As it has been doing on a monthly basis during the current banking crisis, the FDIC has once again updated the page on its website describing the failed bank litigation that the agency has initiated. According to the latest update, as of April 12, 2013, the agency has now filed a total of 54 failed bank lawsuits during the current bank failure wave. But though the new suits continue to come in, the agency’s filing pace appears to have slowed, at least for now. In the month since its last web update, the agency has only filed one additional lawsuit, and only four overall since February 1, 2013, even though the significant numbers of institutions reached the third anniversary of their closure during that period (Due to statute of limitations concerns, the agency typically files its failed banks suits shortly before the a failed bank’s third anniversary.)

 

Since its last update last month, the FDIC did initiate one lawsuit in its capacity as receiver for New Century Bank of Chicago, Illinois, which failed April 23, 2010. On March 26, 2013 (that is, just a few weeks before the third anniversary of the bank’s failure), the agency filed a complaint in the Northern District of Illinois alleging that the six former directors and officers named as defendants “acted negligently and grossly negligently and breached their fiduciary duties by disregarding the Bank’s loan policy, prudent lending practices, and regulatory warnings in connection with numerous commercial real estate and other loans during the period April 2005 through July 2008.” The FDIC seeks to recover “more than $33 million in losses.”

 

With the addition of just this one lawsuit, the FDIC has filed only two new complaints against former directors and officers of failed banks since March 1, 2013 and only four new complaints since February 1, 2013. By contrast, during January 2013, the FDIC filed five new complaints, just in that one month alone. In the two month period including December 2012 and January 2013, the FDIC filed a total of nine new lawsuits.

 

This relative slowdown since February 1, 2013 is all the more noteworthy given the number of banks that failed during the corresponding period three years ago. During the period February-April 2010, there were a total of 49 bank closures. By way of comparison, there were only 51 bank closures during all of calendar year 2012, and there have only been five so far during 2013. Early 2010 was a very active period for bank closures, and so given that the FDIC tends to file its suits, if at all, as the third anniversary approaches, it seemed that 2013 was going to be an active period of new lawsuit filing.

 

In addition, each month the agency updates its website to show the increased numbers of lawsuits that have been authorized. At its most recent update, the agency indicated that the number of lawsuits authorized has once again increased during the past month. As of April 12, 2013, the FDIC has now authorized suits in connection with 109 failed institutions against 888 individuals for D&O liability. This figure of 109 authorized lawsuits is inclusive of the 54 filed D&O lawsuits naming 407 former directors and officers that have already been filed. These figures suggest that there is a backlog of 55 cases that have been approved and not yet filed. The backlog seems to be growing. Given the monthly increase in the number of authorized lawsuits, you would really expect to see the agency’s new lawsuit pace moving along an active clip, not as seems to be the case, entering some sort of a lull.

 

There are a number of possible reasons for the apparent slowdown in the number of failed bank lawsuit filings. The first is just timing. I mentioned above that during the period February to April 2010, 49 banks closed, but of those 49 bank failures, 23 occurred in April 2010 alone (a very busy month for bank failures). Of the 23 bank closures in April 2010, 22 took place on or after April 16, 2010. In other words a very large percentage of the banks that failed during this period failed in late April 2010, and thus still have not yet reached the third anniversary of their closure. The third anniversary is coming up, but we are not quite there yet. There could be a flurry of new failed bank lawsuit filings in the next few days.

 

Another possible explanation for the apparent lull of new failed bank lawsuit filings over the last few weeks is that the agency may have entered tolling agreements with the failed banks directors and officers to see if they agency can reach a negotiated settlement with the directors and officers and with their bank’s D&O insurer. If the parties have entered tolling agreements, lawsuits involving some of the banks still could be filed later.

 

Finally, there are a number of cases in which the agency has reached a negotiated settlement with the directors and officers and with the D&O insurer without the agency actually filing the lawsuit. If the agency was able to reach a settlement agreement of this type in a number of cases, that too might account for the apparent filing slowdown over the past several weeks. (The agency has posted the settlement agreements in a number of these kinds of settlements on its website.)

 

Nevertheless, given the number of banks that failed in the first half of 2010 and given the growing number of lawsuits the agency has filed, it seems as if the failed bank lawsuit filing pace should be picking up again soon. As I have previously noted, there have previously been lulls in the FDIC’s failed bank lawsuit filing activity (refer here, for example, wiht respect to the two month lull during mid-year 2012). But the prior lulls have in most instances been quicly followed by a period of quickened filing actiivity (as discussed, for example, here).. Circumstances may be poised for the same filing pattern again now.

 

Another FCPA Civil Lawsuit: There is no private right of action in the FCPA. Nevertheless, civil litigation has followed in the wake of the proliferation in the number of governmental enforcement actions alleging violations of the FCPA, as investors allege that company management have violated their corporate duties in allowing the bribery to take place or that, by failing to disclose the briber, management has misrepresented the company’s internal controls or financial condition.

 

The latest example of these kinds of civil suits is interesting because at least so far there is no formal enforcement action against the company involved or its senior officials, although the bribery allegations have been the subject of very high-profile publicity.

 

According to their April 12, 2013 press release, plaintiffs’ lawyers have filed a securities class action lawsuit in the Southern District of New York against Wal-Mart de Mexico SAB (“Walmex”) and Ernesto Vega, the Chairman of Walmex’s board of directors and Chairman of the Board’s audit and corporate practices committee. The complaint, a copy of which can be found here, purports to be filed on behalf of investors who purchased ADRs of Walmex between February 21, 2012 and April 22, 2012. The complaint alleges seeks damages under the ’34 Act.

 

The investors’ complaint alleges that during the class period the defendants made false and misleading statements about Walmex’s business practices with respect to unlawful or unethical bribery conduct. Specifically, according to the plaintiffs’ lawyers press release, the complaint alleges that Walmex “failed to disclose that it had been involved in a bribery scheme,” and that as a result of the defendants’ misleading statements the company’s ADRs traded at inflated prices during the class period.

 

Unlike many of these kinds of civil actions, the plaintiffs do not base their assertions on allegations derived from a prior regulatory enforcement action; so far, there has been no formal regulatory enforcement action taken against the company. Rather, the plaintiffs’ allegations rely heavily on information in an April 22, 2012 New York Times article entitled “Wal-Mart Hushed Up a Vast Mexican Bribery Case” (here). The lengthy article detailed the extensive payment program that executives at Walmex allegedly had pursued in order to obtain Mexican zoning approvals, reductions in environmental impact fees and the allegiance of neighborhood leaders. According to the article, an internal Wal-Mart investigation not only found evidence of the payments, but also that Walmex executives knew about the payments and took steps to conceal the payments from Wal-Mart’s headquarters. The lead investigator recommended that Wal-Mart expand the investigation, but instead, according to the article, Wal-Mart’s leaders shut it down.

 

The new compliant quotes extensively from the New York Times article; parts of the complaint are nothing more than lengthy block quotes from the article. Among other things, the Times article notes that in December 2011, after learning of the Times’s reporting in Mexico, Wal-Mart informed the Justice department that it had begun an internal investigation into possible FCPA violations. In subsequent regulatory filings, the company has stated that it is investigating possible improper payments in other countries. To date, there have been (so far as I am aware) no formal regulatory actions taken against Wal-Mart or its officials.

 

Nevertheless, though there had to date been no enforcement action, the Walmex investors have initiated a securities class action lawsuit based on the information provided in the Times article. The case is not the first civil action seeking damages in connection with alleged FCPA violations in the absence of a formal regulatory action. However, it does provide a high-profile example of the way in which FCPA allegations can lead to private civil litigation.

 

One other interesting feature of the Walmex situation is that the alleged bribery allegations first came to light in September 2005 when a whistleblower contacted a senior Wal-Mart lawyer. It is an interesting question of what might happen in similar circumstances today, given the potentially rich whistleblower bounty payments potentially available under the Dodd-Frank whistleblower provisions. The bounty provisions provide a significant incentive for a whistleblower of the kind involved here to go straight to the SEC. These circumstances provide a powerful illustration of the kinds of circumstances that could make the Dodd-Frank whistleblower provisions so significant and could lead to increased regulatory and enforcement activity.

 

Insurance to provide coverage for breaches of representations or warranties in M&A transaction documents has been available in the marketplace for several years, but the specialty insurance product has not always been fully understood. More recently, interest in the product has grown and the product has improved, and so take-up for the product has increased as well.

 

In the following guest post, Joseph Verdesca and Paul Ferrillo of the Weil, Gotshal & Manges law firm take a close look at reps and warranties insurance and explain what M&A transaction participants need to know about the product.

 

I would like to thank Joseph and Paul for their willingness to publish their article on this site.. I welcome guest posts from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly. Joseph and Paul’s guest post follows:

 

No less than two years ago, had one tried to initiate a conversation with a Private Equity Sponsor or an M&A lawyer regarding M&A “reps and warranties” insurance (i.e., insurance designed expressly to provide insurance coverage for the breach of a representation or a warranty contained in a Purchase and Sale Agreement, in addition to or as a replacement for a contractual indemnity), one might have gotten a shrug of the shoulders or a polite response to the effect of “let’s try to negotiate around the problem instead.” Perhaps because it was misunderstood or perhaps because it had not yet hit its stride in terms of breadth of coverage, reps and warranties insurance was hardly ever used to close deals. Like Harry Potter, it was the poor stepchild often left in the closet.

 

Today that is no longer the case. One global insurance broker with whom we work notes that over $4 billion in reps and warranties insurance was bound worldwide last year, of which $1.4 billion thereof was bound in the US and $2.1 billion thereof was bound in the EU. Such broker’s US-based reps and warranties writings nearly doubled from 2011 and 2012. Reps and warranties insurance has become an important tool to close deals that might not otherwise get done. This article is meant to highlight how reps and warranties insurance may be of use to you in winning bids and finding means of closing deals in today’s challenging environment.

 


When Is Reps and Warranties Insurance Best Used?

Deal Size. Reps and warranties insurance is best suited to deals of a certain size range and type. Given the amount of limits that can be purchased in the marketplace for any particular deal, insurance pricing and the size of a typical escrow or indemnity requirement, the “sweet spot” for reps and warranties insurance are deals between $20 million and $1.5 billion. While reps and warranties insurance might have a role to play in larger or smaller deals, it can play a central role in facilitating transactions within this size range. The type of deal is relevant because it is much easier to obtain reps and warranties insurance when the business being acquired is privately owned rather than publicly held. In sum, insurance companies generally prefer to insure transactions where an identifiable seller (rather than a diverse stockholder base) is standing behind the representations of the target business.

 

Sell-Side Examples. For those finding themselves selling a business or asset, situations that may warrant purchase of a reps and warranties policy for the transaction include the following examples

• Minimization of Seller Liability. A Private Equity or Venture Capital seller near the end of a Fund’s life wishes to limit post-closing indemnification liabilities on the sale of a portfolio company in order to safely distribute deal proceeds to the Limited Partners, but the buyer wants a high cap on potential indemnities or a long survival period for the reps at issue. Insurance could be the means to bridge this gap.

• Removal of Tax Contingency from Negotiations. A seller restructures itself immediately prior to the closing of a deal for tax purposes. During due diligence, both seller’s and buyer’s tax advisors agree the deal should be recognized as a tax-free reorganization. In the remote event that the IRS took a different position, the tax consequences to the buyer would be significant. The Seller wishes to retire with the proceeds from the deal, and does not want to provide an indemnity to the buyer for this potential risk. Insurance could serve to remove this risk from the scope of matters needing negotiation between the parties.

• Minimization of Successor Liability Risk. In an asset sale transaction where a portion of assets and liabilities remain with the seller, the buyer would have no control over the seller’s conduct post-closing and does not want to be subject to potential liabilities related to such excluded assets on a successor liability theory. If the seller is unwilling or unable to provide an indemnity for such matters, insurance could help the parties past this issue.

Buy-Side Examples. For those wishing to acquire a business or asset, situations that may warrant purchase of a reps and warranties policy for the transaction include the following examples:

• Bid Enhancement. A competitive auction process is being held by a seller of prime assets. A potential buyer wishes to distinguish his or her bid from others by arranging and agreeing to look to a reps and warranties insurance policy to take the place of an indemnity from the seller. Such a use of insurance could elevate the likelihood of the buyer winning the auction.

• Public M&A Indemnity. In a public M&A acquisition, the buyer could arrange for reps and warranties insurance to provide the indemnity that would not otherwise typically be available in light of the publicly held nature of the target.

• Distressed M&A Indemnity. Similarly, in a distressed M&A setting in which the buyer is concerned about the credit risk of the seller post-closing, the use of reps and warranties insurance would enable the buyer to be indemnified for breaches of reps and warranties in the acquisition agreement, while avoiding the seller’s credit risk.


What Should the Insurance Cover?

While each policy is unique, a reps and warranties policy generally covers “Loss” from “Claims” made by Buyer for any breach of, or an alleged inaccuracy in any of, the representations and warranties made by the Seller in the Purchase and Sale Agreement (“PSA”). Though a rep and warranty policy can be structured to cover very specific reps or warranties, coverage is generally afforded on a blanket basis for all reps and warranties. The definition of “Loss” in the policy should generally mimic the extent of the Indemnity negotiated in the PSA (which could include things like consequential or special damages). Loss can also include defense costs, fees, and expenses incurred by the Insured (for instance, the Seller) in defense of a Claim brought by a third party (for instance, the Buyer) arising out of alleged breach of a representation or warranty. Note that such policies almost always have a self-insured retention (“deductible”) associated with them. The size of the retention can vary considerably from deal to deal, but usually in some fashion equates to the amount of the hold back negotiated.

 

What Should the Insurance Exclude?

Though the exclusions in a reps and warranties policy are not as numerous as those contained in a traditional directors and officers liability policy, they should do exist and be thoughtfully considered and negotiated. Reps and warranties policies do not cover known issues, such as issues discovered during due diligence or described in disclosure schedules. They also do not cover purchase price, net worth or similar adjustment provisions contained in the PSA. “Sell-Side” reps and warranty policies do not cover claims arising from the adjudicated fraud of the seller. Either buy side or sell side policies might have deal-specific exclusions where the carrier involved simply cannot get comfortable in insuring the particular representation or warranty at issue. Lastly, a rep and warranty policy would also generally not cover any breach of which any member of the deal team involved had actual knowledge prior to the inception of the policy or any material inaccuracy contained in the “No Claims Declaration” typically in connection with the issuance of the policy.

Cost of Coverage

Reps and warranties insurance is priced based on a number of factors, including most prominently the nature of the risk involved, the extent of the due diligence performed by the parties, and the relative size of the deductible. Reps and warranties insurance is currently generally priced as a percentage of the limits of coverage purchased. Nowadays, in the United States, a price range of 2.0% to 3.5% of the coverage limits is typical. Thus, a $20 million reps and warranties insurance policy on a moderately complicated deal might cost approximately $600,000. Who pays this premium is generally a function of the deal, and depends to some extent upon who is deriving the benefit from the insurance. If, for instance, a buyer-side policy is being purchased because a seller doesn’t want to deal with putting up an indemnity or hold-back, the premium would generally be the seller’s responsibility.

 

In order to facilitate the due diligence process (described below), many carriers require payment of an up-front underwriting fee. These fees can run from $25,000 to $50,000, and are used by the carrier typically to hire outside counsel to advise it during the underwriting process.

 

Deductible

Carriers typically determine the policy’s deductible according to the transaction value of the deal. In our experience, the current standard deductible ranges from 1% to 3% of the transaction value. The deductible will, however, vary from deal to deal based upon the risk involved. Buy-side policies alternatively tend to use the “hold-back” negotiated between the parties as a deductible.

 

Process to Get the Insurance in Place

The reps and warranties insurance market has evolved in response to prior concerns about the amount of time and effort necessary to put a policy in place. The carriers and brokers understand that, as with the deals themselves, the need for the insurance is typically on a very fast track.

 

Many of the large national insurance brokerages have specialized units that deal with reps and warranties insurance. These units, for the most part, are run not by “insurance people” but by former M&A lawyers who left private practice to become dedicated resources at the brokerages. They are fully familiar with the ins and outs of M&A and private equity transactions, and very little time is needed to get them up to speed. Though not all brokerages provide the same level and depth of resources, the right broker can become quickly integrated into the deal team and, importantly, will serve as an advocate with the insurance carriers.

 

Within 24 hours, a good broker will have you engaged with one of the handful of carriers that are known to service the reps and warranties insurance area. Be advised that not all carriers are created equally, and your broker should assist in advising as to selection of the best carriers for your purposes (including as to responsiveness, experience in corporate transactions, and reputation for proper claims payment decisions).

 

The best insurance carriers in this arena will typically provide a price and coverage quote (called a “Non-Binding Indication” or “NBIL”) within two or three days of the first conversation. Either in connection with the receipt of the NBIL or in a subsequent phone call, you should expect to receive a list of due diligence requests, and likely a request of the carrier for data room access (both the broker and carrier are accustomed to negotiating and executing a Non-Disclosure Agreement early in the process). The best carriers in this arena are, in our experience, capable of running a very efficient due diligence process and getting up to speed as a quick as possible regarding potential risks associated with the deals (e.g. intellectual property, environmental, etc.).

 

Within a week of receipt of the NBIL, the carrier, its counsel, the insured, its business people, its deal team members and its counsel (including sometimes the private equity sponsor) will typically discuss the due diligence done on the transaction, and answer questions of the insurance carrier to ensure the absence of any risks that might imperil the insurance transaction. Assuming the due diligence call goes well (and there might be follow up diligence calls as well on particular issues), the carrier involved will normally issue a draft insurance policy, which is normally then negotiated with the parties (assisted by the broker). A key issue will be “conforming” the insurance so that it matches what would otherwise have been provided by the PSA in the absence of the insurance (or otherwise serves the particular need for which it is being purchased). In negotiating such policy, focus will often be placed on defining the scope of losses included and excluded, the impact of knowledge qualifiers, the term of coverage, operational restrictions, subrogation provisions, and a host of additional issues beyond the scope of this article.

 

In Summary: Reps and warranties insurance (1) can be purchased quickly and efficiently, and won’t delay the deal, (2) can provide real coverage for troublesome aspects of a deal for which alternative solutions may not be readily available, and (3) can serve as a flexible tool to distinguish one’s offer in a competitive bidding situation. Teaming up with a well-experienced broker and insurance carrier is essential to making this happen. We have enjoyed the benefits of utilizing reps and warranties insurance into numerous transactions, and would be happy to share with you our thoughts in this arena in further detail.

Lee Farkas, the criminally convicted former Chairman and majority shareholder of  the defunct Taylor Bean and Whitaker Mortgage Corporation, must repay the nearly $1 million in defense fees the company’s D&O insurer had advanced on his behalf, according to an April 11, 2013 Fourth Circuit opinion. The terse three-page appellate opinion adopts the ruling of the lower court, holding that Farkas’s criminal conviction triggered the D&O insurance policy’s “in fact” conduct exclusions which in turn triggered the insurer’s right to recoup the defense fees it had previously paid. The Fourth Circuit’s opinion can be found here, and the March 21, 2012 district court opinion, which the appellate court affirmed, can be found here.

 

Background

In June 2010, Farkas was indicted on multiple counts of committing and conspiring to commit bank, wire and securities fraud. On April 19, 2011, a jury found Farkas guilty of all 16 counts of fraud and conspiracy to commit fraud. As detailed here, Farkas was, among other things, alleged to have conspired with employees of the failed Colonial Bank to sell the bank approximately $400 million of mortgage assets that had no value. Taylor Bean was also alleged to have engaged in numerous other transactions with the bank that had no value. The bank’s collapse followed after the fraudulent scheme unraveled.

 

After he was indicted, Farkas sought to have his criminal defense fees paid by the company’s D&O insurer. With bankruptcy court approval, the D&O insurer advanced $928,977 toward Farkas’s defense. Farkas incurred significant additional defense expenses, and the carrier’s request for the bankruptcy court’s leave to pay those additional amounts was pending when the jury returned the guilty verdict. Following the verdict, the carrier informed Farkas that, as a result of the verdict and in reliance on the policy’s conduct exclusions, it would no longer fund Farkas’s defense costs, and it reserved its right to seek recoupment from Farkas of the amounts it had previously advanced.

 

Farkas filed an action in the Eastern District of Virginia seeking a judicial declaration that the jury verdict did not terminate the insurer’s defense obligation, and that in any event all of the fees he had incurred prior to the jury verdict must be paid. The D&O insurer filed a counterclaim seeking a judicial declaration that Farkas was not entitled to coverage under the policy and that Farkas was obligated to repay the amounts the insurer had previously advanced. The parties cross-moved for summary judgment. In her March 21, 2012 opinion, Eastern District of Virginia Judge Leonie Brinkema granted the insurer’s motion for summary judgment. Farkas appealed.

 

In arguing that as a result of the jury verdict coverage for Farkas’s criminal defense fees was precluded under the policy, the insurer relied on the policy exclusion specifying that “The Insurer shall not be liable to make any payment for Loss in connection with a Claim against an insured …arising out of, based upon or attributable to the committing in fact of any criminal, fraudulent or dishonest act, or any willful violation of any statute, rule or law.”

 

In seeking to have Farkas repay the amounts that it had advanced, the insurer relied on the language in the policy specifying that “advanced payments by the Insurer shall be repaid to the Insurer by the Insureds or the Company, severally according to their respective interests, in the event and to the extent that the Insureds or the Company shall not be entitled under the terms and conditions of this policy to payment of such Loss.”

 

The Fourth Circuit’s Opinion and the Ruling Below

On April 11, 2013, in a terse three-page per curium opinion, a three-judge panel of the Fourth Circuit affirmed the district court’s ruling. The appellate court said that “having carefully reviewed the briefs, record and appellate law, we affirm for the reasons stated by the district court in its thorough opinion.”

 

In her March 2012 opinion, Judge Brinkema had granted summary judgment for the D&O insurer, finding that the jury verdict in the criminal case represented an “in fact” finding that triggered the conduct exclusion; rejected Farkas’s argument that he was entitled to the payment of the defense costs incurred by not yet paid before the verdict was returned; ruled that the insurer was entitled to recoup from Farkas the defense cost amounts it has advanced prior to the verdict; and rejected Farkas’s argument that the district court should stay its ruling while Farkas’s criminal appeal was pending. (Farkas’s criminal conviction was in any event subsequently affirmed.)

 

In ruling that the jury verdict triggered the policy’s conduct exclusion, Judge Brinkema stated that “there can be no reasonable dispute that the jury verdict here is an objectively verified and pertinent factual finding.” She added that none of the courts that have held that an “in fact” wording in a policy exclusion requires a final adjudication had defined a final adjudication as an appeal. She concluded that “there is simply no support in the case law for plaintiff’s position that a jury verdict does not trigger the ‘in fact’ requirement in the exclusion.”

 

With respect to Farkas’s contention that the insurer should at least pay the defense costs he had incurred but that the insurer had not yet paid when the verdict was returned, Judge Brinkema said that Farkas’s argument “ignores the consequence of a particular claim being excluded.” Farkas’s conduct “was never actually covered under the Policy, and he was therefore never entitled to the monies advanced to him.” Pursuant to the policy language, the insurer, she found, “has the right to seek recoupment of any costs that it advanced before it determined that an exclusion applied.”

 

Discussion

The question of an insurer’s right to seek recoupment of advanced defense expenses is a recurring topic. As I have previously noted (here), although D&O insurers frequently assert their right to seek recoupment, it is still relatively rare for the insurers to actually do so. Among other reasons why the insurers rarely seek reimbursement is that it is relatively unusual for a D&O claim to proceed to the point that there has actually been a factual determination triggering an exclusion. Indeed, one of the many reasons why civil claims triggering D&O coverage frequently settle is that an insured defendant would risk a factual determination that might preclude policy coverage if the defendant were to press the case forward rather than settle.

 

This case’s criminal context obviously presents a different set of circumstances than does a civil case. A criminal defendant does not have the option of a pre-trial settlement that avoids a potentially coverage precluding outcome.

 

Just the same, the coverage outcome here is also due in part to an unusual feature of the policy at issue According to the court record, the D&O insurance policy at issue here was first issued to the Taylor Bean firm in 2008 and subsequently extended by endorsement. Even in 2008 it was standard for most D&O insurance policies to be issued with the “final adjudication” wording, rather than the “in fact” wording. With the final adjudication wording, the preclusive effect of the conduct exclusion does not apply under there has been a final judicial determination that the precluded conduct has occurred. The presence of the “in fact” exclusion language in the Taylor Bean policy is an anachronism that is unexpected and frankly a little bit surprising.

 

Because the policy had the “in fact” exclusionary language, Judge Brinkema had little trouble concluding that the jury verdict precluded coverage. Had the policy had the now-standard “final adjudication” language, the parties would then have had to argue about whether or not the criminal judgment against Farkas was “final” while his appeal was pending. I am well aware that there is extensive case law on the question whether or not a district court judgment if final and enforceable while an appeal is pending. But if the policy had contained the “final adjudication” language rather than the “in fact” language, Farkas might have had a better argument that the insurer was obligated to continue to advance his defense fees unless and until the conviction was affirmed.

 

It is worth noting that these circumstances demonstrate why the preferred exclusionary trigger is not just the “final adjudication” wording but rather the “final non-appealable adjudication” formulation. If the policy had the “non-appealable adjudication” wording, the insurer here would have been obligated not only to advance the amounts Farkas had incurred prior to the verdict but that the insurer had not yet paid, but also to continue to advance his defense expenses for his appeal. Farkas would have been able to continue to use his preferred counsel through his appeal (rather than, as Judge Brinkema noted, counsel appointed for him under the Criminal Justice Act). Farkas may well feel that the appeal might have turned out differently if he had been able to rely on his preferred counsel. I know for sure that if it were me, I would certainly want to be able to use my preferred counsel while appealing a criminal conviction.

 

The fact that Farkas had to rely on appointed counsel for his appeal suggests that he did not have resources of his own to rely on — which begs the question of why the carrier went to the trouble to obtain an order requiring Farkas to repay the advanced amounts. I mentioned at the outset of this discussion that it is relatively rare for carriers to seek recoupment of advanced amounts, and among other reasons why it is rare is that often there is no point for the carrier to seek recoupment because usually by the time a serious D&O claim has concluded, the defendant is usually broke – which seems to be the case here, which in turn begs the question why the carrier even bothered to pursue a recoupment order.  It probably is worth noting in that regard that the D&O insurer did not initiate the coverage lawsuit here, Farkas did. The carrier only sought recoupment in its counterclaim, after Farkas had sued the insurer. Whether the carrier ultimately will recover anything under the recoupment order is a different question.

 

"Everything I Can See From Here": Two Men, a Dog, a Ball, and ….

 

Everything I Can See From Here from The Line on Vimeo.

Securities class action lawsuits involving accounting allegations are less likely to be dismissed, take longer to resolve, and make up a much greater proportion of total securities suit settlement dollars than non-accounting cases, according to a new report from Cornerstone Research. The report, entitled “Accounting Class Action Filings and Settlements: 2012 Review and Analysis,” and which can be found here, shows that the number of securities cases involving accounting allegations declined in 2012, both in absolute numbers and as a percentage of all securities suit filings. However, a number of factors suggest that the number of accounting cases could increase in the months ahead. Cornerstone Research’s April 10, 2013 press release regarding the report can be found here.

 

The report defines a securities suit as an “accounting case” if the lawsuit involves allegations of Generally Accepted Accounting Principles or weaknesses in internal control over financial reporting. The alleged GAAP violations vary widely, but include allegations of accounting irregularities, restatement of financials, and asset write-downs.

 

During 2012, new accounting case filings decreased both in number and in proportion of new securities class action filings, to the lowest levels in six years. The number of accounting cases decreased from 78 in 2011 to 45 in 2012, and the proportion of total filings that accounting cases represented decreased from 42 percent to 30 percent. As a result of declines during 2012 in the number of cases involving Chinese reverse merger companies, as well as a general decline in the number of securities class action lawsuit filings in the second half of the year, the number of securities suit filings overall declined during 2012. The drop in Chinese reverse merger cases alone accounted for approximately two-0thirds of the drop in new accounting cases from 2011 to 2012

 

The total number of accounting restatements actually increased in 2012. However, the total number of accounting cases involving financial restatements decreased during 2012, returning to levels seen in 2009 and 2010, after a significant increase in 2011. Perhaps many of the 2012 restatements did not result in lawsuits because the “many of the restatements during 2012 did not have a significant effect on stock price.” It is also possible that a time lag between the time of the restatement and an eventual filing may result in more restatement related filings in 2013.  

 

For the third consecutive year, the majority of accounting cases included allegations of internal control weaknesses. Over the past three years, nearly two out of three accounting cases included allegations relating to internal controls, a much higher proportion than during the period 2007 through 2009.

 

Accounting cases typically are less likely to be dismissed than non-accounting cases. Of the securities class action lawsuits that were filed in 2007, only 35 percent of accounting cases were dismissed by the end of 2012, compared with 52 percent of non-accounting cases. In addition, 60 percent of accounting cases filed in 2007 settled by the end of 2012, compared to 41 percent of non-accounting cases. Of all cases filed during the period 2007 to 2010, only five percent of accounting cases were voluntarily dismissed, compared with 24 percent of non-accounting cases.

 

Accounting cases continue to represent a substantial portion of the total dollar value of all settlements. While accounting cases represented less than 70 percent of the number of 2012 securities lawsuit settlements, accounting cases represented over 90 percent of the total value of the settlements.

 

Both average and median settlement amounts are higher for accounting cases compared with non-accounting cases. During 2012, the average and median settlement amounts for accounting cases were approximately $73 million and $15 million respectively, compared with $16 million and $6 million for non-accounting cases. This difference is due in part to the fact that accounting cases often involve other factors associated with higher settlement amounts, such as an accompanying SEC action. The report also notes that cases in which the company has announced internal control weaknesses are associated with both higher median settlement amounts and a higher settlement share of “estimated damages.”

 

The report notes that factors such as the Dodd-Frank whistleblower program, a recent increase in the number of restatements by accelerated filers, and the JOBS Act’s extension of the exemption from auditor reports on internal controls for emerging growth companies are all factors that could contribute to an increase in the number of securities class action lawsuit filings involving accounting allegations.

 

Third-Party litigation funding’s moment may have already be here, as I have previously noted. But just the same, it is a little surprising to find stories about litigation funding at virtually every turn, with stories over the weekend appearing, for example, in The Economist and in the Wall Street Journal, among other publications. Two things seem to be driving this media attention: the results that early entrants to the litigation funding arena are achieving; and the arrival of new entrants into the field, undoubtedly attracted by the early entrants’ results.

 

The April 6, 2013 Economist article, entitled “Investing in Litigation: Second-Hand Suits” (here), reports that litigation funders are posting “fat returns.” The article cites the results of two of the publicly traded litigation funders. Juridica, which is listed on the London AIM exchange, on March 15, 2013 reported that during the prior year the company had made cash profits of $38 million on fund of $256 million under investment. Last year, the company “offered the highest dividend yield on London’s AIM market.” Burford Capital, which is also traded on the London AIM but is newer and bigger than Juridica, “boasts a 61% net return on invested capital in 2012.”

 

With results like these, it is little surprise that the litigation funding arena is attracting new entrants. In an April 8, 2013 Wall Street Journal article entitled “Investors Put Up Millions of Dollars to Fund Lawsuits” (here), investors seem to think that litigation is an “increasingly good bet” and that a new generation of investors is “plunging into” litigation funding. Among the entrants identified in the Journal article is Gerchen Keller Capital, which, as described in an April 8, 2013 Crain’s Chicago Business article (here), has raised more than $100 million and which closed its first deal on April 2, 2013. As detailed in an April 7, 2013 interview on Alison Frankel’s On the Case blog (here), the Gerchen Keller firm is well connected and has the advantage, as Frankel puts it, of “sparkly resumes and impressive Rolodexes.” (Question: Does anyone still use Rolodexes? Do they even exist any more? Does anyone under, say, 35 years old have any idea what a Rolodex is? Isn’t the world a better place without Rolodexes? )

 

The Journal article also emphasized that the field of litigation funding is “expanding into new areas,” as Frankel’s interview with the Gerchen Keller firm’s principals shows. The Gerchen Keller firm’s founders believe that their opportunity in litigation funding is on the defense side, where they funding firm funds a defense based on an alternative fee arrangement characterized by reduced hourly rates with a provision for a bonus for good results.

 

Litigation funding proponents contend that the funding arrangements helps to level the playing field by allowing litigants to pursue lawsuits against better financed opponents, or simply allowing litigants to keep litigation costs off their balance sheet. It seems clear that as the litigation funding field grows, the funding companies are offering new approaches – for example, the defense side option that the Gerchen Keller firm will be offering, or the “defense costs cover” that provided protection for prospective RBS claimants sufficient for them to be able to take on litigation in the U.K. notwithstanding the “loser pays” litigation model that prevails there.

 

The obvious concern is that the increasing availability of litigation funding could fuel litigation and even encourage frivolous lawsuits. The Journal article quotes principals at several of the leading litigation funding firms to the effect that the requirement to produce a return on capital acts as a disciplining mechanism, providing a strong disincentive for the firms to become involved in suits lacking merit.

 

The requirements of the capital markets do provide a certain kind of discipline, but history has shown that capital does not invariably make the best choices. Moreover, with the kinds of results that the early entrants are producing, new capital will continue to be attracted to the litigation funding arena. The prospect for rich returns and low barriers to entry increase the likelihood that less meritorious litigation could find funding, or even that funds desperate to produce returns comparable to other funders encourage more speculative suits. Recent history shows what can happen when an asset class gets frothy, and there is nothing about litigation as an asset class that makes it immune from these kinds of risks.

 

Even without the market problems that over-exuberance can produce, the presence of litigation funding could drive up litigation costs. The cost of litigating a dispute in the United States is enormous, but the high litigation costs do enforce a form of self-regulation. The prospect of astronomical litigation costs has a way of driving many commercial litigants to the settlement table. Many litigants find it rational to try to find a business solution rather than prolong a distracting and costly dispute. But if the dispute itself is its own business venture, will litigants (or perhaps their financial backers) choose to prolong a case rather than to try to resolve it?

 

Perhaps these fears about the possible effect of litigation funding are unfounded. Given that litigation funding is here now and appears like it is going to be increasingly important, I hope I am wrong. The problem for all of us is that the litigation funding could have significant effects on our litigation system. The experiment is already underway. The full ramifications of this experiment may only become apparent over time. Like it or not, the test is already in progress.

 

One Final Note. In the past when I have written about litigation funding, I have immediately received a flood of calls and emails from people looking for litigation funding. Friends, I am a blogger. I do not offer litigation funding nor do I make referrals for litigation funders. I have mentioned several funders above and there are many more to be found on the Internet. If you want litigation funding, please contact one of the many litigation funders.  Please don’t call or email me looking for litigation funding.

 

One of the more vexing litigation problems to emerge recently has been the proliferation of multi-jurisdiction litigation, where corporate defendants are forced to litigate essentially the same claim in multiple courts at the same time. This problem is a particular issue in the context of M&A litigation, although not contained to those kinds of lawsuits. In the midst of what has become essentially a jurisdictional competition, Delaware’s courts have tried to establish themselves as the preferred and presumptive court for corporate litigation.

 

As discussed here, in June 2012, in a high-profile and controversial example of the efforts of Delaware courts to control litigation involving Delaware corporations, Vice Chancellor Travis Laster refused to give effect to the judgment of a California federal court dismissing a derivative suit parallel to the case pending in Delaware.

 

However, in a harsh rebuke to Laster, on April 4, 2013, the Delaware Supreme Court entered an opinion reversing the Chancery Court ruling and recognizing the California federal court’s prior dismissal. The Supreme Court’s opinion represents a recognition that principles of federalism and comity require Delaware’s courts to respect the preclusive effects of the California court’s judgment.

 

Background

In September 2010, Allergan pled guilty to a criminal misdemeanor for misbranding its Botox product and paid a total of $600 million in civil and criminal fines. Various plaintiffs’ firms filed multiple derivative suits both in federal court in California and in Delaware Chancery Court. The California cases went forward more quickly, while in Delaware, at least one of the plaintiffs sought to pursue a books and records action against the company, in order to obtain further information pertinent to the company’s board’s actions. The Delaware plaintiff used the information and documentation to amend its complaint. The California plaintiffs ultimately also obtained the same information and documentation and supplemented their complaint as well.

 

The defendants moved to dismiss the California action on the ground that the plaintiffs had not made a demand on the Allergan board to pursue the claims, nor had they established demand futility. The California court granted the defendants’ motion to dismiss. The defendants then sought to have the Delaware action dismissed, arguing that the collateral estoppel effect of the California dismissal was preclusive of the demand futility issue.

 

In an extensive June 11, 2012 opinion (here), Vice Chancellor Laster firmly rejected the suggestion that the California court’s prior ruling compelled him to dismiss the Delaware action. He relied on two grounds in rejecting the argument that the California judgment is preclusive; first, he found that the California judgment was preclusive only as to the individual California shareholder plaintiffs, and second, he found that the California plaintiff did not adequately represent Allergan. The defendants pursued an interlocutory appeal to the Delaware Supreme Court.

 

The April 3, 2013 Opinion

In an April 4, 2013 opinion written by Justice Carolyn Berger for the full Court, the Delaware Supreme Court reversed the Chancery Court’s ruling, holding that the Vice Chancellor had erred with respect to both aspects of his ruling. The Supreme Court concluded that the California judgment was preclusive of the Delaware case and also rejected Vice Chancellor Laster’s conclusion that the California plaintiffs were inadequate representatives.

 

In rejecting the Chancery Court’s conclusion that the California judgment was not preclusive, the Supreme Court noted that the U.S. Constitution’s full faith and credit clause requires courts to give full force and effect to the judgments of other jurisdiction’s courts, including the judgments of federal courts. Vice Chancellor Laster’s refusal to give effect to the California judgment was based on a “mistaken premise” that the question of the effect of the California judgment was controlled by “demand futility” law controlled by Delaware legal principles.

 

The Supreme Court stated that “once a court of competent jurisdiction has issued a final judgment … a successive case is governed by principles of collateral estoppel, under the full faith and credit doctrine, and not by demand futility law,” adding that “in the Court of Chancery, the motion to dismiss based on collateral estoppel was about federalism, comity, and finality. It should have been addressed exclusively on that basis.’  Delaware’s “undisputed interest” in governing the internal affairs of its corporations “must yield to the stronger national interests that all state and federal courts have in respecting each other’s judgments.”

 

The Supreme Court also rejected the Chancery Court’s conclusion that the California plaintiffs were inadequate plaintiffs. The Supreme Court noted that Vice Chancellor Laster had “sua sponte announced and applied an irrebutable presumption that derivative plaintiffs who file their complaints without seeking books and records very shortly after the announcement of a ‘corporate trauma’ are inadequate representatives.” The Supreme Court said that “we reject the ‘fast filer’ irrebutable presumption of inadequacy.” The Court noted that “undoubtedly there will be cases where a fast filing stockholder also is an inadequate representative” but that “there is no record support for the trial court’s premise that stockholders who filed quickly, without bringing a Section 220 books and records action, are a priori acting on behalf of their law firms instead of the corporation.” The Court added that although it “understands the trial court’s concerns about fast filers,” the remedies “for the problems they create should be directed at the lawyers, not the stockholder plaintiffs or their complaints.”

 

Discussion

As I discussed at the time, Vice Chancellor Laster’s opinion in this case was a broadside against certain segments of the plaintiffs’ bar, who, in his view, rush to file actions in other jurisdictions’ courts, to the detriment of litigants that proceeded more deliberately by first pursuing a books and records action in Delaware court and then in due course filing an action in Delaware based on the results of the books and records search.

 

While Laster’s effort to create a Delaware-centric solution to the chaos of multi-jurisdiction litigation is understandable, it put the defendants in the unacceptable position not only have having to face a multi-front war,  but also having to fight the war in piecemeal fashion, rather than trying to move toward a single, comprehensive solution.

 

The Supreme Court’s opinion does not directly take on the problems arising from multi-jurisdiction litigation, but merely recognizes that basic principles of “federalism, comity and finality” required that the judgment of California court be given full force and effect. However, the Supreme Court did reject the Chancery Court’s suggestion that the plaintiffs in the California case were inadequate representatives simply because they failed to first pursue a books and records action before launching their suit. As Alison Frankel noted in an April 5, 2013 post on her On the Case blog (here), the Supreme Court Opinion “puts an end to Chancery’s recent insistence that shareholder lawyers seek corporate books and records before filing derivative complaints.”

 

In effect, Laster’s Chancery Court opinion seemingly embodied a belief that both that Delaware’s courts should be in charge, and that if the Delaware courts were in charge, an orderly process would replace the unseemly spectacle of multi-jurisdiction litigation. There is no doubt that the curse of multi-jurisdiction litigation imposes enormous, duplicative costs on the litigation targets. But Vice Chancellor’s Delaware-centric manifesto threatened to exacerbate the problem rather than solve it, presenting as it did the prospect for multiple conflicting rulings in different jurisdictions on identical issues.  The Supreme Court’s opinion suggests a recognition that the curse of multiple-jurisdiction litigation won’t be resolved by Delaware’s courts grabbing authority or disdaining other courts. 

 

In its April 4, 2013 client alert (here), the Wachtell Lipton law firm noted that the Delaware Supreme Court’s ruling “makes clear that Delaware is sensitive to the unfairness that multiple parallel lawsuits can work on corporations and their directors and is prepared to enforce scrupulously rules of interstate comity that limit this mischief.”

 

The Delaware Supreme Court’s decision is a welcome outcome for corporate litigants. As the Wilson Sonsini law firm noted in its April 2013 client alert about the decision, the ruling "may calm the concerns of those facing multi-forum shareholder litigation that a resolution on the merits in one forum will be given preclusive effect in Delaware (and presumably other jurisdictions)."

 

Just the same, though defendants undoubtedly will welcome the Delaware Supreme Court’s ruling, it will not eliminate the problem of multiple-jurisdiction litigation. The unseemly scramble of competing claimants to pursue claims against companies experiencing adverse developments or involved in corporate transactions will continue. The solution to the problem of multi-jurisdiction litigation has been and remains particularly elusive.

 

As I have previously noted on this blog (most recently here), plaintiffs’ lawyers recently have evolved a new approach to litigation relating to the advisory “say on pay” vote required under the Dodd-Frank Act. Under this most recent version of the say on pay litigation, the plaintiffs’ lawyers seek to enjoin upcoming shareholder votes on compensation or employee share plans on the grounds of inadequate or insufficient disclosure.

 

On April 3, 2013, Northern District of Illinois Judge Amy St. Eve entered an order granting the motion to dismiss of the defendants in one of these latest say on pay cases. A copy of Judge St. Eve’s April 3 opinion can be found here. An April 4, 2013 Reuters by Nate Raymond about Judge St. Eve’s decision can be found here.

 

As reflected in Claire Zilman’s April 4, 2013 Am Law Litigation Daily article about Judge St. Eve’s April 3 ruling (here), the defendants in the case before Judge St. Eve were represented by the Katten Muchin Rosenman LLP law firm. In the following guest post, Bruce G. Vanyo, Michael J. Lohnes and Christina L. Costley of the Katten Muchin  law firm take a detailed look at Judge St. Eve’s ruling and discuss the significance of the decision, including possible implications of the decision for other pending say on pay cases as well as other cases that may be raised in connection with the upcoming proxy season.

 

I will like to thank Bruce, Michael and Christina for their willingness to publish their article on my site. I welcome guest posts from responsible commentators on topics relevant to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly. Bruce, Michael and Christina’s guest post follows:

 

The Dodd-Frank say-on-pay strike suits, if not yet dead, are close. Section 951 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), 15 U.S.C. § 78n-1, requires that public companies permit shareholders to cast advisory votes on executive compensation at least once every three years. Though the Dodd-Frank Act specifically stated it did not “create or imply any change to the fiduciary duties” or “create or imply any additional fiduciary duties,” the plaintiffs’ bar immediately began bringing suits for breach of fiduciary duty following any negative say-on-pay vote. Plaintiffs initially brought the lawsuits after companies’ annual meetings and framed them as derivative claims for waste. In 2011 and early 2012, courts consistently dismissed these cases at the pleading stage, holding that plaintiffs could not plead demand futility based on a board’s decision to disregard an advisory vote. See Gordon v. Goodyear, No. 12 C 0369, 2012 WL 2885695, at *9-10 (N.D. Ill. July 13, 2012).

 

In mid-2012, the plaintiffs’ bar tried a new approach. Instead of bringing derivative suits after a negative say-on-pay vote, they began bringing direct suits seeking to enjoin the say-on-pay vote before it occurred. The real goal, of course, was settlement: if the corporate defendant would agree to make modest additional disclosures, and agree to an attorneys’ fee settlement in the range of $100-$500K, plaintiffs would immediately dismiss the case. Though the cases had little substance, the expense of fighting them and the risks posed by a forced delay of an annual meeting still drove settlements. Some companies chose to fight, however, and in every “pure” say-on-pay case brought, courts refused to issue injunctions. But, because the complaints alleged material omissions (materiality is ordinarily not a matter that can be resolved on the pleadings) most companies answered the complaint instead of moving to dismiss and found themselves in protracted litigation as a result. One notable exception was the Symantec case, which was dismissed by a California state court on the pleadings.

 

On April 3, 2013, the United States District Court for the Northern District of Illinois issued the first federal court decision on this issue in Noble v. AAR Corp., No. 12-C-7973 (N.D. Ill. April 3, 2013). AAR and its directors had already successfully opposed plaintiffs’ motion for a preliminary injunction. Following the decision on the preliminary injunction defendants immediately moved to dismiss and stay discovery. The court granted the motion to stay discovery and postponed all further hearings. Six months later, the court issued a written decision granting with prejudice defendants’ first motion to dismiss. First, the court held that a corporation cannot face liability under the Dodd-Frank Act for omitting information in its proxy statements not required to be disclosed by the applicable federal regulations, Items 402 and 407. Second, the court held, after a say-on-pay vote has occurred, plaintiffs cannot plead a direct cause of action because no injury personal to the shareholder exists. Instead, the court held, any claim that remains can be brought only as a derivative claim for waste. The court called plaintiff’s efforts to maintain the claim as a direct action “painting a derivative claim with a disclosure coating.”

 

The implications of AAR should be far-reaching. The AAR judge also issued the decision in Goodyear, a widely cited decision largely responsible for dispensing of plaintiffs’ efforts to bring post-vote say-on-pay claims. By holding that plaintiffs cannot bring a pre-vote breach of fiduciary duty claim based on the Dodd-Frank Act when a company has already complied with federal regulations, the court offers corporations comfort that strict compliance with pre-existing disclosure regulations should suffice to fend off lawsuits even at the pleading stage. And, by finding that the claim can only be maintained as a derivative action for waste, the court signaled to the plaintiffs’ bar that any attempt to bring a claim based on executive compensation must be strong enough to survive heightened demand futility analysis. In effect, the court has given corporations a way out of these cases at the pleading stage, before they are forced into prolonged and expensive discovery and summary judgment motions, and thus given effect to the Dodd-Frank Act’s stated intent to avoid creating a new basis for litigation.

 

The AAR decision comes just as proxy season is beginning. The proliferation of say-on-pay cases filed in mid- to late 2012 suggested that 2013 proxy season was going to be a mess, with lawsuits being filed in connection with every say-on-pay vote. The AAR decision will go a long ways towards preventing that. The number of say-on-pay investigation notices has already been declining relative to the number of proxy statements being filed, but with AAR, defense counsel will have a concrete tool and a well-reasoned opinion to give other courts comfort that these lawsuits should be dismissed early. The threat is not gone entirely, however, as a second wave of cases related to share authorization and equity compensation have received a relatively warmer reception by courts and have been picking up steam as proxy season continues.
 

 

As a result of the U.S. Supreme Court decision in Morrison v. National Australia Bank, investors who purchased their shares in a company’s stock on a non-U.S. exchange are unable to pursue securities claims against the company or its management in U.S. courts. I have long thought these investors’ preclusion from U.S. courts would force them to try to develop remedies in their home jurisdictions – which is what it appears that RBS investors, whose U.S. securities claims were dismissed,  now appear to be doing.

 

The near failure and British government bailout of RBS was one of the highest profile features of the global financial crisis. RBS’s collapse follow a series of massive asset write-downs that occurred at RBS due to the company’s substantial holdings in subprime and other mortgage-backed assets and as a result of the company’s disastrous October 2007 acquisition of 38% of ABN Amro.

 

As discussed here, in January 2009, the first of a series of securities class action lawsuits were filed in the Southern District of New York against RBS and certain of its directors and officers. As detailed here, in a January 11, 2011 ruling, Southern District of New York Judge Deborah Batts granted the defendants’ motion to dismiss the claims of RBS shareholders who had purchased their company shares on a non-U.S. exchange. As I noted at the time in my post about Judge Batts’s ruling, “The interesting question is whether the disappointed RBS claimants … will now seek to pursue their claims against the RBS defendants in a non-U.S. jurisdiction.” Based on recent developments, the answer to this question now appears to be “Yes.”

 

As detailed in an April 3, 2013 Law 360 article (here, registration required) and in an April 3, 2013 post on Alison Frankel’s On the Case blog (here),  in the last week, two separate shareholder groups have taken step to initiate claims in U.K. courts against RBS and certain of its directors and officers. The shareholder groups claim that in its prospectus for its April 2008 rights offering, the company misrepresented its financial condition.

 

According to a March 28, 2013 article in The Lawyer (here), a law firm representing UK and international financial institutions and pension funds filed a claim in London’s High Court laws week. And as detailed on their website, on April 3, 2013, a separate group called the RBOS Shareholders Action group has separately initiated a High Court action against RBS and four of its directors and officers. The group’s website does not link to an actual copy of their complaint, but the site does provide a brief description of their allegations. The website also claims that the group represents “over 12,000 private shareholders, many of whom are pensioners, and over 100 institutional investors who lost money in the RBS 2008 rights issue” and estimates that the value of the group’s claim may be valued at as much as £4 billion.

 

As Frankel notes in her post about the U.K. litigation developments, one of the impediments in the past for prospective claimants considering these types of claims has been the U.K.’s “loser pays” rules, whereby an unsuccessful claimant has to be prepared to pay its adversary’s legal costs. What has changed is that insurers have developed a product called “After the Event” policies that protect against the risk that claimants might have to pay the defendants’ legal fees if there is an unsuccessful outcome. The RBOS Shareholders Action group itself says on its website that it has “adverse cost cover” in place.

 

The initiation of these actions against RBS is just the latest in a series of developments in which non-U.S investors, precluded from pursuing claims in U.S. courts, have sought to pursue claims in their own country. As the sequence of events here shows, the prospective claimants’ ability to pursue claims depends in many ways on claimants taking an innovative approach. Of course, it remains to be seen whether or not the RBS claimants’ U.K. claims will result in any recovery. But as aggrieved claimants continue to innovate, the opportunity to pursue claims may become more apparent to other prospective claimants. These kinds of claims could become more common, not only the U.K. but elsewhere as well. The development and availability of litigation funding mechanisms will help to spur these developments. This process may already be well under way in Canada, Australia, and arguably even Germany (where disappointed Porsche investors, closed out of U.S. courts, have filed claims against the company in Germany).

 

Today’s Candidate for Coolest Website: How far is it to Mars? One hell of a lot farther than you think it is. Check out this seriously cool website here.

 

Berkshire Hathaway Chairman Warren Buffett is often referred to as the “Sage of Omaha” and is respected for his business insight. But in many ways his reputation for sagacity is simply a by-product of a very basic, company-related project. What Buffett set out to do was to cultivate a certain type of shareholder for Berkshire – one that that understands and appreciates his long-run approach to investing. In the 1988 shareholders’ letter, Buffett makes this explicit when he says that “all of our policies and our communications are designed to attract the business-oriented long-term owner and to filter out possible buyers whose focus is short-term and market-oriented.”

 

Buffett’s annual letters to Berkshire shareholders serve first and foremost to explain what he is doing, so that the shareholders understand what they are in for. The letters assume that the shareholders are long-term owners, and so much of the letters’ content presumes familiarity with prior letters. In other words, each additional letter is a part of a continuing conversation (or, perhaps, monologue) and each letter can be best appreciated within that larger context.

 

All of Buffett’s shareholder letters for the years 1977 through 2012 are available on the Berkshire website, and anyone interested in developing a better understanding of Buffett’s approach and investing philosophy — and in seeing how Buffett has addressed his key themes over time — can freely access the letters.

 

However, most readers would find the prospect of reading 36 years’ worth of shareholder letters to be a forbidding prospect. For starters, the letters are arranged chronologically, not thematically, so even a very determined reader might find it challenging to work through the archive and emerge with a systematic understanding of how Buffett has developed his key themes over time. It can also be daunting to try to find among the various letters the place where Buffett has, for example, mentioned mutual fund directors, or described derivatives as “weapons of financial mass destruction.”

 

Fortunately for anyone interested in better understand Buffett’s philosophy or in trying to find what he has said on a particular topic, there is a brilliant alternative to simply working through all of the letters. George Washington University Law Professor Lawrence Cunningham has collected and edited Buffett’s letters and other writings into a highly readable and topically indexed volume entitled “The Essays of Warren Buffett: Lessons in Corporate America,” the third edition of which was released earlier this year. Cunningham has done a masterful job distilling Buffett’s writings and organizing them by topic

 

The latest edition is updated to include excerpts from Buffett’s most recent letters. The book not only facilitates quick location of Buffett’s statements on specific topics, but it also affords an opportunity to see how Buffett has developed his themes over time, which unquestionably provides great insight into Buffett’s investment views.

 

Because Buffett wants to the Berkshire shareholders to understand the company’s business, one of the principal focuses of Buffett’s annual letters is the topic of how to understand and use financial information. What makes Buffett’s letters so interesting and rewarding to read is how clearly he can explain even relatively complex financial concepts. Buffett also frequently writes with humor – for example, in explaining the need to allow a particular project to unfold , he notes that “No matter how great the talent or effort, some things just take time; you can’t produce a baby in one month by getting nine women pregnant.”

 

Sometimes in the course of his annual letters, it seems as if Buffett has a penchant for going off on tangents. However, reading Buffett’s essays arranged thematically reveals the way that some of these seemingly tangential asides fit into larger themes. For example, Buffett’s fulminations about stock options fit within the larger context of executive compensation, which in turn is a topic that relates the more basic concern of what makes a firm a well-managed company. Understanding what Buffett thinks makes a company well-managed in turn helps explain Berkshire’s investments – which is the ultimate purpose of his letters.

 

The letters obviously have far greater value than simply helping Berkshire investors to understand the company. Indeed, Buffett’s dissertations on investing are full of remarkably good and practical advice. (Indeed, even though I am a long-standing Buffett devotee, and, I should add, a Berkshire shareholder as well, I found it worthwhile to re-read the excerpts about investing collected in this book.) For example, Buffett notes that there are three primary causes for investors to experience poor investment results: high costs, portfolio decisions made based on tips and fads rather than basic principles; and a start-and stop approach to the market marked by untimely exits and entries. Buffett concludes by noting that “Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.”

 

While Cunningham’s book provides a thorough overview of Buffett’s writings, there are omissions. As I also noted in my review of the prior edition of this book, I think the volume would be even more complete were it to include selections from Buffett’s writing over the years about insurance. The insurance business has been the segment on which Buffett has concentrated the most, and his reasons for his focus on this industry convey a lot about his approach to investing and his understanding of how business cycles work. In particular, Buffett’s many comments about “float” and the insurance “cycle” convey a lot about what his overall approach to investing and business.

 

Another gripe I have is, as I also noted in connection with the prior edition, though this volume omits Buffett’s writings generally about insurance, somehow the book manages to include every single instance where Buffett has said that his company does not carry D&O insurance. I have always thought that these statements are dangerous for mere ordinary mortals. It is fine for Buffett and his billionaire board members to disdain D&O insurance (particularly given that the corporate indemnity that Berkshire provides is more financially sound than any insurance commitment would be), but persons of more ordinary means can ill afford to run the risk of uninsured board service.

 

But these quibbles are minor. The book itself is quite an accomplishment; it is that rare business book that is both worthwhile and enjoyable to read.

 

Special thanks to Professor Cunningham for calling my attention to the book.

 

A year ago, President Obama signed the Jumpstart Our Business Startups (JOBS) Act, a legislative product of rare bipartisan collaboration that was intended to improve employment and make it easier for smaller firms to raise private equity. (For an overview of the Act’s provisions, refer here.) Twelve months later, many of the rules needed to implement the JOBS Act remain uncompleted and the legislation’s promise remains largely unfulfilled.

 

As detailed in a March 29, 2013 Washington Post article entitled “JOBS Act Falls Short of Grand Promises” (here), “nearly a year after its enactment, major portions of the act are in limbo, and other parts have failed to measure up to the grandiose job-creation promises.”

 

The JOBS Act was specifically intended to aid “Emerging Growth Companies” (ECGs), which the Act defined as companies with annual revenues under $1 billion. Among other things, the Act was intended to make it easier for these companies to go public. It would be hard to make the case that the JOBS Act has delivered a boost to initial public offerings. As detailed in a March 27, 2013 Wall Street Journal article entitled “JOBS Act Sputters on IPOs” (here), in the twelve months since the Act’s passage IPOs of ECGs “are on track to fall 21% to 63 from 80 in the prior year.” The Journal article does note that a number of market and economic factors “helped chill the climate for IPOs over the past year” and “the IPO market is showing signs of improving health.”

 

Another concern about the IPOs that are taking advantage of the Act’s provisions is that some may not be exactly represent the kind of companies Congress had in mind. For example, one of the companies that completed its offering while taking advantage of the JOBS Act’s so-called “IPO on-ramp” provisions, was Manchester United, a 135 year old sports club based in Manchester, England, that, though obviously unlikely to create any U.S. jobs, nevertheless qualified as an “Emerging Growth Company.” As Jason Zweig noted in his August 3, 2012 Wall Street Journal article entitled “When Laws Twist Markets” (here), among the other companies taking advantage of the JOBS Act provisions are “blank check companies,” noting that “In an irony only Congress could foster, many of the blind pools rushing to list under the JOBS Act have no employees and say in their prospectuses that they might never hire anybody at all.”

 

Even for ECGs that completed IPOs after the JOBS Act was enacted, the impact of the IPO on-ramp provisions has been mixed. A January 2013 memo from the Skadden firm entitled “The JOBS Act: What We Learned in the First Nine Months” (here) analyzed the 53 ECGs that completed IPOs between April 5, 2012 ad December 15, 2012. The memo relates that certain of the Act’s provisions, such as the provision allowing draft registration statements to be submitted confidentially and the provision allowing ECGs to provide scaled-down executive compensation disclosure, have met with “strong acceptance.” Other provisions such as the option for ECGs to provide an abbreviated period of financial statement disclosure, have met with only “weak acceptance.” Yet other provisions, such as those allowing “test the waters” communications in advance of the offering, have met with “mixed acceptance.” As pointed out in the March 2013 issue of CUG.COMments (here), while “certain aspects” of the JOBS Act “have been seized upon by ECGs,” the ECGs’ “utilization of the available benefits” has been “inconsistent.”

 

While the IPO on-ramp provisions have had a mixed effect, the “most significant bits” of the Act, according to a March 30, 2013 Economist article entitled “America’s JOBS Act: Still Not Working” (here) are “bottled up at the SEC.” Most importantly, the SEC still has not issued rules to implement the Act’s provisions relating to Crowdfunding. The SEC also has not issued rules to allow companies to raise as much as $50 million in the public markets without undertaking reporting obligations, nor has it issued rules lifting restrictions on advertising private securities offerings.

 

Among the reasons for the delays on the crowdfunding rules has been an internal debate within the SEC about the best approach to take. According to the Economist, Mary Shapiro, the outgoing SEC chairman was concerned that the JOBS Act would “eliminate important protections for investors” and she was particularly critical of the crowdfunding provisions. It remains to be seen what the approach will be of the incoming chair, Mary Jo White; at a minimum, it may be many months before the final rules are put into effect.

 

My earlier post on concerns about problems with crowdfunding can be found here. A more basic question concerns who will actually be able to take advantage of crowdfunding, given the Act’s statutory constraints, an issue I discussed here.

 

According to the Post article linked above, the Act’s mixed record has occasioned some concerns and even regrets on Capitol Hill. There is now a perception in Washington that the Act, described in the article as “a grab bag of ideas cobbled together for greater impact,” was “hastily introduced” and enacted due to election year pressures with “record speed.” The result, according to unnamed critics, is “laws fraught with risks to investors.” At a minimum, the Act “underscores how difficult it can be for Washington to spur job creation even when there’s strong bipartisan consensus on a plan.”

 

The picture is not entirely negative. According to the Journal, biotechnology companies, which have been “a bright spot for IPOs during the past year,” appear to be “using the new rules more than other companies.” Many biotech firms are unprofitable when they go public and they find that “the ability to save time and money by taking advantage of the relaxed standards was beneficial.”

 

Among many others concerned with the Act and its possible implications, D&O insurers continue to weigh the Act’s effects. For now, most insurers continue to await developments, particularly the introduction of the crowdfunding rules. The insurers remain concerned about possible crowdfunding abuses and about the liability measures in the crowdfunding provisions. Some insurers have already started adding crowdfunding exclusions to their private company D&O insurance policies. At a minimum, the delays attending the Act’s implementation have introduced an element of uncertainty, which likely has increased the insurers’ general wariness. The general perception seems to be that the Act could still have a significant impact on the scope of policyholders’ potential liability, but exactly what that might mean remains to be seen. Even after a year, the Act’s impact remains unclear, for insurers as for other observers and commentators.

 

About the Ruling in the Consolidated Libor-Scandal Antitrust Litigation: Readers interested in Judge Buchwald’s opinion in the consolidated Libor-scandal antitrust litigation (about which refe here), and who are wondering what remains after the recent rulings and what the implications may be for the other Libor-related lawsuits will want to review Alison Frankel’s April 1, 2013 post on her On the Case bliog (here). Frankel has a detailed analysis of what portions of the consolidated cases remain after the ruling, as well as what it all might mean for the other cases before Judge Buchwald as well as the cases that have not yet been consolidated in her court.

 

Yet Another Modest Securities Suit Settlement Involving U.S. Listed Chinese Company: During 2010 and 2011, plaintiffs’ lawyers rushed to file lawsuits against U.S.-listed Chinese companies that caught up in various accounting scandals. However, as I have previously noted, even the cases that have survived the preliminary motions have produced only very modest settlements.

 

In the latest example of one of these cases settling modestly, on April 1, 2013, the plaintiffs’ lawyers in the securities suit involving Deer Consumer Products announced that the case had been settled for $2.125 million. As noted in the parties’ stipulation of settlement (here), the settling defendants include the company and two individuals, although the released defendants appear to include all of the Deer company-related defendants. The settlement does not appear to involve the payment of any insurance funds; the stipulation recites that the settlement amount “shall be paid exclusive by the Settling Defendants.”

 

As I recently noted (here, second item), the exceptions to this pattern of the securities suits against U.S.-listed companies settling modestly are the cases in which there are significant settlement contributions from the companies’ outside professionals. For example, as discussed in the recent post, the recent $20 million settlement in the case involving Sinotech Energy Limited included an $18 million settlement contribution from the company’s offering underwriters. And of course there is the eye-popping $117 million settlement payment by Ernst & Young in the Ontario securities class action lawsuits involving Sino Forest.

 

The plaintiffs’ lawyers in the Deer Consumer Products, perhaps recognizing the impact of the claims against the Chinese companies’ outside advisors, on March 9, 2013 filed a separate action in the Central District of California against the company’s outside auditors, Goldman Kurland Mohindin,  in what appears to be something of a second phase of litigation.

 

Rule 10b5-1 Trading Plans: “Avoiding the Heat”: The SEC promulgated Rule 10b5-1 in order to allow company insiders to safely trade in their company securities without incurring liability under the securities laws. As it has turned out, trading under Rule 10b5-1 plans has been a source of significant scrutiny, as I recently noted here. Nevertheless Rule 10b5-1 trading plans can still provide significant liability protection, if they are set up, implemented and maintained appropriately.

 

A March 11, 2013 memo from the Covington & Burling law firm entitled “Rule 10b5-1 Trading Plans: Avoiding the Heat” (here) lays out the practical steps that companies and their executives can take to try to take advantage of the Rule and to avoid the issues that have caused problems with trading plans in the past. The memo’s authors note that “remains a beneficial and frequently utilized provision to permit corporate insiders to sell the securities of their companies while minimizing the risk of engaging in insider trading.” However, they add that “public companies and insiders seeking to rely on Rule 10b5-1 should renew their focus on ensuring that their trading plans comply with the requirements of the rule.”