the gift as unrestricted. The Valentis’ lawsuit alleged otherwise.” Judge Lynch added that “when a contract is not ambiguous, a party can have no reasonable expectation of coverage when that expectation would run counter to the unambiguous language of an insurance policy.”

 

Discussion

At one level, the outcome of this insurance coverage dispute is unremarkable. The policy had an exclusion that precluded coverage for loss involving any circumstance mentioned in Note 8. Note 8 referred to the Valentis’ gift. The Valentis’ lawsuit related to the gift. Under those circumstances, the outcome is no surprise.

 

However, consider if you will the circumstances involved in the placement of this policy. The school was facing financial difficulties, which were fully documented in Note 8, which was titled “Insufficient Net Assets.” The financial difficulties described in Note 8 obviously would be a concern for a D&O insurance underwriter and the underwriter would want to take protective measures against problems arising from the school’s financial difficulties. Fortunately for the school, it had also received a major gift that potentially could allow the school to continue as a going concern. The gift was described in detail in Note 7, which was titled “Major Gift,” and mentioned in Note 8 in connection with the going concern issue. So the purpose of Note 8, titled “Insufficient Net Assets,” was to describe the school’s financial difficulties and possible relief, and the purpose of Note 7 was to describe the gift.

 

The reason the insurer added the Known Circumstances Exclusion was because of the school’s financial difficulties, described in Note 8. The insurer wouldn’t have been concerned about the gift as that was the school’s best hope to be able to carry on.

 

Unfortunately for school, the exclusion that was added referred generally to Note 8. It did not refer to the specific financials issues within Note 8. The exclusion was written broadly so that it encompassed all circumstances reference in Note 8, not just the references in Note 8 to the school’s financial difficulties.

 

I want to make it clear here that I am not finding fault in any way with the way the exclusion at issue was worded. I have no way of knowing the circumstances surrounding the placement of this policy nor do I have any way of knowing whether the insurer in any event would have agreed to a narrower wording; given the school’s financial difficulties, the insurer may not have been willing to agree to a narrower wording in any event.

 

Nevertheless, this case is a reminder of the critical importance of making sure that when coverage limiting exclusions are added, that they are worded as narrowly as possible. Given the school’s financial difficulties, it may have been unavoidable that the school’s insurance policy would preclude coverage for claims relating to those difficulties. But there is no reason that the exclusion should have been written so broadly that it also precluded coverage for matters that not only were not part of the school’s financial difficulties, but that at that time were among the reasons that the school might hope to be able to continue as a going concern.

 

When organizations have experienced adverse circumstances, it may not be possible for the organization to obtain D&O insurance without an exclusion precluding coverage for those circumstances. (Obviously it is always better to have a policy without the exclusion, but sometimes it is not possible to find coverage without an exclusion.) But if an exclusion is to be added, it should be tailored as narrowly as possible, to try to ensure that the exclusion is not applied to preclude coverage for matters outside the area of concern.

 

On October 23, 2013, the SEC finally approved (unanimously) and released for public comment the proposed rules implementing the crowdfunding provisions of the JOBS Act. 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.

 

The JOBS Act, signed into law in April 2012 (about which refer here), contained statutory provisions providing exemptions under the securities laws allowing certain kinds of 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. The deadline for the regulations came and went, and as time passed anticipation over the as-yet unreleased regulations grew. Indeed, earlier this week, a bipartisan group of eight U.S. Senators sent the SEC a letter urging the agency to “expedite” the release of the crowdfunding rules.

 

The proposed rules, which run some 585 pages, provide further specificity as to who may invest and how much they may invest; specifying what information the firm seeking fund raising must provide; and “create a regulatory framework for the intermediaries that would facilitate the crowdfunding transactions.”

 

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 could not be resold for one year.

 

Certain companies would be ineligible for the crowdfunding exemption, including non-U.S. companies; current SEC reporting companies; certain investment companies, companies currently subject to disqualification; companies that have failed to comply with annual reporting requirements in the rules; and “companies that have no specific business plan or that have indicated that their business plan is to engage in a merger or acquisition with an unidentified company or companies.”

 

The proposed ruled specify that information that companies must provide in the crowdfunding offering documents, including the identities of the company’s directors and officers as well as 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 must include the company’s financial statements, which, depending on the size of the offering, may have to be accompanies by a copy of the company’s tax returns or be reviewed or audited by an accountant. The issuing company would have to provide updates of material changes as well as provide updates on the company’s progress toward reaching the target offering amount.

 

The proposed rules also specify the issuing company’s ongoing reporting requirements after the completion of the offering. This portion of the Act’s requirements has generated  a great deal of comment as some observers wanted to minimize the ongoing requirements on the offering companies while others wanted to provide investor protection through reporting requirements. 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. The company would not be required to provide investors with a physical copy of the report. The annual report would have to include information similar to the information required in the offering document about the company’s business and financial condition. 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.

 

The proposed regulations also provide specifications regarding the funding platforms, which must be operated by a registered broker or by a funding portal, which is a new type of SEC registrant. The platforms are required to provide individuals with educational materials; take measures to reduce fraud; make issuer and offering information available; permit discussions on the platform about the offering; and facilitate the sale of crowdfunding securities.

 

The crowdfunding portals would be prohibited from offering investment advice or making recommendations; soliciting the purchase or sale of the securities offered on its website; avoid paying prohibited compensation and commissions; avoid holding or handling investor funds or securities.

 

In the discussion in the proposed rules regarding the Act’s liability provisions, the rules affirm that the range of persons who potentially could be held liable for misrepresentations in the crowdfunding offering are involved intermediaries, including the offering platforms. The rules provide that in light of these potential liability provisions, the platforms should “establishing policies and procedures that are reasonably designed to achieve compliance with the requirements of Regulation Crowdfunding, and that include the intermediary conducting a review of the issuer’s offering documents, before posting them to the platform, to evaluate whether they contain materially false or misleading information.”

 

The agency undoubtedly will receive extensive commentary on the proposed rules, although they are not likely to be as controversial as they potentially could have been because they largely follow the structure laid down in the Act. Based on the comments submitted during the comment period, the rules may be further revised before they are final and companies can commence conducting financing through crowdfunding offerings.

 

Although we will still have to wait 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 represent 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).

 

Another thing that will be interesting to see is the extent of investor interest, particularly if there are (as there inevitably will be) high profile stories about online scams involving crowdfunding financings. I hope I am not being too skeptical, but it just seems inevitable there will be offerings where the issuing company’s principals abscond with the funds or use them for purposes other than those proposed in the offerings. Even if there are no frauds, there inevitably will be innumerable instances where investors lose their money because the company fails or no secondary market forms for the company’s securities.

 

From an insurance perspective, it will also be interesting to see both how extensively the crowdfunding liability provisions are used and whether a market develops for insurance products providing crowdfunding companies and their directors and officers insurance protection for crowdfunding liability. I suspect that many 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.

 

When the SEC Whistleblower Office presented its first full fiscal year annual report last November, the agency reported that 324 (or 10.8%) of the 3,001 whistleblower reports the agency received came from whistleblowers outside the United States. This statistic suggested that the Dodd-Frank whistleblower provisions could lead to the revelation of financial misconduct overseas, and also suggested the possibility that these non-U.S. whistleblower reports could lead to increased revelation of FCPA violations. (The report noted that 3.8% of the whistleblower reports involved alleged FCPA violations.)

 

However, a recent decision in the Southern District of New York could put a damper on overseas whistleblowing. In an October 21, 2013 opinion, Judge William H. Pauley held that the Dodd-Frank Act’s whistleblower anti-retaliation provisions do not protect whistleblowers outside the U.S. Judge Pauley’s opinion can be foundhere. Judge Pauley’s decision follows a June 2013 Southern District of Texas decision in the GE Energy (USA) case (here) in which Judge Nancy Atlas held that the anti-retaliation provisions do not apply extraterritorially. Without the protection of the anti-retaliation provisions, prospective overseas whistleblowers could be deterred from submitting reports to the SEC.

 

Meng-Lin Liu, a Taiwanese national, served as Group Compliance Officer for Siemens A.G.’s Chinese healthcare division. He became concerned that the Chinese unit was paying kickbacks to obtain imaging equipment contracts with Chinese and North Korean hospitals. He reported concerns to company officials, including his concern that the payments circumvented compliance procedures put in place following the company’s 2008 guilty plea to FCPA charges. Liu received negative performance reviews he believed were written in retaliation for raising concerns. He was later demoted and in early 2011 his employment contract was terminated.  In May 2011, Liu reported possible FCPA violations to the SEC.

 

Liu instituted a Dodd-Frank Act whistleblower anti-retaliation action against Siemens in the Southern District of New York. Siemens moved to dismiss, arguing that the anti-retaliation provisions do not apply extraterritorially.

 

In his October 21 opinion, Judge Pauley granted the company’s motion to dismiss. Citing the U.S. Supreme Court’s decision in Morrison v. National Australia Bank for the proposition that U.S laws do not apply extraterritorially unless Congress clearly expresses intent for a statute to apply extraterritorially, Judge Pauley found that in enacting the Dodd-Frank Act, Congress had not show an intent for the anti-retaliation provisions to apply extraterritorially.

 

Judge Pauley also rejected Liu’s argument that the anti-retaliation provisions should apply to Siemens merely because Siemens has ADRs that trade on the NYSE, noting that in the Morrison case, National Australia Bank had ADRs trading in the U.S. but that that fact was not determinative of the question of the reach of the securities laws.

 

Judge Pauley said:

 

This is a case brought by a Taiwanese resident against a German corporation for acts concerning its Chinese subsidiary relating to alleged corruption in China and North Korea. The only connection between the United States is the fact that Siemens has ADRs traded on an American exchange, just as in Morrison…There is simply no indication that Congress intended the Anti-Retaliation Provision to apply extraterritorially.

 

Judge Pauley also rejected Liu’s argument that he was entitled to protection under the Sarbanes-Oxley whistleblower provisions. He also considered but concluded that he did not need to decide the question whether or not Liu was even a “whistleblower” to whom anti-retaliation protections would otherwise apply given that he did not file his whistleblower report until after he his employment contract had been terminated.

 

Judge Pauley accepted that overseas employees could be a whistleblower within the meaning of the Dodd-Frank Act. Clearly, given the significant number of whistleblower reports from outside the U.S. in the program’s first full fiscal year, overseas employees have responded to the opportunity to provide whistleblower reports.

 

However, many prospective whistleblowers learning that they would not have the benefit of the anti-retaliation provisions might now be less willing to come forward. In the absence of these protections, the volume of whistleblower reports from outside the U.S. might well decline, which in turn potentially could result in fewer reported violations of the FCPA.

 

The one consideration that might reassure prospective overseas whistleblowers is the extent of the SEC’s effort to protect the anonymity of the whistleblower to whom the agency recently awarded the record-level $14 million whistleblower bounty. At least some prospective overseas whistleblowers might yet come forward even without the anti-retaliation protections if they believe their anonymity will be preserved.

 

Nevertheless, the absence of anti-retaliation protection for non-U.S. whistleblower could deter many prospective overseas whistleblowers from filing reports with the SEC.

 

Hat tip to the S.D.N.Y. Blog (here) for the link to Judge Pauley’s opinion.

 

The varied travels of the time-honored D&O Diary mug have continued, with appearances here, there and everywhere.

 

Readers will recall that in a recent post, I offered to send out to anyone who requested one a D&O Diary coffee mug – 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, and here), I published prior rounds of readers’ pictures. The pictures have continued to arrive and I have posted the latest round below.

 

One reaction I often have when reviewing readers’ mug shots is a recurring wish that I had been present for the reader’s photo shoot. That was certainly my reaction when I viewed the first of today’s featured pictures. The first photo comes to us from loyal reader Mary Irvin of Columbia, South Carolina who sent in this warm picture of her D&O Diary mug in the October sunshine amidst the grapevines at the Opus One winery in Napa Valley, California.

 

 

 

 

 

 

 

 

 

 

 

We received quite a number of pictures this time around taken at sporting venues. The first of these sporting pictures comes to us from Mike Parry of Marsh in London, who took a number of mug shots at St. Andrews in Scotland. The picture below is a classic shot of the Swilcan Bridge, with the famous 18th hole of the Old Course in the background.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Our good friend Bill Hopkins of AIG Cat Excess Liability also sent in some golf course pictures, including the one below taken at Stowe, Vermont.

 

 

 

 

 

 

 

 

 

 

 

 

Laura Burke of Lockton also chose a sporting venue for her mug shot. Laura reports that she took this picture from the RT Specialty suite at Soldier Field in Chicago. The picture was jointly submitted by the Lockton Financial Services Team in Chicago with special thanks to Jon Reiner of RT Specialty for taking them to the Bears game.

 

 

 

 

 

 

 

 

 

 

 

 

Apparently inspired by The D&O Diary’s recent travelogue about Lisbon, Richie Leisner of the Trenam Kemker law firm in Tampa sent in this picture of his D&O Diary mug displayed with a number of Lisbon souvenirs. (My Lisbon blog post includes a picture of the actual streetcar to which the souvenir streetcar in the picture below corresponds.)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

It wouldn’t be a D&O Diary mug shot gallery without a picture from Asia. This installment’s Asia picture comes to us from Enoch Zhou of AIG in Shanghai. Enoch sent in the great picture taken in the  ancient town in Shanghai called Nanxiang. Enoch pointed out something which I had not noticed before, which is that The D&O Diary mugs were made in China. Enoch noted that the mugs had traveled all the way to the U.S. and then back to China.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 I have to say, it is so much fun seeing the different places that people have taken their D&O Diary mugs and the great pictures that they have sent back. I never cease to be amazed when people lug their mugs all around the map just to be able to send back a blogworthy mug shot. My thanks to everyone who has sent in a picture.

 

If there are readers out there who want a mug and have not yet ordered one, I still have some mugs left. If you would like one, just drop me a note and I will be happy to send one along to you. 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 take a few days for me to get your mug in the mail.

 

Numerous questions surround the SEC’s new policy requiring enforcement action defendants in “egregious” cases to admit to wrongdoing in order to settle with the agency, rather than simply agreeing to neither admit nor deny the agency’s allegations. As I discussed in a prior post (here), among the questions is the issue of what the impact from these kinds of admissions may be for the availability of D&O insurance for the defendants making the admissions.

 

In an October 17, 2013 article entitled “Recent Changes in SEC Enforcement Policy Require Renewed Attention to Directors’ and Officers’ Insurance Terms” (here), Eric Barber and Charles (Chip) Mulaney of the Perkins Coie law firm take a closer look at the insurance issues arising from the SEC’s new settlement approach.

 

As the authors note, an immediate concern is whether the admissions are sufficient to trigger the conduct exclusions found in D&O insurance policies. These exclusions preclude coverage for claims involving fraudulent or criminal misconduct or the gaining of profit or advantage that is illegal. The authors note that in the event that if an SEC enforcement action defendant were to reach a settlement with the agency that includes admissions of wrongdoing, the defendant’s D&O insurer may argue that the admissions “are sufficient to trigger the conduct exclusion and thus bar coverage in a civil lawsuit arising out of the same set of facts.”

 

The most direct way to avoid this type of coverage issue may be through the way the settlement itself if structured. As the authors note, in the recent JP Morgan “London Whale” settlement (about which refer here), the company kept its admissions vague on the issue of “who did what wrong” and avoided any mention of intent. The authors also note that in the recent Harbinger/Falcone settlement (about which refer here), the defendants preserved leeway in the agreement to deny the allegations in other proceedings arising out of the same conduct. These kinds of settlement features could allow a company room to contend that its admissions to the SEC do not trigger the conduct exclusions.

 

In addition, the conduct exclusions in most D&O insurance policies are only triggered “after adjudication” that the precluded conduct has actually taken place; the authors note that if, like the JP Morgan London Whale settlement, the settlement is in the context of an administrative proceeding that does not require or involve court approval, “the insured may be able to argue that, absent court approval, the conduct exclusion has not been implicated.”

 

The authors also note the importance of so-called severability provisions in the D&O insurance policy. These provisions are found in relation to both the policy exclusions and in relation to the policy application.

 

With respect to the policy provisions relating to severability of the exclusions, these provisions ensure that the misconduct of one insured person will not be imputed to any other insured for purposes of determining the applicability of a policy exclusion. This could be particularly important in the context of a multi-defendant proceeding where one defendant (say, the corporate defendant) is motivated to pursue settlement and perhaps willing to make admissions to put the matter to rest, while other defendants could be less willing to settle based on an admission. The severability of the exclusions provision ensures that one party’s wrongdoing admissions will not be imputed to another for purposes of determining the applicability of an exclusion.

 

The severability of the application provision ensures that any one individual’s knowledge of facts pertaining to an application misrepresentation will not be imputed to any other person. Application severability could be critical if the D&O insurer were to contend in reliance on admissions in an SEC settlement that the D&O insurance application contained misrepresentations. The severability provision could ensure that another party’s admissions would not serve as a basis for the insurer to try to rescind the policy as to other parties.

 

The authors also note that if SEC enforcement action defendants were to provide admissions in an SEC settlement that an insurer contends are sufficient to preclude coverage, the D&O insurer might also seek recoupment of defense fees that the insurer has already paid. The authors note that insurers “have met with mixed success on this issue,” but that the insurers might well seek recoupment in a larger case where millions of dollars have been spent. The authors suggest that insureds “should pay careful attention” to whether the policy explicitly grants the insurer the right of recoupment of previously paid defense costs and whether the insurer has explicitly reserved its right to seek recoupment when it starts making defense cost payment at the outset of the claim.

 

In my view, the possibility that the insurer might seek recoupment of defense costs that have already been paid is a particular concern. There are enough recent cases where insurers have obtained to right to recoupment defense fees, for example, following a criminal conviction (refer, for example, here) to raise the concern that the insurers might seek recoupment in the event of admissions of wrongdoing in an SEC settlement. (For an overview of the issues surrounding the insurer’s right of recoupment, refer here).

 

It is relatively rare for a D&O insurer to seek recoupment. Often by the time the legal proceedings have reached the point where the insurer has a basis on which to try to seek recoupment, the individual from who it would seek recoupment has few remaining assets from which the insurer might recover. In addition, many insurers understand that it is a poor public relations move to be seen suing your own customer trying to recover amounts you previously paid under a contract of insurance.

 

Though recoupment is rare, it comes up often enough to be a concern. The law in this area is not entirely uniform. In some jurisdictions, the courts have held that, if at the outset of a claim the carrier has reserved the right to seek recoupment in the event of a determination of noncoverage, the carrier has the right to seek to recoup defense costs incurred in connection with claims that are not covered under the policy. Court that follow this approach reason that allowing the insurer to recoup the defense costs where a timely reservation of rights was issued promotes the policy of ensuring that defenses are afforded even in questionable cases. Other courts following this line have reasoned that it would be inequitable for the insured to retain the benefits of the defense without repayment where there was no coverage under the policy.

 

On the other hand, other courts have held that the policy itself must specificly address the carrier’s right to seek recoupment and that the mere fact that the carrier has reserved its rights to seek recoupment is not sufficient to create a right that is not otherwise found the policy.

 

In light of these various concerns, it seems likely that there will be a renewed focus among D&O insurance practitioners on the potentially implicated policy provisions. I am just speculating here for now, but given these developments, I can imagine the debate with the industry involving the following.

 

First, I suspect that there will be a renewed focus on the wordings of the conduct exclusions. Among other things, policyholder advocates will try to restrict the fraud exclusion trigger to “deliberate fraudulent or criminal misconduct,” with an emphasis on including the word “deliberate” and eliminating any reference in the exclusion to “dishonesty.” I would also expect policyholder advocates to try to tinker with the “after adjudication” requirement; for example, there might be an effort to include language requiring that the “adjudication” to take place in a judicial proceeding (as opposed to an administrative proceeding).

 

Similarly, there is likely to be a renewed focus on the question of whether or not there are express policy provisions relating to the insurer’s right to recoupment. Although one approach might be simply to try to have the insurer remove policy provisions of this type, the removal of the provision alone (even if the insurers were to agree to it) might not be sufficient to address policyholder concerns about the possibility of the insurer seeing recoupment in the event of wrongdoing admissions in an SEC proceeding.

 

Another approach policyholder advocates might take would be to try to include express policy language to the effect that the insurer will not seek recoupment in the event of admissions in an SEC enforcement action; I would expect that even if the insurers were willing to consider the possibility of including this type of language, there would still be a significant debate over what type of carve outs would be added. That is, the insurer would likely still want to preserve the right to seek recoupment in the event of certain kinds of admissions.

 

The SEC’s new policy is still new and we are all still in the position of seeing how the new policy will be implemented. The agency’s actual practices will have a significant impact on how the D&O insurance industry ultimately responds. But in the meantime, there will likely be a significant debate among D&O insurance practitioners over what the right response will be from an insurance standpoint to the SEC’s new policy. 

 

The Cyber Risk “Governance Gap”: Numerous observers (including this blog) have noted the growing liability exposures facing boards of directors arising from cyber breach risks. Still other commentators have suggested the measures boards should be taking in light of these risks. Yet, at least according to a recent paper summarizing several recent research studies, at all too many companies, there is a “cyber risk governance gap” – that is, a “gap” between “the legal exposure presented by cyber risks and the ability of corporate boards to address these risks effectively.”

 

In a recent Bloomberg Law article entitled “Cyber Risk and the Board of Directors – Closing the Gap” (here), Michael Gold of the Jeffer Mangels Butler & Mitchell law firm explores what he describes as the “cyber risk governance gap.” He cites research from Carnegie Mellon focused on the energy and utilities industries as showing that 71 percent of surveyed boards rarely or never review privacy and security budgets; 51 percent of boards rarely or never review security program assessments; and 54 percent rarely review top level policies. He also notes that industrial companies showed only “modestly better” in a study conducted by the U.S. Department of Homeland Security on companies that experience cyber breach events in 2012.

 

Gold suggests that boards of many companies may be “timid about engaging cyber risk” because these risks have “no real parallel in the experience of most corporate directors.” He notes that many directors, particularly those at mature companies, “are older and are not as comfortable with digital technologies.” Compounding this issue is the fact that the complexity of the technology and the act the frequent use of jargon raise barriers even more.

 

Gold also notes that, perhaps ironically, for many board members the problem may not be too little information, but too much; he notes that the “sheer volume of information” which leaves board members with “cyber security fatigue,” which all too often leads to the default mode characterized by the blanket excuse that “we have a good IT staff.”

 

Of arguably greater concern is that, according to a study Gold cites from the National Association of Corporate Directors, is that many board members are “simply unaware of the operational risks at their company” because they “do not know enough to ask the necessary questions of the right people to obtain the information they need.”

 

Based on these concerns, Gold suggests some steps companies and their boards can take to address the “governance gap.” First he suggests mandatory cyber education for board members, with an emphasis on developing cyber expertise at the board level, including through the consideration of candidates with appropriate expertise. He also suggests creating a board level reporting system that gives directors “timely and usable information to permit a reliable high-level evaluation of the company’s cyber risk profile, defensive strategies and infrastructure.”

 

I found Gold’s article interesting, both in and of itself, and as yet another example of a growing volume of commentary underscoring the fact that many companies seem to be slow off the mark in addressing cyber risks. This message is consistent with the related concern noted in a recent post on this site that despite SEC guidance directing reporting companies to incorporate greater cyber risk disclosure in their periodic filings, many companies have not yet modified their disclosure to address cyber disclosure.

 

Readers interested in a more detailed perspective on the actions boards of directors should be taking and the questions directors should be asking about cyber risks will want to take a look at the prior guest post on this site by D&O insurance industry veteran Dan Bailey discussing director’s “new focus” on cyber risk issues. In any event, as discussed in a separate post (here), one particular question companies should be asking company management is the extent to which the company has secured dedicated insurance to protect the company in the event of a cyber breach or privacy event.

 

Plaintiffs Withdraw Appeal of Forum Selection Bylaw Case: Defense advocates were heartened in June when Delaware Chancery Court Chancellor Leo E. Strine, Jr. entered an order upholding forum selection bylaws adopted by Chevron and Federal Express as statutorily and contractually valid. It was hoped at the time that the ruling validating the forum bylaw provisions might help to reduce the curse of multi-jurisdiction litigation by requiring shareholder claims to be litigated in Delaware. However, a concern at the time was as a lower court ruling only, Chancellor Strine’s decision could be overturned on appeal by the Delaware Supreme Court. The plaintiffs did in fact file an appeal and court watchers had been eagerly anticipating the appellate court’s consideration of the case.

 

As it turns out, the court watchers can relax – – the plaintiffs have decided to drop their appeal. As discussed in an October 16, 2013 post by Widener University Law Professor Lawrence Hamermesh’s on the school’s Institute of Delaware Corporate & Business Law blog (here), the plaintiffs in the Chevron and Fed Ex cases voluntarily dismissed their appeal of Chancellor Strine’s ruling.

 

Professor Hamermesh comments that he thinks this is a “tactically intelligent move” on the plaintiffs’ part. It was widely believed that the appellate court would affirm Chancellor Strine’s opinion. By dropping their appeal, the plaintiffs arguably preserved “at least a residual crack of daylight … to argue, in cases brought outside of Delaware, that exclusive forum bylaw provisions are generally unenforceable.” The professor did note his “disappointment” that the Delaware Supreme Court will now not get the chance to consider the case; he had been hoping for a strong opinion endorsing the enforceability of the provisions.

 

Speakers’ Corner: On Monday October 21 and Tuesday October 22, 2013, I will be co-chairing the American Conference Institute’s 17th Forum on D&O Liability in New York. The two-day conference includes an outstanding cast of speakers. It should be a great session. Information about the conference can be found here.

 

If you will be attending the conference, I hope you will make a point of saying hello to me while we are there, particularly if we have never met previously.

 

Owing to my attendance at the conference, there may be an interruption in The D&O Diary’s publication schedule. Normal publication should resume later in the week.

 

O.K., here’s something – on October 17, 2013, Northern District of Illinois Judge Ronald Guzman entered a post-verdict judgment in the long-running Household International securities class action lawsuit. The judgment award consisted of principal damages of $1,476,490,844.21 and prejudgment interest of $986,408,772, for a total judgment amount of $2,462,899,616.21, along with post-judgment interest and taxable costs. According to the lead plaintiffs’ law firm, the judgment represents “the largest judgment ever in a securities fraud trial.” Household International is now a unit of HSBC Holdings PLC. A copy of the judgment can be found here.

 

Got your attention? Good. Here’s the background.

 

As detailed here, the plaintiffs first filed their lawsuit back in 2002 on behalf of all persons who acquired Household International securities between October 23, 1997 and October 11, 2002. The plaintiffs contended that during the class period, the defendants concealed that Household "was engaged in a massive predatory lending scheme."

 

According to the complaint, Household "engaged in widespread abuse of its customers through a variety of illegal sales practices and improper lending techniques." Household also reported "false statistics" that were intended to "give the appearance that the credit quality of Household’s borrowers was more favorable that it actually was." The plaintiffs allege that the "defendants’ scheme" allowed them "to artificially inflate the Company’s financial and operational results."

 

In the third quarter of 2002, the company took a $600 million charge and restated its financial statements for the preceding eight years, and in October 2002, the company announced that it had entered into a $484 regulatory settlement regarding its lending practices. On November 14, 2002, the company announced that it was to be acquired by HSBC Holdings. (HSBC’s Chairman later admitted that "with the benefit of hindsight, this is an acquisition that we wish we had not undertaken." The entry f the judgment probably doesn’t improve things in that regard.)

 

The defendants in the lawsuit included Household International and its mortgage finance subsidiary, Household Financial Corporation, and Household’s former CEO and CFO, as well as certain other former officers and directors. The company’s offering underwriters were also initially named as defendants, but they were later dismissed from the case (refer here). The plaintiffs also reached a prior settlement with the company’s former auditor, Arthur Anderson.

 

As detailed here, trial in the case commenced on March 30, 2009. Judge Guzman bifurcated the case into two parts, with a damages phase to follow the initial liability phase.

 

As detailed here, on May 7, 2009, the jury returned a mixed verdict in which the jury found for the plaintiff on a number of – but not all – counts. The verdict form the jury entered (which can be found here) is quite complex and very detailed. The jurors were asked to make specific findings with respect to 40 allegedly false and misleading statements. The jury found in favor of the defendants with respect to 23 of the statements. However, the jury found in favor of the plaintiffs with respect to 17 of the statements.

 

The October 17 judgment order, arriving as it did some four and a half years after the verdict, followed several post-trial defense motions to invalidate the verdict as well as defense objections to thousands of class members’ claims. The Court also considered and ruled on issues concerning the reliance of absent class members on defendants’ statements. The entry of judgment follows an October 4, 2013 order from the district judge denying all of the defendants’ post-trial motions.

 

The judgment was entered against Household International; its former Chairman and CEO William Aldinger; its former CFO and COO David Schoenholz; and its former Vice-Chair of Consumer Lending Gary Gilmer. The company, Aldinger and Schoenholz were hold jointly and severally liable for the judgment and Gilmer was liable for 10% of the judgment.  

 

It is worth noting that the judgment includes post-judgment interest. That means that interest will continue to accrue during the pendency of any appeal that the defendants may file. (Even at low interest rates, interest costs can ramp up pretty quickly on $2.4 billion).

 

In addition, according to a statement from the plaintiffs’ firm law firm, the firm is “continuing to litigate defendants’ objections to over 25,000 additional claims with losses in excess of $650 million.” According to the firm, if the defendants’ objections to certain of these claims are denied, the firm will seek entry of judgment in favor of these claimants as well.

 

As readers of this blog well know, very few securities class action lawsuits actually go all the way to trial. Of the slightly more than two dozen cases that have gone to trial since the enactment of the PSLRA, about half have resulted in defense verdicts. Of the trials that have resulted in plaintiffs’ verdicts, none have resulted in damages awards anywhere remotely approaching the size of this judgment. (The post-PSLRA verdicts are detailed in a handy presentation prepared by our friend, Adam Savett.) The only verdict any where near this one (and still not all that near) was the $280 million plaintiffs’ verdict in the Apollo Group case; after the defendants appealed the verdict all the way to the U.S. Supreme Court, the parties settled the case for $145 million.

 

This case may have a long history but it may also be a long way from over. As staggering as the judgment is, it also now give the defendants the opportunity to file an appeal. There is of course the issue of filings an appeal bond on a $2.46 billion judgment. And there is the fact that post-judgment interest will accrue during the pendency of any appeal.

 

As noted above, of the very few securities class action lawsuits have gone all the way to trial, quite a number have resulted in defense verdicts. Just the same, after the Apollo Group verdict and now this verdict, I am going to predict that even fewer defendants will be interested in pushing their securities cases to trial.

A petition for a writ of certiorari filed last month in the U.S. Supreme Court in connection with the long-running Halliburton securities class action lawsuit – which has been up to the Supreme Court once already – takes aim at one of the critical components in the securities plaintiffs’ tool kit: 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 have been able to dispense with the need to prove 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.  

 

The “fraud on the market” presumption has many critics. And in connection with the U.S. Supreme Court’s 2013 decision in the Amgen case (about which refer here), at least four justices (Alito, Scalia, Thomas and Kennedy) appeared to question the continuing validity of the presumption. In his concurring opinion, Justice Alito asserted that the presumption “may rest on a faulty economic premise,” and specifically stated that “reconsideration” of the Basic presumption “may be appropriate.”

 

In recognition that the time may be ripe to take on the continuing validity of the presumption, and to take advantage of the apparent opening to do so now that at least four justices seemed to indicate interest in taking up the question, Halliburton has now filed with the U.S. Supreme court a petition for a writ of certiorari which expressly seeks to have the Court consider whether the Court should “overturn or significantly modify” the Basic presumption of “class wide reliance derived from the fraud on the market theory.”

 

Halliburton filed its petition in connection with a securities class action lawsuit that has been pending against the company and certain of its directors and officers since 2002. In their complaint, the plaintiffs allege that the company and certain of its directors and offices unstated the company’s exposure to asbestos liability and overestimated the benefits of the company’s merger with Dresser Industries. The plaintiffs also alleged that the defendants overstated the company’s ability to realize the full revenue benefit of certain cost-plus contracts.  

 

For several years now, the parties in the case have been engaged in full-scale combat on the issue of whether or not a class should be certified in the case. Indeed, the certification issue in the case has already been before the U.S. Supreme Court; in 2011, the Court unanimously rejected the company’s argument (and the Fifth Circuit’s holding)that in order for a plaintiff to obtain class certification, the plaintiff must first establish loss causation. Following the Supreme Court’s ruling, the case was remanded back to the lower courts and in in June the Fifth Circuit certified a class in the case.  

 

Now the company is back seeking to have the Supreme Court take up the case again and consider again what issues may appropriately be considered at the class certification stage. In its petition, the company argues that the Basic presumption is based on outdated economic theory and that the special considerations given putative class plaintiffs in securities suits are out of keeping with the Court’s more recent class action case law, particularly the Wal-Mart case and the Comcast case. Among other things, the company argues that the stock market just isn’t as efficient as the Basic decision assumed.

 

Halliburton’s petition has garnered some noteworthy support. On October 10, 2013, the U.S. Chamber of Commerce of the United States and the National Association of Manufacturers filed an amicus brief in support of the company’s petition. Among other things, these business groups argue that the Court should take up the case “to address the scourge of securities class action lawsuits that siphon productive capital out of the manufacturing economy while enriching a narrow group of trial lawyers.” These business groups argue that the fraud on the market theory has “greatly facilitated securities class actions” and contributed to their exponential growth since the 80’s.

 

In addition, a group of leading academics and former SEC Commissioners has also come out in support of Halliburton’s petition. According to an October 15, 2013 New York Times column by Ohio State University Professor Steven Davidoff entitled “A Push to End Securities Fraud Lawsuits Gains Momentum” (here), the academics and former regulators have also submitted an amicus brief in support of the company’s petition, arguing that in practice the Basic presumption has essentially eliminated the reliance requirement intended by statute. They rely on academic research by Stanford Law Professor Joseph Grundfest that in the Exchange Act Congress meant to refer to actual reliance.  

 

The fact that in the Amgen decision at least four justices evinced concern about the fraud on the market theory and potential interest in reconsidering the Basic presumption might seem to suggest that Halliburton’s petition might have a good chance of attracting the four votes necessary for the Court to take up the case.

 

Just the same, even if there are four justices who want to have the Court reconsider Basic, that does not necessarily mean that the Halliburton case is the case that those justices, or any others, necessarily want to take up for that purpose

 

First, in their Brief in Opposition to Halilburton’s petition, filed on Friday, the plaintiffs argue that the case is not a “proper vehicle” for the Court to re-consider the Basic presumption because Halliburton has not preserved the issue sufficiently in order now to be able to present it to the Supreme Court. The plaintiffs argue that early in the case, the company conceded that its shares traded in an efficient market, and that, until recently, the company did not argue that the Basic presumption did not apply or should be overturned or set aside. The plaintiffs argue that this procedural history creates insurmountable barriers to the Court considering the issues that Halliburton now wants to raise. In any event, the Supreme Court may not want to take up and reconsider one of its well-established precedents where the issue was not procedurally preserved or fully ventilated in the lower courts.

 

Second, there is the fact that the Court has already fully analyzed the appropriate class certification considerations in this very case, in connection with its 2011 decision. The Court may well question whether it is worth the Court’s time to yet again take up issues surrounding a procedural ruling in a case that it has already considered.

 

In that regard, the plaintiff argues that the company’s petition represents “little more than a thin repackaging of arguments previously presented to and rejected by the Court two years ago.” The second question that the company has presented in its petition [“whether the defendants may rebut the presumption and prevent class certification by presenting evidence that the alleged misrepresentations did not distort the market price of the stock“] does start to sound an awful lot like the issues that were previously argued in the case. While there may be interest at the court at taking up a case that will allow the Court to reconsider the Basic presumption, the Supreme Court may not want to take up a case that might wind up with the Court rehashing a host of arguments it already heard just two years ago.

 

The plaintiffs also argue in the Opposition Brief that the court should not disturb a well-established precedent given that Congress has revised the federal securities laws numerous times since the Basic case was decided. They specifically argue that Congress refused to undue Basic when it revised the securities laws in 1995, and therefore that the Court should defer to Congress and leave things as they are – just as Congress did.

 

If the Court were to take up the case, the potential stakes are enormous. Professor Davidoff said in his column that the case could “put a stake through the heart of securities fraud cases.” Alison Frankel, in an October 14, 2013 post on her On the Case blog (here) commented that this is “a hugely consequential cert petition.” If the Court were to do away with the fraud on the market theory, “it will fundamentally remake securities litigation.”

 

While the potential stakes are enormous, the outcome is not pre-ordained, even if the cert petition is granted. There may be the requisite four votes for the Court to take up the case, but that does not necessarily mean that there would be five votes to overturn a long-standing Supreme Court precedent. In that regard, it is worth noting that in the Amgen case, Chief Justice John Roberts joined a majority opinion written by Justice Ginsberg where she specifically noted that Congress had amended the securities laws in 1995 without altering the Basic presumption.

 

For now, the most immediate question is whether the Court will take up the case. All else aside, it is a fact that for several years the Court has been keen to take up securities cases, for whatever reason. If the Court follows its recent pattern and takes up this case again as well, the case could be one of the most interesting and important securities cases before the Supreme Court in a generation.

 

New corporate and securities litigation filings declined in the third quarter of 2013 compared to the prior quarter and the filings so far this year are on pace for the lowest annual number of filings since before the credit crisis, according to a new report from the insurance information firm, Advisen. The new report, entitled “D&O Claims Trends: Q3 2012”(here), notes that while filings overall are down, the number of filings in some categories – particularly securities class action lawsuit filings – were actually up in the third quarter compared to the preceding quarter.

 

Advisen’s latest quarterly report introduces certain improvements, the most significant of which is that it subdivides prior reporting categories so that, for example, data relating to regulatory and enforcement actions (now presented in a category called “capital regulatory actions”) are separated from data relating to private civil securities actions not filed as class actions (now presented in a category called “securities individual actions”). This change should improve the clarity of the information presented in future reports.

 

As detailed in the report, during the third quarter of 2013, there were 268 corporate and securities lawsuit filings, down from 278 in the second quarter of 2013 (representing a quarter to quarter decline of 4%). Filings during the third quarter 2013 were down 21% from the same quarter a year ago. The 2013 filings represent the lowest quarterly total since the end of 2008.

 

Several different kinds of lawsuit filings declined during the third quarter, including merger objection lawsuits (which the current report has separated out from breach of fiduciary duty lawsuits). According to the report, the absolute numbers of merger objection lawsuit filings have been declining since 2011, and the 2013 merger objection filings are down from 2012. The report notes, without accompanying quantification, that the downward trend in the number of merger objection suits “is likely a result of a decline in overall M&A activity.”

 

While some categories of lawsuit filings were down during the third quarter, securities class action lawsuit filings were up, both as a percentage of all filings and in terms of the absolute number of suits filed. According to the Advisen report, there were 58 securities class action lawsuit filings during the third quarter 2013, compared with 42 in the second quarter. The securities class action lawsuits represented 22 percent of all corporate and securities lawsuit filings, an increase of 7 percent from the second quarter, when the securities class action lawsuits represented 15 of all corporate and securities lawsuit filings. The third quarter securities class action lawsuit filings represent the largest quarterly total since the first quarter of 2012.

 

The report also notes that the trend of securities class action lawsuit filings as a percentage of all corporate and securities lawsuit filings has been downward for a six year period. However, with many types of lawsuit filings continuing to decline, the increase in the number of securities class action lawsuit filings so far this year means that the class action suits as a percentage of all corporate and securities filings in on pace to increase for the year. The report notes that part of the increase in the number of securities class action lawsuit filings is attributable to an increase in the number of accounting fraud cases.

 

Financial firms continued to experience the highest percentage of new corporate and securities lawsuit filing, with new lawsuits in this sector representing nearly one fourth of all third quarter filings. However, while the number of filings against companies in the financial sector remains high, the percentage of all filings against financial companies is down from 2009, which suits against financial companies represented 40 percent of all filings. The report notes that new filings against companies in the financial sector are now “approaching pre-crisis levels.”

 

The Advisen report is very careful to note that information about corporate and securities lawsuit filings outside the U.S. can be more difficult to capture. However, the available data suggest increasing litigation activity involving non-U.S. companies. Overall, identified litigation activity involving non-U.S. companies represented 12 percent of all corporate and securities lawsuit filings during the third quarter, which, while slightly down from the second quarter of 2013, is four percent higher than the third quarter of 2012.

 

The latest quarterly Advisen report also introduces a new feature called Loss Insight Foundation, which consists of a ten-year quarter-by-quarter overview of corporate and securities lawsuit filings segmented by industry and year-end market capitalization, as a percentage of all companies in each segment. By expressing the number of lawsuits in a segment as a percentage of all companies in a segment, the analysis produces litigation rates, permitting a comparison between segments. Among other things, the analysis shows that the rate of lawsuits against companies with market caps over $200 billion is significantly greater than the rate of lawsuits against other companies, with the rate of suits against these mega companies peaking during the credit crisis. The data also confirm that companies with smaller market capitalizations are less likely to have securities class action lawsuit filings.

 

Quarterly Advisen Webinar: On October 17, 2013, at 11:00 am EDT, I will be participating in an Advisen webinar to discuss the third quarter litigation trends and related litigation developments. The hour-long webinar, which is free, will also include AIG’s Rich Dziedziula, Joseph O’Neill of the Peabody & Arnold law firm, and Adivsen’s Jim Blinn. Further information about the webinar, including registration information, can be found here.

 

In its landmark decision Morrison v National Australia Bank, the U.S. Supreme Court said that the U.S. securities laws do not apply to share transactions that do not take place on U.S. securities exchanges. But do these principles operate the same way in other jurisdiction — would courts in other jurisdictions decline to apply the jurisdiction’s securities laws to share transactions that took place outside the jurisdiction? That was the question recently before an Ontario court in a secondary market securities misrepresentation lawsuit brought on behalf of purported class of BP shareholders who purchased their shares both inside and outside of Canada.

 

In an October 9, 2013 ruling, Ontario Superior Court Justice Barbara Conway rejected BP’s motion to stay the action with regard to the Canadian- based BP shareholders who had purchased their shares on non-Canadian exchanges. She also rejected BP’s bid to have the action stayed on the grounds of forum non conveniens as to the BP securities holders who purchased their securities on exchanges outside of Canada. Justice Conway’s ruling, which did not address whether the plaintiffs would be given leave to proceed on their claims or whether a class would be certified, can be found here.

 

Background

Following the Deepwater Horizon oil spill, the plaintiff filed a class action in Ontario Superior Court against BP, alleging that the company had made various representations in its operations and safety program. The plaintiffs purport to represent a class of Canadian residents who purchased BP securities between May 9, 2007 and May 28, 2010. BP’s ADSs traded on the TSX until August 2008, until it voluntarily delisted them. The ADSs are now listed only on the NYSE. BPs common shares are listed on the London and Frankfurt stock exchanges. The plaintiff himself purchased his BP ADSs on the NYSE. The purported class excludes Canadian residents who purchased BP ADSs on the NYSE and who do not opt-out of the U.S. securities class action lawsuit. 

 

In advance of the court’s consideration of whether or not the plaintiff would be given leave under the Ontario Securities Laws to proceed or whether or not a class would be certified, BP moved the court seeking an order to stay the proceedings as to the BP shareholders who purchased their shares outside of Canada on the grounds of lack of jurisdiction, or alternatively seeking to stay proceedings as to those shareholders on the grounds of forum non conveniens.

 

The October 9 Decision

In considering the BP’s jurisdictional argument, Justice Conway said that the question under applicable law is whether or not the there is a “real and substantial connection” between Ontario and the claim. BP conceded that the court had jurisdiction over the claims of BP shareholders who purchased their shares on the TSX. In reliance on the U.S. Supreme Court’s Morrison holding, BP urged the court to adopt an “exchange-based” approach to determine the question of whether or not a tort had been committed in the province sufficient to support jurisdiction as to the claims of the BP shareholders who purchased their shares outside Canada.

 

After reviewing the relevant Ontario Securities Laws, Justice Conway concluded that “there is nothing in the wording of the Act that restricts the cause of action to investors who purchased their shares on an Ontario exchange.” If she were to adopt BP’s reasoning, she would be “imposing a limitation in the Act where none exists.”

 

Justice Conway went on to note that the relevant statutory provisions allowed shareholders to bring secondary market misrepresentation claims without having to prove reliance. She reasoned that “if a responsible issuer makes a misrepresentation and the Act deems the Ontario investor to have relied on the misrepresentation when he purchased shares of that issuer, the statutory tort must be considered to have been committed in Ontario.” She went on the say that she “cannot agree” that the location of the statutory tort “is to be determined, in each case, by the location of the exchange on which the action share purchase occurred.”

 

Justice Conway also rejected BP’s attempt to have the case stayed as to the non-TSX purchasers on the grounds of forum non conveniens. BP had argued that the TSX trading volume was negligible and should not serve as a basis to bring the claims of Canadian BP shareholders who purchased their shares in the U.S. and the U.K. into the Ontario courts. BP argued that U.S. and U.K. were more appropriate forums in which to litigate those claims.

 

In rejecting these arguments, Justice Conway said that in her view, “BP is seeking to restrict and fragment the proposed class at this early stage of the proceedings,” and the outcome BP sought would “result in this potential claim …being litigated in three different jurisdictions. That is not convenient, cost-effective or efficient.” She noted that no class has yet been certified in the U.S. action, and that even if certified, a NYSE purchaser who opted-out would not be able to participate in the Ontario action if stayed. Meanwhile, U.K. purchasers would be required to bring individual actions and seek to have their actions consolidated. “I cannot,” she said, “see how that would be a clearly more appropriate forum for their claims.”

 

She concluded by stating that “BP has failed to meet its burden of establishing that the U.S. and U.K. courts are clearly more appropriate forums in which to adjudicate the claims of the non-TSX purchasers.”

 

Discussion

The U.S. Supreme Court’s decision in Morrison itself is a reflection of the specific wording of the relevant U.S. securities laws. On that basis, it is hardly surprising that a court in another jurisdiction analyzing that jurisdiction’s securities laws might reach a different conclusion on the question of whether or not the jurisdiction’s securities laws apply to securities transactions on exchanges outside the jurisdiction. Nevertheless, it is interesting, at least to this American observer, that Justice Conway declined to adopt the principles described in the Morrison opinion.

 

It seems to have been critical that the purported class consists only Canadian purchasers of BP securities. Indeed, this was the key element to Justice Conway’s conclusion that the “statutory tort’ took place in Ontario. Following the logic of her analysis, it would seem to be much more difficult for a non-Canadian who purchased shares outside of Canada to prove that the “statutory tort” took place in Canada.

 

To put this analysis in terms that had been developed amongst U.S. practitioners, Justice Conway seems to be saying, at least implicitly, that Ontario’s securities laws apply to so-called “F-Squared” claimants – that is, claimants residing in the jurisdiction but who bought their shares in a foreign company on a foreign exchange.

 

By the same token, and based on Justice Conway’s analysis, Ontario’s laws would not seem to apply to a  so-called “F-Cubed” claimant – that is, a foreign resident who purchased their shares of a foreign company on a foreign exchange. Her jurisdictional analysis, in which she concluded that the statutory injury must be considered to have been committed in Ontario if the issuer made the misrepresentation to an Ontario investor, would seem to preclude jurisdiction for a non-Ontario claimant. That is, the negative inference seems to be that the statutory injury would not take place in the province if the claimant were not an Ontario investor.

 

Justice Conway’s analysis of the forum non conveniens issue is interesting. She did not seem to put much weight on the question of where the misrepresentations were made; where the witness and documents were located; or to the fact that the same factual issues are likely to be worked through in the U.S courts. And by contrast to the U.S. courts that have  denied forum non conveniens motions in corporate and securities cases relating to the Deepwater Horizon circumstances because the devastating oil spill took place only a short distance from the courthouse doors, Justice Conway appeared to attach no particular weight in her analysis to the location of the oil spill itself.

 

I find all of this fascinating, but I also recognize my limitations as a non-Canadian observer of Canadian litigation developments. I hope that our friends north of the border will weigh in with their views, particularly if they take exception to anything I have said here. It does seem that the corporate and securities litigation following on in the wake of the Deepwater Horizon oil spill seems destined to require courts to address a host of issues about cross-jurisdictional enforcement of laws and liabilities.

 

Special thanks to Andrew Morganti for sending me a copy of Justice Conway’s decision. Morganti is co-counsel for the plaintiff in the Ontario action discussed above.

 

An October 15, 2013 memo from the Blake’s law firm about the decision can be found here.

 

Since the U.S. Supreme Court issued its opinion in Morrison v. National Australia Bank, would-be claimants who purchased shares of a non-U.S. company outside the U.S. have struggled to find a way to pursue their claims in U.S. courts. Among other things, these claimants have tried to avoid Morrison’s federal securities claim-preclusive effect by filing common law claims against the non-U.S. company in U.S. courts. These efforts have largely proven unsuccessful, as courts have dismissed these claims on forum non conveniens grounds, on the theory that the non-U.S. company’s home court represent a more appropriate forum for the claims.

 

However, as a result of a recent ruling in one of the many lawsuits arising out of the BP Deepwater Horizon oil spill, at least some of the claims of investor claimants who purchased their BP shares on a non-U.S. exchange will be going forward in a U.S. court. Even though the court ruled that English law governed the claimants’ common law and statutory claims, the court found that it could not conclude that an English court is a more appropriate forum for the claims. A copy of Southern District of Texas Judge Keith Ellison’s September 30, 2013 97-page ruling granting in part and denying in part defendants’ motions to dismiss can be found here.

 

Judge Ellison’s conclusions reflect considerations that may be unique to the circumstances surrounding the Deepwater Horizon oil spill. Nevertheless, the case does represent a significant instance where claimants whose U.S. securities laws claims would be precluded by Morrison have found a way to be able to pursue claims on an alternative theory in U.S. courts.

 

Background       

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

 

Judge Ellison’s September 30, 2013 decision related to a separate, individual action that had been brought by three U.S. public pension funds, the Alameda County Employees’ Retirement Association; the Employees’ Retirement System of the City of Providence; and State-Boston Retirement System. The plaintiffs’ separate action was filed against BP and several of its related entities as well as against seven current or former BP executives. The plaintiffs alleged that prior to the spill that the defendants had made material misrepresentations relating to BP’s safety efforts and preparedness, and after the spill with respect to the amount of oil that was leaking from the damaged well.

 

Only Alameda and State-Boston had purchased BP ADSs on the NYSE, and those two plaintiffs asserted claims against the defendants under the federal securities laws.  Alameda and State-Boston also bought BP common shares on the LSE. Providence had only purchased common shares on the LSE.

 

In addition to Alameda’s and State-Boston’s claims under the federal securities laws, the plaintiffs also asserted common law fraud, common law aiding and abetting fraud claims, and negligent misrepresentation claims against the defendants. Each of the three plaintiffs also asserted state statutory claims, under various Texas, California and Massachusetts statutory provisions.

 

The defendants moved to dismiss arguing among other things that Alameda’s and State-Boston’s federal securities law claims allegations were insufficient to state a claim; that English law applies to the plaintiffs’ common law and state statutory claims; that English law did not permit many of the plaintiffs’ common law and state statutory claims; and that even with respect to the plaintiffs’ claims that are recognized by English law, that the plaintiffs’ allegations were insufficient to state a viable claim. The defendants also argued in the alternative that if the Court were to conclude that the plaintiffs stated viable claims under English law, that the court should dismiss the claims under the doctrine of forum non conveniens.

 

The September 30, 2013 Opinion

In his September 30, 2013 opinion, Judge Ellison granted in part and denied in part the defendants’ motion to dismiss. Among other thing, Judge Ellison granted in part and denied in part the defendants’ motion to dismiss Alameda’s and State-Boston’s claims under the federal securities laws. In this post, I do not examine Judge Ellison’s rulings concerning the federal securities laws claims.

 

In considering the defendants’ motion to dismiss the plaintiffs’ common law and state statutory claims, Judge Ellison first had to address the question of which jurisdiction’s laws governed the claims and the dismissal motion. Applying Texas choice of law principles and using the standards enunciated in the Restatement (Second) of Conflict’s of laws, Judge Ellison determined that the laws of England have the “most substantial relationship” to the plaintiffs’ claims.

 

Judge Ellison then undertook to “map” plaintiffs’ claims to English law. He first determined that English law does not recognize claims for aiding and abetting common-law fraud, statutory fraud or statutory unfair and deceptive trade practices, and he therefore granted the defendants’ motion to dismiss these claims.

 

The defendants acknowledged that three English law claims “map” onto the plaintiffs’ theories of liability under state law. The first of these, relating to the plaintiffs’ state statutory claims, map to statutory securities fraud under the Financial Services and Markets Act of 2000 (“FSMA”). The plaintiffs’ claims for common law fraud map to the English action for “deceit.” The plaintiffs’ claims for common law negligent misrepresentation map to the English action for “negligent misstatement.” However, the defendants argued that while the plaintiffs’ state statutory claims and common law claims correspond to claims under English law, the plaintiffs’ allegations were nevertheless insufficient to state a claim.

 

In a painstakingly detailed analysis, Judge Ellison concluded that the plaintiffs’ allegations were at least in part sufficient to state a claim under the corresponding English law legal theories.

 

The defendants argued that the court should nevertheless dismiss the plaintiffs’ claims under the doctrine of forum non conveniens. The defendants argued that England is an available and adequate alternative forum for these claims and that private and public interest factors favored dismissal in preference to the English forum. The defendants argued that most of the alleged misstatements originated in England, that the non-party witnesses are predominantly in England, that English courts would be more familiar with English law, and that it would be difficult for a U.S. court to construe and apply the FSMA, which has not been widely interpreted by English courts.

 

Judge Ellison concluded that “the Court does not find that Defendants have surmounted the high bar for disturbing Plaintiffs; choice of forum.” He fount that “the private and public interest factors, viewed in toto, do not indicate that this Court is an inconvenient forum for Plaintiffs’ English law claims.” He noted that “it would be inefficient to send these claims to England, when nearly the same issues will be adjudicated here in the Class Action and in the individual action asserting Exchange Act claims.” In that regard, he noted in particular that Alameda and State-Boston’s U.S. securities laws claims would remain and be litigated in his court.

 

He also found that the one public interest factor that favored dismissal – the need to apply foreign law to some of the plaintiffs’ claims – “cannot be determinative.” He noted that “the Court is certainly capable of applying English law, which shares so many strong similarities with U.S. law due to a common heritage.”

 

Finally, he noted that the other public interest factors “weigh in favor” of keeping the plaintiffs’ claims in the U.S. court, observing that “the nature of the controversy is unquestionably local.” The oil spill that prompted the claims “occurred only 50 miles off the cost of Louisiana” and “the majority of the misrepresentations alleged by Plaintiffs touch the adequacy of, and the attention paid to, the safety of BP’s U.S. operations.” Because neither the private interest factors nor the public interest factors weigh strongly in favor of dismissal, Judge Ellison declined to “upend Plaintiffs’ choice of forum.”

 

Discussion

Over the course of Judge Ellison’s lengthy and detailed opinion, he dismissed a significant number of the plaintiffs’ claims. He also determined that English law governs that plaintiffs’ common law and state statutory claims, and that there is no English counterpart for many of the common law claims the plaintiffs sought to assert, resulting in dismissal of a number of claims. Nevertheless, he found that the plaintiffs’ allegations were sufficient for those claims for which there are English counterparts. Most importantly, he found that the remaining viable claims could remain pending in a U.S. court and did not have to be dismissed in favor of an English court.

 

Thus, while significant parts of the plaintiffs claims were dismissed, the plaintiffs still succeeded in keeping at least some of their claims alive and pending in a U.S. court. This is significant in and of itself, of course, but it is also noteworthy because it represents a substantial instance where a set of claimants whose U.S. securities laws claims would be precluded under Morrison because they purchased their shares in a non-U.S. company on a foreign exchange nevertheless were able to subject the non-U.S. company to a claim in U.S. courts. In other words, Judge Ellison’s ruling represents the rare instance when prospective claimants have managed to side-step the implications of Morrison in order to subject a non-U.S. company to claims in a U.S. court.

 

Since the U.S. Supreme Court’s Morrison decision, other claimants have tried to circumvent Morrison and subject a non-U.S. company to claims in a U.S. court by asserting claims of common law fraud. By and large, those efforts have not been successful.

 

For example, as discussed here, in December 2012, New York’s appellate court rejected the efforts by short-seller claimants to assert common law claims in New York state court against Porsche and certain of its directors and officers. The claimants’ federal securities law claims had already been dismissed on the basis of Morrison, because the claimants had purchased their securities outside of the U.S. The New York appellate court found that the claimants’ common law claims, which the claimants had filed in state court after their federal securities laws claims had been dismissed, should be dismissed on the ground of forum non conveniens.

 

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

 

But while this case may represent an important instance in which prospective claimants have been able to side-step Morrison and assert claims in U.S. court against a non-U.S. company, there are several reasons why this case may or may not present a playbook for other claimants who are otherwise precluded from U.S. courts by Morrison to try to establish common law or state statutory claims against a non-U.S. company.

 

First, there are several distinct factors that clearly weighed heavily in Judge Ellison’s analysis that are unlikely to be present in other cases. Among other things, Judge Ellison considered the pendency of many other claims in the court relevant, noting that considerations of judicial efficiency weighed in favor of keeping the case in the same court where so many of the same factual issues would be determined. He also was clearly influenced by the fact that the Deepwater Horizon oil spill had taken place nearby and so many of the statements at issue related to events or operations in the U.S.

 

Another thing that could be important about Judge Ellison’s opinion is that it is lower court ruling. Although the defendants will not be able to get appellate consideration of Judge Ellison’s ruling unless they are willing to ride this lawsuit all the way through its procedural conclusion in the district court (barring the possibility of an interlocutory appeal), the possibility that an appellate court might take a different view has to be kept in mind. In that regard, it is worth noting that in the Porsche case mentioned above, the state trial court judge had declined to dismiss the case on forum non conveniens grounds; it was only on appeal that the court determined that the case should be dismissed.

 

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

 

Special thanks to a loyal reader for sending me a copy of Judge Ellison’s decision.

 

UPDATE: Alison Frankel has an excellent October 15, 2013 post about this decision on her On The Case blog, here.