As I have discussed in prior posts (refer here for example), one of the recurring D&O insurance coverage issues that has arisen in connection with the FDIC’s failed bank litigation is the question whether or not the FDIC’s claims as receiver for the failed bank against the bank’s former directors and officers trigger the D&O policy’s insured vs. insured exclusion. In a terse January 4, 2013 opinion (here), Northern District of Georgia Judge Robert L. Vining, Jr. held that, owing to the “multiple roles” in which the FDIC acts in pursuing claims against the former directors and officers of a failed bank, there is “ambiguity” on the question whether the FDIC’s lawsuit triggers the insured vs. insured exclusion.

 

Background

Omni National Bank of Atlanta Georgia failed on March 27, 2009 (refer here). The FDIC was appointed as receiver for the failed bank. On March 16, 2012, the FDIC initiated a lawsuit in the Northern District of Georgia against ten former directors and officers of the bank, asserting claims against the defendants for negligence and gross negligence in connection with the approval of certain loans on low-income residential properties.

 

The bank’s D&O insurer initiated a separate declaratory judgment action seeking a declaration that there is no coverage under the bank’s D&O policy for the FDIC’s claims against the bank’s former directors and officers.

 

The D&O insurer filed a motion for summary judgment the declaratory judgment action, on three grounds: first: the carrier argued that because the FDIC as receiver “steps into the shoes” of the failed bank, the FDIC’s claim represents a claim “by, on behalf of, or at the behest of, the Company,” and therefore is precluded from coverage under the policy’s insured vs. insured exclusion; second, that the losses the FDIC seeks to recover do not fall within the policy’s definition of “loss,” which includes the so-called “loan loss carve-out”; and third that the policy does not in any event provide coverage for wrongful acts alleged against the former directors and officers that took place after the policy’s expiration.

 

The January 4 Opinion

In his January 4, 2013 opinion, Judge Vining denied the carrier’s motion for summary judgment with on the first two grounds, but granted summary judgment with respect to the alleged wrongful acts that took place after the policy’s expiration.

 

In rejecting the insurer’s argument that coverage is precluded by the policy’s insured vs. insured exclusion, Judge Vining said that “it is unclear whether the FDIC-R’s claims are ‘by ‘or ‘on behalf of’ the failed bank.” He added that “it is unclear what exactly is encompassed by the phrase ‘steps into the shoes.” These “ambiguities” arise, Judge Vining found, “in part because the FDIC-R differs from other receivers or conservators that might step into the shoes of a failed or insolvent bank.”

 

Judge Vining then reviewed the FDIC’s authority under FIREEA to recover losses, and the fact that in recovering losses the FDIC has authority to act on behalf of the bank’s depositors, creditors and shareholders.  Judge Vining noted that “the FDIC-R has multiple roles.” Accordingly, he concluded that “the FDIC-R has show that some ambiguity exists in the insured versus insured exclusion,” and he denied the carrier’s motion for summary judgment in reliance on the exclusion.

 

Judge Vining also rejected the carrier’s motion for summary judgment based on the argument that the financial losses the FDIC sought to recover did not constitute covered loss under the policy. Judge Vining found that “ambiguity exists in the definition of ‘loss’” because the “loan loss carve-out” does not “clearly exempt tortious claims” which is “the basis” for the FDIC’s claims in the underlying D&O liability action.

 

Discussion

Although D&O insurers have raised the insured vs. insured exclusion as a defense to coverage in connection with a number of FDIC failed bank claims, Judge Vining’s ruling in the Omni National Bank is so far as I am aware only the second ruling in connection with the current failed bank wave in which a court has made a ruling regarding the applicability of the insured v. insured exclusion to an action brought by the FDIC in its capacity as a receiver for a failed bank.

 

As discussed here, in October 2012, District of Puerto Rico Judge Gustavo Gelpi denied the D&O insurer’s motion to dismiss the coverage action the FDIC had brought against the carrier under Puerto Rico’s direct action statute. The D&O carrier involved had sought to dismiss the suit on the grounds that the D&O policy’s insured vs. insured exclusion precluded coverage for the FDIC’s claims in its capacity of the failed Westernbank against the bank’s former directors and officers. Judge Gelpi declined to dismiss the action, noting that the FDIC has authority under FIRREA to act “on behalf of depositors, account holders, and a depleted insurance fund,” and therefore that “the FDIC’s role as a regulator sufficiently distinguishes it from those whom the parties intended to prevent from bringing claims under the Exclusion.”

 

In both cases, the respective judges held that the carriers were not entitled to a determination as a matter of law that the exclusion precluded coverage. Both Judge Gelpi in the prior case and Judge Vining here determined that the Insured vs. Insured did not preclude coverage as a matter of law because the FDIC has the authority under FIRREA to act on behalf of a variety of different constituencies. The FDIC as well as individual directors and officers seeking coverage under their bank’s D&O insurance policies undoubtedly will seek to rely on these rulings in order to try to fight other carrier’s attempts to assert the Insured vs. Insured exclusion as a defense to coverage.

 

The insurers, however, will likely contend that even if the FDIC is acting on behalf of these other constituencies in bringing the suit, it is first and foremost bringing the suit in its capacity as receiver for the failed bank, as that is the basis upon which it has any right to bring the claims in the first place. The insurers will further argue that the sole basis on which the FDIC has any right to assert the claims is because, by operation of the receivership, it is acting “in the right of” the failed bank, and therefore the preclusive language of the exclusion applies, notwithstanding the fact that the FDIC may have other purposes and motivations in bringing the action.

 

The carriers will further argue that the policy’s exclusion does not require, in order for the exclusion to apply, that the action be brought “solely” or “only” “in the right of” the Organization. The insurers will argue that because the action was brought “in the right of” the Organization, the exclusion applies notwithstanding the fact that in bringing the claim the FDIC was also action on behalf of other constituencies.

 

Though these rulings unquestionably are helpful for the FDIC and the individual directors and officers, it seems likely that these issues will continue to be litigated in other cases.

 

Special thanks to a loyal reader for providing me with a copy of Judge Vining’s January 4 Order.

 

If you were among the many who extended the holiday vacation all the way through the short week following New Year’s Day, you may not have seen the year-end retrospective articles that I posted last week, including my list of the Top Ten D&O Stories in 2012 (here), and my year-end analysis of 2012 securities class action lawsuit filings (here). As it turns out, I am not the only one to have posted year-in-retrospective posts over the last several days. Several other bloggers and commentators have done the same. Here is a quick tour through several of the noteworthy year- end retrospectives.

 

First, over at the Delaware Corporate and Commercial Litigation Blog, Francis Pileggi and his colleague Kevin Brady (both of the Eckert Seamans law firm) have posted their list of the “Key Delaware Corporate and Commercial Decisions of 2012” (here). The post begins with the authors’ selection of the top five cases from 2012 and includes both the authors’ list of the top Delaware Supreme Court decisions and Court of Chancery decisions for the year. The authors helpfully link to their own prior posts on the key cases as well as to the decisions themselves. I should add that the Delaware Corporate and Commercial Litigation Blog is one of the top blogs out there, one that truly is indispensable.

 

By way of interesting contrast, readers may want to refer to Professor Jay Brown’s Race to the Bottom Blog, where the Professor and his blog colleagues are running an interesting series on the topic of “Delaware’s Five Worst Shareholder Decisions of 2012”(refer here).

 

Andrew Trask has a couple of year-end posts on his Class Action Countermeasures blog. On January 2, 2013, Trask posted his list of the ten most significant class action cases of 2012 (here), and then on January 3, 2013, he added his list of the “Ten (Most) Interesting Class Action Articles of 2012” (here). In the latter post, Trask noted (in bold letters, no less) there “there just wasn’t that much that merited the title ‘interesting’ in class action scholarship” in 2012.

 

On the Conflict of Interest Blog (here), author Jeff Kaplan has posted his list of the top ten largest federal corporate criminal fines, noting that “what is interesting is that fully half of the ten largest federal corporate criminal fines in history were imposed or agreed to in 2012. I cannot recall a year with so many new cases on the list.” The list is led by BP’s massive $1.286 fine in connection with the Deepwater Horizon environmental disaster. (The list does not include the recent Libor scandal settlements, as the list is limited just to DoJ criminal fines.)

 

Over at The FCPA Blog, Dick Cassin has posted his 2012 Enforcement Index (here). Cassin reports that twelve companies settled FCPA enforcement actions in 2012, paying a total of $259.4 million. None of the 2012 enforcement settlements were sufficient to make The FCPA Blog’s all-time top ten FCPA criminal fines list but Pfizer’s $45.2 million disgorgement did make the blog’s top ten FCPA disgorgements list.

 

On his Drug and Device Law Blog, Jim Beck has listed “The Best Prescription Drug/Medical Device Decisions of 2012” (here). The post lists the authors’ top ten favorite judicial decisions involving drugs, medical devices and vaccines in 2012.

 

And in the world of accounting, Francine McKenna has listed top 20 posts from her own re: The Auditors blog (here). She helpfully embedded into the post a video of The Kinks’ classic hit “Tired of Waiting” (as an explanation of why has included a list of her own blog posts – that is, because she is tired of writing. Francine, I can relate!).  

 

On a more entertaining note, you can find Inside Counsel’s list of the “10 Strangest Law Suits of 2012” here.

 

And finally, no post on this blog ever really feels complete without a video interlude, so here’s a link to YouTube’s Top Ten Viral Videos of 2012. There were some very amusing videos this year, many of which we have previously embedded on this site. In a salute to the videos, here’s a link to one that we haven’t previously included on this site. Enjoy.

 

https://youtube.com/watch?v=316AzLYfAzw

Seven former independent directors of Satyam – the Indian company known as the “Indian Enron” due to the high-profile accounting scandal that swamped the firm in 2009 – have secured their dismissal from the U.S. securities litigation the company’s shareholder filed in the scandal’s wake.  Southern District of New York Judge Barbara Jones’s January 2, 2013 opinion granting the directors’ dismissal motions can be found here. The opinion contains an interesting take on the U.S. Supreme Court’s 2010 Morrison decision and also, in its observation that the director defendants “were themselves victims of fraud,” provides an interesting perspective on the issues surrounding the liabilities of outside directors.

 

Background

Satyam was quickly dubbed the "Indian Enron" when it was revealed in January 2009 – in a stunning letter of confession from the company’s founder and Chairman — that more than $1 billion of revenue that the company had reported over several years was fictitious. Investors immediately filed multiple securities class action lawsuits in the Southern District of New York.

 

The plaintiffs’ consolidated amended complaint alleges that in addition to fabricating revenues senior company officials siphoned off vast sums from the company to entities owned or controlled by the Chairman and members of his family. The defendants include three inside directors, who were alleged to be primarily responsible for the accounting fraud; and seven independent directors, five of whom were alleged to be on the company’s audit committee; certain entities affiliated with the company’s chairman and individuals associated with those companies; and certain PwC-related entities.

 

As discussed here, in February 2011, Satyam agreed to settle the securities claims against the company itself for a payment of $125 million. The settlement did not resolve the claims against the other defendants, including the individual defendants, all of which remained pending. In May 2011, PwC agreed to settle the claims against the PwC-related entities for a payment of $25.5 million (about which refer here).

 

The director defendants moved to dismiss the securities suits on two grounds. First, they argued in reliance on the Morrison decision that certain claimants who had acquired their Satyam shares outside the U.S. could not assert claims under the U.S. securities laws. Second, they argued that the claimants’ claims did not satisfy the pleading requirements to establish a securities claim.

 

The January 2 Opinion

In her January 2 Opinion, Judge Jones granted the directors’ motions to dismiss on both grounds. First, Judge Jones held that the plaintiffs had not pled sufficient facts to establish a strong inference of scienter at least as compelling as the non-fraudulent inferences. Judge Jones observed that “the majority of the allegations” involve “an intricate and well-concealed fraud perpetrated by a very small group of insiders” that and “only reinforce the inference” that the directors defendants were themselves victims of fraud.”  

 

Judge Jones also granted the director defendants’ motion to dismiss the claims of some of the claimants based on the Morrison decision. The director defendants had moved to dismiss the claims of shareholders who had acquired their Satyam shares on the Indian stock exchanges. The director defendants also moved to dismiss the claims of current and former Satyam employees who had acquired their Satyam shares through their participation in Satyam employee stock option plan. The director defendants argued in reliance on Morrison that because those claimants’ claims did not involve either shares listed on a U.S. exchange or a domestic securities transaction, the claims were not cognizable under the U.S. securities laws. (The director defendants did not seek to dismiss the claims of those who had acquired Satyam American Depositary Shares (ADS) on the NYSE.)

 

In opposing the motion to dismiss the claims of shareholders who purchased their Satyam shares on the Indian securities exchanges, the plaintiffs argued that Morrison did not apply because those shareholders had placed their buy orders in the U.S. and had suffered injuries in the U.S. Judge Jones said that this argument “is predicated on precisely the approach that the Supreme Court rejected in Morrison.” She added that “an investor’s location in the United States does not transform an otherwise foreign transaction into a domestic one.”

 

In opposing dismissal of the claims of Satyam employees who acquired Satyam ADSs through the company’s employee stock option plan, the plaintiffs argued that because the employees acquired ADSs through the stock option plan, and because ADSs traded on the NYSE, Morrison did not preclude the employees’ claims. Judge Jones found that the relevant question was not whether or not ADSs trade on a U.S. exchange; the question was whether or not the employees had acquired the ADSs in the U.S.. In reviewing the materials relating to the stock option plan, Judge Jones found that the “exercise of options to acquire Satyam ADSs occurred in India and therefore fall outside the scope of Section 10(b).” Judge Jones rejected the plaintiffs’ suggestion that the stock option exercise was nevertheless a domestic securities transaction merely because the ADSs acquired were the same as the ADSs that traded on the NYSE. Judge Jones said that fact that Satyam’s ADSs were also listed on the NYSE is “irrelevant” the employees acquired their ADSs in India.

 

Discussion

Many outside directors have significant concerns about their potential securities liability, particularly with the respect to the possibility that they might be held liable for management improprieties.  However, the fact is that outside directors are rarely held liable under the U.S. securities laws. Judge Jones’s scienter determination arguably suggests one reason why that is so. 

 

Notwithstanding the massive scale of the Satyam fraud and the fact that several of the director defendants sat on the audit committee, Judge Jones found that the plaintiffs had failed to satisfy the scienter pleading requirements. In reaching this conclusion, Judge Jones emphasized that the fraud, as massive as it was, had been perpetrated by a small group of insiders, and that the director defendants themselves were “victims of the fraud.” Judge Jones’s determination in this regard may provide some reassurance to outside directors concerned that they could be held liable for management misconduct of which the directors are unaware.

 

Judge Jones’s ruling that the claims of the Satyam shareholders who purchased their shares on the Indian exchanges were not cognizable under the U.S. securities laws is consistent with the developing body of case law under Morrison.

 

However, Judge Jones’s ruling with respect to the claims of the Satyam employees who acquired their shares through the stock option plans is interesting. It is n one respect consistent with prior decisions holding that the mere fact that a class of securities trades on a U.S. exchange does not mean that the U.S. securities laws apply to any transaction involving of that class of securities regardless of where it takes place. Judge Jones’s determination is nevertheless interesting because as far as I am aware it represents the first application of Morrison to securities purchased through a foreign-based employee stock option plan.  Judge Jones’s opinion shows how Morrison should be applied to determine whether or not employees acquiring securities through a foreign-based plan can assert claims under the U.S. securities laws.

 

Jan Wolfe’s January 3, 2012 Am Law Litigation Daily  story about Judge Jones’s opinion can be found here. Special thanks to a loyal reader for providing me with a copy of the opinion.

 

The year just finished included dramatic and important developments involving elections, tragedies and natural disasters. While there was nothing in the world of directors’ and officers’ liability to match this drama, it was nevertheless an eventful year in the world of D&O, with many significant developments. By way of review of the year’s events, here is The D&O Diary’s list of the Top Ten D&O stories of 2012.

 

1. Barclays and UBS Enter Massive Libor Scandal-Related Regulatory Settlements: The Libor scandal first began to unfold more than four years ago, but  with the dramatic announcements in late June 2012 of the imposition of fines and penalties of over $450 million against Barclays PLC, the scandal shifted into a higher gear. But as significant as were the Barclays settlements, the recent announcement by UBS that it had entered its own set of regulatory settlements totaling over $1.5 billion represented an even more substantial development.

 

In both sets of settlements, the banks involved admitted that their representatives had attempted to manipulate the Libor benchmark interest rates. UBS also admitted that its representatives had attempted to collude with third parties – including both interbank dealers and other Libor panel banks – to try to affect the benchmarks, at first to try to extract profits from its derivatives trading activities and later to try to affect public perception of the bank’s financial health during the peak of the credit crisis. The U.S. Commodities Futures Trading Commission expressly concluded that UBS had “succeeded” in manipulating Libor Yen benchmark rates. UBS’s Japanese unit pled guilty to one count of wire fraud.

 

Among the many implications from these developments is their possible impact on existing and future Libor scandal-related litigation. The revelations in the UBS regulatory settlements of collusive activity obviously will bolster the existing antitrust litigation that has been consolidated in Manhattan federal court. The sensational aspect of many of the factual revelations in connection with the UBS settlement may encourage other litigants to pursue claims, just as the revelations in the Barclays settlement encouraged other claimants to file suit. Among other suits that filed the Barclays settlement was the filing of a securities class action lawsuit in federal court in Manhattan. There is the possibility that UBS shareholders could also attempt to file a shareholder suit.

 

Another consideration in the wake of the UBS developments is the possibility of claims against the interbank dealers that allegedly participated in the Libor benchmark rate manipulation efforts. Up to this point, the universe of potential litigation targets seemed to be limited to the small handful of large banks on the Libor rate setting panels. With the suggestion that these third party interbank dealers participated in the allegedly manipulative conduct, for the first time there is a suggestion of the scope of litigation expanding beyond just the panel banks themselves.

 

It seems likely that there will be further regulatory settlements involving the panel banks in the months ahead. Among other features of the Barclays and UBS regulatory settlements that undoubtedly will capture the attention of the other banks is that, as massive as were the settlements that Barclays and UBS entered, both UBS and Barclays were the beneficiaries of credits for their cooperation with regulators. The unmistakable suggestion for the other banks is that they should step up their cooperative efforts with regulators as soon as possible or face the possibility of even more severe consequences. It does seem probable that by the time this scandal plays itself out, there will be many more regulatory settlements, some of which might make the Barclays and UBS settlements look modest.

 

As the other banks attempt to position themselves to reach regulatory settlements, there undoubtedly will be even further factual revelations, which in turn will further hearten prospective litigants and likely lead to either further or expanded litigation. However, there are a number of factors that should be kept in mind on the question of what the Libor-scandal litigation might mean for the D&O insurance industry.

 

First, many of the undoubtedly huge costs that are looming likely will not represent insured amounts. The regulatory fines and penalties will not be insured. The company investigative costs also are likely not covered. In addition, most of the antitrust litigation filed to date has named only corporate defendants. Under the typical D&O insurance policy, the companies themselves are only insured for securities claims. So the antitrust litigation, for example, would likely not be covered under the typical D&O insurance policy.

 

In addition, many of these large banks do not carry traditional D&O insurance or may only have restricted insurance. In some instances, the banks’ insurance may include a substantial coinsurance percentage or a massive self-insured retention. Other banks may only carry so-called Side A only insurance, which covers individual directors and officers only and is only available when the corporate entity is unable to indemnify the individuals due to insolvency or legal prohibition. Given that none of the potentially involved banks have failed, it seems unlikely that this Side A only coverage would be triggered.

 

2. As Bank Failures Wane, the FDIC Ramps Up the Failed Bank Litigation: The number of bank failures dropped significantly in 2012 compared with prior years. Only 51 financial institutions failed during 2012, the lowest annual number of bank closures since 2008, when there were 25 bank failures. By way of comparison, there were 92 bank failures in 2011 and 157 in 2010. Overall, there have been 468 bank failures since January 1, 2007. Of the 51 bank failures during 2012, only 20 came in the year’s second half, and only 12 came after August 1, 2012.

 

Though the bank failure pace clearly is declining, the pace of the FDIC’s filing of failed bank litigation is ramping up. With the addition of the December 17, 2012 filing of its lawsuit against the former CEO and six former directors of the failed Peoples First Community Bank of Panama City, Florida, the FDIC filed 25 failed bank D&O lawsuits during 2012 and a total of 43 altogether during the current wave of bank failures.

 

The signs are that the FDIC’s active pace of litigation filing activity will continue as we head into 2013. As Cornerstone Research noted in its recent report analyzing the FDIC’s failed bank litigation (refer here), the FDIC tends to file its failed bank lawsuits as the third year anniversary of the bank closure approaches, owing to the applicable three-year statute of limitations. The peak period of bank closures came in early 2010, suggesting that we will continue to see further failed bank litigation in 2013.

 

The Cornerstone Research report’s analysis shows that the FDIC has initiated D&O lawsuits in connection with nine percent of the banks that have failed since 2007. During the S&L crisis, the FDIC (and other federal banking regulators) filed D&O lawsuits in connection with 24% of all failed institutions. If the FDIC were to file D&O lawsuit in connection with 24% of all failed institutions this time around, that would imply that the FDIC would ultimately file about 112 lawsuits (based on the number of banks that have failed so far since 2007). The final number of FDIC lawsuits might well get into that range, as the FDIC’s most recent update on the number of authorized lawsuits indicates that the agency has authorized suits in connection with 89 institutions (or about 19% of the banks that have failed so far). The FDIC increased the number of authorized lawsuits each month during 2012, so the authorized number of suits could quickly reach as high as the implied 112 number of suits.

 

For whatever reason, the FDIC’s lawsuits against former directors and officers of failed banks have been disproportionately concentrated in Georgia. Of the 43 failed bank D&O lawsuits the FDIC has filed, 14 have involved Georgia banks, or just under one-third of all lawsuits. Nine out of the 25 D&O suits the FDIC filed in 2012, or about 36%, involved Georgia banks. At one level this is no surprise, as during the current bank failure wave there have been more bank failures in Georgia than in any other state. But the approximately 80 failed banks in Georgia represent only about 18 percent of the total number of bank failures, so the level of failed bank litigation in Georgia is disproportionately high. Of course there may be timing issues contributing to this and the disproportionately high level of lawsuits involving Georgia may even out as the FDIC continues to file new suits in 2013.

 

3. FDIC Wins $168.8 Million Jury Verdict Against Former IndyMac Officers: Even as the FDIC has continued to ramp up the number of lawsuits against former directors and officers of failed banks, the earliest suits the agency filed have been moving toward resolution. On December 7, 2012, in connection with the first D&O suit the agency filed as part of the current bank failure wave and in what may prove to be one of the most dramatic resolutions of any failed bank suit, a jury in the Central District of California entered a $168.8 million verdict  in the FDIC’s lawsuit against three former officers of the failed IndyMac bank.

 

The jury found that the defendants had been negligent and had breached their fiduciary duties with respect to each of the 23 loans at issue in this phase of the FDIC’s case against the three individuals. The just completed trial apparently represents only the first trial phase of this matter. There apparently will be a separate trial phase that will address the FDIC’s allegations as to scores of other loans as well as allegations with respect to the bank’s loan portfolio as a whole. The FDIC apparently is seeking total damages of more than $350 million.

 

While the jury verdict unquestionably represents a victory for the FDIC, the FDIC may face considerable challenges attempting to collect on it. As discussed at length here, in July 2012, Central District of California Judge Gary Klausner held in a related D&O insurance coverage case that all of the various lawsuits pertaining to Indy Mac’s collapse (including the case in which the jury verdict was just entered) were interrelated to the first-filed lawsuit, and thus triggered only the D&O insurance that was in force when the first suit was filed. Because all of the later-filed lawsuits related back to the first lawsuit, the later lawsuits – including the lawsuit in which the jury verdict was entered — did not trigger a second $80 million insurance program that was in force when the later suits were filed. (Judge Klausner’s ruling is on appeal.) 

 

Reports are that defense expenses and other settlements have substantially depleted the first D& O insurance tower. In other words, unless Judge Klausner’s coverage ruling is reversed, there may be little or no remaining D&O insurance out of which the FDIC might try to recover on the jury verdict. However, as discussed on Alison Frankel’s On the Case blog (here), the FDIC hopes to be able to enforce against the D&O insurers the entire amounts of the judgments it obtains against the former IndyMac officers, even those amounts in excess of the policies’ limits of liability.

 

Regardless of whether or not the FDIC will ever be able to collect, the entry of the jury verdict in the IndyMac case represents a significant development. Indeed, in its recent report about FDIC failed bank D&O litigation, Cornerstone Research cited the FDIC’s success at the IndyMac trial as one reason we can expect to see the agency bring more failed bank D&O lawsuits in the months ahead. The jury verdict may also give pause to other failed bank directors and officers who were otherwise determined to fight FDIC claims. However, some commentators have questioned the relevance of the verdict to other FDIC suits outside of California.

 

In a related development a week after the jury entered the massive verdict against the three former IndyMac officers, Michael Perry, IndyMac’s former CEO, reached an agreement to settle the separate lawsuit that the FDIC had brought against him. In his settlement, Perry agreed to pay $1 million, plus an additional $11 million to be funded entirely by insurance. The settlement agreement provides that Perry has no liability for the insurance portion of the settlement and also provides for an assignment to the FDIC of all his rights against IndyMac’s D&O insurers.

 

4. Congress Enacts the Jumpstart Our Business Startups (JOBS) Act: On April 5, 2012, President Obama signed into law the Jumpstart Our Business Startups Act (commonly referred to as the JOBS Act). This legislation, which enjoyed strong bipartisan support in Congress, is intended to ease the IPO process for Emerging Growth Companies (EGCs) and facilitate capital-raising by reducing regulatory burdens and disclosure obligations. The Act also introduces changes that could impact the potential liability exposures of directors and officers of both public and private companies. These changes could have important D&O insurance implications.

 

As discussed at greater length here, the JOBS Act contains a number of IPO “on ramp” procedures designed to ease the process and burdens of the “going public” process for EGCs. For example, EGCs can elect to submit their IPO registration statement for SEC review on a confidential, nonpublic basis, although the registration statement must be publicly filed at least 21 days before the IPO roadshow.

 

Among the other features of Act that has attracted the most attention are its provisions allowing “crowdfunding.” Under these provisions, a company is permitted to raise up to $1 million during any 12-month period through an SEC-registered crowdfunding portal. The crowdfunding provisions have yet to go into effect. The SEC’s implementing regulations are due to be released in January 2013.

 

It remains to be seen how the JOBS Act’s changes will ultimately play out. Many of the Act’s provisions (such as, for example, the crowdfunding provisions) are subject to significant additional rulemaking. Even before the JOBS Act was enacted, the SEC was already straining under rulemaking obligations imposed by the Dodd-Frank Act. As the SEC is far behind on many rulemakings required by the Dodd-Frank Act, the sheer weight of the agency’s obligations, as well as post-election changes in the agency’s leadership, could mean delays for the rulemakings required under the JOBS Act.

 

Though the reduced compliance and disclosure requirements for EGCs reduces costs and affords these companies certain advantages, that does not necessarily mean that D&O insurance underwriters will regard ECGs as having less risk. To the contrary, the reduced compliance and disclosure requirements may well raise underwriters’ concerns that EGCs represent a riskier class of business.

 

In addition, some of the Act’s provisions could increase potential liabilities under certain circumstances. For example, Section 302(c) of the Act expressly imposes liability on issuers and their directors and officers for material misrepresentations and omissions made to investors in connection with a crowdfunding offering. The crowdfunding provisions may blur the clarity between private and public companies. The crowdfunding provisions expressly contemplate that a private company would be able to engage in crowdfunding financing activities without otherwise assuming public company reporting obligations. Yet, at the same time, that same private company will be required to make certain disclosure filings with the SEC in connection with the crowdfunding offering; and could also potentially incur liability under Section 302(c) of the JOBS Act.

 

Many private company D&O insurance policies contain securities offering exclusions.  The wordings of this exclusion vary widely among different policies, and some wordings could be sufficiently broad to preclude coverage for crowdfunding activities. In addition, some private company D&O insurers have already introduced exclusions expressly precluding coverage for claims arising from crowdfunding.  As was the case with the Sarbanes-Oxley Act and the Dodd-Frank Act, the D&O insurance industry may face a long period where it must assess the impact of changes introduced by this broad, new legislation. It may be some time before all of the Act’s implications and ramifications can be identified and understood.

 

5. Credit Crisis Suit Continue to Produce Massive Settlements: The subprime and credit crisis related litigation wave that began all the way back in 2007 continues to grind though the court system, and during 2012 several of the remaining cases resulted in massive securities class action lawsuit settlements The first of these was the $275 million Bear Stearns settlement, which was announced in June 2012. That was followed within a few weeks by the $590 million Citigroup settlement, announced in late August 2012.

 

Then in late September 2012, the parties to the pending BofA/Merrill Lynch settlement announced a $2.43 billion settlement, the largest settlement so far of any of the subprime and credit crisis related lawsuits. The BofA/ Merrill settlement is not only the eighth largest securities class action lawsuit settlement ever (refer here for the Stanford Law School Class Action Clearinghouse’s list of the top ten largest securities suit settlements), but according a September 28, 2012 press release from the Ohio Attorney General (whose office represented several Ohio pension funds that were among the lead plaintiffs in the case), it is the fourth largest settlement funded by a single defendant for violations of the federal securities laws, and it is largest securities class settlement ever resolving a Section 14(a) case (alleging misrepresentations in connection with the a proxy solicitation). According to the Ohio AG, the settlement is also the largest securities class action settlement where there were no criminal charges against company executives.

 

With the entry of these large settlements and of several additional smaller settlements during the year, the various settlements in the many securities class action lawsuits filed as part of the subprime and credit crisis related litigation wave now total $8.092 billion. The average credit crisis securities suit settlement is $139.5 million; however, if the three largest settlements are removed from the equation, the average drops to $80.87 million. Not all of these settlement amounts were funded by D&O insurance but D&O insurance did find a significant part of many of these settlements, including many of the smaller settlements. Moreover, many of the subprime and credit crisis securities class action lawsuits continue to grind through the system, and defense costs continue to accumulate and the prospect for even further settlement costs loom

 

Even as the credit crisis itself continues to recede into the past, litigation continues to accumulate — although the litigation is evolving. That is, many of the most recently filed lawsuits, alleging either misrepresentations in offering documents relating to mortgage-backed securities or put-back rights asserted by issuers that purchased mortgages from lending institutions, are being asserted as individual actions. These latest suits seem to ensure that credit crisis related litigation will continue for years to come.

 

6. Securities Class Action Opt-Outs Return With a Vengeance: One of the more interesting story lines in the securities class action litigation arena in recent years has been the emergence of substantial class action opt-out litigation, whereby various claimants representing significant shareholder ownership interests select out of the class suit and separately pursue their own claims – and settlements. The class action opt-out litigation emerged as a significant phenomenon in the litigation arising out of the era of corporate scandals a decade ago. After attracting a great deal of attention and concern at the time, the phenomenon seemingly faded into the background — that is, until several large public pension funds and mutual fund families opted out of the $624 million Countrywide subprime-related securities lawsuit settlement, about which I previously commented here.

 

Now, more than a year after the high-profile Countrywide opt-out suit, significant class action opt-outs appear to be becoming a regular part of the larger securities class action litigation. Even the $590 million settlement in the Citigroup subprime-related securities class action lawsuit, as massive as it is, has been accompanied by a significant number of class action opt-outs.

 

As discussed in Nate Raymond’s December 13, 2012 On the Case blog post (here), several significant institutional investors have elected to opt out of Citigroup settlement and are pursuing their own separate actions. The article, which notes that “opt-outs have become a regular feature fixture in any big securities class action,” reports that a total of 134 investors have chosen to opt out of the Citigroup settlement, including some institutional investors that had filed separate individual actions as long as two years ago.

 

Similarly, a significant number of institutional investors opted out of the Pfizer securities class action litigation pertaining to the company’s disclosures about the safety of its Celebrex and Bextra pain medication. In their November 15, 2012 complaint (here), seven public pension funds (including CalPERS and CalSTRS) and dozens of mutual funds from four separate mutual fund families have filed a separate lawsuit against the company and five of its individual directors and officers.

 

Why are the opt-out claimants selecting out of the class actions? The answer is that the institutional investor opt-out claimants think the can do better for themselves by proceeding separately. In a November 15, 2012 Am Law Litigation Daily article (here), counsel for the Pfizer securities litigation opt-out claimants is quoted as saying, among other things, that in other opt-out claims that his firm has filed in connection with other pending securities class action lawsuits, the firm has resolved the opt-outs claims for “multiples” of what they would have recovered as class claimants. In addition, based on counsel’s remarks in the news article, there has been a level of significant opt-out activity in recent years that has been going on beyond the radar screen — indeed, the plaintiffs’ firm filing the Pfizer opt-out complaint reportedly has been involved in 14 additional opt-out suits just in the first nine months of 2012.

 

The comments in the Am Law Litigation Daily article suggest that institutional investors’ interest in opt-out litigation is growing, largely due to the growing perception that their recoveries will be increased by proceeding outside of the class. The opt-out claimants also avoid the cumbersome process and delays involved in the class settlement process. Mutual funds, which traditionally have not been involved in opt out litigation, have become more interested and involved in opting out. The article quotes Columbia Law Professor John Coffee as saying that “the trend is toward opting out.”

 

For many years, class action lawsuits have been a favored whipping boy for conservative commentators. But for all of the ills that class actions can sometimes involve, the prospect of a litigation process in which mass group claims are fragmented and can only be resolved in a piecemeal fashion hardly represents an improvement. Given the apparently increasing institutional investor interest in pursuing claims separate from the larger investor class, we could very quickly be getting to the point where resolution of class litigation is only one part of a multistep process.

 

7. Securities Suit Filings, Settlements and Dismissals Decline During 2012: Largely as a result of a slowdown in new filings during the fourth quarter, 2012 securities class action lawsuit filings were below the levels of recent years and well below historical averages. There were 156 new securities class action lawsuit filings during 2012, down from 188 in 2011 and well below the 1996-2011 annual average of 193.

 

The drop in 2012 filings is largely due to the decline in filings during the year’s fourth quarter. There were 45, 45 and 41 filings during the first, second and third quarters, respectively. However, in the fourth quarter there were only 25 new securities class action lawsuit filings. The 66 new filings during the second half of 2012 represented the lowest filing level for any half-yearly period since the first half of 2007. (I detailed in a recent post the differences in counting methodology that may explain how my tally differs from other published securities class action lawsuit counts.)

 

In addition, not only did the number of new lawsuit filings decline in 2012 (at least according to my tally), the number of cases resolved during 2012 through dismissal or settlement also plummeted, according to a recent study from NERA Economic Consulting.  (The NERA report considers the time of settlement as the date on which settlement is approved, so some high profile settlements that were announced in 2012 are not reflected in NERA’s analysis. The NERA report count of dismissals includes dismissals that are not yet final, such as dismissals without prejudice.)

 

According to the NERA report, the 92 settlements projected to be approved in 2012 is the lowest number of annual approved settlements since 1996 and 25% lower than 2011. The 60 dismissals NERA projected for 2012 represent the lowest dismissal level since 1998. The 2012 dismissal total is 50% lower than 2011. The total of 152 cases that resolved (settled or dismissed) during 2012 is also the lowest level since 1996. The NERA report notes that part of the reason for the decline in case resolutions may simply be that there were fewer cases pending and therefore available to be resolved as 2012 began, when there were the lowest level of pending securities cases since 2000. The report also speculates that the slowdown in the number of settlements and dismissals may also be due to “other changes in the legal environment.”

 

While the number of settlements may have declined, adjusted average and median settlements are up. The average securities class action settlement in 2012 was $36 million, compared to a 2005-2011 average of $42.1 million. But if the calculation excludes settlements over $1 billion, the IPO laddering cases and the merger objection cases, the 2012 average of $36 million compares to an adjusted average for the 2005-2011 period of $32 million. The median settlement in 2012 was $11.1 million, which is the largest ever annual median since 1996, making 2012 only the second year since 1996 that the median has exceeded $10 million.

 

8. The Mix of Corporate and Securities Litigation Continues to Change: For many years, the default topic when the question of corporate and securities litigation came up was securities class action litigation. However, in more recent years, a broader range of lawsuits has been relevant to the discussion. This diversification phenomenon got started in the middle part of the last decade with the wave of options backdating lawsuits, many of which were filed as shareholders’ derivative suits rather than as securities class action lawsuits. Another more recent manifestation of this development has been the onslaught of merger objection litigation, as a result of which nearly every merger transaction these days now involves litigation.

 

It seems clear that as the opportunities for plaintiffs’ attorneys to participate in traditional securities class action litigation have diminished, the plaintiffs’ attorneys are casting about, seeking ways to diversity their product line. The opt-out litigation noted above seems to be one manifestation of this effort, along with the merger objection litigation.

 

During the past year, yet another development of the plaintiffs’ lawyers’ efforts to diversity was the development of a new form of litigation involving executive compensation. This new wave of executive comp suits, in which the plaintiff’s seek to enjoin upcoming shareholder votes on compensation or employee share plans on the grounds of inadequate or insufficient disclosure, have resulted in some success – at least for the plaintiffs’ lawyers involved. These new kinds of executive compensation–related lawsuits possibly may be “gaining steam,” according to a recent law firm study.

 

A November 19, 2010 memo from the Pillsbury law firm entitled “Plaintiffs’ Firms Gaining Steam in New Wave Say-on-Pay Lawsuits” (here) reviews the history of say-on-pay litigation that has followed in the wake of the Dodd Frank Act’s requirements for an advisory shareholder vote on executive compensation. The memo shows that of the at least 43 companies that experienced negative say-on-pay votes in 2011, at least 15 were hit with shareholder suits alleging, among other things, that the companies’ directors and officers had violated their fiduciary duties in connection with executive compensation. However, as is well-documented in the law firm memo, these suits have not fared well in the courts; ten of the eleven of the 2011 suits that have reached the motion to dismiss stage have resulted in dismissals.

 

Faced with this poor track record on the 2011 say-on-pay suits, plaintiffs’ lawyers filed fewer of these kinds of suits in 2012 against companies that experienced negative votes. However, as the law firm memo explains, one plaintiffs’ firm has now “orchestrated a new strategy to hold companies liable: suits to enjoin the shareholder vote because the proxy statement failed to provide adequate disclosure concerning executive compensation proposals.” According to the memo, there have been at least 18 of these new types of suits, with nine of them having been filed just in the month preceding the memo’s publication.

 

As detailed in Nate Raymond’s November 30, 2012 Reuters story entitled “Lawyers gain from ‘say-on-pay’ suits targeting U.S. firms” (here), these new style have met with some success. According to the article, at least six of these suits “have resulted in settlements in which the companies have agreed to give the shareholders more information on the pay of the executives.” These settlements have also “resulted in fees of up to $625,000 to the lawyers who brought the cases.” The article also notes, however, that while the settlements have provided additional disclosures and legal fees for the firm that has filed almost all of these suits, “they have netted no cash for shareholders.”

 

These new suits share certain characteristics with the M&A-related lawsuits. That is, they are filed at a time when the defendant company is under time pressure that motivates the company to settle quickly rather than deal with the lawsuit. Just as in the merger context, where the company wants to move the transaction forward and doesn’t want the lawsuit holding things up, companies facing these new style say-on-pay lawsuits, facing an imminent shareholder vote, are pressured to reach a quick settlement rather than risking a delay in the shareholder vote.

 

Both the kinds of say-on-pay lawsuits filed in 2011 and the new style version of the suits that are hot now are symptoms of a larger phenomenon, which is the attempt by some parts of the plaintiffs’ securities bar to diversify their product line. The pressure on the plaintiffs’ firms to diversify will likely continue to lead to more lawyer-driven litigation of these kinds, including not only the varieties of lawsuits noted here but also perhaps other kinds of suits that will emerge in the months ahead.

 

9. Whistleblower Reports Surge, Threatening Further Enforcement Action and Bounty Payments Ahead: When the whistleblower bounty provisions in the Dodd-Frank Act were enacted, there were concerns that the provisions – allowing whistleblowers an award between 10% and 30% of the money collected when information provided by the whistleblower leads to an SEC enforcement action in which more than $1 million in sanctions is ordered – would encourage a flood of reports from would-be whistleblowers who hoped to cash in on the potentially rich rewards.

 

As it has turned out, the whistleblower bounty program has been slow to get started. The SEC finally awarded its first whistleblower bounty in 2012. As reflected in the SEC’s August 21, 2012 press release (here), the agency’s first whistleblower award for the relatively modest amount of $50,000. However, small amount of this single award should not be interpreted to suggest that the whistleblower program will not amount to much. To the contrary, the signs are that the whistleblower program seems likely to turn out to be very significant.

 

In November 2012, the SEC’s Office of the Whistleblower produced its annual report for the 2012 fiscal year on the Dodd-Frank whistleblower program. The report shows that during the 2012 fiscal year, the agency received 3,001 whistleblower tips. The agency received tips from all 50 states as well as from 49 countries outside the United States. The report details the events that must occur and the process that must be followed in order for a bounty award to be made. The prolonged process seems to ensure that some a significant amount of time is required between the time when a whistleblower submits a tip and a bounty award is made.

 

The agency’s report makes it clear that though there has only been one bounty award so far, many more lie ahead. Among other things, the report notes that during the past year there were 143 enforcement actions resulting in the imposition of sanctions in excess of the $1 million threshold for the award of sanction, and that Office of Whistleblower is continuing to review the award applications the Office received during the 2012 fiscal year. In other words, the likelihood is that there will be further awards in the year ahead – and the report notes that the value of the Fund out of which any future awards are to be made now exceeds $453 million.

 

It seems probable that as more awards are announced, interest in the whistleblower program will increase as well. Opportunistic plaintiffs’ lawyers casting about for alternatives to traditional securities litigation are already attempting to position themselves to take advantage of these anticipated developments. Many plaintiffs’ firms are advertising on the Internet and elsewhere seeking to assist whistleblowers to submit their tips to the agency and also to try to get the inside track on any civil litigation opportunities that might follow in the event that the SEC were to pursue an enforcement action based on the whistleblower’s tip. Among the more interesting examples of these efforts on plaintiffs’ lawyers’ part during recent months were the December 2012 publicity efforts of the plaintiffs’ firm representing whistleblower alleging that Deutsche Bank hid billions of dollars of losses on its derivatives portfolio during the peak of the credit crisis.

 

It seems that if 2012 was the year in which the Dodd-Frank whistleblower program finally got off the ground, 2013 will likely be the year when the program picks up serious momentum. It seems likely that in the year ahead that we will not only see increased enforcement activity as a result of whistleblowers’ tips, but that we will see increased numbers of whistleblowers’ bounty awards, as well as the possibility of increased private civil litigation following in the wake of the enforcement actions.

 

10. Rule 10b5-1 Trading Plans Under Scrutiny Once Again: When the SEC brought civil enforcement charges against former Countrywide Financial CEO Angelo Mozilo in June 2009, a critical part of the agency’s allegations was that Mozilo had manipulated his Rule 10b5-1 trading plans to permit him to reap vast profits in trading his shares in company stock while he was aware of increasingly serious problem in the company’s mortgage portfolio.

 

Among other things, the SEC alleged that pursuant to these plans and during the period November 2006 through August 2007, and shortly after he had circulated internal emails sharply critical of the company’s mortgage loan underwriting and the “toxic” mortgages in the company’s portfolio, Mozilo exercised over 51 million stock options and sold the underlying shares for total proceeds of over $139 million.

 

In October 2010, Mozilo agreed to settle the SEC’s enforcement action for a payment of $67.5 million dollars, including a $22.5 million penalty and a disgorgement of $45 million. The financial penalty was at the time (and I believe still is) the largest ever paid by a public company’s senior executive in an SEC settlement.

 

As if all of this were not enough to cast a cloud over Rule 10b5-1 trading plans, the trading plans are once again back in the news, and once again the news about the plans is negative. A front page November 28, 2012 Wall Street Journal article entitled “Executives’ Good Luck in Trading Own Stock” (here), reports on the newspaper’s analysis of thousands of trades by corporate executives in their company’s stock. Among other things, the newspaper reports on numerous instances where executives, trading in company shares pursuant to Rule 10b5-1 plans, managed to extract trading profits just before bad news sent share prices down or to capture gains with purchases executed just before unexpected good news.

 

It appears that the SEC reads the Journal. The agency has launched investigations in connection with trading activities at several of the companies mentioned in the Journal article. While not all of the trades under scrutiny involved Rule 10b5-1 trading plans, possible plan misuse seems to be at least one aspect of the investigation. Insider trading involving supposed tips about various companies has been a significant investigative focus for some time now (for example, as pertains to the various insider trading allegations involving Raj Rajaratnam and others), but these most recent allegations involve alleged improper trading by company insiders in their personal holdings of their company stock. The allegations and ensuing investigations seem likely to produce significant enforcement activity in the months ahead, as well as possible follow on private civil litigation.

 

There is no doubt that these various allegations involving insider trading plans have put the plans in a negative light. However, as discussed here, a well-designed and well-executed plan can still provide substantial liability protection by allowing insiders to trade in their holdings of company stock without incurring securities liability exposure. Notwithstanding these recent developments, a well-designed Rule 10b5-1 plan remains important securities litigation loss prevention

 

Blogging Year in Review: During 2012, the staff here at The D&O Diary tried to keep track of important developments in the world of directors and officers liability. While we strive to maintain our focus on topics within our central area of concern, from time to time we also try to diversify our mix of offerings. During the past year, we managed to work in other fare, such as interviews, book reviews and guest posts reflecting the perspectives of other industry commentators.

 

Though we enjoy diversifying the mix of offerings with these other kinds of articles, we must admit that we derive the greatest pleasure when we venture far off topic in our occasional travel blog posts. 2012 provided a rich variety of opportunities for travel blogging, including trips to London (with a special visit to the Lloyd’s Building), Dublin, Beijing, Hong Kong, Singapore, Munich and Berlin.

 

As much fun as it was to write the travel blogs, our favorite post of the year (and maybe of all time), was the July 2012 post about Summer and Time. If you have not yet read it, you can find the post here. Even if you don’t read the entire post, please take a look at the pictures and read the comments from other readers. Even if you have read it before, you may find it rewarding to read the post again, now that that the chilly winds of winter are blowing.

 

I have a lot of fun writing this blog. But I could never do it without the support and encouragement from readers. I would like to express my thanks here to the many readers who during the past year sent me case decisions, suggestions and document links. I get my best stuff from readers, and the willingness of readers to support my efforts helps to make this site a better resource for everyone. My thanks to everyone who has helped along the way, and to everyone that reads and supports this site.  And finally, I would also like to thank my colleagues at RT Pro Exec and RT Specialty for their support and encouragement I could never keep this going without their backing.

 

I am looking forward to another year of blogging in 2013. I welcome readers’ thoughts and comments and in particular I welcome suggestions for how this site might be improved.

 

Largely as a result of a slowdown in new filings during the fourth quarter, 2012 securities class action lawsuit filings were below the filing levels of recent years and below historical averages. Filing levels remained elevated in the natural resources, life sciences and computer services industries, and filings against non-U.S. companies, though off from 2011 record levels, remained above historical levels.

 

There were 156 new securities class action lawsuit filings during 2012. (Please see the comment below regarding my counting methodology.) The 2012 filing count is down from the 188 securities suits filed in 2011 and is well below the 1996-2011 annual average of 193.

 

The drop in 2012 filings is largely due to the decline in filings during the fourth quarter. There were 45, 45 and 41 filings during the first, second and third quarters, respectively. However, in the fourth quarter there were only 25 new securities class action lawsuit filings. The 66 new filings during the second half represented the lowest filing level for any half-yearly period since the first half of 2007, when 69 new securities suits were filed. (The lowest half-yearly filing period since 1996 was the second half of 2006, when there were only 55 new securities class action lawsuit filings. )

 

The 156 securities class action lawsuits filed during 2012 were filed in 45 different federal district courts, as well as two state courts. (The ’33 Act provides for concurrent state court jurisdiction for liability actions under the Act.) Though securities suits were filed in many different courts, there was a significant concentration of filings of new securities suits in the Southern District of New York. There were 43 new securities suits filed in the S.D.N.Y., representing 27.56% of all 2012 filings. Other courts with significant concentrations of new securities suits included the Northern District of California and the Southern District of California, each of which had 13 new filings during 2012; the District of Massachusetts (8); the Northern District of Illinois (7); and the District of New Jersey (6).  Filings in the S.D.N.Y., N.D. Cal., and S.D. Cal. together accounted for over 44% of all of the 2012 securities suit filings.

 

The 2012 securities suits were filed against companies in a broad variety of industries. The 2012 securities suits involved companies in 81 different Standard Industrial Classification (SIC) Code categories. There were, however, concentrations in certain industries. There were 27 new securities suits against companies in the life sciences industries (represented by companies in the 283 SIC Code group [Drugs] and the 384 SIC Code group [Surgical, Medical and Dental Instruments and Supplies]).These 27 new suits against life sciences companies represented 17.3% of all filing during the year. Of particular note is that there were 15 new filings in the SIC Code category 2834 (Pharmaceutical Preparations) alone, representing nearly ten percent of all 2012 filings.

 

There were 16 new securities suits against companies in the natural resources extractive industries, including mining (SIC Code categories 1000, 1040, 1220, 1221) and oil and gas production (SIC Code category 1311). And there were ten new securities suits in SIC Code group 737 (computer programming, data processing and other computer services).

 

There were 26 new securities suits in 2012 against non-U.S. companies, representing about 16.6% of all 2012 filings. Both the absolute number and percentage of suits involving non-U.S. companies are down from 2011, when there were 68 lawsuits against non-U.S. companies represented 36.2% of all filings. Though the 2012 filings against non-U.S. companies were down from 2011, the 2012 filings against foreign firms were at levels comparable to 2010, when there were 27 suits against non-U.S. firms representing 13.4% of all filings.

 

The record levels of filings against non-U.S. companies during 2011 were largely due to the flood of suits last year against U.S.-listed Chinese companies. There were 41 suits against Chinese-based companies in 2011. Though the number of suits against Chinese companies declined in 2012, there were still 14 suits filed against companies based in China, plus another three suits against companies based in Hong Kong. (Note: I am including in my count of suits against Chinese companies the lawsuit filed on December 31, 2012 in the Southern District of New York against Silvercorp Metals, which is a company with its headquarters in Canada but all of its operations in China.) Overall, the new suits filed against non-U.S. firms in 2012 involved companies based in six different countries. Following China, the country with the highest number of companies sued in U.S. securities class action lawsuits during 2012 was Canada, which had six companies hit with U.S. securities suits.

 

Discussion

My count of 156 securities suits during 2012 will be different from other published tallies of the securities suit filings. My count is slightly above that of the Cornerstone Research because my tally, unlike the Cornerstone Research tally, includes ’33 Act suits filed in state court pursuant to the Act’s concurrent jurisdiction provisions. At the same time, however, my count is below other tallies, such as, for example, the count of NERA Economic Consulting, because I only count related lawsuit filings once, regardless of the number of separate complaints filed. NERA and others count separate complaints filed in separate jurisdictions separately unless or until they are consolidated in the same judicial district. In addition, my count includes only lawsuits that seek to recover damages for alleged violations of the federal securities laws.  As a result, my tally will be lower than other class action  lawsuit counts that include suits  against corporations and their directors and officers that do no allege securities laws violations (for example, merger objection suits).

 

The decline in the number of new securities lawsuit filings during the fourth quarter of 2012 is interesting, but at this point it is hard to know what it might mean, and it is far too early to jump to any conclusions about possible permanent shifts in the level of securities suit filings. There have been periods before (for example, at the end of 2006 and the beginning of 2007) when there were lulls in the level of securities suit filings, but at least in the past, the lulls in filing levels have proven to be temporary and relatively short-lived. Indeed, the lull at the end of 2006 and the beginning of 2007 was followed by a surge of new securities filings during following periods, as securities suits related to the subprime meltdown and credit crisis came flooding in.

 

There seem to be a few possibilities to explain the drop off in securities suit filings in the fourth quarter. The first is the absence of any cyclical phenomenon driving filings. During the period 2007 to 2010, the total number of filings was driven by lawsuits relating to the subprime meltdown and the credit crisis. During 2011, there was a surge of filings against U.S.-listed Chinese firms. By contrast, during 2012, the really wasn’t any particular cyclical development to drive filings.

 

Another factor in the decline in filings during the fourth quarter may be that there were a significant number of lawsuits filed during that time period as individual actions (particularly many of the lawsuits recently filed alleging misrepresentations in connection with mortgage securities offerings, as well as many of the suits filed in connection with the mortgage put-back litigation). It may be that the individual suit filings distracted from class action lawsuit efforts.

 

A third factor behind the decline in securities suit filings may be that the plaintiffs’ securities bar is seeking to diversify its product line. As I have previously noted, the increase in M&A litigation and the surge in say-on-say litigation, among other things, may be understood in part as the efforts by at least certain members of the plaintiffs bar to find new opportunities in lieu of traditional securities litigation, which has both become more costly (owing to electronic discovery) and more difficult (owing to case law developments) to pursue. Of course, if some cyclical phenomenon presenting securities litigation opportunities were to emerge, these diversifying plaintiffs’ attorneys could return to pursue securities litigation again.

 

A final possible explanation for the fourth quarter decline is that the apparent slowdown is purely coincidental and that filing levels will quickly return to normal levels. Just to reinforce this point, though there were only five new filings in October and nine in November, there were seven new securities lawsuit filings just in the final ten days of December alone. It could be that the apparent lull during the fourth quarter was nothing more than a reflection of the natural ebb and flow of securities law suit filings that has characterized filings patterns since 1996.

 

In a decision that could foreclose a possible way for claimants to try  to circumvent the U.S. Supreme Court’s decision in the Morrison v. National Australia Bank case, a New York appellate court has reversed a lower court and dismissed the fraud suit short-seller hedge funds had brought in New York state court against Porsche on forum non conveniens grounds. A copy of the December 27, 2012 New York Supreme Court Appellate Court, First Department, decision can be found here (starting at page 138).

 

The appellate court’s decision is the latest step in an effort by short-seller hedge funds to pursue claims in the U.S. against Porsche. As discussed here, the  hedge funds first filed an action in the Southern District of New York  alleging that during 2008, Porsche and certain of its executives made a series of misrepresentations in which Porsche claimed that it did not intend to acquire control of Volkswagen, while at the same time it allegedly was secretly accumulating VW shares with the purpose of obtaining control. In October 2008, after Porsche disclosed its intent to obtain control of VW, VW’s share price rose significantly and the short sellers suffered significant trading losses. The short-sellers federal court complaint asserted claims under the U.S. securities laws and also for common law fraud.

 

As discussed here, on December 30, 2012, Southern District of New York Judge Harold Baer dismissed the securities claims  based on Morrison, on the grounds that the subject transactions — securities-based swap agreements — represented a foreign transaction and are therefore not within the purview of the U.S. securities laws. Judge Baer declined to exercise supplemental jurisdiction over the common law claims. Judge Baer’s ruling is now on appeal to the Second Circuit.

 

In March 2011, several of the same short sellers launched a separate action in New York Supreme Court against Porsche alleging claims for fraud and unjust enrichment. Porsche moved to dismiss the state court complaint on the grounds of forum non conveniens and for failure to state a claim. Porsche also moved in the alternative to stay the state court action pending the outcome of the Second Circuit appeal in the federal court action. As discussed here, on August 6, 2012, New York (New York County) Supreme Court Judge Charles E. Ramos rejected Porsche’s motion to dismiss the case on forum non conveniens ground. A copy of Judge Ramos’s decision can be found here. Porsche filed an appeal.

 

In its December 27 opinion, a five-Justice panel of the appellate division unanimously reversed Judge Ramos’s decision and entered a judgment of dismissal in Porsche’s favor. In dismissing on the grounds that New York was not an appropriate forum, the appellate court noted that the only alleged connections between the action and New York “are the phone calls between plaintiffs in New York and a representative of the defendant in Germany” and “emails sent to plaintiffs in New York but generally disseminated to parties elsewhere.”

 

The appellate court state that “these connections failed to create a substantial nexus with New York, given that the events of the underlying transaction otherwise occurred entirely in a foreign jurisdiction.” In light of this “inadequate connection” between the transaction and New York, as well as “the fact that defendant and most plaintiffs are not New York residents, the VW stock is traded only on foreign exchanges, many of the witnesses and documents are located in Germany, which has stated its interest in the underlying events and provides an adequate alternative forum,” Porsche has met its “heavy burden” to establish that New York is “an inconvenient forum.”

 

The hedge fund claimants may well attempt to appeal the dismissal to the New York Court of Appeals. IF they do not appeal or if the intermediate appellate court’s ruling stands, the ruling will mean the hedge funds will not be able to pursue their claims in New York state court. The outcome will also undercut the possibility that the hedge fund plaintiffs might have found a way to circumvent Morrison. Judge Ramos’s prior ruling, which would have allowed the hedge funds to pursue their claims in New York state court, seemed to suggest that the hedge funds had found a way to pursue claims against the non-U.S. defendant in U.S. court, by asserting common law claims not subject to Morrison’s constraints.

 

The appellate court’s conclusion that the hedge funds had not established that New York was a convenient forum for this case suggests that the hedge funds may not have found a way around Morrison after all. Of course, it is possible that they may yet be further appeals in this case and so the final story may yet to be told. In that regard, it is interesting to note that the appellate court did not even discuss in its opinion Judge Ramos’s statement in his ruling that the question is whether New York courts “may hold responsible a foreign entity, who conducts business globally, for fraudulent misrepresentation purportedly aimed at New York plaintiffs.” New York, Judge Ramos said, “clearly has a vested interest in such an action.” The appellate court apparently saw it differently.

 

While the Second Circuit appeal in the federal court case remains pending, on March 1, 2012 the Second Circuit did release its opinion in the Absolute Activist Value Master Fund decision, which provided significant interpretation of Morrison and, as discussed here, could have a substantial impact on the Second Circuit appeal in the Porsche case.

 

Yet another alternative for investors who want to pursue claims against Porsche would be to sue them in the company’s home country courts – which is what at least some investors have done. As discussed here, other investors have also initiated an action against Porsche in Stuttgart based on the same allegations. According to news reports, Porsche recently won a procedural skirmish as part of its ongoing efforts to have investors’ civil claim heard in German courts.

 

As noted here, on December 18, 2012, prosecutors in Germany filed criminal charges against former Porsche CEO Wendelin Wiedeking and ex-Chief Financial Officer Holger Haerter alleging that they had made misrepresentations in order to manipulate VW’s shares in connection with Porsche’s efforts to take over VW.

 

Susan Beck’s December 27, 2012 Am Law Litigation Daily article about the New York appelllate court’s ruling in the Porsche case can be found here.

 

An appellate court in New Zealand has “quashed” the controversial ruling of a  lower court ruling that former directors of the defunct Bridgecorp companies are not entitled to defense expense reimbursement under the companies’ D&O insurance policy where the companies’ liquidators have raised (but not yet proven) claims against them exceeding the policy’s limits of liability. The appellate court’s ruling ensures that the companies’ directors have access to the insurance to defend themselves against claims pending against them. A copy of the Court of Appeal of New Zealand’s December 20, 2012 judgment and opinion can be found here.

 

Background

The Bridgecorp liquidators, who have claims against the former Bridgecorp directors in connection with the companies’ collapse, have asserted a “charge” on the Bridgecorp companies’ D&O insurance policy under Section 9 of Law Reform Act of 1936. The liquidators allege that their claims exceed the policy’s limits of liability and that this “charge” gives them priority rights to the policy proceeds. The Bridgecorp directors initiated an action seeking a judicial declaration that the “charge” does not prevent the D&O insurer from meeting its contractual obligations under its policy to reimburse them for their defense expenses.

 

As discussed at length here, on September 15, 2011, New Zealand High Court (Auckland Registry) Justice Graham Lang ruled that the liquidators’ “charge” against the D&O insurance policy proceeds “prevents the directors from having access to the D&O policy to meet their defence costs.” Although Justice Lang acknowledged that this result is “harsh” and even “unsatisfactory,” he reasoned that Section 9 was designed to “keep the insurance fund intact” for the benefit of claimants and that this legislative purpose should not be defeated merely because coverage for both defense costs and indemnity were combined in a single policy.

 

The Bridgecorp directors appealed Justice Lang’s ruling. The appellate court combined their appeal with the application of the directors and officers of the Feltex Carpets. The Feltex officials had been sued in a group action by Feltex shareholders alleging that the Feltex defendants had made misrepresentations in connection with the company’s 2004 IPO. The Feltex directors sought a judicial declaration that they were entitled to have their defense expenses reimbursed under the Feltex D&O policy. Their application to have their petition combined with the Bridgecorp directors’ appeal was  granted. Even though the December 20, 2012 opinion of the Court of Appeal addresses only the Bridgecorp case, the Court’s judgment applies to both cases.

 

The Court of Appeal’s Ruling

In its December 20, 2012 opinion, a three-Justice panel of the Court of Appeal of New Zealand allowed the directors’ appeal and quashed Justice Lang’s lower court ruling. The Court of Appeal overturned the Justice Lang’s ruling on two ground: first, that the Section 9 “charge” does not apply to insurance funds payable with respect to defense costs, even where the defense cost coverage is combined with third-party liability coverage in a policy with a single limit of liability; and second, that Section 9 is not intended to “rewrite or interfere with contractual rights as to cover and reimbursement.”

 

In ruling that the Section 9 does not apply to the D&O policy’s defense cost coverage, the Court of Appeal noted that the policy provides coverage for “two distinct kinds of losses” that operate “independently.” The court reasoned that if the two coverages had been set up in separate policies, Section 9 could not have applied to the defense cost policy, and that the combination of the two coverages into a single policy should not affect the analysis. The court also reasoned that “it is irrelevant” that the policy proceeds would be depleted by payment of defense costs, as that is that is “the necessary consequence of the policy’s structure.”

 

The Court of Appeal also noted that the practical effect of Justice Lang’e ruling was to deny the directors of their contractual rights to defense cost reimbursement. The Court noted that a “charge” under Section 9 is “subject to the terms of the contract of insurance as they stand at the time the charge descends” and it “cannot operate to interfere with or suspend the performance of mutual contractual rights and obligations relating to another liability.” The Section 9 charge cannot deprive the directors of their rights to defense cost protection under the D&O policy.

 

Discussion

There were many troublesome aspects to Justice Lang’s decision, not least of which was that it operated to deprive the insuredsof one of the most important aspects of the policy’s protection at the time they needed it most. The Court of Appeal’s ruling ensures that the directors and officers of Bridgecorp (and of Feltex Carpets) will have access to the proceeds of their companies’ D&O insurance policies to defend the claims pending against them. Justice Lang himself noted that the need for this type of defense cost protection was among the most important reasons companies procure D&O insurance, yet his ruling, had it stood, would have frustrated this most  basic purpose of the policy.

 

Had the Court of Appeals affirmed Justice Lang’s decision, the New Zealand insurance marketplace would have had to have evolved an insurance solution ensuring that the D&O policy’s defense cost protection could not be stymied by a Section 9 charge. The marketplace would have had to come up with some structure separating defense cost coverage from indemnity coverage. While the marketplace certainly could have developed such a structure, it could have added complexity and cost to the insurance equation. . (I am aware that some insurers had already been offering alternatives designed to try to address this concern.)

 

More importantly, the need for a New Zealand insureds to have access to customized insurance solutions would have added further complexity to the already difficult equation of trying to provide insurance solutions that operate consistently and predictably across the globe. As I noted in my discussion of Justice Lang’s earlier ruling, D&O insurers are already struggling to provide insurance products that apply globally and operate locally. Those struggles will continue, but the Court of Appeal’s decision in the Bridgecorp case removes at least one factor that had even further complicated the efforts to provide global D&O insurance protection.

 

A December 20, 2012 New Zealand Herald article discussing the Court of Appeal’s ruling can be found here. Special thanks to a loyal reader for providing me with a link to the Court of Appeal’s ruling.

 

One of the more challenging exposures that many companies face is the possibility of an FCPA enforcement action. Because of the risk of fines, potential prosecution and reputational damages, many companies understand the need to implement compliance programs to try to avoid these problems. In a guest post, Al Vondra (pictured), a partner in the Professional Services practice of PwC makes the case for active compliance monitoring. In his guest post, Vondra suggests that “companies that embrace the opportunity to shore up their compliance program by proactively monitoring policies and training to see if they have gained traction can gain a competitive advantage.”

 

I would like to thank Al for his willingness to publish his guest post on this site. I welcome guest posts from responsible commentators on topics of relevance to this blog. Any readers who are interested in publishing a guest post on this site are encouraged to contact me directly. Here is Al’s guest post.

 

The global anti-corruption movement continues to grow. Today’s business environment prominently features a near zero-tolerance stand when it comes to bribery and corruption. Plenty of companies have already initiated compliance programs and policies. But far too few are taking equally appropriate steps to confirm their effectiveness and adherence. If you are not actively monitoring and testing, you may not be prepared to compete in today’s increasingly interconnected world. Leadership should take heed. Government enforcement of the Foreign Corrupt Practices Act (FCPA) will not be slowing down anytime soon. The staffing level of FCPA prosecutors is at an all-time high, and major US Attorneys’ offices around the country are devoting significant legal resources to active cases, according to government officials.

 

Moreover, while the FCPA may be the most familiar, there is a continued, growing worldwide focus on non-US anti-bribery and corruption enforcement, including the 2011 UK Bribery Act and major initiatives by the Organisation for Economic Co-operation and Development, World Economic Forum, World Bank, and the United Nations Convention Against Corruption.

 

Government enforcement rigor, combined with the continued expansion of US companies into overseas markets, means that business leaders should enhance and continue their efforts to remain in compliance with FCPA or face potential prosecution, fines, and reputational damage.

 

Companies that embrace the opportunity to shore up their compliance program by proactively monitoring policies and training to see if they have gained traction can gain a competitive advantage.

 

The regulatory landscape: Reinforcing the focus on monitoring and testing

Regulators expect companies to assess their corruption risk, establish a compliance program, and actively monitor and test that program. Many businesses currently rely too heavily on corporate policies without field testing their efficacy. They can instead be actively monitoring and testing transactions to confirm compliance. Although many business leaders are more familiar with FCPA anti-bribery provisions, the DOJ and SEC are ever-more frequently citing violations of internal control and books and records provisions. These cases were settled primarily through private letter, deferred prosecution, or non- prosecution agreements.

 

The DOJ frequently uses deferred prosecution agreements and non- prosecution agreements as tools to help establish new leading practices for corporate compliance programs in numerous diverse industries and legal areas. Such agreements enable prosecutors and other government regulators to craft detailed compliance measures for one company in a given industry to serve as a benchmarking signal for other companies.

 

Many settlement agreements refer to agreed upon compliance programs that include active monitoring at foreign locations to avoid future prosecution. There is a strong and increasing regulatory expectation that companies will continuously monitor and test their compliance programs. This is not a new concept. The expectation is cited in the US Sentencing Guidelines, which call upon entities to confirm that their ethics and compliance programs are being followed and to perform ongoing monitoring and auditing to do so. SEC officials also are urging companies to focus on FCPA controls in testing their internal financial controls, even as the agency continues to bring charges against both companies and individuals.

 

 

The recent DOJ deferred prosecution agreement for a large pharmaceutical company addresses their expectation that anti-corruption reviews involving monitoring and testing will be performed proactively, with portions of the agreement containing more detailed compliance obligations than were previously issued.

 

A recent SEC complaint against a large software developer also discussed the company’s failure to audit certain anti-corruption controls, maintaining:

 

•              The entity was vulnerable to misuse of ‘parked’ funds on the part of employees.

•              The entity had failed to audit and compare the distributor’s margin against the end user price to confirm that the price structure did not house excess margins in the pricing structure.

•              The company neither targeted transparency, nor audited distributors’ third party payments on its behalf, despite policies that called for approvals for marketing expense payments.

 

Monitoring and testing: The business case

Active monitoring and testing can help to mitigate the risk that your entity will face costly, time-consuming investigations if potential violations are publically disclosed. In addition to responding proactively to the uptick in anti-corruption sentiment around the world, companies can derive significant benefits from FCPA monitoring and testing. Such efforts can enable them to:

 

•              Alert employees to the commitment of management and the board to ethical business dealings.

•              Reinforce company ethics policies.

•              Gain a better understanding of dealings with third parties and distributors.

•              Give management and the board a better sense of the effectiveness of and adherence to the company’s ethics policies.

•              Reduce employee and vendor fraud.

•              Establish credibility with regulatory bodies; for example, the DOJ recently disclosed its decision not to prosecute a large investment bank, in part because of its compliance program, specifically referencing the way the company tested its policies and procedures on a routine basis.

 

Despite regulatory expectations and the advantages to be gained through proactivity, many companies still are not responding with sufficient, thorough FCPA testing protocols. Operating in a world constrained by finite resources, many business leaders have not implemented effective self-audit programs to measure compliance.

 

The kind of monitoring and testing needed should also not be confused with typical financial statement or operational auditing. For one thing, there is no materiality limit on corruption violations under US law. For another, the monitoring and testing we are concerned with here requires a forensic mindset and delves into areas that usually are not reviewed.

 

Absent thorough active monitoring and risk assessment, including setting objectives, identifying and analyzing risks, and performing checks of related policies and controls, it is difficult to determine how well employees and third parties understand and comply with anti-bribery and corruption policies.

 

Effective policies, training, good tone at the top, and general supervisory authority are just a start. Leaders simply will not typically be able to effectively and quickly detect potential violations if they are relying on ineffective, inconsistent monitoring and testing. 

 

Potential violations, often buried in the company’s books and records, if not ferreted out, simply remain hidden. Account descriptions often are vague and include thousands of transactions that are consolidated in the company’s books. Improper payments can thus be masked from supervisory management reviewing the financial results.

 

In the rare instance that a company has minimal FCPA risk, for example, if it is not a public company and it has no international operations, there may be no need to do FCPA monitoring. However, for a public company with international operations, it becomes a lot harder to ignore the threat of corruption.

 

How are they doing? The monitoring and testing landscape

Where do most companies rank in terms of leading anti-corruption practices?

 

At the high end of leading practices are companies that have at some point already faced government scrutiny relating to a violation; they have paid a lot of money and invested significant management resources investigating and remediating their programs, which tend to be well developed and contain critical elements, including active monitoring and testing in high-risk areas.

 

They ‘get it’ and have already paid the price for an ineffective program.

 

The second group of companies, at the low end of the curve, includes companies that have not faced such scrutiny and may believe that they are ethical and do not have a problem that anyone needs to worry about. They may have a code of conduct posted on the company website, but their training is not very good; their policies are not very clear; and they do virtually no monitoring.

 

Finally, there are companies that fall somewhere in the middle, with some good and some not-so-good practices.

 

Why aren’t more businesses buying in?

Why aren’t more companies doing better monitoring? There are many reasons, including a lack of effective, qualified resources, attempts to save costs, and a lack of commitment by management or encouragement by the board or audit committee. They also may believe that they already are doing enough.

 

Most compliance professionals are capable when it comes to developing policies regarding anti-corruption and anti-bribery and getting those policies into the hands of the business people who need to follow them. But the challenge is this: How do you know that what has been sent out from the corporate or regional center is actually being followed? That is where many companies fall short.

 

They may not have taken the time and effort to adequately test and monitor their employees’ record of following the program.

 

Another challenge is a dearth of qualified testers; that is, there are relatively few people who really know how to do this well, and getting them into one of the higher-risk countries when and where you need them is not always easy. This requires qualified and experienced professionals who can speak the local language; understand local business customs, schemes and regulations; and have experience in transactional testing of local business records and documentation. Many companies struggle to implement the monitoring and testing aspect of the compliance program and then learn from the findings. If asked how detection controls have changed in the last two years because of the compliance program, some companies may not be able to answer. Some companies do it quite well; others have not even started.

 

Testing and analyzing those controls simply cannot be done from the corporate center. You have to go into the countries and review the books and records and see what is happening on site. Sometimes, there is too much of a tendency to believe that it is enough to train people and send them out with the right rules. But you will not know what is really happening unless you pick up the rocks and look underneath. After all, isn’t it better to know?

 

The case for proactivity

Why wait for whistleblowers to alert management and the board to FCPA issues? The CEO, CFO, and others responsible for making certifications surrounding internal control existence and effectiveness in periodic financial filings need to ask themselves: Am I really confident of what is in the books in Country X? Right now, if testing of internal controls for anti-corruption is not yet routine for your company, such comfort may be cold at best. As a result, management may be knowingly or unknowingly putting themselves at personal risk of violating Sarbanes-Oxley’s certification provisions.

 

Active monitoring and testing can better promote compliance by creating a culture where employees know they will regularly be held accountable for their actions — a proven method for strengthening internal compliance. Thorough analysis can enable both preventative and detective measures. An effective monitoring strategy can help confirm compliance with the books and records and internal control provisions.

 

Failing to monitor is like living in a home without a smoke alarm system. You won’t know about the fire until you notice the smoke and your house is gone. Transaction testing also can validate the completeness and accuracy of your books and records. Over time, a process for following up and resolving red flags may itself become a control and provide evidence of a sound compliance program.

 

A proactive program will demonstrate to the regulatory community and the growing global anti-corruption movement that your organization truly understands the importance of engaging ethically enterprise-wide and across your network of stakeholders. This can boost your credibility and even reduce adverse consequences should an unforeseen problem bring regulatory scrutiny your way. At the same time, running a well-established, monitored, and tested program will give you the confidence of knowing that as far as compliance is concerned, your policies are working effectively and as intended.

 

Simply stated, staying clear of corruption is good for your business and good for your brand. It is good to know — and to demonstrate — that you are in good company.

 

Acknowledgement

Albert A. Vondra is a Partner in the Forensic Services practice of PwC in Washington, DC and Cleveland, Ohio. Mr. Vondra is a CPA (licensed in Ohio, Virginia, and the District of Columbia), a Certified Fraud Examiner, Certified in Financial Forensics by the American Institute of Certified Public Accountants, and an attorney admitted to practice law in the State of Ohio. He can be reached at al.vondra@us.pwc.com or by calling (216) 496-7716.

 

Upcoming Event: Readers of this blog may be interested to know about a seminar that will be held at the St. John’s School of Risk Management in New York on February 5, 2013 entitled "A Day at Lloyd’s: An Introduction to teh Lloy’s Market Structure and the Use of ADR to Manage Disputes Involving Lloyd’s."  The event will be moderated by my good friend Perry Granof and includes a number of distinguished speakers, among them anotehr good friend, Nilam Sharma of the Ince & Co. law firm. The event, which will take place on the day prior to the beginning of the PLUS D&O Symposium,  runs from 12:30 to 5:00 pm. Further information about the event can be found here. You can register for the event here.

 

Break in the Action: The D&O DIary will be slowing down over the next few days in recognition of the holiday season. We will resume our normal publication schedule after the new year. Best wishes for a happy holiday season to all.

 

Swiss banking giant UBS has become the second global financial institution to enter a series of massive regulatory settlements in connection with the ongoing Libor scandal investigation. As detailed in its December 19, 2012 press release (here), UBS has agreed to pay a total of about 1.4 billion Swiss francs (about $1.54 billion at current exchange rates) in fines and disgorgements to regulators in the U.S., U.K. and Switzerland to resolve Libor-related investigations. Background regarding the Libor-scandal investigations can be found here.

 

The regulatory settlements include the company’s agreement to pay a $700 million penalty to settle charges with the U.S. Commodities Futures Trading Commission, as disclosed in the CFTC’s  December 19, 2012 press release (here); an agreement to pay a 160 million U.K. pound penalty (about $259.2 million) to the U.K. Financial Services Authority, as discussed in the FSA’s December 19, 2012 Final Notice (refer here); an agreement with the Swiss securities authority, FINMA, to pay a fine of about $64.3 million, as discussed in FINMA’s December 19, 2012 Press Release (here).

 

In addition, UBS’s wholly-owned subsidiary, UBS Securities Japan Co. Ltd., has agreed to plead guilty to one-count of a felony wire fraud in a criminal information filed in the District of Connecticut against the subsidiary. According to the U.S. Department of Justice’s December 19, 2012 press release (here), the subsidiary has agreed to pay a $100 million penalty. The Swiss parent company has also entered a non-prosecution agreement with the DoJ requiring UBS to pay an additional $400 million penalty.  The DoJ’s December 18, 2012 statement of facts in connection with the non-prosecution agreement can be found here.

 

The $500 million in criminal penalties together with the other amounts that the company has agreed to pay in the related regulatory settlements brings the total cost company’s total resolution costs to over $1.5 billion.

 

The Department of Justice press release also discloses that in addition to the criminal information filed against UBS Japan, the DoJ has also filed a criminal complaint in federal court in Manhattan against two former senior UBS traders, Tom Alexander William Hayes and Roger Darin, charging them with conspiracy, wire fraud and price fixing in connection with their alleged attempts to manipulate Yen Libor interest rates in order to produce trading profits in derivatives trading positions that Hayes maintained. A copy of the criminal complaint can be found here.

 

The various regulatory filings describe a course of conduct that was both extensive and enduring. For example the FSA Final Notice alleges violations over a six-year period between January 2005 and December 2010. The Final Notice alleges that the manipulation of Libor rates were “routine, widespread and condoned by a number of Managers with direct responsibility for the relevant business area.” The Final Notice “engaged in this serious misconduct in order to serve its own interests.” The misconduct “caused serious harm to other market participants.”

 

The regulatory filings contain particular detail regarding the alleged manipulation of the Yen Libor rate, but the UBS press release report that the alleged misconduct involve a number of different benchmark rates including, in addition to the Yen Libor: the Libor rates for the Great Britain Pound, the U.S. Dollar, the Swiss France, and the Euro, as well as Euribor rates and the Euroyen Tibor rates.

 

The regulatory and criminal filings not only allege that UBS attempted to manipulate Libor benchmark rates and other benchmark rates by gaming its own rate submissions to the rate-setting authorities, but also that UBS traders attempted to manipulate the rates through conversations and requests made to and through interdealer brokers and even to and through other Libor panel banks. The CFTC’s press release references “more than 2,000 instances of unlawful conduct involving dozens of UBS employees, colluding with other panel banks and inducing interdealer brokers to spread false information and influence other banks.” The CFTC filing expressly states that through these efforts UBS “at times succeeded in manipulating the fixing of Yen Libor.”

 

UBS’s negotiated settlements resolves the pending regulatory and criminal investigations but they hardly represent the end of the company’s Libor-scandal related woes. As the company itself acknowledges in its December 19 press release, investigations by other regulatory authorities, as well as private litigation, “remain ongoing notwithstanding today’s announcements.”

 

Indeed, the various filings and submissions will certainly prove to be extraordinarily helpful to the plaintiffs in the various lawsuits already pending against the company, particularly the consolidated Libor-related antitrust litigation pending in federal court in Manhattan. The regulatory filings are replete with rich details of the alleged efforts to manipulate the benchmark, some of theme quite provocative. The CFTC helpfully excerpted particularly noteworthy examples of supposedly manipulative communications in a separate page on its website; these carefully culled excerpts undoubtedly will make their way into amended pleadings in the various pending antitrust cases. In addition attached to the criminal complaint are copies of the emails and other written communications upon which the DoJ relied in bringing the criminal charges.

 

The extensive detail provided in the regulatory and criminal filings will substantially bolster the claimants’ allegations in the pending civil cases and could even encourage other claimants to come forward. As noted in a December 19, 2012 Economist Magazine article about the settlement entitled “Horribly Rotten, Comically Stupid“ (here), “the details in these settlements suggest that lawyers representing clients in a clutch of class-action lawsuits in America against banks including UBS will have a field day.”

 

Moreover, as detailed in the Wall Street Journal’s December 19, 2012 article entitled “Why the UBS Settlement Really Matters” (here), the various regulatory filings contain extensive factual material suggesting that UBS not only attempted to manipulate the benchmark rates, but that working through interdealer brokers and other Libor panel banks, actually succeeded in manipulating the benchmark rates. The regulators’ affirmative allegation that UBS “succeeded” in manipulating the Libor rates could significantly boost the antitrust claimants’ allegations. The Economist article linked above observed that “UBS tried and apparently succeeded in some cases in getting other firms to collude in manipulating rates. That collusion strengthens the case of civil litigants in America who are arguing in court that banks worked together to fix prices.”

 

There is another interesting aspect to the alleged involvement of the third-party interdealer brokers. These allegations suggest for the first time that the pool of potential defendants for the claimants to target potentially could go beyond just the Libor rate-settling banks themselves. Indeed, last week when British authorities arrested three individuals in connection with the ongoing Libor scandal, two of the three men arrested were employees of interbroker dealer RP Martin. (The third individual is Thomas Hayes, the former UBS and Citi trader named as one of the defendants in the DoJ’s criminal complaint mentioned above.)

 

The FSA Final Notice specifically alleges, without naming the interbroker dealers involved, that at least four UBS Traders made more than 1,000 requests to eleven brokers at six broker firms in connection with efforts to manipulate rates. The implication is that these six interbroker dealer firms could not only themselves become embroiled in the ongoing investigation but also that they could get drawn into related civil litigation.

 

Just as additional private civil litigation followed in the wake of Barclays’ entry into regulatory settlements earlier this year, it seems probable that there could be further civil litigation given the revelations and allegations in UBS’s regulatory settlements. For example, shortly after Barclays announced its settlements, there was a raft of follow-on litigation filed. In particular, the company’s shareholders filed securities litigation against the company and certain of its officers alleging material misrepresentations about the company and its internal controls. In light of the regulatory allegations against UBS, and in particular regulatory allegations about the weaknesses of UBS’s internal controls, it would not be surprising if shareholder litigation involving UBS were to be filed. (Though UBS is based in Switzerland, its shares trade on the NYSE exchange. UBS shareholders that purchased their shares on the U.S. exchange could assert claims against the company under the U.S. securities laws.)

 

While the factual allegations in the various regulatory filings undoubtedly will bolster the claims of private civil litigants, the factual allegations do not provide much help with regard to at least one of the barriers the antitrust claimants face. As I noted in my overview of the Libor-scandal related issues (here), the manipulation of Libor benchmark rates did not necessarily hurt everyone involved in Libor-sensitive transactions. Some market participants would have been aided by the manipulation, particularly debtors whose interest payment obligations were suppressed by benchmark manipulation. Some market participants likely were both helped and hurt across their entire financial portfolio. To further complicate things, the latest allegations seem to suggest that traders maneuvered to push rates up at times and at other times to push them down. Though the regulatory filings assert that UBS’s attempts to manipulate the benchmark rates “caused serious harm to other market participants,” these conclusory allegations, though helpful for the claimants, will not solve the claimants’ problems of substantiated how and to what extent the manipulations damaged the claimants.

 

(At the same time, there are some strong suggestions elsewhere that some investors were significantly hurt by the manipulation of Libor and other benchmark rates. For example, the Wall Street Journal is reporting in a December 19, 2012 article that, according to an as yet unpublished internal report from the inspector general for the agency’s regulator, the interest income losses on mortgage backed securities held at Fannie Mae and Freddie Mac due to the manipulation of the benchmark rates may have exceeded $3 billion. The report supposedly recommends that the agencies consider their legal options.)

 

One particular aspect of the UBS regulatory settlements that the other banks involved in the scandal will want to note is the fact that, as massive as were the fines and penalties to which UBS agreed, the fines and penalties could have been even higher were it not for UBS’s cooperation. The FSA final notice specifically states that UBS received a 20% discount for its cooperation; without its cooperation, UBS’s 160 million pound settlement would have been 200 million pounds. The CFTC also acknowledged UBS’s cooperation. The message to the other Libor panel banks is not only that it could be very costly for them to extricate themselves from the regulatory investigations but also that if their cooperation is not forthcoming it could be even worse for them.

 

The guilty plea of the UBS subsidiary is obviously a significant development as well, but it is not unprecedented. In September 2009, in connection Pfizer’s agreement to pay what was the largest criminal fine in U.S. history in connection with the alleged misbranding of certain pharmaceuticals, one of Pfizer’s subsidiaries agreed to plead guilty to one count of misbranding of a pharmaceutical. 

 

Alison Frankel has a particularly strong commentary on the factual allegations in the regulatory filings relating to UBS’s regulatory settlements in a December 19, 2012 post on her On the Case blog (here).

 

The FDIC’s filing of lawsuits against former directors and officers of failed banks increased “markedly” during the fourth quarter of 2012 after a “lull” during the second and third quarters of the year, according to a new study from Cornerstone Research. The study, released December 18, 2012 and entitled “Characteristics of FDIC Lawsuits Against Directors and Officers of Failed Financial Institutions” can be found here. Cornerstone Research’s December 18 press release about the study can be found here.

 

As of December 7, 2012, the FDIC has filed a total of 23 lawsuits this year, compared to 18 total filed during 2010 and 2011. The FDIC filed nine lawsuits (so far) during the fourth quarter, the same as during the fist quarter, compared to two during the second quarter and three during the third quarter. The 41 lawsuits overall relate to 40 different financial institutions, meaning that so far the FDIC has filed lawsuits in connection with nine percent of the 467 financial institutions that have failed since January 1, 2007.  

 

(Since the December 7 closing date for the Cornerstone Research report, the FDIC has filed one additional lawsuit {refer here, second item} , bringing the quarter to date total to ten, the total this year to 24, and the total overall to 42. For clarity’s sake, throughout this post I have referenced the data used and analyzed in the Cornerstone Research study, rather than attempting to update it to reflect the additional lawsuit.)

 

The FDIC’s D&O lawsuits generally have targeted larger failed institutions and those with a higher estimated cost of failure, though the lawsuits the FDIC filed during he second half of 2012 have involved smaller and less costly failures. Overall the failed banks that have been targeted had median total assets of $647 million, compared to $225 million total assets for all failed banks. However, the failed banks targeted during the third and fourth quarters had median total assets of $136 million and $154 million respectively. The median estimated cost to the FDIC for the failed banks that the FDIC has targeted in D&O litigation has been $134 million, compared to a median estimated cost for all failed banks of $55 million. However, during the third and fourth quarters of 2012, the median total costs of failed banks that the FDIC has targeted in D&O litigation was $27.3 million and $58 million, respectively.

 

Most of the FDIC’s D&O lawsuits have included both officer and directors defendants. Only 11 of the 41 lawsuit the FDIC has filed have involved only officer defendants. 30 of the lawsuits have also involved director defendants, including seven of the nine lawsuits filed so far during the fourth quarter.

 

One particularly interesting observation in the report relates the failed institutions’ CAMELS ratings in the period preceding the banks’ closures. The CAMELS rating ranks the institutions on a scale of 1 to 5, with 1 being the best score and 5 the lowest. (The CAMELS ratings are not public, but in the agency’s loss review of failed institutions includes a short history of the failed bank’s examination ratings.) The study reports that 86 percent of the institutions subject to FDIC lawsuits had composition ratings of 1 or 2 two years prior to their closure. Not until one to two years prior to failure did any of the institutions have a composite rating of 4 or 5, and 36 percent of the institutions still had a rating of 2 one year prior to closure. The report concludes that “Weak ratings were not a persistent historical problem for this group of institutions. The decline in ratings occurred near the end of their independent existence.”

 

The study also includes a helpful summary of all of the FDIC lawsuits that have settled so far, although readers should note that the recent settlement of IndyMac CEO Michael Perry (about which refer here) is not reflected on the settlement table on page 11 of the study. The Perry settlement is referenced in the text of the study.

 

The report notes that the number of lawsuits that the FDIC has filed lags the number of lawsuits that the FDIC has authorized. (The updated number of authorized lawsuits can be found on the FDIC’s website, here.) The report notes that the difference between the number of lawsuits authorized and the number filed increased during 2012. The report comments that “this backlog of authorized lawsuits, the FDIC”s recent success in the IndyMac trial, and the approaching end of the statute of limitations for making a claim against the numerous institutions that filed in 2009 and 2010 suggest that substantially more FDIC cases may be filed in upcoming months.”

 

Discussion

The Cornerstone Research report’s statement that the FDIC has initiated lawsuits in connection with nine percent of the banks that have failed since 2007 is interesting. Just to put that into perspective, during the S&L crisis, the FDIC (and other federal banking regulators) filed D&O lawsuits in connection with 24% of all failed institutions. If the FDIC were to file D&O lawsuit in connection with 24% of all failed institutions this time around, that would imply that the FDIC would ultimately file about 112 lawsuits (based on the number of banks that have failed so far since 2007).

 

 As it turns out, the final number of FDIC lawsuits might well get into that range, as the FDIC’s most recent update indicates that the agency has authorized lawsuit in connection with 89 institutions (or about 19% of the banks that have failed so far). The FDIC has increased the number of authorized lawsuits each month this year, so the authorized number of suits could quickly get reach as high as the implied 112 number of suits.

 

The study’s report that the more recently filed lawsuits involve smaller institutions than the earlier lawsuits had targeted is really not a surprise. The very largest banks that failed during the current banking crisis failed early on. For example, the two largest failures this time around, WaMu and IndyMac, both failed in 2008, and were among the first failed banks that the FDIC targeted in failed bank litigation. It may not be so much that the FDIC is targeting smaller institutions as such now, it may simply be that there are larger failures were the first to work their way through the system.

 

The analysis of the failed banks’ CAMELS ratings is also interesting. The implication of the analysis is that the banks that failed deteriorated rapidly. The failed institutions’ relatively high ratings until just prior to their closure seems consistent with the argument that many of the individual defendants are raising in their defense – that is, that the failure of their bank wasn’t the result of anybody’s fault; rather it was the outcome of problems that no one, including the FDIC itself, saw coming.