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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Background

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

 

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

 

The October 9 Decision

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

 

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Background       

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

 

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

 

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

 

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

 

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

 

The September 30, 2013 Opinion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

 

The agency’s brief two-page letter opens with the observation that the FDIC has “noted an increase in exclusionary terms or provisions contained in depositary institutions’ D&O insurance policies.” The agency notes that the addition of these exclusionary provisions “may affect the recruitment and retention of well-qualifies individuals,” and that when the exclusions apply, “directors and officers may not have insurance coverage and may be personally liable for damages arising out of civil suits.”

The FDIC is concerned that bank officials “may not be fully aware of the addition or significance of such exclusionary language.” Accordingly, the agency urges officials to apply “well-informed” consideration to the potential impact of policy exclusions. The agency urges “each board member and executive officer to fully understand the answers to the following questions” especially when considering renewals and amendments to existing policies:

  • What protections do I want from my institution’s D&O policy?
  • What exclusions exist in my institution’s D&O policy?
  • Are any of the exclusions new, and if so, how do they change my coverage?
  • What is my potential personal exposure arising from each policy exclusion?

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

The letter goes on to note that the agency’s regulations prohibiting insurance indemnifying against civil money penalties “do not include an exception for cases in which the IAP reimburses the depositary institution for the designated cost of the CMP coverage.”

Discussion

On the one hand, the FDIC’s warnings about the need for bank officials to be well-informed about their D&O insurance and to be wary about the addition of policy exclusions are simply good advice. Indeed, the warnings represent worthy counsel for officials at any corporate entity, not just at banking institutions. All corporate officials should be attentive to their D&O insurance, and the questions that the FDIC suggests are good questions for the directors and officers of any institution.

However, the FDIC is not just offering disinterested guidance here. The FDIC doesn’t say it, but it has a very specific concern in mind. The FDIC is worried about the inclusion in banks’ D&O insurance policies of a so-called “regulatory exclusion” precluding coverage for claims brought by regulatory agencies such as the FDIC. Although these exclusions are still somewhat unusual, when a policy has one of these exclusions, the FDIC is unlikely to be able to recover under the policy for any claims the agency files against a bank’s directors and officers. (For background about the regulatory exclusion, refer here.)

The likeliest time for a D&O insurer to try to add a regulatory exclusion is when a financially troubled bank seeks to renew its insurance. The insurer, concerned that the bank might fail, wants to protect itself against possible liability for any post-closure claims that the FDIC might bring in its capacity as receiver of the failed bank.

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

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

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

Because the FDIC’s letter went to all banking exclusions and by its terms is meant to apply with respect to all institutions, insurance professionals that work with reporting institutions should expect that their banking clients will be presenting them with these questions and should be prepared to answer their client’s questions.

For their part, banking officials should consider whether their advisors are adequately answering their questions. Although it is true in most corporate contexts, it is particularly true in the context of banking institutions that the firms and their directors and officers should be sure that their insurance advisor is knowledgeable and experienced. In looking for answers to the FDIC’s suggested questions, bank officials will want to assess whether their advisors’ answers show that their advisor is sufficiently knowledgeable and experienced to counsel them with regard to these important insurance issues.

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

As discussed in a prior guest blog post on this site (refer here), the FDIC had informally been taking the position that bank’s D&O insurance policies should not provide for the indemnification of civil money penalties. However, this type of coverage has long been available in the insurance marketplace and many D&O insurance policies currently in place expressly provide for the insurance of these penalties. One of the ways that banks and their insurers have sought to address possible agency concerns about the insurance is by having the individuals protected by the civil money penalty provisions reimburse the bank for the cost of the civil money insurance protection. As noted in the guest blog post, “This was based on the assumption that if the bank could prove that the directors and officers paid for the coverage personally, that the FDIC wouldn’t object to the coverage.”

These insurance industry practices continued because certain assumptions were being made about the agency’s approach to these issues. With the FDIC’s issuance of the Advisory Statement, the agency’s views are now clear – banks are “prohibited” from purchasing insurance that would pay or reimburse for civil money penalties, and there is no exception from the regulations that allows the insured individuals to reimburse the bank for the civil money penalties protection.

The agency’s issuance of the Advisory Statement and the clarification of the agency’s position with respect to insurance for civil money penalties does raise the practical question about what banks and their insurers should do with respect to the many insurance policies that are currently in force providing insurance for civil money penalties. One immediate question that comes to mind is whether or not the policies should now be specially endorsed to remove the endorsements providing for civil money penalty coverage. Alternatively, some may feel that it is sufficient simply to allow the current policies to run through their natural expiration and at renewal a new policy can be put in place without the civil money penalties provisions.

It seems likely that banking officials will also now want to know if there is anything else that they can do to protect themselves from their exposure to possible civil money penalties against them. Among the topics that are likely to be discussed in the months ahead  is the question whether the FDIC’s Advisory Statement prohibiting banks from purchasing insurance the includes indemnification against civil money penalties does not prohibit individuals from buying insurance on their own to protect themselves from civil money penalty exposures.

The discussion of these latter possibilities would have to include consideration of  (1) whether the operative regulations and the Advisory Statement preclude purchase of insurance protection against civil money penalties by individuals as well as by depositary institutions;  and (2) whether the agency’s clarification that there is no exemption in the regulation allowing individuals to reimburse banks for the purchase of insurance for civil money penalties protection in and of itself precludes the individuals’ purchase of this type of insurance, or at a minimum effectively communicates what the agency’s view would be on the issue.

Finally, there is the practical question of whether insurers would even be interested in trying to offer separate policies for individuals providing insurance for civil money penalties, given the likely low premiums involved and the prospects — for both the insured persons and for the insurers — of running afoul of the FDIC. In the past, the insurers have shown little interest in offering this type of product.

FDIC Updates Failed Bank Lawsuit Information: On October 11, 2013, the FDIC updated the page on its website on which the agency tracks the lawsuits it has filed in its capacity as receiver for failed banks against the banks’ former directors and officers. As of the latest update, the agency has now filed a total of 81 lawsuits against the former directors and officers of failed banks, including a total of 37 so far this year. (By way of comparison, the agency filed only 25 during all of 2012.)

The updated page also notes that as of October 8, 2013, the agency has authorized suits in connection with 127 failed institutions against 1,029 individuals for D&O liability. These figures are inclusive of the 81 filed D&O lawsuits naming 616 former directors and officers. In other words, based solely on the number of authorized suits, there may be a backlog of as many as 46 lawsuits yet to be filed.

While the number of lawsuits and authorized lawsuits continue to increase, the number of bank failures seems to have slowed. As also reflected on the agency’s website, there have been no bank failures in the last month.

Third Quarter Claims Trends Update: On October 17, 2013, I will be participating in Advisen’s Third Quarter Claims Update, along with AIG’s Rich Dziedziula, Joseph O’Neil of the Peabody & Arnold law firm, and Advisen’s Jim Blinn. The free one-hour webinar, which will begin at 11:00 am EDT, will discuss recent corporate and securities lawsuit filing trends as well as key developments to watch. Further information about the webinar including sign up information can be found here.

The D&O Diary’s European itinerary continued this week in Zürich, Switzerland, where I travelled for meetings and to attend the inaugural continental European educational event of the Professional Liability Underwriting Society (PLUS). Zürich is a picturesque city in a beautiful setting, but the grey skies and cool temperatures while I was there came as something of a shock after the sunny warmth of Portugal. Between the weather and the meetings, I did not see as much of the city as I would have liked, but I did have a good albeit brief introduction.

 

Zürich is Switzerland’s largest city, with about 350,000 residents and a metropolitan population of about 1.83 million. The city is frequently identified as the wealthiest city in Europe – the city’s affluence is in fact readily apparent and has certain practical consequences for the casual visitor.

 

The PLUS event was held in a modern business hotel in a high rise district outside the central city. However, I spent my first two days in the city in the Altstadt (Old Town), the historic city center, which is an extended area of narrow, cobblestone streets and well-preserved older buildings along both banks of the Limmat River, which flows into the city from the northern end of Lake Zürich.

 

The river’s right (or east) bank has many hotels and restaurants. The dominant thoroughfare on the left (or west) bank is Bahnhofstrasse, which runs northward parallel to the river from the lakeshore to the main train station and also traverses the rarified world of high finance and luxury retail. Sleek black sedans glide up to the discrete front doors of the numerous private banks along the street; the world’s wealthy warm their hands over their money inside the banks, and then, before heading back to Asia, Africa or the Middle East, they drop some pocket change at the adjacent swish shops, such as Cartier and Tiffany.

 

One consequence of the wealth and of the fact that the city is the center of the Swiss financial services industry is that Zurich is expensive. The fare for my brief cab ride from the airport to my hotel was 60 Swiss francs with tip (a little bit more than $60 dollars). I don’t think I have ever had to pay the equivalent of $9.50 for a beer before, except perhaps at a live sporting event. It quickly became apparent that the 300 Swiss Francs I had brought with me were going prove woefully inadequate.

 

Just about every time I travel overseas, somewhere along the way I have a “Dude, I’m from Cleveland” moment. On this latest trip, the moment occurred when I went into a retail bank branch to exchange Euros for some more Swiss francs, so that I would have enough walking around money. After having established that the teller spoke English “a lee-tell beet,” I explained the transaction I had in mind. The teller asked me, “Do you have an account with this bank?” to which the only response I could think of was “Dude, I am from Cleveland. Do I look like I have a Swiss bank account?” For failing to have established a Swiss bank account, I paid a five franc fee for the currency exchange transaction.

 

I arrived in Zürich with ambitious plans to take a boat ride on the lake and to take a train up into the mountains. Unfortunately, the weather steadily deteriorated throughout my stay. The grey skies first turned foggy, then rainy, and by the time I left town the air temperatures were only in the upper 30s. The boat ride and mountain visit were out. 

 

Instead, I explored the city’s old town and walked for miles along the riverside and lakeside quays. Zurich is beautiful and the old town has been well-preserved. But the city itself lacks any dramatic local landmarks (other than the lake and the mountains of course, which blanketed in fog don’t make much of a statement); there are no castles, ancient ruins or cathedrals, and, other than their distinctive clock towers, the city’s various historic churches are relatively modest affairs. After several hours of striding around and window shopping at the exclusive shops, I began to think that Zurich might a little bit of a dull place.

 

At loose ends as evening approached, I innocently wandered into an old-fashioned beer hall located on the east riverbank quay, and discovered something of a parallel universe that exists alongside Zurich’s orderly upscale propriety. The establishment is called Bierhalle Wolf, which consists of a large wood-paneled dining room filled with long tables and benches. In the late afternoon and early evening, a trio of paunchy, middle-aged men dressed in lederhosen and playing a tuba, a guitar and an accordion played songs ranging from traditional Oompa music to Abba. A crowd of unusually uninhibited people sang along or danced in the aisles, clapping their hands or waiving their napkins over their heads.

 

During their breaks, the band members wandered around the hall chatting with people in the crowd, including me. In their next set after the break, the band leader paused to say (in English) that their next song was dedicated to their new friend Kevin, from Cleveland. For some reason, they played ‘Achy Breaky Heart,” which brought the crowd into the aisles, dancing and whistling appreciatively. What a place. The schnitzel was pretty good too, or at least appropriately matched to the venue and the beer. I left persuaded that Zurich is not a dull place after all.

 

The PLUS event itself was a quite success. It was a pleasure to meet many industry colleagues from around Europe. The sessions were excellent. I congratulate the local committee that organized the event, and I also congratulate PLUS leadership for its initiative in extending the organization’s education opportunities to continental Europe. I will say it was very nice to learn that there are so many D&O Diary readers in Europe. I hope that our European colleagues can look forward to many more events like this one in the years to come. Special thanks to the event committee for inviting me to be a part of this inaugural event.

 

 

 

More Pictures of Zurich: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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.