Two of the significant securities litigation trends we have been following are the subprime-related securities litigation and the securities suits that have been filed against U.S.-listed Chinese companies. As discussed below, in the past few days courts granted dismissal motions in each of these kinds of cases.

 

Jiangbo’s CFO’s and Auditors’ Dismissal Motions Granted

First, just when it seemed that the plaintiffs’ in the many securities suits involving U.S. listed Chinese companies might be making some progress (about which refer here, scroll down to second item), a Florida federal judge has granted dismissal motions in a securities suit involving a Chinese company. On August 1, 2012, Southern District of Florida Judge Marcia Cook, in the securities class action lawsuit involving Jiangbo Pharmaceuticals, granted the motions to dismiss of the company’s CFO, Elsa Sung, and of its auditor. The dismissals are without prejudice. A copy of her opinion can be found here.  (Hat tip: Courthouse News Service.)

 

Jiangbo became a listed company in the U.S. as a result of the Chinese company’s reverse merger with a U.S.-listed publicly traded shell company. As detailed here, shareholders first filed their action in July 2011, following the company’s June 7, 2011 filing on Form 8-K, in which the company announced that members of its audit committee had resigned due to the company’s senior executives’ lack of cooperation with an internal investigation of possible accounting concerns. (The audit committee members’ letters of resignation, which details the extremes to which senior company officials went to avoid the investigators, can be found here and makes for interesting reading.) Among other things, the plaintiffs alleged that the company overstated its reported cash balances and failed to report related party transactions.

 

The company itself has failed to appear in the case, but the company’s former CFO and former auditor –who are both located in the U.S. – have appeared, and they both moved to dismiss. In her August 1 opinion, Judge Cook granted their motions, finding that while the plaintiffs sufficiently alleged that the company’s reported cash balances were materially misleading, the plaintiffs had not sufficiently alleged scienter as to the CFO and the auditor.

 

In granting the CFO’s motion to dismiss, Judge Cook said that the inference that the CFO intentionally or recklessly overstated the company’s cash balances “is not as compelling as the competing inference that Sung failed to disclose Jiangboa’s true financial condition because she either was unaware of, or, at most, was grossly negligent in failing to discover the true amount of the Company’s cash balances.”

 

Judge Cook went on to note that the plaintiffs’ arguments that the CFO “must have known” of the company’s over-reporting of its cash balances were based on “conclusory” allegations that the CFO was involved in day-to-day operations and therefore must have known the cash balances were incorrect. “In fact,” Judge Cook noted, “Sung worked mainly in Florida, while the Company conducted its operations in Laiyung.” These facts “support the competing inference that Sung did not know the Company’s true financial condition.” Judge Cook also found that the plaintiffs had not alleged that there was anything in particular about the cash balance amounts that would make them “suspicious”

 

Judge Cook concluded that “even though Plaintiffs sufficiently allege that Jiangbo’s financial statements may have contained materially false or misleading information regarding its cash balances, they have not alleged sufficient facts to yield a strong inference of scienter as to Sung.” Judge Cook reached a similar conclusion with respect the plaintiffs’ allegations against the company’s auditor. Judge Cook did grant the plaintiffs leave to amend, noting that “further facts regarding the magnitude of the fraud and Sung’s knowledge or involvement in the Company’s operations and preparation of the financial statements may well be sufficient to show scienter in this case.”

 

Deutsche Bank’s Dismissal Motion Granted

In an August 10, 2012 order, and based on Deutsche Bank’s motion for reconsideration of her prior ruling in the case, Southern District of New York Deborah Batts granted Deutsche Bank’s motion to dismiss the subprime-related securities suit that had been filed against the company and certain of its directors and officers. A copy of the August 10 opinion can be found here.

 

As discussed here, the plaintiffs had alleged that the company had failed to properly record provisions for credit losses, residential mortgage-backed securities, commercial real estate loans, and exposure to monoline insurers. In an August 19, 2011 order (here), Judge Batts granted the defendants’ motions to dismiss with respect to certain of the plaintiffs’ allegations, but she also ruled that the plaintiffs had adequately stated claims under the Securities Act of 1933 with respect to the company’s 2007, February 2008 and May 2008 securities offerings.

 

However, just four days after she allowed the plaintiffs’ claims to proceed with respect to those three offerings, the Second Circuit released its decision in Fait v. Regions Financial Corporation. As discussed here, the Second Circuit held that estimates of goodwill and loan loss reserves were not “facts,” but rather are “opinions” and that  in order to state a Securities Act claim, a plaintiff must allege not only that the statements were false, but that the defendants’ opinions were not honestly believed when made. In reliance on Fait, Deutsche Bank moved to have Judge Batts reconsider the portion her August 2011 ruling in which she had permitted certain of the plaintiffs’ claims to go forward.

 

In her most recent ruling, Judge Batts granted the defendants’ motion for reconsideration and granted their motion to dismiss as well. Judge Batts said that plaintiffs’ allegations about valuation measures used in the offering documents “suggest that Defendants were wrong, and perhaps egregiously so, in their internal valuation metrics. “ However, after Fait, “it is clear…that such valuations are a matter of opinion rather than fact.” Accordingly, she concluded, the plaintiffs “must allege that Defendants did not honestly believe those valuations when made. The Complaint in this matter contains no such allegations.” Because the plaintiffs state in their complaint that their claims rely exclusively on theories of strict liability and negligence, Judge Batts denied the plaintiffs leave to amend.

 

The plaintiffs’ allegation in their complaint that they were relying exclusively on theories of negligence and strict liability are fairly standard in Securities Act claims, as plaintiffs typically do not want to have to meet the higher pleading standards required under the Federal Rules of Civil Procedure for pleading fraud. Indeed, companies are generally said to be strictly liable under the Securities Act for material misrepresentations or omissions in securities offering documents. But, according to Fait, the things that the plaintiffs are alleging her to be misleading are not facts at all, but opinions. For the plaintiffs to have to allege that the defendants didn’t believe those things when they said them raises a high barrier for the plaintiffs to have to get over.

 

I have in any event added Judge Batts’s ruling in the Deutsche Bank case to my tally of subprime and credit crisis-related dismissal motion ruling, which can be accessed here.

 

Something to Keep You Awake: A spider really can crawl in your ear while you are sleeping. Here’s the story, with (creepy) pictures.

 

The U.S. Supreme Court’s decision in Morrison v. National Australia Bank presents significant obstacles for claimants who want to pursue securities claims against non-U.S. companies in the U.S courts, as the short sellers who tried to sue Porsche in the Southern District of New York found out—their prior federal court securities suit was dismissed on the basis of Morrison.   However, the short-sellers’ state court common law claims will now be going forward, as a result of a recent New York state court decision that may suggest one way that litigants may be able to avoid Morrison’s constraints.

 

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.

 

As discussed here, the plaintiffs in the federal court suit — hedge fund investors who lost money short-selling shares of German auto manufacturer VW — allege 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 VW, while at the same time it allegedly was secretly accumulating shares with the purpose of obtaining control. In October 2008, after Porsche disclosed its intent to obtain control, 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 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.

 

In his August 6 order, Judge Ramos denied Porsche’s motion. First, Judge Ramos held that “a balancing of the relevant factors reveals that Porsche has not met the heavy burden of demonstrating that this action should be dismissed on the ground of forum non conveniens.” In reaching this conclusion, he noted that the plaintiffs are located in New York; that Porsche allegedly made multiple misrepresentations directly to the plaintiffs in New York; that Porsche representatives transmitted multiple communications to the plaintiffs and others in New York; and that the five principal plaintiffs’ witnesses are all located in New York.

 

He also noted that though many critical witnesses reside in Germany, “large corporations such as Porsche with ample resources have minimal difficulty bringing foreign witnesses or documents to New York Court,” and that the company regularly transacts business in the U.S.

 

Finally, Judge Ramos rejected Porsche’s “characterization” of the case as alleging “the manipulation of the German stock market and the trade of German securities”; rather, 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 “clearly has a vested interest in such an action.”

 

Judge Ramos also concluded that the plaintiffs had adequately stated claims for fraud and for unjust enrichment, and he declined to stay this action pending the outcome of the federal court appeal.

 

Discussion

The outcome of Judge Ramos’s decision is obviously interesting in and of itself, but it is also particularly interesting in light of the fact that the prior federal securities lawsuit was dismissed on the basis of the Morrison decision. These plaintiffs, stymied by Morrison in their attempt to assert federal securities claims, have nonetheless managed to find a way to pursue claims against the non-U.S. defendant in U.S. court, by asserting common law claims that are not subject to Morrison’s constraints.

 

These plaintiffs ability to pursue their claims against Porsche in a U.S. court may suggest ways that other prospective claimants might be able to circumvent Morrison’s constraints and to pursue misrepresentation claims in U.S. courts against non-U.S. companies.

 

However, there are things that may constrain other prospective claimants from pursuing a similar strategy. For starters, the plaintiffs in this case were only successful in avoiding a forum non conveniens dismissal because of the case-specific factors that tied the case and the underlying circumstances to New York. Other prospective claimants may or may not be able to marshal equally compelling evidence of a connection to a U.S. jurisdiction.

 

The other thing that may make this case somewhat distinct is that many of the alleged misrepresentations on which the plaintiffs relied allegedly were made directly to them by Porsche’s representatives. The existence of these direct misrepresentations significantly boosted the plaintiff’s ability here to assert claims for common law fraud – and more particularly to be able to establish the critical element of reliance. (Alison Frankel has a particularly good explicatioin of Judge Ramos’s considertion of the reliance issue in an August 9, 2012 post on her On the Case blog, here.) Other litigants, perhaps relying on market-wide statements, may be less able to show all of the elements necessary to raise claims for common law fraud or other common  law claims.

 

But while there undoubtedly are considerations that may complicate matters for other prospective claimants who want to pursue misrepresentation claims against non-U.S. companies, this case nevertheless does show at least a possible way to pursue those claims in U.S. courts without the constraints of the Morrison decision. It should no noted that, according to David Bario’s August 9, 2012 article in the Am Law Litigation Daily about Judge Ramos’s ruling (here) , the defendants apparently intend to pursue an appeal of the ruling.

 

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 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.

 

Perhaps the Chinese Reverse Merger Company Cases Have Legs After All: Maybe the plaintiffs will be able to make something out of the wave of lawsuits against U.S.-listed Chinese companies after all. Last week, the Second Circuit revived the suit against China North Petroleum Holdings, which the district court had dismissed. And on August 8, 2012, Southern District of New York Judge Katherine Forrest denied the motion to dismiss the securities class action lawsuit that had been filed against China Automotive Holdings. A copy of Judge Forrest’s opinion can be found here.

 

China Automotive Holdings obtained its U.S. listing as a result of a reverse merger. As detailed here, the plaintiff shareholders first filed their action in October 2011, alleging that the company had misrepresented its financial condition by accounting improperly for certain convertible notes, which had the effect of overstating the company’s earnings. The company ultimately replaced its auditor and restated its financial statements for prior periods in order to properly account for the convertible notes. During the class period the individual defendants collectively sold over $40 million of their personal holdings in company securities. The defendants include the company, certain of its directors and officers, and the company’s prior auditor. The company and the auditor moved to dismiss. (The individual defendants have not yet been served and have not appeared in the case.)

 

In her August 8, 2012 opinion, Judge Forrest denied the company’s motion to dismiss but granted the auditor’s motion (with leave to amend).

 

In denying the company’s motion, Judge Forrest rejected two substantial arguments that the company had raised; first, the company had argued  that because almost all of the insider sales on which the plaintiff relied were made pursuant to a Rule 105-1 trading plans, the plaintiffs cannot rely on the trades in order to establish scienter; and the company argued that the plaintiffs cannot establish loss causation, because the decline in the company’s share price was attributable to the market’s loss of confidence in the Chinese Reverse merger companies.

 

In rejecting the company’s arguments that the insider sales were made pursuant to Rule 10b5-1 trading plans, Judge Forrest found that because the trading plans were entered during the class period, they “are not a cognizable defense to scienter allegations on a motion to dismiss.”

 

And in rejecting the argument that the plaintiffs have not established loss causation because the decline in the company’s share price was due to marketplace concerns about Chinese reverse merger companies, Judge Forrest noted that “although Chinese Reverse Merger companies have faced ‘public scrutuny’ … to hold that plaintiffs failed to plead loss causation solely because other Chinese Reverse Merger Companies’ stock dropped contemporaneously with [the company’s] stock price decline would place too much weight on one single factor.”

 

Judge Forrest holding with respect to the Rule 10b5-1 trading plans is interesting. These kinds of plans can serve as a basis for the dismissal of a securities fraud lawsuit (refer for example here). However, these kinds of plans can be abused; indeed, Angelo Mozillo’s notorious alleged manipulation of his Rule 10b5-1 trading plan was a significant feature of the Countrywide securities class action lawsuit (about which refer here). In the present case, the timing of the individual defendants’ plans undercut the company’s ability to rely on the plans’ existence to rebut the inference of scienter.

 

Judge Forrest’s loss causation ruling is also interesting and may be useful for other plaintiffs in cases involving Chinese Reverse Merger companies. Many of these companies also experienced a significant share price decline because of the market’s suspicion about these kinds of companies. Judge Forrest’s ruling that the mere fact that there has been a marketplace decline does not alone undercut loss causation could be relevant in many other cases, particularly those cases that were filed after the general marketplace concerns had already emerged.

 

Though the plaintiffs have survived the initial pleading hurdle they may yet have a challenging road ahead. The fact that the individual defendants have not yet been served or entered an appearance gives a glimpse of the logistical, practical and procedural challenges the plaintiffs may face as they try to move this case forward. Among other things, they may face challenges in trying to get a class certified, as has proven to be the case in a least one other lawsuit involving a U.S.-listed Chinese company (about which refer here). And even claimants that have managed to get their suits against U.S.-listed Chinese companies all the way to the settlement stage have found that they often are forced to accept only modest settlements, often because the Chinese companies carry only very modest levels of D&O insurance (about which refer here).

 

But from the plaintiffs’ perspective, the important thing now is they have survived the initial pleading threshold and will now be taking the case forward.  There were many of these cases involving U.S.-listed Chinese companies filed in 2010 and 2011, and they will be interesting to watch. At least recently, it seems that the cases have been faring better than I had anticipated. Stay tuned for further developments, though.

 

Jan Wolfe’s August 8, 2012 Am Law Litigation Daily article about the China Automotive case can be found here.

 

Friends Don’t Let Friends Drink and Dial: A Tennesee man called 911 because he was running low on beer. I am not making this up.

 

A federal court has ruled in the only FDIC failed bank lawsuit pending in Florida that directors cannot be liable for ordinary negligence under Florida law. On August 8, 2012, Middle District of Florida Judge Gregory Presnell granted the motion of the director defendants to dismiss the FDIC’s claim against them for ordinary negligence. A copy of Judge Presnell’s order can be found here.

 

As discussed here, in March 2012, the FDIC filed an action in the Middle District of Florida in the agency’s capacity as receiver of the failed Florida Community Bank of Immokalee, Florida, against the failed bank’s former CEO and six of the failed bank’s former directors. A copy of the FDIC’s complaint can be found here.

 

 The bank failed on January 29, 2010. In its complaint, the FDIC alleges that the bank’s collapse was caused by “grossly negligent loan underwriting and loan administration, resulting in excessive and dangerous concentrations” of commercial real estate loans and of acquisition and development loans. The FDIC seeks to recover on losses of in excess of $62 million dollars in connection with six specific loans. The FDIC asserts state law claims of negligence against the former directors and against the former CEO, as well as claims of gross negligence under FIRREA against all of the individual defendants.

 

The director defendants (except for one director who has filed for personal bankruptcy and with respect to whom the FDIC’s action as been stayed) moved to dismiss, arguing that Florida law allows recovery for bank directors only for gross negligence and therefore the claim against them for ordinary negligence should be dismissed; and also arguing that the FDIC’s allegations in the claim against them for gross negligence failed to rise to the level of gross negligence.

 

In his August 8 order, Judge Presnell granted the director defendants motion to dismiss the FDIC’s claim for ordinary negligence. He found first that Florida Statutes Section 607.830(1) imposes an ordinary standard of care on directors. However, the liability of directors is governed by Section 607.831, which provides that directors can be held liable only of one of five conditions were met. Judge Presnelll found that the only section that “conceivably “could apply is the provision requiring in order to impose liability on directors a showing that the directors’ failure constituted “conscious disregard for the best interests of the corporation or willful negligence.”

 

Judge Presnell found that the statute “conditions directorial liability on something beyond ordinary neglilgence,” and so the count in the FDIC complaint asserting a claim for ordinary negligence “must therefore be dismissed.”

 

Judge Presnell denied the directors’ motion to have the FDIC’s claim against them for gross negligence dismissed, finding that the FDIC’s allegations “are sufficient at this stage of the proceedings to state a claim for gross negligence.”

 

Even though Florida has had the second highest number of bank failures of any of the states during the current bank failure wave (trailing only Georgia), the FDIC has so far only filed this one failed bank lawsuit in Florida. There undoubtedly are other lawsuits involving other failed Florida banks yet to come. To the extent the FDIC does filed further actions in Florida and to the extent those other action involve former directors of the failed banks, the directors defendant will argue in reliance on this case that they cannot be held liable under Florida law for ordinary negligence.

 

Judge Presnell’s decision pertains only to the director defendants, and the statutes on which he relied in reaching this decision relate only to the liabilities of directors. Accordingly his decision doesn’t reach the question  whether officers (as opposed to directors) may also argue that they can only be held liable for gross negligence., or whether officers otherwise have other protections from liability for ordinary negligence.

 

Special thanks to a loyal reader for sending me a copy of Judge Presnell’s decision.

 

According to papers filed in the Southern District of New York on August 3, 2012, the parties to the Tronox securities litigation have agreed to settle the case for a total of $37 million. As I noted at the time that this suit was first filed back in July 2009 (here), the case, which alleged that the defendants had misrepresented Tronox’s environmental liabilities when the company was spun out of Kerr-McGee and thereafter, involved a host of recurring and interesting issues.

 

A copy of the parties’ stipulation of settlement can be found here. The settlement agreement is subject to court approval.

 

As discussed in greater detail here, the action was filed on behalf of those who purchased certain securities  of Tronox, Inc. between November 25, 2005 and January 12, 2009. The plaintiffs named as defendants certain former directors and officers of Tronox, as well as Kerr-McGee Corporation, Andarko Petroleum Corporation and certain Kerr-McGee executives.

 

As reflected in the their amended consolidated complaint (here), the plaintiffs alleged that Tronox’s IPO was a “scheme orchestrated by Defendant Kerr-McGee to foist the vast majority of its enormous environmental remediation and related tort liabilities, accumulated over decades, onto Tronox, so that Kerr-McGee could thereafter present itself for sale.” The plan, which allegedly involved spinning Tronox out as a separate company in an initial public offering, “reaped massive and almost immediate benefits when, on August 10, 2006, Defendant Anadarko acquired Kerr-McGee for $18 billion in cash and assumption of debt purportedly free and clear of any obligation for what had become, as of that date, Tronox’s environmental remediation and tort liabilities.”

 

The plaintiffs’ case survived, in whole or in part, multiple motions to dismiss, and following mediation, the parties agree to settle the lawsuit. As reflected in the parties’ stipulation of settlement, the $37 settlement consists of the following: Anadarko, Kerr-McGee and the Kerr-McGee director and officer defendants “shall pay, or shall cause their insurance carriers to pay $21,000,000”; the former Tronox individual director and officer defendants “shall cause their insurance carriers to pay $14,000,000”; and Tronox’s auditor, Ernst & Young, “shall pay $2,000,000.”

 

As I noted at the time the case was first filed, one of the interesting things about this case is that it presents the clear example of a securities claim based upon disclosures relating to environmental liabilities. The possibility of this kind of claim is often a key concern at the time of D&O insurance policy placement, as the question often arises whether the standard policy’s pollution exclusion will preclude coverage for a securities claim based on environmentally-related disclosures. As this case demonstrates, it is critically important for the standard pollution exclusion to be revised to carve back coverage for securities claims and derivative claims based on environmental disclosures. (It is probably worth noting that many of the modern Excess Side A DIC insurance policies often have no environmental or pollution exclusion, which could well have been relevant here, given that by the time these suits were filed, Tronox was in bankruptcy.).

 

Another interesting thing about this case is that it involved three corporate entity defendants (Tronox, Kerr-McGee, and Anadarko), but the securities of only one of the three, Tronox. The issue here has to do with the definition of the term Securities Claim in the standard D&O policy. In many policies, the term is defined to refer to any claim based upon the purchase or sale of the securities of the Insured Entity itself. The question here would be whether or not a claim involving the purchase or sale of Tronox’s securities would constitute a “securities claim” under the Kerr-McGee’s and Anadarko’s policies. Of course, the individual Kerr-McGee directors and officers would be entitled to coverage whether or not the lawsuit represented a “securities claim” within the meaning of the term; this question has to do with whether or not there would be coverage under the policies for the entities themselves.

 

In the end, it appears that the portion of the settlement pertaining to the liabilities of the former Tronox director and officer defendants is to be covered by insurance, and the portion relating to the liabilities of the Kerr-McGee director and officer defendants, as well as Kerr-McGee and Anadarko themselves, would be funded in whole or in part by insurance. This outcome suggests that in the course of negotiations these issues, if actually involved in this case, were worked out or compromised in the course of the settlement negotiations.

 

As I previously observed, the allegations in the underlying complaints are noteworthy because they represent specific examples of what I have previously identified (most recently here) as the growing disclosure risks public companies face regarding their environmental liabilities. Although more recently I have emphasized the growing risks surrounding climate change related issues, as this case demonstrates, the disclosure risks also include the risks associated with more conventional environmental liability exposures. The case also underscores the importance of addressing at the time of policy placement the possibility of securities claims arising based on environmental disclosures.

 

On August 1, 2011, in a 2-1 decision characterized by a testy but interesting exchange between the majority and the dissent, the Sixth Circuit held that a fidelity policy provided coverage for nearly one million dollars a bank employee stole from client brokerage accounts. For those who (like me) are not regularly involved in fidelity claims, the two opinions provide an interesting opportunity to consider the purpose and operation of fidelity coverage and how it relates to general liability policies. The Sixth Circuit’s decision can be found here.

 

Background

First Defiance Financial Corporation is a bank holding company. Jeffrey Hunt was a “dual employee” for First Defiance, providing investment advisory services to First Defiance customers and also trading securities for Online Brokerage Services. The clients’ assets were held in individual accounts at a third institution, National Financial Services. These client accounts were accessible only by First Defiance’s investment advisors, which acted as the “exclusive agent” on the clients’ behalf.

 

In April 2007, First Defiance learned that Hunt had transferred a total of about $859,000 from nineteen client accounts to his own bank account. First Defiance ultimately repaid the clients for their losses, including lost interest and unrealized client income. The total amount of First Defiance paid to the customers was about $930,000.

 

First Defiance provided a proof of loss to its fidelity insurer for the amount of its payment to the clients. The fidelity policy provides insurance against “[l]oss resulting directly from dishonest or fraudulent acts committed by an Employee, acting alone or in collusions with others.” In its Covered Property provision, the policy specifies that the policy covers “loss of Property (1) owned by the Insured, (2) held by the Insured in any capacity, or (3) owned and held by someone else under circumstances which make the Insured responsible for the Property prior to the occurrence of the loss.” 

 

The fidelity insurer denied First Defiance’s claim for the loss, and First Defiance initiated a coverage lawsuit against the fidelity insurer. The district court entered summary judgment for First Defiance, holding that First Defiance’s loss was covered under the policy. The fidelity insurer appealed the coverage ruling. The parties also cross-appealed the district court’s calculation of the amount that the fidelity insurer owed. I do not discuss in this post the issues relating to the calculation of the insurer’s obligations.

 

The August 1 Opinions

In a majority opinion written by Judge Jeffrey Sutton for a divided Court, the Sixth Circuit affirmed the district court, holding that the fidelity policy covers First Defiance’s losses. Judge Deborah Cook dissented, writing a separate opinion that is well worth reading.

 

The crux of the majority’s opinion is its conclusion that the money in the client brokerage accounts represented Covered Property within the meaning of the fidelity policy. In reaching this conclusion, the majority determined that money in the brokerage accounts was “held under circumstances that made the insured responsible for the property” and that that responsibility arose “prior to the occurrence of the loss.”

 

The fidelity insurer had argued that First Defiance’s responsibility did not arise prior to the loss, and that First Defiance could have incurred liability only after Hunt stole the money, giving rise at most to a potential tort claim against the bank.

 

The majority rejected this argument, concluding that the definition refers to “responsibility” before the loss, not to liability, and that “the fiduciary relationship” between First Defiance and its clients “pre-dates the theft” making First Defiance “responsible for transactions undertaken with a client’s money from the moment the fiduciary relationship was formed.” The majority added that the bank’s responsibility “need not be established by a tort verdict, which necessarily cannot happen before the theft; it can be established by the terms of the account between the bank and the client and the fiduciary duties that spring from them.”

 

In her dissenting opinion that relies on policy drafting history and the purposes of the relevant language in the fidelity policy, Judge Cook characterizes the majority opinion’s policy interpretation as “simplistic.” Judge Cook asserts that “neither the policy language nor the history of fidelity coverage supports the majority’s view that the customer accounts constituted First Defiance’s ‘Covered Property.’”

 

Judge Cook focused specifically on the language in the definition of Covered Property requiring that the employer’s responsibility must vest “prior to the occurrence of the loss.” Judge Cook reviewed how this language had been added to the policy form to clarify that “a fidelity bond, unlike a general liability policy, provides no coverage for an employer’s vicarious liability for employee torts.” The provision, Judge Cook said, adds a “temporal element” requiring that “the insured’s responsibility for the stolen property must arise prior to the loss, not by virtue of vicarious liability.” First Defiance could have but did not assume responsibility for the risk of theft prior to loss “by placing [a] guarantee in its investment agreements with its customers.”

 

In an irritable response to the dissent, the majority opinion reiterates that First Defiance was “responsible” for money in the customer accounts at the time the accounts were opened, “long before –prior to—the loss of some money in those accounts cause by Hunt’s theft.” The majority opinion emphasizes that the policy does not require that the insured entity’s contract expressly state that insured entity undertakes responsibility for theft from customer accounts, but instead the policy requires only that “the ‘circumstances’ of the relationship must make the insured ‘responsible for the money before the theft.” In a dismissive characterization of the dissent’s position on this issue, the majority opinion adds the concluding comment that this question has been “Asked and answered.”

 

Discussion

The critical issue here is the question of when First Defiance became responsible for the theft. Was it responsible for the theft from the moment the client accounts were created, or was it responsible only after the theft had taken place, on the basis of vicarious liability?

 

The question matters, because the answer to the question determines whether or not this loss properly belongs under a first-party policy like the fidelity policy at issue here, or more properly belongs under a third-party liability policy like a general liability policy.

 

Without presuming to suggest the right answer to this question, I will say that I found the dissenting opinion’s review of the history of the relevant language in the fidelity policy to be instructive. At least based on the sources referenced in the dissenting opinion, it seems that the language at issue here was added to the policy in order to clarify that the fidelity policy, unlike a general liability policy, provides no coverage for an employer’s vicarious liability for employee torts.

 

However, that observation does not alone answer the question of when the bank became responsible for the employee theft. On the one hand, I tend to agree that to agree with the majority’s common sense reasoning that the customer would certainly assume that the bank would be responsible for an employee theft from the customer’s account, and I also agree with the majority that as a practical matter its highly unlikely that there would be a written expression of this assumption in the bank’s agreement with the customer.

 

On the other hand, I tend to agree with the dissent that the expectation that the bank would be responsible for the employee’s theft simply reflects a general assumption that an employer is responsible for employee misconduct. If, for example, First Defiance had not voluntarily reimbursed the customers for their loss as a result of the theft and the customers had been forced to sue the bank, the customers would have, one way or the other, based their claims against the bank on some version of vicarious liability.

 

Framing the question in terms of that hypothetical lawsuit also seems to suggest that – even though the bank voluntarily made the customers whole – the payment to the customers was  as a result of a third party liability claim.

 

All of that said, I would have a hard time subscribing to the dissent’s view of this case if the end result was that there was no insurance at all for this loss. I would be more comfortable altogether with the dissent’s position if I were sure that if the loss were not covered under the fidelity policy, it would be picked up under another policy. I would not be comfortable at all with the dissent’s position if it would result in the loss falling into a crease between policies. In particular, I would want to know whether or not the typical general liability policy would have in fact picked up this loss.  Of particular concern is the possibility that a liability policy might preclude this loss because it was the result of an intentional act.

 

It would seem that, in a world in which there is little certainty, the safe thing for an insured organization to do in a situation like this is to submit a claim under both the fidelity and liability policies.

 

I am very interested to know the thoughts and reactions of readers who work more frequently with fidelity policies. I would like to know what others think of the majority’s position on these issues and also the dissenting opinion as well. I am also curious to know about what readers may think about the possibility that the possible coverage for this claim under a general liability policy. I encourage readers to post their comments to this post using the comment feature in the right hand column.

 

For those readers interested in a good quick introduction to fidelity coverage I recommend the Much Shelist law firm’s November 1, 2011 memo entitled “The ABCs of Fidelity Bonds: What Policyholders Need to Know” (here).

 

SEC, The Jury Has a Message for You: Many readers many be aware that on July 31, 2012, a civil jury in federal court in Manhattan acquitted Citigroup employee Brian Stoker on allegations that he had misled investors in connection with $1 billion of collateralized debt obligations. In a highly unorthodox accompaniment to the verdict form, the jury included a message to the SEC that “"This verdict should not deter the SEC from continuing to investigate the financial industry, to review current regulations, and modify existing regulations as necessary." 

 

In his August 3, 2012 New York Times article entitled “Jury Gets Encouragement from Jury That Ruled Against It” (here), Peter Lattman reports, based on his interview of one of the jurors, how the note came about. As Lattman points out, the note seems to reflect common discontent that persons in the financial industry who were responsible for the excesses that contributed to the credit crisis have not been brought to account. As Alison Frankel notes in an August 2, 2012 post on her On the Case blog (here), for the SEC, the jury’s note “has to read like one more reminder that the public is still waiting for corporate accountability.”

 

In her August 1, 2012 Summary Judgment column on the Am Law Litigation Daily (here), Susan Beck has an interview with the foreman of the jury that heard Stoker’s case. From the foreman’s comments, it seems clear that the jury thought that while there was wrongdoing it was more in the form of collective wrongdoing of the company itself rather than that of one lower level individual. Beck quotes the foreman as saying that  "He did not act in some kind of vacuum where his behavior was not tolerated or encouraged by his bosses. . .To try to hang all this on Stoker didn’t work."

 

Frankel’s column has an interesting analysis of how the acquittal in the SEC’s case against Stoker may affect the long running saga of the SEC’s settlement of its enforcement action against Citigroup in connection with the CDO transaction. As noted here, Judge Jed Rakoff has rejected the settlement and refused to stay the case. More recently, the Second Circuit stayed the case pending an appeal of Rakoff’s rejection of the settlement, in an opinion that strongly suggested that Rakoff was wrong on the merits. Frankel suggests, among other things, that in the upcoming appellate arguments, the SEC may rely on the acquittal to show that the agency was wise to settle its case with Citigroup rather than test evidence that might not have withstood muster. On the other hand, the special counsel representing Judge Rakoff in the appeal may be able to argue (perhaps in reliance on the jurors’ comments in press reports) that the jury verdict actually reflected the jurors’ belief that there was misconduct among higher ups at Citigroup, and so Rakoff was right to reject the settlement.

 

There definitely is something about this case where every single thing that happens is interesting and worthy of commentary. It will in any event be interesting to see how the appeal regarding the erstwhile settlement unfolds. The appellate case is due to be argued in late September.

 

The Unintended Consequences of the JOBS Act: When Congress passed the Jumpstart our Businesses Startups (JOBS) Act earlier this year (about which refer here), it was hoped that the legislation would encourage “Emerging Growth Companies” and facilitate job creation. However, as discussed in Jason Zweig’s August 4, 2012 Wall Street Journal article entitled “When Laws Twist Markets” (here), things are playing out a little different than expected. As Zweig puts it “No matter how Congress monkeys with the laws, one always remains in force: the law of unintended consequences.”

 

By way of illustration, Zweig cites as an example of one company trying to take advantage of the JOBS Act’s streamlined IPO procedures and reduced reporting requirements the 132 year-old British football club, Manchester United, which hopes to launch its $300 million IPO next week. Zweig also refers to “blind pools” and “blank check” investment funds that are angling to take advantage of the JOBS Act’s provisions. Neither type of company is likely to contribute to job creation in the United States. Zweig also reports that at least seven Chinese companies are converting to JOBS Act reporting provisions, in order to be able to reduce the disclosures they are required to file; as Zweig points out, this is “no trivial matter since several other Chinese-based companies have recently been accused by U.S. regulators of filing misleading financial statements.”

 

As I have previously noted (here), a company’s status as an “Emerging Growth Company” arguably is for some companies itself a risk factor of which the company’s investors should be warned, particularly those companies taking advantage of the JOBS Act’s relaxed reporting requirements.

 

It should be noted that none of the comments above about the JOBS Act have anything to do with what may be the Act’s most distinctive feature, its allowance for online “Crowdfunding.” As I discussed here, the Act’s crowdfunding provisions were intended to facilitate fundraising for start-ups, but for many reasons, “crowdfunding is unlikely to be an attractive alternative for start-up companies.”

 

So far at least, it would seem the JOBS Act has produced only unintended consequences.

 

My New All-Time Favorite Headline: The headline for the lead article in the August 4, 2012 Detroit Free Press, regarding legal controversy surrounding Michigan’s emergency management law for financially troubled municipalities, reads simply “CHAOS” in four-inch high letters. (An online version of the article, sans the headline under which the story appeared in the print edition, can be found here.)

 

Given the financial condition of many of Michigan’s municipalities, and indeed given the ongoing developments around the world, the Free Press might well consider using that same headline every day. And newspapers everywhere else, too.

 

And Finally: I am an enthusiastic (if intermittent) fan of European football, particularly English Premier League football. Owing to this interest, I downloaded onto my iPad the Fan Chants app, which has recordings and lyrics of soccer fan chants from around the world. Some of the chants are rude and even profane, but overall the chants are highly entertaining. They can also be highly addictive; for example, since writing the paragraph above referring to Manchester United, I have been sitting here silently chanting to myself “Oh Man-ches-ter (Oh Man-ches-ter) is won-der-ful (is won-der-ful)…”

 

In contemplation of all of this, it somehow seemed appropriate to share this video clip of Sheffield United fans singing the “Greasy Chip Butty Song.” (A Chip Butty apparently is a sandwich consisting of French fries on buttered bread.) Here are the lyrics for those who can’t make out the words in the video:

 

You Fill Up My Senses,

Like A Gallon Of Magnet,

Like A Packet Of Woodbines,

Like A Good Pinch Of Snuff,

Like A Night Out In Sheffield,

Like A Greasy Chip Butty,

Like Sheffield United,

Come Fill Me Again,

Na Na Na Na Na…OOOOHH! 

 

In a July 27, 2012 article entitled “In Sliding Internet Stocks, Some Hear Echo of 2000” (here), the New York Times detailed how the shares of some of the hottest publicly traded social networking and Internet companies have been hammered recently. The Times suggested that as the companies’ shares dropped “there were instant echoes of the crash of 2000, when the money stopped flowing, the dot-coms crumbled and Silicon Valley devolved into recriminations and lawsuits.”

 

Whether or not the attempt to draw parallels to the ear of the dot com crash is valid, the comparison certainly seems apt in one particular sense; all four of the companies the article mentions by name as having had their shares pummeled – Facebook, Groupon, Netflix and Zynga – have been hit with securities class action lawsuits this year.

 

The latest company to be sued is Zynga, the Internet gaming company that relies heavily on Facebook as a platform for its gaming services. Zynga went public in December 2011 and its share price recently dropped after the company issued disappointing financial results. On July 31, 2012, a securities class action lawsuit was filed against the company and certain of its directors and officers in the Northern District of California. A copy of the complaint can be found here. According to the plaintiffs’ counsel’s July 31, 2012 press release (here), the Complaint alleges that: the defendants made certain misrepresentations about the company, specifically that:

 

(a) the December 15, 2011 Registration Statement for the Company’s IPO failed to disclose that under Zynga’s agreements with Facebook, Zynga game cards could only be distributed and redeemed on Facebook until April 30, 2012, or the true extent of the current risk of Facebook policy changes on Zynga’s bookings prospects and overall financial condition; (b) Facebook, upon which the Company was heavily reliant for users and bookings, had already begun to change its platform and user policies to a degree that would negatively impact Zynga’s current and future bookings metrics and growth prospects; (c) the March 2012 acquisition of OMGPOP and “Draw Something” could not support the increased bookings and financial forecasts issued during the Class Period; and (d) in light of the facts set forth above, the Company did not have a reasonable basis for its fiscal 2012 financial forecasts issued during the Class Period.

 

The plaintiffs’ complaint also specifically refers to the company’s April 3, 2012 secondary offering in which company insiders (including the individual defendants) sold more than 18.8 million shares of their holdings in the company’s stock, at a price of $12 per share. (The company’s current share price is $2.72 per share). The complaint refers to and quotes a July 26, 2012 online article by analyst and Internet commentator Henry Blodget entitled “Zynga Insiders Who Cashed Out Before the Stock Crashed” (here).

 

The lawsuit against Zynga follows in the wake of lawsuits that were filed against the other three Social Media companies mentioned in the Times article. Netflix was first; as discussed here, Netflix and certain of its directors and officers were sued in a securities class action lawsuit in January 2012 after the company’s shares dropped following the company’s botched attempt to rejigger the way it charged its customers for its services.

 

The next up was Groupon, which, as discussed here, was hit with a securities class action lawsuit in April 2012 after the company announced that it would have to revise its previously released financial results for the fourth quarter 2011 and for the full year 2011 as well.

 

Finally, and as discussed in a prior post (here), Facebook was hit with a raft of securities class action lawsuit almost immediately following its IPO, largely due to the flawed offering process and the immediate decline in the company’s share price.

 

The lawsuits against these four companies are nothing compared to the litigation wave that followed the dot com crash, But the four suits do seem to represent their own distinct phenomenon, as company’s that were briefly darlings of the new media world of the Internet saw their fortunes quickly falter and the lawsuits quickly emerge.

 

For many years beginning in the 2007 time frame, financial services companies saw the greatest concentration of corporate and securities litigation activity, including securities class action lawsuit filings. While the financial services companies were at the center of the storm, it was pretty quiet for technology companies. As the credit crisis has receded into the past, the activity in the financial services sector has diminished (although stay tuned about the emerging Libor scandal litigations). If nothing else, these four lawsuits suggest that the relatively quiet period for technology companies might have ended.

 

In October 2011, when Southern District of New York Judge Miriam Goldman Cedarbaum dismissed the securities class action lawsuit that had been filed against China North Petroleum Holdings, Ltd, it was the first of the many cases recently filed against U.S.-listed Chinese companies to be dismissed (as discussed at length here). However, in an August 1, 2012 opinion (here), the Second Circuit vacated the dismissal and remanded the case to the district court for further proceedings.

 

The Second Circuit held that the plaintiffs may still pursue their claims even though they had bypassed the opportunity to sell their shares at a profit shortly after the alleged misrepresentations had been disclosed. In reaching this conclusion the Second Circuit rejected a line of lower court decisions that had reached a contrary conclusion on the issue of whether or not price recovery following a stock price drop negates the inference of economic loss and loss causation.

 

As detailed here, the plaintiffs first filed their action in June 2010. According to their amended complaint, during the class period, the defendants inflated the amount of the company’s proven oil reserves, overstated reported earnings inflated profits and misrepresented the company’s internal controls. An allegedly “bizarre series of events” followed the company’s February 23, 2010 announcement that it would be restating prior financials, including “revelation of illicit bank transfers” made to company officials and “a dizzying number of resignations and replacements” of top executives. Over the next few months additional details were revealed regarding the transfers, ultimately resulting in the resignation of the CEO and several members of the board. The NYSE had halted trading on the company’s shares on May 25, 2010, but when trading resumed on September 9, 2010, the company’s share price “plunged.”

 

The defendants moved to dismiss the plaintiff’s complaint on loss causation grounds, arguing that the plaintiff had several opportunities to sell its shares at a profit following the allegedly corrective disclosure at the end of the class period, and contending that had the plaintiff “chosen to sell at those post-disclosure dates, it would have turned a profit.”

 

Judge Cedarbaum agreed. Even though the plaintiff ultimately sold its shares at a loss, she concluded that “that loss cannot be imputed to any of NEP’s alleged misrepresentations,” adding that “a plaintiff who forgoes a chance to sell at a profit following a corrective disclosure cannot logically ascribe a later loss to devaluation caused by the disclosure.” Because she found that the plaintiff “has not suffered any loss attributable to the misrepresentations alleged in the complaint,” and in reliance on a line of district court cases that had reached a similar conclusion, she granted the defendants’ motion to dismiss. The plaintiff appealed.

 

In an August 1, 2012 opinion for a three-judge panel written by Judge Chester Straub, the Second Circuit vacated Judge Cedarbaum’s ruling and remanded the case to the district court. The Second Circuit rejected the reasoning of the line of cases on which Judge Cedarbaum had relied in dismissing the case, and held that the fact that the price of the stock recovered soon after the price dropped does not negate the inference of economic loss and loss causation at the pleading stage. The court said that the reasoning on which Judge Cedarbaum had relied was inconsistent with both the traditional measure of securities fraud damages and the 90 day “look back” provision in the PSLRA. The court said:

 

At this stage in the litigation, we do not know whether the price rebounds represent the market’s reactions to the disclosure of the alleged fraud or whether they represent unrelated gains. We thus do not know whether it is proper to offset the price recovery against [plaintiff’s] losses in determining [plaintiff’s] economic loss. Accordingly the recovery does not negate the inference that [plaintiff] has suffered an economic loss.

 

The Second Circuit’s ruling is obviously significant in that it establishes that a stock price rebound following a corrective disclosure does not in and of itself eliminate the possibility that the plaintiff might be able to prove an economic loss and loss causation. The plaintiff’s law firm’s August 1, 2012 press release about the Second Circuit’s ruling and its significance can be found here.

 

The Second Circuit’s ruling is also significant because it revives one of the securities suits filed against a U.S.-listed Chinese company that had been dismissed. Observers have been watching these cases closely, and counted the dismissal as one of the important early milestones in the development of these cases. It should be noted that on remand to the district court, the defendants will still have the ability to assert the many defenses they have raised in the case and which have not yet been ruled upon because of the district court’s prior dismissal on loss causation grounds. The case has a long way to go yet. Nevertheless, the Second Court’s ruling at least allows this plaintiff to live for another day.

 

As I noted at the time of Judge Cedarbaum’s ruling, because of the unusual movement of this company’s share price, the rulings on loss causation issues here are unlikely to have a significant impact on the other cases involving U.S.-listed Chinese companies. That observation remains true with respect to the Second Circuit’s ruling. However, the Second Circuit’s ruling could prove to be very significant amongst cases in general in which a defendant company’s share price rebounded following an initial price decline..

 

Under the Responsible Corporate Officer Doctrine, corporate officials can be held liable for misconduct in which they did not participate and of which they have been entirely unaware, based on their responsibility for the corporation itself. As shown in a July 27, 2012 opinion from the District of Columbia Court of Appeals (here), a misdemeanor conviction based on the Responsible Corporate Officer doctrine can not only result in criminal penalties  but can also include  “career-ending” consequences, in the form of a lengthy ban from participating in governmental programs. Although the appellate court struck down the specific disbarment at issue in the case, it upheld the government’s right to impose the ban.

 

As discussed below, this case serves as a reminder of the significant exposures corporate executives face under the Responsible Corporate Officer Doctrine.

 

Background

Purdue Frederick Company was accused of fraudulent misbranding of the painkiller OxyContin. Among other things prosecutors alleged that unnamed employees of the company marketed OxyContin as less addictive and less harmful than other painkillers. The company ultimately pled guilty to felony misbranding. Among other things, monetary sanctions of about $600 million were imposed on the company.

 

Under the Responsible Corporate Officer Doctrine, three Purdue executives – Purdue CEO Michael Friedman, general counsel Howard Udell, and medical director Paul Goldenheim—were accused of the misdemeanor of misbranding of a drug. The individuals pleaded guilty to misdemeanor misbranding, for (as the appellate court put it) “their admitted failure to prevent Purdue’s fraudulent marketing of OxyContin.” The individuals were sentenced to extensive community service, fined $5,000, and ordered to disgorge compensation totaling about $34.5 million.

 

Several months after the individuals’ conviction, the Department of Health and Human Services determined that the individuals should be excluded from participating in Federal health care programs for 20 years. During the individuals’ ensuing administrative appeals, the individuals managed to get the length of the disbarment reduced to 12 years. The 12 year disbarment ultimately was affirmed by a U.S. District Court, and the individuals appealed, arguing that the agency did not have the authority to impose the disbarment and also arguing that because the agency lacked a substantial basis for the length of the disbarment, its imposition was arbitrary and capricious and therefore invalid.

 

The July 27 Opinion

In a July 27, 2012 opinion written for a divided three-judge panel, D.C. Circuit Administrative Judge Douglas Ginsberg affirmed the agency’s authority to impose the disbarment, but agreed with the individuals that in this case the imposition of the 12-year disbarment “was arbitrary and capricious for want of a reasoned explanation for the length of their exclusions,” and the court remanded the case to the District Court for further proceedings. Chief Judge David Sentelle concurred in part and dissented in part, noting that he would have affirmed the length of the disbarment.

 

None of the three judges questioned the agency’s authority to impose disbarment. Judge Ginsberg’s opinion expressly rejected the individuals’ argument that the agency’s imposition of the disbarment for an offense lacking a mens rea element (that is, lacking a culpable state of mind) violated their constitutional rights to due process. Among other things, the individuals noted that the imposition of criminal penalties under the Responsible Corporate Officer Doctrine had been upheld in the past only because the “associated penalties commonly are relatively small, and conviction does no grave damage to an offender’s reputation.”

 

The appellate court rejected this constitutional argument, saying that “we do not think excluding an individual … on the basis of his conviction for a strict liability offense raises any significant concern with due process,” adding that “surely the Government constitutionally may refuse to deal further with senior corporate officers who could have but failed to prevent a fraud against the Government on their watch.”

 

The court did hold that the agency had failed to justify its imposition of a 12-year disbarment, noted that “we do not suggest that the appellants’ exclusion for 12 years based upon a conviction for misdemeanor misbranding might not be justifiable; we express no opinion on that question. Our concern here is that the [agency’s administrative review board] did not justify it in the decision under review.” Noting that no prior disbarment had exceeded ten years, the court concluded that the agency’s decision was “arbitrary and capricious with respect to the length of their exclusion because it failed to explain its departure from the agency’s own precedents.”

 

Discussion

If nothing else, this case serves as a reminder of the power that the Responsible Corporate Officer Doctrine gives prosecutors to pursue criminal charges against corporate officials based on the misconduct of the officials’ subordinates in which the officials were not involved and of which the officials may have been entirely unaware. And even though the appellate court reversed the “career ending” disbarment that the agency had imposed on the corporate officials here, the appellate court emphasized that there was nothing inherently wrong with the length of the disbarment; the appellate court’s reversal was strictly based on the agency’s failure to explain the length of the disbarment.

 

Indeed, the appellate court expressly affirmed the agency’s authority to impose disbarment even in the case of strict liability offense that lacked any culpable state of mind. The court seemed entirely untroubled by concerns surrounding convictions under the Responsible Corporate Officer doctrine that these convictions involve the imposition of liability without culpability in the form of a guilty state of mind. (For more about concerns with imposing liability about culpability, refer to my prior post here).

 

To be sure, in connection with their pleas of guilty to misdemeanor misbranding, the individuals had expressly admitted that they had “responsibility and authority either to prevent in the first instance or to promptly correct” the misbranding activity. Their convictions and their admissions, as well as the seriousness of the underlying misconduct, may cast this case in a different light.

 

Nevertheless, I continue to find the willingness of courts and regulatory authorities to impose criminal convictions and “career restricting” penalties on officials who had no involvement in or even awareness of the misconduct to be troubling. The court itself noted that the justification for the strict liability imposition of criminal liability based on the Responsible Corporate Officer Doctrine was premised in part on the supposition that that the penalties involved were relatively small. There is nothing small about the type of career-ending disbarment the government sought to impose here. To the contrary, this case shows that the consequences for individuals convicted under the responsible corporate officer doctrine can be significant.

 

A July 2012 memo from Eric Reed of the Fox Rothschild law firm entitled “Even Without Knowledge or Participation, Corporate Officers Can Be Criminally Liable for Subordinates’ Misdeeds” (here) points out that this case “stands as a reminder” of several concerns about the Responsible Officer Doctrine, including that “ignorance of misconduct by subordinates is not always a defense for corporate officers.” This case also shows that “when violations occur, resolving regulatory or criminal charges may not conclude all liabilities for a particular occurrence” and in parallel administrative or agency proceedings “facts admitted or proved in an initial proceeding may bind in the later matters.”

 

One of the bedrock principles of our criminal justice system is that a prerequisite of liability should be a finding of culpability. Even if, as courts now seem comfortable in assuming, there are circumstances where the kind of strict liability imposed under the Responsible Corporate Officer Doctrine is appropriate, that type of liability should be rare and imposed sparingly. My concern, as I have noted elsewhere, is that the imposition of this type of liability is becoming increasingly common and is imposed far too often. As this case shows, the consequences for individuals on whom this type of liability is imposed can not only be substantial, but it can be career-ending. This deeply troublesome trend deserves far greater attention, and the constitutional concerns raised here deserve much closer consideration than they were given by this court.

 

Susan Beck’s July 30, 2012 article on the Am Law Litigation Daily about the D.C. Circuit’s opinion can be found here.

 

Goldman Sachs Settles Mortgage-Pass Through Securities Suit: The parties to the Goldman Sachs/ GS Mortgage Pass Through Certificates securities suit have reached an agreement to settle the case for $26.6125 million. The settlement is subject to court approval. In addition, as reflected on the parties’ July 31, 2012 motion for preliminary court approval of the settlement (here), the settlement is subject to a $1.3125 reduction if Stichting APB (which filed a separate action relating to the mortgage-pass through certificates) elects not to participate in the class settlement. The settlement fund is inclusive of $5.3 million for attorneys’ fees and expenses. The parties’ stipulation of settlement can be found here.

 

As noted in detail here, the case had in January 2011 survived in principal part the defendants’ motion to dismiss. The court had subsequently certified a plaintiff class. The defendants had sought leave to appeal the class certification to the Second Circuit. The defendants’ petition to the Second Circuit, which remained pending at the time the settlement was reached, has now been stayed pending approval of the settlement.

 

Alison Frankel has an interesting August 1, 2012 post on her On The Case blog about the GS Mortgage Pass-Through Certificates Settlement, in which she asks, among other things, whether the MBS cases are turning out to be a "bust" for the plaintiffs’ lawyers. As always, Frankel has interesting thoughts and observations on the topic. Her post can be found here. I should add that if your not reading all of Alison’s posts every single day,  you are making a very serious mistake.

 

I have in any event added the Goldman mortgage pass-through certificate settlement to my list of subprime and credit crisis-related case resolutions, which can be accessed here.

 

Corrected Link: Yesterday, I wrote about the latest antitrust lawsuit to be filed in the wake of the emerging Libor scandal. Unfortunately, it appears that the link I originally put up on the site to the new case complaint was faulty. I have corrected the link. Readers who may have wanted to see the complaint but were unable to do so owing to the faulty link can see the complaint here. I apologize for the faulty link as well as any confusion the faulty link may have caused.

 

At the risk of sounding repetitive, I must report here that there has been yet another Libor-scandal related lawsuit filed in the Southern District of New York. The latest lawsuit, filed on July 30, 2012, purports to be filed on behalf of a class of investors who bought U.S. dollar Libor-based derivatives beginning August 1, 2007. A copy of the complaint in this latest action can be found here.

 

The lawsuit was filed by 33-35 Green Pond Road Associates, LLC, which bought an interest rate swap with a floating interest rate tied to the U.S. dollar Libor benchmark rate. The plaintiffs’ complaint names as defendants the 16 banks that were members of the U.S dollar Libor panel during the class period.

 

The purported class on whose behalf the action was filed is a detailed construction; the complaint purports to be filed on behalf of all persons or entities “who purchased U.S. dollar LIBOR-Based Derivatives” in the United States from one of 25 non-Defendant commercial banks and insurance companies “based directly on the rates set by Defendants, from at least as early as August 1, 2007 through such time as the effects of the Defendants’ illegal conduct ceased.” The 25 non-Defendant banks and insurance companies include such banks and insurance companies as Wells Fargo, Met Life, Goldman Sachs, Morgan Stanley, Keycorp and Northern Trust, among others.

 

The complaint asserts a single count for damages based on alleged violations of the Sherman Anti-Trust Act. The complaint alleges an unlawful conspiracy to manipulate and suppress the U.S. dollar Libor benchmark rate. The complaint further alleges that by manipulating Libor, the defendants paid lower returns to customers who bought Libor based derivatives. The complaint alleges that the manipulation of Libor affected purchasers of all Libor-based derivatives, whether or not the purchaser purchased from a defendant bank or a non-defendant bank.

 

This lawsuit is the latest purported class action to allege that the U.S. Dollar Libor benchmark rate setting banks illegally colluded to manipulate Libor, injuring investors in securities cased on the benchmark rate. As detailed at length here, a consolidated antitrust class action is now pending before Southern District of New York Judge Naomi Buchwald. There have now been multiple complaints filed raising similar allegations, and I am sure I will not be the only one to note a very striking similarity between the factual allegations in this latest complaint and the earlier complaint.

 

This latest complaint would appear to be an example of what Alison Frankel, in a July 30, 2012 post on her On the Case blog (here), called the “brawl” developing among plaintiffs’ law firms as they jockey to try to get a piece of the Libor-scandal litigation action.

 

The latest suits, including the one identified above, seem to suggest that the later arriving plaintiffs’ firms are now trying a two-pronged approach to try to claim their a piece of the Libor-scandal action. These firms seem to be trying to identify a specific identifiable group within the larger collection of persons aggrieved by the Libor manipulation on whose behalf to try to assert claims; and the firms also appear to be trying to identify distinct legal theories on which to proceed. This latest case represents an example of the former type of initiative, as it purports to be filed on behalf of investors who bought Libor-rate derivative rom a specified group of non-defendant banks and insurance companies.  The new lawsuit about which I wrote yesterday, in which the plaintiff asserted only common law claims but no antitrust claims, is an example of the latter category.

 

From the perspective an outsider (and one to who antitrust litigation is relatively unfamiliar turf), it seems curious that the plaintiffs in this case would expressly define their class to limit it to those derivative purchasers who bought their securities from non-defendant banks. At least based on initial impressions, this approach would seem to invite a defense motion based on the Illinois Brick doctrine, which holds that indirect purchasers cannot assert claims for damages under the antitrust laws. I will be the first to concede, especially since the plaintiff’s approach seems quite calculated, that there may be a method to the plaintiff’s approach that I am simply not registering. (On the other hand, the carefully crafted class description may simply represent an effort to carve out a class distinct from classes identified in previously filed Libor-scandal related antitrust complaints.)

 

There undoubtedly will be many more lawsuits to come. Indeed, the story surrounding the Libor-scandal is still only just emerging. The July 31, 2012 Wall Street Journal carried a lead article entitled “RBS Braces Itself for a Libor Deal” (here), about how RBS is readying itself to get its moment in the spotlight as it attempts to negotiate resolutions of the pending regulatory and enforcement actions pending against the company in connection with the Libor-scandal. Among other things, the article speculates that public outcry in response to the anticipated regulatory and investigative settlements could cost RBS CEO Stephen Hester his job.

 

The Journal article does not go on to speculate on the extent to which any regulatory settlement might be followed by civil litigation. The bank is already the target of many of the pending lawsuits (including for example, the new lawsuit described above) and the possibility of further litigation following a resolution of the regulatory actions seems likely. RBS is of course only one of many banks in line for this same likely sequence of events. There undoubtedly will be more to come over the months ahead.

 

My prior overview on the Libor scandal and related litigation can be found here.

 

In the latest lawsuit to arise from the rapidly evolving Libor scandal, a New York bank has filed a purported class action in the Southern District of New York, seeking to recover damages from the U.S. Dollar Libor rate setting banks for fraud. The complaint, which was filed July 25, 2012 and which can be found here, purports to be filed on behalf of all New York based lending institutions.

 

The plaintiff in this latest suit is Berkshire Bank, which, according to the Wall Street Journal’s July 30. 2012 article about the new lawsuit (here), has eleven branches in New York and New Jersey and about $881 in assets. The bank’s complaint purports to be filed on behalf of a class of “all banks, savings & loan institutions, and credit unions headquartered in the State of New York, or with the majority of their operations in the State of New York, that originated loans, purchased whole loans, or purchased interests in loans with interest rated tied to Libor, which rates adjusted at any time between August 1, 2007 and May 31, 2010.”

 

The defendants in the lawsuit include the 16 banks on the panel that set the U.S. dollar London interbank offered rate (Libor) between August 2007 and May 2012. (There are actually 21 named defendants, as multiple related corporate entities have been named as defendants for certain of the Libor setting banks.)

 

The complaint alleges that the plaintiff banks “suffered damages as a result of Defendants’ fraudulent conduct in artificially decreasing the USD LIBOR rate during the Class Period, causing them to receive lower interest than they would have been entitled but for the Defendants’ fraud.” The specific harm the plaintiff alleges is that the reduction of Libor brought about by the defendants’ alleged manipulation of Libor reduced the amount of interest the plaintiff banks could earn on their outstanding loans. The complaint asserts substantive claims for fraud and for unjust enrichment/disgorgement.

 

This latest suit is an interesting variation on the Libor-scandal litigation theme. Unlike many of the other lawsuits filed so far (including a prior antitrust class action purportedly filed on behalf of all community banks), this latest lawsuit does not allege claims under the federal antitrust laws. The absence of this allegation may relieve the plaintiffs of the challenging burden of showing that the defendants acted collectively in setting the rates. The plaintiffs’ assertion only of common law claims may also avoid certain antitrust claim defenses, such as those available under the Illinois Brick doctrine (which prohibits indirect purchasers from asserting antitrust claims).

 

On the other hand, in order to prevail on their fraud claims, the plaintiffs will have to meet the state of mind requirement — that the defendants acted intentionally. Another concern may be the location of the alleged fraudulent conduct and whether there is a sufficient basis for the assertion of fraud claims in the U.S. And in addition, the plaintiff banks in this case cannot avoid the difficult damages proof problems that will face all claimants in these Libor-scandal cases; that is, the suppressed Libor rates may have helped and hurt the plaintiff banks in different ways and at different times, depending on the specific interest-rate related activities in which the banks were engaged.

 

Evan Weinberger has an July 27, 2012 Law 360 article entitled “Libor’s Complex Web May Limit Rate-Rigging Damages Claims” detail the proof problems associated prospective claimants Libor-scandal related damages claims, here (registration required).

 

 

The purported plaintiff class also seems somewhat heterogeneous. The different depositary institutions may or may not have used Libor-sensitive rates in its lending activities during the class period, or may have used it in different ways. The inclusion of not only banks but S&Ls and credit unions also diversifies the class in potentially complicating ways.

 

Nevertheless, this latest lawsuit represents an unwelcome development for the banks ensnared in the Libor scandal. The case itself represents a new litigation approach based on a new theory of recovery, and it raises the specter that the various rate setting banks could face a multitude of similar lawsuits filed on behalf of depositary institutions in the other states.

 

The other thing about this latest case is that it shows that the potential claimants and their attorneys are now and will continue to be casting about for alternative ways to try to recover damages connected to the Libor scandal. There undoubtedly will be many more lawsuits asserting a variety of purported claims, one of the many possibilities suggesting that the litigation related to this scandal could be a huge burden for the Libor-setting banks.

 

Alison Frankel has an interesting Juy 30, 2012 post on her On the Case blog (here) in which she considers whether this last lawsuit represents a developing "brawl" among the plainiffs’ lawyers to represent members of the class of persons harmed by the Libor scandal.

 

Very special thanks to a loyal reader for sending me a copy of the complaint.

 

My recent overview of the Libor scandal and of the scandal-related litigation can be found here.