As discussed in an earlier guest post on this site (here), entrepreneurial plaintiffs’ lawyers seem to have hit upon a new way to extract a fee from the fights over 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 last year’s say-on-pay suits, plaintiffs’ lawyers have filed fewer of these kinds of suits this year against companies that experience 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 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 lawsuits (of which the article says some 20 have been filed) 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 are another current litigation trend. (Refer here for background regarding the M&A-related litigation trends.)  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.

 

It is hard to disagree with the sentiment of one defense counsel, quoted in the Reuters article, that these lawsuits are nothing more than a “shakedown for a quick buck.” At least some companies are trying to resist these suits. For example, in a November 13, 2012 ruling, Alameda County (California)Superior Court Judge Wynne Carvill rejected the plaintiff’s injunction request, holding that there is “no risk of any interim, much less irreparable harm” if the say-on-pay vote went forward. A copy of the November 13 order can be found here.

 

A battleground issue that may be increasingly important, at least for the companies trying to fight these suits, will be venue. The plaintiffs’ firm that is leading the charge on these cases has chosen to file them in state courts outside of Delaware. The defendants usually seek to remove the cases to federal court, but, as discussed in Alison Frankel’s November 30, 2012 post on her On the Case blog (here), the plaintiffs have had some success in having the cases remanded to state court. As the statements of the defense attorneys quoted in Frankel’s blog post show, however, the defense attorneys have not conceded this issue, which they clearly view as a vital battleground in trying to fight these cases.

 

But while some companies and their attorneys may be fighting these cases, the plaintiffs’ firms pushing these suits seem likely to continue to file them as long as they can make money doing so. As the author of the Pillsbury memo notes, in a quote in the Reuters article, “Where the plaintiffs securities bar sees that they will get a return on their investment, they’re going to keep filing them.”

 

In my view, both the kinds of say-on-pay lawsuits filed last year and the new style version of the suits that are hot right now are symptoms of a larger phenomenon, which is the attempt by the plaintiffs’ securities bar to diversify their product line. The root cause is that there are fewer traditional securities class action lawsuits these days and the ones that are filed are tougher to prosecute as a result of a string of U.S. Supreme Court decisions over the last several years, as well as the cumulative effect of Congressional reforms. Faced with fewer profit making opportunities in their traditional product line, the plaintiffs’ securities firms have been trying to diversity.

 

A number of current litigation trends are the result of the plaintiffs’ securities bar’s diversification efforts – not just the various kinds of say-on-pay lawsuits, but also the M&A-related litigation that has ramped up so much recently, as well as the class action opt-out litigation trends I noted in a recent post (here). (Indeed, you could argue that these diversification efforts first started with the options backdating cases, most of which were filed as derivative suits, rather than as securities class action lawsuits). 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 I have noted here but also perhaps other kinds of suits that will emerge in the months ahead.

 

To be sure, it could be argued that these evolving litigation trends are simply a reflection of the fact that we have an entrepreneurial and opportunistic plaintiffs’ bar in this country. An alternative point of view is that in a global economy our domestic companies are put at an enormous competitive disadvantage as a result of the unproductive costs our over-active litigation system imposes on them. Anybody making a list of unproductive costs accruing due to lawyer-driven litigation would have to put the expenses associated with these new wave say-on-pay suits right at the top of the list.

 

Second H-P Securities Suit Sweeps in a Broader Roster of Defendants: In a post last week, I noted that plaintiffs’ lawyers had quickly jumped on the Autonomy acquisition accounting scandal at H-P and had filed a securities class action lawsuit. As I noted in my post, the first suit filed, at least, named only H-P and certain of its current and former officers as defendants. In particular, I noted that the first complaint did not name as defendant Autonomy or any of its former officers or directors, nor did it name any of H-P’s outside advisors.  However, I also noted that further lawsuit seemed likely, and noted the possibility that additional suits might include additional defendants.

 

Now further lawsuits have in fact been filed and the latest suits have expanded the roster of defendants. As reflected in plaintiffs’ lawyers November 30, 2012 press release (here), the latest suit to be filed names as defendants not only H-P and certain of its officers, but also H-P directors, Autonomy and Deloitte LLC, H-P’s auditors. The complaint can be found here. The individual defendants named in the complaint include not only H-P’s former and current CEOs and its current CFO, as well as two other H-P’s chief accounting officers, but also Michael Lynch, the former CEO of Autonomy, and Sushovan Hussain, Autonomy’s former CFO. (Speical thanks to a loyal reader for providing a copy of the complaint.)

 

The H-P/Autonomy debacle continues to attract critical press scrutiny, including a November 30, 2012 New York Times article entitled “H-P’s Autonomy Blunder May be One for the Record Books” (here) in which James B. Stewart writes that H-P’s acquisition of Autonomy arguable ranks as one of the worst deals ever, ranking right up there with the disastrous Time Warner acquisition of AOL. Among other things, Stewart writes:

 

It’s true that H.P. directors and management can’t be blamed for a fraud that eluded teams of bankers and accountants, if that’s what it turns out to be. But the huge write-down and the disappointing results at Autonomy, combined with other missteps, have contributed to the widespread perception that H.P., once one of the country’s most admired companies, has lost its way.

 

Second Circuit Affirms Dismissal of Securities Suit Filed Against U.S.-Listed Chinese Company: Over the last several years, plaintiffs have filed dozens of securities suits against U.S.-Listed Chinese companies, alleging accounting misrepresentations as well as undisclosed transactions benefiting insiders. (This litigation phenomenon is detailed and discussed at greater length here.)  Though some of these cases have survived dismissal motions, others have not survived the initial pleading hurdles. On November 29, 2012, the Second Circuit, in a summary order (here), affirmed the dismissal of one of these suits.

 

On October 26, 2010, Mecox Lane Limited issued over 11 million American Depositary Receipts in an IPO. As discussed here, on December 3, 2010, following company disclosures, investors filed an action against Mecox, certain of its directors and officers, and its offering underwriter, alleging that the Company’s gross margins had been adversely impacted by increased costs and expenses which made it impossible for Mecox Lane to achieve the results defendants projected at the time of the IPO. On March 5, 2012, Southern District of New York Judge Robert Sweet granted the defendants’ motion to dismiss. The plaintiff appealed.

 

In the November 29 summary order affirming the dismissal, a three judge panel of the Second Circuit noted that:

 

Even taking all of the Complaint’s allegations as true and drawing all reasonable inferences in favor of the Plaintiffs, the statements that they point to as untrue or misleading are neither. The Complaint does not mention undisclosed information, but points to nothing to show that disclosures were required.

More About the U.S.-Listed Chinese Companies: The Mecox Lane case is the second of the recent securities suits involving U.S.-listed Chinese companies to reach the Second Circuit. As discussed here, in August 2012, the Second Circuit revived a securities suit that had been filed against China North Petroleum Holding that had been dismissed by the District Court.

 

In addition to the revived securities suit, China North Petroleum has other problems as well. As described in its November 30, 2012 litigation release (here), the SEC has filed a civil enforcement action in the Southern District of New York against the company, its CEO and former Chairman, and its founder and former director, as well as other officers and the family members of one of the officers.

 

The SEC alleges, in connection with the company’s two 2009 stock offerings, that the CEO and the founder, as well as the other officers, “diverted offering proceeds to the personal accounts of corporate insiders and their immediate family members, and also engaged in fraudulent conduct in connection with at least 176 undisclosed transactions between the company and its insiders or their immediate family members, otherwise known as related-party transactions.” The SEC alleges that the transactions totaled approximately $59 million during 2009.

 

More About Law Firm Management Liability Insurance: As I noted in a prior post (here, second item), unsecured creditors of the bankrupt Dewey LeBoeuf law firm have sought the bankruptcy court’s leave to file an action against three of the law firm’s former managing partners, accusing them of law firm management misconduct and seeking to recover under the law firm’s management liability insurance policy.

 

As discussed in a November 29, 2012 Am Law Daily article (here), the bankruptcy court has granted the creditors leave to pursue the claims. However, as the article also discusses, the claimants could face barriers attempting to recover under the insurance policy. As the article notes, “the lead insurer connected to the policy … has said such suits may not be covered because Dewey, as the policyholder, is essentially suing itself.” The article does not explain the basis on which the carrier is contending that the claims of the creditors represent the claims of Dewey itself. However, given the stakes involved, it seems likely that these issues will be sorted out as the creditors press their claims.

 

Special thanks to a loyal reader for sending me a link to the Am Law Daily article.

 

Deconstructing “Skyfall”: (Spoiler Alert, these comments will give away key plot element of the movie, so don’t read this if you haven’t seen the movie).

 

1. Can I just say that Bond’s idea of luring Raoul Silva northward to Bond’s childhood home was a really crappy plan? Not only did it directly result in M’s death, but M16 never did recover the stolen list of undercover agents. The entire sequence conclusively proved that Bond is no longer qualified for service, as the M16 tests earlier in the movie showed. M chose to disregard what the tests clearly established, which ultimately cost her her life.

 

2. Shortly after we were informed that Bond’s childhood home had been sold, the structure was first strafed with automatic gunfire from a helicopter gunship and then blown up. At the real estate closing, it is going to be a disappointing walk-through for the property’s buyers, that’s for sure.

 

3. In case you were wondering, the poem M said she had learned from her late husband and that she recited (in part) to the Parliamentary committee (just before armed gunmen burst into the Committee room) is “Ulysses” by Alfred, Lord Tennyson. Here is the portion she quoted:

 

Though much is taken, much abides; and though

We are not now that strength which in the old days

Moved earth and heaven; that which we are, we are,

One equal-temper of heroic hearts,

Made weak by time and fate, but strong in will

To strive, to seek, to find, and not to yield.

 

4. So we know for sure that Judi Dench will not be in the next Bond movie. But how about Daniel Craig? Most of Skyfall seemed to be a variation on the theme that Bond is getting old and might just be over the hill. And in the scenes where Bond was unshaven, Craig sure was looking pretty scraggly. I am not making any predictions, but don’t be surprised if Craig isn’t there next time Bond is back.   

 

Every fall, I assemble a list of the current hot topics in the world of Directors and Officers (D&O) Liability Insurance. While the past 12 months have not seen as many headline-grabbing D&O related events as in some past years, the issues that are currently unfolding have had a significant impact on the marketplace. In the latest issue of InSights (here), I take a look at what to watch now in the world of D&O. Readers of this blog will be particularly interested in the first entry of the article, discussing the question of whether the marketplace for D&O insurance is firming.

 

A prior version of the latest InSights article appeared in expanded form on this site, here.

In her authorized 2009 biography of American business icon Warren Buffett, The Snowball,  Alice Schroeder admirably captured how Buffett’s long and successful business career resulted in the accumulation of not only vast wealth, but also of an impressively large and loyal network of close friends. Among Buffett’s buddies is Fortune Magazine’s editor-at- large, Carol Loomis. Loomis not only befriended Buffett and his wife, along the way becoming a Berkshire shareholder and an occasional Buffett bridge partner, but also for the last 35 years she has served as the pro bono editor of Buffett’s widely-read and admired annual letter to Berkshire shareholders.

 

Owing to her unique access to Buffett, Loomis has written a number of perceptive and even revelatory Fortune articles about Buffett. She also provided editorial direction to Fortune colleagues on numerous other articles about Buffett that appeared in the magazine. Many of these articles from the Fortune archives have been collected in a new book, entitled Tap Dancing to Work: Warren Buffett on Practically Everything, 1966-2012. The title is a reference to Buffett’s frequent statement that he enjoys his work so much that he “tap dances to work ” As befits a book with such an upbeat title, the book is a rousing celebration of Buffett’s life and business success. (A disclosure statement seems appropriate at this point: I own BRK.B shares, although not merely as many as I wish I did.)

 

If Schroeder’s book represented a personal biography of Buffett, Loomis’s book is more of a business biography. The Fortune articles about Buffett are arranged essentially in chronological order, as a result of which the book charts the long arc of Buffett’s business life. Buffett himself recently said that “when you look at Berkshire, you are looking across corporate America.” Reading this book is in many ways a guided tour not only through Buffett’s career and business success, but also through the ebbs and flows of the American business scene over the last four decades.

 

There is much to commend and admire about this book. Among other things, the book includes several excellent examples of masterful magazine writing. Loomis’s own April 1988 article entitled “The Inside Story of Warren Buffett” (a version of which can be found here) may be the single best short description available of Buffett and his business philosophy. (Indeed, if you read Loomis’s article, you arguably could dispense with the need the now growing collection of book-length Buffett biographies.)

 

Loomis’s October 1997 article entitled “The Wisdom of Salomon?” (a version of which can be found here), about Buffett’s fraught 1991 involvement in the near-collapse of the Salomon Brothers investment banking firm, is a gripping account of perhaps the greatest crisis in Buffett’s long career.

 

There are also a number of minor gems in this book, including a charming 1978 article about how a still–relatively unknown Buffett helped produce an enormous investment profit for the endowment of tiny Grinnell College (on whose Board of Trustees Buffett served at the time) through a clever and well-timed acquisition of a Dayton, Ohio television station. (The book also reveals that the Grinnell trustees included, during the time that Buffett served on the board, one of the founders of Intel and some guy named Steve Jobs. I have no idea how Grinnell managed to recruit so many corporate titans to its board. I do know that the current value of the college’s endowment is approximately $1.5 billion — or more than $800,000 for each of the school’s 1,700 students.)

 

The book also reprints a 1995 book review written by Bill Gates about yet another Buffett biography. Gates’s book review contains an amusing retelling of the occasion in 1991 when Gates and Buffett first met, as well as a touching account of the friendship of the two men. (In an introduction to the Gates piece, Loomis reports that Gates had not wanted to come to the event at which he met Buffett, but was only persuaded to attend after he learned that Washington Post CEO Katherine Graham was going to be there as well. Loomis also reports that while Buffett arrived at the event in the back seat of Post Managing Editor Meg Greenfield’s “ancient and cramped” Subaru, “Bill and his girlfriend (soon to be wife) Melinda French, arrived more grandly, in a helicopter.”)

 

Another very interesting feature of this book is how its chronological structure highlights  the way earlier events can foreshadow later developments (even though not apparent at the time). For example, Loomis’s riveting account of the Salomon fiasco provides an almost painful premonition of the Lehman collapse 17 years later. And you can’t read the excerpt in the book of Buffett’s 2002 letter to Berkshire shareholders characterizing derivatives as “weapons of financial mass destruction” without thinking about what happened at AIG just six years later. Indeed, if one were to write a work of fiction with so much heavy-handed foreshadowing, most readers would immediately reject it as hopelessly contrived.

 

While this book is both enlightening and enjoyable to read, it has its shortcomings. Among other things, even though there were slight mentions of Buffett in the magazine at earlier times (including one April 1966 item that managed to misspell Buffett’s last name), Fortune didn’t write about Buffett as Buffett until the late 70s, and didn’t get around to writing a feature article about him until the early 80s. By that time, Buffett was already in his 50s and by any measure already a phenomenally successful investor and businessman. Simply put,  other than Loomis’s one article mentioned above, this book lacks a detailed examination of how Buffett got started and how he developed the iron-clad business principles that have guided him ever since.

 

There is another shortcoming with this book’s approach, one that is perhaps an inevitable result of the fact that the book is an anthology of magazine articles written over many decades. Its coverage of Buffett, as thorough as it was, has been episodic and intermittent. Loomis makes up for this somewhat with a running commentary interspersed throughout the book, but inevitably there are gaps. Some of the gaps are huge.

 

For example, there is nothing in the book about Berkshire’s investment in BNSF, by far the largest investment of Buffett’s entire investing career, one that was so large it cost the company its triple-A rating. There is nothing in the book about what I think is one of the most interesting phases of Buffett’s investing career, that is, his opportunistic investment of $15.6 billion in the 25 days of panic that followed the Lehman bankruptcy. There is nothing in the book about the series of unprecedented moves Buffett has made in recent years, including, for example, Berkshire’s $10 billion investment in IBM (following years of repeated statements that Buffett would never invest in technology because he doesn’t understand it) or Berkshire’s 2010 move to buyback its own shares.

 

And in an omission that is common among all of the various Buffett biographies, there is little in the book about the criminal prosecution of the top officers of what was at the time the largest Berkshire subsidiary, General Re, owing to a complex, appearances-only transaction between Gen Re and AIG, of which Buffett may well have been aware at the time and with which Buffett may even have been involved. We don’t know much about whether or not Buffett was involved or not, as to this date no one, especially not Buffett, has provided a comprehensive written account of the events from Buffett’s perspective. (More disclosure: During the relevant period, I worked at a subsidiary of Gen Re.)

 

In addition, one of the great strengths of the magazine’s coverage of Buffett – that is, Loomis’s privileged access to Buffett — may also be another of the book’s shortcomings. By her own admission, Loomis is not objective about Buffett. Her biases are well-disclosed – she describes herself as Buffett’s “close friend.” Over the years, Loomis controlled much of the magazine’s content about Buffett, either by writing it herself or by managing the editorial process of others’ articles. The result is that some of the magazine’s Buffett coverage, especially when read in quick succession as this book’s format requires, starts to feel like hagiography.

 

In short, while I think this new book is great and I have no trouble recommending it, in my view, the quintessential Buffett business biography still has yet to be written. I will say that for anyone interested in getting a handle on Buffett’s investing philosophy and business approach, as well as on the early days of his business career, the best bet may be Roger Lowenstein’s 1995 bio entitled Buffett: The Making of an American Capitalist. Indeed, the Bill Gates book review I mentioned above was written about Lowenstein’s book, of which Gates said “until Warren writes his own book, this is the one to read.”

 

I have managed to get this far in my review of Loomis’s book about Buffett without mentioning what is by far its best part – that is, the numerous pieces written by Buffett himself that are interspersed throughout the book. One of the most interesting items is an article Buffett wrote for the magazine in May 1977 entitled “How Inflation Swindles the Equity Investor” (a version of which appears here).  I had not previously read this article, but it may be the single best piece I have ever read encapsulating Buffett’s conception of equity investing. It also reflects a detailed and edifying analysis of the dangers economic inflation poses, a theme to which Buffett has returned time and again over the years (including his provocative essay in his 2011 letter to Berkshire shareholders about investing in gold).

 

The fact that the best parts of this book are the ones that Buffett himself wrote suggests that the optimal approach to trying to understand Buffett may be to just cut to the chase and read Buffett’s own personal anthology, in the form of his annual letters to Berkshire shareholders. Thirty-five years’ worth of the letters is freely available on Berkshire’s website, here. My own analysis of the most recent years’ letters, along with my other writings about Buffett, can be found here.

 

Some readers may well find it a daunting task to try to work through hundreds of pages of the shareholder letters. Here’s a secret: there is a shortcut. George Washington Law School Professor Lawrence Cunningham has compiled an indexed, thematically arranged anthology of Buffett’s writings in a splendid book entitled The Essays of Warren Buffett: Lessons for Corporate America, the most recent edition of which can be found here. As I noted in my review of an earlier edition of Cunningham’s book, here, “Cunningham has done a masterful job distilling Buffett’s writings and organizing them according to topic. This arrangement not only facilitates a quick reference to Buffett’s comments on any given topic, but it also provides insight into how Buffett’s views on the topic may have evolved over time.”

 

For readers who may be interested, my review of Alice Schroeder’s Buffett biography can be found here.

 

The Wit and Wisdom of the Sage of Omaha: One of the great pleasures of reading (or just reading about) Buffet’s various essays is his gift for the homey aphorism, often told with great humor. Loomis’s book captures a few of the good ones, including Buffett’s own summary of his experiences running (and saving) Salomon: “I felt like the drama critic who wrote, ‘I would have enjoyed the play except that I had an unfortunate seat. It faced the stage.’”

 

Loomis also recounts some career advice Buffett gave to an audience of University of Washington business school students: “I’d advise you when you go out to work , work for an organization of people you admire, because it will turn you on. I always worry about people who say, ‘I’m going to do this for ten years. I really don’t like it very well. And then I’ll do this…’ That’s a little like saving up sex for your old age. Not a very good idea.”

 

Some of my favorite Buffet anecdotes appear in his letters to Berkshire shareholders. In his 1986 letter, he wrote about the tailor who went to see the Pope, whose friends asked him what the Pope is like. Buffett writes that “our hero wasted no words: ‘He’s a forty-four medium.’” Another favorite is the story about the man who asked his vet what to do for his horse that limped sometimes but seemed fine at other times. Buffett states that “the vet’s reply was pointed: ‘No problem – when he’s walking fine, sell him.’”

 

My own personal favorite, from the 1985 letter, is one that I have quoted previously on this blog, but I like it so much, I am reproducing it again here:

 

An oil prospector, moving to his heavenly reward, was met by St. Peter with bad news. “You’re qualified for residence”, said St. Peter, “but, as you can see, the compound reserved for oil men is packed. There’s no way to squeeze you in.” After thinking a moment, the prospector asked if he might say just four words to the present occupants. That seemed harmless to St. Peter, so the prospector cupped his hands and yelled, “Oil discovered in hell.” Immediately the gate to the compound opened and all of the oil men marched out to head for the nether regions. Impressed, St. Peter invited the prospector to move in and make himself comfortable. The prospector paused. “No,” he said, “I think I’ll go along with the rest of the boys. There might be some truth to that rumor after all.”

 

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.

 

The article catalogues a number of deficiencies of at least some plans that undermine the Rule’s goal of allowing insiders to trade in their company shares without creating the impression that the executives were trading because they knew something about the company that other investors did not.

 

Among other plan features that can cause problems, the article shows, is the ability of executives to alter or cancel plans at their own discretion. The article notes that “there is very little in the system to prevent an executive who foresees good news about the company from canceling a scheduled share sale, or an executive who foresees bad news from canceling a scheduled share purchase” 

 

Another weakness is that some plans allow executives to trade immediately after the plan has been set up, creating the impression that the executive set up the plan (and then traded) in anticipation of the undisclosed developments. The article notes that “there is no rule about how long the plans must be in place before trading under the plans can begin.”

 

An additional shortcoming about the plans cited by several commentators in the article is that neither executives nor their companies are required to disclose the existence of their plans, which among other things leave executives free to change or even cancel their plans. The article notes that though there are a number of companies that do disclose that the executives have trading plans, “they rarely disclose the provisions, since they don’t want outside investors to be able to anticipate forthcoming trades.”

 

There is more than a small amount of irony in these concerns about Rule 10b5-1 plans. The Rule was established more than a decade ago in order to provide a way for executives (whose wealth often is entirely locked up in company shares) to be able to trade in the company’s stock without incurring possible liability under the securities laws.

 

There are in fact a number of cases in which courts have held that the inference of scienter that might otherwise arise from insider sales is rebutted when the sales were executive pursuant to Rule 10b5-1 trading plans. Refer here and here for a discussion of recent cases where defendants were able to rely on the Rule 10b5-1 trading plan in order to have the securities claims against them dismissed.

 

In other words, though Rule 10b5-1 plans can cause problems, if done right they can prove to be very valuable. Which of course raises the question — what does it mean for a trading plan to be done right?

 

First of all, there should only be one plan, not multiple plans. If nothing else, Mozilo’s actions show what a problem it can be if an executive tries to maintain multiple plans.

 

Second, the plan should clearly provide for well-defined trades at well-defined times or under well-defined circumstances. Ideally, the plan would specify that the executive will trade at specified times and at specified amounts.

 

Third, the protective value of the plan is severely undermined if the executive retains any discretion about trade execution, including in particular the ability to alter or cancel the plan. As the SEC noted it its April 2009 guidance about Rule 10b5-1 plans, the cancelation of a transaction under a plan affects the availability of the affirmative defense under the Rule, because the cancellations represent an alteration of or deviation from the plan

 

Fourth, to avoid the types of concerns noted above, the plan should be put in place well before the first trade under the plan. Preferably, the first trade would take place only after an interval of a quarter or longer.

 

Finally, in order to address the kinds of concerns noted in the Journal article, companies whose executives have trading plans should consider disclosing both the plans existence and intended trading schedule in the company’s periodic filings with the SEC.

 

The Deal Journal blog has a number of related suggestions in a November 28, 2012 post (here) about how to structure and implement the kinds of problems cited in the Journal article.

 

Because the point of a Rule 10b5-1 trading plan is to try to allow executives to trade in their company securities without incurring potential liability under the securities laws, it is worth taking a look at a trading plan that a court found to provide that very protection. As discussed here, in October 2008, the Eighth Circuit affirmed the lower court’s dismissal of a class action securities lawsuit that had been brought against executives of the Centene Corporation. The appellate court expressly affirmed the lower court’s ruling that because the executives’ trades had been executed pursuant to a Rule 10b5-1 plan, the trades did not support an inference of scienter.

 

The Eighth Circuit stated that the individual defendants’ trading plans "lay out in advance the dates at which the trade will be made in advance and give control of the trades to a broker." The District Court’s dismissal opinion stated further that the plaints "provided for automatic sales on certain dates if the stock price was above $25." The only sales made under the plans, which were instituted in December 2005, were two in February and April 2006. "There were no later sales, not because defendants halted the program, but because the stock price never reached the $25 mark."

 

The critical aspects of the plan appear to have been, first, that the officials entered the plan in advance; second, that the plan specified the trading dates, but subject further to a specified trading price: three, that the trading on those dates, if the price criterion was met, was automatic; and fourth, that a broker controlled the trades. It does not seem to have mattered that the officials did not trade regularly under their plans because of the minimum share price requirement.

 

It is  important to note that the plan lacked many of the attributes that have attracted criticism. That is, the Centene officials’ plans were not changed, nor were the plans stopped and started; and the individuals were not running multiple plans.

 

Given the negative publicity surrounding Rule 10b5-1 plans, the Eighth Circuit’s opinion is a useful reminder that Rule 10b5-1 plans can and should be a part of a coordinated securities litigation loss prevention program. The negative publicity should not deter companies or the executives from creating and implementing thoughtfully constructed trading plans.

 

The Bill Gates School of Deposition Deportment: The credit crisis-related litigation continues to grind through the court system, and many of the cases have moved into active discovery. Among the many high profile cases remaining is the lawsuit monoline insurer MBIA filed against BofA, as successor in interest to Countrywide. MBIA alleges that mortgages underling many of the financial securities that the insurer was asked to guarantee were not made pursuant to the mortgage company’s stated underwriting guidelines.

 

In May 2012, as discovery of the case has gone forward, MBIA finally had a chance to depose BofA CEO Brian Moynihan. Moynihan’s deposition, according to the Rolling Stone’s Matt Taibbi’s November 27, 2012 article entitled “Bank of American CEO Brian Moynihan Apparently Can’t Remember Anything” (here) “will go down as one of the great Nixonian-stonewalling efforts ever, and one of the more entertaining reads of the year.” As the article (and the deposition transcript to which the article links) shows, Moynihan really doesn’t remember much of anything about Countrywide, even though the business has been one of the bank’s biggest problems since Moynihan took over as BofA’s CEO.

 

As Taibbi puts it, “In an impressive display of balls,” Moynihan essentially testified that Bank of America is a big company, and it is unrealistic to ask the CEO to know about all of its parts, “even the ones that are multi-billion-dollar suckholes about which the firm has been engaged in nearly constant litigation from the moment it acquired the company.” Taibbi concludes that throughout the deposition, Moynihan “presents himself as a Being There-esque cipher who was placed in charge of a Too-Big-To-Fail global banking giant by some kind of historical accident beyond his control, and appears to know little to nothing at all about the business he is running.”

 

Moynihan is not the first CEO to take this deposition approach. Readers will likely recall that then-Microsoft CEO Bill Gates took much the same approach in his deposition in the massive antitrust case against the company, which according to the BusinessWeek article about Gates’s deposition testimony, showed him “slouching behind a table on a videotaped deposition, rocking as he reads documents, and often telling government prosecutors that he can’t recall having written E-mails to Microsoft execs on key company issues.”  (The loyal reader who sent me the link to the Rolling Stone article suggested that Moynihan may have also been borrowing a page from another President named Bill, whose deposition performance may have set an unbreakable world record for deposition obfuscation.)

 

Clawback at the SEC?: In a recent post (here), I discussed a recent federal district court decision upholding the right of the SEC under Section 304 of the Sarbanes Oxley act to clawback bonus compensation from corporate executives whose companies later restated the financials on which the bonus compensation was based, even though the executives were not involved in or even aware of the misconduct that led to the restatement . In affirming the policy justifications for the SEC’s clawback authority, the district court judge noted that the executive “should have been monitoring the various internal controls to guard against such misconduct” and that it was there failure to ensure that proper controls were in place that allowed the misconduct to occur. The court added that “where, as here …corporate officers are asleep on their watch,” they are liable for a penalty that is limited to the amounts of their bonus compensation.

 

In a November 28, 2012 post on his eponymous blog, UCLA Law Professor Stephen Bainbridge makes the provocative suggestion that in light of these principles perhaps the compensation of departing SEC chair Mary Schapiro should also be clawed back. Schapiro’s announcement that she is stepping down “raises the question of why she gets a free ride on precisely the same sort of conduct for which corporate executives are subject to having their pay clawed back.”

 

In support of this suggestion, Bainbridge cites the findings of the Government Accountability Office, which “consistently found that the SEC’s internal controls are seriously flawed.” Bainbridge also cites recent whistleblower allegations of misconduct at the agency. Bainbridge asserts that “at the very least, Mary Shapiro has been asleep at the switch while the SEC has continually failed to remediate serious internal control deficiencies that the SEC would never tolerate in a private company.” Bainbridge concludes by asserting that:

 

If clawing back executive pay is necessary to give corporate executives "an incentive for (officials) to be diligent in carrying out" their duties over corporate internal controls, maybe clawing back government official pay when they "are asleep on their watch,” would give future SEC chairs the necessary incentive to avoid Schapiro’s manifold failures to fix the SEC’s internal problems

 

Readers may also be interested in Bainbridge’s take on the Wall Street Journal trading plan article I discussed above; Bainbridge writes about the Journal article “In what may be the dumbest piece of reporting I’ve seen in a while, the Wall Street Journal offers up a breathless "expose" showing that corporate insiders often beat the market when trading in their own company’s stock. This is "news"?”

 

An employer’s management liability insurance policy does not provide coverage for employees’ claims that – contrary to statutory requirements — the employer collected and failed to remit gratuities, because amounts owing due to a preexisting statutory duty do not represent covered loss, according to a recent decision of a Massachusetts federal court applying Massachusetts law. The September 10, 2012 decision can be found here. The decision is the subject of a November 26, 2012 post on the InsureReinsure.com blog, here.

 

Background

The Kittansett Club is a golf club in Marion, Massachusetts. According to the allegations in the underlying complaint, the club typically adds an 18% gratuity to food and beverage bills. A lawsuit filed on behalf of servers and bartenders at the club alleged that the club did not remit the gratuities to the servers at the club, but rather retained the gratuities or distributed them to management, in violation of a Massachusetts statute requiring employers imposing service charge or tip to remit the amounts to the service staff. The claimants also alleged breach of an implied contract, interference with contractual relations and unjust enrichment. The claimants sought restitution, injunctive relief, liquidated damages and attorneys’ fees. The club ultimately settled the servers’ claims.

 

The club submitted the servers’ complaint as a claim under its management liability insurance policy. The policy included both a directors and officers liability coverage part and an employment practices liability part. The club’s insurer denied coverage for the claim, arguing that the damages the claimants sought to recover did not arise from an alleged wrongful act but rather from a pre-existing statutory duty. When the insurer denied coverage for the claim, the club initiated a coverage action against the insurer in Massachusetts state court. The insurer removed the action to federal court, and the parties cross moved for summary judgment.

 

The September 10 Ruling

In her September 10, 2012 Memorandum and Order, Judge Denise J. Casper granted the insurer’s motion for summary judgment. In considering the insurer’s position, Judge Casper reviewed a number of cases — including in particular the Fourth Circuit’s February 2012 opinion in Republic Franklin Insurance Co. v. Albemarle County School Board — standing for the proposition that amounts owing as a result of a statutory obligation do not represent covered “loss” under a liability insurance policy. Judge Casper quoted the Fourth Circuit’s decision as saying that the case authorities on which it relied.

 

stand for the proposition that a judgment ordering an insured to pay money that the insured was already obligated to pay, either by contract or statue, is not a ‘loss’ covered under an insurance policy that requires that the loss be caused by a ‘wrongful act.’ The alleged ‘loss’ in such cases arises from the contract or the statute itself, not from the failure to abide by it.

 

Judge Casper held that the right of restitution for gratuities the club’s servers asserted “arose not from the wrongful act, but the Insureds’ pre-existing duty” under the Massachusetts statute requiring employers collecting tips or service fees to remit those amounts to the service staff.

 

The claimants in the underlying claim sought not only payment of the unpaid gratuities but also statutory treble damages, attorneys’ fees and costs. The insurer argued that these amounts were also outside the definition of loss because they represented penalties for which the policy did not provide coverage. Judge Casper concluded that these other amounts were compensatory in nature, and therefore not excluded as penalties that could be covered under the policy – “if no exclusion applied.”

 

The insurer further argued that the policy’s Earned Wages exclusion operated to preclude these other amounts, and Judge Casper agreed. The exclusion provides that there is no coverage under the policy “for any Claim related to, arising out of, based upon, or attributable to the refusal, failure or inability of any Insured(s) to pay Earned Wages.” The policy defines “Earned Wages” to mean “wages or overtime pay for services rendered.” Judge Casper concluded that “the usual and ordinary meaning of wages in this context would include gratuities.” Therefore, she concluded, “the Exclusions excluding coverage for any claims arising out of an insured’s failure to pay Earned Wages unambiguously applies in this case and the Insureds are not entitled to coverage under the Policy.”

 

Discussion

At one level, Judge Casper’s decision is no surprise. As Judge Casper herself noted, after concluding that the alleged misconduct in the underlying complaint constituted a “wrongful act” within the meaning of the policy, that fact does not, she said, “allow the Insureds to ignore their statutory obligations by shifting costs to their insurer.” Insured companies cannot, Judge Casper seems to be saying, withhold compensation from their employees and then shift the bill for the unpaid amounts to their insurer.

 

The “no loss” argument on which the insurer relied is based on increasingly well-established case authority; as the InsureReinsure.com blog notes, Judge Casper’s decision “joins a series of cases” including the Fourth Circuit’s decision in the Republic Franklin case) holding that “when an Insured is only being forced to return that which it never had a legal right either to receive or retain, insurance is not available.”

 

The more troublesome aspect of this decision relates to the fact that the claimants in the underlying claim sought further relief beyond just the remittance of the unpaid gratuities; they sought amounts that Judge Casper expressly found to be compensatory in nature. In addition, the golf club itself incurred expenses defending against the claimants’ claims, yet all of these amounts were found to be precluded from coverage under the policy’s Earned Wages exclusion.

 

This latter part of Judge Casper’s opinion illustrates how broadly these types of wage claim exclusions can sweep. If nothing else, Judge Casper’s ruling in this case is a reminder to insurance practitioners to review these exclusions to determine whether or not they would apply more broadly than intended. The exclusionary language of the type on which the insurer relied in this case typically is found in an exclusion referred to as the FLSA exclusion or the wage and hour exclusion, designed to preclude coverage primarily for alleged overtime and minimum wage violations. As this case shows, these exclusions can be worded so as to sweep far beyond just overtime and minimum wage claims.

 

Finally, it is worth noting that at least some contemporary management liability policies include some sublimited defense cost coverage for FLSA and wage and hour claims. From the face of Judge Casper’s opinion it does not appear that this policy provided this type of sublimited defense cost protection. This case does however provide a reminder that the sublimited defense cost protection afforded in these types of coverage extensions should be worded broadly enough to extend defense cost protection, for example, to all of the “Earned Wage” violations otherwise precluded from coverage under this policy.

 

One Pound Fish: Here at The D&O Diary, we consider it our duty to constantly scan the horizon in search of important trends of which our readers should be aware. It is in that spirit that we have embedded below the “One Pound Fish” song video, which, with nearly 4 million YouTube views, has gone totally viral. The video features a Pakistani fishmonger in London named Mohamad Shahi Nazir singining a Punjabi folk tune. Background about the video — including the song’s lyrics — can be found here. I will leave it to others to try to explain the complex combination of circumstances that can come together to make, well, for example, a “One Pound Fish” song video, into an Internet phenomenon. Just remember, you saw it here first.  I have to say, you gotta love this guy. (The video starts a little slowly, the song starts about 30 seconds into the video.)

 

When H-P announced on November 20, 2012 that it was taking an $8.8 billion charge after it discovered “accounting improprieties, misrepresentations and disclosure failures” at its Autonomy unit (which H-P acquired in October 2011 for $11.1 billion), there was a great deal of speculation that litigation would quickly follow. The intervening Thanksgiving weekend may have slowed down the filing of the first of the lawsuits, but only a little bit. The first of what will likely be many related lawsuits has now arrived.

 

On Monday November 26, 2012, plaintiffs’ lawyers filed a securities class action lawsuit in the Northern District of California against H-P and certain of its directors and officers. A copy of the plaintiff’s complaint can be found here. The plaintiffs’ lawyers’ November 26, 2012 press release can be found here.

 

The complaint names as defendants the company itself; Leo Apotheker, who was H-P’s CEO until September 2011 and who was CEO at the time the Autonomy deal was agreed upon; Meg Whitman, who became CEO in September 2011, but who had also served on H-P’s board at the time the Autonomy deal was agreed to; H-P’s CFO, Catherine Lesjak; and the company’s Chief Accounting Officer, James T. Murrin. The complaint was filed by an individual H-P shareholder on behalf of a class of investors who purchased H-P stock between August 19, 2011 (the date the Autonomy deal was announced) and November 20, 2012 (the date H-P announced the alleged improprieties at Autonomy).

 

The complaint alleges that the defendants violated the liability provisions of the Securities Exchange Act of 1934. Significantly, and as noted below, the complaint relates not just to the accounting improprieties at Autonomy, but also to the earlier $8 billion goodwill charge associated with H-P’s Enterprise Services business, as noted below.

 

According to the plaintiff’s lawyers’ press release, the complaint alleges that the defendants “concealed that the Company had gained control of Autonomy in 2011 based on financial statements that could not be relied upon because of serious accounting manipulation and improprieties.” The “true facts,” according to the complaint, “which were known by the defendants but concealed from the investing public,” were that

 

(a) at the time Hewlett-Packard acquired Autonomy, the business’s operating results and historic growth were the product of accounting improprieties, including the mischaracterization of sales of low-margin hardware as software and the improper recognition of revenue on transactions with Autonomy business partners, even where customers did not purchase the products; (b) at the time Hewlett-Packard had agreed in principle to acquire Autonomy, defendants were looking to unwind the deal in light of the accounting irregularities that plagued Autonomy’s financial statements; and (c)  Enterprise Services’ operating margin had collapsed from 10% in 2010 to approximately 6% as of April 30, 2011, 4% as of October 31, 2011, and 3% as of April 30, 2012, due to various reasons, including unfavorable revenue mix and underperforming contracts.

 

The reference to the Enterprise Services division relates to the H-P unit that incorporated the business formerly known as Electronic Data Systems Corporation (“EDS”), which Hewlett-Packard had acquired in August 2008 for $13.0 billion. On August 22, 2012, H-P took an $8 billion impairment charge on the goodwill associated with the EDS acquisition. The sequence of disclosures that the complaint cites is arranged to portray a pattern of misrepresentations regarding H-P’s Enterprise Services division, of which Autonomy was a part following H-P’s acquisition of the company.

 

It is interesting to note that the complaint names as defendants only the four current and former H-P officers. It does not name any of the other members of the H-P board, nor does it name any of the outside firms that advised H-P in connection with the Autonomy transaction and that presumably assisted with the due diligence review of the target company. It also seems noteworthy that the complaint does not name any of the former Autonomy directors or officers, even though at least some were also officials at H-P following the acquisition. (The absence of any Autonomy defendants may be due to the fact that Autonomy’s shares were not traded on U.S. exchanges immediately prior to the acquisition, and so, under the Supreme Court’s Morrison decision, the alleged pre-acquisition misrepresentations are beyond the ambit of the U.S. securities laws.)

 

This is of course the first complaint to be filed; there likely will be others, as this event seems likely to keep many lawyers busy for many years. Subsequent complaints may name others as defendants.

 

There is of course some irony that H-P and its senior management are targets of this litigation, as –at least from their perspective and according to the account — the company is itself the victim of the fraud. Indeed, in its press release regarding the Autonomy revelations, the company disclosed that it has contacted the U.K. Serious Fraud Office and the SEC. The company will clearly argue that it could not have knowingly or recklessly misled its investors in violation of the securities laws, as it was itself misled.

 

The complaint does not allege any specific grounds for the assertions that the defendants knew but concealed from the investing public during the class period that Autonomy had misrepresented its operating performance and financial condition.The complaint does not provide any explanation of what the defendants’ motivation would have been to make these misrepresentations. Perhaps in recognition of these potential issues, the complaint refers not only to H-P’s revelations about the accounting improprieties at Autonomy, but also references H-P’s earlier goodwill impairment charge in connection with the EDS transaction. It seems as if the plaintiffs hope to contend that both the EDS and Autonomy deals were part of failed strategy for the company’s Enterprise Services business, which the company sought to try to conceal until the problems could no longer be hidden from shareholders – although if this is the plaintiff’s theory, it is at this point only implied in the complaint, not explicitly stated.

 

As I said, there will likely be other lawsuits to come. The other suits and the likely amended complaints may further elaborate the plaintiffs’ theory of this case.

 

The ABA Blawg 100: I am delighted to report that The D&O Diary has once again been named to the American Bar Association’s Blawg 100, the bar organization’s list of the top blogs about lawyers and the law. The ABA’s Sixth Annual Blawg 100 list can be found here. We are delighted to be included again in this year’s list, if for no other reason than the blogs we follow and respect the most are all on the list as well.

 

As it has done in past years, the ABA is once again inviting readers to choose the top blogs in each of 14 different categories. Voting begins today and ends at close of business Friday, December 21, 2012 Winners will be announced by January 3, 2013. You can vote for your favorite blog here (registration, which is free, is required to vote). You can also vote by clicking on the “Vote for this Blog” box in the right hand column. Everyone here at The D&O Diary would be very grateful to any readers who might consider casting a vote for this site.

 

The Deadline for the Towers Watson D&O Survey is Approaching: As I have previously noted on this site, Towers Watson is once again conducting its annual D&O insurance survey. Everyone in our industry benefits from the survey results, so we all have a stake in making sure that the survey responses are as representative as possible of the industry as a whole. The deadline for this year’s survey is this Friday, November 30, 2012. Please take a moment and think about whether you have a client that could help with this year’s survey. The survey form itself is relatively short and only takes a few minutes to complete. The survey form can be found here. Please take a moment and forward this link to any prospective survey respondents you can think of.

 

This mix of items from around the web may be just the thing after a long weekend of leftover turkey –even though we are well aware that nothing can come close to a heaping helping of Turkey Tetrazzini three days after Thanksgiving. 

 

Adding up the Likely Legal Costs from H-P’s Autonomy Accounting Scandal: Last week’s news that H-P is taking an accounting charge of $8.8 billion dollars following the company’s discovery of “serious accounting improprieties” at Autonomy, which H-P acquired last year, is likely to generate more than just headlines in the business pages. As the various parties try to sort out responsibility for this debacle, litigation that could take years to resolve seems likely, according to Ohio State Law School Professor Steven Davidoff and Wayne State Law Professor Wayne Henning in their November 21, 2012 post on the New York Times Deal Professor Blog (here).

 

H-P’s announcement of the accounting issues and related charges included the company’s statement that it had notified the Serious Fraud Office and the SEC of the supposed accounting improprieties H-P had uncovered at Autonomy. But the likely litigation fall out from the company’s disclosures are likely to include not only regulatory investigations and enforcement actions, but also civil litigation, perhaps involving Autonomy’s former executives and even perhaps officials at H-P itself, as well as H-P’s advisors in connection with the Autonomy transaction.

 

However, all of these likely investigative and litigation initiatives could be complicated by the fact that Autonomy was a U.K company whose shares did not trade in the U.S and by the fact that H-P’s acquisition of Autonomy took place outside of the U.S. It may difficult for prospective claimants to pursue their claims in the U.S. particularly under the U.S. securities laws, as a result of the U.S. Supreme Court’s decision in Morrison v. National Australia Bank.

 

Despite these potential complications, litigation nonetheless seems likely. The professors conclude that “while the matter will probably involve tens of thousands of hours and millions of dollars spent on investigation and litigation, none of this is likely to restore the $8.8 billion the company lost.” 

 

Insurance Coverage for Data Breach Claims: One of the growing liability risks that many companies face is the exposure arising from the possibility of a serious breach of the company’s computer systems. The costs associated with a data breach can be enormous, as the companies involved respond to state law notification requirements and possible third-party claims. As the potential costs associated with data breaches mount, a recurring question has been the availability of insurance to protect against these costs.

 

A November 2012 memorandum from the Kelley, Drye & Warren law firm entitled “Insurance Coverage for Data Breach Claims” (here) takes a look at these recurring insurance coverage questions. The memorandum reviews the considerations affecting the availability for data breach claims under CGL and Property Insurance policies, as well as under specialty insurance policies. The authors conclude that “any time a potential data breach occurs, it is essential for an insured to consider all forms of insurance that it carries and to provide prompt notice to its insurer(s) of any policy that even potentially could apply.”

 

More About the Plaintiffs’ Lawyers’ Latest Say-on-Pay Litigation Gambit: A recent guest post on this site (here) discussed the plaintiffs’ lawyers latest say-on-paylitigation tactic, which involves a pre-emptive lawsuit filed in advance of the annual say on pay vote that challenges the adequacy of the compensation-related disclosures in the company’s proxy statement.

 

A November 19, 2012 memorandum from the Pillsbury Winthrop Shaw Pittman law firm entitled “Plaintiff’s Firms Gaining Steam from New Wave of Say-on-Pay Suits?” (here) describes the plaintiffs’ lawyers “new strategy” of trying to “hold companies liable: suits to enjoin the shareholder vote because the proxy statement fails to provide adequate disclosure concerning executive compensation proposals.” According to the memo, plaintiffs’ lawyers have filed at least 18 of these lawsuits in recent months. The memo notes that these new cases “have met with some success – with two court orders enjoining shareholder meetings and five settlements prior to companies’ annual meetings.”

 

Accompanying the memorandum are two helpful and interesting tables, detailing the outcomes of the various say on pay related lawsuits during the period 2010 through 2012, as well as the disposition of the latest injunctive relief actions that have been filed more recently.

 

Leftovers Again: Did you know that Turkey Tetrazzini is named in honor of the famous early 20th century Italian opera star, Luisa Tetrazzini? Neither did we. In honor of the patron saint of leftover Thanksgiving turkey, here is an audio tribute to Signora Tetrazzini, La regina del staccato:

 

 

The FDIC has been more actively filing failed bank lawsuits than may have been apparent. With the November 20, 2012 update to its online list of failed bank lawsuits, the FDIC made known that it has in recent weeks filed a number of lawsuits that had not previously hit our radar screens. In addition to the agency’s recently filed lawsuit in Georgia (which I discussed in a recent post, here, second item), the agency has also recently filed three additional lawsuits in West Virginia, California and Florida, bringing the total number of failed bank lawsuits the FDIC has filed during the current bank failure wave to 39.

 

The FDIC filed the first of these three additional lawsuits on October 26, 2012 in the Southern District of West Virginia. Acting in its capacity as receiver of the failed Ameribank, of Northfork, West Virginia, the agency has sued five of the bank’s former officers for the defendants alleged negligence, gross negligence and breach of fiduciary duty in allegedly improperly delegating their duties and for failing to properly supervise a third-party mortgage broker and originator, Bristol Home Mortgage Lending. A copy of the FDIC’s complaint in the Ameribank case can be found here.

 

The second of these three lawsuits was filed November 6, 2012 in the Central District of California. The FDIC filed its complaint in its capacity as receiver for the failed Pacific Coast National Bank of San Clemente California. The complaint, which can be found here, asserts claims against six former officers and directors of the bank for negligence, gross negligence and breaches of fiduciary duty in operating and managing the lending function of the Bank.

 

The FDIC filed the third of these three lawsuits on November 9, 2012 in the Middle District of Florida. The FDIC filed its lawsuit in its capacity as receiver of the failed Century Bank of Sarasota, Florida. The agency’s complaint, which can be found here, asserts claims against five former directors (one of whom was also an officer) of the failed Bank for negligence and gross negligence in connection with ten “speculative and high risk transactions.”

 

The new California and Florida lawsuits were both filed as the third-year anniversary of the failures of the banks in question approached. Both of the banks involved had failed on November 13, 2009, and so the FDIC filed those complaints just prior to the third-year anniversary. Interestingly, the West Virginia lawsuit was filed well after the third-year anniversary had passed; the bank involved had failed on September 18, 2008, yet the lawsuit was not filed until October 23, 2012. In the absence of other considerations, the defendants in the West Virginia lawsuit could have significant statute of limitation. It seems likely that some sort of tolling agreement was in place although the complaint says nothing about any agreement.

 

With these three new lawsuits and the others that have recently been filed and noted on this blog, the FDIC has now filed a total of 39 D&O lawsuit as part of the current bank failure wave, 21 of which have been filed in 2012. There had been a period during the mid-part of this year when it seemed as if the agency had entered some sort of a filing lull; as noted here, between the beginning of May and the end of September, the agency filed only two new lawsuits, after a flurry of filing activity earlier in the year. However, since October 1, 2012, the agency has now filed seven new failed bank lawsuits, and the seeming lull during the summer appears to have ended.

 

The high water market in terms of numbers of bank failures was during late 2009 and early 2010, so during the coming months the third anniversaries of the failures of an increasing number of banks will be coming up, which suggests there could be even further filings ahead. Indeed, with the latest update to the FDIC’s litigation page (here), the agency disclosed that as of November 15, 2012, the FDIC has authorized suits in connection with 84 failed institutions against 700 individuals for D&O liability. These figures are inclusive of the 39 filed D&O lawsuits naming 308 former directors and officers that the agency has already filed. Given the number of authorized suits, it seems likely that the new failed bank lawsuit filings will mount in the months ahead.

 

With the addition of the lawsuits filed above, the FDIC has now filed failed bank suits in eleven different states as well as the in Puerto Rico. The states with the largest number of lawsuits are Georgia (11), California (7) and Illinois (6), which is not surprising as these states are also among the leaders in terms of numbers of failed banks. However, Florida is also among the states with the highest numbers of bank failures but even with the new lawsuit described above, the state still has had only two failed bank lawsuits.

 

As Alison Frankel recently reported in her On the Case blog (here), the insider trading charges to which former Morgan Stanley hedge fund manager Joseph “Chip” Skowron pled guilty cost the company a lot of money. And, as demonstrated in the lawsuit the company recently filed against Skowron, Morgan Stanley wants its money back – the company wants not only the almost $5 million of legal fees it paid on Skowron’s behalf, but also the more than $32 million in compensation the company paid Skowron, and even the $32 million the company paid to resolve the SEC’s case against Skowron.

 

An action of this type is unusual, as Frankel’s blog post well documents. (This particular case is also procedurally unusual and complex, as Frankel also shows). But Morgan Stanley’s efforts to recoup all of its costs from Skowron triggered a question to me from several readers on a parallel topic: that is, when can a D&O insurer recoup amounts it has paid out after an insured has pled guilty or  when circumstances otherwise establish that there is no coverage for amounts the insurer has paid?

 

The recoupment question most often comes up in the insurance context with respect to attorneys’ fees. D&O insurers generally take the position that when they pay defense fees under their policy, they are merely advancing defense fees subject to an ultimate determination on whether or not the amounts are actually covered under the policy, and that in the event of a determination of noncoverage they are entitled to be reimbursed for the amount they had advanced.

 

The carrier’s position in this respect may be particularly understandable when it is paying defense fees under the policy’s corporate reimbursement coverage (usually referred to as Side B coverage); in those circumstances, the insurance is providing a funding mechanism for the insured company’s own indemnification obligations. Just as the insured company would typically have the obligation only to advance defense expenses subject to a right of recoupment if it is determined that the indemnitee is not entitled to indemnification, the carrier’s payment on the insured company’s behalf also represents advancement subject to recoupment.

 

But even when the carrier’s is paying defense fees under another insuring agreement (whether it is the individual protection coverage under Side A or the entity coverage under Side C), the carrier will contend that at the outset of a claim a definitive coverage determination is not possible and so the insurer is merely advancing defense costs until it is possible to make the determination.

 

Just the same, it is relatively rare for a D&O insurer to try to recoup defense fees it pays. That is largely because it is pretty unusual in the context of a D&O claim for there to be final factual determinations, because most D&O claims settle long before the factual determinations are made. (Indeed, among the many reasons that securities suit rarely go to trial is the defendants’ concern that an adverse verdict would not only result in a finding of liability against them, but could also result in the loss of their insurance coverage.)

 

There is another practical reason that it is relatively rare for D&O insurers to attempt to recoup defense fees it has paid; that is, by the time an individual or company grinds all the way through a serious D&O claim, the person or company is usually broke. There is not much left for the insurer to go after. It is the very rare case where it is going to be enough left for it to be worth the insurer’s expense and time to try to recoup amounts paid out.

 

There is of course another reason why it is rare for D&O insurers to seek recoupment; in general, it is not a public relations move for insurance companies to go around suing the persons they insure.

 

Nevertheless, over the years there have been a certain number of cases where the D&O insurer has attempted to recoup defense expenses. The law in this area is not entirely uniform. In some jurisdictions, the courts have held that, if at the outset of a claim the carrier has reserved the right to seek recoupment in the event of a determination of noncoverage, the carrier has the right to seek to recoup defense costs incurred in connection with claims that are not covered under the policy. Court that follow this approach reason that allowing the insurer to recoup the defense costs where a timely reservation of rights was issued promotes the policy of ensuring that defenses are afforded even in questionable cases. Other courts following this line have reasoned that it would be inequitable for the insured to retain the benefits of the defense without repayment where there was no coverage under the policy.

 

On the other hand, other courts have held that the policy itself must specific address the carrier’s right to seek recoupment and that the mere fact that the carrier has reserved its rights to seek recoupment is not sufficient to create a right that is not otherwise found the policy.

 

A more interesting question, and one that comes up even less frequently than the question of the insurer’s right to recoup defense expenses, is the insurer’s right to recoup amounts paid as damages or in settlements. An insurer has the right of subrogation, that is, the right to proceed against a third party that caused the loss, to recoup the amount of that loss. Most D&O policies contain subrogation provisions, but even in the absence of an explicit subrogation provision, the carriers will contend that they have rights of equitable subrogation entitling them to go against the persons that caused the loss.

 

The subrogation provisions of many D&O policies often specifically address the question of when the D&O insurer may subrogate against an insured person under the policy. In most modern D&O insurance policies, the clause will specify that the insurer can exercise the right of subrogation against an insured person if the person from whom recovery is sought has been convicted of a deliberate criminal act or has been determined by adjudication to have committed a deliberate fraudulent act. However, because so many D&O claims settle, these preconditions for a subrogated recovery against an insured person are rarely met.

 

But the subrogation provisions and rights only address the conditions on the carrier’s right to assert a claim in the right of the party on whose behalf the carrier paid the claim. The carrier’s own right to recover amounts it paid for which it later appears there is no coverage arguably is a different question. (It is an interesting thought-problem to contemplate whether a carrier seeking recoupment of amounts paid pursuant to a settlement or judgment is proceeding by way of subrogation or in its own right; in the D&O context it may well depend on the insuring agreement pursuant to which the payment was made. If the payment was made pursuant to the corporate reimbursement coverage then the recoupment action would appear to represent subrogation; if the payment was made pursuant to either the individual protection or entity liability coverage parts, then it might be argued that the carrier’s recoupment rights are direct, not by way of subrogation.)

 

Although some D&O policies do contain provisions specifying that the carrier may seek recoupment of amounts advanced as defense expenses in the event of a determination of noncoverage, it is relatively unusual for these provisions to address the carrier’s right to recoupment of amounts other than defense expenses. In the absence of specific contractual provisions addressing the issue, the carrier would be obliged to rely on equitable arguments – that is, that it would be inequitable for the carrier to have to bear costs it was not contractually obligated to undertake and that rightfully should be borne by the person whose conduct caused the loss.

 

I know of various instances where carriers have sought to recoup amounts paid as defense expenses, but I cannot recall an instance where a carrier sought to recoup amounts it paid by way of judgments or settlements — but that isn’t to say that it never happens; in fact, I expect that it has happened, and I would be very interested if readers aware of any occasions where this has happened could share their recollections with other readers by using the comment feature on this blog.

 

I will say that it is interesting how a particular situation, like Morgan Stanley’s new lawsuit against Skowron, can set off a whole cascade of thoughts and associations. My thanks to the several readers who contacted me with their thoughts and questions about the Morgan Stanley lawsuit.

 

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, some of the same claimants, represented by the same law firm, have now opted out of the class action Pfizer securities 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. The Pfizer opt-out litigation has a number of interesting features and raises a number of possible implications.

 

Pfizer’s disclosures and marketing practices relating to the two pain medications have already caused some serious problems for the company. On August 31, 2009, a Pfizer subsidiary agreed to plead guilty to a criminal felony charge. In order to settle the criminal charges, the company paid a fine of $1.195 billion, in what was at the time the largest criminal fine in U.S. history. The company also agreed to pay another $1 billion to settle related civil claims, and also agreed to pay an additional $894 billion to state governments and private litigants to settle the bulk of personal injury litigation and state government probes concerning the two pain medications.

 

In addition, since December 2004, the company has also been involved in securities class action litigation related to the company’s disclosures about the two pain medications, as discussed in detail here. The lead plaintiff in the pending class action securities suit is the Teachers’ Retirement System of Louisiana. Much has happened in this long-running case. On July 1, 2008, Southern District of New York Judge Laura Taylor Swain denied the defendants’ motion to dismiss (refer here), after which the parties proceeded to conduct discovery. On March 28, 2012, Judge Swain granted the plaintiff’s motion to certify a class (refer here, and refer here for the amended order of class certification). Judge Swain certified a class of shareholders who purchased their shares between October 31, 2000 and October 15, 2005. On September 7, 2012, pursuant to the notice sent to the class concerning the litigation, the opt-out claimants filed a request for exclusion from the class.

 

Though the opt-out claimants have selected out of the class suit, they enjoy numerous advantages in their separate lawsuits as a result of the years of class litigation. First, the opt-out claimants are actively relying on the long pendency of the class litigation in order to try to avoid possible statute of limitations concerns. In paragraph 548 and following of their separate complaint, the opt-out claimants contend the timely filing and pendency of the class litigation tolls the statute of limitations (through what is known as American Pipe tolling).

 

In addition, in their complaint the opt-out litigants expressly rely on information developed in the class litigation in support of their claims. In citing the sources on which they are relying as the bases for their allegations, the plaintiffs state in their complaint that they are relying on “documents and information, including internal emails produced by Pfizer, deposition testimony provided by its former officers and employees and court filings in related cases brought against the Defendants” in the consolidated securities (as well as other related cases filed against Pfizer). Of course, the opt-out claimants also get the res judicata benefits of the Judge Swain’s dismissal motion ruling as well.

 

Which is another way of saying that the opt-out litigants, like all of the other prospective class members, are the beneficiaries of the class action litigation which had been filed and was being litigated on their behalf.

 

Which does raise the question — given that the class representative has been actively and successfully pursuing the class litigation on behalf of a class of shareholders including these opt-out claimants for almost eight years, why are the opt-out claimant selecting out of the class?

 

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 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 lawsuit, the firm has resolved the opt-outs claims for “multiples” of what they would have recovered as class claimants. The article explains that the firm has represented opt-out claimants in numerous cases, many of which have resulted in confidential settlements. 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 scree — 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,” and the article also notes that if the U.S. Supreme Court in the Amgen case currently pending before the court raises further barriers to securities lawsuit class certification, the trend toward individual securities suits could accelerate.

 

Though the Pfizer opt out suit is undeniably part of trend, it also is somewhat distinct and perhaps even unique, at least in certain respects. That is, in most of the other high profile opt-out litigation of which I am aware, the prominent opt-outs have chosen to select out of the class only after the class action lawsuit has already been settled. In this instance, the long-running securities suit remains pending.

 

The interesting challenge this poses for the opt-outs’ counsel is that without a class settlement already on the table, the opt-outs have no ready gauge of how a prospective settlement of their case might compare to the recoveries that will be available to the class when and if the class claims ultimately settle. That is, it will be harder for them to ensure that they did better or are going to do better by proceeding separately. Of course, it does remain to be seen whether or not the opt-out suit or the class action settles first.

 

The opt-out litigation raises much bigger problems for Pfizer and the other defendants. Not only does the existence of the opt-out litigation mean that they will only be able to fully resolve the now years-old litigation in a piecemeal process, but it also means that settlement talks will represent a complicated process built around the awareness that settlement of either the class or opt-out litigation will have an enormous impact on whichever piece remains unresolved. Given the likely fragmented and complex process, defense costs undoubtedly will mount, as well.

 

For many years, class action lawsuits have been a favored whipping boy for conservative commentators. But for all of the ills that the class action process can sometimes involve, the prospect of a litigation process in which mass group claims are fragmented and can only be resolved in a piecemeal fashionis no 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.

 

To be sure, it is only going to be in institutional investors’ interests to opt out in certain kinds of cases. As Adam Savett, the CEO of TXT Capital, notes in the Am Law Litigation Daily article, it will only make sense for institutional investors to opt out when the scale of shareholder losses are huge and where there is a solvent, deep-pocketed defendant available from whom to try to recover.

 

But even not every securities class action lawsuit will also involve parallel opt-out litigation, there have still been enough opportunities for some plaintiffs’ lawyers to develop a specialty and a growing practice in the opt-out suits. While this unquestionably represents an opportunity of sorts for the opt-out plaintiffs’ attorneys and their institutional investor clients, it creates a host of problems for other players in the securities litigation process.

 

The class plaintiff”attorneys will see their prospective class recoveries shrink as large institutional investors representing a significant part of the class pursue their own suits separate from the class. The class plaintiffs’ attorneys will watch their own prospective fee recoveries shrink commensurately even as the opt-out plaintiffs’ attorneys’ enjoy the benefits inuring from the class plaintiffs’ attorneys efforts. The defendants will not only incur the additional litigation costs associated with a multi-front war, but they will see their overall litigation resolution costs rise (perhaps significantly) as opt-out plaintiffs pursue separate claims seeking recoveries greater than would be available to the class. Even the courts will face added burdens as suits previously resolved in a single process are fractured into multiple parts. To the extent the added defense fees and settlement costs are insured, these increased costs will drive insurance losses.

 

For all of these concerns, however, it now appears that significant institutional investor opt out litigation increasingly will be a regular feature of securities class action litigation – which has important implications for all concerned. A key consideration to keep in mind while considering all of this is that sophisticated and well-informed institutional investors are opting-out because they believe that at least in certain cases they wil do better by proceeding outside the class. Which in turn raises serious questions about what that means for the investors remaining in the class.

 

Speciall thanks to a loyal reader for providing me with a copy of the Pfizer opt-outs’ complaint.

 

Another Georgia Failed Bank Lawsuit: During the current wave of bank failures, Georgia has been the state with the highest number of bank failures. For that reason, it may be unsurprising that the state also has the highest number of failed bank lawsuits. But though the fact that Georgia more bank failure lawsuits than any other state might be expected, the number of lawsuits filed in Georgia is disproportionately high, higher than would be expected just from Georgia’s share of the total number of bank failure. And late this past week, the FDIC filed yet another bank failure lawsuit in Georgia.

 

On November 15, 2012, the FDIC, as receiver for the failed Community Bank of West Georgia, in Villa Rica, Georgia, filed a lawsuit in the Northern District of Georgia, against three of the bank’s former officers and eight of its former directors. The complaint asserts claims for both negligence and gross negligence “for numerous, repeated and obvious breaches and violations of the Bank’s loan policy and procedures, underwriting requirements, banking regulations and prudent and sound banking practices” as “exemplified” by 20 loans made between May 17, 2006 and October 7, 2007, that allegedly caused the bank losses in excess of $16.8 million. A copy of the FDIC’s complaint can be found here.

 

Interestingly, three of the individual defendants are named “only to the extent of liability insurance.” The complaint recites that the three individuals have each separately filed for Chapter 7 bankruptcy, and that in connection with each of the separate bankruptcy proceedings, the FDIC has obtained an order from the bankruptcy court allowing the agency to name the individuals as defendants “nominally and only to the extent of insurance coverage.” The FDIC expressly does not seek to recover from personal assets. (The question of whether or not a liability insurance policy can apply when the insured person can have no liability is an interesting one that I am sure will be addressed in the course of the FDIC’s suit.)

 

Another interesting feature of the FDIC’s suit is that it was filed well after the expiration of the three-year period following the bank’s closure. The bank was closed on June 26, 2009, but the FDIC did not filed its lawsuit until November 15, 2012 – which, all else equal, would seem to raise statute of limitations concerns. It seems likely that at some point prior to the expiration of the three year period that the parties entered a tolling agreement; however, the complaint says nothing either way in this regard.

 

There is one other interesting feature of the lawsuit, which is that the FDIC has included allegations of ordinary negligence. This is interesting because of the recent decision in the Northern District of Georgia in the Integrity Bank case, applying Georgia law and holding that because of their protection under the business judgment rule, directors cannot be held liable of ordinary negligence. More recently (as discussed here), in the FDIC’s lawsuit against former directors and officers of the failed Haven Trust bank, Northern District of Georgia Judge Steve C. Jones affirmed that Georgia’s business judgment rule is applicable to the actions of bank directors and officers. Based on that determination, Judge Jones dismissed the FDIC’s claims against the directors and officers for ordinary negligence and breach of fiduciary duty. In light of that earlier decision, it would seem that the defendants in the new lawsuit have a basis on which to seek to have the negligence claims against them dismissed. (The FDIC, undoubtedly anticipating this argument, included in its complaint specific allegations asserting that the defendants are not entitled to rely on the business judgment rule, at paragraph 55.) 

 

This latest lawsuit is the 11th that the FDIC has filed as part of the current bank wave involving directors and officers of a failed Georgia bank. Because the FDIC has not updated its online litigation page in over a month, I am not completely sure of the current overall number of lawsuits filed, but I believe that this latest suit represents the 36th that the agency has filed against directors and officers of failed banks so far. In other words, over 28 percent of all the D&O lawsuits the FDIC has filed so far have been filed in Georgia. Of the approximately 440 banks that have failed during the current bank failure wave, about 80 were in Georgia, or about 18 percent of the total. For whatever reason, the FDIC’s D&O litigation activity is disproportionately concentrated in Georgia. By contrast, Florida, which also has seen a significant number of bank failures as part of the current bank failure wave, has only seen one lawsuit – so far.

 

Scott Trubey’s November 16, 2012 Atlanta Journal-Constitution article about the latest lawsuit can be found here. Special thanks to a loyal reader for providing me a link to Trubey’s article and alerting me to the latest lawsuit.