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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Background

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

 

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

 

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

 

The Court of Appeal’s Ruling

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

The regulatory landscape: Reinforcing the focus on monitoring and testing

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

 

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

 

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

 

 

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

 

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

 

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

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

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

 

Monitoring and testing: The business case

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

 

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

•              Reinforce company ethics policies.

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

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

•              Reduce employee and vendor fraud.

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

 

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

 

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

 

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

 

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

 

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

 

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

 

How are they doing? The monitoring and testing landscape

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

 

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

 

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

 

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

 

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

 

Why aren’t more businesses buying in?

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

 

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

 

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

 

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

 

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

 

The case for proactivity

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

 

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

 

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

 

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

 

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

 

Acknowledgement

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Discussion

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

 

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

 

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

 

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

 

IndyMac CEO Michael Perry has reached an agreement with the FDIC to settle the lawsuit the agency filed against him in the Central District of California in July 2011 in its capacity as receiver of the failed bank. In the settlement agreement, filed with the court on December 14, 2012,  Perry agreed to pay $1 million out of his own assets plus an additional $11 million in insurance funds. However, the insurers are not parties to the agreement; rather, the FDIC has accepted Perry’s assignment of his rights under the insurance policies, which the FDIC apparently will now seek to assert against the insurers. The parties’ stipulation of dismissal, to which their settlement agreement is attached, can be found here.

 

Perry’s settlement comes just a week after a jury entered a $168.8 million verdict in the separate case the FDIC filed against three other IndyMac officers. The agency filed the two lawsuits separately as part of an apparent strategy in the separate case against the three officers to recover under a second $80 million tower of D&O insurance. As noted here, in July 2012, Judge Gary Klausner held in a related insurance coverage action that all of the various IndyMac lawsuits relate back to the first lawsuit to be filed, and therefore only trigger a single tower of insurance. Klausner’s ruling is on appeal.

 

Just as the FDIC’s separate lawsuit against the three officers appears to be a part of an insurance-oriented strategy, the FDIC’s settlement with Perry also appears in large measure to be about the D&O insurance. (To be sure, Perry will also be paying $1 million out of his own pocket, but the remainder of the agreement pertains to the insurance issues.)

 

The settlement agreement specifies that the Insurers shall pay the $11 million insurance portion of the settlement within 30 days. However, the insurers are not parties to the agreement, and the agreement appears to fully anticipate that the insurers will not in fact fund the $11 million insurance portion. The settlement agreement includes detailed provisions for the assignment of Perry’s rights against the insurers, including his rights for alleged “breach of the covenant of good faith and fair dealing.” (Perry expressly reserves his rights to try to recover from the insurers his past and future attorneys’ fees.) The agreement specifies that Perry is not personally liable of the $11 million insurance portion of the settlement.

 

The settlement agreement recites that on July 20, 2012, certain of IndyMac’s D&O insurers (that is, insurers in the so-called first tower of insurance) filed an interpleader action in the Central District of California. As I previously noted on this blog in connection with the insurance issues in this case, IndyMac’s collapse has led to multiple lawsuits involving multiple parties, creating competition among the various claimants for the dwindling amounts of insurance available as accumulating defense expenses erode the available limits. Brian Zabcik’s December 14, 2012 Am Law Litigation Daily article about Perry’s settlement with the FDIC  (here) quotes Perry’s counsel as saying that “Perry decided to settle the FDIC’s lawsuit in large part because the insurance funds available to fund his defense had been exhausted by all the various lawsuits brought against former IndyMac officers and directors,"

 

Perry’s settlement agreement with the FDIC specifies that the FDIC “agrees that, in its capacity as Mr. Perry’s assignee, it shall take no position in the Interpleader Action inconsistent with Mr. Perry’s position that the Insurers are obligated to fund other settlements to which Mr. Perry is a party.” (Among the other settlements identified in Perry’s settlement agreement with the FDIC is the $5.5 million settlement in IndyMac securities class action lawsuit known as the Tripp litigation, about which refer here.)

 

In other words, it appears that the $11 million insurance portion of Perry’s settlement with the FDIC basically represents a claim check for the agency to try to redeem in the interpleader action. Because there are numerous other claimants each attempting to assert their own claims to the insurance proceeds, it will remain to be seen how much of the $11 million insurance portion of its settlement with Perry the FDIC will ultimately collect.

 

As discussed here, the FDIC filed its lawsuit against Perry, in its capacity as receiver for Indy Mac bank, in July 2011. The FDIC’s complaint against Perry alleged that he caused over $600 million in losses by having the bank purchase mortgage loans in 2007, just as the mortgage marketplace was destabilizing. The complaint alleges that Perry acted negligently when he allowed IndyMac to generate and purchase $10 billion in loans when the secondary mortgage market was becoming illiquid. When IndyMac was later unable to sell the loans, the bank transferred them to its own investment portfolio, which then caused over $600 million in losses.

 

Interestingly, in its settlement stipulation with Perry, the FDIC expressly acknowledges that the FDIC’s complaint “does not allege that Mr. Perry caused the Bank to fail or that he caused a loss to the FDIC insurance fund.” Nevertheless, on December 14, 2012, the FDIC entered – apparently with Perry’s consent – an Order of Prohibition from Further Participation (here) reciting that Perry “engaged or participated in unsafe or unsound banking practices” at IndyMac; that these practices "demonstrate [his] unfitness" to serve as a director or officer at any FDIC-insured institution; and prohibiting him from involvement in any financial institution. The Am Law Litigation Daily article quotes Perry’s counsel as saying with respect to this order, to which Perry consented, that “the FDIC extracted this condition at the eleventh hour because they could,” and that “the FDIC knew Perry was out of insurance funds, and they took advantage of the situation."

 

Yet Another FDIC Lawsuit Involving a Failed Georgia Bank: For whatever reason, the FDIC’s lawsuits against former directors and officers of failed banks have been disproportionately concentrated in Georgia. On December 13, 2012, the FDIC filed yet another failed lawsuit in connection with a failed Georgia bank. A copy of the FDIC’s complaint, filed in the Northern District of Georgia against three former officers and four former directors of the failed RockBridge Commercial Bank of Sandy Spring, Georgia, can be found here.

 

RockBridge was closed by regulators on December 18, 2009. The complaint asserts claims against the seven individual defendants for negligence, gross negligence, and breach of fiduciary duty. In connection with the defendants alleged “numerous, repeated and obvious breaches and violations of the Bank’s Loan Policy and procedures, underwriting requirements, banking regulations, and prudent and sound banking practices,” as “exemplified” by 16 loans made between February 14, 2007 and November 12, 2008, which allegedly caused the bank losses of in excess of $27 million.

 

Interestingly, one of the defendants, Arnold Tillman, who has filed for Chapter 7 bankruptcy, was sued with leave of the bankruptcy court and “nominally to the extent of insurance coverage only.” (The FDIC proceeded in the same fashion against several individual defendants in the lawsuit it filed in November 2012 in its capacity as receiver of the failed Community Bank of West Georgia, of Villa Rica, Georgia, as I discussed in a prior post, here – second item in the blog post.)

 

The FDIC’s assertion of claims for ordinary negligence against the former directors and officers of RockBridge is interesting in light of the now several district court decisions holding that under Georgia law officers cannot be held liable for claims of ordinary negligence, as was discussed in a recent guest blog post on this site (This issue is now on an interlocutory appeal to the 11th Circuit in the Integrity Bank case.) The FDIC anticipated this argument, and specifically alleges in paragraph 58 of the complaint that the defendants are not entitled to rely on the business judgment rule and therefore liable for ordinary negligence.

 

The FDIC’s complaint against the former Rockbridge directors and officers is the 14th that the agency has filed in connection with a failed Georgia bank and the 42nd that the agency had filed overall, meaning that the FDIC’s D&O lawsuits involving failed Georgia banks represent one-third of all of the D&O lawsuits the agency has filed. The FDIC’s lawsuits against the failed Georgia banks represents a disproportionately high percentage of D&O suits; even though Georgia has had more bank failures than any other state, closed bank in Georgia still represent only about 18% of all bank failures. For whatever reason, the FDIC seems to be concentrating its litigation activity in Georgia. Indeed, the last four suits the agency has filed have involved failed Georgia banks.

 

Readers that follow the failed bank litigation closely will be interested to note that on December 11, 2012, the FDIC updated the page on its website that reports statistics and information on the agency’s failed bank litigation. In the latest update, the agency reports that it has authorized suits in connection with 89 failed institutions against 742 individuals for D&O liability. This includes 42 filed D&O lawsuits involving 41 institutions and naming 331 former directors and officers, inclusive of the latest suit against the former RockBridge directors and officers. The agency clearly will be filing many more lawsuits in the weeks and months ahead.

 

Special thanks to a loyal reader for providing a copy of the RockBridge complaint. Scott Trubey’s December 14, 2012 Atlanta Journal Constitution article about the FDIC’s latest lawsuit can be found here.

 

More About Securities Class Action Opt-Outs: In a recent post, I noted that the incidence of securities class action opt-outs seemed to be on the increase. In the prior post, I referred specifically to the high profile institutional investors that had chosen to opt out of the Pfizer securities litigation. Now it appears that there have been significant opt outs from the Citigroup subprime-related securities class action lawsuit settlement, as well.

 

As discussed here, in late August 2012, the parties to the high-profile Citigroup subprime-related securities class action lawsuit agreed to settle the case for $590 million, subject to court approval. However, 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 the more than half a billion dollar 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.

 

The article notes that institutional investors choose to opt out where they think they can improve their recoveries by proceeding separately from the class. The article notes that this approach is “not without its risks,” including the exposure of the opting-out party to full discovery, depositions and document discovery.” Given these concerns, the allure for institutional investors in opting out will only be there, according to one commentator quoted in the article, if “the losses are substantial enough to grab the defendants’ attention.” The rise in class action opt-outs carries risks for defendants as well, as they are unable to ensure “global peace” through the class settlement, and even run the risk of the opt-outs triggering the “blow up” provision in the class settlement agreement.

 

As I noted in my recent post about opt-outs, class action lawsuits have for many years been a favored whipping boy for conservative commentators. But for all of the ills that the class action process can sometimes involve, the prospect of a litigation process in which mass group claims are fragmented and can only be resolved in a piecemeal fashion is no improvement. Given the apparently increasing institutional investor interest in pursuing claims separate from the larger investor class, we could very quickly be getting to the point where resolution of class litigation is only one part of a multistep process, at least in the class action lawsuits where larger losses are at issue.

 

As I noted in a post earlier this week, last Friday a jury in the Central District of California returned a $168.8 million verdict in the lawsuit the FDIC filed in its capacity as receiver of the failed IndyMac bank against three former officers of the bank. The verdict has occasioned a great deal of commentary. A particularly interesting review of the D&O insurance issues involved can be found in a December 11, 2012 post on Alison Frankel’s On the Case blog (here).

 

I am pleased to present below a guest post from Mary C. Gill and Austin Hall of the Officers & Directors of Distressed Financial Institutions team at the Alston & Bird law firm, in which they discuss their views regarding the verdict and the verdict’s potential relevance for other pending FDIC failed bank cases – or lack thereof.

 

 

My thanks to Mary and Austin for their willingness to publish their guest post  here. 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 Mary and Austin’s guest post.  

 

 

In the first trial of a case brought by the FDIC against former bank officers during this financial crisis, a California jury concluded that three former officers of a division of IndyMac Bank, F.S.B. (“IndyMac”) are liable under California law for negligence and breach of fiduciary duty to the FDIC. FDIC v. Van Dellen,Case No. 2:10-cv-04915-DSF-SH (C.D. Cal.)(“Van Dellen”). On December 7, 2012, the jury in Van Dellen awarded the FDIC damages of $168.8 million following sixteen days of trial.  There are important distinctions, however, between the Van Dellen case and FDIC actions brought in other jurisdictions against former bank officers and directors. In the majority of these cases, the FDIC will be required to demonstrate that the former bank officers and directors committed gross negligence, which is far more difficult to prove than simple negligence or breach of fiduciary duty.

 

 

IndyMac was among the earliest and largest of the bank failures when it was closed on July 11, 2008. The Van Dellen complaint, which was filed in June 2010, was the first action brought by the FDIC against former bank officers, none of whom were directors, during this financial crisis. The FDIC filed a separate action in July 2011 against IndyMac’s former CEO, Michael Perry, which remains pending. FDIC v. Perry, Case No. 2:11-cv-5561 (C.D. Cal.).

 

 

The trial in Van Dellen involved the President and CEO of the IndyMac Home Builder Division, and its Chief Lending Officer and the Chief Credit Officer. The complaint focused upon twenty-three loans, which the FDIC contended were approved without adequate information and in violation of bank policies. With respect to each of these twenty-three loans, the jury concluded that one or more of the former officers were negligent and breached their fiduciary duties in approving the loan.

 

 

Under the federal statute that governs claims by the FDIC, the FDIC must demonstrate that the officer or director conduct was grossly negligent, unless the applicable state law allows liability to be imposed based upon a stricter standard. Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”), 12 U.S.C. § 1821(k).  In many states, officers and directors are not subject to liability for negligence, either by statute or application of the business judgment rule, which generally protects officers and directors from personal liability for ordinary negligence. Thus, for example, FDIC claims for ordinary negligence brought against former bank officers and directors in Georgia have been dismissed.  FDIC v. Skow, Case No. 1:11-cv-0111 (N.D. Ga. Feb. 27, 2012), reconsideration denied (N.D. Ga. Aug. 14, 2012); FDIC v. Blackwell, Case No. 1:11-cv-03423 (N.D. Ga. Aug. 3, 2012); FDIC v. Briscoe, Case No. 1:11-cv-02303 (N.D. Ga. Aug. 14, 2012); FDIC v. Whitley, Case No. 2:12-cv-00170 (N.D. Ga. Dec. 10, 2012).  The Eleventh Circuit recently accepted an appeal in FDIC v. Skow, in which the FDIC seeks review of this issue under Georgia law. FDIC v. Skow, Case No. 1:11-cv-00111 (N.D. Ga. Nov. 19, 2012).   

 

 

The FDIC claims in Van Dellen were based upon California law, which affords directors, but arguably not officers, the protection of the business judgment rule from claims of ordinary negligence.   Prior to trial, the Van Dellen court held that the officers could not rely upon the business judgment rule under California law. This ruling was consistent with the earlier ruling in the action against IndyMac’s CEO, FDIC v. Perry.  In contrast, a 1999 decision from the Ninth Circuit Court of Appeals, which remains as binding precedent, held that under California law bank directors are protected by the business judgment rule from claims of ordinary negligence.  FDIC v. Castetter, 184 F. 3d 1040 (9th Cir. 1999)

 

 

Accordingly, the Van Dellen verdict cannot be viewed as a predictor of potential results in other cases, particularly those in which officers and directors are afforded the protection of the business judgment rule and the FDIC is required to demonstrate gross negligence.  

 

 

Alston & Bird’s Distressed Financial Institutions Team represents and counsels over 200 current and former directors and officers in over 40 distressed or closed financial institutions across the country. The team offers expertise and experience regarding regulatory enforcement actions and the unique fiduciary roles of bank directors in distressed bank situations, as well as providing advice on insurance coverage for bank directors and officers. The team also represents former bank directors and officers in over 80 claims by the FDIC for civil money damages. 

In a December 6, 2012 opinion (here), a New York state court judge applying New York law has denied a D&O insurer’s motion seeking a summary judgment determination that its policy’s “professional services” exclusion precluded coverage for attorneys’ fees that the Andy Warhol Foundation incurred in defending claims brought by art owners disgruntled by the Foundation’s determination that Warhol had not painted the owners’ paintings.

 

Background

The Foundation is charged with protecting the legacy of the painter, Andy Warhol. The primary purpose of an affiliated entity, The Andy Warhol Art Authentication Board, is to review pieces of artwork submitted t it to determine whether or not they were created by Warhol.. (The related entities are collectively referred to in this post as the Foundation.).

 

 In 2007, an art owner filed a class action lawsuit against the Foundation and related entities on behalf of all persons who had sought authentication from the Foundation that art they owned had been painted by Warhol. A separate art owner later filed an individual action against the Foundation. The claimants, who included persons whose artwork had been determined not to have been created by Warhol, asserted claims of fraud, violations of the Lanham Act and violation of the Sherman Act. After extensive litigation, the claimants ultimately withdrew their claims.  

 

The Foundation sought coverage for its defense fees from the insurer that had issued the organization a $10 million D&O policy and a $2 million E&O policy. The insurer initially denied coverage under both policies, but ultimately wound up paying the full limit of $2 million under the E&O policy. The Foundation sought to recover the remaining balance of its defense costs ($4.6 million plus interest) under the D&O policy. The insurer refused to pay and the Foundation filed suit.

 

The insurer filed a motion for summary judgment in the coverage action, arguing, among other things, that coverage for the remaining defense fees was precluded under the D&O policy’s “professional services” exclusion, which provides that:

 

In consideration of the premium paid, it is hereby agreed that the Company shall not be liable to make any payment for “loss” or “defense cost” in connection with any “claim” made against the “Insured” based upon, arising out of, directly or indirectly resulting from or in consequence of, or in any way involving:

1. The furnishing or the failure to furnish professional services by an attorney, architect, engineer,, accountant, real estate agent, financial consultant, securities dealer, veterinarian or insurance agent or broker.

2. The furnishing or failure to furnish professional services by an [sic] physician, dentist, psychologist, anesthesiologist, nurse, nurse anesthetist, nurse practitioner, nurse midwife, x-ray therapist, radiologist, chiropodist, chiropractor, optometrist, or other medical or mental health professional.

3. A “professional incident” as defined herein. “Professional incident” means any actual or alleged negligent:

a) act;

b) error; or

c} omission

in the actual rendering of services to others including, counseling services, in your capacity as [sic] social services organization. Professional services include the furnishing of food, beverages, medications or appliances in connection therewith.

 

The insurer argued that the Foundation’s authentication services constitute “professional services,” precluding coverage for the defense fees. The insurer also argued that the Foundation fits within the category of a “social services” organization under Section 3 of the exclusion.

 

The Court’s Order

In his December 6, 2012 Decision and Order, Justice Peter Sherwood of the New York (New York County) Supreme Court, applying New York law, denied the D&O insurer’s motion for summary judgment. With respect to the professional services exclusion, Justice Sherwood found that the insurer could not carry its “heavy burden” of proving that the exclusion applies, noting that “the Exclusion lists specific occupations that involve specialized training and skill. Authentication services are not listed.” Justice Sherwood further noted that examples supplied in the exclusion “do not relate in any way to art authentication services.” Because the exclusion is “at best ambiguous,”  it must be construed in the policyholder’s favor,  Justice Sherwood denied the insurer’s motion for summary judgment.

 

Discussion

Although Justice Sherwood denied the insurer’s motion for summary judgment, he did not enter summary judgment in Foundation’s favor. Indeed, the docket cover sheet attached to the decision and order indicates that the ruling is a “non-final disposition.” It is unclear whether or not there are other bases on which the insurer is contesting coverage that were not addressed in its summary judgment motion or what other issues may remain for trial.

 

That said, Judge Sherwood’s ruling represents a serious set back for the insurer in this case. There is a peculiar irony in the court’s determination that the professional services exclusion did not preclude coverage yet at the same time the carrier (ultimately) acknowledged coverage for the claim under itsE&O policy. The general expectation between these kinds of policy’s is that a professional liability claim would be covered by one or the other of the two policy’s but not both; indeed, the general purposeof the professional services exclusion is to ensure that the D&O insurer does not pick up coverage for claims that properly belong under an E&O policy.

 

The problem for the insurer is not that the authentication services didn’t involve the delivery of a kind of professional service. Indeed, I think most people would agree that the art authentication services are professional services, as commonly understood. However that does not mean that the authentication services represent professional services within the meaning of the D&O policy’s exclusion. To make that determination, the actual language used in the policy must control. And that’s clearly where the insurer got in trouble here.

 

The exclusionary language used would seem to have little to do with circumstances of the Foundation’s operations. There is no general catch-all language, either — or at least no language obviously intended to provide a catch-all provision. There is no doubt that had the insurer used language better matched to the Foundation’s activities and circumstances that the exclusion might have operated to preclude coverage. Any underwriting manager responsible for policy issuance quality control will want to take a close look at what happened here and draw some obvious lessons about the steps necessary to ensure that the policy as issued reflects the terms and conditions required to meet the risks accepted.

 

Lisa Scuchman’s December 10, 2012 Am Law Litigation Daily article about Judge Sherwood’s summary judgment ruling can be found here.

 

More About that $168.8 Million Verdict in the IndyMac Case: Readers interested in the massive $168.8 million jury verdict entered last Friday on behalf of the FDIC in its capacity as receiver of the failed IndyMac bank against thee banks former directors and officers will want to take a look at Alison Frankel’s December 11, 2012 post on her On the Case blog (here). As I noted in my discussion about the verdict, the FDIC’s strategy in the case is to try to recover under a second $80 million tower of D&O insurance. The agency’s strategy was dealt a major setback earlier this year, in the form of a ruling in a separate proceeding that all of the IndyMac lawsuits relate back to a prior claim and therefore trigger only a single, virtually depleted $80 million tower. That coverage determination is now on appeal. Frankel’s post does an a good job summarizing the FDIC’s strategy as well as its procedural maneuvering with respect to the second $80 million tower. The FDIC apparently hopes not only to be able to argue that the second $80 million tower is triggered, but that the D&O carriers are liable for  amounts awarded in excess of the $80 million as well.

 

Readers may also be interested in taking a look at the Alston & Bird law firm’s memo about the verdict as well. The firm’s December 11, 2012 memo argues that the verdict is of limited relevance outside of California or in any jurisdiction in which a corporate officer cannot be held liable for mere negligence. The law firm, which represents former directors and officers in a host of the FDIC’s failed bank cases, contends that in many of the cases that the FDIC has filed, “the FDIC will be required to demonstrate that the former bank officers and directors committed gross negligence, which is far more difficult to prove than simple negligence or breach of fiduciary duty.”

 

New securities class action lawsuit filing levels were comparable to historical norms during 2012, but the number of settlements and of dismissals were both down for the year, according to the analysis and projections of NERA Economic Consulting in their December 11, 2012 publication “Flash Update: 2012 Trends in Securities Class Actions” (here).

 

According to the report, there were 195 new securities class action lawsuits filed this year through November 30, 2012. NERA projects that there will be around 213 total lawsuit filings by year end. The projected number is slightly below the 2007-2011 average of 221. (It should be noted that NERA counts multiple actions in multiple jurisdictions against the same defendants as different filings, unless and until consolidated, so NERA’s initial lawsuit filing counts will be higher than those published by some other sources. NERA also notes in the report’s footnotes that it “counts” a case if it involves securities, even where the complaint alleges violations of the common law or breach of fiduciary duty. This criterion may also result in counts differing from other published sources, some of which “count” cases only if they allege violations of the federal securities laws.)

 

The report notes that the 2012 filing levels are more or less consistent with recent years, even though the credit crisis-related lawsuit filings have faded away. The report notes that in 2005-2006, just prior to the credit crisis, annual filing levels had been as low only about 160. The report notes that the number of filings has not declined to these prior lower levels, as “the plaintiffs’ bar has found new causes of action, with merger objection cases picking up much of the slack.”

 

Though filings levels have remained more or less level, the number of cases resolved during 2012 through dismissal or settlement has plummeted. (It is important to understand that the report measures the time of settlement as the date on which it is approved, so some high profile settlements that were announced in 2012 – such as the massive $2.43 billion settlement of the BofA/Merrill Lynch merger case – 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 report, the 92 settlements that are projected to be approved in 2012 is the lowest number since 1996 and 25% lower than 2011. The 60 dismissals projected for the year represent the lowest level since 1998 and the 2012 total is 50% lower than 2011. The total of 152 cases that have been resolved (settled or dismissed) is also the lowest level since 1996. The report notes that part of the reason for these declines may simply be that there were fewer cases pending and therefore available to be resolved as 2012 began, the lowest level of pending 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, 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 is $36 million, up from a revised 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, and only the second year since 1996 that the median has exceeded $10 million.

 

FDIC D&O Lawsuits and D&O Insurance Coverage: Former directors and officers of failed banks who are sued by the FDIC may look to the bank’s D&O insurance to defend and protect themselves. However, the bank’s D&O insurer may assert defenses to coverage that could limit the availability of the insurance, according to a December 10, 2012 memorandum entitled “Not So Fast: Directors and officers Sued by the FDIC over Bank Failures Should Not Assume D&O Insurance Will Cover the Claims” (here) by Britt K. Latham and M. Jason Hale of the Bass Berry and Sims law firm.

 

As reflected in the memorandum, among other issues, the carriers are raising the “Insured vs. Insured” exclusion found in most policies as a defense to coverage for claims brought by the FDIC in its capacity as the failed bank’s receiver. The authors review the existing case law and observe that “this issue is expected to be hotly contested in the wake of continuing D&O lawsuits by the FDIC related to bank failures.”

 

My own overview of the impact of the Insured vs. Insured exclusion on the FDIC’s failed bank litigation can be found here. As I discussed in a recent post (here), in October 2012, a federal court in Puerto Rico held that the Insured vs. Insured exclusion does not preclude coverage for an FDIC’s claims as receiver of a failed bank against the bank’s former directors and officers.

 

On December 7, 2012, in a comprehensive victory for the FDIC in its capacity as receiver of the failed IndyMac bank, a jury in the Central District of California entered a verdict of $168.8 million in the FDIC’s lawsuit against three former officers of the bank. As reflected in the verdict form (a copy of which can be found here), 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

 

At the time its July 11, 2008 closure, IndyMac had assets of about $32 billion, making its failure the fifth largest bank failure in U.S. history. But though there have been a few larger bank failures, none have been costlier to the FDIC’s deposit fund. IndyMac’s collapse has cost the fund nearly $13 billion.

 

In June 2010, the FDIC filed against a lawsuit several former officers of the bank’s homebuilder division, in what was the first D&O lawsuit the agency filed during the current bank failure wave, as discussed here. The FDIC’s lawsuit sought to recover damages from the individual defendants for “negligence and breach of fiduciary duties” and alleged “significant departures from safe and sound banking practices.” As discussed here, in July 2011, the FDIC filed a separate lawsuit against IndyMac’s former CEO, Michael Perry.

 

As discussed here, trial in the FDIC’s case against the former homebuilder division officers began on November 6, 2012. The three individual defendants in the case that went to trial are: Scott Van Dellen, the former President and CEO of IndyMac’s Homebuilders Division (HBD), who was alleged to have approved all of the loans that are the subject of the FDIC’s suit; Richard Koon, who was HBD’s Chief Lending Officer until mid-2006 and who was alleged to have approved a number of the loans at issue; Kenneth Shellem, who served as HBD’s Chief Compliance Officer until late 2006, and who is also alleged to have approved many of the loans. (The FDIC’s original complaint had named a fourth individual, William Rothman, as a defendant as well. According to pleadings filed in the case, Rothman settled with the FDIC in exchange for Rothman’s assignment to the FDIC of Rothman’s rights against IndyMac’s D&O insurers.)

 

According to news reports, the jury reached its verdict after 16 days of trial. During the trial, the defendants attempted to argue that they and the bank were victims of an unanticipated downturn in the housing market. The FDIC in turn argued that the bank officials disregarded danger signals about the housing market and continued to approve loans in order to meet production goals and obtain bonus compensation.

 

The jury verdict form reflects separate verdicts as to each of the 23 loans that were at issue in this phase of the trial of the case. With respect to each of the loans, the jury separately found that the specific defendants who were named as to each of the loans had been negligent and had breached their fiduciary duties. The jury assigned separate damages as to each of the loans as well. The separate damage awards total $168.8 million. However, each of the three defendants was held liable for differing amounts. All three of the defendants were named only with respect to 14 of the 23 loans. With respect to five of the 23 loans, only Van Dellen and Shellem were named, and as to four of the loans, Van Dellen alone was named. Thus the jury found Van Dellen liable as to all 23 of the loans, but found Shellem liable only as to 18 of the loams and found Koon liable only as to 14 of the loans.

 

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. In addition, the FDIC’s separate case against Perry, the bank’s former CEO, will continue to go forward as well.

 

Given the magnitude of the jury’s verdict, there undoubtedly will be post-trial motions and, after the conclusion of all remaining trial phases, appeals as well. One issue that likely will be subject of an appeal will be Central District of California Judge Dale Fischer’s October 2012 determination under California law that the three defendants, as former officers (but not former directors), could not rely on the business judgment rule and therefore could be held liable for mere negligence. (The potential appeal value of this issue for the defendants may be diminished somewhat due to the fact that the jury specifically found that the defendants had not only been negligent, but had also violated their fiduciary duty, suggesting that the defendants would still have been found liable even if they couldn’t be held liable for negligence).

 

While the jury verdict unquestionably represents a victory for the FDIC, the FDIC may face considerable challenges attempting to collect on the verdict. There may be little or no remaining D&O insurance out of which the FDIC might try to recover. 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 related to Indy Mac’s collapse (including the case that 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. (The FDIC has filed an appeal of Judge Klausner’s ruling.)

 

In other words, unless Judge Klausner’s insurance coverage ruling is reversed on appeal, the only insurance available out of which the FDIC might be able to try to realize the amount of the jury verdict is whatever is left under the first tower of insurance. However, as I noted in a prior post, in pleadings that they filed in July 2012, the defendants represented to the court that defense fees incurred in all of the various IndyMac-related lawsuits, as well as settlements that had been reached in some of the suits, had exhausted or would soon exhaust the first tower of insurance.

 

Pleadings that the three individuals filed in the case state that “the FDIC specifically structured this lawsuit in order to reach the Tower 2 Policy.” Judge Klausner’s ruling in the insurance coverage case obviously upset the FDIC’s strategy in this case. The outcome of the appeal in the insurance coverage case may well determine whether or not the massive verdict the FDIC just won results in any significant monetary benefits for the agency.

 

This case was not only the first case the FDIC filed against the former directors and officers of a failed bank as part of the current bank failure wave, but it is also the first case to go to trial. Since the FDIC filed this suit back in July 2010, the agency has filed forty more cases against the directors and officers of failed banks. There undoubtedly will be more lawsuits yet to come. Many of the individual defendants named in these cases vigorously dispute the FDIC’s allegations. However, the jury verdict in the IndyMac case may communicate a sobering message about what it might mean to force a case all the way to trial. Given this verdict, it may now be even more unlikely that one of these cases would go to trial.

 

Scott Recard’s December 8, 2012 Los Angeles Times article about the jury verdict can be found here.

 

Special thanks to Thomas Long of the Nossaman law firm for sending me the jury verdict form. The Nossaman firm represented the FDIC at the IndyMac trial.

 

D&O Insurer, FDIC Settle Claims Against Former BankUnited Officials: The FDIC’s efforts to try to recover under failed banks’ D&O insurance do not always involve a lawsuit. Sometimes the FDIC asserts its claims in a demand letter that it presents to the former directors and officers of a failed bank, with a copy of the letter also send to the failed bank’s D&O insurers. Sometimes these kinds of letter demands result in a settlement without a lawsuit ever being filed. That apparently is what has happened in connection with the FDIC’s claims against former directors and officers of BankUnited, a Coral Gables, Florida bank that failed in May 2009, at least according to a December 6, 2012 article in the South Florida Business Journal.

 

As reflected here, on November 5, 2009, the FDIC, in its capacity as BankUnited’s receiver, sent a letter to fifteen former directors and officers of the bank, in which the FDIC presented its "demand for civil damages arising out of losses suffered as a result of wrongful acts and omissions committed by the named Directors and Officers." The letter, a copy of which can be found here, explains that the demand for civil damages is "based on the breach of duty, failure to supervise, negligence, and/or gross negligence of the named Directors and Officers." Though the letter is nominally addressed to the fifteen individuals, copies of the letters also were sent directly to the bank’s primary and first level excess D&O insurers.

 

In addition to the FDIC’s claims against former directors and officers of the failed bank, shareholders of the failed bank’s holding company (which is now bankrupt) filed a lawsuit against certain former bank directors and officers. The bankruptcy trustee asserted claims against the individuals as well.

 

According to the newspaper article, these various parties have reached a settlement agreement, subject to bankruptcy court approval, to divide the bank’s $10 million primary D&O insurance policy four ways: $3.5 million to the class action plaintiff; $2.5 million to the FDIC; $1.65 to the bankruptcy trustee; and the balance going to pay legal defense fees and other costs. The settlement agreement also allows the FDIC to attempt to pursue a recovery from the carrier that issued the bank’s $10 million first level excess D&O insurance carrier, which has refused to pay under its policy.

 

This settlement is interesting because it reflects the tensions that can arise when multiple claims have been asserted against the former directors and officers of a failed bank. When there are multiple claims and only limited insurance, the various claimants are put in competition with each other, as they each race to try to capture as much of the insurance as they can while at the same time accumulating defense fees erodes what little insurance there may be. The division here of the $10 million primary D&O policy reflects an effort between and among the various claimants to try to work out a split of the insurance  so that each of the various sets of claimants at least gets a part of the policy proceeds. The challenge for other claimants trying to work out similar deals in other cases is to try and get a deal done before defense fees exhaust the insurance fund.

 

Special thanks to a loyal reader for sending me a link to the article about the BankUnited settlement.

 

Civic Duty: I will be on jury duty this week. We’ll see if anybody has the guts to allow me to remain in the jury box. If I am called, it may be a few days before I am able to resume normal blogging activities.