One of the most distinctive recent securities litigation trends has been the surge of litigation involving U.S.-listed Chinese companies. As a result of the litigation threat, as well as beaten-down market valuations, many Chinese companies are now taking steps to de-list from the U.S. exchanges. However, this step could entail its own set of litigation risks. Indeed, litigation relating to the de-listing could, according to a recent commentary, “become the next big trend in U.S. securities litigation.”

 

According to a July 11, 2012 memorandum from the Reynolds Porter Chamberlain law firm entitled “U.S.-Listed Chinese Companies: Bump-Up Claims” (here) there have been a total of 57 securities class action lawsuits involving U.S.-listed Chinese companies, 39 of which were filed in 2011. By my count, as of June 30, 2012, there only seven new securities class action lawsuits filed against U.S. listed companies during 2012. Nevertheless, these litigation developments and chronically lower market valuations have encouraged many U.S. listed Chinese companies to see to return to private ownership.

 

Though these companies are de-listing as a risk mitigation step, the process, according to the memo, could “expose the companies, their directors and D&O insurers to bump-up claims by shareholders if it is not managed carefully.” In the bump-up claim, the shareholders allege “that the consideration they received for their shares was inadequate.” The possibility of these types of claims is exacerbated by the fact that share prices for U.S.-listed companies have fallen sharply. Although some of the going private transactions have involved well-known private equity firms, others have involved management buyouts, which may encourage claims that the consideration paid was inadequate.

 

According to the memo, at least 16 U.S-listed Chinese companies have de-listed in the last two years and “at least three further large U.S.-listed Chinese companies are known to be in buy-out discussions.” And according to one source cited in the memo, as many as 50 additional companies are “presently considering, or actively seeking, de-listing.”

 

These concerns obviously have implications for the way the buy-out process is managed. There are also implications for D&O insurers. According to the memo, insurers should “brace themselves for an increase in bump-up claims” involving U.S.-listed Chinese companies. The insurers will also want to update their underwriting routines by “seeking disclosure of any de-listing plans from their insureds” and “considering limiting their exposure by endorsing a bump-up exclusion onto their D&O policies.”

 

The possibility of this type of litigation does indeed seem highly plausible. I note that though the memo refers to buy-out transactions involving U.S.-listed Chinese companies that have taken place in the last two years, it does not cite any actual examples of the referenced buy-outs resulting in litigation. Nevertheless, in an environment where virtually every M&A transaction results in litigation, it seems reasonable to assume that U.S.-listed Chinese companies going private transactions might also entail litigation. Whether this litigation is indeed the “next big trend in U.S. securities litigation” will remain to be seen.

 

For general background regarding bump-up claims and coverage for the claims under D&O insurance policies, refer here and here.

 

D&O Year in Review, 2011: Readers of this blog will be particularly interested in the July 17, 2012 publication from the Troutman Sanders law firm entitled “D&O and Professional Liability: Year in Review 2011” (here). The memorandum takes a comprehensive look at the key D&O and professional liability insurance coverage decisions during 2011. The memo is interesting and will be a great resource.  (In fact, several of the entries in the memo are relevant to items currently on my desk.)

 

Dodd-Frank Rulemaking Far Behind Schedule: It may not be news exactly, but it is still worth noting that many rulemakings required by the Dodd-Frank Act, enacted nearly two years ago, are far behind schedule. As detailed in a July 2012 report from the Davis Polk law firm (here), “Of the 398 total rulemaking requirements, 119 (29.9%) have been met with finalized rules and rules have been proposed that would meet 137 (34.4%) more.” Rules have not yet been proposed to meet 142 (35.7%) rulemaking requirements.

 

As of July 2, 2012, a total of 221 Dodd-Frank rulemaking requirement deadlines have passed. Of these 221 passed deadlines, “140 (63%) have been missed and 81 (37%) have been met with finalized rules. Regulators have not yet released proposals for 19 of the 140 missed rules.”

 

Advisen Webinar on Securities Litigation Developments: On Thursday, July 19, 2012 at 11:00 am EDT, I will be participating in free, one-hour webinar sponsored by Advisen and entitled “Second Quarter Securities Litigation Review.” The webinar will be chaired by Advisen’s Jim Blinn and will also include Terence Healy of the Reed Smith law firm. Further information and registration instructions for the webinar can be found here. I hope all blog readers will listen in, this should be a lively webinar. There is a lot to talk about.

 

Advisen’s quarterly report on 2Q12 corporate and securities litigation can be found here.

 

One of the most important sources of director protection is corporate  indemnification. But as significant as indemnification is for the protection of directors, the directors’ first line of defense, literally, is their right to advancement of their costs of defense. All too often, these two terms – advancement and indemnification – are used interchangeably, but they are in fact separate and distinct. Of critical importance, directors are entitled to the payment of their attorneys fees in advance of any determination that the directors are entitled to indemnification.

 

An interesting July 3, 2012 Ohio Supreme Court opinion (here) highlights the critical distinction between advancement and indemnification and examines the circumstances under which directors are entitled to advancement.

 

Background

Samuel M. Miller (Sam M.) is a 25% shareholder and director of Trumbull Industries, a plumbing supply company. Sam M. is also Trumbull’s Vice President of Sales. Murray Miller (Murray) and Samuel H. Miller (Sam H.) are also Trumbull shareholders and directors. 

 

In 2002, a dispute arose in which Murray and Sam H. alleged that Sam M. had usurped a corporate opportunity for his personal advantage. In February 2003, Murray and Sam H. filed a complaint against Sam M. (among others) seeking injunctive relief and damages.

 

In September 2005, Sam M. sent Murray and Sam H. a memo informing them that he had reimbursed himself out of the Trumbull corporate treasury for the costs of defending himself against their complaint, after executing an “undertaking” under Ohio Code Section 1701.13 (E)(5)(a) to repay the amounts if it is determined he is not entitled to indemnification. The undertaking incorporated the specified statutory undertaking language.

 

In December 2006, both sides sought a judicial declaration regarding Sam M.’s rights to indemnification for his legal fees. Following an almost impossibly complicated procedural odyssey, the indemnification case made its way to the Ohio Supreme Court.

 

The July 3 Opinion

In a 6-1  majority opinion dated July 3, 2012 and written by Chief Justice Maureen O’Conner, the Ohio Supreme Court overturned the intermediate appellate court’s holding that the trial court had improperly ordered Trumbull to pay Sam M.’s attorneys’ fees and reinstated the trial court’s finding that Trumbull was in contempt for refusing to pay Sam M.’s attorneys’ fees.

 

In determining Sam M.’s rights, the “Court interpreted Ohio law, but looked to judicial decisions interpreting Delaware law for “insight,” as advancement is a “Delaware specialty.”

 

At outset, the Court made an important distinction, highlighting the fact that Sam M. sought “advancement,” not “indemnification.” Though the parties and the lower courts had used the terms “interchangeably,” the terms, “though related” are “not the same and should not be used as synonymous.”

 

Murray and Sam H. (hereafter, the appellees) argued, in reliance on the Ohio statutory provisions specifying when a director is entitled to indemnification, that Sam H. was not entitled to have his attorneys’ fees paid because he was not being sued for any “act or omission” he committed on behalf of the corporation. The appellees also argued that he was not entitled to indemnification of his fees because his acts were not within the protection of the business judgment rule.

 

The Supreme Court rejected these arguments, based as they were on the statutory standards for the entitlement to indemnification, on the grounds that “the advancement of fees is neither determined by nor dependent on whether a director is entitled to indemnification.” The only issue, the Court said, is “whether Sam M. is entitled to advancement of his expenses,” not whether he will ultimately be entitled to indemnification based on the adjudication of the allegations against him.

 

The Court said that Trumbull could not avoid its statutory advancement obligation because Sam M.’s conduct, if proven, “would foreclose indemnification due to an alleged breach of his fiduciary duties.” Allowing a corporation to “avoid advancement by asserting that a director breached his fiduciary duty would make the advancement statutory provisions pointless.”

 

The only prerequisite for advancement is the execution of the statutorily required undertaking to repay, which Sam M. had done. When the director seeking advancement has executed the undertaking, “the corporation is required to advance.”

 

The Ohio statutes provide, the Court noted, that a corporation may opt-out of these mandatory advancement provisions by adding a provision to its articles of incorporation specifying that the advancement provisions do not apply. However, Trumbull had not adopted an opt-out provision in its articles, and therefore, given that Sam M. had executed the required undertaking, there was no basis for Trumbull to withhold advancement.

 

Justice Terrence O’Donnell dissented, arguing that Sam M. was not entitled to advancement because the wrongful acts of which he was accused had allegedly been undertaken in his personal capacity or in his capacity as an officer (rather than as a director) of Trumbull. Either way, the acts had not been undertaken in the sole capacity (i.e., as a director) for which he was entitled to advancement under the relevant statutory provisions.

 

Discussion

In my factual recitation above, I omitted the lengthy procedural history of the indemnification case. If nothing else, the tortured procedural history shows how contentious these kinds of disputes can become. Indeed, the original claim underlying the indemnification fight is now in its tenth year. The contentiousness in turn illustrates another point, which is the importance of working out the details of advancement and indemnification arrangements when all is calm and skies are clear. It is a terrible time to try to sort these issues out after the storm has hit.

 

The majority opinion did emphasize that under the relevant statutory provisions, Ohio corporations can amend their articles of incorporation to opt-out of the mandatory advancement provisions. However, I suspect that companies addressing these issues when all is calm are unlikely to include such an opt-out provision in the articles of incorporation. At that point, none of the directors have any way of knowing whether or not they might be the ones that would want to have their defense fees advanced, and so they would be unlikely to adopt such an opt-out provision.

 

After a dispute has arisen, a corporation or some of its board members may well want to withhold advancement from one or more directors. However, that simply underscores how important it is that the right to advancement is automatic. If it were any other way, after a falling out or during an intra-board dispute, a group of directors could act together to deprive another director of his or her rights and ability to defend themselves.

 

The automatic operation of the advancement requirement ensures that directors are able to defend themselves, even when (or perhaps particularly when) the allegations against them are serious. From time to time, controversies can arise when corporations are obliged to provide funds for directors’ defense when the directors are the subject of high-profile allegations. For example, as I discussed here, there were questions when BofA funded the defense for former Countrywide CEO Angelo Mozillo. Because the advancement rights are automatic (subject to only to the undertaking requirement), directors cannot be deprived of their defense protection even if they have become involved in controversy or they are the target of intra-corporate vindictiveness.

 

The advancement right is also very durable. In a July 30, 2008 Delaware Chancery Court opinion (here) in which then-Vice Chancellor Leo Strine held that the Sun-Times Media Group had to continue to advance the defense expenses of four former officers, including Lord Conrad Black, even though: 1) the four had been convicted of various criminal offenses; 2) the four had already been sentenced; 3) the convictions had been upheld on appeal; and 4) the company had already advanced $77 million in defense expenses for the four. Strine held that under Delaware statutory law and the applicable by-law provisions requiring advancement until "final disposition," the obligation to advance expenses continued until the "final, non-appealable conclusion" of the criminal action, which had not yet been reached.

 

Perhaps the most important aspect of the majority opinion is its insistence on the distinct difference between advancement and indemnification. All too often, observers and commentators, like the parties to this dispute and like the lower courts here, blur the distinction between the two. The two, though related, represent distinct statutory rights available for the protection of directors. Moreover, as the Court here emphasized, if mere allegations which if proven might provide a basis for withholding indemnification from a director were sufficient to deprive the director of his or her right to advancement, the statutory provisions relating to advancement would be meaningless. Advancement is available so that directors can defend themselves, without which the right of indemnification itself might also be rendered meaningless.

 

It should not be lost here that a critical prerequisite to the right of advancement is the provision of the undertaking to repay. This requirement is not a meaningless procedural step. Directors taking advantage of the right to advancement may in fact be required to repay amounts advanced in the event of a judicial determination establishing they are not entitled to indemnification. In many instances, when the time comes for repayment, the individuals lack resources out of which the might make the repayment. However, from time to time, corporations do successfully assert and establish their right of repayment. 

 

These issues surrounding the obligation to repay have recently been in the limelight, following the insider trading conviction of Rajat Gupta. Peter Lattman’s June 18, 2012 New York Times article discussing Goldman Sachs’ payment of Gupta’s legal fees and of its rights or repayment for the fees in the wake of Gupta’s conviction can be found here.

 

A potentially important issue that the majority opinion sidestepped but that the dissenting opinion stressed is the question of whether or not Sam M. was acting in capacity for which he is entitled to advancement when he engaged in the alleged misconduct of which he is accused. The majority opinion essentially said that it did not have to address the question because it had not been properly preserved on appeal. Had the majority addressed the question, the outcome of this appeal could well have been quite different.

 

For a basic overview of indemnification rights and the relationship of indemnification to D&O insurance, refer to my earlier post on the topic, here. I published the earlier post as part of my series on the “Nuts and Bolts” of D&O insurance; the complete series can be accessed here.

 

A July 2012 memorandum from the Squire Sanders law firm discussing the Ohio Supreme Court’s opinion can be found here.

 

Criminal Charges Against Former Officers of Failed Bank: It has been weeks since the FDIC has filed a civil suit against the former directors and officers of a failed bank; as reflected here, the FDIC’s last civil suit was filed in May, and that was the only civil lawsuit the FDIC has filed since April. But the FDIC has not been idle. A grand jury has returned a July 11, 2012 indictment (here) against four former officers of the failed Bank of the Commonwealth, or Norfolk, Virginia, as well as two of the bank’s customers. According to the FBI’s July 12, 2012 press release regarding the indictment (here), the investigation of the bank had been undertaking in collaboration and cooperation with the FDIC’s Office of Inspector General.

 

The Bank of the Commonwealth failed on September 23, 2011. The indictment alleges that the bank had grown rapidly between 2005 and 2009, largely based on the bank’s reliance on brokered deposits. In 2008, the volume of the bank’s troubled loans soared. The indictment alleges that from 2008 to 2011, the criminal defendants allegedly masked the bank’s true financial condition out of fear that the bank’s declining health would negatively impact investor and customer confidence and affect the bank’s ability to accept and renew brokered deposits.

 

To hide the bank’s deteriorating loan portfolio and condition, the defendants  allegedly overdrew demand deposit accounts to make loan payments, used funds from related entities—at times without authorization from the borrower—to make loan payments, used change-in-terms agreements to make loans appear current, and extended new loans or additional principal on existing loans to cover payment shortfalls.

 

The indictment also alleges that bank insiders also provided preferential financing to troubled borrowers to purchase bank-owned properties. These troubled borrowers were already having difficulty making payments on their existing loans; however, the financing allowed the bank to convert a non-earning asset into an earning asset, and the troubled borrowers obtained cash at closing to make payments on their other loans at the bank or for their own personal purposes. The indictment also alleges that troubled borrowers purchased or attempted to purchase property owned by bank insiders These real estate loans were fraudulently funded by the bank.

 

The bank’s former CEO, Edward Woodard, is charged with conspiracy to commit bank fraud, bank fraud, false entry in a bank record, multiple counts of unlawful participation in a loan, multiple counts of false statement to a financial institution, and multiple counts of misapplication of bank funds. The other defendants are charged with a variety of related charges.

 

These charges are far from the first criminal charges the enforcement authorities have filed as part of the current wave of bank failures. As discussed here (scroll down), the federal authorities are also pursuing criminal charges against certain former officers of the failed United Commercial Bank. The FDIC has also filed criminal charges against two former officers of Integrity Bank, as discussed here. There undoubtedly have been other criminal charges as well.

 

It is hard to tell from the outside, but it sure would be interesting to talk to somebody on the inside about when the FDIC upgrades its investigation of the circumstances surrounding a bank’s failure to a criminal investigation. The allegations in the indictment alone do not sound all that dissimilar from the kinds of things that the FDIC and that investors have alleged in connection with many other bank failures that have not involved criminal charges.

 

In any event, there undoubtedly will be other criminal charges to come in connection with other banks. At the same it is interesting that the pace of the FDIC’s filing of civil litigation in connection with the failed banks clearly has tailed off. Again, it is hard to tell from the outside what is going on, but it sure would be interesting to talk to somebody on the inside.

 

At the PLUS D&O Symposium in New York this past March, I participated on a panel entitled, “Financial Institutions Underwriting: Is it Safe to Come Out Yet?” The implication of the panel topic was that perhaps with the passage of the credit crisis, financial institutions might not be as big of a D&O underwriting risk as they had been perceived to be during the crisis. At the same time, the presentation of the title in the form of a question suggested that perhaps there might still be further risks ahead.

 

Subsequent events have proven that it was right to continue to ask the question. As I wrote in a post earlier this week, the LIBOR scandal, among other things, shows that the financial institutions arena remains a risky neighborhood. In the earlier post, I questioned whether the follow-on civil litigation arising in the wake of the LIBOR scandal would include securities class action litigation. We now know the answer to that question as well.

 

On July 10, 2012, a Barclays shareholder filed a securities class action lawsuit in the Southern District of New York, against Barclays PLC and two related Barclays entities, as well as the company’s former CEO, Robert Diamond; and its former Chairman Marcus Agius. The complaint, which can be found here, is filed on behalf of class of persons who purchased Barclays ADRs between July 10, 2007 and June 27, 2012.

 

According to the plaintiffs’ lawyers’ press release, the complaint alleges that the defendants participating in an illegal scheme to manipulate the LIBOR rates, and that the defendants “made material misstatements to the Company’s shareholders about the Company’s purported compliance with their principles and operational risk management processes and repeatedly told shareholders that Barclays was a model corporate citizen even though at all relevant times it was flouting the law..” Alison Frankel has a detailed July 12, 2012 post on the On the Case blog (here) detailing this new securities class action lawsuit.

 

Although (as discussed here) there has already been extensive antitrust litigation filed in connection with the LIBOR scandal, this latest securities suit against Barclays is the first securities class action lawsuit filed in the scandal’s wake. Obviously, Barclays is the only financial institution that has reached a settlement with the regulatory authorities. At the same time, however, Barclays wasn’t the only participant in the scheme. Many other companies have been implicated in the scandal. As the regulatory process unfolds and as other financial institutions reach regulatory settlements, it seems very likely that there will be further securities class action lawsuits to come.

 

While early litigation developments in this latest financial sector scandal are only beginning to unfold, the litigation fallout from earlier scandals is slowly playing itself out. There were key developments in two significant cases filed in connection with prior scandals in the financial arena.

 

First, in July 11, 2012 order (here), Southern District of New York William H. Pauley III denied in part the defendants’ motion to dismiss the securities class action lawsuit that had been filed against the Bank of American, certain of its directors and officers, its offering underwriters and its auditors, in a case filed in the wake of the mortgage foreclosure processing scandal.

 

As detailed here, the plaintiffs alleged that the bank had misrepresented its reliance (and the reliance of Countrywide Mortgage, a company Bank of American purchased at the outset of the financial crisis) on the Mortgage Electronic Registration System (MERS), a computerized system for tracking mortgages that tried to eliminate the need for mortgage originators to physically record mortgages. As the mortgage meltdown unfolded it became clear that it would be difficult if not impossible for the bank to foreclose on mortgages in MERS.

 

The plaintiffs also alleged because of the bank’s reliance on MERS, the bank had breached the warranties it had given in connection with mortgage securitizations that it had good title to the mortgages, and also had breached its mortgage underwriting standards, as a result of which, the plaintiffs allege, the bank is liable for repurchase claims by mortgage securitizers for billions of dollars worth of mortgages. The plaintiffs also allege that in connection with a December 2009 securities offering, the defendants misrepresented the problems associated with the bank’s reliance on MERS as well as the bank’s vulnerability to repurchase claims.

 

Judge Pauley granted the defendants’ motions to dismiss the plaintiffs’ Section 11 claims relating to the December 2009 offering, on statute of limitations grounds. Judge Pauley also granted the motions of the individual director and officer defendants, as well as of BofA’s offering underwriters and auditors, as to all of the remaining allegations. However, the dismissal of the claims (other than the Section 11 claims relating to the December 2009 offering) against the individual defendants was without prejudice. And most importantly from the plaintiffs’ perspective, Judge Pauley denied the motion to dismiss of the bank itself other than with respect to the Section 11 claim.

 

I have added this ruling to my running tally of subprime and credit crisis-related dismissal motions rulings, which can be accessed here. Jan Wolfe’s July 11, 2012 Am Law Litigation Daily article discussing Judge Pauley’s ruling can be found here.

 

Second, in an earlier case arising from the subprime meltdown and credit crisis, on July 9, 2012, the parties to the subprime mortgage securities suit involving BancorpSouth filed a stipulation of settlement indicating that they had agreed to settle the case for $29.25 million. The settlement is subject to court approval. According to the parties’ stipulation (a copy of which can be found here), the settlement is to be entirely funded by D&O insurance; the stipulation provides that as part of the settlement, the defendants will “cause their directors’ and officers’ insurers” to pay the $29.25 million into escrow.

 

As detailed here, the plaintiffs had first filed their suit against BancorpSouth and certain of its directors and offices in the Middle District of Tennessee in May 2010.  The plaintiffs alleged that as the credit crisis had unfolded, the bank had been slow to recognize losses in its lending portfolio, instead claiming that it its portfolio was of a higher quality than those of other lending institutions. Ultimately the bank was forced to recognize extensive losses. The plaintiffs alleged that the bank had failed to properly account for its construction and commercial real estate loans, failing to reflect impairment in the loans and had not adequately reserved for loan losses  On January 24, 2012, the court entered an order accepting the magistrate’s recommendation that the defendants’ motions to dismiss should be denied.

 

I have added the BancorpSouth settlement to my list of subprime case resolutions, which can be accessed here.

 

Dodd-Frank Whistleblower Developments: We are still awaiting the payment of the first whistleblower bound under the Dodd-Frank Act’s whistleblower provisions. But that is not to say that there have not been any developments. To the contrary there have been several recent rulings in various legal proceedings involving the Dodd-Frank Act whistleblower provisions.

 

As Jan Wolfe notes in a July 10, 2012 article in the Am Law Litigation Daily (here), several courts have recently shed significant light on the Dodd Frank whistleblower provisions. Among other things, one court has ruled that the provisions give retroactive protection to the whistleblowers at subsidiaries of public companies, not just to whistleblowers at the  publicly traded parent company. However, an earlier court ruled that, because the Dodd-Frank Act is silent about the extraterritoriality of the whistleblower provisions, the provisions do not apply extraterritorially.

 

One of the many gifts my wife brought to our marriage was a generations-long family tradition of spending summers in Pentwater, Michigan. If I were, like a true Michigander, to hold up the back of my left hand as a map of Michigan’s mitten-shaped lower peninsula, I would point to the outside knuckle at the base of my little finger, to show where Pentwater is located, on the eastern side of Lake Michigan, between Muskegon and Ludington.

Pentwater was established in the years after the Civil War as a lumbering and furniture- making center. There is still some manufacturing in town, but the lovingly maintained Victorian homes are now mostly occupied by retirees. The village’s main street runs parallel to the Lake Michigan shoreline, and perpendicular to Pentwater Lake, which connects to the big lake through a channel. Along the Lake Michigan shoreline north of channel outlet is Mears State Park beach. Our cottage is along the shoreline a mile north of the state park.

In Pentwater, we are “off the clock,” both figuratively and literally. Solar time governs daily activities. The day begins at sunup, with a walk through the woods into the village, along the channel, and out to the signal beacon at the end of the channel breakwater. From that vantage point, the beach curves away, about 20 miles north to Big Sable Point, and about 10 miles south to Little Sable Point. The vast expanse of the lake spreads far beyond the horizon, to Wisconsin, 60 miles away. The lake bottom close into shore is only a few feet deep. A couple of miles out, though, the lake is over 500 feet deep, and a little further north the lake is nearly a thousand feet deep. Lake Michigan is big — its surface area is about the same size as West Virginia. Arching over it is the vast blue dome of the sky.

Sheboygan, Wisconsin is directly across on the other side. The good people of Sheboygan are revered in our house, as — according to solemn assurances we provided our children when they were small — at sunset the faithful citizens of Sheboygan catch the sun before it falls in the lake, and then using means both secretive and mysterious, transport the sun back around to the Michigan side of the lake in time for sunrise the next morning.

At midday, the noon whistle in the village sounds, which means it is time to take the bicycles out from under the cottage. We ride out Park Street, past the volunteer fire department, past the library, past the school, and out across the Pentwater River into the countryside. The road traverses a short stretch of the Manistee National Forest, and then rolls out into fields of corn, orchards, pumpkin patches, and Christmas tree farms. As a lifetime city dweller, it is always a little bit of a surprise to me how close the countryside is.

In the afternoon, we pull the kayaks out from behind the dunes and down to the water’s edge. These are the open cockpit, flat bottom kind of kayaks. They are more stable in the lake’s choppy water. When our kids were small, we would have point-to-point races and distance challenges, but these days I prefer a more leisurely paddle along the Lake Michigan shoreline, or through the channel and into Pentwater Lake. It always strikes me how out on the water, even just a couple of hundred feet offshore, the trees, houses and people back on shore look so small and the lake seems  so immense. I suppose that is the reason we go on vacations, to get that kind of perspective. From a distance, all those problems that loom so large can seem so small and unimportant.

These days I prefer a more leisurely paddle along the Lake Michigan shoreline (drone picture captured in July 2024).

As I paddle along, the small boy in me comes out, and I imagine that I am a voyageur, looking for natives with whom to trade for pelts and furs. Actually, the presence of natives is not such a stretch. A prized photograph in my wife’s family’s archives shows her great-grandmother standing on the beach, next to a Native American on a pony. (The presence of the Native American has never been fully explained to me). One of the most interesting features of the photograph is the appearance of the hills in the background. Today the hills are thickly wooded with huge, mature trees, but in the picture the hills are as bare as the face of the moon. The trees were cleared as lumber to help rebuild Chicago after the Great Fire. The wood from the first cut of the virgin forest is still so highly prized that today salvage crews retrieve sunken lumber from shipwrecked boats entombed in the icy depths of the lake’s bottom.

After kayaking, it is time for a swim. My experience with lake swimming prior to first coming to Lake Michigan had been uniformly unpleasant, involving algae-laden brown water and muddy lake bottoms. Swimming in Lake Michigan is an entirely different experience. The lake bottom and shore line are covered with fine, white sand. The vast freshwater reservoir itself is a parting gift of retreating glaciers. The water remains generally clear and clean and refreshing. In the last century, the lake has endured a number of insults – industrial pollution, farm runoff, and invasive species. It is a wonder that the lake is as healthy as it is. We all have a stake in maintaining its health. We can live without oil but we can’t live without water, and the Great Lakes together contain over 20% of the world’s fresh water. A late afternoon swim is a compelling reminder of water’s restorative power.

When the kids were smaller, we would all gather for dinner at the large dining table in our cottage – our kids, my brother-in-law’s kids, and my wife’s cousin’s kids. A hungry, tumultuous mob. We would have barbecued chicken, corn on the cob and green beans from the Farmers’ Market, and fresh bread baked in the wood-fired clay oven my brother-in-law and the kids built next to his cottage a few summers ago. (For obscure reasons, the clay oven is referred to as “Bob.”) We also have local fresh fruit – cherries, apricots, melons, and blueberries. Among the many gifts my wife brought to our marriage is a particular talent for transforming blueberries into delicious treats – blueberry pie, blueberry crisp, blueberry cobbler, blueberry muffins, and more.

We pick the blueberries ourselves at Hayes Farm, out beyond the Driftwood Golf Course (nine holes for ten bucks. If no one’s there, you put your money in a coffee can by the first tee. Just make sure to bring a sand wedge.). With the kids working as conscripted labor, we can harvest many buckets of blueberries in a short time. The farm owners encourage pickers to eat blueberries while picking, which is part of the pleasure. The smaller, sweeter Jersey blueberries are better for baking. The larger, juicier Bluecrop blueberries are better for eating fresh, or for freezing. We put together dozens of freezer bags of the berries, so that in February, we can have the blueberries on oatmeal, like sweet purple marbles of preserved summer sunshine.

On Thursday evening, there is a band concert in the bandstand on the village green. Families gather and sit on blankets or folding chairs, and little kids run around playing chase games or eating ice cream cones from the House of Flavors ice cream parlor across the street. My kids used to like to sit in the branches of a big maple tree behind the bandstand, but two years ago the maple was struck by lightning and they had to remove the rest of the tree. The band members range from their mid-teens to their mid-80s. They play a medley of tunes, including marches, college fight songs, and patriotic melodies. For example, the band might play the Wisconsin fight song, the official words of which, I am informed and believe, are: “On Wisconsin! On Wisconsin! We don’t know the words! We don’t know the words, so we’ll just MAKE THEM UP! Rah Rah Rah!”

The highlight of the concert is when the band plays “Stars and Stripes Forever,” which features a crowd-pleasing piccolo solo. Out in front steps a little girl no bigger than your thumb. With presence and aplomb, she plays the solo as if she were the designated herald for the dawning of the new age.

After the concert, the thing to do is to walk up Hancock Street to the Antler Bar. The Antler Bar looks exactly like you’d expect a place in rural Michigan called the Antler Bar would look. There is a big set of antlers on the wall behind the bar, and several other sets on the other walls. The walls are also covered with sports memorabilia. Like all right-thinking people everywhere, the management of the Antler favors the University of Michigan. (The Village Pub up the street favors Michigan State. We do not patronize The Village Pub – even though it does have a cool outdoor terrace with a view of Pentwater Lake). For the boating crowd, the Antler serves upmarket draft beers like Stella Artois and Guinness, but the thing to do is to order a longneck Bud, and then drop a quarter in the jukebox. You can play any song you like, as long as it’s by Bob Seger.

Because Pentwater is on the western edge of the Eastern Time Zone and so far north, it doesn’t get dark there until quite late. In late June and early July, the sun doesn’t set until about 9:30 pm, and it isn’t completely dark until almost 10:45 pm. Even after a round or two in the Antler, the sun will likely still be above the horizon. Walking home along the beach, we can watch the sun set. As the sun sinks slowly toward the horizon it casts a cascade of colors across the western sky; and  the orange, reds and yellows of the sunset give way to purples, blues and greens after the sun has gone down. After sunset, a small gesture of appreciation for the good people of Sheboygan always seems appropriate. All hail the citizens of Sheboygan, faithful Stewards of the Sun.

When darkness has finally gathered, the sky reveals a brilliant array of stars. Because there are no nearby metropolitan areas, the stars are uncommonly clear. The Milky Way is a broad smear of stars arching across the sky. In August, when the skies are clear, we go down to the beach with blankets and lay on our backs to watch the Perseids meteor shower. The shooting stars arch across the sky about one a minute or so. At times the shooting stars appear so frequently that it can feel as if you are the one that is falling.

In mid-August, the village hosts its annual Homecoming celebration. There are games and prizes on the village green, a sand-castle contest on the state park beach, and a Coast Guard water rescue demonstration in Pentwater Lake. In the afternoon, there is a parade through the village. Proud veterans in uniform carry the flag, and girls in shiny costumes twirl batons. There are squadrons of antique cars (this is Michigan, after all). Political candidates work the crowd. There are floats from various local businesses, and there are also separate floats for Mrs. Asparagus and for the Cherry Princess. The highlight of the parade is the locally famous Scottsville Clown Band. The Clown Band marches in costume, with some dressed, for example, as clowns. A disturbingly large number of the (male) band members are dressed as women. The parade culminates with a band concert on the village green.

On the Saturday evening of Homecoming weekend, the village shoots off fireworks from the channel breakwater. The brilliant colors of the fireworks are beautiful as they reflect off the Lake’s shifting surface. The Homecoming fireworks are always a bittersweet pleasure, because they signal that summer is coming to an end. The next day, it is time to close up the cottage, pack up the car, and head home to school and to work.

When my oldest daughter was young, she would cry as we pulled away from the cottage. I know she was crying because summer was over, but as time has passed, and now that she has a job and a life of her own out on the West Coast, and she can’t come out to the Lake most summers, I appreciate that she was also crying for the fleeting days of her youth, gone now and beyond retrieval. That is a part of parenting I never anticipated — that as a parent I would mourn my own children’s lost youth.

I always wondered what Pentwater looks like out of season. In October a couple of years ago, I had a business trip to Lansing, and afterwards I drove out to Pentwater to have a look. It was one of those sunny October days when it was warm enough to wear shorts and to walk barefoot on the beach. The scene was strange – everything was familiar but somehow altered. The cottages were all closed, the trees had changed colors, and the dune grass was dry and brown. The sun was much further South in the sky than I had ever seen it, and at an odd angle too. As I walked along with the warm sun in my face and the warm sand underfoot, and not another soul around for miles, I thought to myself, I could do this forever.

Forever.

The word reverberated as if it had been sung in my ears by a heavenly host of angels.

Man. I went to see what the beach looked like out of season and came away with a glimpse of eternity so convincing it took my breath away.

Tell you what. Get yourself something cool to drink, and let’s go out and sit on the screen porch. We can talk about anything you like. Or we can just listen to the breeze rinse through the pines, and further off, the waves falling on the shore.

Yes, better just to sit quietly. July doesn’t last forever. We should savor it.

Another busy day in the village

Painted Ladies of Pentwater

Pentwater Lake

The Channel

Until we journey to the Timeless Shore, we should savor the time we have

 

More Pentwater Pictures

Northern Lights, August 2024

Looks like its time for an evening drink with a friend

Moonlight over Lake Michigan

The fallout from the alleged manipulation of LIBOR and other interbank offered rates continues to accumulate. In the wake of Barclays’ record fines, the regulatory investigation continues, and authorities reportedly have also launched criminal investigations. Along with the governmental investigatory and enforcement activity has also come civil litigation activity as well.

 

The latest suit to be filed is an antirust action filed I on July 6, 2012 in the Southern District of New York. The complaint, which can be found here, alleges that Barclays, several Barclays entities, and several other banks, conspired to artificially manipulate the reported European Interbank Offered Rates (“EURIBOR”), which, the complaint alleges is “the baseline interest rate used in the valuation of more than $200 trillion in derivative financial products.”

 

 The complaint, which purports to be filed on behalf of a class of persons or entities in the United States who purchased EURIBOR-related financial instruments between January 1, 2005 and December 31, 2009, relies heavily on documents, emails and other materials and information amassed as part of the governmental investigations. The complaint alleges that the defendants entered an agreement in restraint of trade, in violation of Section 1 of the Sherman Act. The complaint also alleges violation of the Commodity Exchange Act. The plaintiff’s lawyers’ July 6, 2012 press release about the EURIBOR antitrust suit can be found here.

 

Allison Frankel has a thorough overview of the Euribor antitrust lawsuit in a July 9, 2012 post on her On the Case blog (here).

 

The recent EURIBOR antitrust action is far from the only civil action to follow in the wake of the governmental investigation.  According to a May 2012 PLUS Journal article  by Eric Scheiner and Jennifer Quinn Broda of the Sedgwick, Detert, Moran & Arnold law firm entitled “Move Over Subprime? Financial Institutions and Brokers Face Increasing Concerns Over Allegation of Improper Libor Manipulation” (here), in 2011, at least 21 class action lawsuits were filed I n various U.S. federal courts against numerous Libor member banks. These lawsuits were instituted by institutional investors who purchased interest rate swaps tied to Libor and who claim they lost millions through the alleged manipulation of the interbank rate or who lost money on other interest-rate sensitive investments and instruments. Further background about these antitrust suits, which have now been consolidated, can be found here.

 

Nor are these institutional investor lawsuits the only suits to emerge. According to a June 27, 2012 memo from the Kennedys law firm (here),   there have also already been at least two shareholders derivative lawsuits filed, one brought by a Bank of America shareholder and another by a Citigroup shareholder, against former and current directors and officers of those firms, alleging breaches of fiduciary duty “regarding lack of oversight relating to the bank’s purported manipulation and suppression of LIBOR as early as 2006.”

 

The ultimate scope of the Libor scandal remains to be seen, but the stakes involved are clearly enormous. To date, only Barclays has paid regulatory fines, but many other banks, perhaps dozens of banks are likely to become involved. The costs involved – both for defense expenses and for fines and penalties – will be massive. How massive remains to be seen, as we clearly are still just at the outset of this unfolding scandal.

 

What all of this may mean from an insurance perspective also remains to be seen. The regulatory fines and penalties are not likely to be covered. The companies’ costs incurred in the regulatory investigations also are not likely to be covered, as the typical D&O policy provides little coverage for entity related investigative costs, particularly outside of the securities law context.

 

The D&O insurance implications of the civil litigation are  not entirely clear.  The antitrust lawsuits primarily target the company defendants. There have been no individual defendants named in the antitrust suits. The typical public company D&O insurance policy provides entity coverage only for securities claims, which do not appear to be involved in the antitrust suits. In addition, private company D&O insurance policies often have antitrust exclusions. The derivative lawsuits may represent an entirely different matter. The derivative suits name individuals as defendants and alleged breaches of fiduciary duties, not antitrust violations. The derivative claims would be far more likely to be covered under the typical D&O policy.

 

The ultimate consequences for the companies involved and their insurers will only emerge over the coming months and years as this scandal continues to unfold. It does seem likely that the related civil litigation will continue to accumulate. To the extent additional derivative claims are filed, or if shareholders of target banks file securities claims, the follow-on civil litigation could develop into a significant event for the D&O insurance industry. At this point, the one thing that is clear is that it will pay to watch closely as the investigation unfolds and the follow-on civil litigation continues to emerge.

 

A July 2012 memo about the Libor investigation and possible insurance implications from my friend Nilam Sharma of the Ince & Co. law firm and her colleague Simon Cooper can be found here.

 

Special thanks to the several loyal readers who sent me copies of the EURIBOR antitrust complaint. Edvard Pattersson’s July 7, 2012 Bloomberg article about the EURIBOR antitrust suit can be found here.

 

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.