The D&O Diary is on assignment in Europe this week, with the first stop along the way in the beautiful, historic and sun-drenched city of Lisbon, or as the natives say, Lisboa.

Lisbon is the westernmost capital city in Europe, with a population of about 550,000 in the city proper, and a total of around 3 million in the sprawling urban area. History is layered deep in Lisbon. Rising above the city in the Alfama district is the Castelo de São Jorge (pictured left), originally a Visigoth fortification, later held by the Moors until they were thrown out of Portugal in 1147. The castle ramparts provide a scenic overview of the central city and of the Tagus River (pictured below), or the Rio Tejo as the locals call it. Down below to the South of the castelo is the Baixa District, beautifully built in a rigid grid system after the Great Lisbon Earthquake of 1755. Beyond that are the narrow streets of the Bairro Alto climbing to the top of another of Lisbon’s steep hills.

Although with a little vigorous walking you can cover the city center on foot, a more pleasant way to see the sights is to board one of the venerable street cars (electricos). The no. 28 street car (pictured below) provides a particularly fascinating ride as it takes you past many of the city’s most historic sights. There is, of course,  a certain intimidation factor in taking public transportation in a foreign country – first there is the confusion about what the fare is and how to pay it, and then there is the nagging anxiety that perhaps you are on the wrong train or going in the wrong direction. The first time I boarded the no. 28 street car, after having fumbled through the process of paying my fare, I decided just to ride the journey out, to see the entire route. The line terminated, appropriately enough at a cemetery. It is where the journey ends for all of us.

Many of the words in Portuguese are similar to Spanish, but overall the two languages sound very different. The letter “s” is pronounced with an –zh sound or a  –sh sound, and many of the vowels are rounded and spoken far back in the throat. I think if you closed your eyes and just listened to the language, you might think you were hearing a Russian speaking Italian. I memorized a few phrases, the most useful of which was não falo Português (I don’t speak Portuguese)  — which ,for some reason, always drew a laugh, perhaps for the irony of using language to say I don’t speak it. I also came equipped with my one indispensable travel phrase, which in Portugal is said as uma cerveja, por favor. After returning from my not entirely planned visit to the cemetery, I found a sidewalk café on a overlook in the Bairro Alto (the last picture at the bottom of the post, just before the video) where I successfully deployed my one indispensable phrase. I finished the café transaction with the delightfully ornate word in Portuguese for “thank you” – obrigado, which is pronounced with a powerful Iberian trilling of the letter “r.”

Feeling a little bolder about public transportation the next day, I took a tram out to Belém, where the Tagus meets the ocean. Many of Portugal’s famous voyages of discovery set sail from there. The huge Mosterio des Jerònimos was built by Manuel I to give thanks for Vasco de Gama’s safe return from India. The Torre de Belém, built in the early 16th century, sits along the river and affords views out to the great ocean beyond. It is quite something to consider that for a brief time five centuries ago, tiny Portugal (about the geographic size of South Carolina) bestrode the globe as the preeminent maritime power. The moment was short-lived, as the difficulty and cost of defending its mercantile advantages proved too great to maintain, particularly as the country dealt with problems and distractions closer to home. The legacy of the colonial era lives on in Lisbon, in the faces of residents from places like Brazil, Mozambique and Macau.

If Lisbon is figuratively layered in history, it is literally paved in small cobblestones, called calçadas. Many of the walkways are decorated in ornate patters of alternating black and white stones. Hiking around on cobblestone walkways can wear out your feet pretty quickly, but I really came to admire and appreciate the sheer artistry of the elaborate stone patterns. In his book of essays about Lisbon entitled “The Moon, Come Down to Earth,” American writer Philip Graham, who was also fascinated with the cobblestones, describes the experience of taking up a loose calçada in his hand: “I twist and turn it in my hand and feel the attentive craft, how each of the stone’s six sides has been carefully chipped to a rough approximation of a smooth surface. That must be why I feel such affection for these stones – they’re as individual as people. But it’s an affection laced with sadness, because so much of their originality –their five other sides – is normally buried out of sight. And that’s a lot like people, too.”

This innate sadness is something of a theme. One of my main motivations for choosing to go to Portugal was a desire to hear the famous traditional music, called fado. Lisbon is to fado as New Orleans is to jazz. The word “fado” means fate, and the music is infused with mournful sadness. The lyrics convey a spirit of longing and regret, embodied in the Portuguese word saudade. Fado has undergone something of a revival recently, spurred by the popularity of stars such as Mariza (through whose songs I first encountered fado).

I spent a fair amount of time trudging around the narrow streets of the Bairro Alto looking for just the right fado club. I wound up choosing one because it seemed the least touristy, but my instincts proved faulty. Soon after I ordered my dinner,  a tour bus full of Japanese tourists filled the place. Fortunately, the music did not disappoint. The fadista, who was heartbreakingly beautiful as well as talented, was accompanied by a mandolin and a guitar. Although I couldn’t understand the words, her singing conveyed the sorrowful message of the lyrics. (Oddly, many of the songs seemed to be about Lisbon. The chorus of one song was simply “Leezh-bo-ah, Oh!, Leezh-boh-ah.”) It was a great show, even though the Japanese tourists insisted on standing up and taking flash pictures – repeatedly – throughout  the performance.

On my way out of the club, I said to the singer “Amo sua música” (I love your music) to which she responded by saying (in Engish) “In that case, you’ll want to buy one of my CDs.” I laughed and said to her “Quanto é?” (How much is it?), to which she responded (in English) “A bargain at fifteen euros.” I handed her the money, she handed me a CD, and I said to her (in English) “Thank you. Goodbye,” to which she responded by saying “Obrigada. Adeus, meu amigo.”

After I left the fado club, I meant to go back to the hotel. It was late and I was tired. However, on my way  to the hotel, I was drawn by the irresistible sound of Brazilian music. I wound up going into a samba club and standing at the crowded bar. I have always thought of samba music as a cliché, but this was something different. I would say that the place was rocking, but that is not quite right –the place was swaying. It is impossible to listen to samba music and stay still. Everyone’s head was bobbing along to the beat. One impossibly tall young woman (whom I later learned was the bass player’s girlfriend) was walking around the club and drawing random people into dancing. She found it particularly amusing when she tried to dance with me. I am sure part of the amusement was that I was easily thirty years older than everyone else in the place, and I was certainly the only one wearing a blazer and a button-down shirt. Her laugh seemed to say “Look, I got Pops here to dance! What’s this guy doing in this club, anyway?” I survived the samba dance lesson, but I did stay out a lot later than I had intended.

The next morning (a little later than I had hoped), I took a train from the Rossio Station is Lisbon to Sintra, in the mountains about 45 minutes away. Sintra – prounced SEEN-tra, with more of that lovely trilling of the “r” — is the site of several former royal palaces and castles. It sounded pretty interesting from the guidebooks, but what the guidebooks didn’t manage to convey is that it would be crime to visit Portugal and to miss Sintra. The Palacio Nacional de Sintra (pictured to the left) is stunning; even on the warm afternoon that I visited, the beautifully tiled rooms were cool and comfortable. But the best part of visiting Sintra is the Castelo dos Mouros, located about 1,500 ft. above the town on a small mountain. The Castelo, which can only be reached (as far as I can tell) by a very vigorous hike up a steep, rocky incline, was built in the 8th or 9th century by the Moors, later captured by Norse invaders, and ultimately taken by the Portuguese. I arrived at the mountain top drenched in sweat, but the exertion was well worth the effort. The views from the vertiginous battlements were absolutely astonishing. I stayed up there for a couple of hours, exploring the castle walls and admiring the incomparable views.

As I headed back to Lisbon on the train, I was certain that I had done something truly special that day. I also started to understand why the traditional Portuguese music is so mournful. The country is beautiful and has a proud and rich history. Yet its greatest moments were centuries ago. Little of its literature is translated into other languages. Its wonderful and distinctive wine and music are little appreciated outside of the country. The country spent the better part of the 20th century suffering under a repressive dictatorship. Its beautiful capital city is often overlooked in favor of more glamorous places like Paris or Rome. When I told the cab driver back home who took me to the airport that I was going to Portugal, he said “Portugal? Where is that exactly?” (Admit it, when you first saw that this post was about Lisbon, you said to yourself, “Lisbon? Why did he go to Lisbon?”)

Friends, I am here to tell you, Lisbon is a great place. It is a shame that the city is often overlooked. If you have ever sampled a glass of Portuguese vinho tinto and observed to yourself with surprise and delight, “Hey this stuff is really good!” then you know what it would be like to visit Lisbon.

More Pictures of Lisbon:

The Alfama, the city’s oldest district

The Baixa District

Praca Do Comercio

Castelo dos Mouros, in Sintra

Bela Lisboa

Wonder what fado sounds like? Here is a bonus video — this is Mariza peforming a fado concert at the Torre de Belem:

One of the recurring coverage issues that arises in connection with Errors and Omissions (E&O) Insurance is the question of whether or not the activities that are the basis of the underlying claim involve Insured Services (or Professional Services) as that term is defined in the policy. In a September 27, 2013 decision (here), Northern District of Texas Judge A. Joe Fish, applying Texas law, found that an E&O insurer did not have to defend its insured because the failed investment that was the basis of the underling claim was not undertaken in connection with the mortgage broker services specified in the policy’s definition of Insured Services.

 

Background

Halo Companies, Inc. and various related entities were sued in a state court action in Texas in which the claimants alleged that Halo defendants had negligently allowed James Temme and Stewarrdship GP to misuse funds meant for investments. Temme and Stewardship had proposed to buy nonperforming mortgages, restructure their terms and reconstitute the mortgages into performing loans. Halo was to service the mortgages as part of an alliance with Temme and Stewardship. The claimants allege that in reliance on the representations of Halo and others, the claimants invested $5 million in the proposed mortgage plan.

 

The claimants further allege that the proposed assets were never purchased and their funds were never returned. The claimants allege that the Halo defendants failed to perform sufficient due diligence, failed to ensure that Temme was purchasing the mortgages, and failed to inform the claimants that he invested funds were not being used to purchase the intended assets.

 

Halo submitted the claimants’ lawsuit as a claim under its professional liability policy. The carrier denied coverage for the claim and initiated an action seeking a judicial declaration that the underlying claim was not covered under its policy. The insurer moved for summary judgment.

 

In disputing coverage, the insurer argued that the actions alleged in the underlying claim did not fall within the policy’s definition of Insured Services which provides as follows:

 

Mortgage broker services consisting of counseling, taking of applications, obtaining verifications and appraisals, loan processing and origination services in accordance with lender and investor guidelines and communicating with the borrower and lender. Debt settlement and credit services including arbitration and negotiations; real estate sales and brokerage services. Content and services via [four websites identified by their URLs].

 

The September 27, 2013 Opinion

In his September 27 opinion, Judge Fish granted the carrier’s motion for summary judgment with respect to the issue of whether or not the insurer had a duty to defend its insureds in the underlying action. However, he denied the insurer’s summary judgment motion as to the insurer’s indemnification obligations, on the grounds that under Texas law the duty to indemnify could not be determined until liability has been decided.

 

In arguing that activities involved in the underlying claim did not constitute Insured Services, the carrier contended that the underlying action “arises from an investment scenario gone wrong” and does not involve the performance of the kinds of mortgage broker services specified in the definition. Halo, by contrast, argued that the term “mortgage broker services” is not defined in the policy and that the phrases in the definition of Insured Services following the words “consisting of …” are “merely an incomplete list of examples of mortgage broker services.”

 

After reviewing various alternative proposed definitions of the term “mortgage broker services,” Judge Fish noted that “the allegations in the underlying action are fundamentally based on the Halo defendant’s misuse of the [claimants’] invested funds, not in mortgage broker services.” He added the observation that “the fact that the proposed investment scheme was supposed to involve mortgages does not overshadow the fact that the allegations ultimately stem from fraud and misappropriation of funds.”  

 

Judge Fish concluded that the underlying actions fall outside the policy’s definition of Insured Services and granted summary judgment in the insurer’s favor with respect to the duty to defend. However, in reliance on Texas law, which provides among other things that an insurer may have a duty to indemnify even if the duty to defend never arises.” The Texas courts have reasoned that the duty to defend is based on the mere allegations in the complaint, whereas the duty to indemnify is determined by the actual facts establishing liability in the underlying action. Judge Fish said that “Since liability has not been established in the underlying action, the court must deny the plaintiff’s motion for summary judgment on the duty to indemnify.”

 

Discussion

This case underscores the critical importance of the definition of Insured Services (or, as it is sometimes phrased, Professional Services) to the determination of liability under policies of E&O insurance. This case is somewhat unusual in that the policy definition at issue was unusually detailed. It is far more common for the definition to consist of a narrower descriptive term – for example, some policies might have said, with respect to this company, that the covered services consisted of “mortgage broker services.” Just the same, even though the definition of Insured Services here was broader and more detailed, the underlying claim was nevertheless found not to be covered.

 

The problem with these kinds of disputes involving the question whether a particular set of activities fall within the services defined in the policy is that an enterprise of even modest complexity likely is involved in a wide variety of activities.

 

Another issue that can contribute to the problem is that an insured company can be accused of having engaged in activities that it denies ever having been involved in. This concern is another way of saying that the coverage can wind up depending on how the claimant characterizes the alleged activities that are the basis of the claim.

 

I understand why insurers require and rely on narrow definitions. They will argue that in accepting the risk, they intend only to cover activities that are identified as within the operations of the enterprise that they have chosen to insure. They would not want to insure other activities – for example, here, the insurer might well say that it chose to insure Halo’s mortgage broking activities, but it did not chose to and did not intend to insure other activities such as Halo’s participation in an investment opportunity.

 

For policyholders, this line of analysis is highly unsatisfying, They believe they purchased their policy to provide insurance for claims made against them in connection with their delivery of services for a fee. Policyholders take it very badly when insurers contend that – well, we certainly didn’t insure you for that.

 

These issues can sometimes be addressed by the wording of the definition of Insured Services. To the extent the definition more completely and comprehensively describes the range of services and activities, the less likely these kinds of disputes are to arise. However, as this case shows, even a broader definition may not be sufficient to encompass all of the insured company’s activities.

 

When I have run across these kinds of disputes in the past, I have often wondered why the industry can’t come up with a more comprehensive definition of Insured Services, one that takes into account that in this day and age even small enterprises are diverse and complex and therefore that it is hard to describe all of its activities in a single paragraph. Insurers could protect themselves, if they feel they must, through exclusions. While it might be argued that this approach might not result in any greater coverage, at least the categories of activities the insurer are unwilling to cover would be express. In addition, policy exclusions are narrowly construed against the insurer.

 

I freely concede that there are many others in the industry that have much more experience with these issues than I do. There may be readers who disagree with my analysis. I strongly encourage readers who disagree with me or who find flaws with my approach to add their thoughts to this blog post using the blog’s comment feature.

 

The D&O Diary mug continues to make cameo appearances at venues near and far. The latest round of mug shots incudes pictures of a variety of classic American scenes, including sun-drenched shots of city skylines.

 

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

 

Leading off this set of mug shots, we have some great pictures of New York City scenes. The first picture was sent in by our good friend Jim Skarzynski  of the Boundas,  Skarzynski, Walsh & Black law firm. The photo reflects the view from Jim’s New York office window, including, in the background, the Statute of Liberty.

 

 

 

 

 

 

 

 

 

 

 

The next mug shot was sent in by Emily Kanterman of Willis in New York. The picture was taken in front of the 1964 World’s Fair Unisphere in Flushing Meadows-Corona Park. Emily also sent in a picture of her son and future D&O Diary reader, Ethan, holding the mug.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The next mug shot includes a great view of the Chicago skyline. This picture first appeared as a Twitter Pic in a Tweet posted by @MonitorHQ. I wanted to incorporate a screen shot of the actual Tweet but for some reason I couldn’t get the Print Screen function to work. The original Tweet said “A D&O Diary cup rolling over the river in Chicago” and attributed the message to a D&O Diary Fan at Monitor. (Cheers, guys. Sorry I couldn’t figure out how to include an image of the Tweet).

 

 

 

 

 

 

 

 

 

 

 

 

And speaking of skylines, here is a beautiful view of another great American city’s skyline. As you undoubtedly guessed, the beautiful city in the picture is none other than Cleveland, home of The D&O Diary.  Thanks to Jeanne Moscarillo of The Fedeli Group in Independence, Ohio for sending in the Cleveland mug shot.

 

 

 

 

 

 

 

 

 

 

 

 

Finally, Tim Marlin of The Harford sent in this picture taken in Holland, Michigan, in front of “Big Red,” the lighthouse that marks the entrance to Lake Macatawa from Lake Michigan. Long time readers know that Lake Michigan has a very special place in my heart, and the lake apparently is a special place for Tim and his wife as well. Tim reports that he proposed to his wife at the exact spot where the picture was taken.

 

 

 

 

 

 

 

 

 

 

 

 

It is such great fun to receive readers’ pictures and to see the beautiful places that people work, live or visit. I think it so great that readers are hauling their mugs around to all sorts of locations looking for just the right mug shot. My thanks to everyone who has sent in photos.

 

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.

 

A Break in the Action: I will be on the road for the next few days, so there will be an interruption in The D&O Diary’s publication schedule. Normal publication will resume when I return.

 

 

It is not the first whistleblower award under the Dodd Frank Act’s whistleblower bounty program but the “more than $14 million” award to an anonymous whistleblower that the SEC announced on October 1, 2013 is by far the largest so far. The size of the award raises the question of what the award may mean for future awards – as well as the question whether the possibility of awards of this size may encourage whistleblowing and drive enforcement activity.

 

The SEC’s October 1, 2013 press release describing the award can be found here. The October 1, 2013 Order Determining Whistleblower Award Claim can be found here.

 

Section 922 of the Dodd-Frank Act created certain new whistleblower incentives and protections. The section directs the SEC to pay awards to whistleblowers that provide the Commission with original information about a securities law violation that lead to the successful SEC enforcement action resulting in monetary sanctions over $1 million.  The size of the award may range from 10 % to 30% of the amount recovered in the enforcement action. The section also prohibits retaliation against whistleblowers.

 

The SEC released its rules implementing the whistleblower program in May 2011 (about which refer here), but until this most recent award, the agency had made only two prior awards as the program ramped up. The first award made in August 2012 totaled approximately $50,000. In August and September 2012, the agency made awards of more than $25,000 to three whistleblowers.

 

In its press release describing the most recent award, the agency said that the award was made to a whistleblower “whose information led to an SEC enforcement action that recovered substantial investor funds. The press release also states that the whistleblower does not wish to be identified. According to the agency, the whistleblower “provided original information and assistance that allowed the SEC to investigate an enforcement matter more quickly than otherwise would have been the case. Less than six months after receiving the tip, the SEC was able to bring an enforcement action against the perpetrators and secure investor funds.”

 

The SEC has not identified the name of the enforcement action defendants, the nature of the whistleblower information provided, the nature of the violation, or that amount recovered from the defendant.

 

In the whistleblower order, the Commission stated that a claims staff review determined that the amount of the award will exceed $14 million in light of the monetary sanctions already collected and “appropriately recognizes the significance of the information that the Claimant provided to the Commission, the assistance the Claimant provided in the Commission action and the law enforcement interest in deterring violations by granting awards.”

 

The press release quotes SEC Chair Mary Jo While as saying that the whistleblower program has “already had a big impact on our investigations” by “providing us with high quality, meaningful tips.”

 

If you were to stop for a moment an imagine what a difference a cash award of more than $14 million might make for your lifestyle, you will realize that this award is going to capture the imagination of many prospective whistleblowers. Indeed, that is the point. Mary Jo White is quoted in the press release as stating that “we hope an award like this encourages more individuals with information to come forward.”

 

It is probably worth noting that prospective whistleblowers will not only notice the size of the award, but they may also be encouraged by the lengths to which the SEC went to protect the whistleblower’s anonymity.

 

This latest award is huge – but the agency could just be getting started. I am going to go out on a limb here. I think that we about to see many more whistleblower awards and we could see a number of awards even larger that the one just awarded. As stated by a former SEC official quoted in an October 1, 2013 Law 360 article about the award entitled "14M SEC Award is Just the Beginning"  (here, subscription required), "This is just the first of what is likely to be many significant awards coming down the pike."

 

It could turn out that there are not many awards approaching this size of this one, but that may not matter. With even just this one award out there, would be tipsters are going to start flooding the SEC. (Of course, as reflected in SEC whistleblower office’s latest annual report, the tips are already pouring in. This award will reinforce the phenomenon.).

 

The phenomenon of more whistleblowers providing more tips seems likely to result in more enforcement actions – which is of course consistent with the views of the agency’s senior leadership, who are eager to show that the agency is tough. And as this particular case shows, the involvement of whistleblowers can help accelerate the enforcement actoins, as well.

 

And the possibility of increased enforcement activity also implies the possibility of follow on civil litigation, as investor claimants pursue private civil actions to recover from companies and their senior management for violating the securities laws or allowing the violations to take place.

 

The Dodd Frank Act was enacted over three years ago but the impact of many of its provisions is only now just starting to be felt. Indeed some provisions, such as the pay ratio disclosure requirements and the conflict mineral disclosure requirements, have not yet taken effect. And the kinetic potential of the Act’s whistleblower provisions are only now being realized. Before all is said and done, the Act’s many provisions – including in particular the whistleblower provisions, could have a significant impact on the level of enforcement activity and on amount of civil litigation.

 

Among two of the most noteworthy recent global regulatory trends are the spread of anticorruption enforcement and the rise in cross-border enforcement collaboration. Both of these trends were evident in the Canadian government’s recent prosecution of the first individual ever convicted after trial under Canada’s equivalent to the FCPA, the Corruption of Foreign Public Officials Act. As discussed in a September 27, 2013 memo from the Holland & Hart law firm entitled “Canada’s First ‘FCPA’ Trial & Increased International Law Enforcement Cooperation” (here), Canada has added itself to the growing list of countries more actively pursuing anticorruption enforcement. As that list extends, cross-border enforcement collaboration is becoming increasingly common.

 

Nazir Karigar’s prosecution arose out of an effort by a Canadian subsidiary of a U.S. technology company to win a contract with Air India (a state-owned entity) for facial recognition software and other passenger-security equipment. Karigar, hired as a consultant to help guide the company through Air India’s procurement process, allegedly orchestrated a conspiracy to pay bribes to an Air India official and to India’s Minister of Civil Aviation.

 

The company ultimately did not win the contract, and a compensation dispute arose between Karigar and the U.S.-based parent company. As the law firm memo put it, “in an ill-conceived plan to retaliate, Karigar apparently sent an ‘anonymous’ tip about the foreign bribery scheme” to the U.S. Department of Justice. The DoJ passed the information to their Canadian counterparts, who then charged and successfully prosecuted Karigar. On August 15, 2015 the Ontario Superior Court found that Karigar had conspired to offer bribes to foreign government officials in violation of the CFPOA.

 

The FCPA Blog has a more detailed description of Karigar’s prosecution in an August 27, 2013 post, here. (Among other things, The FCPA Blog notes that Karigar was convicted despite the absence of direct evidence of the payment or receipt of a bribe.)

 

Among other things about this prosecution, the law firm memo notes that the implication of this prosecution that “the enforcement of anti-corruption laws is no longer just a ‘U.S. thing.’” For many years, the U.S. had been sort of a “Lone Ranger” on anticorruption enforcement. The CFPOA has been on the books since 1999, but more recently that statutes provisions have been more actively enforced. Now, the Canadian authorities are, in addition to the Karigar case, pursing a criminal prosecution in a wide-ranging scheme involving multiple payments in as many as five countries (including Canada). As the law firm memo puts it, the Karigar conviction is “yet another indication that Canada has joined the United States, Germany, the United Kingdom, Switzerland and other countries in the global anti-corruption enforcement bandwagon.”

 

This prosecution also highlights “growing international cooperation.” The law firm memo notes that the “recent explosion in cooperation” has been facilitated “by the expansion of instantaneous international communications,” as well as “the stationing abroad of FBI and other federal agents from various U.S. law enforcement agencies” and “international consensus and cooperation in defining certain criminal conduct.”

 

The upshot of all of this is a growing risk of regulatory enforcement activity, both for non-U.S. companies operating in their home countries and elsewhere abroad, and for U.S. companies operating outside the U.S. The emerging global regulatory risk is an issue about which we will be hearing a great deal more in the coming months. This emerging risk pertains not just to anticorruption enforcement activity, but also, includes, among many other issues and topics, export control, trade sanctions, money laundering, banking and privacy, antitrust, environmental, and a host of other regulatory issues.

 

One important common thread in the trend toward increasing cross-border collaboration is the frequent involvement of U.S. regulators, which is consistent with a message I highlighted in a recent post — that U.S. regulators are actively asserting their regulatory authority outside of the U.S. In an environment where there already is a growing perception of increasing regulatory risk, the U.S. authorities’ vigorous assertion of regulatory authority outside the U.S. represents a particularly hazardous part.

 

I happen to think that the increasing global regulatory enforcement activity is one of the important emerging trends involving corporate liability. These developments have very important liability implications both for non-U.S. companies in their home countries and operating abroad, and for U.S. companies operating overseas. For D&O underwriters, these developments have important underwriting implications. And for policyholders and their advisors, these developments raise important and challenging questions about the availability and effectiveness of their insurance to respond to these emerging regulatory claims.

 

Weak Banks, Hanging On: As time has gone by since the peak of the financial crisis, the number of bank failures has declined as the economy has recovered. What is more surprising is that banks continue to fail. So far during 2013, 22 banks have failed, including two in the month of September. One reason for this continued drip of bank failures may be that the FDIC has allowed some weaker banks to stay alive, in the hopes that the troubled bank might be able to pull itself back from the brink.

 

An interesting September 29, 2013 Wall Street Journal article entitled “Staying Alive: Weak Banks Hang On” (here) takes a look at how the FDIC seems to be allowing troubled banks to linger for longer periods. According to the article, 13 of the 22 banks that have failed in 2013 were “significantly undercapitalized” for a least a year before they failed. That compares with just 20% of the bank failures in 2012.

 

According to the Journal article, on average, this year’s failed banks were significantly undercapitalized or worse for 6.3 consecutive quarters before failing, compared with 3.5 quarters last year. Of all of the banks that have sunk to significantly undercapitalized status in the last 15 years, 65% have gone on to fail, according to sources cited in the Journal article.

 

The article suggests there is downside to the government’s approach — that the “go-slow approach” can “prompt banks’ management to take extreme risks to survive and can lead to bigger price tags for the government if they ultimately fail.” The article goes on to note that banking regulators have been criticized for the inaction in the run up to the financial crisis, citing a Treasury department report critical of regulators because “they often didn’t take strong, quick action to address risky practices that helped lead to the bank’s failure.”

 

The implication of the Journal article is that despite improvements in the general economy and in the banking sector, there is still a backlog of banks that likely will fail before all is said and done. This is in fact consistent with the FDIC’s most recent quarterly banking profile. As discussed here, in the agency’s latest profile, the FDIC reported that there are still over 550 problem institutions, representing about eight percent of all banks. Not all of these banks will fail; some will be merged into healthier banks and others will be able to complete their recovery. But there will be some that will fail. If the Journal article is accurate, the closure dates for the banks that eventually will fail could be dragged out for some time.

 

All of this is a reminder of the challenges facing D&O insurance underwriters active in the banking sector. Even though the financial crisis is moving further into the past every day, there are still significant legacy issues.. For that reason, D&O underwriters continue to proceed cautiously with regard to banking institutions. Even healthy banks continue to face scrutiny and even increased premiums. Placements of troubled banks remain very challenging.

 

Due to the complexity both of the D&O insurance policy and of the kinds of claims that can arise, the question of whether and to what extent a particular claim may be covered is often disputed. Sometimes though a particular claim is simply not covered. That was the case in a recent coverage dispute in Montana federal court, where a bank sought insurance coverage for losses it incurred on a customer counterclaim in a debt recovery action the bank had initiated. Magistrate Judge Keith Strong’s September 23, 2013 opinion (here) reads like a catalog of the ways that coverage can be precluded under a D&O insurance policy. As discussed below, within the court’s rulings are some noteworthy determinations that merit further consideration. 

 

Background

In July 2007, First Interstate Bank loaned money in connection with a condominium project in Ocean Shores, Washington. The president of the borrower, Paul Pariser, provided a personal guaranty on the loan. At the same time, Pariser had a deposit account at the bank which on April 2, 2009 contained at least $2,623,396.40.

 

In April 2009, the bank decided to exercise certain rights it believed it had under the loan agreement and the guaranty. The bank sued Pariser, declared the loan in default, and also declared itself insecure under the loan. Acting on the declarations, the bank immediately removed $2,623,396.40 from Pariser’s personal account and applied the proceeds to reduce the borrower’s principal and interest. Pariser countersued alleging that the bank had violated the loan documents and seeking to have the funds, restored.

 

The underlying action resulted in a verdict that the bank has not properly exercised its contract rights and thus was entitled to no recovery. On Pariser’s counterclaim, the jury returned a verdict of $2,623,396.40, which as the court in the subsequent coverage action noted, is “the precise amount the Bank simply took from Mr. Pariser’s personal account.”

 

Pariser filed his counterclaim against the bank on June 25, 2009. However, the bank did not formally notify its management liability insurer of the lawsuit until October 18, 2010, more than a year after the policy period during which Pariser first made his claim had expired. In the subsequent coverage action, in order to try to show compliance with the policy’s notice requirement, the bank attempted to rely on a June 30, 2009 litigation summary letter from its outside counsel to the bank that the bank had provided to the carrier in the course of the underwriting of the company’s renewal policy. 

 

Among other things, the June 30 letter contained the following reference to the litigation with Pariser:

 

This much can be summarized about the affirmative claims for damages asserted by Mr. Pariser and the borrower against the bank in both proceedings: (1) all claims involve a common nucleus of facts – the decision of the bank to deem itself insecure, made demand under Mr. Pariser’s guarantee, and setoff his deposit account in the amount of nearly $2.7 million; (2) the decision of the bank to take such action was carefully considered when made, with the full knowledge of the litigation likely to follow, including the associated liability that could arise; and (3) the actions taken by Mr. Pariser and the borrower have been predictable and entirely consistent with those known (and fully anticipated risks).

 

After the bank submitted its formal notice of claim, the insurer denied coverage for the claim and filed an action in the District of Montana seeking a judicial declaration that it owed no duty to indemnify the bank for any loss or expense incurred in the bank’s litigation with Pariser. The bank countersued seeking a declaration that the insurer had a duty to indemnify and also seeking contract and tort damages. The parties filed cross motions for summary judgment.

 

The September 23 Opinion

In his September 23, 2013 opinion, Magistrate Judge Keith Strong granted summary judgment in the insurer’s favor, finding that the insurer had no duty to defend and no duty to indemnify the bank under its policy.

 

The Magistrate Judge first determined that the insurer was entitled to judgment as a matter of law because, he found, the bank had “failed to meet an express condition precedent to coverage by providing notice of a claim first made as soon as practicable during the policy period or within 60 days after expiration.” He noted that the bank’s formal notice for a claim that was first made in June 2009 was not given until October 2010. He noted that “no reason for the delay appears of record.” At the same time, however, he noted that the June 30, 2009 letter from bank’s outside counsel shows that it would have been “practicable” for the bank to notify the insurer of the claim at that time, which “supports a judgment that the Bank did not give notice as soon as practicable.”

 

The court also noted that even though the June 30, 2009 letter had been provided to the insurer as part of the bank’s insurance renewal, the letter did not provide notice of claim to the insurer within the policy’s requirements. As the Magistrate Judge noted, the letter “lacks any suggestion even to [the bank’s] management that the Bank could, would, should or even might seek insurance coverage for any aspect of the Pariser litigation.” The letter “did not give [the insurer] notice that the Bank considered the Pariser loss covered by a policy of (the insurer’s] insurance.” The court added the observation “that a commercial bank is involved in a number of litigated matters does not give notice that insurance coverage is claimed under any specific one.”

 

Though the court’s determination that the bank had not provided timely notice of claim was sufficient to find that coverage was precluded under the policy, the court then went on to consider and reject other grounds on which the bank sought to rely in trying to establish coverage under the policy.

 

He rejected the bank’s argument that the insurer had breached its duty to defend, noting, among other things, that the policy expressly stated in bold, capitalized text on the policy’s first page that “The Insurer has not duty under this policy to defend any claim.”

 

Magistrate Judge Strong also rejected the bank’s argument that the $2,623,396.40 the jury awarded Pariser represented covered loss under the policy. In its verdict, “the jury simply made the Bank return what the Bank wrongfully took.” The verdict “was for the return of money wrongfully taken as principal and interest payment and … all the litigation arose from the wrongful taking and application to principal and interest.”

 

The court went on to conclude that coverage for the claim was also precluded under both the improper profit exclusion and under the contract exclusion. With respect to the improper profit exclusion, the court noted that the June 30, 2009 litigation letter makes it indisputable that “all the litigation centered on the question whether the Bank took money it was not legally entitled to take.” The amount for which the bank seeks coverage is “excluded because it arises from the Bank taking and trying to keep money to which it was not legally entitled. “

 

The court determined that coverage is also precluded under the policy’s contract exclusion because “the dispute was a contract dispute and one that the Bank deliberately started under the guise of its own contract rights. If there had been no contracts there would have been no dispute.”

 

The Magistrate Judge also rejected the bank’s argument that the jury verdict of $2,623,396 should be considered a covered loss because the verdict included a jury finding that the bank had breached the implied covenant of good faith and fair dealing. The bank argued that the breach represented a tort loss, rather than a contract loss, and therefore is not excluded from coverage. The Magistrate Judge rejected this argument based on Montana case law holding that the breach of the implied covenant is a contract breach only, not a tort.

 

In his conclusion, the Magistrate Judge summarized the case this way:

 

First Interstate Bank deliberately exercised what it believed were its loan and guaranty contract rights to seize money from Mr. Pariser’s account and apply the seized funds to principal and interest on the loan. First Interstate Bank was not entitled to do so. It was held liable to return the money it had taken. First Interstate deliberately started [the litigation] all flowing directly from its decision to take Mr. Pariser’s money. For well over a year all of First Interstate Bank’s actions relevant here were consistent with this court’s interpretation: the Pariser litigation did not trigger coverage under [the insurer’s] liability policies. The first litigation summary letter almost seems a summary of exclusions under the policy. The notice was late but there was no coverage under the policy in any event.

 

Discussion

In the end there should be little surprise that a management liability insurance policy does not cover a jury verdict award representing an amount the bank wrongfully took from its customer and was obliged to return. Seriously, was the bank proposing that it should be allowed to keep the wrongfully taken funds and simply pass the bill to the insurer? Though some policyholder side advocates vigorously dispute the principle that a D&O insurance policy provides no coverage for disgorgement amounts or for the return of ill-gotten gains, I suspect that even these advocates would find it hard to argue that this bank could pass off to its insurer the bank’s obligation to restore the funds it had wrongfully taken from its customer.

 

At the same time, the bank had a serious late notice problem – which its own counsel expressly acknowledged when the bank provided notice to the insurer. According to the Magistrate Judge’s opinion, counsel for the bank reportedly said in the email accompanying the notice that “They won’t be happy with the late notice, but these cases have been very well defended and there has been no prejudice.” Readers of this blog know I am no friend of attempts to preclude coverage based on supposed late notice, but here where a sophisticated party has counsel involved throughout and only belatedly provides notice without any apparent excuse or explanation, the arguments against enforcing the notice requirements are more difficult to sustain. (Moreover, counsel’s e-mail comment about late notice evinces awareness that the prior provision of the litigation letter during the renewal underwriting process did not satisfy the policy’s notice requirements, about which see more below.) 

 

But if the possibility of coverage here was always going to be remote, the opinion nevertheless incorporates some important determinations that are worth noting.

 

First, the Magistrate Judge determined that the bank’s provision of the June 30, 2009 letter as part of the renewal underwriting process did not constitute notice. The question whether provision of information about a claim to the underwriting department is sufficient to satisfy a D&O insurance policy’s  claims notice requirements is a recurring issue (as discussed most recently here). In this case, the magistrate judge rejected the argument because there was nothing about the June 30, 2009 letter to suggest that the bank was submitting the referenced litigation as a claim or that it expected coverage under the policy. The magistrate judge did not address the larger issue whether information provided in the underwriting process could ever constitute notice of claim, but he did at least determine that in this case under these circumstances the provision of the litigation letter did not constitute notice under the policy.

 

The magistrate judge’s rejection of the bank’s argument that the policy provided coverage for the breach of the implied covenant of good faith and fair dealing is also noteworthy. Many corporate and business disputes have a contract at the center. Many D&O insurance policies (particularly those issued to private companies) contain an exclusion precluding coverage for contract disputes. However, in these kinds of corporate and business disputes, the complaint often asserts claims other than those specifically arising out of the contract. Policyholders often argue that these other claims are not precluded by the contract exclusion. These kinds of allegations often include a claim based on an alleged breach of the implied covenant of good faith and fair dealing. Carriers often argue that the alleged breach of the good faith covenant is precluded from coverage under the contract exclusion, while policyholders argue that the alleged breach of the implied covenant sounds in tort and therefore is not excluded.

 

The Magistrate Judge’s determination that the breach of the implied covenant represented a contract claim and therefore is precluded from coverage under the policy’s contract exclusion is interesting and relevant to this recurring coverage issue – although it should be noted that his determination in that regard expressly relied on Montana law and a recent decision by the Montana Supreme Court. In other contexts, the law applicable in the relevant jurisdiction might lead to a different result

 

Finally, the Magistrate Judge’s ruling presents the relatively rare occasion where the improper profit exclusion operates to preclude coverage. Although insurers often invoke this exclusion, it is relatively rare that there is an actual determination that the amount for which the insured was seeking indemnity represented a profit or advantage to which the insured was not legally entitled. While this application of this exclusion here is a reflection of the peculiar circumstances of the case, the circumstances do provide an illustration of how the exclusion operates and of the kinds of circumstances to which it would apply.

 

Special thanks to Mark Johnson of the Gregerson, Rosow, Johnson & Nilan law firm for sending me a copy of the opinion.

 

More About State and Local Government Securities Litigation Risk: In recent posts, I have noted the increasing involvement of state and local governments as defendants in securities enforcement actions and even in private securities litigation. In a September 27, 2013 Law 360 article entitled “Municipal Underwriters On SEC’s Fraud Radar” (here, subscription required) William E. White and Jeffrey A. Lehtman of the Allen & Overy law firm take a look at what they describe as the “notable uptick in municipal securities actions” by the SEC’s enforcement division against state and municipal government entities, as well as against municipal underwriters.

 

According to the authors, the SEC has “increasingly dedicated attention and resources to the municipal securities market, and there has been a corresponding uptick in enforcement actions involving municipal securities market participants.” The authors cite five cases the agency has launched since March 2013, including, among others, actions against the state of Illinois; South Miami, Florida; and Harrisburg, Pa.

 

The authors state that “there is every reason to believe that these cases are not a blip.” In addition to specific features of the Dodd-Frank Act (including the whistleblower provisions), the authors cite the increased public scrutiny that has filed in the wake of a number of high profile municipal bankruptcies. The authors conclude that “the public pressure for regulators to examine municipal finances, including the underwriting of municipal bonds, is greater than ever.”

 

In other words, though there may as yet still be a low level of awareness of the risk, there may well be further enforcement actions against state and local governments to come.

 

Court Preliminarily Approves a Mostly Stock Class Settlement: On September 26, 2013, Northern District of California Judge William Alsup preliminarily approved an unusual proposed securities class action settlement. The parties to the Diamond Foods securities class action had proposed to settle the case for a combination of $11 million in cash and the issuance to the class of 4.45 million shares of the company’s common stock.

 

The cash component of the settlement represented the amount of the company’s remaining D&O insurance. The stock component was worth about $85 million as of the date the plaintiffs moved for approval of the settlement. The parties explained the inclusion of the stock in the settlement as owing to the company’s poor financial condition. As Judge Alsup noted in his order preliminarily approving the settlement, “Given Diamond’s strained financial state and the uncertainty (over) lead plaintiff’s ability to collect on any judgment,” the decision to enter a settlement consisting mostly of stock was justified.

 

As Alison Frankel notes in a September 27, 2013 post on her On the Case blog (here), Judge Alsup did insist on a number of tweaks to the settlement, but “on the big question of whether it’s OK to compensate allegedly deceived shareholders with more stock in the company that supposedly lied to them, Alsup answered with a reluctant yes.”

 

My own concern when I first learned of this settlement was that the cash portion of the settlement would all go toward payment of the plaintiffs’ attorneys’ fees, while the class members would get stuck with only stock. However, Frankel notes that class action activist Ted Frank is arguing that the lead counsel fees ought to be paid in the same cash-to-stock ratio as the class’s recovery. As Frankel notes, “Knowing what they know about Diamond’s prospects, lawyers for the class probably aren’t thrilled about that. But considering who the judge is, they probably won’t have much of a choice.”

 

Can You Detect the Pattern?:

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3. A season after losing 94 games, the Cleveland Indians win 92 games — including their last ten regular season games in a row — to clinch a wild card playoff berth.And the Cleveland Browns win their second game in a row, winning both with their third string quarterback. (Admittedly, this entry is here for the benefit of those few sports fans who may not follow Cleveland sports as closely as the rest of us do.)

It has been nearly two years since the SEC Division of Corporate Finance issued its Disclosure Guidance on cybersecurity risks. During this period reporting companies have had the opportunity to incorporate disclosures in their reporting documents about the cybersecurity risks they face. To develop a picture of what companies are disclosing and what the disclosure suggests, the insurance brokerage firm Willis reviewed the cyber disclosures in the SEC filings of the Fortune 1000 companies. The August 2013 report based on that review can be found here.

 

As readers will recall, the SEC Division of Corporate Finance issued its Disclosure Guidance on cybersecurity in October 2011 (about which refer here). Among other things, the Guidance suggested that appropriate risk factor disclosures might include:

 

  • Discussion of aspects of the registrant’s business or operations that give rise to material cybersecurity risks and the potential costs and consequences;
  • To the extent the registrant outsources functions that have material cybersecurity risks, description of those functions and how the registrant addresses those risks;
  • Description of cyber incidents experienced by the registrant that are individually, or in the aggregate, material, including a description of the costs and other consequences;
  • Risks related to cyber incidents that may remain undetected for an extended period; and
  • Description of relevant insurance coverage.

 

Willis reviewed the 10-Ks and annual reports of the Fortune 1000 companies in order to assess the extent of cyber risks and exposures identified and the steps being taken to reduce the risks and exposures. The firm also compared disclosure practices between the largest 500 companies with the Fortune 501-1000 companies.

 

Among many interesting things, the report notes that a large number of companies have chosen to remain silent in their filing documents about cybersecurity risks – the filings of 12% of the companies in the Fortune 500 contained no cyber disclosures and the filings of 22% of companies in the Fortune 501-1000 contained no cyber disclosure. On the other hand, the majority of companies in both groups reported either that cybersecurity risks could “impact” or “materially impact” their businesses, or that they could “materially harm” or “seriously harm” their businesses.

 

Though many companies are now disclosing their concerns about cybersecurity risks, few of the companies disclosed that they had in fact been the subject of an actual cyber event. Only 1% of the Fortune 1000 disclosed a cyber event in their reporting documents. As the Willis report notes, this is “a seemingly low number given the number of attacks that appear in the press on a regular basis.” The report notes further that none of the companies that disclosed actual attacks included the associated cost, even though the SEC’s Guidance requests the dollar costs of the attacks that have occurred.

 

The report groups the kinds of cybersecurity risks that reporting companies specifically identified, noting that the most frequently used terms to describe the cyber exposures facing companies include “privacy/use of confidential data” and “reputation risk.” Interestingly, given recent prominent publicity, relatively few companies identified either cyber terrorism (less than 20% overall) or loss of intellectual property   (less than 12% overall) as among the cybersecurity risks the companies face.

 

Even the SEC’s disclosure guidance specifically references the availability of insurance for cyber security exposures as among the appropriate topics for companies to address, only about 6% of reporting companies referenced insurance in their disclosures. The Willis report notes that based on the firm’s own informal survey of companies that many more companies purchase cyber insurance than the disclosure reports would suggest; for example, their survey of life and health insurance companies suggests that more that 60% of companies in that sector purchase cyber insurance, but only 1% of companies in that industry in the Fortune 1000 mentioned purchasing it in their SEC filings. The report observes that “many companies may be under-reporting insurance covering cyber-risks.”

 

The report interestingly analyzes by industry how different companies have characterized their cybersecurity risks, as well as the number and type of different kinds of cyber exposures the company faces and the loss control measures the companies have taken.

 

The SEC has not just received the companies’ filings, but, according to published accounts, the SEC has sent comment letters to approximately 50 companies asking them to supplement or amend their filings. As discussed here, the kinds of things on which the SEC has requested further elaboration include: that companies disclose whether data breaches have actually occurred and how the companies have responded to such breaches;  that cybersecurity risks should be broken out separately and stand alone from disclosure of other types of risks because of the distinct differences between the risk of cybersecurity attacks and the risk of other types of disasters or attacks; and for companies that have suffered cyber breaches, additional information regarding why the public company does not believe the attack is sufficiently material to warrant disclosure.

 

By focusing only on the companies large enough to be included in the Fortune 1000, the report does not include any analysis of smaller companies’ disclosure practices. Just the same, the report does note perceptible differences in reporting and disclosure between the companies in the Fortune 500 and the Fortune 501-1000, which suggests that a review of companies outside the Fortune 1000 would likely find that disclosures are even less robust.

 

However, regardless whether companies are larger or smaller, the SEC has made cyber disclosure remains a priority item for the SEC. Indeed, in May 2013, Mary Jo While, the SEC’s new Chairman reported that she had asked her staff to evaluate the SEC’s current guidance for cybersecurity exposures and to consider whether more stringent requirements are necessary.

 

The likelihood is that cybersecurity disclosures will remain a priority. The one area that seems likeliest to receive attention is the issue of disclosure of actual breaches. The low level of reported breaches that the Fortune 1000 disclosed: the focus on the issue in the SEC’s comment letters; and the importance of the issue to shareholders and other constituencies all suggest that this will be an area of continued focus and scrutiny.

 

As always whenever there are disclosure requirements, there is always room for allegations that the disclosures are misleading or incomplete. Whether or not plaintiffs’ attorneys target companies for their cybersecurity disclosures, there is the possibility that the SEC may target a company for its cybersecurity disclosures as a way to highlight the importance of the issue and as a way to encourage other companies to focus more on their cybersecurity risk disclosures.

 

While the way that all of this will play out remains to be seen, it seems likely that the issue of cybersecurity disclosure will only become more important in the months ahead.

 

Special thanks to Jim Devoe at Willis for sending me a copy of the report.

 

Every fall, I put together a list of the current hot topics in the world of Directors and Officers (D&O) Liability Insurance. In the latest issue of InSights (here), I review the critical issues to watch now in the world of D&O. This year’s list includes several key regulatory and litigation developments as well as the latest evolving D&O insurance coverage issues. Readers of this blog will be particularly interested in the final entry in the article discussing the current state of the D&O insurance marketplace.

 

A prior version of the latest InSights article appeared in expanded form on this site, here.

As I have noted in prior posts (most recently here), plaintiffs’ lawyers have rushed to file “say on pay” lawsuits, either after a negative advisory shareholder vote on executive compensation, or more recently before the vote occurs based on alleged deficiencies in the proxy materials related to the vote. In the latest in a lengthening string of cases, yet another court has now rejected the plaintiffs’ “say on pay” claims. As discussed below, a California state court judge has rejected plaintiffs’ claims pertaining to the executive compensation proxy disclosures at Clorox Corporation. While this ruling and the other prior decisions could discourage plaintiffs’ lawyers from pursing these kinds of say on pay cases, it seems likely that executive compensation-related litigation will continue.

 

A special hat tip to Jordan Eth and Mark R.S. Foster of the Morrison & Foerster law firm, who discussed the Clorox decision in a September 25, 2013 memo, here.

 

The plaintiff first filed his lawsuit in California (Alameda County) Superior Court on October 10, 2012, seeking to enjoin the shareholder vote on compensation issues schedule to take place at the company’s annual shareholders meeting. The plaintiff alleged that that Proxy Statement Clorox filed in advance of the shareholders’ meeting omitted material information related to executive compensation. On November 13, 2013, Superior Court Judge Wynne Carvill denied the motion for preliminary injunction, concluding that the plaintiff had failed to show irreparable harm if the vote went forward, and finding that the plaintiff’s “evidentiary showing with respect to the merits of his claim was meager, at best.” The shareholder vote took place the next day.

 

The plaintiff subsequently filed an amended complaint seeking to have the shareholder vote set aside. The parties then filed cross-motions for summary judgment relying on expert witness statements and deposition testimony. On September 23, 2013, Judge Carvill entered judgment in the defendants’ favor in reliance on his August 21, 2013 tentative statement of decision in the case. (A copy of the tentative decision can be found here.)

 

In concluding that the defendants did not have a duty to say more in the proxy statement, Judge Carvill noted that

 

What the Plaintiff has done is simply discovered what additional information was presented to the [compensation committee] and not included or summarized completely in the Proxy and then described why such information would be “helpful.” Were this court to find on this record that material information was withheld, it would be a license to file suit when anything was withheld, for any information can always be labeled as potentially “helpful.” Delaware law provides no such license.

 

The Court’s decision in the Clorox case follows on several other recent cases in which the courts have dismissed plaintiffs’ claims based on alleged deficiencies in the proxy statements, including the August 2013 California state court decision in the Symantec case and Northern District of Illinois Amy St. Eve’s April 2013 decision in the proxy disclosure-related say on pay case involving AAR.

 

As the MoFo attorneys noted in their recent memo, these courts rejected the plaintiffs’ proxy statement disclosure claims and recognized “that the asserted claims were trying to impose new obligations.” The memo’s authors comment that the defendants’ recent track record in these cases “should deter plaintiffs counsel from bringing disclosure claims against public companies.”

 

Just the same, executive compensation remains, as the authors note, “a hot topic for shareholders, for proxy advisory firms, and for the SEC.” For that reason, companies can “expect continued scrutiny of their executive compensation decisions and disclosures.” Even if lawsuits related to say-on-pay disclosures “abate in light of recent rulings,” it can be expected that “plaintiffs’ counsel will continue to look for and find ways to target companies and their directors in this type of litigation.”

 

One place that plaintiffs’ lawyers may turn next as they continue to agitate on executive compensation issues is the SEC’s new pay ratio disclosure requirements. As I discussed in a post earlier this week, the SEC’s proposed new rule will not be finalized until after the comment period, and are unlikely to go into effect until 2015 or 2016. Nevertheless, the very existence of disclosure requirements creates an opening for plaintiffs’ to allege that companies did not follow the pay ratio disclosure guidelines or used calculations and comparisons that made the disclosure misleading.

 

The current round of say on pay litigation may or may not have finally played itself out. Either way, it seems likely that we will continue to see plaintiffs’ lawyers attempting to pursue compensation related claims.

 

Portions of the JOBS Act are Now in Effect, But Crowdfunding is Still a Long Way Off: An important provision of the JOBS Act went into effect earlier this week, but there has been some confusion in the mainstream media that what went into effect was the Act’s crowdfunding provision. However, as discussed in detail in a November 24, 2013 post on the New York Times You’re the Boss blog (here), “equity crowfunding – as most people understand it – remains a long way off.”

 

What went into effect earlier this week is a new rule lifting the longstanding ban on “broadly advertising a private stock placement,” a restriction that has been in place since Congress enacted the Securities Act of 1933. The important thing to understand is that, with a few exceptions, this type of private offering can only be sold to an institutional investor or an accredited investor – someone meeting the specified net worth requirements. Under the new rules, companies may now advertise their private offerings widely, but they may only sell the stock to accredited investors.

 

The elimination of the general solicitation ban is something different than what is commonly known as crowdfunding. The JOBS Act crowdfunding provisions were meant to provide a way for ordinary people to make small investments in small companies. The law “limits how much investors can put into these stocks and restricts issuing companies to raising $1 million in a year.” The law also specifies the types of financial disclosures the company seeking to conduct a crowdfunding offering must provide investors.

 

None of these provisions apply to companies conducting a private placement offering. The company can “raise as much capital as they wish, [qualified[ investors can sink as much as they would like, and no financial disclosure is required.”

 

As the blog post points out, some of the confusion may have arisen from crowdfunding’s boosters, who are growing impatient that the SEC has not yet released its rules implementing crowdfunding. The SEC has “not yet even proposed these regulations, much less finalized them.” As a result, some of the platforms that were organized to try to facilitate crowdfunding are “attempting to turn themselves into platforms to facilitate private placements.” But if these would-be crowdfunding process participants are growing impatient, they may yet have much further to wait. It could be some time yet before the SEC releases its proposed crowdfunding rules.

 

In any event, if you have read this far, now you know that the recent implementation of the rules lifting the solicitation ban for private placements did not institute crowdfunding. It may be some time before crowdfunding gets off the ground. Now that you know, you have to make sure to point this out when you are around somebody that thinks that the recent JOBS Act provision implementation had anything to do with crowdfunding.

 

NCUA Files Libor Manipulatoin Antitrust Suit: Even though the federal judge presiding over the consolidated Libor antitrust litigation has granted the defendants’ motion to dismiss the antitrust claims, the federal credit union regulatory agency has filed a new action against Libor rate-setting banks alleging violation of the Sherman Act. As described in the National Credit Union Administration’s press release (here), on September 23, 2013, the agency filed an action in the District of Kansas in its capacity as receiver for five failed corporate credit unions alleging that thirteen Libor rate-setting banks manipulated the Libor benchmark rate, costing the failed credit unions millions in lost interest. The NCUA’s complaint can be found here.

 

The arguably surprising thing about the NCUA’s complaint is that it alleges only antitrust claims. As discussed here, in March, Southern District of New York Judge Naomi Reece Buchwald ruled in the consolidated Libor antitrust action that the claimants lack antitrust standing because the defendants’ alleged actions did not affect competition, as the rate-setting banks were not in competition with one another with respect to Libor rate-setting. Judge Buchwald said ““the alleged collusion occurred in an arena in which defendants never did and never were intended to compete.”

 

The claimants in the consolidated antitrust action had sought to amend their complaints, but as Alison Frankel discusses in a September 24, 2013 post on her On the Case blog (here), in August, Judge Buchwald refused to allow the claimants to file their second amended complaint and confirmed her previous finding that the class does not have standing to assert antitrust claims because the claimants have failed to allege that defendant banks were in competition with respect to Libor rate-setting.  

 

In the wake of Judge Buchwald’s decision, other claimants have opted to file their Libor manipulation claims in state court, alleging state law claims (as shown for example here), or to try to proceed on other legal theories – for example, under the federal securities laws. However, the NCUA did not attempt to pursue any of these alternative approaches; instead, its complaint alleges only antitrust law violations. This approach is all the more puzzling as the NCUA case almost certainly will wind up be consolidated before Judge Buchwald for pre-trial purposes, even though the agency filed the action in Kansas. Moreover, the agency has not raised any additional allegations that would establish that the rate-setting banks were in competition with respect to the Libor rate-setting, as Frankel discusses in her blog post.

 

Based on appearances, it would seem that the agency believes that Judge Buchwald’s antitrust analysis is incorrect and will be overturned. According to Frankel, some of the claimants in the consolidated action have already filed a notice of appeal. There is of course a possibility that the Second Circuit will overturn Judge Buchwald’s ruling. On the other hand, the Second Circuit could also affirm Judge Buchwald. You would think that NCUA would have hedged its best by seeking relief on alternative grounds or at least based on different theories other than an alleged antitrust violation. Just the same, as Frankel points out, “there are billions riding on this appeal.”

 

Prosecutors Use of FIRREA to Pursue Banks Gets a Another Boost: As I discussed in a recent post, regulators and prosecutors have resurrected a statute from the S&L crisis era to pursue financial fraud claims related to the financial crisis. FIRREA allows the government to seek recoveries for violations “affecting federally insured financial institutions.” Using this statute, the federal government has recently filed a number of actions against banks alleging that the defendant banks engaged in fraudulent activity and harmed themselves. The government has relied on this theory to bring claims against Bank of America, JP Morgan Chase and BNY Mellon. The government also relied on claims under FIRREA in the civil action it filed against Moody’s and its Standard & Poor’s unit in connection with the unit’s credit rating activities (as discussed here).

 

The banks have tried to argue that in order for the statute to apply the affected institution must be the victim or an innocent bystander to the alleged fraud, and that the statute was not meant to apply to the type of “self-affecting” claims the government has raised. Several courts have rejected these defense arguments, and on September 24, 2013, the government’s attempts to rely on this theory got another boost when Southern District of New York Judge Jesse Furman denied Wells Fargo’s motion to dismiss in an action the DoJ brought alleging that the bank had defrauded the government by knowing certifying to federal regulators that thousands of mortgages were eligible for Federal Housing Administration insurance.

 

In his opinion (here), Judge Furman said that Wells Fargo’s theory that FIRREA was not meant to apply to the type of “self-affecting” claim the government asserted against it “is unsupported by the text of the statute which does not exempt from the relevant affected financial institutions those that perpetrate fraud on themselves.”

 

The government’s success in establishing its ability to rely on FIRREA to bring fraud claims against banks could be even more important going forward, as prosecutors continue to try to assert financial crisis related claims. Even though the crisis retreats further into the past each day, FIRREA has a ten-year statute of limitations, which, now that the government has established that it can use the statute to pursue claims that banks managed to harm themselves for their own fraudulent activity, allows prosecutors plenty of time to continue to assert claims related to the financial crisis.

 

As detailed in a September 24, 2013 Bloomberg article (here), even though the statute is a “relic” of the S&L crisis, it has become “the weapon of choice for federal prosecutors investigating the root causes of the financial crisis.” In additional to the extended limitations period, the statute provides a lower burden of proof that is required in a criminal case, and it allows the government to extract hefty penalties. The extended timeline that FIRREA affords makes the statute a formidable weapon for the government as it continues to pursue financial crisis-related claims.

 

Plaintiffs’ Lawyers Continue to Target U.S.-Listed Chinese Companies: As has been well-noted (on this site and elsewhere), in 2011 and 2012, plaintiffs’ lawyers filed a host of securities class action lawsuits against U.S.-listed Chinese companies. But the number of these lawsuit filings declined in 2012 (when there were 18) compared to 2011 (when there were 40) and it seemed that these kinds of filings would dwindle in 2013. However, as evidenced by an action filed earlier this week in the Southern District of New York, plaintiffs lawyer are still continuing to file lawsuits against U.S.-listed Chinese companies.

 

According to their September 23, 2013 press release (here), plaintiffs’ lawyers have filed an action against L&L Energy and certain of its directors and officers alleging that the defendants misled investors by misrepresenting or failing to disclose that “(1) the Company improperly accounted substantial revenue from operations that were already shut down; (2) the Company claimed acquisitions and divestitures of various properties through swap transactions that never occurred through the exchange of assets it never owned in the first place; (3) the Company lacked adequate internal and financial controls.” Through subsidiaries, L&L Energy mines, process and distributes coal in China.

 

The complaint (which can be found here) relies heavily on a report from short-seller GeoInvesting that appeared on Saving Alpha on September 19, 2013. The complaint alleges that:

 

that the Company has been “defrauding investors by booking substantial revenue from operations that have been idled for quite some time.” Specifically, GeoInvesting stated that the Company’s numerous acquisitions and divestitures through the years have amounted "to a bait and switch shell game" by utilizing "swap transactions that never occurred." Moreover, the article concluded "that revenue of $77.6 million disclosed in LLEN’s 2013 10K, generated from its Hong Xing coal washing factory, was actually close to zero, if it is not actually zero" as the factory "has been shut down since 2012."

 

GeoInvesting’s Saving Alpha article can be found here. The Company’s September 24, 2013 press release refuting the GeoInvesting claims can be found here.

 

This latest complaint has many features in common with many of the actions that plaintiffs’ lawyers filed during 2011 and 2012, including the assertion of misrepresentations of assets and accounting fraud, as well as the appearance of the allegations in an online article written by a short-seller.

 

L&L Energy itself has its own set of links to the wave of lawsuits filed during 2011 and 2012, in that the company itself was sued in 2011 in a securities class action lawsuit filed in the Western District of Washington.. As detailed here, the prior lawsuit, which raised a different set of allegations against the company, has been dismissed without prejudice, and the plaintiffs in that case have filed a further amended complaint.

 

Though the securities suit filings against U.S.-listed Chinese companies are down significantly from the high water mark in 2011, the fact is that plaintiffs’ lawyers are still continuing the file suits against the Chinese companies. Of the roughly 118 securities class action lawsuits filed so far this year, 19 (or bout 16%) have involved non-U.S. companies. Of the 19 non-U.S. companies, 6 (or about 5% of all 2013 filings YTD) have involved companies organized or headquartered in China or with their principal place of business in China. (Yet another complaint involves a company from Taiwan.) .

 

These factors have been more pronounced so far during the year’s second haff. Of the roughtly 42 new securities lawsuits that have been filed since July 1, 2013, nine (or about 21%) have invoved non-U.S. companies. Of the nine non-U.S. companies, three have been from China, representing about 7% of all second half filings.

 

A recent post detailed how corruptoin allegations have led to the filing of a securities lawsuit against a U.S.-listed Chinese company can be found here.