Former CFO’s Dismissal Motion Denied in Longtop Financial Securities Suit: Longtop Financial Technologies may be unique among U.S.-listed Chinese companies that have been caught up in the wave of accounting scandals and related securities litigation. Unlike many of the others, Longtop did not obtain its U.S.-listing by way of a reverse merger, but instead, in order to obtain its NYSE listing, it went through the full IPO process. Nevertheless, as discussed here, its share price collapsed in April and May 2011 following online research reports critical of the company’s accounting practices.

 

As detailed here, securities litigation against the company and certain of its directors and officers followed. One of the individual defendants, Derek Palaschuk, the company’s former CFO, moved to dismiss.  As detailed in Jan Wolfe’s July 2, 2012 Am Law Litigation Daily article (here), Palaschuk’s motion has now been denied. In a June 29, 2012 opinion (here), Southern District of New York Judge Shira Sheindlin, acknowledging that the online research reports may well have been biased owing to the online analysts’ financial interests as short sellers of Longtop’s stock, nonetheless rejected Palaschuk’s motion.

 

The motion involved only the CFO and not the company itself, owing to the fact that the company, though it has been served, has not yet entered an appearance in the case. As Wolfe put it in the Litigation Daily post, after reading Scheindlin’s opinion, “we can understand why Longtop might be avoiding U.S. courts.”

 

Corporate Directors in the Hot Seat: As research by Stanford Law Professor Michael Klausner and others has found, outside corporate directors are only rarely directly held personally liable for their actions as corporate directors. Nevertheless, directors are increasingly “in the thick of it,” according to an interesting article by Philippa Masters entitled “Corporate Directors on the Firing Line” (here) in the latest issue of Corporate Counsel, dated July 9, 2012.

 

The article opens with an interesting discussion of the recent events that have swamped the beleaguered board at Yahoo (whose members were memorably described by departing Yahoo CEO Carol Bartz as “doofuses”). The article describes how shareholder activists and others are increasingly seeking to hold directors accountable for problems at their companies. As a result of these recent developments, there has been an upsurge in litigation involving corporate directors – for example, in the form of “say-on-pay” litigation and M&A-related litigation, as well as in FDIC failed bank litigation. The article also notes the increased use of such theories as the responsible corporate officer doctrine, to try to hold corporate officials liable.

 

The article is a little longer than the usual online fare, but I recommend taking a few minutes to read the entire piece. It is wide-ranging and interesting.

 

Questioning the Theory of Shareholder Value Maximization: One of the currently accepted tenets of corporate oversight is that companies should be managed to best maximize shareholder value. An interesting June 26, 2012 post on the Dealbook blog (here) takes a look at a recent book by Cornell Law School professor Lynn A. Stout, in which the professor questions the shareholder value “myth.” According to Stout, the misleading shareholder valuation theory is the product of misguided analysis from economists and business professors that has been propagated by the “corporate governance do-gooder movement,” as a result of which short term investors like hedge funds have manipulated companies into delivering short-term stock price driven results at the cost of companies’ long run interests.

 

Stout contends that based on a proper reading of the law, corporate officials are empowered to take a broader range of considerations into account. They might, for example consider the interests of their customers and their employees and may even consider social responsibility. Stout calls for a return to “managerialism,” where executives and directors can run companies without being preoccupied with shareholder value. It is, she contends, in the long run interest of all constituencies that companies move away from short-term strategies and toward consideration of longer range issues.

 

Evergreen Fund Suprime-Related Securities Litigation Settled: The parties to the subprime-related Evergreen Ultra Short Opportunities Fund Securities have settled the case. According to the parties’ June 29, 2012 stipulation of settlement (here), the parties have agreed to settle the case for a payment of $25 million. The settlement is subject to court approval.

 

As described in greater detail here, investors first sued the fund, affiliated entities and certain individuals associated with the fund, in a securities class action lawsuit in June 2008. The plaintiffs alleged that, contrary to its marketing materials, the fund was not managed to preserve capital and avoid principal fluctuations, but rather was composed of illiquid, risky, speculative and volatile securities, particularly mortgage-backed securities. The fund ultimately liquidated at a substantial loss to investors. On March 31, 2010, the court entered an order granting in part and denying in part the defendants’ motion to dismiss.

 

The settlement stipulation does not reveal whether any portion of the $25 million settlement is to be funded with insurance. I have in any event added the Evergreen Fund settlement to my running tally of subprime and credit crisis-related case resolutions, which can be accessed here.

 

Evolutionary Biology and the Dynamics of Law Firm Management: Readers of The New Yorker magazine will recall an article that appeared in the magazine in March 2012 discussing the writings and research of evolutionary biologist Edward O. Wilson and the theory of altruistic behavior among animals. An amusing June 28, 2012 post on the Adam Smith, Esq. blog (here) takes a look at the biological theories of altruistic and individualistic behaviors to suggest that law firms that develop altruistic group behaviors are more likely to survive and thrive than are firms that built upon aggressive individualism.

 

Special thanks to loyal reader Matt Rossman for the link to the Adam Smith, Esq. blog post as well as the article above about Professor Stout’s study of shareholder value.

 

In a June 29, 2012 opinion (here), the Seventh Circuit, applying Illinois law, held that when the defendants in a lawsuit include both persons who are insureds under the defendant company’s D&O policy and persons are not insureds, the policy’s Insured vs. Insured exclusion does not preclude coverage for the entire lawsuit, but only the portion attributable to the claims brought by the non-insured person defendants. The extent of coverage available when the defendants include both insured persons and non-insureds is to be determined by the policy’s allocation provisions.

 

Background

The underlying claim (referred to as the “Miller action”) involves a lawsuit brought by five individuals against Strategic Capital Bancorp, Inc. (SCBI) and two of its officers. In their suit, the plaintiffs asserted claims for fraud, civil conspiracy for alleged violations of the Illinois Consumer Fraud and Deceptive Business Practices Act. Three of the plaintiffs in the Miller action are former SCBI directors and therefore qualify as “Insureds” under the SCBI D&O policy. The other two Miller action plaintiffs are not Insureds under the policy.

 

The SCBI D&O policy includes an exclusion (of a type found in most D&O policies, and usually referred to as an “Insured vs. Insured” exclusion) precluding coverage for “Loss on account of any Claim made against any Insured: …brought or maintained by or on behalf of any Insured or Company in any capacity.” The Policy also contained an allocation provision, specifying that when loss from a Claim incudes both “covered and uncovered matters” the amount “shall be allocated” between covered Loss and uncovered loss based upon the relative legal exposures of the parties to the covered and uncovered matters.”

 

SCBI submitted the Miller action as a claim under its D&O policy. The carrier denied coverage for the claim in reliance on the Insured vs. Insured exclusion. Coverage litigation ensued. The District Court ruled in favor of the carrier, holding that the “plain language” of the exclusion precludes coverage for civil proceedings “brought or maintained by any Insured.” SCBI appealed.

 

The June 29 Opinion

In an opinion written by Judge David Hamilton for a three judge panel, the Seventh Circuit affirmed in part and reversed in part the holding of the district court. The appellate court affirmed the district court to the extent the lower court had held that coverage under the policy for the claims brought by the three former directors was precluded by the Insured vs. Insured exclusion, but reversed the district court to the extent that the lower court had held that the exclusion also precluded coverage for the claims brought by the plaintiffs who were not Insureds. The Seventh Circuit, In reliance on its 1999 decision in the Level 3 Communications, Inc. v. Federal Insurance Co.  case (here)– which the Court said was “practically indistinguishable“ from this case — held that there was coverage under the policy for the claims brought by the non-insureds, and that defense costs and any indemnity amounts would have to be allocated between covered Loss and uncovered loss using the policy’s allocation provisions.

 

In the Level 3 case, the Seventh Circuit had also addressed the question of the application of an Insured vs. Insured exclusion in a D&O policy to a claim that ultimately included both insured and noninsured claimants. Initially, the claimants in the underlying case had only consisted of non-insureds. However, six months after the underlying lawsuit had been commenced, an insured person joined as a plaintiff. The Seventh Circuit held in the Level 3 case that in that situation “the insurance contract requires allocation of covered and noncovered losses rather than barring all recovery because of the presence of an insured on the plaintiff’s side of the case.”

 

The D&O insurer in this case attempted to distinguish the Level 3 case based on two factual differences: timing and “majority rule.”   The carrier first argued that in the Level 3 case, the insured plaintiff did not join the underlying suit until six months after it was filed. The Seventh Circuit said that its ruling in Level 3 had not depended on the timing, and so rejected this attempt to distinguish the earlier case.

 

Second, the carrier argued, in reliance on what the appellate court described as a “counting noses” approach that coverage in a mixed claimant case like this should be based o n the number of insured plaintiffs or proportion of damages claimed by insured plaintiffs. The court said that this “proposed additional requirement for a majority of non-insureds claimants or dollars has no basis in the …policy language.”

 

The appellate court also noted that the carrier attempted to rely on the Eleventh Circuit’s 2005 opinion in the Sphinx International v. National Union Fire Insurance Co. case (here), which also involved a claim brought both by insured persons and noninsureds. In that case, a former director initiated a securities suit and then published a nationwide notice soliciting other shareholders to join the suit. The former director then amended his complaint to add the additional plaintiffs.  The Eleventh Circuit held that coverage was precluded for the entire suit based upon the company’s D&O policy’s Insured vs. Insured exclusion., which precluded coverage for loss arising from a Claim brought “By or at the behest of … any DIRECTOR or OFFICER … unless such claim is instigated and continued totally independent of, and totally without the solicitation of, or assistance of, or active participation of, or intervention of any DIRECTOR OR OFFICER of the company.” The Eleventh Circuit had held that the director plaintiff had actively solicited the other plaintiffs, and therefore the exclusion precluded coverage for the entire claim.

 

The Seventh Circuit found the Sphinx decision to be distinguishable by its fact, including in particular with regard to the policy language involved in that case. The Seventh Circuit also noted that Sphinx itself had distinguished the Level 3 case because the policy language in the earlier case was “too dissimilar” to the language at issue in Sphinx “to be decisive.”

 

Discussion

One of the reasons carriers include Insured vs. Insured exclusions in their policies is that, in addition to avoiding collusive suits, the carriers don’t want to pick up coverage for corporate infighting. Internecine battles can be vexatious and often are not susceptible to resolution on a rational business basis. Given this justification for the inclusion of an Insured vs. Insured exclusion in the policy, I can see how the carriers would take the position that if any one of the plaintiffs is an insured person, the entire claim should be excluded. The argument would be the involvement of even one insured presents too great a risk that the carrier might be dragged into corporate infighting or persona score settling.

 

There may be something to this argument; the carrier did succeed in convincing the district court that the involvement of even one insured as a plaintiff – or more specifically, the involvement here of three insured persons among the five claimants  – is sufficient to preclude coverage for the whole claim.

 

The problem with this argument – that one insured person plaintiff “taints the entire suit,” as the appellate court put it– is that it can lead to some hard questions. As the appellate court noted, the carrier here took this “proposed rule” to “its logical limit,” arguing that it should apply and control even if there were 99 plaintiffs who were not insureds and only one insured person plaintiff. The appellate court also noted that the carrier had argued that the rule should apply even if separate complaints by an insured person plaintiff and non-insured were consolidated, even if only for pretrial proceedings. These examples from the logical limits of the insurer’s argument proved to be more than the court could accept, leading the appellate court to follow a solution based on allocation of between covered Loss and uncovered loss.

 

For carriers that nonetheless believe that Insured vs. Insured exclusion should apply even if only one of many plaintiffs is an insured person will want to consider the Seventh Circuit’s analysis of the Sphinx International opinion. The more encompassing exclusionary language at issue in that case seems likelier to preclude coverage when claimants include both insured person plaintiffs and non-insureds, particularly where the insured person plaintiff is actively involved in t he litigation.

 

For all D&O insurance practitioners the potentially different claims outcome based on the differences between the exclusionary language at issue in the Sphinx International case and the language involved here underscores the critical importance of these differences in policy wordings. In particular, those of us who are involved in representing policyholders in the insurance purchasing process will want to play close attention to the language used in the Insured vs. Insured exclusion in prospective policies, in order to determine whether it more closely resembles the language at issue in the Sphinx International case or the language involved here.

 

It is probably worth noting one particular challenge the carrier faced on appeal in the Seventh Circuit. The three judge panel that heard this case included Judge Richard Posner. Judge Posner wrote the opinion in the Level 3 case. Given that fact, it was always going to be the case that the Level 3 decision was toing to loom large here.

 

For general background regarding the Insured vs. Insured exclusion, please refer here and, here (in the bankruptcy context) and here (in failed bank litigation).

 

The number of securities class action lawsuit filings came in slightly above historical averages during the first half of 2012, with filings against natural resources companies, life sciences companies, and foreign issuers leading the way. Filings related to mergers and acquisitions transactions continued to be an important factor in the number of filings, although not as significant of a factor as was the case in 2011.

 

During the first half of 2012, there were 103 new securities class action lawsuit filings. This figure annualizes to 206, which would be above the 1997-2010 annual laverage number of filings of 194. Though securities suit filings were active during the year’s first half, the filings were not evenly distributed during the period. There were 58 filings in the first quarter — 44 in January and February alone — but only 45 filings in the second quarter. Given the relative filing slowdown after the first two months of the year, it may be that by year’s end the overall filing level may not remain at the relatively elevated levels that we saw in the first half. .

 

A surprising number of the first half filings involved companies domiciled or with their principle place of business outside the U.S. There were 18 filings in the year’s first six months against these non-U.S. companies, representing about 17.5% of all filings. This level of filings against non-U.S. companies is down from 2011, when 36.2% of all filings involved non-U.S. companies, but the filings against non-U.S. companies are still up from 2008-2010, when the filings against non-U.S. companies averaged about 13.4% of all filings.

 

The largest numbers of these filings involving non-U.S. companies related to companies domiciled in or with their principal place of business in China. There were seven of these suits against Chinese companies during the first half. In addition, there were three more companies that are headquartered or domiciled in Hong Kong but that have their operations in China .Taking all of these into account, there were ten China-related filings. This level of filing against China-related companies is down from 2011, when filings against Chinese reverse merger companies largely drove the filings during the year. The numbers of filings against Chinese-related companies in 2012 still is a little unexpected, as the wave of filings involving Chinese companies in 2011 was largely assumed to be a temporary phenomenon. To be sure, the filings against Chinese-related companies is down significantly from 2011. Nevertheless, the continued level of filings against Chinese-related companies is noteworthy.

 

It should be noted that there were also six filings against Canadian companies, many of them natural resources companies (about which see more below).

 

There were a number of “ripped from the headline” lawsuits in the first six months, including in particular the fillings during the first half against J.P. Morgan, Wal-Mart, Facebook and Netflix. Given the anemic rate of IPO activity during the first six months of 2012, the numbers of IPO related lawsuits are a little bit of a surprise. There were six suits involving IPO companies, including the high profile IPO fizzles Facebook and Groupon.

 

About 15% of the first half filings involved M&A related allegations, which while significant is down from 2011, when M&A related filings accounted for about 22.9% of all filings.

 

The first half securities suits were filed in 38 different district courts. The court with the largest number of filings in the year’s first six months was the Southern District of New York, which had 33 filings (or roughly a third of all filings in the first half). No other court had nearly as many filings. The courts with the highest filing levels after the Southern District of New York were the Central District of California (6); and the Northern District of California, Northern District of Illinois and District of Massachusetts, each of which had five filings. These top five courts together had more than half of all first half filings (52.42%).

 

Many kinds of companies were sued in securities suits in the first half. The companies involved were drawn from 62 different Standard Industrial Classification (SIC) code categories.  However, there were concentrations of filings in certain specific areas

 

The largest concentration of filings was in the 283 SIC code grouping (Drugs), where there were a total of 13 filings, included eight  in the 2834 SIC code category (Pharmaceutical Preparations). Another area of concentration was in the 384 SIC code group (Surgical, Medical and Dental Instruments), which had six filings. The single category within this group that had the highest number of filings was SIC code category 3845 (Electrochemical and Electromagnetic Apparatus). Taking all of these groups and categories together, there were a total of 19 filings against life sciences companies, or about 18.4% of all filings.

 

Outside of life sciences companies, the next highest concentration of filings was in the SIC code series from 1000 to 1400 (which includes mining and natural resources companies), in which there were 15 first half filings (about 14.5% of all filings). The largest single category with this group was SIC code category 1311 (Crude Petroleum and Natural Gas), which had eight filings.

 

Another group with a significant number of first half filings was the SIC code group 737 (Computer Programming and Data Processing), which had a total of eight filings. Finally, there were four filings in SIC code group 8200 (Educational Services),.

 

It is worth noting that there were only a modest number of filings in the 6000-level SIC code series (Finance Insurance and Real Estate). In recent years, subprime and credit crisis-related filings has driven filings among companies in these categories, which as recently as 2010 predominated all filings. However, during the first half of 2012, there were only ten filings against companies in these SIC Code categories, representing about 9.7% of all filings.

 

Discussion

The above comparison to historical filing levels is based on absolute numbers of filings. It could be argued that on a relative basis, the filing rate is actually increasing. According to data on the World Federation of Exchanges website, in the ten year period between January 1, 2002 and December 31, 2011, the number of companies trading on either NYSE or NASDAQ has declined by about 25% (from 6,586 to 4,900), yet in absolute terms the number of filings remains within about the same range (that is, around 200 per year). Relative to the declining numbers of public companies, the rate of securities class action lawsuit filings arguably is increasing.

 

The level of securities litigation activity involving mining and natural resources companies is interesting. Historically, companies in these categories have seen relatively little securities class action filing activity. The single largest factor in the increase of filing activity is litigation arising from M&A transactions. But litigation has also arisen due to the fluctuating pricing of minerals or petroleum; questions about mineral or petroleum reserves; or as a result of extraction mishaps, such as crude oil spills. It does seem as if the increased global competition for natural resources has made companies in these categories more vulnerable to securities class action litigation activity than they have been in the past.

 

There are some important aspects in which my analysis will likely vary from other published versions. There is a significant amount of judgment about what to include in the tally of filings and then about how to categorize the various filings. To use one example of this problem, it is unlikely that other published versions will show the same figures as I have for the number of China-related companies. There are a variety of ways these companies might be tracked, whether limited purely to Chinese domiciled companies, or broadened to also include companies that have their principal place of business in China or companies that have their principal business activities in China. I have used the most inclusive grouping, including within the group companies that have the business activities in China, even if they are not Chinese domiciled and even if they don’t have their principle place of business in China. This categorization may result in a larger tally of China-related companies than you may see published elsewhere. This same precaution about categorization applies equally to the more basic task of tallying up the lawsuit filings; due to differences in counting methodology, my tally is likely to vary from other published counts.

 

Failed Bank Litigation Fizzle?: A number of commentators, including even me, had been projecting that as 2012 progressed then numbers of FDIC failed bank lawsuits would escalate sharply. In the event, quite the opposite has happened, at least so far. In particular, during 2Q12, new FDIC filed bank lawsuit filings have slowed to a crawl.

 

As reflected on the FDIC’s website (here), during the first quarter of 2012, there were nine new FDIC lawsuits against the former directors and officers of failed banks, including four in March along. However, during the second quarter of 2012, the FDIC filed only three new failed bank lawsuits total. The agency filed no lawsuits at all during June.

 

It may well be that new failed bank lawsuit activity will pick back up in the year’s second half. Indeed. on its website, the FDIC indicates that a lawsuits involving a total 65 failed institutions have been authorized (inclusive of the 30 lawsuits involving 29 institutions that have already been filed), which suggests that there may be as many as 36 lawsuits that have been approved but not yet filed.

 

With all of these authorized lawsuits, it seems probable that new lawsuit filings will soon resume and that the period during the second quarter will turn out to have been a short-term lull only. Nevertheless, the relative dearth of new failed bank lawsuit filings during the second quarter is noteworthy and even a little puzzling.

 

The FDIC has in any event continued to take control of failed financial institutions during the first half of the year. There were a total of 31 bank failures during the period, which though well below the  pace of closures during the last few years, is still above even the annual total for 2008, where there were 25 bank failures during the entire year. In other words, even if the pace of failed bank litigation filing seems to have dipped during the second quarter, the problems associated with the current wave of bank failures continue to accumulate and the likelihood is that the fallout from the bank failures will have to be sorted out for years to come.

 

Collegiate Hunter Gatherers: An article in the July 2, 2012 issue of the New Yorker entitled “The Hunter Games” (here)  takes a look at the annual Scavenger Hunt at the University of Chicago known to the undergraduate students there simply as “Scav.” What began a few years ago as a modest diversion has grown into an enormous nerd ritual that exceeds traditional limits of normal human behavior. To cite but one example of the kinds of things the annual event leads to, the article mentions that “in 1999, for five hundred points, a pair of physics students built a working breeder reactor in a Burton-Judson dorm room in one day, converting thorium powder collected from inside of vacuum tubes into weapon-grade uranium, using a device made from scrap aluminum and carbon sheets. A concerned nuclear physicist attested to the machine’s efficacy.”

 

The list of objects to be found or constructed is devised by a group of judges, whose bylaws provide that the planning meeting “could not be adjourned while beer remained on the table.”  Here is a representative sample of a typical challenge: “Build a laptop charger using only materials available in the sixteenth century.” Another requirement is to create “a Scrabble game consisting of nonexistent words, for which the player has to supply definitions (‘mervifeet’ is a medical condition in which only the outer edges of the afflicted person’s feet touch the ground).”

 

The article catalogues the event’s sheer lunacy. However, the article also notes that, despite its “pervasive commotion,” only about ten percent of the undergraduate student body takes place in the event. Others consider it a distraction. The student newspaper parodied the kinds of items on the Scav search list with its own spoof list, including items such as: “Bite your own teeth. Birth a child that is larger than yourself.” One undergraduate is quoted in the article as saying that the Scav is “just really white and socially awkward,” adding that “there’s nothing wrong with being white and socially awkward, but as someone who is not white or socially awkward, it’s not exactly appealing to me.”

 

The Scav may not be universally popular, and it is undeniably a veritable nerd Olympics, but it still stands as an ironic contrast to the University of Chicago’s well-known tag (quoted in the article) that the school is the place “Where Fun Goes to Die.” The contestants come off in the article as brainy and humorous. And seriously odd.

 

When plaintiffs first filed their securities class action lawsuit against IndyMac Bancorp back in March 2007, the suit was one of the first of what later became a wave of subprime and credit crisis-related securities class action lawsuits. The suit itself, which has come to be known as the Tripp litigation, initially was dismissed and ultimately went through multiple rounds of dismissal motions. In March 2008, during the round of preliminary motions, and in what is the fifth largest bank failure in U.S. history, regulators closed IndyMac Bank. In August 2008, IndyMac Bancorp itself filed for bankruptcy. By the time all of these events had completely unfolded, including in particular the many rounds of dismissal motion rulings, the sole remaining defendant in the Tripp litigation was the company’s former CEO, Michael Perry.

 

According to papers filed in the Central District of California this week, Perry has now reached a settlement of the securities suit against him. As reflected in the parties’ June 26, 2012 stipulation (here), the parties have agreed to settle the case for a payment of $5.5 million. According to the stipulation, the settlement amount will be entirely funded from “insurance policies providing coverage to former officers and directors of IndyMac for the period March 1, 2007 through March 1, 2008.” The settlement is subject to court approval.

 

The litigation involving IndyMac’s former directors and officers includes not only this securities suit, but also a separate securities suit relating to IndyMac’s alleged misrepresentations regarding its exposure to Option ARM mortgages. In addition, there are two different FDIC lawsuits against former IndyMac executives. Indeed, the FDIC’s first lawsuit against former directors and officers of failed banks filed during the current wave of bank failures was filed against two former IndyMac executives (about which refer here). The FDIC also filed a separate lawsuit against Perry. The FDIC’s suit against Perry has been watched closesly as a result of the ruling in the case that Perry, as a former officer, is not entitled to rely on the business judgment rule under California law (the business judgment rule being construed by the district court as protective of directors only, not officers).

 

As noted in an accompanying post, as a result of a June 27, 2012 determination in the IndyMac insurance coverage litigation, there is insurance coverage if at all for these various lawsuits under the 2007-2008 insurance program, meaning that the various claimants in the various cases are in competition with each other for the proceeds of the 2007-2008 insurance program.  It is probably fortunate for the claimants in the Tripp litigation that the parties in the Tripp litigation were able to reach a settlement before the June 27 ruling in the insurance coverage litigation, as the competition for insurance under the 2007-2008 program could have even further complication the settlement of the Tripp litigation.

 

The stipulation provides that insurers from the 2007-2008 insurance program that will be funding this settlement may be required to seek the approval of the bankruptcy court in the IndyMac Bancorp bankruptcy proceedings in order to obtain the bankruptcy court’s approval to use the proceeds for the settlement. The stipulation adds that the parties to the settlement “expressly acknowledge and agree that all obligation of the Defendant with respect to the Settlement Amount are subject to the funding of such Settlement Amount by the Insurers,” adding that the Defendant “shall under no circumstances have an obligation to fund such amount from personnel assets.” The stipulation does provide that if the settlement amount is not paid according to the terms of the stipulation, the settlement is null and void.

 

I have in any event added the Perry settlement to my running tally of subprime and credit crisis-related case resolutions, which can be accessed here.

 

One of the perennial D&O insurance coverage questions is whether or not subsequent claims are “interrelated” with a prior claim and therefore deemed first made at the time of the prior claim. This question can be particularly critical when the subsequent claims arose during a successor policy period; the answer to the “interrelatedness” question can determine whether the claims trigger one or two insurance programs.

 

In the wave of litigation that arose in connection with the subprime meltdown and the credit crisis, many of the organizations involved were hit with multiple lawsuits filed over period of time, and thus often presenting, in connection with the determination of the availability of D&O insurance coverage, the interrelatedness question.

 

A June 27, 2012 opinion in the D&O insurance coverage litigation arising out the collapse of IndyMac bank takes a close look at these issues. A copy of the opinion can be found here. In his opinion, Central District of California Judge R. Gary Klausner concluded, based on the relevant interrelatedness language, that a variety of lawsuits that first arose during the bank’s 2008-2009 policy period were deemed first made during the policy period of the bank’s prior insurance program, and by operation of two other policy provisions were excluded from coverage under the 2008-2009 program. Because of high profile of the IndyMac case and the sweeping reach of Judge Klausner’s opinion, his ruling could prove influential in the many of the other subprime and credit crisis cases presenting interrelatedness issues.

 

Background

IndyMac failed on July 11, 2008. The bank’s closure represented the second largest bank failure during the current banking crisis, behind only the massive WaMu failure. (IndyMac has assets of about $32 billion at the time of its closure).

 

As I detailed in a prior post (here), the bank’s collapse triggered a wave of litigation. The lawsuits include a securities class action lawsuit against certain former directors and officers of the bank; lawsuits brought by the FDIC and by the SEC against the bank’s former President; and a separate FDIC lawsuit against four former officers of Indy Mac’s homebuilders division. There are a total of eleven separate lawsuits and claims pending. The first of these lawsuits was a consolidate securities class action lawsuit initiated in March 2007, which Judge Klausner refers to in his June 27 opinion as the Tripp litigation. (As noted in an accompanying post, the Tripp litigation has recently and separately settled.)

 

Prior to its collapse, IndyMac carried D&O insurance representing a total of $160 million of insurance coverage spread across two policy years, the first applying to the 2007-2008 period and the second applying to the 2008-2009 period. The insurance program in place for each of the two policy years consists of eight layers of insurance. Each layer has a $10 million limit of liability. The eight layers consist of a primary policy providing traditional ABC coverage, with three layers of excess insurance providing follow form ABC coverage, followed by four layers of Excess Side A insurance. The lineup of insurer involved changed slightly in second year.

 

In the insurance coverage litigation, the carriers in the 2008-2009 raised essentially three arguments: first, that the lawsuits and claims that arose during the 2008-2009 policy period were interrelated with the Tripp lawsuit, and therefore are deemed first made during the 2007-2008 policy period; that because the subsequent claims and lawsuits are interrelated with the Tripp lawsuit, which was noticed as a claim during the prior period, the subsequent claims and lawsuits are excluded from coverage under the 2008-2009 program under the applicable “prior notice” provision; and all of the subsequent claims are excluded from coverage under a specific exclusion endorsed onto the policies in the 2008-2009 program precluding coverage for claims related to the Tripp litigation. The former IndyMac officers and directors filed counterclaims contending that they were entitled to coverage under the 2008-2009 program. The various parties filed cross-motions for summary judgment.

 

The June 27 Opinion

In his June 27 opinion, Judge Klausner, applying California law, granted the insurers’ motions for summary judgment and denied the former IndyMac directors and officers cross-motions. Although his opinion is detailed, it boils down to his conclusions that each of the three sets of policy provisions at issue are unambiguous; that under each of the three sets of policy provisions, the subsequent claims are interrelated with the Tripp litigation; and by operation of the prior notice and Tripp litigation exclusions, all of the subsequent litigation is precluded from coverage under the 2008-2009 insurance program.

 

In concluding that the subsequent claims were interrelated with the Tripp litigation within meaning of the relevant language in the various policies, he noted that the policies’ definition of “interrelated wrongful act” is unambiguous and “describes a broad range of relationships between the original claim and other lawsuits that will be deemed as part of that same claim and made at the time of the first claim.”

 

The prior notice exclusion in the various policies, Judge Klausner noted, “describes a broad relationship between subsequent claims and claims that were made during prior policies such that these subsequent claims will be excluded from coverage.”

 

The Tripp litigation exclusion, Judge Klausner noted, is unambiguous and “excludes from coverage cases that have a broad range of relationships to the facts in the Tripp Litigation.”

 

Judge Klausner found that all of the subsequent claims and lawsuits “are sufficiently related to the Tripp litigation to be excluded under at least one clause of the [2008-2009] policies.”  The set of allegations that Judge Klausner found to be common among the various claims and lawsuits was the assertion that IndyMac failed to follow its underwriting standards and the resulting alleged issuance of high risk mortgages. Judge Klausner found that this commonality extended among the various suits and claims even if the specific allegations in a particular claim or suit “may fall outside the temporal scope of the Tripp litigation.”

 

Discussion

Judge Klausner’s opinion in this case is potentially significant, and not just because it means that the insurance under IndyMac’s 2008-2009 insurance program will not be available for the defense and settlement of the various subsequent claims. As I noted at the outset, many of the claims, lawsuits and disputes that have arisen in the wake of the subprime meltdown and the credit crisis present this same interrelatedness issue. Judge Klausner’s broad reading of the interrelatedness provisions, and in particular his willingness to interpret the policy provisions as not limited temporally but instead as having a broad meaning and reach, could prove influential.

 

It is important to note as an aside that Judge Klausner did not consider wording differences between the interrelatedness provisions in the “traditional” A/B/C policies and in the Side A policies in the 2008-2009 to be particularly significant (although, to be sure, he did note the differences). From an outcome determinative standpoint, the broad scope Judge Klausner gave to the interrelatedness provision could be the most significant feature. Because the interrelatedness language at issue, or substantially similar language, is found in most current D&O insurance policies, Judge Klausner’s analysis and the broad scope he gave to the policy language, could prove significant in a broad variety of other cases.

 

There is one aspect of Judge Klausner’s analysis that may limit its applicability to other disputes. That is that his ultimate conclusion that the various subsequent claims and lawsuits are precluded from coverage depended on the operation of all three of the policy provisions on which the insurers’ relied. It may be argues that it not enough for Judge Klausner to reach his conclusion that there is no coverage under the second tower that the subsequent claims were interrelated with the Tripp litigation; his conclusion that the subsequent claims were precluded from coverage also depended on the operation of the prior notice exclusion and the Tripp litigation exclusion arguably may distinguish this case from other interrelatedness disputes that may arise.

 

The practical effect of Judge Klausner’s decision is that there is insurance coverage, if at all, for the various subsequent claims under the 2007-2008 program. Although the 2007-2008 program represents a total of $80 million in insurance, the program has been eroded by over five years of attorneys’ fees in the Tripp litigation, as well as by the settlement of the Tripp litigation. The claimants in the various subsequent claims will now be in competition with each other for the remaining proceeds, while at the same time any amounts remaining will be further eroded by additional attorneys’ fees. The finite and dwindling amount of insurance and the sheer number of claims and claimants could make it challenging to resolve the claims and suits, at least to the extent insurance funds are to be involved. This observation is relevant to all claimants but it is probably worth noting that it is also applicable to the FDIC in connection with the two lawsuits the agency has filed in its role as IndyMac’s receiver against former officers of the bank.

 

A June 27, 2012 memo from the Wiley Rein law firm discussing Judge Klausner’s opinion can be found here.

 

I would like to thank the several loyal readers who sent me copies of this opinion. I appreciate everyone’s willingness to make sure that I am aware of significant developments so that I can pass them along to my readers.

 

Leading off the second day of the annual Stanford Directors’ College at Stanford Law School in Palo Alto, California was a keynote address from Delaware Chancellor Leo Strine. Strine is surprisingly outspoken and his presentation was lively and interesting.

 

The centerpiece of his presentation was a discussion of the lessons for directors based on the cases he has seen over the years. As a preliminary matter, and actually throughout his discussion of these issues, he emphasized that it is very rare that outside directors are actually held individually liable. He pointed out that, for example, cops, teachers and doctors are held liable much more frequently. But even if an outside director’s chance of being held liable is low, the chance of “looking like a chump” or that you have “failed your mission” is very high if you don’t watch out for certain things.

 

First, from the outset, the director should understand his or her role. In particular, if the director is unable or unwilling to make a decision adverse to management, they should not be in the position. The director also needs to understand the business, how it makes money and its principal risks. The director can’t be voting on things he or she does not understand. Where people tend to get in the most trouble is when they fail to do the work to understand the company and the specifics of the issues on which they are voting.

 

Second, conflicts of interest cause most of the worst trouble. Making sure that there aren’t interested parties involved in the object of board attention is critical. Along those lines it is vital that the board members remain independent, which can be compromised over time if a director’s relationship with the manager. The director needs to be sure that they he or she is still able to be adverse to management when that is what the situation requires.

 

Third, a very specific danger arises when directors are insufficiently skeptical of M&A activity originating within the company itself, particularly through a management buyout brought up when the company is otherwise not for sale or in play. Strine said that this is not the way a company should operate. If a CEO thinks there is a strategic move the company ought to be making, then the directors should be advised and guide the process. The CEO should not be taking advantage of inside information and tampering with employees and enlisting the company’s outside advisors in the interest of a management initiated buyout. (Stine was quite emphatic when he described the problem with this type of situation.)

 

Fourth, one the CEO’s key roles is preparing for management succession. Strine said that if the CEO has been in office three years and there is not a designated successor, the CEO has failed in one of his or her key roles. One of the most important jobs for the CEO is the “build the bench.” Strine cited the example of Johnson & Johnson, which has been a very successful company for decades with a succession of CEOs (all of whom who have been very low profile) that have continued to move the company forward.

 

In response to a question, Strine discussed the massive fee award he granted to the plaintiffs’ attorneys’ in the Southern Peru case. As discussed here, that case had resulted in an award of $1.263 billion, which with interest, approach nearly $2 billion. Strine awarded fees of $285 million, which he defended saying, the only reason the plaintiffs received the massive judgment in the case was the efforts of the plaintiffs’ lawyers. He said that he has much more trouble with cases like the disclosure-only merger objection suit settlement, where the plaintiffs’ lawyers wind up walking away with a $400,000 fee award.

 

The real problem is not a case where plaintiffs’ attorneys produce real value. If the plaintiffs has “delivered something really beneficial, they should be rewarded accordingly.” Rather, the problem is that there are too many incentives for plaintiffs’ attorneys to bring suits where the only beneficiaries are the attorneys. We have, Strine said, an “excess of litigation” that “has no meaningful societal benefit.” Strine commented that the extra costs associated with this litigation have caused the cost of capital for American companies to rise.

 

Strine rejected the suggestion that the Delaware courts might be managing fee awards because of a competition from other states’ courts. Strine stressed that Delaware’s courts are not “trying to attract litigation.” Just the same, he took care to question the effort of other states to try to develop specialized business courts. You can, he said, file suits in “goofy place” and what you will wind up with is corporate law that is “junk.” The movement to form specialized business courts has been “problematic” because all too often those courts have “become places where you can forum shop.” His view is that all courts, by their own account are “overburdened.” That being the case, Strine contends, the each court should “stay in its own lane.” When something is appropriately “in someone else’s lane, then let them do it.”

 

On Monday evening, the keynote speaker at dinner was the CEO of Netflix, Reed Hastings. Hastings also serves on the boards of Microsoft and Facebook. Hastings focused his discussion on the role of the board at very large publicly traded companies, taking pains to emphasize that he was not discussing the boards’ roles at smaller public companies, private companies or at non-profits.

 

Hastings said several times that for the board of a large publicly traded company “the fundamental job is to replace and compensate the CEO.” Where the company has the resources to hire outside consultants as needed, it is not the board’s role to offer counsel or advice. He was dismissive of new directors who come in and try to  “add value” by offering advice. He contends that board members offering advice creates a conflict of interest, because management might feel obliged to follow the advice even if it is poor and if the advice turns out to be mistaken, there is no accountability for the board member.

 

It is fair to say that Hastings remarks drew a very lively response from the audience. He emphasized in responses to questions from the audience that he was only talking the largest public companies, not other types of companies that might need the board’s involvement and guidance. He also said that he was not talking about companies in special circumstances where the situation might require the board to become much more involved. The interaction between Hastings and the audience might have been one of the high points of the conference for me. The audience was engaged in the discussion and Hastings was animated and articulate in discussing his position.

 

Hastings did tell one story from earlier in his career that is worth repeating here. He told the story to emphasize that a CEO must have both leadership qualities and a strategic vision. He said that when he first started working as a young software designer, he kept unusual hours and often had used coffee mugs strewn around his cubicle. He noticed that every few days the coffee mugs would appear on his desk, cleaned. He assumed the janitorial staff was cleaning the mugs. But one morning he arrived at the office at 4 am, and found the company’s CEO in the kitchen, cleaning Hastings’ coffee mugs. The CEO explained that he felt that Hastings did such great work, it was the least the CEO could do for him. Hasting said that this incident made him feel such deep personal loyalty to the CEO that Hastings would have “followed him to the ends of the earth” – which, Hastings said, is where the CEO led the company. It isn’t enough, Hastings said to be able to create a loyal work force, you also have to have a strategic vision.

 

For the record, Hastings did acknowledge that the whole Netflix pricing change was a mistake for which he took responsibility.

 

The D&O Diary is on assignment this week at The Stanford Directors’ College at the Stanford Law School in Palo Alto, California. As always, the conference is well-attended (it is, in fact, sold out, as usual) and the agenda is full of timely topics and interesting speakers.

 

The conference began on Sunday evening with opening keynote speech from Robert Greifeld, the CEO of the NASDAQ OMX group. NASDAQ is one of the event’s sponsors, and Greifeld joked  with conference co-Chair Joseph Grundfest that next year his firm would increase its sponsorship level so that he would not have to speak at the conference — a line that drew a knowing laugh from an audience that was all too familiar with the public discussion of the possible involvement of NASDAQ in the problems that surrounded the recent Faacebook IPO.

 

To Greifeld’s credit, he did not run from the topic of the Facebook IPO, and in fact it was the first issue he addressed. He acknowledged that a “design flaw” in NASDAQ’s IPO process allowed problems to come into the early trading, particularly with respect to the timing of order cancellations. He acknowledged that there may have been some “overconfidence” and even “arrogance” in the team that was running the IPO process because they were relying on procedures and routines that had been used in 480 IPOs over the course of several years without a problem.

 

In retrospect, Greifeld said, the pre-offering testing was not rigorous enough. He said that the company has tremendous pride in its technology group, but that perhaps the business unit because too “subservient” to the technology group, as a result of which, there was “not enough business judgment” in the process. He said that the company has reached out for external help from IBM to examine the trading process from an outside perspective. IBM will report at the end of July.

 

As for whether the events surrounding the Facebook IPO will undermine the market for IPOs generally, Greifeld acknowledged their may be some short run effects. However, he added, he expects that over time, IPOs will track the overall market. Over the medium and long term, the markets will mirror GDP growth in the economy, because the markets are tied to the fundamental economic health of the economy.

 

He did observe that the equity markets have had issues since 2008, as since that time there has been a “steady flow” of money from equity investments to fixed income investments – even though in the current interest rate environment, fixed income investments are effectively paying zero return. This, he notes, is not good news for the equity markets.

 

He added that the markets are now “fundamentally different” than they were ten years ago. They are much more fragmented with many more trading platforms, which has produced beneficial competition but has also led to fragmentation. These developments, and other recent developments such as dark pools and high frequency trading, are more beneficial to larger cap companies, because it can help to ensure that the spreads on trading in their securities are tight. For other companies, these developments are bad, and can affect the market liquidity in trading for their shares.

 

Today’s sessions began with a Keynote Presentation from Marc Andreessen and Ben Horowitz, the founders and general partners of venture capital firm Andreessen Horowitz. Andreessen is well known as the founder of early Internet browser company Netscape and Horowitz was the co-founder of Opsware (formerly Loudcloud). Their presentation was in a Q&A format, and one question they received provoked a particularly interesting answer.

 

In response to a question about how a Board should prepare a company for an IPO, Andreessen’s initial response was that the company should first consider every other possibility other than going public. He emphasized that the IPO process and the life for a company post-IPO has changed so much in recent years, that now a company completing an IPO is immediately surrounded by a host of constituencies all of which are prepared to try to extract a “pound of flesh” from the company. If the company has to go public, Andreessen would prefer that the company remains a “controlled” company – that is, subject to control by the founder. He explained that the way for investors to make money on technology investments is for the investors to pick a founder, like a Jeff Bezos, Sergey Brin or Michael Dell, and to make a long-term commitment to them to try to achieve their goals for the enterprise.

 

He went on to say that a faulty premise has emerged around corporate governance, in that there is now a perception that corporate governance ought to operate on basic principles of democracy, particularly as embodied on the “one man, one vote” principle. From Andreessen’s perspective, democracy is not the correct model. According to Andreessen, the correct analogy is the military, and specifically, war. In a wartime environment, politicians cede control to the military commanders so that they can deploy assets and take initiative necessary to “take the hill.” The objectives are more likely to be met if the founders retain control.

 

Horpwitz discussed a number of topics that he has previously addressed on his blog, Ben’s Blog. In particular, he discussed the difficulty for a yoind company to try to function with outside managers who are brought in from the outside for their management knowledge but who lack the institutional history and tribal knowedge of the entrepreneur found. In his view, it is easier to teack the entrepreneurial founder the basic principles of management than it is to try to teach the professional manager the firm history and tribal knowledge.

 

The conference continues to run though Tuesday, and I hope to be able to continue to report while I am here. On Tuesday, I will be participating in a session at the conference on the topic of Indemnification and D&O Insurance with my good friends Priya Cherian Huskins of the Woodruff Sawyer insurance brokerage firm, and Chris Warrior of Beazley. The complete program guide for the conference can be found here.

 

In a harsh June 21, 2012 opinion (here), Southern District of New York Judge Paul A. Crotty rejected the motion to dismiss of Goldman Sachs and three individual defendants in the securities class action lawsuit pertaining to the infamous “built to fail” Abacus CDO transaction and other ill-fated deals. Judge Crotty did, however, grant the defendants’ motion to dismiss with regard to the plaintiffs’ claims based on the company’s failure to disclose its receipt of a Wells Notice.

 

What makes the decision interesting, besides the sharpness of the Judge’s tone, is that in order to establish that Goldman’s alleged misstatements and omissions about its business ethics and conflicts of interest practices and policies are actionable, the plaintiffs relied on Goldman’s misstatements and alleged fraudulent conduct in connection with the Abacus transaction and three other CDO deals. Judge Crotty found that Goldman’s alleged conduct and statements in connection with the CDO deals made the statements to Goldman’s shareholders about its business practices and ethics materially misleading.

The order is also interesting because of the weight Judge Crotty gives to admissions Goldman made in the Consent it entered in its July 2010 agreement to settle the enforcement action the SEC had filed against Goldman about the Abacus transaction. As described here, in the Consent, in which Goldman neither admitted nor denied liability, the company “acknowledges” that the Abacus marketing materials “contained incomplete information” and that it was a “mistake” for the materials to state that the Abacus CDO reference portfolio was selected by ACA Management without disclosing the role of short-interest investor Paulson & Co. or that Paulson’s interests were adverse to those of the Abacus CDO investors.

These concessions fell short of an admission of fraud, but as Jan Wolfe notes in a June 22, 2012 Am Law Litigation Daily article about Judge Crotty’s decision (here), “if Goldman and its lawyers thought that this linguistic compromise would help it avoid trouble in shareholder suits, it turns out they were wrong.”

In addition to the Abacus transaction, the plaintiffs’ conflict of interest allegations also are based on three other CDO transactions – Hudson, Anderson and Timberwolf. With respect to the Hudson transaction, the plaintiffs allege that Goldman had said its interests were aligned with those of CDO investors based on a $6 million equity investment, while omitting that it also had a 100% short position at the time, representing a $2 billion interest.

With respect to the Anderson CDO transaction, Goldman stated that it would hold up to 50% of the equity tranche, worth $21 million, but omitted its $135 million short position. And with respect to the Timberwolf transaction, Goldman stated that it was purchasing 50% of the equity tranche, but failed to disclose that it was the largest source of assets in the structure and held a 36% short position in the CDO.

The plaintiffs claim that Goldman’s conduct, discloses and omissions with respect to these CDO transactions made a number of the company’s disclosures  to shareholders about its conflicts of interest policies and procedures and its commitment to legal compliance and ethics (including its commitment to “integrity” and “honesty”) materially misleading.

The defendants argued that these statements are non-actionable statements of opinion, puffery or merely corporate mismanagement. Judge Crotty called these arguments “Orwellian,” adding that:

Words such as “honesty”, “integrity”, and “fair-dealing” so not mean what they say; they do not set standards; they are mere shibboleths. If Goldman’s claim that “honesty” and “integrity” are mere puffery, the world of finance may be in more trouble than we recognize.

Judge Crotty concluded that Goldman’s conduct and disclosures in connection with the four CDO transactions “made its disclosures to its own shareholders, concerning its business practices, materially misleading,” adding that given “Goldman’s fraudulent acts, it could not have genuinely believed its statements” about its business practices and ethics. Goldman should not be able to “pass off” its “repeated assertions” as “mere puffery.” Moreover, Goldman’s “allegedly manipulative, deceitful and fraudulent conduct” in hiding its conflicts of interests in the four CDO transactions “takes the Plaintiffs’ claim beyond mere mismanagement.”

On the issue of scienter, Judge Crotty specifically relied on Goldman’s concessions in the SEC settlement, among other things, including internal emails. He noted that Goldman clearly played an active role in the Abacus asset selection process: “How else could Goldman admit that it was a ‘mistake’ not to have disclosed such information.” Crotty found that “given Goldman’s practice of making material misrepresentations to third-party investors, Goldman knew or should have known” that its statements about its conflicts of interest practices and business ethics “were inaccurate and incomplete.”

Judge Crotty also concluded that scienter allegations as to each of the individual defendants were sufficient, as each of them “actively monitored” Goldman subprime deals and assets and each knew that Goldman was “trying to purge those assets from its books and stay on the short side.”

Judge Crotty did, however, dismiss plaintiffs’ claims that Goldman had misled its shareholders by failing to disclose its receipt of a Wells Notice, noting that because a Wells Notice “indicates not litigation but only the desire of the Enforcement staff to move forward,” and therefore is a “contingency” that need “not be disclosed.” He also found that the plaintiffs’ had not shown that the company’s nondisclosure of the Wells Notice made the company’s prior disclosures about “ongoing governmental investigations” materially misleading.

Discussion

Judge Crotty’s opinion clearly quells any suggestion that Goldman’s SEC settlement – in which it made a number of admissions – offers an alternative to the “neither admit nor deny” SEC settlement approach which has proven so controversial. A frequent justification for the “neither admit nor deny” approach is that defendants can’t admit liability in an SEC settlement for fear the admissions will be used against them in related shareholder litigation. Some (including even Judge Jed Rakoff, who has been so critical of the neither admit nor deny settlements) had suggested that the Goldman settlement — in which the company admitted no fraud but only mistakes – offered a middle ground.

However Judge Crotty found that Goldman’s attempts to argue in support of its motion to dismiss the share holder suit that it had neither admitted nor denied liability in the SEC settlement were “eviscerated” by the company’s concession that it had made a “mistake” in not disclosing Paulson’s role in the Abacus transaction. The fact that the plaintiffs were able to rely on the company’s SEC settlement concessions, and that the concessions also entered directly into Judge Crotty’s analysis of both misrepresentation and scienter issues, eliminates the Goldman settlement approach as an enforcement action settlement alternative that other defendants might be able to accept.

It is interesting that so many of the misstatements or omissions on which the shareholder plaintiffs rely were not made directly to shareholders themselves, but rather were made to CDO investors. The misleading omission in statements to the CDO investors were relied upon to show that statements that were made to Goldman shareholders about the company’s business practices and ethics were misleading.

There is a particularly harsh aspect to Judge Crotty’s decision, in that the statements to shareholders to  which he referred in denying defendants’ motion to dismiss were the company’s statements about it business ethics and integrity. What makes this particularly troubling is that his assessment that these statements were misleading was not based – as would usually be the case at this stage of the proceedings – on plaintiffs’ mere unproven allegations. Judge Crotty’s conclusions were based, at least in part, on the company’s own admissions.

Goldman likely recognized long ago that this case might well survive a motion to dismiss. (The company wouldn’t have agreed to pay over half a billion dollars to settle the SEC enforcement action if it didn’t recognize that there were serious problems with the Abacus transaction, and in addition the separate state court fraud action brought by the bond insurer on the Abacus transaction had previously survived a dismissal motion.) Nevertheless, Judge Crotty’s opinion, and in particular the harshness of its tone, has to represent an unwelcome and troubling development.

One final note has to do with Judge Crotty’s ruling with regard to the Wells Notice nondisclosure allegations. The question of whether the receipt of a Wells Notice must be disclosed is frequently debated, and many companies, out of an abundance of caution, will disclose it. Judge Crotty’s conclusion that a Wells Notice represents a “contingency” that need not be disclosed will clearly be relevant for companies considering whether nor not they must disclose receipt of a Wells Notice, and may lead more companies to withhold disclosure of receipt of a Wells Notice.

I have in any event added the Goldman decision to my running tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.

Professor Peter Henning has an interesting post about the Goldman decision on the Dealbook blog (here).

Is the Business Judgment Rule Available as a Defense for Corporate Officers: One of the questions that is receiving close scrutiny in the litigation the FDIC has filed against former directors ad officers of failed banks as part of the current wave of bank failures is whether or not corporate officers – as opposed to corporate directors – can rely on the business judgment rule as a defense to claims of ordinary negligence. As discussed here, at least one court has held under Georgia law that officers can rely on the business judgment rule to preclude claims for ordinary negligence.

However, as California attorney Jon Joseph wrote in his April 11, 2012 guest post on this blog (here), courts applying California law on the issue and considering whether corporate officers as well as directors can rely on the business judgment rule have split on the issue. The ruling in the FDIC lawsuit against former IndyMac CEO that Perry could not rely on the business judgment rule is on interlocutory appeal to the Ninth Circuit.

Because of this mixed case law, the June 7, 2012 ruling in the FDIC’s lawsuit against certain former officers of County Bank of Merced, California is of interest. In the decisions, which can be found here, Eastern District of California Judge Lawrence O’Neill held that the defendant officers cannot rely on the statutorily codified business judgment rule under California Corporations Code Section 309, because the statute by its terms refers only to officers not directors.

However, with respect to the defendant officers’ efforts to rely on the common law business judgment rule, Judge O’Neill also denied the defendants’ motion to dismiss — but not on the basis that they could not rely on the business judgment rule; rather, he said only that “the business judgment rule is an affirmative defense which involves factual issues to preclude its application to dismiss the complaint’s claims.”

While Judge O’Neill did find that the defendants’ entitlement to rely on the common law business judgment rule is a factual issue, what he did not say is that the defendants were not entitled to rely on it as a matter of law. Which can be interpreted to suggest at least by negative inference that there is a common law business judgment rule separate and apart from the statutory provision, and defendants can rely on the common law rule, if they can establish as a factual matter that the qualify for the rule’s protection.

Hat tip to Alan Makins, who had a post about the ruling in the County Bank case in his California Corporate & Securities Law Blog, here.

Beginning in 2010 and accelerating in 2011, plaintiffs’ lawyers filed a wave of securities class action lawsuits against U.S.-listed Chinese companies, many of which obtained their U.S. listings via reverse merger. These cases have been making their way through the courts, and some have now reached the settlement stage. The settlements seem to share more in common  than the involvement of U.S.-listed Chinese companies – the settlements are also relatively modest.

 

The latest of these cases to settle is the lawsuit involving Orient Paper and certain of its directors and officers. According to the company’s June 21, 2012 press release, the parties to the suit have agreed to settle the case “in exchange for a $2 million payment from the Company’s insurer.” The settlement is subject to court approval.

 

As I discussed in a post at the time (refer here), the Orient Paper case was the first of the of the Chinese reverse merger company securities suits to survive a motion to dismiss. On July 20, 2012, Central District of California Judge Valerie Baker Fairbanks denied the defendants’ motion to dismiss.

 

The Orient Paper case is not the first of this group of securities suits filed against U.S.-listed Chinese companies to settle. For example, on March 15, 2012, the parties to the securities suit involving Tongxin International filed a settlement stipulation in the Central District of California indicating that they had settled the case for $3 million. The Tonxin settlement will be funded by the company’s insurer.

 

An earlier securities suit involving a U.S. listed Chinese company China Shenghguo Pharmaceutical Holdings, filed back in 2008, settled in 2010 for $800,000. According to the parties’ settlement stipulation (here), $600,000 of the settlement amount is to be funded by the company’s insurer, with the remainder to be funded by the company.

 

You probably noticed that these three settlements have something in common. They not only all three involve U.S.-listed Chinese companies, but all three of the settlements are relatively small. (By way of comparison, Cornerstone Research reports that the median of all securities class action settlements through 2010 was $8.1 million.)

 

The relatively small size of the settlements might be a reflection of the merits or of the companies’ relatively small size. I suspect a different factor. In my experience, U.S.-listed Chinese companies generally carry very low D&O insurance limits. The low limit levels mean that when these companies are sued, defense expenses alone could quickly deplete a significant percentage of the total amount of insurance, leaving little remaining with which to try to settle the case. The relatively low level of these settlements and the fact that all three settlements were settled in whole or in substantial part with insurance funds suggests to me that something like that may have happened here.

 

In 2010 and 2011, when the plaintiffs’ lawyers flooded the courts with these securities suits against U.S.-listed Chinese companies, I wondered at the time why the plaintiffs’ lawyers found these cases so attractive. Even though the factual allegations were in some cases quite sensational, they were always going to be difficult cases to pursue. Service of process on the individual defendants alone would in many cases pose significant challenges. Discovery will also pose substantial challenges, including not just the absence of reliable procedures to effect discovery in China, but also the problems associated with distances, language distances and cultural differences. The plaintiffs in these cases may also face barriers getting a class certified (about which refer here).

 

But even beyond these procedural difficulties, there was always this fundamental problem that in the end there might be very little insurance money out of which to try to collect any settlement or judgment. Given the modest size of these settlements, the attorneys’ fee awards are or will likely be small as well. Small enough to make you wonder how these cases could be worthwhile for the plaintiffs’ lawyers. Of course, going in, they almost certainly had no way of knowing about the lower insurance levels that the Chinese companies often carry.

 

I have made this point before –about the relative unattractiveness of these cases for the plaintiffs’ firms – to others in the insurance industry, which provoked the response that perhaps the real targets in these cases are the investment banks, lawyers and accountants who advised these companies and who helped them obtain their U.S. listings. It may be that these outside professionals may represent attractive targets, but with the limitations on the reach of the securities laws to those who are not primary violators, these cases against the outside professionals pose their own sets of issues.

 

There are many more of these cases against U.S.-listed Chinese companies yet to be resolved. Some of course will be dismissed but the ones that survive the motions to dismiss will likely move toward settlement. As these cases progress, perhaps there will be more sizable settlements and the smaller settlements discussed above will look like early outliers. However, my suspicion is that the relatively low levels of D&O insurance that many of these companies carry will mean that many of the settlements will be similarly diminutive.

 

Special thanks to the several readers who sent me copies of the Orient Paper settlement press release.

 

Every Now and Then I Read a Headline and Say—What?: Like this June 21, 2012 New Scientist article: “Tiny Human Liver Grows Inside Mouse’s Head” (here).

 

Matt is Back! And He’s Still Dancing!: My all-time favorite video is the classic Where the Hell is Matt Video (here). The simplicity of the concept is pure genius. The video consists of short clips of Matt, dancing. In places all over the world, with hundreds and hundreds of people. The background music is awesome too.

 

The great news is that Matt is still dancing. And even better, he has made a new video. It just came out on June 20, 2012. It is every bit as fun as his prior videos. You have to watch it. (Sorry about the commercial at the beginning, it is short). I would like to add a special shout out to my Cleveland friends, you look fine dancing around the “Free” Stamp.” I hope everyone enjoys this video as much as I did.

 

 

Along with everyone else in the professional liability insurance industry , I was fascinated by the news that my good friend David Bell, with whom I served on the Professional Liability Underwriting Society (PLUS) Board of Trustees, was leaving Bernuda and  his position at  Allied World Assurance Company Holdings, to return to Montana, where he would be taking up a position as President and Chief Operating Officer of ALPS Corporation, a Montana-based lawyers’ professional liability insurance to over 12,500 attorneys nationwide.

 

I was so intrigued by the news of David’s move that I communicated with him to see if he would be willing to be interviewed for this site about the reasons for his move and about his plans and objectives going forward. I am pleased to report that David accepted, and the interview is reproduced below.

 

Until May 1st, David was the Chief Operating Officer of Allied World Assurance Corporation, AG (NYSE: AWH) a position he held for more than four years. Prior to that David was one of the founding executives at AWAC, where he had worked since its formation in 2002 as the SVP and Global Professional Lines Manager. Prior to that David had been both an Executive Protection Manager and in External Affairs with the Chubb Corporation.

 

Over the course of his career, David has served in a number of leadership positions in the Professional Liability Society, serving as its President in 2008-09 and as a Trustee from 2004-08. David is also a cofounder – along with John McCarrick – of Grateful Nation Montana, a first-of-its-kind in the country public private partnership that provides tutoring, mentoring and a full college scholarship for every child of a Montana solider killed in action (KIA) in Iraq or Afghanistan. Montana has the highest KIA rate per capita of any state in the nation. He serves on the board of The Mansfield Center, which promotes a better understanding of Asia, and of U.S. relations with Asia. He has also presented to the Council on Foreign Relations (CFR), focusing on expropriation and kidnap/ransom in Asia and the Middle East

 

My interview with David follows. My questions appear in italics and David’s answers are indented and in plan type. I would like to thank David for his willingness to participate in this interview, for the frankness of his answers, and for his willingness to allow me to print the interview here.

 

Why did you decide to move from Bermuda to Montana?

 

I think the best way to articulate it is to say that I feel I am following my own “path”. I really do believe that there is a unique path available for each of us to choose whether or not to pursue. Call it fate, or spiritual inspiration (perhaps both), but whatever the name, it subtly illuminates each of our paths;, often running counter to the direction society says we should go. I believe that one has to listen carefully for it and be willing to look at a possible future through a lens that doesn’t necessarily correlate “success” with money or influence. My path pointed west and it was time for me to take my own leap of faith.

 

You were COO Of a $3 billion market cap publicly traded international insurance company, but you traded that in to become the President and COO of a relatively small risk retention group based in Missoula, Montana. How have your reconciled the ambition that put you into a senior role at Allied World at such a relatively young age with the decision to move to Montana in this new role?

 

It certainly was not an easy decision. Steady, increasing success can create its own inertia, and I candidly found it difficult to walk away from a successful career with a great company. That said, there is more to life. I left a wonderful career opportunity, talented colleagues and many friends to join an equally great, albeit much smaller, company. But make no mistake about it: that decision comes at a very real monetary and reputational price. But for me it’s absolutely the right decision. I’ve come back to Montana, a state I’ve loved since I first arrived here as a college freshman, and where I hope to make an impact in ways both inside and outside of our industry.

 

I am certain from the decisions I have made in my own career that there are personal reasons behind your decision to return to Montana, in the form of life lessons that have guided your decisions about your career and your family. What were the life lessons that guided your thinking and how did they affect your decision-making?

 

 A pastor at a church my wife and I attended years ago gave a great sermon about “joy”. He compared “true joy” to just being “happy,” especially in the context of how the word “happiness” is commonly defined these days. I couldn’t do his comparison justice in a few lines but I have to tell you that his sermon spoke to me in a powerful way that has stayed with me for all these years. The direct answer to your question, though, is that my life lesson is about trying to stay on my own path toward true joy and awareness; being always conscious and careful about who (or what) it is that I serve.

 

Your move is not only a big chance for you but for family as well. I know that you and your wife Brittany have two small children. What do you think the effect of this move will be on your family and why?

 

Kids are resilient and that has certainly proven to be true for my two young children in the short time since we’ve been back in Montana. Trent and Ivey instantly adapted happily to their new life here. I marvel at that gift: I grew up with a single mom and never lived in the same place for more than four years while growing up. My wife is just the opposite: Brittany is a fourth-generation Montanan who was raised on a Montana ranch her whole life, so we bring very different perspectives from our respective upbringings. In many ways, Bermuda was an easier place for me to live given my upbringing. Bermuda is a transient place by nature. During the years I lived there, people seem to be constantly moving on and off the Island. But here’s where it’s really different: when one leaves Bermuda it’s not like leaving a neighborhood you can later go back and visit, and where everything has stayed the same — except for your departure. As I think about it, life in Bermuda is more like a point-in-time: defined by one’s friends that happen to have stopped in Bermuda on their career journey at the same time you stopped there on yours. We developed great friendships in Bermuda, and many of them will stay lifelong friends –wherever in the world we – or they — are. I have no doubt, though, that when we next visit Bermuda, it will feel like a very different place.

 

Bermuda has changed significantly since you first arrived there in 2002. What were the biggest changes during your time there, and what changes do you see in the years ahead?

 

In my opinion the biggest change to Bermuda between 2002 and 2012 has created its biggest challenge going forward. In 2002 the Island began struggling to keep up with and manage the infrastructure strain created when significant amounts of capital and guest workers flooded the Island during the post-9/11 hard market. Over the next several years, Bermuda expanded its infrastructure it relied more heavily on various elements of that outside capital to fund and support that growth, and it became more dependent on the expectation of permanent outside capital. But, alas, economists tell us that capital moves where it can be deployed most efficiently (and where it feels most welcome), and other offshore jurisdictions have made a compelling case for several companies to move their base of operations away from Bermuda in recent years. I expect that trend to continue in the future. So Bermuda has some real challenges these days, some visible to the visitor and/or macro economist, but others more subtle while equally important. All of these challenges will need to be addressed in the years ahead by the Bermudian government in conjunction with the sources of outside capital. The ability to address these challenges head-on will make a tremendous difference to Bermudians and ex-pats alike — all who call the Island home.

 

What advice would you give to others in our industry who are thinking about taking a position with an insurer, reinsurer or broker in Bermuda?

 

Bermuda can add a fantastic dimension to an insurance career. It’s one of very few places where large company professionals rotate through regularly, and where those professionals are much more accessible and visible – especially in comparison to New York or other insurance markets. I strongly believe that two of the most important ingredients for success in our industry are technical competency and relationships: these are what comprise your personal brand. Both can be achieved to greater career success over time in Bermuda. By the same token, notwithstanding its tropical appeal, Bermuda is not a place where insurance professionals can kick back and relax. It’s a small marketplace where everyone knows everyone else.   So it’s critically important to work at and maintain a strong work ethic, a reputation for integrity, and strong professional relationships if one wants to make the most of a Bermuda work experience.

 

We have all seen a lot of changes in the professional liability insurance industry over the past few years. What do you think are the most important changes in the industry since you first joined, and what do you see for the industry in the years ahead?

 

One of the most important changes I’ve seen over the years has been big companies retreating from robust entry-level training programs. Some of this training has been picked up by PLUS and other organizations, and I certainly understand that it is a challenge for companies administering in-house training to quantify with any certainty the return on the training investment. But I worry about any drop-off in technical competency among the newest generation of professional liability underwriters and brokers. That would hurt our business in almost every way possible. Our industry is becoming even more complex, and we should all be very concerned about the prospect of an underwriting environment where risks are taken that aren’t clearly understood, and where underwriting companies simply follow the decisions of other underwriters because they lack the technical skills or experience to conduct their own risk/reward analysis.   I would favor a comprehensive -back- to-basics educational and training commitment for new folks pursuing a career in professional liability. The great news is that our industry is full of experienced professionals who already have demonstrated – through PLUS and other educational outlets – their willingness to share their insights and experience with the upcoming generation of professionals.

 

What advice would you have for someone just starting out in the professional liability insurance industry?

 

I would say the following: find someone in the industry who really understands technical language and who has witnessed the carnage of loss examples. Stay close to that person and learn from their experience and history. Otherwise, history will surely repeat itself – for you.

 

I know that throughout your career, you’ve devoted considerable time and energy away from work to support organizations and causes, including your service as a trustee and officer of PLUS, your role as a founding member of the Grateful Nation Montana charity, and your participation in numerous charity efforts. What are your motivations for these activities and why are they important to you? How have you been able to reconcile all of these activities with the demands of your various jobs? How do these activities fit into your longer-term career goals?

 

I was blessed with many things growing up — although financial security and a traditional family structure weren’t among them. So I don’t take either financial security or a traditional family home life for granted. To the contrary, I feel blessed every day to have my family around me. As a corollary to that thought, I believe that once blessed with resources – family support, monetary and otherwise, we have an obligation to extend ourselves for others who are less fortunate. I suppose the main driver for me (and for Brittany too), certainly with respect to Grateful Nation Montana, is the admiration and respect we have for both those brave men and women serving in our military, and for their families back at home who provide the primary emotional support for our warriors serving in the most dangerous places in the world.   Through our work with Grateful Nation Montana, Brittany and I have been privileged to walk a small part of a very tough journey with a parent, sibling, spouse or child of a soldier who has just been killed in action. It’s been a humbling and special gift to be invited into that circle of grief and healing. It’s a circle where outsiders are not often welcome. Brittany and I often marvel at the strength and courage of these family members, and how our experiences with them make us better people because of these interactions.

 

In many of your outside activities, you have teamed up with your alma mater, the University of Montana. What is it about the school that gives this University such a prominent role in your philanthropic and Foundation activities?

 

I have had a unique opportunity to build a strong, mutual trust relationship with UM over the past several years. I believe they know I will execute on part whenever we partner on an initiative, and that gives them confidence in me as partner. With that greater level of confidence, I notice that UM now seems to move in a more progressive, less bureaucratic, way on our joint initiatives. Together we have been able things that neither of us could have accomplished independently. My proof of concept? There is now a large, moving war memorial to Montana’s fallen soldiers in the Iraq and Afghanistan wars now situated prominently on the main campus of a public state university. I can’t imagine that happening anywhere else besides the University of Montana.

 

 Now that you are your family are off in Montana, will we ever see you again?

 

Of course!, I am hoping to make Montana and ALPS into a destination for quality professional liability insurance.