There seems to be a general consensus that the amount of M&A-related litigation is increasing. The question of how to quantify the increase has attracted quite a bit of attention lately. In a recent post, I previewed a forthcoming report from Cornerstone Research that will provide detailed statistic analysis of the M&A litigation phenomenon.

 

My post attracted considerable commentary, and also drew a communication from NERA Economic Consulting, which has released its own statistical analysis of M&A-related litigation, and which they shared with me.

 

In addition, this week I separately received from Ohio State University Law Professor Steven Davidoff a copy of the January 1, 2012 paper that he and Notre Dame Finance Professor Matthew Cain have written entitled “A Great Game: The Dynamics of State Competition and Litigation” (here), in which they analyze M&A related Litigation from 2005-2010., with particular attention to the question of whether or not there is now competition between the states for this type of corporate litigation. Davidoff should be familiar to many readers as The Deal Professor from the New York Times Dealbook blog.

 

These two reports add substantial additional quantitative and analytic support for the general observations surrounding the growth in M&A-related litigation. Both of these reports corroborate the explosive growth in M&A-related litigation in recent years. I examine both of these reports below, starting first with Professors Davidoff and Cain’s analysis.

 

Professors Davidoff and Cain’s Paper

The Professors’ primary interests relate to the question of whether or not the states are competing for corporate litigation. Their interest in this question is driven in part by recent analyses suggesting that Delaware may be losing “market share” for this type of litigation. In order to determine how “both attorneys and courts interact in this game,” the authors examine state court merger litigation. The authors analyzed 955 merger transactions that took place between 2005 and 2010 and having a transaction value great than $100 million.

 

The authors found that 49.7 percent of transactions during that period attracted at least one shareholder lawsuit, and that the litigation rate increased “sharply” during the period, with only 38.7 percent of the transactions incurring litigation in 2005, compared to 84.2 percent in 2010. In addition, merger transactions increasingly are attracting multiple lawsuits. In 2005, only 8.6 percent of the deals attracted litigation in more than one jurisdiction, compared to 46.5 percent in 2010.

 

The authors found that during the sample period, 69.8 percent of cases settled, while 30.2 percent were dismissed. Only 4.9 percent of the settlements involved in increased in the amount of the transaction consideration, while 52.1 percent of the settlements involved only the disclosure of additional information. The average plaintiffs’ attorneys’ fee for settled suits is $1.4 million. Cases that settled for additional disclosure only pay the lowest level of attorneys’ fees (average attorneys’ fees of $793,000) while settlements involving an increase in the deal consideration  pay the most (average attorneys fees $8.5 million)

 

The authors used this information to calculate an expected dismissal and attorneys’ fee baseline, as a way to measure “unexplained” dismissal rates and attorneys fees. The authors used these unexplained amounts as an “indicator for state competition.” The authors found significant variation across states, with certain states awarding higher fees than others. Delaware awarded fees $400,000 to $500,000 higher while dismissing a greater portion of cases than other states.

 

The authors found some statistical support for the claims that Delaware is losing the state court litigation competition, but they also found that “the game” is complex and that the dynamic varies depending on which states are compared. The authors also found evidence that Delaware’s courts are responsive to this competition, concluding that Delaware’s courts award” higher attorneys’ fees to compensate for a higher dismissal rate,” and adjust “dismissal rates down when it loses prior cases to other jurisdictions.” The authors cite the recent $300 million award in the Southern Peru Copper case as an indication that Delaware is” competing more overtly in this game.”

 

The NERA Economic Consulting Presentation

In a December 6, 2011 presentation done in conjunction with the Wilson Sonsini law firm and entitled “Merger Objection Litigation” (here), NERA provided a detailed statistical review of M&A-related litigation. The NERA study is based on the firm’s examination of the 731 merger transactions it identified as having been announced between 2006 and 2010 and that were completed by February 28, 2011, and that had a value equal to or greater than $100 million. NERA found that 285 of those transactions were challenged in a state or federal lawsuit, through June 20, 2011. NERA also found that litigation settlements had been reached in connection with 162 of the deals.

 

The NERA study found that while there were fewer deals overall in the last three years of the 2006-2010 study period, the incidence of M&A related litigation escalated significantly in those three later years. Thus, while only 26.1% of the 2006 deals and only 21.9% of the 2007 deals attracted litigation, 45.4% of the 2008 deals, 78.6% of the 2009 deals, and 60.7% of the 2010 deals attracted litigation. Though the 2010 figure represent a slight decline from the prior year, the 2010 level of litigation still represents a significant increase compared to the earlier years in the study period.

 

The NERA study also found that throughout the 2006-2010 period, the litigation rate increased as the size of the deal increased. Thus, only about 25% of the deals under $500 million attracted litigation, but 38.7% of the deals between $500-$999 million, 40.8% of the deals between $1 billion and $1.9 billion, 53.0% of the deals between $2 billion and $4.9 billion and 70.1% of the deals equal to or greater than $5 billion attracted litigation.

 

Merger objection litigation can be expected to arise fairly quickly after the deal is announced. The NERA study shows that a third of the litigation arrives in the first two days after the deal is announced and about 60% arrived in the first week. 81% of the merger litigation arrives within the first thirty days after the deal is announced. Although the takeover target is consistently named as a defendant in this litigation, 70% of the time the named defendants also include the acquirer.

 

The vast majority of the litigation is filed in state court only. 83% of the deals that were litigated attracted only state court litigation. Another 14% attracted both state and federal litigation. Only three percent of the deals attracted only federal court litigation.

 

The NERA study suggests that many of the deals that attract litigation are attracting litigation outside Delaware. Of the deals that were litigated, 20% were litigated only in Delaware and another 13% were litigated in both Delaware and another state. So about one third of the deals that attracted litigation were litigated at least in part in Delaware. The remaining two thirds of the deals were litigated only outside Delaware. However, the presentation does not show how many of the deals that were litigated only outside Delaware involved target companies that were incorporated in Delaware. The presentation also does not show whether or not the prevalence of litigation outside Delaware changed during the 2006-2010 study period.

 

With respect to the M&A-related lawsuits in the study period that had settled, the NERA report found that the vast majority of the settlements involved cash payments of less than $1 million. 106 of the 154 settlements in the settlement analysis (nearly 69%) settled for less than $1 million. Another 33 out of the 154 in the settlement analysis settled for less than $10 million. Only 15 of the 154 settlements in the analysis settled for amounts of $10 million or greater, including only 4 with settlements between $100 million and only one with a settlement greater than $1 billion. (The NERA presentation includes a detailed list of the largest settlements at slide 19.)

 

Thus, while the settlement period included a few very large settlements, the vast majority of the settlements were for less than $10 million, and more than two-thirds were below $1 million.

 

In fully 87% of the litigated deals that had settled, the only beneficiary from the monetary settlement was the plaintiffs’ attorneys. In only 9% of the settlements did the beneficiaries include both the plaintiffs’ attorneys and class members. Thus the vast majority of monetary settlements pay only for the plaintiffs’ attorneys’ fees and expense, and the “benefits” to the class, although occasionally monetary, more often take another form, such as reduced target company termination fee; fuller disclosure; or improved corporate governance.

 

Discussion

The information in these two studies provides valuable additional perspective on the increasingly important M&A-related litigation phenomenon. The two studies corroborate that in creasing numbers of M&A transactions are attracting litigation. The NERA data also provides some interesting additional information that has not been a part of other statistical perspectives on this litigation phenomenon, including in particular the data showing how quickly the lawsuits arrive and the information showing the range of settlement outcomes.

 

The Professors’ report provides additional information about the increasing prevalence of multi-jurisdiction litigation, as well as average attorneys’ fees and dismissal rates. Perhaps most significantly, the Professors’ study provides important insight into the question of state competition for corporate litigation.

 

The data in these studies are directionally consistent with the previously released studies, including the information I previewed in a recent post about the forthcoming Cornerstone Research report. They are also directionally consistent with each other, while differing somewhat in their details. The two reports also differ somewhat from the Cornerstone Research data I previously reviewed.  (The Cornerstone Research analysis suggests a higher litigation rate both in 2007 and in 2010 than the analysis in either of the two studies discussed above, although all three of the analyses agree that that the litigation rate increased between 2007 and 2010.)

 

The difference between the analyses may be attributable to the differing data sources used in the studies. There may have been methodological differences as well. For those of use who are studying and trying to understand the growing M&A-related litigation phenomenon, it will be important to understand these differences. We can certainly hope as the various research sources release their analyses that they will help the rest of us understand not only where their data came from and how it was analyzed, but how the approach they used may differ from other analyses that have been published.

 

In any event, no matter how you slice it, the level of M&A related litigation is growing. The defense expenses and settlement amounts associated with this litigation represent a growing problem as well. All signs are that this phenomenon will remain a significant part of the corporate and securities litigation landscape for the foreseeable future. For that reason it will remain important to understand what this litigation means. The willingness of NERA and of the Professors to share their analysis is extraordinarily helpful in that regard. Along those lines, I would like to express my deep thanks here to NERA and to Professor Davidoff for their willingness to share their presentations with me.

 

Seven Nation Army: Even though I was not even really focusing on it, I had noticed recently that marching bands and sporting fans everywhere have picked up the same tune, as a rallying cry, as a communal chant, as basic crowd background noise. But if you had asked me to focus on it, I still might not have been able to name the tune. A January 13, 2011 article on Deadspin identified the tune, and also explained how it managed to take over the sportworld.

 

The song is “Seven Nation Army,” a 2003 tune from the alternative rock band, The White Stripes. Just in case you don’t think you know the tune, I have included a video below of the band performing the song. (I guarantee you if you listen to it, you will say – “Oh yeah, that song. I always wondered what that was.”) I was on the alert for it this past weekend, and I noticed that both the San Francisco crowd at the 49ers/Saints game and the west London crowd at the English Premier League game between Chelsea and Sunderland were chanting the tune during their respective games on Saturday. All very odd for an alternative rock song. But I guess it isn’t any weirder than that fact that a lot of marching banks have also picked up “Carmina Burana” from classical composer Carl Orff.

 

In any event, for today’s musical interlude, here’s The White Stripes performing “Seven Nation Army.” Now you will know what the heck all of those fans are trying to chant. (My apologies to all of those rock music aficionados – most half my age — who think I am an idiot for not knowing the song before; please consider my age, location and occupation, and I think you will see how unlikely it is that I would be fully versed in the contemporary alternative rock scene.)

 

In a January 12, 2012 opinion that quotes from (and relies upon) former Treasury Secretary Henry Paulson’s credit crisis memoirs, Southern District of New York Judge Richard Holwell granted in part and denied in part the motion to dismiss in the subprime and credit crisis related securities class action lawsuit that investors had filed against General Electric, certain of its directors and officers, and its offering underwriters. A copy of Judge Holwell’s opinion can be found here.

 

Background

As discussed in greater detail here, the plaintiffs first filed their action in March 2009, alleging that the company had failed to disclose information regarding the company’s health and the health of its financial subsidiary, GE Capital, at the height of the financial crisis. As Judge Holwell summarized it, the plaintiffs allege that “during a time when the financial markets were crumbling and companies across the United States were scrambling to disclose their holdings in subprime loans, GE withheld information regarding its substantial holdings in subprime and non-investment grade loans and touted GE as safe in comparison to its competitors, despite the fact that GE was also feeling the impact of the financial crisis.”

 

Specifically, the plaintiffs allege that GE made misstatements about its ability to fund itself through commercial paper; the quality of its loan portfolio; its ability to maintain its dividend; and its projected 2009 profits. The plaintiffs also alleged that GE violated GAAP by improperly recharacterizing certain of its assets from short-term to long term and by maintaining inadequate loan loss reserves. The plaintiffs allege that the defendants made misleading statements on these topics throughout the class period from September 25, 2008 to March 19, 2009, in violation of the Section 10 (b) of the ’34 Act; and in connection with GE’s October 7, 2008 stock offering, in violation of Section 11 of the ’33 Act.

 

Three particular alleged statements on which the plaintiffs sought to rely proved to be particularly important in Judge Holwell’s rulings on the motion to dismiss. First, with respect to the plaintiffs’ allegations regarding the company’s ability to rely on commercial paper as the credit crisis peaked in September 2008, the plaintiffs’ rely on statements in Henry Paulson’s book, On the Brink, in which Paulson states that GE CEO Jeffrey Immelt called Paulson at least twice that month  allegedly to report that the company was finding it very difficult to sell its commercial paper for any term longer than overnight.

 

Second, the plaintiffs’ relied on Immelt’s statements in December 2008 with respect to the company’s $1.24 annual dividend: “What can you count on? You can count on a great dividend,” specifically referencing the $1.24 dividend level. The company later cut its quarterly dividend for the second half of 2009 from 31 cents a quarter to ten cents per quarter.

 

Third, according the plaintiffs, throughout the class period the defendants made statements describing their loan asset portfolio as “very high quality” and using various similar descriptions. The plaintiffs contrasted this with GE’s March 2009 release in which it specified that 42% of GE Capital’s $183 billion in consumer loans were made to non-prime borrowers and at least $145 billion of its $230 billion commercial lending and leasing portfolio consisted of loans to non-investment grade companies.

 

Judge Holwell’s Opinion

In his January 12 opinion, Judge Holwell held that the plaintiffs had adequately alleged falsity as to their allegations about the GE’s ability to access the commercial paper marketplace; as to the quality of its loan asset portfolio (and in particular its exposure to subprime credits); and with respect to the reliability of the company’s annual dividend. He concluded that the plaintiffs had not adequately alleged falsity as to the other allegations.

 

In concluding that the plaintiffs had adequately alleged that Immelt had acted with scienter, Judge Holwell found, in reliance on the statements from Paulson’s book, that the plaintiffs had adequately alleged that Immelt himself made “contradictory statements to Henry Paulson.” With respect to Immelt’s December 2008 statements about the reliability of GE’s dividend, Judge Holwell rejected the competing inference that Immelt made the statements while struggling to come to terms with a rapidly changing environment:

 

Immelt’s categorical statements that investors could “count on” a dividend and that GE was having “no difficulties issuing commercial paper are not the sort of cautious statements one would expect of a CEO attempting to come to grips with the effects of the economic crisis on his company. Instead, it can be argued that Immelt was attempting to convince the public that the economic crisis was not affecting GE too drastically and that they should continue to invest in GE. Of course, a CEO is allowed to convince the public to invest in his company, but not at the expense of providing it with accurate information about the company’s financial health.

 

In concluding that GE’s CFO Keith Sherin acted with scienter with respect to certain statements about the quality of the company’s loan asset portfolio, Judge Holwell essentially said that the plaintiffs had adequately alleged that Sherin should have known the extent to which GE Capital had made extensive loans to lower quality borrowers. Judge Holwell said “it is highly improbable that Sherin, the CFO of a company 50% of whose revenues were derived from financial services in 2008, would not inquire whether his company was exposed to the subprime consumer borrower and its counterpart in the commercial sector.”

 

Significant parts of the plaintiffs’ ’33 Act claims also survived the motion to dismiss, including in particular plaintiffs’ allegations about the company’s ability to access commercial paper and the quality of the company’s loan asset portfolio and its exposure to subprime credits. Judge Holwell found that the plaintiffs’ remaining ’33 Act allegations were insufficient, but his denial of the motion to dismiss with respect to at least some of plaintiffs’ allegations means that the offering underwriter defendants remain in the case.

 

Victor Li’s January 13, 2012 Am Law Litigation Daily article about Judge Holwell’s ruling can be found here.

 

Discussion

At least a part of plaintiffs’ case would have survived the defendants’ motions to dismiss even without the benefit of Henry Paulson’s statements in his book about his September 2008 telephone conversations with Jeffrey Immelt. But Paulson’s account of the conversations clearly had an impact. At a minimum, Judge Holwell referenced the Paulson’s account of the conversations several different times in his opinion.

 

I am not aware of a prior case where the statements of a former cabinet secretary in his or her memoirs has provided even a partial basis for the denial of a motion to dismiss in a securities class action lawsuit. The plaintiffs’ reliance on Paulson’s memoirs has to qualify as one of the more unusual ways that plaintiffs have established (at least for pleading purposes) that there was a difference between what the company was saying publicly and what its officials were saying behind closed doors. (The defendants will of course argue that there was no difference or if there was it is entirely explainable, which of course are arguments they will raise as the case goes forward.)

 

It is interesting to reflect on the sheer fortuity of the fact that Paulson chose to report on those conversations in his book, and that his book was published at a time that allowed the plaintiffs to be able to rely on those statements in their amended complaint. Of course, all of this does mean that as (or perhaps if) the case goes forward, Paulson’s deposition in this case would appear to be inevitable. (Of course, this case is not the only one in which the underlying narrative involved Paulson; Paulson’s conversations with BofA CEO Ken Lewis in December 2008 also play a central role in the securities class action lawsuit arising out of the BofA/Merrill Lynch merger.)

 

It is also interesting to reflect that in the middle of one of the worst financial crises in the country’s history, Immelt could pick up the telephone and call the Treasury Secretary to tell him about the problems his company was having. The CEOs of a vast number of companies were also going through crises at that very moment, but very few of them had the option to call the Treasury Secretary to complain to him about their companies’ problems. It is rather remarkable, even given how large a company GE is, that Immelt had this option. Indeed, given what we know about what else Paulson had on his plate during September 2008 (i.e., avoiding the collapse of the entire  global financial system), it really is kind of astonishing that Immelt could just call him up and that Paulson could take his call.

 

In any event, this case will now be going forward. Given the size and prominence of the company, and the fact that the case has now survived the motion to dismiss, this case has to be added to the list of pending high-profile subprime and credit crisis-cases worth watching. Very few of these cases go to trial; most settle. In this and some of the other high profile credit crisis cases – Citigroup; the BofA/Merrill Lynch merger case; Bear Stearns; AIG – it will be very interesting to see how the likely settlements of these cases will unfold. Without knowing for sure how any one of them ultimately will turn out, there undoubtedly will be some very interesting settlements from among these cases.

 

I have added Judge Holwell’s ruling to my tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.

 

More About the $40 Million Lehman Brothers Mortgage Backed Securities Settlement: The news that the parties to the Lehman Brothers mortgage-backed securities case had settled the suit for $40 million was announced in November 2011 (refer here). But the complete papers related to the settlement have only just been filed in the court docket. The papers reveal a few interesting details about the settlement.

 

First, the $40 million settlement is to be funded in two ways; $31.7 million of the settlement is to come from the company’s D&O insurance and $8.3 million is to come from Lehman Brothers Holdings itself. As the January 13, 2012 memorandum in support of the plaintiffs’ unopposed motion for preliminary approval of the settlement states, the bankruptcy court supervising the Lehman bankruptcy has approved the release of funds for these purposes.

 

Second, the parties’ settlement stipulation contains in interesting detail about the source of the D&O insurance funds for the settlement. The stipulation states (at page 15) that the $31.7 million insurance contribution to the settlement is to be paid by “certain insurers (‘Insurers’) that issued directors and officers insurance policies to LBHI, for the 2007-2008 and 2008-2009 policy periods.” What is interesting about this statement is that it suggests that the funds for this settlement are coming from two different policy periods.

 

In an earlier post (here), in which I discussed the $90 million settlement of the securities suit involving former Lehman executives, I had determined that the $90 million amount, together with defense expenses and other amounts, exhausted about $200 million of the applicable $250 million insurance tower. Based on that analysis of Lehman’s insurance, I would have assumed that the $31.7 million insurer contribution was drawn from what was left of the $250 million tower.

 

However, the reference in the parties’ settlement stipulation to the two different policy years suggests that a second tower of insurance has been broached and is being drawn upon in payment of losses arising from Lehman’s collapse.

 

In an earlier post (here) about how rapidly defense expenses were eroding Lehman’s D&O insurance, I had determined that during the 2007-08 policy period, Lehman carried a total of $250 million in insurance. I had noted that, though Lehman did not file for bankruptcy until September 2008, the May 2007-May 2008 insurance tower was the one implicated, because the first of the securities class action lawsuits was filed during that policy period and the subsequent matters related back to that initial filing (or so the insurers) argued. I noted that Lehman carried a separate $250 million tower of insurance for the May 2008 to May 2008 policy period, but that up to that point the losses had accumulated only with respect to the earlier of the two insurance programs. When I later analyzed the $90 million settlement on behalf of the directors and officers, I assumed for purposes of analysis that only a single $250 million tower was available for all purposes in connection with the Lehman collapse.

 

The cryptic note in the parties’ settlement stipulation in connection with the $40 million Lehman Brothers mortgage-backed securities settlement suggests, for the first time to my knowledge, that the second tower of insurance had been drawn in and is funding losses attributable to the events surrounding Lehman’s collapse. It would certainly change things (for example, the way that the prior $90 million settlement looks) if there were to be two insurance towers totaling $500 million potentially available in connection with these matters, rather than only a single $250 million tower.

 

If there were to be two towers rather than just one, the losses from the Lehman debacle could wind up being far more costly for the D&O insurance industry than has been assumed (depending of course on how extensive the second tower’s involvement ultimately proves to be). I suspect there are a number of readers out there who may have additional insight on these issues. I welcome additional perspective that any reader may be willing to provide (anonymously if that is the preferred approach).

 

In any event, this settlement is just further corroboration for a point I have long made about the litigation arising out of the subprime meltdown and credit crisis – that is, when all is said and done, this litigation, taken collectively, will prove to have been a massive loss event for the D&O insurance industry.

 

The Totally Awesome Sledding Crow: Here at The D&O Diary, we never, ever waste our time looking at Internet videos of animals doing amusing things. Just the same, we were distracted by this video of a crow that to all appearances is engaged in trying to perfect his snowboarding style. Watch this video carefully. The crow, standing at the apex of a snow covered roof, slides down the incline on a plastic lid. The crow then picks up the lid and tries to slide down another part of the roof. But when that doesn’t work, the crow picks up the lid, returns to the original spot, and slides down the roof again.

 

A scientific discussion of the crow’s behavior can be found in this January 13, 2012 article in The Atlantic (here). While science cautions against ascribing anthropomorphic explanations for animal behavior, I find myself imagining that as the crow is sliding down the roof, he is singing to himself “If everybody had an ocean/across the U.S.A./then everybody’d be surfin’/like Caiforn-Aye-Yay…”

 

 

https://youtube.com/watch?v=DYcgL7Nif30

The tone public companies use in their disclosure statements can affect the companies’ susceptibility to securities class action litigation, according to a recent academic study. The authors found that firms hit with securities litigation generally used more optimistic language in their disclosure statements than did firms that were not sued. Based on these findings, the authors conclude that managing “disclosure tone” could provide “a straightforward means of reducing litigation risk.”

 

In their November 2011 paper “Disclosure Tone and Shareholder Litigation” (here), University of Chicago Business School Professors Jonathan Rogers and Sarah L.C. Zechman and Ohio State Business School Professor Andrew Van Buskirk set out to determine whether or not corporate managers’ use of optimistic language increases litigation risk. Using statistical techniques, they examined the extent to which differences in qualitative language are systematically related to differences in litigation risk.

 

The authors began by examining a range of plaintiffs’ complaints, in order to determine which disclosure channels are likeliest to affect the probability of litigation. Based on their review, the authors determined that the earnings announcements are the most consistently cited type of communication referenced in plaintiffs’ complaints.

 

The authors then used dictionary-based measures of optimism to analyze the tone used in the portions of earnings announcement that plaintiffs chose to quote in their class action complaints. In order to determine whether or not the sued firm’s disclosures were “unusually optimistic” the authors compared the tone of the sued firms’ earnings announcements to the tone of disclosures made my non-sued firms at the same time, in the same industry and experiencing similar economic circumstances. The authors concluded that the firms that are hit with securities class action lawsuits use “substantially more optimistic language in their earnings announcements than do non-sued firms.”

 

The authors also took a look at the combined effect of optimistic language and insider trading. The evidence they reviewed “is consistent with optimism and insider selling jointly affecting litigation risk.” The interaction between optimism and “abnormal insider selling” is “associated with an increase probability of being sued.” The authors found no evidence that insider selling on its own exposes the company to increased litigation risk; insider selling is “only associated with litigation when firm disclosures are optimistic.”

 

The authors’ conclusions suggested to them some ways that companies can try to mitigate litigation risk. That is, though disclosure tone “is certainly not the sole determinant of litigation,” disclosure tone “is both associated with litigation risk and under the discretion of management.” All of which led the authors to conclude that “monitoring and adjusting disclosure tone could provide a straightforward means of reducing litigation risk” – that is, “managers can reduce litigation risk by dampening the tone of disclosure.” On the other hand, the authors also note that shareholder litigation can be “an effective ex post mechanism” to assure investors that managers “are not simply engaging in cheap talk when they use positive language.”

 

One final note about the authors’ methodology. In order to quantify the tone used in firms’ disclosures, the authors used a form content analysis that relies on a pre-specified word list. The analysis simply counts the occurrence of words characterized defined as optimistic or pessimistic based on prior research and linguistics theory. However, rather than relying on a single categorization, the authors used three different libraries of words, each of which was used to study firm disclosures. The word counts using the three measures were then compared against a benchmark standard that was based upon a control group of non-sued firms. The sued firms “optimism” was then compared against the benchmark standard. The authors also applied control variable to isolate the effect of a firm’s optimism that is driven by management discretion, rather than by the firm’s economic circumstances.

 

Discussion

On the one hand, the authors’ analysis might seem simply confirm a common sense proposition that companies that are hype-ish with their disclosures are likelier to get sued. But a closer reading of the authors’ analysis suggests that the authors have established a more specific and more important conclusion. That is, the authors’ analysis establishes that there is a direct statistical relationship between a firm’s use of unusually optimistic language and the likelihood of the firm being sued. This statistical relationship has two important implications.

 

First, the existence of this relationship could have important D&O insurance underwriting implications. D&O insurance underwriters interested in selecting away from companies that are likelier to be sued in securities class action lawsuits will want to develop tools to help them identify disclosure statements that are unusually optimist. The key here is that the predictive relationship is based on the use of unusually optimistic language. That is, in order for an underwriter to use the existence of the relationship as a risk selection tool, the author would have to have a developed ability to determine what constitutes unusual optimism.

 

In connection with the D&O underwriting implications of the authors’ analysis, it is also significant to note the added relationship the authors found about the interaction of optimistic disclosure and unusual insider trading. The two factors together had a combined predictive effect. In other words, the presence of insider selling in combination with overly optimistic disclosure is particularly predictive of securities litigation risk.

 

The other significant implication of the authors’ analysis has to do with their conclusions about how companies might mitigate their securities litigation risk. There is definitely some good news in the authors’ report. That is, companies that are interested in trying to control their securities litigation risk exposure can reduce their litigation risk by managing their disclosure language. The authors’ conclusion in this regard are consistent with larger messages that many of us who advocate securities litigation loss prevention have been preaching for year – that is, that companies can control their securities litigation exposure by managing the disclosure process, in order to avoid the kinds of statements that attract the unwanted attention of class action securities lawyers.

 

The SEC has commenced an enforcement action against a private company and its former Chairman and CEO in connection with the company’s repurchase of company shares from company employees and others prior to the company’s acquisition.

 

The action involves Stiefel Laboratories, which prior to its April 2009 acquisition by GlaxoSmithKline for $68,000 a share, was, according to the SEC “the world’s largest private manufacturer of dermatology products.”  On December 12, 2011, the SEC filed a complaint (here) in the Southern District of Florida alleging that the company and Charles Stiefel, its former chairman and CEO, defrauded shareholders by buying back their stock at “severely undervalued prices” between November 2006 and April 2009. The SEC’s December 12, 2011 press release about the enforcement action can be found here.

 

The company had an Employee Stock Bonus Plan through  which employees gained ownership of company shares. The company also engaged in direct share transactions with other shareholders. Because the shares did not trade on public markets, company share purchases were essentially the only way for shareholders to liquidate their shares of company stock.

 

The price for company share purchases was set through an annual l third-party share valuation each March. The company relied on a third-party accountant to perform the valuation. However, the SEC alleges that the accountant “used a flawed methodology and was not qualified to perform the valuations.” In addition, the SEC alleges that that shareholders were not told that after the valuation process, the defendants “discounted the stock by an additional 35%.”

 

In addition, beginning in 2006, the company began a series of conversations that culminated in the April 2009 sale of the company to Glaxo Smith Klein. During the course of these various discussions, the defendants received a series of valuations that were significantly higher than the third party valuation used for share repurchase purposes. The company did not advise employees or the accountant who performed the annual share price valuation of these much higher valuations. In addition, the company not only did not inform the employees about the ongoing negotiations, but repeatedly indicated that the company would remain private.

 

While these discussions were going forward, the company continued to repurchase company shares at valuations that were significantly below both the valuations that the prospective company buyers were using and that were also well below the ultimate sale price of $68,000 per share. Thus between November 2006 and April 2007, the company purchases 750 company shares at $13,012 a share. Between June 2007 and June 2008, the company purchased more than 350 additional shares at $14,517 a share, and bought an additional 1,050 shares from shareholders outside the Plan at an even lower stock price. Between December 3, 2008 and April 1, 2009, the company purchased more than 800 shares of its stock from shareholders at $16,469 per share.

 

The SEC alleges that shareholders lost more than $110 million from selling their shares back to the company based on the misleading share valuations. The SEC alleges that the defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, by repurchasing the shares at undervalued prices and in reliance on undisclosed material information, including both the higher valuations and the possibility of the company’s sale. The SEC’s complaint seeks declaratory relief, permanent injunctive relief, an officer and director bar, disgorgement and civil penalties.

 

Discussion

The allegations against the company and its former Chairman involve alleged misconduct that took place when the company was still a private company. I suspect that many readers will be surprised to learn that an SEC enforcement action against or in connection with the actions of a private company.

 

As explained in a January 10, 2012 memorandum from the Stites & Harbison law firm (here), Rule 10b-5 “prohibits, in connection with the purchase or sale of any security (public or private) making any untrue statement or omitting to state a material fact necessary in order to make the statements not misleading.” The allegations against the defendants here present a “cautionary tale for any private company,” underscoring the fact that federal and state securities laws govern even private company securities transactions and “restrict small closely held firms no differently than they restrict large, publicly-held corporations.” 

 

The law firm memo emphasizes that a private company in possession of material nonpublic information that is under a contractual obligation to consummate a transaction involving its own securities could face a dilemma — for example, a pending transaction may put the company in a position where it may neither disclose pending negotiation nor abstaining from repurchase obligations under stockholder or similar agreements. The memo’s authors observe that private companies should “thoughtfully scrutinize the structure of a transaction in its own securities and would be well served to tailor corporate policies to ensure compliance with securities law obligations.”

 

The SEC’s allegations here present a cautionary tale in another sense as well. Some private company D&O insurance policies may be procured or written based on the assumption that, because the company is privately held, the company and its directors and officers face no potential liability under the federal securities laws. Or at a minimum, D&O insurance policies may be structured with insufficient awareness about the possibility that even a private company potentially could fact liability under the federal securities laws. This case shows that a company and its officials can fact potential liability under the securities laws in connection with transactions involving the companies own securities, even if the company’s shares are not publicly traded.

 

Of particular concern here is the securities offering exclusion found in many private company D&O policies. The wordings of these exclusions vary widely. Depending on the wording used in any particular private company policy, the exclusion might potentially preclude coverage for the type of claim presented here. The best versions of these types of exclusions specify that they do not apply unless the company has conducted an initial public offering. But as this case highlights, a private company D&O policy could be called upon to respond to an action alleging a securities law violations; indeed, it could be called upon to respond to an SEC enforcement action even where, as here the company’s shares are not publicly traded and where there has been no IPO. There might ultimately be no coverage under the policy for amounts representing disgorgements or fines or penalties, but the question of whether or not there is coverage for defense expenses (which could be quite substantial) could well depend on the wording of the securities exclusion.

 

All of which means, at a minimum, that the wordings of the securities offering exclusion in private company D&O insurance policies need to be reviewed closely with an eye toward the possibility of claims of this type.

 

Don’t Be That Guy: According to a January 12, 2011 Wall Street Journal article (here), Alan Gilbert, the conductor of the New York Philharmonic, brought a performance of Mahler’s Ninth Symphony to a halt when the orchestra’s performance of the music piece’s final movement – a sonorous rumination on the meaning of mortality – was interrupted by a persistent cellphone ringtone the article described as having a xylophone sound with a marimba beat. The cellphone’s owner apparently was seated in the front row at the performance at Avery Fisher Hall. 

 

I suspect that the next time the cellphone owner is asked to turn off their cellphone, he or she will actually make sure the phone is powered down.

 

The number of publicly traded companies that filed for bankruptcy protection under either Chapter 7 or Chapter 11 declined in 2011, compared to the year prior, although the 2011 bankrupt companies collectively  listed greater amounts of pre-petition assets than 2010 bankrupt public companies did, according to data recently released by BankruptcyData.com (here).

 

According to the report, 86 publicly traded companies filed for bankruptcy protection in 2011, compared to 106 in 2010, and compared to 211 in 2009. The number of 2011 filings represents a 17% decline from the prior year, and nearly a 60% decline from 2009. Though the number of public companies filing for bankruptcy declined in 2011, the 2011 public company bankruptcies represented aggregate pre-petition assets of $104 billion, compared to $89.1 billion in assets in 2010. The 2009 public company bankruptcies represented $281 billion in assets.

 

The company average pre-petition assets rose to $1.2 billion in 2011 from $840 million in 2010. The increase in aggregate and average assets that the 2011 bankruptcies represent is largely a factor of two very large public company bankruptcies during the year: the $40.5 billion asset MF Global bankruptcy and the $25 billion AMR Corporation bankruptcy. Those two bankruptcies alone represented more than close to two thirds of all of the aggregate 2011 asset value. The MF Global bankruptcy represents the eighth largest U.S. bankruptcy of all times. None of the bankruptcies in 2010 are among the top ten. The two large 2011 public company bankruptcies had the effect of driving up the average bankruptcy size during the year.

 

The report notes that the increase in aggregate and average pre-petition asset size during 2011 is “all the more striking considering the low number of financial company bankruptcy filings” during the year. Bankruptcies in the Banking & Finance industry “typically reflect a higher pre-petition asset figure than other industries.” But there were only four public company bankruptcies in the sector during 2011, compared with 2010, when 21 of the 106 public traded bankruptcies involved companies in the Banking & Finance sector.

 

The sector with the largest number of 2011 bankruptcies was Health Care & Medical, which had a total of 11 bankruptcies; followed by Technology and Energy which each had nine filings each.

 

Though the number of public company bankruptcies has declined in each of the last two years, the public company bankruptcies remained at elevated levels. The 86 public company bankruptcies in 2011, though below the annual totals in 2010 and 2009, are above the totals in the years preceding the credit crisis and going all the way back to 2005, when there were also 86 public company bankruptcies.

 

In terms of what may lie ahead, the report includes the comments of one observer, George Putnam III, the founder of New Generation Research, BankruptcyData.com’s parent company, as saying that, “I expect to see an increase in bankruptcies in 2012 as some of the massive amount of debt that was issued before 2008 begins to come due.” These comments about the likely bankruptcy levels are consistent with other public commentaries (refer here) that have also suggested that 2012 could be a busy year for business bankruptcies.

 

A January 10, 2012 Los Angeles Times article about the public company bankruptcy data can be found here.

 

In several recent posts (most recently here), I have written about the problems associated with the growing wave of M&A related litigation. In writing about this topic, I have tried to marshal the evidence supporting my position, but for many reasons my analysis has been more descriptive than statistical. However, I have been provided with advance access to some of the data from a forthcoming Cornerstone Research publication to be entitled “Recent Developments in Shareholder Litigation Involving Mergers and Acquisitions.” The data provide interesting additional statistical perspective on the recent M&A-related litigation trends.

 

UPDATE (as of Jan. 17, 2012): Cornerstone has now released its report, entitled "Recent Develpments in Shareholder Litigation Involving Merger and Acquisitions" (here) online. The full report iincludes additional information beyond what is discussed in this blog post.

 

In their preparation of the report, Cornerstone Research reviewed SEC filings related to acquisitions of U.S. public companies valued at $100 million or greater and announced during 2010 and 2011. For purposes of historical comparison, Cornerstone Research also collected information on litigation related to deals announced in 2007 valued at $500 million or greater.

 

Based on their review, Cornerstone Research identified 789 lawsuits filed in connection with U.S. public company acquisition transactions valued at $100 million or greater and announced in 2010 and 696 lawsuits for deals of that size announced in 2011.

 

Cornerstone Research found that litigation arose in connection with 91% of all deals announced during the 2010-2011 period with values greater than $100 million. The average number of lawsuits per deal announced during that period was 5.1. Both of these figures grow relatively larger as the size of the deals grows larger. Thus for deals announced in 2010-2011 with valuations between $100 million to $500 million percentage of deals involving litigation is 85%, and the average number of lawsuits per deal is 4.1, while 96% of all deals valued over $1 billion during that period attracted litigation, and averaged 6.1 lawsuits per deal.

 

Certain deals announced during the 2010-2011 proved to be particularly litigation attractive. For example, Blackstone’s $600 million acquisition of Dynegy attracted 29 lawsuits. Express Scripts’ $29.3 billion acquisition of Medco Health Solutions attracted 22 lawsuits. Attachmate’s $2.2 billion acquisition of Novell attracted 19 lawsuits. Overall, there were nine deals during that period valued at $100 million or greater that attracted 15 or more lawsuits.

 

To provide historical perspective, Cornerstone Research compared M&A litigation in 2007 and in the 2010-2011 periods, by comparing deals valued greater than $500 million announced in each of those two periods. There were 289 lawsuits in connection involving deals of that size in 2007 and 557 involving deals of that size in 2010, representing a 92% growth in the absolute number of lawsuits between the two periods. There were 473 lawsuits involving deals of that size that were announced in 2011, which is 63% higher than in connection with deals of that size announced in 2007.

 

Obviously, this growth in the absolute number of lawsuits might be attributable to an increase in the level of M&A activity involving deals greater than $500 million. In fact, there were 195 deals valued over $500 million that were announced in 2007, but only 108 and 80 deals valued over $500 million that were announced in 2010 and 2011, respectively.

 

The Cornerstone Research analysis shows that only 50% of the deals valued at $500 million or greater announced in 2007 attracted litigation, whereas 95% of the comparably sized deals announced in 2010 attracted litigation, and 96% of such deals announced in 2011 attracted litigation. In other words, the litigation activity was both absolutely and relatively greater for deals valued at $500 million or greater in the 2010-2011 period compared with comparably sized deals announced in 2007.

 

In addition, the number of lawsuits filed per deal has also increased. Deals valued at greater than $500 million announced in 2007 attracted an average of 2.8 lawsuits, whereas deals of that size announced in 2010 attracted an average of 5.4 lawsuits, and deals of that size announced during 2011 attracted an average of 6.1 lawsuits.

 

One of the recurring questions associated with the increase in M&A-related litigation has been whether or not courts in Delaware, traditionally the forum of choice for this type of litigation, has been losing “market share” to other jurisdictions that may be perceived as more plaintiff-friendly. The Cornerstone Research analysis suggests that Delaware’s courts are not in fact losing market share, at least with respect to deals meeting Cornerstone’s criteria.

 

Cornerstone Research’s analysis of this issue compares deals involving Delaware incorporated companies that were valued at greater than $500 million announced in 2007, on the one hand,  to deals involving Delaware incorporated companies where the deal was valued at greater than $500 million and announced in 2010-2011, on the other hand.

 

The Cornerstone Research analysis shows that in terms of where the lawsuits were filed in the two respective periods, in 2007, 34% of the lawsuits were filed in Delaware, while in the 2010-2011 period, 41% of the lawsuits were filed in Delaware.

 

This analysis is reinforced when the lawsuits are looked at on a per deal basis. Looking at the venue of lawsuits in which acquisitions involving Delaware incorporated companies were being challenged, the Cornerstone data show that 29 of the 2007 deals involved at least one lawsuit filed in Delaware, and 32 of the deals involving only litigation outside Delaware. By comparison, in 2011, 41 of the deals had at least one lawsuit filed in Delaware, and just nine of the deals involved litigation only outside Delaware. In other words, in the later period, a much greater portion of the deals involved litigation in Delaware, either exclusively or in combination with litigation in other jurisdictions, and a much smaller proportion of the deals involved only litigation outside Delaware.

 

Discussion

The Cornerstone Research data tend to corroborate many of the points I have made in recent posts on this blog – that is, M&A litigation is increasing, on both an absolute and relative basis; that a much higher percentage of deals is attracting merger objection litigation; and the average number of lawsuits per deal is also increasing.  The Cornerstone Research analysis is particularly interesting with respect to the number of deals that are attracting unusually higher numbers of lawsuits.

 

The data in the Cornerstone Research report are directionally consistent with many other data sources I have cited in prior blog posts on this topic, but the Cornerstone figures appear to differ in certain specific details. For example, the Cornerstone Research analysis suggests that a much higher percentage of deals attract merger objection lawsuits than the figures in other reports have suggested (refer here, for example).

 

There likely are many explanations for the differences in the details between the Cornerstone Research data and other reports, but one particular aspect of the Cornerstone analysis should be kept in mind. That is, the Cornerstone Research analysis for the 2010 and 2011 period involves only M&A transactions with announced values greater than $100 million. Deals involving smaller valuations and the related litigation are not a part of the Cornerstone Research analysis. By the same token, Cornerstone Research’s historical analysis refers only to deals announced in the 2007 period with valuations greater than $500 million, which omits an even broader range of deals (and related litigation) based on the size of the deal valuations. These data set definitions could result, at a minimum, in differences between the Cornerstone Research data and other analyses of comparable time periods.

 

But in any event, the Cornerstone Research analysis makes a very important contribution to the consideration of these issues. The Cornerstone Research report clearly shows that M&A related litigation is becoming a more significant issue. With the increasing average numbers of lawsuits per deal, M&A-related litigation is becoming an increasingly more costly problem, as the increased numbers of lawsuits in multiple jurisdictions means both procedural complications and increased defense expense.

 

The Cornerstone Research analysis of the Delaware court “market share” issue could prove to be particularly interesting. The question whether or not litigants are self-selecting away from Delaware is and will be a very hot topic. The stakes are high, as the continued involvement of Delaware courts in corporate and securities litigation could determine whether or not Delaware’s courts continue to play a leading role on legal issues in these areas. And on a more practical level, if Delaware’s courts are not losing market share after all, there is no reason for its judges to be as concerned with attempting to curry favor with the plaintiffs’ bar in order to preserve market share.

 

The Cornerstone Research data certainly offers a variety of interesting statistical perspectives on the issues surrounding the growth of M&A litigation. We can all look forward to the forthcoming publication of Cornerstone Research’s complete report on these issues.

 

Very special thanks to Cornerstone Research for their willingness to share this data with me and with readers of this blog.

 

Back in February 2007, when investors in New Century Financial Corporation filed a securities class action lawsuit against the company and certain of its directors and officers, there was little reason to suspect at the time that problems at the company represented the leading edge of a looming financial crisis or that the case itself was the first lawsuit in what ultimately grew to become a mountain of subprime and credit crisis-related litigation. But even now, five years later, the litigation wave continues to churn through the system, though we are now mercifully well past the depths of the financial crisis.

 

As reflected below, though many of the cases have now been resolved, many more remain pending, and the likelihood is that the litigation will continue for years to come.

 

In the five years since the first of the credit crisis lawsuits was first filed, there have been nearly 230 subprime and credit crisis related lawsuits filed, including four in 2011. A list of all of the filings can be accessed here. 2008 was the peak year of the financial crisis and also the peak year for credit crisis related lawsuit filings, when there were 102 subprime and credit crisis-related cases filed. After that, the filings began to diminish. There were 62 credit crisis related securities class action lawsuit filings in 2009, and only 23 in 2010. Maintaining a precise count over time has been challenging, as cases have been consolidated, removed, transferred, and so on. The count of 230 lawsuits should be viewed as indicative of the total number of filings, rather than an exact representation. For analytic purposes below, I have used the 230 figure, but it should be kept in mind that all calculations are approximate.  

 

Dismissal Motion Rulings

By my reckoning, about 144 of the cases, or about 63%, have reached the motion to dismiss stage. A list of all dismissal motion rulings can be accessed here. As time has passed it has become increasingly complicated to track the dismissal motion rulings, as well. Several cases have had multiple rulings and there have even been a handful of cases that have made their way up to the appellate courts.

 

For purposes of counting the dismissal motion rulings, I have counted as dismissals all cases in which a dismissal motion was granted, whether or not the dismissal was with prejudice. However, I did not count cases in which the dismissal motion was initially granted but in which the motion was denied on subsequent rehearing. If any part of the plaintiffs’ case survived the dismissal motion, I counted the ruling as a dismissal motion denial, even if the ruling may have resulted in the dismissal of a substantial part of the plaintiffs’ case.

 

One particularly complicated variant that I have tried to factor in my analysis are the rulings in which a dismissal with prejudice was granted as to some but not all the parties. I have tried to factor those rulings out of my analysis here. In addition, I have counted cases in which dismissal motions were reversed on appeal as dismissal motion denials. Finally I have counted summary judgment grants in my tally of dismissals.

 

Using these principals to categorize the dismissal motion rulings, and disregarding the small handful of cases that were voluntarily dismissed and not refilled,  it appears that dismissal motions have been granted in 76 cases, or slightly more than half of the cases in which dismissal motions have been heard (that is, about 52%).

 

Although this dismissal rate is slightly higher than the historical rate of all securities class actions, which runs about 40%, it is important to keep in mind that I have included dismissal without prejudice in the tally.  Some of the dismissed cases may yet survive renewed dismissal motion, as was the case with a number of cases in which dismissal motions were initially granted – for example, the Washington Mutual case (here), the Credit Suisse case (here), the New Century Financial case (here), PMI Group (here), and IndyMac (here). The inclusion of summary judgment grants may also inflate the apparent dismissal rate somewhat as well.

 

In addition, appellate courts proceedings could also affect the dismissal rate calculation. In at least two cases, Nomura Asset Acceptance Corporation (about which refer here) and Blackstone Corporate (here), appellate courts reversed the dismissals granted in the lower courts. There may well be other reversals on appeal, which could affect the dismissal rate calculation, at least marginally. To be sure, the dismissals of a number of other cases has been affirmed on appeal, including the dismissal in the NovaStar Financial case (refer here), Centerline (here);  Impac Mortgage (here); Home Banc Corporation (here); Regions Financial Corp./Trust Preferred Securities (here); Morgan Keegan Asset Management (here); General Electric (here); American Express (here); and Fremont General Corporation (here).

 

Finally, it should be noted that dismissal motions are still yet to be heard in over a third of the subprime and credit crisis-related lawsuits. With further proceedings yet to unfold in many cases and with so many other cases yet to be heard, it would be premature to make any definitive pronouncements about whether or not the subprime and credit crisis cases are being dismissed at a greater rate than securities class action lawsuits generally.

 

40 Settlements and a Trial

So far 40 of the subprime and credit crisis related securities class action lawsuits have settled, representing $4.419 billion in the aggregate. It is interesting to note that of these 40, 23 of the settlements were announced in 2011, representing $2.48 billion total. The pace of settlement quickened considerably in the year just ended, as more of the earlier cases reached the settlement stage. It seems likely that we will see even more settlements in 2012.

 

The average of the settlements so far is about $110 million. However, the largest settlements are pulling this average upward. If the four largest settlements (the $627 Wachovia Preferred Securities settlement, the $624 Countrywide Settlement; the $475 Merrill Lynch settlement and the $415 Lehman Brothers Offering Underwriter settlement) are removed from the calculation, the average drops to about $63 million.

 

Not every case that survives dismissal settles; though it is very rare in the securities class action lawsuit context, some cases still do go to trial. In November 2010, a jury in the Southern District of Florida entered a plaintiffs’ verdict in the securities class action lawsuit filed against BankAtlantic Bancorp and certain of its directors and officers. (It is interesting to note that this case is one of the cases mentioned above in which the dismissal motion was initially granted but was denied on reconsideration.) However, as noted here, in April 2011, Southern District of Florida Judge Ursula Ungaro granted the defendants’ motion to have the jury verdict set aside. The plaintiffs have appealed Judge Ungaro’s ruling to the Eleventh Circuit.

 

Observations

Even if subprime and credit crisis-related dismissal rate may be running ahead of historical norms so far, it seems that the highest profile cases are surviving the dismissal motions. Thus, for example, the dismissal motions were denied in the Lehman Brothers case (about which refer here), in the Bear Stearns case (here), in the BofA/Merrill Lynch merger case (here), as well as in the Citigroup case (here), the AIG case (here) and the Washington Mutual case (here).

 

One particular subset of the cases that presents some particularly interesting issues, and where the plaintiffs lawyers have seen large parts of their cases dismissed, are the cases that have been brought on behalf of mortgage-backed securities investors. From fairly early on these cases, courts have granted the dismissal motions as to specific mortgage-backed securities offerings in which the named plaintiffs had not purchased the securities. A more troublesome standing challenge has arisen in cases in which the courts have held that the named plaintiffs can only represent investors that purchased securities in the same investment tranches, but not investors who purchased securities in other tranches in the same securities offering. Rulings along these lines have been granted in the Washington Mutual mortgage- backed securities case (about which refer here), in the Countrywide Mortgage-Backed securities case (here), and in the J.P. Morgan mortgage-backed securities case (here). These rulings have dramatically narrowed the potential scope of these cases. If the line of analysis were to be followed in other mortgage backed securities cases, it could substantially diminish the potential value of these cases for the plaintiffs.

 

At the same time, during 2011, there were a couple of attention- grabbing settlements of mortgage-backed securities cases. The first of these was the $125 million settlement of the Wells Fargo mortgage backed securities case, which represented the first settlement of any of the mortgage backed securities cases. This settlement was followed in December with the $315 million settlement of the Merrill Lynch mortgage-backed securities case. These settlements demonstrate that the mortgage backed securities cases potentially have substantial value. However, it will be interesting to see how the rulings involve tranche standing described in the preceding paragraph affect these cases going forward.

 

There were a number of other interesting aspects of the subprime and credit crisis securities class action lawsuits that settled in 2011. Among other things, the year’s settlements included the largest settlement yet as part of the wave of litigation, the $627 million settlement in Wachovia Preferred Securities Litigation. The settlements also included the rather unusual resolution in the Wachovia Equity Holders’ action, which settled for $75 million while the case was on appeal from its dismissal in the lower court. This latter settlement underscores the fact that looking at the current dismissal rate of these cases may not reveal everything there is to know about these cases.

 

It is not a mere coincidence that the two cases I noted in the preceding paragraph involve Wachovia, which was acquired in December 2008 by Wells Fargo. In fact, a very large part of the aggregate amount for which the cases have settled so far has come from just two companies, Wells Fargo and Bank of America, due to the two firms’ acquisitions of companies that were at the center of many of the key events in the subprime meltdown and credit crisis.

 

Take Bank of America, for instance. So far, the settlements on BofA’s tab include the $624 Countrywide settlement; the $475 million Merrill Lynch settlement; the $150 million Merrill Lynch bond action settlement; and the$315 million Merrill Lynch mortgage-backed securities settlement. For those of you keeping score at home, that adds up to a cool $1.56 billion, or nearly 30 percent of the aggregate settlement dollars so far.

 

By the same token, Wells Fargo had some large bills to pay, too. The settlements on its tab include the $627 Wachovia Preferred Securities settlement and the $75 million Wachovia equity investors’ settlement mentioned above, as well as the $125 Wells Fargo mortgage backed securities settlement. Those three settlements add up to $827 million.

 

The total of the settlements funded or to be funded by BofA and Wells Fargo collectively add up to $2.38 billion — or more than half of the aggregate $4.419 billion of subprime and credit crisis-related settlements so far.

 

It is interesting to contrast these mammoth settlements, involving as they do a solvent surviving entity, with the smaller settlements in cases in which the target company did not involve a surviving entity. Even though the Washington Mutual collapse was the largest bank failure in U.S. history, the securities case settled for $208.5 million, of which $103.5 million was contributed on behalf of the underwriter defendants and the company’s auditor. And even though the failure of Lehman Brothers was the central event of the credit crisis, the securities case against the former Lehman executives contributed settled for $90 million. (Separately, the Lehman Brothers offering underwriters agreed to a $417 million settlement.) Obviously both of these settlements are very substantial, but still stand in contrast to the much larger settlements I n which a solvent surviving entity was involved.

 

The WaMu settlement and the Lehman executive settlements do illustrate one critical aspect of the resolution of the subprime and credit crisis-related securities class action lawsuits and that is the importance of D&O insurance to the settlement of many of these cases. Insurance likely was not much of a factor in the larger cases involving BofA and Wells Fargo. D&O insurance was also likely not much of a factor in the $417 million Lehman Brothers offering underwriter settlement. But D&O insurance has been a significant factor in many of the other settlements.

 

For example, the $105 million settlement on behalf of the individual defendants as part of the $208.5 million WaMu settlement was funded entirely by D&O insurance. Similarly the $90 million settlement on behalf of the Lehman executives was funded by D&O insurance (a settlement that largely exhausted the company’s $250 million D&O insurance tower). D&O insurers will contribute $68.25 million of the recent $79 million settlement of the E*Trade case. $30 million of the $37.5 Popular Inc. securities class action settlement is to be funded by D&O insurance, as discussed here. Other important settlements also obviously involve substantial D&O insurer contributions, even if the exact amount is not entirely clear – see here for example with respect to the $68 million MBIA settlement.

 

In other words, D&O insurance has been a critical part of many of these settlements. Taken together these cases have been enormously costly to the D&O insurance industry, particularly when the fact that D&O insurance is also funding a substantial portion of the costs of defending these cases as well. Taking into account that many more cases are yet to be resolved, it is clear that by the time all is said and done, the subprime and credit crisis-related litigation wave taken collectively will prove to have been a major event for the D&O insurance industry. With only a small portion of the cases resolved to date, the ultimate magnitude of the industry’s losses from this event is still yet to be told.

 

SEC Modifies Its Policy – A Little Bit: Many readers may have been surprised as I was to learn on Friday that the SEC no longer would be accepting the “neither admit nor deny” settlements. This aspect of the disputed Citigroup enforcement action has been the subject of heater controversy before Southern District of New York Judge Jed Rakoff (as discussed here).

 

However, the policy modification turns out to amount to substantially less than first appeared. As Alison Frankel explains in a January 6, 2011 post on Thomson Reuters News & Insight (here), the new policy only applies where the enforcement action target has admitted guilt or been convicted in a related criminal action. As Frankel puts it, “in other words, defendants whose guilt has already been established under the higher standard of criminal law can no longer deny civil charges. Which leads, of course, to the question of why it took the SEC 40 years to change such a ridiculous policy.”

 

No matter how you look at it, this change “does not represent a major change in policy,” as one commentator noted on the WSJ.com Law Blog (here). It should have no effect on the pending Citigroup controversy.

 

The Chevron Ecuador Environmental Lawsuit: I confess that I have not been closely following the long-running lawsuit that was filed against Texaco (now part of Chevron) on behalf of Ecuadorians in connection with Texaco’s oil production operations in that country. Over time, the case seemed to represent the absolute embodiment of litigation run amok and I long ago lost interest.

 

Nevertheless, I have to say that I found Patrick Radden Keefe’s January 9, 2012 The New Yorker (here) article about the case entitled  “Reversal of Fortune” in to be absolutely fascinating. The story about the case is full of outsized characters, including in particular the crusading lead plaintiffs’ counsel Steve Donzinger. The tale is worthy of a John Grisham novel. The case, which is no closer to resolution than it has ever been, has taken on a very peculiar life of its own. Though the case does very much represent litigation run amok, the story of the case makes for some very interesting reading.  

 

As a result of developments during 2011, there is a “growing sense of urgency amongst FCPA practitioners as to the direction the statute will take in the coming years,” according to a law firm’s year-end FCPA report. The January 3, 2011 memo from the Gibson Dunn law firm, entitled “2011 Year-End Update,” can be found here. Whatever else might be said, according to the report, “these are interesting times for the FCPA.”

 

According to the report, FCPA enforcement activity remains near all time highs. In terms of FCPA enforcement actions initiated by the Department of Justice and the SEC, 2011 “was the second most prolific ear in the history of FCPA enforcement.” The 23 DoJ actions and the 25 SEC actions are “outmatched only by the juggernaut that was 2010.” However, the report notes, the 2010 statistics were “elevated substantially” by the 22-defendant SHOT  show arrests.

 

The report notes a number of interesting FCPA enforcement trends during 2011, including the increasing practice of U.S. regulators to pursue enforcement actions against individual defendants after negotiated settlements with the individuals’ employer. As an example, the report cites the recent enforcement actions brought against seven former Siemens executive and two former Siemens third-party agents. Among other things the report notes, the nine targeted individuals are all foreign nationals. In other words, the parent company, the alleged wrongful activity and the targeted individuals all took place or are domiciled outside the United States, which illustrates the U.S. regulators’’ willingness to “polic conduct beyond [U.S.] borders that it perceives as affecting U.S. markets.

 

The report also referenced the SEC’s willingness to bring unsettled FCPA enforcement actions as evidence of the agency’s “more aggressive enforcement stance.” In the past the agency “has not been known to file many FCPA cases absent an advance agreement to settle the matter.” But during 2011, the SEC brought 10 unsettled FCPA enforcement actions, more than in the previous 33 years of FCPA enforcement combined.”

 

FCPA enforcement actions during 2011 also reinforced the “imperative that acquisitive companies conduct thorough pre-acquisition due diligence and equally robust post-acquisition compliance integration.”

 

The report also notes the DoJ’s recent initiative to pursue foreign government officials who received the bribes paid by FCPA defendants. The FCPA itself does not criminalize the receipt of bribes by foreign officials, but the Department of Justice has tried to use two tools to reach the recipients: money laundering statutes and civil forfeiture actions. These aggressive efforts are still in their early stages.

 

The report notes that though the FCPA itself does not provide for a private right of action, “enterprising plaintiffs have circumvented the FCPA’s lack of a private redress mechanism by filing derivative lawsuits, securities fraud actions, tort and contract law claims, employment lawsuits, and private actions under the Racketeer Influenced and Corrupt Organizations (RICO) Act.” Among other cases the report cites is the FCPA-related derivative lawsuit involving Avon Products (refer here, footnote 5 to the financial statements), and the FCPA-related derivative lawsuits involving Bio-Rad Laboratories (refer here) and Tidewater, Inc. (refer here). Avon is also the subject of an FCPA-related securities class action lawsuit as well (refer here).

 

The report also canvasses the various pending legislative and policy developments that could lead to changes to the FCPA itself or its enforcement during 2012. The report also catalogues global anti-corruption enforcement developments. Overall, the report is interesting and well-written, and well worth reading in its entirety.

 

Readers of this blog will be most interesting in the report’s commentary about FCPA-related civil litigation. The follow-on litigation provides what I have called in the past the link to the D&O insurance policy. There would not be coverage under the typical D&O policy for the fines and penalties imposed in connection with an FCPA enforcement action, although defense fees incurred in connection with the action potentially could be covered under many policies, depending on the policy wording. But the filing of a civil lawsuit against members of the board of directors, as a follow on to the FCPA action, is an event much more directly linked to the D&O policy and much more likely to give rise to covered loss under the policy.

 

As the escalating levels of FCPA enforcement actions continues to increase, this type of potential Board liability exposure will continue to be a growing concern for Boards, their advisers, and their D&O insurers.

 

Those readers who want a more comprehensive overview of both the historical and current state of FCPA enforcement will want to refer to the Shearman and Sterling law firm’s mammoth 692-page January 3, 2011 “FCPA Digest” (here). The Shearman and Sterling report has a more detailed statistical overview and an exhaustively detailed case summarization. The Shearman & Sterling report also sets out in specific case detail a catalog of follow-on civil actions arising out of FCPA enforcement activities (refer to pages 538 through 620 of the report). The value of the Shearman & Sterling approach is that it is not limited just to actions filed or pending in 2011, but is historically all-encompassing – although some readers may find the report’s sheer size intimidating.

 

The Morrison  Foerster law firm has a January 5, 2012 client alert (here) detailed the fines and penalties assessed under the FCPA in 2011. A January 6, 2011 Corporate Counsel article reviewing the Gibson Dunn and Shearman & Sterling memos can be found here.

 

Readers interested in the phenomenon of FCPA follow-on civil litigation will want to read the very interesting post on the FCPA Professor Blog (here) about the $45 million settlement that Innospec in an antitrust lawsuit brought by a competitor following Innospec’s $25.3 million settlement of an FCPA enforcement action. Professor Mike Kohler has some very provocative observations about the case and the settlement.

 

Finally, for reference purposes, The FCPA Blog has a comprehensive list (dated January 4, 2012) of all severity-eight companies that have disclosed in their respective SEC filings currently pending FCPA investigations.

 

On December 29, 2011, in what appears to have been the final year-end step as the FDIC ramped up its failed bank litigation activity during 2011, the FDIC filed a civil lawsuit in the Western District of North Carolina in is capacity as receiver of The Bank of Ashville, of Ashville, North Carolina, against seven former directors and officers of the bank. Though this lawsuit is only the latest in a series of failed bank actions the agency has filed, there are some interesting aspects to the case, as discussed below.

 

The Bank of Ashville was closed on January 21, 2011, and the FDIC was appointed receiver (about which refer here). The FDIC’s complaint in the recently filed action alleges that during the period June 26, 2007 through December 24, 2009, the defendants, “enticed by the ‘bubble’ in the real estate sector of the Bank’s lending markets,” caused the bank to pursue a growth strategy concentrated in “higher risk, speculative commercial real estate loans.” This focus resulted in rapid growth during the period.

 

The complaint alleges that that the defendants’ all but one of who lacked previous banking experience were “ill-equipped to manage the risks associated with the nature and extent of the Bank’s growth,” and that they increased the Bank’s risks by “implementing policies and procedures void of the most basic lending controls and neglecting to adequately supervise inexperienced and under qualified lending personnel.” The complaint further alleges that the defendants’ “failures to establish and to adhere to sound policies and procedures resulted in the approval of poorly underwritten and structured real estate dependent loans.”  The complaint also alleges that the defendants ignored regulatory and audit warnings.

 

As the problems in the real estate market began to emerge in 2008 and 2009, the defendants allegedly “took actions that masked the Bank’s mounting problems,” including approving additional loans or advances to borrowers on nonperforming loans.

 

The complaint asserts claims against the defendants for negligence, gross negligence and breaches of fiduciary duty, and seeks to recover $6.8 million in losses that the bank suffered on thirty commercial real estate and business loans.

 

At one level, there is nothing particularly striking about the allegations in the complaint. The amount of the alleged losses in the grand scheme of things is relatively modest, at least by comparison to those alleged in connection with other failed banks.  There are no particularly egregious facts alleged, such as self-dealing or even person enrichment. There are no provocative aspects of the complaint, like the inclusion of the failed bank’s D&O carrier as a co-defendant (as was the case here), or the inclusion of the bank’s outside lawyer as a defendant (as was the case here).

 

On the other hand, it could be that the lower level temperature of the case it itself noteworthy. It is possible that the FDIC’s willingness to initiate a lawsuit even in these circumstances suggests a certain level of aggressiveness on the FDIC’s part. This suggestion is further reinforced by the fact that the FDIC has brought this action relatively quickly after the bank’s failure, at least by comparison to other situations where the FDIC has pursued litigation. In most of its other lawsuits so far, the FDIC has only filed its lawsuit after the lapse of two years or more from the date of the failed bank’s closure. The modest amount of the damages sought together with the relatively accelerated filing date makes me wonder whether or not there is a context for the lawsuit filing.

 

The litigation activity of the FDIC as receiver is essentially a salvage operation. The FDIC is trying to reduce, or at least offset, the failed banks’ losses. The salvage operation often consists of an effort to capture the proceeds of the failed bank’s D&O policy. (Indeed, even the FDIC’s lawsuit against three former officers of Washington Mutual, the largest bank failure in U.S. history, turned out to be largely about the D&O insurance, as discussed here.) More than one of the FDIC’s lawsuits has looked like negotiation with the D&O carriers pursued by other means (consider this prior case involving the First National Bank of Nevada, here).

 

All of which makes me wonder whether this latest lawsuit, particularly given its timing and the quantum of damages sought, might be directed at  the failed bank’s D&O carrier. I do not mean to suggest that I am questioning the merits of the FDIC’s lawsuit, as I have no basis one way or the other to assess the merits. I am simply saying that the motivations for the lawsuit’s filing could have a lot to do with the failed bank’s D&O insurance – as in, the FDIC felt it needed to make a little noise to get the D&O carrier’s attention.

 

In any event, this latest filing represents the FDIC’s 16th lawsuit of 2011, brining the total number of failed bank lawsuits the FDIC has filed during the current bank failure wave to 18, involving 17 different institutions. Based on the number of lawsuit authorized (as disclosed on the FDIC’s website) there clearly will be many more lawsuits to come during the New Year.

 

Goal Kick, For Real: In what has to be one of the most insane soccer goals ever, in a January 4, 2012 match, Everton goalie Tim Howard (a U.S. national who was the goalie for the U.S team at the 2010 World Cup) scored a wind-blown goal on a field-length kick. Sadly it was not enough for his team as Bolton would go on to beat Everton, 2-1.

 

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Securities class action lawsuit filing activity seems to have picked right up in the New Year where last year’s filings left off, as what appears to be the first filed case of 2012 involves a U.S.-listed Chinese company. Camelot Information Systems, a Chinese-based company whose American Depositary Shares (ADS) trade on the NYSE, and certain of its directors and officers have been sued in a securities class action lawsuit dated January 5, 2012. A copy of the plaintiff’s complaint can be found here.

 

Camelot is a provider of IT business solutions. Unlike many of the other U.S.-listed Chinese companies that have been sued in securities suits involving Chinese companies, Camelot did not obtain its listing by way of a reverse merger; it actually conducted a full IPO, in July  2010. The company also conducted a secondary offering on December 9, 2010. 

 

The company was the subject of an August 15, 2011 article on Seeking Alpha entitled “Extremely Cautious on Camelot Information Systems” (here) that questioned the company’s statements regarding its employees, revenue and other key business components. The company’s ADS price declined. On August 19, 2011, the company released its fiscal second quarter results and also lowered its guidance for fiscal 2011. Its ADS price declined further.

 

According to the plaintiffs’ lawyers’ January 5, 2012 press release (here), the complaint alleges that the defendants concealed from investors that:

 

(a) the Company’s IT professionals were not a competitive advantage to the Company and many were dissatisfied with Camelot, which would adversely affect Camelot’s ability to retain its customers; (b) the Company was suffering from undisclosed attrition of employees, which was having a negative impact on the Company’s ability to attract new customers; (c) Camelot did not have the large numbers of highly trained professionals at its disposal that it had represented; and (d) Camelot’s contract with its most important customer, IBM, was not as solid as represented, and would not be renewed on the same terms.

 

The complaint also names as defendants the offering underwriters that conducted the companies ADS offerings.

 

As I recently noted (here), lawsuits against U.S.-listed Chinese companies were one of the most significant parties of 2011 securities suit filings. The 39 lawsuits filed against Chinese companies represented nearly one fifth of all 2011 securities class action lawsuit filings. Although these filings were weighted to the first half of the year, there were 13 in the year’s second half, including two in December.

 

Eventually this filing trend will go away, as the plaintiffs’ lawyers sooner or later run out of additional Chinese companies to sue. But for now the filing trend appears to have carried over into the New Year, with the filing of this new lawsuit involving Camelot Information Systems.

 

Deloitte Must Produce Longtop Financial Documents: In an interesting development in connection with the SEC’s investigation of Longtop Financial Technology, a Chinese companies who had been delisted from a U.S. exchange, on January 4, 2012, a Magistrate Judge for the U.S. District Court for the District of Columbia ruled that Deloitte Touche Tohmatsu Ltd. must appear in court ad produce documents on work the firm did for Longtop. The Magistrate ruled that Deloitte could be compelled to appear even though it had not been served with a show-cause memorandum. A copy of the Maistrate’s january 4, 2012 order can be found here. A January 4, 2012 Blog of the Legal Times article discussing the ruling can be found here.