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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

The defendants moved to dismiss the plaintiff’s complaint.

 

The January 10 Opinion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

One of the reasons Saul Steinberg’s iconic 1976 New Yorker cover – the one showing that civilization ends at the Hudson River – is so humorous is that it accurately captures the way some (many?) New Yorkers look at the rest of the world.

 

Before moving to Cleveland almost two decades ago, I lived in Washington, D.C., another city that all too often considers itself the only relevant reference point in the entire universe. So I had no illusions when I made the move to Cleveland — I knew that I was about to take up residence in what many consider fly-over country.

 

I don’t mind the jokes about my adopted city. (From my perspective, the funniest thing about the jokes is how little they have to do with the actual city in which I live.) I have gotten used to the occasional telephone conversation in which it is clear that the person on the other end is confusing Ohio with Iowa. Or even Idaho.

 

Nevertheless, it still catches me short when somebody asks me what time zone I am in. The question might make sense if Cleveland were anywhere near the time zone line. The fact is that it is a long way from Cleveland to the Central Time Zone. Before a Clevelander would have to re-set their watch to Central Time, he or she would have to go all the way across the rest of Ohio (more than 160 miles), and then he or she would have to go clear across Indiana (another 140 miles). Let’s put that into perspective. Cleveland is about as close to the Central Time zone as New York is to Richmond, Virginia.

 

The basis of this time zone confusion puzzles me. I am sure that very few people – even New Yorkers — would ever assume that, say, Fort Myers, Florida is in the Central Time Zone. Yet Cleveland and Fort Myers are at the same longitude (81 degrees west). For some reason, Cleveland apparently drifts out westward into the Plains States in the imaginations of many.

 

The time zone question is only one of the many things that show how much confusion there is about Cleveland’s location. On several occasions, I have had someone say to me, “There’s going to be a meeting in Cincinnati. Since its right there in your back yard, why don’t you attend?” The problem is that it is further from Cleveland to Cincinnati (250 miles) than it is from New York to Washington (229 miles). I doubt many New Yorkers think that Washington is right in their back yard.

 

An extreme example of this location confusion occurred when a colleague suggested to me that I ought to look into a business prospect in Evansville, Indiana, again as if that were right around the corner. However, it is further from Cleveland to Evansville (470 miles) than it is from Washington to Boston (442 miles).

 

I also know that in the popular imagination, Cleveland is very far north. Looking out the window now at my snow-covered yard, Cleveland certainly has the appearance of a northern city. But the fact is that at 41 degrees north, Cleveland is at the same latitude as Barcelona, Rome and Istanbul. For that matter Paris and Munich, at 48 degrees north, are both even further north than Montreal (46 degrees north). London, at 51 degrees north, is even further north than Moose Jaw, Saskatchewan (50 degrees north). 

 

I know that Cleveland is not the only U.S. city that suffers geographical confusion. The U.S. is a big country and the geographic relationship of its many parts does not always conform to armchair assumptions (particularly to those of residents of the U.S. East Coast). For example, if a random sample of people were asked which city is further west, Atlanta or Detroit, just about everyone would say Detroit. However, Atlanta (at 84 degrees west longitude) is further west than Detroit (83 degrees west longitude).

 

There are a host of expectation-defying geographical features of this country. One of the most interesting and surprising has to do with El Paso. Most people would be very surprised to learn that El Paso is closer to San DIego (724 miles) than it is  to Houston (747 miles).

 

The surprising distance from El Paso to Houston is a reflection of the sheer size of Texas. I was interested during a recent trip to Germany to observe that Texas is almost twice the size of Germany in geographic area — Texas is 268,581 square miles, Germany is 137,847. (For some reason, this observation seemed to trouble my German hosts.) Texas, it turns out, is larger even than France (260,558 sq. mi.), which really kind of astonishes me. Texas is big. But though Texas is both the second largest and the second most populous U.S. state, its population (26 million) is less than a third of that of Germany (81 million) and less than half of France (65.3 million).

 

A few years ago, before smart phones became ubiquitous, I was out at a business dinner, and it suddenly became extremely important to my table mates for us to determine whether California or Japan is geographically larger.  Large stakes depended on the answer to this question. We thought of an industry colleague whom we all agreed would still be at work despite the late hour. (She was.) We called her and she was able to determine for us that California (165,695 sq. mi.) is materially larger than Japan (145,925 sq. mi.) But though California is the most populous U.S. state, its population (38 million) is less than a third of that of Japan (126.6 million).

 

The extreme case of this mismatch between geographic area and population density is the comparison between the U.S. and China. The two countries are about the same size (roughly 3.7 million square miles), but China’s population (1.35 billion) is about four times that of the U.S. (315 million). There are a lot of empty places in the U.S. – and no, that wasn’t a reference to Oakland.

 

We live in an age of GPS devices and smart phones with map applications. At any moment, we can fix our own physical location with pinpoint precision. The entire world has been turned into one gigantic diagram with a continuous read-out to tell everyone “you are here.” However, it doesn’t do anyone any good to know you are “here” if you don’t have any idea where that is and how it all fits together.

 

So – in case you hadn’t noticed, it does kind of bother me when people don’t know what time zone Cleveland is in. Ladies and Gentlemen, Cleveland is in the Eastern Time Zone. So are Detroit, Indianapolis, Dayton, and Chattanooga. And so is Quito, Ecuador.

 

There is more to knowing where you are than just establishing your own physical location.

 

A distinctive feature of the current wave of FDIC failed bank litigation is the aura of déjà vu surrounding the suits. The resemblance of the current lawsuits to those filed during the S&L crisis is uncanny. And not only are the suits similar, but in many instances they even involve the same lawyers as last time around.

 

Just the same, any suggestion that the risks and exposures for financial institution directors and officers have not changed since the S&L crisis would be mistaken. The liability risks for FI Ds & OS have changed dramatically in recent years. In that earlier era, there was no Sarbanes Oxley Act and no Dodd-Frank Act, and there was no criminal money laundering liability. There was no Consumer Financial Protection Bureau or its requirements for compliance with consumer protection laws. There were no data privacy liability exposures of the type now emerging. Through these and a myriad of other legislative and judicial developments, the liability exposures of financial institution directors and officers have changed exponentially.

 

The individual directors and officers at financial institutions must navigate a difficult course in a treacherous environment. Fortunately for these individuals and their advisors, there is now a comprehensive resource to guide them. Samuel Rosenthal, a partner in the New York office of the Patton Boggs law firm, has written an exhaustive single-volume desk book  entitled Director and Officer Liability in Financial Institutions (here). Rosenthal’s 1045-page book is an indispensable reference for anyone who wants to understand and address the liability exposures of financial institution directors and officers.

 

Rosenthal’s book is built on a familiarity with the earlier litigation from the S&L crisis era as well as an awareness of the fraught circumstances now facing financial institution directors and officers following the subprime meltdown and ensuing credit crisis.

 

What makes this book so valuable is that it not only broadly organizes the traditional background regarding director and officer liability exposures but it also incorporates a thorough review of the new range of liability risks that have emerged as a result of legislative and judicial developments in recent years.

 

Thus for example, Rosenthal not only reviews the traditional civil liabilities facing financial institution directors and officers under the common law and federal statutory law, but also the myriad new criminal provisions to which FI Ds & OS are now subject, as well as the new potential consumer protection and privacy exposures they now face. Rosenthal brings many years of practical experience to this review; here is his perspective on the many recent changes:

 

This period over the last twenty-five years has witnessed a stunning trend in enforcement efforts has it has moved from traditional concepts dependent upom mens rea to one criminalizing conduct that might have been regarded – at best – to be a civil violation years ago. Directors and officers can be sued, barred from the industry or even jailed for conduct that years ago would have merited little or no attention from regulatory authorities and prosecutors.

 

In recognition of this new environment, Rosenthal’s book provides a detailed yet practical overview of the current state of governmental enforcement actions to which FI Ds&Os could be subject, including in particular a thorough summary of the recent civil actions and enforcement actions of the relevant federal agencies, as a way to afford insight into these agencies’ current expectations and approach.

 

Finally the book provides a practical manual for directors and officers of financial institutions on how they can best try to defend themselves – from the investigative stage through ensuing civil and criminal proceedings. The defense overview section includes a separate chapter on the indispensable question of how the directors and officers can pay for their costs of defense. This section includes a critical review of the relevant indemnification and D&O insurance issues.

 

The one thing that is hard to capture in this short book review like this is how detailed and specific this book is. The book’s scope and depth are extraordinary. As I browsed the book’s lengthy table of contents, I found myself turning frequently to the interesting and perceptive discussion of a host of issues on which I am currently involved. In each case, the book’s treatment of the topic was thorough and helpful.

 

Just the same, the book is written with the directors and officers themselves in mind. The book is intended to inform them of their duties and exposures; of the steps that can take to try to mitigate their risks; and what they should do when claims arise. The book also aims for those who counsel financial institution directors and officers. The book will also be valuable for anyone involved in claims concerning FI Ds&Os, including regulators, claimants, defense counsel, and D&O insurance claims counsel.

 

In short, Rosenthal’s  book is a comprehensive, practical and helpful guide for financial institution directors and officers written by a knowledgeable and experienced practitioner. For anyone called upon to address liability and enforcement issues, having this book at hand will be like having a hotline to a skilled and trusted advisor. This book is an essential resource that everyone involved in D&O liability issues should have on their desks.

 

One of the most vexing problems that can arise in the D&O claims context is when the amount of insurance available proves to be insufficient to resolve the pending claims. Although this problem can arise in many claims contexts, one particular context in which the problem can arise is in the context of claims by the FDIC as receiver of a failed bank against the bank’s former directors and officers.

 

In the following guest post, John F. McCarrick takes a look at these issues in the failed bank context and proposes a solution. John is a partner in the New York offices of the law firm White and Williams LLP, and focuses his practice on director and officer liability and related insurance coverage issues. The comments in this article are those of the author and do not represent the views of White and Williams LLP or any of its clients.

 

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

 

            It’s a point of increasing discussion – and heated debate – in FDIC claims against the directors and officers of failed banks: the available D&O insurance limits of liability are insufficient to meet the FDIC’s settlement expectations, Who bears responsibility for purchasing adequate bank D&O insurance limits? And who should be blamed if the available D&O insurance coverage proves to be insufficient? To make matters worse, quantifying adequate D&O insurance is akin to aiming at a moving target. D&O insurance is a wasting asset; amounts spent on defense costs and on resolving non-FDIC claims reduce – on a dollar-for-dollar basis – the limits of liability left to settle an FDIC claim made during that same policy period. Should defendant directors and officers of a failed bank be expected to contribute to settlements out of their own, now-thinner wallets. Is this a fair outcome? On a more practical level, isn’t there a better way to avoid this outcome?

 

The Scorecard to Date

Since January 1, 2007, 467 U.S. financial institutions have failed. Of this total, the FDIC thus far has sued the directors and officers of 40 failed banks, and has reported agency authorization to file an additional 49 lawsuits. According to Cornerstone Research, the failures of the 40 institutions that are the subject of FDIC-initiated D&O lawsuits had a median estimated cost to the FDIC of $134 million.   Only six of these lawsuits had settled as of December 2012.

 

One FDIC case has gone to trial. On December 7, 2012 a jury in federal court in Los Angeles awarded $169 million to the FDIC in its suit against three former officers of IndyMac. Given the absence of significant personal assets of the three former IndyMac officers to satisfy this judgment, the FDIC is seeking to intervene in pending coverage litigation in an effort to recover some or all of the remaining D&O limits from IndyMac’s 2007 and 2008 D&O insurance towers. However, even a complete win by the FDIC in the D&O coverage litigation would allow the FDIC to recover just a percentage of the awarded jury verdict.

 

            The FDIC’s track record in settlement recoveries is not significantly better. The chart below shows reported settlement amounts compared to FDIC estimated losses.

Name of Institution

FDIC Est’d Cost of Failure

Claimed Damages in Complaint

Settlement Amount
 

(Millions)

(Millions)

(Millions)

Westsound Bank

$108

$15

$2

County Bank

$135

$42

TBD

Heritage Community Bank

$42

$20

Not Reported

Washington Mutual Bank

$0

TBD at Trial

$64[1]

First National Bank of Nevada

$862

$193

$40

Corn Belt Bank & Trust Co.

$100

$10

Not Reported

Source: Cornerstone Research,Characteristics of FDIC Lawsuits Against Directors and Officers of Failed Financial Institutions (December 2012)

 

 

Shortly after the above Cornerstone Research report was issued, former IndyMac CEO Michael Perry reportedly reached an agreement with the FDIC to settle the FDIC’s lawsuit against him for a payment by Perry of $1 million out of his own assets plus an additional $11 million in potential insurance funds through an assignment of Perry’s rights under his D&O policies.

 

With respect to the FDIC D&O cases still pending, the insured deposit losses paid by the FDIC in each case generally far outstrip the available D&O insurance proceeds. Moreover, because each failed bank’s D&O policies must respond to not only FDIC claims, but also other potential sources of D&O claims, including for example, shareholder and derivative claims, debtor claims brought by or on behalf of the bank holding company and claims brought by creditors of the failed bank, the FDIC is often faced with a materially-depleted insurance asset when it comes time to settle FDIC litigation against the directors and offices of a failed bank. To make matters worse (for the FDIC), the available limits of liability under D&O policies are eroded on a dollar-for-dollar basis by defense costs incurred prior to any settlement across all of these categories of claims and in defending collateral regulatory investigations. 

 

A Solution That is Not Novel

If the perceived inadequacy of D&O insurance limits is an issue of real concern for the FDIC, there is a simple solution to this problem: use the FDIC’s regulatory authority to require the purchase of D&O insurance limits in an amount proportional to the amount of risk created for the FDIC by aggregate insured deposits. This approach is by no means novel or creative: in fact, the FDIC already mandates that banks purchase fidelity bond insurance coverage.

 

By statute, the Federal Deposit Insurance Company can require insured financial institutions to maintain fidelity bonds to insure against such losses, and the FDIC has chosen to mandate that requirement. Other federal banking regulators, as well as most state regulators, also require universal fidelity coverage. For instance, the Comptroller of the Currency requires national banks to have "adequate fidelity coverage."

 

Similar mandatory purchases of fidelity bond coverage are detailed in the Employee Retirement Security Act of 1974, as amended (“ERISA”). ERISA Section 412(a) requires that every fiduciary of an employee benefit plan and every person who handles funds or other property of the plan must be bonded, with limited exceptions.

 

The amount of the ERISA fidelity bond is fixed at the beginning of each plan year and cannot be less than 10 percent of the amount of the funds handled. The amount of funds handled is determined by the amount of funds handled by the person, group, or class to be covered by the bond and by their predecessor(s), if any, during the previous reporting year.[2]

 

The FDIC also presumably has the authority to specify the kinds of D&O products most directly accessible for primarily FDIC recovery purposes. The following chart shows some of the obstacles faced by the FDIC, and the D&O insurance market solutions that have developed in response to similar concerns raised by other kinds of D&O insureds.

 

Types of Available D&O Insurance

FDIC Perceived Concern

Available D&O market solution

Comments

Inadequate insurance limits

Ample D&O limits capacity through U.S., Bermuda and Lloyd’s markets

Limits could be tied to FDIC exposure for insured deposits, as a correlated percentage of those deposits

Dilution of available limits

Side-A D&O insurance

Side A limits are preserved for claims against D&Os when advancement or indemnification from the bank is unavailable due to its insolvency, and provides no coverage for the bank’s own liability

Preserved limits for potential

FDIC claims

Side-A insurance potentially sitting excess of a traditional ABC D&O tower

Underlying limits would be used for defending and resolving competing D&O claims, including by shareholders and creditors, preserving limits for a more limited set of liability exposures above the standard D&O limits

Denial of coverage by

underlying D&O insurers

Side A DIC insurance

DIC (Difference-in-conditions) contains, as one coverage trigger, a denial of coverage by an underlying D&O insurer

So why are these D&O market solutions available now, and why weren’t they available in the late 1980s during the last significant wave of bank failures?

 

The Changed Landscape for Bank D&O Liability — and for D&O Insurance

The battleground over available D&O insurance for regulatory claims over failed banks bears little resemblance to that of the so-called S&L crisis of the late 1980s. Although D&O insurance had been available for 30-odd years before the wave of FDIC/RTC litigation against failed banks and S&Ls, D&O insurance was still, in the late 1980s, a relatively immature insurance product — one that had been designed primarily for public companies and their directors and officers facing shareholder class actions and derivative litigation exposures.

 

The S&L crisis and accompanying D&O litigation brought by banking regulators arguably comprised the first systemic loss event for the financial institutions sector of the D&O insurance industry, and the industry’s arsenal of defensive weaponry — in the form of “insured v. insured” exclusions, regulatory exclusions, aggregation of losses and multiple deductibles — were tested, to varying outcomes, in state and federal courts throughout the United States. The experience was both difficult and instructive for D&O insurers and bank policyholders. As a result of that experience, D&O underwriters became more aware of the size and scope of potential claims involving bank insureds, and began underwriting to a fuller set of potential exposures. Buyers of D&O bank policies obtained more certainty about how the policies would respond in the event of a bank failure.

 

In the intervening years since the S&L crisis, there have been two major developments impacting bank D&O insurance. The first is that a series of lengthy competitive (or “soft”) underwriting market cycles (punctuated by short “hard” markets) has led to a material broadening of D&O policy terms across all underwriting segments, such that the typical D&O policy of today is materially broader in scope than the typical D&O policy of 1987. Expanded insuring agreements, key definitions and liberalizing endorsements, coupled with narrower exclusions and exclusion triggers, have collectively resulted in a materially broader D&O insurance contract, covering a wide range of entity and individual insureds. 

 

A related development has been an increase in the number of insurers willing to sell D&O policies. This increase in competition, coupled with broader D&O policy terms, has meant that D&O buyers could purchase materially broader coverage from a larger number of insurers, at lower prices.   D&O insurers also now offer a number of other related D&O insurance products, such as Side-A only coverage, independent director liability coverage, and investigations coverage to D&O insurance buyers.

 

The foregoing is an overly-abbreviated list of significant changes relating to D&O insurance that have had the intended effect of making D&O insurance available to buyers on materially better (and broader) terms, and at lower prices. Banks have benefitted from these insurance market developments, and D&O insurance is a routine – albeit voluntary — purchase for large and small banks in the United States.

 

 The second significant development relating to bank D&O liability insurance since the late 1980s is that banks have materially changed the way they operate and make money. There are numerous reasons why banks have changed their business models since the late 1980s but here are a few of the most significant reasons:

 

1.      The repeal of Sections 20 and 32 the Glass-Steagall Act in 1999 allowed larger banks to engage in commercial activity outside traditional bank deposit and lending activities, including investment banking, securities underwriting and insurance, and even smaller banks were forced to adapt their business models;

2.      The rise of mortgage securitizations encouraged banks to sell off their mortgage portfolios, and focus on earning money primarily through loan initiation fees; and

3.      Proprietary trading allowed banks to make money by trading for their own accounts.

 

Of course, not all banks engaged in all of these activities; however, market competition among banks is being increasingly driven by their success in business activities outside traditional bank deposit and lending activities. In the wake of the credit crisis, it is clear that these non-banking activities have the ability to generate – and indeed, have generated — significant D&O and professional liability claims activity from shareholders, customers, creditors and non-banking regulators, posing significant competition for the very D&O insurance limits the FDIC targets as its primary source of recovery in failed bank D&O litigation.  

 

These two significant developments — broader D&O polices sold for lower premiums and a potentially broad range of business activities carried out under a bank banner — set the stage for a drastically different test for the next wave of bank failures.

 

That next wave of bank failures arrived beginning in 2008 courtesy of the so-called subprime crisis. Falling house prices undermined the packaged securities holding residential mortgages, leading to a near collapse in credit availability, choking off cash flow for banks and their customers.

 

Of the banks most significantly impaired by the credit crisis, some banks were acquired by larger, more stable banks – with some unfortunate results. Other banks simply failed, requiring the FDIC to compensate depositors for their insured deposits, and place the failed banks into an unduly liquidation process. Litigation inevitably followed — not just by the FDIC, but also by shareholders of bank holding companies, bank employees whose 401(K) retirement savings were held in the bank’s now worthless stock, and bank creditors too.

 

The FDIC does not appear to have kept up with the collateral liability and D&O insurance developments impacting the financial institutions whose customer deposits the FDIC insures. But, as discussed above, there appear to be some relatively simple fixes available.

 

For example, the FDIC could require that a bank purchase a minimum level of insurance limits of Side-A D&O coverage, under the reasoning that the FDIC would not want its regulated limits of liability impaired by defense costs, settlements or judgments payable to other claimants by, for example, the insured entity or non-officer employees. Such a required purchase would not prohibit a bank or bank holding company from purchasing broader types of D&O policies including, for example, conventional D&O policies that insure the named entity for securities related claims and other non-FDIC claims.

 

It is not the ordinary preference of bank managers (or the bank’s shareholders) to allocate substantial additional monies each year to D&O insurance premiums. Moreover, bank D&O insurance rates increase across the board when – as was the case in 2007-2010 — the entire industry sector is financially weakened. Nevertheless, it seems apparent that a scenario in which defendant directors and officers of failed banks must make personal settlement contributions to facilitate the settlement of an FDIC claim in light of impaired or otherwise inadequate D&O insurance limits proves the point that current models used in estimating and purchasing appropriate bank D&O limits are flawed, and negatively impact the FDIC’s ability to obtain a reasonable recovery for taxpayers — while placing bank managers’ personal assets at great risk.

 

This type of solution probably would not have been feasible in the late 1980s, when fewer than 10 insurers regularly underwrote D&O insurance. Today, there are more than 60 insurers selling D&O insurance for U.S. risks, enhancing the ability of banks to secure necessary additional limits of liability from numerous well-capitalized D&O insurers. Of this number, 26 carriers also actively underwrite Side A D&O insurance, suggesting that there are numerous purchasing choices for D&O insurance in general, and Side A insurance, in particular.

 

Conclusion

Neither policyholders nor D&O insurers favor unnecessarily outsized settlements of bank D&O claims, and there is always a legitimate concern that policyholders could be waste money unnecessarily on overly large or complex D&O insurance programs. On the other hand, absent some compelling reasons — such as fraud, self-dealing and the like – it is a questionable rationale for the FDIC to demand personal settlement contributions from directors and officers of failed banks based primarily on allegations of simple negligence and for failing to procure sufficient D&O insurance to meet the FDIC’s resolution expectations. If indeed a key driver of demands for personal contributions by the FDIC is inadequate amounts of D&O insurance, there is an easy fix to that problem.

[1] Composed of $39.575 million cash obtained from the D&O insurance policies, cash payments from the defendants of $425,000, and their agreement to pay the FDIC an additional cash amount based upon the amounts defendants actually receive, after tax, from certain of their claims pending in the WMI Chapter 11 proceedings (with a $24.7 million pre-tax face value).

 

[2] If there is no previous reporting year, then the amount is estimated under ERISA Reg. Sec. 2580.412-6.

 

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

 

Background

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

 

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

 

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

 

The January 4 Opinion

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

 

Background

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

 

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

 

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

 

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

 

The January 2 Opinion

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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