In a January 22, 2013 opinion (here), Southern District of New York Judge J. Paul Oetken has dismissed one of the many securities class action lawsuits that were filed against U.S.-listed Chinese companies in 2011. Though the primary interest in the case may be that it involves U.S. securities suit against a Chinese company, Jinkosolar Holdings, the case is also interesting with respect to the alleged misrepresentations on which the suit is based, which relate to the environmental problems in one of the company’s manufacturing facilities.

 

Jinkosolar is a manufacturer of solar technology products with operations based in China. In May 2010, the company conducted an Initial Public Offering of American Depositary Shares on the New York Stock Exchange. In November 2010, the company completed a secondary offering.

 

In April and May 2011, the company had a series of communications with the Chinese environmental authorities regarding hazardous waste disposal issues at its Zhenjian plant. The company did not disclose these communications to its shareholders. However, as the Court later put it, a “kerfuffle” at the company’s plant “forced Jinkosolar’s hand.” In August and September 2011, Residents living near the plant became concerned about a large scale fish-kill near the plant. In mid-September, the media began reporting on locals’ demonstrations outside the company’s plants. In two press releases in late September, the company announced that it had suspended operations at the plant and also revealed the earlier communications with the environmental authorities. As the news came out, the price of the company’s ADSs declined 41%

 

In October 2011, holders of the company’s ADSs filed a securities class action lawsuit in the Southern District of New York against the company, eight directors and officers of the company; and the company’s offering underwriters. The plaintiffs’ complain asserted claims under both the ’33 Act and the ’33 Act. In support of their allegations, the plaintiffs relied on three statements in the company’s offering prospectus in which the company explained its environmental compliance efforts and the consequences to the company if it were found to be in violation of the applicable environmental requirements. The defendants moved to dismiss.

 

In his January 21, 2013 order, Judge Oetken granted the defendants’ motions to dismiss. Judge Oetken found with respect to two of the three statements from the prospectus on which the plaintiffs sought to rely that he could “easily dispense” with the allegations. He noted with respect to these two statements that:

 

These paragraphs do, of course, explain to shareholders that Jinkosolar is obliged to follow certain regulations. But if anything, they weigh the pluses and minuses of following such regulations with a disquieting frankness. The first paragraph, for instance, explicitly balances the costs of “compliance” with safety regulations with the “adverse publicity and potentially significant monetary damages” stemming from “non-compliance.” Similarly, the second paragraph notes that Jinkosolar is “subject” to Chinese regulations, but – particularly when read alongside the first paragraph – does nothing to indicate any sort of commitment on the part of Jinkosolar to follow those regulations.

 

The third Prospectus statement on which the plaintiffs sought to rely presented, Judge Oetken found, “a more complicated matter.” The statement indicates, among other things, that the “we generate and discharge chemical waste, waste water, gaseous waste, and other industrial waste,” reiterates the company’s monitoring efforts and adds that “we are required to comply with all PRC national and local environmental protection laws and regulation.”

 

With respect to these statements, the plaintiffs argued that these statements “falsely imply that Jinkosolar had an effective pollution treatment system and a good pollution record, suggesting that the company had put the environmental issues “in play” and creating an obligation to keep shareholders updated.

 

Judge Oetken said that was “a close call” whether the statements on which the plaintiff’s sought to rely are materially misleading. In particular one sentence “does give the court pause”: the sentence stated that “We also maintain environmental teams at each of our manufacturing facilities to monitor waste treatment and ensure that our waste emissions comply with PRC environmental standards.” Judge Oetkin said that one way the sentence could be read is to signify that the company is able to “ensure that our waste emissions comply with PR environmental standards. “ But read another way, the statement is merely saying that the environmental teams are “maintained” with the purpose or function to “monitor and to ensure” compliance.

 

The Court found that the second of these two alternative readings is “the more sensible one.” The Court went on to say that it “cannot say that a reasonable investor would, or even could, read this one ambiguous sentence as a pronouncement that Jinkosolar is ‘ensuring’ environmental standards were met.” This, the court said, is “all the more true given how cautious Jinkosolar was in it Prospectus.” The company “carefully laid out the plusses and minuses” of abiding by the Chinese regulations and “underscored to investors that fines due to pollution are a real possibility.” These warnings, “taken together with the overall weakness of the instances f material misstatements and omissions proffered by Plaintiffs, indicate that no reasonable investor coul d have believed that the Prospectuses ensured a positive environmental record.”

 

In granting the defendants’ motions to dismiss, Judge Oetken did not expressly indicated whether or not the dismissal was with prejudice. However, in his final line of his opinion, he did direct to Clerk to “close this case.”

 

Discussion

For many readers, the primary interest of this case will be that it involves a U.S.-listed Chinese company. However, unlike many of the U.S.-listed Chinese companies that have been hit with securities class action lawsuits in recent years, this company did not obtain its listing by way of a reverse merger transaction. This company completed a full-blown IPO, which may have made a difference in the outcome of this case.

 

It was only as a result of the company’s IPO that the company completed a full and detailed Prospectus. (The company also completed a full Prospectus in connection with its secondary offering.) The Prospectus contained extensive and detailed precautionary statements. It was the detail and extent of these statements that seemed to have made a difference to Judge Oetken. Thus, in his opinion, Judge Oetkin refers to what he calls the “disquieting frankness” of the company’s disclosures regarding its environmental compliance risks.” He also noted “how cautious” the company was in its environmental compliance risk factors in its Prospectuses.

 

Because of the depth of the disclosures in its offering documents, Jinkosolar was able to make arguments and raise defenses in reliance on the detailed Prospectus disclosures. Because so many of the U.S.-listed Chinese companies did not complete a full-blown IPO, but rather obtained their U.S. listings through reverse merger transactions, they likely did not create offering documents with similarly precautionary disclosure. For that reason, the outcome of this dismissal motion ruling may not be all that helpful to many of the other U.S.-listed Chinese companies involved in U.S. securities suits. Indeed, most of those other companies are unlikely to be able to raise the kinds of arguments that Jinkosolar raised here, and certainly seem unlikely to be able to cite disclosure statements that a court might describe as reflecting “disquieting frankness.”

 

For me, the most interesting thing about this case is not that it involves a Chinese company defendant, but rather that it involves alleged misrepresentations with respect to environmental liabilities and exposures. As I have previously noted on this blog (refer, for example, here), these kinds of cases, involving alleged misrepresentation of environmental issues do arise periodically. The possibility of this kind of claim is often a key concern at the time of D&O insurance policy placement, as the question often arises whether the standard policy’s pollution exclusion will preclude coverage for a securities claim based on environmentally-related disclosures.

 

As this case demonstrates, it is critically important for the standard pollution exclusion to be revised to carve back coverage for securities claims and derivative claims based on environmental disclosures. (It is worth noting that many of the modern Excess Side A DIC insurance policies often have no environmental or pollution exclusion. In addition, some carrier’s primary D&O insurance forms omit the standard pollution exclusion and simply provide that the policy’s definition of “Loss” does not include costs of environmental remediation. Unless the insured company’s primary D&O insurance policy omits the environmental exclusion in this way, it will be indispensable for the standard environmental liability exclusion be revised in order to preserve coverage for securities claims and derivative claims based on alleged misrepresentations or misconduct relating to environmental issues. These considerations are likely to become increasingly important as environmental disclosure issues become of greater regulatory concern (about which refer here).

 

The one final thing I will say about this case and the fact that it does involve a U.S.-listed Chinese company is that it is yet another case involving a Chinese company in which the plaintiffs have struggled. Although some of the U.S. securities suits have managed to survive motions to dismiss, others (like this one) have not. Even the cases that have survived motions to dismiss have proved challenging for plaintiffs as they have faced numerous procedural hurdles (refer for example here). In addition, in other cases involving U.S.-listed Chinese companies that have reached the settlement stage, the settlement amounts have proved to be modest. (On the other hand, as noted here, E&Y did recently agree to settle a Canadian securities case relating to Sino-Forest, and a Hong Kong arbitration panel did just make a more than $70 million award based on its determination that China MediaExpress Holdings is a “fraudulent enterprise.” Notably, and arguably ironically, neither of these big recoveries involved one the many U.S. court securities suits filed against Chinese companies.)

 

Special thanks to a loyal reader for sending me a copy of Judge Oetken’s opinion in this case.  

 

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 the Lloyd’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 another 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.

 

Securities class action lawsuit filings were down “sharply” in 2012 compared to the prior year and to historical average, according to Cornerstone Research’s annual report. The study, published in conjunction with the Stanford Law School Securities Class Action Clearinghouse and entitled “Securities Class Action Filings: 2012 Year in Review,” can be found here.  A short, single-page graphic summary of the report’s conclusions can be found here. The two organization’s January 23, 2013 press release discussing the report can be found here. My own analysis of the 2012 securities suit filings can be found here.

 

According to the report, there were 152 securities class action lawsuits filed in 2012, which is below both the number of filings in 2011 (when there were 188) and the 1997-2011 annual average number of filings (193). The 152 filings in 2012 represents a 19 percent decrease from 2011 and a 21 decrease from the 1997-2011 annual average.

 

A significant factor in the reduced number of filings in 2012 was the decline in filing activity during the year’s second half, particularly during the fourth quarter. There were only 64 filings in the second half, compared with 88 in the first half. The filing level in the second half of 2012 was “lower than all semiannual periods other than the historic low observed in the second half of 2006.” The 25 filings in the year’s fourth quarter was “the lowest number of filings in any quarter in the last 16 years.” The report notes that these observations are consistent with “a declining trend since the first half of 2010.”

 

The report states that the decrease in 2012 filings was “largely due” to declines in federal mergers and acquisitions objection litigation and in the number of lawsuits involving Chinese companies (particularly Chinese companies that obtained a U.S. listing through a reverse merger transaction). According to the report, on a year-over-year basis, M&A filings decreased 70 percent (as plaintiffs appeared to prefer state court forums for this type of litigation) and filings related to Chinese reverse merger companies decreased by 68 percent. The report also noted that for the first time since 2007 there were no new securities class action lawsuit filings related to the credit crisis.

 

The number of filings against foreign issuers dropped from 61 in 2011 to 32 in 2012 (a 48 percent drop). Though filings against foreign issuers represented only 24 percent of all 2012 filings, compared to 32 percent in 2011, the 2012 percentage “reflects a level that is greater than al prior years other than 2011.” The continued elevated level of filings against foreign issuers in 2012 is largely due to filngs related to Chinese firms. There were a total of 18 filings against Chinese companies in 2012 (including Hong Kong companies) compared to 40 in 2011.

 

Larger companies were less likely to be the target of a securities suit in 2012 compared to recent years. 3.4% of S&P 500 companies were named in securities suits in 2012, compared to an annual average of 6.1% for S&P 500 companies during the period 2000 to 2011. The 2012 level is comparable to the 13-year low observed in 2011 (3.2%).

 

The most targeted industrial sector in 2012 was Consumer Non-Cyclical, representing 32% of all filings. Health care and life sciences companies comprised 67 percent of all Consumer Non-Cyclical filings (33 filings), compared to 62 percent (28 filings) in 2011. Filings against companies in the financial sector continued a declining trend with 15 filings in 2012, compared with 43 in 2010 and 25 in 2011.

 

As I noted in my own analysis of the 2012 securities suit filings, it is too early to tell whether the late-year decline in filings represents a trend or just a temporary dip in the general ebb and flow of securities suit filings. The report noted that the previous low semiannual filing level was in the second half of 2006, which was quickly followed by the onslaught of the subprime meltdown and credit crisis-related litigation wave.

 

One obvious factor in the overall 2012 decline was the absence of any episodic even driving filing levels. Indeed, Dr. John Gould, one of the report’s authors, is quoted in the press release as having said that “the absence of a filings trend…influenced the total number of new cases,” by comparison to recent years when filing levels have been dominated by “observable filings types,” such as, more recently, the M&A related litigation and litigation involving U.S.-listed Chinese companies.

 

While it is hard to know whether the trend will continue, the press release identifies at least one development that could result in a possible increase in future securities lawsuit filings. The press release quotes Stanford Law School Professor Joseph Grundfest, who notes that the upsurge in SEC whistleblower reports raises the questions whether the SEC will translate these reports into enforcement actions, and, if so, whether “private-party plaintiffs will be successful in prosecuting ‘piggyback’ claims that copy the Commission’s complaints.”

 

One factor that could also explain the declining number of 2012 filings is the plaintiffs’ securities bar’s continuing shift to diversity their inventory. Going back to the options backdating cases in 2006, the plaintiffs lawyers have been pursuing types of litigation other than securities class action litigation (in part due to unfavorable U.S. Supreme Court decisions). While the Cornerstone Report notes the absence of any new credit crisis-related securities class action lawsuit filings in 2012, there were a host of credit crisis-related lawsuits filing as individual actions in 2012. It is hard to tell, but it seems likely that this diversifying trend will continue.

 

Finally, it is worth noting that, as one reader observed in a comment to my blog post analyzing the 2012 securities suit filings, Superstorm Sandy could have had an impact on fourth quarter filings, since the storm basically closed New York’s downtown business district for several weeks during the fourth quarter.

 

Jan Wolfe’s January 22, 2013 Am Law Litigation Daily article about the Cornerstone Research report can be found here.

 

 

Picking up where it left off at the end of the year, the FDIC has filed its first failed bank D&O lawsuit of 2013. The lawsuit, which the agency filed on January 17, 2013 in the District of New Mexico, names as defendants ten former directors and officers of the failed Charter Bank, New Mexico. The complaint, which the FDIC filed in its capacity as receiver for the failed bank, alleges claims for negligence, gross negligence and breach of fiduciary duty, can be found here.

 

Charter Bank failed on January 22, 2010, so the FDIC filed the complaint just before the third anniversary of the bank’s closure (and just before a long holiday weekend as well.) The complaint alleges that prior to its failure the bank committed 72% of the bank’s core capital to a “highly speculative and risky” subprime lending operation in Denver, Colorado in late 2006, when the defendants “knew or should have known” there was no secondary market for subprime mortgage loans. The operation made loans that “no reasonable institution” would have made at the time, and relaxed underwriting standards to do so. Unable to sell the mortgages into the secondary market, the bank had to take the loans onto its own balance sheet, which cause the bank to suffer financial losses.

 

The lawsuit, the first that the FDIC has filed in 2013, is also the first that the agency has filed in New Mexico as part of the current failed bank litigation wave. This latest lawsuit is the 45th that the agency has filed as during the current banking crisis, 26 of which were filed in 2012. (These figures, both overall and for 2012, include the lawsuit filed just before the holidays in the Central District of California in connection with the failed Alliance Bank of Culver City, California. The FDIC’s complaint, filed on December 21, 2012, in its capacity as receiver for the failed bank against X former directors and officer of the bank can be found here.)

 

There undoubtedly are more lawsuits to come. On January 22, 2013, the FDIC updated the page on its website on which the agency indicates the current number of lawsuits that the agency has authorized. According to the latest update, as of January 15, 2013, the FDIC has authorized suits in connection with 95 failed institutions against 788 individuals for D&O liability. This includes 45 filed D&O lawsuits naming 355 former directors and officers. The 45 lawsuits filed involve 44 failed institutions, so the implication is that there are lawsuits involving some 51 failed institutions yet to come – based on the number of lawsuits that have been authorized so far. Since the FDIC has increased the number of authorized lawsuits each month for several months in a row now, the likelihood seems to be that there are at least 51 more lawsuits – and possibly many more – to come in the months ahead.

 

In a January 18, 2013 order (here), the U.S. Supreme Court granted a writ of certiorari to hear the appeals of three separate petitioners in cases arising out of the Ponzi scheme of R. Allen Stanford. The petitioners are two former law firms for the Stanford International Bank and an insurance brokerage that allegedly was involved in the sale of certificates of deposits for the bank. The petitioners are asking the Supreme Court to decide whether or not the plaintiffs are precluded under the Securities Litigation Uniform Standards Act (“SLUSA”) from asserting state-law class action claims against the three firms. By taking up the case, the Supreme Court will decide important issues about SLUSA’s scope that have divided the lower courts.

 

Congress enacted SLUSA in 1998 in order to prevent erstwhile securities law claimants from circumventing the restrictions of the Private Securities Litigation Reform Act (PSLRA) by filing their claims in state court under state law. As the Supreme Court said in 2006 in the Dabit case, “To stem the shift from Federal to State courts and to prevent certain State private securities class action lawsuits alleging fraud from being used to frustrate the objectives of the [PSLRA], Congress enacted SLUSA.”

 

SLUSA precludes most state-law class actions involving a “misrepresentation” made “in connection with the purchase or sale of a covered security.” The lower courts have wrestled with the question of what it required in order to satisfy the “in connection with” requirement and trigger SLUSA preclusion.

 

In these cases, the investor plaintiffs contend they were misled to believe that the CDs in which they invested were backed by quality securities traded on major exchanges (though it later appeared that the CDs in fact had little or nothing behind them). The defendants moved to dismiss the state law class actions that had been filed against them, arguing that, though CDs themselves were not “covered securities” within the meaning of SLUSA, the state court class action claims were nevertheless precluded under SLUSA because the plaintiffs claimed they were induced to purchase the securities by misrepresentation that the CDs were backed by SLUSA-covered securities.

 

The district court before which the cases were consolidated granted the defendants’ motions to dismiss and the plaintiffs appealed. In a March 19, 2012 opinion (here), a three-judge panel of the Fifth Circuit reversed the district court, specifically holding that the alleged purchases of covered securities that back the CDs were “only tangentially related to the fraudulent scheme” and therefore that SLUSA does not preclude the plaintiffs from using state class actions to pursue their claims.

 

In reaching its decision, the Fifth Circuit panel exhaustively reviewed the prior case law in which other Circuit courts had considered the question of what connection between an alleged fraud involving uncovered and a downstream transaction in covered securities is required for SLUSA preclusion to apply. The Fifth Circuit’s review of the case law shows that there are divergent and potentially inconsistent views among the various Circuit courts on this question.

 

The two defendant law firms and the defendant insurance brokerage firm filed petitions for writ of certiorari to the U.S. Supreme Court. The cert petitions of the Proskauer Rose and Chadbourne & Parke law firms can be found here and here, respectively. The cert petition of the insurance brokerage, Willis of Colorado, Inc., and its related entities and firms, can be found here. (Hat tip to the SCOTUS Blog for the links to the cert petitions.)

 

In its petition, the Chadbourn & Parke law firm argued that split in authority among the various circuit courts has resulted in inconsistent interpretations and applications of SLUSA preclusion. The firm argued that the Fifth Circuit had adopted an interpretation of the “in connection with” standard that resulted in a determination that SLUSA preclusion did not apply, allowing the case against the firm to go forward, while at the same time rejected a conflicting standard prevailing in the Second, Sixth and Eleventh Circuits that would have resulted in the application of SLUSA preclusion here. The petitioners argued that the Circuit split not only threatened inconsistent outcomes among the Circuits, but it frustrated the very purposes for which Congress enacted SLUSA – that is to establish “national standards” for class actions “involving nationally traded securities.”

 

The Supreme Court’s consideration of these three consolidated cases promises to be interesting and potentially significant. If nothing else, the consolidated cases involve a high-stakes dispute relating to a high-profile fraud. This consideration alone ensures that the Supreme Court’s consideration of these three consolidated cases will receive significant attention.

 

On a more basic level, the Supreme Court’s consideration of these issues should resolve the split among the Circuits in their interpretation of the “in connection with” requirement in the SLUSA preclusion provision. Resolving this split should reduce the possibility of different outcomes in different cases based on nothing more than the judicial Circuit in which the different cases were filed.

 

More importantly, the Supreme Court’s consideration of these issues will help define the scope of SLUSA preclusion in more complex cases where the alleged fraudulent scheme involves a multi-layered transaction. These kinds of questions have been unfortunately common in recent times: for example, the same kinds of questions arose in connection with the Madoff feeder fund suits. (The Courts in the Madoff feeder fund cases concluded that SLUSA preclusion applied.)

 

In a very important sense, the Supreme Court is just the latest battle in the continuing struggle that first emerged after the enactment of the PSLRA. The struggle involves the efforts of the plaintiffs’ securities bar to try to find ways to circumvent the strict standards that Congress imposed in the PSLRA. The plaintiffs’ lawyers first tried to avoid the PSLRA by pursuing their claims in state law suits to which the PSLRA. To avoid that, Congress enacted SLUSA. In these consolidated cases, the Supreme Court will determine the extent to which plaintiffs pursuing claims against remote actors are or are not subject to the constraints of the PSLRA as well as the subsequent Supreme Court case law interpreting the PSLRA

 

In their cert petition, Chadbourne Park argues that the plaintiffs’ filed their claims as state law class action precisely for the reason of circumventing Supreme Court case decisions that restricted federal securities law claims against third party advisors, which is precisely the outcome SLUSA was intended to prevent. In making these arguments, the law firm emphasizes that the aiding and abetting claims the plaintiffs are attempting to assert under state law are not allowed under federal law. The Supreme Court’s determination of these consolidated cases will significantly determine the extent to which plaintiffs can pursue state law securities-related claims against third party advisors. The determination matters because of the possibility it presents that the plaintiffs could pursue these state law claims in circumstances in which federal statutory and case law would not permit such claims.

 

The Supreme Court’s cert grant in these three consolidated cases is just the latest in a series of securities-related disputes that the Court has been willing to take up. The Court already has the Amgen case on its docket this term; the Amgen case has already been argued and the Court’s decision in expected before the end of the current term in June.

 

It used to be that years would pass between Supreme Court cases considering securities law issues. In the past five or six years, though, the Court has seemed to want to take up several securities cases each term. While the Court’s willingness to take up more securities cases certainly provides great blog fodder, it has made the securities litigation environment more volatile and it has occasionally introduced significant and unanticipated changes (as happened for example with the Supreme Court’s paradigm-shifting opinion in Morrison v. National Australia Bank). In final analysis, that is the real reason it is interesting when the Supreme Court agrees to take up a securities case – you never know for sure what might happen when the Supreme Court makes its determination.

 

The Deepwater Horizon platform explosion and oil spill took place in the Gulf of Mexico, about 250 miles southeast of Houston. The environmental damage took place in the Gulf and along the Gulf shore in the Southeastern United States. When BP’s shareholders tried to sue the board of directors of BP — a corporation organized under the laws of England — in a derivative suit filed in federal court in the U.S. alleging breaches of fiduciary duty, they clearly hoped their suit would do better in a court closer to the site of the disaster and ensuing spill. But the district court dismissed the suit on forum non conveniens grounds. In a January 16, 2013 opinion (here), a three-judge panel of the Fifth Circuit affirmed the dismissal.

 

As discussed here, plaintiffs filed the first of several derivative lawsuits in connection with the Deepwater Horizon oil spill in May 2010. Though many of the lawsuits were first filed in the Eastern District of Louisiana, the cases were ultimately consolidated through the multidistrict litigation process in the Southern District of Texas. However, while the lawsuits were filed in U.S. courts, they asserted claims under the U.K. Companies Act 2006 (about which refer here). The defendants moved to dismiss the consolidated derivative litigation in the grounds of forum non conveniens.

 

In a September 15, 2011 ruling, Judge Keith Ellison of the Southern District of Texas determined that, notwithstanding the fact that the Deepwater Horizon disaster took place in the U.S. and caused extensive environmental damage here, “the English High Court is a far more appropriate forum for this litigation,” and accordingly he granted the defendants’ motion to dismiss the cases.  Judge Ellison’s decision can be found here. My prior post discussing Judge Ellison’s opinion can be found here.

 

In its January 16 per curiam opinion, the Fifth Circuit panel affirmed the district court’s decision, concluding that the lower court had not abused its discretion in granting the dismissal on forum non conveniens grounds.

 

Among other things, the Fifth Circuit reviewed the multipart analysis a district court must use in order to determine whether or not to dismiss a case on forum non conveniens grounds. Among the most important of considerations is whether or not there is an alternative forum where the matter can be heard. In order to satisfy the availability requirement, the district court had conditioned its dismissal on the Defendants filing a stipulation that they would submit to the jurisdiction of the English courts, which the Defendants had done. The Fifth Circuit concluded that the stipulation satisfies the availability requirements.

 

Another important consideration a district court must consider in connection with a motion to dismiss on forum non conveniens grounds is the existence of a local interest in the dispute. The Fifth Circuit concluded that the district court had not abused its discretion in determining that, because this dispute was not intended to redress the impact of the Deepwater Horizon disaster in the United States but rather was intended to compensate the British company BP for its financial and reputational harm, England had the greater local interest in the matter.

 

The Fifth Circuit also concluded that the district court had “reasonably” determined that public interest factors weighed heavily in favor of England as a more convenient forum, given that the English statute on which the plaintiffs sought to rely had only recently been enacted leaving the U.S. courts with little jurisprudence to use to try to apply the statute properly.

 

The plaintiffs chose to file their suit in the U.S. rather than in the U.K. undoubtedly had something to do with a perception that a court in closer proximity to the damages caused by the spill might prove to be a more receptive forum. The selection of a U.S. court over an English one also reflects the more general advantages a plaintiff enjoys here by comparison to English courts – for example, the absence in the U.S. of a “loser pays” model, among other things.

 

These kinds of advantages often encourage plaintiffs with claims involving non-U.S. companies to try to pursue their claims in U.S. courts. But the outcome of the dismissal motion in the BP derivative suit represents just one more example of the many ways prospective litigants are finding it increasingly more difficult to pursue corporate and securities claims against non-U.S. companies in U.S. courts. Courts interpreting the U.S. Supreme Court’s Morrison decision have significantly narrowed the circumstances in which securities claims involving foreign companies can go forward in U.S. courts. The Fifth Circuit’s affirmance of the dismissal of the BP derivative suit underscores the difficulties prospective claimants may fact in pursuing derivative suits involving non-U.S. companies here as well.

 

Among the many other lawsuits filed in connection with the Deepwater Horizon disaster, there also was, in addition to this shareholders’ derivative suit, a securities class action lawsuit. Though the separate securities class action lawsuit will be going forward at least in part, the preliminary motions in the securities suit also demonstrate some of the challenges plaintiffs now face in trying to pursue claims in the U.S. against non-U.S. companies. As discussed here, in a February 2012 ruling, Judge Ellison denied in part the motions of defendants to dismiss the securities class action lawsuit that BP shareholders had filed in connection with the Deepwater Horizon disaster.

 

Though Judge Ellison denied the motions to dismiss with respect to the claims asserted by securities class action plaintiffs who had purchased BP ADRs on the U.S. securities exchanges, he granted the motion to dismiss all of the claims – including claims asserted under New York state law and English common law – of U.S.-domiciled investors who purchased their BP shares on the London Stock Exchange. Judge Ellison specifically concluded that because the federal securities laws do not apply to the securities transactions on LSE, he also lacked supplemental jurisdiction to consider the English common law claims. By shaving off the claims of the shareholders who purchased their shares, Judge Ellison dramatically narrowed the scope and range of potential damages in the securities class action lawsuit.

 

Jan Wolfe’s detailed January 18, 2013 Am Law Litigation Daily article about the Fifth Circuit’s ruling in the BP derivative suit can be found here.

 

If to err is human, then writing a blog is a most human endeavor. Tight deadlines and late-night drafting sessions ensure that mistakes infiltrate even carefully composed posts. It is a painful exercise for me to review old posts and see the errors that managed to make it onto my site.

 

In my best efforts to try to avoid mistakes, I try to read my draft posts very carefully (or as carefully as I am able at the late hours at which I am usually composing my posts). Over time, I have developed reading habits that I now carry over to all of my reading. Through this process, I have noticed a number of recurring writing errors that I have outlined below.

 

I have acknowledged the many  errors in my own writing here to assure readers that my comments below about writing are not just the pedantic rant of some self-appointed grammar scold. I offer my observations here with all due humility and in recognition that we all make mistakes, I offer these observations in the hope that others might find them helpful. In this post, I concentrate on word choice errors. Perhaps in a later post I will come back to grammatical errors.

 

Word Choice

Sometimes when I am reading along I will see a word so completely misplaced that I wonder what in the world the author was thinking – or whether the author was thinking. Just yesterday morning I read this sentence on a blog that I follow: “Chief Justice Roberts and Justice Alito dominated the questioning of the water district’s counsel, Paul Wolfson, and appeared exacerbatedby Mr. Wolfson’s argument that the property owner must accept a conditional permit to be able to challenge the condition as violative of Nollan and Dolan.” Don’t you hate it when Supreme Court Justices get “exacerbated” in public? I suspect (although I am not entirely certain) the author meant to say that the two Justices were “agitated.”

 

The preceding example illustrates the kind of word usage errors to which all of us are prone. Here are some recurring word choice mistakes I have noted where the context makes it clear that the author intended to use another word. I am sure some of these errors are Auto Correct blunders, while others are the product of simple inattention. Some of the boo-boos are doozies.

 

Tenant/Tenet: A “tenant” is a person who has a lease. A “tenet” is guiding principle or doctrine. So when I want to refer to a matter of belief, I might use the phrase “a fundamental tenet.” If I were instead to use the phrase “fundamental tenant,” I would be referring to someone who pays a lot of rent.

 

Marquee/Marquis: The sign that projects out from the façade of a movie theater is a “marquee.” A “marquis” is a nobleman ranking below a duke but above an earl or count. So a featured product or attribute is a “marquee product” or a “marquee attribute.” I guess a “marquis product” would be something made by the British aristocracy. 

 

Clique/Click: A “clique” is a small, exclusive group. A “click” is a small, sharp sound. If you are a member of a “clique,” you are smug and self-satisfied. If you are a member of a “click” you are in the sound-making business. (I can’t believe that anyone could make this mistake, but I recently saw it in an angry letter-to-the-editor).

 

Tack/Tact: One of the meanings of the word “tack” comes from sailing, and means to change the boat’s direction relative to the wind by shifting the boat’s sails. The sailing term has come to be used metaphorically. For example, when someone changes their approach to a situation, we might say they are “taking a different tack.” The word “tact” refers to a sense of propriety. I recently read a legal essay in which the author said that “the defendant’s counsel decided to try a different tact.” Maybe the lawyer started holding his tea cup with his little pinky raised?

 

Rein/Reign: A “rein” is a leather strap attached to a bridle and used to lead a horse. A “reign” refers to the period during which a sovereign occupies the throne. These words get mixed up when somebody is trying to say that he or she wants to control something the way they might control a horse (as in “I am going to have to rein him in”) but instead they use the word “reign” and thereby inappropriately invoke the monarchy.

 

Tortious/Tortuous/Torturous: I would say that about half the time anyone uses any one of these three words, they actually meant to use one of the other two. The word “tortious” is a legal term, which essentially means of or pertaining to a tort or wrong. “Tortuous” means full of twists or turns, as in “a tortuous path.” The word “torturous” means causing torture or suffering. The most common confusion of these words occurs when a non-lawyer intends to use the word “tortious.” I have a very simple suggestion on how to avoid confusing these three words. That is, if you didn’t already know the difference between these three words before you read this blog post, then you should just avoid using any of these three words altogether.    

 

Reticent/Reluctant: There appears to be a common misconception that the word “reticent’ is simply a highfaluting form of “reluctant.” Though the two words are somewhat similar, they are not equivalent. The word “reticent” means to be disposed to be silent. The word “reluctant” means unwilling or disinclined. It does not make sense to say that someone is “reticent to get involved.” Here’s my advice: If you feel the urge to use the word “reticent,” just say “shy.” Why use three syllables when one will do just fine?

 

Waive/Wave (Waiver/Waver): A “waiver” is an intentional relinquishment of a known right. A “waver” is somebody saying goodbye to a loved one at the airport. When you “waive” your rights, you are agreeing not to assert them. When you “wave” your rights, you are trying to dry them off in the breeze. 

 

Council/Counsel: These words get conflated when someone is trying to refer elliptically to a lawyer or to legal advice. The word “counsel” can be used as a noun or as a verb; that is, it can be used to describe an advisor or to describe advice. A “council” is an assembly of persons gathered for deliberations. Near my house when I was a child, there was a Catholic church called “Our Lady of Good Counsel.” By contrast, the moniker “Our Lady of Good Council” refers to a popular assemblywoman. Anyway, if you are referring to a lawyer or to legal advice, the word to use is “counsel.” To avoid confusion, just say “lawyer” or “advice” and be done with it.

 

Advice/Advise: The confusion of these two words somehow feels like a blood relative to the confusion of council and counsel. When a lawyer counsels you, she is advising you. When a lawyer gives you her counsel, she is giving you her advice. Here’s how to keep them straight: “advise” is a verb and “advice” is a noun.

 

Site/Cite: A “site” is a location. A “cite” is a reference or quotation. This blog is a web site. When I refer to a legal case on this site, it is a cite to that case. I try to keep this distinction in my sights.

 

Used to/Use to: The confusion of these two short phrases use to bother me, but then I got used to it.

 

When Words are Lacking: It is one thing to confuse words, but it is an entirely different problem when there are no words. An anecdote will illustrate the problem.

 

Like many newlyweds, when I was newly married I was unsure how to address my new mother-in-law and father-in-law. I wanted to use their first names, but that seemed a little bit forward at that point. I decided I would just ask them how they wanted me to address to them, in the hope that they would then authorize me to use their first names. In making this calculation, I did not make sufficient allowances for the peculiarities of the specific people I was dealing with. (I know better now.) My mother- in- law, a scholar of Chinese art, said that the Chinese have words for everything, and they even have words for a son- in- law to use to address his mother- in- law and father-in- law. She suggested that I use these Chinese words to address them. If I recall correctly, the words were something like “kung-kung” and “tai-tai.” She wasn’t kidding. (I didn’t learn the Chinese words, but I did learn something important about my new in-laws.)

 

The point of this story is that there are a lot of things for which there are no words in English, such as forms of address for a son-in-law to use when addressing his father-in-law or a mother-in-law. As illustrated in this January 8, 2013 article from The Atlantic, there are also many emotional states and circumstances for which other languages have names but for which there are no English equivalents. My personal favorite from this list is “Backpfeifengesicht (German): A face badly in need of a fist.”

 

Once you get started, apparently there are a lot of things for which are no words in English and there are a lot of lists of words in foreign language for which there are no English equivalents. I have linked here and here to a couple of the better lists. Here is a good example from one of the lists: “Zeg (Georgian): It means ‘the day after tomorrow.’ Seriously, why don’t we have a word for that in English?”

 

And Now, A Complete Waste of Time: On the website for Abbey Road Studios, the studios have a page with a live webcam feed of the street crossing that the Beatles made famous with their Abbey Road album cover. The camera is set up at a reverse angle from the album cover shot, but if you watch the webcam feed for a few minutes during the daytime you will see various people in the crosswalk trying to take pictures of their group striking the album cover road crossing pose. I watched for about ten minutes yesterday morning and saw several different groups of people trying to capture the album shot. Click here if you want to watch the webcam feed — but only if you are prepared to waste the next quarter of an hour. (Another day I will write the essay about our amazing modern technology and the ridiculous ways we use it.).

 

In what is as far as I know the first determination of liability in connection with the recent wave of litigation filed against U.S. listed Chinese companies, a Hong Kong-based arbitration panel has entered an award in favor of an investment unit of C.V. Starr of over $77 million against China MediaExpress Holdings and related persons and entities, based on the panel’s determination that the company was a “fraudulent enterprise.” The panel’s December 19, 2012 award, which can be found here, makes for fascinating reading. (Hat tip to Jan Wolfe, who reported the award and related U.S.-court filings in a January 16, 2013 Am Law Litigation Daily article, here.)

 

In October 2010, China MediaExpress obtained a U.S. listing through a reverse merger with a U.S. listed publicly traded shell corporation. Prior to the reverse merger, the predecessor entity was owned by Zeng Cheng (“Cheng”) and Ou Wen Lin and Lin’s brother. China MediaExpress allegedly was in the business of providing advertising on inter-city busses. The company’s financial statements showed growing profits and large cash reserves. Starr invested a total of $53.4 million in China MediaExpress in two private transactions in January 2010 and October 2010. 

 

In early 2011, online analysts published reports questioning China MediaExpress’s financial statements. Shortly thereafter, China MediaExpress’s auditor and CFO resigned, as well as members of its board of directors. (Refer here for background.) Trading in China MediaExpress’s shares was halted. Pursuant to provisions in its stock purchase agreements with China MediaExpress, Starr initiated two Hong Kong arbitration proceedings against China MediaExpress, as well as Cheng, the Lin brothers and related entities. Separately, Starr initiated a securities fraud class action against China MediaExpress, its principals and related entities, and the company’s auditor in the District Court of Delaware. (In addition, certain other shareholders separately filed a securities class action lawsuit against China Media Express in the Southern District of New York, about which refer here.)

 

The arbitration panel, which was chaired by former Delaware Supreme Court Justice Andrew Moore II, heard evidence in the two consolidated arbitrations in May 2012. On December 19, 2012, the panel delivered its Award.  A copy of the arbitration award was filed in the District of Delaware lawsuit on January 13, 2013 (refer here).

 

The 49-page award makes for some fascinating reading. Among other things, the panel concluded that the company was “a fraudulent enterprise that caused Starr to lose the total value of its investment.” Cheng, the panel concluded, has “no credibility whatsoever”. Ou Wen gave the impression on the witness stand that “he would say whatever he thought would advance his case.” 

 

Among many things that troubled the panel was what had happened to the supposedly thriving business that had been represented to Starr. The company attempted to argue that the business had been destroyed by short sellers, a contention the panel described as “ridiculous,” observing that:

 

To put it bluntly, this claim of Cheng and CME that short sellers destroyed his business is nonsense. It is a fabrication evidently designed to hide the fact that CME never had the business it represented to the world that it had or that, if it did, it has been ravished by dishonest conduct on the part of those who conducted the business. Coupled with the conduct when challenged with the matters raised by [the company’s auditors] and other matters, Cheng’s claim that the short sellers destroyed his business indicates that Starr was correct with it contended that CME was a fraudulent enterprise.

 

The one specific transaction Cheng offered to explain what happened to all of the cash that the company had reported on its balance sheet was “a land transaction at Shoushan Waterfall.” However, the “evidence concerning this transaction was so implausible and contradictory that it is impossible to accept his claim that any money invested in that transaction was for the benefit of CME and its shareholders even if money of CME was used to finance this transaction.” Overall, the evidence Cheng offered regarding this transaction (which had not been approved by the Board or reported to shareholders and involved a company in which Cheng had an ownership interest) established that Cheng was “in breach of his fiduciary duty.” The evidence concerning the transaction “simply reinforces the conclusion that Cheng was both an unreliable witness and a dishonest businessman.”

 

As Jonathan Weil said in his January 11, 2013 Bloomberg column about the latest accounting scandal involving a Chinese company, “Chinese stocks may not make for trustworthy investments, but they sure can be entertaining to watch from a distance.”

 

The arbitration panel’s award represents a devastating judgment against China MediaExpress and its key officials. It remains to be seen how Starr will be able to use this judgment in its separate U.S. securities fraud suit and whether it will be able to collect on the Hong Kong panel’s award. It will also be interesting to see what the claimants in the separate securities class action lawsuit will be able to make of the arbitration award. On the one hand, the panel’s brutally worded conclusions about the company and its principals are damning. On the other hand, the issue preclusive effect of these determinations in separate proceedings involving separate parties and separate evidentiary standards is the kind of thing good lawyers could argue about for a long time.

 

In any event, whatever the ultimate effect of the arbitration’s panel’s determinations may prove to be, the fact is that, according a statement by Starr’s lawyer quoted in the Am Law Litigation Daily article linked above, the panel’s ruling represents the “first time any of these issues concerning Chinese reverse mergers have been adjudicated.” The implication for other companies involved in these cases – many of which involve allegations even more sensational than were raised here – is ominous.

 

As the current wave of bank failure litigation has unfolded, the directors and officers of banking institutions rightly have become more concerned about the own potential liability exposures and interested in learning more about how they might be able to reduce their risks and exposures. In the following guest post, Joseph T. Lynyak III , Michael Halloran, and Rodney R. Peck of the Pillsbury law firm take a look at the current litigation environment facing directors and officers of financial institutions and provide some practical steps that these officials can take to try to mitigate their risks

.

I would like to thank Joe and Rob for their willingness to publish their articcle 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 Joe’s and Rod’s guest post.

 

 

 

In this article, we analyze the steps that officers and directors of bank and non-bank financial companies and their holding companies and affiliates can take to address personal liability for alleged breaches of duty to manage and supervise a financial company’s operations, allegations which are being made in an increasing number by federal and state regulatory agencies, including the federal banking agencies and the U.S. Consumer Financial Protection Bureau (CFPB).

 

On December 10, 2012, a California jury returned a verdict of $169 million in a case brought by the FDIC against three former IndyMac Bancorp Inc. executives after determining that those officers were negligent in making loans to homebuilders by continuing to push for growth in loan production without proper regard for creditworthiness and market conditions. Soon thereafter, the former CEO of IndyMac Bank agreed to pay $1 million from his personal assets in addition to available insurance proceeds to settle another FDIC claim related to the failure of IndyMac Bank. In an unrelated yet problematic series of developments, the newly formed CFPB recently assessed civil money penalties against three holding companies for aggressive marketing practices in an aggregate amount exceeding $500 million.

 

Approximately 25 lawsuits were filed in 2012 by the FDIC against former officers and directors of failed institutions, up from 16 in 2011. In total, more than 40 lawsuits have been filed against officers and directors of failed institutions since 2010. Since the beginning of 2007, approximately 467 financial institutions have failed. The FDIC has indicated that it is continuing its investigation of many bank failures and additional actions can be expected. Outside directors, in addition to inside directors and senior officers, were named in 30 of the cases. (See, Cornerstone Research, “Characteristics of FDIC Lawsuits Against Directors and Officers of Failed Financial Institutions,” December 2012.)

 

These and similar administrative and civil enforcement actions brought by governmental entities have caused considerable concern among officers and directors of financial services companies. Specifically, many individuals have raised questions whether—and in what circumstances—management or members of a board of directors might be held personally liable for similar penalties or damages, and if so, what prudent actions could be taken to mitigate that risk.

 

Although these issues are complex and the risk will vary based upon differences between the corporate laws of state jurisdictions and the possible applicability of several banking and securities laws (among others), this article presents an overview and proposed approach to analyzing the risk of personal liability. It also includes a methodology to evaluate protections that might be available under current corporate governance provisions.

 

What follows is a summary of pertinent legal issues relating to the risk of personal liability, distinctions to be drawn between liability arising in the bank and non-bank context, and steps that directors and officers might take to minimize personal liability risk, as well as a methodology for taking an inventory of existing protections available to a board and management.

 

Overview and Summary—State Corporate Laws

From a traditional corporate law perspective, both officers and directors of a corporation owe a duty to the corporation to avoid self-dealing and conflicts of interest (the “duty of loyalty”) and an affirmative obligation to use reasonable efforts to properly manage and supervise the business of the company (the “duty of care”). The degree or standard by which an officer or director must comply with his or her duty of care is generally governed by the corporate law of the state in which the company is incorporated. That standard can range from an obligation to act in a reasonable manner and avoid negligent actions or decisions, to a diminished level of care that creates personal liability only in the case in which one acts in a grossly negligent fashion.

 

Because most state legislatures have considered these questions, each state’s Corporations Code has its own version of the duty of care, and in many jurisdictions the courts have further refined that standard by judicial interpretation. For example, in several states, liability for breaching the duty of care can only be actionable when a director or officer is grossly negligent, while in other states the standard of gross negligence protects only outside directors while management is held to the higher standard of mere negligence. Further, in many jurisdictions there is recognition—either by statute, case law or common law—that directors and/or officers may rely upon the so-called “business judgment rule” that protects them against personal liability provided that the officer or director took reasonable steps to come to a decision even when the decision is proven to be wrong.

 

In addition, several states have authorized limitations of liability for corporate misfeasance by permitting a corporation to adopt provisions in its articles or bylaws that further limit liability for board members or management. Importantly, in recent years, several states have adopted expanded indemnification rights for corporate stakeholders by permitting a corporation to adopt in its articles and bylaws very broad rights to indemnify officers and directors against individual damage claims brought against them in their individual capacities.

 

The lesson to be learned is that concerned officers and directors should establish a baseline to identify by what state law standard they will be measured when being judged regarding compliance with the duty of care, as well as related state law limitations regarding liability.

 

Additional Concerns for FDIC-Insured Institutions, Subsidiaries and Holding Companies

In addition to the state law standards regarding a director or officer complying with his/her duty of care, there are several other significant considerations that require attention for an officer or director of an FDIC-insured institution or a bank or savings and loan holding company.

 

First, an important U.S. Supreme Court decision, Atherton v. FDIC, confirms that there is no federal common law regarding the duty of care for a national bank or a federal savings association. Accordingly, based upon the Atherton decision (which interpreted a provision of the Federal Deposit Insurance Act, or the “FDI Act”, for receivership claims brought by the FDIC following a failure of a bank or thrift), the standard for national bank and federal association officers and directors generally follows state law, except that state law cannot impose a standard lower than gross negligence. Of course, for banks and bank holding companies organized under state corporate laws, the duties of care on the part of officers and directors are governed by such laws (subject to the partial preemption under the Atherton decision).

 

Second, applicable regulations for national banks and federal savings associations provide a useful alternative that permits a national bank or federal savings association to adopt for corporate governance purposes the Corporations Code of the state in which the institution is located, the Model Business Corporations Act or the Delaware General Corporations Code. This is a potentially valuable option that should be carefully considered. For example, in states in which liability for bank officers is based upon the higher standard of mere negligence, adopting the corporate law of Delaware not only lowers the standard for breach of the duty of care to gross negligence, but may also provide enhanced protection in regard to indemnification and the availability of the Delaware version of the business judgment rule.

 

However, it should be noted that Section 18(k) of the FDI Act (and thus, FDIC’s regulations) severely (and unfairly) limits indemnification rights of officers and directors of FDIC-insured institutions, their subsidiaries and their holding companies in instances in which civil money penalties and other regulatory enforcement orders are assessed against an “institution affiliated party,” which includes officers and directors of an FDIC-insured institution, its subsidiaries and any parent holding company. Even though defense costs may be paid or advanced by an institution (and commercial insurance may be purchased to pay such expenses), the proceeds of the insurance cannot be used to pay for penalties assessed.

 

Mitigation Considerations for Officers and Directors

If there is a key conclusion that can be drawn from this discussion, it should be that individuals acting as officers and directors of financial intermediaries should engage in advance planning and clearly understand the nature of their rights in regard to administrative enforcement actions that might be brought by one of the federal banking agencies or the CFPB. Importantly, when complying with his or her duty of care, an officer or director should ensure that the record reflects reasonable steps to comply with that standard.

 

In that regard, an officer or director should be provided with legal advice as to what degree of diligence and review should be incorporated into the decision-making process, as well as how that process is reflected in the records of the institution. Particularly in the case in which the business judgment rule is available, the business records of the entity should reflect that all appropriate steps were taken prior to decisions being made.

 

It should be noted, however, that a distinction should be drawn between an FDIC receivership claim and assessment of civil money penalties by the CFPB or one of the federal banking agencies. In the case of a receivership claim following a bank failure, the above-referenced duty of care for personal liability purposes (e.g., negligence, gross negligence, etc.) is most often a determinative factor. However, in the administrative context in which civil money penalties are being assessed, culpability need not be based upon the failure to comply with a duty of care, but rather, can be based upon an institution’s compliance or non-compliance with an enforcement order previously issued in which officers and directors are ordered to take specific remedial steps to achieve compliance.

 

A Methodology for Determining and Achieving Reasonable Risk Mitigation to Avoid Personal Liability

As even the casual observer can see, being an officer or director for a financial institution—whether FDIC-insured or otherwise—presents a range of challenges. Complicating the situation is the nature of legal representation of companies, in that counsel for a company is usually not deemed to be providing individual legal advice to officers or directors, and hence the use of in-house counsel or a company’s outside lawyers to provide personal advice may not be appropriate or available in all cases.

 

We suggest that several steps be considered to address the concerns discussed by this article.

 

First, as noted above, officers and board members should obtain an overview of the rules governing compliance with the duty of care applicable to the company, including how courts and agencies have interpreted those rules. Among other things, identifying process issues and evidencing development of policies and procedures is essential, as well as ensuring that business records reflect robust discussion and reasonable reliance on experts (i.e., to be able to take advantage of the business judgment rule).

 

Second, a corporate governance review should take place to determine whether corporate documents such as articles and bylaws include the most favorable indemnification rights permitted under applicable law. (In that regard, it is important to note that in most cases such protections are optional under state corporate law and must be affirmatively adopted by a company’s board of directors.)

 

Third, employment agreements and indemnification agreements should be reviewed and updated on an annual basis to maximize contractual rights for designated officers and directors.

 

Fourth, extreme care should be exercised when transactions or other matters arise in which the director or officer may be seen as having a conflict of interest. All corporate processes should be followed, including full disclosure of the nature of the conflict, approval of the matter by a majority of disinterested directors, advice of counsel, etc.

 

Fifth, directors should work with management to establish internal tracking systems on matters requiring attention (“MRA”) arising out of regulatory examinations. Repeat violations of law or failure to remediate troublesome conditions by the next examination can be seen as a lack of proper board oversight. Careful attention should be given to the regulators’ evaluation of management and appropriate action taken when poor ratings are given. However, reliance on the regulators’ evaluations of management alone may not be sufficient because it appears that regulatory evaluations of management in many cases of failed banks have not been significantly downgraded by the regulators until a year or two before the bank’s failure. (Cornerstone Research, supra.)

 

Finally, a legal review of a company’s directors’ and officers’ liability insurance policies should be conducted and benchmarked against similar institutions in similar circumstances. It should also be noted that the contractual terms of directors’ and officers’ liability policies are frequently negotiable, and can result in valuable additional liability protection.

 

Other Standards of Liability Impacting Officers and Directors of a Financial Company

Although this article focuses on corporate and banking liability standards applicable to officers and directors of a financial intermediary, other standards of care arise in particular circumstances as part of the performance of the activities of an officer or director of a financial company. For example, in several instances under the federal securities laws, a corporate officer for a registered company can be held liable in civil or SEC actions for material misstatements in offering materials unless the director has engaged in a “due diligence” review. In regard to companies and “institution affiliated parties” that are subject to Section 8 of the FDI Act, liability might be viewed as a strict liability standard if a federal banking agency views the actions of an officer or director as having engaged in a violation of a federal law, regulation, or unsafe or unsound banking practice. Similarly, the newly established CFPB may also directly access civil money penalties and other remedial measures if an officer or director has participated in the violation of a covered federal consumer protection law.

 

Please note that this article summarizes several complex liability topics and by its nature is a starting point for further inquiry by officers and directors of banks and non-banks participating in the financial services industry.

 

Joseph T. Lynyak III is a partner in the Finance practice at Pillsbury Winthrop Shaw Pittman LLP in Washington, D.C., and Los Angeles. He can be reached at (213) 488-7265 or joseph.lynyak@pillsburylaw.com.

 

Rodney R. Peck is a partner in the Corporate & Securities practice at Pillsbury in San Francisco. He can be reached at (415) 983-1516 or rodney.peck@pillsburylaw.com.

 

The U.S. Supreme Court’s 2011 decision in Wal-Mart Stores v. Dukes continues to agitate the employment practices litigation arena while at the same time both EEOC enforcement activity and wage and hour litigation continue to surge, according to the annual review of workplace litigation by the Seyfarth Shaw law firm. The law firm’s January 14, 2013 press release about this year’s ninth edition of the annual Workplace Class Action Litigation Report can be found here. The report’s introductory “trends” chapter and the “top ten” settlements chapter can be found here.

 

Among the many changes that the Wal-Mart case has brought about during the past year is that it resulted in a decline in the levels and numbers of employment discrimination class action settlements in 2012. According to the report, the 2012 total for all employment discrimination class action settlements was about $49 million, which is well below the $348 million level in 2010, the year before the Wal-Mart decision, and the lowest annual level since 2006. (As discussed n greater detail here, in its June 2011 decision in the Wal-Mart case, the Supreme Court established a heighted standard to satisfy the “commonality” required in order to certify a class.)

 

This decline in aggregate settlements is due to the fact that employers settled many fewer employment discrimination cases during 2012, fewer than “at any time over the past decade and at a fraction of levels as in the period from 2006 to 2011.” The decline reflects the difficulty in the wake of Wal-Mart in certifying a nationwide class, as well as the ability of the defendants “to dismantle large class cases or to devalue them for settlement purposes.” Indeed, according to the study, the Wal-Mart case has “caused both federal and state courts to conduct a wholesale review of the propriety of previous class certification orders in pending cases.”

 

At the same time, though, governmental enforcement activity remained at “white hot” levels in 2012. According to the report, more discrimination charges were filed with the EEOC in 2012 than in all but one previous year since the Commission was founded. The Commission is particularly focused on its “systemic investigation program” in which the agency is emphasizing the “identification, investigation and litigation of discrimination claims affecting large groups of ‘alleged victims.’” According to the study, the agency is focused on “high-impact, high-stakes litigation.”

 

In particular, the EEOC’s prosecution of “pattern or practice lawsuits” is “an agency-wide priority.” The Commission completed work on 240 systemic investigations in fiscal year 2012, resulting in 94 ‘probable cause’ determinations and 46 settlement agreements or conciliation agreements that yielded a total recovery of $36.2 million for systemic claims.

 

And while workplace litigation overall has remained level with prior years, wage and hour related litigation “continued to out-pace all other types of work place class actions.”   Thus, while ERISA litigation was down slightly for the year (from 8,414 cases in 2011 to 7,908 in 2012, a decline of about 6%) and employment discrimination filings were also down (from 14,411 in 2011 to 14,260 in 2012, a decline of 1%), there were 7,908 FLSA lawsuit filings in 2012, representing about a 16% increase from the 6,779 filings in 2011. In addition, state court wage and hour class action lawsuit filings also surged in 2012. The report projects that “the vigorous pursuit of nationwide FLSA collective actions by the plaintiffs’ bar will continue in 2013.”

 

While the U.S. Supreme Court’s Wal-Mart decision, as well as its 2011 ruling in AT&T Mobility v. Concepcion (recognizing the enforceability of contractual arbitration agreements), have unquestionably had an impact on the workplace litigation arena, the plaintiffs class action bar has moved quickly to respond. According to the report, 2012 saw “rapid strategic changes based on evolving decisions and developments.” The plaintiffs’ bar “began the process of ‘re-booting’ class–wide theories of certification, as well as establishing liability and damages on a class-wide basis.”

 

As a result, “workplace class action litigation case law is in flux, and more change is inevitable in 2013.” Among other things, the report suggests that as a result of these changes, “future employment discrimination class action filings are likely to increase due to a strategy whereby state or regional-type classes are asserted rather than nationwide, mega-cases.”

 

A January 14, 2013 Corporate Counsel article about the Seyfarth Shaw report can be found here. Special thanks to Gerald Maatman, the report’s co-author and chair of the Seyfarth Shaw class action litigation group, for providing me with a copy of the report and press release. Maatman’s January 14, 2013 post on the Workplace Class Action Blog about the report can be found here.

 

On January 10, 2013, in a detailed and interesting opinion with features that may be helpful to other life sciences securities suit defendants, Middle District of Tennessee Judge Kevin Sharp granted the motion of Biomimetic Therapeutics to dismiss the securities class action lawsuit that had been filed against the company over its disclosures concerning developments in the clinical trials of its flagship product. A copy of Judge Sharp’s opinion can be found here.

 

The clinical trials were conducted in support of the company’s efforts to obtain FDA approval of its bone grafting product called Augment. Biomimetic conducted the clinical trial pursuant to protocols it had proposed and that had been approved by the FDA. As later became apparent, Biomimetic based its analysis of the testing results on a different patient population than had been identified in the FDA-approved protocols. The results associated with the different population were more favorable to the company.

 

The FDA expressed concerns to Biomimetic about the population used and other aspects of the clinical trials in a December 3, 2012 deficiency letter. The FDA also raised a number of concerns about the trials in a May 10, 2011 briefing document released in advance of the public expert panel meeting. Following the meeting, the expert panel narrowly voted in favor of approval of the Augment’s safety and efficacy.

 

Biomimetic’s share price declined 35% following the FDA’s May 10, 2011 disclosure of the testing concerns. Its share price declined a further 12% following the narrow expert panel vote, out of concerns that in view of the narrowness of the expert panel vote, FDA approval without additional processes was unlikely.

 

Following the share price decline, shareholders filed a securities class action lawsuit in the Middle District of Tennessee against Biomimetic and certain of its directors and officers. The shareholders alleged that throughout the class period, the defendants made unjustifiably positive statements about the Augment clinical trials and omitted to disclose the specific concerns that the FDA had raised about the trials.

 

According to the court, the “heart” of the plaintiffs’ allegations was that the defendants had engaged in a regulatory “bait and switch” by changing the patient population used to analyze its trial results in a way that allowed the company to report more favorable results that would have been shown if the original population were used. The plaintiffs also alleged that the defendants had failed to disclose the other problems with the clinical trials, including in particular that Biomimetic had failed to include processes to capture measurements on additional items that were of particular concern to the FDA.

 

The defendants moved to dismiss the plaintiff’s complaint.

 

The January 10 Opinion

In his January 10, 2013 opinion, Judge Sharp granted the motion to dismiss without leave to amend, finding that the plaintiffs’ allegations failed to meet the pleading requirements of the PSLRA.

 

Judge Sharp rejected the argument that the company’s use of a modified patient population to analyze the trial results violated the FDA-approved protocol. He also found that in a press release and in an earnings call, the company had “acknowledged the confusion that had been generated between the classifications of patient populations.” In light of these disclosures, the company’s statements about the patient populations “do not suggest a knowing and deliberate intent to deceive or defraud, let alone highly unreasonable conduct.”

 

In reaching this conclusion, Judge Sharp put particular emphasis on the fact that the company had “never suggested approval by the FDA was assured,” adding that “quite to the contrary,” the company “repeatedly and consistently warned that there were no guarantees that Augment would be approved.”

 

Judge Sharp also found that plaintiffs’ allegations that the defendants had deceptively omitted to disclose other clinical trial deficiencies were also insufficient. He concluded that “the alleged deficiencies and the omission in the clinical trials do not raise a strong inference of fraudulent intent as required by the PSLRA.”

 

In particular, Judge Sharp rejected, as insufficient, the plaintiff’s argument that the company was “cutting corners by failing to conduct certain tests or studies.” He noted that

 

The notion that [Biomimetic] would recklessly forego necessary tests and studies or hide adverse events makes little sense, even disregarding Defendants’ assertion that they poured their own money into the company. Plaintiffs’ own allegation is that Augment is [Biomimetic’s] flagship product and necessary to the companies [sic] success, begging the question why it would sabotage all of the company’s efforts on the point.

 

Along those lines, Judge Sharp noted that neither the company nor the individual defendants had engaged in securities sales after the company received the FDA’s deficiency letter.

 

One particularly interesting aspect of Judge Sharp’s opinion is his consideration of the plaintiffs’ allegations that the defendants had deceptively failed to disclosed the FDA’s concerns in the deficiency letter while at the virtually the same time had made positive statements about the progress of the Augment clinical trials. Judge Sharp noted that “a deficiency letter is not a final FDA decision, but a request for more information, and in fact, very few [applications] are approved without the issuance of a deficiency letter.” Judge Sharp then cited with approval language from a prior opinion to the effect that “it simply cannot be that every critical comment by a regulatory agency has to be seen as material for securities law reporting purposes.” He concluded that based on the overall factual allegations, the company “had a reasonable basis for optimism” notwithstanding the concerns noted in the deficiency letter.

 

Discussion

As I noted in my recent analysis of 2012 securities class action lawsuit filings, life sciences companies continue to be a favored target for securities class action litigation. The reason the companies attract securities suits has a lot to do with the complex and unpredictable regulatory process to which the companies are subject. The regulatory process is. As this case shows, many things can happen during the course of a clinical trial, which in turn can significantly affect investors’ perceptions of the prospects for the company involved.

 

There are several aspects of Judge Sharp’s opinion that should be heartening to life sciences companies that find themselves targeted by securities litigation as a result of setbacks the companies experience in the clinical trial process.

 

First, Judge Sharp showed an uncommon willingness to immerse himself in the complexities of the regulatory process and the science involved with the Augment clinical trials. Because of his willingness to understand the complex details, he was able to understand what had happened concerning the change in patient population used for analytical purposes. He was also able to understand the company’s disclosures about the populations used. Because he had this understanding, he was not persuaded by the plaintiffs’ characterization of the change in patient populations as a “bait and switch.” Of course, other life sciences securities suit defendants may not always have a court as wiling to do the hard work to develop those kinds of detailed understandings of the process and of the science. But this case does show the possibilities arising from trying to make those kinds of arguments to the court.

 

A second and more interesting aspect of Judge Sharp’s opinion has to do with his analysis of the plaintiffs’ allegations concerning the defendants’ alleged failure to disclose the concerns noted in the deficiency letter. Although he does not come right out and say that life sciences companies do not have an obligation to disclose an FDA deficiency letter, Judge Sharp’s opinion certainly will provide support for other life sciences securities suit defendants who want to argue that the mere fact that the FDA has sent a deficiency letter alone is not necessarily material and that the failure to disclose concerns identified in a deficiency letter does not by itself amount to securities fraud. This aspect of Judge Sharp’s opinion could prove to be quite helpful for other life sciences securities defendants.

 

Another important aspect of Judge Sharp’s opinion has to do with his analysis of the company’s precautionary disclosures. He clearly considered it important that the company avoided any suggestion that approval of Augment was assured and emphasized the possibility that Augment might not be approved. The company’s precautionary disclosures, along with the absence of any insider or company stock sales at sensitive times, seems to have gone a long way toward reassuring Judge Sharp that the defendants had not set out to deceive anyone. Judge Sharp’s opinion underscores the importance for life sciences companies to avoid overly optimistic statements about future regulatory outcomes as well as for the companies to use the disclosure documents to “bespeak caution” to investors about the uncertainties of the regulatory process.

 

One final note about Judge Sharp’s opinion has to do with the simple fact that the dismissal was granted. Because of the unpredictability of the FDA regulatory process and because of the resulting volatility of life sciences companies’ share prices, the companies tend to attract significant levels of securities litigation. But though the companies may attract lawsuits,  that does not always mean that the suits are always great cases for the plaintiffs. As one industry observer noted (refer here), “courts continued to grant with relative frequency life sciences companies’ motions to dismiss due to plaintiffs’ inability to sufficiently plead scienter.”