In a criminal case against defendant Donald Powell pending in Tennessee (Williamson County) Circuit Court, the prosecution filed a motion in limine seeking to prevent defense counsel from referring to the prosecution as “the government.” In his brief in Opposition (here), Powell’s defense attorney, Drew Justice, pointed out that the term “the government” is frequently used by the courts to refer to the prosecution, and in any event, that the defense’s right to refer to the prosecution  as “the government” represents speech protected by the First Amendment.

 

The defense attorney had a few more things to say, just in case the court was inclined to grant the prosecution’s motion.

 

As defense counsel put it, if the court is “inclined to let the parties basically pick their own designations and ban words, then the defense has a few additional suggestions for amending the speech code.”

 

First, defense counsel advised the court that “the Defendant no longer wants to be called ‘the Defendant,’” a term that has “a fairly negative connotation” that “unfairly demeans and dehumanizes” Powell. Instead, defense counsel suggested that Powell “should be addressed only by his full name, preceded by the title ‘Mister.’” Alternatively, defense counsel suggested, Powell could be referred to as “the Citizen Accused,” adding that the designation “that innocent man” would also be acceptable.

 

Next, the defense attorney turned to how he wished to be referred to in court, rather than as a “lawyer” or as a “defense attorney:”

 

Rather, counsel for the Citizen Accused should be referred to primarily as the “Defender of the Innocent.” This title seems particularly appropriate, because every Citizen Accused is presumed innocent. Alternatively, counsel would also accept the designation “Guardian of the Realm.” Further, the Citizen Accused humbly requests an appropriate military title for his own representative, to match that of opposing counsel. Whenever addressed by name, the name “Captain Justice” will be appropriate. While less impressive than “General,” still, the more humble term seems suitable. After all, the Captain represents only a Citizen Accused, whereas the General represents an entire State.

 

Counsel – of should I say the Defender of the Realm — them moved on to the use of term “defense” because “the whole idea of being defensive comes across to most people as suspicious” So to “prevent the jury from being unfairly misled by this ancient English terminology, the opposition to the Plaintiff hereby names itself ‘the Resistance.’” This terminology “need only extend throughout the duration of the trial – not to any pretrial motions” as “during its heroic struggle against the State, the Resistance goes on the attack, not just the defense.”

 

Having completed his arguments, defense counsel wound up his Opposition by saying that “Captain Justice, Defender of the Realm and Leader of the Resistance primarily asks this Court to deny the State’s motion as lacking legal basis.” In the alternative, “the Citizen Accused moves for an order in limine modifying the speech code as aforementioned and requiring any other euphemisms and feel-good terms the Court finds appropriate.”

 

No word yet on the outcome of the prosecution’s motion or the court’s response to defense counsel’s opposition.

 

The question of when domestic securities laws provide remedies for investors who purchased their shares in foreign companies on foreign exchanges vexed U.S. courts for years until the U.S. Supreme Court sorted out the issues in Morrison v. National Australia Bank. But while the U.S. courts now have the  bright line standards of the Morrison case, the courts in Canada are still struggling to develop consistent principles to define when their securities laws should apply to foreign securities purchases. The results so far involve decisions in different Canadian provinces that seem to reach opposite conclusion s on the jurisdictional issues.

 

As discussed in an October 30, 2013 Financial Post article entitled “Canadian Courts Grapple With Jurisdiction in Securities Class Suits” (here), “a schism is forming between Ontario and Quebec courts over the extent to which they will entertain lawsuits for breaches of securities laws when shares are purchased on foreign exchanges.”

 

The article compares the September 4, 2013 decision of the Quebec Superior Court in the securities class action lawsuit filed by a Facebook IPO investor (about which refer here), in which the court concluded that it did not have jurisdiction,  with the October 9, 2013 decision by the Ontario Superior Court, in which the Court rejected BP’s attempts to stay Ontario proceedings with regard to the Canadian-based BP shareholders who had purchased their shares on non-Canadian exchanges (about which refer here).

 

As the Financial Post article states, in the Facebook case, the Quebec court “seems to have closed the door on such suits,” while in the BP case, the Ontario court “is taking an open-door approach.”

 

As the article notes, the courts are struggling to determine whether or not there is a basis for the exercise of jurisdiction in these cases. The jurisdictional question requires the court to determine whether or not there is a “real and substantial connection” between the dispute and the court.

 

As discussed here, in the Facebook case, the Quebec court held that the claimant’s brokerage account records did not show where her Facebook share transactions had occurred or where she paid for the shares. The court said that “nothing in the record indicates that the sales transactions occurred in Quebec,” adding that under Quebec statutory principles, “the Facebook shares would have been notionally delivered either at the NASDAQ exchange in New York or at Facebook’s head office in California.” On this basis, the court concluded that the claimant’s alleged loss would have occurred in the United States. The court said that “there is no basis to conclude that a real and substantial connection exists between the alleged facts of her motion and this Court,” and so the Court lacked jurisdiction.

 

The Quebec court when on to say that even were there jurisdiction, the court would have declined the jurisdiction (“a tenuous jurisdiction at best”) in favor of the Southern District of New York, under the principles of forum non conveniens. The court noted that the consolidated New York actions raised the same allegations; that the putative class in the consolidated action included the claimant and the class of Quebec purchasers she purported to represent; that New York law would govern the claims; that the underwriting defendants are domiciled in New York; and that any judgment would have to be executed in the United States.

 

As discussed here, in the BP case, the Ontario court, by contrast,  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.” The court reasoned that if it were to adopt BP’s reasoning and to decline jurisdiction over the claims of the BP investors who purchased their shares outside of Canada, the court would be “imposing a limitation in the Act where none exists.”

 

The Ontario court went on to note that the relevant statutory provisions allowed shareholders to bring secondary market misrepresentation claims without having to prove reliance. The court 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.” The court went on the say that it “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.”

 

The Ontario court 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, the Ontario court 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.”

 

The Ontario court expressly rejected BP’s argument that Canadian courts should adopt the kind of bright-line, exchange-based test that the U.S. Supreme Court adopted in Morrison v. National Australia Bank.

 

The Ontario court’s ruling in the BP case follows a March 30, 2012 Ontario Court of Appeal ruling in the Canadian Solar case (about which refer here). Canadian Solar’s shares traded only on NASDAQ. Its shares did not trade on any Canadian exchange and its principle place of business is in China. However the company is registered as a Canadian federal corporation with registered office and executive offices in Ontario. The Court of Appeals held “there is a sufficient connection between Ontario and Canadian Solar to support the application of Ontario’s regulatory regime.” The Court also noted that the claimant was an Ontario resident who placed his order in Ontario for shares in a corporate based in Ontario, and therefore could “reasonably expect that his claim for misrepresentation on documents released or presented in Ontario would be determined by an Ontario court.”

 

The Financial Post article quotes plaintiffs attorneys as saying that a narrow, exchange-based test like that adopted in Morrison does not make sense in a financial marketplace characterized by global electronic trading. Defense lawyers, by contrast, argued that corporations “need certainty” and that the application of too broad of a test that would subject non-Canadian companies to the jurisdiction of Canada’s courts is a “very vexing problem.” The defense counsel asked whether companies will be “potential liable to every securities regulator and subject to every securities regime around the world?” adding that “that is a troubling prospect for public issuers.”

 

These jurisdiction questions become even more complex when there are competing cases on opposite sides of the borders. The lawyers involved must struggle to avoid overlapping or conflicting case resolutions.

 

The article concludes with a statement from a defense attorney that “the reality is that we are still grappling in our lower courts with very preliminary issues associated with these types of actions. We’re a bit surprised by how long and arduous the process is.”

 

One thing that the Financial Post article does not address is whether or not there are differences between Quebec laws or procedural requirements and Ontario laws or procedural requirements that might explain the differences in outcome.

 

Towers Watson Releases 2013 D&O Insurance Survey: As D&O insurance practitioners know well, the annual Towers Watson D&O Insurance survey is one of the important information tools to which we all refer and on which we all rely. Towers Watson makes the survey results available for free to the entire industry. But as is the case with any survey, the survey results are only as meaningful as the level of survey participation. The more respondents that participate in the survey, the more helpful the survey results will be. For that reason all of us have a stake in trying to make sure that as many companies as possible participate in the survey.

 

Towers Watson has released the survey form for the 2013 D&O Insurance Survey. The survey form can be found here. Because we all have a stake in having as many companies as possible participate in the survey, it behooves all of us to try to get as many company as we can to respond. The more companies that respond, the more useful the survey report will be. Please consider providing the survey link to your clients and customers.

 

Although D&O insurance represents an important risk management tool for every company, the protection that a D&O insurance policy affords directors and officers is particularly important in the bankruptcy context, when the company is no longer able to indemnify the individuals. Yet, as industry practitioners know, a number of issues recur in the bankruptcy context, particularly as creditors and bankruptcy trustees seek to preserve policy proceeds while the failed company’s directors and officers are seeking to rely on the policy to defend themselves against pending claims.

 

The problem of trying to fund individuals’ defense expenses under the D&O insurance policy while the insured company is in bankruptcy is a recurring theme on this blog (refer, for example, here and here). Over time, a number of standard practices have evolved to facilitate defense expense funding in the bankruptcy context. For example, it is now fairly standard for the insureds and the insurers to approach the bankruptcy court to seek a “comfort order” allowing the insurer to fund the individuals’ defense expenses, notwithstanding any objections of the creditors or the bankruptcy trustee to the use of policy proceeds for these purposes.

 

Though these procedures are now routine, problems still nevertheless emerge, as discussed in an October 22, 2013 memorandum from the Lowenstein Sandler law firm entitled “How to Handle D&O Coverage in a Bankrupt Co.” (here).

 

As the memo’s authors note, while bankruptcy courts now routinely grant the requests of the insurers and the insureds to allow the D&O insurance to be used to fund the individuals’ defense, the order is often subject to an interim funding cap (sometimes called a “soft” cap) and accompanied by a requirement that the parties provide periodic updates on defense expenditures. To see an example of a recent case in which a bankruptcy court entered an order allowing the insurance to be used to fund the individuals’ defense subject to an interim cap and reporting requirements, refer here.

 

The authors refer to other recent cases where the order permitting the individuals’ defense expenses to be funded subject to an interim cap and reporting requirements. One of the cases the authors refer to is the high profile MF Global case. As discussed here, in April 2012, the bankruptcy judge lifted the stay in the MF Global bankruptcy to allow the company’s insurers to fund the company’s former directros and officers’ defenses, subject to an interim cap of $30 million and to reporting requirements. The law firm memo notes that the creditors and claimants who had opposed the order appealed the ruling to the district court, which affirmed the ruling, and have now appealed to the Second Circuit. The appeal is scheduled to be argued in late November.

 

One inherent problem with the use of interim funding caps became apparent in the MF Global case this summer, when the parties returned to court in order to try to get approval to fund defense expenses in excess of the initial $30 million cap. As discussed in a June 28, 2013 Law 360 article entitled “MF Global Judge Rips $40 Million Defense Cap Request” (here, subscription required), U.S. Bankruptcy Judge Martin Glenn took a negative view of defense requests to increase the interim cap to $40 million. He expressed concern that the defense expenses had so quickly reached the cap, particularly given that the case had barely gotten underway. According to the report, Judge Glenn said “individual insureds may have the right to coverage. They don’t have the right to a blank check.”

 

On September 20, 2013, Judge Glenn deferred ruling on the request to increase the cap, in light of the pending appeal. As discussed here, the executives recently asked the court to reconsider his ruling, in light of the fact that their defense expenses to date have exhausted the amounts within the initial cap, and that without relief they are unable to maintain their defenses in the ongoing proceedings.

 

As the law firm memo’s authors note, a bankruptcy court’s limitations imposed in interim funding agreements present a number of problems; first, the existence of interim caps and reporting requirements

 

puts directors in the awkward position of having the party that is suing them looking over their shoulders as they defend themselves and in a position of potentially scaling back a vigorous defense for fear of a future petition to limit the insurer’s reimbursement obligation for defense costs incurred.

 

The ruling also provides the committee with the added benefit of being able to “look behind the curtain” during settlement discussions to know exactly how much insurance money is available.

 

The other problem with the conditions bankruptcy courts place on the funding orders is demonstrated in the MF Global case; the interim funding cap creates the possibility that the court might refuse to increase the cap, putting the individual defendants in “limbo” as they are unable to access additional defense cost coverage for the claims pending against them.

 

The memo’s authors suggest that the funding problem in the MF Global case could have been avoided if it had had different wording the priority of payments clause in its D&O insurance policy. These clauses, which are now standard in most D&O insurance policies, address how the D&O insurance policy’s limits of liability are to be paid out so that the liabilities of the individual insureds are to be given priority and paid first. The authors suggest that the possibility that the problems the MF Global directors and officers are now facing could have been averted if its policy had the type of priority of payments provision that “unambiguously state that the corporate entity and any successor, trustee or receiver has no rights to the insurance policy proceeds until all claims asserted against the individual insureds have been resolved.”

 

There is no doubt that stronger wording of the priority of payments provisions is desirable and that policyholders should always endeavor to obtain the wording that is most protective of the individuals’ payment priority. However, I am not entirely sure that a different wording in the priority of payments provision alone would have been sufficient to avoid the problems the former MF Global officials are now facing.

 

First of all, MF Global’s policy not only has priority of payments provisions, but those provisions were instrumental in Judge Glenn’s initial ruling lifting the stay and allowing the individuals’ defense costs to be paid. As discussed here, in his initial ruling, Judge Glenn considered it particularly important that the primary D&O policy had a provision giving priority to payments under the insuring provisions that protects the individuals. Judge Glenn specifically stated about these provisions that “coverage potentially afforded to the Individual Insureds for non-indemnifiable losses must be paid prior to any payments for matters implicating coverage potentially provided to the Debtors.”

 

Second, Judge Glenn’s decision to defer a ruling on the individuals request to increase the cap apparently was based on the pendency of the appeal of his initial ruling lifting the stay and allowing the interim funding. His views on the petition to raise the interim funding cap seem to have been influenced more by what he viewed as the surprising magnitude of the fees incurred to date, rather than any specific interpretation of particular policy provisions.

 

I am not certain that different wording of the priority of payment provisions alone would eliminate the now fairly standard bankruptcy court practice of granting an order lifting the stay to allow D&O insurance to fund defense expenses subject to an interim cap and reporting requirements. The courts’ insistence on these requirements is more about the maintenance of judicial control than it is about the provisions of the insurance policy. In many bankruptcy cases (for example, even in the high profile Lehman Brothers bankruptcy) these judicial requirements are administered routinely and without incident. The problems involved in the MF Global case arguably are a reflection of circumstances unique to that case – particularly the pendency of the appeal.

 

I have always thought that all of these recurring bankruptcy court problems are the result of a fundamental misconception of the D&O insurance policy. For obvious reasons, claimants and creditors want to establish that the D&O insurance policy exists for their protection and benefit. For less obvious reasons, some courts fall for this, which I have always found frustrating.

 

The fact is that insurance buyers purchase D&O insurance to protect the insured persons from liability. No one pays insurance premium as a charitable act for the benefit of prospective third party claimants. Liability insurance exists to protect insured persons from liability, not to create a pool of money to compensate would-be claimants. The very idea that claimants who have not even established their right of recovery from the insureds should somehow be able to deprive the insureds of their right to use their insurance to protect themselves stands the entire insurance proposition on its head.

 

All of that said, I agree completely with the memo’s authors that the wording of the priority of payments clause is critically important, and that the time to address these concerns is at the time the coverage is placed.

 

A Final Note: The memo’s authors suggest that in light of the fact that D&O insurance policy wordings can be negotiated and that wordings are constantly changing, directors and officers “should consult with experienced coverage counsel and/or make a commitment to remain abreast of key changes in the policy forms.” I agree that the involvement of coverage counsel can be useful in the policy placement process. We frequently work with outside counsel when we place policies for our clients and generally find counsel’s involvement to be productive.

 

However, the memo’s authors also state the following in support of their contention that outside counsel should be involved in the D&O insurance placement process: “most individual officers will rely on their insurance brokers to ‘take care’ of policy placement and review of the policy terms. This is a mistake.”

 

Although we often work with our clients’ outside counsel in connection with policy placements, in the vast majority of the placements on which we work, there is no involvement of outside counsel. The fact is that in most instances there is absolutely no need for these companies to incur the added cost of outside counsel in the insurance placement process.

 

Of course it is important for companies to insure that they have knowledgeable, skilled broker involved in placing their insurance. If the company has taken care to ensure that it has a capable broker involved, it is not a “mistake” for the company to rely on the broker.

 

In some D&O insurance placements, counsel should be involved, and in other cases it is helpful to have counsel involved. Fortunately, in the vast majority of D&O insurance placements, there is no need for companies to incur the cost of outside counsel – and the suggestion that it is a “mistake” for those companies to rely on their brokers is unwarranted. Again, if the company has taken care to ensure that its broker is knowledgeable and experienced, the company is completely justified and conducting itself prudently in relying on their broker.

 

Fortunately, I find that knowledge outside lawyers involved in the placement process fully appreciate that the broker has a valuable and important role to play.

 

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.